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Slipping on oil

As the Russian economy faces its toughest challenge in two decades, Putin’s government is looking to engage partners like India and China for financing and investments.

Published: December 8, 2014 12:15:29 am
the positive factors mentioned earlier are not sufficient to withstand the downward pressure of sanctions and the oil-price crash. (Source: Reuters photo) the positive factors mentioned earlier are not sufficient to withstand the downward pressure of sanctions and the oil-price crash. (Source: Reuters photo)

By Sergei Guriev

Russia is facing its most difficult challenges since the 1990s. The economic slowdown — driven by corruption and lack of reforms that resulted in capital outflow and fall in investments — had already started last year. However, this year has added two more major and unusually strong headwinds.

First, following the annexation of the Crimea and the escalation in eastern Ukraine, the West introduced sanctions against major Russian state-owned banks and oil companies. The sanctions closed the banks’ and companies’ access to Western financial markets and technology (badly needed for exploring new oil fields). In addition to  official sanctions, Western banks and markets also stopped financing even those Russian corporations not formally on the sanctions lists. This raises a question as to whether Russian banks and corporations will be able to refinance their foreign debt of almost $700 billion (out of which about $300 bn is due in the next couple of years). Fearing possible additional sanctions, capital flight accelerated further.

Second, oil prices went down by about 40 per cent. Given that oil and gas constitute about two-thirds of Russian exports and account for approximately half of government revenue, this is a critical problem for the Russian rouble and the budget.

The Russian economy is not going to collapse overnight. There are many grounds for optimism. The Bank of Russia (or the Central Bank of the Russian Federation) has moved to the floating exchange rate regime that will help buffer the shock and increase the competitiveness of Russian firms. Also, the Central Bank still holds substantial reserves (about $400 bn) that can help refinance the external debt of the corporates.

The fiscal position is also not desperate. Russian sovereign debt is very low (13 per cent of the GDP). In addition, Russia has about 9 per cent of the GDP in two sovereign funds, the Reserve Fund (RF) and the National Welfare Fund (NWF). Finally, there are many countries that have not introduced sanctions against Russia — most importantly China, but also India, Turkey, Brazil and Argentina. Russia is now trying to engage these partners to attract financing and investment.

Unfortunately, the positive factors mentioned earlier are not sufficient to withstand the downward pressure of sanctions and the oil-price crash. China does not seem to be able or willing to replace the West — and other partners are even less likely to do this. Even $400 bn is not enough to support Russian banks and corporations over the next several years. And the sovereign funds are likely to be get exhausted in the course of the next two to three years. The NWF is already committed to infrastructure projects — notoriously overpriced due to corruption — and to supporting state-run banks and companies suffering from sanctions. The RF will have to be spent to make up for the government budget deficit by 2016 or 2017. As the Russian government will not be able to borrow, it will have to make substantial spending cuts that will result in serious political risks.

Another risk is the likelihood of the government’s own economic policy mistakes. In August, it imposed an embargo on agricultural imports from the EU and the US. This, of course, hit Russian consumers much more than European exporters (the US has not felt the impact of these “counter-sanctions” at all). Moreover, the government did not take into account the fact that it previously joined a customs union with Belarus and Kazakhstan, who did not rush to join Moscow’s anti-Ukrainian and anti-European policies. Naturally, European agricultural products immediately arrived in Russian markets through Belarus. Russia reacted with “sanitary” bans against agricultural imports from Belarus, effectively destroying the customs union it has been building for many years (and disagreement over which eventually led to the current crisis in Ukraine).

Not surprisingly, the markets believe that the Russian economy is in serious trouble. In the last week, the rouble lost 20 per cent against the dollar or the euro. The net outflow in 2014 is expected to exceed $120 bn — more than double the 2013 level. Stock prices went down to mid-2009 levels. Unlike just three months ago, the consensus forecast for 2015 is that the Russian economy will be in recession and will decline by at least 1 per cent — and many analysts except a 2 per cent decline or worse.

What do Russia’s economic problems imply for politics and international relations? The ultimate goal of the Russian government — of any government — is to stay in power. As the Russian government cannot afford to step down, its stakes are certainly much higher than those for any democratic government. What will Russia do? One scenario is the Russian government will withdraw from Ukraine, which is unlikely. Such a move would undermine its domestic political credibility (given a whole year of nationalist propaganda). Another scenario is that Russia will continue to undertake “non-conventional foreign policy”. This year has shown that annexing new territories helps boost domestic political approval ratings — even amidst economic troubles. This strategy will be disastrous in the long run, but it may help the government stay in power for the immediate future. What is certain is that the Russian government is facing unresolvable challenges and its future actions are hard to predict.

The writer, an economist, was rector of Moscow’s New Economic School and closely associated with Russia’s economic transformation until his resignation in April, 2013, following his co-authored critical report on the Mikhail Khodorkovsky trial. He is currently with SciencesPo, Paris

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