4 key problems for Russia’s economy to overcome

Compared to the crisis of 2008-2009, the figures for GDP and various industries in Russia at year-end 2015 did not show a catastrophic decline.

Compared to the crisis of 2008-2009, the figures for GDP and various industries in Russia at year-end 2015 did not show a catastrophic decline.

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Debate about the need for structural reforms has intensified in Russia. But what should they be directed at? At the Foreigners Life conference in Moscow from Feb. 5-7, leading Russian economists identified four main problems with the Russian economy.

1. The population is becoming impoverished faster than before

Compared to the recent crises in the Russian economy, the population is getting poorer much faster this time. By year-end 2015, the amount of goods purchased by Russians had decreased by 10 percent.

Even during the most serious crisis in modern history of the country – in 1998 – this figure (final consumption of households) fell by only 5 percent, and by 4 percent after the global financial crisis in 2009.

There is also another reason why the population is running out of money. Businesses are deliberately reducing wages in order to increase their own profits. In 2015, nominal wages grew by 4.6 percent, while company profits increased by an average of 49 percent. One of the reasons for this is the lack of effective trade unions to defend the rights of workers in Russia.

2. A free-floating exchange rate leads to inflation

In 2014, Russia moved to a free-floating exchange rate, making the Russian currency value market-determined.

During this time, the ruble has fallen against the U.S. dollar and the euro by 60 percent; in addition, the value of the ruble is affected by fluctuations in oil prices. As a result, the ruble may fall or grow by 20 percent in one month. Possible rate shifts are included in the price of all contracts in the country.

Economists estimate that the instability of the currency provides an annual inflation of 7 percent. For comparison, at the end of 2015, inflation in Russia amounted to 15.5 percent.

In this situation, interest rates on bank loans, including those for the purchase of equipment, cannot be lower than 15-20 percent. It turns out that businesses just cannot afford to buy new equipment and expand production – and this is another big issue.

3. Companies are not buying new equipment

Compared to the crisis of 2008-2009, the figures for GDP and various industries in Russia at year-end 2015 did not show a catastrophic decline.

For example, GDP declined by 3.7 percent compared to 7.9, the volume of construction fell by 7 percent compared to 16 percent, while the figures for railway freight have not changed at all.

According to economists, the bad news is that indicators that determine future economic growth – primarily investments – fell much more. Investment in fixed assets fell by 8 percent, while the import of equipment from abroad has decreased by as much as 38 percent.

As a result, equipment on average sees use of 14 years in Russia compared to seven years in the West, and about 20 percent of machines are way beyond their expected lifetime and may be discarded at any moment.

Even the country's wealthiest customers – oil and gas companies – are reducing their investment programs.

According to estimates by researcher Abel Aganbegyan, at a price of $35 per barrel, oil companies' investments will decrease by 20 percent, while the Gazprom gas monopoly may postpone investments in the Power of Siberia pipeline, designed to carry gas from Russia to China.

4. Hopes for Chinese investment fail to materialize

Yes, in spite of all the bold political proclamations, Chinese investments have yet to arrive on the Russian market.

In fact, some investors from China have even begun to withdraw funds from Russia. On Feb. 4, China's Chengdong Investment Corp. decided to sell its stake in the Moscow stock exchange.

The Chinese may be replaced by investors from India; in its time, the USSR implemented a number of investment projects with India.

But what is most likely is an inflow of funds from Western capital markets. Many European countries have negative interest rates, meaning that money is almost worthless within the country, and investors are being forced to seek projects abroad.

Russian borrowers, including the government, have always been disciplined and have typically paid their debts on time.

It is no coincidence that, on Feb. 7, the Russian Finance Ministry sent proposals for the possible issuance of Eurobonds in 2016 to 25 foreign banks. The last time that Russia borrowed from the international markets was in Sept. 2013, when it sold $6 billion worth of bonds.

This article is based on material prepared by participants of the Foreigner's Life forum: reports by researcher Abel Aganbegyan, Konstantin Korishchenko, the Central Bank's former deputy chairman, and Oleg Zasov, director of the Department of Macroeconomic Forecasting at Vnesheconombank – the country's key development institution.

Read more: At what point are oil prices too low for firms to survive?

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