In 2016, the Russian economy slowly moved from crisis to stagnation. Is it possible to expect a further improvement in 2017?

People in a park on Moscow's Tverskoi Boulevard. Photo: RIA Novosti

2016 was a year of mixed results for the Russian economy. The government tried hard to balance between addressing economic problems and reaching social development goals, but it was not always successful in this effort. The majority of socio-economic indicators are likely to remain negative at the beginning of 2017, so the key trend of the passing year is the continuation of the crisis that started back in 2014.

On the other hand, almost all negative trends in the Russian economy seem to be showing signs of improvement, with some of them already moving in a positive direction. 2017 will represent a turning point for the national economy. The key questions one should ask today are: What is the new model of economic development going to look like? Is the economic growth possible in Russia in 2017? If so, to what extent will it be stable?

“Quiet reforms”

Russia’s macroeconomic indicators in 2016 leave one hopeful. The authorities managed to maintain their ability to control the economy, fulfill their social obligations and ensure that budget-funded salaries and pensions are paid. The main challenges facing the economy remain the same as before: low energy prices, Western sanctions, more protectionist measures in the Russian financial markets, and the weakness of the country’s economic institutions.

It is expected that the Russian economy in 2016 will grow by only 0.5 percent. In fact, the country’s economy has already transitioned from crisis to stagnation with a prospect of overall growth in the first quarter of 2017. For now, the rate of growth is projected to reach 0.5-1 percent. A higher rate might occur only if large-scale structural reforms are implemented.

The question of structural reforms is among the most discussed problems within the Russian expert community. Many Russian and foreign observers think that real structural reforms have not been implemented yet. However, other pundits argue that the authorities introduced the program of large-scale structural reforms in 2016. They took place in a number of areas.

First, the government carried out privatizations that became the key source of funding of the state budget and ensured that the country would be able to overcome the negative effects of the Western financial and economic sanctions. The sale of 19.5 percent stake in Russia’s energy giant Rosneft to foreign investors was the key event in this area. In 2017 one might see further privatization initiatives.

Second, the fight against corruption has moved to an unprecedented level in 2016. For the first time in Russia’s modern history, the country’s top economic official, Alexei Ulyukaev, was arrested on charges of corruption. At the same time, a number of criminal investigations took place against many government officials at the federal and regional levels. Corruption, which was traditionally the key obstacle on the path of efficient economic governance, is now being addressed more actively.

Third, the Kremlin made steps to encourage competition on the domestic market. Decreasing the amount of shadowy state funding programs creates a new business climate and the country’s stock market is growing rapidly while the price of national companies’ shares has grown by 27 percent and this trend is continuing.

Fourth, the state has been carrying out a strict monetary policy that might lead to a decrease in inflation in the near future and a boost in investment. It might also make macroeconomic policy more predictable and transparent than it has been in decades.

Exchange rates, inflation rates and interest rates

After several unexpected spikes in January-February of 2016, Russian ruble’s exchange rate remains stable at the level of 62-67 rubles per dollar and in the long term it might strengthen to the level of 55 rubles per dollar. The inflation was decreasing over the past year and reached a record low in post-Soviet history -  5.8 percent.

During 2016 Russia's Central Bank decreased the key interest rate very slightly by only 1 percent (from 11 to 10 percent). Amidst decreasing inflation, such a high interest rate clearly limits economic activity and the ability to overcome the crisis in the country.

On the other hand, such a high rate keeps inflation risks low. These risks represent one of the key factors of uncertainty for all economic stakeholders. In 2017 the Russian Central Bank plans to decrease the key interest rate to the level of 6.5-6.75 percent a year if  inflation falls to the basic level of 4 percent.

The budget deficit stopped growing and stabilized at the safe point of 2.4 percent of GDP (1.8 trillion rubles, or $29.9 billion). The deficit is being financed from the government’s accumulated savings and from the profits from privatization and loans.

The oil price growth at the end of 2016 marked the beginning of a new trend. Over the course of the past year, the oil price fluctuated significantly and this hampered long term planning in Russia, but now there is confidence that the average price of oil in 2017 will be around $55 per barrel. This is higher than the government forecasts ($40 per barrel) that are used for the current state budget planning.

Therefore, further improvement of Russian macroeconomic indicators is quite possible in 2017. Only external shocks (new sanctions, military conflicts, etc.) might hamper this positive dynamic.

Industrial development

Russia’s forest, light manufacturing and chemical industries - as well as production of machinery and equipment - experienced growth in 2016. The large-scale state support of the auto industry helped to avoid bankruptcy  of the companies but could not yet lead to significant structural changes in this area.

The policy of Import substitution has become more visible in practice. In 2016 the government finally put its bet on the development of the high-tech sector, which is crucial for the country’s national security. Hence, import-substitution projects in industry receive the most attention from the authorities.

Metallurgy - the traditional “locomotive” of the Russian economy in times of crisis  - is going through a difficult period right now. This is due to the fact that domestic demand in its products continues to fall and external markets become inaccessible to Russian companies.

The construction industry is also going through a crisis. In 2016 it will fall to 4 percent,  which will lead to the decrease of production in adjacent industries.

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Investment, agriculture and living standards

The fall in foreign direct investment into the Russian economy that happened over the past three years is directly related to Western sanctions that left Russian banks and companies unable to request loans on global financial markets. Yet, in 2017 investment might grow, but only if the West does not impose new sanctions, Russia’s GDP grows and the general uncertainty in the country’s business climate decreases.

What is worrying is that the retail trade turnover in the country continues to fall and this can only be stopped by ensuring overall economic growth and rebuilding the public’s trust. Today 80 percent of the population does not have any savings and this is due to the low level of living standards and financial literacy. The majority of the other 20 percent of Russians prefers to save their earnings rather than spend them.

Agriculture is one of the few sectors of the Russian economy that is developing rapidly and successfully. In 2016 it will grow by 3 percent due to large-scale state financial support and Russia’s retaliatory sanctions imposed in August 2014. Russia’s “food sanctions” created favorable conditions for domestic producers to grow.

The level of consumption and overall living standard in the country remain low and continued to fall in 2016. The government failed to address this problem. Before the crisis, 12 million people in Russia earned less than the minimum living wage. By the end of 2016, this number reached 20 million.

The public’s real incomes started to fall in 2014 and continued for the last three years. In 2016 the overall decline will be an additional 5.3 percent. The absolute majority of the Russian population has become “consumption depressed” and there is no cure for this yet.

As a result, the retail trade turnover in 2016 will fall by 5.1 percent and housing construction will decrease by 6.5 percent. Over the course of the year, the authorities were too slow to index pensions. Inflation and salaries of the state employees grew much faster.

What to expect in 2017

The state apparatus is actively preparing for the upcoming presidential election in 2018. It is likely that the program of “quiet reforms” will be continued, but it is clear that the most difficult and painful reforms will take place after the election.

It is very likely that the Russian economy will grow by more than 1 percent next year. The key obstacles hampering economic growth at the moment include the crisis in real incomes and unbalanced state budget. The state initiative to carry out substantial changes to the country’s tax system in the near future might have a negative impact on the country’s small and medium enterprises. Large businesses involved in import-substitution are likely to benefit from the tax reform.

In 2017 Russia has prospects for a return to stable and balanced economic growth rates, but this will depend on the government’s ability to implement structural reforms, fight corruption and carry out productive dialogue with business.

The opinion of the author may not necessarily reflect the position of Russia Direct or its staff.