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Oh Mama: “The Sanctions Are in Tatters”

The unexpectedly strong Russian economy is growing immune to Western sanctions

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US President Barack Obama famously proclaimed in his State of the Union Address in January that Western sanctions had left Russia isolated and its economy "in tatters." But a slew of good news on the Russian economy prompted a European executive in Moscow to retort that it is the sanctions that are in tatters.

More and more investors and analysts seem to agree, like Newsweek and Bloomberg.

<figcaption>They thought they had the Russian bear cornered</figcaption>
They thought they had the Russian bear cornered

The ruble has made a spectacular 25% rise against the dollars from the end of January low. The Russian MOEX and RTS indexes have risen by 16% and 11% respectively in Q1 2015. According to data from Bloomberg, some 78 percent of Russian companies on the MICEX index showed greater revenue growth in the most recent quarter than their global peers did making them more profitable than other leading emerging markets corporations.

Most recent economic data points to a broader recovery across all indicators. Industrial production for the first quarter took analysts by surprise showing only a modest decline of 0.4% year-on-year. This could be compared with a 5.1% drop in industrial production (Jan-Feb) for the one of the sanctions imposing countries, Finland. We would expect that things will get only better with time. Q1 had to absorb the immediate shock. Russia will be better prepared for the future periods and import substitution and other industrial development programs will have a bigger impact later on in the year. And so does the large infrastructure and industrial investments and trade deals with China and Russia’s other Asian partners.

The strong industrial production figures correlate with a fairly robust labor market with unemployment at only 5.8%.

The vital trade balance is also recording gains as the drop in the dollar value of oil exports is more than compensated by imports, down by one third.

Western analysts like Anders Aslund and Paul Krugman made much fuss was about Russia's supposedly evaporating currency reserves following a forecasted capital flight as Russian companies would have to struggle to pay back their foreign debts.  We criticized the rationale of the analysis of Messrs. Aslund and Krugman respectively and have been proven right as the reserves have solidified at a level of $355 billion (down 26 percent). Economic analyst Elliott Auckland explained on the Awara Economic Outlook briefing in Moscow on Wednesday that the reduction of reserves should not properly be seen as capital flight but rather a deleveraging process Russian companies paying off considerable amounts of foreign debt without renewing the stock. According to Mr. Auckland this was a one-time problem and such significant amounts of repayments are not foreseen anymore.

This partially explains the ruble strength but the ruble appreciation has also been fueled by high interest rates. In its fight against inflation the Central Bank hiked the key lending rate to 17% and presently maintains it at 14%.  But the rates are expected soon to drop as the weekly inflation reading out this Wednesday showed a significant drop to 0.1%. This translates to a predicted future inflation rate at pre-crisis levels of 6 to 7%. Given these developments it is expected that the key interest rate would fall to 12% soon and perhaps 8% by year end.  

The Lowering of interest rates will revive the economy and normalize the economic situation as corporate, mortgage and consumer lending will pick up. Lower rates will also weaken the ruble, whose sudden strength is considered excessive.

In the backdrop of these figures it is not overly important what will be the actual GDP growth figure of the year. It could be anywhere from -3 to 0%. Whatever it is within that range is a good reading considering that this was the year Russia’s economy was supposed to be devastated and torn into tatters. And certainly Russia has had to cope with an extraordinary shock wave following the sanctions and the drop in the oil price. Not many expected that the Russian economy would be this resilient and become practically immune to the sanctions. From now on the West can bang its head all it wants with sanctions but Russia’s economy will stay put.

The fundamental fallacy that lured the West to think that the sanctions war would be an easy game is the gross misconception that Russia does not have an industry of its own and that it is only dependent on export of oil and gas, or as John McCain put it so poetically:  Russia “is a gas station run by a mafia that is masquerading as a country." – Not a good idea to actually believe in your own witticisms. Real data would have been available to show that Russia’s economy in fact was much stronger, more diversified and modern than the Western narrative insisted as shown by a study on Russia’s economy published last December.


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