Russia economy shrinks for second quarter with worst yet to come

Russia’s economy shrank for a second quarter as the shock of sanctions over the Kremlin’s invasion of Ukraine disrupted trade and upended domestic demand, with the worst of the downturn likely early next year.

Gross domestic product fell an annual 4% in the third quarter, in line with the central bank’s estimate but faring better than every forecast in a Bloomberg survey of analysts. It follows a drop of 4% in the prior three months, in what was Russia’s first GDP contraction in over a year.

In a statement on Wednesday, the statistics service, also known as Rosstat, cited a steep decline in wholesale and retail trade alongside a drop in industries including manufacturing.

A boost in government spending and Russia’s ability to divert exports to friendly nations have helped offset the damage wrought by sanctions, with construction among the few sectors to expand last quarter thanks in part to a state program of subsidized mortgages.

Expectations for the economy have shifted from a near-collapse soon after the invasion of Ukraine to a shallower recession that will extend well beyond 2022. Ahead is a contraction that may represent Russia deepest slump since the global financial crisis more than a decade ago.

Another Bloomberg poll has predicted a steeper GDP decline this quarter before the recession culminates with a decline of over 8% in the first three months of 2023. Just two months ago, the low point was expected already this year.

“We see a persisting supply-side shock and a forced structural transformation to a lower-tech economy resulting in a prolonged recession and lower potential growth,” Morgan Stanley economists including Alina Slyusarchuk said in a report this week.

The economy may not eke out growth until the third quarter of 2023, the survey shows.

Bloomberg Economics predicts GDP will shrink 3.5% in 2022 and 2% in 2023, with the government possibly dialing back on some of the support measures it used to shore up demand and construction.

“The Russian economy will continue to shrink over the next six months for two reasons,” Russia economist Alexander Isakov said. “First, the energy commodity sector and manufacturing will continue to shrink as sanctions bite. Second, some of the key tools Russia used to boost domestic demand throughout this year, such as indiscriminate mortgage subsidies, are now exhausted.”

Looming restrictions on oil shipments will test Russia’s resilience, with exports of gas to Europe already plunging amid supply disruptions, and consumer demand under increasing pressure from President Vladimir Putin’s callup of reservists to fight in Ukraine.

Russia’s oil and gas production started declining in September, creating a drag on industrial output and leading to a worse contraction than expected. Prospects are turning even more grim, with state gas producer Gazprom PJSC reporting its daily exports are now extending the multiyear lows hit last month.

Speaking to lawmakers on Tuesday, Bank of Russia Governor Elvira Nabiullina warned the state in the economy could worsen.

“We really need to look at the situation very soberly and with our eyes open,” she said. “Things may get worse, we understand that.”