Despite the current rebound the long-term prospect for higher growth rates is subdued due to structural weaknesses and the negative impact of sanctions.
Head of state: President Vladimir Putin (since May 2012)
Head of government: Prime Minister Dmitry Medvedev (since May 2012)
Form of government: Government formed by the Party United Russia and non-partisan technocrats
Population: 147.0 million
Domestic politics: continued stability - but at the expense of democracy
Nationalistic sentiment has risen since the outbreak of the Ukraine crisis and the annexation of Crimea, supported by aggressive propaganda through the state-controlled media. Playing the nationalist card, especially in relation to the EU and the US, appears to be the key to keeping approval ratings up.
Any opposition has been marginalised by a hardening of authoritarianism: hardliners have effectively been given license to attack liberals and crack down further on independent media and non-governmental organisations.
The upcoming September 2017 parliamentary elections will be tightly managed and most likely keep the current government in control.
Relationship with the EU and the US remains tense
Since the outbreak of the Ukraine crisis in early 2014 the relationship between Russia and the EU and US has gradually deteriorated. Russia´s intervention in the civil war in Syria added another area of conflict to the already strained relationships.
Moscow´s annexation of Crimea in March and its tacit support of separatist forces in Eastern Ukraine triggered several rounds of sanctions from the EU and the US, mainly in the form of frozen assets, travel bans on Russian and Crimean individuals, long-term financing limitations restricting access to EU/US capital markets for major Russian banks and some oil and defense businesses and restrictions on the export of certain types of products to Russia, including dual-use technologies and high-tech equipment for the oil industry. Russia itself imposed retaliatory sanctions on the import of food and agricultural products from the EU, the US, Australia, Canada and Norway.
The EU/US sanctions may have a very significant impact on the Russian economy in the longer term. In particular, they will influence the refinancing capacity of major domestic corporations and banks.
A modest economic rebound in 2017 and 2018
Russian GDP growth has rebounded since H2 of 2016, and after two years of contraction the economy is expected to grow about 1.5% in 2017 and 2018. This recovery is mainly due to the rebound in oil prices. Private consumption, investments and exports are expected to pick up again.
The rouble has strengthened again on the back of higher oil prices, by about 20% since March 2016. Together with a strong harvest that helps to curb food prices (which are still elevated due to the on-going sanctions that Russia has imposed on EU imports), the rouble appreciation is having a positive effect on inflation: the increase in consumer prices is expected to slow down to just about 4% in 2017 and 2018. This should sustain the rebound in private consumption, which is expected to increase 2.6% and 2.8% respectively.
Both the rouble appreciation and decreased inflation have provided the Central Bank with more leeway to lower interest rates, which have been decreased to 9% (after having reached an all-time high of 17% in December 2014). This should also support the economic rebound.
The Central bank allows the rouble to float. This has an impact on inflation if the currency depreciates, but also acts as a shock absorber for the current account, which is expected to remain in surplus in 2017 and 2018. At the same time, the fairly large international reserve position of Russia hardly erodes as capital outflows are contained.
Russia´s short-term economic policy during the previous recession has been rather prudent. Despite very low public debt of about 10% of GDP and pressure from the low oil price on the budget, the government deficit has been kept within acceptable margins. In 2017 and 2018 fiscal tightening is expected, with lower deficits of 2.1% of GDP and 1.3% of GDP respectively. The government has confirmed its plans to balance the budget by 2020, using a fixed USD 40 per barrel oil price. Any extra revenue generated by a higher oil price will be used to further build up currency reserves.
Major structural weaknesses remain
Despite the on-going economic rebound, the long-term prospect for higher and sustainable growth rates remains subdued, as structural weaknesses and the negative impact of sanctions on productivity and investment will continue to weigh on growth.
The Russian business climate is plagued by uncertainty regarding property rights, a weak transport infrastructure and lack of competition in goods and services markets. The authorities failed to seize the opportunity during the windfall years to strengthen Russia’s economic structure and enhance its non-oil potential by prudently investing high oil revenues in other industries to diversify the economy away from the dominant oil and gas sector.
There is an underlying deterrent for investments, badly needed to modernise the energy sector and help to diversify the economy. Even before the outbreak of the Ukrainian crisis, the investment level was too low and foreign direct investment too limited, partly due to an unfriendly business climate and the firm grip of the state on large parts of the economy. This is now exacerbated by the international sanctions imposed by the EU and the US that aim to prevent technology transfers and financing to Russian firms, especially in the energy and military sectors.