What will become of Russia given cheap oil?
Life after oil
In recent weeks, nothing appears to have drawn as much of the attention of experts in Russia and beyond as oil prices. Prices of the Russian Urals brand oil have tumbled by more than 25% in less than two months: from $59.2 to $44.3 per barrel. The collapse in oil prices has also begot flight from the ruble which depreciated by nearly 22%, nearing its record low against the dollar recorded in late January. It is noteworthy that this drop in oil prices has already generated two important pieces of news: firstly, Brent closing below $52 a barrel as of July heralded the technical completion of the uptrend in this market which evolved back in the late 1990s and its shift to a downturn; and secondly, on August 20, quoted prices slid beyond the low ebb of last winter, and currently the nearest support level is within the range of $38 - $39.50 a barrel, which is one and a half times lower than the provisions set out in the already adjusted Russian budget for the current year.
Falling oil prices lead to serious problems for Russia’s closest allies too: Kazakhstan was recently forced to devalue its national currency, the tenge; and far greater problems will come to light in Belarus immediately after the presidential elections, due on October 11.
Here we shall not speculate about what exactly puts pressure on the oil market and what factors lead to a drop or rise in prices. It seems far more interesting to consider what will happen to Russia should oil quotes ‘be drifting’ between $35 and $48 a barrel or, God forbid, slide even more dramatically. Assessing the prospects of the country, one should, in my opinion, give special consideration to three aspects, none of which inclines one to make optimistic forecasts.
The first consequence of falling oil prices will be not so much the ‘drying up’ of budgetary flows (presently, the government has enough reserves to suffice well into 2018 and perhaps longer) as will the dramatic (in part, cautionary) reduction in consumption which will be a powerful blow to private business. The relative stabilization of the economic situation in summer 2015 has largely resulted from the tacit agreement of the manufacturers as regards maintaining current prices – a lot of companies recorded losses, but refused to cease their operations in the hope that improved market conditions were around the corner. It will become clear as soon as in September-October that there is no chance of improvement; the price of the ruble has reached approximately 70 rubles/$; the government is not prepared to implement stimulus packages - and manufacturers will be forced to increase prices by 10-20%. Such a move will decimate sales and trigger a wave of business closures – moreover, I should like to emphasize that private businesses will be the first to fall, since state-owned companies happen to have considerable foreign currency revenues as well as access to loans and subsidies. All of this will result in the destruction of thousands of private companies and an increase in the share of state-owned enterprises in the economy – Russia will progressively transform into a kind of a replica of the Soviet Union, albeit with certain differences in living standards and lifestyle.
I insist that a relatively insignificant extent of the GDP fall noted in Russia in the first half of 2015 is not in the least due to active government policy, but solely to imperfect information, on the basis of which business operates; thus far opting to go on manufacturing rather than to record losses. Had Russian entrepreneurs been aware of the future effects of the crisis which is underway, the decline in industrial activity would have dipped manifold. Today, only ‘faith in serendipity’ prevents the economy from collapsing – but a continuation of the decline in oil prices will see off this factor.
The second consequence of the price collapse in the oil market will be a continuation of the depreciation of the ruble under conditions of relatively low inflation. The abovementioned curbed demand will become the underlying reason for that: when nobody buys anything there are no objective reasons to raise prices. Accordingly, the ruble depreciation against the backdrop of relative price stability will bring about the rapid expulsion of imported goods from the market – but import substitution will not take place; primarily because of the complex business climate and the ‘sluggishness’ of state-owned enterprises.
Citizens and businesses will try to economize – choosing cheaper and lower-quality goods than those they acquired pre-crisis. This means that said companies will not produce truly competitive goods that will be the most successful, but rather those which bring about maximum savings at the expense of quality. The latter will generate – and already in the relatively near future – a wave of economic autarchy and primitivization: as in the first case, against the backdrop of confrontation with the West, this will be justified by the necessity for self-reliance. However, the real consequence will be Russia’s retreat from the global market and its economy’s transformation into one which is much more closed (I do not foresee anything close to the USSR with its distribution of currency to purchase low-quality FMCG, but the quality of consumption will fall far beyond its volume).
This also means that one shouldn’t hope to ‘get off the oil needle’: on the one hand, modernization of production is always targeted at improving the quality of manufactured goods, whereas the basic tendency will be precisely the opposite; on the other hand, nowhere in the world is modernization achieved in any other way than through powerful technological transfer – and it will turn out to be impossible in Russia, first of all because of the inhibitory high dollar and euro exchange rates which stand in the way of new equipment purchases. Thus, over the course of the next few years the country can rather expect to see the resuscitation of old enterprises rather than the development and formation of new ones – including even primary industry. It turns out that the decline in oil prices and the depreciation of national currency create a sort of a ‘trap’ leading to the impossibility of modernization. Even when dying, primary industry will not change its specialization.
The third problem is the country’s inability to take advantage of potential benefits; not so much lower prices but the consequences of which in the form of advancing devaluation. In the majority of countries faced with a plummeting national currency, a growth in exports follows due to the increased competitiveness of their goods. However, this is true only of industrialized countries – Russia has managed to choose an insane model in which even contemporary enterprises are orientated towards the domestic market. If, for example, the output of American and European car manufacturers established in China, let’s say, is largely earmarked for re-export, in Russia output is solely targeted at the domestic consumer. Produce of ‘native Russian’ manufacturers will not sell on the world market all the more so (and if it should, its volume will in no case compensate for the losses from the reduction in the influx of ‘petrodollars’). Accordingly, even growth in ‘substitution’ due to the expansion of the domestic market is also unlikely – it has already contracted more than in 1998.
The situation might be improved somewhat by the decisive actions of the authorities should they undertake steps to sustain final demand: radically increase subsidies for farmers by buying up their agricultural produce and supplying it to processors at low prices; subsidize passenger transportation; initiate a program of interest-free loans for auto purchases; the allocation of plots of land; preferential rate mortgages.
However, nothing of the kind will occur primarily because the authorities are focused on the preservation of reserves for use only in the case of absolute political, and not economic, necessity.
To conclude, it is noteworthy that the current decline in oil prices will not beget ‘new Russia’ which plummeting oil quotes in 1998 and 2008 could have helped to create. In the first two cases Russia found itself (or felt it was) at a certain crossroads – and hence it was ready to change to a certain extent (even Medvedev’s modernization could bring about far greater results should prices of $40 a barrel maintain in 2009 not for a number of months but for two to three years) – but now, Russia has deliberately reverted to reinstalling a quasi-Soviet industrial structure – and low oil prices, paradoxically, do not get in the way but rather connive to advance this ‘journey’.
The growing share of the state in the economy, the primitivization of the industrial sector, falling imports, sliding consumption – all of this, supplemented by the rhetoric of the confrontation with the West (which, as it will most certainly ‘turn out’ , ‘intentionally’ provoked the sharp drop in oil prices ‘to destabilize’ Russia) points to the only possible way forward for Russia given cheap oil. This way leads us towards a quasi-Soviet economy detached from the world and, at the same time, proud of its autarchy; towards a deteriorating economy which compensates for the drop in living standards with pervasive propaganda. Can Russia ‘opt out’ of contemporary globalization? I do not see any reasons which would prevent this. How long will it remain stable under the new conditions? I believe much longer than the majority of today’s analysts are prepared to admit…