MACRO ADVISOR: Russia’s economy – wavering, not drowning

MACRO ADVISOR: Russia’s economy – wavering, not drowning
By Chris Weafer of Macro-Advisory November 13, 2015

Over the past few years, Russia’s economy has been hit with a succession of debilitating events, starting from the slowdown in consumer spending in 2012 through to sanctions and the oil price collapse. The result is that GDP is expected to contract between 3.5% and 4.0% for this calendar year. That is only the second year of contraction since the 1998 default.

A pragmatist’s response to the decline might be “it could have been worse” – and certainly there were plenty of predictions that circulated widely in late 2014 of default risk and a much steeper recession. The optimists might take it one step further and point to the way that the government has responded, ie. in terms of fiscal and monetary policy, offers a lot of encouragement that this is the crisis which finally shakes off the 15 years of hydrocarbon-induced complacency and marks the start of long-awaited real changes in the economy. Whether that view is justified remains to be seen, but there is no doubting that the actions of such agencies as the Central Bank of Russia (CBR) and Ministry of Finance have been relatively effective. Policy and spending errors would certainly have made the situation so much worse and left little scope for optimism coming into 2016.

The most important policy changes and strategy decisions taken in 2015, and which should have a positive legacy impact in the years ahead, ie. if not reversed when/if the oil price again rallies, include:


•  Monetary policy. The CBR has made a 180-degree turn in its ruble policy. For the previous 15 years it has prioritized a strong ruble policy and has, on several occasions, spent huge sums from its forex reserves in efforts to support the currency. That has now changed in favour of allowing the ruble to fully free float against the oil price, but with a recovery cap in the RUB55-58 range against the US dollar. In other words, the ruble will not be allowed to recover beyond that range no matter what the oil price does. The weak ruble policy is now ingrained in the “competitive economy” strategy and is strongly supported by the finance ministry, which sees it as essential in keeping the budget deficit manageable.

•  Budget discipline. The finance ministry has successfully blocked demands from politicians to pump money from the sovereign wealth funds into the economy as a short-term fix. Instead they have kept a tight rein on spending and this year’s deficit is expected to be no more than 2.5% of GDP. For 2016 the result should be similar, although could be better if the finance ministry were to win its battle for so-called windfall profit taxes in the extractive industry sectors.

•  Focus on achievable strategies. Senior government officials are much more focused on long-term recovery strategies that are more achievable and less theoretical than heard previously. Gone is talk about vague “structural reforms” or the “innovation economy”. In their place are plans to, eg. grow more food to reduce imports and to try to create a more competitive economic base to encourage investment in manufacturing.

•  Ease of business ranking. Russia has not lost sight of the goal to reduce business costs and bureaucracy and, in its recently issued 2016 survey the World Bank now ranks Russia in 51st position, having been well over 100 only a few years ago. Russia’s ranking is also much more favourable than any of the other BRICS – China is in 84th and India in 130th place. Throughout the worst phase of this crisis, the Russian government was adamant it would not consider capital controls or any other measure that would make it more difficult to attract investment later.


As stated, all of that is very encouraging, but the pessimists will continue to argue that this is a knee-jerk response to this crisis and, when oil revenues recover, the government will revert to complacency.

There are, however, many compelling reasons to believe this will not be the case and that this crisis marks a critical turning point. That is because the consequences of failing to change, ie. longer-term stagnation leading to social and political problems, are worse for the Kremlin than the short-term pain, or inconvenience, resulting from the process.

New drivers required

The main reason for believing this is because of the fact that the economy had already started to slow down from mid-2012. Growth in 2013 was 1.3%, or one-third that of two years earlier. That was despite an average oil price close to $110 per barrel all year and against a backdrop of global economic recovery. The old growth model, based on trickle-down oil wealth fuelling a consumer and credit boom, had started to mature and was no longer capable of driving headline growth in isolation.

It became clear that a new growth driver is required. That driver can only be achieved with a sustainable increase in investment into infrastructure and into industrial sectors that will lead to meaningful diversification in the economy. Hence the optimism based on the very tangible policy changes observed so far in 2015. Simply waiting for oil revenues to recover is no longer an option, as was clearly demonstrated in 2013.

As 2015 comes to a close, there is evidence that the worst phase of the downturn has passed. The decline in the third quarter was recorded at 4.1% compared with 4.6% in the second. The fourth-quarter number will be much better because of delayed spending and the base effect from the year-earlier period. But inflation is still stubbornly high above 15% and the CBR’s benchmark interest rate is in double digits. The sectors bearing the brunt of the downturn, ie. the consumer and construction sectors, have been particularly badly impacted by that combination.

The result for 2016 will be better, partly because of the base-effect comparison with 2015. GDP expectations range from a second year of contraction, albeit modest at minus 0.5%, to growth between 1% and 2%. The key variable is not the oil price, which was the main culprit in dragging the economy into recession this year, but the start of easing of financial sector sanctions. It is the block on accessing new external debt, particularly at competitive rates, which will be key to the revival and return to targeted growth in the economy. 

Once that happens the bounce should come relatively quickly. Partly that is because of the policy changes referred to and the fact the government has consistently made clear that it views investment openness quite differently to difficult politics. Russia’s balance sheet is also in good shape, which is not what one usually sees after such a difficult period. The country has been forced to go cold-turkey with debt and total external debt is now down to $500bn, from $740bn at the start of 2014. The current account reported a surplus of almost $60bn over the first three quarters of this year, mostly because of the collapse in imports. Capital outflows are now back to normal, while debt and trade flows and the CBR’s forex reserves have been relatively stable, at close to $360bn, since mid-March when the new ruble policy started to emerge.

There is a long way to go and many difficult decisions to make before we can start to predict a return to sustainable growth. Not least of which is the decision to freeze all public sector salaries and raise pensions by only 4% nominal in 2016, ie. an election year. The government’s resolve will surely be tested, especially when either the opportunity to borrow returns or the oil price rallies. The one thing we can say as we approach the end of 2015 is that Russia has survived this crisis much better than its critics had predicted and hoped for. It is in much better shape to start rebuilding in 2016 when recession ends.

Chris Weafer is a founding partner of Macro-Advisory, which helps investors cut though the noise & focus on underlying trends, real political risks, & opportunities in Russia/CIS, Eurasia Union, & Mongolia. Follow him on @ChrisWeafer