Article by Olga Kuvshinova for Vedomosti
Russia’s economy is completing a two year recession. Although it has been relatively shallow – just over 4% over 2015-2016 – much more has been lost.
According to the Ministry of Economic Development’s best case scenario, it will take three years to fully recover from the prior two of contraction. This projection sees oil prices rising to $55 per barrel by 2019, and by 2020, the economy will have returned to its 2014 level. But growth had slowed even before the crisis to just over 1% in 2013, when oil prices were twice as high as in MinEcon’s optimistic scenario. Since 2010 (and with the exception of 2012), Russia’s growth rate has chronically lagged behind the global indicator, and over the past decade, the accumulated gap has reached two figures: according to the IMF, since 2007, the global economic has grown by 38%, while Russia’s has expanded by less than 16%. This is in contrast to the aughts, in which Russia’s economy grew faster than the global figure, even including the recession of 2009.
However, these results have been crossed out by recent years. IMF data since 2000 shows that that the global economy expanded by 89%, while Russia’s grew by 85.6%.
The Problems of Low Growth
In the future, the gap is likely to grow wider: with global growth at 3% in the coming years, Russia’s potential is limited to between 1-1.5% per the IMF and Bank of Russia and 2% per MinEcon. The markets expect very modest growth too, of between 1-1.5% for 2017 and 2018, per Bloomberg.
Recent years have seen the entrenchment of a stagnant economic dynamic, says the head of analysis and projection at TsMAKP, Dmitri Belousov: “we’re in stagnation, long and clingy.” Investment is stagnating, as is overall turnover, as a consequence of shrinking real wages; all major markets are at a standstill. Moreover, since 2015, retail has seen a contraction in food sales and flatlining non-food sales. The population has become divided between an increasingly large layer of the poor, who economize even on food, and the more-or-less well off, Belousov concludes. And beyond a growth in inequality await much graver problems, he notes.
Tactically, the problem is that with low growth, the state and society lack the resources to resolve key social problems, for the war on poverty, and for infrastructure development. Strategically, low growth mean there are insufficient resources for the modernization of production. Belousov lists a number of consequences: a gradual erosion of Russia’s technological foundation, a dissipation of human capital and competitiveness, and a destabilization of the balance of payments and exchange rate.
A Preparatory Year
2016 was a breakthrough year for monetary policy: inflation reached a historical minimum due to weak demand and a hawkish central bank. MinEcon expects inflation to reach 5.6% by the end of the year. The Bank of Russia’s target of 4% has come into view for the first time. But this target must still be reached and then maintained. It is far from a given that inflation hits 4% next year: the consensus prognosis for 2017 at the Higher School of Economics is 5% while Bloomberg’s is 5.1%, with 4.5% in Q4. The risks stemming from domestic factors include both psychological factors such as sticky inflation expectations, and political ones, such as increasing budget expenditures.
After a year long break, fiscal policy has seen a return of three-year planning. A three-year budget consolidation plan that sees the deficit reduced to 1.2% of GDP by 2020 has been prepared and approved. However, this year showed again how unpredictable fiscal policy can be: late in the year, defense spending was increased by 1% of GDP at the expense of a larger deficit, and despite falling revenue and overall austerity. Experts at the Higher School of Economics express doubt over how realistic the three-year consolidation is: there are risks of spending increases (for example, on defense), the crowding out of productive spending on education and healthcare, and insufficient borrowing and revenue. Moreover, the resolution of the more complicated questions: the balancing of regional budgets, pension system, and funding of healthcare, has been put off.
2016 saw another precedent as well: the government’s removal of statutory social guarantees – pension indexation at last year’s level. The budget was unable to compensate for a spike in inflation to 12.9% in 2015, with each percentage point costing roughly 36 billion rubles. Counting a one-off 5000 ruble payment to pensioners next month, pension indexation for 2016 will come in at only about 5.6%. In 2017, indexation at inflation will return, but the precedent fits into a new trend of reducing social spending and partially transferring them to citizens themselves; one that will grow. As such, the indexation of pensions for working pensioners has been halted into the future, and they will see a weaker standing in the pension system (for a year of work they will receive 3 points compared to a maximum of 10 for other citizens). The indexation of maternal capital payments has been halted as well, as have raises for state workers. The Ministry of Labor has raised the possibility of making formally non-working Russians pay for financing they receive from the state medical insurance system, while the Ministry of Finance has raised increasing the retirement age again. In anticipation of a new budget cycle, various options for savings on social spending have been proposed, as well as for increasing the tax burden on Russians: raising the income tax, or a ‘tax maneuver’ that would lower insurance premiums and increase the VAT – an indirect tax that would in practice be paid by consumers.
In the next year and a half to two year, the political mood in the Kremlin will be determined by the looming 2018 presidential elections, and these events will determine the time frame for key economic reforms, including fiscal, tax, and pension, believes Vladimir Tikhomirov, head economist at BKS. He expects that in all likelihood, the majority of controversial or politically questionable proposals will be put forward by the Kremlin after the elections.
Where to Grow
Even in 2011 and 2012, the government and Kremlin expressed worry over the slowing of the economy, indicating that 4% was their desired annual target. This is higher than the global growth rate; that’s to say it would help reduce the living standards gap with developed countries. It’s also the growth rate that would provide enough revenue for the development and fulfillment of social obligations. Now, in conditions of limited finances and a slowly recovering economy, only a minimal social obligations will be provided, per MinEcon’s three year prognosis. The turn to stagnation birthed an unexpected effect: it nested in the minds of official. All long term projections promise nothing above 2% per year, notes Belousov with surprise. He underlines that in order to solve the country’s problems, a growth rate of no less than 4.5% is needed. When growth is below this figure, problems can be solved only at the expense of others.
“There’s no economic development, and the minister of economic development is in front of you,” confessed Aleksei Ulyukayev in the fall of 2013. In the fall of 2016, the economy went without a minister of economic development too, with the arrest of Ulyukayev one of the main mysteries of the year. The new minister, Maksim Oreshkin, has been charged with strengthening the role of the ministry as a center for upcoming socioeconomic reform. In the run-up to elections, the president has again ordered the preparation of a plan of action for improving economic growth above global levels, a new strategy that will be prepared by experts (with the participation of officials) under the leadership of Aleksei Kudrin. It should be ready by the end of spring. Its predecessor, “Strategy 2020” remains only a third implemented, per the Center for Strategic Planning.
The structure of the economy has remained almost unchanged from Soviet times, Tikhomirov notes. The raw materials sector and military industrial complex dominate, and more than half the country directly depends on the state as main source of income. Such structural deficiencies make the Russian economy dependent on commodities markets and political preferences in the government. Both factors are difficult to predict, and there’s a total lack of long term planning among both businesses and in the political arena, Tikhomirov believes. The ‘strategies’ that appear from time to time are constantly rewritten or more likely to be written off. The same can be said of the rules of doing business in Russia.