Russian Economic Development: Before and After the Crisis of 2008

Summary of the presentation given on December 22, 2008, by Boris V. Kuznetsov　　

The Russian economy has been demonstrating rather high, if not spectacular, economic growth for the past 8 years. This growth is commonly attributed exclusively to high oil prices and high export revenues. So, the crisis of 2008 in Russia is often looked on just as a consequence of falling oil prices. While to a great extent this may be true, such an approach cannot fully explain the scale or the speed of impact the world crisis of 2008 had on the Russian economy. To better understand the internal mechanisms of the crisis processes, it is important to look more closely at the model of growth that evolved in Russia in 2001-2007 and on fundamental problems of the Russian economy and of the Russian manufacturing industry, in particular.

While export revenues grew very quick due to increasing oil prices as well as the prices for other raw materials and primary goods (metals, in particular), they were not translated into high investments until 2006, but mostly resulted in the growth of private consumption. Part of the consumption demand was for services and non-tradable goods and had a stimulating effect on the economic growth in those sectors, but growing demand for other goods had limited influence on the economy. Russian manufacturing was unable to satisfy the growing domestic demand, both because of the relatively high costs of production and the inability to provide quality goods at competitive prices . Capital inflow largely consisted of portfolio financial investments coupled with export revenues which put additional pressure on the exchange rate and led to high growth rates of prices, in particular on the stock market and in the real estate market. FDI into Russia mostly were concentrated not in manufacturing but in the extraction industries and had a modest impact on production and efficiency growth. So, extremely high rates of import growth (in 2007 import growth rates were 9 times higher than export growth rates) became an important feature of the Russian growth model.

Russian economic and monetary authorities had a difficult task of trying to prevent a sharp appreciation in the currency which threatened to make most of the manufacturing industry/sector uncompetitive on one hand and fighting high inflation on the other hand. This contradictory and inconsistent policy resulted in high foreign reserves of the Central Bank and in high interest rates on the domestic financial markets. The high cost of finance to some extent was facilitated by a large accumulation of oil revenues in the state reserve funds (more than $150 billion USD at the end of 2008). Due to financial resources being too expensive inside the country, large Russian corporations and banks sought short-term loans from the world financial markets that were at that time providing extremely cheap loans because of excessive liquidity. Thus, the Russian growth model in 2002-2008 was based on the state accumulating foreign reserves and simultaneously huge growth of corporate debts which increased to about $500 billon USD.

Thus, the crash of world financial markets in 2008 immediately put both the banking sector and the corporate sector in a very dangerous position, making interference from the government and Central Bank necessary to stabilize the situation. It has very little to do with decreases in oil prices, though the problems were highlighted by the drop in export revenues and a subsequent drop in the international ratings of Russian corporations and national economy in general, which made getting loans on the world markets very expensive and near impossible to get.

Although those consequences of the crisis are more or less successfully dealt with by the use of state reserve funds to substitute short-term foreign loans, much more serious and strategic decisions are needed to fight serious economic problems, caused by the falling prices of Russian exports. The most important and complicated task for the Russian government is to try to change the existing model of economic growth, which has been based on using relatively cheap financing from the world financial markets to invest mostly into such domestically oriented industries as construction and real estate, retail trade and services. The current crisis, while having evident negative consequences in terms of industrial output decline and unemployment growth, may have a positive impact on the Russian economy by facilitating delayed structural and institutional reforms and by making the Russian industry more efficient and competitive. Just nationalizing struggling corporations and increasing protectionist policies is not an option.

Dr. Kuznetsov is a Senior Researcher at the State University - Higher School of Economics and Chief Researcher at the Interdepartmental Analytical Center in Moscow. He specializes in the field of Industrial policy and research of Russian industrial firms’ behavior. He is the author of a number of publications on industrial development in Russia. Recent publications include “Russian Industry at the stage of economic Growth” (Gonchar K and Kuznetsov B. eds.), HSE, “Vershina” Publishing house. Moscow. 2008; a chapter on the productivity of Russian manufacturing (with Mark Schaffer) in “Can Russia Compete? Enhancing Productivity and Innovation in a Globalizing World” (Raj M. Desai and Itzhak Goldberg eds.). Brookings Institution Press. 2008

＊The views expressed in the essay belong solely to the author and do not represent the official position of any organizations to which the author is permanently or was temporarily affiliated.

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