The Russian Economy During the Crisis and the Near-Term Outlook

The present condition of the Russian economy has been a concern to many since the start of the financial crisis. The economic decline and the fall in stock markets has been far worse than in many countries both in the developed and developing world. This has been observed by many, admitted and conclusions were drawn but what is about to change and what are the economic reforms that are going to alter the economic policy that has been followed to date? I believe little or none. The general public remains relatively ignorant of the issues despite the effects and so far the existing governing bodies are showing no signs that change is to come.

"No Future" for the Russian economy without rapid economic reform was the latest comment of the Russian President, Dmitry Medvedev.¹ The rhetoric of the Russian government continues to be unchanged. Is it another political maneuver or are we going to witness real change? Having seen the televised report of Mr. Putin, the current Prime Minister, back when the crisis was at it peaks, I am certain that the current approach will not yield anything significant.

Rapid economic reforms are clearly needed to diversify the economy, no one doubts this. Economic survival is dependent on the export of natural resources and raw materials, as has been the case for a long time, even during the Soviet era. Existing measures so far implemented by the current government have been all too often short-sighted and will surely have little or no long-term effect.

The main measures have been to spend. Russia still has an enormous stabilization fund it amassed during the Putin era of high oil prices for a "rainy day". Now it has become very handy. Friends of the Kremlin seem to be first in line for the help. During the previous years, many of the companies owned by the prominent Oligarchs took massive amounts of debt secured against equity, the same equity they got at rock-bottom prices during the privatizations.

The most famous of the many cases has been the empire of Oleg Deripaska whose personal wealth tumbled from being in excess of $40bn down to $3bn in a matter of months. While state intervention to support over-leveraged companies has helped reduce to some extent unemployment, it has not done very much to support the plummeting economy and combat the illnesses that have sickened it. Most of the cushion was provided by a relatively high oil price and the ruble devaluation so one could argue that if not for these effects, the position today would resemble January-February of this year, a far more gloomy outcome.

ECONOMIC GROWTH POOR RELATIVE TO OTHER EMERGING MARKETS

2Q 2009 results show GDP contracting 11% while other emerging markets faced recovery.² I often note that many top officials like to see Russia among the BRIC nations. There is no doubt that the other members are very different from Russia. China reported 7.9%³ economic growth in 2Q 2009 while the Indian economy is expected to have grown 8.5% in the same period.⁴ Both are diversified economies with strong growth potential driven by foreign direct investment and expanding sectors based on technology and intellectual property rights protection.

Many economists and political figures have criticized the current economic policies of the government. One of the most visible evidence that the existing anti-crisis economic policies have not been effective was the well-publicized index developed by the Moscow-based audit and consulting company FBK. The index takes into account openly available data published by national services for United Kingdom, Canada, Germany, USA, France, Kazakhstan, Ukraine and Russia including macroeconomic variables such as GDP, inflation, industrial output, unemployment and others.

The results were staggering but not surprising with Russia receiving the lowest value, even below Ukraine where the economy remains on the brink of bankruptcy. Moreover, the Russian economic conditions appear to be very similar with one significant difference of inflation which has been a chronic disease within the Russian economy. The government has not been able to deal with inflation despite numerous pledges.⁵

Uralsib economists⁶ in the latest report have suggested that the economy has already bottomed out with signs of industries recovering and debt being restructured. It is no doubt however that the economy remains extremely sensitive to commodity prices and to conditions in the global financial system. Russia is now far more integrated into the world economy than it was a decade ago with far more foreign owned debt and equity as well as foreign investment than in there was in the 1998 crisis.

So where is the economy really heading? As it stands, the balance sheet remains strong and as long as commodity prices remain where they are today little change will occur. The policies of interfering in the private sector are continuing to bear their fruits. Western investors already view Russia as a bad place to invest after the erratic behavior in Yukos, Mechel and Begun/Google deal. Now these policies will be felt even more as many industries and regions of Russia are more desperate for new investment than ever before.

It is surprising that nothing is being done to combat the big government bureaucracy and non-transparent practices that are literally strangling the entire country. One simple statistic is the number of police officers. I heard this recently on the radio. It is said that there are twice as many police officers in Russia as there is in the United States even though the population of Russia is twice as small.

During the Putin era, the number of civil servants has continued to swell as has the budget. At the start of this year, the budget underwent numerous revisions by the government in order to reduce the deficit created as tax revenues fell. Despite the cuts it looks now that the deficit is permanent. For the first seven months of the year the deficit totaled 4.3% of GDP or ~$30 billion. Nothing is being done and this is similar to many other problems.⁷

What have we got? We have an economy that is sick with a multitude of problems such as corruption, bureaucracy and high inflation to name a few. The sick beast feels better when he is fed so let's hope the worst is indeed over and the global recovery is near. After all as we have seen from history, bad times in Russia have only led to the worst.

^{1 - http://www.cbonds.info/all/rus/news/index.phtml/params/id/440418
2 - http://russiatoday.com/Business/2009-08-11/russian-economy-slumps-further.html
3 - http://www.chinadaily.com.cn/bizchina/2009-07/16/content_8435594.htm
4 - http://www.highbeam.com/doc/1G1-184579551.html
5 - http://www.fbk.ru/news/5419/164115/
6 - Uralsib Report: Russia Strategy by Numbers, June 2009
7 - http://www.gzt.ru/economics/254267.html}