Through a glass darkly: the direction of the Russian economy

More Russians will experience a decline of welfare. Photo: Reuters.

More Russians will experience a decline of welfare. Photo: Reuters. 

2016/07/19 • Analysis & Opinion, Economy, Russia

At mid-year the Russian economy may be going up—or down.  In what amounts to an ongoing ritual, in a June 17 interview President Putin sounded positive about the direction of the Russian economy.  He is quoted as saying, “we expected a slight economic decline by the end of this year, but now we are seeing growth,” although he noted that investment continued to decline because of structural problems, sanctions, and low oil prices.  It was not clear however if he was speaking about the economy overall or areas in which it has done well.  Russian economic policymakers in the latest Russia IMF Article IV 2016 released on July 13 expect the economy to decline by -0.2 percent in 2016 and the IMF forecasts a decline of -1.2%.

The IMF notes that, after oil prices and geopolitical tensions, the banking sector remains a specific risk, although it remains stable.  The IMF is less concerned about public sector finances.  Although the government is running a substantial deficit, the IMF believes that measures taken already have proven effective, public debt, although growing, is low, and, if need be, the National Welfare Fund “with liquid assets worth 5% of GDP” could be used to cover the deficit.  The IMF notes the government’s plans to manage the budget deficit through drawing down the Reserve Fund and from “privatization receipts from a number of large state-owned companies.”

However, evidence of severe financial strains abound. 

IMF reference to the National Welfare Fund arises because the Reserve Fund is projected to decline to about $15b at the end of 2016 and to run dry in 2017.  The government was running through the Reserve Fund at about $6-9b a month early in 2016, so even if the burn rate is lower now, $15b could disappear quickly.

The Welfare Fund, which was meant to cover pensions, not to provide budget support, is said to hold about $73b and the government expects to use $12b in 2017.  However, the Welfare Fund is exposed to considerable financial risk because its assets consist of investments in public and private corporations whose financial health is in question.  It has for instance a large exposure to VEB, Russia’s development bank, which is widely reported to be virtually bankrupt.

The other leg of the government’s plan, privatization, may not provide the income expected, with would put more pressure on the Reserve and Welfare Funds. 

The Russian government recently tested the market for privatizations with the sale of part of its stake in diamond miner Alrosa PJSC, which sold at a 3.8% discount to its market value.  Similar results for sales of other assets may reduce the government’s income from privatization, as well as reduce the value of what it continues to hold.  The IMF itself cautioned that Staff also recommended preserving more of the RF [Reserve Fund] as liquidity risks could materialize (e.g. drop in oil prices, low privatization receipts, and/or a tightening of sanctions)…”

Meanwhile, the IMF has warned that the Russian financial system will require additional recapitalization.  According to the IMF, non-performing loans might be higher than reported by some 3.5 percentage points resulting in a capital shortfall of about 0.5-1 percent of GDP.  Under stress scenarios, the shortfall could reach up to about 4½ percent of GDP” (roughly equivalent to the size of the Welfare Fund).  Central bank governor Elvira Nabiullina, is said to be looking into creating a troubled assets fund, putting a further strain on government finances.  In addition, the IMF notes, Support to the loss-making Russian Development Bank (VEB)…could reach up to 2 percent of GDP over the next few years.”

Moreover, the government expects to run a budget deficit until 2020. 

Ultimately, it plans to balance the budget through reforms that include pension reform, means-testing social benefits, postponing investment and improving capital budgeting, cutting subsidies, and improving tax collection.”  Many of these measures make sense, such as raising the pension age and focusing social benefits, but these measures mean greater pressure on incomes.  Postponing investment will also weaken growth.

In fact, with all the uncertainty regarding the return to growth and the pace and scope of reforms due to upcoming elections, further pressure on livelihoods is the only certainty.  The IMF refers to livelihoods only obliquely, mentioning in passing the government’s “tight income policies” and a fall in real wages that led to a rebalancing of national income in favor of corporate profits”.  The impact on livelihoods, however, will greatly influence the return to economic growth, because the renewal of even very modest growth next year is based on the expectation of an increase in demand.

A World Bank report expects the poverty rate (people living at or below the subsistence level of US$139/month) to reach over 13 percent of the population in 2016.  The World Bank believes that “even the improvement in economic conditions projected in the baseline scenario would be unlikely to stop the erosion of household incomes in 2017.”  The poverty rate could peak at 15.2 percent in 2017 before declining in 2018 if economic growth returns.  Pressure on incomes will continue due to the government’s intention to freeze government spending for the next three years, cut social spending, not to fully index pensions and public sector salaries, and raise the pension age.

For the vast majority of Russians, their economic welfare will continue to decline.

Of interest also may be that, a step below the oligarch class, Russia’s economic upper class (with incomes of 15 to 100m rubles), where private investment and discretionary spending might come from, is reported to have lost between 25 to 75 percent of its income in 2015 (Moscow Times).

Sixty percent of these are business owners who as a group lost 50 percent of their income, undercutting small to medium-size business investment. It is interesting to note that 84 percent of the economic upper class live in Moscow and thus might be expected to have a significant influence on government policy, which, economically, might be all for the good if it brings policy closer in line with the economic reality of everyday Russians.

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  • Yoshua Zafoy

    The time of easy oil is over, the oil that is left in the ground now is much more expensive to extract. The oil producers around the world are going broke since no one can produce oil for $50 per barrel, not even Saudi Arabia who went $100 billion minus in 2015.

    The oil industry consumes today 60 percent of the global oil production to be able to produce (extract, process and distribute) oil to the economy. The net energy that the global economy receives is in decline. The central banks are printing money to fight this net energy decline, but are losing the battle since it’s only artificial stimulus versus a physical decline.

    Venezuela, Ukraine, Syria, Yemen and Greece is the future that awaits us all.

    • Eddy Verhaeghe

      Yoshua Zafoy,
      You talk of the oil price that is needed to balance the state budget in e.g. Saudi Arabia and not of the production cost of said oil. Even at 20 $/barrel Saudi Arabia still makes a large profit on its production cost…
      So you might be right that a lot of the oil-producing countries will go the Venezuela way, but that the same is awaiting us all is nonsense. For consuming countries the oil price drop is a bonanza.

      • Yoshua Zafoy

        No one can produce oil for $50 per barrel. The oil fields in Saudi Arabia are over 50 years oil and need today Enhanced Oil Recovery projects to maintain production according to official Saudi Aramco statements.

        • Dagwood Bumstead

          SA can still produce oil for far less, so can several other countries in the Gulf region. Venezuela has the world’s largest proven reserves, though I’m not sure of the cost for developing new fields there. They will probably be much less than $50, however.
          Dwarfstan, for instance, is a different matter as the “easy” fields have already been developed. New fields are in remote areas with harsh climates (e.g. Kara Sea) which cost far more to develop, and require Western technology.

    • Dagwood Bumstead

      It costs no more than $8-10 per barrel to bring oil to the surface in Saudi Arabia, so even at a price of $20 per barrel SA will be making a profit. Whether that is enough to balance the state budget is another matter entirely. Venezuela needs a price of $130-140 to balance the budget; Dwarfstan about $100-110, as does Iran.
      SA has huge financial reserves and can stand current prices for 7 years or so. That cannot, however, be said of many other oil-producing countries; Venezuela is practically bankrupt, Dwarfstan is burning up its reserves not least because of the dwarf’s senseless wars in the Donbas and Syria, and his lunatic spending on the armed forces and security services at the expennse of trivia such as education, health care, infrastructure etc etc.
      As the Ukraine is not an oil exporter I fail to see why you include it in a list with Venezuela, especially as its economic problems are to a large extent caused by Pedo Putolini’s aggression. Venezuela has no such excuse.

      • Yoshua Zafoy

        The list of collapsing nations can be made longer. Kremlin will need its army to maintain order inside Russia at some point when the people start to revolt.

        • Dagwood Bumstead

          There won’t be a revolt in Dwarfstan. The people of Dwarfstan are a bunch of apathetic and lethargic Oblomovs. Expecting such people to revolt is naive, the dwarf has nothing to fear from them.
          The country will simply continue its irreversible slide into a slow implosion and irrelevance. It’s only the weak, irresolute “leaders” in the west- Obama, Merkelain, Hollandier etc- that allow it any relevance. Leaders of the calibre of Truman, Churchill, de Gaulle, Bismarck would already have made Dwarfstan totally irrelevant.

          • zorbatheturk

            Russia has existed in political darkness from the time of the tsars to today.

  • Dirk Smith

    Deeper sanctions to remove this dysfunctional and corrupt mafia syndicate from the kremlin.

    • Quartermaster

      As long as Russia remains a mafia state, the decline will continue.

      • Dagwood Bumstead

        The decline is irreversible, the only variable is the speed of the decline.

  • Dagwood Bumstead

    What the article does NOT mention is that anyone who buys into a “privatised” company runs the very real risk of having that privatisation reversed without compensation whenever it suits the dwarf. The law is meaningless in Dwarfstan and “ownership” means nothing.
    Anyone investing in Dwarfstan needs his/her head examined.

  • zorbatheturk

    Russia’s economy is going down the toilet. Kleptocratic totalitarian states do not have good records when it comes to economic management. Russia is cursed by bribe-taking at all levels. The most it can hope to do is limp along. Russian banks are likely to be riddled with bad loans, and the opaque accounting of entities like Gazprom cannot be trusted. Much of Russia’s export income is never received in Russia. It stays in Cyrus, Switzerland, or wherever.

    China is also on the economic road to Hades. But that’s another story.

    • Dagwood Bumstead

      Peking will defeat Dwarfstan, it is already slowly gobbling up vast parts of Dwarfstan’s Far East. Dwarfstan has nothing to fear from the west, but everything to fear from Superpower China.