World News

04.11.14

Flex Muscle Spending Has Left Putin’s Russia in an Economic Freeze Frame

The Russian leader may have won some accolades for his decisiveness, strength, and overall toughness, but it’s hard to be an assertive global power when yours is the only major economy that’s shrinking.

This a pretty benign time for the global economy. Interest rates are uniformly low. The U.S., China, and Japan—the three largest economies in the world—are all growing. Developing markets in Africa are surging. The European debt crisis seems to have ended. In this climate, one of the only ways to get a recession is to engineer one.

Which is precisely the trick Vladimir Putin may have just pulled off with Russia’s $2 trillion economy. And his adventurism may already have cost the Russian economy about $40 billion.

Even before the saber-rattling began last fall, Russia’s economy was not so hot. Despite its vast natural resources and the stimulus of the Sochi Olympics, Putin and his cronies have basically failed to create a modern, thriving economy. Russia may have been lumped in with Brazil, India and China in the famous “BRIC” block of emerging powers, but it has showed little of those countries’ dynamism. In 2013, Russia’s economy grew at a meager 1.3 percent rate, down sharply from 3.4 percent in 2012.

This year is likely to be no better. In its world Outlook issued this week, the International Monetary Fund downgraded its projection for Russian economic growth in 2014, blaming “the lack of more comprehensive structural reforms [that] has led to the erosion in businesses’ and consumers’ confidence.”

But the Crimea situation is making matters much worse. The World Bank now projects that given a “limited and short-lived impact of the Crimea crisis,” growth could fall to 1.1 percent in 2014. Should things get messier, however, the World Bank warns that Russia’s economy could shrink by 1.8 percent in 2014. Russian officials, the designated cheerleaders for Putin, are even more pessimistic. According to Reuters, Andrei Klepach, the deputy economy minister, now says Russia’s economy could grow at a rate as low as .5 percent in 2014—perilously close to flatlining. “The sheer market uncertainty has brought down Russian expected growth this year from 2.5 percent to .5 percent,” said Anders Aslund, senior fellow at the Peterson Institute for International Economics in Washington, D.C. “That is, the Putin aggression against Crimea and Ukraine cost two percent of Gross Domestic Product. (And with a GDP of about $2 trillion, that two percent adds up to $40 billion.)

Russia is likely to face significant costs as a result of the Crimea annexation. They must now provide power, social insurance and infrastructure to a poor region.

The economic toll is a moving target because things progress quickly. In ordinary times, Russians tend to stow their money overseas—in Miami condos, Cyprus bank accounts, New York office buildings, and, above all else, in London. But when the going gets tough, the Russians really get going—to Zug, and Geneva, and Hong Kong. Since things got hairy in Crimea, companies, rich people, and ordinary Russians have hastened to turn their ruble into dollars, Euros, and Yen, and then to ship them out of the country. As Reuters reported, Russia’s central bank says that in the first quarter of 2014, $63.7 billion in cash left the country—more than the amount that left in all of 2013.

That’s good news for real estate brokers in global superstar cities. But it’s bad news for Russia’s central bankers and stock brokers. Investors liquidating Russian stocks have pushed the main stock market index down more than 20 percent since last October. When money leaves, turning rubles into dollars, Euros, and everything else, that puts pressure on the ruble. Since Putin began flexing his muscles in the Crimea last fall, the ruble has lost 10 percent of its value against the dollar. A sharply declining currency tends to push inflation higher. And sure enough, consumer prices in Russia are now rising at a 6.9 percent annual rate. What’s the Russian word for Stagflation?

Oh, and beyond the psychological impacts, Russia is likely to face significant costs as a result of the Crimea annexation. Aside from picking up its assets—Black Sea ports and resorts—Russia must also assume Crimea’s liabilities. They must now provide power, social insurance and infrastructure to a poor region.

Not all is lost, of course. Russia still has vast energy resources, which help bring in hard currency and much-needed foreign investment. Even as western governments threaten sections, French oil company Total is holding talks with Russian energy giant Lukoil about pursuing shale resources.

Still, Russia’s economic performance is rather pathetic. And it’s likely to get worse. “All the risks are on the downside,” Aslund notes. Should things continue along their current trajectory, “my guess is that it will result in a Russian GDP decline this year of between two and three percent.”

That said, the possibility of Russia spinning the whole world into recession is really remote. Russia constitutes less than three percent of the world’s economy. If it stops selling oil and natural gas into international markets that could have an impact. But even here, it’s influence is declining. The US surpassed Russia last year as the world’s largest producer of hydrocarbons—oil and natural gas combined—and Europeans are already moving aggressively to diversify their supplies. That may be the ultimate insult: Russia may shrink economically, but the rest of the world will hardly notice.