Russia’s fortune and growth prospects remain tied to its most important economic partners in the Euro area and its main export products: oil and gas. In the last decade Russia grew at around 6 percent (if we exclude the crisis year of 2009 - 4.7 percent on average otherwise).
In the past, given the buoyant oil revenues, Russia followed a pro-cyclical growth model of stimulating domestic demand, partly through public investment projects and partly through increasing public wages and other public income sources such as pensions.
If the prices of oil and gas were to drop in the near future, Russia’s growth model might be in need of urgent adjustment.
At present, growth in Russia is experiencing great headwinds of external and domestic nature, which could jeopardize its medium-term growth outlook. Growth slowed to 1.4 percent in the first half (H1) of 2013, compared to 4.5 percent in H1 2012. One reason for this was sluggish external demand. Falling exports and lower resource prices reduced the trade surplus to US$91.6 billion (9.1 percent of GDP) in H1 2013, from US$108.3 billion (11.5 percent of GDP) in H1 2012. For most of the first half of 2013 oil prices were around US$ 100/bbl.
Lower oil prices in H1 were immediately translated into lower federal oil revenues (dropping from 11.2 percent of GDP to 9.8 percent). The Federal Government reacted and exercised higher control over budget spending during the first seven months of 2013. Federal expenditures declined in January-July 2013 to 19.1 percent of GDP from 20.9 percent of GDP during the same period in 2012.
The World Bank’s recent Russia Economic Report projects that Russia’s growth will recover in 2014 to around 3 percent, with oil prices at around US$105 /bbl. However, with the budget situation in the US and the withdrawal of the monetary stimulus becoming more certain, the prospect of a sustained recovery is unsure and could contribute to lower global trade and growth impetus. Lower commodity prices are not inconceivable in this scenario. What would this mean for Russia’s outlook? We have developed an alternative scenario with a decrease in oil prices to US$80 /bbl, which illustrates the downside risks to our own forecast. The Ruble would depreciate by about 20 percent, the current account surplus would shrink in nominal terms and net capital outflows would double to -4.4 percent of GDP. The economy would contract by 2 percent and the budget would fall into deficit.
Table 1: Growth outlook with one time oil price shock in 2014
But, perhaps there is even more to worry about with respect to the health of the Russian economy and its medium-term growth prospects. In addition to Russia’s continued high external vulnerability to oil prices, and the risk of high volatility in external demand, we believe the economy will be facing binding constraints to domestic demand growth. The pace of future expansion will be held back by the economy operating near its full capacity. Recently, one could observe very high capacity utilization – over 80 percent and near pre-crisis levels when the economy was growing at 8 percent annually- and Russia had record low unemployment rates. Also, in H1 2013 non-tradable sector growth slowed dramatically. We see little dynamism in the manufacturing sector, which suffered from the high volatility of Russia’s growth in the past and also from the lack of competition. Unless a growth model which also includes supply-side constraint to growth in Russia will be more squarely implemented, target growth rates of 6-7 percent might be an elusive goal.
With this blog I hope to start a discussion about the weaknesses of the past growth model in Russia and what could be done to improve it. I look forward to reading your comments and views.