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Economics & Finance

Russia’s Invisible Economy

Shellie Karabell, Editor-in-Chief |

It’s not all about exporting natural resources to the developed world. Russia has a vibrant network of SMEs operating under the radar screen, fuelling growth.

Think of Russian business and an image of burly businessmen making deals in oil and gas comes to mind.   But Russia’s economic life today is more than digging commodities out of the ground and selling them through listed companies such as Gazprom and RUSAL. Granted, this is where the bulk of Russia’s export revenues come from and some 50 percent of the Federal budget is derived from direct taxation of the oil sector. However, the real economic growth in Russia comes from elsewhere, according to Evgeny Gavrilenkov, chief economist of Sberbank, the largest retail bank in Eastern Europe, and the third largest by assets in Europe. It is the people’s bank of Russia – founded some 170 years ago by Tsar Nicholas I, and serving 70 percent of the country’s retail banking customers.

“This raw materials extraction sector didn’t grow at all in material terms in the last several years – just 0.5 to 1 percent a year,” Gavrilenkov told INSEAD Knowledge in an interview in his offices in central Moscow recently. “There was growth in nominal terms because of higher oil prices, but in real terms, the extraction of oil and gas was not growing.”

The Russian economy, however, has been growing ahead of Brazil, South Korea, Turkey, and much of the Western industrialised countries: 4.3 percent in 2011 and 3.4 percent in 2012, according to World Bank statistics. It’s still a relatively small economy: GDP is running at roughly two trillion dollars a year. Public debt was just 10 percent of GDP last year, thanks to oil prices and a trade surplus.  Unemployment in Russia last year was a record low of 5.4 percent - lower than Western Europe and the U.S. – while wages have increased at a steady pace. But of the 71 million Russians working, only one million work in the raw materials sector, says Gavrilenkov. So where are the other 70 million working?

“It’s a hidden part of the economy, these local producers – small and medium-sized companies - who are responding to consumer and investment domestic demand,” he explains. “They normally don’t borrow that much, they are not listed. Nonetheless, that’s where the growth comes from. That’s the driver of the Russian economy.”

Consumer Overheating?

Recently, however, that consumer demand has been fuelled by borrowing: consumer loans ballooned by nearly 45 percent last year, and that worries the Sberbank chief economist. “That’s too much – the economy doesn’t grow that fast; when demand grows that fast it means that risks are not taken into account. This is a clear sign that there is overheating on the consumer side.”

Inflation in Russia was already at 7.1 percent in January of this year according to the World Bank, up from 4.2 percent in January of 2012, so Gavrilenkov’s concerns are not without foundation. He cautions the Central Bank to be more conservative, but fears his warnings are falling on deaf ears because the Russian Finance Ministry itself has been borrowing despite a balanced budget last year (and a surplus the year before) and no obvious need for financing.  “They had this strange idea of replenishing the reserve fund via domestic borrowing,” he recalls. “ They borrowed locally at let’s say 7 percent and then they put this money into the reserve fund – into (dollar-denominated) U.S. treasuries, junk bonds and other low-yielding instruments.”

The result?  Capital outflow, and Gavrilenkov is not happy about it. “If the government does that – borrow locally and convert those rubles into dollars – why should others bet against the Russian Finance Ministry?”

He’s worried that all the quantitative easing in the U.S. could drive down the dollar, and is not really helping the Western economies; “Printing money doesn’t stimulate structural change,” he points out. “On the contrary, it preserves the existing structure… what major central banks are now doing is exactly the same as what the Central Bank of Russia was doing in the 1990s [ed note: amassing crippling public debt and propping up the ruble so precariously that it crashed, sending the Russian currency from 7R to the dollar to 28R overnight in August, 1998]. “The difference with the ruble is that it wasn’t a reserve currency and Russian institutions and the scale of the Russian economy were very different then.”

Today the Russian ruble is fully floating but – because of the country’s dependence upon the oil sector for its foreign trade – is subject to gyrations fuelled by fluctuating oil prices. Over the past 12 months, the ruble has held to a trading band of 33.7 to the dollar (June 2012) to 29.3 to the dollar (February 2013). In April 2013 the exchange was hovering around 31.3 R to the dollar.

Gavrilenkov is no stranger to Russian economic policy, starting with Gosplan’s Bureau of Economic Analysis and continuing through the market-driven bureaux of economic modelling and analysis, before moving into the chief economist role at Russia’s first and most important investment concern, Troika Dialog – which was acquired by Sberbank in 2012. He’s also been a visiting researcher at Hitotsubashi University in Japan, as well as in Finland, Paris and at the IMF.

Foreign Influence

Gavrilenko's Take on the Rest of the World 

Western Europe and the United States: Given the debt burden we have in the developed part of the world, I wouldn’t expect economic growth at more than two percent in the next decade.

Russia: This country has a chance to grow slightly more, but I don’t expect six or seven percent as we’ve seen in the past decade; I think four percent is more likely. That can easily be achieved with proper domestic policies. If these are not good then growth will be slower.

China: It’s already half of the U.S. economy: almost eight trillion dollars. It can’t grow indefinitely at around eight to ten percent; otherwise, there won’t be enough resources on the planet for China. So China has to slow down as well: four to six percent would be normal in my view. This will bring overall global growth to about three percent – back to what we have seen as “normal” in the past.

Chief concern: I hope there will not be any major overheating. There is a major uncertainty regarding debt restructuring and how it’s paid off. 

He sees a net influx of foreign workers these days – unlike the 1990s when new travel reforms allowed Russians to emigrate more freely. “If you look at the immigration balance today, there are more Germans coming into Russia than Russians leaving for Germany; the same is true for other countries: there are more Greeks coming to do business in Russia. Clearly business culture is being brought into Russia – not just from the major oil companies but from a number of small and medium-sized companies from Finland, Sweden, and again Germany  – they are here doing business with our SMEs. And they bring with them skilled labour and modern business practices. We see this, for example, in the Kaluga region near Moscow where there is a lot of auto-making business.”

WTO membership, expectable in the next six years, will be another modernising force for business, though with little impact on the Russian economy or consumer.  “Russia’s import tariffs are not that high,” he points out.  “And foreign exchange rate fluctuations would offset those cuts, so I don’ t expect WTO membership will have a major impact on consumers.  But in the longer term, joining the WTO means that we’ll be subjected to stronger pressure, which is good… always good. The main beneficiaries in the longer term are Russia’s medium-sized companies which are not seen now by the West and the rest of the world; they may have the opportunity to start exporting something.”

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