With the headline rate of GDP growth announced in late September, the release of data on end-use components by RosStat on 2 October completed the picture of trends in economic activity in the second quarter and the first half of 2008. The growth of gross fixed capital formation and personal consumption remained impressive but slowed relative to the pace in the first quarter. Personal consumption growth slipped to 12.2% year-on-year (y/y) from a red-hot 14.1% in the first quarter but for the first half of 2008 the 13.1% rate of growth of personal consumption still exceeded the 12.6% growth posted a year earlier. The rate of growth of gross fixed capital formation slowed more notably, however. While gross fixed capital formation was up 23.0% y/y in the first half of 2007 and 19.4% in the first quarter of 2008, the pace slowed to 12.9% in the second quarter of 2008 and came in at 15.4% for the first half of the year. Gross capital formation, which includes investment in inventories, posted higher growth in the second quarter than in the first, 17.8% y/y vs. 10.4% in the first, clearly due to greater accumulation of inventories. Collective consumption growth held steady at 2.3% through the first two quarters of 2008, down from 5.4% growth registered in the first half of 2007.

While gross fixed capital formation remained a key driver of aggregate output in the second quarter of 2008, the marked slowdown relative to a quarter earlier and to the pace registered in the first half of 2007 reflected a deterioration of the investment environment. The negative developments included periodic shortages of liquidity in the banking sector that stalled investment plans for lack of financing. The liquidity shortage reflected a sell-off of rouble-denominated assets by non-residents and even some Russian citizens in order to cover losses encountered elsewhere as a result of turmoil in global financial markets and a world-wide credit crunch. Perhaps just as significant, the Russian government spooked investors, both foreign and domestic, by its continued campaigns to intervene in the private economy in the interest of the state and/or government-business alliances within the Kremlin or with close ties to the Putin government. This included harassment of the British-Russian energy joint venture TNK-BP in an apparent effort to push out the foreign partner in favour of the Russian side and perhaps eventually state-controlled energy giants as well as threats of harsh sanctions against coking coal supplier Mechel aimed at lowering the cost of deliveries to domestic steelmakers.

Government consumption has been growing at a relatively modest pace in the first half of 2008. This more modest rate of expansion reflects greater fiscal caution this year as consumer price inflation surged. There have been clear signs that the Russian economy has been overheating during the past three quarters, tempering the urge to boost social spending and grant large public-sector salary increases, especially after the parliamentary election in December 2008 insured an overwhelming majority for the dominant United Russia party, now under the leadership of Vladimir Putin.

The other notable development in the second quarter of 2008 was the dramatic deceleration of real growth of exports of goods and services on a national income accounting basis. This slowed to only 5.4% y/y from 14.4% in the first quarter of 2008, although it was still ahead of the 4.6% registered in the first half of 2007. Growth of energy exports, a large proportion of Russia's export basket, remains sluggish both due to production problems as older deposits are depleted and to growing domestic requirements for energy. Growth of imports of goods and services also decelerated but only very modestly to 22.6% y/y from 27.3% in the first quarter of 2008 and 28.7% in the first half of 2007. As a result of the divergent trends of exports and imports, the surplus on trade in goods and services was cut by nearly two-thirds in the second quarter of 2008 compared with a year earlier. The surplus for the first half of 2008 was diminished by one-fifth compared with the first half of 2007. Thus, developments in net trade in real terms continued to serve as a drag on GDP growth. In nominal terms, however, due to rising domestic prices of energy, the share of the trade surplus on a national income accounting basis in GDP increased to 11.5% in the first half of 2008 from 9.4% in the same period a year earlier.

Outlook and Implications

Russian domestic demand will continue to be relatively buoyant and while growth rates are likely to moderate somewhat in 2008 and into the medium term, GDP growth in Russia will still be enviable from the point of view of developed Western economies. Investment activity will likely expand at a considerably slower rate in the third quarter of 2008 but government and central bank actions should bolster the liquidity of banks and enterprises substantially going forward. While this will ease financing for investment, business confidence will still be a problematic factor given the very negative external economic environment and slowing domestic growth as well. Some of the slack may well be taken up by government consumption as inflationary pressures ease back and excess capacity begins to open up a bit. While consumers will continue to draw on rising real wages and incomes to boost their expenditures, consumer confidence may well be shaken somewhat as well while consumer credit is likely to expand at a more moderate pace. Receding world market prices of energy and other key Russian export commodities will also dampen growth somewhat. We do not expect to see rates of growth of Russian GDP still above the 7.0% y/y mark in the coming quarters