Western Sanctions - Russia's Transition

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Co-authored by William Witenberg a contemporary artist focused on abstract painting

Russia's transition, in the first half of 2015, to pronounced stagflation - a combination of economic downturn and ultra-high inflation is a result of a lower ruble and declining oil prices.

In the first quarter of this year, the economic downturn in Russia amounted to 2.2% year over year, industrial production fell by 5.5% . Retail trade turnover at the end of May decreased by 9.2%, export decreased by 33.9%, imports decreased by 40.8%, and real wages declined by 7.3%. The total number of unemployed in May of this year was 13.5% higher than in May of 2014. This May consumer prices were 15.8% higher than last year. As of June 22, inflation since the beginning of the year was a disturbing 8.5%.

In the fight against drastically high inflation the government resorted to tight monetary policy. This makes it difficult to service the debt of banks in the country. After my recent visit to Russia I came back with a feeling that the country is going back to pre-industrial revolution primarily as a result of highly unpredictable currency rate. Since the ruble is so volatile long-term contracts cannot be sustained, and people cannot be assured they are paid adequately for the work they do. Hence, a lot of firms pay their employees with the goods produced, which in turn are being distributed and exchanged between peers. The barter of goods and services is also going on between businesses.

Russia, with deep stagflation in the first half of the year has justified the worst expectations of foreign investors concerned about the prospects of developing countries. In September 2013, Morgan Stanley came up with the concept of "Fragile Five" developing countries, which includes Brazil, India, Indonesia, South Africa and Turkey. It was understood that a combination of high inflation and current account deficits resulted in these countries exports becoming too expensive, and currencies evaluating. In Indonesia, South Africa, Brazil and Turkey by the end of 2014 the exchange rate actually fell by about 5%; in India, on the contrary, increased by 10%. However, the leader of the fall was not the member of the "Five" - Russia, which just has a current account surplus. Brazil, India, Indonesia, South Africa, Turkey and Russia combined unusually high by Western standards inflation, and budget deficits. However, all these countries, unlike the industrialized countries have quite high economic growth, apart from Brazil and Russia. In the eyes of foreign investors, Brazil and Russia looked in early 2015 worse than the others. Price of the real, and the ruble reached historic lows. Both countries suffered from the fall in world oil prices, especially Russia, the world's second largest exporter.

During the first six months of 2015 the dollar versus the Russian currency market has decreased by 0.8%, the euro was down 9.8%. In the second quarter the dollar fell by 3%, the euro rose by 0.5%. In the second half of the year the ruble will suffer from relatively low oil prices, the nervousness of the global foreign exchange market in connection with the events in Greece, the expectations that the US Federal Reserve will raise interest rate, and potential oil exports from Iran which will lower oil prices even further. With regard to all these circumstances the dollar in the second half of the year will be higher than 50 rubles. In the second half of 2015 inflation has shown some signs of stabilization, but already almost two times higher than last year, so that prices since the beginning of the year will be likely to grow by more than 11%.

All of these factors assure that the second half of 2015 will be continue being a difficult period of stagflation in Russia.