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The Russian Economy: Is the Glass Half-Full or Half-Empty?

Despite a lack of structural reforms that will finally wean the Russian economy off its dependence on oil and gas, there are some encouraging signs for economic growth in 2017

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A sharp drop in oil prices in the winter of 2014 vividly revealed the structural economic problems in Russia, triggering an economic recession from which the country still has not fully recovered. The new reality of lower oil prices and sanctions has forced the Russian government to undertake certain steps aimed at adapting the economy to these new financial conditions.

As experts point out, Russia’s economic decline also coincided with a global economic development trend of lower growth. In general, the world is experiencing weak economic growth. According to World Bank data, global growth slowed down to 2.2 percent in 2016 from 2.6 percent in 2013. This slowdown coincided with the stagnation in global trade in 2016, the lowest it has been since 2013. Moreover, oil prices remain low, averaging $44.7 per barrel (bbl).

As a result, Russia is currently experiencing a sustained fall in real incomes, which keeps domestic demand depressed. In 2016 Russia experienced the most significant fall in real incomes since 2008, when the global economic crisis struck.

According to Russian Deputy Prime Minister Olga Golodets, Russia has experienced a rise in the number of people living in poverty since 2014. Professor at St. Petersburg State University Stanislav Tkachenko agrees, underlining that, while the tendency of falling living standards has been somewhat stopped, Russians are poorer today than at any time in the previous 7-10 years. “It is unclear what measures the government can utilize to change this situation,” suggests Tkachenko.

Such a situation has made many politicians and experts speculate about the possible rise of protest activity in Russia, especially on the eve of the national parliamentary elections in September. However, no serious protest has been organized and the socio-political situation remains quite stable overall.

According to recent pollsconducted by the independent Levada Center, only 12 percent of Russians are ready to protest against the falling living standards while 80 percent are not ready for that. In addition, 76 percent of the population think that protests against falling living standards are not likely to erupt and only 18 percent believe that they might happen.

Russian economy inches forward

In an attempt to assess how Russia is dealing with its economic challenges and whether it is succeeding in reforming its economy, the World Bank released its new analytical report. In general, amidst external headwinds, the recession continues in Russia, although at a slower pace.

According to the World Bank’s lead economist for Russia and the main author of the report, Apurva Sanghi, Russia’s economy is projected to contract by 0.6 percent in 2016 and grow by 1.7 percent in 2017. Oil prices are forecast to continue recovering ($55.2/bbl in 2017 and $59.9/bbl in 2018) and positively affect domestic demand. In fact, this pretty much correlates with Russia’s Ministry of Economic Development’s own forecast, which predicts Russia’s GDP contraction by 0.6 percent in 2016, 0.6 percent growth in 2017 and 1.7 percent growth in 2018.

In general, Russia continued its adjustment to lower oil prices in 2016 in an environment of economic sanctions. The report states that the Russian government’s policy response package of a flexible exchange rate policy, expenditure cuts in real terms, and bank recapitalization - along with tapping the Reserve Fund – has helped facilitate this adjustment.

The Russian government achieved quite impressive results dealing with the crisis: Unemployment remains at relatively low levels (5.6 percent), while inflation decreased twofold from 15.9 percent in September 2015 to 7.5 percent in September 2016. Despite unfavorable trends in global trade and international sanctions, which restricted Russia’s access to international capital markets, the balance of payments remains stable and in May, for the first time since 2013, the government successfully issued $1.75 billion 10-year Eurobonds with an effective rate of 4.75 percent.

Oleg Buklemishev, associate professor in the Department of Economics at Lomonosov Moscow State University (MGU) and a former assistant to the Finance Minister, largely agrees with the World Bank’s analysis: “Indeed, the Russian economy has successfully adapted to the multiple shocks caused by the crisis.

However, given those positive developments, budgetary consolidation threatens economic growth and the financial health of the regions, and the chronic decrease of the real income of the population and investment stagnation are taking place,” concludes Buklemishev. He also argues that the most important question – much needed structural reforms – has not even been addressed.

Negative details

However, despite this positive trend, it is unlikely to turn the tide in terms of building a more diversified economy, argues the World Bank report. Risks coming from oil price volatility and structural constraints remain in place, which places into question the overall sustainability of Russia’s economic growth.

The devil is in the details and this is exactly true with regard to the Russian economy. Inflation expectations are still high and the banking sector, though stable, remains vulnerable to macroeconomic risks of low growth and weak demand. With the active usage of the Reserve Fund, it is expected to be depleted in 2017. According to Russia’s Finance Ministry data, the Reserve Fund shrank by 64 percent from $88 billion in January 2015 down to $31.7 billion in November 2016.

Although the government made certain expenditure cuts in different spheres, it did not help to stop the federal budget deficit from growing: now it is 2.6 percent and expected to rise to 3.7 percent by the end of 2016. As Tkachenko notes, “The federal budget deficit will only continue its slow growth and might have negative impact in the form of low investment, weak economic growth and low purchasing power of the population.

However, the government developed a draft law on the federal budget, which assumes a conservative oil price of $40 bbl and associated medium-term expenditure framework for 2017-2019. It presumes budget consolidation mainly through expenditure cuts. They will be decreased by 3.7 percent of GDP over a three-year period, with the biggest cuts in national defense (1.8 percent), social policy (0.5 percent), and national security (0.4 percent). That might well help to improve the situation but it remains to be seen.

As Buklemishev told Russia Direct, “Prospects for the success of the import substitution policy and diversification of the economy are very much in doubt.” The World Bank’s report shows that, while exports have expanded in some non-oil sectors, such as textiles, wood processing, metal and metal goods, and agriculture, the total value of non-oil exports declined by 13.4 percent in 2016. In addition, over half of the non-oil sectors contracted.

Assessing the prospects

Thus, while the overall story about the Russian economy is a positive one, and Russian institutions are dealing ably with the challenges, they are mainly just reacting to these challenges as they occur. As World Bank Country Director for Russia Andras Horvai told Russia Direct, “There is an understanding in the Russian government that the new reality is in place and the country should adjust to it. But so far its policy has been reactive. In order to achieve long-term sustainable results, Russia should conduct proactive economic policy.”

“Unfortunately, active economic policy is absent in today’s Russia, which is a fair but hardly cheering assessment,” sums up Buklemishev.

Therefore, the World Bank and Russian economists characterize the situation in the Russian economy as unstable. However, they underline positive trends that appeared in the second half of 2016 as a result of the measures undertaken by the government and overall favorable tendencies in the global commodities markets.

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