Report EAK - Russian financial crisis and the economy of the West

Putin seeks and hopes for the disintegration of the West (especially the disintegration of the EU and the distancing of the US from Europe). Weaknesses of the European Union are visible and are reflected in the difficulties in constructing a common and uniform policy. Putin strives to ensure bilateral relations with individual countries which allows him to spin the differences of interest between them to his benefit. The Kremlin's policy is not without its effectiveness, although the Kremlin must have been surprised by the establishment of sanctions after the annexation of the Crimea.


The West can count on the exhaustion of Russian economic resources and consequently a failure of Moscow's current policy (as happened at the end of the Cold War). The Russian economy is 16-18 times smaller than the economies of the West and this seems to give the West a huge – but not decisive – advantage.

An important question for the assessment of the situation is: what are the financial resources of Moscow and how long is it able to pursue its aggressive policy, posing a serious threat to the West?

1. An assessment of the economy and finances of the Russian Federation should be an important component of the assessment of the political situation linked to the Kremlin's aggressive policy towards Ukraine, Syria and indirectly to the Arctic region, as it is seriously directed against the whole West.

2. The substantial burden on the economy is due to rapidly falling oil prices and sanctions towards the Russian Federation, which partly exclude it from the international financial circuit.

3. In 2015, the Russian economy experienced symptoms of crisis, which manifested itself in the reduction of GDP, relatively high inflation and a reduction in consumption. Part of the comments referred only to temporary difficulties, as well as to symptoms of the economy, which has had to adapt to the new environment (lower oil prices and sanctions).

4. The policy pursued by the Kremlin entails significant costs and a serious strain on the budget while the economy of the RF is eight times smaller than the EU economy, as well as eight times smaller than the US economy. This represents an aspect ratio of about 1:16 in favour of the West.

5. The important question is: how far is the Russian economy able to finance the current aggressive policy, and what are the forecasts for the next five to ten years? According to a fairly widespread stereotype, the Russian economy has an almost "unlimited" resources (eg. gold) and is able to finance its external conflicts. On the other hand, in many media reports the Russian economic situation is described as nearing a crisis and exacerbating (as stated in reports from the Russian media also), while it is clear that such reports are generally based on limited information. According to cautious forecasts of JPMorgan, the RF economy will stabilize in 2016 after the difficulties it experienced in 2015. The economy will be able to bear the burden, but at the expense of serious limitations in social policy.

6. The previous forecasts by global financial institutions on the RF economy came to a similar conclusion as the JPMorgan's prognosis. The analysis of the Russian economic forecasts for the recent period suggest, however, that they have been steadily turning more and more pessimistic (as e.g. in early 2015 they expected a growth rate of around 0%, while at the end of the year the expectation reached a value of - 4%).

7. This analysis is to present the basic macroeconomic data that may facilitate the understanding and interpretation of reports concerning the state of the RF economy which to some extent are contradictory. The intention of this analysis is not to present any explicit forecasts, although it highlights the risks for the RF economy and finances related to the costs of an aggressive policy.

Putin seeks and hopes for the disintegration of the West (especially the disintegration of the EU and the distancing of the US from Europe). Weaknesses of the European Union are visible and are reflected in the difficulties in constructing a common and uniform policy. Putin strives to ensure bilateral relations with individual countries which allows him to spin the differences of interest between them to his benefit. The Kremlin's policy is not without its effectiveness, although the Kremlin must have been surprised by the establishment of sanctions after the annexation of the Crimea.

The West can count on the exhaustion of Russian economic resources and consequently a failure of Moscow's current policy (as happened at the end of the Cold War). The Russian economy is 16-18 times smaller than the economies of the West and this seems to give the West a huge – but not decisive – advantage.

An important question for the assessment of the situation is: what are the financial resources of Moscow and how long is it able to pursue its aggressive policy, posing a serious threat to the West?

The budget and the budget deficit

Russia's budget revenue in 2016 is projected at 13,738 billion rubles, and expenditures at 16,980 billion rubles and, as we conclude, the deficit is expected at 2,36 billion rubles, which constitutes about 3% of GDP. The budget adopted for 2016 assumes the price of oil at $ 50 and the average ruble exchange rate at the level of 63.3 ruble to the dollar1. If rubles convert into dollars according to the assumed exchange rate, Russia's budget for 2016 will reach $ 207 billion, (obviously, the ruble/dollar course affects the assessment of the amount of the budget), and the deficit $ 37 billion 2. 90% of the deficit in 2016 is to be covered by the so-called Reserve Fund. This is money collected in previous years as taxes from the windfall profits in the oil trade. In 2016 the resources of the fund will be largely exhausted and cannot be relied upon to cover budget deficit in the next year. The head of the central bank Elvira Nabiullina spoke about it openly in the Duma.

The budget deficit can also be financed under normal circumstances, by running up a public debt through cummulative debt issuance. Russia's public debt, which is definitely low in comparison with EU countries, has a value of only 15% of GDP. This fact was considered a strong part of the Russian economy. Under normal circumstances (e.g. the borrower's confidence in the state), the national debt could easily be expanded to finance the deficit even for a few more years and up to 30% or 50% of GDP. In Western economies, public debt is generally much higher. However, Russia's isolation from the international financial markets (due to sanctions) substantially reduces the possibility of funding the budget deficit. Hence, it is necessary to finance it with its own reserves, which includes the reserve fund mentioned earlier. In many earlier comments, evidence was mentioned that the Kremlin does not need to worry about sanctions and can easily cope with their consequences. Today, it has become apparent that such a diagnosis had been short-sighted and in any case did not take into account a number of other important factors such as the possibility of a decline in oil prices, or the sanctions and a strong devaluation of the ruble.

Paradoxically (for non-economists) a reduction of the ruble (from about 30 to 60 rubles for the dollar) facilitates the financing of the state budget. The dollar acquired in foreign trade is in fact much more valuable on the internal market. The surplus in foreign trade, although much lower than before, still allows to strenghten the budget with the "expensive" dollar exchanged into rubles. It should be noted though, that such "aiding" of the budget must be accompanied by strong inflation, which in the short run has already brought adverse effects. As early as in 2015, inflation reached about 20%.

Where do such significant financial difficulties of the Kremlin come from? One reason has already been stated: the sanctions which cut Russia off from the international financial system. The second, sometimes referred to as the key problem, is low oil and gas prices. Additionally, growing military spending plays a part. And it is difficult to tell whether the latter was fully planned and budgeted.

Reduced revenues from oil exports and troubles in the energy sector

It should be noted that the price of oil estimated in the budget at an average annual level of $ 50 may be overstated. According to some forecasts, the price of oil in 2016 will average around 45 or even $ 40, which would decrease the planned revenues by $15-30 billion. The forecasts are in fact related to the decline in oil prices that has been taking place since 2013 and its gravity has had a huge impact on Russian foreign trade.

Russian export in 2013 amounted to $ 507 billion, and imports to $ 325 billion, which meant a $ 182 billion surplus (at an oil price of around $ 110 per barrel). 65% of export revenue came from oil and gas exports. The fall in oil prices to around $ 50 per barrel represents a decline of income from oil and gas exports from ca. $ 380 billion to ca. 170 billion $, and the decline of total exports to about $ 300 billion (3). This does not mean that in 2015 Russia will have a deficit in foreign trade, and the decline prevents significant reduction in imports, the result of which seriously reduced the whole trade turnover of the Russian Federation. Put together, the prediction is that Russia's trade turnover will fall by ca. 34%.

The Kremlin reacted to the decline in export earnings by a significant depreciation of the ruble (a decrease of approximately 30 to 63 rubles to the dollar), which primarily greatly restricted imports, making for foreign goods more expensive for Russian importers. It is worth noting that the cuts in imports are presented as "counter sanctions" and they punish countries with sanctions against the Kremlin (e.g. for Polish apples, which is obviously a ridiculously low sum of the total bill). In fact, they are, as one commentator called, "auto sanctions", hitting mainly the Russian consumer by narrowing internal consumption.

This import restriction by devaluing the ruble has proven to be so effective that Moscow succeeds in this way to keep a surplus in foreign trade of $ 60 billion.

The expenditure on the army and regions in crisis

Another source of financial tensions Russian economy are military spending.

Spending on the army, according to the official data, the equivalent of $ 84 billion (although it is not clear according to which ruble exchange rate). According to another measure, it represents 9% of the state budget. According to some data, however, expenses are rising so fast that in the first two quarters of 2015 much more than 50% of the planned amounts were spent, and in the second half of the year, to this extra expenditure came Russia's intervention in Syria. For understandable reasons, this expenditure is very difficult to estimate.

Russia's Crimea annexation cost $ 7 billion in 2014 and it should not be assumed that these costs have fallen in 2015 or will fall in subsequent years.

The Kremlin bears the costs of supporting the Lukashenko regime, as well as Transnistria. Transnitria owes the Kremlin 4 billion for unpaid gas supplies.

Also, Armenia, Tajikistan (Russia covers 2/3 of the budget of that state) and Kyrgyzstan are countries that consume Russian money, if Russia wants to maintain its influence in them.

The costs of the war in Donbas (an estimated 4-5 billion) are not revealed 4.

The intervention in Syria is estimated to cost at least $ 4 billion annually 5.

Eminent Russia expert Walter Laqueur assesses the costs of expansive or aggressive Kremlin policy at $ 25-35 billion per year, which in his view represents about 6% of the budget (Laqueur accepts a dollar rate at which the Russian budget is equivalent to about 400 mlrd $).

Some experts, however, argue that the costs of war are even higher, and taking into account indirect costs, amount to about $ 100 billion 6.

The Kremlin maintains that all of these costs are included in the budget and the money is derived from the planned budget. But this is not so completely obvious, seeing as the policy has priority before the economy, which is valid for the Kremlin 7.

Financial resources and national income

International resources of Russia (currency plus gold) are the equivalent of $ 380 billion. In theory, they would allow to cover the budget deficit for many years (hoping that it will be fixed at an equivalent of $ 40 billion). The problem is that to the budget deficit added are large debts of major Russian companies such as Gazprom, and a number of smaller companies. These debts require dollars to service. The external debt is around $ 521 billion 8, and its servicing in 2015 is estimated at about $ 120 billion 9. It can be assumed that the following years, these debtss can achieve a similar order of magnitude, but without a careful analysis of the debt structure it is difficult for an accurate assessment 10.

Under normal circumstances, this would not be a problem, as in the case of the budget deficit, because debts are restructured (taking out new loans to repay old debts, when economic growth is not a problem). However, being cut off from financial markets this strategy creates growing difficulties 11.

Such a debt would not pose a problem if Russia had an assured inflow of foreign investments. These are foreign currencies changed within the domestic market for the ruble. Yet investments have not only dried up in Russia, but there is a tendency where they are reversed (which is associated with the outflow of currency), although in particular months, fluctuations of a plus and a minus are observed. The Kremlin attempts to present any change on the plus (although it sometimes is small) as a reversal of the negative (a propaganda of selective fortune-telling) trends, but sometimes this opinion is shared by Western commentators 12.

On the question of whether financial reserves are sufficient to protect the Russians against an escalation of the financial and economic crisis it is extremely difficult to clearly answer. The Duma budget plan for 2016 may suggest that the state of the Russian economy has stabilized to such an extent that it threatens to collapse. Note, however, that the established average oil price of $ 50 seems at the moment too optimistic, and it could go down to $ 40 (which of course should not be a full-year forecast). This could mean a further decline in export revenues, the need to devaluate the ruble and a possible revaluation of the budget, with the difficulty of budgeting for 2017 (it is worth noting that Moscow has resigned from the previous three-year budget planning, in a sense admitting hereby that the current situation is somehow exceptional).

It is worth recalling that the World Bank called on Russia to reduce budgetary spending due to limited reserves. This depletion of reserves means lack of liquidity in what is essentially a bankruptcy. That actually happened to Russia in 2000, but then it was not as dramatic as today, and the West was ready to help. The upward swing was also aided by rising oil prices.

How bad a mistake has Putin made in his economic reckoning?

In the West, and especially in Germany, the hope that windfall profits from oil sales would be used to fund the Kremlin policy of modernizing the Russian economy. Could this be used to create a reserve fund, in an imitation of a similar procedure in Norway, whose economy also drew windfall profits from oil exports? In the case of the Russias, we can mention the "curse of the raw material economy of raw materials" – when prices are high and there are high profits, the need for reform is not felt, but when prices are low there is no money for reform. Finally, the policy of modernization associated with opening up to foreign investors has collapsed in the wake of the sanctions.

At the beginning of this decade there was speculation about the strong economic growth of Russia, even to the point of it becoming the largest economy in Europe, rivalling not only France but also Germany. These speculations were not entirely fabricated. When oil prices rise, a growing Russian economy results. Until a few years ago there were scenarios of the slow depletion of oil reserves (the so-called peak oil) and consequent increase in prices to a sky-high $ 250/barrel. Could the global economy bear such prices, or seek refuge in alternative energy sources? Today, such speculation can only be a lesson in how careful you have to be in the forecasts.

It is clear, however, that with these black scenarios of the depletion of world energy reserves, Putin's Russia would be an almost insurmountable powerhouse today, at least until the emergence of technologies related to renewable energy. Their development, however, has been slower than expected, and Russia would have had huge financial resources and the enormous possibilities of political blackmail. Putin would be able to finance Russia's expansion plans, and its western opponents would be much weaker.

The more astute analysts saw as the true weakness of the Russian economy the lack of deeper reforms and the oligarchy no doubt, but high oil prices would allow the Kremlin to hide these weaknesses.

However, the shale revolution has constituted a fundamental upheaval on the oil and gas market, and its effects have been further enhanced by the new technology of LNG liquefied gas carriers. The Russian economy faces this competition on its essential and in fact its only major asset.

Yet in 2013 the Kremlin believed that it could address the West from a position of strength, and combining energy blackmail with possible elements of hybrid war (psychological and propaganda war using the Internet has also been planned for a long time) to reach submission of the West and strategic success. Russia with a large reserve fund and foreign currency reserves seemed an empire, which in would be difficult to stop, and certainly even more difficult to bring to its knees. When oil prices fell substantially the situation was reversed.

20% of the proceeds of Russian GDP comes from oil and gas exports. This means (with a very broad estimate) that the decline in oil prices of 1% means an national income reduced by $ 3 billion (annually). So a drop by more than 70% in oil prices (which occurred) means an average annual loss of $ 210 billion. To this, political tensions must be addded as a result of losses due to lost investments.

All of this is reflected in macroeconomic data. Russian nominal GDP (i.e., calculated in rubles and converted to dollars at an appropriate average exchange rate) in 2013 amounted to 2,096,000; in 2014 slightly reduced to 1,860.000. But by 2015, according to preliminary assessments, ir fell to $ 1,175 billion. The latter makes the Russian economy only two times the size of the Polish economy and moves it from tits former high (seventh) to 15th place in the world economic ranking.

The possible effects of financial difficulties in social policy

Serious financial difficulties of the Kremlin must also affect the standard of living of the population. The years 2001-2012 can be determined as a great success of Putin. The standard of living in Russia almost doubled, financed by a high income of trading oil and gas. A pension security fund was created (with the equivalent of about $ 120 billion). Two groups of the population ensured particularly high income growth (officials, constituting approximately 15 million people, and about 40 million pensioners). A new middle class grew accustomed to a relatively high standard of living, and conditions that neither the USSR 1990s could have hoped to offer. This resulted, among others, in mass tourism to countries such as Turkey, Italy, Egypt and so on.

These achievements are being scaled back. In their place have come serious problems in many households associated with high inflation. Another effect is the massive collapse of small and medium-sized enterprises. Difficulties may also hit the entire pension system, which would be a return to the nightmare of the end of the 90s, when pensions were not regularly paid.

The financial crisis may also create serious problems in relations with the Kremlin macro-regions that feel now financially drained.

An often repeated stereotype says that "the Russians can withstand anything," and are able to carry the burden of sacrifices. This stereotype has Stalinist roots from the time the so-called Patriotic War – the heroic Russian incurring casualties for the victory of fascism. Already, Putin refers in some way to this stereotype of creating an atmosphere of external threats. But whether today's Russian society is ready for such serious sacrifices is not at all obvious.

In this context also look at other substantial economic indicators, which is the PPP GDP (national income measured in purchasing power). As we know, purely arithmetically, PPP GDP and nominal GDP can vary significantly, and so too is the case with the Russian figures ($ 1175 billion and $ 3458 billion respectively). Inflation will rapidly decline the GDP PPP indicator to measure, among others, consumption (the rate is more readable after converting it per capita). Russia in the years after 2000 caught up with Poland in income per capita (at incomparably higher social stratification – a Gini index of 41.6 and 32.4 respectively), and the current situation must lead to a significant decline, leaving Russia far behind Poland.

There are many indications that the central Russian institutions such as the Central Bank and Ministry of Finance are aware of this fact. To prevent most black scenarios, they mention such moves as shifting the retirement age and so on.

What can be the economic response of the West to the approaching Russian crisis?

Rating macro-economic processes can have only a very approximate nature. The more is made of the details and specifics (e.g. balances for each major Russian companies including Gazprom, Rosneft), the number of unknowns increases. There are also quite unpredictable phenomena (e.g. the appearance of a technology enabling the exploitation of oil shales). Therefore, the general predictions are exposed to a high degree of uncertainty, and must be treated ina with caution.

It should be noted that the projections of the international financial institutions are divergent, while at the same time so far mainly adjusted downward. For example, in early 2015, they estimated zero growth, while the decline at the end of the year is now foreseen to reach minus 4%. It seems that these forecasts are built using linear approximation, while a long-lasting economic crisis, in which Russia has entered, can cause more dramatic declines.

There are also arguments that Russia's financial situation is better than the result from the macro-calculation of public debt because the debt is in large part to Western financial institutions, but owned by the Russian entities 13.

Current forecasts of declining oil prices, even far below the $ 40 and maintaining such a state of affairs until 2020, does not bode well for the Russian economy. If Russia perseveres until 2020 without breaking, and oil prices go up, it is possible to imagine a scenario where it meets the growing challenges it faces now. This may be done at the expense of a very serious reduction in living standards.

While the prognoses of growing and very serious financial and economic difficulties for the Kremlin in the next four or five years seems very likely, it's much harder to predict their political impact, and, since Russia is a vast country, the impact on the entire global policy. During the Russian crisis of 2000, Russia was granted substantial assistance, starting from the assumption that the deepening of the crisis may have negative consequences for international politics. The question is whether such assistance should be extended this time, should certainly be posed.

But the fact is that the support needed for Russia would be incomparably greater than in 2000. And it would need to seriously burden the Western banking sector.

Behind a condition for such support, Russia should consider resigning its currently pursued aggressive policy. It is hard to imagine massive loans to support a country, which is at war with potential lenders even if it is only hybrid war.

Another option is to wait for the deepening of the crisis and the pursuit of a fundamental turning point, regardless of how much of this may be related to uncertainties and unknowns. Achieving this aim can then be a political objective, achieved through economic policy, instead of military means. Under this assumption, a sanctions policy has its own economic and political reasons.

Not only does the Kremlin's aggressive policy place world politics for serious dilemmas, but also can the possible failure of this aggressive policy open up no less difficult questions which will drive the policy toward Russia if it falls into a deep economic crisis.

Issues with respect to Russia, and support for the sanctions policy, is an important aspect of European policy. They are also an important point of Polish-German relations, when one takes into account the sometimes revealing differences on this issue in Warsaw and Berlin.




4 a także


6 Walter Lagueur, Putinismuz. Wohin treibt Russland?, 2015 s.179-180.

7 The Kremlin has said the money for the Syria campaign is coming out of the existing defense budget — one of the few departments to escape sweeping cuts this year — but the real source of funding is opaque, said Pyotr Topychkanov, an analyst at the Carnegie Moscow Center, a think tank. It is a paradox, he said: Russia has mimicked U.S.-style publicity for its Syrian offensive, blitzing the press with glossy images and film of missile launches and bomb strikes and posting daily updates on Facebook and Twitter in multiple languages. But on the money issue, officials have been silent.








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