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An anchor in Russian nationalism

  • 03May 16
  • Viktor Szabo Senior Investment Manager, Fixed Income

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

International sanctions, the oil price hitting $28 per barrel and several wars have plunged Russia into a deep recession. The country’s economy has been contracting since mid-2014. The current account has improved since that time. Between 2013 and 2015, the surplus increased 3.3 percentage points to 5% at the end of 2015, in terms of in gross domestic product (GDP).

It’s clear the country is undergoing a painful adjustment, felt most by households. How has President Vladimir Putin managed to improve the country’s current account at the expense of the electorate yet maintain unconditional support? Putin’s approval rate soared even while Russia faced a financial crisis, according to both state and independent polls. It may all be 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 national character, which many believe to be characteristically stoic, is shaped 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 for 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. 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 because of 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.

The move to ban Western imports seemed at the time to be in retaliation to international sanctions. 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. The price of basic foods has also materially increased. The price of grain and sugar has gone up by about 40% in the last year alone, according to the International Monetary Fund (IMF). Putin’s sustained popularity may signal that attitudes towards the government have yet to turn sour. This means Putin’s cabinet has had the flexibility to enact import tariffs or extend bans as they see fit.

The lack of diversity in Russia’s cheese offerings is the least the country’s worries. The age of generous public spending is 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 after taking inflation into account. These various rounds of fiscal tightening have compounded the financial effect of the import collapse. Russian households haven’t had it easy. But it’s the tolerance of these 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. Much of the income taken away from households is diverted to local companies in the hopes 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. Earnings before interest, taxes, depreciation and amortization (EBITDA) among major Russian companies increased by 19.6% last year in ruble terms, according to Merrill Lynch. That said, it’s not quite working as planned yet. Many of the companies benefiting from the boost are using the spare cash to pay back debt or borrow more money.

Listed Russian companies are showing a moderate increase in earnings.

Is staunch nationalism enough to save Russia? Low commodity prices and Western sanctions are set to continue for the foreseeable future, and the patience of the Russian people is still being tested. The recession is showing only small signs of abating. The country could still face a tough time even when it can break out of a 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.

Important Information

Foreign securities are more volatile, harder to price and less liquid than U.S. securities. They are subject to different accounting and regulatory standards, and political and economic risks. These risks are enhanced in emerging markets countries.

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