Swedbank Baltic Sea Analysis No. 30 - Russia: Political turbulence and significant economic pressures going forward

1. Swedbank Baltic Sea Analysis No. 30  16 Dec 2011
Russia
Political turbulence and significant economic pressures
going forward
 Charges of cheating and manipulation in the December 5
parliamentary elections have led to major protests and a loss of
confidence in political leaders. Putin is likely to be elected president
next March, but with great uncertainty whether the road there will be
paved with repression or a renewed commitment to modernizing
politics and the economy. Declining support for Putin and Medvedev
shows that promises of stability are no longer a winning political
strategy. This could undermine Medvedev’s future position as prime
minister.
 The Russian economy is benefiting short-term from the election
campaign and expansive fiscal policies that go with it. We expect
lower growth in the next two years as the global economy slows and
fiscal policy has to be tightened. As a result, we are revising our
forecast downward to below 4% in 2012 and 2013. Relatively high
oil prices will lessen the need for austerity, but the Russian economy
remains vulnerable. The biggest risk comes from a combination of a
rapid slowdown in the euro zone and declining global commodity
prices. Political turbulence domestically is also a threat to the
business climate.
 Russia is on the brink of membership in the World Trade
Organization (WTO). Although Russian companies will initially see
tougher competition, consumers will benefit and in the long term
Russian competitiveness and growth potential will be strengthened.
Business conditions continue to improve, but from low levels. In the
last six years Russia ranks among the 25 countries that have made
the biggest improvement in the ease of doing business, according to
the World Bank’s “2012 Doing Business,” confirming the progress
also noted in Swedbank’s Baltic Sea Index.
Economic Research Department, Swedbank AB (publ), SE-105 34 Stockholm, tel +46 (0)8-5859 7740
e-mail: ek.sekr@swedbank.se Internet: www.swedbank.se Responsible publishers: Cecilia Hermansson +46 (0)8-5859 7720
Magnus Alvesson +46 (0)8-5859 3341, Jörgen Kennemar +46 (0)8-5859 7730 ISSN 1103-4897

2. Duma election – stability no longer an election
winning strategy
United Russia – Vladimir Putin and Dmitry Medvedev’s party – lost Putin and Medvedev
nearly a fourth of its support in the parliamentary elections in early are losing support…
December, despite accusations of election fraud. Though it remains
the largest party, it can no longer dominate politics as it has in the
past. Perhaps the most important message was that the favoritism
shown by authorities to United Russia did not produce the expected
results and that Russian voters are realizing they have a greater
impact on the political process. This could lead to a higher turnout in
the presidential election in next March and give the campaign some
real political significance. In other words, Putin may be forced to
actually make a political case for his candidacy.
Among the other parties, “A Just Russia” and the Communist Party … but the opposition in
made the biggest progress, nearly doubling the votes they received. the Duma is fractured
A Just Russia is a social democratic party that previously supported
United Russia and Putin. The Communist Party is the largest
opposition party and heir to the Soviet Communist Party. The Liberal
Democratic Party, a populist, nationalist party led by Vladimir
Zhirinovsky, also increased its support, while Yabloko, the only liberal
party in a Western sense, attracted fewer than 5% of the voters. With
a cut-off of 7% to be represented in the Duma, only the four largest
parties made it. United Russia, with nearly 53% of the mandates, thus
retained a majority.
Duma election results (preliminary), 2011 and 2007
(% of valid votes)
Yabloko, 3.4 Patriots of
Liberal Russia, 1.0
Democratic
Party, 11.7 2011
0.9
8.1 1.6
7.7
A Just
Russia, 13.3
United
11.6 2007 Russia, 49.3
64.3
Communist
Party, 19.2
Source: Central Election Committee
The election was followed by considerable protests, especially in Charges of election
major cities. There were widespread reports of election fraud, with the fraud led to major
Organization for Security and Co-operation in Europe (OSCE) stating protests
that it had seen “frequent procedural violations and instances of
apparent manipulations, including serious indications of ballot box
2 Swedbank Baltic Sea Analysis No. 30 • 16 December 2011

3. stuffing.” The first spontaneous demonstrations in Moscow were
estimated at around 10 000 people and were met by riot police and
arrests. The protests have since grown in scope. In a statement,
President Medvedev said he accepted the protests as a Democratic
right, but at the same time characterized many of the protesters as
“confused.”
It is too early to say whether the protests are the beginning of a Need for further
bigger movement that leads to more extensive political reforms. democratic reform
There are few direct parallels with the political turbulence in the
Middle East, since democratic principles are more developed and
ingrained in Russia. With increased centralization of political power,
the growing influence of oligarchs and tight control over the media,
the situation is more reminiscent of Ukraine prior to the Orange
Revolution. At this point the discontent seems to be concentrated in
large cities. The leading politicians are maintaining control over the
government apparatus and have access to the state’s considerable
financial resources. In addition, many of the richest oligarchs are
closely allied with United Russia and have little interest in political
upheaval.
There has been speculation that political concessions will have to be Medvedev’s political
made, however. Since much of this discontent arose after Putin and future may be in
Medvedev decided to swap positions as president and prime minister, jeopardy
signaling that the elections were basically meaningless, there is a
possibility that Putin may be forced to replace Medvedev. Alexei
Kudrin, the former finance minister known for supporting tight fiscal
policies as well as his long relationship with Putin, has recently
announced his intention to create a new liberal party. As it is hard to
interpret Russian politics, it is uncertain whether the Kremlin is
involved or Kudrin genuinely wants to create a political alternative.
Many observers believe that it is a first step to position Kudrin as a
future prime minister.
The protests and discontent will have an effect on the presidential Putin will probably win
election. To date four candidates have decided to run: Putin (United the presidential
Russia), Gennady Zyuganov (the Communist Party), Sergey Mironov election, but in what
(A Just Russia) and Mikhail Prokhorov (independent oligarch). way?
Though it is considered unlikely that Putin will lose the election, this
could affect the campaign and the promises made. There is a risk that
Putin will counter the growing dissatisfaction with increased control
and repression. This would move Russia even further from Europe’s
political tradition. The parliamentary elections showed, however, that
Russian voters are no longer as interested in stability as a political
alternative. Thus, there is an opportunity to resurrect the goal of
modernization and liberalization Medvedev outlined in the last
presidential election. But it is uncertain to what extent Putin believes
this would give him the greatest chance of getting reelected.
In the short term the political upheavals will not have a major impact Short-term election
on economic policy. We could see more proposals benefiting voters, budget
but a relatively large stimulus has already been put in place. In
addition to raising public sector wages and pensions, social insurance
fees are being reduced from January 2012. The need to please
voters could mean that the tax hikes scheduled to be instituted at the
same time to offset the loss of revenue will be put off until after the
Swedbank Baltic Sea Analysis No. 30 • 16 December 2011 3

4. election. In the longer term the issues of pensions, healthcare and
education have to be addressed. There has been little discussion of
them in the election campaign.
Slower growth after the election – risks are piling up
The Russian economy has continued to grow at a decent pace during Unemployment is an
the first three quarters of 2011, averaging slightly over 4% at an important factor in
annual rate. Domestic demand in the form of consumption and consumption
investment has been the biggest contributor to growth. Real wage
increases have been positive since the beginning of the year and
unemployment has trended lower. The World Bank has shown that
household spending in Russia is highly dependent on unemployment
(Russian Economic Report, the World Bank, September 2011). The
Russian labor market is adapting to an economic chock mainly
through wage changes. This means that households consider lower
wages to be temporary, while an increase in unemployment is
perceived as permanent. When wages are cut, households are
therefore more likely to dip into their savings and when the
unemployment rate goes up they tend to cut back on spending. With
a relatively stable job market, household spending has been an
important driver of growth and retail sales have continued to expand
at an accelerating pace.
Unemployment, real wage growth and retail sales, 2005- 2011
(Unemployment and annual growth, %)
20 10
9
15
8
10 7
Percent of labor force
Annual change in %
6
5
5
0
4
-5 3
Retail trade
2
-10 Real wages
1
Unemployment rate (rs)
-15 0
Jan-05 Oct-05 Jul-06 Apr-07 Jan-08 Oct-08 Jul-09 Apr-10 Jan-11 Oct-11
Sources: Ecowin and Rosstat.
The labor market and household income have been supported by High oil prices facilitate
expansive fiscal policies. Since 2007 the budget deficit (excluding oil expansive fiscal policy
revenue) has grown from about 3% of GDP to about 13% in 2010.
High oil prices have facilitated an expansive fiscal policy. As a result,
the reserve fund, which is supposed to compensate for falling budget
revenue if oil prices drop, has not increased significantly despite an
average oil price of $111/barrel as of November 2011 (compared with
$79/barrel in 2010 and $62/barrel in 2009). At the same time
spending on pensions and wages has risen as a share of total public
expenditure. These forms of “permanent” spending are difficult to
slash in the short term, which will make it hard to switch fiscal gears
4 Swedbank Baltic Sea Analysis No. 30 • 16 December 2011

5. after the election. Furthermore, there is a growing risk of an
escalating budget deficit if oil prices quickly fall.
Currency reserves, budget deficit (excl. oil) and price of oil, 2007 - 2011
(US$ billion, % of GDP and $/barrel)
160 16
2009
2010
140 Reserve Oil price 14
2011p
Fund Non-oil budget ($/barrel)
120 def icit 12
Percent of GDP
100 10
2008
US$ bn
80 8
60 6
2007
40 4
20 2
0 0
q1-08 mar-09 sep-09 mar-10 sep-10 mar-11 sep-11
Sources: Ecowin and Rosstat.
With inflation falling in 2011 the Russian central bank has been able In an uncertain
to keep policy rates unchanged. Slower price increases are mainly economy, monetary
the result of falling food prices, however, and when the effect of last policy remains
year’s poor harvests fades at the same time that public spending unchanged
continues to expand during the first half of 2012 prices could start
increasing again. In addition, the credit expansion to households and
businesses continues. Lower price increases and a weaker ruble
have also, made Russia more competitive this fall. There is a risk that
inflation picks up during next spring, but this is moderated by a
slowdown in the global economy. Thus it is likely that the Russian
central bank will take a wait-and-see approach in coming months
before revising monetary policy.
Inflation, real exchange rate and the ruble
150 20
140
15
130
10
Change in %
120
Index
5
110
0
100
Rubel basket (monthly, USD, EUR, rs) -5
90
Real exchange rate
Inf lation (annually, rs)
80 -10
Jan-05 Oct-05 Jul-06 Apr-07 Jan-08 Oct-08 Jul-09 Apr-10 Jan-11 Oct-11
Sources: Ecowin and Rosstat.
Swedbank Baltic Sea Analysis No. 30 • 16 December 2011 5

6. Russia's economic prospects in the next two years have worsened Weaker growth
significantly. GDP grew by 4.8% at an annual rate in the third quarter, prospects are partly
driven by strong consumer spending and expansive fiscal policy. Now offset by stable energy
the global slowdown is bound to cool off the Russian economy again. prices
Not least, the growing concerns about Europe’s financial markets will
affect Russian banks and capital flows, and exports to the euro zone
are likely to weaken. Even if oil prices fall compared with 2011, we
expect them to remain relatively high, which will moderate the effects
on the Russian economy from the global slowdown.
GDP growth and its components, 2010- 2013
(Annual growth and contribution, %)
11.0
9.0
7.0
5.0 4.5
4.5 4.8 4.4
5.0 4.1 3.8 3.7 3.8 3.6 3.6 3.7 3.8
3.5 3.4
3.1
3.0
1.0
-1.0
-3.0
-5.0
2010 Q1 2010 Q3 2011 Q1 2011 Q3 2012 Q1 2012 Q3 2013 Q1 2013 Q3
Final consumption Gross investments
Net export GDP
Sources: Rosstat and Swedbank.
For the next two years we are revising our growth forecast for Russia Slower growth in the
downward to between 3% and 4% on an annual basis (see table on next two years
next page), compared with nearly 4.5% in our previous forecast.
Household demand is expected to remain strong during the first half-
year of 2012 before fiscal policy is tightened. Together with weaker
global demand, this will hurt the labor market and income growth.
With deteriorating global prospects and growing uncertainty, we
anticipate that private businesses will reduce their rate of investment
compared with the previous forecast, which can’t be fully
compensated by the public sector. Given the slowing economy,
inflation pressures will remain weak in 2012, supported by a modestly
stronger ruble. In 2013, when the price of oil, according to our
forecasts, falls even further, we expect growth to decelerate further.
6 Swedbank Baltic Sea Analysis No. 30 • 16 December 2011

7. Key macroeconomic indicators, 2008- 2013
(Annual change, %, unless indicated otherwise)
2008 2009 2010 2011 2012 2013
proj. proj. proj.
Gross Domestic Product 5.5 -8.0 4.0 4.2 3.9 3.7
Of which:
Private Consumption 10.6 -4.8 3.0 4.8 3.3 3.4
Gross Investments 10.6 -14.4 6.1 4.6 6.9 5.5
Exports 0.6 -4.7 7.1 2.4 2.8 3.2
Imports 14.8 -30.4 25.6 16.5 5.1 2.3
Inflation (%, ave) 14.1 11.7 6.9 8.6 7.0 7.5
Inflation (%, eop) 13.3 8.8 8.8 8.0 6.2 8.6
Unemployment rate (% of labour force, eop, ILO) 7.8 8.2 7.2 6.5 7.0 7.0
Current account (% of GDP) 6.2 4.0 4.0 4.5 2.5 2.0
Fiscal deficit (% of GDP) 3.5 -5.9 -6.5 -2.5 -2.0 -2.5
Government debt (% of GDP) 7.8 10.9 12.0 10.0 10.0 10.5
Rouble (basket USD/EUR) 35.4 36.1 35.2 35.5 35.0 36.5
Oil prices (USD/b) 97.0 62.0 78.5 112.0 103.0 96.0
Sources: Rosstat and Swedbank.
Our forecast scenario is surrounded by significant risks, largely on the Significant negative
downside. The Russian economy is increasingly dependent on forecast risks, of which
commodity markets and in particular energy prices. It has been the price of oil and
estimated that Russia would need an average oil price globally of sovereign debt crisis in
$110/barrel to balance its budget (Carnegie Investment Bank). This is Europe are the biggest
nearly double the level estimated in 2008. This means that a larger
price drop for oil would require significant budget cut-backs and have
major consequences for Russia's growth prospects. The commodity
markets are tightly linked to global development, so a worsening
sovereign debt crisis in Europe that spreads to the global financial
markets would probably have a significant effect on Russian banks,
with a risk of increased capital outflows. The domestic risks for the
economy are largely attributable to political developments. There are
significantly fewer signs of overheating than in 2008, but at the same
time political conditions are uncertain and an escalation of political
protests could lead to increased repression, and thus less desire to
invest both externally and domestically.
Long-term growth prospects are cautiously positive
Despite that economic development in the coming years is Increased trade
overshadowed by significant domestic and external risks, Russia has opportunities will
taken a number of steps to become more competitive in the long term. benefit foreign, and
One of the first items on the agenda of the newly elected Duma could eventually domestic,
be ratifying membership in the WTO. Joining the trade group would companies
open up a considerable market for foreign companies, with lower
customs duties and obstacles to trade. Retailers in particular have
significant potential, although markets tied to infrastructure
investment are also huge. This will especially benefit foreign
companies that can set up operations in Russia, while Russian
companies will face greater competition and price pressure. The
benefits for Russian consumers could be substantial, however. In the
longer term it is likely that the greater competition and integration will
also benefit Russian businesses through higher productivity and
efficiency. At that point they will be able to take advantage of both
their proximity to a large domestic market and opportunities to
compete internationally.
Swedbank Baltic Sea Analysis No. 30 • 16 December 2011 7

8. Conditions for Russian business will also continue to improve. In its The business climate
“Doing Business 2012” report, the World Bank ranked Russia among is also making
the 25 countries that have made the biggest improvements in the progress
ease of doing business since 2004. This is confirmed by Swedbank’s
Baltic Sea Index in the latest Baltic Sea Region Report (October
2011). Although Russia still ranks among the least business-friendly
countries in the world, progress has been made in a number of areas.
Among other things, an electronic contract register has been
introduced and obstacles to property sales and import restrictions
have reduced. There is still plenty of room for improvement in terms
of the business climate, especially as regards fighting corruption and
energy supplies, as well as strengthening protection for investors.
Magnus Alvesson
Economic Research Department
SE-105 34 Stockholm Swedbank Baltic Sea Analysis is published as a service to our customers.
Telephone +46-08-5859 7740 We believe that we have used reliable sources and methods in the
ek.sekr@swedbank.se preparation of the analyses reported in this publication. However, we
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ISSN 1103-4897
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