A year ago, Russia was seen as just another emerging market.
This meant all the usual risks: structural deficiencies, ineffective management and undeveloped legislation protecting property and investor rights, as well as opportunities, such as market potential and cheap valuation of stocks.
Granted, Russia’s economy has been showing signs of weakness for some time: GDP growth decelerated from 4.5% p.a. in 2010 to 1.3% in 2013. But many investors were not greatly concerned, interpreting the weakness as a potential trigger that would prompt the government to push forward with more ambitious structural reform.
This all changed in February and March 2014, following the so-called ‘Euromaidan’ revolution in Kiev, the ousting of Ukraine’s pro-Russian president and Crimea’s contentious referendum to re-join the Russian space. Since then, relations between Russia and the West have undergone a sea change. An exchange of sanctions followed, exerting pressure on businesses and undermin-ing the attractiveness of Russia for investors.
This geopolitical shift also exacerbated many of the existing structural impediments to growth. In our view, the Russian economy has long been hostage to externalities, plagued by low competitiveness and hamstrung by high levels of state involvement.
Russia is still a commodity-based econ¬omy with a low level of diversification. We would argue that many of Russia’s current woes, such as rouble devaluation and rapid deceleration in growth, stem not from geopolitical developments but from a fall in global prices of commodities and crude oil.
That said, the shift in the political landscape has accelerated this macroeconomic trend. Russia’s investment and domestic demand has weakened sharply, hit by lack of access to global capital markets, plunging oil prices and devaluation of the rouble.
However, an irony has emerged. Despite the bearish short-term economic outlook held by most major investment houses and the Russian Government (mild recession is forecast for the first quarter of 2015), the current politico-economic environment has triggered a few positive developments.
– The Central Bank of Russia (CBR), two months ahead of plan, authorised the free-float of the rouble in November – a major liberalisation of monetary policy.
– Russia has made significant inroads to diversify its trade and investment networks to Asia, Latin America and Africa, making Russia’s current economic and trade structures far more stable and balanced.
– Western financial sanctions and Moscow’s self-imposed bans on food imports have highlighted the importance of efficient and competitive domestic banking and food-processing, prompting the CBR to intensify development of these sectors.
Any economic crisis has a Darwinian nature. A crisis is fraught with challenges for policymakers and citizens alike. However, it can also carry the seeds of politico-economic rejuvenation. Pressured to restore health to an economy, policymakers are often compelled to adopt reforms, reducing inefficiencies and opening new growth opportunities.
Unlike the global financial crisis of 2008 and 2009, when, thanks to its huge reserves, Russia opted to buy itself out, the current crisis presents unique challenges. Reserves are almost one-third smaller than in 2008, the economy is weaker and Western sanctions mean no access to low-cost funding from abroad.
That should be sufficient to prompt Russian policymakers to adopt existential reforms. The stage is set and progress has been made – but the jury is still out.