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OPINION January 24, 2018

Through the Looking Glass: A 2017 Retrospective of Russia’s Economy

Nothing succeeds like success and who would know better than Lewis Caroll, the author of the acclaimed “Alice’s Adventures in Wonderland.” However, few know what triggered him to title his sequel, “Through the Looking-Glass and What Alice Found There.” The very fact that Lewis Carroll made his only trip abroad - in 1867 - to Russia may give us a hint. And that puts me in good company as I strive to describe what I find in Russia since my appointment as the Moscow-based World Bank Lead Economist for the Russian Federation.

In this inaugural column for Forbes Russia, my commitment to this column’s readers is to present as objective a view as possible of Russia’s “twist-and-turn” economy. I find it rather interesting, frustrating, and occasionally funny, how Russia’s economy is so stereotypically characterized in bipolar terms: “good or not good.” The looking glass is either rose-tinted or lined with lead.

Hence, my clear-cut commitment to objectivity.

You might rightly ask, how? The answer is simple. By basing this column on data-driven evidence and when data are not available, drawing on economic theory. Sure, data can be flawed, and economics, misguided. Nonetheless, data and economic logic remain our best defense against our human biases.

So how did Russia’s economy perform in 2017?

Let’s start with the positives. After nine successive quarters of recession in 2014-2016, it is a remarkable achievement that Russia’s economy has emerged from recession to recovery. Growth bottomed out at a recessionary, minus 2.8% just two years ago and today, it is plus 1.7%. This turnaround was due to three factors:

First, deepening domestic macro-stability: Thanks to the Russian Central Bank targeting inflation, the country is enjoying its lowest inflationary environment in history: annual inflation is currently averaging a mere 4%—less than a third of just a few years ago. Had inflation trends of 2015 sustained, a plate of Olivier salad would have been 402 Rub instead of 312 Rub today.

Meanwhile, a comfortable import cover for over 16 months; high levels of international reserves (over $420 billion); and a flexible exchange-rate regime continue to help the economy navigate external shocks. Government debt to GDP is around 17% (the euro area's is almost 90%).

And by the end of 2017, fiscal deficits (both general and federal) are expected to be a shade above 2% of GDP – not exactly a sign of profligacy. Add to that Russia’s renewed fiscal rule and one can almost say that the macro is getting boring. Perhaps macro, like accounting and dentistry, ought to be boring?

Second, firming global commodity prices: Oil prices, which had fallen to $27 a barrel in early 2016, are now in a comfortable mid- $50 range. Compliance among oil-producing nations is also growing. This is all good news for any commodity exporter, including Russia.

Third, a recovering global economy: This is the first time since the 2008 global financial crisis that major advanced economies have grown synchronously. With expected growth at 2.1% and 1.5% in 2017, the economies of the United States and Japan strengthened, while in the Euro Area economies, growth, at 1.7%, is well above its estimated potential of around 1%. In 2017, Asian economies, namely China, India, and Vietnam – all important trading partners in Russia’s pivot East – are expected to post strong growth of 6.7%, 7.2%, and 6.3%, respectively.

In essence, a combination of macro-stability and good luck (of firming oil prices and a recovering global economy) has helped Russia. Here, I must emphasize the understated recognition of luck. We often over-attribute growth to policies when the underlying factor is, really, just luck.

A famous paper by William Easterly et al titled “Good Policy or Good Luck?” makes this point nicely. As this paper provocatively argues, luck matters more than policies. This reminds me of a story about somebody who once brought a talented general to Napoleon. Napoleon retorted: “I don’t care if he’s talented. Is he lucky”? No doubt, Russia has profited from good luck (including that of good climate, contributing to Russia’s place as the world’s topmost wheat producer and exporter).

What about problem areas? Well, there are a few:

One obvious one is again luck, but this time, bad luck. While headline global growth (projected to be almost 3% this year) is strong, it may not be sustained because of a decline in investment and measured productivity growth. Moreover, high indebtedness is also an issue (household debt is growing in developing countries, and there are indications of corporate balance sheets becoming more vulnerable, including Russia’s, where non-financial corporate sectors have also shown weaker conditions). The point is if the current run of good global luck sours due to these factors, or others such as a significant drop in oil prices, or a sudden tightening of global financial conditions, that will not bode well for both the world or for Russia.

There are others, as our latest Russia Economic Report discusses. First, despite a modest decline in the poverty rate in 2017, almost 20 million Russians still remain below the poverty line. Second, even with historically low unemployment rates of about 5%, unemployment by regions remains unequal: from a low 1.3% and 1.7% in Moscow and Saint-Petersburg to a high 18.7% in the Tuva Republic and 27% in Ingushetia.

As another of our report shows, the regions have also borne the brunt of fiscal adjustment during the crisis years through massive cuts in social spending. More cuts may not be sustainable nor desirable. Third, the banking sector remains fragile. Recent bail-outs of the 3rd, 5th, and 9th largest private banks (Otkritie, B&N Bank, and Promsvyazbank) point to a continued fragility in the Russian banking system.

How the new banking resolution mechanism is implemented will be key to preserving stability and restoring public confidence. While these recent failures have not caused noticeable stress across the broader banking sector, their long-term effect—absent full divestment—will likely increase public ownership of the banking sector. This raises concerns about longer-term issues of competition and innovation.

This is perhaps a good point to end this column. To sum up 2017: Russia is edging from recession to recovery and can withstand not-so-major disturbances in the global economy. However, improved macro-stability came at a cost of cutting growth-enhancing physical and social capital. Indeed, Russia’s challenges now lie primarily within its borders, such as boosting competition and innovation, which drag Russia’s productivity growth – the ultimate driver of economic growth. As most commentators somehow fail to point out, Russia’s productivity was low and declining even before the dual oil price and sanctions shock hit in 2014.

Can 2018 change that? Stay tuned…

PS: I welcome both compliments and criticisms, as well as suggestions, from readers for future topics. You can also follow me on twitter @Apurva.Sanghi