In Russia, Economic Recovery Remains Elusive

6 MINS READMay 1, 2015 | 09:02 GMT
In Russia, Economic Recovery Remains Elusive
A police officer guards the entrance to the head office of the Central Bank in Moscow on Dec. 17, 2014.

It appears there may be some good news for Russia's battered economy. On April 30, Russia's Central Bank lowered its benchmark interest rate from 14 percent to 12.5 percent. Earlier in the month, Russian Central Bank Governor Elvira Nabiullina announced that the ruble is "in more or less a balanced situation." Throughout April, after months of scrapped bond sales, Russia successfully auctioned bonds. Moreover, during his Direct Line television appearance April 16, Russian President Vladimir Putin said that the worst is over for Russia's economy.

But these seemingly positive signs do not indicate an overall long-term economic recovery. Russia's energy sector, mining industry and foreign businesses continue to face financial challenges. Ordinary Russians continue to experience food inflation and continued lack of access to affordable credit. Ultimately, these economic troubles will complicate, if not undermine, the Kremlin's ability to lead while raising its perennial fears of social unrest.

After falling about 40 percent in 2014, the ruble's value has begun to improve, rising by more than 17 percent so far this year and stabilizing at about 50 rubles per dollar. Russia's central bank has already cut its benchmark interest rate three times this year, and the stabilization of the ruble has led to greater confidence in the Kremlin's ability to manage the country's economic crisis. However, Russia's economic problems continue, creating difficulties for companies and ordinary Russians alike.

Energy and Mining Sector Difficulties

Russia's economy is highly dependent on natural resources. Consequently, fluctuations in global prices directly affect both the economy and government revenues. Russia's energy industry is key for government income and supporting public spending. However, low oil prices and Western sanctions targeting Russia are limiting the sector's growth. Both the United States and the European Union imposed sanctions in August 2014 that forbid exporting to Russia advanced technology used for exploration and production of oil and natural gas in Russian deep-water and Arctic offshore locations and shale formations. Usually importing about one-third of such equipment, Russian firms have been unable to purchase drilling equipment and rigs in the West, preventing long-term production and exploration.

In an effort to promote the use of domestic equipment, Moscow introduced a law that would require firms to present their purchasing plans to a special council. But increased reliance on domestic equipment is a concern for some energy firms. Such concerns were made evident April 29 when reports emerged that several Russian energy companies, including energy giants Rosneft, Gazprom, LUKoil and Novatek, sent a letter to Putin to protest the law.

The fall in oil prices is exacerbating the financial problems of energy firms as well. Rosneft is now seeking large-scale assistance from the government in order to remain financially stable in the face of $42 billion in debt due over the next two years. Moreover, due to the sanctions, Rosneft has few ways of accessing foreign credit. Other firms, such as natural gas company Gazprom, are also ailing. In late April, Gazprom reported a net profit of $3.1 billion in 2014, down 86 percent from 2013 and partially the result of Gazprom's reduced influence on pricing in Europe. With sanctions set to remain in place in the medium term and oil prices remaining relatively low, Russia's energy sector — and the Russian state it funds  — will continue facing substantial financial problems.

The mining sector, another key element of Russia's economy, is also suffering. In 2014, Russian mining giant Mechel, a major producer of coal, iron ore and steel products, lost 75 percent of its market value. The company also has $6 billion in debts. Mechel employs more than 70,000 people, and the Russian mining industry as a whole reportedly employs about 1.6 percent of Russia's total workforce. The declining fortunes of the industry similarly lower government revenues and could increase unemployment, contributing to protests and unrest.

More Effects of the Downturn

But Russia's economic challenges go beyond its extractive industries. Sanctions, a volatile ruble, the crisis in Ukraine and low oil prices also led to a decline in foreign investment in a variety of Russian sectors while disrupting or reducing the operations of foreign firms in Russia.

One sector where foreign firms are experiencing large losses is the auto industry. Car sales are an indicator of consumer sentiment; in past years, Russia's improving economic conditions led more Russians to purchase vehicles. Many foreign carmakers have manufacturing centers in Russia, as the country was at one time regarded as a highly promising market for car manufacturers. Foreign carmakers invested in Russia believing that the country's growing middle class would purchase personal vehicles.

However, the current crisis has greatly reduced consumer demand for cars, despite an initial rush to buy vehicles as a way of investing in durable goods when the ruble's value plunged in December 2014. The downturn reduced the purchasing power of Russians, the ruble's fluctuations made production more expensive, and high interest rates decreased demand.

Car manufacturers responded. In March, General Motors announced that it would cease most of its production inside Russia by the end of the year and close its factory in St. Petersburg. Other companies followed suit, at least temporarily: Citroen and Mitsubishi stopped production of some models at a joint venture for three months starting in April.

After plunging in January, car sales have gradually recovered, buoyed by the strengthening ruble. Nevertheless, Russia's March car sales were more than 40 percent lower than March 2014 sales. Russia's broader economic problems, specifically high inflation and relatively high interest rates, are again responsible for a sector's weak recovery.

Russian Citizens Feel the Impact

Russia's economic woes are directly affecting daily life inside the country. On April 29, the deputy chairman of Russia's Sberbank reported that the bank had seen a 30 percent decline in applications for retail loans compared to the previous year. High interest rates are dissuading Russians from taking out loans, and while the April 30 interest rate cut to 12.5 percent is a positive signal to businesses and consumers, the rate is still high compared to the 7.5 percent interest rate just a year ago. Loan rates are not likely to rebound quickly.

Inflation is also a major problem for Russia's citizens. A ban on Western agricultural goods, combined with the ruble's fluctuations, has led to a marked increase in food prices. Ordinary Russians are expected to spend more than half their income on food this year. The Kremlin is aware of the dangers of high food prices; inflation and food shortages have contributed to the fall of every Russian government since 1917. To pre-empt unrest over Russia's perceived failure to provide sufficient alternatives, Putin dismissed Agriculture Minister Nikolai Fyodorov on April 22. Nevertheless, with no announcements of significant policy changes, personnel shifts may not be enough to prevent dissatisfaction or unrest over agricultural policies and high food prices.

The stabilization of the ruble has relieved some economic pressure; the Central Bank no longer spends large amounts of its reserves on supporting the currency. International markets have also become more open to investing in Russian bonds. But Russia's economic troubles are still hampering several sectors, and firms, domestic and foreign, are struggling to operate in Russia. They are also affecting ordinary Russians' ability to take out loans and afford food.

Russia's dependence on natural resources will ensure that its economic recovery will in part be contingent upon factors outside Moscow's control, such as world energy prices. While the Kremlin is working to address these challenges, using tools such as a bailout fund and gradually lowering interest rates, the effects of the economic crisis are likely to continue, as are the threats of large-scale protests or political shake-ups that go along with them. 

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