Russian policymakers face economic perfect storm

Russian policymakers face economic perfect storm
Russia's economic growth appears to be slowing as problems like capital flight, sanctions and the coronavirus pandemic pile up. Policymakers will have a difficult time trying to balance these competing demands.
By bne IntelliNews December 15, 2021

A host of factors including the adverse economic effects of the coronavirus pandemic, an ageing population and capital flight have converged to create a nightmare scenario for Russian economic policymakers.

The rapid economic growth which Russia enjoyed in the 2000s following the transition to a market economy has slowed considerably over the past decade. This year has been no exception, with lockdowns and other restrictions related to the coronavirus (COVID-19) pandemic further hindering any prospects of Russia’s economy finding its feet. Policymakers have been left in an unenviable position, attending to competing demands in an economy beset by challenges.

Russia’s economy is unique for a number of reasons. The Soviet legacy means that the State continues to play an outsized role in industry, which often makes it hard for smaller private players to compete. Russia also shares many characteristics of advanced economies, including an educated and remarkably tech-literate population, but living standards remain fairly low.

Consensus among economists suggests that investment in innovation and infrastructure in high-productivity sectors will be an essential component of successful economic policy in Russia. Existing development plans like the National Priority Projects (first announced in 2005) and the Unified Development Plan to 2030 (recently approved, but yet to be published) were designed with this aim in mind, hoping to nurture the sectors which have the greatest growth potential and the most overspill into other areas of the economy.

The emergence of the coronavirus pandemic and rising geopolitical tensions, however, have thrown a spanner in the works, and beleaguered policymakers have had to adapt their plans to account for a tougher economic climate. Thus reports from June 2021 suggest that total planned funding of national priority projects from the public sector has been cut by about 7%. Targets for growth, meanwhile, have been extended from 2024 to 2030, and more is being spent on social issues, with ecology also getting a mention for the first time. Conspicuously absent, though, are plans for institutional reforms, which most economists agree are sorely needed.

 

Reforming institutions

Tackling the high dependency ratio created by an ageing workforce has long been an aim of Russian policymakers. This underpinned the controversial plans announced in 2014 to increase the retirement age. But overcoming Russia’s demographic woes will require a more holistic approach, with the World Bank estimating that the workforce will increase by only 0.9% as a result of existing reforms.

A drive to attract highly skilled foreign workers is one potential solution. But this would necessitate large-scale reform of institutions in order to make Russia as attractive a business environment as possible. From property rights to the legal and regulatory systems, every aspect of civil life in Russia would need to be carefully examined.

A recent announcement that foreigners living in Russia will have to undergo regular extensive medical examinations suggests that the drive to make Russia a more attractive working destination is being reconsidered, or at the very least has been relegated below other concerns.

Meanwhile, the arrest of American businessman August Meyer on fraud charges has also been held up by some economists as evidence that Russia remains a difficult business environment for high-profile foreign workers.

A recent survey of Russian businesspeople conducted by PWC found that possibilities to conduct honest business have improved since the 1990s. But around 70% still report that corruption has not diminished at all over the past three decades. Much remains to be done before Russia becomes a leading destination for foreign businesspeople.

 

Attracting investment

Another important target for policymakers is attracting more investment. Foreign direct investment (FDI) in Russia last year was the lowest since 2003. Of the FDI which was recorded last year, much is assumed actually to be domestic investment which was sent through offshore centres for reasons of tax and bureaucratic planning, according to information cited in a recent report by the Bank of Finland Institute for Emerging Economies (BOFIT).

Ever since sanctions were implemented in 2013, Russia’s net inflow of FDI has nearly halved, as investors grapple with the blow dealt to Russia’s international reputation and complications associated with owning Russian assets abroad due to the legal implications of sanctions.

In the shorter term, foreign investment has been leaving Russia as a result of the new coronavirus variant and rising geopolitical tensions, as followed by bne IntelliNews. As of 14 December, Russian assets have seen five consecutive weeks of outflows, with $90mn outflows of equity and bond funds in the week ending December 8, according to EPFR Global Data.

State investment, meanwhile, is roughly on a par with that of developed countries like the US, but is considerably behind emerging economies in Asia, according to BOFIT’s report on the long-term challenges to Russian economic policy.

 

Diversifying

Diversifying the Russian economy is no simple task. The oil and gas sector currently accounts for about 20 % of Russian GDP, and fluctuations in commodity prices continue to influence the whole economy. The national targets for 2030 include increasing the exports of non-oil and gas products by 70 %.

High-technology sectors, meanwhile, have considerable potential for growth. Russia is among the world leaders for fintech usage – coming in at number three globally, according to EY. Russia’s technology usage in general is very widespread, and 73% of Russians use the internet daily, according to BOFIT’s report.

As demographic, geopolitical, structural and global health problems continue to accrue, growth prospects for the Russian economy look scarce. A report published by the World Bank in December lowered forecasts for Russian GDP growth to 2.4% for 2022, with further easing to 1.8% anticipated for 2023. If this is to be avoided, wide-ranging reforms will be necessary not just in those areas most obviously tied to the economy, but throughout public life.

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