Tag: Russia

Important Policy Lessons from Swedish-Russian Capital Flows Data

Posted on March 21, 2016 | Policy Brief

A recent study of capital flows between Sweden and Russia provides many policy lessons that are highly relevant for the current economic situation in Russia. In line with studies on other countries, bilateral FDI flows were more stable than portfolio flows, which is important for a country looking for predictable external sources of funding. However, much of the FDI flows came with trade and growth of the Russian market. The sharp decline in imports and fall in GDP is therefore bad news also when it comes to attracting FDI. The conclusion is (again) that institutional reforms and reengaging with the West are crucial policies to stimulate both the domestic economy and encourage much-needed FDI.

In a recent paper (Becker 2016), I take a detailed look at the trends and nature of bilateral capital flows between Sweden and Russia over that last 15 years. Although the paper focuses on the capital flows of a relatively small country like Sweden with Russia, it sheds some light on more general theoretical and empirical issues associated with FDI and portfolio flows that are highly relevant for Russia today.

Measuring Bilateral FDI

One general qualifier for studies of bilateral capital flows is however the reliability of data; Not only is a significant share of international capital flows routed through offshore tax havens which makes identifying the true country of origin and investment difficult, but also many investing companies are multinationals (MNEs) with operations and shareholders in many countries so it is hard to have a clear definition of what is a “Swedish” or a “Russian” company. In addition, when different official data providers, in this case Statistics Sweden (SCB) and the Central Bank of Russia (CBR), report capital flows on the macro level, there are large discrepancies.

Private companies also gather company level data on FDI that can be aggregated and compared with the macro level FDI data. This data is on gross FDI flows and should not be expected to be the same as the net macro level FDI flows data but is a bit of a “reality check” of the macro data.

Figure 1. Average annual FDI flows

Fig1Sources: SCB, CBR, fDi Market, MergerMarkets

The reported annual average flow of FDI from Sweden to Russia varies from around USD500 million to USD1.2 billion depending on the data source. Russian flows to Sweden are rather insignificant regardless of the source but the different sources do not agree on the sign of the net flows (Figure 1).

The differences between data sources suggest that some caution is warranted when analyzing bilateral FDI flows. With this caveat in mind, there are still some clear patterns in the capital flows data from Sweden to Russia that emerge and carries important policy lessons in the current Russian economic environment.

FDI vs. Portfolio Investments

There is a large literature discussing the distinguishing features of FDI and portfolio flows (see Becker 2016 for a summary). Some of the key macro economic questions include which type of flows provides most international risk sharing; are most stable over time; or most likely to contribute to balance of payments crises when the flows go in reverse. In addition, there are potential differences in terms of the amount of international knowledge transfers and how different types of capital flows respond to institutional factors.

Figure 2. FDI and portfolio investments

Fig2Source: SCB

Figure 2 shows that FDI has been much more stable than portfolio flows in the years prior to and after the global financial crisis as well as in more recent years. Although all types of capital flows respond negatively to poor macroeconomic performance, and the stock of portfolio investments swing around much faster than FDI investments, i.e., portfolio flows go in reverse more easily and can contribute to external crises. This makes FDI a more preferable type of capital flow for Russia.

FDI and Trade Go Together

Since FDI is a desired type of capital flow, it is important to understand its driving forces. The first question to address is whether FDI and trade are substitutes or complements. Since the bulk of FDI comes from MNEs that operate in many countries, we can imagine cases both when FDI supports existing trade and cases when it is aimed at replacing trade by moving production to the country where the demand for the goods is high.

In the case of Sweden and Russia, the macro picture is clear; FDI has increased very much in line with Swedish exports to Russia (Figure 3). Both of these variables are of course closely correlated with the general economic development in Russia, but even so, the very close correlation between FDI and trade over the last 15 years suggests that they are compliments rather than substitutes.

Figure 3. Swedish Exports and FDI to Russia

Fig3Source: SCB

Most FDI is Horizontal

FDI flows are often categorized in terms of the main motivating force for MNEs to engage in cross-border investment: vertical (basically looking for cheaper inputs), horizontal (expanding the customer base), export-platform (producing abroad for export to third countries) or complex (a mix of the other reasons) FDI.

Looking at the sectoral composition of FDI from Sweden to Russia (Figure 4), most investments have come in sectors where it is clear that MNEs are looking to expand their customer base. Even in the case of real estate investments, a large share is IKEA developing new shopping centers that host their own outlets together with other shops. Communication and financial services are also mostly related to service providers looking for new customer. Only a small share is in natural resource sectors that would be more in line with vertical FDI, while there are very few (if any) examples of MNEs moving production to Russia to export to third countries.

Figure 4. Sectors of Swedish FDI to Russia

Fig4Source: SCB

Policy conclusions

The above figures on bilateral capital flows from Sweden to Russia carry three important policy messages: 1) FDI is more stable than portfolio flows; 2) Trade goes hand in hand with FDI; and 3) FDI to Russia has mostly been horizontal and driven by an expanding customer base.

In the current situation where Russia should focus on policies to attract private capital inflows, the goal should be to attract FDI. Instead, the government is now looking for portfolio inflows in the form of a USD3 billion bond issue. But FDI is a more stable type of international capital than portfolio flows and also come with the potential of important knowledge transfers both in terms of new technologies and management practices.

However, as we have seen above, FDI inflows have in the past been correlated with increased trade and an expanding Russian market. In the current environment, where imports with the West declined by 30-40 percent in the last year, GDP fell by around 4 percent, and the drop in consumers’ real incomes have reached double digits in recent months, it is hard to see any macro factors that will drive FDI inflows.

Instead, attracting FDI in this macro environment requires policy changes that remove political and institutional barriers to investments. The first step is to fulfill the Minsk agreement and contribute to a peaceful solution in Ukraine that is consistent with international laws. This would not only remove official sanctions but also provide a very serious signal to foreign investors that Russia plays by the international rulebook and is a safe place for investments from any country.

The second part of an FDI-friendly reform package should address the institutional weaknesses that in the past have reduced both foreign and domestic investments. It is telling that many papers that look at the determinants of FDI flows to transition countries include a ‘Russia dummy’ that is estimated to be negative and both statistically and economically significant (see e.g. Bevan, Estrin and Meyer, 2004 and Frenkel, Funke, and Stadtmann, 2004). One factor that reduces the significance of the ‘Russia dummy’ is related to how laws are implemented. Other studies point to the negative effect corruption has on FDI.

Reducing corruption and improving the rule of law are some of the key reforms that would have benefits far beyond attracting FDI and has been part of the Russian reform discussion for a very long time. It was also part of the reform program that then-President Medvedev presented to deal with the situation in 2009 together with a long list of other structural reforms that would help modernize the Russian economy and society more generally.

As the saying goes, don’t waste a good crisis! It is time that Russia implements these long-overdue reforms and creates the prospering economy that the people of Russia would benefit from for many generations.

References

  • Becker, T, 2016, “The Nature of Swedish-Russian Capital Flows”, SITE Working paper 35, March.
  • Bevan, A, Estrin, S & Meyer, K 2004, “Foreign investment location and institutional development in transition economies”, International Business Review, vol. 13, no. 1, pp.43-64.
  • Frenkel, M, Funke, K & Stadtmann, G 2004, “A panel analysis of bilateral FDI flows to emerging economies”, Economic Systems, vol. 28, no. 3, pp. 281-300.

Non-Tariff Barriers and Trade Integration in the EAEU

Posted on February 29, 2016 | Policy Brief

It is a commonly held view that the Eurasian Economic Union (EAEU) is a political enterprise (Popescu, 2014) that has little economic meaning other than redistribution of oil rents (Knobel, 2015). With a new reality of low oil prices and reduced rents, a legitimate question is how stable this Union is, or whether there is any hope for mutual economic benefits that can provide incentives to all the participants to maintain their membership in the Union? Our answer is yes, there is hope, but only if countries, especially Russia, make progress on deep integration such as services liberalization, trade facilitation, free movement of labor and especially in the reduction of the substantial non-tariff barriers (NTBs). NTBs are hampering trade both within the Union (World Bank, 2012; Vinokurov, 2015), as well as against third country imports. Our research shows (see Knobel et al., 2016) that all the EAEU members will reap benefits from a reduction of NTBs against each other, but they will obtain considerably more substantial gains from a reduction in NTBs against imports from the EU and China.

Since the early stages of creation of the Customs Union (CU) between Belarus, Kazakhstan, and Russia back in 2010, the economic benefits of the CU have been questionable. The main reason for this in Kazakhstan was the increase in its import tariffs in order to implement the common external tariff of the CU, which initially was Russia’s external tariff (Tarr, 2015). Kazakhstan almost doubled its average tariff from 5.3% to 9.5% (Shepoltylo, 2011; Jondosov and Sabyrova, 2011) in the first year of its CU accession. Belarus did not increase its average tariff, but the structure of its tariffs shifted toward a protection of Russian industry.

In 2015, the CU was transformed into the EAEU, and Armenia and Kyrgyz Republic have joined the EAEU. These two countries are WTO members; Kyrgyzstan entered the WTO in 1998, and Armenia in 2001. In 2014, the simple average most-favored nation (MFN) applied tariff rate in Armenia was 3.7%, and 4.6% in the Kyrgyz Republic. Due to differences between Armenia and Kyrgyzstan’s WTO commitments and the EAEU tariff schedule, the new members of the EAEU are not implementing the full EAEU tariff schedule. That is, they have numerous exemptions. However, they have started a WTO commitments modification procedure.

Despite adverse impacts from the higher import prices from implementing the common external tariff of the EAEU in Armenia and the Kyrgyz Republic, there are potentially offsetting gains. Given the importance of remittances to the Kyrgyz Republic, the benefits coming from the right of workers to freely move and legally work inside EAEU likely dominate the tariff issues. Armenia also benefits from the free movement of labor, receives Russian gas free of export duties, and wants to preserve the military guarantee granted by Russia through the six-country Collective Security Treaty Organization.

In the case of Belarus, it receives Russian oil and natural gas free of export-duties, which, when oil prices were high, tended to dominate their calculus. Kazakhstan hopes for more FDI as a platform for selling to the EAEU market; but President Nazarbaev has expressed concerns that the EAEU is not providing net benefits to his country.

To date, the members have judged participation to be in their interest, but with the plunge in the price of oil and gas, the calculus could swing against participation in the EAEU. That is why it is so important to achieve progress with deep integration in the EAEU. One of the most important areas of deep integration for the EAEU is the substantial reduction of non-tariff barriers in goods trade, both between the EAEU members and against third countries. Estimates by the Eurasian Development Bank (Vinokurov et al., 2015) reveal that NTBs account are 15% of the value of intra-union trade flows.

In our paper, Knobel et al (2016), we estimate substantial gains to all the EAEU members from a reduction of NTBs. We employ a global computable general equilibrium model with monopolistic competition in the Helpman-Krugman style based on Balisteri, Yonezawa, Tarr (2014). Estimates of the ad-valorem equivalents of NTBs were based on Vinokurov et al (2015) for the EAEU member countries and Kee, Nicita, Olarreaga (2009) for non-members.

We find that the effects of deep integration are positive for all countries of the EAEU. Armenia’s accession to the EAEU will have a strong positive effect only if coupled with a decrease of non-tariff barriers. Armenian accession is associated with an increase in external tariffs, which causes a negative economic impact and decrease in output.

The effect of deep integration in the EAEU will be even greater if any spillovers effect reducing NTBs for EAEU’s major trading partners are present. Knobel et al. (2016) simulate a 50% decrease in “technical” NTBs inside the EAEU and a 20% spillover effect of reduction NTBs toward either the EU and USA or China. Reduction of NTBs in trade with the EU and the USA dominates the comparable reduction of NTBs with China for all countries of the EAEU in terms of the welfare gain. Armenia’s welfare gain with a spillover effect towards the EU is 1.1% of real consumption compared to 1.02% with a spillover effect towards China. Growth in welfare in Belarus will be 2.7% with a EU spillover versus 2.5% with a spillover effect towards China. Kazakhstan’s gain in real consumption is also greater in the first (EU+USA) case: 0.86% versus 0.66% (with spillover towards China). Russia’s gain in real consumption in the case of a spillover effect with the EU is 2.01% versus 0.63% in the case of China.

Summing up, our findings suggest an answer to the recent concern about stability of the EAEU. We think that eliminating NTB, hampering mutual trade, and decreasing NTBs in either European or Chinese direction could provide mutual economic benefits that could tie countries of the EAEU together, thereby giving a much needed solid economic ground for the Union.

References

Did Russian Migration to Russia Affect the Labor Market?

Posted on January 25, 2016 | Policy Brief

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As a result of the collapse of the Soviet Union, five million Russian and Russian-speaking people repatriated to Russia during 1990-2002. I use this natural experiment to study the effect of a large migration wave on the employment and wages of the local population. Taking into account the non-random choice of location by migrants within Russia, I find a negative effect of the inflows of immigrants on the local population’s employment but not on wages. The initial negative effects on employment are particularly large for local men, but they disappear after about ten years from the peak of the migration wave.

The effect of migration on the labor market of the host country is a long-standing question within economic literature and in public debate. In many cases, researchers try to estimate this effect using the data on large and unanticipated migration movements. The most famous study of this kind is probably Card (1990). Another case is the Russian migration to Russia resulting from the collapse of the Soviet Union. According to the 2002 Russian Census, 5.2 million of the people living in Russia in 2002 resided outside the country in 1989. That is, 3.6 percent of the 2002 population immigrated to Russia after 1989. Almost all of them (94.4 percent) immigrated from the former Soviet republics, most notably Kazakhstan, Ukraine and Uzbekistan.

The existing literature on migration flows in the former Soviet Union (fSU) since its collapse has emphasized the socio-political factors of migration. Locher (2002) finds that ethnic sorting was a major determinant of migration among the fSU countries, with the countries’ stage of transition and wealth level playing a minor role. Yerofeeva (1999) shows that ethnic repatriation was one of the main reasons behind migration from northern and eastern Kazakhstan.

In Lazareva (2015), I study two sides of the labor market effects of the immigration from fSU countries to Russia. The first side is the process of assimilation of migrants in the Russian labor market. The second side is the effect that inflows of immigrants had on the labor market position of the local population in Russia. Data used for estimation span a long period of time, which allows for tracing dynamic long-term effects of the influx of immigrants. This is the first comprehensive study of the labor market effects of one of the largest migration waves in Europe in recent history.

Method

In order to estimate the effects of the inflow of immigrants on the employment and wages of the local population, I exploit variation in the share of immigrants across Russian regions. According to the Census in 2002, migrants were quite dispersed over Russia’s vast territory; their share in population varied from 0.42% in the Tyva region to 8.5% in the Kaliningrad region. A relatively large share of migrants is observed along the border to fSU countries as well as in the oil-rich regions of Western Siberia.

A major problem when using regional variation to estimate labor market effects is that the migrants’ choice of region may be affected by the condition of that region’s labor market. Naturally, migrants tend to choose locations with higher wages and more employment opportunities. If this is the case, the estimates of the labor market effects will be biased.

However, the immigrants’ choice of location was not completely unconstrained due to the costs of migration related to the distance and access to information. Given these constraints, there is a relative crowding of immigrants in the regions of Russia that are closer to the border with fSU countries. Hence, I use the variation in the share of migrants across regions, which depend on the geographical distance from the source countries. In other words, I obtain the estimates from the comparison of regions that are similar in all their characteristics except for the distance to the border with fSU.

Data and Results

I use panel data on households from the Russian Longitudinal Monitoring Survey for the period 1995-2009. In the 2009 survey, the respondents were asked since what year they live in the Russian Federation. I define as immigrants, people at the age of 18 and above who moved to Russia after 1989. Note that the RLMS sample, which consists of people residing in the same dwelling units in each round, is unlikely to include illegal migrants or temporary (seasonal) labor migrants. Rather these are mainly people who settled in Russia permanently at some point during the 1990s and 2000s.

In the RLMS sample, 3.6 percent of the respondents moved to Russia after 1989. This is consistent with the national-level statistical data on immigration flows. A majority of the immigrants arrived to Russia in the early and mid-1990s. Immigration peaked in 1994 when almost 1.2 million people moved to Russia. After that, immigration steeply declined; during the 2000s, the registered level of immigration was at about 200,000 people per year.

A majority of the immigrants (71.7%) in the RLMS sample are of Russian ethnicity, and there is a slightly higher share of males. Importantly, migrants are not significantly different from the locals in terms of their education levels. The statistics on marital status show that a higher share of migrants compared to locals have families and children. Apparently, family migration was a large part of this migration wave.

Using the methodology described above, I obtain an insignificant effect of the share of immigrants on the wages of the local population over the period of 1995-2009. The effect of immigrant share on the unemployment of the local population is also insignificant. In contrast, estimates for the labor force participation (LFP) show a significant negative effect of immigration on the LFP of the local population. The size of the effect is non-negligible: a one-percentage point increase in the share of immigrants in a region reduces the probability for a local person to be in the labor force by 0.6 percentage points. Thus, over the whole period of 1995-2009, Russian immigration is estimated to have had some displacement effect, but only in terms of the labor force participation of the local population.

Since the inflow of immigrants was mostly concentrated in the first half of 1990s, I estimate my model for three sub-periods: 1995-2000, 2001-2004, and 2005-2009. The results for the wages remain insignificant in all sub-periods. Immigration is shown to increase the unemployment among locals in the first half of 2000s, but this effect dissipated in the second half of 2000s. The effect of immigration on the labor force participation is negative and highly significant for the late 1990s, still negative and significant but smaller in magnitude in the early 2000s, and disappears in the late 2000s. This analysis suggests that the immigration wave had a quite significant displacement effect for the local population in terms of unemployment and labor force participation, but not in terms of wages. This effect slowly declined and had disappeared by the second half of 2000s. My results also suggest that the negative labor market effects were more significant for men than for women.

Conclusion

The results of this study have implications for the debate on the effect of immigration on local labor markets, in particular on wages and employment opportunities for the native population. The majority of existing studies find only minor negative effects of migration on the labor market position of locals. My results suggest that immigrants who are close substitutes to the local labor force, due to the common language and similar education, have more significant effects on the labor market outcomes of the local population.

The finding that displacement effects in Russia dissipated quite slowly may be related to the very low migration rates of the local population in Russia throughout the transition. In order to reduce negative labor market effects of large influxes of immigrants, policy measures are needed that improve labor mobility across regions. These may include moving or housing subsidies, retraining programs and policies ensuring equal access to jobs and public services for internal migrants across the regions of Russia.

▪

References

  • Card, David, 1990, The Impact of the Mariel Boatlift on the Miami Labor Market, Industrial and Labor Relations Review, Vol. 43, No. 2, pp. 245-257.
  • Lazareva O. Russian Migrants to Russia: Assimilation and Local Labor Market Effects //IZA Journal of Migration. 2015. No. 4:20
  • Locher, Lilo, 2002, “Migration in the Soviet Successor States,” Applied Economics Quarterly, 48 (1), 2002, 67-84
  • Yerofeyeva, Irina, 1999, “Regional aspects of Slavic migration from Kazakhstan on the basis of examples from North Kazakhstan and East Kazakhstan provinces”. In: Vyatkin, Anatoly, Kosmarskaya, Natalya, Panarin, Sergei (Eds.), V Dvizhenii Dobrovoljnom i Vynuzhdennom [In Motion—Voluntary and Forced]. Natalis, Moscow, pp. 154–179

Does Social Media Promote Protests?

Posted on November 23, 2015 | Policy Brief

 Author: Ruben Enikolopov, CEFIR.

Despite a lot of speculations about the role of social media in recent political protests throughout the world, there is still no persuasive empirical evidence to support these claims. We fill this gap by providing evidence that social media indeed played an important role in promoting political protests in Russia in 2011-2012. Using data on the dominant Russian online social network, VKontakte, we show that higher penetration of the social network across cities increased the likelihood of protest occurrence and the number of participants in these protests. Additional evidence suggests that reducing the costs of coordination is a mechanism behind social media influence.

Environmental Implications of Russia’s Accession to the WTO

Posted on October 26, 2015 | Policy Brief

Authors: David G. Tarr, NES and Natalia Turdyeva, CEFIR.

We investigate the environmental impacts of Russia’s World Trade Organization (WTO) accession with a computable general equilibrium model incorporating imperfectly competitive firms, foreign direct investment and endogenous productivity. The WTO accession affects CO2 emissions through technique (−), composition (+) and scale (+) effects. We consider three complementary policies to limit CO2 emissions: cap and trade, emission intensity standards, and energy efficiency standards. With imperfectly competitive firms, gains from WTO accession result with any of these policies.

Russia: Increasing Concentration of the Economy and Low Investment

Posted on October 12, 2015 | Policy Brief

Author: Oleg Shibanov, New Economic School and Corporate University of Sberbank.

The Russian economy became more concentrated in 2014. The new RBC-500 rating shows that the 643 largest companies in Russia produce 77% of the country’s GDP. Moreover, 94% of the net profit of these companies was generated in the oil and gas sector. This is up from 71% in 2013. This increasing concentration appears unstable at times of huge external shocks on commodity prices.

Urban Land Misallocation and Markets in Russian Cities

Posted on June 8, 2015 | Policy Brief

Authors: Paul Castañeda Dower, CEFIR and William Pyle, Middlebury College.

Former socialist countries inherited factory-dominated cityscapes since planners made industrial location decisions in relative ignorance of land’s opportunity costs. Drawing on unique survey evidence and policy variation across territorial units within Russia, this brief discusses the relationship between land tenure reforms and land reallocation. The evidence points to land privatization as an important factor in the reallocation of land in Russian cities.  

Expected Effects of Tobacco Taxation in Five Countries of the Former Soviet Union

Posted on May 18, 2015 | Policy Brief

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Authors: Irina Denisova and Polina Kuznetsova, CEFIR.

In this policy brief, we discuss the results from a study of different dimensions of tobacco taxation policy in five former Soviet Union countries: Belarus, Kazakhstan, Kyrgyz Republic, Russia and Ukraine. We find that the increase in budget revenue from raising excises on filter cigarettes is high in all studied countries. Furthermore, due to a low elasticity of the demand for cigarettes, the increase in excise taxes needs to be substantial to lead to a noticeable improvement in public health.  

New Light on the Eastern Front – Contributions from Russia to the 70th Anniversary of the Victory in Europe in World War Two

Posted on May 4, 2015 | Policy Brief

Author: Lennart Samuelson, SITE.

Interesting results of the post-Soviet research on the Second World War are now presented in 12 imposing volumes, Velikaia Otechestvennaia Voina 1941 –1945 (Great Patriotic War 1941–45) written by specialists in military, political, international and economic history. Each chapter reflects the research frontier. Their style contrasts positively against Soviet works during the Cold War, and also against renewed anti-Russian historical campaigns in the West in recent years. Open archives, abolition of censorship, freedom of print as well as joint projects with Western scholars are the preconditions for progress in the historiography of Russia in the 20th century in general and of the Eastern Front during World War Two in particular.

A Russian Sudden Stop Still a Major Risk

Posted on April 27, 2015 | Policy Brief

Image from central Moscow with red traffic lights representing Russian sudden stop of the economy

The Russian economy is facing serious challenges in 2015 even after the currency and stock market have strengthened on the back of (expectations of even) higher oil prices. Policy makers that ignore these challenges may be in for a rude awakening when more statistics on the real economy are now coming in. It is time that actions are taken to deal with Russia’s structural problems, mend ties with its neighbors that are also important economic partners, and refocus political priorities towards generating growth and prosperity for its population. In the long run, this is what creates the respect and admiration a great nation deserves.

Recent developments

The value of Russian assets, including shares and the currency, was more or less in free fall in the second half of 2014 and into the beginning of 2015. The annexation of Crimea and continued fighting in Eastern Ukraine and the associated sanctions contributed to a general loss of confidence in Russian assets, but the fall in international oil prices was an even more decisive factor (for a detailed account of the sanctions, see PISM (2015)).

Figure 1 shows how the stock market first took a big hit at the time of the invasion of Crimea, but then recovered before the massive downturn in mid-2014 as oil prices collapsed. The ruble followed a similar path, but with less volatility than the stock market, which is not too surprising given that the Central Bank of Russia (CBR) intervenes to stabilize the currency. However, the ruble had a short time of extreme volatility in mid to end-December when the uncertainty about the impact of financial sanctions was very high.

Figure 1. Oil price, Ruble and Stocks

fig1Sources: CBR, US EIA, MICEX

Financial sanctions were particularly troubling since Russian companies, both private and state owned, have significant external debt that became increasingly hard to refinance. The magnitude of this external debt is also such that it is not a trivial matter for the government or central bank to handle despite the fact that public external debt is very low and international reserves are among the largest in the world. As a matter of fact, external debt was around $250 billion more than then the value of CBR’s international reserves at the peak, but the difference has come down somewhat to around $200 billion as external loans had to be paid back when new external funding was not available at attractive terms.

Sudden Stops

Before turning to the outlook for the Russian economy, a short discussion of sudden stops is warranted. “Sudden stops” is short for sudden stops or sharp reversals in international capital flows. Sudden stops and its effects on the real economy have been analyzed for some time now (see Calvo (1998) for an early contribution). Becker and Mauro (2006) concluded that sudden stops have been the most costly type of shock for emerging market countries in terms of lost GDP in modern history. In their study the average country that experienced a sudden stop had a cumulative loss of income of over 60 percent of its initial GDP before recovering back to its pre-crisis income level.

Sudden stops in capital flows have such large effects on the real economy because of the adverse effects reduced external funding has on imports. A first look at the accounting identity for GDP (GDP=Y=C+I+G+X-M) makes it hard to see how reduced imports can be a problem since imports (M) enter with a negative sign. This in itself suggests that reduced imports should increase GDP. However, imports are used for domestic consumption (C) or investment (I), two factors that enter the same identity with positive signs, which means that when they fall so does GDP. If this were the full story, the net effect on GDP from falling imports would be zero since the positive direct effect from imports would be exactly offset by reduced domestic consumption and investment.

Unfortunately the accounting identity does not make clear the dynamics that follow from this reduction in consumption and investment. For example, the foreign car (or machine) that is no longer imported and will not be sold, will also not require a domestic sales person, annual service, a parking space etc., so the eventual decline in consumption (or investment) will be much larger than the first round effect that is captured by a static accounting relationship. This is one reason why “improvements” in the trade balance stemming from the sudden decrease in imports is not necessarily a good thing for the economy.

Russia is also part of the international financial system with important capital flows both in and out of the country. As such, it is also subject to the risk that changes in sentiment and large capital outflows can affect imports and the real economy. For a time before the global financial crisis, net capital flows to Russia tended to be positive. However, this changed in 2009 and since then most quarters have been showing outflows.

Figure 2. Private Sector Capital Outflows Continue (Q1 2015 in red)

fig2Source: CBR

The speed of outflows picked up dramatically in 2014, reaching more than $150 billion for the year. The general picture of outflows has continued in the first quarter of 2015, with outflows of around $35 billion (which for comparison is twice the $17.5 billion IMF package that was agreed for Ukraine in March 2015). Although Russia still has resources to support a high level of imports, the more capital that leaves, the less money there is to spend and invest in the country.

The Outlook

Everyone knows that Russia generates most of its export revenues from natural resources in general and from oil more specifically. The fact that the health of the economy is closely related to international oil prices is no secret either and Figure 1 showed the tandem cycle of oil prices, the ruble and the stock market. But how important is oil prices as a determinant of GDP growth? This is of course a big question that requires sophisticated thinking and modeling to figure out at a more structural level. But if we are just looking for a back of the envelope estimate, a simple regression of growth of oil is potentially interesting. Perhaps somewhat surprisingly, oil price growth has very high explanatory power: regressing annual changes in GDP per capita in real dollar terms on annual changes in real oil prices (and a constant) for the period 1998 to 2014 generates an R2 of 0.64! Not bad for a one variable macro “model” of the Russian economy. The coefficient on real changes in oil prices is estimated to be 0.15 and hugely significant and the intercept, which could be interpreted as the underlying growth rate in this “model”, of 2.4%.

Using the same IMF data on the real oil price for the first three months of 2015 and comparing that to the average oil price for the full year 2014 implies a drop in the real oil price of 46 percent. Using this oil data as the forecast for all of 2015 and plugging this into the estimated equation suggests that the oil price drop in itself would be associated with a decline in income of almost 7 percent. Adding back the underlying growth rate of just over 2 percent still means a negative growth rate of almost 5 percent in 2015, without even starting to think about sanctions, capital flows or structural problems.

However, there is more data that points in the directions of the economic troubles that lay ahead in 2015, which is trade data. We just discussed the importance of sudden stops and associated drops in imports in explaining large drops in output in emerging markets. Figure 2 already showed the continued capital outflows, and Figure 3 provides a scatter plot of changes in imports and GDP growth. Over the years, Russia has displayed a strong positive correlation between import growth and GDP growth that is in line with the description of sudden stop dynamics.

Figure 3. Imports and GDP Growth (Q1 2015 in red)

fig3Source: Author’s calculations based on CBR and the Federal State Statistics Service (GKS) data

Figure 3 shows the import change in Q1 2015 (i.e., Q1 in 2015 compared to Q1 2014) as a red diamond and puts it on the linear regression line of past observations to get the implied GDP growth number for Q1 2015. First of all, the 36 percent drop in imports is at an all time high for the decade and at roughly the same level as in the worst quarter of 2009 in the global financial crisis. The implied drop in GDP is 10.5 percent (compared with a drop of 9.5 in the worst quarter of 2009). Again, this is not a formal model to generate GDP forecasts, but it is certainly a signal that suggests that the Russian economy has problems to deal with.

Concluding Remarks

The IMF (2015) just released its latest forecast for Russia together with the other countries of the world. The projection for 2015 is a decline of real GDP of 3.8 percent, which is not a great growth number by any means but less negative than what was discussed at the end of 2014. The Economist (2015) in its latest issue is also quoting a banker who says that the situation is not as bad as was previously imagined. The upward revisions have also led to statements among policy makers that seem to suggest that the problems for the Russian economy are behind the country.

Although the free fall associated with the sharp drop in oil prices is halted, recent data on capital flows and imports suggest that the problems for the Russian economy are far from over. If oil prices stay at current levels, capital outflows continue, and imports remain as suppressed as they were in the first quarter, the fall in GDP may be in the same order as in 2009. At that time GDP declined by 8 percentage points, or more than twice the recent forecasts for 2015.

Russian policy makers need to make serious structural reforms and mend ties with its important economic partners near and far to put the country on a more healthy growth trajectory. Simply praying for increasing oil prices is not enough; it is time that Russia becomes the master of its own economic faith.

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References

  • Becker, T., and P. Mauro (2006), “Output drops and the shocks that matter”, IMF Working Paper, WP/06/197
  • Becker, T. (2014), “A Russian Sudden Stop or Just a Slippery Oil Slope to Stagnation?”, BSR Policy Briefing 4/2014, Centrum Balticum
  • Calvo, G. (1998), “Capital Flows and Capital-Market Crises: The Simple Economics of Sudden Stops,” Journal of Applied Economics, Vol. 1, No. 1, pp. 35–54.
  • Economist, The (2015), “Russia and the West: How Vladimir Putin tries to stay strong”, April 18-24 issue
  • IMF, (2015), World Economic Outlook, April
  • PISM, (2015), “Sanctions and Russia”, Polski Instytut Spraw Międzynarodowych, (The Polish Institute of International Affairs)

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