Russian Economic Crisis

Since it came out from behind the socialist iron curtain in the closing days of 1991, Russia has taken sensational strides in transitioning from an isolated, centrally planned economy to a more integrated and market-driven one.

Endowed with some of the world’s richest resource reserves from oil to gas to precious metals, the country rode the commodity boom of the opening decade of the new millennium with an envied average annual economic growth rate of 7%.

And then came 2011, with the commodity super cycle running so hard it jumped its tracks and derailed. Russia, economists say, is now in a slow-motion derailment of its own.

What happened to one of the darlings of emerging economies? Once esteemed as one of the best four emerging markets in the world – becoming the “R” in the “BRIC” group of nations – is Russia about to succumb to the economic pandemic sweeping across Europe?

Rags to Riches – Thrice

Russia is not a novice when it comes to navigating financial crises. Its recent emergence as a free-market society actually stems from an economic crisis that ultimately brought down the ex-Soviet Union more than 20 years ago.

As Russia transformed its economy wholesale from top to bottom in the decade immediately following the collapse of the communist block, industries were privatized and desperately-needed foreign investment poured in over its borders. It was an economic revolution that took the nation on its first journey from rags to riches in very short order.

But transitions of that magnitude are never easy, and by 1998, the nation had stumbled into its first post-communist financial crisis, returning to the rags it so recently shed.

Yet this turned out to be a mere respite along the road to prosperity, with a much more powerful second wave of riches coming Russia’s way. In the opening decade of the new millennium, with its economy averaging 7% annual growth, a Russian middle class emerged with a real disposable income that had more than doubled. Russia had become one of the four most promising emerging markets in which to invest – alongside Brazil, India, and China, the hailed “BRIC” group of nations.

But as the new millennium’s first decade was coming to a close, the 2008-09 financial crisis that started in American and quickly engulfed the globe had invaded Russian territory as well. Russia’s ever increasing integration into the global market made contagion inevitable, especially given the nation’s heavy reliance on crude oil, which took a serious hit in price.

But the resilience of the Russian people to bounce back from hardship had – for a third time – enriched them yet again, with oil providing the bulk of the windfall. By 2011, the commodity super cycle had propelled Russia ahead of even Saudi Arabia as the new top oil producer, in second place among natural gas producers, first place in gas reserves, and second place in coal reserves, plus the top spot among platinum-group-metals producers.

Back to Rags Soon?

Yet the disproportionately large reliance on commodities that pushed Russia screaming past most every resource-based economy on Earth has now turned out to be its Achilles’ heel. The collapse of the commodity space from 2011 until present is threatening to drag Russia into recession.

While the nation’s economic planners have been steering the nation toward greater diversification since the 2008-09 crisis, with an increasing focus on manufacturing and technology, Russia is still too heavily dependant upon commodities to avoid a slowdown. Where 2012’s GDP grew at an acceptable 3.6%, 2013’s growth is expected to be less than half that at 1.6%.

At a time when the country really needs manufacturing to help offset lower revenues in the resource sector, industrial production’s growth has instead fallen from 3.1% during 2012’s H1 to a snail’s pace at 0.1% in this year’s H1. As a sign that things will only get worse, construction output this year is already down an alarming 8%.

Professors at the Moscow Higher School of Economics have strongly criticized the Russian government’s “unpredictable” economic policies. Income is on the decline as the foreign trade surplus is shrinking; while June’s exports rose 0.4% to $41.6 billion, imports rose by 5.7% to $27.9 billion. Rising inflation is making Russia’s reliance on imported finished goods more costly.

Meanwhile, problems financing economic expansion are being exacerbated by a reduction in foreign investments by 3.7% and an increase in capital outflows from a previously forecasted €25 billion to a more recent expectation of €40 billion. Russian economic experts are convinced the nation’s only remaining option is to increase public debt – to borrow.

Government Spin

Of course, as in any nation facing a negative economic outlook, ruling government officials come out to calm the fears of citizens and foreign investors alike. Far from calling it a slowdown, Russia’s Ministry of Economic Development has declared the country’s recent stagnation is nearing an end, citing foreign investment as a key driver behind its expectation of expansion during H2.

An optimistic Andery Belousov, head of the Ministry of Economic Development, believes “there will be a turning point in negative trends in the second quarter and that economic growth will surpass 3% in the second half of the year,” quotes the Russian news network RT.

But a leading Russian investment bank, Renaissance Capital, expects that rate to be not more than 2%.

The Russian government’s optimism is based on an upcoming stimulus package widely expected to stimulate growth. On July 27^th, the Russian central bank will put on offer $15.3 billion (500 billion rubles) in one-year loans with a floating rate of 5.75%. The measure has impressed Russian economists, including Rosbank’s Vladimir Kolychev, who praised the central bank for “rolling out the big bazooka”.

Russia’s economy minister, Alexey Ulyukayev, was reportedly confident that recession will be avoided. “Recession is not expected,” he predicted. “I think that the growth in the second half [of 2013] will be higher than in the first.”

Touch and Go

Weighing all the recent numbers of slower growth and lowered projections, it is difficult to see Russia simply skimming along the surface without splashing into the water. Its economy still extremely overweight resources, revenues will most likely continue to decline as low commodity prices have necessitated the closures of mines and scaling back of operations.

There is, though, one bright spot in the commodity sphere: the recent spike up in oil. A rising oil price can be an early sign of a recovering global economy. After two or three years of slowed production, it looks like the world’s factories are coming back online, and fuel demand is rising from crude oil to natural gas, with which Russia is richly endowed.

Another bright sunbeam shining on Russia’s economy will come from its central bank’s first stimulus package since the 2008-09 global crisis. What is more, with interest rates still in the 4 to 6% range, Russia’s central bank has plenty of room to lower borrowing costs should more stimulus be required. Russia is only at the beginning of such measures, with plenty of room to push the gas pedal down if its economy needs more oomph.

Since the second half of the year is historically a roaring good time for commodity and energy prices, perhaps Russia will avert recession after all – for now. But it is doubtful that it can escape the conflagration burning across Europe. If even America – which has had a head start over everyone else in implementing stimulus measures – has still not yet completely recovered, Europe for its part surely has many more quarters to go, and Russia is even further behind them all.

Remember too that Russia is still dependant on foreign investment. Given the global squeeze on liquidity, there won’t be much cash from the outside to help Russia diversify into manufacturing and technology. For a few years more, it will remain highly correlated to commodity boom-bust cycles.

Russia should manage to keep its head above the water during the second half of this year – again, due to the traditional strong period for commodity and energy prices and a newly instituted stimulus program.

But by the middle of 2014, it is doubtful Russia will have had enough time to build a defensive wall to keep Europe’s crisis from invading. The fire is spreading, and there is very little liquidity to put it out. Russia has only just begun to feel the heat. But it too will inevitably catch fire.

Joseph Cafariello

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