Source: IMF
The International Monetary Fund’s latest report on Russia paints a grim picture of the state of the economy and confirms what the government even acknowledged for the first time in May: the country is in crisis. Officials have recognized in the past that the ongoing battle between Moscow and the West over Ukraine would “weigh on the economy”. The IMF on Tuesday added its viewpoint: “Concern about a possible escalation of sanctions has increased the uncertainty of doing business in Russia and is having a chilling effect on investment, while bond issuance has declined sharply.” And it hints towards the fact that investment will further contract due to the uncertainty around the geopolitical situation.
The Fund kept its growth forecast at 0.2% this year, from 1.3% in 2013. Even without the escalation of the Ukrainian crisis “prolonged uncertainty and the resulting deterioration of confidence could lead to lower consumption, weaker investment, and greater exchange rate pressure and capital outflows than assumed under the baseline,” the IMF said in a report. The grim outlook should worry policy makers and business leaders in the Russian Federation.
Worth reading into from the IMF’s paper on the Russian economy are the regional spillovers from the large country, which could be sizable and spread through trade flows, remittances, and the financial linkages. Here are a few that the international lender mentions:
Neighboring countries could be affected by the slowdown in Russian growth via trade and remittances flows. Exports of goods and services to Russia amount to over 20% of GDP in Belarus and are substantial for a number of countries in the Baltics, Eastern Europe, Caucasus, and Central Asia. While direct trade links with central Europe are smaller, they may understate the importance of Russia for their tradable sector where exports to Russia are channeled via Germany. Several Commonwealth of Independent States (CIS) countries receive large amounts of remittances from Russia.
Russia supplies about one-third of European oil and gas consumption. While oil is relatively easy to substitute, natural gas is less so. Finland, the Baltic countries, Belarus, and Czech Republic rely almost entirely on Russian gas for their domestic consumption. Dependence is also high at 40-60% in central Europe and southeastern Europe. About half of gas exports from Russia transits through Ukraine, 40% of which could be re-routed by using Belarus and Nord Stream pipelines at full capacity. However, it would be hard to re-route LNG gas from Western Europe coastline facilities to central Europe. From Russia’s perspective, the possibility of re-routing its gas exports to Asia in the near term is limited by the absence of an appropriate pipeline system to China.
Most countries’ direct banking sector linkages with Russia are limited but some international banks derive substantial profits from their Russian operations. Cyprus, Austria, and Hungary are most exposed to the Russian banking system, with total asset of their subsidiaries in Russia of about 4-10% of national GDP. Foreign claims by BIS-reporting countries point to further exposures of Austria, Sweden, and the Netherlands at about 2-4% of GDP in cross-border lending. Russian banks, on the other hand, are major lenders in Armenia, Belarus, Cyprus, and Ukraine.
Direct financial linkages between Russia and most other countries via FDI and equity and debt portfolio positions are limited. Russian FDI is important for immediate neighbors, financial centers, and the Montenegro real estate sector. While 70% of outward and 65% of inward FDI positions (stocks) for Russia in 2012 was with five countries, net FDI positions with these countries were close to zero. Low net FDI positions suggest round tripping of Russian money through these locations to take advantage of better property rights and favorable tax treatment. This limits the scale of spillovers for host countries should these flows stop. Similarly, Russian inward and outward portfolio investment has been channeled mostly via financial centers both for equity and debt flows. The largest FDI investors in Russia are the US, Germany, U.K., France, and Finland, mostly in consumer sectors, such as the automotive and food markets. Withdrawal of this “real” FDI from Russia would affect technology and knowledge transfer, with an impact on potential GDP growth.
What the IMF recommends for Russia is a list of different structural reforms to boost its growth potential such as improving labor markets and reducing tax burden, administrative barriers, and corruption; pushing ahead with privatization; as well as greater fiscal consolidation. The Fund also calls for continued efforts at global integration and the need of a new growth model to realize the full potential of the economy. Don’t expect any of the recommendations to flesh out in the upcoming months.
