Waiting for a Slump: Experts predict a significant correction of the economy after a period of rapid growth, but its depth and duration are still unclear

Inflationary pressure in the Russian economy remains high. The rate of price increases from May to July corresponds to an annual inflation rate of 10%. Inflationary expectations continue to rise. Pro-inflationary factors include the growth of household incomes, which boosts consumer demand, and issues with import supplies.

At the same time, the economy is starting to show signs of slowing down. Economic activity assessments showed a sharp decline in July. Investment activity is slowing. According to analysts, consumer activity dynamics have also plateaued.

Experts from the Central Bank say that the economy is ready to return to a trajectory of balanced growth. More pessimistic assessments predict a ‘dip’ or recession after a prolonged period of overheating. A number of experts explain economic growth in the second quarter of 2024 by the influence of short-term market factors. The exhaustion of their effect will leave the economy facing a host of structural constraints.

Thus, the economic slowdown will begin (if it begins) only a year after the cycle of raising the key interest rate started. However, it will not signal a rate cut. In the new economic reality, where internal resources will be the only source of investments, a higher level of interest rates will be necessary to stimulate savings.

However, the main question is whether the economy will return to a new growth phase after the expected slowdown in the second half of 2024, or whether the wartime economic growth impulse, associated with the increased use of export income, has finally run out? Before the war, the Russian economy grew at about 1% per year. During the wartime period, growth accelerated to 4%, but with a ‘shifted’ structure. The question of which trajectory is balanced under the new constraints remains open.

Inflationary pressure in the Russian economy remains high, with monthly price growth in May-June corresponding to an annual inflation rate of 10%. The July value will also be high due to a one-off factor (an increase in housing and utilities tariffs), but the trend inflation of the first two weeks (0.38%) also points to double-digit annual figures. Although the observed inflation rate by citizens stabilised in July (14.2% after 14.4% in June), inflation expectations have continued to rise for the third consecutive month (12.1% after 11.9% in June), according to the latest monitoring by inFOM. As a result, these expectations themselves become an inflationary factor, spurring household credit activity. To curb inflation, monetary conditions in the second half of the year need to be tighter than in the first half, states the Central Bank's report ‘What The Trends Say’.

The Central Bank is not only preparing for another rate hike but is also trying to psychologically influence the market with these warnings. This has had a certain effect: actual loan rates are rising, notes the regulator. At the same time, high consumer demand, driven by wage growth associated with labour market tensions and military payments (→ Re:Russia: Three Trillion for The Living and The Dead) remains an inflationary factor. Another pro-inflationary factor has been problems with import supplies (→ Re:Russia: Battle for Imports). Despite the strengthening of the ruble, prices in commodity groups with a high dependence on the exchange rate (i.e. with a high import component) tend to rise rather than fall, according to the Central Bank's monitoring.

Meanwhile, 'the economy is preparing to shift to a trajectory of balanced growth', which means slowing down, the regulator's experts conclude. However, recent months' growth dynamics remained high – 5.4% year-on-year by the end of the first quarter; in the second quarter, despite the 'April hitch', the growth compared to the first quarter was 0.8% seasonally adjusted, according to the Central Bank. The growth structure still predominantly features ‘heavy’ investment industries, while consumer sectors show moderate positive dynamics. For example, compared to December 2023, the index of investment industries increased from 144 to 164 points in May 2024, the index of investment industries without the 'heavy' ones rose from 131 points to 136, and the index of consumer industries went from 119 to 124 (100 being the average monthly value of 2019).

Growth decomposition by industry group, 2019-2024, 100 = 2019 monthly average

The long-expected slowdown of the economy is indicated, in particular, by the sharp decline in business assessments in the latest monitoring by the Central Bank. While current situation assessments remained positive, they dropped significantly from 7.3 to 2.6 points. This 4.75-point monthly decline appears almost crisis-like. The largest drops were observed in the extraction, manufacturing (excluding investment sectors), and trade industries. Although investments continued to grow in the second quarter according to surveys, growth rates were slower across almost all sectors compared to the previous two quarters. In the coming months, business sentiment is expected to deteriorate further, according to Egor Susin, author of the TruEcon Telegram channel: 'Businesses actively took out loans until late spring, hoping for significant rate cuts, but that won't happen, and they will have to adapt.' The MMI Telegram channel takes an even more apocalyptic view: 'Economic slowdown is inevitable due to the exhaustion of labour resources – the only question is whether it will be a soft landing or a deep recession.'

The Centre for Macroeconomic Analysis and Short-Term Forecasting (CMASF) offers a somewhat different picture in its latest review. They identify four periods in the wartime economic dynamics: 'shock correction' (March-May 2022), 'recovery adaptation' (June 2022-April 2023), 'near stagnation' (May-December 2023), and 'new rise' (January-June 2024). During the second stage, the industry adapted to new conditions and restored production volumes after the initial fall. However, the production structure changed: metal products compensated for declines in the automotive, woodworking, and chemical industries. Significant contributions to the 'near stagnation' in the third stage came from worsening conditions in export sectors – the oil and gas sector and ferrous metallurgy.

According to CMASF analysts, the new rise in the first half of 2024 was driven by a 'unique combination of short-term factors' in several sectors, which accounted for two-thirds of the overall industrial output increase. This included exceeding oil export volumes, the recovery of petroleum product production, and the completion of large orders in metalworking. However, they continue, the unfavourable structural factors accumulated in the economy make a 'transition to near-stagnation dynamics in industry a matter of the near future.' At the sectoral level, growth will increasingly concentrate in the segment of priority 'non-market' sectors (again referring to the military-industrial complex), experts clarify.

In this scenario, fluctuations in economic dynamics are largely determined by the dynamics of Russian exports and government orders in military sectors, which, through transmission mechanisms, stimulated the consumer sector but will no longer be able to sustain this in the future.

There is also a relative consensus among experts that consumer demand as a driver of economic dynamics has reached its limits. Analysts from the Institute of National Economic Forecasting of the Russian Academy of Sciences believe that it has plateaued: retail trade turnover growth in May amounted to +7.5% year-on-year after +8.2% in April (in the non-food segment, this was +8.8% and +10.6%, respectively). According to SberIndex, consumer spending growth was 0.1% month-on-month in April, +0.3% in May, and +0.2% in June. If this trend continues (+0.2% month-on-month in the coming months), consumer spending in the third quarter will increase by only 0.7% compared to the second quarter, which is close to a balanced growth trajectory, notes the MMI Telegram channel. However, consumer lending is still growing. In June, as in May, the growth was 2% compared to the previous month, according to the Central Bank's report on the state of the banking sector. Yet, the growth in June might have been supported by the imminent end of the largest subsidised mortgage program and changes in the parameters of the family mortgage program. Borrowers often use consumer loans to finance down payments. The issuance of mortgage loans jumped by 3.1% in June – after +1.7% in May. The end of the program and rising rates will lead to a decline in lending.

Thus, as the basic scenario for the second half of the year, experts expect to see stagnation or a ‘dip’ in the economy, meaning the economy will exit its overheating phase. However, this will not signal a reduction in the key rate. In the ‘What The Trends Say’ report, the Central Bank analysts discuss the changing role of the interest rate in the new model of the Russian economy. In their opinion, in the absence of foreign financing, the economy will develop through internal sources, meaning savings. To increase savings, deposit rates must significantly exceed the inflation rate, and thus, remain high. ‘The greater the sustained need for financing (investment rate), the higher the neutral rate should be, all other things being equal’.

The broader question is whether the economy will return to another surge in the first half of 2025 after a ‘slump’ in the second half of 2024, or if we are facing the exhaustion of factors that fueled growth in the previous two years. The CMASF analysis suggests the latter. Ultimately, the key driver of growth during wartime was the increase in the budget's 'cutoff price', meaning the export revenues directed towards financing the economy. Over two years, the economy absorbed this stimulus through various transmission mechanisms: credit, investment, consumer. Now it will cool down and adjust, moving towards a new long-term trajectory under sanctions and elevated spending levels, the parameters of which are not yet fully known. However, this is only a hypothesis for now.