Spring in the Middle of Summer

Julia Tsepliaeva, Chief Economist Russia & CIS Senior Director of Global Securities Research and Economics / Merrill Lynch

We see the first signs of Russia’s economic recovery. We believe that Russia has finally bottomed, and a recovery has begun on the back of higher oil prices, fiscal spending, stabilizing credit, and re-stocking. The initial recovery is likely to surprise on the upside, in our view: we forecast double-digit annualized quarter-on-quarter GDP growth even while year-on-year figures remain negative in for the second half of 2009. For 2010, we expect average GDP growth of 2.4%.

As the recession appeared to be very deep, recovery is beginning from a very low level. Month-on-month and quarter-on-quarter improvements should be considered as indicators of recovery. In May-June, real wage and real disposable income growth turned to positive territory, making us more optimistic on recovery in consumption. Consumer sentiment index also showed sizable 3 percent quarter on rebound in June. Last month, we saw encouraging month-on-month dynamics in industrial production and GDP growth.

Leading indicators confirm the beginning of recovery. The oil price is the main “leading indicator” for Russia — with a very short lag. We see rebound in oil prices in the second half of 2009 and into 2010, which makes us more optimistic on economic performance. If oil prices increase by 28 percent year-on-year in 2010 as we believe now, it could add 1.9-2.8 percentage points to GDP growth in 2010 and 3.2-4.8 percentage points in 2011-13.

Another thing that will have to resurface in the 2H 2009 is the long-awaited increase in fiscal spending. In 2009, practical implementation of the fiscal stimuli was delayed and we expect budget expenditures to remain skewed towards the fourth quarter of 2009. We expect fiscal rain to be very supportive for economic growth in the fourth quarter, pushing seasonally adjusted figure to 5 percent quarter on quarter (-1.5 percent year-on-year). In the first quarter of next year, the seasonal trend foresees a decline in fiscal spending, pulling quarter-on-quarter growth down, but then recovery could continue and accelerate on the back of further improvements in oil prices and 2010 fiscal plan.

Furthermore, we believe return to economic growth is possible even without the full recovery in the financial sector. Although we see first signs of improvement (banking deposit growth, slowdown in NPL growth and so on), credit expansion may lag and the contribution of credit component to the initial stage of recovery is likely to remain minor. In the fourth quarter of 2008 and the first half of 2009, the crisis in the banking sector fueled the economic crisis, and we certainly think that gradual stabilization in the banking system is necessary precondition for credit expansion.

 To us, the sustainability of the recovery is the main question. We see risks for positive developments on economic front associated with decline in oil prices or with negative developments in the banking sector. A spike in recapitalization needs to above $70-80 billion may slow down or postpone recovery. Fortunately, this is not the most likely scenario and the second wave of the crisis is likely to be avoided, in our view.