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Mainstream, VOL LV No 22 New Delhi May 20, 2017

Russian Economy Overcomes Long Drawn-out Crisis

Saturday 20 May 2017, by Arun Mohanty

The year 2017 brings good news for the Russian economy that looks all set for a steady growth trajectory overcoming the long crisis stemming from widespread international sanctions. The economy looks confident to register positive growth from the current year onwards. The most convincing argument in favour of the crisis being a thing of the past is the dynamic growth in industry as well as agriculture. According to the statistics available from Gosstat, the official statistics body of Russia, all the branches of Russian industry have registered confident recovery growth. According to economists, the growth can be a steady trend in the coming years on the basis of import substitution.

The latest micro-economic data provided by Gosstat confirms that most of branches in Russian industry have come out of the negative growth zone. During the last 11 months of the outgoing year compared to the same period in 2015, the food industry has registered 2.5 per cent growth while textile industry has grown at a rate of five per cent, leather and shoe industry by 6.3 per cent, wood industry by 3.2 per cent, chemical industry 4.5 per cent, rubber and plastic production 5.9 per cent. The most important news definitely is that the machine-building branch—the backbone of Russian industry that was worst hit by the crisis—has displayed significant growth. The production index of the machine-building industry in the 11 months of 2016 is 103.6 per cent compared to the same period in 2015.

The first month of 2016 when Russian industry displayed confident growth was November that witnessed the production index at the level of 103.7 per cent. According to experts, two factors that facilitated this encouraging trend are the long working day in November and the cold weather that helped in the rise of electricity production. This factor apparently ensured almost 1.1 per cent of the industrial growth.

Independent experts attribute the fact of recovery growth not to November but to the period from the beginning of 2016 if not from the end of 2015. The average monthly recovery growth rate constituted 0.2-0.3 per cent while the average annual recovery growth rate constituted 2.55-4.5 per cent. The rise in business activity, that was a clear indication of recovery growth which was evident in the positive zone in the entire half of 2016, was not observed in the last five years.

Further indication of recovery growth was rise in consumption and investment by large and middle-scale enterprises. As a whole the growth in investment in the entire economy registered 0.9 per cent growth whereas this indicator constituted 1.9 per cent. In a nutshell the second half of 2016 witnessed a lot of symptoms of growth. The sectors that witnessed dynamic growth becoming drivers of GDP growth were agriculture, chemical industry and extraction industry which even did not notice the crisis. The year 2016 saw recovery growth in the most affected sectors of the economy like the machine-building industry. Here the recovery growth touched all most all branches.

The double trouble for the Russian economy were international sanctions in the aftermath of the Crimean re-incorporation into Russia as well as the steep decline in oil prices, the main source of income for the Russian budget. While the sanctions turned out to be a blessing in disguise by stimulating import substitution, the recent upward trend in oil prices in the range of US $ 50 to 60 has contributed to economic recovery in no small way. Apart from this, the axiom that devaluation of the national currency exerts favourable impact on the national economy has proven wrong in the case of Russia. Surprisingly the Russian ruble in the last couple of years has shown not only resilience but even gained strength against the US dollar. Oil price rise and streng-thening of the ruble have provided strong boost to economic recovery through cheaper imports. This factor stimulating acceleration of economic recovery needs adoption of producers to shocks and new conditions.

Now the issue that agitates the minds of economists is how long will this growth continue. Most experts agree that this growth trend would continue in 2017 and do not see any production decline in any of the sectors. Strong companies that withstood the effects of the shock would be the drivers of the recovery growth and would discover new avenues for development as a result of those who have been driven out of the market. Enterprises that did not perish as they are not sitting idle managed to learn how to survive in new conditions. Certain limitations on financial resources helped this process., indicating gradual reduction of key interest rates of the Central Bank. The growth potential of the economy in the sense of market compulsion remained, and it has to be utilised. The Russian market has the potential for growth but there it needs enterprises that would implement the development strategy. Only effective business can implement this strategy. And presently this process has started. The situation in most affected enterprises is serious, but it can hope for government support, for example, in the automobile sector.

However, there are some experts who believe that the current growth is the effect of a low base. They are of the opinion that such a growth can be accidental in a long drawn-out economic crisis and a possible three to five per cent decline in oil production would spoil the industrial statistics already in the first half of 2017 and that it is too early to talk about growth in industrial production. In addition to this, the level of real income of the population is the real indicator of steady growth. In the first 11 months of 2016 the real income of the population has declined to the level of 94.2 per cent compared to the same period of 2015. The average monthly salary of the population in this period has grown by 7.7 per cent but if you convert that into real income in terms of purchasing capacity, the growth is barely half a per cent.

The overall decline in domestic trade volume also indicates the fall in real income. In the first 11 months of 2016 the total domestic trade has declined to 94 per cent of the level of 2015. The external trade has also indicated a similar trend.

The prospects for income growth in future are not very clear. Deputy Prime Minister Igor Shubalov’s statement that the income of the population is not growing as we wished also confirms this conclusion. However, real income of certain sections of the population is no doubt growing, says the official statistics. And it is expected that there would be growth in the income of almost all sections of the population in 2017. Stabilisation of the ruble might have prevented inflation to happen but it has triggered the arrival of a huge mass of speculative money of the non-residents who are investing their euro and dollar in rubles for higher interest. But after some time they might convert this ruble mass into hard currency receiving exorbitantly high profit. This is a standard recipe for provoking a financial crisis in the country, which has happened already three times and could take place for the fourth time.

The government has set the objective to take the economy to a trajectory of sustainable growth. The set of necessary structural reforms such as privatisation, liberalisation and competition for accelerating growth is well-known. The government and society do not seem ready for such serious changes.

Some economists believe that the expectation for oil price hike and further strengthening of the ruble might not come true. Some Russian economists believe that the Russian economic model can prove sustainable and successful in case the global economy has to pass through yet another cyclical crisis for one or two years. President Putin in his state of the nation address has set the objective of achieving a growth rate higher than the average global growth rate, and this could be easily achieved in case of the above-mentioned global crisis.

Political stability can be used for attracting more foreign investment as there is a sort of guarantee in Russia for not changing the rules of the game for the next 6-7 years. It can really help the Russian economy in fulfilling the task of import substitution in a paradoxical manner.

Russia lost a substantial part of the machine-building industry, particularly production of equipment for different sectors of the economy, during the years of the disastrous neo-liberal reforms. In the meantime Russian companies started procuring those equipments in the global market, and it is not all that easy to orient them to domestic manufacturers. That is why it requires more efforts to attract global producers of equipments to invest in Russia, particularly in the segments such as heavy machine building, oil equipments, railway transport. There are not many such companies, some sectors are highly monopolised; that is why companies need concrete concessions. Now the paradoxical situation lies In the fact that Russia is one of the major oil extracting countries in the world but it uses imported equipments for oil extraction and transportation. Russia has to develop this sector for production of oil industry equipments, not only for the domestic market but also for export. Things look much better in agricultural machine-building over the years. Import substitution In this sector has emerged as a fact of life. It is necessary to prevent the return to the situation when imports will grow faster than the GDP.

The ruble has become an astonishingly stable currency hardly reacting to the vacillation in international oil prices. The ruble has streng-thened by almost 15 per cent in a single year; inflation has reached single digit. Western economists, predicting doomsday for the Russian economy, are forced to acknowledge positive dynamism in the Russian economy.

Transport machine-building, that includes automobile, aviation and wagon building sectors, is the leader in the machine-building industry. The government’s anti-crisis measures as a whole helped in achieving positive results for the economy. The state’s anti-crisis programme, that covered 199 major enterprises in different branches, included first of all automobile, aviation, wagon building and good transportation etc. The budget allocation for these sectors amounting to 300 bilion rubles provided serious support for their development.

Special attention to these 199 major enter-prises is not accidental at all. These enterprises constitute the backbone of infrastructure which is protected by any government first and foremost. If the transport system is disrupted, the economy of any country would collapse in no time. Secondly, these enterprises constitute the system-formation, on which depends a lot of production in different spheres as well as people. For example, decline in the aviation industry would lead to a decline of production in many spheres. Thirdly, the social significance of the sector is very important as it employs almost one-fifth of country’s workforce. And its share in the GDP constitutes more than 20 per cent.

According to Moody’s forecast, the Russian economy is expected to grow by 1.5 per cent to two per cent as a whole in 2017. The Russian Ministry of Economic Affairs is careful in its forecasting that economic growth would register 1 to 1.15 per cent in 2017.

The Development Centre in Higher School of Economics, a liberal think-tank, conducted a survey about the perspective of the Russian economy among Russian as well as foreign economists in which 22 leading experts took part, and the consensus prediction was that the GDP decline in 2016 would be 0.7 per cent, and the economic growth in 2017 would touch 1.4 to 1.9 per cent.

Experts draw attention to the fact that the size of the GDP has not grown beyond the level of 2008, the pre-crisis year; which prompts them to talk about the ‘lost decade’. The size of the Russian GDP in the year 2016 would be more than just 1.5 per cent compared to the pre-crisis year of 2008. The Russian GDP growth between the year 2002 to 2008 has been 158 per cent.

All economists agree that the Russian economy would witness steady growth from 2017 onwards primarily as a result of the import substitution policy.

IMF experts also paint a positive picture of the Russian economy stating that it has succeeded in withstanding the double-shock stemming from oil price decline and international sanctions imposed on Russia in the aftermath of the Crimean re-incorporation into it. They forecast a GDP decline of just 0.6 per cent in 2016 and the GDP growth of 1.5 per cent in 2017, pushing the crisis to the past. The Russian economy has registered a positive growth both in November and December of 2016 and the inflation rate is at the level of five per cent which is likely to further reduce in 2017.

Oil and chemical industry followed by metallurgy are leaders with their production achieving new records. Considering the positive trend in industrial production, experts believe that industry would grow by 2.5 per cent in the coming years. Now it is important not to disturb the complete adaption of the economy and its movement to the expansion zone. One thing is evident: that the monthly five per cent negative industrial growth of 2015 is a thing of the past. One more factor suggesting improvement of the economic situation is the ruble’s stability, which has been strengthened almost by 15 per cent against the US $ compared to the beginning of 2016, making the ruble a very strong currency. Considering the positive showing, international agencies are likely to increase Russia’s sovereign rating.

If you look at sectoral growth, Russia’s military industrial complex has established itself as the leader in the economic growth sphere thanks to serious efforts put by the state to revamp the sector and increase the state’s defence order. Labour productivity in the military—industrial complex has grown three times which is a significant record. This kind of growth is explained by primarily the rise in the state’s defence order. During the period from 2011 to 2015 labour productivity in this has grown by 1.7 times. In 2016 the military-industrial complex has witnessed a 15 per cent annual growth rate.

This has helped Russia to occupy the second place in the global arms market with exports reaching US $ 14.5 billion in 2015. The total portfolio orders for defence supplies in 2015 have reached 56 billion US $. The military-industrial complex has displayed 20 per cent growth as a whole in 2015, while the radio-electronic sector has registered 32 per cent, ship building industry 18 per cent, rocket space industry nine per cent, aviation industry six per cent growth. Here again import substitution did wonders in revamping the industry and guaranteeing its sovereignty.

Russian President Vladimir Putin in his address to the nation has advised the military-industrial complex to move into conversion and diversification of production since state purchase would most likely diminish starting from 2018.

Reduction in state purchase would be explained by budgetary constraints and lack of possibility to increase financing in future. State purchase of military hardware, that amounted only 300 billion rubles, in 2007 had reached 1. 5 trillion rubles in 2013 and had touched 1.8 trillion rubles in 2015 which was less than that of 2014.

The exchange rate of one US dollar fell from 80-85 rubles to 61 rubles, which facilitated the inflation decline, making the ruble one of the strongest currencies in the world. Here the rise in oil prices from 30 $ to 55$ per barrel also came to the rescue of the Russian economy. Increase in oil prices after a long time could be possible because of the agreement to reduce production by the exporter countries.

In spite of financial constraints, budget deficit never crossed 3.7 per cent of the GDP, which was acceptable in the backdrop of trade balance in favour of Russia to the tune of 70 billion US $. One of the encouraging phenomena in Russian economy is the sharp reduction in capital flight which has declined five times in 11 months.

Agriculture has been one sector which brought good news for the economy by growing at an average annual rate of four per cent. Growth in agricultural production coupled with growth in machine-building, light industry and processing industry provided boost to the GDP growth. Industrial production as a whole has grown by 0.9 per cent, while certain industrial sectors have registered growth up to 20 per cent.

The import substitution policy has brought success to the ailing economy by reducing imports from 49 per cent to 39 per cent of the consumption. Serious efforts have been made in pharma, chemical, light industry, heavy machine building, transport equipment sectors to increase production through import substitution. Some of the high-tech sectors in the Russian economy have become absolutely competitive in the international market, making Russia the leader in nuclear technology, space and rocket technology, aviation industry etc.

Agriculture over the years has brought a lot of cheer for the Russian economy by maintaining a steady growth and making Russia a leading grain exporter. The grain production has reached 119 million tonnes this enabling grain to replace oil as the major export item for Russia. Eighty per cent of milk and meat products consumption in the country are now met through domestic production. This has helped in strengthening Russia’s food security which was in the danger zone when Russia was importing 70 per cent of its consumption from abroad during the 1990s of Yeltsin’s disastrous reforms.

There are indications that the long-drawn-out economic crisis is finally over laying the foundation for sustainable growth of the Russian economy in the coming years. The government needs to consolidate the gains by further strengthening the import substitution policy and diversifying the economy.

Prof Arun Mohanty, the Director of the Delhi-based Eurasian Foundation, belongs to the Centre for Russian and Central Asian Studies, School of International Studies, Jawaharlal Nehru University, New Delhi.

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