The Russian Economy in Crisis

December – January 2014 | Companies and Markets

Most people perceive that Russia’s financial position is quite stable. The country’s currency reserves are around $500 billion, which is almost three times the public debt. But considering the slowing rates of economic growth, the high dependency on oil and gas, and the accelerating outflow of capital from the country, the 2014 macroeconomic forecast does not have any notable successes in store for Russia.

The Russian economy in the last quarter grew only by 1.2%, while the rate of growth of investments and industrial production is approaching zero, which are evidence that the economic situation in Russia is stagnating. The Russian Ministry of Economic Development (MED) expects that stagnation will continue in 2014, and that the depreciation of the ruble will be more rapid than previously anticipated. According to the MED, the economic growth forecast for 2014 has been lowered from 3% to 2.5%. Experts at the International Monetary Fund provide the same pessimistic macroeconomic outlook for 2014. The MED also lowered its longterm economic development forecast to 2030 from 4% to 2.5%.  Thus, the country will share last place with Brazil within the BRICS group of countries, by growth rate.

“In 2014 the country will be in recession, although the reduction in GDP will not exceed 0.5–0.7%,”  Vladislav Inozemtsev, Doctor of Economics and Director of the Centre for Post-Industrial Studies, told WEJ. “Government budget revenues for the first time in recent years will fall (by 4–7%) due to a reduction in tax payments and a slight decrease in the value of exports (primarily due to discounts on gas, a general reduction in its price, as well as falling metal prices). Business will continue to shy away from extremely excessive tax regimes, which will also impact declining budget revenues.”

Throughout the 2000s, the Kremlin directed revenues from oil and gas to the rest of the economy, mainly through public investment projects and by increasing wages and pensions. As a consequence, there was a rise in consumer consumption. Industrial potential carried over from the Soviet era has accustomed managers to think that it is not necessary in principle to invest additional funds into production. There is no need to maintain and modernize existing production capacity when it is possible to expand production by utilizing idle capacity. Today, such a model of economic behavior is outdated. According to data from the World Bank, the Russian economy is now very close to its maximum possible performance. Production is slowing down across the country, and growth rates of consumption – the main driving force of economic growth in the past – have also seriously slowed down compared to the previous year. And this is happening even though the number of consumer loans is much higher than ever before, unemployment is only about 5%, and the average wage has continued to grow. However, according to Mr. Inozemtsev, “real income growth will slow from 3.5% in 2013 to 1.5–2.0% in the coming year.”

Budget revenues in the coming years will likely decline. Russia is still a resource-based economy, and about half of its budget is replenished by proceeds from the sale of oil and gas. The price of oil that Russia can use to finance its budget without borrowing increased from $34 per barrel in 2007 to more than $100 in recent years. Currently, the price of oil remains high ($108.86 per barrel as of December 9, 2013), but it may fall due to increased production of shale oil in America, the development of new fields in Africa, and the increase in production in Iraq. But even the high price of hydrocarbons will not be able to solve all the problems of the Russian economy. It is currently structured based on the assumption of a high oil price. Therefore, future growth can be achieved only by increasing labor productivity and investments in new technologies. The government spending picture is not rosy. Currently 13% of the Russian population is comprised of people who are 65 years of age or older. By 2050 it is expected that this figure will rise to 23%, which means an additional burden in the form of pension payments and a parallel reduction in tax revenues due to there being fewer workers. In addition, the older the population, the more the state is forced to spend money on healthcare. We should not forget that Russia’s population is declining at an annual rate of 0.5%. Out of a country with 140 million people, there are currently 20 million public sector employees and 40 million retirees, which is a share that continues to grow.

Investment in Russia is slightly greater than 20% of GDP, which is below the average indicator for emerging markets (27% of GDP). In addition, most investments in the Russian economy are made in energy, which reinforces the old growth model based on natural resources. The opportunities for profitable investment in the country are very few, so holders of domestic capital seek alternatives abroad. In the first three quarters of 2013 alone, the outflow of savings of Russian companies to investments abroad amounted to $48.2 billion. In general, the country’s investment activity, according to Mr. Inozemtsev, “will fall by 7–10% as compared to 2013. Large companies will spend a significant portion of their funds on debt service, and will not take out any new large loans. Sales by medium and small businesses will be massive. Capital outflows could reach $70–80 billion and will probably exceed the figures for 2013. Inflation will remain relatively low due to the freezing of prices for goods and services provided by natural monopolies and will be around 6–6.5%. The decline in construction, manufacturing of building materials, and railway transport will be most noticeable.”

Continuing his predictions about how the Russian economy will develop in 2014, Inozemtsev told WEJ about the measures that the Russian government will take. “The government will revise the budget during the year, reducing the forecast of revenues and covering missing funds by attracting loans, including on foreign markets. This, however, will do nothing to alter negative trends in the economy, which will gradually grow. The year will post negative results due to an accelerating decline in the second and fourth quarters. The peak of the domestic crisis will be reached in the first half of 2015. To ensure that the budget is large enough, the authorities will adjust the exchange rate in favor of achieving gradual support of the ruble. By the end of 2014, I see the rate as being 35.0–35.5 rubles per dollar and about 48 rubles per euro. During the period under review, domestic peaks in these values, with subsequent correction, are possible. The Russian stock market will continue to stagnate with an uncertain downward trend. At the end of the year, the MICEX index will be around 1,300 points, with fluctuations in the range of 1,500–1,150 during the year.”

Text: Olga Irisova