Slow and Steady Won't Win Russia's Economic Race

7 MINS READAug 14, 2019 | 09:00 GMT
Russian ruble coins are seen in this photo illustration.

Russian ruble coins are seen in this photo illustration. Russia may be staring at poor economic growth down the road.

  • As a result of persistent Western sanctions and low global energy prices, Russia will continue its efforts to insulate its economy.
  • The Kremlin has implemented an economic strategy that will enable it to prevent a major crisis in the short term — even if the United States continues to ratchet up sanctions pressure — but economic growth will likely continue to stagnate for the foreseeable future.
  • In the longer term, such efforts will undermine Russia's economic growth, just as other downward pressures like demographic decline and migrant outflows will weigh more heavily on the Russian economy amid rising political uncertainty.

From the worldwide slowdown and the U.S.-China trade war to growing uncertainty over Brexit and a seven-month low for oil prices, the global economy is contending with its fair share of challenges. It's all of great concern to Russia, which is no stranger to economic worries, particularly since 2014 when the country faced twin economic shocks — a crash in global energy prices, as well as the West's implementation of sanctions following Moscow's intervention in Ukraine.

The developments initially drove Russia into recession, as its gross domestic product contracted by more than 2.5 percent in 2015 before beginning a slow recovery in 2016. But since that time, U.S. sanctions have gradually expanded to cover everything from Ukraine to Russian political meddling in U.S. elections to Russian arms proliferation, affecting Russia's energy industry and finances, as well as hundreds of officials and oligarchs. In response, Moscow has worked diligently to blunt the effect of the sanctions, but its focus on merely putting out fires means it's not in a position to substantially grow the economy anytime soon — particularly as its population continues to decrease and questions emerge as to a successor to Russia's longtime president, Vladimir Putin.

The Big Picture

Given that Russia's standoff with the West shows no signs of abating, Russia has shifted its economic strategy to insulate itself from sanctions and weather low global energy prices. While this has enabled Moscow to avoid a major economic crisis for the time being, the conservative nature of the policies it is pursuing is likely to cloud its longer-term outlook, especially as the country faces demographic and attendant political challenges.

Weathering the Storm

Faced with the West's sanctions, Russia has undergone a significant macroeconomic shift over the last five years to limit its exposure to the United States and create a large enough financial cushion to manage future economic shocks in the event of more serious sanctions and low energy prices. Accordingly, Moscow has bolstered its foreign currency reserves and wealth funds; reduced external debt; drawn down its holdings of U.S. Treasury bonds in favor of euros, yen and yuan; and expanded economic ties with non-Western countries, especially China. Russia has also reduced dollar-based transactions with many of its key trading partners, opting to use the euro for nearly a third of its annual $108 billion in trade with China in the first quarter of 2019 and the ruble for two-thirds of its $11 billion in trade with India during the same period.

In addition, Russia has budgeted for a very conservative oil price of $40 per barrel to ensure that it meets its budgetary needs and avoids a budget deficit that would require foreign borrowing. Russia has also restricted imports of most agricultural products from the United States and the European Union while boosting support for its own agricultural sector. The move enabled Russia to decrease imports and raise food exports by up to $25.8 billion in 2018 — a huge increase over the pre-sanctions level of $16.8 billion in 2013.

As a result, the Russian economy has managed to weather the worst of the sanctions' blow, as the measures only slowed national growth by an average of 0.2 percent (or roughly $15 billion) between 2014 and 2018, according to the International Monetary Fund. In comparison, the fall in oil prices hit Russia three times as much, slowing GDP growth by 0.65 percent (or roughly $49 billion) per year over the same period. In the meantime, Russia's international reserves (including gold) stood at $520 billion as of July 19, up 11 percent from the end of 2018, while Russia's National Welfare Fund totaled $124.1 billion at the end of July.

These graphs provide an overview of Russia's macroeconomic fundamentals.

At the same time, Europe's hesitation to expand sanctions and the back-and-forth between Congress and the Trump administration has diluted the more disruptive impacts of sanctions on Russia. For example, the U.S. Treasury decided to reverse sanctions against major Russian aluminum company Rusal after the restrictions hurt the global aluminum industry. And in the second round of sanctions following the poisoning of former spy Sergei Skripal, the Trump administration decided to pursue a narrower band of debt instruments than was available to it, choosing to only bar U.S. banks from participating in the Russian primary debt market and exclude Russian treasury bills that are more popular with foreign investors. According to ratings agency S&P Global, such limited sanctions would not impact Russia's investment-grade credit rating — even in the event of more extensive measures that would also prohibit participation in the secondary market for Russian sovereign debt.

The Clouds on the Horizon

Its efforts to insulate itself from sanctions notwithstanding, Russia's economy is not in the clear moving forward. Russia's conservative fiscal and monetary policies have fostered some macroeconomic stability, yet they have also set the stage for longer-term stagnation. Indeed, Russia's tightened fiscal policy has cut economic growth by 0.1 percent per year, while restrictive monetary policies have cut growth by 0.2 percent, the IMF has reported. And according to Rosstat, Russia's official statistical agency, the country is estimated to have grown just 0.5 percent year on year in the first quarter of 2019. And for the first half of this year, the estimated GDP growth rate is just 0.7 percent over the first six months of 2018, according to the Economic Development Ministry. In the meantime, Russia's central bank downgraded its GDP growth projection from 1.2-1.7 percent to 1-1.5 percent for 2019, while the IMF and World Bank have projected a GDP growth rate of 1.2 percent.

Even this marginal growth could fall if the oil price drops further or the West expands its sanctions; indeed, the U.S. Congress is currently processing several sanctions bills, including a motion targeting the Nord Stream 2 pipeline from Russia to Germany and a more assertive version of the Defending American Security from Kremlin Aggression (DASKA) bill that was first introduced in the U.S. Senate last year.

Russia's efforts to insulate itself from sanctions notwithstanding, its economy is not in the clear moving forward.

Other longer-term issues are looming on the horizon as well. One key challenge is Russia's demographic outlook, as the country is projected to lose nearly 10 percent of its population by 2050. Indeed, the Russian labor force has already been shrinking for three consecutive years, according to the Presidential Academy of National Economy and Public Administration (RANEPA) and the Gaidar Institute for Economic Policy. In fact, the decrease in the workforce appears to be accelerating, as Russia lost 800,000 workers in the past year, compared with 100,000 people the previous year. Naturally, this will compound Russia's taxation issues, as the Kremlin will face the difficult choice of either taxing civilians more (thereby decreasing purchasing power even further) or putting the brakes on government spending.

Russia has also encountered obstacles in its efforts to attract migrants from neighboring countries like Ukraine and Armenia. While the country did manage to draw more non-Russian migrants in the first quarter of 2019, it is not clear that this positive trend will prove sustainable. At the same time, real incomes have been declining in Russia over the past five years as consumer debt rises and many young, skilled workers emigrate from the country. These trends will create shortages of high-skilled workers and limit access to advanced technologies, thus restricting Russia's ambitions in sectors like the space industry or the oil sector, where sanctions also limit access to foreign technology or funding.

Barring extreme external economic shocks such as an oil price collapse or the most aggressive form of sanctions, Russia's cautious economic policies will allow it to muddle through the next few years as Putin sees out his fourth (and perhaps final) term in 2024. Beneath the surface, however, Russia's deeper and more structural issues portend greater economic challenges for the country down the road — just at a time when the question of who will ultimately replace Putin creates its own political uncertainty.

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