The economic forecast for Russia: Dire with a chance of deflation

The economy stalls as incomes decline and spending shrinks “This will be the case not for months but years”

Russia’s longest recession in two decades has obliterated consumer demand. Price growth has slowed for a seventh month. Goldman Sachs predicts Russia’s annual inflation, now 7.3 percent, will slip below 6 percent in the third quarter and finish the year at 4.5 percent. In March of last year inflation was 16.9 percent. It’s enough for Bank of America to warn that the country faces a “sharply rising” risk of deflation.

A reliable source of growth for more than a decade, the Russian consumer is exhausted as the economy contracts for a second year. After President Vladimir Putin came to power in 2000, the poverty level fell until 2014, when oil prices collapsed. Now millions are sinking into poverty and wages are rising minimally. As a result, the breadth of goods being bought has shrunk. Food accounted for more than half of all retail sales in February, the highest proportion in more than eight years, a study found.

Sberbank CIB’s latest survey of “the Ivanovs,” using a common last name to describe the typical shopper, found a record 76 percent of respondents describing themselves as

price-sensitive and 60 percent trying to save on staples by using promotional offers. “Price wars are now being waged in retail, but they aren’t like before,” says Alexander Malis, head of Russia’s largest handset seller, Euroset. Before, a retailer would lower prices for a brief period; now the discounts are yearround. “This will be the case not for months but years, until the Russian economy recovers,” says Malis.

Forces such as higher youth unemployment have added to the erosion of demand. Households worried about the future are opting to bank what they can rather than spend, according to Morgan Stanley. Savings rose to 14.1 percent of disposable income last year, up from 5.4 percent in 2008, according to the Federal State Statistics Service.

BofA’s warning for Russia foresees a “sharp spike” to high from minimal deflation risk. The Russian Central Bank disagrees—to a point. At least over the short to medium term, Ksenia Yudaeva, Bank of Russia’s first deputy governor, sees no risk of deflation.

Price increases were once a big part of Russian life; in the early 1990s, inflation peaked at more than 2,500 percent. Consumer inflation now barely registers as a problem. Just 5 percent of respondents said it was the biggest challenge facing the country in March, ranking it ninth behind issues ranging from health care to foreign policy, according to a poll by the state-run Russian Public Opinion Center.

The decrease in inflation growth and the ruble’s surprising strength should have helped boost the economy this year. But it made no difference. As low oil prices hobbled Russia’s major industry, retail sales in March dropped more than forecast by economists, and unemployment was worse than the median estimates compiled by Bloomberg.

Eldar Vakhitov, a London-based economist for BNP Paribas, suggests the downturn is a result of more than the oil crash. High borrowing costs and repayments of large debts accumulated during the boom times are souring the outlook for households, he says. “A consumption recovery will be likely postponed to 2017.”

Poor demographics add another wrinkle. The working-age population has shrunk by 5 million since its peak in 2006 and will continue to contract, cutting Russia’s potential economic growth to near zero in 2016-17, according to BofA economists Vladimir Osakovskiy and Gabriele Foa. “The steady reduction of the working-age population in Russia is an important factor behind the current long-term disinflation trend,” the economists wrote on April 8. “The lack of labor force and employment growth is also an integral part of the general weakness of consumer demand.” Anna Andrianova and Andrey Biryukov