How does the price of oil affect Russia's economy?

During the second half of 2014, Americans celebrated a rapid decline in the price of oil and gas. Cheap oil has an impact similar to that of a tax cut for a country that purchases much of its oil from abroad and whose citizens count gasoline as a major monthly expense. However, in Russia, a decline in the oil price has a significantly different effect.

Net importers benefit from a declining oil price

Some countries prosper when oil prices decline and suffer economically when they rise, while the opposite is true for others. Countries whose economies benefit when the price of oil is low tend to be net importers of oil, meaning they import more than they export. Low prices are preferred when doing more buying than selling. Most countries that experience tangible benefits from cheap oil are developed countries with high energy demands.

The United States, for example, exports a minuscule amount of oil compared to what it imports, and Americans consume more oil than people in any other country. As a consequence, the U.S. economy benefits from cheap oil and gas. Lower import prices ease stress on the federal budget, while Americans enjoy greater purchasing power because less of their disposable income is spent at the gas pump.

But net exporters suffer when the oil price drops

The price of oil and Russia's economy have the opposite relationship. When oil prices drop, Russia suffers greatly. Oil and gas are responsible for more than 60% of Russia's exports and provide more than 30% of the country's gross domestic product (GDP). The effect of the 2014 oil price collapse on Russia's economy was fast and devastating. Between June and December 2014, the Russian ruble declined in value by 59% relative to the U.S. dollar. At the beginning of 2015, Russia, along with neighboring Ukraine, had the lowest purchasing power parity (PPP) relative to the U.S. of any country in the world. Declining PPP lowers living standards, as goods purchased using the home currency become more expensive than they should be. Moreover, Russia receives less economic benefit from lower pump prices than the U.S. does, as Russians consume much less oil and gas than Americans. Less than 30% of Russia's oil production is retained for domestic use, while the remainder is exported.

Oil prices also affect imports for Russia, as was seen in 2014. Because the country is a net importer of almost everything except oil and vodka, the sharp increase in import prices caused by a falling ruble touched off major inflation, which the Russian government attempted to tamp down by raising interest rates as high as 17%. As the U.S. discovered in the early 1980s, a sudden and significant interest rate hike can precipitate a deep recession.

Fending off dual threats of sharp economic contraction and rampant inflation is a tenuous proposition for policymakers in any nation; for Russia, it is an unfortunate reality when oil prices decline.