Of all of the G20 members, Russia was hit hardest by the crisis. Its GDP is expected to contract by 9.5–10 percent this year, with budgetary revenues projected to fall by 25 percent (33 percent for the federal budget) and federal reserves likely to disappear by the end of next year1, contrary to the Minister of Finance’s statement that they would balance the budget within the next five to seven years.
A combination of three factors led to these results. First, the global debt crisis played a central role. Russian banks and companies had rapidly expanded their foreign debt from $100 billion at the beginning of 2005 to more than $500 billion by the middle of 2008. While that debt only amounted to 35 percent of GDP, which is not extraordinary, 40 percent of it was short-term with maturities before the end of 2009 and most of it was held in foreign currency. The bulk of Russian borrowers had expected either to refinance their short-term debt, or to raise sufficient capital in time to pay. The global financial crisis crushed those hopes, and has also blocked growth in the sectors that relied most on foreign credits (e.g., banks, retail, development).
Of all of the G20 members, Russia was hit hardest by the crisis.
Second, the slowdown of the global economy led to a decline in the demand for and prices of commodities that account for most of Russia’s exports. Ferrous and non-ferrous metals—along with the oil industry, which cut its investment plans for 2009 by 20–50 percent—were most affected. This year, the gas industry joined those sectors, as its exports declined by 35 percent. The reduction in physical exports affected demand for transportation services, with railway transportation having fallen 30 percent by December 2008 and another 20 percent in the first half of this year.
Third, in August 2008, the Russian government launched a war against Georgia, which triggered intensive capital outflows.
Is the Recession Bottoming Out in Russia?
This recession is the first cyclical recession in Russia’s history, making forecasts difficult. However, experts agree that the economy’s free fall was over in April and that the bottom has been reached. While government experts may try to engender optimism by announcing that the recovery has started, independent specialists are more restrained in their assessments. The Development Center shares the latter view and believes that several factors will hinder economic recovery in Russia for the near future.
While government experts may try to engender optimism by announcing that the recovery has started, independent specialists are more restrained in their assessments.
1) The bulk of the 10 percent decline in GDP this year is attributed to a significant decline in inventories. During Russia’s period of expansion from 2005 to 2008, inventories climbed from 22–23 percent to more than 28 percent. As a result, even if inventories simply normalized, GDP would still be negatively affected. On the other hand, despite growth in unemployment and decline in revenues, Russian households tried to oppose the crisis by continuing to increase their spending until the end of the first quarter of 2009.2 Consumer spending started to decline only in the second quarter, but in July retail sales declined by 8 percent (y.o.y). This process will likely continue another two to three quarters, and will exert another strong, negative influence on Russia’s economy.3
2) In 2009, the government increased its federal budget expenditures by 33 percent. If we look at this as anti-crisis stimulus, it amounts to a package of 6.25 percent of GDP. If we add to this the tax cuts adopted in fall 2008 (the main beneficiary of these cuts was the oil sector), the size of the stimulus package increases to 8 percent of GDP. A stimulus of that magnitude should definitely affect the economy, but no indication of an effect has emerged to date.
Many experts (including those from the IMF and the OECD) believe that this lack of influence may be explained by the specific structure of the stimulus. Approximately 40 percent of the package was used for subsidies or budgetary credits to less efficient companies. The multiplier effect of such expenditures is usually less than one.4 Another 40 percent was allocated for additional social expenditures (e.g., pensions, transfers, subsidies to households), which tend to exhibit a multiplier of around one.5 Finally, no more than 20 percent of the package was used to increase investment, promote additional public demand and/or create incentives for companies with sound balances. Such policies would likely have had a multiplier of more than one.
3) The decline in tax revenues will not allow nominal budgetary expenditures to increase in 2010 but, taking into account the 10-12 percent inflation rate, this will nonetheless result in a real decline. And, as the government plans to cut investment and even current expenditures in 2010, the overall decline in public demand may be the deciding negative factor for the economy.
Positive developments in the commodities sector have not been reflected in the rest of the economy to date.
4) Another factor that may slow economic recovery is the banking system’s current “bad debt crisis.” Though authorities try to demonstrate optimism and declare that they see no serious problems, the overall amount of credit provided to the real sector continues to decline. Despite the fact that banks keep huge cash positions with the Central Bank and state-controlled banks are fueling credit as they receive funds and guarantees from the new budget, this decline has not been stemmed. This process is far from over; Russian banks will not resume lending before the year-end. In addition, Russia will have to use domestic savings to repay foreign debt instead of investing it for the near future, which will only hurt the recovery.
5) Finally, one should not overlook the overall quality of Russia’s economic policy. Weak monetary and budgetary policy have resulted in annual inflation rates of 12 percent, corruption abounds, the legal system is non-functioning, and the administration pressures the shareholders of many companies. These factors clearly contribute to an unfavorable business climate and only increase the challenges Russia’s economy now faces.
The Russian economy is likely to stagflate rather than recover.
Factors that may support optimistic forecasts for the country’s economy are limited to the commodities sector (e.g., oil, gas, metals, chemicals). The recovery of prices in international markets, ruble devaluation, and tax cuts for the oil sector helped the commodities sector boost profitability, maintain crucial investments, and repay debts. However, these positive developments have not been reflected in the rest of the economy to date. As a result, if there is no significant boost in the global economy and international capital markets do not recover immediately, the Russian economy is likely to stagflate rather than recover as high inflation (10–15 percent) combines with virtually zero growth (+/- 1 percent) in coming quarters.
1 All projections in this piece were made by the Development Center, unless otherwise noted.
2 This may be attributed to a general hope that this crisis, similar to the one that happened in 1998, will be V-shaped.
3 Private consumption represents slightly less than 50 percent of GDP.
4 One ruble of expenditures generates less than one ruble of GDP.
5 It is only around one because part of that money will be saved and another part of it will be used to purchase imported goods.