Russia: Putinomics Pushing Recession Towards Crisis
Russia’s economy has come under sustained pressure in the final quarter of 2014, with falling energy prices, economic sanctions and a rapid devaluation of the rouble all contributing to a sense of imminent crisis. Global oil prices began a sustained slide, from a high of almost US$112 per barrel in June, to just US$62 per barrel in December. This, in turn, has spurred the collapse in the value of the rouble, from a pre-October average of 35RUB:USD to 57RUB:USD at time of writing.
While many officials from the technocratic wing of Russia’s elite have been warning of the possible threats to the Russian economy for years, they have been unable to effect policy change and been ignored by those who can. Now, with Russia inexorably moving towards recession, the Kremlin does not appear to have any policy options to address the coming crisis.
‘Putinomics’ coming to an end
Russia’s ample currency reserves have prevented it from entering a full blown crisis, and the depreciation of the rouble will help to balance the federal budget in the short term. But the current economic situation stems from more fundamental failures in the political and economic model that Putin has developed in Russia.
Developed market economies are generally based on the development of new sources of wealth and economic activity, with small- and medium-sized enterprises (SMEs) constituting a key pillar of economic growth and employment. By contrast, Russia’s economy remains based on predation, where revenue streams are identified and seized, and then redistributed via patrimonial networks.
On a national level, this has been the basis of Putin’s political power and legitimacy. The re-establishment of control over huge swathes of the economy has enhanced the Kremlin’s political dominance and allowed it to deliver steady increases in the standard of living for most Russians.
While effective, this political economic model is crude and comes at significant long-term opportunity costs. Entrepreneurism has been stymied, preventing Russia from becoming a more diverse and technologically sophisticated economy. Earlier this year, Pavel Durov, founder of Russia’s most successful social network, VKontakte, was forced out of his company and later fled abroad after he resisted demands for greater state access to user data.
In the absence of domestic organic growth, the predatory economy has only remained viable due to continually high prices for export commodities, principally oil and gas. This has allowed for a continuous injection of new resources into the economy, which can then be redistributed as a substitute for economic activity. So instead of a diverse array of companies in an innovation-centred economy providing jobs, full employment has been achieved through the further growth of Russia’s famously expansive state bureaucracy.
Deterioration could rapidly become collapse
This dynamic also means that Russia has very limited space to adapt to significant changes in the underlying economic conditions. In the absence of commodity-export driven growth, the state will lose its ability to remain the guarantor of full employment and provide generous social welfare provisions. Simultaneously, the absence of new revenue sources for larger ‘predator’ corporations to acquire may result in them turning on one another, in order to grab a larger slice of a shrinking pie.
These developments have the potential to prompt a vicious cycle of economic decay. While Russia’s official debt to GDP ratio is a very healthy 13.41%, the corporate sector has over US$650 billion in outstanding debt. Much of this is dollar-denominated, making debt servicing comparatively more expensive. More pertinently, much of Russia’s financial sector and several key companies have been locked out of Western financial markets due to the sanctions regime, leaving them unable to re-finance their existing debts, let alone finance new capital investment.
These companies have turned to the state to help them meet their obligations. The US$83 billion national pension fund has already been raided to help pay for the annexation of Crimea, and Deputy Prime Minister Arkady Dvorkovich has indicated the government will also use it to bail out struggling companies. Russia has access to other cash reserves and can theoretically raise additional funds via sovereign bonds. But most economists estimate that Russia can prevent its current stagnation from turning into an outright economic collapse for two years, at best, before its reserves are exhausted. This will also leave the Russian state unable to provide for its legions of employees and dependents, with the private sector unable to step in to fill the gap.
Searching for a policy response
It is becoming increasingly apparent that the Kremlin has no real plan to address Russia’s accumulating economic challenges, particularly the continual slide in the value of the rouble. During his annual state of the nation address on 4 December, Putin offered little beyond vague assertions that ‘speculators’ had caused the fall in the rouble and that they would be ‘punished.’
While Putin did offer a ‘no questions asked’ amnesty for repatriated capital, this appears more an indicator of desperation than a solid plan. The proposal amounted in effect to the de facto legalisation of money laundering. And given the shaky state of Russia’s financial sector and weak rule of law, the promise that repatriated funds would remain secure was dubious at best. Similarly a rate hike by the Central Bank of Russia from 9.5% to 10.5% on 11 December had almost no impact on the rouble exchange rate, which continued to decline steadily.
No way out?
Russia might be able to gain more economic breathing space, and time for reforms, if it could succeed in getting Western financial sanctions lifted. But this would require a humiliating volte-face in Ukraine that Putin might not be able to survive politically. Even if this could be engineered, Putin’s authority is based on Russia’s current, fundamentally corrupt, patrimonial system. Even if he desired reforms, it is not clear Putin could enact them.
This leaves Putin and Russia in a quandary. The current system cannot go on forever, which means that eventually it will end. How it would end was up until recently an open question, with reform at some future point a real possibility. However, the last quarter has made a much messier cycle of economic and political collapse close to inevitable. The only question is when.
By Dr Daragh McDowell, Senior Russia Analyst at Verisk Maplecroft, a Natural Gas Europe Industry Partner.