Russia's Economy Is a Mess — and Its Problems Aren't Going Away

Russia's economy remains mired in a recession that leaves little room for the Kremlin to maneuver, as its foreign reserves dwindle and prices for basic goods continue to rise.

In mid-2013 — before the country's annexation of Crimea and military involvement in eastern Ukraine, the imposition of Western sanctions in response, and a steep fall in oil prices that began in June 2014 — Russia's currency, the ruble, traded at just over 30 to the US dollar. It fell to an exchange rate last week of nearly 72 per dollar, which is roughly the same level it reached in late January at the height of concerns over the country's finances.

The ruble has since recovered somewhat to trade at 66 per dollar, reflecting a momentary uptick in global oil prices over the past five days that has already begun to recede. With prices for crude halved from a year ago, the fundamentals of Russia's economy remain precarious.

Earlier this year, the government intervened as the ruble fell, spending heavily to keep it from plummeting further. In the past two years, its foreign currency reserves have fallen by some $157 billion — roughly a third — according to government figures.

The Kremlin now appears to be allowing the ruble to move more freely, and some analysts see any future slide in oil bringing the currency even lower than where it was in January.

"If you look at the fluctuations of the currency, they track very, very closely to oil prices, not with overall growth and GDP," Jeff Mankoff, deputy director of the Russia and Eurasia program at the Center for Strategic and International Studies, told VICE News.

Russian oil sales, which are generally transacted in dollars, provide roughly 50 percent of state revenues. In theory, if oil prices were to remain steady, a weaker national currency could translate into higher revenue in ruble terms for exporters, of which oil producers are the largest segment in Russia. Indeed, the Kremlin having allowed the ruble to depreciate has helped some producers increase their bottom lines, as long as they report profits in rubles.

Related: There's No Saving Russia's Imploding Economy from the World's Hurt Feelings

But the country's economy contracted by 4.6 percent in the second quarter of this year, measured year-on-year, and the overall fall in crude prices is what matters most. Critically, it has complicated Russia's much-heralded turn toward China as an export market for energy projects, as the Chinese economy experiences a downturn of its own.

"It's quite possible that if oil prices remain at the low levels for long, oil production could decline, as had been the case before," Deputy Prime Minister Arkady Dvorkovich said on Tuesday, according to the Russian news agency TASS. Such cuts would not be "significant," he noted, partly due to the high cost of restarting production that is temporarily halted.

In May 2014, the Russian energy giant Gazprom and China's CNPC signed a massive 30-year contract for the exportation of gas to China valued at $400 billion. Gas prices were $350 per thousand cubic meters at the time. Last month, Gazprom forecast that its average export price would be in the neighborhood of $235-$242 — well below what it had predicted. Company officials admitted that they did not negotiate a floor for prices as part of the deal, according to the Financial Times, and some analysts predicted prices could fall as low as $175 per mcm. This means a lot of lost money for Russia.

"Time and again, the Chinese have demonstrated themselves to be very hard-nosed negotiators," Mark Galeotti, professor of global affairs at New York University and an expert on Russia, told VICE News. "In a way, the Russians are almost in the position of someone going the pawnbroker — you have the family silver, you know you aren't getting a good price for it, but you need the money tonight."

Demand for oil worldwide hasn't kept pace with supply, leaving oil-producing nations struggling to manage the sharp declines in revenue. Despite the pleas of members such as Venezuela and Iran, the Organization of the Petroleum Exporting Countries (OPEC) has so far resisted cutting production in order to help stabilize prices, mainly due to the influence of Saudi Arabia, which has sought to maintain market share.

Russia, which is not part of OPEC but has pushed for collaboration, is currently pumping around 10.7 million barrels per day, the most since the end of the Soviet Union.

Related: China Is Becoming Russia's Economic 'Loan Shark'

According to Galeotti, those affected by the recession in Russia can be divided into three groups: the hyper-wealthy and well-connected, many of who have safeguarded assets abroad; the middle class and entrepreneurs who feel the pinch of bank loans drying up; and the majority of Russians for whom higher prices for basic necessities is an everyday challenge, and who are increasingly finding it difficult or impossible to afford travel abroad.

According to government figures, the average monthly salary in Russia is only $500 — nearly half, in dollar terms, of where stood at last year. Russia responded to Western sanctions by banning many Western goods, moving to replace them with domestic products or items produced in former Soviet republics whose currencies hew closely the ruble, but prices continue to rise across various sectors. The Russian Central Bank reports that the purchasing power of Russians fell by more than 8 percent in the second quarter of 2015 compared to last year.

"Whereas once upon a time there would be fruit from Spain or elsewhere in the West, increasingly it's coming from Azerbaijan instead," said Galeotti. "If you look at [state-funded broadcaster] RT, there are all these upbeat tales of how wonderful it is. But there is a limit to how much the Russians can rely on import substitution."

Retail sales in Russia have fallen by 8 percent since the start of the year. Recent analysis shows that prices for clothing and footwear could soon spike as much as 20 percent, further eroding consumption.

Anastasia Nesvetailova, director of City University of London's Political Economy Research Centre, said that the economic downturn and the ruble's decline will ensure that these problems remain well into the future.

"It will be a very long recession that is comparable to the late 90s or late 80s — it's not really a crisis only triggered by external factors but it's a crisis of the whole production model," Nesvetailova told VICE News. "It's a crisis of an economy relying too heavily on imports, and it's a crisis of a heavily state-dominated, corrupt system of government."

Russian authorities have already announced far-reaching salary cuts and wage freezes for many government employees. In July, Putin signed a decree reducing the country's police force by 10 percent. Amid war in Ukraine and diplomatic tension with Europe and the US, military spending has been spared — Russia's defense budget increased nearly 40 percent in dollar terms between 2010 and 2014. Some have questioned whether Russia can continue to afford this expenditure under the circumstances.

Related: Vladimir Putin's Approval Rating Is Sky High Despite Russia's Floundering Economy

Despite the increasingly dismal well-being of average Russians, support for Russian President Vladimir Putin remains high. Sporadic wildcat strikes and protests over wages at government projects have been reported, but few analysts see them as culminating in a concerted opposition movement.

"People complain about inflation, and they notice prices are going up, but overall there isn't a situation where social groups are ready to act," said Nesvetailova.

As a growing genre of videos showing the destruction of imported foods illustrates, some are still buying the line that Russia's troubles are entirely to blame on foreigners.

In one of the most popular videos, Stas Baretsky, an almost impossibly rotund former rock star, wearing an equally large red sport coat, makes his way through a French-owned supermarket, telling observers he is the minister of culture for the Cossacks Union.

Baretsky is looking for foreign brands; he picks up a can of fish.

"Goldfish — is that a Russian firm?" he asks. "Doesn't seem like it."

At one point, Baretsky finds a non-Russian beer, and asks a store worker why the beverage is "on the most visible display." Baretsky takes a can of the beer and bites into it, breaking the can and spraying beer everywhere.

But the best efforts of the country's viral nationalists doesn't change the fact that Russia requires foreign investment. While sanctions have dried up much of the foreign lending that its businesses need, Russia continues to look to China as a market for its natural resources. After Western sanctions hit Moscow, Russian officials viewed those ties as even more vital.

Kremlin officials say Putin will discuss energy ties and the possibility of brokering a new gas deal with Chinese President Xi Jinping when the leaders meet later this week in Beijing for commemorations marking the 70th anniversary of Japan's defeat in World War II. Russia might try to negotiate higher prices, but if previous dealings are any indication, the Chinese won't budge. Faced with its own collapsing stock market and rapidly slowing growth, China will be hesitant to ink another arrangement or fork over more investment in Russian energy projects.

"There was this assumption that China was a bottomless fount of money, but even when the economy was doing better, Chinese businesses and the Chinese government were wary of Russia and recognized that there was a lot of risk," said Galeotti.

Russia could end up with egg on its face after betting so heavily on the East.

"China is slowing down — it's not a blip, it's a long-term trend," Nesvetailova said. "In all these negotiations, the Chinese have proven to be sympathetic to Russian ceremonial requests. They sign and go on camera, but on practical matters they are very shrewd and haven't given Russia what it wants."

Follow Samuel Oakford on Twitter: @samueloakford