DOCUMENTARY: The 2014 Financial/Energy Crisis Failed to Ruin Russia. Here’s Why

Every generation of Russians has witnessed their economic crisis. Because of that, we have acquired a tendency to listen to every warning, every speculation regarding a crisis, and even every mention of the word.

These shocks happen once every 8–10 years and follow approximately the same scenario. The oil prices rapidly decrease, and our economy instantly loses its balance. But what this imbalance looks like and how heavy the consequences highly depend on the response of the economic policy.

Russia encountered the last large-scale challenge in 2014 after energy prices collapsed made worse by Western sanctions.


Anton Siluanov, Minister of Finance: "The exchange inflows went down by 13% of the GDP. Comparing it to other, similar crises in the 80s, when the USSR collapsed, the index was about 8.9% of the GDP. I remind you that many of our Western colleagues said that the sanctions and the oil prices would tear the Russian economy apart".

The new reality came quickly. In June 2014, oil cost $115 per barrel. In January 2015 — only $45. And in January 2016, the price slumped to $27 which amounts to 10 rubles for a liter of oil. It became cheaper than water.

Maxim Oreshkin, Minister of Economic Development: "When the oil prices slumped to $25 for a barrel in early 2016, very few understood what negative consequences it might have. Even though we tried to assure that there would be no grave consequences and the situation is under control, it's clear that the general public felt great uncertainty."

At the same time, access to foreign capital markets was restricted. New sanctions were imposed parallel to the decline in oil prices. The situation made companies extinguish their foreign debt. As a result, in 2014, the capital outflow amounted to a record amount of $152 billion.

Gabriel Di Bella, Permanent Representative of the IMF in Russia: "Both shocks hit simultaneously. If we assess their structure, I'd say that 60% of the crisis was caused by a decrease in oil prices. Only 40% was caused by the sanctions. I would even go for 2/3 due to oil prices and 1/3 due to foreign restrictions".

The outflow caused sharp fluctuations in the foreign exchange market. In December 2014, the exchange value of the ruble was unprecedentedly low. On December 16, the dollar cost 80 rubles on the Moscow stock exchange, and the euro was approaching 100 rubles. It triggered a chain reaction. Fearing increases in import prices, Russians stormed the shops. The demand for consumer staples skyrocketed. All that caused inflation to skyrocket. In a few months, it rose to 17%, and the food inflation — to a shocking 23%.

This radical change in the external circumstances and the internal situation required a fast response from the economic policy.

Maxim Oreshkin: "At that time, there were two highly debated points of view. One urged an increase in government spending, and use government investment to try to compensate for the capital outflow, which means trying to copy the USSR's policy in the late 80s. The second perspective was that fiscal and economic policies had to remain responsible and adapt to new external circumstances".

Indeed, the problems of 2014 weren't unique. A similar decrease in oil prices occurred multiple times. And there were always some aggravating circumstances. The period between 2014 and 2016 received an unequivocal diagnosis: A balance-of-payments crisis. Oil-exporting countries have been encountering its modern form for almost half a century. During the early 80s, hydrocarbon fuel prices decreased sharply. At that time, the USSR felt the change in external circumstances to the full extent.

Of course, the events of 1985–1986 occurred in another country that had a different size and a different economic structure. But from an analytical point of view, it really reminds us of the 2014 situation both in its essence and scale.

"We'll carry out the historic decisions of the XXVII Communist Party Congress. Hooray!"

At that time, the USSR's economy was hit by a brutal external shock, a blow it wasn't prepared to take. The country had got used to good times. Prior to the 1980s, the oil prices had been steadily growing. In December 1979, the price peaked, amounting to $40 per barrel. It's approximately $120 in today's money. By the end of 1985, the index decreased to $26 per barrel. And in 1986, they got lower than $10. That's $33 in today's money.

The loss of export income forced the country to make a tough choice. The USSR decided not to curtail state spending for political reasons. The result was a huge budget deficit. In 1989, it exceeded 10% of the GDP.

Mark Harrison, Professor of Economics, Warwick University: "Threats to the Russian economy came from the politicians themselves. I assume that in order to get the position of the General Secretary, Gorbachev had to acquire the support of the military-industrial complex, which was one of the major lobby groups that required resources. Basically, instead of searching for a way to cut its spending and focusing on creating a social security system, the Russian government financed the military. Defense spending had been growing until 1987 or 1988".

In order to finance government spending, Russia had to resort to extensive foreign debt. Foreign debt snowballed, and, as a result, the USSR became one of the world's biggest debtors. In the 80s, the foreign currency portion of the debt increased 25 times: from $8 billion in 1981 to almost $200 billion in 1989, adjusted in today's dollars.

Mark Harrison: "Ultimately, in 1985, the financial difficulties were caused by the foreign debt, while the internal financial issues weren't as serious because, at that point, Russia didn't have a well-developed financial sector yet".

At that time, oil prices, together with foreign-currency earnings, were rapidly sinking. It called for a drastic cut in imports, something the government decided not to do. Instead, it decided to burn through the gold reserves. In 1989, it resulted in a trade deficit amounting to almost $14 billion.

Evsey Gurvich, Economic Expert Group: "This economy could function only in a single regime, in the one it was used to. It couldn't adapt to a system where a barrel cost $30. They tried to plug that hole by borrowing from abroad, but the oil prices weren't going to increase. Only in 20 years did they manage to get back to the level of 1986. That's why the policy was doomed to fail".

Refusing to cut imports and abusing foreign loans made the economy even more imbalanced. And burning through gold reserves drastically decreased its stability. In the late 1980s, the inability of Soviet organizations to make payments becomes obvious to their Western partners. It became harder to attract foreign currency loans, and the conditions became more restrictive. The debt was too expensive to keep.

So imports still got cut, but it was a forced measure. There were enough reserves only for critical purchases, mainly medications. As imports went down, the internal market started suffering from a consumer staple deficit. The government partially adopted a distributive model for food products — the so-called coupons.

Elvira Nabiullina, head of the Central Bank of Russia: "The Soviet planned economy, even with the elements of monetary exchange, a "market element" as they called it back then, wasn't really flexible. And the role government planning and public provisioning were playing shows that the economy primarily relied on state planning and the traditional ties between the enterprises and not the supply and demand. That's why it was inflexible and led to a deficit."

By the year 1989, the situation became critical. The study of the All-Union Research Institute for the Study of Demand and Market Prices shows that out of a thousand consumer staples, only 11% were being sold smoothly. Televisions, refrigerators, washing machines, detergents and other household chemicals, perfumes and cosmetics disappeared from the shops.

In 1990, an unexpected growth of incomes against the background of economic instability led to a surge in the agitated demand even for food products, which brought the market further out of balance. All types of food were experiencing a deficit.

Evsey Gurvich: "In the middle of 1991, there was a total deficit. The most basic goods were distributed by coupons even in Moscow, not to mention the rest of the country. The shelves were empty at the stores. And only the liberalization of the prices on January 1, 1992, managed to fix it".

But it's not just the consumer sector the government managed to mess up. It also didn't reduce various investments abroad. The government continued the scheduled import of equipment until the reserves ran out. Afterward, imports rapidly decreased, and the Soviet industry got deadlocked. In 1989, industrial development stagnated. In 1990, it began to deteriorate.

Due to the rebalancing of the economy being artificially delayed, it all ended dramatically. In 1991, when the accumulated monetary overhang was released, the price for consumer staples doubled. In general, during the crisis period between 1985 and 1991, the prices tripled. Then, in 1992, they grew 25 times. Inflation couldn't be tamed until the end of the 1990s.

By that time the country managed to pass through yet another economic crisis.

Movie segment:

"Ah, why aren't you eating, Count Suvorov?"

"I'm fasting, my dear. No food until the first star rises. And so I wait".

The year 1998. By that time, talks about the GKO pyramid became trendy. And then the public learned the expression "financial meltdown." All the ongoing discussions concerned the unstable fiscal policy that brought about some problems.

But one must remember that it was a headache back in 1985 as well. In both cases, the crises happened at the precise moment when the government couldn't deal with its expenses due to the low oil prices.

After the elections of 1996, Russia became politically paralyzed. Boris Yeltsin managed to get his second term, but meanwhile, a Communist Duma was formed. It was impossible to execute difficult decisions in that context.

The result of the several years of idle economic policy was the appearance of the so-called double deficit — in budget and foreign trade. Exports stagnated and imports kept doubling due to the overpriced ruble. As a result, there was a negative account balance. At the same time, state finances were deteriorating. That was the situation in early 1998.

Alexei Kudrin, Head of the Strategic Development Council: "At that moment we were already feeling the crisis. Our parliament urged us to increase expenses while our country didn't have enough income. And often, even in Duma discussions, they urged an increase in spending, trying to prove that we failed to count our income correctly, that the number should be higher. Later, we obviously discovered that the income was low, the expenses were too high, and the gap was covered by borrowing. In 1997, the situation resulted in the state budget requiring 2/3 of the free resources in the market to cover its expenses".

Attractive profits, together with the predetermined rate of the ruble led to a boom in the GKO market. In three years, it grew almost ten times in relation to the GDP.

Alexei Kudrin: "In order to cover the deficit, you borrow some money, make payments, and then you borrow some more. You cover it, but then you need some more money. The pyramid was growing. The key event that toppled the pyramid was a decrease in oil prices".

The moment of truth arrived in late 1997 when a financial crisis broke out in Southeast Asia. By August 1998, the Brent oil price had halved. The price was less than $9 per barrel, which would now amount to $13. Most foreign investors began extracting funds from the developing markets. It became harder for Russia to finance government spending. Foreign exchange reserves were declining rapidly despite the support of the IMF.

In spring, a new government began to cut government spending, but it was too late. The rates in the GKO market skyrocketed up to 80% by July. On August 17, 1998, the government announced a default on the national debt and said they would refuse to make payments on foreign loans.

Evsey Gurvich: "Our mistake was the following: in early 1998, we didn't devalue. Investors were expecting the ruble to devalue. They weren't ready to invest in ruble assets, primarily into the state debt in the form of the GKO".

At the same time, the currency band was terminated. The ruble’s rate to the dollar became three times weaker, and the inflation reached 85%. The cumulative losses of the economy during that crisis amounted to more than 10% of the GDP.

The situation took a heavy toll on the population. People were afraid to get fired or be forced to take unpaid leave. From 1993, the unemployment level was already growing until 1998, when the default happened. By that time, the unemployment rate was the highest it had been in post-Soviet history: 16%.

But even that number doesn't reflect the actual losses. Salaries suffered even more from the crisis. During the years 1998-1999, incomes declined by 34%. Retirement benefits went down by 42%, as in, almost halved. And, to cap it all, the banking crisis broke out. Not only did Russians lose their incomes, but they lost their savings. Savings account holders suffered a heavy blow. They lost $19 billion.

Alexei Kudrin: "This crisis toppled the banking system. The key private banks went bankrupt. Some may remember the Imperial Bank, Stolichniy Bank Sberezheniy, Interros Bank, and Rossiysky Kredit. At that moment, these major banks seized to exist. People lost all their savings".

The scenario of the 1985 and 1997 crises are quite similar. Oil prices declined, and the economic policy couldn’t respond in time. Government spending remained too high. Foreign debt grew, and foreign exchange reserves went down.

Despite the tough economic consequences, Russia managed to recuperate rather quickly. It wasn't caused solely by the normalization of the economic environment. The economic reforms of the early 2000s also played their role. They were adopted by the new president — Vladimir Putin.

Ten years later, the economic growth was interrupted by the global financial crisis. The problems started in a small segment of the US derivatives' market: in the subprime mortgage market. The rapid depreciation of these securities caused the collapse of two large banks: Bear Stearns and Lehman Brothers. The collapse of the latter one in September 2008 ultimately turned the crisis into a systemic and global one. The radical deterioration of the global economy provoked yet another reassessment of raw materials, first of all, oil. The price decreased from $147 to $36 per barrel. All developing markets took a heavy blow.

The collapse of energy prices obviously affected our economy as well. In 2009, the Russian GDP decreased by 7.8%.

Still, this crisis was different from all others. Its origins were far away from Russia. The year 2008 has one other reason to stand out. By that time, Russia managed to build up its foreign exchange reserves. A critical change. In the 80s and 90s, the country was spending more than it earned. During the period between 1999 and 2004, we were spending everything we managed to earn. In 2004, Russia finally started to save, forming a golden parachute in case of a crisis.

In 2004, the Stabilization Fund was created. In it, federal budget surpluses from selling oil were saved for a rainy day. Saving up was possible only if oil prices exceeded a certain threshold. Despite the protest of numerous lobbyists, the Fund was established.

Alexei Kudrin: "Gref, on behalf of the Ministry of Economics and Trade and Ignatyev, on behalf of the Central Bank, supported it. They understood the risks, but our position was reasonable, that's why later on, we acted together. Three key economic departments were acting together. That's why Putin didn't hesitate and supported us. At that time, his decision became the determining factor".

In 2008, the money accumulated by the Fund financed the budget deficit. It allowed the blow coming from the global financial crisis to be much softer. During the years 2009 and 2010, Russia used about $125 billion reserve money. The reserves could cover all the expenses of the budget. During the 2008 crisis, the income of the population didn't decrease.

Evsey Gurvich: "The Russian government was often reproached for ineffectively investing its petrodollars in the American and European bonds instead of investing into the Russian economy. But if not for that reserve, we would have been in the same situation as in 1998. The consequences of the 2008 crisis could have been comparable to the ones in 1998".

Besides that, in 2005 and 2006, a capital inflow was finally recorded in Russia. The total sum amounted to $131 billion. The accumulated reserves allowed us to make a smooth devaluation in 2008. At that time, it was a crucial step for the Russian financial system. For the first time since the late 80s, a decline in oil prices didn't cause a banking crisis.

Elvira Nabiullina: "There was an opportunity to support the banking system with additional capital, the system was capitalized, which I think was the right thing to do, and all efforts were put into supporting it. There were collateral-free loans and insurance of the interbank market. The insured amounts were also increased. All in order to avoid a banking crisis".

External factors helped suppress the crisis as well. The US government and the Federal Reserve took emergency measures to stabilize markets and banks. The FED cut its rates to zero and launched the notorious quantitative easing.

At the same time, the 2008 crisis brought together the largest economies in the world. It was basically then, when G20 took shape as an independent platform for establishing a political agenda. The summits in Washington, London, and Pittsburgh created an opportunity to establish a coordinated plan of global measures that would restore economic growth.

As a result, the acute stage of the crisis was quickly countered. Russia's GDP declined only in 2009.

Alas, not just the crisis itself, but the restoration period after it, didn't last long. By the end of 2012, the rates of GDP growth were approaching zero. Two years remained before the collapse in the oil market, but the economic challenges already looked ominous.

Economists quickly agreed that weak growth is the consequence of so-called "structural limitations". The existing growth model had exhausted itself. And when the external environment started to quickly deteriorate in 2014, failing to adapt could have been a grave mistake. The main blow of 2014, as mentioned before, was the profound and rapid drop in oil prices. During the period between June 2014 and January 2016, in just a year and a half, they decreased by 3/4.

Mark Harrison: "All Russian crises were different, but they all had a common factor. A drop in oil prices had always been a huge problem that made the government make tough choices and decisions".

Experts claimed Russia was in big trouble. Analysts competed in predicting the lowest GDP rates. Fitch estimated an annual 4% drop. Moody's expected a 5% drop. All respected analysts produced roughly the same numbers. For example, the EBRD was still expecting an annual 4.5% drop in the Russian GDP in the middle of 2015.

The same scenario happened in January 2016, when oil prices decreased again. International rating agencies and organizations were expecting the Russian GDP to decrease by 1.5–2% in 2016.

Maxim Oreshkin: "I remember New Year's, it was 2015 when we received information that Standard and Poor's was going to lower Russia's rating by two positions. During the January holidays, my colleagues and I quickly flew to Frankfurt to the head S&P office. We shared our estimates that 2015 would be the only crisis year, that in 2016 the economy would begin to stabilize, and that the double-digit inflation would return to the target level of the Central Bank by 2017. That was our estimate. Obviously, they didn't believe us. But our words made them doubt their own decision. Russia's rating was lowered only by a single position".

The crisis was supposed to take a heavy toll on the population. In the middle of 2014, the IMF published its estimates, predicting a 6% growth of unemployment and a high inflation, almost 8% by the end of 2016. The loss of income by the population was expected to resemble the 1998 crisis, meaning, they would go down by a third.

The outlook for capital movement and the exchange-value of the ruble was also quite pessimistic. Virtually nobody expected the foreign exchange market to stabilize quickly.

Gabriel Di Bella: "I come from Argentina and I remember a lot of currency crises, many periods of high inflation and even hyperinflation. During the hyperinflation of 1989, I was a student. I remember going to class in the morning, seeing the austral's rate to the dollar at 80, and when I was coming home in the evening it was at 90. In two months it reached 600. It became part of my DNA. I got used to that. If you ask me whether I was surprised by the way Russia adapted to the latest shocks, because there was a second shock when oil prices dropped again in early 2016, at some point the prices slumped to $25 per barrel and everyone became extremely worried. I expected a panic among the Russian population, and I expected people to be more worried about the exchange rate and their savings but it didn't happen. What surprised and pleased me was the fact that people managed to quickly adapt to the exchange rate fluctuations".

The cumulative losses during the three-year crisis amounted to just 3.3% of the GDP. By the end of 2016, the consumer price inflation rate dropped to 5.5%. It wasn't even close to the events of 1991 or 1998.

The reason for such results was the ingenious response by economic policymakers. The reaction of the Russian government was the complete opposite of the measures in the 80s. In 2014, it made the decision to adapt to the change of the external environment and not ignore them the way the USSR did.

Mark Harrison: "If we take the latest crisis, there was a budget consolidation which was extremely necessary. Import substitution measures were developed. Also, the Russian monetary policy helped as much as it was needed".

Instead of increasing government spending, Russia focused on the consolidation and mobilization of revenues, while raising cost-effectiveness. The budget deficit peaked in 2016 at 3.4% of the GDP. In the 80s, the peak rate was 10%.

Anton Siluanov: "The revenues of the federal budget decreased by 4% of the GDP, which is approximately 1/4. Without any cost-cutting measures of any kind, we would have quickly disbalanced the situation. It would have made us burn through all the reserves that we'd accumulated, and we would have been forced to return to making interest-only payments, which was completely unacceptable, because it would have made the inflation, already high at that time, to grow even more, and we would have been forced to index our social obligations and programs. The inflation would have devoured the incomes of our citizens. Everything we wanted to restore through our budget, they would have been devoured by the so-called "inflation tax".

The budget adaptation went smoothly. The money accumulated by the sovereign funds created room to maneuver. Russia plans to stop using its reserves to cover its expenses within three years after the crisis — an exchange-rate policy adapted quicker than before. In October 2014, oil prices dropped especially rapidly. The Bank of Russia made a policy decision to adopt a floating exchange rate ahead of schedule. For several years, it had been preparing for a new exchange rate regime and was going to adopt it in January 2015 anyway.

Elvira Nabiullina: "I started working at the Central Bank in the middle of 2015. Within the framework of the preparation to adopt a floating exchange rate, we gradually liberalized the rate. At that time there was a "floating corridor," which we were broadening, making the rate more flexible and lowering the number of foreign-exchange interventions. At the same time, we were preparing a toolkit, because you can't just say that tomorrow the ruble will float and we'll leave the market. When adopting a floating rate, one must ensure there's another anchor. We had to learn to control interest rates. That's why we needed our toolkit".

The depreciation of the ruble was caused by a deterioration of the balance of payments. However, the timely nature of the adjustments helped Russia mitigate export losses and avoid a deficit in the internal market. If you recall, despite the strong exchange rate in 1985, there was simply nothing to buy.

Elvira Nabiullina: "In 2014, when it all began, there was a flurry of discussions. Many suggested to give up the idea of the floating rate, and they were pretty numerous. They mentioned the commodity economy, said it wasn't the right time because it was the pre-crisis period and oil prices were sinking. They said it was too risky. At the Central Bank, we were sure that it was the right time to adopt the floating rate. Although a fixed, managed rate gives the citizens and the economy a sense of predictability, when there are some severe changes in external markets, it calls for an intensive correction, which is usually a substantial devaluation, like what happened in 1998 or 2008. A floating rate allows the economy to gradually adapt to the changing external environment".

The inflation made the transition to a new regime painful. However, the price tags had to be changed only once, and there was no negative inflationary spiral. This time, the authorities quickly adapted to the changes in the external environment, which allowed them to minimize the losses. The decline in the GDP was the smallest, compared to the previous crises. They also managed to prevent an inflationary spiral. There was a single inflationary outburst.

Gabriel Di Bella: "New budget rules and inflation targeting made the economy more stable and less vulnerable to future shocks. It's important that these measures become an integral part of Russia's policy on the way paved by Norway. I believe Russia should stick to this policy. The next step would be establishing an open economy in order to be able to exploit the situation after implementing the policies. The openness will allow Russia to recognize the best strategic partners and the markets where Russian goods could be sold. The domestic market alone wouldn't be enough for high growth rates".

Currently, our economic growth is recuperating against a record low inflation rate, which helps the recovery of real salaries. However, future qualitative welfare gains must be linked to an increase in productivity. According to the current estimates, we should expect nearly a 2% growth rate in the coming years. Any further acceleration in economic growth requires a progressive economic policy.

Maxim Oreshkin: "Right now, we are preparing for a new wave of economic development. Our key priority is building a modern economy, a modern economy that has the individual as its core value. It means reaching the full potential of an individual, a constant drive for self-improvement, and the creation of a comfortable environment for people to live in and grow in. That's why we have some serious tasks ahead of us. For example, we need to develop the urban environment across the country, improve our infrastructure to a new level, and create the necessary environment for a person to fulfill their potential. We need to implement new technologies that deal with the digital economy".

These measures are obviously called for. That's the only way for our country to become globally competitive and occupy stronger positions in the global economy.