Russia’s economic growth accelerated in September in relation to the month of August. According to the Ministry of Economic Development, GDP growth, discounting seasonal factors, increased from 0.3 percent observed in the first and the second quarters, to 0.5 percent in the third quarter. However, the rate of growth continues to slow down relative to the corresponding period of the previous year. GDP grew in the third quarter by 2.8 percent after rising by 4.5 percent in the first half of the year.

At the same time, the annual rate of growth has decreased, and, according to the Ministry of Economic Development, for the fourth consecutive month ending in September, growth did not rise above 2.5 percent. The slowdown was prompted by the loss of the crop due to drought, higher inflation, lower credit growth, and a fall in investment demand. A significant factor for lower growth rates in relation to the previous year is the high growth benchmark set last year. In the second half of the previous year, Russia experienced a record high crop level, as well as a significant acceleration of investment activity in the technological sectors, against which the performance seen in the second half of 2012 does not look that impressive.

According to the Ministry of Economic Development, in September, GDP growth was 2.5 percent compared to the same month of the previous year. In August, the corresponding GDP growth figure was 2.8 percent. According to Rosstat, the size of Russia’s GDP for the second quarter of 2012 stood at RUR14,571 billion in current roubles, exceeding the corresponding period of the previous year by four percent.

Meanwhile, the Institute of Economic Forecasting (IEF) of the Russian Academy of Sciences published a quarterly macroeconomic forecast, which predicts an increase in oil prices to USD122 per barrel in 2015 and offers increasing public and quasi-public investment and expanding the resource base of the banking system in order to accelerate GDP growth. The main thesis of the IEF forecast is that dynamic growth can be accompanied by lower inflation.

The IEF analytical summary of the quarterly forecast sets out the Institute’s assessment of the reasons for the slowdown in the economic activity within the Russian Federation: “What is happening in the economy can already be seen as a crisis: a crisis of growth mechanisms and a crisis of economic management mechanisms.”

The main reason for the crisis, according to the IEF forecast, is the reduction of external demand, the reduction in government consumption, and tighter monetary and fiscal policies. As the IEF summary explained, “what is happening at the moment already requires extensive anti-crisis measures and an active economic policy.” Such measures should consist of increasing the resource base of commercial banks to maintain the current overheated lending and provide loans to companies. The second mechanism of growth must be increased public and quasi-public investment. Companies with state ownership and part state ownership account for 40 percent of capital investment in the country.

In essence, the Institute of Economic Forecasting believes that the thesis common in macroeconomic theory to the effect that price stability is preferred over rapid economic growth is wrong. Recognizing the transition of the Central Bank to the policy of stepwise inflationary targeting, which allows for a more efficient reserve management and balance of payments regulation, the authors of the IEF forecast believe that the current economic reality is not a time for new monetary experiments. The economic forecast warns that if the state does not follow its recommendations, the Russian economy is in for a “frontal slowing.” “The force of inertia will inevitably lead to the deterioration of the economic situation, and the resources required for accelerating growth after a major downturn will be considerably more significant than the resources needed to take prophylactic measures,” the forecasters warn.

Industrial production growth slowed slightly in September, and was only two percent over the figure for September 2011 and 2.1 percent over the figure for August 2012. Discounting seasonal and calendar factors, growth was positive in September, after a slight decline in August (July: +0.4 percent, August: –0.4 percent; September: +0.3 percent).

The largest contribution to the overall growth of industrial production in September came from the manufacturing sector, with an increase in production of 3.3 percent and total contribution of 86.8 percent. Within manufacturing, 36.9 percent of the total growth came from metallurgical production and the manufacture of metal-based products (an increase of 4.5 percent); 27.3 percent came from the manufacture of food products, beverages, and tobacco products (an increase of 3.6 percent); 22.3 percent came from the manufacture of coke and refined petroleum products (an increase of 2.6 percent); and 23.3 percent came from the manufacture of other non-metallic mineral-based products (9.5percent).

The growth in mining for September was 1.8 percent, and the overall share of mining in the total growth of production was 16.3 percent. The production and distribution of electricity, gas, and water in September declined by 0.9 percent over the month of September of the previous year.

According to the Federal State Statistics Service, in September, the rate of investment activity as against the same month of the previous year moved into the red zone, with a registered decline of 1.3 percent. The rate finally decreased after three months of continued slowdown (the increase in May was +11.1 percent; in June it was +6.3 percent; in July it was +3.8 percent; and in August it was +2.3 percent). Third quarter growth in investment activity slowed down in the annual comparison largely due to last year’s high results. As such, third quarter growth stood at 1.4 percent compared to the corresponding quarter of the previous year. Growth reached 8.5 percent in the second quarter and 16.6 percent in the first quarter. In the first nine months of this year, investment increased by 7.2 percent.

In early November, the Duma introduced an updated version of the Guidelines for Single Monetary Policy for 2013-2015. Inflation in Russia up to 2012 will be at seven percent, according to the updated version of that document. Earlier, the Central Bank predicted the rate at no more than six percent. In August, the forecast for 2012 was revised to reflect an increase in inflation to seven percent from 6.5 percent previously expected. The Central Bank explained the change in its expectations with the accelerated growth in food prices.

According to the latest data from Rosstat, in October 2012, inflation slowed to 0.5 percent against 0.6 percent in September. Consumer prices for the 10 months rose by 5.6 percent. Since the prices mostly held firm in the last week of October, inflation in general, over the last month has been well below forecasts of both the authorities and the independent analysts. The deceleration of inflation, according to Rosstat data, was due to a sharp reduction in the rate of growth for the costs of services. As such, the cost of services was only 0.1 percent higher in October than in September, explained in large measure by the lowering of transportation costs on long-distance travel by the Russian Railways, which went down by anywhere from 7.7 to 9.8 percent.

Food inflation in October remained at the same level as in September, at 0.5 percent. Higher prices on bakery products have traditionally been offset by cheaper vegetables. The cost of gasoline in October saw the largest increase in the value of non-food products, going up by 2.4 percent.

In addition to inflation, the Bank of Russia also raised its forecast for net private capital outflows in 2012 to USD67 billion from USD65 billion previously anticipated. The Economy Minister Andrey Belousov earlier expressed hope that the net outflow of capital from Russia in the fourth quarter could dramatically slow down to zero. For the nine months of this year, according to preliminary estimates of the Central Bank, the figure was USD57.9 billion. In the third quarter, outflows accelerated to USD13.6 billion from USD9.7 billion in the second quarter. Still, according to the forecast of the Economic Development Ministry, net capital outflows in 2012 are expected in the range of USD60-65 billion.

The surplus of current operating accounts as a whole for the year 2012, according to the Bank of Russia, will be USD83.4 billion. With exports worth USD532.5 billion and imports worth USD341.8 billion, the trade surplus will reach USD190.7 billion. The services account shortfall could rise to USD39.4 billion.

Meanwhile, S&P experts say that next year the national debt of the Russian regions will grow at least by one half. According to the Finance Ministry, the national debt at the beginning of the year for the subjects of the Russian Federation was 1.171 trillion roubles. In 19 regions, the debt was higher than 50 percent of all regional revenues. “In the next few years, municipalities will be forced to take an active role, as they will need to raise more funds from the market,” said the manager of the regional and municipal finance section of S&P Boris Kopeikin. With the growing rates on borrowing money, some regions may face the threat of default, although the Finance Minister Anton Siluanov in early October claimed that no such risk exists.

Macroeconomic problems will force the regions to take on more debt. “We do not expect rapid growth in oil prices. Regions and municipalities have to get used to the new situation where incomes are rising much more slowly. After 10 years of rapid income growth, dealing with this reality will be difficult even psychologically, and even more so politically,” analysts warn.

At the same time, the revenue base of the regions is expected to go down. “We expected that the income tax, which accounts for 30 percent of local revenues, will grow faster than inflation, but the data on taxes already collected says that it is not growing as fast as it needs to. In real terms, these revenues are reduced,” summarized Boris Kopeikin. As a result, although the average indicators are now good, “it is expected that in a short period of time, more than half of the regions will not have sufficient income to cover planned budgetary outlays.”

In addition, the promises made by the national government affect the regions. According to the calculations of Capital Economics, campaign promises of Vladimir Putin (defense spending and other social contracts) will cost the treasury 4.8 trillion roubles, or eight percent of GDP in 2012. A significant portion of these costs will have to be borne by regional budgets. The federal treasury will fund only 15 percent of the consolidated budgetary expenditures on health care and 19 percent on education.

As the Ministry of Finance explained, additional earmarks in the amount of 100 billion roubles will be allocated to the regions in order to balance regional budgets. 60 billion roubles of the total amount will be spent on partial compensation for the rise in wages of public sector employees. Also, according to the Finance Ministry, the draft budget provides 75 billion roubles for loans to the regions. However, according to Boris Kopeikin, in the best case scenario, the funds allocated would be enough to fund only a quarter of planned additional expenditures.

There are limited ways to find additional revenue streams for regional budgets, with the only possibilities seen in the road fund and the fund for social expenditures, Vladimir Nazarov, an analyst with the Gaidar Institute noted. Formally, the regions do not have to fulfill the promises the President has made, as Russia is a federal republic. However, for political reasons, the regions will have to do it. “Obviously, allocating 100 billion is not enough for all the campaign promises, so regional authorities will have to seek out their own sources or to perform these promises in some other manner,” said Vladimir Nazarov.