The Russian economy will have to endure a difficult period of adaptation before it reaches a new equilibrium point, economists predict. For at least a year, economic growth rates will be negative while Russian officials search for a more effective “anti-crisis” plan.
People stand waiting at a bus stop in Novyi Arbat street with with a currency exchange office sign is in the background in Moscow, Russia, Wednesday, Dec. 24, 2014. Photo: AP
Since March 2014, when the first round of sanctions was introduced, the Russian economy has had to face a number of serious challenges, including slumping oil prices, investment outflow and a devaluation of the national currency. Sanctions that mainly targeted the banking, energy and arms industries were designed to make the Kremlin refrain from supporting pro-Russian separatists in Ukraine.
A year later, it is yet hard to tell whether the West succeeded in its efforts, especially since the crisis in Ukraine is still far from being over. Another question is whether the external economic pressure from the European Union and the U.S. has indeed weakened Russia’s economy.
As U.S. government officials continue to argue, financial penalties have contributed to Russia's major economic problems. “The combination of our [U.S.] sanctions, the uncertainty they've [the Kremlin] created for themselves with their international actions and the falling price of oil has put their economy on the brink of crisis," said Jason Furman, who chairs the U.S. President's Council of Economic Advisers.
Russian and international experts, on their part, also seem to acknowledge the role of sanctions in the crisis. However some of them, including Obama’s former ambassador to Moscow, Michael McFaul, believe that the Western economic pressure had only a ‘marginal’ impact in Russia’s case.
As Bernard Sucher, member of the board of UFG Asset Management, puts it: "Western sanctions didn’t provoke a crisis in Russia. The country’s economy has been slipping since 2012 and would likely have been stagnant in 2014 even if there were no shocks from Ukraine or oil. The real culprit has nothing to do with the rest of the world. Simply put, 'State capitalism' has been choking the dynamism out of Russia’s economy."
Sergey Drobyshevsky, the Head of the Center for Macroeconomics and Finance at the Gaidar Institute for Economic Policy, agrees: “Sanctions and the fall of oil prices were not the main reasons for the eruption of the crisis. These factors only made it possible for the existing negative trends to become more apparent. Such development as the slowdown of economic growth and investment activity were evident since 2013. The decline in oil prices basically left the Russian economy without a ‘shield,’ so the crisis erupted.”
"The crisis was coming no matter what, and it’s not actually the sanctions to look at but Russia’s actions," Christopher Hartwell, the president of the Center for Social and Economic Research in Warsaw (CASE), told Russia Direct. "If the West did absolutely nothing and business remained as usual, Russia would have still seen declining investment, oil prices still would have fallen, and the huge expenditures required to sustain Crimea and the Russian military would have continued to drain the budget," he insists.
The experience of the economic crises of 1991-1995, 1998 and 2008-2009 should have been a helpful start to tackle the new economic slowdown. However, a $35 billion "anti-crisis" spending plan that the government announced in January was actively criticized by the Russian expert community.
According to Igor Nikolaev, Director of the FBK Strategic Analysis Institute, the major mistake is that this is exactly the same strategy that was used six years ago – pumping money in until the crisis is over and hoping for oil prices to bounce back. “We need to take into account that this is a fundamentally different crisis – in its reasons and duration,” he said.
Indeed, Russia is going through an extremely difficult period, which is even worse than the crisis of 2008-2009, according to First Deputy Prime Minister Igor Shuvalov. “On the face of it, we’re getting indications that it’s better than in 2008-2009,” Shuvalov said. “But this only seems so. In fact, in terms of depth and difficulty, it looks to me like we’ve already spent a year on the verge of a longer and more difficult crisis.”
Source: Institute for Economic Policy
And there are signs that can confirm this. According to the findings of the Institute for Economic Policy, Russia’s activity on the global market is already in decline due to the influence of sanctions, reduction in investment and domestic demand and the deterioration of prices in key markets. At the same time, the country’s trade with both the “far abroad” and the “near abroad” also experienced a serious cutback. Food imports from the sanctioned states are not yet substituted either by agricultural products from other states or by domestic ones.
The situation in industrial production seems to be quite ambiguous due to a number of factors that play against each other. It is, on the one hand, the devaluation of Russian national currency (and to a lesser extent, the food sanctions) that led to new opportunities for import-substitution, and, on the other hand, the decline in demand and the shock from the higher prices for import, components and equipment.
As a result, there was distinct growth in industries that saw new opportunities for growth (food industry, rubber and plastics production, chemical industry, production of non-metallic products and metallurgy) and a drop in other sectors (textile and clothing industry, production of leather and footwear as well as vehicles and equipment) that are highly dependent upon the income behavior and imported materials and components. In a sense, Russian industries are divided into those sectors that grow and others where the production is declining.
In this situation, it might be a good strategy to support Russian exports abroad. As Pavel Kadochnikov, Vice-Rector of the Russian Foreign Trade Academy, points out, at the current moment Russian authorities should make the most of new opportunities available to support Russian non-primary exports abroad. “They are very cheap – we need to make use of that … There all necessary mechanisms for that but exporters still find it hard to get access to it. The government is working on it so it should start working quite soon,” he said.
What is also important is that in order to sustain competitiveness of Russian products the economy needs investment. In the current situation "Russia hasn’t been getting its share of that capital – or the technology and innovation that come with it – because investors were intimidated by the high political and governance risks that are inevitable when you don’t have a level playing field for commerce," thinks Bernard Sucher. "And because they have been one of the few truly committed sources of private capital for Russia, even the first sanctions – which most people were deriding as “wimpy” – were significant," he says.
In response to Russia Direct’s question of whether Russia could expect its former investors to come back, Pavel Kadochnikov said that, even though the devaluation of ruble made it very alluring for investors to come back, they will not do so until the political situation has stabilized. “The risks that still exist are seen by investors as too high to accept. Only if the situation in politics improves can we expect investors to find their way back,” he explained.
The economic analysts see the year ahead as quite gloomy for Russia’s economic development. According to the forecast by the Russian Ministry of Economic Development released in January, by the end of 2015, inflation might grow up to a point of about 12.2 percent while other indicators of economic activity are most likely to decrease: GDP – by 3 percent, investment in fixed assets – by 13.3 percent, and real disposable incomes – by 6.3 percent.
Source: Institute for Economic Policy
Taking as one of its prerequisites a $50 price for a barrel of crude oil, this forecast seems to be more optimistic than that of the experts from the Gaidar Institute for Economic Policy, RANEPA (the Russian Presidential Academy of National Economy and Public Administration) and the Russian Foreign Trade Academy. Assuming the oil price will be around $55 per barrel, their findings show that the figures will be higher during the course of the year: inflation will grow up to 17.1 percent, GDP might decrease by 6.8 percent, investment in fixed assets – by 19 percent, and real disposable incomes – by 8.5 percent.
The Russian economy will have to endure a difficult period of adaptation to the new environment, these economists say. For at least a year, economic growth rates will be negative while the possibility for a recovery will be highly dependent upon how soon a new equilibrium point is reached. If energy prices remain low while geopolitical instability and sanctions persist, negative economic dynamics will continue in the coming years.
What Russia could do to improve the situation is to "fire 20 percent of the civil administration, remove the long list of permissions/stamps/signatures needed to do business in the country, invest the money that should have been spent in education and stop sinking it in mega-projects like Sochi and the military, make it easier to trade across borders," Christopher Hartwell suggests. Intervening in Ukraine, from his perspective, is one of the major factors that is "draining Russia dry." If the authorities realize that there is a possibility to prevent further deterioration.
UPDATE: This article was updated on March 13, 2015 to include commentaries from Bernard Sucher, member of the board of UFG Asset Management, and Christopher Hartwell, the president of the Center for Social and Economic Research in Warsaw (CASE).