Self-imposed food embargo hurts Russian consumers

Self-imposed food embargo hurts Russian consumers

The ban on European and American food imports to Russia may not be as beneficial for Russian companies as President Putin hopes. Many of them are dependent on imports of raw materials, and are unprepared for the unexpected expansion.

On August 6, 2014, Russian president Vladimir Putin signed a decree introducing a one year ban on imports of certain agricultural products and foods from countries that impose economic sanctions on Russia. Prohibition applies to food that comes from the EU and the United States as well as Australia, Canada, and Norway.

The list includes meat and meat products, fish, dairy products, fruits and vegetables, but does not apply to some ready-made foods such as pasta, coffee, soft drinks, and alcoholic beverages. The embargo may be lifted earlier in response to cancellation of sanctions against Russia.

According to the Russian Federal Customs Service, in 2013 Russia imported food products valued at $43 billion, which constituted 44% of households’ spending on food. The restricted countries together accounted for $19 billion of Russia’s food imports, of which the banned products amounted to around $11 billion.

While the stated aim of the ban was political retaliation, Russian media and officials spun the story as an opportunity to stimulate domestic production and import substitution. Following the news, the Russian stock market experienced a speculative rise in value of food producers: “Russian Sea” (+18.7%), “Razguliay” (+39.9%), “Cherkizovo” (+6.7%), “Glavtorgprodukt” (+30.9%), “Rusgrain Holding” (+36.4%), “Ostankino Meat Processing Plant” (+30.3%), etc.

Nevertheless, this rise and high expectations may be premature, due to the following factors.

1. Dependence on imports

The embargo will mostly affect food categories of fresh and chilled beef (import constitutes 62% of retail sales), fish and seafood (50%), cheese (48%), and nuts and fruit (45%). Fish and seafood supplies are seen as the most prospective sectors for a quick import substitution, while beef and dairy products require substantial time for the natural increase of cattle stock.

The total fish export from Russia in 2013 was over 1.7 million tons and potentially can be redirected to the domestic market. Nevertheless, Russia manly imports and consumes trout, salmon and herring, but exports primarily frozen Pollack.

One of the leaders in Russia’s fish and seafood industry, “Russian Sea,” may be badly hit by the embargo. The company’s revenue (c. $0.5 billion in 2013) mainly consists of imported fish resale, while its fish farms in Russia’s North produce less than 1% of sales. Its main suppliers – Shetland Catch (UK), Marine Harvest (Norway), Norway Pelagic (Norway) and Atlantic Pelagic (Norway) – are in restricted countries.

Another big producer, Murmansk Fish Processing Plant, had to stop operations due to the lack of Norwegian fresh fish and even considers suing the Russian Government.

The future of these companies, as well as the Russian food sector, will depend on the ability to switch quickly to supplies from unrestricted countries (mainly Chile and Peru), which is already happening.

2. Infrastructural and technological limitations

Aside from the natural limitation of animal reproduction cycles and agricultural seasonality, it will take considerable effort before any real import substitution appears. Even Russian officials admit that import substitution development will take at least 3-4 years and $3.8 billion of additional government support for the agricultural sector.

Yet, there are serious doubts about the sector’s ability to absorb such funds efficiently. An injection of money alone cannot resolve the issues of domestic production. For example, Rosselkhozbank (Russian Agricultural Bank, a quasi-state institution responsible for developing private agriculture) reported that in the first half of 2014 non-performing loans reached a record high $3.7 billion (12.8% of total loan portfolio). Accordingly, bad investments and loans made during the embargo may drag the agricultural sector down after the inevitable return of the imports from the restricted countries.

Despite apparent commitment, the government is still unable to create necessary legal frameworks for stimulation of domestic food production. Much needed law on aquaculture and fish farms has been on the parliament review for 2 years and came into force only in 2014. Supporting regulations to make the law workable are still in discussion.

Russia’s geographical span poses additional risks and obstacles for import substitution. For instance, 65% of domestic fishing takes place in the Far East, which makes it expensive to transport seafood to western Russia and requires deep freezing, leaving consumers with no fresh or chilled fish.

Furthermore, the embargo causes exceptional problems for the Kaliningrad region due its enclave status, as well as the newly acquired Crimea. The situation is so pressing that the Russian government decided to develop a special regime for Kaliningrad with possible exceptions to the embargo.

3. “Grey” imports

Russia’s partners in the Customs Union of Eurasian Economic Community, Belarus and Kazakhstan, will face serious temptation to benefit from the situation. Although President of Belarus Alexander Lukashenko assured Vladimir Putin that his country will obey the Russian embargo, he specifically said that Belarus will not allow transit of banned foods to Russia, but will continue buying European products for its internal purposes.

Such wording gives a wide range of opportunities for Belarusian businesses to engage in profitable re-labeling and light processing of banned food products.

In this vein, it is interesting that in 2013 Russia imported 189 tons of Belarusian bananas, 802 tons of Belarusian lemons, and 16 tons of Belarusian shrimp. Belarus is also well known for its grey re-export of Russian oil and gas. While Belarus is provided with cheap oil and gas exempt from Russian customs duties on the condition to process and use it in the country, it often violates this condition by directly reselling the energy commodities at market prices to Europe.

So, it is doubtful that Lukashenko will miss such an opportunity to improve the chronic budget deficit in his country.

4. Hit on Russian agricultural exporters

Russia annually exports $13 billion worth of food products (2.5% of total exports). Food exporters with modern production, logistics, and management are the most advanced businesses in Russia’s agricultural sector. These exporters now risk being damaged by retaliation from Europe and the US. In addition to obvious WTO disputes, the EU now considers answering Russia with similar restrictive measures.

Currently, Russian officials resolve critical issues in the food sector through ideology, by exploiting nostalgic feelings for the Soviet past and representing the embargo as a great opportunity for domestic agriculture. However, the situation may end up ruining illusions and high hopes of Russian consumers. Russia is likely to experience price pressure and deficit due to damaged supply chains and overstretched infrastructure.

The urgency of the situation forces authorities to act in the fastest and most simple way by redistributing money from other public sectors like the pension system. Such actions will result in stimulating crony capitalism to the benefit of well-connected elites rather than agricultural development.

At the same time, landlocked Belarus, with its temperate climate, may experience a boost and “magically” become a sizable supplier of seafood and exotic fruits to Russian consumers.

Categories: Economics, Europe

About Author

Alexey Kobylyanskiy

Alexey Kobylyanskiy currently works for a leading Russian mining company. He previously worked for the political risk insurance arm of the World Bank. He also has experience working for Russian regional government bodies and as an international election observer during the 2010 presidential elections in Ukraine. Alexey holds an MA in International Political Economy from Fordham University and an MA in International Relations from St. Petersburg State University, Russia.