Russia’s Economy: A Changing Trend

15. 3. 2017

The country now enters a kind of a Brezhnev-era stagnation, where the non-development may even be portrayed as the much-wanted “stability”

Consolidating its firm position as the most outspoken adversary of the Western values and principles among countries that may be counted as European, Vladimir Putin’s Russia now enters a quite challenging period. Being guaranteed against all kind of aggression from abroad both by its nuclear arsenals and its large conventional armed forces, with a regime that enjoys tremendous rate of support at home due to its adventurous foreign policy and its skillful propaganda, the country still remains vulnerable to many economic factors. In the first quarter of 2015, the economy contracted by 2.2 percent, the real wages fell 8.3 percent short of the figures for the same period of 2014, and the overall volume of exports was down by 36.3 percent. And economists—both Russian and international— do not see any perspective for substantial improvement in the rest of the year, some predict the recession to continue well into 2016, if not into 2017. Reflecting on these perspectives, one should first and foremost address three main questions.

Why Has It Happened?

The crisis that began in late 2014 was easy to predict in its every element. During recent years Russia’s economy showed impressive growth and generated steady improvement in people’s life due to three obvious reasons.

Firstly, there were the high oil prices—and not only high, but also rising. If one recalls that in 1999, Russia’s oil output amounted to 304.8 million tons, while its average price stood at $19.97/ bbl, one may (by subtracting the total value of oil pumped in 1999 from oil revenues of any consecutive year) get the actual size of Russia’s “windfall oil earnings.” For the time from 2000 to 2003, they totaled $133.7b, or $33.5b a year; for the period from 2005 to 2008 they went up to $894.4b, or $223.6b in annual terms, while for the first part of Mr. Putin’s third official term as president, that is from 2011 to 2013, they have reached $1.3trn, or $394.0 billion per year. For the period between 2008 and 2010 were the prices considerably lower than both the peak figures for the first half of 2008 and the average for 2011–2013, and it caused an acute crisis in 2009–2010. The current downturn also develops alongside the sliding oil prices that hit local lows at $43.8/bbl in December 2014, and even though they rose to $65–67/bbl in June 2015, the economy clearly feels the pressure—first, because the oil in Russia is priced on the base of the six months moving average, which means that right now Russian oil companies are paid for their produce at around $52–55/bbl, and, secondly, the oil revenues have a critical importance for all other branches of the economy being the primary source of budget proceedings. Some rough estimates will put the loss of oil revenues at around $110–130b in the whole 2015, which equals to 8 percent of the country’s GDP. In any case, this is a heavy blow to Russia’s prosperity.

Secondly, in its most successful years the economy used to rely on a great amount of foreign investment—but, contrary to the major part of the emerging markets, the money had arrived in Russia not as FDI, but rather in a form of commercial loans. The explanation is quite simple, and deals with the state control over country’s economy: since the oil, gas, and energy sector was closed for foreigners, there were no infrastructural concessions proposed, and the major sectors of the economy that strongly depend on the budget outlays were controlled by Putin’s personal friends, so there was actually neither enough room for direct investment, nor the feeling it may be secure in such a surrounding. Therefore the Western financial institutions preferred to provide loans to both Russian banks and corporations—and there was a big demand for them, since the ruble appeared stable and the interest rates on the global markets were from three to four times lower than on Russian domestic market. Because on this, the overall debt of Russian private companies (both in banking and corporate sectors) rose from $34.2b back in early 2002 to $175.1b in 2006 and to a staggering $653.8b by the beginning of 2014. By the beginning of 2014, the Russian companies owed more money to the Western than to domestic lenders ($678b vs. RUB 18.8trln). The closure of the international markets after the annexation of Crimea in March 2014 caused a credit crunch where the Russian companies were due to repay around $160b in debts from that time to May 2015—that amounts, if annualized, to 5.5–6 percent of GDP, which caused another strong blow to country’s economic performance.

Thirdly, the investment climate in the country aggravated all the time from 2012, when Mr. Putin announced his “May Decrees,” demanding a huge hike in social spending, pension financing and allocations for the development of the military. This caused the rise of taxes and all the state’s “law enforcing” agencies were put to work for increasing the amount of taxes collected. As a result, e.g., an entrepreneur who paid his worker a salary of 900,000 rubles a year (RUB 75,000 or €1,200 a month), was due to channel into social security funds 100,800 rubles annually in 2009, but in 2014 the amount stood already at 216,100—an increase of 95 percent in just several years. Between 2012 and 2014 around 20 new taxes and duties were introduced—and the money collected was used for the most unproductive purposes, mainly on the rising expenditures on domestic security and on the military (the federal outlays for the purposes indicated in the budget as “national defense” and “providing security” increased from circa RUB 1.88 trln in 2008 to RUB 5.17 trln. in 2015 budget—i.e. by 2.75 times). Of course, one may hardly expect any acceleration in economic growth if the business community is seen only as the source of money for the government, which can be used for its military adventures and for the further oppression of the opposition politicians. As the result, Russia experienced a massive flight of both capital and people (capital flight increased from $34.4b in 2010 to $151.5b in 2014, and the number of emigrants leaving for a permanent settling abroad—from 36.8 thousand in 2011 to 305 thousand in 2014).

Therefore one may say that the crisis was inevitable: being caused by Russian leadership’s irresponsible economic policy, it aggravated due to the falling oil prices, and became extremely acute because of financial sanctions imposed on the country after its aggression on Ukraine. Saying this, I would underline the point that the sanctions actually came as an additional shock—the crisis would happen even without them. The current crisis in Russia is caused by the reliance on the oil economy combined with the constantly present desire to waste the oil revenues on “security” at a time when no one is actually threatening Russia.

May It Be Reversed?

Every time a country faces an economic crisis, its government tries to step in for softening the impact of the market forces—but in Russian case it seems terribly difficult due to both the economic structure and the ideological approaches of the country’s leadership.

One major challenge comes from the nature of Russian economy on the micro-level. As one knows, in the times of crisis the governments prefer to ease taxes and to soften the financial policy in order to provide more money to the businesses to encourage then to invest, to lower prices and therefore to counter the shrinking consumer demand. This strategy actually worked well from the beginning of the 1930s—but few may understand why it is not working in Russia these days. The answer, however, is rather simple. To make sure money will work one must possess a healthy private sector—if it’s in place, the government orders will create more production and jobs. This was the case of the New Deal policies that were so successful in fighting the Great Depression: back then the American government spent $4.2b (that corresponds to $190b in current US dollars) for accomplishing 34 thousand different projects—roads, dams, bridges, airfields, schools and hospitals) which were all build in less than eight years by private construction companies and at the lowest possible costs. Russia these days is simply incapable of replicating this—on the one hand, the government declines to grant the contracts on the competitive basis to the most able companies, on the other hand, there are actually too few contractors who can do the job since the economy is too strongly controlled by the state. Therefore the money disbursed only enriches the loyal entrepreneurs, boosts corruption and pushes up construction costs while not producing meaningful results. Up to this day, the Russian government channeled RUB 930 billion (around $20b in current dollars, or more than 10 per cent of the New Deal’s funding) into just 6 projects, of which for example the highway from Moscow to St Petersburg has now been under construction for more than 20 years and may well become the most expensive road ever build. As a respected Russian economist and politician Valery Zybov insists, current Russian investment policy aims on redistributing money from profitable private businesses into a money-losing public ones, so he calls the whole phenomena a “surrogate investment system,” and I fully agree with such a definition. Therefore the main lever of overcoming the crisis appears to be of little use in contemporary Russia.

The second point is that the government these days clearly decided to prefer social spending to investments—and this move might be considered reasonable if being introduced anywhere except in Russia. Since the everyday spending of an average Russian household is dedicated by 40 percent or more to buying food and by 25–30 percent to acquiring everyday clothes and cheap home appliances and gadgets, one must realize that up to two thirds of all these goods have been imported. Therefore the multiplying effect of this kind of spending seems to be rather limited, and they are unable to push the country’s domestic growth. At the same time all this doesn’t help to accelerate the productive investment and therefore to lay down some foundation for a long-lasting economic development.

This very fact may also be explained when one assesses the overall logic of the current Russian leadership. It simply is obsessed by the short-term goals—and all these somehow are aimed on the preservation of its own powers—to be aware of long-term challenges. The attempt at modernizing the country’s economy therefore failed because modernization is a dramatic and expensive effort that cannot pay off in the nearest future, and the government seems to be preoccupied only with today’s troubles. Once again, there is little hope the crisis may be fought with some “conventional” measures.

Looking on what the Russian government had done so far, one should compare its moves to what it did six years ago, during the 2008–2009 crisis. Such a comparison will tell everybody that the strategy consists in just surviving the downward spill of the crisis while hoping for the recovering of oil prices and for the sanctions being lifted. A simple analysis of the rhetoric of the high-ranked Russian officials between July 2014 and May 2015 makes it clear that they are living in an illusionary world relying on the chance the crisis will not last long. This strategy was quite successful during the previous downturn, proving that the policy of piling up the reserve funds proposed and realized by the then Finance Minister Alexei Kudrin was a right one, and should be pursued now as well.

All of the above may drive us to a conclusion that Russian leaders are now trying to cope not with the economic crisis as such, but rather with its possible socio-political consequences. They believe the real trouble with the economy is not as disturbing as the prospective social unrest that may unveil if the middle class together with the elderly truly feel their living conditions worsening. Therefore the government now claws between the interests of the people and the desires of bureaucracy, who both wish more immediate spending—either on salaries and pensions, or on huge and ineffective projects. Both lines of spending do not imply any growing freedom of the private business or any real investment into the productive sphere that may produce returns, even into a distant future. Thus, I believe, the absolute reluctance to reform and the negligent ineffectiveness of budget spending will both guarantee that the crisis will endure.

How Is the New Trend Sustained?

Here we come to the last big question of whether the new downward slide in the Russian economy will develop into stable trend, will it endanger the regime and, finally, what the logic of its progress may be.

My answer on the first point is a definitive “yes”—first of all because the current crisis differs a lot from a traditional one that many countries (Russia included) faced in the past. In most cases the crises came after a sharp boom, and therefore they had a chance to evolve in a V-shape term, since even at the bottom point people remember the lost prosperity and are living with the hope it will soon return. In Russia such crises were recorded both in 1998 and 2008. The 1998 collapse happened after the economy showed first signs of revival in 1997 (1.4 percent of GDP growth) after eight years of continuous slump (as huge as 9.4 percent a year on average in 1992–1996). The stock indexes peaked in 1997 at the heights unseen up to 2003, and the country placed its first Eurobond issues since the Soviet Union’s collapse. In 2008 the situation was similar—the slump was preceded by a prolonged boom (the growth rates in five years prior to it stood at 7.5 percent per annum) and the RTS stock index reached 2,487 points (these days staying at around 950). Therefore both crises were believed to demonstrate just some market excesses, leaving hope for a return to business as usual.

Contrary to that, the 2014 crisis developed steadily, with no signs of leaving the previous one behind. The growth rates decreased step by step since Putin’s return to the Kremlin—from a 4.9 percent on an annual basis in the Q1 2012 to 3.4 percent for the whole year, and then to 1.3 percent in 2013 and a mere 0.6 percent in 2014. Seven years after the stock market peaks of 2008 the RTS index is traded at 62 percent below its record level while seven years after the 1998 collapse it stood 75 percent up if compared to 1997 figures. Not long ago the Prime Minister Dmitry Medvedev famously said that we not so much entered a new crisis than got into another downward trend of the previous one, from which Russia actually never recovered. I am talking about this in minute details to prove that the new crisis takes an L-shaped curve and is now assumed as a something “normal”—so both the citizens and the business community become more and more accustomed to it. And the more “normal” is the situation considered, the less active the attempts to change it will appear; so, I believe, Russia now enters a kind of a Brezhnev-era stagnation, where the non-development may even be portrayed as the much-wanted “stability” President Putin proclaims as both his major goal and his greatest achievement.

So the “normality” of crisis may become the first reason it will not be dealt with seriously. But the second reason looks much more important and much more challenging. Since both crises of 2008 and 2014 erupted at the time of downturn in the oil market and at the time of political quarrels between Russia and the West (in the first case it was a local war in Georgia, in the second—the conflict in Ukraine), the ruling elite in Moscow is trying (and will continue to try) to attribute the economic problems to the external factors (so, either to international financial crisis of 2008 or to the hostile Western actions of 2014). The second case is even more beneficial for the government since it presupposes a kind of aggression that the West undertook against Russia (even if it looks crazy, what the ordinary Russian dweller hears these days is particularly this very formula). If one believes that the crisis is due to the West’s attempt to counter Russia’s rise from its knees and is artificially orchestrated to make Russia keep low profile, the natural feeling will be to support one’s government and to put all the thoughts about economic hardships aside. Therefore, I would argue that while the economic crisis that begun in Russia in 2014 will definitely turn into a long and chronic one, it will not undermine Putin’s popularity and produce any significant political challenges to the regime. The Russians understand quite well that their leaders are not to be blamed for the falling oil prices, and at the same their national pride will not allow them to criticize the president in a time which is largely considered to be a time of war that the whole world quite suddenly—and for sure without any rational cause—declared on the Russian Federation.

I will reiterate: this may be the only one point where I do agree with the Russian traditionalist thinkers saying that Russia “is not Europe.” Russia actually is not Europe because here the worsening economic conditions in a hostile international surroundings do not count as the grounds for opposing the current government and calling in favor of long-needed reforms—and no one should hope they would. Therefore the president may not preoccupy himself too much with the economy— and because of this the crisis will go on.

The last point touches on a forecast of the nearest economic dynamics. Even while many government officials insist Russian economy may return to growth in the early 2016, I would strongly disagree with such a hypothesis.

The first blow of the crisis in the late 2014 brought the ruble down from around 35 to 67–70 to the US dollar, led to the collapse of the stock market, and provoked a sizeable disinvestment in major sectors of the economy. At the same time, however, it caused a sharp increase of demand for any durables, being seen as a good investment opportunity in hard times. After the first shock the ruble rebounded to 50–55 to the US dollar, and the inflation, which was projected in January to reach at least 22–25 percent for the whole year of 2015, levelled off. The result appeared rather contradictory: the government cut the panic while strengthening the ruble, but it undermined its own revenue base since the cheaper the ruble is, the more rubles are channeled into the state coffers from the oil custom duties denominated in US dollars. Therefore the Q1 brought an enormous fiscal deficit at around 812b rubles, or 4.9 percent of GDP. The regional budgets are all in huge debts, up to 34 percent of their revenues on average. The Novgorod region in North-West of Russia actually defaulted on its debt in early June, to be followed by many others. Both the government and business are now trying to economize, and the citizens try to cut their spending. Therefore beginning from May 2015, the indicators of economic expectations look much worse than the current ones. Being faced with tough times, the people cut their spending much faster than their disposable incomes contract. Since the banking system is in big trouble (32 banks were declared bankrupt since the beginning of 2015), the middle class will not turn their forced savings into any kind of investment. I will say that after four to six months of a comparative stabilization, the economy will feel the effects of the new wave of shrinking public and private spending—and this will be seen from July and August. Then the government will respond by increasing spending and lowering the ruble, unfortunately both processes will appear too gradual to produce any feasible results. One may remember that in 1998 it was a five-fold devaluation of the ruble that resulted (alongside with increasing oil price) in a long economic boom—but today the government cannot afford such a maneuver. Therefore the economy will go a long way from bad to worse (e.g. from zero growth to a new downturn period), which, I think, may continue up to 2018. The rebound in oil prices to more than $100/bbl remains doubtful, the lifting of sanctions is simply out of question, and the government’s reserves will not become bigger.

I would argue that under such conditions the government will become focused on social spending, since it desperately needs a kind of popular support for the parliamentary elections (which are already put three months ahead of schedule on September 2016) and the presidential ones due in 2018 (these for sure will not be called earlier, since it would shorten Putin’s legal stay in the Kremlin). Therefore no liberal changes may be expected—and the logic of propaganda will also force the Russian leadership to deliver either new advances in Ukraine or sudden successes of the Eurasian Union, both eventually being very costly. So there will be no money left for the genuine economic development, and therefore every new crisis in Russia from today onwards will develop before it has overcome the previous one. This crisis may see slow recession that by 2018 will deprive Russia of at least 10 percent of its current GDP, bringing the country’s economy back to its 2005– 2006 levels. Whether President Putin wanted it or not, with his return to the Kremlin in 2012 has Russia definitively entered a lost decade that its people will remember for long.

Vladislav Inozemtsev

Professor of Economics, Chair of the Department of International Economy at Moscow State University’s School of Public Governance.

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