Russian Economic Diversification in the Face of Sanctions is Reaping Benefits

When sanctions were imposed on Russia, many thought it would lead to their economic implosion especially when aligned to falling oil prices. So how has the Russian economy weathered this storm and seemingly turned the corner in recent months?

Following Crimea’s decision to secede from Ukraine and join Russia, the US and EU imposed sanctions against Russian businesses and individuals. Russian acted in kind by imposing its own sanctions in August 2014 which included the import of food produce including meat, vegetables, fruit and dairy.

Russia was acutely aware that its reliance on the exportation of oil and gas was an external influence which could be brought to bear with devastating consequences. During the 2000s, hydrocarbons where a rich source of rising income and increasing production volumes. In recent years that has changed due to falling oil price in a market were Russia does not set the price on world oil markets. With respect to the gas pipeline market, Russia does exercise control with long-term contracts but their ability to influence price changes is limited to the medium and longer term. Despite all this Russia has been able to survive the falling oil price due to movement in its own currency and because it has relatively low oil production costs.

However Russia did not rest on its laurels and even prior to the imposition of Western sanctions they began a programme termed export substitution which in simple terms meant diversifying from gas and oil production and exportation. The diversification required is that which would result in GDP growth that is not correlated to the performance of their hydrocarbon industry. What is poorly understood is that Russia poses a significant manufacturing sector in global terms.

Moscow recognised that Russia was competitive, broadly speaking, only in natural-resource sectors, and that the country needed to diverse and develop businesses in a range of other sectors. Russia embarked on a programme that offered support for exporters and import substitution. Organisations engaged in these programmes were supported by exemption from profits tax and by having 30 per cent of their output open to purchase by the state without competitive tendering.

Russia also introduced its high-profile import substitution initiative and in November 2015 The Minister of Industry and Trade , Denis Manturov, announced at a State Council meeting that 570 import substitution projects had commenced. Plans for the implementation of 2059 projects across 19 branches of the economy were due to commence between 2016 and 2020.

Import substitution is already having a significant impact. In late 2016, Manturov commented that import substitution in the pharmaceutical industry had reached 76% whereby that percentage of products on the list of essential medicines are manufactured in Russia. It is envisaged that within 12 months that figure will rise to 90%. Import substitution has proved to be successful in the engineering sector, were the share of imports fell from 60% in 2014 to 48% by the end of Q3 in 2106.

Import substitution has also improved in engineering industries. In heavy engineering the share of imports fell from 60 percent in 2014 to 48 percent over the first nine months of 2016. In the power engineering the drop was from 33 to 24 percent, while in oil and gas engineering from 55 to 46 percent. Russia also managed to double the production of agricultural machinery in 2015.

Sanctions and import substitution were also responsible for grain production of 126 million tons in 2016 which was a record high in Russian history and 16% more than in 2015. Food produce also showed increases e.g. sunflower oil and milk.  Meat and poultry production was also a significant beneficiary of such policies with an increase of 6.3% compared to 2015 and in the same period, Russian meat imports fell by 21%.

Such has been the success of the Russian import substitution programme and given Russia’s status of a country free of foot-and-mouth disease, Russia’s Agricultural Ministry is preparing a sub-program on the state support of export of agricultural products within the framework of WTO regulations. Russia is now in the position of turning their successful import substitution programme into export substitution and the necessary diversification from hydrocarbon industries.

The programme will include support of participation of targeted global trade fairs which are of most interest to Russian exporting companies.  A brand will be created, which will include market positioning of Russian agricultural produce and food products abroad, exploration of market possibilities, access to foreign markets and increasing the quality criteria associated with exported Russian products.

In the face of this diversification of the Russian economy which have seen in recent months increasing vocal opposition in Europe to Russian sanctions with a recognition that not only are they counterproductive but the damage to Europe has been greater than that of Russia in many instances.

One such nation is Austria were there are calls to end sanctions and a realisation that the challenges to re-enter the Russian markets will be tough due to a shift in Russian trade and Russia’s import substitution policy.

Prior to the imposition of sanctions, Austrian exports to Russia had risen, in a fourteen year period from 2000, from €654 million to €3.5 billion, and imports from Russia to Austria grew from €1.2 billion to €3.2 billion in the same period. Sanctions severely hit bilateral trade volume which fell by 38% in 2015 and 10% in 2016.

What Austria is experiencing is a common experience across Europe who are bearing the cost of a Washington driven policy decision. We anticipate change in the US stance given the election of Trump and Europe should follow suit. Perhaps more than anything else the West failed to appreciate the resilience of Moscow, the Russian people and their ingenuity and guile to devise solutions which would benefit their nation in the face of an economic assault by the cabalists.

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