During the second quarter, Russia’s real gross domestic product (GDP) dropped by 4.6% on a year-over-year basis,1 falling short of initial expectations and driving the country into a recession for the first time since 2009. Falling oil prices have been the main driver of Russia’s economic collapse, while its support for Eastern Ukraine rebels — and retaliatory sanctions imposed by western governments — have compounded the effects.
Energy-dependent economy lacks diversification
Russia’s economy is powered by the energy sector. Other sectors have lost competiveness due to lack of capital investment — which was down 28.5% year-over-year as of March (the latest available data)1 —as well as a culture of political patronage that awards funding from state-owned banks only to companies perceived to be supportive of President Vladimir Putin.
In addition, the economy’s ability to substitute domestic equivalents for imported goods — as happened after Russia’s 1998 default when Soviet-era factories produced sufficient substitute goods — has been greatly diminished because that option no longer exists.
Oil roils ruble
Because Russia’s currency is so closely tied the price of oil, the price collapse since mid-2014 has been disastrous. The ruble exchange rate has been highly volatile since August 2014 — halving in value from 36 against the dollar to 72 in December.1 The rate currently stands at 64 rubles per dollar, compared with its average of 29.4 rubles per dollar for the 10-year period preceding last year’s decline.1
Last December, the Central Bank of Russia (CBR) responded to the plummeting ruble by nearly doubling its key lending rate from 9.5% to 17%; it’s since been cut to 11% as the currency and prices have stabilized.1 Against the backdrop of low oil prices, further depreciation of the ruble and economic stagnation, I believe it’s likely that the rate hikes will be reversed as market rates fall with the weakening economy.
Inflation peaked in March at 16.4% year-on-year1 but has since stabilized. However, with the ruble falling again on the back of further weakening of oil prices, I anticipate that inflation will likely remain about 15% until early 2016 and then fall back to about 5%.
Russia still enjoys a both a current and trade account surplus due to the roughly equal magnitude of the fall in both imports and exports. However, due to the sanctions imposed by western economies and the lack of competiveness of Russia’s nonenergy sectors, these sectors haven’t been able to take advantage of the ruble’s sharp devaluation to boost exports significantly
Money and credit growth slump
From 2000 to 2008, Russia’s M2 money supply grew at an average rate of 40% annually, generating consumer price inflation of 14% to 15% a year.1 However, since the Global Financial Crisis of 2008 and 2009, money and credit growth have been much more constrained. This reflects both Russia’s increased dependence on oil and its post-crisis price weakness, which has led to the marked reduction in capital spending on oil and gas projects and capital outflows.
Despite concerns that the CBR may print money to repay debt in the near future, causing a surge in money growth, I believe it’s much more likely that slow money and credit growth will both reflect and lead to stagnant conditions in the Russian economy as long as oil prices remain depressed and western sanctions remain in force.
Repaying corporate debt with foreign exchange reserves
The ruble’s collapse last year created much concern that Russian companies wouldn’t be able to repay their $100 billion foreign debt in 2015.1 However, Russia has been using its large official foreign exchange reserves to help offset the currency crisis. The CBR launched a $50 billion program to lend dollars to companies at a concessionary rate when the ruble collapsed last December. But with the weak outlook for world oil prices, will foreign reserves, although significant, be able to sustain this support policy?
In short, Russia needs a higher oil price to help stabilize its economy in the near term. Over the long term, the country needs to diversify away from energy and restore market forces to the economy rather than relying on political patronage and cronyism.