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updated: 8/12/2014 8:24 AM

Russian economy stalls as Putin's reprisal threatens spillovers

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Bloomberg News

Russia's economic growth slumped to the weakest in five quarters, underlining the risks to a recovery in the region as President Vladimir Putin retaliates after penalties imposed over the deepening conflict in Ukraine.

Gross domestic product advanced 0.8 percent in the second quarter from a year earlier after 0.9 percent growth in the first three months of the year, the Federal Statistics Service said today in an e-mailed statement, citing preliminary data. The Economy Ministry in Moscow had projected 1.1 percent expansion. GDP growth in Poland, Hungary and the Czech Republic probably slowed in the April-June period on a quarterly basis, according to analysts surveyed by Bloomberg.

The economies of former Soviet satellites are getting caught up in the crossfire of sanctions, compounding months of sagging Russian demand for their exports, after Putin slapped import bans on an array of foods last week. The fallout is ricocheting, with Finland, Poland and Lithuania planning to ask the European Union for compensation to ease the economic pain.

Regional economies from the Baltics to Poland will be "much more affected by the food ban that Russia imposed than Russia's slowdown," Ivan Tchakarov, an economist at Citigroup Inc. in Moscow, said by e-mail. Russia's "risks of recession are certainly higher for the second half of the year as we suspect that investment spending will re-enter negative territory while consumer spending may continue to slow on the higher inflation, including because of the food import ban."

Forint, Ruble

Investors are punishing many former communist nations. The cost to insure the Polish government's debt against non-payment widened 22 percent, the most in the last five days among the 19 developing economies tracked by Bloomberg. Russian five-year credit-default swaps widened 9.6 percent in the same period to 269 basis points.

After the ruble, currencies from eastern Europe accounted for five of the six worst-performing emerging-market exchange rates in July, led by Hungary's forint and Romania's leu. Stock indexes in Bulgaria, the Czech Republic and Hungary joined Russia's among the 10 biggest declining markets in the world last month.

Regional Spillover

Russian counter-sanctions "definitely are going to affect emerging economies in eastern Europe because Russia is an important market," Juri Kren, an economist at IdeaGlobal in London, said by phone. "Russia can avoid a recession this year but in any case, growth is going to be very weak and close to zero."

Based on data from Eurostat, Russia was the destination for 19.8 percent of Lithuania's exports last year. For Latvia, Estonia, Finland and Poland it was 16.2 percent, 11.4 percent, 9.6 percent and 5.3 percent respectively.

The ban may knock 0.2 percentage points off Lithuania's GDP growth, according to the country's economy minister, and inflict about the same damage in Estonia, its central bank said today.

Putin and his government have struggled to kickstart the $2 trillion economy as fighting rages next door in eastern Ukraine. The standoff with the U.S. and the EU has spurred ruble devaluation and capital flight.

Near Standstill

Russia's GDP may grow 0.5 percent this year, according to the median estimate of 38 economists surveyed by Bloomberg July 18-23, unchanged from the previous month's results. The economists cut their 2015 growth forecast to 1.6 percent from 1.8 percent. Analysts predicted 0.7 percent growth last quarter, according to the median forecast of 20 economists in another poll.

The government estimates the economy will gain 0.5 percent this year, the slowest pace since a 2009 contraction.

"More depressed domestic demand is probably the main reason for the economic slowdown in the second quarter," said Vladimir Tikhomirov, chief economist at BCS Financial Group in Moscow. "The fourth quarter may bring a negative surprise as there will be more significant effects from sanctions and an inflation jump due to Russia's sanctions."

Penalties levied against Russia were having a "serious indirect influence" on the economy even before the U.S. and the EU broadened sanctions to include banks and the energy industry, according to Deputy Finance Minister Sergey Storchak.

Demand Wobbles

Consumer demand, the mainstay of Russia's recovery in recent years, is cooling as expansion of real wages slows. Retail sales decelerated for a third month in June, growing the least since January 2010, and real wages rose 1.7 percent, the weakest since February 2011.

"Even before the Ukraine crisis, consumption, the main source of growth, was flagging," Vladimir Bragin, head of research at Alfa Capital in Moscow, said by e-mail before the data was published. "The deceleration of consumption is the result of the household debt load and the slowing growth of real wages."

Along with political uncertainty, structural factors are affecting economic growth even as unemployment remains at a record low, according to policy makers. "Labor productivity growth is sluggish," the central bank said in a statement July 25, when the regulator unexpectedly raised the benchmark interest rate for a third time since March.

Investment, Confidence

The geopolitical tensions have also constrained investment demand and business confidence, while limiting access to long- term financing at home and abroad and hurting corporate profits, policy makers said in the statement. Investment in production has contracted every month this year, except June, when it expanded 0.5 percent from a year earlier.

"We see a risk of a GDP contraction in the third quarter as sanctions may affect business activity and may lead to a reduction in corporate loans, while inflation, decelerating slower than expected, will impact consumer consumption," Dmitry Polevoy, chief economist for Russia and the Commonwealth of Independent States at ING Groep NV in Moscow, said by e-mail before the statement.

While inflation decelerated in July for the first time this year, price growth has exceeded the central bank's target for the 23rd month, limiting the central bank's ability to deploy monetary easing.

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