The Tale of The Russian Economy and Kiosks

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By Christopher Weafer

As usual, the arrival of spring and the prospect of summer always lightens the mood in Moscow. This year that positive trend is also getting a boost from the better rouble exchange rate, a more optimistic tone from state officials and the relatively improving trend in the economy. I say ‘relatively better’ because the economy is still in recession but the pace of decline is much slower than was the case through all of last year. The State Statistics Service announced that the economy fell by only 1.2 percent in Q1 over the same period of last year. That compares with an average decline of 3.7 percent for 2015.

There is always an ‘however’ when any article about the economy starts with good news. This one is no exception. A big part of the reason for the much smaller decline in because the Statistics Service has changed the way it calculates some data and has moved the reference base from 2008 to 2011. That makes a difference and has ‘technically’ improved the headline result. The second point to make is that the sector which led last year’s decline, i.e. retail and consumer activity generally, is still reporting a five to six percent drop year on year and that is on top of last year’s ten percent decline. So most individuals and households continue to experience a lifestyle deterioration, albeit at a slower pace than previously.

But so as not to be branded a kill-joy, it is fair to say that the economy has now definitely passed the worst and that is a reason to be hopeful. The country has proven to be much more resilient than many had expected given the scale of the oil price fall and sanctions which forced the country’s banks and corporations to return almost $250 billion to international creditors over the past 24 months. At today’s exchange rate that is about one-quarter of the entire GDP. Most other countries would have collapsed under that pressure so resilience – or maybe stubbornness – is a very apt description.

But surviving and passing the bottom are still a long way from meaningful recovery and growth. These are two entirely different issues. Moving to a sustainable growth trajectory will require fundamental changes in the way the economy works. A return to the old model of trickle-down oil wealth will no longer drive the growth required. Relying on that course will certainly lead to near stagnation, or growth so low that it will feel like stagnation. The better news is that at least it appears that a growing number of officials in policy-making, or policy influencing, positions have more openly embraced that fact.

A very good analogy to understand where the economy is today and how the transition will feel is to consider what has happened to the kiosks in Moscow. As people who have lived in the city in the 1990s and noughties know well the transition from the Soviet-era centrally controlled economy to free (er) enterprise resulted in the emergence of thousands of kiosks in perekhods, street corners, train stations, etc. These quickly became a core part of the emerging retail and service sector. It was the easy route to follow to satisfy people’s demand for goods and services while a more structured retail sector, such as shopping malls and fixed shop units, developed more slowly.

Residents of Moscow at one point were almost entirely reliant on these small units for such services as photos, key cutting, electrical parts, buying flowers and the innumerable units selling women’s clothing the nature and purpose of which being unfathomable to most males. Kiosks made life convenient. Now that they have been so abruptly removed life is much less convenient and most of us complain that we don’t know where to go anymore for these life easing goods and services. Of course you can still get everything but it takes greater effort and more time.

Kiosks were always an anomaly. The proliferation of these units is not something you see in major developed cities in Europe or the US. They emerged as a stop-gap to satisfy a public need during the unique period in the country’s history which was the transition from communism to consumerism. But, complain as we will, it is time to move on to a more normal and regulated economic structure. Eventually there will be more corner shops and fixed location convenience stores and the convenience of life will return. Online retailing, or E-Commerce, one of the fastest growing segments of the economy, is already replicating, actually enhancing, the convenience of consumer life.

But there is a transition period during which life will be less convenient. Arguably it would have been better to ease out the kiosks rather than bull-dozing them so quickly. This is where the analogy with the economy is evident. The strong growth recorded in the economy in the noughties was primarily driven by double-digit growth in retail, financial services and some other related sectors such as construction. All of which was indirectly funded with the $3 trillion worth of oil and gas export revenues not so much earned as injected into a low base economy. Economic management could not have been more convenient. Hydrocarbon wealth was the economy’s kiosk.

Now that revenue stream has been sharply reduced and with the unexpected speed at which the kiosks were removed. Managing the economy is a lot less convenient for the government and it too is now looking at alternatives. The oil kiosk is no longer available or, not as abundantly as before, so new locations for revenue have to be found. The indications are that a great deal of hope is being invested in the import-substitution or localization plan which, in theory, should not only see the economy become self-sufficient in basic goods but create a broader manufacturing base from which to grow non-extractive industry exports. It is the right strategy to pursue but, as with life without the kiosks, it will require a new approach and will be frustrating during the adjustment period. But, also as in the case of the kiosks, there is now no other choice; the oil wealth driver is gone forever. As was seen in 2013, even $110 per barrel average oil can now longer grow the economy as it previously did.

As for the outlook for the oil price and for the rouble exchange rate over the summer months? Both look over-stretched currently. As everybody now understands, the primary driver of the rouble exchange rate is the oil price. In turn the primary driver of oil, over the medium term, is what actions the Saudi’s take at the June OPEC meeting, what happens to US shale and Iranian oil production and how soon the Canadians can put out the devastating fires and restore the oil flows from the Alberta Sands. A big part of the reason for the rise in the oil price in recent months was the favourable (for oil) trend in these factors. But the fires will be put out and US shale volumes are more likely to stop falling or even start to recover with a near $50 oil price. The greater likelihood is that the price is near a medium peak and will slide lower in the summer and early autumn. The rouble has not strengthened as much as the oil price since early February mostly because currency traders are also sceptical about the sustainability of the oil rally. Still, the safer bet is that both will slide in the coming months.

Let me finish with another however. The threat of a steep rouble collapse, as was the case in late January, has also now eased. The trading range is more likely to be relatively narrower for the rest of this year than was the case in 2015. The rouble too has passed the worst but, as is the case with the economy and life without the convenience of kiosks, the way forward will be frustrating and difficult for some time to come. At least now we can be more confident that there is a more positive way forward.