An Oxford Analytica Briefing Book
Russia in
Focus
Specially prepared for the EBLC
Northern Light fact finding mission
Moscow, October 2014
Chapter title
Introduction
Oxford Analytica is delighted to present this
Russia Briefing Book to delegates attending the
Northern Light fact finding mission in Moscow.
Its aim is to provide an overview of the outlook for
the Russian economy, politics and foreign policy
and thus facilitate discussion among participants
at the Moscow forum.
Graham Hutchings
Managing Director, Oxford Analytica
md@oxford-analytica.com
Oxford Analytica is a global analysis and advisory firm that draws on an
network of experts at universities and think tanks around the world to help
its clients understand the impact of political, economic and social events on
their operations and decision-making.
The firm has a 35-year track record in serving governments, corporations and
international organisations on every continent.
Please do contact me to learn how Oxford Analytica can help you secure your
goals in a volatile, uncertain macro environment – in Russia and elsewhere
around the world.
CONTENTS
The economy – potential v problems ............................................................................................................................... 2
Politics: Putin and after ........................................................................................................................................................................ 7
Russian foreign policy ........................................................................................................................................................................... 9
Oxford Analytica is a global analysis and advisory firm which draws on a worldwide network of experts to
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www.oxan.com
The economy - potential v problems
It is hard to be optimistic about the Russian economy in the near term. Output is
flat, investment is falling and consumer-price inflation is above 7% per annum.
Above all, investment and other economic decisions are being made under
conditions of unusually high uncertainty as a result of the crisis in Ukraine and
the sanctions the United States and EU have imposed on Russia.
Russia’s economy remains heavily dependent on the oil and gas sector, with hydrocarbons
revenues contributing 52% to federal budget revenues in 2012 and more than 70% of total
exports. Moreover, the recent fall in fixed investment will dampen the growth of capital stock. As
the Ukraine crisis persists, Russia’s economy stands on the brink of recession.
Yet Russia’s longer-term strengths should not be dismissed. Analysis of potential growth
before the 2012-14 slowdown concluded that GDP could grow in the medium term at a trend
rate of about 4% per annum. The underlying conditions allowing that rate of growth have not
disappeared.
RUSSIAN MIDDLE CLASS WILL HELP GROW SERVICE SECTOR
A source of potential advantage is simply the amount of ‘catch-up’ available.
Output per employed person is about two-fifths of the German level. That means that there is
plenty of room for growth in terms of the introduction and diffusion of new technologies and
management techniques and of the scope for reallocation of resources across lines of economic
activity. The country’s high levels of education make it attractive to investors. In 2014, the World
Bank classified Russia as a high income economy. The World Bank also reported this year that
between 2001-10 the poverty rate fell sharply – from 35% of the population (2001) to just 10%
(2010). Additionally, the Bank observed that during the same period the Russian middle class
doubled from 30% to 60% of the population.
In 2013 GDP per capita was 14,612 dollars as compared to its BRICS partners China (6,807
dollars), India (1,499), Brazil (11,208) and South Africa (6,618 dollars). Indeed, on this indicator,
Russia is significantly ahead of the other BRICS. These figures add greater weight to an
increasingly substantial middle class, who will be key to driving growth, particularly in the
professional services sector.
CHINA WILL BE KEY ECONOMIC DRIVER FOR BRICS BANK
However, the World Bank reported Russia’s GDP in 2013 at 2.097 trillion dollars, compared with
2.522 trillion for the United Kingdom and 2.735 trillion for France. Given Russia’s size, population
(143.5 million), and resource base, it should eventually develop a significantly larger economy
than these two EU members. The World Bank 2013 report ranked Russia’s economy as eighth
largest in the world with the United Kingdom sixth and France fifth. When compared to its BRICS
partners, Russia ranks in the middle of the grouping with China ranked second (9.240 trillion
dollars), Brazil seventh (2.246 trillion dollars), India tenth (1.877 trillion dollars) and South Africa
thirty third (350.6 billion dollars). Compared to China, Russia lags a distant third and it is China
that will provide the BRICS grouping with the economic muscle to act as an alternative source of
development and emergency finance (BRICS Bank) to the IMF, World Bank and other Westerndominated institutions.
2
Economy
To highlight further how Russia has not fulfilled its true economic potential, US 2013 GDP was
nearly eight times larger, at 16.80 trillion dollars. According to the Russian Central Bank, Russia’s
Current Account in Q1 2014 was 27.1 billion dollars while the IMF calculated Russia’s official
reserve assets in June 2014 to be 478.25 billion dollars.
WORKING POPULATION DECLINE
It is true that for several years the number of working-age people will decline, even when
allowance is made for expected net immigration. In 2013 the Russian Economic Development
Ministry said that it expected the working-age population in Russia to decline 8-9% to 79-80
million people by 2020. In 2013 the working age population was 87 million.
CAPITAL FLIGHT AND LOST CONFIDENCE
As the standoff with the West continues, capital flight will increase as investor confidence
falls, heaping further pain on the economy. While Western sanctions have, so far, not been as
punishing as they might have been, it is the level of capital flight that is the real risk to the
economy.
With Russia’s incredibly rich resource base and overall potential it is likely that some brave
international investors will continue to invest – there is money to be made for those willing to
take the risk. However, it is also likely that Russia will miss out on some key partnerships –
and importantly the technical expertise that comes with international partnership – as some
investors shy away.
Russian capital outflows by year (net, billion dollars)
125
100
75
50
25
0
2008
2009
2010
2011
2012
Q1
Q3
Q2
2013
Q4
Q1
Qs2-4 (est)
2014
FOREIGN DIRECT INVESTMENT WILL SLOW IN 2014
Since 2009, foreign direct investment (FDI) net inflows to Russia have generally increased each
year – highlighting the appetite of businesses to invest. Net FDI inflows to Russia were: 36.58
billion dollars in 2009, 43.27 billion dollars in 2010, 55.10 billion dollars in 2011, 50.69 billion
dollars in 2012 and 79.30 billion dollars last year. The Russian Central Bank reported FDI inflows
of 30.78 billion dollars in Q1 2014.
3
Economy
However, while this Russian Central Bank FDI figure looks extremely positive if extrapolated
across all 2014 quarters, the deteriorating relations with the West over the last few months will
have seriously dented FDI inflows as investor confidence has been lost. It is therefore highly
likely that 2014 FDI will be considerably lower than in 2013.
CORRUPTION REMAINS A PROBLEM
Corruption and ease of doing business are potentially the most significant factors stopping
the economy from fulfilling its true potential. In the 2013 Transparency International Corruption
Perception Index (TICPI), Russia was ranked 127/177 with a score of 28/100 (for comparison, in
the 2013 TICPI New Zealand was ranked 1/177 with a score of 91/100).
DOING BUSINESS IS NOT EASY
The World Bank Doing Business 2014 survey ranks Russia 92/189. This marks an improvement
on the 2013 result (111/189) but still highlights serious difficulties for businesses operating in
Russia. By way of comparison, the other BRICS members were ranked: South Africa (41), China
(96), Brazil (116) and India (134).
OIL AND GAS
For the foreseeable future, the economy will depend heavily on oil and gas. The crisis in Ukraine
has done long-term harm to Russia’s energy relationship with one important client – Kiev – and
many others in the form of its big EU customers. In the long term, the EU will look to diversify
supplies, either by importing gas from elsewhere or developing domestic shale gas production.
High oil prices over the last few years have boosted Russia’s two sovereign welfare funds. As
of September 1, the National Wealth Fund and Reserve Fund were valued at 85.31 billion dollars
and 91.72 billion dollars respectively, according to official figures. Yet the government may have
to call heavily on these funds in the face of current economic difficulties and the additional
burden of Western sanctions. Any fall in oil and gas prices would make it hard to replenish these
funds.
As a major exporter of oil and gas, Russia has been vulnerable to some of the maladies
associated with large natural-resource rents. It must continue to exploit the comparative
advantage that the country has in hydrocarbons – but manage more effectively the enormous
rents accruing from oil and gas. It is clearly inefficient to use hydrocarbon dollars to prop up
ageing and non-competitive businesses or Soviet-era enterprises.
Assisted in the short term by Western oil-industry sanctions, Russia will be under pressure
gradually to wean itself off its addiction to natural-resource rents. It is likely that Russia will
continue to push for development of the South Stream pipeline as a way of supplying southern
Europe and avoiding the problems associated with transit through Ukraine.
4
Economy
Current and planned major gas pipelines to Europe
Norway Sweden
Finland
Main gas pipelines
Russia
Proposed gas pipelines
-
al
Nord
Stream
e
op
r
Eu
m
Ya
n
er
th
or
ts
gh
Li
d
oo
N
h
ot
Br
h
er
Kazakhstan
Belarus
Poland
Germany
Ukraine
Austria
Italy
Hungary
Romania
am
Bulgaria
TAP
uth
So
e
Str
TANAP
Blue Stream
Turkey
HIGH TECH DEVELOPMENT
New sources of growth could come from the non-natural-resource sector. Russia has
internationally competitive companies in software, in steel and non-ferrous metals, in nuclear
energy and in the manufacture of weapons systems. Firms such as Yandex, Kaspersky Lab (antivirus software producers), Severstal, Evraz and NLMK (steel) and Rusal (aluminium) are among
the firms that have the potential to help drive Russia’s economy away from an over-dependence
on oil and gas.
Other promising developments:
__ almost all international car manufacturers have set up plants in Russia, including Ford’s
Sollers Elabuga Assembly Plant and the VW Group Kaluga plant;
__ leading Russian retail groups compete well against foreign companies in the domestic
market; and
__ t he service sector, notably professional recruitment and accounting, is growing.
5
Economy
SKOLKOVO
Skolkovo is a further example of the huge potential within Russia and its attractiveness to
international investors. With its close proximity to Moscow, Skolkovo could become a major centre
of excellence for research and start-up businesses in IT, finance and technology if the investment
climate is favourable. However, so far Skolkovo has shown only potential and has not lived up
to the hype of 2010 and its billing as Russia’s future Silicon Valley. Construction delays and the
continuing deteriorating relationship with key centres of investment and knowledge such as the
United States and EU have stunted Skolkovo’s development. The success of Skolkovo and other
possible future centres in cities such as Vladivostok – with its close proximity to China – will be
vital in helping Russia to diversify the economy away from oil and gas.
DEFENCE INDUSTRY SHORTFALLS
The defence industry will remain a key sector but will take several years to recover from the
loss of key suppliers in Ukraine. Russia’s huge military reform and rearmament programme will
suffer delays. Increasing cooperation with defence industries in Belarus and Kazakhstan is likely
in order to attempt to offset supply issues. The defence industry may also have some trouble
fulfilling all its export orders.
TOWARDS FULL POTENTIAL
Several measures are required of Russian policymakers in order to allow the economy to reach
its full potential:
__ Less state interference – reducing the excessive regulation that helps to breed corruption.
__ Stronger rule of law – to reinforce the protection of property rights and give international
partners and investors greater confidence. Such measures would stimulate investment,
innovation and competition.
__ D evelopment of a scientific research community – to integrate the ‘Russian mind’ into the
world’s ‘invisible colleges’ of peers and partners in research. Skolkovo and the development
of top research universities have gone some way to achieving this but more work is needed.
__ O penness to the wider world – the economy is still in some respects ‘closed’.
__ V isa free travel – to make it easier for international business executives to visit Russian
companies and build links.
In terms of Russia’s economy it is a story of potential, as yet, unfulfilled.
6
Politics: Putin and after
President Vladimir Putin is currently riding high in the opinion polls thanks to
the Ukraine crisis. Yet the current political order may be less stable than it
looks. It is likely to come under growing strain as the full effects of the crisis
and international sanctions take their toll.
Putin must manage a broad domestic political spectrum. It is bound by the ‘siloviki’ –
policymakers with a background in the security or military forces who have been boosted by the
Ukrainian intervention – at one end, and the so-called ‘civiliki’ – those who often have a legal
or economics background – at the other. Other key players spread out along this spectrum are
‘oligarchs’, many of whom have a more pro-Western, business-friendly orientation.
As the Ukraine crisis drags on, Putin must consolidate his perceived gains and secure a
political solution deemed acceptable to Moscow. The price of failure in these respects could be
damaging to his political authority at home.
SECURITY AGENCY TURF WARS
The greatest challenge to Putin’s presidency is likely to come from within the system rather than
from outside. It most probably will come from someone within the ‘siloviki’ ranks.
As the power and influence of the GRU (Russian military intelligence) grows, Putin will need to
manage future ‘siloviki’ turf wars as other security agencies struggle to maintain their positions.
An unrestrained turf war could seriously destabilise the political system.
SUCCESSION STRUGGLES
Another potential source of trouble is the question of the succession to Putin. His departure
from office still seems some way off, but key power brokers in Moscow can be expected to
jostle for influence.
The stifling of political dissent and lack of genuine party system mean that the current system
is unlikely to offer a genuinely democratic transfer of power. Freedom House, an independent
organisation focused on the expansion of freedom, considers Russia to be overall ‘Not Free’ with
only a ‘Partly Free’ internet and a press which is ‘Not Free’. The Kremlin can be expected to try
and engineer a managed transfer of power similar to the one that brought former President and
current Prime Minister Dmitry Medvedev to the presidency in 2008. However, Putin will need all
his skills to prevent the transfer of power from providing the spark for wide-scale protests.
FOOD PRICES AND MIGRANTS
In the meantime, Moscow will be keen to ensure that food price rises are manageable following
the embargo on Western foodstuffs. Russia will improve agricultural relations with fellow BRICS
members as well as others who have traditionally not been significant partners in this area.
Key lenders to the agricultural sector are likely to require more government support, which
in turn could force domestic producers to raise prices. As the chart below shows, the current
‘social mood’ is broadly positive but subject to volatility over time.
7
Politics
MANAGING MIGRANT TENSIONS
Managing immigration, in particular from Central Asia to large cities such as Moscow, will also
be a key challenge. The government will be keen to avoid any repeat of the serious tensions
seen in October 2013, when hostility towards migrant workers broke out following the killing of
ethnic Russian Yegor Shcherbakov. An Azerbaijani suspect was arrested and there was serious
rioting directed towards migrant workers – the majority of whom are Central Asian.
In 2013, the Russian Federal Migration Service estimated that approximately 2.5 million
Uzbekistanis, more than 1.0 million Tajikistanis and around 550,000 Kyrgyzstani citizens were
working in Russia. Central Asians make up approximately 10% of Moscow’s population. If the
Russian economy falters seriously, it would cause serious problems for Central Asian countries
– especially Tajikistan and Kyrgyzstan – which are heavily dependent on remittance payments
from migrant workers in Russia.
Remittance payments (largely from migrant workers in Russia) constitute nearly 48% of
Tajikistan’s GDP while in Kyrgyzstan the figure is 31%, according to the World Bank in 2013. The
Russian Federal Migration Service said that, of 11.3 million foreign citizens entering Russia in
2013, 3.0 million work illegally.
Index of Russian social mood – January 2000-January 2014
100
90
80
70
60
50
2000
01
02
03
04
05
06
07
08
09
10
11
12
13
14
Source: Levada Centre
8
Russian foreign policy
The Ukraine crisis has seriously strained Russia’s standing with its Western/
G8 partners, and it will take many years for relations to return to the status
quo ante. The EU is Russia’s most important trading partner; Moscow cannot
simply turn its back on Europe.
Russian mistrust of the EU and NATO will continue to grow. Moscow will strengthen traditional
alliances with its Customs Union (Eurasian Economic Union 2015 (EEU)) partners. It will seek
to entice more countries to enter the Union in order to mask the damage caused by Ukraine’s
refusal to join.
In June 2014, Russia’s trade surplus narrowed by 24% to 13.97 billion dollars from 18.28 billion
reported in the previous month. Exports to countries outside the CIS region account for about
85% of total exports.
Aggregate trade between Russia and selected states in 2012 (dollars)
European Union:
$374.5bn
China:
$89.74bn
Ukraine:
$34.02bn
Total trade in 2012:
$661.36bn
Belarus:
$33.74bn
United States:
$26.46bn
Japan: $23.8bn
Turkey: $23.8bn
South Korea: $22.54bn
Kazakhstan: $21.7bn
Switzerland: $11.06bn
Moscow will seek to re-orient its international interests away from the West in favour of
its BRICS and Latin American partners. Yet it can only go so far. Relations with the United
States and EU have deteriorated significantly, but practical cooperation will continue on key
international issues such as Syria, the struggle against the Islamic State in Syria and Iraq, and
the P5+1 (US, France, China, UK, Russia and Germany) negotiation process concerning Iran’s
nuclear programme. Both sides are aware that they need each other to secure their strategic
goals. Additionally, cooperation on Afghanistan is likely to grow: Moscow is concerned about
the spread northwards of extremism into Central Asia, and shares with the United States the
imperative that Afghanistan does not descend into total chaos.
9
Foreign policy
BRICS AND THE SCO
Moscow will certainly be keen to strengthen the newly created BRICS Bank. In the long term,
it will seek to build up this ‘non-Western’ international financial body as an alternative to the
World Bank/IMF, which it views as too much under the control of the West.
Similarly, closer working relations will be sought with the Shanghai Cooperation Organisation
(SCO). There is much debate about the potential of this organisation, which appeals to Moscow,
again, as a form of defence and security cooperation with ‘non-Western’ states.
CHINA – A STRATEGIC PARTNER, FOR NOW
Moscow wants to enhance bilateral ties with Beijing, partly as an insurance policy following the
deterioration of the relationship with the EU.
For Russia, Chinese demand for gas will be crucial. This year’s 400 billion-dollar, 30-year
Russia-China gas deal is an indication of how Moscow is working to diversify its customer base.
However, such deals will not eliminate Russia’s vulnerability to gas market price fluctuations.
It will have to fight hard for dominance in the China gas market as Central Asian suppliers –
particularly Turkmenistan – are now of great importance to Beijing. After years of reliance
on Russia as the key export market for their gas – which Gazprom often re-sold to European
markets – Central Asian counties, and particularly Turkmenistan, are looking to Beijing as a
reliable customer.
For the foreseeable future, Moscow and Beijing will be partners rather than rivals. They
understand their strategic value to one another in countering ‘US ‘hegemony’. And, given
Washington’s ‘pivot towards Asia’ and tensions between China and US allies such as Japan and
South Korea, Beijing will be keen on close ties with Moscow.
However, tensions in Russian-China relations can also be expected. One of them will be over
China’s growing presence in Central Asia, which Moscow has seen as its traditional sphere of
influence. Much will depend on whether Chinese involvement in the region is mainly economic.
In the unlikely event that Beijing sought a large military presence there, relations with Moscow
could deteriorate.
BACK TO BERLIN
However promising these ‘new’ relationships may be, they are no substitute for the EU, or for
Russia’s most important bilateral commercial partner: Germany.
Moscow will be keen to maintain the special relationship with Berlin; it needs German support in
discussions with the EU, and counts on it to ‘moderate’ moments of tension with the West. In this
context, Putin is likely to look favourably on German firms when it comes to key infrastructure
projects as a way of helping to rebuild confidence.
10
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