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Russia enters 2016 coming off two recession years. The country’s GDP peaked at $2.15 trillion in 2013. In 2015 it will not exceed $1.2 trillion, and the Ministry of Finance and the Central Bank expect GDP to decline even further in 2016. Though 2014 was not technically deemed a recession year thanks to some statistical sleight of hand, Russia’s economy is now smaller than Mexico’s and is only the 15th largest in the world (or 75th based on per capita GDP).
Current trends in the Russian economy can be traced back 15 years, to the beginning of Vladimir Putin’s first term as president. By the time Putin took office in 2000, Russia was beginning to operate according to a rent-based economic model, with cash flows from natural resource exports increasingly consolidated in the hands of a small group of people closely tied to the Kremlin. Over the next twelve years, this model predominated. Budget revenues, gold and hard currency reserve volumes, GDP growth, and the exchange rate all began to correlate directly with oil prices.
Dutch disease was partly to blame. Russia could not escape the negative side effects of a booming natural resource sector despite enacting stringent measures to sterilize the money supply, and amassing gold and hard currency reserves that amounted to more than 33 percent of GDP. Foreign investment and credits flowed into the economy, but unlike “domestic” cash flows—which were largely tied up in U.S. securities—this money supply was expensive and sucked revenues out of the economy. At the peak of Russia's Dutch disease in 2013, the market-based exchange rate and the inflation-adjusted exchange rate differed by 50 percent.
Economic development was also crippled by the destruction of institutions, corruption, and the absence of legal protection for businessmen and investors. Moreover, the investment of petrodollar revenue streams into non-oil businesses began to decline sharply in 2009. Following a brief recovery from 2010 to 2012, GDP growth began to decelerate by 1.5 percent per year as a result of dwindling investment and shrinking capital expenses, even with petrodollars rolling in and the state openly embracing foreign investment. Structural issues quickly became visible at the macro-level, as the growing monopolization of the Russian economy and its dependence on state-controlled behemoths such as Gazprom, Rosneft, and Russian Railways led to high inflation.
Confident that oil would remain expensive and in demand in Europe in the long run, the Kremlin used primitive tactics to maintaining high approval ratings when stagnation began to set in. It raised wages in the bloated public sector (which accounts for 38 percent of Russia’s labor force) faster than the pace of GDP and productivity. It increased social security benefits unreasonably quickly. It spent budget funds ineffectively and irresponsibly. In 2013, wages in Russia rose by double digits and tariffs increased by more than 8 percent, even though GDP hardly grew at all. At the same time, investment, capital construction, and exports all declined.
In 2014, the shock of falling oil prices began to exacerbate Russia’s stagnation. This shock curtailed the country’s inordinate consumer consumption.The plunge in Russian GDP was less a reflection of reduced production value in the resource sector than of falling imports, and decreased spending by households and companies. The oil shock softened Russia’s skid into stagflation, while measures taken by the Central Bank kept gold and hard currency reserves sufficiently high, which allowed the ruble to lose half of its value compared to the U.S. dollar, and offset the Dutch disease that had ailed the country since 2005.
Low oil prices in 2015 ravaged all of Russia’s key economic indicators. Demand for durable goods shrank by almost half, imports plummeted 35 percent, trade turnover in rubles fell almost 12 percent, and foreign investment—which had fallen to almost zero in 2014—was nonexistent in 2015. A GDP decline of about 3-5 percent in real terms will be accompanied by inflation of at least 14-16 percent when all is said and done in 2015.
Nevertheless, Russia enters the New Year having nearly recovered from the effects of declining oil prices. Its gold and hard currency reserves are equivalent to roughly two years of imports, the ruble exchange rate is relatively stable, and inflation is gradually declining. Of course, the consequences of fifteen years of irresponsible economic policies won’t just disappear. Russia still has an undiversified rent-based economy with no institutional, technological, or demographic engines of growth.
Having survived the oil shock, Russia has simply returned to its long-term trajectory of stagnation, only now with a much smaller economy.
Still, 2016 promises to be even worse. Poor Central Bank policies have left the banking industry so crippled that it risks entering a period of instability reminiscent of the financial crisis of 1998. In a best-case scenario, Sberbank President German Gref’s prediction will materialize and 10 percent of Russian banks will have their licenses revoked. In a worst-case scenario, the collapse of one or two large banks will set off a chain reaction and cause panic throughout the entire banking system.
As the government has openly admitted, the two key programs it championed as panaceas for the Russian economy—import replacement and the pivot to China—are failing to yield the desired results. Import replacement is unfeasible with the unemployment rate below 5 percent and production capacity utilization at almost 90 percent. Meanwhile, China, which has never viewed Russia as a serious partner (Russia’s share of trade in the Asia-Pacific Region is 1 percent) has more important issues to deal with than a philanthropic pet project on its northern border.
The Russian government has thus far taken a wait-and-see approach to the economy. The 2016 budget leaves no hope for reform or for the development of economic alternatives to natural resources. Still, the government understands that it may face a crisis in the coming year, and is already openly discussing whether to substantially raise taxes on Russia’s remaining businesses and individuals (which would certainly intensify the recession and possibly reduce the tax base) or make significant cuts in social spending (which could spark mass unrest). It will be increasingly difficult for the government to resist the temptation to depart from its monetarist policies embracing the free movement of capital, market exchange rates, and limits on cash issues.
Russia certainly has enough reserves and economic inertia to make it through 2016, so there is no reason to expect serious changes immediately. Instead, the coming year is likely to feature a behind-the-scenes struggle between two special interest groups: those who will profit if industries are nationalized, and those who will benefit from globalization and foreign investment. Those who benefit from state financing and are pushing for complete nationalization will be pitted against those who want to buy up Russian businesses inexpensively and privatize them. The winner will emerge sooner or later, but probably not in 2016.
Carnegie does not take institutional positions on public policy issues; the views represented herein are those of the author(s) and do not necessarily reflect the views of Carnegie, its staff, or its trustees.
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