Russia: Risk Assessment
Country Risk Rating
Business Climate Rating
- Abundant natural resources (oil, gas and metals)
- Floating of the ruble since November 2014
- Market size and skilled labor force (but shrinking population)
- Sound public and external accounts
- Efforts to clean up the banking sector
- Dependent on hydrocarbon prices
- No trade agreements beyond immediate neighbors
- Dependent on foreign technology
- Poor infrastructure and lack of investment
- Heavy social security contributions favoring informal economy
- US and European sanctions hindering offshore field development and innovation
- Institutional and governance weaknesses (insolvency treatment, property rights, corruption)
Russia has consolidated its recovery from the 2015/16 recession, yet growth seems timid when compared against the rise in hydrocarbon prices. However, the expansion reflects the country’s economic capacity and the authorities' desire to separate growth from oil and gas wealth. Household consumption (50% of GDP) will remain the key growth driver. Its rate of increase will be slow, echoing that of the economy. Households face a hike in the VAT rate from 18% to 20% on January 1, 2019. However, unless food and energy prices, or the ruble, go off track, inflation should remain under the control of the central bank, which had the key rate at 7.5% in early November 2018. With wage growth outpacing productivity growth, and in view of the inflationary expectations (4%), the central bank will proceed with caution. At the same time, pay rises in the public sector (28% of jobs) will be reined in, pensions will also get a smaller increase, while employment should increase slightly now that the retirement age has been pushed back by six months. Private investment, particularly foreign investment, will not be vibrant given the backdrop of sanctions and geopolitical tension. Given the size of the public sector (33% of GDP, 38% of reported value added with 32,500 companies), its investment is very important. In his May 2018 decree, President Vladimir Putin pledged to increase spending on infrastructure, health and education to 1.1% of GDP each year by 2021. Companies, both public and private, are strongly encouraged to participate. Non-oil exports – especially minerals, timber, grains and oilseeds, basic and intermediate industrial products and transport equipment – are expected to grow less than imports, maintaining a slightly negative trade contribution to growth. Crops are expected to be below average, while hydrocarbon sales could stagnate.
Surpluses on the Back of Hydrocarbon Prices
The fiscal policy is set to remain restrictive. First, the 2017/19 three-year budget forecasts a one percentage point reduction in the non-oil deficit each year (9% of GDP in 2017). Dividends paid by state-owned companies will reach half of their profits, and excise duties on tobacco and alcohol will go up, as will the taxation of extractive activities at the expense of export taxation. Expenditure control will be complex because public pensions and salaries are indexed to inflation. Second, a fiscal rule, based on primary equilibrium (i.e. excluding debt interest) for a price of USD 40 per barrel of oil, applies from 2019 onwards. Given the dissatisfaction with the pension reform, this rule could be slightly relaxed by temporarily setting a higher reference price. This would allow the authorities to use part of the additional hydrocarbon-related revenue spent on foreign exchange to replenish the sovereign wealth fund (SWF, 7% of GDP at the end of 2018) and ease expenditure pressure. Public debt and its servicing are low, as the SWF was used during the recession. Its external share represents about 5% of GDP and tended to decline in the second half of 2018 with US threats on Russian public debt holdings.
The current account surplus is expected to remain significant in 2019. It is based on the large trade surplus (10% of GDP in 2018) linked to hydrocarbon exports (60% of total exports), which more than compensates for the services and income deficit (oil and gas engineering expenditure, Russian stays abroad, dividends from foreign companies, transfers from foreign workers). Excluding hydrocarbons, the trade and current account balances are negative at 5% and more than 9% of GDP respectively. Despite efforts made since the sanctions were imposed, the substitution of domestic products for imports has had little success, except in the agri-food sector. The financial account is negative at 2% of GDP, as the Russian private sector makes financial and real estate investments abroad and is deleveraging, while new foreign investment in Russia is low. However, funds are returning to Russia in the form of loans contracted abroad, often by those who have invested money there. For this reason, private external debt (27% of GDP) should be put into perspective, especially since growing foreign exchange reserves already represent 17 months of imports and more than five times short-term debt.
Political Stability but an Uneven Business Environment
Vladimir Putin, who has been in power for 17 years, began a new six-year presidential term in May 2018. Popular in the past for his annexation of Crimea, counter-sanctions, and strong international activism, he saw his popularity plummet following the adoption of the pension reform. Despite a satisfactory rating in the Doing Business and Global Competitiveness reports (scores of 77/100 and 66/100, respectively), institutional, regulatory, commercial and judicial performances (government interventionism, random contract enforcement, patronage) need to be improved.