Russian construction industry set to drop 3% in 2018

Vitalie Iambla, Starszy Analityk Rynku Budowlanego PMR

PMR’s latest report, entitled “Construction sector in Russia H1 2018. Development forecasts for 2018-2023”, suggests that the Russian construction output logged a cumulative reduction of more than 9% between 2014 and 2017. Furthermore, in Q1 2018, the construction industry’s business confidence index was at the lowest level seen since 2005.

Between 2014 and 2017, the Russian construction industry witnessed a substantial reduction. Russian construction output contracted by 2.3% year on year in 2014. The negative trend in the industry has worsened in the last few years, with a 4.8% year-on-year reduction in 2015 and a preliminary estimate of a 4.3% fall in 2016. Furthermore, the negative trend continued in 2017, when the preliminary release indicated a fall of 1.4% year on year, but the official reduction recorded last year is difficult to compare with the results observed before 2015. Since January 2017, Rosstat has presented data in accordance with OKVED 2 (which is a new statistical classification pertaining to economic activities, in step with the EU’s NACE rev.2), with data only for 2015 and 2016, so far, recalculated in terms of the new classification. The recalculation indicates that the Russian construction industry was reduced by 3.9% in 2015, and by a further 2.2% in 2016.

Given the low base effect established after four consecutive years of reductions, along with the increasing political determination to carry out multi-billion initiatives to modernise and expand the country’s civil engineering infrastructure, and to support the renovation and construction of non-residential public buildings, an upward trend is expected to re-emerge in the construction industry in 2019, after an 11% cumulative reduction between 2014 and 2017, followed by a predicted 3% fall in 2018. Contraction is expected to continue in the Russian construction industry in 2018, to a considerable extent also because of:

  • Construction of the Kerch combined road and railway bridge, as well as of access infrastructure, has been largely completed by the end of 2017. The road section was activated in May 2018, whereas the railway part had a completion level of about 60% that month.
  • Construction of stadiums and repair of transport infrastructure in the 2018 FIFA World Cup host cities had been almost fully completed by the end of Q1 2018.
  • Construction of the Power of Siberia gas pipeline and connected infrastructure had reached a high completion level by early 2018. About 1,480 km of the pipeline had been completed by February 2018, including more than 900 km in 2017. Only about 678 km are yet to be completed, with first supply planned for December 2019.
  • Relatively high-base effect created in 2017. According to preliminary data, there was a -1.4% reduction in construction output last year. Given the recent track record of Rosstat, by the end of 2018 it will not be a substantial surprise if the decline is reduced after revision, revealing ultimately a flat dynamics.
  • Real wage growth is expected to resume positive trend in 2018, though only an up to 5% growth is expected. The modest recovery in real wages will delay the revival of the non-residential construction activity this year.
Construction output in Russia (RUB bn) and real change (%, y-o-y), 2012-2018
Table 1: Construction output in Russia (RUB bn) and real change (%, y-o-y), 2012-2018

 

In recent years, the construction activity in Russia has been mainly driven by residential projects, even though a downward trend emerged in 2016 and continued in 2017. The total floor space of residences listed in official records in 2017 contracted by 1.9% to 78.2 million m², which is the fourth highest figure ever recorded in Russia. An upward trend in registration of residential space is projected to re-emerge in 2018, but a growth rate of only around 1% is expected this year.

However, the results for housing space registration in Russia in recent years must be assessed cautiously, as it consists to an important extent of dwellings completed in the respective years, along with many residential properties completed a long time ago but listed in official records recently in accordance with Federal Law No. 93-FZ of 30 June 2006, which is commonly described as a “dacha amnesty”.

As suggested in the chart above, in recent years housing completion has been strongly correlated with the dynamics in real disposable income. Taking into account that real disposable income of population in Russia is not expected to grow annually by more than 4%, PMR does not forecast annual residential completion levels of 100 million m² in Russia anytime soon. It is worth remembering that in March 2018, Vladimir Putin tasked the government and regional administrations to find solutions to boost annual housing completion to 120 million m².

The number of new homes commissioned in multi-dwelling buildings in 2017 decreased by 2.3% year on year to 888,582, the third most substantial annual housing listing result ever recorded in Russia. Nevertheless, and upward trend in the number of multi-residence buildings completed is likely to resume in 2018, because of the significant increase in the number and size of new multi-residence construction projects launched in 2017, mostly following the government’s intention to prohibit shared-investment agreements in the near future.

 

Completion of housing space in Russia and change in real disposable income (%, y-o-y), 2010-2018
Chart 1: Completion of housing space in Russia and change in real disposable income (%, y-o-y), 2010-2018

 

 

Since 2017, the recovery in construction of multi-residence buildings has been also supported by the rapidly growing mortgage market. After a 27% surge in mortgage approvals last year, Russia’s mortgage market is set to skyrocket in 2018. This year, the mortgage market is being fuelled overwhelmingly on account of all-time low mortgage interest rates and government’s commitment to continue to provide subsidised mortgages. The increasing willingness of the banking industry to boost mortgage lending has been, to a great extent, possible to support on account of the relatively small proportion of bad mortgages in Russia, particularly in comparison with the lending to SMEs. The condition of bank mortgage portfolios has not deteriorated notably since the moment at which the radically limited access to Western banking money for Russia’s core banks was imposed. At the end of July 2014, the proportion accounted for by overdue payments (at least one month overdue) was only 2.6% of the total value of mortgage debt outstanding in Russia, whereas the figure for overdue payments on loans by SMEs was almost 8%. At the beginning of 2018, the proportions were also 2.6% and 15%, respectively.

Given this substantial difference, banks in Russia have been poised to boost mortgage lending this year, even though in early 2018 real wages were at levels not seen since 2012 and only up to 5% growth is expected this year, as lending to the corporate sector and SMEs poses higher risks under current macroeconomic conditions. Revised data indicate an average increase in real wages of only 3.5% in 2017, following a 0.7% rise in 2016 and a 9.3% reduction in 2015. Furthermore, the remarkable uptrend in mortgage approvals this year has been propelled also by the all-time low inflation, generating mounting pressure on the Central Bank to continue to cut its key interest rate in the first half of 2018, and the reduction will resume most likely in 2019 when geopolitical tension and the pressure from new US sanctions on the ruble will ease.

However, expansion of the Russian mortgage market is expected to decelerate markedly in the near future, slowed down by the fact that the average interest rate on mortgage loans has only a minor potential for further decline. In June 2018 mortgage loans were granted to population with an average interest rate of 9.5%, which is the all-time low level, and the rate is highly unlikely to drop to less than 8% by the end of 2019 and to less than 7% in the foreseeable future. In contrast, the rate dropped gradually 5 p.p. in the last three years: from 14.7% in March 2015.

 

 

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