Russian economic dilemmas

Ce texte a été écrit pour le numéro spécial du magasine EKSPERT consacré à la stratégie économique de la Russie, qui doit paraître à la fin du mois de janvier (en russe)

 

Prospects for the Russian economy are gloomy for 2016. Quite certainly, the situation is not to be as bad as it was in 2015. Growth could resume by the end on the second quarter and hit, by the end of 2016 a mere 0,7%. Of course Oil prices are an important factor but definitely not a decisive one. Even if oil prices are to be back at 50 USD a barrel by the end of 2016, the impact on Russian economy is to be moderate. The truth is that the development model of years 2002-2008 has exhausted its capacities. A new model is to be created. But it will take time and will need protracted efforts. The main issue is not just to develop diversifying and modernising sectors but also to understand that nothing could be really successful without changing rules in the banking and financing sector. To change the model of development implies a truly integrated effort.

 

The post-1998 development model

Russian growth has been impressive since 1998. But it was linked to different factors. In the years following the 1998 crisis, the GDP “rebound” as it was called was mostly linked to direct and indirect effects of the sharp ruble depreciation. Imported good became overnight much too expensive, opening a window of opportunity for local producers. This raised their profits and they had to largely increase the production level to face the demand. By doing so they induced first a huge movement of inventories rebuilding and then, from 2001 on, a similar movement for investments. The large increase in labour productivity enabled production costs to be kept relatively low. Destruction of a large part of speculative markets (i.e. markets for GKO) implied that savings could not be used on these markets and were mostly used for investment.

By 2002, when commodity prices began to increase a new mechanism began to set in. The large financial inflow coming from exports first began to beneficiate the population but also led to a creeping raise of the exchange rate (notably after early 2006). The increase of income level, be it linked to a direct mechanism (the economy rebuilding) or to indirect ones (the real exchange rate appreciation), boosted internal demand. A significant number of foreign enterprises came then to Russia, not just through imports but also notably by developing their owns production capacities, boosting economic efficiency. This became obvious with high prices for hydrocarbons. Economic growth became strongly linked to consumption and the huge consumption lag accumulated since the late 1980’s gave birth to consumption frenzy.

 

Figure I

Russian GDP since 1998

A - 01 PIB growth

The Government played ball and supported through direct or indirect investment the development of public infrastructure. Then Russia partly avoided to end into a grossly unbalanced growth. But support to innovation and to the development of small and medium enterprises was sill low.

 

Contradictions and dependency to Western finance

In retrospect these years gave birth to a very specific development model where Russia was not just specializing into commodities export but became dependant too of the Western financial banking system to fund its development. This was one of the biggest challenges for Russian sovereignty. Capital exports, fuelled by the huge trade surplus, were used as a kind of guaranty for Western loans. Reasons behind this trend were complex. Certainly, the fact that interest rates were lower on international finance markets that in Russia, a fact made more obvious by the Real Exchange Rate appreciation, played an important role in these developments.

The Central Bank policy, with its preference for high interest rates, but the state of the Russian banking industry too, were a distinct factor into this preference for borrowing money abroad to finance industrial development. But they were not the only factor. Uneasiness of Russian industry owners or stakeholders with the current Russian government, uncertainty in the Russian institutional system, corruption, all these were important factors too in this preference for using foreign financial mechanism. This could explain why Russian banks and large enterprises have become so dependent in foreign money even if to a large extent internal financing capabilities existed and could have been used to fund economic development.

 

Time is running short

This development model was actually undermined by the world financial crisis of 2008-2010 but it collapsed when the United-States and the European Union implemented the so-called “Sanctions” regime. It is to be understood that material sanctions have been mostly counter-productive[1]. But financial sanctions, cutting Russian banks and large enterprises from western financial markets, or at least severely constraining their ability to borrow money created serious difficulties. They were compounded with the huge drop in oil prices weakening the rubles.

Figure 2

The Ruble exchange rate and its relation with oil prices

A - 0012 TxDeChange

It is true to say that the Russian government has put a priority on the development of a modern manufacturing sector for years. But, when the Ukrainian crisis began to shape international relations Russia has not broken with its traditional model. To some extent the crisis in international relation has to effect to make the change of model both an absolute necessity but also a very hard undertaking. So far Russia is still caught in the middle of a kind of new “transition”, but time is running short. The fact that oil prices are at their historical low since 2004 is then compounding the transition problem.

Figure 3

Oil prices (BRENT index)

A - 0012 prix BRENT

Limited success

Quite clearly Russia needs to develop a strong industrial sector to provide both the internal market and the export market too. Such a development doesn’t imply to stop developing the commodity sector. Actually, the oil and gaz sector could become major consumer of Russian manufactured goods. The main issue here is more how to ensure the development of manufactured goods without compromising the production of commodities. It is not just a problem of developing new productions but also one of changing the whole structure of Russian industry as a significant number of new enterprises are to be created to develop these new productions, and their development is challenging an industry used to rely on large integrated groups.

Some progresses have been made. In 2015 for the first time since the early 1990’s exports of manufactured goods have been more important than hydrocarbon exports. The share of manufactured goods in the total amount of exports has jumped from 38% to 48%[2]. This is in part linked to the huge Ruble exchange rate depreciation that is boosting competitiveness of manufactured goods and to other part to the boom of weapons exports. But whatever factors behind it proves that Russia has a strong export potential for manufactured goods[3]. The share of internally produced consumption goods is also increasing fast on the internal market. But, the issue of defining a new integrated development model is still pending and this could be seen on to the fact that investment is still depressed and still mostly funded through borrowing on foreign financial markets.

 

Toward an integrated effort

This raises one major question. Could the Russian government really engineer this change of model without massively revamping the financing system? So far the government has pledged its willingness to use market-based mechanism. There is nothing wrong here. But it depends a lot of what kind of market-based mechanisms are used. Loans made for specific sectors of for specific kind of enterprises at low interest rates either to cover circulating capital or investment in fixed capital have been a characteristic of European economies in the 1950’s to early 1980’s. Because the Central Bank and the Ministry of Finance are still very cautious, and caution could be well explained by painful memories of the 1998 crisis, Russia’s financing system has been let quite undeveloped. The main problem Russia is facing now is to revamp its financing sector to give emerging enterprises the possibility to really develop and to strongly reduce its exposure to international finance. To do so the Russian government has to admit it would need a larger budget deficit than the 3% planned so far for 2016 and probably till 2018 (something it could be done quite easily), but even more important it would develop a new financing structure channelling Russian savings toward the new sectors and enterprises.

This is an absolute priority for the government but would induce tremendous institutional change not just in the Banking sector but also in the way the Central Bank is managing it and in practices used by the Ministry of Finance.

 

Notes

[1] Asford E., « Not-so-Smart sanctions », in Foreign Affairs, January-February 2016, https://www.foreignaffairs.com/articles/russian-federation/2015-12-14/not-so-smart-sanctions

[2] Central Bank of the Russian Federation data.

[3] Hansl B., « With the ruble depreciation, ‘Made in Russia’ could once more become a worldwide trademark” in Brookings Institution, November 3rd, 2015, http://www.brookings.edu/blogs/future-development/posts/2015/11/03-ruble-depreciation-russia-hansl


Jacques Sapir

Ses travaux de chercheur se sont orientés dans trois dimensions, l’étude de l’économie russe et de la transition, l’analyse des crises financières et des recherches théoriques sur les institutions économiques et les interactions entre les comportements individuels. Il a poursuivi ses recherches à partir de 2000 sur les interactions entre les régimes de change, la structuration des systèmes financiers et les instabilités macroéconomiques. Depuis 2007 il s'est impliqué dans l’analyse de la crise financière actuelle, et en particulier dans la crise de la zone Euro.

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