HSBC to Keep Headquarters Located in London

By John Gallagher,
International Business Assistant Editor

After a 7.8 percent contraction in GDP during the global financial crisis in 2009, Russia’s economy looked like it had regained its footing, rebounding with 5 consecutive years of growth, with the economy growing more than 3 percent annually in three out of five years during that stretch.  However, in 2015 amidst low oil prices and western sanctions placed on Russia over their annexation of Crimea, Russia’s economy fell back into recession as their gross domestic product fell 3.7 percent.  To make matters worse, they suffered inflation of 15.6 percent and a sharp devaluation of their currency, the ruble.

The CIA World Factbook cites the reason for the recession as “a combination of falling oil prices, international sanctions, and structural limitations.” Russia has the 8th largest labor force in the world and a relatively low unemployment rate of 5.4 percent, although with the recession that figure is closing in on 6 percent. Many Russians spend over 50 percent of their income on food and over 25 percent of the population is living in poverty according to CBCNews.

In order to cope with a falling currency, Russia, unlike China, allowed their currency to depreciate, rather than burning through foreign reserves. This left them excess cash to finance the void in their budget left by lower oil prices while not burning foreign exchange to the lost cause of a stable exchange rate. Luckily enough for Russia, Brent crude, the global benchmark, was trading at above $100 a barrel from February of 2011 through September 2014, making their largest export extremely profitable.  During this time, the Russian government increased their foreign reserves stock pile to $500 billion according to Bloomberg data. Unfortunately for Russia, the ruble collapsed as the prices of oil plummeted, and an untimely application of western sanctions on Russia essentially cut off their access to western capital markets, a deadly combination deterring investment, increasing the price of goods for Russians, and crippling their economy.

The government had previously forecasted and created the budget under the assumption of their oil exports selling at $60/barrel.  They had to readjust that figure down to $40/barrel after the collapse in crude prices.  The currency has depreciated 50 percent since the collapse of crude prices and their central bank reacted by lifting interest rates from 10 percent to 17 percent overnight in an attempt to attract yield seeking investors to Russia.

Russian central bank actions have been very interesting to watch as they have decided to let the ruble float as opposed to blowing through foreign currency reserves in order to prop up the currency, a tactic used by China.  Because of this foreign currency reserves have only fallen from 22 percent of GDP to 17 percent of GDP.  They are holding onto this extra cash in case of sustained low oil prices.  Their reserves have decreased mainly because of dipping into the reserves to compensate hurting banks and energy companies during this time of contraction, helping keep the economy alive until oil prices rebound.  The Russian government projects a year with no economic growth, which is better than the World Bank’s projection of a 1 percent contraction.  If oil prices stay lower for longer, Russia will need serious structural reform to become an attractive investment destination.

A version of this article appeared in the Tuesday, April 26th print edition.

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