The Economic Association Agreement with the EU signed by Ukraine, Georgia, and Moldova on June 27th, 2014, will have a limited impact on Russia's GDP growth rates, given that Ukraine's share in Russia's foreign trade was just 4.6% in the first quarter of 2014, and the share of all CIS countries combined was 12.7%.
Even the unofficial embargo on Ukrainian imports will not make a big difference. A drop in Ukrainian imports by almost 22% (to US$ 2.8 billion) in the first quarter of 2014, accounts on an annualised basis for a slight increase of 0.13 percentage points in Russia's GDP (imports are deducted from GDP).
At the same time, current statistics suggest significant changes in the composition of Russia's foreign trade, independent from Russia's relations with Ukraine or trade with the EU, but reflecting broader trends, such as the Russian rouble weakening over the past 18 months or Russia’s accession to WTO two years ago and the consequent significant implications for the country’s economic growth rates.
Table 1: Russia's trade turnover with major partner countries in the first quarter of 2014
| Exports | Imports | The share in Russia's foreign trade turnover, % | |||
| million US$ | % of the 2013 1st quarter | million US$ | % of the 2013 1st quarter | ||
| Total | 122,69 | 97 | 66,633 | 94 | 100 |
| non-CIS countries | 106,23 | 97 | 59,065 | 96 | 87 |
| Germany | 9,412 | 110 | 7,647 | 97 | 9 |
| Italy | 8,829 | 89 | 2,791 | 96 | 6 |
| Netherlands | 16,739 | 95 | 1,213 | 95 | 10 |
| Poland | 4,545 | 95 | 1,707 | 98 | 3 |
| U.K. | 3,928 | 105 | 1,626 | 87 | 3 |
| Finland | 2,723 | 84 | 1,038 | 91 | 2 |
| France | 1,853 | 68 | 2,897 | 101 | 3 |
| China | 9,43 | 108 | 12,224 | 98 | 11 |
| U.S. | 2,552 | 127 | 3,886 | 106 | 3 |
| Japan | 4,129 | 96 | 2,518 | 72 | 4 |
| Turkey | 6,298 | 99 | 1,611 | 101 | 4 |
| Switzerland | 1,625 | 76 | 756 | 127 | 1 |
| CIS | 16,461 | 96 | 7,568 | 82 | 13 |
| Belarus | 4,804 | 95 | 2,561 | 71 | 4 |
| Kazakhstan | 3,016 | 77 | 1,657 | 111 | 3 |
| Kyrgyzstan | 452 | 84 | 19 | 71 | 0 |
| Tajikistan | 188 | 110 | 5 | 38 | 0 |
| Uzbekistan | 672 | 139 | 228 | 104 | 1 |
| Ukraine | 5,834 | 107 | 2,822 | 78 | 5 |
Source: Rosstat
Considering the exchange rate factor and its impact on foreign trade, experts note a decline in imports from Belarus and Japan by almost 30% in the first quarter of 2014, even greater than the drop in Ukrainian imports-despite these three countries accounting for comparable portions of Russia's foreign trade. As of the beginning of 2014, the exchange rate factor has contributed almost 0.4 percentage points to Russia's GDP – a significant contribution, given an annual GDP growth of less than 1%.
That said, one should not overestimate the role of the exchange rate in the decline of imports or the impact of declining imports on economic growth. It is not yet clear whether the decline in imports has been caused by a boost in domestic production or by a drop in demand amidst a looming recession, which is often preceded by a drop in imports.
As shown by numerous earlier studies of the post-Soviet economy, ongoing trade and cooperation between Russia and Ukraine (and Belarus) may have medium- and long-term benefits for these three countries by boosting exports of manufactured products, such as airplanes, products of the military-industrial complex, and machinery, particularly transportation. External markets operate with bigger volumes than any domestic market and favour economies of scale, which is the main reason why countries join the WTO.
Will Russia mark its approaching two-year anniversary of the WTO accession with higher non-commodity exports? A review of data available from the Federal Customs Service on key exports in January-April this year compared to the same period two years ago suggests that little progress has been made in terms of diversification, so commodity exports continue to prevail. Even though Russia's exports of cars and trucks increased by 59% and 18%, respectively, exports of vodka increased by 48%, sawn timber by 18%, plywood by 39%, and cotton fabrics by 17%, Russia still does not export either furniture or clothing, its exports of machinery dropped by 12%, and exports of compound and potassium fertilisers and synthetic rubber dropped by about a third over the two-year period.
Commodities continue to make up the lion's share of Russian exports, while semifinished products with minimal processing have been a particularly fast-growing category of exports since Russia's WTO accession-ammonia and methanol exports have doubled over the two years of WTO membership.
Last week, President Putin instructed the Government to set up, before the end of 2014, a loan and insurance provider to support the country's non-commodity exports based on a merger between the EXIAR export insurance agency and Eximbank, both of which belong to VEB, Russia’s state-owned development bank. Continued government support for both non-commodity exports and innovative high-tech sectors is crucial for a Russian economy prone to Dutch disease, but approaches to providing such support need to change for it to make the necessary impact. Indeed, EXAIR and Eximbank were established quite a while ago (in fact, Eximbank was set up back in 1994) for this purpose, but so far have made little difference to exports diversification.
But why?
First, government bureaucracy is not particularly good at identifying areas of growth – the market can do it much better. Moreover, international experience reveals that successful exporters account for 2-3% of the top companies, usually small and medium-sized (i.e. often unnoticed by decision-makers in Moscow) and spanning all sectors of economy (while the Russian government tends to support only certain priority sectors deemed, for some reason, more important than others).
Second, non-commodity exports are not limited to sophisticated finished products, such as power units, airplanes, cars, or smartphones. They also include exports of parts and components for the upstream global value chains (GVCs). Russia already participates in the less profitable downstream GVCs, but not in upstream ones.
Third, participation in upstream GVCs is closely linked to foreign direct investment (FDI) in the country, but Russia is likely to face problems in this area due to the current geopolitical situation.
According to UNCTAD's World Investment Report 2014 published on June 25, 2014, foreign direct investment in Russia increased in 2013 by 57% to 79 billion dollars, making Russia the third largest country in terms of this indicator for the first time ever.
This increase, however, was due to several unsustainable factors.
First, good economic growth after the unprecedented 2009 crisis, together with high yields in the energy sector, made Russia attractive to investors who invested funds borrowed from their parent companies. Now the situation has changed due to looming sanctions.
Second, BP's purchase of 18.5% in Rosneft contributed to Russia's good FDI statistics and made Britain the largest investor in Russia in 2013. The Chinese Chengdong’s purchase of 12% in Uralkali had a similar effect. No more deals of this scale are expected in the near future.
In recent years, Russia has faced an extremely high, by global standards, FDI outflow (relative to GDP), explained only partially by the expansion of transnational companies making strategic investments in European markets. In 2013, these included the deals between Gazprom and the Austrian company, OMV, and between Lukoil and Italy’s ISAB.
It is difficult to project the future of FDI in Russia, and thus, Russia’s participation in GVCs. On the one hand, the conflict with Ukraine may adversely affect both investments and non-commodity exports. In addition to this, Russian transnational companies may be affected by limited access to foreign loans, offset only partially by loans from domestic government-owned banks.
All commodity-driven economies are plagued by weak institutions and high corruption, therefore the key challenge is to support non-commodity exports while avoiding bribes and kickbacks. The planned involvement of government-owned banks and particularly their mergers (e.g. between EXAIR and Eximbank) can be risky both in terms of avoiding monopolies and in terms of the appropriate selection of non-commodity companies to be supported.