Is Russia weakening economically?

-DR. ABDUL RUFF COLACHAL

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Stagnation

Most Russians, if not all, feel the loss of super power status to USA and they also see a deep rooted conspiracy against Russia by the Western powers seeking to impose imperialist norms on the course of intentional politics. However, they don’t want to be dictated terms f by USA and Europe.

The ongoing confrontation with the West has caused Russia huge money loss, upsetting economic diversification Russia sought in the post-Soviet era. The Kremlin may have withstood the pressures due to economic sanctions from USA and Europe. Though Moscow could somewhat protect and sustain its economy from reeling under the pressure but its economy has not moved further up as the impact of sanctions has been tough. 

Economists spot a new era of stagnation in Russian economy. According to the IMF, the Russian economy was already in recession from early 2014 mainly as a result of the 2014 Crimean crisis and the subsequent capital flight. But this turned out to be false and the IMF revised its rhetoric to close to being in recession and a forecast of 0.2% growth in 2014 and 1.0% through 2015.  Foreign investment in Russia is very low. Cumulative investments from US sources of about $4 billion are about the same as US investment in Costa Rica. Over the medium-to-long term, Russian companies that do not invest to increase their competitiveness will find it harder either to expand exports or protect their recent domestic market gains from higher quality imports.

Russia is unusual among the major economies in the way it relies on energy revenues to drive growth. The country has an abundance of natural resources, including oil, natural gas and precious metals, which make up a major share of Russia's exports. As of 2012 oil and gas sector accounted for 16% of the GDP, 52% of federal budget revenues and over 70% of total exports. Russia has a large and sophisticated arms industry, capable of designing and manufacturing high-tech military equipment, including a fifth-generation fighter jet. The value of Russian arms exports totalled $15.7 billion in 2013—second only to the USA. Top military exports from Russia include combat aircraft, air defence systems, ships, submarines.

Oil

Economy of Russia is a mixed economy with state ownership in strategic areas of the economy. Market reforms of the 1990s privatized much of Russian industry and agriculture, with notable exceptions in the energy and defense-related sectors.

Russian economy depends on the sale of arms, oil and gas, among other goods.  The Russian economy has risen and fallen over the past decade largely on the price of one commodity: oil. High prices meant prosperity, and a fall to $38 per barrel following the 2008 financial crisis sent Russia's currency and GDP plummeting.  Now, with the price of oil below $95 to a barrel and the United States steadily increasing oil production, Russia is looking to a future where that reliance could well become a liability.

Russia runs regular trade surpluses primarily due to exports of commodities. Russia main exports are oil and natural gas (58% of total exports), nickel, palladium, iron and chemical products. Others include: cars, military equipment and timber. Russia imports food, ground transports, pharmaceuticals and textile and footwear. Main trading partners are: China (7% of total exports and 10% of imports), Germany (7% of exports and 8% of imports) and Italy. This page includes a chart with historical data for Russia balance of trade. 

Logic

Crony capitalism imposes stagnation in any big economy. Russian economy is the sixth largest in the world and also suffers from crony capitalism.  New Russia just promoted private economy without any control over the growth of crony capitalism. Between 2000 and 2012, Russia's energy exports fuelled a rapid growth in living standards, with real disposable income rising by 160% in dollar-denominated terms this amounted to more than sevenfold increase in disposable incomes since 2000.  However, these gains have been distributed unevenly as 110 wealthiest individuals were found to own 35% of all financial assets held by Russian households. Since 2008 Moscow has been repeatedly named the "billionaire capital of the world" by Forbes. 

The Economist published a "crony-capitalism index" in March that evaluates the wealth of billionaires holding monopolies or direct ties to the state, and compared that with their respective countries' gross domestic products. Russia placed second after Hong Kong. The authors of the study hoped that visible global historical trends would continue and that oligarchs in developing countries would gradually shift their holdings away from revenues made possible through government connections to more transparent types of businesses. That might eventually happen in Russia, but obviously not soon. With the country practically at war, the "crony capitalism" and "crony socialism" systems in place will probably only intensify.

Close Kremlin associates who received business preferences in peacetime can now expect to receive direct government bailouts as compensation for losses caused by Western sanctions, with leaders extorting that money from other Russian businesspeople or even seizing their businesses outright.

The government plans not only borrow against Russia's future development; they reallocate funds already earmarked for current investment and infrastructure projects, putting the eventual realization of these projects at risk. According to Russia's Economic Development Ministry, the government might pull money from frozen pension funds to bolster the beleaguered oil and gas sector, or else raid the Reserve Fund, which ironically was first created to protect the Pension Fund from losses.

Russia faces years of stagnation even before the Ukraine crisis and is ducking decisions needed to achieve a new economic model.  Moscow has decided to undertake few steps to contain the recession process.  Cuts and investment as reform package are considered vital. 

Many leaders in Russia have questioned, at least quietly, the logic of the confrontation with West with the West over Ukraine. Former finance minister and a leading liberal Alexei Kudrin, a long-time ally of Russian President Vladimir Putin, is one of the weightiest figures questioning government policy at a time when Russia is feeling the economic chill from confrontation. Kudrin who shepherded Russia's finances for over a decade before resigning in 2011 in a row over rising government spending says there will be stagnation and recession, adding there would need to be a renewal of the government to achieve change. Kudrin reiterated his calls for liberalizing economic reforms in order to create a new economic model, which, according to him, also requires a "renewal" of the government. 

Kudrin said at the Reuters Russia Investment Summit that Russia’s depressed economic growth will be exacerbated by isolation from global markets. He expected that it would be years before Russia was able to borrow again on global financial markets. Another case in point is Russia's attitude to the World Trade Organization, which it joined in 2012, prompting hopes of economic liberalization. "Russia in essence will temporarily not observe the rules of the WTO, he said, I'm afraid that we'll have an exclusionary regime for more than one year. I think it will happen for several years and it will be difficult to return." 

Kudrin argued failure to introduce long-discussed reforms was a sign that the government lacked both political will, and people capable of introducing reforms. He even suggested that around 6 percent of gross domestic product spent on subsidies should be redirected to areas such as infrastructure investment. The government also needs to break generous spending promises — known as the "May decrees" — made by Putin after his 2012 election.  "The economy can't stagnate and policy continues as if nothing had changed." Instead of facing up to the new realities, a three-year budget approved recently lacked needed reform measures, showing that the government was ducking hard decisions. 

Kudrin said that, despite the repercussions of the Ukraine crisis, he was confident Putin was committed to economic reform in the long term, with no desire to turn Russia into a closed economy. 

Although the current economic stagnation resembles the one during the last part of Soviet era,   the present crisis is set to overcome the difficulties sooner or later. By the 1970s when the Soviet Union had entered the era of Stagnation, the complex demands of the modern economy and inflexible administration overwhelmed and constrained the central planners. The volume of decisions facing planners in Moscow became overwhelming. The cumbersome procedures for bureaucratic administration foreclosed the free communication and flexible response required at the enterprise level for dealing with worker alienation, innovation, customers, and suppliers. During 1975–85 corruption and data fiddling became common practice among bureaucracy to report satisfied targets and quotas thus entrenching the crisis. Since 1986 Mikhail Gorbachev attempted to address economic problems by moving towards a market-oriented socialist economy. Gorbachev's policies had failed to rejuvenate the Soviet economy, though. Instead, Perestroika set off a process of political and economic disintegration, culminating in the breakup of the Soviet Union in 1991.

That may not be the case now primarily because Putin is not Gorbachev.   

Support

The moderate recovery that was under way at the end of 2013 has been halted by the turbulence related to the events in Ukraine. Associated increased uncertainties and capital flight are now weighing on investor confidence. Consumption growth will weaken as real income growth slows and consumer credit becomes more expensive. The weak rouble will provide some support to the slowing economy and the budget.

Tensions over Ukraine and international sanctions weigh heavily on the economy, which is forecast to grow by 0.7% in 2014-15. The weaker rouble and Russian counter-sanctions on western food imports will push up inflation and hold down household consumption. Business sentiment has worsened and investment will contract sharply. Government finances will come under increasing strain from 2015. If sanctions are prolonged for several years they could significantly impair potential oil output.

The European Union has imposed sanctions on Russia's finance, defence and energy sectors and has frozen the assets of some 140 Russian and Ukrainian individuals and companies over Moscow's role in Ukraine. 

Some economists have suggested that state support for manufacturing is one crucial way for a resource-based economy, such as Russia's, to insulate itself from these price fluctuations and spur economic growth. The new manufacturing enterprises first require investment, which is increasingly hard to come by in Russia, where Western sanctions have cut off state-owned banks from EU and US capital markets, thereby raising the cost of lending across the board.

Valery Mironov, chief economist at the Higher School of Economics' Center for Development argues that support must be administered with extreme caution, however, as the money funneled into government programmes could simply disappear due to corruption and institutional inefficiency.  Spending on infrastructure and trimming state spending is, of course, only half of the story. Economists say Russia's economic future will have less to do with government spending than with renewing the influx of investment. They quote VTB Capital which currently employs less than 20 people in the United States. Financial sources say VTB Capital has already cut and relocated some staff in London and New York this year. 

VTB Bank, Russia's second-largest bank by assets, was sanctioned by the United States and European Union in the summer over Moscow's role in the Ukraine crisis, limiting its access to international capital along with other Russian state banks. Russian investment bank VTB Capital is switching focus to Asian markets, the chairman of the bank's board of directors said, after the West imposed sanctions on its parent, VTB Bank. VTB Capital has slipped to third in a ranking of investment banks in Russia by fees earned so far this year, according to data compiled by Thomson Reuters and Freeman Consulting Group. 

Russia faces isolation from global market institutions for a similar length of time. These predictions, which contrast with more optimistic official forecasts, will be sobering for investors hoping that the end of a conflict in eastern Ukraine would also mean an easing of Russia's economic problems.  Even if Western sanctions were not intensified further, economic growth would be 1 percent lower than it would have been for at least three years.

Shift

As Russia slowly moves from West to Asia, Asian investors are concerned about the Russian impact of sanctions, even if they are not directly prohibited from dealing with sanctioned entities, and there has been little appetite in Asia for equity and debt issues by Russian firms this year. Gazprom completed a stock listing in Singapore in June but did not raise any new funds. Asian investors, however, are concerned about the impact of sanctions, even if they are not directly prohibited from dealing with sanctioned entities, and there has been little appetite in Asia for equity and debt issues by Russian firms this year. Gazprom completed a stock listing in Singapore in June but did not raise any new funds.

Russia's  Rosneft's chief Igor Sechin, a close ally of Putin, has been on the US sanctions list since April. Rosneft itself was added to the list in July. Rosneft is preparing to more than double oil exports to China to over 1 million bpd, seeking to secure market share and billions of dollars in pre-payments. Vankor project is vital for Rosneft to meet its growing commitments to supply Asian markets, above all China. In a major about-turn, given the Kremlin's long resistance to allow its powerful neighbour access to such deposits, Putin last month said he welcomed the idea of China joining the prized Vankor field.  

Rosneft has offered stakes in its two east Siberian oilfields to India's Oil and Natural Gas Corp , as the sanctions-hit Russian company looks beyond Western firms to develop its vast resources. The sanctions imposed on Russia by the United States and Europe to punish Moscow for its incursion into Ukraine, have cut Rosneft's access to Western financing and technology. Rosneft has offered an up to 49 percent stake in Yurubcheno-Tokhomskoye and 10 percent share in Vankor field to the state-run ONGC.  ONGC would firm up its decision on participation in the two projects before the planned visit of Russian President Vladimir Putin to Delhi in December, this source said, adding the two fields are in geologically challenging areas. 

Production at Yurubcheno-Tokhomskoye will start in 2017. The field is to supply Asian markets via the East Siberia-Pacific Ocean pipeline and feed a yet-to-be-built petrochemical plant in Russia's Far East.

India says Russians need money and want to hire partners from Asia. They want to demonstrate to the USA and Europe that there are partners available for them.  

The current crisis provides an opportunity for Russia to diversify its foreign economic relations in Asia  as well.  What's more, the new contacts with Asia will endure even after the current sanctions are lifted.

Ways

A significant number of the economic sanctions that the United States and European Union have imposed on Russia involve not just restrictions on exports of advanced and dual-use technologies, but also technology aimed at purely civilian use. And, in contrast to restrictions on Russia's financial and energy sectors that are also painful for the West, the blockade on technology exports might remain in force for decades. An example is the restrictions that the U.S. and Europe placed on military technology exports to China in 1989 in response to events on Tiananmen Square. Those restrictions remain in place today, even though the events that prompted them have receded into history and economic relations between the West and China have greatly improved during the intervening years.

The West has long enforced numerous informal restrictions on technology exports to Russia. Russian industries have often faced refusals when attempting to purchase highly complex U.S.-made industrial equipment that Washington willingly sells to its allies. But now the West has formalized those restrictions and will not cancel them in the foreseeable future. That forces Russia to look for alternative suppliers of complex technological equipment, and China is the logical first choice.

However, Russia needs basic technologies from the West for at least 20-30 years. Economists suggest the higher fiscal revenues from the increasing rouble value of oil revenues (reflecting rouble depreciation) should be used to support the weaker domestic economy. Priority should be given to growth-enhancing spending programmes, in particular education, innovation and active labour market programmes.  The Central Bank of Russia should maintain its transition schedule to a full inflation-targeting framework, but will have to balance transitory inflation changes related to currency movements against the need to prevent inflation expectations from unanchoring. 

Although the Ukraine-related sanctions are set to weigh heavily, they were not the only major reason why Russian economic growth is now stalling. Today the decline of Russian economic growth is not so much the result of sanctions as of the lack of reform of the economic system, at a time when the oil price is not rising but falling. Whereas the oil price rose steadily during the previous decade, the price has now peaked and is likely to keep falling over the years ahead. One result is that within three or four years Russia would see a fall in its oil-and-gas tax revenues equivalent to around 1.5-2 percent of economic output ($30-40 billion) per annum. Russians need another economic model. 

To compensate for these trends, Russia needs to develop new oil-and-gas resources in the Arctic and Far East as quickly as possible. But Western sanctions mean that the process will be slower and more difficult than otherwise, restricting Russian oil companies' access to needed Western technologies. Russia needs the west.

The uncertainty in the political climate arising out of conflict with West has to end first and then only growth would follow. Russia has bought around $5 billion worth of VTB Bank's preferential shares in a bid to shore up its Tier 1 capital ratio, which in the first half dropped below the 10 percent level required by the central bank. The VTB Capital had weathered the effects of sanctions on its parent bank well, despite lower volumes across its key markets, including mergers and acquisitions. The deals and volumes are almost there, they hope to restore their overall No. 1 position by the end of the year. 

While it is correct to involve Asian partners, Russians say they are so far an inferior substitute for Western oil companies which possessed the most relevant technologies. More generally, developing economic ties with Asian countries could only go so far in substituting for relations with the West. China is weak at innovation and lacked many sectors important to Russia. 

Russia with its great empire ambitions does not want to be seen as part of developing world  but seeks to be another  super power and  it cannot achieve that  goal now without the  collaboration  with USA and Europe.