Russia: Risk Assessment
Country Risk Rating
Business Climate Rating
- Abundant natural resources (oil, gas and metals)
- Diversification efforts
- Floating of the ruble since November 2014
- Market size and skilled labor force
- Macroeconomic stability: strong public and external accounts that ensure resilience to external hazards
- Efforts to clean up the banking sector (469 institutions in May 2019 compared with about 900 in 2013)
- Digitization and innovation capacity
- Dependent on hydrocarbon prices
- Declining demographics
- No trade agreements beyond immediate neighbors
- Dependent on foreign technology
- Weak infrastructure aggravated by lack of investment
- Heavy social security contributions (30% of salaries) favoring informal economy
- US and European sanctions hindering offshore field development and innovation
- Institutional and governance weaknesses (insolvency treatment, property rights, corruption)
Acceleration conditioned by public investment
Russia has recovered from the 2015/2016 recession. While growth may appear timid when compared against the rise in hydrocarbon prices, the expansion reflects the country’s economic capacity and the authorities’ desire to separate growth from oil wealth, which is subject to wide variations. To this end, and against the backdrop of Western sanctions, Russia adopted a fiscal rule in 2018 to reduce its non-hydrocarbon deficit and diversify the economy. In this context, the focus is on investment. However, household consumption (50% of GDP) will remain the main contributor to growth, expanding in line with the economy. Remuneration will benefit from tight labor market conditions, productivity efforts and increases in public wages (28% of jobs) and pensions. Credit growth, although slower, will remain comfortable, while the central bank could cut its key interest rate further (6.25% in December 2019) with inflation close to its target (4%). Investment (21% of GDP) is expected to contribute almost the same amount to growth by rising strongly, at least if the 13 national projects laid out by President Putin in 2018 get underway. Targeting roads, education and health, these projects aim to increase growth potential and reduce poverty (14% of the population lives below subsistence level and 65% of people receive assistance). Russia’s sovereign wealth fund (SWF) may provide financing for the projects, which will be three-quarters public. However, an overly great impact should not be expected, as the projects overlap with pre-existing initiatives and public expenditure has a weak multiplier effect. Moreover, despite measures to promote economic diversification, private investment, which is already squeezed by the size of the public sector (38% of reported value added with 32,500 companies), is unlikely to be vibrant. It has to cope with sanctions that include restrictions on access to international financing, while domestic credit to companies remains parsimonious and more expensive. While grain exports will benefit from the better 2019 harvest, oil exports will face flat prices and the production cap contained in the OPEC+ agreement, while other exports (ore, timber, basic and intermediate industrial products, transport equipment) will be affected by cooler global demand. At the same time, imports are set to grow faster, in line with domestic demand, despite encouragement to use substitute local products and increase local content.
The fiscal rule introduced in 2018, following on from those of 2004, 2008 and 2012, has been somewhat relaxed: it forecasts a primary deficit (no longer a balanced budget) over the 2019/2024 period based on an oil price of USD 40 (2017 price adjusted for US inflation). Additional government revenue generated by a higher Urals oil price is set aside as foreign assets in the national stabilization fund. However, as the fund has exceeded 7% of GDP, money can be spent on public investments. Adoption of the rule was accompanied by fiscal consolidation, which enabled the crude oil price required for a balanced primary budget to be lowered from USD 110 in 2013 to USD 43 in 2018, while the non-oil deficit fell from 9.4% to 7%. Non-oil revenues represent 26% of GDP, while the rest are equivalent to 8%. These revenues are mainly used to finance current expenses including subsidies (7% of GDP). Public debt and its servicing are low, as the SWF was tapped during the recession. The external share represents 3% of GDP.
Even if it narrows, the current account surplus will remain high in 2020. Despite declining, the trade surplus (11% of GDP in 2019) linked to hydrocarbon exports (54% of total exports) will be considerable and will more than compensate for the deficit in services and income (oil and gas engineering expenses, Russians traveling abroad, dividends from foreign companies, transfers of foreign workers). Excluding hydrocarbons, the trade and current account balances would be negative at 3% and 8% of GDP respectively. Despite the efforts made since the application of sanctions, the substitution of domestic products for imports only goes so far, except in the agri-food sector. The financial account has become slightly negative (estimated at -1% of GDP in 2019). The Russian private sector has stopped deleveraging, while net foreign investment flows are negative. Private external debt has fallen to 24% of GDP, while growing foreign exchange reserves already stand at 18 months of imports and more than five times short-term debt.
Power fatigue and an uneven business environment
Vladimir Putin (67), who has been in power for 17 years, began a new 6-year term in May 2018. His popularity has been eroded by pension reforms. Demonstrations on an unprecedented scale have taken place in large cities, but also in small towns, to protest the barring of opposition candidates from running in the September 2019 local and regional elections, as well as corruption and economic difficulties. Despite a satisfactory rating in the Doing Business and Global Competitiveness reports (78/100 and 67/100, respectively), institutional performances (corruption, regulation, justice, insolvency treatment, protection of minority interests, random contract enforcement, patronage) need to be improved.)