Time to Prepare Your Business in Russia for Crisis

Russia has been one of the few CEE markets with strong growth as the eurozone crisis drags Eastern Europe into recession. Russia’s GDP expanded 4.9% YoY in Q1 2012 and the economy seems set on a stable trajectory for the rest of the year. This stability, however, is illusionary.

Russia’s growth is already slowing down compared to 2011, a trend that plays out both in the consumer and in the industrial sectors. This is not surprising – both the IMF and the Russian government itself have already warned that Russia’s ability to grow on the back of high oil prices has reached its potential. The economy is set to grow at a sluggish 3-4% per annum unless there are major structural reforms to reduce red tape and improve the business climate in the country.

With Putin back in the Kremlin, none of these reforms are likely to materialize. The recently-announced new Russian government, dominated by Putin loyalists and weak bureaucrats, is unlikely to be a major driver of policy change. Putin’s agenda remains heavily centered on the energy sector, maintaining a large public sector, and sustaining high social spending. His program will only increase Russia’s dependence on oil prices.

In the near term, significant external risks loom over the economy. Global oil prices are unsupported by demand-supply fundamentals and are already on their way down; a deeper eurozone crisis will lead to their further decline. Brent prices declined by 25% in the last three months and the worst of the eurozone crisis is still ahead of us. As Russia’s dependence on oil prices has increased since the 2008-2009 financial crisis, the impact of an oil price bust on the economy will be severe – S&P estimates that Russia will enter recession if oil prices fall below US$80 per barrel.

As a result, Russia’s prospects should be a source of concern, rather than optimism: in the short term the economy is slowing, in the medium term the eurozone crisis poses a significant risk of recession, and in the long term there is little reason to expect growth to improve significantly. While none of these risks have fully materialized yet, companies with significant exposure in Russia need to prepare now to respond to them.