Russia needs to come up with a new growth model

Russia oil
The scary part is inside the dotted square: GDP slowdown even with high oil prices. Morgan Stanley

Russia’s eyeing its second recession in just seven years.

This is no surprise: the 40% oil price drop slammed an economy whose energy sector makes up 20% of the GDP, and western sanctions added salt in the wound.

However, those are just the short-term obstacles that’s Russia is facing.

“[T]he growth slowdown in 2011-2013, with oil averaging over US $US110/barrel, reveals a structural component to the current slowdown,” according to Morgan Stanley’s Alina Slyusarchuk.

“Structural headwinds to growth including a shrinking and ageing population, high capacity utilization, a flat oil production outlook with oil prices lower for longer and restrictive conditions for fixed investment mean that the government needs to look for new drivers of growth,” she adds.

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So far, Russia has focused on a three-fold growth strategy that benefits its domestic producers (aka the oil and gas guys): import substitution, a weaker ruble, and a reduction in labour costs.

However, Slyusarchuk writes in her note:

“An import substitution policy is likely to restrict modernization and productivity growth in the medium term, as technological imports play an important role in domestic investment and the production process [and] is also likely to result in inflation pressures.

We see a risk that the policy of a weaker exchange rate will preserve the old structure of the economy, with a prevalence of export-oriented commodity-based sectors, while high-tech industries are likely to suffer.”

As a result, MS analysts suggest that investment growth is the “key for successful import substitution and productivity growth.”

However, Russia’s foreign policy agenda might affect business confidence and delay structural reform — meaning that investment prospects aren’t looking too hot right now…

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