Vladimir Putin's Russia has spent the past year re-asserting its standing as a global political force. From its UN veto on sanctions in Syria, to the two-week extravaganza of the Sochi Olympics, to its regional aspirations in Crimea and eastern Ukraine, Russia appears to be trying to regain some of its past status. The only problem is that the Russian economy is slowly slipping into mediocrity and will be hard-pressed to support such adventurism.
The first decade of the 2000s was good to the Russian economy. Strong global growth, higher energy prices and ready access to the European Union (EU) energy market allowed Russian growth to soar, reaching 8 per cent in 2006. Russia was included as a member of the "BRICS" (Brazil, Russia, India, China and South Africa). But times have changed, and the decade of dynamic economic growth has come to an end. Mediocre economic performance is setting in and there is little reason to believe the slow-growth path will change course any time soon.
According to the International Monetary Fund (IMF), the Russian growth slowdown began in 2011, as a result of the financial crisis in Western Europe and internal structural problems such as growing state intervention, cronyism and insufficient competition. Gross domestic product (GDP) growth was only 1.3 per cent in 2013. Investment contracted, while consumption remained robust owing to factors that are not sustainable, notably strong real wage growth and booming consumer credit. The central government drifted into deficit and inflation crept upward, but the central bank did little to adjust monetary policy to these changed circumstances.
The rate of economic decline has picked up in 2014, spurred on by Russia's political adventurism in Crimea and eastern Ukraine. The Russian economy has now essentially come to a standstill. The IMF projects negligible real GDP growth in 2014, with what it calls "considerable downside risks." Interest rates rose about two percentage points this spring, the stock market fell and the ruble has declined in value by about 10 per cent. Concerns about economic sanctions by the U.S., EU and Canada have had a chilling effect on private investment, and capital outflows could reach $100-billion (U.S.) this year.
The IMF's outlook for 2015 is not much better, with growth of only 1 per cent currently projected – and there is considerable downside risk to that projection. Further economic sanctions, faster capital flight and internal political turbulence could dampen any recovery and leave Russia in limbo economically.
While the short-term outlook for the Russian economy is not great, arguably the more important issue is what lies ahead. Population growth is a critical driver of any jurisdiction's long-term growth potential – and Russia's population is shrinking. The active labour force reached its peak in 2011, and is projected to decline by two million workers over the next five years. As a consequence, Russia's future sustainable growth is expected to fade to 2 per cent or less – and even that mediocre growth rate will depend critically on a pickup in private investment, on innovation-driven productivity growth, and on deeper Russian integration into the global economy.
What does all of this mean for Russia's geopolitical aspirations? The harder economic reality does not seem to have been factored into the government's political calculus, just as it was not factored into the imploding Soviet political and economic model a generation ago. The recent long-term natural gas deal with China might help Russia to diversify its energy supply into other markets, but the deal depends on adequate infrastructure to deliver the product, and on the natural gas price paid to Russia (where China had all the leverage in the negotiations).
In short, Russia today is in a no-growth world with capital fleeing the country. A recovery in growth is hardly assured, since Russia has drifted away from the underlying conditions that would foster private initiative and global integration. The most likely scenario is for negligible growth in 2014, very weak growth in 2015, and continued mediocre growth (well below 2 per cent) in the years to come, with pressure on fiscal balances and monetary intervention required to shore up investor confidence.
Sustained geopolitical adventurism that might trigger additional economic sanctions would only further impair the Russian economy's ability to innovate, integrate and grow. This does not sound like a recipe for success – economic realities cannot be fooled.
Glen Hodgson is senior vice-president and chief economist at the Conference Board of Canada.
Glen Hodgson