Russia’s recession could hurt European trading partners

Russia’s recession could hurt European trading partners

The beginning of 2015 in Russia was marked by further depreciation of the ruble, burgeoning inflation, and withdrawal of some more MNCs from its market. Experts no longer doubt that the country is heading into a deep and lasting recession that could affect Russia’s trading partners in the region.

The ruble has been losing value at an unprecedented rate during the past six months. In the first two weeks of 2015 alone the Russian currency depreciated 17.5% against the US dollar. Russia’s financial crisis was spawned by the slump in oil prices and by Western sanctions over the conflict in Ukraine that amplified the long-standing structural weaknesses of the Russian economic model. With oil prices sliding to below $50 per barrel, analysts have reconsidered earlier estimates and now forecast the country’s GDP to decline by 3 to 5% this year. Furthermore, Alexei Kudrin, former Russian finance minister, warns that the devaluation of the currency will push inflation to a rate of 12% to 15% this year.

Therefore, this looming economic situation will significantly undercut the purchasing power of Russians, thereby having a detrimental effect on the economies of Russia’s main trading partners. Russian imports will decline as consumers have to tighten their belts. Preference will be given to goods produced domestically, rendered more competitive following the devaluation of the ruble. In addition, as a recent UN DESA report concludes, Russia’s withdrawal from international trade will have a multiplier effect on its European partners, leading to a weaker aggregate demand. While European suppliers of all kinds of goods to Russia will experience considerable revenue cuts, the states with economies highly dependent on exports to the country will be greatly hindered, as their commercial balance will deteriorate.

Belarus, a member-state of the Eurasian Economic Union, is the first one to feel the aftershock of the economic meltdown of its main trading partner. Russia accounts for more than 40% of its exports, making Belarus vulnerable to the significant deterioration of Russian consumer’s purchasing power. The weakening of demand for Belarusian products is exacerbated by the ban of its foodstuffs, allegedly introduced to prevent prohibited European products from penetrating the Russian consumer market. The Belarus central bank was, therefore, forced to announce emergency measures to defend its economy from Russia’s turmoil, as to boost competitiveness and state revenues. It repeatedly devaluated the Belarusian ruble, raised the interest rate to 25%, and dropped its plan to extend a zero duty on potash exports. The Belarusian government has not yet succeeded in reorienting the country away from its dependence on Russia and will thus be heavily affected by the current recession.

Ukraine, Armenia, Georgia, and Moldova are other European ex-Soviet Republics that are highly dependent on Russia for their state revenues. In the case of Armenia, Russia is not only the main export destination for Armenian products, but it is also a source of remittance that represents 21% of its economy. However, the economic contraction and ruble devaluation mean there are now fewer jobs available in Russia and the value of migrant workers’ wages is significantly lower. According to the World Bank, Armenia, together with eight other countries that rely on cash sent back home from Russia, could collectively lose more than $10 billion.

Impact on Baltic states

Likewise, the Baltic states – Estonia, Latvia, and Lithuania – export to and import from Russia through their sea ports. Although all three countries are expected to take a hit from Russia’s slowdown, Lithuania will experience the greatest blow to its economy. The country is already suffering from Russia’s self-imposed embargo on European alimentary and agricultural products, as these goods represents the lion’s share of Lithuania’s exports to its eastern neighbour. Domestic appliances, lighting, and furniture, all products that Russia purchases from Lithuania, are becoming unaffordable for Russians. Also, Lithuania draws significant revenues from the transit of European products, which accounted for 83.5% of its total export to Russia in 2012.

Foreign goods

Furthermore, the loss of purchasing power is forcing Russian consumers to give up on expensive leisure goods, including foreign cars and apparel. Retailers are also now compelled to significantly increase prices of the imported goods to be able to cover their expenses, rendering them increasingly unaffordable. German Volkswagen, Audi, BMW and British Jaguar and Land Rover had to temporarily suspend their sales in Russia and cancel any new deliveries. Swedish Ikea and Finnish Stockman are motivated to stay on the Russian market, but have expressed strong concerns over contracting demand for their products. Spanish apparel giant Inditex also had to halt its deliveries in December, but was able to renew its normal operations.

Additionally, experts have alerted European banks that in case of further ruble devaluation, Russian companies will have difficulty repaying their loans. As a result, analyst Michael Mross warns of a possible banking crisis in Western Europe in the longer run, especially considered the already fragile financial situation.

Russia’s recession will indeed weaken economies of European countries. Those states that depend on exports to Russia, including Belarus and Armenia, could be adversely affected. Although manufacturers in Western Europe will also experience significant profit cuts, they will not have a devastating effect on the overall economic climate of these countries. Therefore, MNCs with operations in Russia and in affected countries will have to develop contingency plans, as strategies developed earlier will not allow for loss mitigation in current economic situation.

Categories: Economics, Europe

About Author

Alina Yablokova

Alina is a political risk analyst covering Russia and Eastern Europe. A Russian-born Londoner, she holds an MA (SOAS) and a BA (Warwick) in Politics, International Relations and Diplomacy. Alina has experience in working in international and government institutions. She speaks English, Russian, French and Spanish.