Downturn in Russia Not Quite as Bad as Feared in Q1

Domestic demand likely contracted sharply in Q1, although net trade may have offset some of this weakness. Although the seeds of recovery are slowly being sown, growth will likely remain negative for most of the year.

Consumer Spending Appears to Have Led the Downturn 

Data released this morning showed that real GDP in Russia contracted 1.9 percent on a year-ago basis in the first quarter (top chart). The bad news is that the Russian economy is back in recession again, which really comes as little surprise. The good news is that the contraction in Q1 was not as sharp as many analysts had expected. The data are preliminary and do not include a breakdown of GDP into its underlying demand components. That disaggregation will not be available until next month. However, it seems likely that consumer spending slumped sharply in the first quarter. Monthly data show that growth in real retail spending plunged from a year-over-year rate of 2.9percent in Q4-2014 to -6.6 percent in Q1. Retail sales do not include spending on services, so the downturn in overall consumer spending may not be quite as sharp as these aforementioned numbers imply. That said, it seems likely that real personal consumption expenditures have weakened markedly thus far in 2015. 
The slump in oil prices last year and the impositions of western sanctions on Russia related to the Ukrainian crisis led to a collapse in the value of the Russian ruble (middle chart). The sharp rise in CPI inflation (bottom chart) associated with the collapse in the value of the currency caused real income to weaken sharply—real wages were down more than 9 percent on a year- ago basis in March—thereby weighing on consumer spending. In an attempt to stabilize the currency and keep inflationary expectations in check, the Central Bank of the Russian Federation jacked up its main policy rate from 5.50 percent in February 2014 to 17.00 percent in December. This sharp increase in interest rates undoubtedly caused investment spending to tank in the first quarter. In sum, domestic demand in Russia likely contracted very sharply in Q1. However, net exports probably offset some of the weakness in domestic demand. Although the value of exports was down about 27 percent on a year-ago basis in Q1, the value of imports nosedived more than 37 percent.  In other words, net exports probably made a positive contribution to the year-over-year rate of GDP growth in the first quarter.  
The Russian ruble has retraced about half of its losses over the past few months, and it appears that the CPI inflation rate has peaked (bottom chart). Consequently, the central bank has started to reverse some of its previous tightening, cutting its main policy rate to 12.50 percent over the past three months. Although the seeds are slowly being sown for an eventual recovery, the year-over-year rate of Russian real GDP growth likely will remain in negative territory for most of the year. (For further reading, see “Russian Economic Outlook: Light at End of Tunnel?” available on our website).