Russia began addressing structural problems in its economy some time ago, but the work had not been finished when the Ukraine crisis erupted, making it vulnerable to a downturn. Although the government launched an economic modernization program during the global financial crisis in 2007-2009, the agenda quickly became less of a priority when oil prices started to skyrocket.
Now, with a drop in oil prices and the ruble, and expanding Western sanctions, Russia faces economic contraction. This time, though, there is little hope for a resolution in the near term as the Kremlin faces off against the United States and the EU over the conflict in Ukraine.
Unquestionably, no one likes to see a recession. It causes discomfort for industry and the public alike. But it also poses a unique opportunity that the government is attempting to seize. Through its efforts to expedite structural reform and diversify the economy, it is striving to ensure that Russia emerges stronger than ever. Indeed, making the right moves now will make it better prepared to ride the next economic wave and to avoid, or at least mitigate, future cataclysms.
Whether Russia succeeds will depend largely on the government’s ability to diversify its political- and economic-partnership base, and to attract support from countries with which it had limited ties before.
It began making those moves several months ago, both heightening its rhetoric and taking concrete steps to achieve cooperation with alternative economic partners.
The other BRICS countries – Brazil, India, China and South Africa – have received special attention given their economic influence and inclination to support Russia at this sensitive time. Not only do they share the Kremlin’s view that a country’s political and economic system should evolve naturally; they also hope to depose a unipolar international system driven by American decree.
As part of Russia’s efforts to advance economic ties with fellow BRICS nations, Finance Minister Anton Siluanov announced in early February that the country will soon ratify the agreement to create a New Development Bank for the trillion-dollar bloc. Despite internal issues slowing its roll-out, the bank will finance infrastructure projects across the developing world, helping Russia gain a foothold in budding markets.
The years 2014 and 2015 also saw – and will, expectedly, see – Russia boost its ties with India. The two countries have recently signed 20 deals in energy, defense, trade and other sectors.
Today’s geopolitical and economic turmoil is undoubtedly testing Russia’s economic strength and flexibility. Along with diversification measures, however, the government is attempting to identify neglected areas of the economy, and introduce reforms to increase efficiency and resistance to shocks. The overarching idea behind this is that the more institutionally resilient Russia becomes today, the greater will be its future success.
History shows that Russia has bounced back from economic turmoil time and again.
It weathered economic ‘shock therapy’ in the 1990s, when it was transitioning from a planned to a market economy. The worst moment was the financial collapse in 1998-1999 that rocked the economy to its core. But by 2001, only two years after the end of the collapse, the economy was performing well enough for Goldman Sachs to include Russia among the emerging-market BRIC nations. It also survived one of the worst international financial crises in recent memory between 2007 and 2009. These examples demonstrate the resilience of the Russian economy in recent decades.
The government has never just sat back twiddling its thumbs, when a downturn occurred. It has always remained proactive, taking steps to end the crisis at hand and make the economy less susceptible to the next one.
In response to the current sanctions and oil-price shock, the government has also moved to rapidly intensify diversification efforts while emphasizing the production of value-added goods.
Reliance on raw materials served Russia well in the past, but the recent dramatic shifts in geopolitics convinced the government that it was time to press harder for a more diversified economy.
This diversification not only includes moving existing industries up the value chain, but also developing new ones. The good news is that such a change is already well under way.
Since the sanctions struck, Russia's leaders have repeatedly called for developing the non-petroleum sectors of the economy, ramping up innovation and high technology, and broadening Russia’s international partnerships.
The Asia-Pacific region will be at the heart of the partnership-broadening effort. But Russia is also developing closer ties with Central Asian and Latin American suppliers. Both regions are now supplying it with more agricultural goods, as Russia cuts back on such imports from Europe.
As part of its economic refocusing, in recent months Russia has accelerated a program to export high-tech goods.
The sanctions have given it a crucial incentive to step up its ties with China — the largest BRICS economy. Recent statistics indicate that Russia has obtained a larger share of China’s oil import market. Russian petroleum imports jumped 30 percent in 2014, with imports from OPEC members falling substantially.
In October 2014 the countries signed 38 agreements in sectors such as energy and finance, including a deal to open a yuan-ruble swap line worth 150 billion yuan (24.5 billion USD) to reduce dependence on the dollar and promote investment and bilateral trade. China also agreed in January 2015 to finance a high-speed railway between Moscow and Beijing at a projected cost of 242 billion USD. These signs of warming ties follow a heavily publicized agreement signed in May 2014 that will see hundreds of billions of dollars in Russian natural gas exported to China.
As China becomes a growing creditor and energy partner, the Kremlin is subtly resetting the chessboard in East Asia, which will negatively impact America's future plans for the region.
Another sign of the government’s evolution in thinking is the Kirishi-2 Oil Refinery, Russia's first waste-oil refinery, which will open in 2017. Since the fall of the Soviet Union, Russian oil companies have shipped millions of tons of ‘waste oil’ overseas, for pennies per ton.
Soon it will be possible for the country to convert waste oil into petroleum products. The government has always backed the Kirishi-2 project, but since the West imposed sanctions, it has shown even more support for this effort.
The major shift in the economy that our government is pursuing will generate long-term benefits, but inevitably require short-term sacrifice, particularly in certain sectors.
Take military electronics, for instance. Russia is reducing military-electronics imports to develop the industry at home. The goal is to have 95 per cent of electronics made in Russia by 2020. This will mean short-term inconvenience for military and security operations that need such devices, but also a new industry that contributes to the economy in the long term.
Although it will pose challenges, import substitution will not only improve existing domestic industries, but also spur the development of new ones. The bottom line is that Russia has a chance to emerge from the current crisis with stronger production capacity.
To facilitate the shift to more innovation, more high tech and more valued-added products, the government and private sector need to work hand-in-hand to ensure that there is more funding for research and development. Much of the R&D could be done at Russian universities, which have long had a reputation across the world for scientific achievement and innovation.
The government’s efforts to assist in developing international universities functioning under the auspices of the BRICS partnership and the Shanghai Cooperation Organization are a step in the right direction. These educational institutions will not only help develop closer ties between member-states. They will also help Russia showcase its capacity for innovation, while allowing it to recruit the region’s best minds to its hubs of entrepreneurship, such as the one at Skolkovo.
In the future, innovation and information technology will be the only difference between a country that is an economic powerhouse and the one that is an economic also-ran. The government needs to continue building on these successes and working to make better use of Russia’s comparative advantage in brainpower – because that is the key to its becoming a global leader in innovation and high tech.
Another goal that Russia is continuing to pursue – one which will help it to become stronger and more competitive over the long run – is to develop the Eurasian Economic Union, which currently consists of Russia, Kazakhstan, Belarus and Armenia. The EEU’s economic potential is immense, with industrial production already hitting 1.5 trillion USD in 2013, oil and gas production the highest in the world and a lower unemployment rate – 5.5% – than in the EU (10.8%), the United States (7.4%), and the world (6%). As Russia and China develop closer ties, the EEU is bound to have an impact that is not just regional, but global.
As Russia persists in its efforts to establish greater economic integration across the EEU, the free-trade bloc will inevitably attract more members, and their economies and collective political influence will grow. As the largest member of this bloc, this is particularly true for Russia.
There have been snags in the integration process, but nothing that cannot be overcome. Russia needs to continue smoothing out the bumps on the basis of member equality and sovereignty and the collective economic good. The goal is for all member states to reap benefits from the union that bolster their economies and improve their people’s livelihoods.
Although coping with sanctions, plummeting oil prices and a devalued ruble is challenging, it is paramount that Russian leaders continue to spend time and energy to address the economy’s structural problems and give it a new focus. That is the path to creating an economy that is stronger, more efficient and more flexible in the years to come.
Andrei Yermolaev is a former deputy of the Leningrad Regional Assembly and the general director of the Kirishi-2 Oil Refinery, Russia's first waste oil refinery, to launch in 2017.
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