Key Challenges Facing the Russian Economy

On March 18, nearly 110 million Russian citizens are expected to elect their next President. While the outcome of the vote leaves little doubt as to the reappointment of Vladimir Putin, the election represents an opportunity to take stock of the economic state of the country and the results of Putin’s previous mandates. Sergei Guriev, Chief Economist of the European Bank for Reconstruction and Development, Research Fellow at the Center for Economic Policy Research (London), decrypts the issues at stake.

What are the main economic challenges Russia will have to face in the next decade? 

Russia needs to carry out structural reforms, improve investment to fight climate change, fight corruption, deregulate and privatise, end the economic isolation, invest in human capital. These reforms have been outlined by the Russian government several times, in particular, in President Putin’s 2012 electoral program. 

These reforms - as announced in Putin’s Decree No. 596, signed on May 7, 2012, the first day of his current presidential term - were supposed to create 25 million high value-added jobs (this is a huge number for Russia, where the total employment is 72 million people). The government has yet not announced how many of those jobs actually ended up being created. 

These policies were supposed to raise a much-needed investment - from 21% of GDP to 25% of GDP in 2015 and to 27% of GDP in 2018. In reality, the investment/GDP ratio in Russia declined to 19% in 2015 and 18% in 2016 (in the meanwhile, Russian GDP itself felt by 3 percentage points - mostly due to the decline in oil prices). 

One of the other objectives of these reforms was to raise Russian labor productivity by 50% between 2011 and 2018. Given that population and employment have not changed, this promise was equivalent to 50% growth in GDP between 2011 and 2018 (that’s about 6% growth per year). In reality, the cumulative GDP growth in 2011-17 was only 5% (that’s less than 1% per year). The consensus forecast of growth in 2018 is below 2%. In other words, instead of 50% growth, the Russian economy will only see the cumulative 7% growth during these years (that’s 1% per year on average).

What best explains the difference between promises and reality is the lack of reforms, which were announced but not implemented, as well as the economic isolation that started in 2014. The consensus among international financial institutions and market participants (with the exception of Goldman Sachs, which is much more optimistic than others) is that without these reforms, Russia will continue to stagnate (growing at 1-2% per year) and lag behind the rest of the world. In the baseline scenario, Russia will be overtaken by China (and then by Kazakhstan) in the coming years in terms of per capita incomes and wages. 

This directly implies what Russia needs to do in the future to catch up with the fast-growing world economy. Russia should overcome economic and technological isolation and carry out reforms that would provide incentives for domestic and international investment in Russia. The fact that this has been discussed and promised so many times does not make this statement any less true.

What was the impact of economic sanctions on Russia's economy? And on European economies? 

The direct impact of economic sanctions on Russia’s economy is not trivial, but it is limited: about 0.5-1% of GDP. However, sanctions have a major adverse dynamic effect - undermining incentives for domestic and foreign investment, for transfering modern technology, and for making Russian companies participate in global value chains, etc. This effect is hard to assess. But it has certainly contributed to the decline of investment. It has also been reflected in low stock market valuations. Russian assets are valued at about 5-6 times annual net profits, while other emerging economies enjoyed valuations in the range of 12 or 16, and the developed countries’ assets are priced at 20-25 annual net profits. Much of the pessimism of investors is due to Russia’s country risk, which is explained in part by Western sanctions.

The impact of sanctions on Europe is negligible. For individual companies that used to export to Russia and invest in Russia, this impact is noticeable but for the European economy as a whole, there is no significant impact. The total European agricultural exports have grown in recent years, not declined - European exporters switched to other markets.