Economic Outlook: Opportunity & risk in the CIS

By Scott Hazelton11 November 2013

A number of factors affecting the Russian economy are expected to keep growth moderate for the medium term at least. Economic expansion is slowing amid declining export earnings and slackening domestic demand, and the country remains overly dependent on energy exports (71.3% of export revenues in the first half of 2013) to drive growth.

With this in mind, it is worth noting that energy prices are expected to remain relatively stable at somewhat lower than recent levels in the near-to-medium term. This is down to geopolitical tensions in producing regions, which are offsetting the impact of moderate global demand, even as alternative supplies of energy are rapidly coming on stream.
Although domestic credit markets have thawed since the global recession, commercial lending rates are still high. At the same time, capital continues to leave Russia as investors seek safer havens.

GDP growth for the first half of the year was a paltry +1.4%. While the second half of the year appears stronger, IHS Global Insight still expects 2013 GDP growth to average just +2.4%. Some traction is expected to be regained in 2014, when Russian economic growth will rebound to +3.3%, before it returns to the +3.8% range for the medium term.

The currency, which has suffered from a sell-off and slipping oil prices, looks set to regain some strength in real terms against the US Dollar and Euro when international capital markets grow calmer. Fiscal revenues will slip with slower economic growth and will not cover spending commitments for expansive social spending and public sector investment programs in 2013 to 2014.

Given the importance of investment, the Ministry of Finance will allow up to half of the National Prosperity Fund (NPF) to be spent on major infrastructure projects. The US$ 86.9 billion NPF and the US$ 85.4 billion Reserve Fund accumulate windfall hydrocarbon revenues and were originally created to provide emergency funds in case of a major economic downturn.

Hydrocarbon funds

However in April, the government decided to use hydrocarbon royalties to plug the growing budget deficit. And in June, President Putin indicated that money from the NPF would be used to fund construction of a high-speed rail link between Moscow and Kazan, modernisation of the Trans-Siberian railway and construction of the Central Ring Road in Moscow.

The President also hopes public-private partnerships will play a greater role in stimulating growth. Even so, IHS Global Insight expects only very slow progress on market-oriented institutional and structural reforms.

Indeed, finances and a lack of transparency in business practices create a high risk for construction companies in Russia. The natural resource extraction sector, which represents 25% of the entire Russian economy, faces capacity constraints due to an extended period of insufficient investment.

The situation adds to the urgency of improving the investment environment to attract resources. This is necessary to both shore up the extractive sector and to modernise the manufacturing sector to reduce dependence on production and export of basic commodities.


Residential construction in Russia grew just +0.2% in 2012 and is likely to decline -3.2% in 2013 as real per capita GDP slows. However, Russia is committed to increase housing construction with a goal to have 33% of Russian families able to afford their own home by 2015 (up from 12% in 2011).

This is partly an effort to reverse population declines with a goal of having three children per family. For example, St. Petersburg is poised to see residential construction on 22 sites over the next 15 years as € 11.6 billion (US$ 16 billion) is invested to provide 450,000 new apartments.

The residential sector will turn the corner in 2014, with an increase of +4.5% as the economy improves, and the medium term is positive with +2.4% annual growth expected through 2017.

The headliners for non-residential construction are world class sporting events – the 2014 Winter Olympics and 2018 FIFA World Cup. Most of the estimated US$ 10 billion Sochi construction is completed or nearing final stages, however, another US$ 22 billion is expected to be spent by federal and local governments as well as private investment for the World Cup.

Roughly one fifth of this will be spent on stadiums in 13 different cities with another two fifths dedicated to road projects, such as a highway connecting Moscow and St. Petersburg. The budget also includes the expansion of Russian rail projects including the Baykal-Amur mainline.

Real spending on the construction of non-residential structure grew +2.5% in 2012, with institutional structures leading and industrial structures lagging as export demand slumped. Spending will increase +2.3% in 2013 and +4.5% in 2014 as economic conditions improve.

Over the medium term, growth should average +5.0% per annum, with office construction yielding the highest growth rate and institutional structures the weakest performer.

Since energy is the lifeblood of the Russian economy, investment here is expected to continue. Russia plans to implement incentives such as tax breaks and opening off-shore fields to foreign investment to draw US$ 500 million into the oil and gas industry over the next 30 years.
Construction should begin on the South Stream gas pipeline in 2014. The pipeline will run from the Black Sea to Bulgaria and then on to central Europe with a throughput capacity of 63 billion m3 per year, with four separate offshore pipeline strands.

On the whole, infrastructure construction spending grew +3.5% in 2012, and despite falling back a bit in 2013, will see renewed expansion at a +5.9% pace in 2014. Over the medium term, expect +4.7% annual growth over the next five years, with the strongest performance coming from the transportation sector.

Taken together, IHS Global Insight estimates that Russian construction spending will post a slight decline in 2013, mostly a function of faltering residential construction. However, the medium term will see strong +4.3% annual growth over the next five years, led by the non-residential sector, although housing will see healthy increases as well.

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