RaboResearch - Economic Research

Country Report Russia

Country Report


Flag Russia

Russia’s economy is slowing down as a result of western sanctions and a drop in oil prices. Its outlook has also deteriorated due to lower investor confidence and a strengthening of the government’s control over the country.

Strengths (+) and weaknesses (-)

(+) Strong external position

Russia has a net international investment surplus, a vast amount of FX-reserves which covers twelve months of imports and an has been running trade and current account surpluses for years in a row.

(+) Strong fiscal position

Russia has a 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 contributing 28% to GDP. This makes government revenues highly susceptible to global oil price fluctuations. 

Key developments

1. Conflict with Ukraine is Russia’s main risk concern       

The conflict in east Ukraine and Russia’s involvement in the matter has largely determined Russia’s economic and political trends in recent months. The western stance towards Russia started to became more distant after the annexation of Crimea and the start of the conflict in east Ukraine. But, only after the downing of flight MH17 in east Ukraine on 17 July, there was a strong will to implement severe sanctions on Russia’s finance, defense and energy industries. In response to these sanctions Russia introduced a one year ban on imports of agricultural products, raw materials and food, originating from the west. The western sanctions of July were given a follow-up on 12 September, when the previous sanctions were extended. How the situation will evolve from now on is highly uncertain. But, a frozen conflict in east Ukraine resulting in additional western sanctions on Russia is still a real option.

2. Economic outlook deteriorates

Russia’s economy was already slowing down in recent years, but the conflict in Ukraine and the (fear for additional) sanctions have further dampened Russia’s economic performance. In the second quarter, the economy grew by 0.8% compared to the same quarter a year ago. Meanwhile, industrial production still shows modest growth, but consumer spending seems to slow down, as real disposable income is under pressure due to higher inflation. Based on monthly data on spending and output, GDP growth was around 0.4% (year-on-year) in the third quarter.

3. Russia’s external position deteriorates

A first estimate of the balance of payments figures for 14Q3 indicate a current account surplus of USD 11.4bn, compared to a deficit of USD 0.7bn a year earlier. This surplus was offset by a deficit on the capital and financial accounts and has resulted in a slight drop of Russia’s reserves by USD 5.7bn. But, as the outflow was relatively small compared to previous quarters, the figures were better than anticipated. That said, Q4 may be less positive, as the Central Bank of Russia (CBR) intervened quite heavily in the FX-market to support the ruble. The ruble depreciated so fast that it reached the upper bound set by the CBR. To slow down the depreciation, the CBR restarted its interventions in the FX-market begin October and this has led to a further drop in foreign exchange reserves. Although it is not possible to exactly identify the underlying reasons for the depreciation of the ruble, it seems plausible that; the fall in oil prices, the sanctions imposed by the west and the tightening of the government’s control over Russia play an important role.

Figure 1: Pressure on the ruble
Figure 1: Pressure on the rubleSource: Reuters EcoWin, Central Bank of Russia
Figure 2: Assumptions for the 2015 budget
Figure 2: Assumptions for the 2015 budgetSource: Ministry of Economic Development

The combination of a slowdown in economic growth, a falling ruble that results in higher inflation and falling FX-reserves due to market interventions has put the CBR in a difficult position. The most probable reaction of the Central Bank is an increase of the policy rate, as this will support the ruble and lower inflation in the medium term. However, economic growth will be further constrained and therefore politicians may exert pressure on the Central Bank not to raise the policy rate.

4. Budget 2015

Last month, the Russian government approved the 2015 budget. Most notable is that one month later, the underlying assumptions already seem to be too optimistic. First, economic growth is expected to be 0.5% this year and 1.2% next year. This while most institutions project Russia’s GDP growth to be lower. The IMF for example expects growth to be 0.2% and 0.5% respectively. Second, the oil price is forecasted to be USD 100 per barrel next year, while oil is currently traded at around USD 85 per barrel. All in all, the economic outlook is more pessimistic than anticipated by the Ministry of Economic Development a month ago.

5. The government is strengthening its control over the country

Except from the (indirect) effects from the sanctions, Russia overall business environment also seems to deteriorate, as Putin also seems to bring strategic companies under his control. In September, the Moscow arbitration court froze the 74% stake in oil company Bashneft owned by Sistema and Sistema-Invest. The case hearing is scheduled to take place on 30 October. Prosecutors filed the suit on allegations that Sistema's chair and co-owner Vladimir Yevtushenkov has illegally acquired the company. However, the case seems to be politically motivated, as Yevtushenkov refused to come to terms for the sale of Bashneft to Rosneft. If Yevtushenkov had sold Bashneft, the episode would probably have faded. This latest developments rings alarm bells about a possible resurgence of Yukos-style tactics.

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

Background information

Since the break-up 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 privatised most industries. These privatisations 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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