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1. Swedbank Baltic Sea Analysis No. 21 23 June 2009
Economic Research Department, Swedbank AB (publ), SE-105 34 Stockholm, tel +46 (0)8-5859 1028
e-mail: ek.sekr@swedbank.se Internet: www.swedbank.se Responsible publishers: Cecilia Hermansson +46 (0)8-5859 1588
Magnus Alvesson +46 (0)8-5859 3341, Jörgen Kennemar +46 (0)8-5859 1478 ISSN 1103-4897
Russia – sharp slowdown and protracted recovery
• The Russian economy contracted during the first quarter by slightly
more than 9.5% at an annual real rate. This is more than expected,
and we are revising down our 2009 growth forecast to -6%, followed
by a limited recovery in 2010 of 1%. The largest decline was seen in
domestic demand, in particular consumption and investments,
aggravated by the slowdown in global trade and financial flows. One
trouble spot is an increase in loan losses and further weakening of the
banking system. On the other hand, the recovery could be aided by
the significant reserves at the disposal of the Russian government for
expansive fiscal stimulus measures as well as a return to higher oil
prices.
• Russian authorities face difficult choices in the short and medium
term. The economic slowdown appears to be deeper than previously
expected, and the risk of major swings in the financial markets, both
externally and internally, still remains. Large fiscal stimulus packages
can mitigate the impact of the recession, but have to be balanced
against the need for stability in domestic prices and exchange rates.
In the medium term, Russia cannot hope for a repeat of the previously
high growth levels without extensive structural reforms of the
economy.
Unexpectedly large drop in economic activity
The economic slowdown in Russia was surprisingly severe during the
first quarter of 2009. GDP is estimated to have shrunk by 9.5% on an
annual basis, mainly due to a contracting manufacturing sector,
although indicators for retail sales and investments also pointed to
significant declines. After a long period of steady growth, driven by
favorable global economic conditions and exceptionally high energy
prices, the Russian economy now faces challenges not seen since
the last crisis in 1998-99. This time around, however, it cannot expect
much support from global economic environment, and it is unlikely
that oil prices and capital inflows will reach the same levels as in
2006-08.
The downturn is the
most severe since
1998-99

2. 2 Swedbank Baltic Sea Analysis No. 21 • 23 June 2009
Economic activity, 2003 – 2009
GDP (real) Manufacturing Retail Investment
Source: Reuters EcoWin
Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3
03 04 05 06 07 08 09
Annualchangeinpercent
-25
-20
-15
-10
-5
0
5
10
15
20
25
30
The external demand contraction exacerbates the downturn. The
global recession has hit the Russian export sector hard and the value
of exports fell by nearly 50% during the first three months of the year
compared with the same period of 2008, largely due to falling oil
prices. Despite lower imports, the trade surplus fell significantly,
reducing Russia’s foreign reserves. The rouble was devalued
stepwise last fall, but rising oil prices and tighter monetary policy has
strengthened the value slightly in recent months.1
The value of the
rouble has not fallen in real terms as much as during the crisis in
1998-99, when it dropped by more than 50%. In May 2009, it had
declined about 11% compared with November last year. This
provides the Russian economy with a slight competitive advantage,
while, however, the servicing of foreign debt becomes more costly.
Foreign trade and oil prices, July 2006 – April 2009
Export (value, USD)
Import (value, USD)
Oil price (Ural)
Rouble against basket (55% USD; 45% EUR)
Source: Reuters EcoWin
jul okt jan apr jul okt jan apr jul okt jan apr
06 07 08 09
USDperbarrel
30
40
50
60
70
80
90
100
110
120
130
140
150
Annualchangeinpercent
-50
-40
-30
-20
-10
0
10
20
30
40
50
60
70
1
Russian exchange rate policy is built on a target rate for the rouble against
a basket consisting of dollars (55%) and euros (45%). During the latter half
of 2008, the target rate was raised as the international financial crisis
worsened and oil prices dropped. At present, the Russian central bank has a
target of 41 versus the basket.
Global demand
is slowing …

3. Swedbank Baltic Sea Analysis No. 21 • 23 June 2009 3
Domestic demand is also weakening quickly. Growing losses for
companies and banks, coupled with a rapid slowdown in foreign
capital inflows, have created liquidity problems in the financial sector,
reducing lending to businesses and households. Though lending
volumes have fallen from exceptionally high levels, the rapid cutback
is, in turn, creating liquidity problems for companies. This, together
with a more downbeat outlook for the economy, led to a drop in
investments of slightly over 2% in real terms during the last quarter of
2008, a decline which continues in early 2009. Foreign direct
investment has also fallen substantially, by 43% in the first quarter
2009 compared with the same period in 2008.
Lending to businesses and households, September 2007-March 2009
Lending rate (RHS) Credit to households Credit to enterprises
Source: Reuters EcoWin
sep nov jan mar maj jul sep nov jan
07 08 09
Percent
10
11
12
13
14
15
16
17
18
Annualchangeinpercent
0
10
20
30
40
50
60
Household demand has also slowed. Falling real wages and rising
unemployment have pushed real disposable income down. The
Russian labor market is flexible in terms of wage setting and is
quickly adapting to lower demand, but unemployment is still rising
substantially, and reached in April 10.2% before moderating slightly in
May to 9.9%. Growing wage arrears further worsen the economic
situation for households. Lower labor costs are helping to ease
declining profitability in the private sector, but could, at the same time,
create social unrest and tension. The consequences of the economic
crisis have been especially tangible in cities and regions dominated
by few industries and employers.
Labor market development, August 2002 – April 2009
Disposabel income (real) Real wages Unemployment rate (RHS)
Source: Reuters EcoWin
aug dec apr aug dec apr aug dec apr aug dec apr aug dec apr aug dec apr aug dec apr
02 03 04 05 06 07 08 09
Percent
5.0
5.5
6.0
6.5
7.0
7.5
8.0
8.5
9.0
9.5
10.0
10.5
Annualchangeinpercent
-20
-15
-10
-5
0
5
10
15
20
25
30
35
… reinforced by
weaker domestic
demand
Households are
struggling with real
wage cuts and
rapidly rising
unemployment

4. 4 Swedbank Baltic Sea Analysis No. 21 • 23 June 2009
The Russian government has the will and the fiscal resources to
mitigate the economic slowdown, but there are risks inherent in overly
expansive policies. Lower interest rates and a weaker rouble,
combined with fiscal measures, have mainly supported the financial
sector and businesses. To ease the impact of the growing recession,
a fiscal stimulus package equivalent to up to 10% of GDP is planned
in 2009. The main part has, to date, been allocated to corporate tax
cuts, but it is expected that an increasing share will be used to
alleviate the social consequences of the crisis.
The risks remain high, however. Overly expansive policies could
exhaust the possibilities of fighting the crisis at a later stage. The
problems in the financial sector could be more severe than currently
estimated, and may require considerably greater resources to avoid
acute liquidity problems. Furthermore, tax cuts and increased
subsidies to the business sector could be hard to claw back once the
economy rebounds, eroding fiscal sustainability. Expansive policies
also put pressure on exchange rates and inflation. External capital
inflows and investments could also decline further if the international
outlook on the Russian economy deteriorates. Moreover, oil prices,
which are currently helping Russia to mitigate the crisis, could quickly
reverse again. The economy, thus, remains vulnerable.
Fiscal resources, 2006 – 2008
0
1
2
3
4
5
6
7
8
2006 2007 2008K1 2008K2 2008K3 2008
PercentofGDP
300
350
400
450
500
550
600
USdollarbillion
Reserves
Budget balance
(LHS)
Source: Russia Economic Report No. 18 (World Bank, 2009)
The political situation in Russia can still be considered stable, despite
that the number of protests has grown in the wake of the economic
crisis. Rumors are flourishing about President Medvedev’s and Prime
Minister Putin’s roles, and about the possibility of a new presidential
election to reinstate Putin. This is unlikely, however, and both are still
popular and the opposition remains divided. The biggest risk of
disturbances is thought to be in regions where the recession has
been especially severe, and it is likely that a considerable part of the
fiscal stimulus package will target these areas. Foreign policy has
received less attention despite the BRIC2
summit last week.
Discussions of Russian membership in the WTO also seem to have
hit a roadblock. If anything, the latest maneuver by Russia
announcing that it would seek to join the WTO as part of a customs
bloc together with Belarus and Kazakhstan will delay rather than
speed up the membership process
2
Brazil, Russia, China and India.
A massive fiscal
stimulus will ease
the recession …
… but the economy
remains vulnerable
The political situation
is stable, but openness
to the world tends to
be limited

5. Swedbank Baltic Sea Analysis No. 21 • 23 June 2009 5
Productivity gains for long-term growth
Looking beyond the current recession, it seems clear that the growth
potential of Russia’s economic will stagnate if reforms to raise
productivity are not implemented. The recovery was rapid following
the crisis in 1998-99. This was largely the result of extensive
overcapacity following the breakdown of the Soviet economy. Labor
was shifted from an inefficient agricultural sector to more productive
service and manufacturing industries, and productivity rose
significantly as a result. That can only happen once, and without an
underlying driving force that raises productivity, the potential for
higher growth levels is reduced. At the same time, real wages have
been boosted by large capital inflows and significant surpluses in the
oil sector. A real appreciation of the currency has affected Russia’s
competitiveness, and an increasing share of domestic consumption
has been met through imports, leaving a large share of Russian
industry with low value-added production.
Higher productivity and growth potential often require extensive and
controversial reforms. Certain industries and segments of the
population will benefit, while others will not. The political costs could
be high. However, periods of economic crisis can offer an opportunity
to implement such reforms. When large sectors of the population are
financially affected by the crisis, there tends to be less resistance to
reforms that lead to change.
In many respects, Russian reform policy was put on hold during the
recent years of high growth. Investment, both public and private, has
been neglected. In the EBRD Transition Progress Index, which
measures the transition to a market economy, Russia trails the
countries that have made the most progress in terms of infrastructure
reforms (see diagram). Despite, or perhaps as a result of, Russia’s
large energy resources, investments in energy-efficient technologies
have suffered. For example, nearly 40% of heating plants in Russia
are more than 40 years old, compared with less than 3% in China.
Low electricity prices have left little incentive to expand capacity and
make efficiency improvements. Other public investments have also
proved insufficient, and limited construction of roads and transports
have hindered productivity growth in the private sector.
Infrastructure reforms in Russia – EBRD transition index, 1989 - 2008
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
Russia
Best
Source: Transition Report 2008 (EBRD)
The last decade’s
productivity gains
won’t be repeated
Opportunity to
increase economic
reforms
Investments are
lagging

6. 6 Swedbank Baltic Sea Analysis No. 21 • 23 June 2009
The Russian labor market is flexible in terms of wages and
employment conditions, but mobility is often low. Education, which
otherwise maintains a high level, does not always fit the needs of
modern businesses. Insufficient investment in the education system
and occupational training has led to a shortage of the right
competencies. Mobility is limited by the social insurance system,
which is far from comprehensive and not tied to the employee.
Demographic trends are another factor that could limit growth
opportunities. Life expectancy and birth rates are low, and health
problems persist, which will lead to a dwindling population and
growing share of pensioners. In the next two decades, the Russian
population is expected to fall by 12%, from about 140 million to
slightly over 120 million. Moreover, participation rates are already
high.
Other important aspects affecting the productivity development are
business conditions and the degree of competition. The business
environment and opportunities for domestic and foreign companies to
set up and expand operations in Russia have improved significantly in
recent years. The regulations have been simplified and start-up costs
are relatively low compared with countries such as Brazil, China and
India. Still, Russia is not considered a stable market and is ranked
75th of 177 countries in a recent survey on the efficiency of its
regulatory framework (World Economic Forum). In addition, there
remains a widespread notion that private enterprise is limited by
corruption (Transparency International, 2009). In the latest “Doing
Business” report from the World Bank, Russia fell from a ranking of
52nd last year to 65th in 2009. Productivity growth is also hurt by the
lack of competition. In Russia, reforms in this area have stagnated
compared with more reform-friendly emerging market economies (see
diagram).
Competitive reforms in Russia – EBRD transition index, 1989 - 2008
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
Russia
Best
Source: Transition Report 2008 (EBRD)
Labor skills do not fit
the business sector’s
needs
Russian demographics
pose a big risk to
economic development
Doing business isn't
easy enough yet

7. Swedbank Baltic Sea Analysis No. 21 • 23 June 2009 7
A crossroads for Russian economic policy
Russian economic and financial policies are, in the near term, geared
toward counteracting the global economic turbulence until financial
markets stabilize and oil prices bounce back. To do so, the country
has considerable financial reserves that were built up during the
boom years. High commodity prices and large financial resources will
not resolve Russia’s long-term growth challenges, however. Growth
potential will stagnate unless reforms are implemented to raise
productivity. In the medium term, the Russian economy must grow
more organically to withstand economic fluctuations and lessen its
dependency on global development. Previously high growth levels
were partly the result of huge surpluses from commodity production
and capital inflows, and partly of the overcapacity in the economy.
Without reforms to stimulate productivity, Russian growth may not
rebound to those levels.
Magnus Alvesson
Economic Research
Department
SE-105 34 Stockholm, Sweden
Telephone +46-8-5859 1031
ek.sek@swedbank.se
www.swedbank.se
Legally responsible publishers
Cecilia Hermansson,
+46-8-5859 1588.
Magnus Alvesson, +46-8-5859 3341
Jörgen Kennemar, +46-8-5859 1478
ISSN 1103-4897
Swedbank Baltic Sea Analysis is published as a service to our customers. We believe that we
have used reliable sources and methods in the preparation of the analyses reported in this
publication. However, we cannot guarantee the accuracy or completeness of the report and
cannot be held responsible for any error or omission in the underlying material or its use. Readers
are encouraged to base any (investment) decisions on other material as well. Neither Swedbank
nor its employees may be held responsible for losses or damages, direct or indirect, owing to any
errors or omissions in Swedbank Baltic Sea Analysis.
A new growth model
is needed to realize
Russia’s potential