The response to the last global crisis only consisted of kicking the can further down the road, and the chickens are showing signs of coming home to roost. Of particular note: (1) the recent upwards spike on bond yields for Italy and Spain*; (2) The political paralysis in the US that may (conceivably, if unlikely) shut down government on August 2nd and send it into default; (3) oil prices are again inching up to the levels that coincided – and some argue significantly contributed to – the last recession; due to the realities of peak oil and rising Chinese demand, there is little to be done about this.
Question for consideration: How will Russia be affected by a possible Greece-style scenario unfolding in Italy, Spain, or even the US? (More generally, how do you think the next global financial and economic crisis is going to play out? What effects will it have on the Eurozone, US dollar’s status as reserve currency, etc?).
I don’t know the answers to any of these questions (if I did I’d be out there getting rich not writing this post). However, I can offer a provisional framework that may help you think about this issue.
Russia Positives
- Very low sovereign debt; fiscal books are more or less balanced.
- High oil prices… for now.
- A moderately paced recovery has almost returned output levels to peak-2008.
- Households far less reliant on borrowing to finance consumption than in typical developed nations.
Russia Negatives
- Dependence of the budget on oil prices.
- In 2008, one of the main causes of the sudden collapse in industrial output was the draining of liquidity. Russian industrial groups had relied on Western financial inter-mediation for accessing capital. From August, this suddenly dried up as the crisis exploded and global investors scurried to the “safe haven” of US Treasury bonds. So several related questions for today:
- To what extent has the Russian private and quasi-state sector reduced this dependence on foreign credit since 2008? (My impression: by a bit, but not fundamentally so).
- In the case of a global credit crunch, will Russia be spared? On the one hand, its macroeconomic fundamentals are very good (RELATIVELY speaking); on the other hand, this was the same case in 2008 and widespread sentiments that Russia was a “haven of stability” patently didn’t work out.
- To what extent will the fact that the next crisis will likely be one of sovereign collapses benefit Russia relative to other countries? After all in 2008 investors parked their savings in the bonds of countries perceived to be stable; above all, US bonds. This was because this was a primarily financial / banking crisis and sovereigns remained solvent. This calculus may be fundamentally different in the next crisis. Where can the safe haven investor invest? Euro bonds are out of the question. No bond vigilantes have yet appeared for US Treasuries, but surely with the chronic inability to cut the deficit this will eventually change? The yuan isn’t convertible… for now.
- So only commodities are left as a major investment vehicle (which benefits Russia), HOWEVER… big sovereign defaults will force the world economy back into recession, lower oil demand, and relieve pressure on commodities leading to a collapse of their prices – which is bad for Russia. Alternatively, prices may remain high if investors remain big on commodities and Asian demand quickly makes up for any shortfall in developed country demand for commodities – which is good for Russia. Which of these two forces will win out?
- Dependence on credit for consumption. Credit based purchases were beginning to play a huge role in Russian consumption in 2007-2008; this was cut off and constitutes another main cause of the depth of its 2009 recession. This dependence on credit for consumption is already creeping back in 2011, though it has yet to reach the levels of early 2008.
- Stampede effect. Despite aforementioned good fundamentals, many institutional investors have rules to abandon EM’s if a global financial crisis strikes (regardless of the specifics of the country in question). To avoid losses, other investors are forced to flee too.
Go, discuss.
* At the beginning of this year I speculated which of the “dominoes” among the PIGS, the US, and Japan would fall first when the global economic crisis resumed. Perhaps the PIGS will prove to be the weakest link after all.
A good thing about the 2008 Great Recession is that it deflated a financial bubble in Russia. There was too much real estate speculation (note the stalled development in “Moscow City” complex). Russia’s development benefited greatly from the 1998 crisis where the GKO pyramid collapsed and real economic policies had to be adopted (thanks to Primakov who ended the laissez-faire romanticism and started to monetize the economy properly, something the monetarist idiots couldn’t understand). I do not believe there is much of a bubble to burst now so some implosion by the PIIGS will have little impact. FDI in Russia has always been a joke and Russia does not depend on consumer goods exports (although the PIIGS are hardly a major group of consumers anyway and so are basically a side show).
People in Russia are pessimistic since they have been effectively brainwashed into believing that Russia’s GDP depends on oil exports. This is in spite of the fact that only 20% of it depends on fossil fuel extraction. They also haven’t heard about peak oil apparently. There is not going to be a $10 per barrel oil price ever again. Domestic consumption is the primary driver of Russia’s GDP growth and not oil exports (Russia’s GDP growth in 2008 dropped in the first three quarters even though the oil price was about $147 per barrel). I haven’t heard about mass unemployment in Russia, in contrast to the USA. So Russia is not going to join the PIIGS and will stay part of the China growth club (internal consumption, development driven).
I don’t find much of this very convincing, unfortunately, as most of the same could have been said in 2008.
A good thing about the 2008 Great Recession is that it deflated a financial bubble in Russia. There was too much real estate speculation (note the stalled development in “Moscow City” complex).
Perhaps… but nonetheless, what percentage of GDP is the construction sector? No more than 6%. This can’t have played a big role, nor were Russians ever using their homes as ATM machines.
There is not going to be a $10 per barrel oil price ever again.
No, there won’t; but there might be $40 oil for a short time if the system collapses as in 2008. Perhaps, even less – after all, sovereign defaults should be much more destructive than a mere financial crisis in which the banks are bailed out anyway? Besides, Russia now needs oil at around $100 just to balance the budget.
I do not believe there is much of a bubble to burst now so some implosion by the PIIGS will have little impact.
The BRIC’s are the immediate concern, but what if contrary to expectations its the US that goes belly up on August 2nd?
So Russia is not going to join the PIIGS and will stay part of the China growth club (internal consumption, development driven).
I certainly don’t expect Russia to join a PIGS group, its practically impossible, but staying part of the China growth club depends on its major state companies and banks retaining access to affordable credit. UNLIKE China, these Russian companies and banks are dependent on Western credit, both for investment and in order to continue rolling over their debt (this is linked to the underdevelopment of the domestic financial system).
In 2008 this foreign credit access got cut off and contributed in a major way to the crisis. This may happen again in 2011/12 if Western creditors again desert Russia. The signs don’t look good – according to the Central Bank, as of April 2011 general debt levels of banks and the commercial sector is again approaching close to its mid-2008 peak. (Although thankfully, percentage of those that are краткосрочные has fallen).
Dear Anatoly,
I agree with all the points you make in this post. I would add (pace your previous article about Russia’s “stagnating” economy) that the reason growth has been “only” 4% so far this year is precisely because the economy is being affected by worries about what would happen in the event of another global financial crash this autumn. In my opinion this has been a far more important factor than political uncertainty. I speakk on the basis of personal contacts I have within the Russian business community. I ought to say that the latest figures seem to show a quiet strengthening in performance over the last few weeks but all this could be thrown into doubt by another crash. One point I must make, which might be different this time from 2008. The capital outflow that affected Russia so badly was a global phenomenon that was at least partly deliberately orchestrated by the US Federal Reserve Board and to a lesser by the Bank of England and the ECB as part of their efforts to re capitalise the global financial system. I know of at least one banker who was ordered to pull back a loan of $200 million made to a Russian company for precisely this reason. In the event of a new crisis will the same happen again especially if the problem is perceived as one of sovereign debt rather than of debt in the financial system itself? I do not know.
Dear Anatoly,
Just one further point/question: could the capital outflow that was underway be at least partly explained by a desire to build up financial reserves as a cushion in the event of another crash? If so there might be some logic in placing some of this money in overseas accounts given the lower inflation in Europe and the US as compared to Russia. I ought to say that the latest figures suggest that this capital outflow (about which a great deal of nonsense has been written) is now starting to abate, which suggests that whatever its cause the factors behind it are starting to abate. In any event the government is surely right to focus so much effort on lowering inflation. One reason why the Russian financial system is so weak is because of the low rate of personal saving. High inflation deters saving.and it is Russia’s high rate of inflation that in my opinion explains why levels of personal savings in Russia are so low. If the inflation rate falls then if wages were to continue to rise this might change dramatically especially as land prices in Russia are low, which as you rightly say means that Russians do not/cannot use their homes as ATM machines and do not have to borrow so much.
The foreign credit “dependence” is only due to the high internal interest rate. This foreign borrowing mainly affects sectors like real estate. It does not affect the fossil fuel sector and the government sector (which includes military contractors and aircraft manufacturers). Oil prices at $40 dollars for anything longer than a quarter is simply not credible. We already had this “collapse” after 2008, it did not produce a new low price plateau. Also, the Russian federal budget assumes an oil price for Urals blend of about $55.
In addition, the grow rate of 7% in 2007 was driven by internal consumption as reflected in real estate (“construction”) and retail trade (http://siteresources.worldbank.org/INTRUSSIANFEDERATION/Resources/RER15ppt_Eng.ppt). The current growth rate of 4% in spite of all the pain in foreign borrowing (remember that western banks have not been lending even to their own economies) and capital flight shows that negative growth rates in Russia’s GDP are not likely to result from foreign credit contractions. Really, based on events since 2008 Russia is more or less immune to western financial crises. It is still developing with real internal demand, unlike the USA where demand is lubricated by cheap credit in the face of serious job exports to China and India (i.e. long term contraction in domestic demand).
Dear Kiril,
Two points:
(1) High domestic interest rates are a consequence of high inflation.
(2) I agree that there is little prospect of oil prices remaining for long at %30 a barrel. However my understanding is that to balance the federal budget needs oil prices at $120 a barrel as opposed to $60 a barrel as was the case before 2008.
I am sure that Russia will be able to get through a crisis since it is in better shape than most economies. Also the influx of “hot money” before 2008 though making the growth rate higher was causing inflation and damaging exports. That thankfully has stopped and is a plus compared to the situation then. However I am less confident about the immediate future than you. If there are shocks in the world economy this autumn then I cannot predict how they will affect Russia and I would not be surprised if the economy suffers from further turbulence in the months ahead,
Sorry, at question (2) that should have said $40 a barrel!
http://www.vedomosti.ru/img/newspaper/2010/10/19/247933_a_pic1.GIF
A graph is worth a thousand words. If the Russian economy was hypersensitive to western financial problems, then the Russian banking industry would not be making the same profits in 2010 as in 2007. I am sure the banking sector of the PIIGS did not see the Great Recession as a one year blip in profits.
As for inflation in Russia, it is structural and not the monetarist phobia it is made out to be. If you look at the 2000s, the Russian money supply was growing at about 50% per year but the CPI was less than 13%. In the last two years world food prices have been going up because of weather related disruption. I am sure in Russia this is being blamed on Putin and his crony capitalism. But then liberasts and their fellow travelers don’t deal in reality, they deal in con artistry.
I am not sure where you get the $120 per barrel of oil figure from. The federal budget was based on an oil price of $58 in 2010, $59 in 2011 and $60 in 2012 (http://georgiandaily.com/index.php?option=com_content&task=view&id=17294&Itemid=77).
Banking profits are so high because interest rates are so low and state lend enormous amounts of money. Not because the economy is doing great
You are not being clear. Russian banks were not being propped up anywhere near the levels of their western counterparts (size adjusted) by state bailouts.
Anyway, where’s the massive unemployment in Russia if things are as bad as you claim.
Dear Kiril,
The figure of $120 a barrel came from an interview with Natalia Orlova, the chief economist of Alfa Bank on RT. As I am in my fifties I am not good at links (sorry!) but the interview is still on the RT website. Having thought about I wonder though whether we are talking about the same thing? Orlova says that oil has to trade at $120 a barrel for the budget to be at break even level, which is not the same thing as saying that the Russian budget is based on that price.
The Russian government has grown an IQ and understood that balanced budgets all the time are an idiotic monetarist fantasy. Every government in the developed world, and in China as well, operates on deficits when needed since cutting to the bone is a clear example of disregarding opportunity cost.
Not only governments. Most well run companies also run deficits.
One fundamental point to bear in mind is that if there is another crash the psychological environment will be very diffferent. In 2008 the crisis was entirely within the banking community. In the event of another crash the crisis will happen as against a background of a sovereign debt crisis and another crisis in the banking community. In 2008 it was possible to believe that a combination of bailouts and fiscal and monetary loosening would see the problem out. It is difficult to see how that could be the case a second time round. Of course because of the sovereign debt and deficit problems the scope for a fiscal loosening is far less if it exists at all. In fact it is not really clear what in the event of a new crisis the response could be. Given the very different psychological calculus the response might be very different. Instead of people pulling out their money from places like Russia they might this tme prefer to keep it there. I am not saying this would happen. I simply do not know.
One last contribution to this discussion. If things really turn critical (and we are in that case talking about critical not just for Russia but for everywhere) Russia does possess a unique advantage, which is that the government still possesses tools that are simply not available in most western economies whilst the country always has the option of retreating into self sufficiency. I am not saying this is something Russian leaders would want to do or which in an ideal world Russia should do, but it can always draw up the drawbridge so to speak and carry on its trade on its own terms. It has after all done this in the past. I stress this is a catastrophe scenario, which I neither want nor expect. What I do think is that Medvedev’s single minded policy of trying to attract western investment (which is where many of the “liberal” posturings that have so annoyed Anatoly come from) is a little misguided. If Medvedev devoted less time to western investors and more to sorting out Russia’s own banking system by for example working hard to encourage savers he might in the end achieve more.
How U.S. Default Would Hit Russia
http://www.themoscowtimes.com/business/article/how-us-default-would-hit-russia/440741.html#axzz1SZGD32sj
Dear DF,
Thanks for this though in truth I find much of the writing in the article (like many of the articles in Moscow Times) hysterical. For example the “anonymous banker” who says that in the event of a US default the Russian economy would be “wiped out” because of there would be no one to buy Russia’s oil, gas, steel etc appears to be prophesying the apocalypse. If there is no one around to buy these commodities than that would mean that the state of the international economy would be so completely disastrous that Russia because of its self sufficiency (see my previous posts) would actually be well off compared to everyone else! Seriously, I do not believe that things will be quite as bad as this whatever happens. We could be in for a very bad recession or even depression but somehow life will go on. As for the risk of a capital outflow, the question is into what? In contrast to 2008 both the dollar and the euro at the moment look extremely shaky. Why would be people want to buy US Treasury Bonds (as happened in 2008)) if the US had just defaulted on its debts? Surely a stampede out of the dollar is more likely? With a growing crisis in the eurozone why however would people want to put their money in euros? This it seems to me is a critical difference between 2008 and now. Unlike 2008 there is no obvious safe haven. Again I don’t want to sound complacent about the situation, far from it. As I said I genuinely do not know what might happen. I don’t think this article in Moscow Times tells us much.
I think it’s pretty good at illustrating the fundamental uncertainty that seems to be in place about Russia’s prospects.
I’m very cautious now as I got burned – thankfully, only on the blog – by predicting growth of 0-3% as embarrassingly late as early December 2008. In reality, it was -7.9%.
Speaking of the current approaching crisis, it seems safe to say that practically all the developed world will get hammered. It also appears safe to say that China will power on (its financial system is largely independent of the global one, and collapsing foreign demand for its products can be compensated by massive government stimulus and monetary loosening).
Russia is more of an either-or play. If 2008 withdrawal of credits repeats, so do the events of 2008. If instead investors flood into it away from the collapsing markets of the developed world, then it will perform relatively well.
There probably aren’t many things that Sberbank president and former economy minister German Gref tries not to think about. But a U.S. default, which will take place if warring political parties in Washington cannot agree on a deficit reduction plan, is one of them.
“I don’t even let that thought cross my mind. If it happens, it will have, to put it mildly, catastrophic consequences for the world’s financial system,” Gref said at a news conference Friday.
If that’s what he said and does, the criminal incompetence is beyond words.
It’s inconceivable that the US will default. There will either be a compromise at the last minute or Obama will surrender to the Republicans. Wall Street will be making it very clear to Congress that default is unacceptable.
Greece, Italy, the US and the UK are likely to have debt reductions, perhaps even Japan if the situation continues like this.Belgium, Spain, Ireland and Portugal have sound economies that can come back with aid for the bad years. Creating a PIIGS category was a bad idea because it mixes fundamentally different systems. At least the dominoes are unlikely to fall hard in the EU where the Germans, French, Netherlands and Scandinavians do well.
Here’s a question: if the problems in the U.S. and Europe preclude using either the dollar or the Euro as a safe reserve currency in the future, and the yuan is not convertible enough to take its place (and the yen is no substitute for obvious reasons), could that result in a de facto return to the gold standard? If so, does Russia’s status as one of the world’s major gold producers help it weather the transition better than most?
There’s a whole lot of capital out there which is accustomed to being able to use the dollar as the neutral, safe place to stay when things are bad. It is apparent that China and others are becoming increasingly worried about this. When trying to figure out whether or not capital would flee Russia when things go bad, I’m wondering who would benefit most from a return to gold as the reserve “currency”.
Dear Rossdavitch.
The simple answer is that if there is a flight into gold then since gold is ultimately a commodity the situation would benefit the world’s biggest commodity producer, which is Russia. To be specific Russia would in that case be demanding payment for its oil, gas and food either in gold or in gold based currencies. The essence of a gold standard is that currencies are convertible into gold so countries would be obliged to retain stocks of gold. You would be looking in that case at a “catastrophe” scenario in which gold is being hoarded (since it has only a finite quantity). World trade would be very strictly controlled as countries would be reluctant to part with their gold. They would therefore as far as possible limit imports of goods they could make themselves, which would hit manufacturing exporters badly. There would be a collapse of world trade and a return to protection. Modern economies, even extremely depressed modern economies such as you would have in these crisis conditions, cannot however do without commodities and Russia because of its self sufficiency and its position as the world’s biggest commodities producer would be in a position to dictate its terms of trade. I have to say that I find this scenario totally implausible to say the least. I do not think we are anywhere near this sort of situation. If there is a crisis in the autumn we might conceivably see bank runs and a further rise in the gold price but I simply cannot imagine a situation where confidence had collapsed to the point where there was no confidence in currencies at all so that al return to the gold standard became necessary.
It would seem that members of the US House do not see any downsides to defaulting. They have placed the sick and the elderly at the back of the queue for payment and the military at the front. However, if cost of borrowing climbs (and it is predicted to dramatically do so), then the military would stop receiving payments – just like the Russian army in the aftermath of the USSR’s collapse.
If economic conditions are extreme and NATO dramatically collapses, then it could pave the way for a new global superpower – possibly called Rus-Germania. Germany is obviously unhappy with the southern European countries and thinks the British are just obstructionists. Russia (unfortunately) does not seem to care about Serbian affairs anymore. Poland is obstructionist too, but both countries have been trying to ignore the fact that it is there. It is not powerful, and it is dependent on EU funds mostly from Germany. It would go along with the alternative to depression.
This is what the British have tried to keep from happening for over a century, but the US and UK are too powerless to interfere now.