Discussing Russia's Commodity-Based Economy Growth Strategy

Updated on January 23, 2018
Angelo Grant profile image

Master of Business Administration (M.B.A.) at Wilmington University Sigma Beta Delta

Russia's Economy Performed well From 2001-2013. Why did it run Into Trouble in 2014?

According to the CIA World Factbook Russia has a commodity-based growth model that is heavily dependent on the extractive industries: oil, natural gas, and metals such as steel and aluminum. The Russian economy experienced a boom as the global demand for its primary extracts grew profoundly and the prices of these commodities surged. Russia's reliance on commodity exports makes it vulnerable to boom and bust cycles that follow the volatile swings in global prices. The economy, did well as oil prices rose rapidly, but has seen diminishing growth rates since 2014 due to the exhaustion of Russia’s commodity-based growth model. In 2014 Russia was significantly affected by a combination of falling oil prices, international sanctions, and the rise of ISIL.

From 2001-2013 the Russian economy performed well because of historical actions that were taken in the nineties. After the collapse of USSR, Russia experienced tremendous changes in political, economic, social and cultural aspects. The country transitioned from a communist one party to a democratic state with multiple political parties. A number of economic reforms focused on stabilization of the ruble, liberalization of prices and mass privatization. Despite the effort, the economy in 1991-1998 lost 30% of GDP (Johnston, 2016). Further, in 1998 Russia experienced a financial crisis that caused the devaluation of the ruble and default on the debt, which lowered GDP by 4.9% (Johnston, 2016). However, the 1998 financial crisis created a base for rapid and exponential economic growth in the near future. In 1999 Putin, as a new president started many successful economic and legal reforms. Some of them were lowering tax rates and simplifying the business registration process, and changing privatization of agricultural land. Further, Putin began renationalization of essential companies from newly privately owned to state-owned. Moreover, the prices on a significant export product like oil and gas were rising worldwide, which pushed the Russian economy to approximate growth of 7% during 2001-2013.

However, In 2014 the United States increased its production and export of oil, and within the space of one-year toppled oil prices from $110 per barrel to $50 (Hill, 2017). Low oil prices exposed Russian economy's strong dependency oil and gas. Further, in 2014 political crisis and revolution in Ukraine resulted in ongoing war in the eastern part of Ukraine and the annexing of Crimea from Ukrainian to Russia. As a consequence of these aggressive geopolitical actions, the US and Its allies imposed hard-hitting economic sanctions on Russia. Per Dmitriy Medvedev, Prime Minister of Russia sanctions costs to Russia $26.7 billion in 2014 and $80 billion in 2015. Nevertheless, the Russian economy is recovering, and surprisingly Putin’s support has grown even stronger.

Russia Seeks to Spread Its Geopolitical Influence

Vladimir Putin meets with the U.S. Secretary of State
Vladimir Putin meets with the U.S. Secretary of State | Source

Is This a Country Where a Western Enterprise Would Want to do Business?

Absolutely yes. Businesses are primarily concerned with return on investment and residual income and therefore would adapt to the political environment to be able to thrive and take advantage of the opportunities present in Russia’s commodity-based growth model. Many sectors of the Russian economy are underdeveloped and therefore offers what is called first-movers advantage.

How Does the Current Political and Economic Climate is Impacting Foreign Direct Investment?

Russia shifted toward a centralized authoritarian state under the leadership of President Vladimir Putin (2000-2008, 2012-present). The fact that much of Russia’s oil and natural gas production remains in the hands of enterprises that the government has a controlling interest in means that investment opportunities and profitability are limited. Russia ranks 92nd in the world in terms of ease of doing business this simply means that new business relationships are hard to form. (Hill, 2017) However, Western businesses that have already secured relationships will be able to profit from the next economic boom this commodity-based economy offers. Putin’s strong political hold provides some measure of stability while its commodity-based economic model waits for the next surge in global commodity prices.

The short answer is; “it depends on the type of business and time of investments”. Since the collapse of USSR, Russia has undergone many changes and financial challenges. Over more than two decades Russia performed numerous economic and political reforms that mainly focused on bringing and protecting foreign investors. Even during a financial crisis, there are areas to invest in Russia, like agriculture and Western franchises. However, Western businesses have to adjust to local administrative problems, corruption, and bureaucracy. Some of the regions in Russia are not as developed and established as others, which brings high uncertainty when trying to assume ROI. The current political and economic climate is creating challenges for western business. Russia imposed several sanctions on imports from Western countries, as a response to the US and EU sanctions which inevitably hurts Western Enterprises doing business in Russia.

What are the Factors That Contribute to the Attractiveness of a Country as an Investment Site?

To measure the overall attractiveness of a country a business must weigh benefits such as the size of the economy and the likeliness that it will grow against costs such as corruption, lack of infrastruture and legal cost. Business must also seek to balance the risks by acknowledging political risks(social unrest/antibusiness trends), economic risks, and legal risks (failure to safeguard property rights).

Given what is happening in Russia today, what do you think will happen to foreign investment in Russia going forward?

Vladimir Putin has tightened his grip on power, therefore, foreign investment will continue to be limited to those companies who have existing ties with the Russian government. If Russian aggression continues in Ukraine and Putin remains allies with the Bashar al Assad Syrian government western investment will be anemic.

Per recent reports, Foreign Direct Investments in Russia increased over the past few years (www.ceicdata.com). Especially in 2017, FDI increased by $12.5 billion in Jun 2017, compared with an increase of $4.9 billion in the previous quarter. Additionally, the Russian economy is slowly growing now due to increased domestic market and labor in addition to increased oil prices. The number of foreign transactions risen from 2015 to 2017 by 61%. (Egorova, 2017). US and Germany are the leading counties that invest in Russia. Western Europe is also among the top investors. Further, at 21st St. Petersburg International Economic Forum (SPIEF) on June 2, 2017, Putin pledged his support to foreign investors and improving investment process. Russian law protects foreign businesses from discrimination from local businesses. However, many companies are watching Russian market very closely without rushing into investments. Some of them reluctant to invest in Russia yet due to imposed sanctions. Nevertheless, foreign investments in modern Russia should expect its ROI, because of healthy afford from Russia and its allies to recover and return rising economy to steady growth. All prognoses agree that Putin will be the president for the next six years, so no political surprises and substantial changes are expected.

Further, Russia is a country where the Western enterprises would want to do business right now, because of high currency exchange to American dollar and Euro. Real estate is one of the top industries to invest in Russia. Western and American investors will get double the property for their money due to the currency exchange.

References

Hill, C. W., & Hult, G. T. (2017). International business: competing in the global marketplace. New York, NY: McGraw-Hill Education.

Egorova, K. (2017, June). Foreign investors sign record number of deals in Russia. Retrieved from: https://www.rbth.com/business/2017/06/06/foreign-investors-sign-record-number-of-deals-in-russia_777635

Johnston, M. (2016, January). The Russian Economy Since the Collapse of the Soviet Union. Retrieved from: https://www.investopedia.com/articles/investing/012116/russian-economy-collapse-soviet-union.asp

The World Factbook — Central Intelligence Agency. (2018). Cia.gov. Retrieved from: https://www.cia.gov/library/publications/the-world-factbook/geos/rs.html

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