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«    June 2017    »

How will macroeconomics influence construction microeconomics in 2017?

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How will macroeconomics influence construction microeconomics in 2017?

Analysis and forecast from a financial analyst

The new financial year has started and construction organisations have to adopt new business plans or must update existing ones. What values of the financial and economic parameters should be introduced for consistent mapping of the results of the activity?


Actually, the loan rate and the inflation level are ambiguous. The bank credit rate mainly depends on the key rate of the chief participant of the monetary market, the Bank of Russia, and the complex risks in the macroeconomic system.


Presently, according to the CB’s official data, the key rate and related rates of interbank lending add up to 10%, and the level of December’s inflation was 5,4% but forecast to decrease to 4%. There seems to be a  contradiction between the achieved level of inflation and the twice as large value of the money [I don’t understand this - RJ] offer.


Should the business expect a significant decrease in the key rate and, correspondingly, a twofold reduction of the lending cost? I do not think so. 


Despite the declared policy of inflation targeting, when setting the key rate the CB is guided not by the official level of inflation calculated according to Rosstat’s (Federal State Statistics Service) institutional methodology, but by the monetary market’s objective indicators.


These stock exchange instruments are the historical and internal volatility, and the cost of currency options.


The strict monetary police of the CB last year helped to level down the volatility from 20% in the beginning of the year to 15% by the end of 2016. It is the 15% interior volatility level calculated via the cost of currency options that makes it possible for the banking regulator to retain the key rate at a level of 10%.


If the CB lowers the key rate to the level of common inflation, we shall see a repetition of 2014’s scenario with the fall of the rouble exchange value and a huge acceleration of inflation.


Additionally, the national currency volatility may be considered as the level of its inflation/deflation. And as the rouble is also a product, the same as the consumer basket in Rosstat’s calculations, the volatility level may perform the function of an alternative level of inflation in the macroeconomy. 


The microeconomy of the construction industry provides the two-stage financing of projects: a preliminary one, plus the construction and operation stage. At the preliminary stage (title registration and permit granting) a contractor has no sound backing of banking credits, and the financing should be provided by the project owners or borrowed from the non-banking market. 


What is the cost of self-finance in 2017? Evaluating this one may add 15—20% of the project’s expected cost-effectiveness in hard currency (usually USD) to the 15% (as previously noted) of the rouble’s inflation per dollar.


At the second stage, after the construction has begun, contractors with a good financial condition and a positive credit report have a good opportunity to receive bank financing at a rate of 12—15%.  Without bank financing and co-sharers’ investment the capital efficiency of the projects undertaken must be over 30% which is quite rare for the current market.


With bank credit borrowing and contractors with a steady financial condition the required efficiency decreases to 20%, which presumes the involvement of a large number of objects in the investment process. The bottleneck here is not from the interior economy but, rather, the population’s effective demand. This means those macroeconomic risks which will not go down this year and, from my point of view, at least 5% should be added to the assessment of the profitability.


And now let us consider the opportunity of the attraction of co-investors’ financial resources for the significant improvement of the construction economy. From the point of view of a contractor, such an opportunity, where its successful implementation is concerned, from the null cycle on, will create an opportunity to implement the projects with a low margin on sales (sales profitability)  - 10%, and high profitability of own funds.  


But would a customer like to invest money in an incomplete construction object? It is doubtful.


In 2016 the bank deposits rate was on average 10% annually, and the rouble-dollar rate also grew by 10%, which together brought an income of about 20% in USD! It is difficult to imagine that housing buyers have sharply changed their preferences from free money investment to that of participation in co-funded construction.


Accordingly, to my mind, the complex of macro- and microeconomic factors does not provide any significant improvement to the condition of the construction sphere in 2017.


Alexander SINELNIKOV, financial analyst

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