Russia in Free Fall
Op-ed in Capital
English language version © Peterson Institute for International Economics
Since November 2014, it has been obvious that the Russian economy would shrink sharply this year, and the January statistics indicate a serious decline has started. The Russian Ministry of Economic Development has forecast a decline of GDP of 3 percent this year, while the Central Bank of Russia predicts a decline of 4.5 to 5 percent at an oil price of $50 per barrel. These forecasts appear overly optimistic. An abrupt fall of 10 percent seems more likely, because key Russian indicators look worse than in 2009, when Russia's GDP contracted by 8 percent.
In July 2014, the United States and the European Union imposed serious financial sanctions on Russia. In parallel, the global oil price started falling and with it the ruble. As if these factors were not bad enough, the Kremlin is pursuing an economic policy that aggravates the decline.
Russia is not likely to return to economic growth until it abandons its war of aggression in Ukraine.
Tightened Western financial regulations have made the Western financial sanctions more severe than expected. The official Russian currency reserves are still large at $368 billion on February 13, but they have fallen by $110 billion since July 2014. However, the situation is considerably worse. The Ministry of Finance controls two sovereign wealth funds, the Reserve Fund with $88 billion and the National Welfare Fund with $78 billion on February 1. These funds will be used for bailouts of companies and infrastructure investments and are not real international reserves. The government plans to spend half of its Reserve Fund this year. In addition, the Central Bank of Russia holds gold worth $49 billion.
Therefore, the liquid international reserves held by the Central Bank of Russia have declined from $257 billion on July 1 to $153 billion on February 13. Considering that Russia's foreign indebtedness is almost $600 billion and the expected currency outflow is about $100 billion this year, Russia's reserve situation is approaching a critical limit. At present, Russia loses more than $10 billion a month, which means that a real reserve crisis will erupt in the third quarter.
Apart from the oil price and the reserves, the key indicators to watch now are demand, investment, and real wages. The Ministry of Economic Development has predicted a decline in investment this year of 14 percent, but it was merely 6.3 percent in January. The key concern, however, is real wages that fell by 8 percent year-over-year in January. These are the two factors that will draw down Russian GDP in 2014.
The public sector is the engine in the decline. The Ministry of Finance is slashing most budget expenditures by 10 percent, and it is arguing that additional cuts of 6 to 7 percent are needed. Government agencies are given the choice of sacking staff or cutting their wages.
Although Russia currently has nearly full employment with unemployment of only 5.1 percent, Russians are scared. The state-controlled pollster VTsIOM just published a survey that showed 35 percent of Russians expect their family's income to fall within the next three months because of anticipated wage cuts and 26 percent expect a member of their family to be fired.
Since November Russian real wages and incomes have been falling substantially. The Ministry of Economic Development forecasts that real wages will plunge by 9 percent this year. That has not happened since Vladimir Putin became president in 2000 because of the abundant oil boom. For the first time after 15 years in power, he will have to face a majority of the Russian people experiencing a sharply declining standard of living. No one knows what that will lead to.
Naturally, Putin is reacting against this blow, but his reactions are not the least reassuring. His bottom line is that he knows how to handle crisis because he did so in 2008–09. That is true, but none of the G-20 leaders did so worse than Putin, and now he wants to repeat his failure. His flawed idea then was to pour money into state corporations and his cronies, and they have grown even worse in recent years. Then, Putin wasted $200 billion on his flawed bailouts. Now, he can only afford $38 billion on his anti-crisis program, which will not make any difference, which is perhaps the best one can say about it.
Macroeconomic destabilization is another concern. Russia's inflation has risen to 15 percent, while the Central Bank for no good reason cut its policy rate to that level in January. The Central Bank needs to raise its policy rate to keep currency in Russia and to beat inflation, but that will also reduce investment and consumption.
Face it: Russia is not likely to return to economic growth until it abandons its war of aggression in Ukraine so that the West has reason to raise its financial sanctions.