RaboResearch - Economic Research

Country Report Russia

Country Report


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Due to the Ukraine-Russia conflict, Russia’s economy deteriorated; growth fell and the Ruble depreciated. In recent weeks the situation has improved, but risks remain to the downsize, as we may not exclude additional sanctions from the west. 

Strengths (+) and weaknesses (-)

(+) Strong external position

Russia has a vast amount of FX-reserves which cover twelve months of imports and an acceptable external debt burden of 25% of GDP in 2013.

(+) Strong fiscal position

Russia has a structurally very low government debt of only around 8% of GDP and posts marginal budget deficits.

(-) Weak governance and weak rule of law

Corruption is deeply embedded and widespread throughout society, severely hindering the business environment, especially for foreign investors.

(-) High dependence on single commodity export revenues

The oil and gas sector dominates the economy by making up 70% of total exports and by contributing 28% to GDP. This makes government revenues highly susceptible to global oil price fluctuations. 

Key developments

1. Conflict with Ukraine

After months of negotiations on an association agreement between Ukraine and the EU, Ukraine finally decided to sign an agreement with Russia on 17 December 2013. The deal included lower gas prices and the purchase of Ukrainian government bonds worth USD 15bn by Russia. Although it is largely unclear what Russia got in return from the deal, it is evident that Russia wanted to gain more control over Ukrainian (foreign) policies. In recent years, Russia has been increasingly using strong-arm tactics to extend its influence in the CIS region given the intensified competition with the EU. Last year, Russia imposed trade restrictions against imports from Ukraine, as Ukraine came closer to an association agreement with the EU. The agreement signed between Ukraine and Russia triggered anti-government protests in Ukraine and eventually president Yanukovych fled the country on 21 February. Just days after interim-president Turchynov was inaugurated, Russia started to gradually take control over Crimea. A step that fits in the recent year’s developments whereby Russia has been expanding its grip on countries in the CIS region. However, in contrast to earlier actions by Russia, the occupation of Crimea led to rising tensions between Russia and the west. Both Europe and the US have imposed sanctions against some Russian people, businesses and banks. In recent weeks tensions have eased somewhat, but there are still risks that the dispute between Russia and Ukraine escalates. It seems unlikely that Russia and Ukraine will find common ground on the status of Crimea. In addition, Ukraine and Russia will find it hard to reach agreement on the level of federalisation in Ukraine and any constitutional changes will take months to implement. 

2. Economic outlook deteriorates

Although the conflict between Russia and Ukraine started at the end of February 2014, the impact on the economy has already been visible in the first quarter data. In the first quarter of 2014, the economy grew by 0.9% compared to the same quarter a year ago. In the fourth quarter of 2013 the economy still grew by 2.0% on a yearly basis. Although a contribution breakdown is not available yet, the fall in growth seems mainly to be the result of a slump in investment spending by businesses, while private consumption contributed more than was expected. A likely explanation for the fall in investment is a loss of business confidence in Russia. But, also the (possible) sanctions play a role. The direct impact of the sanctions on the economy has been limited, the indirect impact however has been significantly larger. Both the EU and the US have threatened Russia that they will impose heavier sanctions if Russia keeps undermining the government in Ukraine or invades the country. Currently, the IMF expects the Russian economy to grow by 0.2% in 2014. Early April, the IMF still expected the economy to grow by 1.9%. The deterioration of the Russian economy is also reflected in the depreciation of the ruble. Early March, the ruble had depreciated by 11% against the US dollar since 1 January 2014. On 3 March, the central bank raised its policy rate by 150 basis points to 7%, while it intervened with USD 11.3bn in the FX-market the next day (figure 1). Although the actions of the central bank did not led to considerable strengthening of the exchange rate, without the actions the ruble might have depreciated further. In addition, S&P lowered Russia’s sovereign debt rating by one notch to BBB- on 25 April, the lowest investment grade rating. On 28 April, the central bank raised its policy rate by an additional 50 basis. Since then the ruble has appreciated against the US dollar, an indication that tensions eased somewhat. The balance of payments showed no alarming capital flight from Russia in the first quarter. Although Russia’s foreign exchange reserves decreased by USD 27.4bn, similar to 2013 as a whole, there is no reason for concern, as Russia currently has USD 472bn in FX-reserves . Most notable is the negative contribution of ‘other financial accounts’ which consists of ‘loans’ and ‘cash foreign currency’ (figure 2). That said the outflow from the private sector amounted to USD 50.6 billion and if transactions between the central bank and Russia’s private banks are included the total sums up to USD 63.7bn. 

Figure 1: Pressure on the ruble
Figure 1: Pressure on the rubleSource: Reuters Ecowin, Central Bank of Russia
Figure 2: Balance of payment worsens
Figure 2: Balance of payment worsensSource: Central Bank of Russia

3. Gas deal with China

On 21 May, Russia and China signed a 30-year gas supply deal worth USD 400bn. Whether the deal is an economic win for Russia or a political statement towards the west is difficult to tell, as some major details are not made public. First, the costs to build the pipeline are estimated to be USD 70bn, of which Gazprom has to finance a significant part. It is however unknown whether China will pay part of the infrastructure upfront, while Gazprom has to pay higher yields on the back of possible western sanctions. Second, the gas price China will pay is not made public, but is likely to be lower than the price paid by the west. Third, Europa will remain Russia’s main off taker of gas. The supply contract is for 38 bcm/yr, while Europa consumes around 160 bcm of Russian gas per year. 

Factsheet of Russia
Factsheet of RussiaSource: EIU, CIA World Factbook, UN, World Economic Forum, Transparency International, Reporters Without Borders, World Bank.

Background information

Since the fall of the USSR in 1991, Russia has shifted from its post-Soviet democratic ambitions in favour of a centralized semi-authoritarian state. Russia’s economy has undergone significant changes since 1991, moving from an isolated, centrally-planned economy to a more market-based and globally-integrated economy. Economic reforms in the 1990s privatized most industries. These privatizations were marred by corrupt conduct of the government, which resulted in an oligarchic economy and created a very wealthy and lawless elite. By maintaining a firm grip on this elite, President Putin ensures their continuing economic and political support. Nominal GDP amounted to USD 2,093bn end-2013, making Russia the 8th largest economy in the world.  Demographics are unfavorable, as the population of Russia is shrinking; it has decreased from 148 million in 1992 to 143 million in 2013 due to an unhealthy life style and alcohol abuse among men specifically. The business environment is hampered by a plethora of factors. The Russian labor force is skilled, but there are shortages in banking and other professional services. While the level of infrastructure varies throughout the country, the roads are generally poor. Corruption remains deeply embedded in Russia and is a widespread problem. Although the country’s economy is somewhat diversified, the non-energy sector is largely uncompetitive. Therefore, the economy is overly dependent on commodity production, particularly on the oil and gas sector. Oil and oil products account for 50% of Russia's goods exports, 80% when including gas and metals. To sustain economic growth in the longer term, Russia must diversify its economy away from the hydrocarbon sector, especially by improving the business climate. 

Economic indicators of Russia
Economic indicators of RussiaSource: EIU
Maarten van der Molen
Rabobank KEO
+31 30 21 62666

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