….falling off. At least that’s the case with Russia’s long-term economic outlook. I’ve been banging on about how Russia is nothing more than a banana republic. A one trick pony that has substituted oil for banana’s. It seems that the conditions are slowly ripening to bring about the perfect economic storm in Russia. Could it be this that eventually topples Putin’s stranglehold on power?
Russia’s best and brightest have either long since left, or are working on ways to leave, because they do not feel comfortable building a business in an environment where he who pays most to the judiciary or tax inspectors wins, where bribery is the accepted norm, even if it is for something so important like getting your child accepted into the best university! And none of this encourages either any long-term inflows of western capital or internally developed innovation in areas other than the mainstay of oil and gas.
There is one simple thing that is scares the shit out of Putin, which is how does he deliver on his promise of continued economic growth and stability, thus ensuring the avoidance of a dissenting middle-class. The only reason his approval ratings are so high is because people have grown accustomed to having money in their pockets and being able to afford the nice things in life.
During the turbulent Yeltsin years, it was the norm for workers to go months without being paid. In fact this worked to the Oligarch’s advantage because families who had received “shares” in the previously state-owned companies they worked for ended up selling their shares to the management for pennies because having the cash to buy food was more useful than owning “worthless pieces of paper” (share certificates).
Fast forward two decades later and look at the new Russia, which has been built on two things….rising oil prices and credit (well actually one thing, because the credit is also a derivative of the oil price).
The Kremlin has traditionally based their budget on a lower than expected yield on the price of a barrel of oil. When oil in 2003-04 was reaching the dizzying heights of $40 a barrel, the economists at the Kremlin laid out their spending plans on an estimated $16 a barrel – which was the average price for the 5 years previous. This meant that they had a win-fall of $24 which they could either squirrel away for a rainy day, or use to develop and enhance the living standards of the average Russian.
Now those of you who’ve been fortunate to have visited either Moscow or St. Petersburg, and were astute enough to notice the number of fancy cars driving the clogged arteries of these two cities or the number of women touting the latest in designer fashion might think “Oh, clearly they spent the money on the average Russian”. But that’s not the case. The average Russian doctor earns just $650 a month ($1270 a month in based in Moscow), whilst the average teacher earns just $350 a month! And the police and other state officials are typically no better off. Which is the core reason low incomes are then bolstered by way of bribes and back-handers. If you want your child to go to a good college, a thousand dollars will go a long way to ensure they get the requisite mark. You want 1st class medical treatment? Well, you COULD pay a bribe to the doctors and nurses tending to your loved one, to ensure they get the proper treatment. But if you’re REALLY wealthy, then you’re better off taking them abroad to the likes of Germany, Austria or Switzerland to get the necessary treatment.
What’s my point in all of this, I hear you ask. Well, it’s a prediction of sorts. I am predicting that within the next 3-5 years, Russia will find itself on the back of the curve, so to speak. There is a growing middle class, limited for the most part for now in Moscow and St. Pete, but it’s slowly starting to grow in the other regional capitals like Yekaterinburg, Samara, Perm, Nizhny Novgorod, Kazan & Omsk to name but a few. And as the size of the middle class begins to swell, they will become even more demanding. But that’s what has Putin and his merry band of kleptocrats worried. Because the economy has begun to stall (latest growth numbers show only a 1.6% increase in the economy) and at 6.5%, the rate of inflation is not easing either.
This means two things, price rises and job cuts. The affluent Russian will start to feel the pain. Gone are their holidays abroad (made all the more difficult with a currency that has fallen off a cliff). Those flashy cars, bought with credit (30% interest rates!) still need to be paid for, or worse, it’s repossessed and you’re forced back onto the already overcrowded metro (a fall in status). And their glorious leader Putin, the man who was responsible for all the great things they’ve enjoyed so far, has no idea what to do to get the economy going, other than pumping more oil. But that’s not going to help them either.
With the US powering ahead with shale gas exploitation and exporting that shale gas across the Atlantic for processing, Europe has already started to turn off the tap from Russia. In addition, the new pipelines which bi-pass Russia completely and now pipe gas under the Caspian straight into Europe is also helping reduce the dependency on Russia and has Gazprom scratching its head on how to avoid being left out in the cold. The Chinese, already learning from Europe’s mistake, now deals with the Kazakhs direct for her gas needs.
Found in the same boat, other countries would have long ago looked at alternative industries to develop and nurture, such as high-tech, finance, agriculture, in which to spur on economic growth. But the Russian’s have had a brain drain for the past two decades. And their business environment is so corrupt and bereft of transparency, justice and trust that very few Russian’s are willing to repatriate themselves and base their business or brainchild in or near Russia.
Recent spats with Moldova and Ukraine over perceived heath risks over food and agri-products have resulted in food and drink never making it past the border. Funnily, the Moldovan’s don’t care. In what was once their biggest market, Russia has become second fiddle. Their wine industry used to sell 4 out of every 5 bottles to Russia. They now sell 4 out of 5 to the EU and have geared their health and safety requirements to mirror those of the EU. Why something that is safe enough to be sold on the shelves of a German supermarket is now considered so unsafe by the Russian’s is mindboggling. But it’s not really. Because by trying to put the squeeze on Moldova, banning imports, and forcing them to join Putin’s Customs Union, in the same way they’re doing with Ukraine, Russia is trying to protect her market and her economy, and in the end stave off any potential economic disaster and the ensuing civil unrest that would accompany it.
But it’s doomed to fail. One of the key components the Kremlin are using to measure the success of their plans is by tracking the number of new mortgages issued in a given year. In a country whose property market is already over inflated, and whose mortgage interest rates are akin to those of Gaullist era France, in the high teens, they do very little to persuade local discretionary expenditure. In fact, looking at Russia’s balance of trade, with the EU for example, if you exclude the oil and gas influence, there is more money leaving the country than coming in. Russian’s are travelling more, spending copious sums of cash abroad, and buying anything that has a “Made in EU” sticker on it because it’s believed to be much better than it’s Russian or Chinese equivalent.
And this discretionary spending, which normally fuels internal economic growth, will actually stifle it. Why? Well firstly the not-so-cheap credit is funded by Russian banks lending to Russian consumers. This money is funded by the excess revenues the government gets from the higher price of oil. With oil plateauing, and spending on the rise, the government will soon run out of ways to finance the banks as that budget win-fall will erode over time. And it is this credit boom which is in turn funding the hyper consumerism that is rampant across Russia today.
With sources of consumer credit drying up, and the government already looking at ways to shore up its coffers by introducing new taxes on property and wealth, you can very quickly see the average Russian suddenly feeling the squeeze. They’ll be in a precarious position worrying about jobs uncertainty, high personal debt, inflation in the 9%-10% range and a closet full of expensive, out-of-date designer fashion and no cash to splash to replace any of it. Reminds me of Ireland, circa the Celtic Tiger era.
It’s an economic certainty that unless you diversify and truly manage your economy’s money, sharing out the benefits and the pain fairly, then you will always find your economy being driven into an abyss. Russian’s have been riding the wave of heightened consumerism for a while, but that wave is set to crash on the shores of economic disaster unless the country finds a way of enticing outside investment and keeping it there.
The recent fall in the rouble has only served to demonstrate that in a crisis, no matter big, small, political or economic, the flight of capital in an emerging market is very real. And this capital flight further unsettles the economic stability, potentially setting in motion a chain of events that could ultimately bring on the collapse of an entire country. It happened before under Yeltsin. It could easily happen again.