Russian Economy in Next Three Years: Path and Risks
The Russian economy has turned out to be more resilient than many experts predicted, however, the ‘reserves’ of the factors underlying these dynamics have been exhausted, experts concluded at the session of the Financial Congress of the Bank of Russia devoted to the prospects and risks of economic development in the next three years. What do the economists see as a baseline scenario for the development of the Russian economy, what will help avoid growth in inflation but what is likely to trigger a new round of inflation, and what role will fiscal policy and competition play in this? Econs provides excerpts from the discussion.
Economic path
According to Oleg Vyugin, Professor at HSE University and former Chairman of the Supervisory Board of Moscow Exchange, economic growth in 2022–2023, which was predicted to be much lower, was driven by more extensive use of the oil rent, restrictions on capital outflows, and the maximum utilisation of labour.
‘In fiscal policy, we have switched from $45 per barrel [the cut-off price according to the budget plan; the revenues from oil sales in excess of this price have been channelled into savings] to more extensive use of the current oil revenues for financing the economy. Furthermore, we used the savings of the National Wealth Fund (NWF) – the NWF’s liquid funds substantially shrank, especially over 2023. Also, financial resources seem to have been made available through the termination of the intensive capital outflow. Finally, labour resources were utilised to the maximum extent: at present, nearly all sectors are experiencing labour shortages. Yes, the resources have mainly been used to meet the needs of the defence and military sector, however, this is not critical for GDP as the final indicator,’ Vyugin notes.
However, both financial and labour resources have almost been exhausted: ‘We have already heard a warning bell, as the taxes have been raised: in order to maintain the level of budget expenditures achieved, internal resources have to be redistributed,‘ Vyugin continues. In view of the above factors, the HSE professor believes that the assumptions of the baseline scenario for economic development in the coming years are as follows: export resources (prices and supplies to the external market) will remain nearly the same, sanctions will further increase transaction costs, and the labour shortages will persist.
According to Vyugin, with no labour reserves available, economic growth could be driven by the rise of productivity, however, technological constraints do not allow for this. ‘Technological constraints and sanctions are always ranked third after financial and labour restrictions, but they are actually very serious, since all modern technologies boosting labour productivity require a vast market,’ the economist continues. ‘For example, it is not by chance that when Russia tried to design the SSJ aircraft, a provision was made that it would have to be sold worldwide, since the investment costs were so great that they would have been justified only if the product is competitive in the wider market. If the economy is closed and characterised by technological autarky, the creation of new products facilitating breakthroughs in labour productivity is not cost-efficient.’
The resources that have driven economic growth over the past two years have been depleted, and therefore, the growth rates will drop starting from 2025, Vyugin concludes: ‘It is difficult to provide an accurate forecast, but we can talk about rates of 1-2%.’
According to Natalia Orlova, Chief Economist at Alfa-bank, the slowdown may not be very significant, because a number of territories are likely to have experienced an increase in potential economic growth rates. Therefore, the new growth path may appear to be higher than before 2019.
Orlova suggests that the forecast for the coming years be based on the ratio between the demand for and supply of resources. She believes that, as regards demand, the key issue is what happens with fiscal policy: ‘There has been a structural change in the approach to fiscal policy’. The past years have demonstrated that, amid external challenges (which may be associated with the pandemic or geopolitics), it is hard to keep the budget tight.’ As the supply of labour resources is limited, the stimulation of demand will result in inflation risks, Orlova concludes: ‘The context is as follows: economic growth slows down as inflation risks increase – the ratio will depend on the budget to a significant extent.’
The adjustment of the oil price from a bit more than $40 per barrel to the current $60 per barrel made when planning the budget seems to be permanent, Sofia Donets, Chief Economist at T-Investments, points out: ‘The price of $60 per barrel is still below the current level, but taking countercyclical expenditure into account, the price for the budget is probably closer to $70 per barrel. If the price remains the same, risks may follow: volatility and a long-term decline in oil prices should always be taken into account.’
Artem Fedorko, Chairman of the board at DOM.RF bank, is convinced that the higher than expected economic growth rates and relatively moderate inflation are mainly attributable to the market nature of the economy and elevated competition: ‘The market nature of the economy will help overcome various future shocks. That is, the key task is to ensure that the market segment of the economy maintains at least the same share.’ The difference between the priorities of government policy aimed at investment demand and household demand may become an additional challenge, Fedorko continues: ‘We see that the government prioritises industrial production support, whereas household demand is focused on the consumer sector. This difference between the priorities of government policy and what is in demand among households is a challenge. How it will be addressed depends on fiscal policy and monetary policy. The relevant decisions will largely determine the paths of both growth and inflation.’
Maria Bagreeva, Deputy Mayor of Moscow, believes that the economy has been caught in two traps. The first is associated with the fact that the high rates of 2022 and 2023 were subsidised, which boosted demand, acting as a proinflationary factor, and pushed the rates up even more. Subsidies should be granted to priority sectors and enterprises, otherwise there will be a vicious cycle. The second trap is associated with the significant contribution of wage growth to inflation. The only way out is to increase labour productivity. ‘Russia has been implementing a project of the same name – Labour Productivity – for a few years already. It involves the active integration of lean manufacturing technologies,’ Bagreeva reminds. ‘This option may yield a quick effect within 4–6 months. Subsequently, automation is needed.’ Bagreeva believes that escaping from these two traps could have a significant anti-inflationary effect: ‘But I do not believe in miracles: our inflationary wave is of a non-monetary nature, so we will be dealing with this problem for a long time.’
Inflation factors
Alexey Zabotkin, Deputy Governor of the Bank of Russia and moderator of the session, notes that inflation factors can be thought of in three dimensions: supply-side factors (the labour market, production and transport capacities, and technologies), demand-side factors (consumer confidence, higher incomes, the budget, subsidised lending, and the mechanics of inflation expectations), and external conditions (the state of the global economy and sanctions). He asked the participants in the session to share their views as to which factors may reduce inflation and which of them may entail inflationary risks.
Natalia Orlova believes that the inflationary risks are still far outweighing the disinflationary risks. ‘The global economy is segmented, and this poses a strong proinflationary risk: the segmentation translates into higher logistics and production costs.’ This will affect inflation in Russia through imports. According to Orlova, supply-side proinflationary factors are also in force: unemployment is so low that any additional demand for labour is likely to produce an inflation effect. An additional inflation factor is associated with households’ consumer behaviour, Orlova continues: for now, households are striving to save rather than to spend, but the situation may turn around.
Artem Fedorko believes that it is largely a political choice between the high and low inflation scenario: ‘This issue depends on whether the fiscal and monetary policies are synchronised or not.’ If the government creates incentives for maintaining competition, market agents independently adjust to the challenges and points of demand growth in the economy. According to Fedorko, at present, the sectors prioritised by the government enjoy subsidies and benefits, and it is easier for them to tolerate tight monetary policy, which creates unequal conditions and the market segment may start to shrink: ‘Meanwhile the market segment is much more effective in terms of adaptability, potential, and contribution to labour productivity and a decline in inflation.’
‘When the treasury faces limits to a further increase in government spending, there is an urge to search for other sources of raising money. An attempt to nationalise enterprises is one of the examples of an inappropriate method of doing so,’ Vyugin points out.
The HSE professor believes that the disinflationary scenario is quite possible if a reasonable approach is taken: ‘Certain political decisions require that external contradictions, putting it mildly, be resolved. If they are resolved somehow, it will be possible to ease the pressure on public finances.’ Then, individual sectors will no longer require additional fiscal stimulus and there will be a move to a lower rate within one year and a half, which will launch market mechanisms for financing investments and technological development, Vyugin believes.
In the short run, there will be more proinflationary risks, while disinflationary risks are hard to imagine, as they are a matter of luck, Sofia Donets agrees with her colleagues. But in the long run, factors are disinflationary: these are the demographics and the ruble exchange rate realignment, Donets points out. The lowest inflation rates are characteristic of the ‘ageing’ countries. The ruble exchange rate no longer makes any significant contribution to inflation, largely due to capital controls: ‘In this respect, the somewhat closed nature of the economy may become a factor stabilising inflation,’ she believes. If previous spikes in inflation have usually resulted from devaluation, currently, Russia is experiencing ‘textbook’ inflation caused by overheating. ‘And, of course, the basic factor that can bring inflation back to the target is that we never give up this target,’ concludes Donets.
