Superpowered stagnation: what next for the Russian economy?

February 2015  |  FEATURE  |  ECONOMIC TRENDS

Financier Worldwide Magazine

February 2015 Issue

February 2015 Issue

Mother Russia is, and always has been, a proud and dignified land. However, the national mood is currently none too happy. For the sixth largest economy in the world, 2014 was a particularly sombre year in the history of a nation that has experienced plenty of turmoil over the centuries.

At present, the Russian economy is stagnating. Business and consumer confidence is near the bottom of the scale and the prospects for future growth are hardly optimistic. Many, including the ex-Russian finance minister, Alexei Kudrin, believe that the Russian rouble, which fell almost 30 percent against the dollar in 2014, will continue its current plummet throughout 2015 and into 2016.

Put simply, the rouble’s current troubles are a result of a pre-existing slowdown of Russian economic growth – falling from 3.4 percent in 2012 to a current 1.3 percent – now being compounded by a fall in global oil prices and the ongoing sanctions imposed by the West over Russian intervention in Ukraine.

The current Russian finance minister, Anton Siluanov, equals his predecessor for pessimism, telling the International Financial and Economic Forum in November that his country is “losing around $40bn a year due to Western sanctions”, but that these were “not as critical to the economy as lower oil prices” – a determinant which adds $90-100bn to Russian losses, according to Siluanov.

The US and EU sanctions, having progressed beyond visa-bans and asset freezes to a response with a little more bite, are now having a greater impact on the Russian economy, with banks and companies experiencing a ‘credit crunch’ and many struggling to pay foreign debts. Additionally, companies doing business or planning to do business in or with Russia face devastating penalties should they pursue transactions without official consent. Indeed, the US Bureau of Industry and Security (BIS) has recently increased its restrictions pertaining to Russia’s energy sector – an area which, along with banking, is central to the Russian economy.

Uncomfortably for President Putin, the West, obliged to consider all the options for getting the Russian leader to soften his stance on Ukraine, is continuing to explore new targets for a fresh round of sanctions.

According to Dr Richard Connolly, co-director of the Centre for Russian, European and Eurasian Studies, oil is certainly the key reason for Russian unrest. “If the oil price plummets and stays low for longer than six months, I would expect that more radical economic solutions will be proposed. This may be either liberal or statist, depending on the wider context,” he says. “As well as the oil price, the issue of sanctions may also shape economic development next year and beyond. It is plausible that Russia may choose to limit the effects of sanctions by reducing Russia’s integration with Western economic structures.”

Despite plummeting growth, rising prices and constant economic woes, some analysts, such as Timothy Frye, a political scientist at Columbia University in New York, insist that the West’s economic sanctions will have little effect on the Russian economy, at least in the short to medium term. “For sanctions to be effective, they really need to be coordinated and far-reaching, and it is not clear what set of sanctions would be able to do that,” says Mr Frye.

The impact of sanctions in the long-term is, of course, much more difficult to predict.

Economic attrition

Whatever the result of the ongoing economic sanctions imposed by the West, for the moment they represent an additional source of difficulty for an already struggling economy according to many Russian power brokers. “Geopolitical problems and the deterioration in external economic conditions occurred amid the exhaustion of the traditional sources of economic growth,” noted Elvira Nabiullina, governor of the Central Bank of the Russian Federation, within the pages of the Bank’s ‘Guidelines for the Single State Monetary Policy in 2015 and for 2016 and 2017’.

Ms Nabiullina said: “This started in the preceding years and has become a serious challenge to Russia’s economic policy in general and to monetary policy in particular. In the face of increased uncertainty the determination of clear guidelines for households and firms, including inflation benchmarks, has become crucial for domestic long-term investment and economic growth.”

Business and consumer confidence is near the bottom of the scale and the prospects for future growth are hardly optimistic.

Believing that the rumbles over the rouble are far from over, Ms Nabiullina has forecasted zero growth and 8 percent inflation for 2015.

Marcel Fratzscher, a former head of international policy analysis at the European Central Bank, while in agreement with the Central Bank’s stance, draws comparisons with the financial crisis which engulfed Russia in 1998. In a blog for the World Economic Forum he wrote: “Consider Russia’s 1998 financial crisis. In August of that year, then-President Boris Yeltsin declared there will be no devaluation – that is firm and definite. Three days later, the rouble was devalued, and Russian financial markets went into a tailspin. With capital pouring out of the country, the Russian government was forced to restructure its debt, and the economy entered a deep recession.

On the effectiveness of sanctions, Mr Fratzscher is open-minded: “Sanctions that hit the real side of the Russian economy – such as energy, natural resources and the military – could provide a better solution. Though such sanctions may not work as quickly, they would be targeted, temporary and credible, enabling the US and Europe to control – and adjust – the impact on the Russian leadership and economy.”

To recap, then: oil prices are falling, Western sanctions are now beginning to bite, the value of the rouble has sharply declined, economic growth is stagnating, and Russian leaders are treated as something akin to pariahs on the international stage – and all of this against a backdrop of a Russian economy that was already flat-lining and at serious risk of recession.

So far, so bad. But at the dawn of 2015, is there any light at the end of the tunnel for the Russian economy?

2015 and beyond

Yakov Mirkin, head of both the department of international capital markets at the Institute of World Economy and international relations at the Russian Academy of Sciences, certainly thinks there will be opportunities for the Russian economy to recover – just not in the short to medium term. “Russia stands at a crossroads,” he says. “Ahead lies the unknown. The best response would be to modernise, release the potential of business and the middle class, increase incentives for growth, and do everything possible to attract foreign direct investment and new technologies.

“There is no doubt that fault lines will appear over the coming years. Temporary reconciliation with Western countries may be possible, and the sides may take a step back from the brink of conflict. But the wounds inflicted by the events in Ukraine are deep. Restoring Russia’s former level of integration in the international community could take 10 to 15 years. On the other hand, if we become stronger as an economy, do whatever it takes to modernise and catch up while remaining open and market-based, we can improve our quality of life.”

Mr Mirkin’s sombre take on Russia’s strategies for economic recovery and its prospects for positively re-ingratiating itself with the international community is broadly echoed by that of the Central Bank of the Russian Federation, but with predictions for better economic growth in the short term as the major difference of opinion.

The Bank’s ‘Guidelines for the Single State Monetary Policy in 2015, 2016 and 2017’ states: “As the external political situation normalises, economic uncertainty falls, access to foreign financial markets is restored, and the expectations of economic subjects improve, investment activity will revive. In view of the assumed external conditions and current foreign trade balance, the financial account balance is expected to remain negative throughout 2015. With the limited access to external financial markets for Russian companies and banks, external debt is expected to shrink significantly in 2015-2017, while demand for foreign assets is expected to fall.”

Ominously, but perhaps not disastrously, the Central bank forecasts a capital outflow of roughly $100bn in 2015.

The guidelines continue: “Under the assumed external and internal conditions shaping the development of the Russian economy, economic growth rates will remain close to zero in 2015-2016. In 2017, economic activity is forecast to pick up, in part due to growth in import-substitution industries and the increased competitiveness of Russian exports.”

Throwing its hat into the ring, the World Bank’s baseline scenario for the Russian economy suggests one of stagnation with projected growth of 0.3 percent in 2015 and 0.4 percent in 2016.

Clearly, the future of the Russian economy, especially in the short to medium-term, is up for debate. However, President Putin’s attempts to forge an alliance with the Chinese and other Asian markets (a deal was signed on 10 November with Chinese President Xi Jinping that will see Russia export gas from Siberia to China via new pipelines) may provide some respite for the beleaguered nation, however long such alliances take to bear fruit.

Russia’s dependence on Western markets may be a source of irritation for President Putin, but the multi-billion dollar, 30-year natural gas deal represents a colossal contract – securing a major new consumer of Russian energy in a long-term arrangement that could lead to Europe being usurped by China as Russia’s main export market.

The importance and timing of the deal is underlined by the drop in oil prices – by approximately a third since June – and the resultant impact on gas prices. Undoubtedly, the price of oil will continue to be a significant factor in determining Russia’s economic future.

Kristel Van der Elst, senior director of strategic foresight at the World Economic Forum, agrees: “Unfortunately for the sustainability of the country’s economy, many of the developments currently at play are reminiscent of one of the scenarios – called Precarious Stability – we put forward in a report two years ago. Specifically, instead of serving as a wake-up call for institutional reform and economic diversification, the sharp drop in oil prices has arguably led to a further concentration of the economy with heavy public sector engagement.”

Analysts agree that 2015 will see Russia experiencing either recession or continued stagnation at best. And yet, despite the continuing damage being wrought on the Russian economy, public support for President Putin currently stands at 88 percent. The Russian leader is intransigent, unlikely to back down, even in the face of ever more punitive sanctions imposed by the West.

“Going forward, there is a risk – though it can still be avoided – that the economy may be increasingly driven by political rather than economic rationales, something that would make the Russian economy increasingly hard to navigate for both domestic entrepreneurs and foreign investors,” believes Ms Van der Elst.

Uncertainty is the order of the day, for the Russian economy and the world.

© Financier Worldwide


Fraser Tennant

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