Former Russian prime minister Evgeny Primakov warned that, if Vladimir Putin continues his Ukraine policies, Russia will become a pariah third-world petro state. The fundamentals of the Russian economy, as it enters 2015, suggest that Russia is fulfilling Primakov’s prophesy. Russia’s fate depends on economic factors beyond its control (energy prices and gas markets) and on Putin’s continued international adventurism, which he is loath to abandon for fear of regime change. Putin can no longer keep his promise to the Russian people of prosperity and stability. No wonder his propagandists are fighting full time to convince the West to drop its sanctions. Unlike the 2008/9 financial crisis, Russia faces a long and deep recession because the underlying causes are unlikely to go away in the near term.
Russian President Vladimir Putin (Alexei Nikolsky/RIA-Novosti, Kremlin Pool Photo via AP)
The two crises compared
The Russian economy has been struck by lightning twice during the short span of seven years. In 2008/9, a massive storm of falling oil prices and credit-market collapse struck Russia along with the rest of the world. The storm inflicted more serious damage on Russia than elsewhere (an 8 percent drop in GDP), but it passed over relatively quickly as oil prices recovered and world credit markets unfroze. In the 2010-11 period, economic growth averaged 5 percent, before falling to anemic rates in the buildup to Ukraine. Lightning struck Russia again in mid-2014 with the worldwide collapse of energy prices and Ukraine sanctions that bumped Russia from credit markets.
The initial voltages of the 2008/9 and 2014 lightning strikes were about the same, but the damage will be longer and deeper the second time around. Low energy prices will not disappear soon, and sanctions will remain in place as long as Russia makes no serious moves toward peace in Ukraine.
The accompanying table shows the same negative factors at play during the 2008/9 financial crisis (Column A) and the current “precrisis” period (Column C), with similar collapses of oil prices (Row 2), foreign borrowing (Row 3), and diminishing central bank reserves (Row 4). Column B shows the quick comeback from the 2008/9 crisis, with rising oil prices, revived foreign borrowing, and a restocking of central bank foreign exchange reserves.
From whence is Russia’s second comeback to emerge this time around? Despite divergent opinions on the long run, oil prices are expected to remain low for the foreseeable future. As long as financial sanctions remain in place, Russia has few sources of external borrowing for investing in and refinancing its highly leveraged companies. Russia had little control over the first lightning strike. The world recession drove down energy prices, and Russia lost access to world credit markets as credit froze to emerging markets. If Russia had less dependence on energy and had kept its hands, troops, and equipment out of Crimea and east Ukraine, it could have mitigated the second strike. But it did not.
Estimating the depth and duration of Russia’s ongoing crisis
The past is an imperfect guide to the future, but it is rare to have two similar economic crises caused by roughly the same factors and not far apart in time. In the case of Russia, we can use the 2007 to the first quarter of 2015’s statistical relationship among GDP growth, energy prices, foreign borrowing, and foreign exchange reserves to project GDP growth through 2016 using the constellation of oil prices, credit market access, and availability of international reserves we expect to prevail in 2015 and 2016.
The accompanying chart plots the actual GDP, oil prices, foreign borrowing, and central bank reserves from the first quarter of 2007 through the first quarter of 2015. The baseline figures (such as $60 a barrel of oil and negative borrowing) are plotted from the second quarter of 2015 through the last quarter of 2016. GDP growth is projected from the statistical relationship between GDP growth and the explanatory variables (see notes to the accompanying table).
We see that the 2008/9 financial crisis consisted of collapsing oil prices and diminished foreign borrowing pulling GDP growth into negative territory as Russian financial authorities drew down reserves to stabilize the economy. Recovering oil prices and foreign borrowing then restored positive economic growth, with a slight lag behind the oil price and borrowing recovery. Russia’s 2008/9 financial crisis consisted of four quarters of negative growth, after which the economy returned to positive, albeit weak, growth through the first quarter of 2015.
Notably, Russian GDP growth averaged a paltry 2.4 percent from 2011 to 2014 despite high oil prices and renewed access to credit markets. Among the BRICS countries (Brazil, Russia, India, China, and South Africa), Russia experienced the deepest recession and the slowest recovery. These disappointing figures (with no relief in sight) support the hypothesis that Putin turned to foreign adventurism to distract attention from growing economic malaise.
Given the baseline assumptions for 2015 and 2016, the model projects a sharp drop in growth in early 2015, followed by slightly less negative growth through 2016. The reasons for the GDP collapse are clear: low oil prices, no foreign borrowing, and diminishing reserves. Unlike 2008/9, there are no signs of sources of recovery on the horizon. Russia must learn to live with negative growth for the near future.
These projections send an ominous message to the Kremlin: Russia faces an 8.2 percent drop in output in 2015 and 6.4 percent in 2016. Worse still, negative growth is poised to continue beyond 2016 unless oil prices recover and the sanctions are lifted.
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