Media Fellow Michael Moran speaks with Sergey Aleksashenko, Former deputy chairman of the Central Bank of Russia and former chairman of Merrill Lynch Russia and Clifford Gaddy, Senior Fellow, Senior Fellow, Brookings Institution and author, “Mr. Putin: Operative in the Kremlin” about Russia's economic challenges and its dependence on oil.
Sergey, let’s begin with you. In your time at the Russian Central Bank, you developed a deep appreciation for the inputs that affect or retard growth in Russia. How do you assess the health of the Russian economy today.
MORAN: Hello and welcome to Diffusion: Russia in Focus, our deep look at the state of the US Russian relationship. I’m Michael Moran, Visiting Media Fellow at the Carnegie Corporation of New York and in this, our fifth episode, we are going to focus on the impact of economics on US-Russian affairs. With me are two esteemed Brookings Institute economists - Sergey Aleksashenko, a former deputy governor of Russia’s central bank, and Clifford Gaddy, a senior fellow in Brookings’ Center on the United States and Europe and co-author of “Mr Putin: Operative in the Kremlin.”
ALEKSASHENKO: If we try to understand why the Russian economy is in crisis, there are a couple of factors, three in fact. First is the decline in oil price. Oil price is always important to Russia, just as it was to the Soviet Union. Second, the western sanctions that have been imposed on Russia have cost it. Third is domestic policy. Many experts who predicted an economic collapse in the end of 2014 and beginning of 2015 were impressed by the financial collapse and crisis that occurred in December 2014. But that took place during the same period of time as a rapid decline in oil price. That was also the season of maximum payment, peak payments, of Russian banks and companies of foreign debt. There were some mistakes made by the management of the Central Bank as well which disoriented the market. Many people believed that the collapse of the ruble would lead to the collapse of the economy, but the Russian economy, despite all its corruption issues, its weak institutions, inefficiencies, state involvement and so on, is still a market economy.
In a market economy, equilibrium is reestablished by free prices and free exchange rate. As Russian authorities did not try to freeze prices, as they may have done in Venezuela, the Russian economy adjusted. The most painful price in that adjustment was paid by Russian households that lost approximately 15% of their consumption. All that said, the crisis occurred, and, due to a combination of external and domestic factors, the Russian economy declined by a significant 5.5% while the rest of the world was growing.
MORAN: Cliff Gaddy, your perspective?
GADDY: In 2008-2009, the policy of the government was to protect the value of the ruble and protect incomes (personal incomes, household incomes, wages, etc.). They spent a significant amount of their huge foreign currency reserves to extend the exchange rate of the ruble in 2008. If you looked at the results in 2009, despite the drastic drop in GDP, real incomes (i.e. incomes adjusted for inflation), were actually pretty much flat. They did not decline, which is a real anomaly. But what did happen is there were job losses, and of course there was a lot of concern about social instability as a result of it.
The difference from 2009, 2010, is that today oil prices haven’t rebounded. In 2009 and 2010 they bounced back up to $100 a barrel – and that certainly has not happened here. This is a much more prolonged depression.
I stress oil prices because it’s really all fundamentally about the oil prices. Everything that happens in the Russian economy is fundamentally about oil prices. But it’s never automatic, it also depends on how policy adjusts to either negative or positive shocks in the oil price, and, in my opinion, their policy was very, very smart in late 2014, 2015, and into this year.
MORAN: Have the experiences of the last two years prepared Russian policymakers to think about better preparing for future shocks? Is there a long-term effort underway to build some resilience in Russia’s economy?
ALEKSASHENKO: A very important factor in the stability of the Russian economy has been the reserve funds accumulated by the Ministry of Finance from 2005-2006 and 2011-2012. Those funds allows the Russian Federal budget to not cut expenditures significantly, at least in nominal terms, and to not use Central bank financing funds. So, the budget was able to fulfill the bulk of its commitments and that of course helped the economy. I cannot say that the government did a lot in this crisis, because the main adjustment of the economy made to deal with external shocks was the freeing of prices and the freeing of the exchange rate. All the good the government did was that it stood back and did not touch the processes. The government, President Putin and the Central Bank, are afraid to freeze either prices or exchange rates, because those things helped the economy to receive the correct signals and react accordingly. The economy stabilized, but on a lower level.
Russia cannot find sources of income that would replace its oil; it just can’t do that. But, one way it protects itself against negative shocks is by diversifying sources of income. You think ahead and you save money. You may have to borrow money, but you know that there’s a good chance you can get by. This is called consumption-smoothing, and it is what Russia has done with its oil and petroleum funds – which started out as one fund but then was split into two. The other form of smoothing your consumption in the face of these kinds of shocks would be to borrow, and knowing, or hoping, that your income flow (i.e. the oil price) will be high at some point in the future, and you will be able to pay back these funds. Circumstances have changed for Russia in that regard, because of its isolation from international capital markets and so forth.
The idea that the magic bullet for Russia, that it can diversify by developing some magic new industries that are going to replace oil revenues, is so much of a fiction. The idea that Russia in particular could diversify enough to make itself immune, or even relatively immune, to oil shocks in the next – 20 to, even, say, 50 years – is completely unrealistic.
MORAN: Cliff, let’s stay with you for a moment. You’re skeptical that any diversification strategy can work. But some have suggested Russia’s natural response should be - if you’ll excuse the phrase - a pivot to Asia. Could that work?
GADDY: Maybe there will be a pivot to Asia. The question there is – how much capital is in Asia, available, and could that be an adequate substitute for what they would get from the European and American market, and what would it cost to make happen? Money is everywhere in the world, but how much does it cost to get it? It’s the political conditionalities, whether they be explicit or implicit, usually implicit, that limits what Russia would try to get from China. They don’t want to mortgage their entire political future to China, so they have limits there. As a result, I don’t think there has been any great revolution in terms of a pivot to Asia. I think that if sanctions were relaxed and Russians were allowed access back to Western markets, then all the corporations would turn that way immediately, at the drop of a hat.
MORAN: Sergey, do you agree?
ALEKSASHENKO:I would say that in the short term there is no evidence of either import substitution or a pivot to Asia. Either of those requires much more time and no one investment project can be realized in six or twelve months that may impact the economy.
MORAN: What kind of demographic trends are we seeing in Russia, and how do they play into the medium and long-term reform prospects for Russia?
ALEKSASHENKO: I would say that demography and the demographic forecasts we see are not a problem for reforms, but a problem for the Russian economy and its sustainability despite the economic policy. It is fair to say that Russia is still experiencing huge demographic waves as a result of the Second World War and we have generations that are low and generations that are high. That’s why all fluctuations of birth rates and the national growth of population were linked to those waves. But what is really a danger and what is really the long-term problem for the Russian economy is that sometime starting between 2020 and 2025, the long-term changes in Russian demography should be start becoming visible.
GADDY: as an economist, the last thing I ever want to do is take some linear projection of a trend and assume that this is going to stay steady and necessarily result in one outcome, without taking into account that policymakers over there see what’s happening. They’re going to feel it, and they’re going to react, and they’re going to behave differently. Individuals are making their decisions, households are making decisions, and business leaders are making their decisions. All of it is based on fluctuating conditions. In Russia today we don’t have central planning. We have business entrepreneurs who will see opportunities where other people see some kind of absolute crisis or shortage or something else. I think you have to recognize that things have a way of turning out very differently than suggested by simple linear projections, of which the demography story has always been the worst example.
MORAN: Gentlemen, thank you. And thanks to our listeners. Join us next week for Episode Six and a focus on cyber security issues with Austin Long of Columbia University and Stanford’s Amy Zegart. For now, on behalf of my colleagues at the Car-NAY-gie corporation of New York, this is Michael Moran. Goodbye.
Diffusion is the podcast of Carnegie Corporation of New York, promoting the advancement and diffusion of knowledge and understanding around issues of peace, education and democracy.
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