• In terms of economic growth Russia will be closer to developed rather than developing countries in the short term. The recession is over, judging by GDP switching back to weak positive dynamics and in view of how the economy uses available resources. The years to come are to see labor productivity changes driving most of growth, which may also be influenced by a restraining effect of the demographic situation and a steady decline in inflation and interest rates. That said, even amid high oil prices the potential GDP growth is likely to be capped at 1-1.5% over the next five years. Despite low inflation and obvious, although modest, economic growth, household income may still show a slightly negative trend by end-2017.
  • Inflation receding to sustainable lows may impair labor market efficiency. Climbing consumer prices bolster real wage flexibility (inverse correlation), allowing employers to adjust to changing external environment without adjusting remuneration. Steadily declining average inflation rates may also limit flexibility of consumer prices and wages. This may bolster natural unemployment and whip up formation of labor unions and other collective forms of employee protection.
  • Real interest rates are to remain positive throughout the forecast horizon. From the economic growth viewpoint they will to restrain the forced fiscal stimulus, reducing both investments funded with borrowed funds and final consumption.
  • An extensive array of reforms has been put off till after 2018, although part of them are likely to be implemented not in 2019 and 2020, but later, as their success hinges on social perception. When large in number, reforms are prone to be regarded as growing regulatory pressure, despite their obvious positive effect in the future.
  • The 2017-2020 forecast update has mainly affected raw material extraction dynamics and tax system prospects after 2018. Compared to our forecast published in September 2016, we now consider the options of global oil prices going higher and local inflation reaching the Bank of Russia target sooner, helped by a tighter monetary policy. We have also revised slightly upwards our global growth outlook.

The forecast has been prepared in accordance with the General Principles of Socioeconomic Indicators Forecasting of ACRA.

Table 1. Key Russian and global economy figures in 2014-2021

1 According to the World Bank Methodology.
2 According to the new Federal State Statistics Service Methodology, based on System of National Accounts 2008 (accounting for February 2016 revision).
3 Physical volume growth index corrected by the investment deflator.
4 Under the new methodology accounting for adoption of the Russian Product Classification 2 and the Russian Classification of Economic Activities 2.
5 Excluding FX transactions in compliance with the new budget rule.

Source: Federal State Statistics Service, Bank of Russia, Federal Treasury, Ministry of Finance, World Bank, national statistics agencies, ACRA estimates

Developed countries almost recovered after 2008 crisis

See the ACRA January 24, 2017 commentary titled “U.S. interest rates in 2017 and 2018: What to expect?”.

In the coming years, developed countries are likely to scale back their monetary stimulus programs, as the latter are expected to achieve most of their goals in 2017-2018. By our estimates, the Fed may raise its key rate four times in 2017, bringing it eventually to 3% by late 2018, early 2019, while the pace of this increase is likely to directly depend on the velocity of changes the US budget policy is to undergo in the course of its aligning with the new president’s campaign promises. The eurozone is to follow suit, but with a lag of at least a year, as, in contrast to the US, its labor market is still in a much worse shape than in 2007, although economic growth risks have materially subsided and unemployment is showing a clear downward trend. An increase in indicative rates here will probably be triggered by a steady growth in core inflation.

In Japan, this could happen as soon as late 2017, if labor market “overheating” transforms in wage growth and has a positive impact on consumer prices. Ceteris paribus, gradually climbing interest rates in developed countries will build up their investment appeal and push their currencies towards strengthening – a trend unlikely to be seen in developing countries.

China will probably go through a cycle of increased rates over the forecast period, as the country needs to curb its extremely fast lending expansion greatly outstripping economic growth in recent years. However, economic growth is also likely to fare below the past decade’s average, pushed down among other factors by the declining working-age population. The cumulative effect of the mentioned trends will probably be slower global growth. This will restrain the climb in commodity prices, although the latter might be more affected by commodity supply dynamics and the prospects of building up protectionism in global trade caused by slowing demand and stiffening competition for markets.

See the ACRA January 30, 2017 commentary titled “Future looks promising for oil producers”.

The key long-term price benchmark for the oil market will still be US shale oil production costs, which are expected to climb in the years ahead as a result of growing demand for oil production equipment and services, and backed by accelerating inflation in the US. The coming years are likely to see global economic growth stimulate an oil demand increase of some 1.2% per year, which will at least compensate for climbing supply. The US is set to post the fastest production growth, fueled by rising extraction of shale oil, on the one hand, and surging output in the Gulf of Mexico, on the other. Non-OPEC oil production growth will be moderate on traditional fields as a result of insufficient investment in 2015-2016. As for OPEC, even if the agreement on production freeze is not extended into 2H2017, the cartel may still revert to the quotas system that will hold back its production growth.

Persistently low inflation may undermine labor market efficiency

Real wage is inflation-adjusted wage, i.e. the one expressed through base year prices.

By 2017, OECD countries failed to revert to the pre-crisis unemployment average, while Russia achieved it back in mid-2012 and almost completely avoided a decline in employment during the 2015-2016 crisis. High real wage flexibility is one of key factors ensuring Russian labor market efficiency, manifested in low unemployment and its low-magnitude and short-lived spikes during recessions6.

6 Refer to “Russian Labor Market Mechanisms” by Gurvitch and Vakulenko, Delo Publishers, 2016.

The real wage average in Russia fell 3.5% in 2009 and lost another 9.3% in 2015.

Such flexibility is supported by institutions and high inflation. The labor legislation guarantees fairly high protection of employee rights, while workforce mobility is relatively small. The market also features a high proportion of the non-fixed wage component and a relatively active role played by the state in terms of job creation. Another key to real wage flexibility is relatively high inflation. In the 2000s, it allowed for a 10-15% reduction in real annual labor costs, provided that employers avoided changing figures in labor contracts. Such way of saving is of particular importance for employers at times of waning demand for their products or sudden growth in other costs, including the periods of economic recession. Moreover, inflation helps optimize labor costs even when the going is not tough.

Natural unemployment is unemployment observed even during equilibrium periods on key markets and related to the time needed to find a job even if it is available (frictional unemployment), and/or resulting from technology evolvement or other forms of development leading to a mismatch between employee qualifications and employer requirements (structural unemployment).

Lower and stable inflation does not necessarily imply smaller inflation spikes at times of recessions and shocks on the labor market, especially if they are caused by exchange rate transition, typical, for example, for raw material exporters. Therefore, achieving a low inflation target does not automatically translate into a reduction in real wage flexibility. That said, firstly the possibility of such an effect does not contradict the experience of the 2008-2009 crisis (see Figure 2), and secondly it was noted in empirical research based on individual country data7 and cross-country comparisonsprior to 2008. If the observed patterns are applicable to Russia, achieving the inflation target may result in lower real wage flexibility and higher natural unemployment, with more pronounced outbursts in crisis periods (see Figure 1).

This environment may incentivize formation of labor unions and other collective forms of employee protection, and stimulate expansion of state programs covering unemployment insurance and employment support (jobless claims, professional retraining, etc.). A higher impact in real terms should be expected from counter-cyclical stimulus measures in economic policy. Another way to ensure a compensating wage flexibility increase lies through labor market institutions, such as the percentage of payouts that depend on company and employee performance.

7 For example, refer to “Low Inflation vs. Stable Inflation: Evidence from the UK, 1688–2009” by Karras and Georgios, Scottish Journal of Political Economy, Vol. 62, Issue 5, pp. 505-517, 2015.
Refer to “Is Moderate-to-High Inflation Inherently Unstable?” by Michael T. Kiley, International Journal of Central Banking, vol. 3(2), 2007.

Figure 1. Unemployment surge per unit of GDP decline during the 2008-2009 crisis was lower in countries with higher ‘background’ inflation

Source: World Bank, ACRA estimates


Figure 2. ‘Background’ inflation before the crisis positively correlated with real wage fluctuations caused by the crisis

Source: World Bank, ACRA estimates

Not all economic reforms to start simultaneously after 2018

Electoral cycle lengthening coupled with recession have put many decisions off for 2019. Six of the discussed reforms in the field of economic policy affect most of the population, and their successful implementation requires that new rules of the game are consciously accepted by all players (see Table 2). Although obviously positive in the long run, the reforms may well be interpreted merely as a growing regulatory burden at the initial stage, with such attitude potentially reducing their effect. Therefore, it seems highly improbable that all of the changes discussed will be implemented simultaneously. By ACRA’s estimates, the highest priority at the moment is given to the taxation maneuver beyond the oil and gas sector and to the introduction of individual pension capital (IPC). Consequently, we have included both of these reforms in our 2019-2021 forecast. Other changes will probably start closer to 2021 or later, beyond the current forecast horizon.

Table 2. Economic reforms possible after 2018

Source: ACRA

In terms of economic growth Russia will be closer to developed rather than developing countries

Upper estimate of economic growth potential:
1.5 pps =

+0.3 pps (a one-off)

1) The potential Russia's GDP growth rate is capped at 1.5% per year, which is confirmed by the analysis of possible sources of economic growth:

Reengagement in economic activities of idle capacities and people unemployed as a result of the economic downturn, in order to meet renewed demand (“cyclical” growth).

The latest recession in Russia was not fully cyclical, as free workforce and idle capacities are now next to unavailable. Unemployment is at its historical low of 5.5%, while industry capacity utilization stands at 68%, which is close to the previous maximum. The only potential resource still unused is the working time, as the proportion of employees officially working part time at the employer’s initiative is still 22% above the average pre-crisis level. That said, even accounting for off-the-books employment, their number is minor in absolute terms (less than 1% of the employed), and the potential impact of this resource on economic growth may be just some 0.3 pps, and this will be a one-off.

+0.2 pps

2) Growth of available production factors, i.e. land, mineral resources, labor, capital (extensive growth).

Investments in the oil and gas sector in the early 2010s will provide for production increase until the early 2020s. Coupled with the coal industry, this may provide for physical production growth till 2020 of up to 0.8% per annum, or 0.2 pps of GDP.

-0.4 pps

The working-age population will shrink 2-2.5% in the next 5 years, even despite an increase in the proportion of people working after reaching their retirement age coupled with net migrant inflows. The latter, by the way, will be hampered by a relatively cheap ruble and negative demographic trends similar to those across all of the former USSR. In all, this factor is expected to restrain economic growth by some 0.4 pps annually.

+0.8 pps

The dynamics of available production capital in non-resource sectors will be partly determined by investments made in the first half of 2010s and their slump seen in 2015-2016. For example, output growth in agriculture together with import substitution became possible thanks to earlier made investments that have largely played themselves out and can hardly further bolster production capital growth. Relatively low ruble costs will stimulate fixed capital investments in sectors that can rely on non-resource exports or import substitution. On the other hand, growth here will be held back by more costly investment imports. The total contribution that growth in available capital can make to economic growth may run up to 0.8 pps per year.

+0.9 pps

3) Introduction of new technologies, structural changes to the economy favoring more capital-intensive industries, and productivity increase through personnel training (intensive growth).

The intensity factors, or total factor productivity (TFP), in Russia ensured 0.9 pps of the average annual GDP growth in 1989-20169, which is close to the maximum level shown by European countries and even higher than in the US and Japan10. With no technological breakthrough expected, it would be overly optimistic to anticipate a higher contribution by this factor in the coming years11. If any opportunities for the government policy here exist at all, any development programs here will surely produce results will a significant lag, probably beyond the forecast horizon.

For example, refer to the chapter “Growth Trends in Russia after 1998” by R. Entov and O. Lugovoy, published in the book “The Oxford Handbook of the Russian Economy”, edited by M. Alexeev and S. Weber, Oxford University Press, 2013.
10 OECD Compendium of Productivity Indicators 2016.
11 0.9 pps is indeed a top estimate for Russia in the coming years: under the targeted and moderately optimistic 2030 forecast scenarios by the Russian Economic Development Ministry, the cumulative TFP’s contribution amounted to 0.9-1 pps per year.


Dmitry Kulikov
Director, Sovereign and Regional Ratings Group
+7 (495) 139 04 80, ext. 122
Natalia Porokhova
Senior Director, Head of Sovereign Ratings and Forecasting Group
+7 (495) 139 04 90
Maria Mukhina
Operating Director
+7 (495) 139 04 80, ext. 107
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