Russia: Risk Assessment
Country Rating1
Rating: B
Business Climate Rating1
Rating: B
Risk Assessment2
Economic growth has remained below pre-crisis levels despite a boost from high oil prices
The Russian economy began to grow again in 2010 after suffering a very severe recession in 2009. Spurred initially by the rebound in oil prices and foreign demand and then strengthened by very favorable base effects, GDP growth is now underpinned by the upturn in household consumption. But investment has been slow to recover. The summer heat wave and fires have had a temporary and relatively limited impact on growth, which benefited early in the year from the income effect of rising oil prices and from the strengthening of domestic demand. Although undermined by the increase in social contributions and inflation in the first half, domestic demand will benefit from the government's active policy on pensions (up 10% in April 2011) and civil service wages, the recovery of consumer credit, and the decline in the savings rate. GDP growth will nonetheless fail to return to pre-crisis levels. It will likely suffer in the short-term from an upsurge of inflation and in the medium term from its overdependence on oil. Persistent structural weaknesses (deficient banking system, difficult business environment, aging demographics, and so on) have continued to undermine investment and impede modernization of the economy. And at this juncture an investment recovery will only be likely to develop gradually with private investment remaining constrained despite the gradual easing of domestic credit conditions and the coming into force of tax measures making foreign debt less attractive. The inflow of FDI is moreover expected to remain limited amid the relative instability of the political environment in the run-up to the next elections.
Public-sector deficits and privatizations
In 2011 the government is expected to launch a vast privatization program involving over 850 companies including a few flagships of the economy like Rosneft, RusHydro, Sberbank, VTB, and Russian Railways. The partial privatizations planned are expected to pump $10 billion a year into government coffers over a five-year period and thereby cover 15% of public deficits in coming years: Public finances have been in deficit since they deteriorated in the wake of the crisis. The increase in spending, which reflects the government's social policy and its support for key economic sectors, will not be called into question before the elections scheduled in 2012. It will only be offset slightly by the new fiscal revenues envisaged. Excluding oil, the fiscal deficit has continued to grow. In 2011, a price of $110 per barrel will be necessary to balance the budget whereas the comparable threshold price was just $34 in 2007. The government has drawn heavily on sovereign funds to finance the deficits (over $100 billion on the reserve fund) and has returned with increasing frequency to capital markets, particularly the domestic market. Though the impact on the outstanding debt has been limited, the eviction effect on the private sector has been substantial with Russian banks preferring the liquidity of sovereign debt.
But lacking concentration and consolidation, however, the banking system has remained weak and polarized. Despite a still high level of nonperforming loans, the banking sector nonetheless seems relatively stable at this juncture. The banks have emerged from the crisis well capitalized, debt-free, and with new assets on hand. Meanwhile, the credit market gradually recovered in 2010. The sector is, however, still exposed to high risk and polarized by the excessive number of banks clustered around five leading public or quasi-public banks with some 20 to 25 private banks still exposed to liquidity risks (ineffective banking market, lack of confidence) and nonperforming loans, handicapped by their relatively small size in relation to the market been affected by endogenous shortcomings: lack of long-term strategy, poor risk management, own funds lack of transparency, inadequate oversight, and so on.
Persistent governance shortcomings
Although President Dmitry Medvedev policies have in practice strayed little from the course set by Vladimir Putin, the run-up to presidential elections in 2012 could be conducive to discord between the two political leaders: especially since they will have to deal with the growing discontent of an active middle class that feels increasingly squeezed by the repressive methods deployed by the central government. Domestically, a considerable resurgence of violence in the Russian Caucasus attests to the growing unrest in the region against the background of the several autocratic regimes pilloried by the Arab spring and of the rapid approach of the 2014 Sochi Olympic Games. Meanwhile the reset policy initiated by President Barrack Obama has paved the way for improved diplomatic relations with the West that Russia hopes to leverage in attracting the investments and transfers of technology necessary for the modernization of the economy considered crucial by President Medvedev. Achieving that objective will be handicapped by deficiencies in the business climate and the lagging pace in making the necessary improvements in governance. In May this year, Russia nonetheless adopted the OECD-sponsored agreement on combating corruption. According to Coface payment records, moreover, after the frequent incidents observed in 2009 payment behavior has improved with the resumption of economic growth. Payment incidents have nonetheless remained high due to the lack of transparency among companies and the deficiencies in the legal protection afforded creditors.
Strengths
- Abundant natural resources including oil, gas, and metals
- Skilled labor force
- World’s third largest foreign exchange reserves
- Infrastructure development opportunities in the framework of the 2014 Winter Olympic Games in Sochi
- Reasserted regional and energy power
- Political stability
Weaknesses
- Limited economic diversification, because the economy is highly dependent on raw material prices
- Excessive private sector foreign debt
- Banking sector still very weak
- Persistent deficiencies in the business environment
- Lack of competitiveness in the industrial sector