Jan. 1 is Russia’s answer to Christmas, a day for exchanging gifts after a night of feasting. But as shoppers crowd into Moscow’s malls and big box stores before the holiday, they may glimpse some truths about their economy that could spoil the festive mood. At the huge Mega Belaya Dacha mall, entire sections of M.video, a consumer-electronics store, have been stripped bare by customers who hauled imported televisions, washing machines, and microwaves off to the checkout counters. They were buying as a hedge against rising prices after the ruble plunged almost 20 percent on Dec. 16. Ruble volatility led Ikea to suspend sales of kitchen furniture and appliances for several days. Many stores, still selling inventory from before the ruble crash, haven’t raised prices yet. But no one doubts they will. Apple (AAPL) announced a 35 percent price hike on Dec. 22.
A devalued currency ought to be good for an economy like Russia’s, which is forecast to contract as much as 5 percent in 2015. With a cheaper ruble, domestic manufacturers could gain an edge in export markets, and growth could get a boost as consumers switch to local goods.
President Vladimir Putin has been urging his countrymen to do just that. The prescription only works, though, if manufacturers make things people want—and few Russian companies do. Computers and smartphones? Russians are hooked on Apple, Samsung (005930:KS), and other foreign brands. Ditto for appliances, clothing, and children’s toys. Apart from food and beverages, just about everything sold in Moscow’s malls comes from abroad. As for exports, Russia does make cars, but its main domestic brand, Lada, has a poor reputation for quality and has suffered declining sales even as import prices have jumped.
Alexey Kutenkov, a 21-year-old student in Moscow, would like to buy Russian goods. “I am of course a patriot,” he says. He’s not ready to shell out 32,990 rubles ($602) for a YotaPhone 2, a Russian-made smartphone—at least not until he’s certain that “some of my wiser friends use it and like it.”
Consumer surveys show that in almost every category, “Western quality is perceived to be better,” says Emma Beckmann, who heads the Moscow office of Landor Associates, a branding consultant. One exception is food, though until Putin slapped retaliatory sanctions on European imports, Russians were voracious consumers of French cheese and Norwegian salmon.
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Of course, made-in-the-USA items are pretty scarce in American stores. But even as U.S. manufacturers outsource production to low-cost locales, they often spur innovation at home by keeping high-value work such as R&D close to their headquarters—think “Designed by Apple in California. Assembled in China.”
No Russian company can make a similar boast. Russia devotes only 1 percent of its economy to R&D, vs. 2.7 percent in the U.S. and almost 2 percent in China. “This economy hasn’t created the necessary value chain, financing, and other forms of support that are necessary for small businesses to become successful,” says Bernie Sucher, an American entrepreneur and investor who’s worked in Russia for more than two decades.
For years, the country’s oil revenue gave consumers the means to afford imports while easing pressure on the government to enact reforms that would have made industry more competitive. Subsidized Soviet-era factory towns persisted even as red tape and corruption discouraged entrepreneurs. As a result, small businesses account for 20 percent of Russia’s gross domestic product, vs. 50 percent to 60 percent in the U.S. and Europe.
The economy was already well on its way to stagnation before Russia annexed Crimea, says Neil Shearing, an emerging-markets analyst at Capital Economics in London. The resulting sanctions imposed by the West have intensified the strain. But Russia’s economic woes are “largely self-inflicted,” he says.
Putin and other leaders have long talked about diversifying the economy and pushing innovation. Yet projects such as the Skolkovo technology hub, Russia’s answer to Silicon Valley, have languished despite billions in subsidies. A few startups have thrived, including search-engine group Yandex (YNDX) and Kaspersky Lab, an Internet security company. But state companies increasingly dominate the economy: They accounted for about 35 percent of GDP in 2010 and today more than 50 percent.
“No normal business can make money with rates this high.”—Bernie Sucher
Some businesspeople who ran afoul of the Kremlin have been arrested or have fled the country. Such episodes scare away investors who might have strengthened the services sector and consumer-goods manufacturing. Now that the central bank has raised interest rates to 17 percent to support the ruble, Sucher says, business development is in the deep freeze: “No normal business can make money with rates this high.”
That leaves holiday shoppers with a choice between pricey imports and … well, not much else. Even homemade gifts may have imported content. Anna Luchinina, selling handmade mittens at an outdoor market near Moscow’s Garden Ring road, frets she’ll have to raise prices because she buys her materials from Italy. “The Russian equivalents are of inferior quality,” she says.