“We need an economic breakthrough,” declared Vladimir Putin back in December 2018, during his now legendary annual press conference. Acknowledging Russia’s gloomy economic outlook, the President forecast 1.8% growth in 2019, down from 2.3% the year before.

Twelve months on, during this year’s annual Question and Answer Session, the economy was again part of Putin’s presentation. But the headline growth numbers barely featured.

Russia is now the world's largest grain exporter, the President declared, having surpassed the US and Canada. The capital base has modernised, with three-quarters of industrial equipment no more than 12 years old. During his 20-year term of office, as President and Prime Minister, Russia has built three new airports, a dozen new railway stations and the number of major trunk roads has doubled, Putin told his huge audience.

Yet Russian GDP growth of just 1.3% that is officially forecast for 2019 is 0.5 percentage points short of last year’s Presidential prediction. The World Bank, in fact, estimates just 1% growth this year, having downgraded its forecast four times since January.

Things didn't go according to plan in 2019.

The Russian economy has suffered a double blow, resulting in five years of falling incomes, which have dragged down Putin’s popularity ratings and fuelled a succession of public protests. Oil prices have fallen sharply over the last half-decade – from an average of $93 a barrel in 2014, to just $56 so far this year, impacting tax and export revenues. On top of that, Western sanctions related to hostilities in Southern and Eastern Ukraine have also stymied growth, as East-West relations have fallen to a post-Cold-War low.

There are signs of a growth uptick, as Putin was keen to highlight. Real wages grew 3.8% during the year to October, with retail sales in November 2.3% up. Russia’s services sector also remains buoyant, with the PMI Services index registering 55.6 in November (measures of 50-plus indicate growth).

The ruble rallied during the first half of December, gaining 2.3% against the dollar. That marked an 11% year-on-year rise against the US currency and a 14% increase against the euro. Russia has lately seen capital inflows, partly because government bond yields remain high, despite successive rate cuts.

From 7.75% at the start of 2019, Russia ends the year with a base rate of 6.25%, after the Central Bank of Russia lowered rates five times over twelve months. This reflects steadily falling inflation – which ends the year at 3.2%, well below the CBR’s 4% target. Inflation has eased due to a stronger ruble and lower food prices, the result of higher agricultural output. But it also stems from much lower producer price inflation, which, towards the end of 2019, tipped into deflationary territory.

Producer prices fell year-on-year in both October and November, in the latter month by no less than 4.9%, with suppliers slashing prices in the face of falling demand. As a result, Russia’s PMI manufacturing index plunged to 45.5 in November, its lowest since mid-2009. In turn, the closely-watched Rosstat Business Confidence Index also dropped further, hitting minus 5 in November, down from minus 3 the month before.

Russian consumers remain cautious in the face of what they see as an uncertain future, with 68% of adults favouring saving over spending, according to a recent authoritative poll. This compounds the difficulties faced by Putin’s government, as it tries to reinvigorate the Russian economy – which remains the sixth biggest in the world on a PPP basis, adjusted for living standards.

To most outside observer, relatively low growth seems unimportant. The RTS index of leading Russian shares boasted a year-to-date gain of 40.5% up until mid-December, placing this dollar-denominated composite among the world’s best-performing stock market benchmarks during 2019.

International investors have been rediscovering Russian markets – drawn by attractive dividends paid by state-run companies and the high yields on state bonds – despite on-going US sanctions. The ruble-based MICEX put on 26.5% over the same period – more than twice the rise of the MSCI EM index of leading emerging market stocks.

Putin is keen to secure a sustained rise in growth and living standards before a new State Duma is elected in 2021 and prior to the next Presidential contest in 2024, by which time he will be 72 years old and, anyway, constitutionally obliged to step down.

Soon after the 2018 Presidential vote, the government carried out several tough reforms – raising both VAT and the retirement age, passing unpopular laws early in the electoral cycle. Yet, while Putin now talks about higher growth, he still presides over an economic policy-making model, which appears to prioritize the accumulation of reserves and budgetary restraint above everything else.

Russia will this year run a current account and fiscal surpluses equal to 4.6% and 1.6% of GDP respectively – demonstrating this “safety first” approach. State debt is equivalent to 13% of GDP – among the lowest in the world. On top of that, lingering heavy regulation and the actions of the siloviki (the security services) are clearly constricting private investment.

The effectiveness of budget spending is also in doubt. Putin’s RUB25.7 trillion ($390bn) investments planned for the 12 national projects – a series of infrastructure initiatives – has been proceeding rather slowly, amid rows over procurement. Russia has become, in emerging market terms, a slow-growth economy – managing annual real GDP growth of well below 2% over the last three years that are below the global average growth rate. And, while he wants to see an improvement, Putin’s interest in the details of economic policy appears to have waned over the last twelve months.

“How do we kick-start growth - that is the biggest question the government faces,” declares Russian Deputy Finance Minister Alexei Moiseev, speaking with me during a Renaissance Capital event in London this autumn. “Capital market reform has progressed strongly, but business is still over-regulated,” he acknowledges. “We’re working on a regulatory guillotine, finally getting rid of the remaining Soviet era legislation – the idea is that all business regulations from before the mid-1990s will be scrapped”.

The recent introduction of mandatory electronic tax declarations means “the de facto tax burden on business has risen as more and more activity has come onto the books”, says Moiseev. “We need to look at the idea of a tax holiday for small- and medium-sized enterprises”.

Explaining how “overseas debt has caused us a lot of problems in the past, as currency values have shifted”, Moiseev indicates that the Russian government is “keen to discourage firms from borrowing in foreign currency”. The CBR, he says, is “slowly introducing regulations to discriminate against the holding of foreign currencies in Russian banks”.

The exception is China – given growing links between Moscow and Beijing, the most recent symbol of which is the opening this month of the 3,000km “Power of Siberia” gas pipeline from Siberia’s Lake Baikal to the Chinese border. This now sits alongside the “East-Siberia-Pacific-Ocean” Sino-Russian oil pipeline, operational since 2010. “There are no plans to issue sovereign Russia debt in China, but renminbi bonds will soon be issued in Moscow,” says Moiseev. “This is a ground-breaking operation for Russian corporates – and the government supports these efforts”.

Since 2014, the US has barred transactions with many Russian individuals and businesses, while banning some exports to the country. Sanctions have also restricted Russian access to Western financial markets and services, while imposing few limitations on foreigners buying Russian stocks and bonds.

In January, Washington’s stance appeared to ease, as some sanctions were lifted. But in August, President Trump then barred US banks from lending foreign currencies to the Russian state and participating in primary market for non-ruble-denominated Russian sovereign bonds. “We simply cannot forecast the actions of the US administration,” says Moiseev, referring to this summer’s volte face. “We were surprised, but we always prepare for the worst – and sanctions are something we have to live with,” he says.

“We don’t want to separate ourselves from the US financial system – but the US financial system clearly wants to separate itself from us,” says Moiseev. “From the mid-nineteenth century, reliance on foreign funding have been troublesome for Russia – so we must heed those lessons, pursuing a policy of a strong budget, low inflation and low government debt”.

Oleg Vyugin, a First Deputy Minister from the 1990s, and one of Russia’s most celebrated economic reformers, laments this cautious approach, but agrees it is necessary “Our macro policy is extremely conservative, but this is a domestic political reaction to the external environment,” he tells me, at the same London-based Renaissance Capital conference. “It is a policy of self-preservation against a possible worsening of some of our most important international relationships – and I think it will continue”.

Vyugin argues government expenditure should now rise to boost growth but warns against this becoming a permanent feature. “This is not our strategic future,” he says. “The state should not substitute for the private sector, but it can help for now given the reaction of the domestic economy to the diplomatic environment”.

Looking back over almost three decades of post-Communist reforms, Vyugin’s emotions are mixed. “There has been much progress and our economy has been completely transformed since the early 1990s – but I am disappointed, given the hope there was back then,” he says.

“Some major reforms are still needed – particularly to the judicial system,” Vyugin argues. He also wonders aloud why his government initially detained the US businessman Michael Calvey, who remains under house arrest in Moscow. “There will be disputes and sometimes courts will rule the wrong way,” he says. “But pre-trial detention scares people and fixing this situation would have a big impact on our image overseas”.

Vyugin maintains, though, that blame for the breakdown in US-Russia relations should be split. “Over the years, Russia has made some big, generous offers to the West, which have been turned down – a gift to Russian isolationist lobbies,” he says. “But Russia, in turn, has sometimes over-reacted – so there is blame on both sides”.

Perhaps the most striking aspect of President Putin’s recent press conference was that he dismissed the current impeachment process against Donald Trump on Capitol Hill as “far-fetched”, recognising his US counterpart will likely be acquitted in the Senate. Putin likened this process to the earlier probe into Trump-Russia pre-election collusion, which Putin downplayed as groundless.

Despite this friendly gesture, or possibly because of it, Trump then responded by approving sanctions on firms involved in the construction of Nord Stream 2, the second undersea gas pipeline between Russia and Germany. Being built at a cost of $11bn, NS2 will allow increased gas exports to Western Europe’s largest economy. The White House claim the 1,225km pipeline is a “security risk”, possibly turning Germany “into a hostage of Russia”. As well as tightening Russia’s grip on Europe’s energy supply, this new pipeline will reduce the share of the lucrative European market for American liquefied natural gas.

There seems little chance that an improving international environment will help reboot the Russian economy anytime soon. Heightened trade and geopolitical tensions (above all, the trade war between the United States and China) could well cause a slowdown in global economic growth in 2020, lowering demand for Russia’s energy exports. And with the US facing ten months of campaigning ahead of the October White House vote, any talks between Russia and the US risk being interpreted as Moscow interference in the election. 

In his annual press conference, Putin also said that when it comes to Eastern Ukraine, the 2015 peace agreement signed in Minsk, brokered by France and Germany and granting separatist-held areas self-rule, must be observed. Moscow clearly rejects Ukrainian President Volodymyr Zelenskiy's efforts to force renegotiation.

Putin wants an “economic breakthrough” and knows that becomes more likely if Russia is back in the international fold. But he can afford to be patient. “There is nothing but the Minsk agreement,” he said, as the world’s media looked on. “If we start revising it, there can only be more deadlock”.