Home > 2016 > Russia: Economic Crisis — Causes and Consequences

Mainstream, VOL LIV No 15 New Delhi April 2, 2016

Russia: Economic Crisis — Causes and Consequences

Monday 4 April 2016

by R.G. Gidadhubli

Russia is facing a major economic crisis. The magnitude of the economic crisis is evident from the following. In 2015, as per official sources, the GDP declined by 3.7 per cent, while a few experts contend that the fall was nine per cent. During the last couple of years Russia has also been facing the problem of decline in investment by 8-10 per cent and has been suffering from a high inflation rate of over 11-15 per cent. In 2015, Russia’s imports declined and the country became a net exporter. But this was not on account of economic growth but due to Russia’s retaliatory ban on imports of food from the EU countries and USA and a weak rouble. It is important to note that the rouble lost its value against the dollar by 50 per cent since 2014, the present exchange rate being 69-70 roubles per dollar.

Some of the Western analysts and financial institutions, including Moody, have estimated that in 2016 Russia’s GDP growth will be virtually negative below 0.7 per cent and that it might remain low for a few years to come.

Russia has been facing several economic problems since the last couple of years. The question arises as to what are the causes for the economic problems leading to the crisis. Firstly, the main reason for the economic crisis has been the sharp fall in global energy prices to below $ 35-40 per barrel that has very adversely impacted on the Russian economy. Russia has been over-dependent on the energy sector as oil and gas account for nearly 60 per cent of Russia’s exports and 43 per cent of the government’s revenue. Since 2014-15, oil prices dropped by roughly half from the levels of over $100 a barrel and have plunged to below 40 dollars a barrel since there has been a fall in demand due to the global recession.

In fact Russia’s over-emphasis on the energy sector leading to dependence was a deliberate policy pursued during the last decade to emerge as the ‘Energy Super Power’ when international energy prices were rising up to $ 145 per barrel bringing a huge inflow of petrodollars by exporting oil and natural gas. Russia utilised these hard currency resources for investment in the energy sector both in Russia and abroad, including Kazakhstan, Turkmenistan, the Middle East and Latin American countries, rather than diversifying and modernising the economy.

Secondly, agriculture is the only sector of the Russian economy that has shown continuous growth during the last few years, but agricul-ture’s share of the Russian GDP is just over three per cent and cannot solve the persisting economic problems. Thirdly, Moscow would like to rely more on exporting armaments. But that accounts for just about five per cent of the overall Russian exports. Similarly, Russia also has tried to export trucks and cars to the neigh-bouring countries. But that accounts for less than two per cent of exports. Moreover, external demand cannot be a significant driver of the Russian economy.

Impact on the Economy 

The decline in oil prices has caused a reduction in Russia’s fiscal reserves and rise in the budgetary deficit. Hence there is a possibility that Russia may have to borrow which might increase the debt burden for a few years to come, since oil prices might continue to be low. But Russia has become a victim of economic sanctions by the Western countries which have strongly opposed its alleged ‘illegal accession’ of Crimea in March 2014. Hence borrowing from the West, which was a source to tide over the revenue deficit, will be difficult. This is evident from the fact that economic sanctions on Russia by the West did make a major adverse impact on Russian banks in 2014 when Moscow had to repay its foreign debt amounting to 10 per cent of the GDP. But by the end of 2015 this burden reduced to three per cent. Hence while some Russian analysts opined that economic sanctions had a limited impact on the economy, this is not supported by Western financial experts.

Thirdly, the Russian economy suffers from lack of competiveness since there are basic structural problems that the country has been facing for almost two decades. Technological levels of several sectors of the economy, including engineering, defence and aviation, have been lagging behind due to lack of modernisation. For instance, Moody is a well-known financial agency and its Vice-President, Kristin Lindow, has opined that the structural shock to the oil market has weakened Russia’s economy and, most importantly, its credit profile.

Fourthly, persisting high inflation and decline in import of consumer goods, including food products, have worsened the economic plight of the ordinary citizens. In February 2016, the Levada Centre released its poll, according to which 80 per cent of the respondents have felt the burden of the economic crisis. As per the poll, 47 per cent of the respondents blame the crisis on the falling global energy prices, while 33 per cent blame it on corruption, 27 per cent on Western sanctions, and 26 per cent on “excessive” spending on defence and the bureaucracy. Equally important is the fact that more than 50 per cent have to cut their spending on food and other essential necessities which shows the magnitude of impact of the economic crisis.

Fifthly, contrary to the Western contention, the Russian President, Vladimir Putin, has expressed his confidence that the economy will recover and that ordinary Russians will withstand the hardships brought about amid deteriorating relations with the West over his foreign-policy manoeuvres. But Putin’s hope and expectation are not acceptable to the Russian financial experts, including Sergei Aleksanshenko, who was the former Deputy Chairman of the Russian Central Bank. In his opinion, the Russian economy might not grow in the near future.

Sixthly, under persisting economic problems facing the country, the middle-class population is struggling for survival since they have to spend more than half of their income on food and other necessities. In this context the Russian media has highlighted the sad plight of thousands of lower and middle-class Russians who, being victims of lack of employment opp-ortunities, are unable to repay the loans that they had taken for their survival and medical treatment. The magnitude of the problem lies in the fact that with about 142 million population, there are 42.5 million Russians with loans and credit-card debts. It is reported by Tom Adshead, a partner at Macro-Advisory, a Moscow-based financial consulting firm, that the problems of bad debts have worsened in 2015-16 due to the persisting economic crisis. The semi-urban and rural areas are the worse affected due to lack of healthcare and infrastructure services.

In fact in post-Soviet Russia borrowing loan has become a major socio-economic issue. Apart from borrowing from banks, a new social issue has emerged in Russia known as “micro-financing organisations”, which sounds like a euphemism for loan sharks, including small lenders, who pay little regard to banking regulations. While handing out short-term loans to poor and needy clients at high interest rates, they often resort to in-house debt collectors. Hence thousands of Russians have become victims of such debt collectors who have gone to any extent torturing them to get back their money. This is a most deplorable situation in contemporary Russia. There are cases of meagre debts of a few thousand roubles which they are unable to repay and become victims of torture by debt collectors. Highlighting this problem Russian journalist Vladimir Markin wrote on November 15, 2015, warning Russians about the perils of such borrowings calling those ‘Deadly Debts’. In this context he mentioned about the murder of a Russian worker by a collector after he was fired from his job and got stuck in a spiral of debt. It is important to note that such illegal ‘Collection Agencies’ are still not regulated by the federal law and not licensed.

Seventh, in contrast to the hard life of a majority of Russian citizens, a new class of millionaires has emerged in Russia during the last two-and-a-half decades. As stated by Carl Schreck on February 26, 2016, there are five kings—Arkady Rottenberg, Gennady Timchenko, Kirril Shamalov, Leonid Mikhelson and Igor Rottenberg, son of Arkady Rottenberg—all Putin insiders who are reigning in government contract ranking. Hence there are accusations by critics in Russia as well, including social activist Navalny, that Putin has close economic ties with a few coteries in Russia who are taking advantage of getting state funding for their projects and have become rich. Among them is Kirill Shamalov, the son-in-law of Putin, who got a loan of about $ 1.75 billion in 2015 from Russia’s National Wealth Fund at an unusually low interest rate for the Sibur Project which is Russia’s largest gas and petrochemicals processor. It is alleged that several billionaires are also close to Putin who, according to some critics, is also a millionaire. But Kremlin spokesman Dmitry Peskov has disagreed with Navaly contending that government contracts are distributed on the basis of clearly defined rules and laws and those are ‘not arbitrary’. Thus while there are conflicting claims and arguments, the Russian economy continues to face persisting crisis.

Policy Alternatives

Considering the fact the Russian economy is highly dependent upon the energy sector, Russia’s energy giants—Alexei Miller of Gazprom and Igor Sechin of Rosneft—have advised Putin that under the prevailing circumstances of a sharp decline in oil prices and the global demand for oil, Russia should work jointly with the OPEC countries to cut down oil production to prevent the persisting decline in oil prices leading to loss to the global energy producers. This is in contrast to the past when Russia derided this cartel and was competing with them in the world oil market.

Supporting this view, Russian leaders have tried their best for the first time to cooperate and work with other energy giants, including the OPEC countries, among those Saudi Arabia, Kuwait, Qatar etc., to shore up the global oil prices by agreeing to freeze oil production considering the fact that the glut in global oil production has caused depression in the oil prices globally. But Iran, though a close ally of Russia, has refused to cut down its production as it has no other alternative for generating income for its economic sustenance.

Secondly, one alternative for the Russian Government could be to privatise the state owned companies to raise resources in the domestic market to finance the budgetary gap. This may partly help Putin to bring back the Russian hard currency parked in the West during the last two decades.

Thirdly, since the last few years Russia has adopted a ‘Look-East’ policy focusing on China for its geo-political and geo-economic objectives. Hence Russia’s external trade with China has immensely increased. But from 2015 China has also become a victim of recession affecting Russia as well.

Fourthly, apart from the Crimean issue, Russia’s involvement in the Syrian crisis for over a year and the persisting differences with the West on this issue have forced the country to spend heavily to support its ally, Syrian President Assad, despite its own economic problems. It is understandable that this was the price Russia had to pay for its geo-political ambitions. But there is some change in the situation and in fact the high economic burden could be one of the reasons why in March 2016 Putin at last decided to withdraw the Russian troops from Syria. Moreover, it was a shrewd policy initiative of Putin: declaring to withdraw from Syria to coordinate and improve relations with the USA and West as a whole.

Thus from what is stated above, Russia faces major challenges to deal with the economic crisis and socio-economic problems. If Russia continues to be over-dependent on the energy sector for a few years to come, it may not be possible for it to recover from the deep recession and crisis it is facing.

Dr R.g. Gidadhubli is a Professor and the former Director, Centre for Central Eurasian Studies, University of Mumbai, Mumbai.