Russia Economy Worsens Even Before Sanctions Hit

Apr 17th, 2014 | By | Category: News, Russia

APRIL 16, 2014

MOSCOW — Margarita R. Zobnina, a professor of marketing here, has been watching the Russian economy’s gathering woes with mounting alarm: friends who have moved abroad with no plans to return; others who put off new business ventures because of rising uncertainty. Meanwhile, Ms. Zobnina and her husband, Alexander, also a professor, have rented a safe deposit box to hold foreign cash as a hedge against the declining ruble.

Most shocking, she says, is that her local grocery is now selling anchovies packed in sunflower oil rather than olive oil, an obvious response to the soaring cost of imports. “That really freaks me out,” she said.

While the annexation of Crimea has rocketed President Vladimir V. Putin’s approval rating to more than 80 percent, it has also contributed to a sobering downturn in Russia’s economy, which was in trouble even before the West imposed sanctions. With inflation rising, growth stagnating, the ruble and stock market plunging, and billions in capital fleeing the country for safety, the economy is teetering on the edge of recession, as the country’s minister of economic development acknowledged on Wednesday.

Mr. Putin, who just lavished $50 billion on the Sochi Olympics, also must now absorb the costs of integrating Crimea, which economists and other experts say has its own sickly economy and expensive infrastructure needs. The economic costs have been masked by recent patriotic fervor but could soon haunt the Kremlin, as prices rise, wages stall and consumer confidence erodes.

Even before the Crimean episode, and the resulting imposition of sanctions by the West, Russia’s $2 trillion economy was suffering from stagflation, that toxic mix of stagnant growth and high inflation typically accompanied by a spike in unemployment. In Russia, joblessness remains low, but only because years of population decline have produced a shrunken, inadequate labor force.

In recent weeks, international and Russian banks have slashed their growth projections for 2014, with the World Bank saying the economy could shrink by 1.8 percent if the West imposes more sanctions over Ukraine. By some accounts, more than $70 billion in capital has fled the country so far this year and the main stock market index fell by 10 percent in March — and a dizzying 3 percent just on Tuesday over fears of greater Russian involvement in Ukraine.

“This is our fee of sorts for conducting an independent foreign policy,” Aleksei L. Kudrin, a former Russian finance minister, said at a recent investor conference in Moscow. He added that the sanctions and the fallout from Mr. Putin’s foreign policy moves would drain hundreds of billions of dollars from the national economy and strangle growth for the remainder of the year.

But Mr. Kudrin, who quit his post in a dispute over the Kremlin’s economic policies, said the population had yet to confront the full bill, which he predicted would grow as a result of the steep costs of absorbing Crimea, a geographically isolated peninsula. “Society has not yet seen the final result, and that will be when this puts the brakes on real incomes,” he said. “For now, society accepts this fee.”

From a textbook perspective, the deep-rooted ills in Russia’s economy have been clear for years: The decade-long skyrocketing in energy prices that buoyed Mr. Putin’s popularity has flatlined, exposing the country’s dangerous over-reliance on revenues from oil and natural gas. Efforts to diversify into manufacturing, high technology and other sectors have failed, and officials have been unable, or unwilling, to stop the rampant, corrosive corruption that scares off foreign investors.

Consumer demand, which had been a primary driver of the Russian economy in recent years, stalled hard in 2013. Surveys by the Levada Center, Russia’s only independent polling institute, show that consumer sentiment has been on a slow, steady decline since 2010, while fears of inflation — especially rising prices for basic necessities, which have persisted since the 1990s — have grown along with new anxiety about a potential drop in wages or rising unemployment.

“If you want to open your eyes, you would admit that it is a slow, downward trend of social optimism and consumer optimism,” said Marina Krasilnikova, who leads income and consumer research for the Levada Center.

“The situation with Ukraine and Crimea has resulted in patriotic and imperialistic optimism,” Ms. Krasilnikova said. But, she added, “this optimism will not last long.”

Some analysts said that Russia’s annexation of Crimea had proved that Mr. Putin puts politics ahead of reasonable economic decisions, and that there was little reason for economic optimism, particularly given his inward, xenophobic turn, including his vow to create Russia’s own cashless pay systems and even its own credit rating agency so it would not have to rely on the global financial system.

Miljenko Horvat, a private equity investor who ran Citibank’s office in Russia in the 1990s, said that Russia had simply failed to make itself economically relevant beyond its energy supplies.

Mr. Horvat, who now lives in Vancouver, British Columbia, said that he often challenged his Russian friends by making the following point: “I wake up in the morning and drink coffee from a machine made by a Swiss company, Nescafé. I wear something that was designed in France or Italy but probably made in Turkey. I get into a German car, look at a Korean phone, use a computer that was designed in California but made in Japan or Korea. Russia just doesn’t touch me in my daily life. It just doesn’t matter. It’s just not relevant. So where is the economic engine going to come from?”

Mr. Horvat said that he had lived in Russia through defaults in 1991, 1993 and 1998 and that he expected another one. “I am not long in Russia,” he said, invoking the financial term for betting on a rising stock, “neither in my portfolio, nor in life.”

Given the recent turmoil, a catastrophe has been averted so far largely because the price of oil has remained stubbornly high, at nearly $110 per barrel of Brent crude on Wednesday, even as production steadily rises in the United States. For now, that has kept the federal budget in decent shape with still no deficit projected for the year.

But even without a shock, it is not clear how Russia will manage to climb out of the current quagmire. Stagflation is among the most confounding economic problems that policy makers can face, and officials here seem flummoxed, with the Central Bank, Finance Ministry and Economics Ministry urging contradictory steps.

Last month, the bank raised its key interest rate to 7 percent from 5.5 percent to combat inflation and support the ruble, a step that could slow growth. Meanwhile, the Economics Ministry, worried about growth, favors borrowing and government spending as a stimulus and to reduce capital flight, a possibly inflationary strategy that is opposed by the Finance Ministry, which wants to keep debt low and reserve funds available to weather any unexpected drop in oil prices.

“All of them have their clear priorities, and they stick to their priorities,” said Alexei Deviatov, the chief economist for Uralsib Capital, an investment bank here, “and there is very little coordination between these authorities.”

While Russian and global investors and businesses have been moving billions of dollars out of Russia to places perceived as less risky, it is not just money that is fleeing. Ms. Zobnina, who teaches at the Higher School of Economics in Moscow, said that one of her classmates had left for the United States after college 10 years ago, and that another friend followed three years ago to pursue a Ph.D., with no plans to return. Still another friend, a journalist, moved to London last summer with her husband and three children.

Ms. Zobnina, 32, said that she and her husband, 30, were thinking about finding posts in Europe or the United States, and for now were keeping their savings in dollars and euros. In an interview, she conceded that putting cash in a safe deposit box hardly amounted to sophisticated financial planning, particularly for two economics professors.

“It’s absolutely not rational to prefer safe box than deposit because you lose interest,” she said. “But in this unpredictable situation, when the ruble is falling and banks are unstable — and who knows when we’ll be cut off from the global financial system or which bank will be next to be closed — it’s better to have this small bird in hand.”

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