The heat is on the Russian economy

This record-breaking heat wave has hurt the economy and the effects have spilled over to the rest of the world, with food prices soaring.

In 2009 Russia was the world’s third largest exporter of grain but around a quarter of the country’s farm land damaged by fires in the first half of August, according to some estimates, expectations for this year’s crop have plummeted to about 60m tonnes, down from last year’s 97m tonnes.

International grain prices have already risen around 25pc since after Prime Minister Vladimir Putin announced a ban on grain exports in mid-August and Russia may even be forced to import grain this year, which will force international food prices up further, although officials deny the possibility.

In Britain, commentators believe the prices of basic commodities such as beer and bread could be affected. Also, there is the feeling that the ban on exports was unwise, because once Russia has left the league of top grain exporters (which includes the USA, China and the EU), it will be difficult for it to get back.

Moreover, as the fires have delayed the planting of Russia’s winter crop – which produces one and half times more than the summer crop – production is expected to fall further, raising the possibility of a repeat of the food price shock that hurt economies around the world in 2008. But its uncertain what the full effect of the drought on the country’s economy will be until the harvesting is over.

In the short term Russia faces a big bill to repair the damage. The state has promised to rebuild the houses that burned down. The total repair bill is an estimated 12bn roubles ($400m), emergencies minister Sergei Shoigu said, although some say it will be closer to 33bn roubles.

And the knock-on effects will only add to the price. Analysts estimate that the drought and fires could shave up to 1pc from GDP, a loss of $15bn.

Farmers, already reeling from a collapse in demand caused by the financial crisis that started in 2008, now find themselves deeper in debt due to the heat wave; analysts estimate that as much as 127bn roubles of agricultural credits – 15pc of total banking sector credits – will need to be restructured, with the two state-owned banks, Sberbank and agricultural specialist Rosselkhozbank, bearing the brunt of the blow. The state has already said it plans to offer 10.5bn roubles to subsidise interest rates to farmers in 2010/11.

The nascent livestock farming is another victim as feedstock costs soars. Russia only recently become self-sufficient in chicken meat, but pork and beef farming is still being developed. The price of meat, eggs and milk are all likely to rise significantly.

Food producers and retailers will need to balance higher prices from suppliers with a government desperately trying to cap inflation.

Russian shipping and transport companies will also feel the heat. Following the government ban, the total volume shipped (mostly to the Middle East) is unlikely to top 4.5m tonnes in 2010 verses 21.5m tonnes last year.

And the crisis has jarred a fragile economic recovery that was just getting underway. In July industrial production was up 5.9pc year-on-year and investments was back in positive territory, up 0.8pc, but both indicators were down by 10pc month-on-month.

Olga Sterina at UralSib said: “Investments fell more than anticipated [and] the August data may also be weaker.”

Rapidly rising food prices has caused most analysts to re-rate their inflation forecasts, increasing them by as much as 3pc over and above the government’s official prediction for 2010 of a maximum of 7pc – lowest for years.

The reversal of inflation rates will come as a big blow as after nearly 20 years, June saw interest rates turn real – higher than inflation – making the economy “normal” for the first time since the fall of the Soviet Union.

If rates stay real the Central Bank of Russia gains sorely-missed efficient levers to control the economy. As the full effects of the heatwave unfold in the autumn, the hopes that real interest rates will return this year are fading.

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