Russian economy staggering as sanctions bite

As the conflict over Ukraine drags on, capital flight is high and growth forecasts very low

May Day celebrations in Moscow’s Red Square. Russia celebrated the annual spring and labour day holiday against a dispiriting economic backdrop. Photograph: Reuters/Sergei Karpukhin

May Day celebrations in Moscow’s Red Square. Russia celebrated the annual spring and labour day holiday against a dispiriting economic backdrop. Photograph: Reuters/Sergei Karpukhin


International sanctions threaten to trigger a painful economic recession. But tens of thousands of Russians set aside cares about the precarious future and flocked joyfully to the May Day parade in Moscow’s Red Square this week, waving banners proclaiming support for Vladimir Putin.

In between fielding irate calls from European leaders about the Ukraine crisis, Russia’s president bestowed Hero of Labour medals on outstanding workers, including an oilman, a dairy farmer, a museum curator and a swimming coach, for services to the motherland.

Then, wearing his Uncle Vlad hat, Putin greeted trade union leaders in the Kremlin, promising that his government would do its best to honour its pledge to raise public sector wages despite the economic downturn.

Russia celebrated the annual spring and labour day holiday against a dispiriting economic backdrop. Investors have fled the stock market in Moscow and the Russian rouble has lost 8 per cent of its value against the US dollar since the start of the year, driving up the cost of imports.

Adding to the gloom, the International Monetary Fund reduced its 2014 Russian growth forecast to 0.2 per cent this week – the second downgrade in less than one month – and warned the economy was already in recession. Russia’s economic performance could deteriorate further if the conflict in Ukraine escalated and prompted the US and the European Union to roll out harsher sanctions.

Energy-based wealth
Russia has benefited during Putin’s 14-year rule from high world oil prices that have boosted prosperity in the energy rich country. While the fabulously rich oligarchs have benefited most, poverty rates have fallen sharply, boosting the ranks of the new middle class who look to Putin as their saviour.

Thanks to the oil windfall, Russia boasts the world’s fourth-largest financial reserves and is not burdened by large sovereign debt. But even before the Ukraine crisis erupted, there were signs that its oil-based growth model was failing.

Putin has overseen the rise of vast state corporations that, often run by his close associates, dominate the economy. Structural reforms to create a level playing field and encourage investment in innovative industries have repeatedly been shelved, leading to an economic slowdown.

As growth fell last year, Russians stopped spending so freely, bringing a consumer boom to an end. Falling sales combined with the depreciation of the ruble forced car makers and steel plants to begin laying off workers.

So far, the US and European Union have targeted sanctions on Russian officials and companies close to Putin in an attempt to persuade the Kremlin to change its policies in Ukraine. The idea is to inflict pain on the Russian president’s inner circle, while avoiding harming the blameless wider population.

But international reprisals against Putin’s cronies are adding to pressure on Russia’s faltering economy.

Speaking at a press briefing in Moscow this week, Antonio Spilimbergo, the head of the IMF’s Russian mission, said the sanctions had undermined business confidence and were starving Russia of much-needed investment.

Capital flight is soaring, with $64 billion moving out of the country in the first quarter of the year, more than total outflows in 2013. “What we have noticed is that fear of sanctions could be even more powerful than sanctions,” themselves, Spilimbergo said.

Russia’s central bank has raised interest rates twice since the Ukraine crisis began, in an attempt to shore up the rouble. However, the measures were not enough to prevent inflation rising above the government’s 5 per cent inflation target this year, according to the IMF.

Subsiding euphoria
Putin’s already-high approval ratings have soared since Russia annexed Crimea in March. But there’s a risk that once the wave of euphoria subsides, people will start grumbling about the cost of territorial expansion.

The Ukraine crisis could be a game-changer for the Russian economy, either in a positive or a negative sense, said Chris Weafer, senior partner at Macro-Advisory, the Moscow-based political and economic consultancy.

An economic slowdown could have a silver lining, providing impetus for badly needed structural reforms. But there are high risks that “hawks could prevail over the doves in the government and set a backdrop for further disputes in the Arctic or the Middle East while placing lower emphasis on reforms and privatisations.”

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