Russia’s economy: surviving but not thriving

Moscow has not solved its structural problems, and the scale of its informal economy won’t help

The Russian economy has ostensibly avoided disaster during a difficult year in which it faced the threat of new sanctions, dramatic fluctuations in oil prices and pandemicinduced restrictions on economic activity. Exports and investment inflows fell, but output as a whole was better than expected and better than in several other developed countries. The numbers raise questions about the Russian economy’s resilience to external pressure, and whether reforms are reducing the state’s dependence on revenues from energy exports. But although this looks like good news for Russia, the official statistics don’t cover every aspect of life in Russia. Beneath the surface, the picture is graver than it appears.

The Kremlin has certainly suffered a series of setbacks during the pandemic. Gross domestic product fell by 3.1% in 2020 according to preliminary estimates, the largest drop since the 2009 crisis. The federal budget deficit grew to 3.8%, or 4.1 trillion roubles ($54 billion). Foreign direct investment fell to levels last seen in the traumatic 1990s. Energy exports – traditionally the most important aspect of the Russian economy, accounting for more than 60% of all exports – hit a 20-year low, making up only half of exports. The energy sector is the main source of money for Russia’s economic and social programs, but in 2020 it accounted for only 30% of the contributions to the federal budget, down from 40% in 2019.

At the same time, the Kremlin kept unemployment and inflation largely stable. It spent an estimated 4.5% of GDP on coronavirus relief, and the Russian tax service may actually collect 2.5% more in taxes and fees in 2020 than in 2019, despite a tax deferment scheme. The decline in energy exports was partially offset by a rise in exports of precious metals and especially agricultural products and foodstuffs, which increased by 20% by both value and volume compared to 2019.

And contrary to concerns that the price of oil is not sufficient to form a cushion in the National Wealth Fund, in January 2021 the fund reached $183.36 billion, or 11.7% of GDP, which is enough not only to cover the budget deficit for several years but even to support national projects and periodic social assistance.

The Russian economy’s unexpected resilience even in the face of reduced oil cash flows raises a number of questions. Is Russia less dependent on the oil and gas trade than we thought? Has the state’s attempted transformation of the economy in recent decades succeeded? The answer in both cases is no. The Russian economy still relies on revenues from oil and gas exports, and the federal budget is still funded mainly through taxes on oil and gas extraction and sales. What’s more, there are a number of microeconomic indicators, many of which don’t factor into the official statistics, that give a more complete picture of the economic situation.

A significant amount of Russia’s economic activity is hidden in the shadow economy, which is not included in real GDP, real wages and other important statistics. According to the federal statistics office, Russia’s informal economy is valued at as much as a fifth of its official GDP (other sources say it’s 40% or more), and so-called envelope wages may be 30% of official wage bill. Almost half of the Russian labour force, or about 33 million people, is employed in the gray market. The largest share of informal production is in real estate, agriculture, trade and construction, and about 40% of transactions for services are carried out without proper registration. The Kremlin is creating small taxes on the self-employed and is offering incentives to try to tax these hidden incomes, but with little result.

Some experts say the lockdown was especially damaging for the shadow economy, since those in the informal sector were excluded from state income support, but we tend to disagree. During the height of the lockdowns in Russia, the informal economy was the only part of the economy that was still operating, especially in Moscow. Hair salons, tutors, doctors and others in the shadow economy just switched to working from home. Even those with official employment who saw their wages or hours cut rejoiced at any part-time work, even if it was unofficial. By definition, the size of the informal economy is impossible to pin down, but in Russia it is certainly huge, and it feeds a lot of families in both the good times and the bad.

Another underappreciated aspect of Russia’s economic performance is the undervalued rouble. The government and the central bank have been pursuing a policy of artificial devaluation for the past year and a half, during which the rouble fell by almost 20% against the dollar. The rouble, despite the government’s efforts, remains dependent on oil prices – though less than it used to. In the event of negative trends in the global economy, the Russian government and central bank try to push the rouble down against the dollar so that commodity exporters can compensate for their lost income, which in turn means Russia continues to receive good income from taxes on energy giants even when demand is down. Right now, with oil at more than $60 per barrel, Russia decided to continue this policy to make up for the losses from low demand.

But neither a bloated shadow economy nor an undervalued rouble will lead to recovery. The artificially depressed rouble means higher consumer prices, lower consumption and a general decline in living standards. This only exacerbates the poverty gap in Russia, where 34.4% of young households with children already have incomes below the subsistence level, and where almost every other child (49.4%) lives below the poverty line. This trend only encourages more people to wade into the informal economy, depriving the state of tax revenues and generally doing nothing to make the life of the average Russian better or safer. These trends allow the Russian economy to stay afloat but do nothing to contribute to long-term growth.

In light of all this, and with anti-Russian rhetoric and the threat of new sanctions growing in the West, the relatively stable Russian economy looks much less so. It’s not enough to look at macroeconomic indicators to judge the Russian economy. Much more valuable is the complex, unpublished microeconomic indicators, which to a greater extent determine the state of the economy. Russia has survived the coronavirus, but a hard road to recovery lies ahead, requiring structural changes to become less dependent on energy exports and improve productivity and wages. The Kremlin is aware of these weaknesses and is in no rush to spend the money in its reserve fund until the next major crisis.