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The key to Russias trade account success

Russia’s perplexing current account success

  • 28Apr 16
  • Viktor Szabo Senior Investment Manager, Fixed Income

Russia’s economy has faced its fair share of headwinds but it may be the nationalism so baffling to the West yet so characteristic of the country that is its saving grace.

International sanctions, the oil price hitting 28 dollars per barrel and several wars have plunged Russia into a deep recession. The country’s economy has been contracting since mid-2014. Yet the current account has improved over this time. Between 2013 and 2015 in GDP-terms the surplus has increased 3.3 percentage points finishing 2015 at 5% according to the International Monetary Fund (IMF).

It’s clear the country is undergoing a painful adjustment, felt most by households. So, how has President Vladimir Putin managed to improve the country’s current account at the expense of the ‘electorate’ yet maintain their unconditional support? Putin’s approval rate has soared amid Russia’s financial crisis according to both state and independent polls and it’s all down to the notion of the ‘Social Contract’: ‘you give me your unconditional support; and I’ll give you a strong Russia to be proud of.’ The sense of nationalism in Russia is inherently strong and has been for a long time.

The Russian people are famously stoical. The national character is shaped at least in part by the experience of its turbulent political past. Nowadays critics still live under constant threat. In 2003, the now-exiled Russian businessman Mikhail Khodorkovsky was jailed for fraud amid international claims that his charges were politically motivated. The liberal politician and vocal critic of Putin, Boris Nemtsov, was assassinated near the Moscow Kremlin last year. You are allowed to be critical, but only to an extent. That social culture has enabled Putin to force a very painful adjustment on the Russian people in the last few years underlined by big cuts in government spending and the contraction of imports.

Putin banned agricultural goods from a number of Western nations in 2015. Meat, fish, dairy products, fruit and vegetables were embargoed. Though the dramatic reduction in Russia’s imports is largely down to Putin allowing his economic cabinet free reign of the economy and they made bold moves. The Central Bank of Russia allowed the currency to depreciate, making imports very expensive. Both these tactical moves had dramatic results. While export revenues have collapsed due to lower commodities prices, the current account surplus increased by 2.1 percentage points of GDP between 2014 and 2015, with a 28% drop in imports playing an important part in it (IMF). The move to ban Western imports seemed at the time to be in retaliation to international sanctions. But it appears the import embargo was an important tool in limiting the negative hit on the trade balance as a result.

The unfortunate upshot for the Russian people is that imported luxuries are pretty much impossible to come by. Parmesan has been eradicated from the country altogether. Even worse, the price of basic foods has materially increased. The price of grain and sugar has gone up by about 40% in the last year alone according to the IMF. Putin’s sustained popular appeal means that attitudes towards government have not yet turned sour and Putin’s cabinet has had the flexibility to enact import tariffs or extend bans should they see fit.

The lack of diversity in Russia’s cheese offering is least of people’s worries though. The age of generous public spending is very clearly over.

The lack of diversity in Russia’s cheese offering is least of people’s worries though. The age of generous public spending is very clearly over and sweeping fiscal restrictions are now in place to prevent depleting reserves. Government budget cuts have had a huge effect on Russian households with salary freezes, below inflation increases in pensions and wage arrears an all-too-common site. Wages fell around 10% last year when you take account for inflation (IMF). These various rounds of fiscal tightening have compounded the financial effect of the import collapse and Russian households are hurting. However, it is the tolerance of those households that allows policymakers to implement the ambitious fiscal consolidation that is desperately needed in the country at the moment. Without it, Russia faces an even more difficult job of pulling itself out of current high inflation levels.

Bizarrely much of the income taken away from households is diverted to local companies in the hope that better profitability will unleash investments. The move (alongside the ban on imports) has succeeded in growing the margins of the local corporate sector. Listed Russian companies are showing a moderate increase in earnings. Merrill Lynch reported earnings before interest, taxes, depreciation and amortization of major Russian companies increased by 19.6% last year in ruble terms. That being said, it’s not quite working as planned yet. Many of the companies benefiting are using the spare cash to pay back debt or borrow more money.

Is staunch nationalism enough to save Russia? Low commodity prices and Western sanctions are set to continue for the foreseeable future and surely there’s only so long that Putin can depend on the unrelenting patience of the Russian people. The recession is showing just small signs of abating and the country still faces a tough time even once they’re out of recession. Growth will be slow. The issue for Putin will be how far he can stretch the social contract he holds with his people. History suggests it can be stretched quite far.

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