Figure 7:Excess returns and volatility.
Source: Author’s calculations based on data and estimations in Table 4.
In order to select the events to investigate further, we focus on days where the residuals are unusually large and volatility is at extreme levels. In Figure 8, this is defined as negative daily returns of more than 5% and a rolling 20-day daily return volatility of more than 2%. In terms of number of days with negative returns, years 2000 and 2008 stand out. Both years were associated with major events in global financial markets (dot-com crash and global financial crisis), while in 2000, Putin was elected president for the first time and Russia was fighting a war in Chechnya. As for years with high volatility, 2000 and 2008 are again high on the list, but so are 2003 and 2014 (and 2015). In 2003, there was the Yukos affair and trial of its owner Mikhail Khodorkovsky, and in 2014/2015 there was the annexation of Crimea, involvement in Eastern Ukraine and long list of sanctions and counter-sanctions between Russia and the West. For sure, a significant amount of volatility in the Russian market is due to external events, but an even greater amount of volatility is home-made by Russian domestic and foreign policy decisions during Putin’s term in office. It is again important to note that volatility plays a key role around the home-made events, so studies that simply focus on the impact on returns and absolute levels of capital flows may miss a significant part of the effect these events will have on investments and future growth.
The observations from Figure 8 can be complemented by a listing of the most negative days on the Russian market and the days with the highest volatility. If we construct a top-20 list of the days with the most negative returns since Putin became president, 2008 stands out with 9 of the 20 days with the stock market falling by 16% on the worst day as Russia was hit by the global financial crisis. The year 2014 accounted for 3 of the 20 worst days with a 1-day drop of 12% being the worst day in 2014. Other years have one or two days of the stock market losing around 10%. When we instead list the 20 days with the highest volatility, 2014 and 2015 account for a stunning 18 of 20 days with the highest volatility, while 2008 only has 1 day on the volatility top-20 list. This again underlines how much uncertainty the annexation of Crimea and subsequent involvement in Eastern Ukraine has generated in the Russian market and most likely in the economy in general.
Since we have seen how volatility reduces capital flows, which in turn lowers investments and growth, this home-made uncertainty carries significant costs both in terms of lost incomes and approval for the president. In the end, these long-run costs have to be weighed against the short-run gains in popularity that the Russian leadership enjoys.
Figure 8:Days of large negative returns and high volatility.
Source: Author’s calculations based on residuals from estimation in Table 4.
Conclusions and Outlook
Growth is a key economic indicator in Russia as elsewhere, with direct effects on the leadership’s popularity even if this effect at times is overshadowed by other (often external) events. How to diversify the economy away from oil and boost long-term growth has been the subject of many policy discussion and reform programmes as well as academic studies [see, for example, Kudrin and Gurvich (2015)]. In the academic literature, the focus is often on the role of institutions to create a business environment conducive to sustainable growth and strengthening institutions is an often-heard argument in Russia as well. In particular, improving rule of law, property rights and control of corruption are mentioned.12
It is hard to see why this advice would not be true for Russia, given its current rankings in these areas and the importance of these factors in leading academic studies of institutions and growth (see, e.g., Rodrik et al., 2004 and Barro, 2015). However, it is hard to show that the institutional changes that have taken place in Russia along a number of dimensions including membership in international organisations, EBRD indicators or business rankings have generated growth, investment or trade within the time frames most often used. This is consistent with the finding in Sutyrin and Trofimenko (2017), where the authors look at the effect of formal institutions on FDI flows to Russia and find very little effect from changing institutions.
One reason for the apparent lack of institutional impact on growth is that so much of growth at the macro level is driven by changes in international oil prices, which is not a domestic policy variable, nor linked to institutional developments in Russia. Furthermore, specific policy actions that are not part of an economic development plan create so much uncertainty that it has a greater effect on growth than regular economic policies. In sum, in the short and medium term, it seems that Russian policy actions speak louder than formal institutions when it comes to capital flows and investments, and thus growth.
What does it mean for the Russian outlook? Table 5 summarises Putin’s different terms in office along the dimensions that have been discussed in the previous sections. It is clear that the external factors that facilitate growth in Russia have become increasingly less supportive as we move from the first two terms in office to the third. Instead of the massive increases in oil prices that Putin enjoyed in his two first terms, the third term (and the term as prime minister) saw oil prices falling. This change in fortunes was also reflected in income and investment growth, exchange rates, stock market returns and approval ratings.
The fourth term in office for Putin starts at a time of sanctions and counter-sanctions, volatile oil prices and a general uncertainty in the global economy about trade, financial systems and global growth. As the external environment in general and outlook for oil price increases in particular are less supportive of growth, the priority of the president and his economic team should be on policies and actions that facilitate investments that will generate high growth. This is very much in line with the modernisation and diversification agenda that has been repeated many times in Russia but not been implemented. To make the strategy work this time, the focus should be on a combination of institutional reforms that create a stable business environment and offer incentives for innovative foreign companies to make investments in Russia. Reforms on paper will not be enough but have to be followed up with a consistent path of implementation and avoiding short-run fixes that undermine long-run institutional capital. The previous analysis has shown that policy actions in the past have overshadowed the role of formal institutions and this lesson has to be kept in mind when implementing a new growth strategy. It is therefore crucial that the president refrains from external policies that in the short run detract from economic shortcomings but in the process also generate more uncertainty that is detrimental to capital inflows, investments and growth. The economist’s choice of generating political support through high growth by reforming institutions and avoiding policies that create uncertainty is obvious, but possibly not the most likely choice of Putin in the current domestic and external environment.
Table 5:Putin’s record on growth and its correlates.
Notes: Approval rating, oil price,