Russian Financial System and Economy Hit by ‘Perfect Storm’

The last two weeks in Russia were a nonstop holiday, which only ends on January 12, when the nation returns to work as usual. The banks and the stock exchange will reopen, and no one is expecting anything good to happen: The price of oil has been sliding on world markets and Russian stocks may plunge together with the ruble. According to Rosstat figures, last December, inflation increased substantially, pushing 2014 annual inflation up two digits to 11.4 percent, as compared to a 6.5-percent annual inflation rate in 2013. Food prices have grown even faster: a 15.4-percent annual rate in 2014 (Interfax, December 31, 2014). Some 80 percent of Russians agree this crisis will be severe and long lasting (up to two years). The majority of Russians have begun cutting family spending and economizing on essentials. Some 70 percent are worried by the ruble’s steep decline against the dollar; half believe Russia’s economic deterioration is the result of Western economic sanctions, the other half thinks that there is something wrong with Russia itself (Interfax, December 30, 2014).

The only good New Year’s consumer news seems to be an official announcement that beginning next February the minimum official price of vodka will decrease from 440 rubles (over $7) a liter to 370 rubles (about $6) (Interfax, December 29, 2014). The production cost of vodka is some 10 percent of the shelf price and the rest is taxation. For about a decade, the Kremlin has been steadily increasing the taxation of alcoholic beverages in Russia to pour more money into the budget in order to rearm the Russian military among other things, and to push Russians to drink less. The populace, in turn, has increasingly turned to drinking various types of moonshine. The announced vodka price reduction is the first in many years and comes at a time when the Russian budget is experiencing a steep decline in revenue. The official reason for allowing cheaper vodka on the market is to decrease the consumption of “alcoholic surrogates,” like moonshine. But experts and officials agree it was a political decision made in the Kremlin and, to some extent, an act of desperation by the authorities. The coming crisis will hit the population hard and social tensions will likely grow. Whereas, cheaper vodka could decrease such social frictions and keep the Russian population happy (Moskovsky Komsomolets, December 29, 2014).

According to Vladimir Mau—a leading economist and long-time Kremlin adviser—a “perfect storm” has hit the Russian financial system and economy: “The price of oil is falling, sanctions are hurting, the national workforce is decreasing as Russian baby-boomers born in the 1950s are retiring.” The twofold devaluation of the ruble during 2014 cannot quickly or substantially stimulate local industrial output, because there is “practically zero spare output capability,” according to Mau. Russia badly needs massive investment and new technologies that do not seem to be forthcoming. The Russian economy was heading into a prolonged period of stagnation even absent the dramatic fall in oil prices, without the Crimea annexation or the crisis in Ukraine. But now the economy is heading into a freefall. The consensus opinion of Russian economic experts is to expect a GDP rate of 4 percent or more, and inflation reaching 15–20 percent, in 2015 (rbc.ru, December 26, 2014).

Former finance minister Alexei Kudrin believes the Kremlin “must find a way to improve its relations with the West” and solve the “smoldering Ukrainian conflict.” While Moscow and the West are at loggerheads, other anti-crisis measures will not work, Russia’s credit rating will fall, and there will be increasingly serious problems with the country’s closest allies, Kazakhstan and Belarus, Kudrin warns (Interfax, December 22, 2014). Despite Kudrin’s advice, the authorities seem to be hedging in the opposite direction—increasingly using administrative measures to crisis-manage the markets. According to Kudrin, “We are on the way to build a mobilization-type economy” (Vedomosti, December 25, 2014).

Last month the Kremlin used administrative pressure to stabilize the ruble exchange rate. Officials, including president Vladimir Putin, pressed the major Russian oil and other natural resources exporting corporations to sell off their hard currency deposits to strengthen the ruble. On December 25, Putin publicly defended the use of administrative economic regulation (rezim ruchnogo upravlenya—or “manual regulation regime”). De facto, Russia has imposed currency regulations, which may be an effective stopgap measure, but could backfire later. Capital flight could accelerate and investment could falter. The worst possible scenario, according to Mau, would be an attempt by the government to forcibly stimulate growth—the Russian economy could collapse in a couple of years (Rbc.ru, December 26, 2014). The Russian people are already reacting to the threat of more intrusive government regulation: dollar-denominated accounts in Russian banks are decreasing. The citizens appear to be emptying their accounts and stuffing piggybanks at home with cash dollars, afraid their bank accounts might become frozen or be forcibly converted into rubles at a fixed rate (Vedomosti, December 25, 2014).

Kudrin resigned from the government in 2011, protesting an ambitious military rearmament program worth some 23 trillion rubles until 2020 (some $760 billion at the then exchange rate; two times less now). Kudrin argued Russia could not afford such spending, and when the price of oil decreased, the rearmament program would collapse. In 2015, the Russian defense budget is 3.3 trillion rubles ($55 billion at the present rate) or 4.2 percent of the national GDP. Deputy Defense Minister Tatyana Shevtsova, responsible for defense spending, insists that continued calls for defense spending cuts are tantamount to treason. According to Shevtsova, “The West is hell-bent on stopping or seriously postponing Russia’s rearmament program, and if we yield and sequester our spending, they win.” The North Atlantic Treaty Organization (NATO) is moving forces closer to Russia’s borders, the military threat is growing and “now is the wrong time to cut spending,” using falling oil prices and sanctions as a pretext, insists Shevtsova (Kommersant, December 23, 2014).

Many in the West hope that sanctions and Russia’s economic decline will push Putin to compromise on Ukraine and seek an overall de-escalation with the West. But there are powerful forces in Moscow that do not want any de-escalation and would rather go all in instead. Putin’s ultimate decision is pending, the bourses open on Monday (January 12), and the clock is ticking.