As the Russian economy enters a new period of turbulence, more and more ordinary Russians are not so interested in scientific theories and curious economic data. They want brief, qualitative answers to their straightforward questions about what has happened and what the future holds.

The biggest question is whether the Russian economy is facing imminent breakdown, to which the answer is “not yet.” But in three-four years’ time, the threat of this will be considerably more grave.

In several forthcoming articles, I will try to tackle some of these “frequently asked questions” about trends in the Russian economy. Some of them don’t have simple answers. It doesn’t make much sense to ask how much something will cost (or grow, or decrease), as random and unknown factors will affect the value of assets, exchange rates, and refinancing rates far more than we can predict. But we can at least name those factors and try to narrow down the realm of possibilities.

Two more caveats are in order. First, the answers are based on the current situation and available data, and we may lack adequate information to assess the situation as it changes.

Secondly, for the most part, economic change is not driven by organic shifts in supply and demand. Instead, policy is made by the personal or collective decisions of decisionmakers who aren’t always rational and are often incompetent. They pursue the interests of their clans and parties, or their own interests, which have little to do with the needs of maintaining a balanced economy.

What has been the main story of the Russian economy in the twenty-first century, since Vladimir Putin became president in 2000? We can say that for the last decade and a half, it has experienced two well-known phenomena that are not unique to Russia: a classical resource cycle and “Dutch disease,” in which over-reliance on energy exports damages the economy as a whole.

The rapid rise in oil prices at the start of the century dramatically boosted state revenues and relieved the government of the requirement of broadening its tax base. Moreover, because the ruling regime controlled oil revenues, it was able to consolidate its control over the energy and banking industries and therefore the entire economic and political life of the country. This hampered the development of non-oil-related businesses and made economic and budgetary decisionmaking much less effective.

By 2008, hydrocarbon export revenues effectively comprised 65–70 percent of Russia’s budget directly or indirectly, but there was a close correlation of 90–95 percent between the levels of GDP growth, federal budget revenues, and reserves on the one hand and changes in oil prices on the other hand—proof of much tighter relation between the inflows of cash generated by oil exports and economic life in the country. No surprise that the massive influx of petrodollars significantly distorted the ruble market exchange rate, which at peak times exceeded the inflation-adjusted rate by more than 35 percent.

On top of that, three negative factors influenced Russia’s economic development:

1.    In its effort to control financial flows, the regime deliberately made the investment climate worse by refusing to protect the rights of investors and entrepreneurs. This led to a decline in investment, further disproportions in exchange rates, lower entrepreneurial activity, and ever-increasing financial and human capital losses. Capital flight amounted to over $1 trillion during this period, and some of the best businesspeople and professionals left the country.

2.    Depositing extra profits into reserves in parallel with extensive borrowing in international markets at a significant spread led to a disproportionate increase in the price of debt capital, thus making investments even less attractive and preventing the development of capital-intensive and slow-growing sectors of the economy.

3.    The overvalued ruble and populist government policies of unjustified wage increases and higher taxes drastically increased production costs, making domestic production a losing proposition.

In the end, all sectors of the Russian economy suffered. The manufacturing sector never became competitive, despite overall higher revenues fueled by hydrocarbon exports and greater-than-anticipated consumption growth. Hydrocarbon extraction constitutes up to 20 percent of Russia’s GDP. As of the last verified data (Y2014), another 29 percent comes from trade. This is a disproportionately high number inflated by the enormous influx of petrodollars, a figure that twice exceeds the average in most developed countries.

The domestic energy market and infrastructure comprise another 15 percent of the GDP. Public projects make up a further 15 percent, while banking accounts for almost 10 percent, which means that no more than 10 percent of the country’s GDP comes from the independent service sector and non-resource production.

On top of this has come unreasonable social policy. Personal incomes have outstripped GDP growth even when the oil factor is taken into account. The public sector employs 30 percent of the workforce directly and another 8 percent indirectly, thus shouldering an excessive burden. Halfhearted and indecisive government policies have led to the failure of pension reform. The federal budget was further overloaded by ambitious but inefficient projects and inflated defense and security spending. Finally, massive corruption blew budget spending out of proportion.

As a result of all this, as oil prices declined, Russia was stuck with an undiversified, quasi-monopolized economy that lacks factors and resources to stimulate growth.

So, is Russia about to experience an economic crash? No, not yet. The country has accumulated ample reserves in the years of high oil prices. Foreign currency and gold reserves are three times higher than anticipated import volumes. Businesses have acquired sufficient fixed capital. People have over $250 billion in bank savings and probably no less in cash. The average housing space per capita has more than doubled. Russian homes are well stocked with consumer durables.

Of course, there has been an unprecedented drop in household income, but even with oil prices hovering around $35 per barrel, that brings us back to the relatively stable—though not so affluent—levels of 2004–2005. The least optimistic per capita GDP projections for 2016—around $7,500—put Russia close to 70th place in world rankings, right next to Turkmenistan and a bit below China.

The PPP (purchasing power parity) figures will be around $13,000–14,000, which puts Russia below 80th place, alongside Algeria, the Dominican Republic, Thailand, Columbia, Serbia, and South Africa. While these indicators are quite modest, they’re far from catastrophic. Popular uprisings are more likely to start in countries with nominal per capita GDP of under $6,000 and GDP (PPP) of $9,000–10,000.

In conclusion, if the current situation endures—if oil prices remain below $35 per barrel and no reforms are undertaken—Russia may stave off a large-scale economic crisis for at least three more years. Having said that, however, we assume that no major unexpected event, such as a failure of the banking sector, takes place. In further articles, I will focus in particular on where such disruptive events could come from.  

  • Andrey Movchan