Russia's Recession: A Necessary Re-Balancing

Russia's recession is necessary to re balance the economy after the rouble devaluation and the oil price fall.  Meanwhile the Western sanctions ensure that it is the West which is blamed.

Fri, Jun 5, 2015
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Recession sure - but no collapse many hurried to predict

My fellow contributor to Russia Insider, Dr. Gilbert Doctorow, has published a piece criticising attempts to “sugarcoat” the state of the Russian economy (see Stop Sugarcoating Russia's Economic Situation, Russia Insider, 30th May 2015).

He is right to do so.

The picture Dr. Doctorow describes is of an economy in recession. That was also my impression during a brief visit I made to Moscow in the run up to Easter.

That the Russian economy is in recession is not in doubt. There is also no doubt of its cause: the steep devaluation of the rouble last year caused by the collapse in oil prices.

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The fall in the value of the rouble has caused inflation to surge and this has led in turn to a sharp fall in real incomes - the first time that has happened since Putin came to power.  

That fall has been made worse by the government’s decision to cut spending to limit the size of its budget deficit. Part of that cut involved a 10% cut in pay for state employees, which has reduced real incomes further.

The fall in real incomes has in turn led to a steep fall in consumer spending, which explains the failure of the small businesses (which depend heavily on consumer spending) that Dr. Doctorow saw and which in his article he writes about.

The Russian government and the Central Bank have responded to this situation by prioritising inflation reduction. That explains the still very high interest rates (currently 12.5%) and the budget cutbacks.

Inflation reduction has in fact been the government’s and the Central Bank’s priority since 2012, when the simultaneous tightening of fiscal and monetary policy first caused economic growth to fall.

The high interest rates have however inevitably taken a toll on capital lending and investment, which explains the difficulties there are in obtaining credit in the secondary housing market and in the agricultural sector that Dr. Doctorow writes about.

In my opinion the high interest rates bear a greater responsibility for the tightening of credit conditions than the sanctions.  

The sanctions have undoubtedly created difficulties for the big Russian state banks - which are obliged to meet their foreign debt payments in full - and are therefore obliged to deleverage faster than they might have wished whilst being at the same denied access to western financing.  

However there is no doubt Russian banks can meet their debt payments as can Russia as a whole (see Doomsayers Proven Wrong: Russia Has Not and Will Not Run Out of Money, Russia Insider, 4th June 2015).  

Once interest rates come down there should be more than sufficient money available from domestic sources to cover the needs of the domestic economy.  Western scare stories that sanctions will cause a credit crunch that will cause the entire economy to grind to a halt are misplaced.

The big question is how quickly inflation and interest rates will come down.

Inflation is currently running at an annualised rate of 15.8% - down on its level at the start of the year of over 17%, and a faster reduction than many expected.  Interest rates have fallen from 17% at the start of the year to a still high 12.5% now.

There is still however a long way to go.  

I am one of those who thinks the Central Bank could bring interest rates down more quickly than it is doing without this causing the economy any major risk. However the decision is not mine to make and the Central Bank ever since 2012 has made it clear that its priority is inflation reduction over growth, with a medium term inflation target of just 4%. The Central Bank has also repeatedly made it clear that it will pursue a tough interest rate policy to achieve it however hard that is and however long it takes.

Experience of other economies with chronic inflation problems (such as Britain in the 1970s to 1990s) suggests that for inflation to be squeezed out of the system economic policy must be geared to that objective. This inevitably reduces growth, at least in the short term. 

That seems to be the situation Russia is in now. It has been clear since 2012 that the Russian authorities have prioritised inflation over growth. 

Having said this, provided inflation does indeed continue to come down at the rate it is currently doing, monetary policy will ease, eventually to the point when it will bring the current recession to an end.

Dr. Doctorow’s assessment of the state of the Russian economy is therefore essentially correct. The economy is indeed in recession.

However that does not mean that there is a crisis or that the recession Russia is currently going through is in any way exceptional.

The one further comment I would make is that I don’t personally know of anyone who doubted when the rouble fell last year that Russia would experience a recession in 2015. The debate as I recall it was not whether or not there would be a recession. It was whether there would be a recession or a full=scale collapse, with the Western commentariat mainly predicting a collapse.

It is now quite clear that there will not be a collapse - a fact Dr. Doctorow makes himself.  

The only question is how deep the recession will be. As of the time of writing it appears that it will be shorter and shallower than most people (including the Central Bank) were expecting last year, with the lowest point probably being reached in the second or possibly the early part of the third quarter.

As I discussed in two long pieces discussing Russia’s credit downgrade, recessions for all the pain they cause are an unavoidable and even necessary fact of economic life (see Russia Credit Rating Downgrade Is Blatantly Political. Here's Why, Russia Insider, 12th January 2015 and see How the Credit Rating Agencies Got Russia Completely Wrong, Russia Insider, 28th April 2015). Given the scale of the devaluation last year, a recession was not just inevitable.  It was necessary, in order to enable the economy to rebalance away from its reliance on foreign capital and imports.

It is that rebalancing we are now seeing and which is causing the recession that Russia is currently going through.  

I will finish with one final observation.  

At the same time that Russia finds itself in recession and Russian living standards have fallen, Putin’s popularity and that of the Russian government has hit unprecedented levels.

That is the reverse of what one would normally expect in such a situation.

I would suggest the main reason for that is the sanctions and that it is in fact the chief result of the sanctions.  

If there were no sanctions and the economy had been hit purely by the oil price fall and the rouble collapse, then it is difficult to believe Putin’s popularity would have held up, let alone increased to the stratospheric levels we are now seeing.  

As it is, though the economy’s difficulties have actually been caused far more by the oil price fall and the rouble collapse than the sanctions, virtually every Russian thinks otherwise and blames the sanctions.  

Since the sanctions are universally seen as wrong and unfair - Dr. Doctorow himself comments on the extraordinary burst of patriotism that is underway and which the sanctions have in large measure provoked - they have caused Russians to blame the fall in their living standards not on Putin but on the West.

In other words, and not for the first time, the West has acted in a way that actually helps Putin politically, explaining why after 15 years he remains in power with no challenge in sight.  

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