The Anti-crisis Trap: How crisis management creates an economy of permanent crisis

Crises and institutions

In economic regulation, institutions often emerge as a response to crises. For example, deposit insurance systems were created in response to banking crises, creditors' clubs were formed in response to debt crises, and even the Bretton Woods system emerged largely in response to the challenges of World War II. To deal with a crisis, economic authorities usually resort to temporary regulation, which may differ from or even contradict normal procedures. However, in the medium and long term, the newly established institutions adapt to new conditions and grow stronger to cope better with future crises.

Russia is no exception. Striking examples include the tax system reform in response to the payment crisis of the 1990s, the introduction of deposit insurance and restrained budgetary policies after the 1998 crisis, as well as the transition to inflation targeting after the 2008 financial crisis. At the same time, the market institutional environment in Russia has been degrading rather than strengthening over the past 15 years. By 2023, many past achievements, such as predictable tax policies, budgetary rules, and fiscal federalism, have fallen victim to anti-crisis management — they have either deformed or ceased to exist altogether.

After the full-scale invasion of Ukraine, Russia became the world leader in terms of the number of sanctions imposed on it. Meanwhile, the decline of the Russian economy was significantly less than some observers expected — 2.1% of GDP in 2022, with growth exceeding 3% of GDP in 2023. The Russian economy has proved resilient to shocks thanks to the exceptionally high revenues from energy exports and the exceptional anti-crisis competencies of the economic authorities. Over the past 15 years, Russia has weathered four major crises, during which financial authorities honed their skills in anti-crisis management. The main lessons learnt from the crisis are a special focus on reserve accumulation and a conservative approach to spending, except for those expenses that support political stability or those personally insisted upon by Vladimir Putin.

Perpetual crisis

Economic crises are cyclical in nature, and as a rule, they occur on average every 10 years. Due to its dependence on the dynamics of energy markets, Russia has a specific crisis profile — over the past 15 years, it has faced four major crisis episodes: in 2008, 2014–2015, 2020, and 2022. Consequently, economic crises in Russia happen much more frequently — approximately once every four to five years. Five crisis quarters experienced by the Russian economy can be associated with external shocks (the global financial crisis in 2008, Covid in 2020) accompanied by a decline in oil prices. Another five quarters are linked to a decrease in oil prices (2014–2015). Six more quarters are solely attributed to political decisions by Russian authorities, leading to international sanctions (the annexation of Ukrainian territory in 2014 and the invasion of 2022). The heightened frequency of crises, tied to energy price volatility and the voluntarism of political decisions, required the country's financial leadership to enhance crisis management and engage in more manual control practices rather than strengthening traditional institutions.

Russia’s real GDP index, seasonally adjusted, 2008-2023

Remarkably, throughout this entire period, the same team has been at the economic helm of Russia. The captains of the Russian economy—Elvira Nabiullina and Anton Siluanov—were already high-ranking bureaucrats by 2008 and were involved in formulating anti-crisis policies. The series of crises shaped a specific psychological outlook for them: the constant need to deal with the consequences of non-monetary and non-fiscal shocks forced them to live in a perpetual anticipation of a 'black swan'. This was reflected in the implementation of conservative policies, the restraint of state investments in favour of building reserves, and ultimately in inhibiting institutional development. As demonstrated in 2022, such an approach proves effective in times of shock but is more detrimental to the economy in the medium term.

Stages of crisis management formation

The first crisis faced by the government of Vladimir Putin (then Prime Minister) was caused by the global financial crisis of 2008-2009. In the preceding years, the Russian economy and financial sector had grown rapidly. Under a quasi-fixed exchange rate regime and against the backdrop of rising oil prices, the monetary authorities accumulated foreign exchange reserves, while non-financial companies and banks actively increased external borrowing. The bankruptcy of Lehman Brothers and the ensuing global market panic had acute repercussions for Russia: the price of Brent crude oil fell from its peak of $146 per barrel in July 2008 to $37 per barrel in December, resulting in a net outflow of private sector capital from Russia amounting to $133.6 billion, and the Central Bank's foreign exchange reserves shrank by $215 billion. 

The 2008–2009 crisis marked the beginning of active state intervention in the economy: over 1 trillion rubles were spent to support companies, primarily benefiting the financial sector but also including large companies — for example, $4.5 billion was received by Rusal, $1.8 billion by Evraz, state support was provided to AvtoVAZ and defence industry businesses. The government compiled a list of systemically significant enterprises and sectors of the economy, manually allocating financial aid. Vladimir Putin would later call this practice of economic management 'optimal'. One of the key lessons learned from this crisis for Putin and his team was an understanding of the finite nature of reserves. In the subsequent years, the central bank actively engaged in their accumulation, and the government replenished the National Welfare Fund.

In the second crisis episode, in 2014–2015, the Russian financial sector faced two simultaneous shocks: first, the imposition of sanctions against key Russian banks and companies by the United States, the European Union, and several other countries and second, the end of the commodity market supercycle and a sharp decline in oil prices (from late June 2014 to early January 2015, the Brent price dropped by 60% to $47 per barrel). During this period, 70% of Russia's budget relied on oil and gas revenues, and the drastic reduction in the price of the primary export commodity led to a restructuring of the balance of payments, a weakening of the ruble, and an increase in inflation. The exchange rate of the dollar rose from 32 rubles at the beginning of 2014 to 56 rubles, reaching 79 on the ‘Black Tuesday’ of December 16, 2014.

In the autumn of 2014, the Central Bank began the transition to an inflation targeting regime earlier than planned, involving a shift to a floating exchange rate for the national currency. On 5 November, the Central Bank cancelled unlimited foreign currency interventions, replacing them with foreign exchange repos. By 10 November, it essentially completed the transition to a free-floating ruble by abolishing regular interventions and the floating corridor of the dual-currency basket. On 15-16 December 2014, an extraordinary situation unfolded in the currency market as a result of several negative events (a statement by an OPEC representative about maintaining oil production quotas despite possible oil price declines to $40 per barrel, as well as the opaque bond transaction of 'Rosneft"), triggering panic. Two days later, at an emergency meeting, the Central Bank raised the interest rate to a historic high of 17%.

Amid this dual shock, the market expected the authorities to devalue the currency in order to restore the balance of payments. Exporting companies did not convert foreign currency revenue into rubles, as they were preparing for external debt payments denominated in dollars and anticipated further ruble depreciation. The government refrained from introducing mandatory sale of foreign currency revenue. But Vladimir Putin 'kindly’ requested the heads of large companies to sell foreign currency, and the government demanded that the five largest exporting companies reduce the amount of currency holdings. The transition to a floating exchange rate led to a sharp depreciation of the ruble, which ultimately fell by about half. However, maintaining a fixed exchange rate would have meant that the Central Bank had to continuously sell foreign currency to maintain it. And, its reserves would not have been sufficient to maintain the pre-crisis exchange rate for very long. The lesson from the past crisis has been learnt, a financial bloc official recalled.

At the traditional New Year's Eve meeting with the government, Vladimir Putin called on economic authorities to implement a ‘manual control regime for the economy’. According to him, this entailed coordinating actions between the government, the Central Bank, and the presidential administration, as well as increased control over significant sectors of the economy. Putin referred to the management practices used in the fight against the 2008 crisis as a model:'We will turn to the experience of 2008. At that time, some innovative and powerful means were used. But we must take these measures quickly. We don't have time to go through various coordination circles." Essentially, this meant the manual allocation of government support among the corporate sector in exchange for greater involvement of officials in company management.

The main lessons learnt after this crisis were the need to dedollarise the corporate sector and the stable operation of the banking system. To address the first problem, the Central Bank introduced additional regulations for foreign currency portfolios of credit organisations. To cope with the second, it strengthened supervision over the banking sector, gradually eliminating weak and unscrupulous participants. As a result, the balance in the banking system shifted in favour of state-owned banks, primarily because of their access to state support measures. As a result, they became too big to fail, and their size has prevented the creation of conditions for competition in the sector.

Perpetual crisis as a new norm

It can be stated that since the 2014-2015 crisis, the economic authorities have never managed to get out of 'manual control' mode. Attempts to establish long-term rules of the game, such as the budget rule, the procedure for investing from the National Wealth Fund, or the commitment to change tax rates every six years, have fallen victim to subsequent crises and manual control. In 2017, for example, the government introduced additional levies on oil companies and Gazprom, a recycling levy on heavy machinery (7%) and an investment levy on seaports (25%), and increased duties on imports of machine tools and equipment in order to fill the budget. In 2018, the government attempted to seize so-called excess profits from metallurgical and chemical companies using non-tax methods. And, from 1 January 2019, it increased the VAT rate to 20%. It is noteworthy that these measures were taken during the period of post-crisis recovery, i.e. there was no need for emergency decisions. However, the habit of acting manually, bypassing institutional mechanisms, persisted, redistributing more funds through the budget as in moments of crises.

The third major shock to the Russian economy occurred in 2020 as a result of the COVID-19 pandemic. A distinctive feature of the new crisis was that it primarily affected non-financial companies, which lost revenue due to quarantine restrictions. This led to an increased need for loans to replenish working capital, pay employee salaries and meet other needs. Unlike previous crises, the Central Bank managed to switch to a soft monetary policy and reduced the key rate to a historically low level of 4.25% (without resorting to emergency meetings). This was reflected in the cheapening of new loans and a significant portion of the existing loan portfolio. Cost reduction occurred both through loan restructuring with a simultaneous reduction in the interest rate and through a reduction in the interest rate on loans with a floating interest rate. Problems with ruble liquidity were only observed at the beginning of the crisis, and there were no difficulties with foreign currency.

Unlike previous crises, no additional capitalisation of the banking sector was required in 2020. Thanks to high regulatory reserve requirements, banks built up various capital buffers, the dissolution of which freed up more than 0.5 trillion rubles and supported lending. During the COVID-19 crisis, the government introduced several significant business relaxations. The most substantial ones included deferring payments to pension and social funds, tax holidays, and subsidies for affected industries, direct subsidies to systemically important companies, low-interest rate loans for various business categories, and increased advances on state contracts, among others. The combined cost of the three anti-crisis packages was estimated at 2.7% of GDP.

However, the large-scale state support measures had a downside: the growing number of so-called zombie firms — inefficient, unprofitable industrial organisations with low productivity, whose products are not in demand. These companies remain afloat thanks to available financial resources (through lending or state support), although they are in a state of pre-bankruptcy. According to the Center for Economic and Financial Research at HSE University, by mid-2021, the share of zombie firms among the country’s industrial enterprises was 15%.

Russia coped with the consequences of the pandemic quite quickly, primarily due to adaptive business strategies: the real sector of the economy turned out to be sufficiently resistant to supply chain disruptions. Informed by previous shocks, businesses approached the crisis with high levels of material reserves, lower levels of indebtedness to banks and suppliers, and flexible relationships with employees. In many respects, the arsenal of measures and practices implemented during the pandemic were used to mitigate the consequences of the subsequent crisis. Consequently, the expectation of the crisis and preparation for it by economic authorities generates similar expectations and behaviour in businesses. This is reflected in a lower risk appetite for enterprises, and consequently, for expansion and investments. In other words, government behaviour has created negative stimuli in the economy.

War and crisis management

By 24 February 2022, the Russian economy was in good shape: GDP increased by 3.5% in annual terms in the first quarter, citizens' salaries, lending, and mortgages were growing, the population, tired of COVID, was actively spending, and tourism and transportation were recovering. Unemployment was at historically low levels. The main external risks for Russia were considered to be the tightening of monetary policies in developed countries and the possibility of new coronavirus strains.

The military aggression against Ukraine and the subsequent Western sanctions changed this favourable picture in a matter of days. The Russian authorities were prepared for restrictions, but the freezing of reserves and the ban on importing cash dollars and euros came as a surprise. After the announcement of these sanctions, the exchange rate of the ruble to the dollar and the euro exceeded the 120 and 150 mark respectively, and people rushed to banks to stash their deposits at home. The outflow of funds from the banking system exceeded 2 trillion roubles ($30 billion) in the first two weeks of the ‘special operation’. The government and the Central Bank responded with a combination of bans on the withdrawal and physical export of currency from the country for both Russians and non-residents, requiring exporters to sell 80% of currency revenue within three days of its receipt, closing the exchange, and raising the key rate to 20%. Effectively, the Central Bank and the Ministry of Finance put the economy into an artificial coma. Restrictions on capital flows literally locked foreign currency liquidity inside the Russian financial system, thus maintaining its stability. The rate increase, on the one hand, cooled down economic activity as few people are ready to take loans at such a price, and on the other hand, made deposits attractive again as households and companies started to return funds to their bank accounts.

By mid-2022, the Russian financial leadership had developed an understanding that the financial sector and the economy had been stabilised. After a short fall, the ruble strengthened sharply (to 50-60 rubles per dollar in June-November 2022). Consumer prices, which spiked in March 2022, almost stopped rising altogether in April. A year later, price growth exceeded last year's level by only 2.3%. For any prosperous and non-warring developing country, such an inflation rate would be more than acceptable. However, this prosperity was the product of a paradoxical combination of several factors, which ceased to operate by the spring-summer of 2023. After this, the authorities reverted to the manual economic management practices of the early invasion: in response to the sharp weakening of the ruble, the Central Bank raised its key rate and the government began to discuss capital controls.

How anti-Crisis policy turns into pro-crisis policy

The main task of economic policy is to tame the 'economic cycle', i.e. to smooth out its fluctuations and to adapt businesses and households to these fluctuations. This task is especially relevant for countries with emerging markets, including Russia. Current research shows that the quality of institutions and their relationship with countercyclical policy play a key role in determining the economic and financial consequences of global shocks for developing economies. At the same time, countries with comparatively more effective countercyclical policies have less incentive to strengthen their institutions. In both the 2014 and 2020 crises, the Russian Central Bank and government were able to overcome resistance from lobbyists and act countercyclically, largely because the president sided with the crisis managers and technocrats.

The conclusions drawn by Putin and his economic team from the frequent succession of crises have led them to an ultra-conservative macroeconomic policy based on reluctant spending of reserves (and accelerated accumulation during inter-crisis episodes), increased reserve requirements within the financial system, reduced competition in the banking sector (for the sake of manageability), and a strict monetary and budgetary policy. In many respects, this course has cost the economy growth: its average rate in 2013-2022 did not exceed 1%, and the increase in fixed capital investment averaged less than 2% per year from 2009 to 2022, according to Rosstat.

The state of 'constant combat readiness' of financial authorities forces them to address most problems manually, while the economy, accustomed to this style of management, does not resist much. In 2022, the part of the budget rule that tied the government's hands in terms of additional expenditures was suspended, and in 2023, the second part of it, requiring the accumulation of oil and gas revenues above a certain amount, was also suspended. 'Gazprom' did not object to record payments to the budget, oil companies did not object to the latest changes in taxation, and businesses supposedly came to the government themselves and asked for the imposition of additional taxes. In combination with super profits — Russia's trade surplus in 2022 reached a record $332 billion — this management system allowed the Russian economy to cope with the major shocks caused by the war and subsequent sanctions.

The habit of working in a crisis and finely honed crisis management practices, combined with ultra-conservative economic policies, became the main factors of resilience for the Russian economy in 2022. At first glance, this may seem like a success. Although not one without costs. But, at the same time, the habit of manual management has become one of the factors hindering the development of market institutions, which form the backbone of the economy. 'If you wear a helmet all the time, you can save money on accident insurance,' one federal official was fond of saying. Crisis management allows for effectively addressing acute manifestations of a crisis and maintaining political stability but deprives the economy of incentives for development and triggers new crises. The cause lies in the voluntarism of political decisions, a tendency that increases as the cost of crises for political leadership decreases.