Putin’s Economic Dilemma

20 june 2018

Brigitte Granville is Professor of International Economics and Economic Policy at the School of Business and Management, Queen Mary, University of London and a former economic adviser to the Russian Ministry of Finance.

Vladimir Mau is Rector of the Russian Presidential Academy of National Economy and Public Administration.

Resume: Despite Western sanctions and oil-price volatility, Russia is currently on sturdier economic footing than most of its critics ever could have imagined just a few years ago. But while prudent fiscal and monetary policies have laid the groundwork for long-term sustainable growth, the government must resist the temptation of short-term stimulus.

Russia has a way of illustrating universal problems. Consider the goal of economic development. Political leaders have an interest in delivering economic prosperity very quickly, and yet the policies needed to enable sustainable long-term growth can take quite a while to bear fruit. The political and policy clocks are rarely synchronized.

We saw this first-hand while advising the first post-Soviet Russian government on its macroeconomic policies in the 1990s. At the time, there was much heated debate about whether the priority should be to control inflation, or to reverse the economy’s sharp decline in output. But by the end of that tumultuous decade, it was clear to everyone that monetary and fiscal stabilization were preconditions for a return to economic growth.

Today, a similar tension is visible once again. At a time when the Russian economy faces significant challenges, President Vladimir Putin, having secured another six-year term in March, wants to achieve an annual growth rate that outpaces the average for the global economy.

To Putin’s critics, that goal no doubt seems fanciful. But, unlike in the 1990s, today’s Russian government already has macroeconomic stabilization “in the bag.” The 1990s have long been maligned as a lost decade for Russia. But it turns out that the steps taken during that period laid a foundation upon which a modern economy could emerge, provided that the right policies are put in place.


Russia has managed to achieve macroeconomic stability in recent years without the world really noticing. Moreover, it has done so in spite of – or, perhaps, because of – the twin shocks of 2014: the collapse of oil prices and the introduction of Western sanctions in response to Russian actions in Crimea and Eastern Ukraine.

Russia owes its economic resilience largely to its independent central bank and conservative fiscal policy. In keeping with the monetary-policy approach adopted across advanced economies since the 1970s, the Central Bank of Russia (CBR) has pursued inflation targeting by relying on positive real interest rates and a free-floating exchange rate.

Incidentally, Russia’s successful stabilization has put to rest (in our favor) 1990s-era arguments about the relative importance of monetary and non-monetary (“cost-push”) causes of inflation. Under Elvira Nabiullina’s governorship, the CBR has maintained a tight monetary policy and driven the annual rate of inflation below the official target of 4%. It is worth remembering that when the CBR first set the 4% target a few years ago, many financial-market participants dismissed that goal as a fantasy.

At the same time, the Russian government has carried out an equally important – and equally painful – fiscal adjustment. On several occasions prior to 2014, Russia maintained annual budget deficits, even with oil prices exceeding $100 per barrel. But the government has since replaced that lax approach with one that assumes a long-term oil price of around $40 per barrel. As a result, Russia’s public finances are on a much more sustainable footing than in years past.

Russia’s fiscal tightening has largely come in the form of spending restraint, combined with stepped-up efforts to reduce tax evasion in the “grey” economy – such as by enforcing excise duties on vodka – rather than through tax hikes. Moreover, the budget has benefited from additional oil-tax revenues as the price per barrel has increased to almost double the $40 benchmark. This windfall has been funneled into a “rainy day” fund, under an updated version of a countercyclical fiscal rule first introduced during the 2000s oil boom by then-Finance Minister Alexei Kudrin. After the election in March, Putin appointed Kudrin to chair the powerful Accounts Chamber of the Russian Federation – a position that Kudrin could use to exert real influence on fiscal policy (and economic policy more broadly).

And now, with a brilliant policy innovation, the government has updated the Kudrin fiscal rule to weaken the correlation between the ruble exchange rate and the oil price. What may sound like a dry procedural adjustment is actually vital for freeing the economy from its excessive dependence on oil and gas, and for making faster progress on economic diversification.


Before the fiscal rule change, Russia was constantly threatened by what economists call the “Dutch disease,” named for what happened to the Netherlands after it discovered natural gas in the 1960s. When a country becomes too dependent on oil or some other sought-after resource, its currency will strengthen when the global price of that resource increases, which undercuts the competitiveness of other sectors exposed to international competition.

Now, Russia’s real exchange rate will remain much more stable in the face of oil-price volatility, and its other tradable sectors – including agriculture, chemicals, civil nuclear engineering, aerospace, ballistics, and defense equipment – will be more competitive. That, in turn, should stimulate investment, which is the only way for the Russian economy to grow sustainably under the current conditions of minimal spare capacity, full employment, and high labor-force participation.

Russia’s ostensibly strong labor market reflects a fundamental demographic weakness that threatens its growth potential. Although the country’s “headline” population has broadly stabilized over the course of the current decade after experiencing sharp declines in the previous two, its working-age population has been falling by over 1% per year.

Russia’s macroeconomic stabilization set the stage for real (inflation-adjusted) GDP growth of 1.5% last year, following a two-year recession following the shocks of 2014. Yet demographic constraints and a lackluster investment rate of just over 20% of GDP mean that the economy does not have the potential to grow much faster. Accordingly, the latest official forecasts show growth improving somewhat this year, but not exceeding 2%, compared to 3-4% global economic growth.

This takes us back to the age-old tension between economic aspirations and facts on the ground. The benefits of macroeconomic prudence cannot be denied. But nor can Putin ignore the political urgency of delivering faster growth, given the material decline in living standards experienced during the post-2014 recession. Though it is now decreasing, Russia’s poverty rate still has not returned to the post-Soviet low recorded in 2013.


Under tense political and economic conditions, governments will always be tempted to make a mad dash toward growth, by stimulating consumption in the near term. In Russia’s case, this would be at odds with its long-term strategy of creating stable macroeconomic preconditions for higher investment and sustainable growth; but it risks being seen as the most expedient course.

Moreover, with public debt amounting to just 14% of GDP, Russia has a degree of “fiscal headroom” that would make even much richer countries envious. That fact no doubt amplifies the siren call for relaxation of macroeconomic discipline. But Russian policymakers must heed the dangers of sailing in that direction. They need only recall the late-Soviet period, when successive attempts at debt-fueled stimulus, under the slogan of “acceleration,” failed to produce sustainable growth and modernization. Indeed, the last round of stimulus under Mikhail Gorbachev accelerated only one thing: the collapse of the Soviet Union.

Fiscal stimulus probably would not prove any more effective today than it did then. Given the Russian economy’s “supply-side” demographic and investment constraints, expansionary monetary and fiscal policies would produce only inflation, real exchange-rate appreciation, and deteriorating external balances. A classic boom-bust overheating episode would be all too predictable.

Russia’s only viable path to higher growth, then, runs through the same macroeconomic policies that have ensured price stability in recent years. To be sure, investment is being deterred by high real interest rates of almost 5%. But interest rates will not fall unless the CBR is allowed to continue pushing back against the expectations of high inflation that took hold of Russian society during past periods of price instability.

Moreover, rash stimulus measures would do nothing to alleviate the effects of Western sanctions on Russia’s growth potential. In fact, while sanctions create uncertainty and undercut investor confidence, they also may be pushing Russia in the right direction economically. Specifically, by limiting Russia’s access to goods and services from abroad, sanctions have forced Russia to engage in import substitution (though not the traditional twentieth-century variety, by which the government would restrict foreign competition to support national producers).

One result of this is that Russia is now the world’s largest grain exporter. In other words, sanctions are compelling the Russian government to do what it should have been doing all along: improving the investment climate, bolstering productive industries, and taking more seriously the imperative to diversify the economy.


At this year’s Saint Petersburg International Economic Forum, senior Kremlin officials made it clear that they understand the importance of encouraging entrepreneurship and competing for human capital. They promised to simplify taxes for small businesses; to preserve the current fiscal rules; and to keep the government’s extra borrowing limited to infrastructure investments worth around 3% of GDP. Meanwhile, all other planned spending increases, such as on health care and education, will be funded by structural reforms to improve efficiency and boost dividend payouts from state-owned enterprises.

Governments and investors around the world have been anxious for signs indicating Russia’s likely economic prospects over the next six years. To that end, they should keep a close eye on whether Putin and his team stick to their stated course.

Project Syndicate

} Page 1 of 5