Russia in the Global Storm

Originally published by the Carnegie Endowment for International Peace
Participants: James Collins, Uri Dadush, Zeljko Bogetic

Russia is among those countries that have been hardest hit by the global economic crisis.  The economic and social ramifications of today’s crisis will likely be longer and deeper than those experienced in recent Russian history, unless the country’s leadership takes quick and targeted action to mitigate the impact on households, warned Zeljko Bogetic, Lead Economist for Russia at the World Bank. Bogetic presented an assessment of the Russian economy at Carnegie, with comments by Carnegie’s Ambassador (Ret.) James F. Collins and Uri Dadush.

A Suffering Russia
Bogetic noted that the global downturn has fueled three main shocks to the Russian economy: the precipitous drop in oil prices from $140 to $40 a barrel; the evaporation of capital inflows of $80 billion in 2007 to outflows of $130 billion in 2008; and deteriorating financial conditions as Russia experiences dramatic drops in access to finance and large increases in sovereign and corporate bond spreads.  While much of Russia’s downturn is due to its reliance on oils and metals, it also suffers from a strong dependence on capital inflows and external borrowing by banks.  The narrow structure of the Russian economy, which features only a weak small- and medium-enterprise sector, limits the nation’s competitiveness in the face of a global recession.  Russia, like many other nations, has been hit severely by the unexpectedly large drop in global demand.

The impact of the crisis on the Russian economy has been both swift and severe.  In January, GDP shrunk almost 9 percent y/y.  Industrial production was down 16 percent y/y.  Fixed capital investment was down 15.5 percent y/y.  Both trade and non-trade sectors have been heavily hit, though construction and transport are fairing particularly badly.

Mitigating Policy Response
Despite the severity of these figures, the impact of the crisis would be much worse had monetary and exchange rate policy not offered some relief, explainedBogetic.  In the initial phases of the crisis, monetary policy aimed to alleviate the liquidity crunch plaguing Russian financial markets by lowering interest rates.  However, in response to the devaluation of the ruble, brought on by a sharp reversal of capital inflows, Russian monetary policy has since tightened.

Fiscal policy has focused almost exclusively on support to banks and enterprises.  Out of a stimulus package that comprised 6.7 percent of GDP, 3.3 percent of GDP was allocated to the financial sector and 2.5 percent to the real economy.  Only 0.2 percent was spent on direct relief for households.

Growing Social Impact of the Crisis
The lack of attention towards greater social safety net programs is particularly worrisome in light of the growing social impact of the crisis, cautioned Bogetic.  Russia’s relatively flexible labor markets have experienced rapid adjustment.  Unemployment has spiked from a record low of 5.4 percent in May 2008 to 8.5 percent in February 2009.  Real incomes declined substantially at the end of 2008 and the beginning of 2009, dropping 5.8 percent in the fourth quarter of 2008 alone.  Previous years’ double-digit increases in real wage growth came to a full halt in January and February.

Bogetic estimated that 4.7 million Russians would fall into poverty this year, compared to the 1.1 million that did so last year.  Most of the newly poor are low-income families who have large numbers of children and have become unemployed during the crisis, he explained.

Affordable Policy Steps could have a Big Impact
Bogetic advocated for the expansion of already existent social safety net programs, such as unemployment benefits, child allowances, and pensions, to rapidly address the growing social impact of the crisis.  Such expansions would assist the Russian economy more broadly because the poor have a relatively higher propensity to spend money on domestic, non-traded goods than do the non-poor, who are more likely to save or spend on imports.  Bogetic estimated that increased spending of 1 percent of GDP for the next 12 months on social safety nets would keep 4 million people out of poverty.

Bogetic also recommended that Russia spend an additional 0.5 percent of GDP on alleviating the infrastructure bottlenecks that could choke off nascent growth during a recovery and on reducing the regulatory burden of small- and medium-sized enterprises.  Finally, he advocated for quick-moving structural reforms to modernize the banking sector, improve the investment climate, and advance the WTO agenda.

Policymakers must take these decisive steps quickly, Bogetic warned.  The downside risks of rising social tensions and second round effects in the financial sector are too great to ignore.

The International Context
Uri Dadush offered insights into the global context of the crisis in Russia, noting that the country is suffering not only from strong oil-dependence, but also from high inflation and a banking sector that is fully globally integrated and heavily reliant on foreign currency. He predicted that if there is a recovery in Russia in 2010, it will be a very modest one.  Despite some optimistic signs in purchasing manager indexes, equity markets, and industrial production, Dadush noted that declines in production are still worse than those seen in the Great Depression.   Further, even the Great Depression saw some brief pick-ups in industrial production along its deep slide into depression; similarly, we should not read too much yet into today’s recent positive signs, Dadush warned.  Therefore, he endorsed Bogetic’s suggestion that Russian policymakers to take a strong stance to mitigate the economic and social impact of the crisis.

The Crisis as an Opportunity for Reform
Ambassador Jim Collins suggested that the current crisis throws several political trends into question.  He noted that it is unclear now how President Medvedev will continue former President and current Prime Minister Putin’s agenda of modernizing the Russian economy, reestablishing the state, and reestablishing Russian in the world.  He also questioned how regional governments will respond to financial struggles on the part of the central government.  However, Ambassador Collins also suggested that the crisis presents an opportunity for Russia to become a bigger player in global economic institutions.

Question & Answer
Asked to elaborate further on the regional impact of the crisis, Bogetic outlined three regional categories in Russia that have been particularly hard hit: those that rely on only a single source of employment, those that had pre-crisis high unemployment and poverty rates, and those with large stakes in sectors that have been most affected, including manufacturing, construction, and retail trade.

Bogetic and Ambassador Collins also responded to a participant who questioned whether Russian leadership has the political will to pursue the opportunities for reform presented by the crisis.  Bogetic noted optimistically that the up and coming generation of Russian leaders is comprised of people who do not have ties to the Soviet Union, who have studied in the West, and who want Russia to reform and integrate with the global economy.  Ambassador Collins, however, was more pessimistic, predicting that the government will adopt a “muddle through” attitude, in which it tries to adapt only at the margins to survive the current crisis without taking more long-term, major reforms.