To Russia With Love

Read the Russian Translation of this Article
In this blog we try to profile all of the BRIC countries, and how their economic emergence will impact the world political stage. So far, we have given lots of attention to India and China(because they have the largest amounts of trade and direct investment from the US), but I realized that we have not once talked about Russia on this blog. In many ways the Russian economy is much better poised than India's, and for the most part the country is already industrialized(albeit inefficiently). The Russians seem to be determined to regain their status as a world superpower, and they will be a force to reckon with in the future. (To read more about Russia's history click here)

I did a little research about the Russian Federation, and I discovered that their country could be moving into serious long term financial problems. The Russian economy is inextricably intertwined with commodity prices. 30% of the governments budget revenues come from the hydrocarbon(collective term for oil, natural gas, and refinement) industry, and 60% of their export revenue is from the sale of these hydrocarbons.

In the short term, a drop in commodity prices will devastate the Russian economy. Their oil production is at a staggering 9 million barrels a day, and 50% of this oil is exported. A drop of 20$ in oil prices lowers their oil revenue by $100M a day. This will negatively affect their account balance, and drive down the value of the ruble. For this reason, the government set up a fund, valued at $150B, to help stabilize their financial state. Their economy is extremely sensitive to fluctuations in these commodity prices. Even worse their government is increasing their expenditures, and is banking on the rising fuel prices. They are expanding their military, and their global presence around the world. Building up a military requires significant investment, and prevent them from saving money in case the commodity bubble bursts.

If steel prices, oil prices, and natural gas prices drop, the Russian economy will have a failure. Oil prices fluctuate quite significantly over extended periods of time. The markets can not sustain permanently high prices, because those would result in a drop in demand. Therefore it would be in a petroleum producing nation's interest to have sell oil at future equilibrium prices and lock in these prices, rather than over producing at unsustainable prices and production levels. However, with Russia this is not the case. What's more Russian production is much higher than can be sustained on their current proven reserves. Their current proven reserves are estimated at 60 billion barrels(We can assume that about 50% more is waiting to be discovered). That means (assuming a full production year round) they will pump their current reserves dry within 20 years, and definitely run out(assuming future discoveries) of tradition crude oil deposits by 30-40 years. It is important to note that after the "Hubbert peak" in oil production, the costs for extracting this oil will increase barrel by barrel. Also, 50% of their production is exported and thus will also impact their foreign exchange reserves.

Russia's economy is still very industrial and manufacturing oriented. They don't have a very matured service industry. Russia can not compete with China, Vietnam, etc. in manufacturing just because of costs. And, without a serious service industry the country really has no other source of trade. The emerging Russian IT industry will loose out to cheaper labor in India and China. Russian goods are non-existent in the Western world. Even India, which has a crumbling manufacturing sector, manages to export goods to the US. Russia can not sustain such a large economy on trade within the CIS. So without commodities Russia is just like any other European economy, and very much unlike an emerging market. Stagnating non-commodity sector growth and a high poverty rate will also lead to political unrest.

Russia is falling into the same trap the ruined the Soviet Union. They are resuming strategic activities such as long range bomber flights, and reinforcing their nuclear triad. For the US, such spending is distributed through NATO and an individual country doesn't feel as much of the pain. Russia is attempting to face off with NATO over the Czech Republic, Georgia, and the Baltic nations without any allies. The CIS nations have their own issue and don't want(and need) to oppose NATO expansion. They are expanding their "global strike" abilities and rapidly improving their military hardware. The only problem is they are in this alone, and China or India is unlikely to provide them with military, ideological, or moral support. Without support, NATO is free to outspend the Russians on everything producing an interesting Catch-22. If they take the bait and match our military, they risk a financial crisis. If they don't NATO will expand right to their borders, severly comprimising their security.

From my research, I concluded that though Russia is an emerging power, their emergence needs to be taken with a grain of salt. Historically, we have a bad habit of overestimating the threat that they pose to us. Russia will become a regional powerhouse, but their scope of influence will be restricted to Europe, who rely on their fuel. The growth in Russia is very similar to the growth in the Middle East, and we need to realize that unless their industrial efficiency massively improves they will not succeed in anything other than commodites. Only if Russia, makes the right investments with their current windfall revenues, will their country avert this impending crisis.

I want to know your thoughts on Russia, and whether their growth is "real"(as opposed to speculative short term growth)

All data from CIA world factbook

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