The impact of sanctions and falling oil price on Russia’s economy

The drop in the price of Brent oil from US$115 a bbl in June 2014 to US$65 a bbl in May 2015 represented an important development for the Russian economy. As over 50% of the Russian federal budget is founded upon the energy industry, low oil prices have weakened the currency and reduced the country’s revenues.

The 2014 federal budget was calculated with US$93-a-bbl oil prices in mind, while 2015 counted on about US$95 a bbl. Due to the mix of sanctions and cheap oil, the economy is expected to contract by at least 3% in 2015. Furthermore, Russian banks and companies have a total external debt of nearly US$660 billion and have to raise US$105 billion to repay their creditors in 2015 alone. Without access to Western capital markets due to sanctions, this puts additional strain on the economy.

Nevertheless, the Russian economy is pretty large and even the dramatic fall in the oil price cannot cause a dramatic and immediate negative effect. The effect is likely to be felt 6-12 months down the road unless the oil price recovers. Furthermore, the Russian government is seeking to mitigate the country’s difficult economic situation by borrowing, reducing expenditures and spending money from the reserve fund built up when oil prices were higher. The state will also capitalise the banks and may increase its stake in them. In turn, the banks may buy industrial enterprises and become financial-industrial groups.

Not every sector of the Russian economy will shrink however. As with other emerging economies, lower oil prices will help manufacturing and agriculture to expand, and a weak ruble will help exporters. The Russian balance of payments will most probably stay positive, thanks also to the reduction in imports, and reserves remain quite liquid. In the long run, Russia should try to develop industries other than energy and break the ruble-oil link in order to reduce volatility. The current link results in appreciation when the oil price goes up and depreciation when it goes down, with consequent inflationary highs and deflationary lows.

Adapted from press release by Joseph Green

Published on 22/05/2015

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