What does Putin’s Conciliatory Tone on Crimea say about the State of the Russian Economy?

The great tragedy happening in Europe presently has to be the tensions between Russia and Ukraine following the annexation of Crimea by the Russian government.  Ukraine, a former Soviet state of the U.S.S.R has been plagued with civil unrest from rebel forces opposing the ruling government creating chaos on the street of Kiev.

Antagonist in Chief, Vladmir Putin has been assertive of his stance and until recently refused to compromise. This has resulted in the West, comprising of the United States and European Union imposing sanctions on his government, much of which has been brushed aside or countered with tit-for-tat measures against his opponents such as a ban on airlines in Russian airspace.

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However financial markets around the world reacted positively to the news coming out of Crimea late in the week where Putin and various lawmakers met to discuss continuing tensions. Putin’s comments were understood to be conciliatory in nature. Why the sudden about turn?

Unpacking key economic indicators can help us understand why Putin may have taken this stance. I would like to share with you some of the charts I thought could be useful in explaining this.

Since the sanctions imposed by the West is related to trade with Russia, I’d like to start off with trade indicators because any impacts that will be seen first will come from this part of the economy. 

Some interesting trends do emerge when we look at the chart of the Russian Ruble:

This is a chart of the US Dollar against the Russian Ruble for the last 2 years. Going back to the beginning of 2013 an uptrend has emerged which seems quite strong.  Emerging market currencies have been hit hard and Russia is no exception.  Although a weak currency does make Russian goods cheaper and does stimulate local manufacturing, it hasn't helped them over the last 3 months since they haven’t exported any goods to EU region as a result of the ban.  Russia’s biggest exported goods are oil and natural gas which make up roughly 60% of total exports. Most of these go to Europe.

We should note that the above chart does not represent the previous 3 months but rather 2 years, however what is does indicate to us is that there is a strong upward trend which can remain in place for as long as a solution can be found.

The next chart is Balance of Trade, but before I continue let me explain what is the balance of trade and why is it so important.

The balance of trade is the difference between exports and imports of goods and services and should not be confused with balance of payments; however it does form a large part of it.  When a country exports more than it imports we say there is a trade surplus and when it imports more than exports there is a trade deficit.

It’s a fallacy to think that it is good to always have a trade surplus and bad when you have a trade deficit. It is more dependent on the state of the economy which will ultimately decide if it’s good or bad.  Trade surplus are good when an economy is contracting, by exporting more than importing it helps stop an economy from declining and reverse upwards so it is able to once again grow.

Trade deficit works well when an economy has expanded rapidly and might be over exerting itself with a need to slow down. One way to do this is to tap into the surpluses made so as to slow down the expansionary process.  

The chart above shows the Russian balance of trade from 2000 till present.  Russia has been known to run trade surpluses due to their supply of oil and gas to European region. Over the last 6 years there has been a steady uptrend in the balance of trade. This would suggest that a Russian export has been expanding faster than its demand for imported goods and services.

But as said before a surplus is only useful when an economy has expanded rapidly and needs to cool down. Let’s see what the Russian economic growth looks like and compare the two. 

What we see is a very different picture to what we've seen on the balance of trade.  The Russian economy peaked in 2008 and has been in a steady downtrend since then.  Let’s use some data points to assess the correlation.

Notice the peak in the economy in 2008 in both the trade surplus and the GDP growth. Observe how the follow through happens almost immediately afterwards as Russian policymakers run down the surplus. Again when the economy builds momentum from the bottom of the Financial Crisis and reaches a high in 2010. The same procedure follows, both charts turn down and the same with 2012.

But look at the charts nicely and you’ll see the Russian economy flirted with recession in 2013 and has since turned negative in 2014. What can we conclude from these observations?

Although Russian has a trade surplus and if the government wanted to run it down the Russian economy is in a very poor conditions to do so.  However we know the government is not running it down, that’s being done by the EU and US with trade bans.

Russia is at a critical breaking point here, if the current situation were to be prolonged it has the ability to plough the Russian economy into the depths of recession, the worst since the fall of communism.  What does it mean for Putin’s political aspirations?

The people of Russia are beginning to get frustrated with the lack of traction in the economy.  Once the economy paths its way downwards jobs are lost and manufacturing is slowed down that can’t be good for consumer sentiment. 

Here’s another graph of Russian Inflation: 

Russian policymakers have been able to normalise inflation over the past 6 years but notice the band the inflation rate has been in since late 2012 early 2013. Sideway band suggesting everything is in check until recently where it popped above the upper band and has broken past the previous lower high. This could suggest that inflation in Russia could increase dramatically in the next few months which would make sense taking in consideration the weak Russian Ruble.

It’s clear from the above analysis that there is economic distress in the Russian economy both in the long and short term.  What Russian policymakers need to realize is that supporting or creating wars with other nations is not going to solve these problems and will only attract condemnation from the rest of the world.  

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