Maija Kostareva's Blog

IS THERE THE WAY OUT OF THE DARK: THE FUTURE OF THE RUSSIAN ECONOMY

February 25, 2016
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Is there the way out of the current financial crisis? The answer to this question unequivocally depends on the prices of oil, fueled by the ongoing economic sanctions imposed on Russia by the West and worsening geopolitical situation. According to many western and eastern media, the forecasts about the future of the volatile oil prices are clearly multifarious. The prices of oil at the beginning of the year 2016 fluctuated around $30 per barrel, compared to the price bouncing around $100 at the beginning of 2010. In modern world it is much cheaper to buy oil than bottled water.

 

Portfolio managers are divided in opinion in evaluation of the future of Russian economy and financial market. There are some optimists, who assure that there is hope for rising prices up to 100% per barrel and a consequent growth of Russian economy on the one hand. Others say that the fall to as low as $8 per barrel is around the corner. What can clearly be said out of all the forecasts is that the Russian economy and stock market will move in the same direction as prices of ‘black gold’.

 

So, why the oil prices are falling so fast since 2014? What we can expect next? There are too many variables in the equation and it is hard to predict the exact direction of the prices of crude oil in the future. However, The predictions about the future price of oil could be based on several significant factors. Positive sign for recovering crude oil price is the growing Chinese economy in 2016-2017. This growth will consequently lead to a growth in oil prices.  China, being a biggest consumer of oil (along with USA) can affect the price of oil. In the simple model of supply and demand it is evident, that with the growth of Chinese economy the demand for oil will also growth. The demand for oil will push the prices of oil up. India is moving in the same direction. Sustained growth of Indian Economy also requires solid amount of energy. This will also push the demand for oil and prices up.

 

However, the future is not so bright. More participants have entered the crude oil market in the past decade. The boom in the energy production in USA in the last several years is one of the reasons for falling prices of oil in the world market. Crude stockpiles in USA are continuing to increase and supply is rising every month. According to Wall Street Journal, by January 2016 the weekly numbers of the crude oil produced in US reached 503 million barrels. In addition oil production in Canada and Iraq is also growing steadily. Even Russian Federation, despite its stagnating economy, is still gradually producing oil. The world is drowning in oil as supply of oil exceeds demand for at least 1 million barrels per day. Making matters worse, the elimination of sanctions from Iran, will lead them to supply solid amount of additional oil to the world market. This will clearly push the prices of oil down. World major oil market players should reach an agreement and cut production of oil, in order to push the prices up. However, nobody wants to loose its share in the world oil market and it may probably take many years to reach an agreement and stabilize oil supply. In addition, it appears, that ‘invisible hand’ of supply and demand is not the only thing that determines prices of oil. Prices of oil are estimated by futures market –contracts for supply of hydrocarbon for fixed price on fixed date. Sales of these securities exceed sales of actual petroleum product tens of times on stock market.

 

Oil production takes around 70% of the total GDP in Russia. Clearly, when the prices of oil fall, it has a profound effect on the overall growth of the country. While it is hard to predict the direction, in which the prices of crude oil will move, Russian government should transform Russian economy and take advantage from the free-floating ruble. The decreasing national currency is not always a bad sign. Russia could increase export volumes in the future due to cheap ruble. This could make manufacturing companies in Russia more competitive on the world market.

 

Even, if the oil prices would stabilize in the next coming year, the ruble would not necessary strengthen. Apart from oil, ruble exchange rate is dependent on active ruble mass, which can be mathematically connected to inflation. In such a manner, when the oil prices are stable, ruble exchange rate fluctuations can be monitored through inflation. In 2016 this indicator will be high, most likely two-digit. This is related to record-breaking budget deficit, which can only be covered with issue in the conditions of the lack of source of state loans. Respectively, the ruble will devaluate even with rising oil prices. Ruble is extremely volatile small size currency in a country with disintegrated economy. We should also take into an account unexpected factors such as bankruptcies of several large Russian banks or serious government mistakes, which can also push the ruble down.

 

Russian Federation will exhaust the Reserve Fund by the end of 2016. However, there is a solid amount of gold and forex reserves, though, they can be spent in a four years time. Nowadays government in Russia does not offer any arrangements in order to change the situation in a country, so it is right to assume that the economy will be contracted and will loose its reserves. Taxes and retirement age will grow and the collapse of the economy is around the corner. At this time, structural revolutionary reforms in legislation, judicial system, tax system and foreign policy, should be implemented to restore Russian economy, regardless of ruble exchange rate. Many countries have best practices in such reforms. Such reforms could radically change the situation in Russia for the better. One possible solution for Russian economy to recover is to reduce its dependency on oil and switch from oil production to something more stable. Russian economy should adapt to low oil prices and could switch to a production of other goods and services, such as agriculture and tourism. Otherwise, Russia will be on the way back to socialism.

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Poll conducted

  1. In your opinion, what are the US long-term goals for Russia?
    U.S. wants to establish partnership relations with Russia on condition that it meets the U.S. requirements  
     33 (31%)
    U.S. wants to deter Russia’s military and political activity  
     30 (28%)
    U.S. wants to dissolve Russia  
     24 (22%)
    U.S. wants to establish alliance relations with Russia under the US conditions to rival China  
     21 (19%)
 
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