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New Europe Weekly

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Russia’s strong performance

Fri, May 30 2008, 15:25 GMT
by Danske Research Team

Danske Bank A/S

While growth has been slowing in the developed markets over the last quarters, economic expansion in Russia has, on the contrary, accelerated, driven by buoyant domestic demand.

Rising energy prices have led to strong rises in government spending, in recent years and in 2008, and this has caused demand pressures to build up, inflation to rise and imports to soar.

Admittedly, the Russian authorities have had virtually no chance of preventing rising world market food prices from pushing up inflation, but the energy price shock has only had limited effect on Russian prices due to heavy subsidisation of utilities.

Rising inflation is thus mainly a result of strong demand pressures – private and public – tight factor markets, which push up unit labour costs and producer prices, strong credit growth, and an unsustainable “managed currency peg”, which have led to a strong rise in the money-to-GDP ratio.

The Russian central bank (CBR) is very much aware of these problems and it tightens conditions through higher rates and higher reserve requirements. But it needs help from the government, as it can only reduce demand pressures to a limited extent, due to weak transmissions mechanisms from monetary policies to the real economy.

Slower-growing public outlays will most likely be the most efficient way to cool off the economy and reduce inflationary pressures. It will, however, be interesting to see whether the Russian government is able to reduce spending growth in 2009-10. This will be a real test for the new administration!

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Published on  Fri, May 30 2008, 15:28 GMT