Rocky Ride for Russia’s Economy Set to Continue

12.03.14

Rocky Ride for Russia’s Economy Set to Continue

12.03.14
RIA NovostiRIA Novosti

By Matthew Morgan for Global Risk Insights

2014 has been a difficult year for Russia. The Russian economy has been pummeled by low oil prices along with EU and US sanctions levied in retaliation for its annexation of Crimea and support for separatists in Eastern Ukraine. The Russian ruble has dropped to an all time low of 48.65 against the US dollar, with the IMF estimating that sustained capital flight following the enactment of sanctions will trim 1% off Russian GDP this year.

As one of the world’s leading importer of food, sanctions have hit the Russian consumer particularly hard, with shortages and price jumps of 60% in some regions of the country occurring. Despite the precarious economic situation, Russia is likely to maintain or even ratchet up its hostility to Western corporate and political actors.

By employing a highly nationalist rhetoric Putin has successfully positioned himself as a man who is returning Russia to greatness following the chaos of the 1990s. With his approval ratings surging to 86% it is clear that the Russian population is largely willing to ignore the possibility of sustained economic hardship in favor of a more assertive international role.

Putin’s position has been solidified by the lack of any coherent elite opposition. Oligarchs who have attempted to oppose Putin have been imprisoned or forced into exile. Those who remain adhere to the Kremlin’s line and avoid taking contrary political stances. Indeed, increasing Russian isolation has drawn many oligarchs into a closer relationship with the Russian state.

This subservient relationship has been replicated in Russia’s financial sector. While the sanctions regime has had a significant negative impact on Russian finances, the political ramifications have been negligible. In contrast to the US where Wall Street’s concerns exert a great influence upon politicians, Russia’s financial sector is woefully undeveloped: The valuation of Apple is higher than the entire Russian stock market.

Beyond the turmoil in the Russian economy and the highly fluid geopolitical situation in Eastern Europe, with political leaders warning about a return to the tense atmosphere of the Cold War, the spillover effects upon global markets are likely to be muted. Many Western banks have reduced their holdings in Russia, while Russian policymakers have sought to further insulate their economy from the world market by providing financing to domestic companies and increasing gold reserves.

Despite Russia’s fraught relationship with many of Europe’s leaders and its growing international isolation, Russian gas will continue to flow unimpeded to European markets. Ironically, the sanctions regime and falling oil prices has increased the importance of Russia’s gas contracts with European countries. Russia, more than ever, needs the revenue that its gas shipments provide, while European dependence upon Russian gas remains as great as ever.

Russia is Europe’s largest sole supplier, providing a quarter of continental demand. Thus sanctions on other areas of the Russian economy will not be extended to cover those involved in the Russian gas industry.

An era of steadily worsening relations between Russia and the West looks likely for the foreseeable future. At the moment, both sides are digging in for an extended confrontation. Barring any major developments, such as Ukraine joining NATO, a dynamic of managed hostility that does not threaten the economic fundamentals of the world economy may continue to define the relationship between Russia and the West.

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