There has been little to cheer about in the Russia economy since Crimea was annexed on March 18, 2014. In real terms, gross domestic product has been shrinking ever since. The economy continues to struggle and full recovery seems a distant prospect.
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Even so, it must be admitted that the contraction has been smaller than many, including myself, had predicted. We certainly cannot speak of an economic collapse.
To grasp Russian economic developments over the last two years, it is useful to distinguish between demand and supply shocks.
The biggest negative demand shock has been the plunge in oil prices observed since mid-2014. Even though the oil-price peak and the seizure of Crimea (which marked the onset of the conflict in Ukraine) occurred within a few months of each other, the two events were almost completely unrelated. Yet each is considered to have had a devastating impact on the Russian economy.
In fact, I believe the drop in oil prices was significantly more damaging than any negative supply shock ensuing from greater political uncertainty and Western sanctions.
That said, President Vladimir Putin’s regime has done little to calm investor fears, and there is no doubt that perceptions of Russia’s economy in Western financial circles are very negative.
Monetary policy is the reason Russia’s economy has not performed much worse than other oil exporting countries
Despite all that, Russia’s economy has not performed much worse than other oil exporting countries. There is a very clear reason – monetary policy. Russia has a floating exchange rate, and its central bank under Governor Elvira Nabiullina allowed the ruble to weaken in response to lower oil prices and increased economic and political uncertainty.
This did not happen right away. Initially, the authorities tried to curb the ruble sell-off in late 2014 by aggressively raising interest rates and intervening in the currency market. After burning through billions of dollars, the central bank concluded that the financial sector might collapse unless the ruble was allowed to weaken.
Since early 2015, the market has more or less set the price of the Russian currency, allowing the Bank of Russia to slash interest rates significantly. This flexible policy response is the answer to why Russia’s economy has not succumbed to numerous external shocks.
Understandably, Russia’s consumers are not happy about their much-weakened currency. But a depreciating ruble is what saved the Russian economy from meltdown – a lesson that other commodity exporters and members of the “dollar bloc” would do well to heed.