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Russia s Changing Growth Model: Toward Greater Stability

Macroeconomic conditions look solid

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Russia s Changing Growth Model: Toward Greater Stability

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    2. Macroeconomic conditions look solid… Despite the recent global financial turmoil, 2007 was another good year for the Russian economy. GDP grew 8.1%, resulting in over 70% cumulative GDP growth since 1999. In dollar terms, Russian GDP approached $1.3 trln. This year, the dollar-denominated GDP may near $1.7 trln. Growth acceleration last year can be attributed to increased investment activity by state companies. The Central Bank’s policy of nominal ruble appreciation does not seem to have done much to help contain inflation. Moreover, inflation accelerated on the back of massive capital inflow in 1H07. Inflation was also high due to a generous fiscal policy, expenditures increasing by over 37% in 2007. Inflation reached 11.9% in 2007, accelerated to 13.3% y-o-y in March, and will, under an optimistic scenario, stay at around 12.5% in 2008, though higher numbers look more likely as the government will keep increasing spending. Access to global finance is becoming an integral part of the country’s growth story as the current account shrinks.

    3. … despite recent financial turmoil The effects of the recent bout of global financial turmoil were limited in Russia. Despite deceleration in foreign borrowing in 2H07 and 1Q08, growth will remain strong in 2008. This deceleration will bring the economy back on track to annual growth of around 7% in 2008 and beyond. Investment activity, which accelerated in 1H07 (up more than 22% y-o-y), decelerated on the back of the turmoil, but nevertheless demonstrated growth of over 21% in 2007 and 19% in January 2008. Strong double-digit growth is expected in 2008 and in the years to come. It is questionable, however, how long the country can afford these double-digit numbers. Efficiency of investments is crucial for Russia, while mushrooming state corporations create some concerns. Consumer demand is also expected to grow rapidly (at close to double-digit rates) going forward. Although the deliberate appreciation of the nominal effective ruble did not help to contain inflation, it has contributed to a change in the growth model; a stronger currency stimulates the domestic market’s development. Russia is gradually shifting from an export-driven growth model toward a model in which domestic demand plays a greater role.

    4. The economy continues to expand, especially in dollar terms

    7. The gap between Russia’s GDP per capita and that of other countries is quickly narrowing…

    8. … and the consumer market is growing fast

    9. Russia’s private consumption/GDP ratio is low, and set to rise

    10. No need to artificially inflate investment/GDP

    13. The exchange rate policy is changing gradually; the appreciation of effective nominal ruble may stop

    16. …albeit quite gradually

    17. Inflation is a serious threat in medium term Budget expenditure growth accelerates inflation. High inflation reduces households’ propensity to save. The basis of ‘long’ money is shrinking. The borrowers face problems at the domestic credit market. The private sector suffers more than state companies (or companies oriented on servicing the state sector). On the back of higher inflation, the state sector crowds out private companies. As a result, the economy’s competitiveness deteriorates. Inflation accelerates the real ruble’s appreciation and may cause Dutch disease.

    22. Russia’s dependence on external factors has increased over the last few years Russia has become deeply integrated into the global economy over last several years and is now more dependent on external factors. The model of economic growth was based on a depreciating dollar against the euro, inflation of commodity prices and inflow of cheap capital. If the oil price just stops growing, the trade balance will start shrinking. The accumulation of gross international reserves is the mayor driver of money supply growth. In the future, the demand for refinancing operations will appear. The volatility at the currency market will increase. The appreciation of the dollar is a serious threat for the Russian economy, as the correction of commodity prices and devaluation of the ruble against the US currency will become possible.

    23. GDP in nominal terms correlates with oil price

    24. Accumulation of gross international reserves remains the driver of money supply growth

    25. Net exports shrinking in real terms

    26. Russia’s dependence on capital inflow will increase, as the current account will start shrinking

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