RUSSIA'S QUARTERLY GDP DROP WORST EVER: HAS IT

C O N F I D E N T I A L SECTION 01 OF 02 MOSCOW 002141

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STATE FOR EUR/RUS, EEB/IFD
TREASURY FOR TORGERSON, WRIGHT
DOC FOR 4231/MAC/EUR/JBROUGHER
NSC FOR MCFAUL

E.O. 12958: DECL: 08/20/2019
TAGS: ECON EFIN RS
SUBJECT: RUSSIA'S QUARTERLY GDP DROP WORST EVER: HAS IT
BOTTOMED OUT?

REF: MOSCOW 02064

Classified By: A/ECON JStepanchuk for reasons 1.4 (b) and (d)

1.(C) Summary: Russia reported its worst quarterly drop in
GDP ever in the second quarter of 2009, with a year-on-year
decrease of 10.9%. Stocks tumbled as a result.
Nevertheless, whereas just a few months ago the consensus
view was that there would be a severe "second wave" of the
financial crisis in the second half of 2009, expectations of
a recovery this year are growing. Most analysts NOW believe
Russia has hit bottom, that the second half of 2009 will not
be as bad as he first half, and that 2010 will see very low,
albeit positive, growth rates, barring a large drop in oil
prices. Nevertheless, the absence of structural reforms and
continued reliance on commodity exports will put Russia
behind other developed economies and emerging markets in
terms of growth and investment. End Summary.

Worse Than Expected GDP Results...
--------------

2. (SBU) Russia turned in its worst quarterly economic result
ever after the economy contracted by 10.9% year-on-year (YoY)
in the second quarter of 2009. This was worse than the 10.4%
YoY preliminary estimate in July from the Ministry of
Economy, in part because of a greater drop in inventories
than in 1Q09. The news sent stocks tumbling below the 1000
mark on Russia's main exchange, RTS. The ruble reacted
strongly to both the GDP numbers and GOR's growing budget
deficit (reftel). Alfa Bank reported that volatility
increased dramatically and the ruble dropped by 1.5-2.0% vs.
the basket over the course of 20 minutes, adding, "which in
our view confirms that the market is concerned over Russia's
growing budget deficit."

...But Future Not as Bad
--------------

3. (SBU) Russia's poor quarterly results were not much worse
than expected, however, and many analysts believe that the
Russian economy has hit bottom. Troika's chief economist
Yevgeniy Gavrilenkov wrote: "The trends in GDP are in line
with our expectations, and we reiterate our view that the
economy will start growing (though moderately) in 2H09. The
revival will be supported by increasing gas exports,
restocking and gradually improving crediting." Expectations
of a recovery in 2H09 are becoming the consensus among
economists. Whereas Gavrilenkov forecast a GDP decline of
around 5.0% this year, Aleksandra Yevtifyeva of VTB Capital
estimated the drop in GDP for 2009 at a more modest 4.2%,
implying an even stronger bounce back in 2H09.

4.(C) The public reports cited above echoed what our contacts
have been telling us privately. Chief Economist at Merrill
Lynch Julia Tsepliaeva told us that "the bottom was found"
and "we're past the worst part." She pointed to customer
sentiment, industrial production, and increasing inventories
as signs of a recovery, which she attributes less to
government stimulus and more to increasing oil prices. HSBC
Chief Economist Aleksandr Morozov said that there would be a
recovery on the back of the real sector, but that the
financial sector would not be an engine for growth. He
thought that 1H10 would still see declining GDP, but only on
the magnitude of 1-2%. According to most analysts, the
largest looming threats to recovery are the ever-present
possibility of a large decrease in oil prices, a worsening
global economic situation, and, specific to Russia, the
growing number of non-performing loans held by banks
(reported septel).

Comment
--------------

5.(C) Russia's financial crisis was an opportunity to fix
many of the country's structural economic problems, and many
analysts initially expected such changes. Instead, the GOR
has been depleting its Reserve Fund in order to minimize any
popular dissatisfaction with the government while leaving
inefficient market mechanisms in place. As a result,
Russia's economy is as dependent on commodity prices as it
ever was, but the next boom-and-bust cycle will likely find
the GOR without the financial cushion in the form of the
Reserve Fund that it had this time around. Most financial
experts tell us that the next few years in Russia will see

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"underperforming" GDP growth rates in the range of 3-4%,
substantiating concerns in some quarters of the GOR that
Russia will continue to lag behind most developed economies
in terms of growth and other emerging economies in terms of
investment. End Comment.
RUBIN