low? According to conventional wisdom, the plunging energy prices are predicated on the effort by Arab countries, particularly Saudi Arabia, to drive down the price to make it commercially challenging for US producers to launch cutting-edge extraction technologies. In this view, leading Arab producers seek to sustain a crumbling oligopoly through low-cost responses.

An alternative explanation is that the military interests between the US, Saudi Arabia and the Gulf states, along with US-Egyptian relations, override commercial considerations. Low prices are not just economic realities but can serve geopolitical purposes.

According to Russia’s central bank (CBR), the likelihood of oil prices remaining below $60 barrel for a long time is probable. As those prices now hover around $44, the year-end figure is likely to stay close to or below $60. That’s $5 less than what US. shale-oil producers claim can profitably increase production. Reportedly, two-thirds of Russia’s oil-processing firms are operating at a deficit.

At end of July, the CBR cut the key rate by 50 bps to 11 percent, while warning on cooling economy and downplaying inflation. Until recently, Moscow’s accommodative fiscal policies, monetary easing and large buffers have helped to absorb the shocks. However, investment has been falling.

In the pre-crisis years, Russia’s outward foreign direct investment (FDI) was about 16 percent of gross fixed capital formation. Last year, it was 14 percent. What has changed dramatically is the role of the inward FDI. It was over 15 percent in 2013 but plunged to barely 5 percent last year. As far as international investors are concerned, Russia needs greater progress in the implementation of structural reforms and rule of law.

Unsurprisingly, dissension is forming in the CBR as its monetary chief Dmitriy Tulin is speaking for easier credit and targeted lending to industry to rejuvenate the economy. In contrast, the central bank’s governor Elvira Nabiullina advocates traditional market-based policies. Both are concerned that the continued fall of the oil prices could drain further the CBR’s $360 billion in reserves.

Destabilization Ahead

Washington cannot afford to underestimate Russia’s strategic power and its popular unity. Russia remains the third biggest military spender in the world, right after the US and China. In the US, military expenditure fell by 7 percent last year, whereas in Russia the figure increased by 8 percent. While Putin remains committed to upgrade the Russian military at the cost of $600 billion through 2020, the US-EU sanctions have fostered support to these objectives among Russian people.

Most importantly, Russia is a nuclear superpower. While the US has an estimated 2080 deployed warheads, Russia’s corresponding figure is 1780 and the number of total warheads is actually greater in Russia (7,500) than in the US.

In the past year and a half, the sanctions have further deepened stagnation in Europe, while reducing the impact of euro economies’ fiscal policies and the effectiveness of the European Central Bank’s quantitative easing. The repercussions are reflected in diminished global growth, thus reducing growth prospects in the US as well, while contributing to rising anti-US and anti-EU sentiments in Russia.

As the oil prices continue to remain low and as the Fed prepares to hike the interest rates in the fall, emerging economies that are reliant on oil and gas, such as Russia, are likely to take the heaviest hit.

There are real disagreements between US and Russia, and Russia and EU. But sanctions will only amplify these differences, not reduce them. Shouldn’t the ultimate objective be to foster economic growth and minimize geopolitical friction?

About the Author

Dr. Dan Steinbock is an internationally recognized expert of the nascent multipolar world. In addition to advisory activities, he is Research Director of International Business at India China and America Institute (USA) and Visiting Fellow at Shanghai Institutes for International Studies (China) and the EU Center (Singapore). He was born in Europe, resides in the US and spends much time in China and Asia. For more, see www.differencegroup.net 

 The original commentary was released by The European Business Review on August 20, 2015

Bank of Russia Ponomaryov

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