China Research

A discussion forum on emerging markets, mainly China – from a macro, micro, institutional and corporate angle.

How fast can Russia grow in the future?

October 2, 2013

Boom and bust

During the boom years of 2000-2007 Russian economy grew on average by more than 7% p.a. While the global economy also expanded vigorously, Russia’s growth was boosted further by ever-higher oil prices and productivity improvements especially in the services sector.
Russia’s rapid GDP growth meant that Russians’ average standard of living also increased during this time, and by 2008 per capita GDP (at purchasing power parities) was 34% of the corresponding level in the US from 21% in 2000. Partly this rapid growth was a rebound from the economic crisis of 1998, but growth was also helped by restructuring of the economy towards services, which were very much underdeveloped during the Soviet times and early years of the economic and political transition. Moreover, productivity growth in the services was also fast, especially in the high-skill sectors such as financial intermediation and business services, which is natural given the relatively low starting level.

However, growth during the boom years was not only driven by productivity improvements. According to a recent Discussion Paper published by the Bank of Finland Institute for Economies in Transition (Marcel P. Timmer and Ilya B. Voskoboynikov: Is mining fuelling long-run growth in Russia? Industry productivity growth trends since 1995, BOFIT DP 19/2013, http://www.suomenpankki.fi/bofit/tutkimus/tutkimusjulkaisut/dp/Pages/dp1913.aspx) growth in the capital input has also accounted substantially to the growth in value-added. Moreover, growth in labor input has accounted for almost equally large share of value-added growth. At the same time many sectors where productivity growth has been very low, such as mining, have been able to increase their share of the economy, as they have been able to attract more capital and labour.

Lower growth in the future
In 2009 Russian economy suffered from the global financial crisis, but its post-crisis growth has been clearly slower than many expected, even though the price of oil soon returned to over $100 per barrel. While the average GDP growth between 2010 and 2012 was 4%, growth continued to decelerate. In late 2012 and early 2013 quarter-on-quarter growth was practically non-existent. While the slowdown in growth has partially been cyclical, it is also a sign of clearly lower growth in the potential output.
First, working-age population is already declining, and at the same time unemployment is very low. Officially the unemployment rate is around 5%, which in practice means full employment. Unless retirement age is increased soon, labor supply continues to decline, which will have a negative effect on future growth.

Second, investments are also declining. Between 2010 and 2012 the average share of gross fixed capital formation in GDP was 21.8%. This is below the average investment ratio of other middle-income countries (see Figure 1), many of which are currently growing faster. Moreover, during the first half of 2013 investments actually declined year-on-year, and especially large energy as well as infrastructure companies cut back their investments. At the same time capacity utilization rates are even higher than during the boom years of 2006 and 2007 (Figure 2). This tells us that Russian companies do not view their future prospects favorably, and the large capital outflows basically tell the same story. During the past quarters net capital outflows have averaged some 2.5% of GDP.

Figure 1 Share of fixed capital investments in GDP and per capita GDP (middle and high-income countries
(Click the image to zoom in)
Source: World Bank World Development Indicators database

It is noteworthy that even relatively high oil prices have not been enough to boost Russia’s growth in the recent quarters. It seems that the uncertain global environment and Russia’s own well-known problems with business environment are hindering investments. It is especially noteworthy that Russian companies and investors are deeming investments into Russia lacking when taking into account the expected profits and perceived risks.
The aforementioned factors have led many analysts inside Russia and outside it to drastically reduce their estimates of Russia’s long-term growth potential. Many of the estimates seem to cluster between 2.5% and 3% p.a. While this is still quite respectable in comparison to many EU countries, it will mean substantially slower increase in incomes and delayed convergence with the OECD countries. Also, slower growth may at some point be in conflict with the many fiscal responsibilities of the public sector.

Figure 2 Capacity utilization rates in manufacturing industry
(Click the image to zoom in)
Source: Rosstat

 

 

 

 

 

 

Iikka Korhonen
Head of Bofit (Institute for Economies in Transition) at the Bank of Finland

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The BRICS Turmoil: Reality or Overshooting?

September 4, 2013

During summer, we have seen – and still see – quite some nervousness about the so-called BRIC countries in the emerging world – and some contagion to a couple of emerging market countries that also try to catch up, like Indonesia and Turkey. Three questions seem to be particularly interesting:

¤ Is the current nervousness about BRIC countries really motivated?

¤ Why do we have these contagion effects to several countries – to some extent similar to developments during the Asian crisis of 1997-98?

¤ Do we currently see the beginning of a real BRIC crisis which may turn much worse and which will also mean a notable downsizing of BRICS countries’ potential (trend) growth?

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BRIC is a term that has been coined in the beginning of the past decade by an economist from Goldman Sachs, a major American investment bank. BRIC –nowadays BRICS since South Africa joined the “club” a few years ago – are the initial letters of Brazil, Russia, India and China. I always considered the BRIC(S) thing mainly as a marketing instrument for asset allocation. In reality, these countries did not have enough in common to put all four eggs in one basket. Relatively good economic growth during a couple of years and a large population were simply not enough to “harmonize” analysis and investment strategies for these countries.

By the way, similar simplifications could be recognized already in the latter part of the 1990s when Eastern Europe Equity Funds and Asia Equity Funds were launched as attractive alternatives for investors. At that time, countries with different structural and institutional conditions were put in the same investment baskets, too. This proved to be wrong after some time. BRIC supporters from all over the world could have learnt from these examples.

Many experts see the main reason for the current “BRICS problems” in the expectations of – right or wrong – forthcoming cautiously rising interest rates in the traditional industrial world, especially in the U.S. Such a development could (probably) lead to (further) substantial capital outflows from BRIC countries to North America (the U.S.) and (parts of) Europe, according to the BRICS pessimists.

This explanation, however, is too fluffy. A deeper analysis of the BRICS problems is urgently needed. Are there fundamental reasons for the contagion? Or have we got a new example of overreacting financial markets?    

Let’s first look at possible common characteristics of the four BRIC countries – South Africa is excluded in this context – that may have caused negative feelings about the BRICs as a group.

¤  Portfolio shifts?  More financial inflows to the traditional OECD countries – at the expense of portfolio investments in emerging markets because of expected gradual, cautious monetary tightening by mainly the Fed  (with the assumption that the four above-mentioned, leading emerging markets are running the highest outflow risks)
–> could partly serve as an explanation because the four above-mentioned BRIC countries represent the economically four most important emerging economies.

¤  Substantial slowdown in GDP growth?   A rapid weakening of GDP could actually been noted in only two BRIC countries during the past year – in Russia and in India. Brazil even stands for growth improvements four quarters in a row after a couple of growth stimuli.

The last GDP-growth numbers for the BRIC countries look as follows:

Brazil:    2013, q2: 3.3%;    2012, q2: 0.5%         –> coming down from around 9% in early 2010

Russia:  2013, q2: 1.2%;     2012, q2: 4.3%        –> coming down from roughly 5% in early 2010

India:    2013, q2:  4.4%;    2012, q2: 5.3%         –> compared with about
9% in early 2010

China:   2013, q2:  7.5%;    2012, q2: 7.6           –> compared with about 10% in early 2010

Obviously, GDP growth has not developed simultaneously in all BRIC countries in the past few quarters – but more visibly on trend during the past 3-4 years. This is indeed true for all BRIC countries.  This development strengthens the view that more positive growth signals that currently come from the U.S., Japan and some European countries to a high extent more strongly triggered the worsening cyclical view of financial investors on BRIC countries than any other single factor. But looking at GDP-growth developments since 2010 gives also certain reasons to find structural components in the now more dampened growth outlook for BRIC. Thus, we have
–>  an obvious  cyclical BRIC phenomenon combined with certain negative structural components (like, for example, demand from Southern Europe) – and not a pure structural problem.

¤  Current account problems?   Current account deficits are frequently used explanations for the problems of the BRICs – and the need for foreign capital inflows for financing these deficits. But only India has a (somewhat) too high deficit ratio in relation to GDP (around -4.5-5% in 2013).  Brazil’s predicted deficit in the range of 3 ¼ – 3 ¾ % for 2013 is a little bit high but should not be as scaring as markets consider the entire BRIC situation. China and – probably – Russia should even continuously manage current account surpluses which takes us to the conclusion
–-> that current account problems should not really be considered as a major common problem for all the four major BRICS countries. From this point of view, the contagion effects that have been created by global financial markets, seem to be overdone. But they exist!

¤  Insufficient fiscal stability?  Public debt – annual and total – is, of course, an economic indicator that all country analysts watch very carefully. In this respect, Russia and – probably – Brazil seem to have their structural fiscal conditions roughly under control. China seems to be on the safe side for the time being – at least when official numbers are analyzed (about which, unfortunately, one may have serious doubts). India finally has been affected by negative fiscal developments since a long time ago. Thus, the question is
–> why well-known fiscal conditions – which are not really bad in all four BRIC countries – suddenly should lead to general worries on global financial markets. We probably can find psychological explanations in this respect. This urges for deeper analysis.

¤  Lagging structural reforms?  Sure, all emerging countries have more or less burdening structural or fundamental shortcomings. What concerns Brazil, one may mention, for example, insufficient productivity gains and declining international competitiveness, lagging education and pension systems, etc. Furthermore, Brazil is nowadays increasingly competing with – currently – a more reform-minded and economically improving Mexico. Russia suffers from a significant number of institutional deficits – the financial system and support of entrepreneurship included – a too large role for the government/state in the economy and a too high dependence on the energy sector.

India, on the other hand, has more obvious fiscal problems than Brazil, Russia and China and more growth-impeding infrastructural shortcomings which are – also according to my own micro experience from these countries – much more serious than in the three other large emerging countries. The same conclusion can be made about the Indian current account deficit. Last but not least China. Nobody questions that China’s economy has proceeded substantially in the past two decades or so. But we know also that China despite all economic progress still suffers from lots of structural shortcomings particularly when it comes to microeconomic and institutional conditions – unfortunately combined with worrying transparency shortcomings.

Putting together the reflections of the above-mentioned structural thoughts means that structural shortcomings exist in all four  BRIC countries  
–> but without strong logical correlation for motivating sudden distortions and disappointment for the BRIC region as a whole as we have seen in the past months.    

Conclusions                                                                 

In my opinion, the recent negative pressure from global financial markets on the artificial BRIC group – South Africa is excluded in this analysis – should not be considered as the result of a completely consistent and logical approach. Several factors point also at psychological overshooting. Common issues for all four BRIC countries are the insufficient demand for their exports, mainly caused by weak global demand – an issue that probably is characterized by both cyclical and structural dimensions – and the expected future monetary tightening in the U.S.

I have also found that several negative macroeconomic indicators do not point at the same degree of imbalance in all four BRIC countries (if at all).Consequently, it can be singled out that certain psychological overreactions are/were in place.

For this reason, I would argue that current developments have re-set the previously overdone BRIC enthusiasm – to some extent the result of artificial financial marketing – to a more justified stance of growth expectations (without considering the issue of the middle-income trap). This should induce some reduction of previously exaggerated expectations of BRIC countries’ potential GDP growth – but probably less dramatically than described in many recent analytical pieces. Again: Almost all countries have their own characteristics. This makes it most doubtful to put several “(emerging) country eggs” in one single analytical basket.

However, occasional negative contagion effects from one country to another will most probably be inevitable in the future as well. Here we have another example that clarifies the need for more research in behavioral finance.

Hubert Fromlet
Visiting Professor of International Economics, Linnaeus University
Editorial board

 

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Russia Enters Calmer Waters

February 6, 2013

Last winter’s demonstrations in Moscow and elsewhere have more or less died out. This is an expected outcome as this non-movement always lacked of a leadership. Neither did it have any common program beyond the goal “Putin out!” But nature and society alike abhor a vacuum: there was no answer to that question. Polls claim that those participants that had any political identity divided quite evenly into nationalists, communist and new leftists and modernizers. The last ones are routinely called liberals in outside media. That is a problematic piece of terminology, because in Russia even self-nominated liberals are often supporters of a strong state.

This is not the end of opposition in Russia. There will be re-births and new declines. Part of the lesson should have been learned already of the Arab Springs. One can call together demonstrations through social media, but nothing compensates repeated face-to-face contact in building a genuine political movement. It has to be an organization. And Russia lacks the Muslim Brotherhoods and traditionally politically active armies in place to fill the organizational vacuum left by the street demonstrations.

The regime in power continues to put out potential bush fires. This and that visible oppositional is put in front of court and very probably condemned in due course. Foreign aid to NGOs is squeezed out and other barriers to cross-border contacts will be established. Some Russians vote with their feet and many more at least consider the possibility. But on the level of large-scale politics the regime sits tight – for the time being at least. At least three large dangers loom.

The first one is complacency. It has economic as well as political roots. The macroeconomic situation of the country is better than perhaps ever before. Economic growth is a multiple of most European levels, unemployment a fraction of some. Inflation is lower than ever in independent Russia, official reserves are as high as they have been. Both investment and consumption grow faster than aggregate production. Both the budget and current account have a surplus.

This is a dangerous situation, as the Russian policy advice consensus is right when it calls for profound but at the same time difficult decisions. The low hanging fruit of systemic change were picked years ago, though they continue to impact the society now and in the future. Neither can one count on continuous growth in export. On the other hand, a collapse of them – even of gas prices – is not in the cards.

Typically the decisions now ahead are difficult, socially divisive and without a ready-made recipe. Russia is not alone in this respect. Pension reforms are nowhere particularly easy. No political regime finds it easy to allocate scarce resources between social needs, much needed infrastructure investment and military outlays. Preparing for demographic change is a common European challenge.

The regime should also be able to control itself. Though statistics are inevitably murky, corruption is widely seen as the big problem faced. There is a fair possibility that Vladimir Putin is finally serious about fighting corruption. He is also ready to call it a systemic feature of his country, and thus also of his own regime. If the former Defense Minister Serdyukov actually goes to court, a leaf in Russia’s history has turned. There was no necessity for doing that: a dismissal with lukewarm thanks would have sufficed.

But if that is the case, the Putin regime has to be able to control the Pandora’s box. In a society where so many people reportedly have files of negative material on so many others, a war of everybody against all would be easy to ignite. And when there is no political opposition or alternative society ready to take and use power that would be a recipe for catastrophe.

Finally, though new goods and services have flooded Russian markets, export-wise Russia remains as dependent on energy and other commodities as before. Being rich in resources is glorious, but they cannot continue maintaining an economy which is growing. Measured – as it should – in constant prices the share of the wide energy sector in Russia’s GDP peaked at about thirty per cent. It has already declined, and may well reach ten per cent in a couple of decades. This at least is what the Russian experts say, and the policy makers seem to concur.

This is a tall order and must imply a new kind of integration in the world economy. The first months of Russia’s membership have shown that Russia tends to be more apt in defensive than offensive measures. The country is testing the limits of what WTO membership allows in terms of protectionism and such. Established members are testing the limits of Russia’s resolve.

But that, naturally, was fully to be expected.
 

 

 

 

 

Pekka Sutela
Nonresident Senior Associate Carnegie Endowment, Washington D.C. & Visiting Professor at the School of International Affairs, Paris

 

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