Russia’s recent annexation of Crimea has sent it’s under-performing economy and stock market into a tailspin. From the halcyon days of spring 2008, the Russian stock market has lost more than 50% of its value. Recent days have seen a steady stream of bad news from economic sanctions, to a weak ruble and the threat of a ratings downgrade.
The Russian economy was hardly a model of growth and efficiency before President Putin made the fateful decision to send troops into the Crimean peninsula – the economy stuttered in 2013 posting GDP growth of 1.3% (compared to 3.4% in 2012) on the back of weak domestic consumption and sagging investment – but this political situation has only made the economy weaker.
Amidst all this bad news, investors wonder whether there is any hope for Russia to turn the corner. In the current environment, the odds of inflation in Zimbabwe reaching single digits seem higher than the odds of a Russian economic renaissance.
Curse of oil
“I call petroleum the devil’s excrement.”
Juan Pablo Perez Alfonso, a founder of OPEC
Most economists agree that Russia has failed to take advantage of the bounty received from oil over the last decade to make structural changes to its economy. Instead it seems to have fallen victim to the “Dutch Disease”, a phenomenon named for the economic hardships faced by Netherlands in the 1970s on finding gas in the North Sea. In this scenario, a country’s hydrocarbon riches leads to an appreciation of local currency which makes exports from non-oil sectors like agriculture and manufacturing uncompetitive.
The economic landscape of oil rich states is littered with basket cases like Libya, Venezuela & Iraq. In fact, the “curse of oil ” is so all-pervasive that it is hard to find a model state that has wisely used its mineral wealth to enable a stable, diversified and prosperous nation.
The Nor – way?
However, there is one country that has bucked this trend to emerge as a model for managing a resource-rich economy. Norway’s experiment with economic diversification is now being lauded as a template worthy of emulation by Gulf countries in the Middle East awash with oil money. Ironically it was a man from the middle east, an Iraqi geologist named Farouk Al Kasim, who saved Norway from the “oil curse”.
To achieve this unprecedented feat, Norway decided to control the flow of oil money by holding almost all of its revenues in a pension fund. This is now the biggest sovereign fund in the world, with over $700 billion in assets. To avoid flooding the economy with cash and making locally industry uncompetitive, it invests most of its funds abroad and has capped its annual withdrawals at 4%. It has also made carefully considered local investments to help develop its traditional industries like forestry and fishing. As a result it has developed an alternate export base that rivals the oil industry.
While Russia has sovereign funds (National Welfare Fund and Reserve Fund) of its own, it has not managed its investments nearly as well as Norway. It has also yet to invest these funds to boost infrastructure and promote local industry.
There are several lessons that Russia can learn from Norway as it is also blessed with plenty of natural resources outside of oil and gas, unlike the Gulf countries. Some of the lessons include: thoughtful allocation of oil money to develop a new industrial base, improving the business climate by clamping down on corruption and crony capitalism, active diversification of the economy and investment in human capital.
Also, unlike the Gulf countries, which have to import high-skilled immigrants, it has an excellent base of technical expertise and human capital (a legacy of the Soviet era) to build on.
The Gulf countries have been open to learning and experimenting with new economic models in spite of their limitations but Russia still seems to be stuck in its old ways. This is one of the reasons why Russia ranks dead last on the ten driver model we developed for The Emerging Markets Handbook.
We hope that President Putin leverages his current 70%+ approval ratings to make large structural changes to the Russian economy and build a self sustaining non-oil economy that will lift the country out of stagnation.
By Pran Tiku CFP & Vikram Kondur CFA
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