No time is perfect, one has to work in any conditions
With high economic growth rates and trade volumes now a thing of the past, global economy has found itself in a situation of New Normal. Faced with global demand constraints that brought about the decline of commodity markets, Russian economy experiences even greater problems. What comes next?
Commodity prices are to remain low for a long time
Making long-term strategies is a thankless job. It involves many risks and dangers, although it does have its bright side too. As for the risks, it was John Maynard Keynes who put it best. “In the long run we are all dead,” he said. Hence, the strategy is useless; it does not help make decision on current issues. This, I believe, is the main risk in any strategy-making: no one needs a strategy that does not help make right decisions today. Nevertheless, there is also a bright side to it. It was described by another economist Nasreddin Hodja in his well-known saying that before thirty years are up “either I will die or Timur will die. Or, the donkey will die!” An irresponsible saying, one should recognize.
Those two risks, the lack of linking between the strategy and decision-making on current issues, and the lack of responsibility for those who elaborates the strategy are the main things to be avoided.
A strategy elaborated in 2000 for Vladimir Putin’s first presidential term, was notable as it linked long-term objectives with making important daily decisions. Decisions are made today but have longer-term consequences. Indeed, the consequences are to happen within the period up to 2030, or later. What is more, the team of both politicians and professionals who elaborated and implemented that strategy took responsibility.
Second, we live in times of tremendous change. I refer to demographic, science and technological changes. The world becomes fundamentally different from what it used to be. There are many things that formed part of our life until recently both in technology, government, administration that I cannot explain to my own children. The new generation merely cannot understand those things.
These fundamental global changes can be perceived in different ways. To most experts they apparently mean business as usual. Look at the forecasts by international institutions, including the IMF and the World Bank. Year after year they say that global economy is about to accelerate, and then they review their forecasts. They always start at 4 percent, which later turns into 3.7 – 3.8 percent, 3.6 – 3 percent, and finally 3 percent. This is what happens every year. Some people believe that things will go back to normal in some mysterious way and that once again everything will be okay.
This is also true of businesses. Those refrain from making important decisions as to cutting costs, reducing staff, adjusting their wages and bonuses policies, cutting other costs, as they believe that in a year or two the sales will grow, one just has to be patient. But the sales will not grow back again, and the costs will have to be adjusted to the new future. That is why the choice between the Business as Usual and the New Normal option is a fundamental choice that we have to make while elaborating our new strategy.
We are entering the era of New Normal when economic growth is seriously constrained and the drivers of economic growth — I refer to geographical drivers — will merely cease to exist.
Economic growth rates of the emerging market were high due to the fact that initial conditions in those markets were bad, and labor was very cheap, and start-up costs were low. This leads to the middle income trap, middle per capita income trap, and subsequently, if a country creates no proper institutional capability, it loses its competitive edge. That is what we see today, we see developing markets loosing this edge and economic growth rates of the advanced and the developing economies moving closer towards the average.
This is a global trend that is here to stay. There will be no shifting of the center, and there will be no new driver of growth either in Africa, or Latin America, or the Antarctic, because there are powerful global constraints, primarily those of demographic and environmental nature. I believe, the hope that we will be able to get over these constraints through some innovative solutions, is vain and that economic growth based on “exporting” consumer standards from advanced economies to all other countries is an illusion.
Global economic growth has to be attained through different means. It cannot be consumerist, based on consumer behavior. It should be driven by higher levels of savings and by redistribution of savings to innovation or green energy and economy, etc. At the same time it should involve cutting costs, including cutting labour costs.
To raw-material economies like Russia’s this means that commodity prices will remain low for a very long time, and one can hardly say for sure, whether it is a low stage of the global commodity cycle or a new normal as assessed by Moody’s. Anyway, I am convinced that this situation will last for a very long time.
I believe we should be afraid of oil prices of $20 or $15 a barrel, as we are now. It is the logic of the market that the lower the price falls today the more likely it is to go up tomorrow. This is not the main risk. The main risk is that the prices will remain low for long, for years or even decades. In such a case fundamental decisions would have to be made relating to the structural changes in economy.
A strategy involves more than merely extrapolating current trends, a fault that many of us make. Both government analysts, and bankers, and energy analysts are constantly revising their consensus projections depending on what happens during a given trimester: what happens in this trimester, determines what happens in the next one. Yet this wave of changes is shrinking. By way of an example one can cite consensus projections for oil. In the first trimester of the year it fell considerably, in the second one there was a fall. Nevertheless, there was hardly any change for the year. Therefore, in 2017 the oil price will stand at $63 a barrel, and in 2018, $70 a barrel.
Such extrapolation makes little sense. On the contrary, setting goals and determining the targets that take into account fundamental constraints, on the one hand, and, on the other hand, generate challenges that mobilize the internal forces of an economy, is very helpful. If a strategy is based on correct risk assessment, it will be helpful in elaborating a correct economic policy.
Let me cite two examples. What are the risks that will be facing Russian economy in the near future? The first one, and to my mind a very serious one, is the change in the population’s consumer behavior. Basically, a shift from consumption to saving is already underway. Retail volume in real terms is deeply negative, and stands at just above zero if inflation is disregarded. This is important, and it implies that people’s perception of future has changed. Without knowing, people started living in the conditions of New Normal. On the one hand, this is a risk, but on the other hand, this can be a powerful development driver. Indeed, this is consistent with the global new normal that involves limiting consumerism, a dynamic growth of consumer demand. Intense saving serves as a resource that, if relevant institutions and instruments are in place, will provide a basis for investment growth. I refer to investments in intellectual capability, in conservation technologies, and in cost reduction. Therefore, it is our task to find a way to channel the population’s saving activity to these areas.
There is also another associated risk, an external risk that we have already faced. I refer to the fact that global capital markets remain closed for Russian borrowers. On the one hand, this is really a risk. On the other hand, this is also a challenge that can be made proper use of. This means that the dream that we have had since 2000 to switch from the foreign loans-based model to a model based on transforming income accumulated within the country into domestic savings, is coming true. Russian companies’ debts are reducing; there is an improvement as regards payment account and the capital account of the foreign balance. On the other hand, this also implies that certain savings should be made use of, which we have already discussed above. This necessitates a powerful system to process such savings. Hence, the banking system should be developed, and its capitalization should be increased.
All of this is a kind of a jigsaw puzzle in which one must see both global trends and our own domestic risks. And as we put its pieces together into a strategy up to 2030, we should each time make a conclusion relevant for our today’s economic policy.
This leads us to a number of practical conclusions. We should identify our goals and global trends, challenges and existing risks correctly. We should “rewind the tape” and make decisions that would be consistent, or at least would not run counter to those, today. In this case long-term strategy-making will turn out to be something that enables us to make right decisions and avoid mistakes rather than something either in vain or useless.
Investment dynamics can be brought back to its previous high levels
We often use words like crisis, recession, decline, depression. To certain extent — I would rather say, to a large extent — we are right in doing so. There are statistically measurable indicators. Indeed, last year the GDP fell by 3.7 percent, inflation grew by 12.9 percent, there has been a fundamental change in exchange rates and lending rates as compared to two years ago. We know why that happened, we understand the mechanics of this process and the global challenges: shrinking global demand, geopolitical issues, our domestic structural issues resulting from the fact that recovery completed in 2012 and we had created no powerful instruments to ensure a take-off in investment. This is also true. So what is next?
My first point is that Russia’s economy has proven very adaptive, flexible and ready to respond to the changing reality correctly. A comparison of two shocks that we faced in late 2014 and late 2015 is a good illustration of this point. When the first one happened in 2014, oil prices fell by 60%, from $112 a barrel to approximately $45 a barrel during six months. Russia’s economy responded with more than two times’ devaluation, and the inflation rate growing almost 2.5 times. The Bank of Russia raised its key rate from 7.5 to 17 percent. As a result the GDP fell by about 2.5 percent.
The following year, 2015 saw the same shock. Oil prices reverted to $65 a barrel and then once again fell by 60 percent to $27 a barrel, hitting bottom between 2015 and 2016. There was sharp devaluation, but not as sharp as it had been the previous year. The inflation did not merely not grew but fell, and the enterprises stopped using this situation as a pretext to raise prices, starting to cut costs instead. The Bank of Russia did not merely raise its key rate but managed to reduce it by 150 bps, (1.5 percent). It could have been better, but the situation still somewhat normalized. In November 2015 there was a short period when the GPD dropped by 0.3 percent as compared to the previous month, but that was almost it.
In other words, the economy started responding in a different way, through cutting costs, primarily those related to adjusting the dynamics of wages to performance. For the first time a balance has been reached in this area. Our companies have gained from the altered exchange rates, which influenced their total costs. We started controlling natural monopolies’ tariffs more carefully. As a result, the costs reduced considerably and enterprises received additional income of 9 billion rubles in 2015, which is more than 2014. That is a lot of money, indeed.
In the global context, a number of factors happened to coincide: common problems faced by all emerging markets, the specific problems of Chinese economy resulting from its structural reorganization, and the problems that typically happen in advanced economies. The whole world faced a prolonged stagnation. European economy has not been able to get over this for several years. Risks emerge in Latin America as well.
Yet everyone has to adjust to these conditions. Chinese colleagues are searching for ways to do that, and so are we, as we realize that for us it implies a different demand for our raw materials and our exports. We should diversify our exports, and develop the export of goods other than raw materials, and thus to insure ourselves against unwelcome volatility.
In recent one year and a half or two years the trade between Russia and the European Union dropped by 37%. Today Russia and the European countries have renewed intergovernmental contacts. There is a considerable influx of investment. I think, the ratio between the risks and the rate of return in Russia is quite acceptable, which makes it possible to do business efficiently with Russian partners. The cooperation between European companies and their partners in Moscow and Russia in general is on the whole fruitful and beneficial for everyone.
Some say that Russian economy turns towards the East, which is not correct. We do not turn anywhere. We just want a more solid basis for development. It is more reliable and stable to stand on both feet, than on one, isn’t it? So we are merely remedying imbalances. And those who argue whose economy is the largest and say that China challenges the United States and so on, tend to forget that it is in fact the EU who has largest economy. As our European partners say, they are also interested in restarting the dialogue. We, from our part, strive to make business environment favourable.
We see the investors’ interest and believe that Russian assets are currently considerably underestimated. This creates additional demand. We have a number of joint investment platforms, and foreign investment volume in itself is growing, rather than falling, although at lower rates as compared to some years ago. This is mainly driven by sanctions, as well as by economic situation in Russia related to the cost of funds, lending rates, and the key rate. However I believe that all these issues will be addressed in a relatively short time.
… There was a joke in the Soviet Union that said “We all work for the welfare of man, and we all know who that man is”. In fact, we also know who that person is. It is each of us. Our country of 2030 is a country where all of us will feel comfortable. I don’t know whether you had that feeling when you were children, when you woke up in the morning and thought that it was great that you lived in the Soviet Union. To a certain extent that was due to the fact that institutions and organizations that were in place matched your internal sensation. This is very important, because in this case the share of active life increases. I refer to the period of life when a person makes decisions, moves, has vacations, goes in for sports, participates in cultural life, and so on. This involves a completely different consumption pattern, in which the consumption of goods will grow, but not very much, while the consumption of services will increase significantly. Those will primarily include education services, like professional training and development, sports and cultural services, personal development. This balance of structure will involve different behavior and different world view. This will be a country where every single kopeck of tax paid will be matched with a government service of corresponding quantity and quality. Finally, that will be a country where no one cares how much oil costs today and what is dollar to ruble exchange rate.