Friday 6 February 2015

Why Peace in Ukraine Won’t Save the Russian Economy


Angela Merkel and Francois Hollande’s push for peace in Moscow has helped fuel optimism about the prospects for Russia’s spluttering economy. On the morning of the meeting, the rouble had strengthened against the dollar and the euro, and both the dollar and rouble-based sections of the Russian stock exchange saw sharp gains.

Unfortunately for those in the Kremlin, however, Russia’s economic woes are so deep-rooted that peace in Ukraine is likely to offer only temporary respite at best.

The end of sanctions?

The most obvious boost to the Russian economy would come from an end to the economic sanctions regime that might accompany any peace deal. But this would be unlikely to happen anytime soon. After the failed Minsk agreement in September, Western leaders will want proof of Russia’s commitment to a durable peace that would not only bring an end to the fighting in south eastern Ukraine, but that would also solve the wider geopolitical issue of Ukraine’s future relationship with Europe and Russia.

Given how intractable these problems have been to date, it is likely that the existing sanctions regime will remain in place for some time to come. After all, why would Western leaders relinquish one of the few forms of leverage that they have over Russia to push it towards the negotiation table?
It is also by no means assured that a peace deal negotiated with European leaders will automatically result in the lifting of US sanctions further down the line. Because of its power in international financial markets, any continuation of US financial sanctions would mean that access to Western capital markets for Russian corporations would remain restricted.

What really matters

But even in the unlikely event that the sanctions regime were to end soon, it wouldn’t make much difference to Russia’s growth prospects. It is true that sanctions have dampened business sentiment in Russia and have certainly restricted the availability of capital for investment there. But what really matters to Russia is the price of oil.
Revenues from oil extraction and exports account for around half of the Russian central government’s revenue. When oil prices are high, the rouble tends to be stronger, making Russians feel better off. But when oil prices are low, the rouble weakens, raising the price of imports and eroding the purchasing power of Russian citizens and corporations. Recession usually follows.



The fall in oil prices shows now sign of abating. www.moneyAM.com

The slump in global oil prices that has seen prices fall from over US$110 per barrel in June to close to US$50 per barrel today explains nearly all of Russia’s poor economic news in recent months. It accounts for the weakness of the rouble, which tends to move almost perfectly in line with the price of oil. It also explains why the Russian government is considering large-scale spending cuts while at the same time drafting an anti-crisis plan.

The most important question in Moscow is therefore not “when will sanctions end?” Instead it is “when will the price of oil rise again?” Although oil prices are notoriously hard to predict, the enormous expansion of oil production that has taken place in North America in recent years shows no signs of abating.

Most forecasts see global oil production continuing to rise despite low prices. Meanwhile, demand for oil has slumped as the economies of Europe, China and Japan all slow down. For as long as the imbalance of supply and demand persists, oil prices are unlikely to return to anywhere near the levels of recent years.

Deeper-rooted problems

Even if oil prices were to rebound to levels last seen in the summer, a return to high growth rates in Russia would still not be on the cards. The truth is that the model of economic growth in Russia has been exhausted for some time now. High oil prices helped paper the cracks over a failing system. Investment and output in Russia were falling long before the price of oil plummeted.

That Russia has proven so susceptible to the downward movement in oil prices is because so much of its system of political economy depends on an ample supply of energy revenues. When these dry up, economic activity across all sectors – not just energy – falls.

Economic sanctions and declining oil prices have thus amplified the underlying homegrown problem of a brittle economic structure that is excessively dependent on the redistribution of oil revenues across the economy. To reignite growth, Russia needs to create the conditions in which new industries can emerge, and in which new firms can compete with established incumbents. This would require an opening up of the closed political system that is currently in place.

Only through a greater intensity of economic and political competition can Russia ever hope to truly modernise. Peace in Ukraine, welcome though it would be, is unlikely to help make this happen.

The Conversation
This article was originally published on The Conversation. Read the original article.

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