Russian GDP shrinks 3.7% in 2015 as domestic demand falters

RosStat has published its preliminary estimate of developments in GDP in 2015, disaggregated by sector of origin and expenditure category. Even before the publication of the data, spokesmen for the statistical agency had announced that GDP declined by 3.8% year on year (y/y) in the fourth quarter and was down 3.7% in the full-year 2015. The fourth-quarter figure was better than the 4.1% drop in the third quarter and the 4.6% decline y/y in the second, but also reflected a lower base of comparison given the difficulties for the Russian economy that already characterised the final quarter of 2014.

The data on value added in the various sectors of production reveal very sharp contraction in several major sectors. The strongest downturn, by 10.1% y/y, came in value added in domestic trade. This reflected the similar drop in the real volume of retail sales in 2015 as nominal wage increases fell far short of surging consumer prices, impinging on household budgets and dampening consumer sentiment. A lesser, but still significant, decline in value added occurred for restaurants and hotels, by 5.2%, for much the same reason. The downturn in domestic trade was followed by the 7.5% contraction of value added in construction. Declining construction activity stemmed from cutbacks in investment by enterprises facing narrowing profit margins and excess capacity in the wake of slackening demand. Tighter credit conditions also affected construction orders as well as big-ticket consumer durables and particularly automobile sales. Value added in the financial sector, which has been growing at double-digit rates in recent years, slipped by 1.3% y/y in 2015. Bank lending was limited by the inability to tap external capital markets due to Western sanctions imposed on Russia by the United States and European Union in response to the country's annexation of Crimea from Ukraine and support for separatist militias in Eastern Ukraine. The higher cost of attracting deposits was a factor, as well as the growing problem of non-performing loans, the latter of which caused banks to tighten requirements for qualifying borrowers. The only sectors of origin that contributed positively to the change in GDP y/y were agriculture, which enjoyed a relatively successful harvest and a competitive advantage due to the embargo on most agricultural products from the EU in retribution for sanctions on Russia, natural resource extraction, and healthcare.

Turning next to the breakdown of GDP by expenditure categories, a troubled picture emerges as well. The sharpest downturn came in gross capital formation. Gross fixed capital formation was down 7.6% y/y, already a serious drag on overall GDP, but total gross capital formation was down by an even larger 18.3%. This implies a far more severe double-digit decline in inventory change. Enterprises did not replace inventory as it was sold off in anticipation of dampened demand for their products and, as we have seen above, cutting their rate of output and generation of value added. An even more serious blow to overall GDP, because it is by far the largest component, came in the form of the 10.1% drop in household consumption. Although government consumption declined by a far more moderate 1.8% y/y in 2015, the much larger weight of household consumption (53.2% of 2015 GDP compared with 18.8% for government consumption) meant that total final consumption still fell by 7.9%. Partly offsetting the downturn in domestic demand, net exports increased by an incredible 71.8% y/y. Although real exports of goods and services expanded by 3.1% y/y in 2015, this was hugely inflated in the net export calculation by the dramatic cutback in real imports of goods and services, by 25.6% y/y, in train with domestic demand and magnified by the continued plunge of the rouble against the dollar and euro. Although the depreciated rouble might have added some momentum to Russian exports of manufactured goods, the increase registered in real terms in 2015 was not impressive.

Outlook and implications

As anticipated, the fall in global oil prices and the imposition of economic sanctions on Russia had a substantial negative effect on Russian aggregate output in 2015. The decline in GDP would have been far more severe had net exports not plunged due to the sharp cutback in imports of goods and services in the face of contracting real incomes and reduced import purchasing power. These same two factors will figure importantly in 2016 as well. Even prior to the recent further drop in global oil prices and the renewed assault on the rouble that accompanied it, IHS had expected that domestic demand and GDP would contract again in 2016, but at a far lesser rate given the reduced base of comparison and some adaptation of the Russian economy to the new reality. Now with the average price of Brent crude projected by IHS Energy to come to only USD38.50 per barrel (the federal budget for 2016 was built on an assumption of USD50 per barrel), our 2016 GDP forecast and the state budget of the Russian Federation must be revised. The forecast revision does not change the assumption that sanctions will not be lifted before the end of 2016 even if there is agreement on the part of Western governments that the Minsk II agreement on a ceasefire in Ukraine has been fulfilled. From an earlier projected decline of 1.1% in GDP in 2016, we will be boosting the downturn probably to 2% or slightly beyond in our upcoming forecast round.