- In terms of economic growth Russia will be closer to developed rather than developing countries in the short term. The recession is over, judging by GDP switching back to weak positive dynamics and in view of how the economy uses available resources. The years to come are to see labor productivity changes driving most of growth, which may also be influenced by a restraining effect of the demographic situation and a steady decline in inflation and interest rates. That said, even amid high oil prices the potential GDP growth is likely to be capped at 1-1.5% over the next five years. Despite low inflation and obvious, although modest, economic growth, household income may still show a slightly negative trend by end-2017.
- Inflation receding to sustainable lows may impair labor market efficiency. Climbing consumer prices bolster real wage flexibility (inverse correlation), allowing employers to adjust to changing external environment without adjusting remuneration. Steadily declining average inflation rates may also limit flexibility of consumer prices and wages. This may bolster natural unemployment and whip up formation of labor unions and other collective forms of employee protection.
- Real interest rates are to remain positive throughout the forecast horizon. From the economic growth viewpoint they will to restrain the forced fiscal stimulus, reducing both investments funded with borrowed funds and final consumption.
- An extensive array of reforms has been put off till after 2018, although part of them are likely to be implemented not in 2019 and 2020, but later, as their success hinges on social perception. When large in number, reforms are prone to be regarded as growing regulatory pressure, despite their obvious positive effect in the future.
- The 2017-2020 forecast update has mainly affected raw material extraction dynamics and tax system prospects after 2018. Compared to our forecast published in September 2016, we now consider the options of global oil prices going higher and local inflation reaching the Bank of Russia target sooner, helped by a tighter monetary policy. We have also revised slightly upwards our global growth outlook.
The forecast has been prepared in accordance with the General Principles of Socioeconomic Indicators Forecasting of ACRA.
Table 1. Key Russian and global economy figures in 2014-2021
Developed countries almost recovered after 2008 crisis
See the ACRA January 24, 2017 commentary titled “U.S. interest rates in 2017 and 2018: What to expect?”.
In the coming years, developed countries are likely to scale back their monetary stimulus programs, as the latter are expected to achieve most of their goals in 2017-2018. By our estimates, the Fed may raise its key rate four times in 2017, bringing it eventually to 3% by late 2018, early 2019, while the pace of this increase is likely to directly depend on the velocity of changes the US budget policy is to undergo in the course of its aligning with the new president’s campaign promises. The eurozone is to follow suit, but with a lag of at least a year, as, in contrast to the US, its labor market is still in a much worse shape than in 2007, although economic growth risks have materially subsided and unemployment is showing a clear downward trend. An increase in indicative rates here will probably be triggered by a steady growth in core inflation.
In Japan, this could happen as soon as late 2017, if labor market “overheating” transforms in wage growth and has a positive impact on consumer prices. Ceteris paribus, gradually climbing interest rates in developed countries will build up their investment appeal and push their currencies towards strengthening – a trend unlikely to be seen in developing countries.
China will probably go through a cycle of increased rates over the forecast period, as the country needs to curb its extremely fast lending expansion greatly outstripping economic growth in recent years. However, economic growth is also likely to fare below the past decade’s average, pushed down among other factors by the declining working-age population. The cumulative effect of the mentioned trends will probably be slower global growth. This will restrain the climb in commodity prices, although the latter might be more affected by commodity supply dynamics and the prospects of building up protectionism in global trade caused by slowing demand and stiffening competition for markets.
See the ACRA January 30, 2017 commentary titled “Future looks promising for oil producers”.
The key long-term price benchmark for the oil market will still be US shale oil production costs, which are expected to climb in the years ahead as a result of growing demand for oil production equipment and services, and backed by accelerating inflation in the US. The coming years are likely to see global economic growth stimulate an oil demand increase of some 1.2% per year, which will at least compensate for climbing supply. The US is set to post the fastest production growth, fueled by rising extraction of shale oil, on the one hand, and surging output in the Gulf of Mexico, on the other. Non-OPEC oil production growth will be moderate on traditional fields as a result of insufficient investment in 2015-2016. As for OPEC, even if the agreement on production freeze is not extended into 2H2017, the cartel may still revert to the quotas system that will hold back its production growth.
Persistently low inflation may undermine labor market efficiency
Real wage is inflation-adjusted wage, i.e. the one expressed through base year prices.
By 2017, OECD countries failed to revert to the pre-crisis unemployment average, while Russia achieved it back in mid-2012 and almost completely avoided a decline in employment during the 2015-2016 crisis. High real wage flexibility is one of key factors ensuring Russian labor market efficiency, manifested in low unemployment and its low-magnitude and short-lived spikes during recessions6.
6 Refer to “Russian Labor Market Mechanisms” by Gurvitch and Vakulenko, Delo Publishers, 2016.
The real wage average in Russia fell 3.5% in 2009 and lost another 9.3% in 2015.
Such flexibility is supported by institutions and high inflation. The labor legislation guarantees fairly high protection of employee rights, while workforce mobility is relatively small. The market also features a high proportion of the non-fixed wage component and a relatively active role played by the state in terms of job creation. Another key to real wage flexibility is relatively high inflation. In the 2000s, it allowed for a 10-15% reduction in real annual labor costs, provided that employers avoided changing figures in labor contracts. Such way of saving is of particular importance for employers at times of waning demand for their products or sudden growth in other costs, including the periods of economic recession. Moreover, inflation helps optimize labor costs even when the going is not tough.
Natural unemployment is unemployment observed even during equilibrium periods on key markets and related to the time needed to find a job even if it is available (frictional unemployment), and/or resulting from technology evolvement or other forms of development leading to a mismatch between employee qualifications and employer requirements (structural unemployment).
Lower and stable inflation does not necessarily imply smaller inflation spikes at times of recessions and shocks on the labor market, especially if they are caused by exchange rate transition, typical, for example, for raw material exporters. Therefore, achieving a low inflation target does not automatically translate into a reduction in real wage flexibility. That said, firstly the possibility of such an effect does not contradict the experience of the 2008-2009 crisis (see Figure 2), and secondly it was noted in empirical research based on individual country data7 and cross-country comparisons8 prior to 2008. If the observed patterns are applicable to Russia, achieving the inflation target may result in lower real wage flexibility and higher natural unemployment, with more pronounced outbursts in crisis periods (see Figure 1).
This environment may incentivize formation of labor unions and other collective forms of employee protection, and stimulate expansion of state programs covering unemployment insurance and employment support (jobless claims, professional retraining, etc.). A higher impact in real terms should be expected from counter-cyclical stimulus measures in economic policy. Another way to ensure a compensating wage flexibility increase lies through labor market institutions, such as the percentage of payouts that depend on company and employee performance.
7 For example, refer to “Low Inflation vs. Stable Inflation: Evidence from the UK, 1688–2009” by Karras and Georgios, Scottish Journal of Political Economy, Vol. 62, Issue 5, pp. 505-517, 2015.
8 Refer to “Is Moderate-to-High Inflation Inherently Unstable?” by Michael T. Kiley, International Journal of Central Banking, vol. 3(2), 2007.