3 Economic Challenges Russia Faces in 2016

Falling oil prices and the imposition of trade sanctions following conflict in the Ukraine have been the two major factors impacting the Russian economy during 2015. Due to Russia's heavy exposure to oil export revenues, depressed oil prices have simultaneously led to falling economic output and rapid inflation, creating challenges for policy makers. Sanctions placed by the United States and European Union compounded the oil price impacts, straining GDP and leading to depreciation of the ruble. In 2016, Russia will continue to be challenged by the lingering effects of these issues. Low oil prices, inflation and investor confidence are the three largest challenges faced by the Russian economy in 2016.

Oil is Russia's largest export, representing 58.6% of total exported value in 2014. Exported oil contributed more than 8% of GDP that year. Other raw materials, such as metals, are also important contributors to the country's exports. Tumbling energy and commodity prices throughout 2015 took a heavy toll on the economy, limiting the income available to Russia's largest industries and threatening wages and employment. Prolonged low oil prices will likely sustain recession conditions in Russia, and announcements from OPEC, Kuwait, Saudi Arabia and Iran have all indicated major oil producers are expecting oil prices will remain low in 2016.

Russian GDP is forecast to decline again in 2016, though expectations regarding the severity of contraction vary from less than 1% to nearly 4%. Russian monetary authorities have indicated willingness to focus policy on offering relief from inflation, but popular and political pressure exists to ease interest rates in an attempt to catalyze economic growth. Russian consumers should expect continued pressure on employment and wages driven by continued low oil prices and structural issues, while the Russian government has to assess the severity of output contraction relative to the fiscal and monetary risks associated with recession curtailment measures.

In response to the economic shocks in 2013 and 2014, the Russian government devalued the ruble multiple times, but this did not lead to the desired increase in exports. European Union and U.S. sanctions on Russian banks also caused the ruble to depreciate, as Russian businesses were forced to draw on foreign currency reserves from the central bank. Falling oil prices have also caused the ruble to drop relative to other currencies, while embargoes on imported food and consumer goods caused the cost of living to increase.

Inflation and rising consumer goods prices have negatively impacted households, and this will continue to plague the Russian economy in 2016. Rapid inflation has also limited the policy measures available to Russian monetary authorities. Reducing interest rates is a common policy response to recession conditions, which creates incentive for investment and job creation but also leads to inflation. With inflation rising about 15% in 2015, the Russian central bank was unable to sustain the currency valuation strategies employed to stimulate the economy. Russian consumers will likely continue to see purchasing power erode, even if inflation is reduced from its high levels. The Russian government will have to closely monitor the success of its more restrictive monetary moves while ensuring interest rates are not too high to encourage growth.

Numerous factors have combined to limit investor confidence in Russia. Concerns over corruption and ease of doing business have historically kept some investors from dealing with Russian assets, though improving reporting standards and legal structures have helped to assuage these fears in recent years. Other observers suggest private property rights, especially those pertaining to intellectual property, are insufficient to attract capital inflows in the same magnitude of the most developed economies, but this stigma cannot be deemed universal. These issues aside, political turmoil has caused capital flight as conflict with the Ukraine and Turkey have dissuaded investors from dealing with Russian companies. Access to global capital markets is important for the financial stability of large companies, so Russian policy makers must be mindful of their reputation in the eyes of capital allocators around the world.