As 2015 sets in, Russia’s economy is bracing for tougher times ahead. It remains to be seen if the Kremlin will be able to use the crisis to conduct structural economic reforms.
A view at the Moscow-City skyscraper. Photo: RIA Novosti
The price of Russia’s main export, crude oil, has collapsed. Russia’s currency, the ruble, has fallen precipitously. Inflation is running in double digits as officials predict recession in the first quarter.
Yet is the picture all dark? Not quite.
There is room to suggest that, given a few plausible assumptions about conditions in 2015, the crisis may create a new impetus for Russia to make the difficult changes necessary to reduce its dependence on the export raw materials. In the medium and long term, such a move would be a sea change for Russia’s economy, opening up new horizons of growth.
Indeed, the need to break Russia’s addiction to expensive oil has never been so acutely apparent to both the state and the private sector. The events of 2014 proved this basic necessity once and for all. With that in mind, let’s take a fresh look at the situation, starting with the impact on the national budget.
The Russian state treasury gets about half of its revenue from the hydrocarbon trade. However, to correctly assess the budgetary squeeze caused by the drop in oil prices, one must take into account the exchange rate between the U.S. dollar and the Russian ruble.
Over the course of 2014 the ruble fell approximately 85 percent against the U.S. dollar — from 32.87 rubles per dollar at the beginning of the year to 60.74 rubles at the end of the year. In 2014, the price of oil and the ruble exchange rate fell almost in lockstep. As a result, the price of oil as denominated in Russian currency barely changed at all. At the end of 2013, the average price of North Sea Brent was about 3,560 rubles per barrel. At the end of 2014, it was 3,540 rubles per barrel.
So in ruble terms, the price of oil fell only 0.56 percent. This represents a less than 0.3 percent drop in oil revenues on the government’s balance sheet, when calculated in the national currency. What caused the ruble to fall?
Since most sectors of the Russian economy depend on imports, there was a natural increase in consumer prices. The Central Bank of Russia’s initial forecast of 5-6 percent inflation for 2014 was half the actual figure. The consumer price index for the year saw a rise of 11.4 percent.
Inflationary pressures led to costlier credit. On the back of the Central Bank’s hike in the key rate of interest in mid-December last year, the lending situation deteriorated considerably. Against this backdrop, Russia’s investment appeal declined significantly. Weak growth prospects, exchange rate risks and sanctions created a tsunami of capital flight from the country.
The explosion in demand for foreign currency added a powerful destabilizing force, and compelled Russia’s financial authorities to divert attention and resources to stabilize the situation.
That much is history. Now, where do we go from here?
First of all, following the historic oil price collapse of 2014, energy markets have begun to show signs of life. Many analysts forecast that crude could stabilize in the range of $60-70 per barrel this year. Such partial recovery would certainly be a comfort to the Russian economy.
If such a price range does materialize for oil, the ruble may hold at 50-60 to the dollar. A recovery in the ruble could significantly reduce inflationary pressures, making credit more available.
Investing in the Russian economy could regain attractiveness, causing capital flight to fall to a more natural level. If so, favorable conditions for domestic suppliers of goods and services would encourage development of the real sector of the Russian economy.
There is no doubt that stabilization of the hydrocarbons market would help facilitate the process of reducing Russia’s dependence on oil – at a moment when oil’s recent collapse has demonstrated the necessity of doing so.
Yet for Russia to successfully kick its addiction to expensive oil, the role of the state, and interest rate policy, will be crucial.
If Russian Central Bank’s key rate remains high, the real sector won’t be able to borrow money at reasonable rates.
But the state could alleviate this problem by providing preferential lending to sectors outside the energy industry. It could also reduce the tax burden of priority segments of the economy, stimulating their rapid development.
The good news is we can already see the government actively working on these issues, developing anti-crisis measures that provide large amounts of investment. In addition, Russian sanctions on Western suppliers of food products are having the unintended consequence of stimulating domestic producers, increasing their competitiveness and clearing the market, freeing it from imported goods.
Of course, reforming the Russian economy will require a great deal of time, effort and money. The ruble must be shored up to reduce inflationary pressures, and to lower the cost of credit. And the country needs to be made more attractive to investors.
In summary, the second wave of the crisis that has gripped the world economy struck a very painful blow to the Russian economy. But it could also, given a few highly plausible conditions, act as a strong impetus for Russia to develop and reduce dependence on raw materials. Winston Churchill once reportedly remarked, “Never let a good crisis go to waste.” It can only be hoped that Russian officials take this maxim to heart.
The opinion of the author may not necessarily reflect the position of Russia Direct or its staff.