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Despite Sanctions, Russia's Economy Still Stuck With Oil & Gas

If Russia doesn't use this opportunity to diversify, it will never be able to leverage its huge economic potential 

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Russia has weathered sanctions and low oil prices better than most people imagined. The country is not going bankrupt. It’s too-big-to-fail banks have been thrown a lifeline by a fairly rich Russian Central Bank. And a totally free-floating ruble has been glued to oil. Oil goes up, the ruble goes up. If oil goes down, the ruble goes down. This movement has managed to keep Russia’s current account from dangerous deficit levels.

Yet, despite this, Russia remains wedded to the fortunes of oil and gas. Dutch disease, that nasty virus that attacks resource rich countries, is still in Russia’s blood.

Listen to Vladimir Putin or any of his cabinet speak about the national economy and they will inevitably talk about two thing: structural problems managing such a large country, and the government’s over-dependence on the energy sector.

One would think that after two years of oil falling nearly 50% below what the government based its budget would lead Russia to come up with new ways to develop money-making sectors of the economy. Russia can build space ships that orbit the Earth for decades and has a hotbed of cybersecurity geeks working both sides of the law that clearly it could become a more integral part of the global capital goods chain, like the Germans, or IT, like here at home in the States.

Russia continues to disappoint in this regard.

Dutch Disease is the Zika virus of one-note commodity countries. Increased revenues from natural resources — in Russia’s case oil and gas — impact the real foreign exchange rate and can lead to a decline in manufactured goods exports. The term owes its origins to the discovery of natural gas in the Netherlands in 1959 which ultimately depressed manufacturing activity for 20 long years.

The phenomenon has since been used to describe a diverse set of episodes in Norway and the UK in the 1970s, and Canada and Australiabeing the developed market’s version of Russia today.

For Russia, natural gas is clearly the vector. What does this vector bring? It brings in a steady and reliable stream of capital that leads to spending more on that sector to bring in even more capital flow. Wages rise. Energy sector employees spend it. The increased spending leads to real exchange rate appreciation and ultimately an uncompetitive manufacturing sector.

“Russia’s heavy dependence on energy production is clear, even when compared to other energy exporters,” says Daniel Hewitt, senior emerging markets economist with Barclays Capital in London. The direct effect of oil on Russian growth comes via net exports. A 10% increase in the oil price boosts net exports in Russia by about 8%. Only Venezuela and Saudi Arabia — both one-trick ponies — have a higher base effect.

This has not gone away, even as energy becomes less of a factor in Russia’s overall GDP growth. It now accounts for around 25% to 30% of Russian GDP.

Unlike other countries that have had resource dependency issues in the past, Russia’s Dutch disease is worn more like a curse.

Most resource rich countries underperform resource poor ones. It’s easy to understand, really. Resource rich people have easy access to low hanging fruit. In Russia, there’s natural gas all over the place. And it’s cheap to produce, not to mention well connected to Europe and China, two major consumers. Resource poor people don’t have access to low hanging fruit. They have to get up, find it, plant it, and deal with the elements.

Dutch disease has its side effects.  In Russia, this includes the increased incentives of rent seeking behavior and corruption.  Yukos Oil, once owned by exiled anti-Putin billionaire Mikhail Khodorkovsky, is the best example here if not the only one.  It also leads to weak institutions, particularly law enforcement and the courts. There are also issues over property rights, especially corporate property. There is a fear among foreign businesses in particular that their assets can be expropriated if they run afoul of the ruling United Russia party. Putin is the party boss.

Serious reform is hindered by an autocracy that is able to enjoy the benefits of monopoly and allows for more control over special-interest groups, including rich and powerful Russian oligarchs. Increased fuel dependency worsened governance in many post Communist states,according to some scholarly studies published by the World Bank. 

Other studies find a significant negative effect of natural resource abundance on long-term growth prospects.

A 10% rise in the ratio of natural resource exports as a percentage of GDP correlates with lower output growth of 0.4-0.7 percentage points, says Hewitt. For Russia, this implies a lowering of potential growth by 1.2-2.1 percentage points under the assumption that oil prices remain at current levels

Gazprom executive Alexander Medvedev told investors in New York on Feb. 1 that the company will actually increase supplies to Europe to record levels. Like the Saudis, the Russian state owned enterprises are frantically trying to strip Iran and the U.S. of market share before they become serious competitors. Europe, meanwhile, keeps buying.

Last year, Gazprom alone accounted for 31% of Europe’s natural gas imports and they plan to boost deliveries by 2% this year and even more next year, according to its non-public budget obtained by Bloomberg.

As such, says Hewitt, “all this implies potential growth in Russia could easily be zero as the resource curse and Dutch Disease implications play out.”


Source: Forbes
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