Media Call: Russian Economic Sanctions—No End in Sight
April 19, 2017
During a recent media call, Andrew Weiss and Andrey Movchan discussed the current stand of the Russian economy. Having provided some relevant statistical data on the GDP growth and the general economic performance in Russia, Movchan explained why the population’s support for the governmental policy/political regime remains relatively high, although the economy is declining.
Andrew Weiss: Good morning, everyone! It’s Andrew Weiss from the Carnegie Endowment headquarters in Washington. And I’m delighted to be joined this morning by Andrey Movchan, who is the director of our Economics program in Moscow. This media call is going to be on the record. It’s also going to be recorded and we’ll have a transcript up on our website in the next day or so. And obviously we’d welcome questions you might have. I’ll let Andrey speak for a few minutes in the beginning and then we’ll pause to see if there are any questions, and then we’ll continue the conversation. By way of introduction, Andrey has been with us at Carnegie for about two years. He is one of the founding fathers of the Russian banking sector, with more than twenty years of very practical experience. He is a leading financial professional in Russia, most recently as CEO of Third Rome and before that of Renaissance Asset Management. Andrey has just completed a project that looks at the resource dependency of the Russian economy in a comparative context. There was a rollout event for the project a couple weeks ago in London, which was supported along with the core project, which garnered support from the UK Foreign and Commonwealth Office. We are delighted to have you here today, Andrey, with us. Could you maybe just speak for a couple minutes about the project and what your key findings were? And then we can sort of dig deeper.
Andrey Movchan: Of course. Thank you, Andrew, so just me being very concise about what we’ve done. We’ve looked through the universe of the countries which have different sources of dependency on mineral resources in the recent resource cycle. The purpose of the project was to look through the international experience and observe to what extent it is applicable to the Russian situation, given the fact that Russia is heavily dependent on the oil and gas exports and oil and gas production domestically. And the Russian economy is in its major indicators: 99 to 100 percent correlated with the price of oil. We obviously needed to look through the other experiences and the best practices to understand what to do with regards to the diversification of the Russian economy. Despite the fact that the current government of the country does not actively work on the problem of diversification, it looks like the status quo is the most comfortable position for the government as of today. Still we understand that going forward, given the situation with major Russian economic indicators, which are gradually sliding down, the government will eventually come to the point when certain decisions should be made, otherwise the country would get into uncontrollable recession. The project observed ten countries with oil dependency. We also used data from other countries as supporting data. The general observations are put in the printed materials, couple materials will follow in a few days; one of them would consist of a set of particular recommendations for Russia given the information we’ve gathered. The major findings deserve a lecture of like an hour and a half at least. Generally speaking, in a few phrases, liberal economy, tough monetary policies, open trade are the most important part of the success in overcoming resource dependency. Other things include such kind of non-obvious things like investments in education and healthcare. A specific way of operating with foreign funds is also important, in particular the spending of foreign funds should be very limited, and the mandate of management of foreign funds should be very specific providing for the maximization of returns. A few other particular things concerning the policies with regard to monetary environment, with regard to the import substitution, yielding to the export diversification programs and other things were explored,and you’ll find the material about that in the Carnegie papers.
Weiss: Well, now. That’s really a great overview, Andrey. What is sort of hard for me to understand, and maybe you, because you’re in Russia now and you can understand how people in the government are thinking, is how does stagnation look to them? Does this seem like—do they feel like they have a dependency, or do they feel like eventually things will be better because price of oil will somehow recover because of the geopolitical factors, or because the world economy will strengthen? Does the addict feel like he is an addict? I guess, is the simple question, when conditions are basically north of $40 a barrel.
Movchan: Generally it is really hard to be sure about what do people think in the Russian government. They are quite closed in terms of what they report to the general public. They usually hesitate to talk openly. We can suppose or imagine that people in the government understand what’s going on—they have plenty of figures, plenty of numbers, which they see every day. The Rosstat is working more or less accurately about the data, and Rosstat shows that the shrinking of the economy is continuing through the year 2017 already. And we have first data for the first quarter, which confirms that the construction, for example, fall dramatically and retail sales continue to fall dramatically. The incomes fall, despite the fact that the oil prices recovered partially in this year. Then there is a great and long-standing habit in Russia of misrepresentation. Top officials report the successes based on nothing, based on their eagerness to report good things. The Prime Minister of Russia, Medvedev today just said that Russia overcame the crisis and now the economy is growing. He said it about an hour after the official report of the Russian statistical agency, which reported the recession in clear figures. So with that regard, I would not rely upon what they say. On the other hand, the country is very tightly structured around the so-called power vertical, which is essentially a contract between the power, the Kremlin, and the elite, which delegates to the elite unjust powers in exchange for loyalty. With that regard, if you want to do reforms, if you want to change the economy to an open one and to a liberal one, if you want external capital to come, if you want to protect investors’ rights, first and foremost you will find enemies inside the country – the elites, which control businesses, which control regions, which control law enforcement agencies, would fight against that, understanding that it cuts off their profits. With that regard, the government probably is just looking for the stability, as a way of prolonging the agony, as opposed to a quick negative result of the reforms.
Weiss: That makes a lot of sense. I apologize to everyone on the call. I should’ve mentioned, if you want to pose a question, if you could please hit 01. So again, if you could hit 01 on your keypad, that way I can know that there is a caller waiting to ask a question. Can we talk a little bit about how the societies you looked at dealt with their dependency and what the social impacts were. There’s obviously been a lot of interest in the recent wave of anti-corruption protests in Russia at the end of March, and I’m just curious if political stability and resource dependency are related in any way, and what the research showed in that department.
Movchan: We should understand how the society in Russia is structured. The society is pretty much dependent on the state. 38% of the workforce is working for the state directly, and about 55% of the population is dependent without personal income, and most of them are children who are not participating in the political process and pensioners who are fully dependent on state pensions. Given that, people look at the government, at the Kremlin, as a source of funds—the only source of funds they see and understand—and they negotiate with the Kremlin not about the freedom of business, for example, not about the liberalization of the economy, but about the size of the subsidies, the size of the social payments. And the Kremlin has been quite generous in terms of that, the salaries were growing faster than the GDP was growing when the oil price was high. Now, of course, the oil price is low, and the traditional discourse in Russia says that the major problems of Russia is obviously the conspiracy of the United States against the oil prices and the general conspiracy of the United States against Russia as a country, and that the sanctions are the reflection of such a conspiracy. And because of that we have to struggle, and we have to fight against it, and we have to stand against this conspiracy to survive, and it’s a bad time to negotiate conditions because everybody is on fight. It’s a war for the independence, in a sense. And quite a big number of people, quite a big share of the public, support such a position, and share such views, not without the help of the mass media, which are controlled by the government. They are actively projecting such a position onto the public. And on the other hand, we, of course, have people who understand that their incomes fall, we have more and more people who try to protest generally against the economic situation—there are no political demands so far. They protest against corruption, which is a theme—it’s quite fancy now—but people who participated in the protests against corruption are counted in like tens of thousands, not more. And like a hundred thousand protesters for a country with 145 million inhabitants is not too much; it doesn’t change the picture. And then we have pure economical protests like the strikes of the lorry drivers. Again, if we calculate carefully the number of lorries on strike, it’s like four percent of the market, which is very low. It doesn’t change the situation economically in the country, doesn’t change the political situation at all. So we have to conclude that there are no sensible and meaningful social protests, although we definitely have people who write criticizing, and who speak criticizing the government and the policies, and the voice of them is heard by approximately 15 to 20 percent of the population. So we reasonably can expect that if elections are free to the opposition, the opposition would get as much as 15 to 20 percent of the election, which for presidential elections it means little, there’s just one president of the country. And for the upcoming Duma elections, which will come after the presidential elections, at quite a distance, we may expect for the first time in the near past and the present times that the opposition would pass the five percent barrier and become part of the Duma. But I think that limits the ability of the opposition leaders and the possibility of the reforms.
Weiss: That’s really interesting. One of the things that you’ve written about in the past, which I think challenges some of that conventional wisdom—and before I do that, I’ll just say, if anyone has a question please hit 01 on your keypad and I’ll recognize you—was the sense that the average person hasn’t necessarily shared in the prosperity of this resource dependency, which is a little counter to the standard assessment, which is that Russians have had dramatic socioeconomic gains over the last fifteen years. You saw a sharp rise in incomes; you saw a sharp rise in consumption, and other indicators, as a middle class was developing in the early 2000s. And your research is sort of pointed in a different direction, which is to say that many of the gains of this period of resource dependency—of intense resource dependency—were highly concentrated. Can you talk a little bit about that? Because I think it does challenge some of the conventional wisdom.
Movchan: Okay. We know a few figures for sure. First, we know that the average individual income in Russia is now equal to about 21.5 thousand rubles, which is approximately $350 per month. Another thing is much more interesting. When we talk a median income, it falls down about 40 percent and the median income in Russia is 14 thousand rubles, which means that the income is very unevenly distributed. And then if you take 50% of the population which receives income less than the median income, the average income for them would be 11 thousand rubles, which is about $150 per month. Mathematically, it shows that the distribution is very uneven, the inequality grew over 15 years, and still even if you come back to the average indicators– the average salary in 2005 in real rubles was pretty much equal to what we have now. Generally salaries grew when oil prices were skyrocketing and now they just came back to the level they were 12 years ago, and they are going down again. As we see in the last Rosstat data, the index is minus about 3% here today, which can correspond roughly to about 7-8 percent for 2017 if nothing changed. Given that, my idea when I was writing about that was not many people were really benefiting from the boom, which means not many people will be hurt by the downfall of the oil price, and we see that. We see that the most depressed class is the middle class. The size of the middle class shrunk back to the level of early 2000s, like 2002-2003 in definitions of financial times of the middle class. And the majority of protesters is from the below middle class—small businessmen and managers and office workers and individual entrepreneurs who lost their jobs, lost their markets, and when we go down deeper to people who work for the budget (we call them “budgetniki”), these people, they feel their situation isworse but not that much, they usually see about a mild contraction of their incomes.
Weiss: And how much of a cushion does that provide the authorities that people especially in the “budgetniki” sector feel that they can adapt to this world and basically move to a more subsistence-based lifestyle, defer large purchases, defer the sort of frivolous things that people might have bought during the boom. Does this create a kind of large reservoir of residual support for the current political regime, or does it basically create a lot of unmet, a lot of dissatisfaction within society because people feel that the opportunity to advance was denied them due to the stagnating economic environment?
Movchan: We don’t know for sure, of course, it’s hard to predict the intentions and the mood of the crowd is changing all the time quite unpredictably. What we know is that, for example, when we analyze the distribution between people who prefer the “great country” and who prefer the “prosperous country,” which is measured by independence such as in Russia, we see that the ratio is about 1 to 1 now. The same ratio was in early 2000s, in the years 2000, 2001, 2002. After that many more people preferred the “great country” over the “prosperous country,” which meant that people were satisfied with the level of prosperity of the country, they were thinking about greatness. And again now it came back to the level of the early 2000s, which was not kind of a dangerous level for the government. The support for the government at that time was quite high. So we can spoof - justly or unjustly I don’t know - that the government still has much space for the maneuver, the government can wait for quite some time before the situation changes and people start demanding economic prosperity in a much more rigid way. Then, when we compare to the international data, we know that problems with the color revolutions, with the copes and with mass protests start usually when countries cross the level of $6000 per person of GDP. Russia today is at the level of $9000 of GDP—Russia is looking like Mexico now in many senses, including the GDP per capita, including many other things, including the economic complexity for example, which is quite the same. And Mexico looks like a quite stable country at the moment. With that regard we do not have much base for being afraid of mass social unrest in the country for the foreseeable future.
Weiss: That’s really interesting as well. The other major theme that people talk about is that there is somehow a big plan that could change the structure of the Russian economy, and it would be politically beneficial to the regime to improve living standards, to improve the level of investment in the economy, to create a basis for sustainable higher levels of growth. But let us not do it right now, because the external environment is very hostile, because the elections coming up in a year, because there is an uncertain question about how long President Putin desires to stay in power—whether it’s till 2024 or longer. How does this look to you, does this look like the idea there’s a reform blueprint that will somehow be presented to decision-makers sometime soon and then that they will pull the trigger on these important structural changes? Does that seem like something that is realistic in the next 18-24 months, or is it something that is likely to be what we call in English a “make-work exercise” where people can basically put their energies into a project, but it doesn’t really matter if it’s happening or not, it’s just to keep them occupied—and I mean that sort of technocratic economic reform block especially in the government.
Movchan: I don’t really think it’s realistic to have the government or the Kremlin, if you wish, changing their policies so much in two years, and the problems, the barriers to that are not only in the unwillingness of the Kremlin to change the situation, there are at least three big barriers on that way. The first barrier is obviously the government. People currently are afraid of uncontrollability of the reforms, of the situation when reforms cause even worse situations in the economy for some time, and people would not tolerate that. Everybody knows that people in Russia do not tolerate even the word ‘reforms.’ After the 90s, the attitude toward reforms is extremely negative—toward such a term, toward such an idea. The second barrier is the general elite, like 100,000 people who control the power in Russia, control specific things, specific positions, specific parts of the power, and who do not want to change anything because they know how to live and work in such society, they do not understand their place in the future if something changes. And the third thing is the dramatic lack of resources: Russia lacks financial resources for the reforms, Russia is not trusted by the international society, and nobody would invest in such reforms. The internal players do not invest in Russia, and they would not trust this government because this government broke the trust many times with them. And then Russia has neither a school nor an internal resource of efficiency, and we have no products to present to the market. Even if we invest in producing something, we have nothing to produce to be consumed by the international market, and the local market is too small to satisfy the needs of open reforms and of growth. And given that I think the government is quite sober at looking at what is going on—we have no chance of changing anything without changing everything, and changing everything is not on their agenda. And the plans which Kudrin and his colleagues are working on, or the Stolypin’s club is working on, or other agencies are working on is more exercise of finding small and quick wins, fixing that, and then fixing that, to allow the system to work a bit longer, or maybe just longer then it would have worked if no small changes would have been done. And we will definitely see small changes after the elections, we know that taxes would be changed, presumably increased, we know that the monetary policy would change slightly, and that the experts would be eased and then we pretty know how it would be eased for specific companies and specific products. We know that the social system would be shrinking after the election because such social security system which we have is not tolerable for the budget anymore. We most probably will see a great shift in defense and security expenses which are unbearable anymore. Russia would probably cut dramatically the defense expenses, but speaking about the real reforms, the real transformation, I wouldn’t expect any movement in that direction.
Weiss: So we are running a little short on time and I would like to ask you maybe one more question and then we will wrap up. It’s interesting that in this conversation I think I shouldn’t maybe draw too much from that but it’s really interesting that the role of sanctions is not a key factor in your assessment of what weights the Russian economy, and I’m just curious if you could talk a little bit about why you think that the sanctions program that was imposed as the result of the annexation of Crimea and Russia’s aggression in Eastern Ukraine does not have that much impact on Russia’s overall growth outlook. If that’s indeed the case, if that’s indeed your view, you know there’s the sense that surely the sanctions, along with the drop of the price of oil, are going to have a lasting impact on Russia’s growth outlook. Do you share that view which is pretty common in the West? Or do you think that it is misguided?
Movchan: As far as sanctions are concerned, if we decompose the sanctions into pieces – we’ll have the financial sanctions, which prohibits specific companies in Russia and specific banks for borrowing money abroad on specific terms, generally, in the long-term over years they might work if they persist. As of today, Russia has excessive reserves — about 400 billion dollars — and the country just doesn’t need money. We decreased the balance of the banking system for about five years now, that process started before the oil prices collapsed. The country was in a mild recession already in 2012 and 2013. Nobody wanted to invest, nobody wanted to take new money, banks and companies started to pay back the loans – in such an environment where only commercial banks have about 2 trillion rubles with the central bank or reside in the area of zero rate, Russia just does not need money anymore and for quite substantial amount of time. With that regard, if you don’t need money sanctioning you from money is not helping change the behavior. The second thing is the equipment for exploration of oil – this is limited to the equipment of exploration of the heavy oil and expensive oil and nobody’s exploring such fields today, when oil prices are $55 per barrel, and heavy oil starts on $75-80 per barrel. With that regard, Russia is not using such equipment anyway, regardless of the sanctions. The third part of the sanctions concerns the dual use equipment and the military equipment, and it could have hurt the exports of the arms. But it actually didn’t, because what Russia does now, instead of buying the avionics and the precise devices from the West and putting them on its aircrafts and tanks and other equipment and selling them to the counterparts, Russia is now selling the shell — the empty aircrafts and tanks, and the management complexes and whatever, and then it’s being stuffed with the international electronics by the buyers. Given that the overall margin of the defense complex hasn’t fallen and 2016 showed pretty much the same figures as 2015. And personal sanctions do not affect the economy anyway, as there are just a few individuals concerned, and the sanctions prevent them from having money abroad and assets abroad. And the fact that they have brought money and assets back into the country is helping the economy, not hurting the economy. The World Bank tried to estimate the damage caused by the sanctions. Their last estimate was half percent of the GDP –I think it’s still too generous, I think the damage is not zero, but it is definitely less than half % of the GDP. Even if we talk about half percent of the GDP — it is incomparable with the loss of about 16-17% of the dollar-denominated GDP during last 3 years
Weiss: Very interesting. So the project on “Russia’s Resource Dependency” is available in Russian and in English on the Carnegie.ru website. Andrey Movchan, the leader of the project, you’ve done a really fantastic job this morning and a fantastic job on this project. I’m grateful for everyone for dialing in. We’ll get the transcript around to you in the next day or so. Thank you Andrey for your time thanks for all of your insights.
Movchan: Thank you Andrew, thank you everybody.
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