Analysis: Drought to crimp not cripple Russia recovery

MOSCOW (Reuters) - Russia's worst heatwave on record may knock up to a full percentage point off economic growth this year, setting back business and government's efforts to reboot the economy after the worst recession in 15 years.

With a more than month-long drought raging in some of the country's most fertile regions, analysts reckon sugar output may fall by around an eighth, while the government sees the grain crop down by at least a third.

The thick cloak of toxic smog from forest and peat fires has halted production in some factories and is keeping shoppers away from the Moscow malls that form a huge chunk of Russia's retail business.

Prior to the surge in temperatures, the country had been enjoying an economic revival and 2010 gross domestic product was expected to make up around half of last year's 7.9 percent slump.

Alexander Morozov, chief economist for Russia and CIS at HSBC, expects the heatwave and its aftermath will now shave 1 percentage point off that growth -- or some $14 billion.

"The losses in agriculture now look more serious, and I expect that will contribute 0.5 percentage points. The remaining half a percent will come from other sectors -- lower industrial output, lower demand and lower productivity," he said.

The cost for the state budget may reach some tens of billions of roubles but that is of less concern given that spending this year is planned to top 10 trillion roubles and the deficit is covered comfortably by borrowing and Moscow's oil wealth.

Central bank policymakers are also expected to hold fire on reacting to a rise in food prices and hence headline inflation, trusting that bans on grain exports and the rouble's relative strength will help ease the temporary impact on the economy.

Stock, bond and currency markets have yet to react sharply to the events of the past fortnight, though that may be partially because many players are away from their desks in Moscow. The main MICEX index is trading just off three-month highs reached last week; the rouble has eased somewhat, particularly against the euro.

SETBACK

The government is also seeking to develop business outside of the commodities and oil and gas industries which have driven a boom since the late 1990s. If higher inflation were to continue, it could eventually mean higher costs of borrowing and investment for companies. The drought also bodes ill for similar plans to develop the agricultural sector.

UBS -- which estimates that grain related agriculture accounts for about 2 percent of Russia's oil-focused economy -- has already cut its 2010 growth forecast to 7 percent from 7.5 percent, although it still remains much more optimistic than last month's Reuters consensus of 4.2 percent.

A grain export ban -- enforced from August 15 in a bid to tame inflation -- may undermine Russia's reputation, shave $2-3 billion off export revenue and worsen the trade balance by raising food imports, according to Italian bank Unicredit.

Farming, forestry and hunting contributed 854 billion roubles ($29 billion), or some 5 percent, to 2009 GDP although not all of that will be affected by drought.

More expensive grain could also push up animal feed costs and may force farmers to slaughter livestock. The government will have to come up with rescue plans for the hardest hit to keep its popularity ahead of the 2012 presidential election.

For now though, the detrimental effect on the economy as a whole may be partially cushioned by the higher prices producers will receive for what they do manage to harvest and by government subsidies.

OFFICES CLOSE, CONSUMERS ESCAPE

A quarter of Moscow's offices have cut working hours, according to a survey on Superjob.ru, while a tenth encouraged people to take holidays. The capital's streets, shops and restaurants are notably more quiet than usual.

"The smog might harm consumption in August, as Moscow plays such a big part in Russian retail sales and services," said Sanna Elina Kurronen, analyst at Danske Bank.

The services sector was already hurt by July heat, before the smog or the drought were fully felt and a widely expected rise in food prices will leave people with less to spend on other things.

The Association for European Business warned on Monday that "emergency weather conditions" may see car sales growth slow in August and September after a very strong July.

However most analysts said consumption and production would recover once the heat ends, now expected at the end of August.

"Factories will catch up on production in following months," said Maxim Oreshkin, senior strategist at Credit Agricole. He sees total economic damage at 0.5 percentage points, as does Sergei Moiseev from Moscow University of Industry and Finance.

Danske's Kurronen sees the GDP impact at under 1 percentage point "assuming that the weather normalizes at some point."

For some sectors there are upsides. Air conditioning use pushed power demand 5.1 percent up year-on-year in July.

SMALL DROP FOR BUDGET

The government -- facing its second year of deficit after a decade in the black -- will have to pay for some of the damage.

The hit will include 35 billion roubles in subsidies and loans pledged to the agriculture sector, at least 6.5 billion roubles to rebuild damaged homes, plus compensation for the families of the dead and the cost of putting out the fires.

The sums could well rise if the heat continues, but still seem like a drop in the ocean compared to this year's government spending plan of 10.2 trillion roubles ($340 billion).

"I do not think there will be any kind of serious losses for the budget. It is not a comparable figure -- it is not a 25-30 percent rise in (state) pensions," said Oreshkin.

(Additional reporting by Nastassia Astrasheuskaya)