Russia: Country Economic Forecast: 13 Dec 2010

According to preliminary estimates, year-on-year GDP growth fell sharply to 2.7% in Q3 on the back of an estimated seasonally adjusted quarterly contraction of 0.6%. The result was consistent with high frequency data, which had suggested significant economic weakness following the severe summer drought that decimated the wheat harvest and disrupted activity. Although a breakdown of expenditure is currently unavailable, Q3 balance of payments data imply that net trade acted as a significant drag. Given that seasonally adjusted retail sales volumes fell 0.6% on the quarter, we expect that consumer spending contracted. On the other hand, monthly data suggest that fixed investment held up reasonably well. Latest indicators show that activity has begun to recover in Q4. Seasonally adjusted retail sales volumes increased 0.5% on the month in October, while industrial production rose by an estimated 2.3%. However, the November PMIs suggest that some of this momentum may have been lost and we have revised down our forecast for 2010 GDP growth to 3.6%, a disappointing result after the steep 7.9% contraction in 2009. Driven by a rapid increase in food prices, inflation has risen sharply, reaching 8.1% in November. The central bank held rates at 7.75% in November, noting that the recent rise in inflation had been driven largely by temporary factors. Our baseline case is for a tightening cycle to commence in 2011Q1, with rates ending 2011 at 8.5%.