Summary:
– The fall in oil prices (from $110/barrel to $55/b, a 50% drop between April 2014 and December 2014) has weighed on government revenues and the activity of energy companies, which are the main exporters and drivers of growth.
– However, the situation in Russia highlights two major weaknesses that have been apparent for several years: demographic aging and lack of investment.
– The domestic economic environment and sanctions have led to the collapse of the ruble (-40% in 2014), which is weighing on the financing of the economy.
– Today, the economic outlook is therefore very bleak, with the stagnation seen in 2014 (+0.6% GDP) likely to give way to a deep recession in 2015 (-3.5%).
As part of the Country Risk Conference organized by COFACE at the end of January 2015, a round table was held to highlight the geopolitical tensions surrounding the structural weaknesses of the Russian economy. While the sanctions are having a much greater impact on companies trading with Russia than on the Russian economy itself, the crisis the country is currently experiencing is, in some respects, much more conventional than it appears.
Russia, the new « fragile » country among emerging economies
According to Y. Zlotowski, chief economist at COFACE until the end of February 2015, Russia has joined the club of six « fragile » countries, which includes Indonesia, Turkey, Brazil, South Africa, and India. The problems facing the Russian economy are internal and have been identified for several years now:
– a lack of investment (a sharp decline over the past two years): on the one hand, this lack of investment stems from the public sector, which has not committed to a policy of major works aimed at improving the quality of the country’s infrastructure (particularly the transport network, in order to promote trade). On the other hand, the negative contribution to growth of private investment is certainly due to the slowdown in the domestic and global economy, but also to one of the weakest business climates in the world (Russia ranks136thin the Corruption Index compiled byTransparency International). Indeed, the instability of property rights (expropriation is commonplace), administrative red tape, corruption, and pressure from the authorities on foreign companies in particular are all factors that undermine the business environment and the ease of investing.
– A negative demographic trend (-14 million young people since the early 1990s), which certainly pushes unemployment figures down but also reflects a shortage of labor.
Sanctions mainly affect companies exporting to Russia
The sanctions are less serious than the difficulties inherent in the Russian economic system. According to P. Pegorier, president of the Association of European Businesses (AEB) in Russia, three-quarters of the decline in Russia’s GDP in 2014 is attributable to the fall in oil prices, with the rest of the adjustment relating to the contraction in investment. The Russian recession is therefore exogenous to the sanctions. This makes it easier to understand why only the Kremlin can help Russia emerge from this economic crisis. The need for reform is becoming urgent, particularly with regard to investment. Infrastructure needs to be modernized, not through massive investments linked to major events (as was the case for the Winter Olympics, the 2018 World Cup, etc.), but through a sustainable approach.
Furthermore, sanctions could push exports towards China and India. However, this diversification of markets and the strengthening of bilateral economic relations between China and Russia are relatively weak compared to the predominant weight of the European Union (EU). The EU still accounts for 75% of FDI inflows into Russia. In fact, among private actors, European companies that export to Russia are the most affected by economic sanctions. It is estimated that between 500,000 and 1 million jobs in the EU depend on activity in Russia. For example, German manufacturers (machinery, cars, electronics) are heavily impacted by the Russian slowdown, with sanctions being an additional difficulty for them. There is therefore renewed interest in setting up production sites on Russian territory (especially in the context of a very weak ruble). To date, very few multinationals operating in Russia have left, but several of them are sounding the alarm (notably Danone very recently). In addition, the establishment of the Customs Union with Belarus and Kazakhstan (which was at the heart of the outbreak of war in 2013, when Russia offered financial aid to Ukraine, conditional on integration into the Customs Union) will certainly never replace the EU as a market, but it could expand the consumer market for companies already present in Russia. From a microeconomic point of view, this is good news for manufacturers, but from a macroeconomic point of view, the impact is virtually nil.
The main loser as a result of these sanctions remains Ukraine, whose industry is mainly exposed to the Russian market. As long as there is a question mark over 20% of its GDP, the country cannot embark on the planned structural reforms and attract investors again (see comments by C. Lagarde in Le Monde on January 27, 2015).
As regards Russian gas supplies, the issue is a prisoner’s dilemma. Both parties, the EU and Russia, have every interest in reaching an agreement, the former for obvious reasons of particularly attractive Russian gas prices, the latter with a view to ensuring the necessary and sufficient level of budgetary revenue. It is for these reasons that Europe continues to import gas from Russia. Although Russia recently announced that it was abandoning the construction of the South Stream gas pipeline (which was intended to open up a new gas supply channel for the EU via the Black Sea), the renewed competitiveness of LNG, thanks to shale gas, should enable the EU to diversify its sources of supply and reduce the energy dependence of certain countries (100% of gas imported into Finland is Russian, 40% in Germany, etc.).
The financial context is another important factor in this crisis.
Although little mentioned during the conference, banks are facing significant financing difficulties on the international capital markets. The collapse of the ruble against the euro and the dollar (see chart), by 36% and 47% respectively between February 2014 and February 2015, will weigh heavily on the financing of private players (banks and non-financial companies) over the coming quarters, especially since Russia’s sovereign rating was downgraded to « Non-Investment Grade » (S&P, January 26, 2015).
The various measures taken by the Russian Central Bank (raising key interest rates on December 16, 2014, from 10.5% to 17%, and buying up large quantities of rubles to support its exchange rate) have not been enough to stem the fall of the national currency. Between November and December 2014, the Central Bank’s foreign exchange reserves fell by $130 billion to $380 billion. The currency’s decline, combined with international investors’ aversion to Russian risk (particularly since the introduction of financial sanctions), has put considerable pressure on borrowing rates in the markets. In fact, while the government is not facing any liquidity or solvency problems (public debt at 16% of GDP), the high level of short-term financing needs of financial and non-financial companies could pose a problem as early as 2015. Furthermore, despite the recent cut in key interest rates (CB decision dated January 30, 2015), the level of key interest rates will automatically weigh on economic activity at a time when the economic situation in the country is extremely poor.
References:
– BSI Economics, 2015, » Behind the gloom lies recovery , » Official report of the 2015 Coface Country Risk Conference, BSI Economics and Coface Group.
– BSI Economics, 2015, » 2015: a black year for oil! , » BSI Economics
– Julien Moussavi, 2014, » The Russia-Ukraine crisis: is one man’s misfortune another man’s fortune? , » BSI Economics.
– Stanislas de Bazelaire, 2014, » Sanctions against Russian state banks: heading for a liquidity crisis? , » BSI Economics.
