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Weathering the economic winter

“Выйди замуж за Морозка, станешь богатой”

Из русской сказки пересказанной В. Панюшкиним

 “Marry Father Frost, and you will become rich”

From a Russian fairy tale retold by Valery Panyushkin


In the longest of a recent spread of articles focused on Russia, the Economist begins its coverage in a restaurant, where items targeted by western sanctions have reportedly disappeared from the menu.  This is then linked to the imminent threat of an economic recession which Russia faces, following the introduction of sanctions against Russia.

The Economist is right that Russia does indeed find itself in a very precarious economic position.  However the idea that this has been predominantly brought about by sanctions is very misguided.  Russia’s biggest problems are entirely of its own doing.  And it is this very fact which should allow the ‘wounded bear’ to weather the storm. 

To start with, we should highlight the nature of Russia’s problems. While the Economist implies that incorrect decision have been made in the past, it is rather through a lack of decision-making by the Russian government that these problems have been created.

The lack of crucial decisions is visible in several key areas, including the hardly justified exchange rate of the national currency, the depth and development of local capital markets, and the maintenance and expansion of capital infrastructure. What these areas suffer from is neglect, rather than any kind of deliberate sabotage. The Economist argues that the largest state and private corporations have grown disproportionately compared to available capital markets, but in fact there has often been a misalignment between the terms of debt and the investment period of the projects for which this debt had been sourced. So it is not that the Russian majors cannot service their debt, they simply cannot refinance it through new issues to correct such misalignment. If we look at both the corporate and sovereign debt as a proportion of GDP, Russia is still far below the OECD average.

While it might be true that Russia has not fostered sufficient competition in industry, we must not get mixed up about the reasons for why the current challenges have occurred.

As the investment bankers’ slogan goes, “when the wind blows, the chicken flies”, and it is fair to say that the current government has been fortunate over the past fifteen years: the macroeconomic conditions surrounding its trade and exports have been more favourable than at any time since the late nineteenth century. Rather than being seen as the endgame for Russia’s economy, the present circumstances are better viewed as an experience which is at last forcing the country to take stock of missed opportunities.

In fact, a correction in the stock market should have few implications for direct investment, since in Russia the stock market’s reach across the sectors of national economy is very limited. I have long argued that any sensible investment portfolio which includes Russia cannot be compiled relying on publicly traded instruments alone, since penetrating such lucrative sectors, including food production and private healthcare to name a few, is only possible through PE or direct investments.

It is also worth noting that Russia is far from unique in suffering at the current time due to the combined effects of falling commodity prices and underutilised domestic capital. The week before, the Economist wrote that large state-owned enterprises in countries as diverse as Brazil, Vietnam, India and the United Arab Emirates are suffering similar problems – governments globally have become distracted from shoring up the fundamentals during the good years.

Russia has a clear to-do list, irrespective of any sanctions the West might introduce. Domestic capital markets must be deepened, investment opportunities expanded and the broader trade situation rectified, including the value of the currency. On the latter point, the current downturn is doing some of the economics planners’ work for them: oil prices are forcibly bringing the rouble down to a level which makes more sense for purchasing power parity. The latest pressure on the rouble also appears to be spurring some growth in long-neglected domestic manufacturing, which saw a notable 2.9% uptick in October.

If there is one thing to be said of Russians, it is that we are experts at seeing out harsh conditions to the end. This can be seen each year with the first snow – every time it brings about surprise and disruption. But within a week, the country is back to business as usual. The current ‘first snow’ conditions serve as a timely wakeup call for the country. The government is in the fortunate position of having the support of the population as a backdrop for making the necessary policy reforms and rebalancing the economy.

If we accept that there will be no economic collapse, the big question is: where exactly can Russia look for the road out of its troubles?

This raises a whole host of debates about future possibilities, across a range of sectors. Tellingly, in its short profile of Kaluga, the Economist alluded to one such area in which investment conditions are stable and actively incentivised by smart local governments. But as I have also described on previous occasions, Kaluga is far from alone in offering an attractive investment environment in somewhat ‘off the beaten path’ locations.

Russia must now tread a relatively unknown path of its own, taking measures to improve access to capital and spur on domestic innovation, investment and industry. In the end, however, if the country emerges with a more balanced economy and a wider spread tax burden, with no industry being regarded as vital / critical to balance the books, I would be hesitant to label the current developments as necessarily bad. Even if this is a label that we often see in the Economist and elsewhere.

The quotation at the head of this piece references the Russian fairy tale about Morozko (Father Frost) who could bring death to the unworthy, and riches to the patient and virtuous. But the Russian winter and colds have also prompted the folk to create the beautiful and enchanting story of Snegurochka (Snow Maiden). According to the story, an old man and woman made her from snow because they had always wanted a daughter, and she was brought to life by Father Frost. She has always been an essential part of the New Year’s celebrations in Russia. Young, beautiful, and smiling, she always travels with Father Frost on a horse-drawn troika sledge to visit children and to give them gifts; she acts as a mediator between Father Frost and the children.

Essentially, Morozko and Snegurochka are two sides of the same coin: products of the harsh conditions that our ancestors had to endure to survive. But if one brings potential death, the other brings joy and gifts to the young and old alike, on the night of the year’s favourite celebration.

Russians have a long history of being confronted with extreme adversity, and eventually managing to flip the coin towards prosperity. Knowing Russia and Russians, my instinct is that this is exactly what Russia will do again on this occasion (at least until the next snow). But in the mean time, even though I personally like the cold, it makes little sense to wonder out in the wild without a nice woolly sweater and a Gore-Tex shell ;)

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