Russia's economy is failing, but that gives it a chance to reform

Since the summer, the global price of oil has plummeted. After hovering above the US$100 per barrel level since 2010, prices have declined by around 40% in the space of just a few months. Brent crude has fallen below the $70 a barrel mark, with OPEC’s recent decision to leave production levels unchanged raising the possibility that oil prices may have further to fall.

While this is good news for importers and consumers of oil, it is causing policy makers in oil-producing states to worry. From Iran to Venezuela, many have come to rely on elevated oil prices to fuel their economic growth and to support government spending. And one country that is worrying more than others is Russia.

A slowing economy

Since undergoing a near decade-long depression in the 1990s, the prolonged bull market in oil prices driven by a rapid expansion of demand for oil in developing countries (most notably China) enabled Russia to post a decade of impressive economic results. As GDP grew, so the Russian state’s revenues expanded, enabling it to allocate resources to a range of socio-economic activities. These include increasing social welfare payments, paying off the bulk of state debt, expanding the state bureaucracy and funding a massive programme to bolster its armed forces. Living standards rose rapidly, helping explain the immense and genuine popularity enjoyed by the president, Vladimir Putin.

But a prolonged decline in oil prices threatens to reverse many of these gains. Even before prices started to fall, the economy was slowing as many in Russia sensed the need for a new model of economic development that was less dependent on oil. The strain on public finances was already showing; political struggles over government spending have intensified as growth in oil revenues has slowed. Confidence within the business community has been low, as shown by the enormous spike in people moving their money abroad in 2014.

Matters have since been made worse by the dramatic decline of the rouble against other currencies – it has lost nearly 50% of its dollar value this year. As a result, inflation is rising and the living standards that to which many Russians have become accustomed are under threat.

This rapid deterioration of the Russian economy has taken place against a background of heightened tensions with the West. In particular, events in Ukraine, which resulted in economic sanctions imposed by the West. Indeed, it is likely that sanctions have only added to already high levels of uncertainty within Russia’s business community.

It is in this context that policy makers in Russia are now faced with the invidious task of simultaneously responding to both immediate and longer-term challenges. Success under such adverse conditions is by no means assured, and the political leadership may come to regret not undertaking more ambitious economic reforms to wean the country of its oil addiction during less turbulent times.

The short-term fiscal health of the state is not in immediate danger. One silver lining to the dark cloud above the Russian economy is that because the lion’s share of Russian export revenues are denominated in dollars – and because the rouble has depreciated even faster than oil prices have fallen – one dollar buys more roubles today than it did in the summer. Consequently, Russia is forecast to run a federal budget surplus this year.

A chance for change

But despite this, in circumstances that are beginning to resemble a crisis, the urge for the political leadership to take the country’s economic policy in a new direction may grow. Over the past three decades, a precipitous drop in oil prices has precipitated more liberal economic policies being undertaken in Russia. Mikhail Gorbachev’s perestroika emerged after the decline in oil prices in 1986, Vladimir Putin’s earlier, more liberal economic policies were carried out after oil dropped close to $10 per barrel in 1999 and Dmitri Medvedev’s modernisation agenda was strongest in the aftermath of the global recession of 2008-09.

It is, therefore, plausible that policy makers in Russia might make a virtue out of adversity and respond to the fall in oil revenues with a reinvigorated reform package that will ignite private investment and propel Russia along the path of modernisation. This would surely benefit Russian society over the long term.

Unfortunately, the prospects for a similar turn to liberal economic policy today are less rosy. This is because tensions between Russia and the West threaten to change the trajectory of political and economic development in Russia for the worse. By boosting factions within Russia’s policy elite who favour increased state control and a move away from Russia’s integration with the global economy, poor relations with the West threaten the prospects for a liberal, market-oriented turn in economic policy in Russia.

In this environment, the prevailing system of political economy that is in such urgent need of transformation may in fact be preserved but in an even more ossified form. Instead of responding to adversity through openness, Russia may take the historically well-trodden path of relative isolation to strengthen the existing ruling elite.

Dr Richard Connolly is Co-Director of the Centre for Russian, European and Eurasian Studies (CREES) at the University of Birmingham. This article was originally published on The Conversation.