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24 June 2015

The Russian Economy: Downturn Management

What is happening today in the Russian economy shows that the authorities have shifted policy from what can be described as growth management to downturn management

Something really unusual has been happening in Russia over the last few weeks: the statements of the leaders of the governmental economic bloc are becoming increasingly optimistic as the statistical data which characterize the shape of the economy appear ever more alarming. Such a disjunction between words and figures, appearances and reality has not been observed for many years. Even, perhaps, since consultations with experts, who were strictly forbidden from using the word ‘crisis’, were held in the presidential administration in late autumn of 2008. 

Assessing the ‘here and now’ in the development of the Russian economy, in the first instance, you might imagine a patient who, after a few months of suffering from an unknown ailment, visits a physician and is diagnosed with a severe form of cancer. First, the patient is injected with a powerful dose of hormonal drugs in preparation for his or her first phase of chemo or radiotherapy and then, for a few weeks, it seems that the disease has been overcome. But this is merely an appearance – a temporary illusion.

What happened in Russia from autumn 2014 to early 2015 resulted from a panic that ensued against the backdrop of the rapid drop in oil prices, the tightening of sanctions and the fall of the rouble. The authorities were so afraid that they undertook a number of measures which were identical, in terms of their effect, to the hormone injection: the main offensive was aimed at stabilizing the rouble, suppressing inflation and filling the shelves through import substitution. Surprisingly, even the ‘return to normality’ which we observed as a result of these efforts pointed rather to an aggravation of the problems.

What do we see today – and what underlies what we see?

First of all, the rouble indeed gained ground from 65.9-66.7 roubles against the US dollar in mid-January to 54.8-53.5 roubles in mid-June. As the saying goes, ‘the entire population is cheering and rejoicing!’. However, the reasons for the strengthening of the rouble are clear: to begin with, these are high interest rates and the lack of liquid assets in banks (not to mention the fact that more than 30 banks have collapsed since the start of the year). At the same time, sales of foreign currency earnings by export companies, undertaken mainly to pay taxes, (the president has repeatedly said that he strongly recommends that large corporations do not accrue foreign-exchange assets) influence the rate. The rouble monetary aggregate has contracted during the crisis (the M2 monetary aggregate is now lower than at the start of the year, whereas the money base, in broad terms, has decreased by 18.8% since January 1) – which seems insane from the point of view of any anti-crisis theory. One can recall that in the mid-1990s attempts were also made to fight inflation by ‘reducing the supply of money’. The results of which were less than impressive.

Secondly, inflation itself seems to have stopped: what was seen at the beginning of the year as a trend of around 22-25% by year end, dropped to 8.31% over the course of five months, with prices remaining stable in June. I would go as far as to predict that they will even start to decline in the coming months – especially given the perennial summer growth in food supply. However, the end of rising inflation points not so much to economic recovery but rather to a fall in ordinary demand. Thus, the real income of the population declined by 1.4% whereas consumer spending slipped by 6.9% in the 1st quarter. Citizens refrain from spending their income since they prepare for the worst. This is confirmed by the fact that the index of expected changes in the economic situation for the short term fell to minus 18% in the 1st quarter of 2015 versus minus 14% in the 4th quarter of 2014. The index of expected changes in personal financial standing constituted minus 19% versus minus 12% in the 1st quarter of 2014, whilst the cumulative consumer confidence index plummeted from minus 18% to minus 32% which is lower than it was at any point during 2009.

Thirdly, an entirely different reality underlies the stories about import substitution. ‘Success’ is largely limited to the defense industry, the produce of which is bought up by the state. In addition, the economy produces fewer and fewer goods for general consumption: otherwise, why would imports decline slower than exports? And why from January to April did trade surplus not only fail to increase, but decrease by 16.5%? A steady fall in industry is behind the rhetoric: even in January – a month it is better to forget – the industrial sector showed an increase of 0.9% but then the decline only accelerated reaching -5.5% in May year-on-year (it reached -8.3% in manufacturing). What the authorities intend to do in this regard is wholly unclear.

Fourthly, officially, everything is just fine with the budget’s implementation! Over the course of five months it has been implemented both in terms of income and expenditure in line with extrapolations (42 – 43% of the annual plan). However, revenues generated both by the Federal customs service and the Federal tax service between January and May dropped by almost 20% and expenditure – by almost 40%! Here we can see the same tendencies: the state is obviously implementing austerity measures, and the effects of these measures which appear after a delay of 3-5 months will result in yet another slide in growth (or acceleration of the downturn, to be more precise). The government believes that it should economize when it comes to what was referred to as ‘the non-production sphere’ in the Soviet days (and Soviet people are in power today) – that is, education and healthcare.  Such a course is unlikely to please everyone, and in the relatively short term, we are going to see a new wave of negative (if not panic) sentiments.

The government, having brought about the current results, has not cured the economic ills of the country. In restoring the position of the rouble in many respects, it thereby reduced the government’s nominal revenue. Oil, in fact, has not become more expensive, which means that duties denominated in dollars equate to fewer roubles. By ‘squeezing’ inflation, the authorities have destroyed one of the major incentives for business – the premise that what has been produced today can be sold at a higher price tomorrow – but have not, at the same time, reduced the rates which still exceed 12% even with the current, zero-level of growth in prices. ‘By investing’ in import substitution, the Kremlin is simply throwing increasingly scarce financial resources to the winds.

At the same time, if we are to continue with our previous analogy, the ‘doctors’ would have apparently decided to limit treatment to a one-off injection of hormone stimulators without having given a second thought to proper treatment (let alone going to the lengths of performing an operation). Having perceived temporary superficial equilibrium as overcoming the crisis, the authorities, it seems, have returned to a state of calm and to business-as-usual: organizing military holidays and rubber stamping laws limiting all and everything. One should not count on any reformative efforts in the coming years.

However, this does not hide the fact that today the Russian economy is at a critical point. Arguments between Aleksey Uliukaev and Elvira Nabiullinova about whether the fall in GDP will amount to 2.8% or 3.2% this year are now irrelevant. The more pertinent question is for how many subsequent years the economic downturn will endure. Judging by the indicators of ‘normality’ the government is attuned to, the country has 3 – 5 years of constant – although not rapid – recession ahead of it. When the downturn accelerates, the authorities may devalue the rouble once again, as comrade Lukashenko has already taught us: it is extremely useful when it comes to the spectacular stimulation of consumer demand. This measure will also, temporarily, bring more roubles with which contemporary problems can be fixed. Hence, the desire to show that all of this was a product of excessive panic will prevail and stabilization will again subsequently follow, albeit on a lower level.

What is happening today in the Russian economy shows, in my opinion, that the authorities have genuinely shifted policy from what can be described as growth management to downturn management: today they are trying to manipulate the downward movement in order to prevent the provocation of serious social problems. And, if it turns out that such problems do not transpire – and under the conditions of rising indoctrination and the feeling of being in a besieged fortress they will not occur – it seems all of us will have to long forget that not so long ago, rapid economic growth was something considered normal in this country …

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