The Russian economy managed to get out of the downward cycle after 2014 caused primarily by sanctions and falling oil prices, which considerably affected the Russian economy still suffering from Dutch disease with its over-dependence on exports of natural resources. The economy tends to have a positive balance of trade and positive current accounts, the budget deficit is low and close to 0% of GDP, there is low unemployment (4.5%), and relatively low inflation (a forecast of 4% for 2019) compared to previous periods. The central bank manages to grow its currency reserves by buying currency as part of the budget rule. 

Nevertheless, economic growth in Russia is weaker than expected. It was 0.3% in 2016, 1.6% in 2017, and 2.2% in 2018. In July the leading GDP indicator compiled by the Ministry of Economic Development rose to show growth of 1.7% year-on-year. The forecasts for 2019 are still below 2% growth. Consumption as a driver of economic growth (the share of consumption oscillating at around 70% of Russian GDP) is stagnating, on the verge of stagnating, or shrinking disposable income. Over 15% of Russians live below the poverty line. 

The share of Russia’s economy in the global economy is still low. Under the USSR the Union’s share varied from 5% to 12% of the global economy; today Russia’s share is below 2%, at the same level as South Korea, whereas China, India, and Brazil are largely outpacing Russia, despite its richness in natural resources and land. 

Yakutians (the inhabitants of a Russian region which is roughly 5 times the size of France) often joke: “We have the whole Mendeleev table on our land” referring to the land’s richness in natural resources. However, still in 2019, Yakutia is running a deficit. This story is not about Yakutia, but about income distribution, about the principles of budget federalism as a system of tax generation and distribution, and the system of economic management. 

The first systemic challenge is the lack of economic incentives from regional authorities to stimulate regional economic growth. Russia is still relying mainly on the principle where taxes are collected locally, but are spent and distributed at the federal level. The taxes that remain at the regional level can hardly provide a sufficient financial cushion to finance growth. At the same time, VAT constituted 37% of all budget revenues in 2018, making it the main source of revenue in the federal budget, more important than the revenue from taxes on resource extraction, on profits or excise duties. VAT as the tax on development is generated at the regional level, but is fully transferred to the federal government. VAT is supposed to be a motivational tax for regional authorities to attract investment, but the regions are reluctant to do so because the tax keeps leaving their regions. 

On the other hand, spending on social policies, healthcare, and culture accounts for 36% of all spending, much of it being the responsibility of the regions. This results in a peculiar situation, where relatively deficit regions, instead of generating new wealth, are trying to get their extra wealth from the federal government through budgetary transfers, subsidies and other allocations. The government is now leveraging this misbalance in the system of regional incentives to economic development by introducing key performance indicators (KPIs) to governors, which include attraction of investment and other instruments.

Yet interregional misbalances are not much better than they were during the last 20 years: the top 5 to 10 regions out of 85 remain donors, while the others receive donations.

The second problem is inflation policy. The Central Bank of Russia, often considered by international economists one of the world’s most successful regulators, is conducting high interest rate policy. One of the reasons is to stem potential inflationary pressures. Thus, the central bank’s interest rate policy is often between the Scylla of inflation if the key rate is too low and the Charybdis of low spending if the  key rate is too high. In 2015, the central bank increased the key rate to almost 17% in an effort to curtail inflationary pressures, gradually decreasing it in the following years in order to stimulate consumption. Despite another reduction in the key rate at the end of October 2019, it is still 6.5%, thus creating an obstacle to stimulating new investment, spending and private consumption. Russian citizens hold over 18 trillion rubles on deposits, whereas the entire GDP is 89 trillion rubles in 2016 prices. Capital flight is still high – 60 billion USD in 2018. 

German Gref, the president of the leading Russian bank, Sberbank, suggests that the current state of the Russian economy is largely the result of managerial challenges, especially at the bureaucratic level. In fact, the most recent initiative of introducing national projects to stimulate economic growth and social stability tends to demonstrate relatively conservative results despite great attention and KPIs. Primarily because such spending is still only a minor portion of all spending, secondly because national projects take a long time to start due to bureaucracy, and thirdly because the move to digitalization is not fast enough. Managerial inefficiencies pertain to the size of the administrative apparatus, but also to the frequent redistribution of functions. Nevertheless, national projects can lead to positive outcomes as the government declares, sets and enforces the system of KPIs of ministers and regional governors. 

Third, Russia continues its policy of low international borrowing. Instead of the massive growth of foreign debt, the government tends to develop mechanisms to attract national money. Ever since Russia paid off its London Club and Paris Club debts (in 2010 and 2006, respectively), it has tended to avoid the common European and American model of relying on foreign debt to stimulate development. 

Fourth, the existing economic and financial opportunities in Russia tend to receive insufficient coverage abroad. However, Russia can propose instruments that are unique to the territory or have proved their global efficiency, like Special Economic Zones, special development zones, special administrative areas for the repatriation of foreign capital and others. 

The future of the Russian economy also largely depends on its ability to leverage Russia’s participation in the Belt and Road Initiative and to use its geographical potential as a bridge between Europe and Asia. In this initiative, Moscow works and competes with Nur-Sultan (the capital city of Kazakhstan), which inaugurated its international financial center, providing special tax and visa regimes, but especially legal regimes that are all-new to the CIS, like English and Welsh common law principles that foreign investors familiar with best international practices might find particularly attractive. Russia should propose instruments and the necessary media coverage to be competitive for Foreign Direct Investments. Indeed, in 2011-2019 Russia made a major leap in the international Doing Business ranking from 100th to 28th place in 2019, scoring higher than France, the Netherlands, Japan, Poland or Switzerland.

One of the most serious challenges facing Russia is brain drain. Tens of thousands of workers, especially the highly-qualified ones, keep leaving the country every year: today, 1.5 million Russians live abroad while retaining their Russian passports. The inability to develop efficient mechanisms to retain the labour force curtails the mid- and long-term potential of economic growth. Plus, while Russia is one of the world’s leading countries in human capital development, it demonstrates poor results in its international competitiveness, which is especially evident if we plot the two variables on a diagram. 

Despite the existing challenges, Russia remains an intriguing and promising land for international business and investors, having the potential to develop very productive relationships with other major global economies.