British Foreign Office evaluates the state of the Russian Economy at its October 2014 newsletter.
Russia’s current economic slowdown is primarily the result of domestic constraints, but sanctions since Crimea are estimated to have cost over 1% of growth this year.
The rouble has hit historic lows against the dollar, and inflation is at a three-year high.
No expectation of a crisis in the short term, but pressures will continue to grow.
The government now expects that GDP will grow by just 0.5% in 2014, and in its latest report the IMF argues that “the economic outlook appears bleak”, predicting that growth will remain below 2% for the remainder of the decade.
Sanctions have deepened the slowdown
The economic slowdown since 2007 (when GDP grew by 8.5%) is primarily the result of domestic constraints. Commodity exports are no longer driving growth as the oil price has stabilised and begun to fall. Having taken up the post-Soviet slack, the economy is now operating at capacity and structural reforms are needed to improve productivity. Russia also needs to increase investment, which was already suffering due to the slowdown, and which, since Crimea, has been further depressed by the escalating cycle of sanctions and counter-sanctions. Some analysts believe that sanctions may have cost 1% or more of economic growth this year.
Of the tier-III measures, the introduction of financial sanctions have had the most significant immediate effect. Although the EU measures are targeted to restrict lending to state-controlled banks, corporates in all sectors of the economy are finding it harder to access finance. Listed banks are unable to pass funds through to the real economy, and international financiers are cautious with lending to any Russian company in the present environment. As a result, lending rates have increased by around 1-1.5%, and the value of bond issuances in July-September more than halved year-on-year. This is weighing on already weak investment. Morgan Stanley assessed that the expansion of tier-III financial sanctions on 12 September was “not a major escalation”, but they demonstrated to the market that – despite the emergence of a ceasefire – there would be no easing in the short term.
Restrictions on the import of technologies used in the oil and gas sectors are also of significant concern for Russia. It needs to tap less accessible reserves to sustain production levels.. Most notably, ExxonMobil’s work in Russia has been significantly affected as a consequence of the expansion of US sanctions on 12 September, particularly in the Arctic.
Falling rouble and rising inflation
The rouble reached a new historic low against the dollar on 30 September. It has now fallen by 20% across 2014 and by 15% since the middle of July when tier-III sanctions were first introduced, as the restrictions on Western financing have increased demand for foreign currencies on international exchanges. Russia saw a net outflow of capital worth $74.6 billion in the first half of 2014, more than double the outflow for Q1 and Q2 in 2013. This has also contributed to depreciation, as have the fall in the oil price and the Central Bank’s transition towards a full inflation targeting regime. The exchange rate is an important psychological figure for Russians: large neon signs flash the latest rates on every major Moscow street, and the devaluation in 1998 remains a painful memory.
The rouble’s depreciation has contributed to rising inflation, which reached 8.1% in September, the highest rate since 2011. But Russia’s self-imposed food import ban has also played a role: the government’s forecast for food price inflation this year has risen from 7% before the introduction of the ban to 12-13% last week. Analysts expect that inflation will remain high for the rest of the year, and some project that it could reach 10% in 2015. As well as the impact on ordinary Russians through lower real income growth, high inflation makes it difficult for the Central Bank to use looser monetary policy to stimulate the economy.
The Ukraine crisis and the West’s response have added further pressures to Russia’s already-struggling economy. But while they have proven a constraint on growth this year, the scale of the impact of tier-III measures will depend on how long they remain in place.
There remains no expectation of an immediate crisis. Russia continues to hold the fifth-largest international reserves in the world, worth $465 billion, and the weaker rouble will increase budget revenues from oil and gas sales.
But predictions for the economy in 2015-17 suggest that the impact on ordinary Russians will continue to grow.