This month has become for the majority of the Russians the most uncertain time economically since the autumn of 1998, when the country defaulted on its short-term debt and the ruble fell from 5.9 to 20.6 to the U.S. dollar. That crisis reflected the weaknesses of the ill-fated “stabilization” of 1996-97. Today, everyone is trying to figure out whether the current collapse (the dollar appreciated from 45 to 75-80 rubles in less than a month) may undermine Putin’s “stabilization” efforts, which started in the early 2000s and have been heralded as an unparalleled success by all his supporters.
The current ruble plummet is a consequence of three main trends, all of them clearly visible over the past six months and discernable for even longer if you knew what to look for.
First, there has been an overall decline in growth rates during Putin’s most recent term in the Kremlin, dropping from a healthy 4.9 percent on an annualized basis in Q1, 2012 to 0.8 percent in Q1, 2014. New taxes and stifling bureaucratic measures simply made Russia too uncomfortable for businesses, many of which contributed to a more or less orderly stampede for the exits, with capital flight for 2012-14 averaging $80 billion a year, or 4.5 percent of GDP.
Second, Western sanctions, imposed after Russia’s occupation of Crimea and its involvement in the war in eastern Ukraine, left the country without additional capital. This is particularly dangerous because since, prior to the Crimean adventure, Russian companies owed more money to foreign financial institutions ($678 billion, or 22.4 trillion rubles), that to domestic ones (19.3 trillion rubles, or $584 billion). To pay back even a portion of these debts—which certainly were not denominated in rubles—Russian businesses have been forced to sell rubles against the dollar, which has been a large contributing factor to the exchange rate hike.
Finally, the effect of the falling oil prices has also been profound. Though most of Russia’s oil and gas being currently shipped abroad reflects contract prices struck before the recent sharp descent, markets understand that lower prices are likely to persist for a good while, and so forecast a further deterioration in Russia’s budget conditions—perhaps to the point of full-scale financial crisis. Hence anticipation folds back to affect the present.
Additional problems have arisen from the fact that Putin’s government ultimately felt comfortable with the decline of the ruble. Putin has on several occasions explained that there is nothing bad in it, since now Russia will get many more rubles for every barrel of oil it sells, even as the dollar-denominated price of oil declines. With around 35.5 percent of federal budget receipts coming not from ruble-denominated taxes, but from dollar-denominated custom duties for the exports of oil and gas, Russian leadership has believed that, in the case of a controlled devaluation, it might get its hands on additional ruble revenues to covering its domestic social obligations.
Maybe so, but the government erred in the “style” of its devaluation: Instead of an immediate, one-time change in the ruble’s value, it has presided over a slow and painful process, leaving nervous lenders and debtors with no basis to know when and at what particular point it would come to an end. One can see the difference in styles between the devaluation in Kazakhstan in February 2014 (a 19 percent increase of dollar value in tenghe), which produced no hike in the Central bank rate (set at 5.5 percent) and modest inflation (close to 7 percent in 2014), and in Belarus in January 2011 (a 62 percent increase of dollar value in Belarusian roubles), that resulted in Central bank rate of 45 percent and 105 percent inflation. The first took one day; the second, four months. The Russians opted for the second scenario, and got the predictable results.
So, now we have ruble at above 60 per dollar (the maximum was around 80 on December 16); the Central Bank rate at 17 percent against 5.5 a year ago; inflation exceeding 10 percent for 2014, and the growing disruption in supply chains everywhere. What does this mean for the Russian economy in 2015, and possibly beyond?
The immediate consequences will be severe. Russia’s economy crucially depends on exports—the country gets from abroad around 35 percent of foodstuff, up to 60 percent of clothing, 70 percent of medicines, close to 90 percent of office appliances and 100 percent of computers, mobile phones, and some other hi-tech stuff. Prices will shoot up in coming months, with domestic producers also pushing their prices upwards, just because they can. I predict that the Q1 consumer price index will reach 20-25 percent on an annualized basis, easing for the whole 2015 to 17-20 percent.
As people try to spend their rubles, and as companies try to buy dollars to secure their foreign access to capital, banks will raise both deposit rates (now already at 15-18 percent) and lending rates. Investment will thus dip by at least 20-25 percent compared to 2014. Some industries, like foreign travel, air transportation, and residential construction, will simply collapse. The decline of GDP will reach at least 7-8 percent year-on-year in 2015. Capital flight will rise to more than $150 billion, and the Central Bank’s currency reserves will decrease from current $413 billion to less than $250 billion (with $160 billion inside this sum representing the Reserve fund and the National Welfare fund being under Government, Central Bank, control). Russia will become much weaker and much more vulnerable than it was before Putin’s Crimean adventure. 2015 will become the first year that Russia manifests visible signs of being a power in decline, after one-an-a-half decade of supposedly “rising from its knees.”
The price of oil remains a critical variable in all of this. Russia in Putin’s years experienced a massive windfall in petrodollars: $33.5 billion more per year on average in 2001-04 than it did in 1999; $223.6 billion more per year in 2005-08; and $394.0 billion more per year in 2011-13. Putin’s regime therefore was able to thrive, but it needed an ever-rising price to feel truly comfortable. His regime may survive a price of $60 per barrel of oil—or even $40—but not for long. Today, financial sanctions deserve around 70 percent to blame for the decline in the ruble, with only around 30 percent going to falling oil prices. 30 percent, obviously is a large number in this sort of thing, but in 2015 oil prices and revenue will become far more important. My forecast will be a 7-8 percent decline in GDP at $60 per barrel, and more than 10 percent if the price falls below $50 and stays there. If the price rebounds to around $80-85, the contraction may be limited to 3-5 percent. Even so, nothing short of a miracle will save Russia from a sharp economic downturn in the coming year.
Nevertheless, Western analysts would do well to keep in mind that the current upheaval will not significantly diminish Mr. Putin’s popularity, and will not cause a wave of street rallies against the current leadership. Russians have long become accustomed to the notion that economic difficulties are something the government should not be blamed for. If the ruble falls or prices go up—well, it’s the economy, stupid; it’s not politics that’s to blame. Russians will instead try to find additional work, many will scrimp and save on everything, various shadow economies will develop and the already large informal sector will grow. But protests are not in the cards. Who is to blame for the low price of oil? Of course, not the Kremlin. In his televised marathon Q&A session today, Putin predicted that the Russian economy would recover after two years of hardship. That probably won’t happen, but it will take at least two more years of hardship for thorough-going disillusionment with Putin’s petro-economic policies to set in. In the meantime, no signs of modernization or reform with be apparent and share of state enterprises in the economy will continue to grow.
Vladimir Putin has became the world’s most extravagant entertainer in 2014: He started the year with the spectacle of the Olympics in Sochi, went on to annex Crimea and intervene in Ukraine right before the eyes of the stupefied West, and is finishing the year with a spectacular dismantling of Russia’s economic system. No one knows exactly what his next moves may be, but his room for maneuver has became much more limited. This offers a glimmer of hope for his return from the megalomaniacal world he has been living in to a more normal one. On the other hand, he may well be tempted to save his own neck with short-term theatrics, all at the expense of Russia’s longer-term interests, setting the stage for a truly memorable flameout. We shall see.