by Colm Delaney, an analyst at Global Risk Insights
Questions arise over the long-term viability of the Russian economy after the IMF downgrading of Russia’s GDP forecast from an estimated 2.5 to 1.5 percent in 2013 and 3.25 to 3 percent in 2014. This followed an internal forecast from the Russian Ministry of Economic Development, which slashed the country’s predicted growth rate to 2.5 percent through 2030.
The IMF report has placed much of the blame for the Russian slowdown in growth on the fact that its economic model over the previous decade has reached a stage of exhaustion. Under this model economic growth was fed by a combination of channeling oil and gas profits into the economy via state-directed investment projects and wage/pension increases, and exploiting spare industrial capacity left over from the Soviet era. As with any state that relies heavily on natural resources sold on the international energy market, this has left Russia vulnerable to drops in either the price of oil and gas contracts or an economic turn-down among its trading partners. However, this state of affairs has also given President Vladimir Putin’s government valuable breathing room to explain away any economic ills by blaming international conditions and problems in other countries.
The most worrying aspect of the IMF report for Russia is that it has shifted the blame for Russian economic weakness from external factors to domestic political and economic shortcomings. In particular, foreign investment (or lack thereof) to reduce dependence on oil/gas receipts and to fund much-needed infrastructure projects has been sorely lacking. The Economist estimated earlier this month that in the first three quarters of 2013 some $48.2 billion had been pulled from various Russia-focused equity funds. Russia’s own Economic Development Ministry predicts that this could peak at up to $70 billion by the end of the year.
Beyond falling commodity prices and a slowing economy, much of this capital flight can be blamed on the lack of transparency and stability in the business environment. Many investors continue to be spooked by widespread corruption and a weak justice system. Promises by Putin to press ahead with efforts to sell state assets, fight corruption, and bureaucracy and strengthen property rights have been met with intense skepticism both at home and abroad. Even if the capital flight was not an issue, Russia’s anemic financial sector has proven to be consistently ineffective at directing investment to the businesses that require it.
Demographic trends also do not fall in Russia’s favor in medium-term economic forecasts. The current data classes 13 percent of the Russian population as over-65. By 2050, this is predicted to increase to 23 percent. Put simply, Russia will be forced to spend more on pensions and healthcare at the same time that its taxpayer and labor base drastically shrinks.
These negative economic trends may also be the catalyst for equally negative political trends. ‘Stagnation’ is as unpleasant a word and reality in Russia as it is anywhere else, perhaps even more so given the hangovers of its communist past. While Putin appears to have survived the fallout from the bitterly disputed 2011 election, his legitimacy and popularity among the Russian population (especially the urban middle classes) has been permanently undermined. Disputes between Putin and the various Russian elites have also become more public, including a confrontation between Igor Sechin, the president of Rosneft and one of Putin’s right-hand men, and Deputy Prime Minister Arkady Dvorkovich over the consolidation of the energy sector.
To shore up his position, Putin has pursued a repressive domestic policy with an emphasis on unpopular minorities (such as homosexuals and Muslims) and a strident foreign policy since his re-election. However, a significant slowdown or drop in GDP may be the catalyst for pushing grumbling into open dissent. To prevent such a scenario, Putin may very well resort to the ‘bad old ways’ of attempting to maintain economic growth via state regulation, natural resource exports, and increased spending.
While a complete financial collapse is highly unlikely – Russia’s low government debt of 8.4 percent of GDP and high foreign exchange reserves of $538,562 million gives it the ability to purchase a modicum of stability – an increased dependency on oil and gas reserves to pick up the strain will significantly hamper any reforming of the economy and leave the country more vulnerable to international events. Even in 2013, the oil price that would allow Russia to finance budgeted spending without borrowing has skyrocketed to $117 per barrel from $34 per barrel in 2007.
Developments such as the US shale gas boom and an increased interest in nuclear power in Asia make predictions that oil will stay at the necessary price level optimistic at best. Far from being the emerging market of choice, Russia’s self-inflicted economic and political weaknesses may leave it dangling on a precipice with no easy remedy at hand.