Will the Russian Economy Collapse or Muddle Through?

Over the past year, a number of factors have contributed to an end to economic growth in Russia and to predictions that the Russian economy is on the verge of a collapse.  First, Russia’s participation in the war in Ukraine and its annexation of Crimea led to economic sanctions being placed on Russia and the blocking of Russia’s access to global capital markets.  Later, the collapse of oil prices, together with the sharp fall in the price of many other natural resources, caused major problems for the key sectors of Russia’s resource-dependent economy.  While these factors have undoubtedly caused severe damage to the Russian economy, it is possible that predictions of an economic collapse have been overdone.

In the first three months of 2015, the Russian economy shrank by 1.9% on a year-on-year basis.  While this is undoubtedly a very poor performance for a large emerging market, it is, in fact, a much better performance than had been expected.  Some economists had expected that the Russian economy would shrink by 3.0% or more in the first quarter.  Even with a sharp decline in consumer spending and investment activity in the first quarter, the Russian economy avoided a free fall.  This was due in no small part to higher levels of government spending, particularly defense spending, which has continued to rise sharply in recent years.  Moreover, foreign investment levels in Russia appear not to have fallen as far as had initially been feared. 

While the level of confidence in the Russian economy is starting to slowly improve, there continue to be a number of factors that suggest that the worst is yet to come for Russia.  First, international sanctions remain firmly in place against Russia and the threat of more unrest in Ukraine means that these sanctions will remain in place for the foreseeable future.  Second, despite a recent increase in oil prices, they remain well below the levels of previous years and are far too low to improve Russia’s worsening government financial position.  Finally, Russia’s demographic situation continues to deteriorate, with Russia having one of the world’s fastest-declining working-age populations and this is continuing to erode Russia’s domestic market, leaving the country more reliant than ever on natural resource exports for growth.

Despite these major obstacles, it does appear that the full-blown collapse of the Russian economy is unlikely in the near future.  Certainly, the Russian economy appears set to avoid the scale of a recession as it experienced in 2009, when the Russian economy contracted by 7.8%.  Nevertheless, the Russian economy is likely to shrink by as much as 3.0% this year and, if sanctions remain in place and natural resource prices remain depressed, this recession is likely to linger into 2016.  While the depth of this looming recession is unlikely to be as severe as those in previous years, a prolonged downturn could have major ramifications for the political situation in Russia, as a good deal of President Vladimir Putin’s support was built on the back of the strong performance of the Russian economy between 2000 and 2008, when it expanded by an average of nearly 7.0% per year.  Since, 2009, the Russian economy has expanded by just 1.1% per year, so there is little room for a prolonged recession that could significantly dampen the mood of Russian voters in the coming years.