Russia’s economy is in grave danger. But the cause is not - as expected – the sanctions themselves imposed by the West, writes Professor Stefan Hedlund.
The Kremlin could have realistically assumed that Russia would endure the sanctions for a couple of years, by which time the crisis in Ukraine would have settled. What it did not appreciate is the extent to which markets would be ready to inflict damage, without political instruction.
The grim lesson for the Kremlin is that investors and creditors alike are now reluctant to deal with a country under threat of sanctions. The risk of getting burnt is too high.
Bankers, in particular, will be cautious fearing penalties for being found in breach of often-complex sanctions rules. The Kremlin has counted on Chinese lenders to step in when Western markets dried up. But the Chinese have proved to be very hesitant.
Market actors are voting with their feet. Capital outflow for 2014 as a whole will exceed US$100 billion. The downward pressure on the ruble has seen the exchange rate against the dollar drop from 32.6 at the outset 2014 to around 40 at present. Central Bank reserves have dropped from US$509 billion at the start of 2014 to US$454 billion at the end of September. And the Moscow Stock Exchange has dropped by more than 20 per cent, year-to-date.
The precautionary funds that were wisely built during Russia’s good years are being drained. The National Welfare Fund, which holds close to US$90 billion, is now fully committed for bailouts; and the Reserve Fund, with a similar amount, will be phased back into the budget. The situation is still far from critical, but the outlook should give pause for thought.
The downward pressure on the price of oil is particularly worrying. Urals Crude has dropped from US$110 at the outset of 2014 to presently below US$88. Given that half of federal budget income derives from gas and oil, this is extremely serious. If the price drops further, and stabilises at US$70 or below, then we may forget about the impact of sanctions. That cost will be dwarfed by the collapse in export revenue.
Senior government officials are clearly concerned. Cautious suggestions are being made that the massive outlays on rearmament, in particular, should be reconsidered and that a number of other measures must be taken to shore up the budget. But Russian President Vladimir Putin remains in denial.
In early October, Mr Putin cancelled his traditional budget address to the Duma. The Economic Council has met just four times over the past two years and the informal club of economic advisors has not been summoned to the Kremlin for some time.
In a recent op-ed in Russian business daily Vedomosti, Russian economist Konstantin Sonin bemoans the fact that all now revolves around politics. He suggests that a major economic train wreck is about to happen.
His outlook is not for imminent collapse but for an inevitable slow strangulation of any future prospects for economic revival and or modernisation.
It will be a tough winter, both in Russia and in Ukraine.