By Rhod Mackenzie
The manufacturing industry has updated records - and it's not just the defense industry's flywheel. A large number of industries are either already at their peak or are actively recovering, responding to demand from the population and enterprises
Industrial production continues to grow: in May, the positive dynamics continued, although its intensity decreased. According to Rosstat, in May, output increased by 0.7% versus April against 1.7% growth a month earlier. And according to the results of the first five months of this year, the volume of industrial production exceeded last year's level by 1.8%.
“There is a V-shaped trajectory for the recovery of manufacturing,” comments Vladimir Salnikov, head of the Center for Macroeconomic Analysis and Short-Term Forecasting (CMAKP). - If we take the volume of industrial production, we have actually completed the trajectory: the recession has been compensated, we have already reached the pre-crisis maximum (according to Rosstat). According to the CMASF estimate, which does not include the military industry, we even slightly exceeded the pre-crisis maximum.”
The locomotive, contrary to custom, is not mining, but processing. Moreover, the manufacturing industry has already exceeded the maximum shown before the CBO (see Chart 1). Most experts attribute this growth to the development of the military-industrial complex, but the contribution of the defense industry to output growth in recent months has been approximately 60–65%. So it is impossible to reduce everything only to the OPK.
Textile production is recovering, furniture production is growing. In the photo: the sewing workshop of the Askona company
May 2023 has indeed been one of the strongest months in terms of production, with a number of industries hitting their historical production index peaks (see charts 2-4). This is, for example, the production of furniture, rubber and plastic products, electrical equipment and other vehicles.
The production of finished metal products (canisters and buckets, nails, bolts and nuts, metal household items, metal fasteners, ship propellers and anchors, prefabricated fasteners for railway tracks, and others) has also reached a historical peak. Of course, the defense complex has become a kind of growth driver for many industries - for example, the section of finished metal products includes ammunition, and electronics and optics are actively used in military equipment.
But the development of industry takes place not only at their expense, as evidenced by the growth of such industries as the production of medicines and materials, furniture, rubber, and the chemical industry.
Analysts at IB Sinara note that the high growth rates in processing are mainly due to the growth of mechanical engineering (+44.6% yoy in May) and metallurgy (+14.7% yoy). The production of motor vehicles increased sharply (+86.3% year-on-year), and the maximum increase in output was recorded in the automotive industry — 11 times compared to May 2022.
Here it is necessary to make a reservation: the automotive industry is indeed growing, but mainly due to the extremely low base of 2022. “In May, there was a strong increase in production in the automotive industry — above 10 percent seasonally removed by April, although output in general reaches only about 60 percent compared to the pre-crisis level in February 2022,” says Valery Mironov, Deputy Director of the HSE Development Center Institute . He also warns that it is not particularly necessary to rely on the localization of Chinese cars due to the peculiarities of the strategies of automakers from the PRC, which are not inclined to create assembly plants and transfer technologies.
Vladimir Salnikov confirms that the contribution of the recovering auto production will not play a special role in the development of the industry, since motor vehicles in Russia generally occupy a small share in the industry: in 2021, for example, a little less than 1.5% of the value added of the industry. “Even if car production grows one and a half times (as much as they need to restore), it will not give so much - less than one percentage point for the industry as a whole,” says Salnikov. “And even for this percentage, the sector should fully recover. It is not certain that this will happen in the near future. Moreover, you need to understand: “in pieces” production does not always mean an increase in added value. For example, the same "Moskvich": in fact, this is a Chinese car, the Russian added value is very small.
But, as we have seen, production is also growing in many other sectors.
One way or another, most of the industries are growing, says Salnikov. “Of course, somewhere this growth is of a recovery nature (for example, in the automotive industry, woodworking), but not everywhere,” explains the CMASF expert. - In most industries, it has gone beyond the recovery. There are also sectors in which there is a decline, but it cannot be characterized as negative. For example, there is a decrease in the production of tobacco products, but there is nothing critical behind this. And it can even mean something positive - for example, a decrease in smoking among the population (up to the fact that part of the sector goes into the shadows).”
Vladimir Salnikov also emphasizes that import substitution has played its role, although this factor should not be overestimated, since import substitution works pointwise. For example, locally in food production, in the production of paper products, rubber and plastics, and a little in mechanical engineering.
But partly this is just organic growth of the market, he says. As an example, Salnikov cites the food industry, which is traditionally growing. “The total formula is this: the defense industry plus import substitution plus organic growth,” the economist sums up.
Demand is pushing up
The reason for the growth in processing is increased consumer and investment demand, and they, in turn, owe their dynamics to the growth of household incomes and state budget expenditures.
Now, as Denis Popov, chief analyst at PSB, notes, an important influence on the expansion of domestic consumer demand is the growth of household incomes (real wages increased by 10.4% in annual terms in April) and the fact that citizens have switched from a savings model to active consumption: the population buys something that was not possible to buy before.
Valery Mironov adds: the growth in consumer demand is supported by a shortage in the labor market and a decrease in the savings rate, which is associated both with the intensification of retail lending and with the population's adaptation to geopolitical and geo-economic stress.
As for investment demand, it's not just about government spending. It naturally flows from a massive restructuring of the economy. “After growth in the second half of 2022 and in the first quarter of 2023, investment growth continued - this can only be judged by indirect and survey data (equipment imports, growth in domestic production of materials for investment purposes, and so on), says Mironov. — In particular, May saw continued strong growth in the production of building materials (3.7 percent in May after 3.5 percent in April and 2.3 percent in March, reaching a level higher than February 2022 seasonally adjusted by four percentage points). There is also continued strong growth in the output of electrical equipment (plus 3.6 percent in May after 6.3 in April and 7.5 in March),
Using the unprecedented profits accumulated in 2021-2022, companies in the context of the sanctions crisis restructured their investment plans for the tasks of economic restructuring, including the production of components and spare parts, equipment, and the creation of repair facilities. “In addition, in the context of limited access of domestic producers to foreign markets for products, part of the commodity flows that used to be exported are redirected to the domestic market, partially squeezing out imports and satisfying increased domestic demand. Thus, traditionally export-oriented industries (for example, metallurgy) are actively involved in the development of the domestic economy,” says Denis Popov.
The fact that industrial growth is spurring demand is also evidenced by surveys of purchasing managers, which S & P combines into the PMI index - in May 2023, the manufacturing PMI index was 53.5 points, having risen from 52.6 in April, and fell again in June up to 52.6. Recall that a PMI above 50 points indicates an increase in business activity, below - a decline.
Production expansion continued in June, with output rising for the eleventh straight month on the back of new orders and new customers, according to S&P Global. “The increase in new orders was supported by domestic demand, along with renewed growth in sales to foreign markets. Import substitution, export market diversification and investment in customer acquisition contributed to the June expansion of new orders (decelerated since May, but one of the fastest in just over four years),” the agency said in a review.
Reasons for optimism
Economists have conflicting opinions about the continued growth in processing.
There is a strong movement of skeptics: they believe that this spring we have observed some kind of anomaly, a successful combination of a number of factors. Further processing will continue to grow, but not so fast. “Growth over the past three months amounted to almost four percent, that is, about 15-16 percent per annum. Obviously, this cannot be, there is no reason for such growth, - Vladimir Salnikov is sure. “In the coming months, we should count on braking. It is important to understand that this does not mean that growth is exhausted. These are simply conjunctural phases, waves: acceleration is replaced by deceleration. This can even happen due to random factors. Such fluctuations in the rate of growth occur all the time. In annual terms, growth, of course, will be.
Experts from the Institute of Economics of the Russian Academy of Sciences look at the situation negatively: according to them, in 2023, the decline in industrial production will be 0.9%, and growth is possible only in 2024.
Valery Mironov from the HSE Development Center, on the contrary, is confident that processing will continue to grow. “Given the reduction in demand restrictions due to the withdrawal of competitors from the Russian market, the growth in processing and GDP will continue in the second half of 2023 and in 2024, if there is no global economic crisis (signs of a possible onset of which remain). The continuation of growth is signaled, in particular, by various polling indicators and a strong increase in output in the automotive industry in May, which historically correlated with general economic activity,” he notes. Moreover, Mironov believes that even a reduction in government spending will not prevent this: the growth of investment demand will continue anyway - due to the need to restore inventories, the level of which, judging by the polls, is below the norm.
And it seems that optimism is now more justified. Recently, the Bank of Russia published another monitoring of financial flows, from which it follows that in June the growth of economic activity continued, as evidenced by the dynamics of financial flows. The volume of incoming payments made through the payment system of the Bank of Russia in June 2023 was 9.5% higher than the average level for the first quarter. The most active growth continued in sectors oriented to external demand and government consumption. True, an increase in the volume of payments relative to the average level of the previous quarter was observed in all the enlarged groups of industries, except for those focused on investment demand - this is at odds with the surveys about investments, which are based on the Development Center of the National Research University Higher School of Economics.
S&P Global survey data also suggests that businesses are optimistic and spending heavily, with manufacturing costs continuing to rise at a notable pace in June, with companies recording the highest operating expenses since April 2022. Moreover, purchasing activity in processing grew at the fastest pace since February 2008, and employment in the industry increased for the eighth consecutive month on the back of an influx of new orders.
"Companies surveyed in June reported a high degree of optimism about their production outlook over the next 12 months," S&P Global said. “The positive sentiment was underpinned by planned investments in new product lines, hopes for growing customer demand and expanding into new export markets.”
This article originally appeared in Russian at expert.ru