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Source: www.asiaecon.org |


After a decade of robust growth, plunging commodity prices fueled by the international economic crisis, have severely slashed the value of oil, the mainstay of Russia's economy.

After a decade of robust growth, plunging commodity prices fueled by the international economic crisis, have severely slashed the value of oil, the mainstay of Russia’s economy. The country now faces a reversal in capital flows, credit crunch, a falling stock market, and a severely strained national currency. The Russian government has already cut the 2008 growth forecast from previous estimates of 7.3% to figures ranging between 6.8% and 7%.  Economical growth rate for 2009 is forecast to reach 2.3 %, however, analysts argue the Russian economy will further contract and likely reach a recession before the end of the year.  Critics believe the crisis could have been avoided, while efforts to stabilize the Russian economy are still lacking.


Russia announced a series of appropriate and timely economic measures aimed at cushioning the impacts of the current economic pressures, including a $200 billion program involving help for companies in refinancing foreign debt, a fiscal stimulus package,  tax cuts, increase in loans and liquidity injections into the banking systems.  While the government implemented comprehensive plans to lessen the damages of the crisis, more efforts are needed to establish a sustainable long-term economic recovery.


For instance,  Russia’s approach to the current currency crisis has been extremely controversial. Until recently, Russia has been on a basket peg composed of 55% for the dollar and 45% for the Euro. With the decrease in oil prices the ruble has become extremely overvalued. The government has thus started a slow devaluation of the currency in order to save some of the country’s reserves while adjusting the exchange rate to the low commodity prices.


The release of the currency peg allows for the flexibility of the exchange rate and the decrease of its overvaluation.  Since November 11th the Russian government has depreciated the ruble twelve times while widening the trading band seven times, creating a 17%  currency value fall.  The government hopes to further depreciate the ruble by 10%, assuming that a barrel of oil can stabilize at around $50 in 2009.


The slow and controlled devaluation is an effort to avert public panic as the process strikes fearful resemblance to the 1998 Russian currency crisis, where the ruble was devalued by 70% against the dollar, creating panic withdrawals from bank and a government default of $40 billion of debt.  Russia has since then, been able to control devaluation as it counts with the world’s third largest foreign reserve,  allowing the country to efficiently protect its currency during exchange rate moves.


However, economists, including the world renowned Nouriel Roubini, have argued that a single sharp decline of the ruble would be far more efficient as small and slow devaluations only encourage further outflows of money from the country,  trigger sharp increases in domestic interest rates, decrease the rate of investments, and further depletes foreign reserves; all of which would push the economy closer to a recession.


In fact,  the current stable and predictable devaluation process showed a 5.9% contraction in Russia’s money supply in the month of November. Russia’s central bank has already threatened to cut banks off the liquidity lifeline as they desperately seek to convert rubbles into foreign currency, fearing further devaluation. The central bank has also resulted to reduce access to collateral-free liquidity auctions for around 34 of the country’s commercial banks.  Capital flights have already reached over $100 billion. Investors have pulled more than $211 billion out of the country since last August. Meanwhile, foreign reserves have lost about $ 162.7 billion while protecting the rubble in the last four months. The country has also began to face severe external debt financing problems as a result.  Moreover, purchasing power and overall consumer confidence is decreasing in rapid rates, due to the constant fear and anticipation of further depreciation. A larger and faster devaluation made in an unexpected way, would protect reserves while also avoiding expectations of further depreciation.


While sharp currency devaluation is necessary,  it might not be enough to save the Russian economy from a substantial slowdown.  The country’s lack of economic diversification has resulted in an unhealthy reliance on the energy sector, making the national economy extremely vulnerable to the global financial crisis.


The country currently faces growing unemployment rates ( reaching a 6.1% rate in October),  near zero industrial production growth rate,  a current and fiscal account very close to deficit, and a slowing consumption rate. The World Bank states that 1.3 million Russians will remain in poverty from 2007 to 2009.  GDP growth already dropped 6.2% in the third quarter of 2008. In 2009, the country will require oil barrels to average at $70 to balance its annual budget, although commodity prices are expected to remain low well into the following year.


Russia’s energy sector accounted for 73 % of exports to country’s outside the former Soviet Union in the first 10 months of 2008, and made up for about 20% of the country’s fiscal revenue. Contrary to the government’s assessments, Russia’s extraordinary economic success during the past decade has not been a product of stable and comprehensive economic growth, instead, it has essentially been a result of high oil prices.  Yet, the future of Russia’s energy sector is uncertain, and should not by any means be highly depended upon.


Russia’s oil reserves are expected to last no more than 22 years, a relatively low life span,  and production growth has slowed substantially in the past years. Annual growth since 2004 has only reached 2.5% compared with 11% in 2003 and 9.1% in the year before. Growth in 2008 i reached 1%. Russia is the world’s lead producer of natural gas, however, production has declined by 0.8% in 2007, after constant growth since 2002. Therefore, in order to sustain long term growth, Russia will need to decrease its reliance on the energy sector and strengthen its currently neglected financial sector.


Russia’s financial sector, while containing strong macroeconomic fundamentals, has suffered from lack of competitiveness and diversification.  Small and medium enterprises have experienced anemic growth, restricting further broad based economic growth. Low production capacity and lack of modernization have lead to an overheated economy and resulted in a significantly lowered consumption rate.  At the same time decaying infrastructure poses constraints in overall growth, and labor intensive sectors are struggling with higher borrowing costs and uncertain demand during the credit crunch. As a result,  economic growth has been uneven and unsustainable, while also decreasing Russia’s competitiveness levels on the global market.


Production capacity and competitiveness would be increased with infrastructure, specifically in areas of transportation.  Higher technology and modernization would raise the efficiency and quality of products and boost levels of foreign and domestic investment.  Increased productivity is crucial and will be key to avoiding domestic shortages as a weaker national currency will push up import prices.


SME growth will largely depend on investments, infrastructure, technology, and a banking reform. The country’s banking system is now largely fragmented and would benefit from organized consolidations. Banks must also adjust to tighter liquidity conditions and avoid poor lending decisions.

A stronger and more transparent system of financial intermediation would allow for more efficient operations.


Russia’s successful long term economic growth also depends on the building of human capital, as it is the base for growth in any economy.  So far, the government’s response has been hopeful as Russia’s president, Dmitry Medvedev, has vowed to spend around $10 billion on housing, education and health care in 2009, despite the foreseen budget deficit.


In order to overcome the economic crisis, Russia needs to not only push for a single and sharp currency devaluation action, but also review its economic model by focusing on the expansion of the private sector.  A stronger, dynamic and product led growth,  will further allow Russia to raise its level of global integration. Global integration will be crucial for growth as Russia diversifies its economy and increases production outside of the energy sector. However, government transparency and lowered corruption will be essential for increased effectiveness of the banking sector,  liquidity injections and the establishment of an attractive investment environment. Finally, addressing resource dependency and effectively promoting diversified economic growth, will be the only way to ensure Russia’s long-term economic sustainability.


Source: www.AsiaEcon.org

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Source: www.asiaecon.org |

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