EDB Macroeconomic Forecast. The Return of Inflation: For How Long and Should We Fear It?

07 July 2021

The global economy is in an upswing. The global aggregate PMI in May reached a 15-year high of 58.4 points. Business activity is rising in almost all major economies, with the U.S. showing the strongest momentum. The service sector is playing an increasingly important role in the global economic recovery. Activity in the tourism and leisure sector increased in April for the first time since January 2020, and in May, it grew at the fastest rate ever observed over the period. Industry is also maintaining its growth momentum. Large-scale fiscal and monetary stimuli reinforce a strong global economic recovery, foremost in developed countries.

The EDB operating region was not immune to global trends in the first half of this year, as business activity recovered rapidly. The economies of Russia and Kazakhstan, according to the EDB estimates, were already reaching the pre-pandemic level by the end of 2Q 2021. That was possible largely due to government support measures and the marked easing of fiscal and monetary policy last year. Kyrgyzstan’s economy will achieve positive growth early in the second half of the year. A strong trend is seen in Armenia and Tajikistan, where GDP could grow by around 4.0% and more than 7.5% YoY, respectively, over the six-month period. The exports of the Bank’s member states in the first half of the year were substantially supported by stronger global economic activity and soaring prices for key export commodities. It is thanks to the increasing external demand that Belarus’s GDP growth is expected to be around 3% YoY for January–June. The easing of restrictive measures as a result of an improved epidemiological situation attributed greatly to the increase in business activity in the region.

The global incidence of coronavirus is gradually declining and restrictive measures are being relaxed. The situation in the EDB member states evolved within this trend in the first half of the year, which is broadly in line with the assumptions of our previous forecast. In Russia and Kyrgyzstan, however, there was an increase in reported cases of COVID‑19 in June. The immunisation campaign, which has begun in the Bank’s member states, may help reduce the rate of infection further during the year. However, vaccination rates in the region are still moderate. According to our baseline scenario, we expect vaccination rates to increase and the rate of spread of coronavirus in the region to slow down, but the risk of new upsurges of the disease persist.

The economies of the EDB operating region’s key trading partners this year will register their fastest growth in a decade as they recover from the pandemic-caused downturn. We project China’s GDP to increase by 8.5% this year. We assume that China’s business dynamics will stabilise near their potential growth rate from the second half of 2021 after a surge in the second half of 2020 and early 2021. A strong recovery is expected in the Eurozone, with its GDP likely to add 4.3% in 2021 and 4.7% in 2022. In the U.S., the baseline scenario expects the economy to grow by 6.5% this year and 3.9% next year. As early as 3Q 2021, the U.S. economy may be overheating due to massive budget and cash injections. The U.S. expects a positive output gap throughout the projection horizon of 2021–2023. However, the baseline scenario assumes that the Fed’s policy remains soft this year and that a cautious rate hike will start from late 2022–early 2023. The 2021 Urals oil price projection has been raised from USD 55 to USD 64 per barrel amid a strong global economic recovery and growing market optimism. In 2022–2023, oil prices are expected to range between USD 60 and USD 65 per barrel.

The 2021 projection for aggregate GDP growth of EDB member states is raised by 0.7 p.p. to 4% due to strong support from the global economy. The revision is attributable to an improved GDP growth estimate for Russia this year, from 3.3% to 4.1%. We forecasted a strong recovery in Russian economic activity, but the reality of the first half of the year has exceeded expectations. Higher oil prices will add an additional 0.3 p.p. to Russia’s GDP growth, and higher budget revenues are likely to result in additional support for business activity on the spending side. The EDB’s GDP growth forecasts for Armenia and Belarus have also been raised to 4.2% and 1.3% in 2021, respectively. The stronger economic recovery of Russia, a key trading partner of Armenia and Belarus, has boosted the exports of these countries. At the same time, consumer and investment activity in Armenia and Belarus are expected to be moderate. However, Belarus is projected to see a slowdown in economic growth in the second half of the year due to the introduction of restrictive measures by the U.S., EU, and UK.

The EDB maintains its projection for Kazakhstan’s economy to grow by 4% in 2021. Fiscal policy and a comfortable oil price level will continue to support economic activity in Kazakhstan. However, the more protracted effect of restrictive measures largely offsets the positive impact of the external environment. The EDB’s growth forecasts for Kyrgyzstan and Tajikistan for 2021 are also maintained at 3.9% and 6.1%, respectively. We expect that the faster-than-projected recovery of the Russian economy may not have a significant effect on the growth of the Kyrgyz and Tajik economies this year, as restrictions on cross-border labour migration are set to linger.

Most countries in the region are expected to achieve sustainable economic growth in the medium term. However, the growth dynamics may be varied in 2022. In Russia, active economic recovery will end in 2021. GDP growth will then slow down to its potential growth rate as monetary and fiscal stimulus eases. In the baseline scenario, the EDB projects that the Russian economy will grow by 2.2% in 2022. In Kazakhstan, we expect economic activity to rise by 4.4% in 2022, which will become possible once sanitary restrictions in the country are lifted. GDP growth is also projected to accelerate in Kyrgyzstan next year, to 5.2%, thanks to an expected increase in gold production and higher remittances. Armenia and Tajikistan are expected to perform strongly in 2022, at 4.7 and 7.8% growth, respectively. Business activity in these countries will also be supported by an influx of remittances as a result of the restrictive measures being lifted. The Belarusian economic dynamics remain highly uncertain. In the baseline scenario, the EDB projects Belarus’s GDP in 2022 to remain at the same level as in 2021. We expect the economy to adjust to the U.S., EU, and UK restrictive measures gradually, with their effects likely to limit GDP growth in the Republic in 2022. If, however, the Belarusian economy adapts quickly to the imposed restrictions, the country’s GDP could grow by up to 1% in 2022.

Inflation in the EDB member states is moving in line with the global trend, with the regional average rising to 6.6% YoY in May from 5.6% in December 2020. The inflation path in the Bank’s member countries is broadly in line with the previous EDB projection, but the effect of inflationary factors has been stronger than expected. The price rises in the region are now largely imported. They are due to higher commodity prices and the weakening of national currencies during the previous year. With continued global constraints and rapidly increasing demand, delivery times are often longer and the choice of suppliers and components is shrinking. As a result, business costs are rising at the highest rate in recent years, and demand-side pressures on prices are becoming increasingly persistent in most states in the region. In the current conditions, central/national banks in the region have reduced their monetary stimulus to economies. The refinancing rate in Belarus has risen by 0.75 p.p. to 8.5% YTD; in Armenia and Tajikistan, by 1.25 p.p. to 6.5% and 12.0%, respectively; in Kyrgyzstan, the policy rate has increased by 1.5 p.p. to 6.5%; the Bank of Russia has increased its key rate by 1.25 p.p. to 5.5%.

Many inflationary factors are temporary, but it takes time to neutralise them. With the pandemic waning, the recovery of production chains will be on track, thus relieving pressure on business costs. As before, we expect metal, food, and oil price increases to slow down by the end of the year as the active phase of the Chinese economic recovery is completed. As a result, consumer inflation in the Bank’s operating region is projected to fall to an average of 5.6% by the end of 2021. In Armenia, we expect inflation of 5.4% at the end of the year; in Belarus, 8.7%; in Kazakhstan, 6.7%; in Kyrgyzstan, 7.7%; in Russia, 5%; and in Tajikistan, 7.4%. In 2022, the EDB’s baseline scenario projects an easing of demand-side inflationary pressures and the recovery of production chains. As a result, the regional average inflation rate could fall to 4.1% by the end of 2022.

In the baseline scenario, the EDB expects a gradual transition to neutral monetary conditions in most member states over the medium term. At present, the scale of the monetary stimulus varies widely across the region. In Russia, the key rate, even though it has risen to 5.5% since the start of the year, remains a stimulus for economic activity. We acknowledge that it might rise to 6–6.5% to keep the economy from overheating. In the medium term, we see an optimal key rate of 5.5% with a projected slowdown in inflation. In Kazakhstan, we assess monetary conditions as close to neutral and believe that keeping the base rate at 9% this year will balance inflationary risks and risks to economic growth. Going forward, we expect a gradual rate cut as inflation decreases. We believe the same pertains to Tajikistan. In Armenia and Kyrgyzstan, the effort to introduce a neutral monetary policy could lead to a slight increase in key rates in 2022–2023. In Belarus, the baseline scenario assumes that a tight monetary policy will remain in place in 2021–2023 due to increased risks to the exchange rate of the national currency and inflation. We should note that, in general, the EDB’s forecast assumes a gradual convergence of inflation and interest rates in its member states, as integration processes in the region deepen.

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2021