The path to healthy growth
Russia could re-emerge with a new, more robust growth model that is more stable and less dependent on the global commodity markets.
Maxim Oreshkin, Chief economist for Russia at VTB Capital:
Russia’s abundant natural resources and skilled labor force make it a nation of great potential and many in the investment community believed this would be enough to maintain strong growth rates for years to come. However, the success of the 2000s was brought to a halt by the crisis and has been followed by a period of weak growth.
A paradigm shift in the energy markets – shale gas, the oil revolution in North America and booming oil production in Iraq – have limited the chances of future gains in oil prices. The consumption boom of the last decade, partly supported by skyrocketing oil prices, has come to an end. There are now many who are less optimistic about Russia’s prospects. The country has to prove it can use its potential to deliver strong and sustainable growth, without support fr om rising oil prices.
From the macroeconomic point of view, Russia had the fortune to come out of the boom years in good shape. In stark contrast to developed and most emerging countries, Russia’s debt-to-GDP ratio stands at around just 10%. Indeed, if you take into account the money Russia has accumulated in different funds, the nation is free of debt. In the past couple of years Russia has run a balanced, and in some cases, surplus budget. The 2008-09 crisis proved the value of prudent macroeconomic policies – an area that Russia has continued to strengthen in recent years.
Last year, Russia improved the long-term sustainability of government finances by introducing a new “budget rule,” setting a maximum spend based on long-term average oil prices. With this rule in place, any temporary increase in oil prices only results in a further build-up of the reserve fund, not an increase in budget liabilities.
The major change was on the FX market, wh ere the ruble has significantly increased its flexibility, while the Central Bank has concentrated on managing interest rates and controlling inflation. In recent years, discussions about Russia’s economy have typically started with a question about the break-even oil price for the budget. However, with the more flexible exchange rate regime, the budget’s dependence on oil prices has decreased.
As all Russia’s budget expenditures are ruble-denominated, what matters is not the dollar oil price but the ruble oil price. And as the ruble now weakens in response to declines in oil price, it means that the ruble oil price (and therefore government revenues and the budget balance) remains relatively isolated from global volatility.
Improvements in the macroeconomic framework are not sufficient to achieve strong growth rates alone. This year, the economy is set to show a healthy yet modest growth rate of about 2%-2.5%.
These are not remarkable figures – and there are also a number of challenges that will be difficult to overcome. For example, demographics remain the Achilles heel of the Russian economy and are almost impossible to remedy. Given the situation, growth must come from increasing productivity, strengthening investment and improving efficiency.
But Russia’s potential growth is trapped below the 3% level by the poor quality of institutions and the investment climate.
The positive news is that Russia has finally understood there are no free lunches and that reforms are crucial to reaccelerate growth. Last year, the country finally became a fully fledged member of the World Trade Organization and accession to the Organization for Economic Cooperation and Development is next on the list. Russia currently stands 112th in the World Bank’s Doing Business rating, and although it is ahead of Brazil and India in this league table, it has set the ambitious goal of moving towards the top 20 by 2018. Nobody is under any illusions about how hard it will be to achieve this target, but I expect Russia to break into the top 50 within five years.
Russia now has to create a better institutional framework and improve the investment and business climate to build on the solid macroeconomic base. If it succeeds, Russia could re-emerge with a new, more robust growth model that is more stable and less dependent on the global commodity markets.
We may never return to the high rates of the past, but events of recent years have shown once again that it is better to have lower and healthier growth.