No. 48: Russia and the Financial Crisis · 2015. 2. 11. · the letter. Russian oil stocks have...

No. 48

Otto Wolff -StiftungResearch Centre for East European Studies, BremenDGO

analyticalanalyticaldigestdigest

17 October 2008

RUSSIA AND THE FINANCIAL CRISIS

russianrussian

www.res.ethz.ch

ANALYSI ■ S Th e Impact of the Global Financial Crisis on Russia 2 Peter Rutland, Middletown, CT

STATISTIC ■ S Financial Indicators 5

STATISTIC ■ S World Commodity Prices 9

OPINION POL ■ L Th e Financial Crisis as Perceived by the Russian Population (Late September 2008) 12

ANALYSI ■ S After 10 Years of Growth, the Russian Economy May Be Losing Steam 15 Vladimir Popov, Moscow

DIAGRAM ■ S Economic and Social Indicators 18

Center for Security Studies, ETH Zurich

www.laender-analysen.de/russland

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russianrussianrussian analytical digest 48/08

Analysis

Th e Impact of the Global Financial Crisis on RussiaPeter Rutland, Middletown, CT

AbstractRussia’s rosy economic development outlook has been thrown into question by the global fi nancial crisis. Th e stock market has lost about 60 percent of its value. So far only two banks have fallen into bankruptcy, but industry has suff ered from the twin problems of the slump in global commodity markets and the credit crunch. In the short term, the crisis may help Russia reintegrate into the international community following its invasion of Georgia, but in the long term, its fate depends heavily on the price of oil.

Commodities Connect Russia to Global MarketFor the fi rst few weeks, as the fi nancial crisis unfolded in the United States and metastasized around the globe, the Russian reaction was rather calm. Only a small frac-tion of Russians, less than two percent of the popula-tion, personally hold shares or mortgages – in sharp contrast to the situation in the US, where a majority of the population could see the impact of the crisis on their pension fund, or on house prices in their neigh-borhood. As late as mid-September, a poll reported in Ekspert magazine found only 42 percent of Russian re-spondents felt that a crisis was coming.

Th e government, for its part, was also confi dent that the crisis was a “made in the USA” problem. All Russians remember the devastating impact of the 1998 fi nancial meltdown, which led to a default on foreign debts, a 75 percent depreciation of the ruble, the col-lapse of most private banks and the loss of personal sav-ings therein. But the situation in 2008 looked vastly dif-ferent. Sitting on $560 billion of hard currency reserves, with low foreign debts and a huge current account sur-plus, the Russian Central Bank was confi dent that it could meet Russia’s obligations and defend the ruble at its preferred rate of 24–25 to the dollar. Regulation of the banking system had been tightened since the 1998 crash, and the majority of personal deposits were se-cure in the state-owned Sberbank. More broadly, GDP had been growing at 7 percent a year for the past eight years, and living standards had been rising at an even faster rate. Th e future looked bright.

However, while Russia was insulated from the im-pact of the US fi nancial crisis in some respects, it was dangerously vulnerable in others. It had less domestic exposure – but high international exposure, and limited institutional depth to cope. Th e Russian stock market (RTS) had been weakening over the summer well before the US crisis hit. In the two months after 18 May, the US stock market fell by 11.5 percent, and the Russian mar-ket by 13.1 percent. Th en in the next two months, the

RTS crumpled by 51.8 percent, while the US fell only 8.5 percent. Various factors combined to drag down the Russian stock market – the messy fi ght for control over TNK-BP; the outbreak of fi ghting in Georgia on August 8; and a tiff over the steel-producer Mechel. (On July 24 Putin casually accused the company of price-goug-ing, causing its stock to fall by one third.)

But the main factor was the plunging price of com-modities – the backbone of Russia’s export-led growth

– due to the global economic slowdown. Oil fell from a peak of $147 in July to $86 by October 10. (Th ese are prices for West Texas Intermediate.) Metals prices have also fallen considerably since the start of the year. Th e last time the world oil price fell by half was 1998, and prior to that 1986 – both of which triggered devastat-ing political consequences in Moscow.

As US stocks plummeted, international investors cashed out their Russian holdings – which accounted for about half the Russian stock market – in a bid to generate cash and cover their obligations. Foreigners have now pulled $74 billion out of the market, and both the dollar-denominated RTS and ruble MICEX have fallen by more than 60 percent – while the US markets have fallen about 50 percent. Bloomberg rates RTS as the sixth worst performing out of the 88 stock indices it tracks. Th e Federal Financial Markets Service (FSFR) introduced a blanket ban on short-selling – one of the few countries to introduce a blanket ban (most limit-ed the prohibition to fi nancial companies). But this did nothing to stem the slide.

After Russian shares fell 20 percent on September 16, the exchanges were closed for two days, during which a $130 billion rescue package was assembled. Th e Central Bank and fi nance ministry would intervene to buy shares in Russian companies and strengthen bank balance sheets. Th e Central Bank and National Welfare Fund would loan the equivalent of $36.1 bil-lion to Sberbank, VTB (formerly Vneshtorgbank) and VEB (Development Bank) at 7 percent interest for fi ve years (later raised to ten). Th ey in turn were to lend the

3



money to banks and companies. Ekspert has estimat-ed the total value of the rescue package at 3 trillion ru-bles, or 10 percent of GDP.

Th e market recovered 25 percent when it reopened on Friday September 19, but fell again the next week as a number of bank failures in Europe deepened the global crisis. On October 6 oil fell below $90 a bar-rel, and the RTS and Micex fell 19 percent on Monday October 7, leading to another two-day market closure. (Like the Asian markets, the Russians failed to enjoy a bounce after the US House of Representatives approved its $700 billion bailout.) On October 3 the State Duma introduced a bill authorizing a rescue package, which passed its second and third reading on October 10. Th e bill also raises the state guarantee on personal bank de-posits to cover the fi rst 700,000 rubles ($26,800, up from 400,000). Th ere is no sign of organized politi-cal opposition to the government’s actions, as even the Communist Party has refrained from criticism.

Th e bailout deal included an immediate cut in oil export tariff s, worth 140 billion rubles for oil produc-ers. Still, on September 24 four Russian oil compa-nies sent a letter to Putin, complaining that they hold $80 billion in foreign loans and asking for low-inter-est loans from the state to enable them to continue in-vestment projects. It’s hard to feel sorry for the oil bar-ons, though. On October 10 TNK-BP paid out all of its fi rst half year’s profi ts, some $2 billion, in dividends. Surgutneftgaz, fl ush with $20 billion cash, did not sign the letter. Russian oil stocks have fallen by more than 60 percent, in contrast BP stock fell 38 percent since the start of 2008, and Exxon Mobil by only 17 percent (as of October 6). Th e total value of all Russian oil com-panies on October 6 was $128 billion – while Brazil’s Petrobras alone was valued at $135 billion.

Th e nominal exchange rate against the dollar fell 3.2 percent in August and 4.5 percent in September, standing at 26.2 to the dollar on October 10. But the Central Bank spent $16.7 billion defending the ruble in the week ending October 3, leaving the total hard currency reserves at $546 billion, down from a peak of $596 billion on July 31.

Th e government has been able to hold the ruble steady and to prevent a rash of bank collapses. But it has not been able to stabilize the stock market: it has been pouring money into a bucket without a bottom.

Sectoral impactSo far only two banks have fallen into bankrupt-cy. Svyaz-bank was taken over by the state-owned Vneshekonombank, and after several weeks of rumors

on October 8 it was announced that the investment bank KIT-Finans was being taken over by Alrosa and the Russian Railways for a nominal 100 rubles. In both cases the government took over their liabilities

– which amounted to $6 billion in the case of KIT-Finans, including $1 billion lent to it by Gazprombank in September. It seems that KIT-Finans was handed over to Russian Railways simply because the giant state corporation wanted its own bank. Th ere is clearly a dan-ger that most of the bailout package will be channeled to well-connected state corporations, keen to strengthen their holdings. Such fears were expressed in an open let-ter published by Aleksandr Shokhin, the president of the Russian Union of Industrialists and Entrepreneurs, on October 9 (“An Appeal to the Country’s Leadership”). He warned that an ongoing bailout could drain the Stabilization Fund (which now stands at $143 billion) in two years, with no discernable impact on the coun-try’s economic development. On October 10 Standard & Poor’s lowered the rating of 13 Russian private banks from stable to negative, including Alfa Bank and Troika Dialog. People have been pulling money out of private banks and putting it into state-owned banks like VTB-24, which saw deposits jump from the equivalent of approximately $494 million to more than $8 billion. Some private banks, such as Renaissance and Standart, introduced limits on cash advances.

Th e industrial sectors aff ected by the crisis can be divided into two groups. First, there are those suff ering from the slump in global commodity markets. Second, there are those who were exposed to the credit crunch

– notably, construction and retailing. Th e metals sector’s output is expected to contract by

20 percent during the fourth quarter, and some com-panies (such as Magnitka) have already put workers on short-time. Steel-makers in China and India are facing similar cut-backs. Export markets are no lon-ger profi table and Russian customers cannot aff ord to pay. Th e market capitalization of the top six fi rms (Norilsk Nickel, Evraz, NLMK, Severstal, Mechel and Magnitka) has fallen by 75 percent this year, from a combined total of $170 billion to $40 billion.

Construction and retail fi rms have been leading Russia’s domestic economic growth, and were borrowing heavily to expand. With interest rates jumping from 12 percent to 20–25 percent in a matter of weeks, they im-mediately began delaying or cancelling new projects. On October 10 Sberbank and VTB agreed to provide loans to nine retail chains at 15–18 percent interest. Priority will be given to fi rms with a debt/cashfl ow (EBITDA) ratio of three to one or less. Although a slump in con-

4



struction and retailing will aff ect GDP growth, labor economist Vladimir Gimpelson argues that adjustment will come through wage cuts and not layoff s, so it is un-likely that we will see an increase in the current report-ed unemployment rate of around 6 percent.

Among manufacturing industries, the hardest hit is likely to be auto sales – a big ticket item for con-sumers. Auto sales across Europe fell by one quarter in September. Inside Russia, sales of domestic brands such as Ladas have slumped 40 percent in the past two months, but half of the foreign brands did not experi-ence a decline in sales, in part because they have been discounting heavily. Some auto producers have cut hours or temporarily closed production lines, includ-ing truck manufacturer Kamaz, hit by the construction freeze. Daimler may be having second thoughts about its plan to buy 42 percent of Kamaz.

Even fi rms with substantial cash fl ows were not im-mune if they had borrowed heavily to fi nance acqui-sitions. For example, Gazprom needs 400 million eu-ros to buy Serbia’s NIS; Lukoil $2.1 billion to buy the Italian ISAB refi nery and $555 million for the Turkish distribution company Akret. Th e total value of foreign debt owed by banks and corporations is around $440 billion, with $48 billion falling due over the next four months (and another $115 billion next year). Such loans were often granted using company stock as collater-al. Plunging share prices led lenders to issue margin calls – requiring the borrowers to increase their collat-eral. Th e primary case in point is leading oligarch Oleg Deripaska. In April Deripaska agreed to buy 25 percent of Norilsk Nickel from Mikhail Prokhorov for $13 bil-lion, with the help of a $4.5 billion loan. By October the entire market capitalization of Norilsk had fallen below $12 billion (though the company did book fi rst-half profi ts of $2.6 billion on revenue of $8.31 billion). Scrambling to meet his payment schedule, Deripaska sold a $1.4 billion stake in Canadian auto parts mak-er Magna and his 10 percent stake in the German con-struction fi rm Hochtief. Th e combined assets of the 25 top oligarchs on Forbes magazine’s billionaires list are estimated to have shrunk by 62 percent, or $230 bil-lion, between May and October.

ImplicationsTh e fi nancial crisis may actually help Russia’s re-entry into the international community after its ostracism fol-lowing the Georgian war. One unexpected example was Iceland’s appeal to Russia for a 4 billion Euro loan to avoid national bankruptcy. President Dmitry Medvedev has tried to make common cause with the Europeans

in blaming the US for the crisis. In his speech to the World Policy Forum in Evian, France on October 8, he said that the crisis was caused “by the economic ego-ism of certain countries,” and was “a consequence of the unipolar vision of the world and of the desire to be its megaregulator.” He added that “Globalization must be accompanied by an increased role of states as guarantors of successful national development.” At the same time, on October 10 Medvedev argued that

“Europe understands that today no economic problems of a global order can be solved without Russia’s partic-ipation, just as the global nature of the economy pre-cludes Russia from resolving all the problems associat-ed with the crisis in fi nancial markets alone.” Russia was excluded from the G7 fi nance ministers meeting in Washington on October 11 – that failed to come up with a plan – though it was included in the simultane-ous consultations with G20 countries.

What of the long-term prospects? Th e main source of concern in the medium to long term is of course oil. Oil alone accounts for one third of Russian government revenues and 60 percent of export earnings. Th e bud-get is projected out three years ahead, based on a con-servative price estimate of $70 a barrel. However, rising costs of production mean that some of the new fi elds may simply not be profi table at $70 a barrel. Some of those production costs – such as steel pipe – are now coming down thanks to the crisis. But the cost of capi-tal has gone up. Compounding the problem is the fact that sluggish investment over the past decade has led to a slowdown in oil output. In the fi rst half of 2008 Russia saw a decline in oil production of 0.8 percent and volume of oil exports by 5.2 percent. Finance Minister Aleksei Kudrin openly mused that Russian oil output may have reached its historic high (know as “Hubbert’s peak”). Th ese negative trends in oil output volume and price may erode the current account surplus, which was still a healthy $64 billion in the fi rst half of 2008.

Th ere are several reasons for believing that the Untied States is better placed than Russia to ride out the crisis – notwithstanding the fact that the crisis is of the US’s own making. First there is the oil factor – lower prices for oil and other commodities ease the US trade defi cit and bring immediate and visible relief to US consumers. Second, given the role of the dollar as the main global currency, and the credibility of the US government, there has paradoxically been a fl ight of frightened investors into US treasury bonds, and a strengthening of the dollar. In the long term, once the fear subsides, it may be replaced by greed – and a search for higher returns outside the US.

5



Th ird, there is the political dimension. Th e legiti-macy of the US political system is not on the line, and the upcoming wave of elections will produce a new set of leaders. In Russia, however, the political system is os-sifi ed, and discontented citizens have few options oth-er than taking to the streets. Th ere have already been some unconfi rmed reports of panic buying of consum-er staples (“salt and matches”). Th e crisis will clearly in-

crease an already excessively high level of state control of the Russian economy, which bodes ill for effi cien-cy, growth and the battle with corruption. With wild-ly gyrating asset values, and vast fl ows of rescue cash, one can expect a fresh round of turf wars between new-ly-empowered banking corporations on one side and the old stalwarts like Gazprom, Rosneft and Russian Railways on the other.

About the author:Peter Rutland is Professor of Government at Wesleyan University.

Statistics

Financial IndicatorsDiagram 1: Indices of the Russian Stock Exchanges 1995–2008

1,500

2,000

2,500

RTS MICEX

0

500

1,000

3 000 00

2 500 00

3,000.00

RTS MICEX

2 000 00

2,500.00

1 500 00

2,000.00

1 000 00

1,500.00

500 00

1,000.00

0 00

500.00

0.00

Nov 2007

Dec 2007

Jan 2008

Feb 2008

Mar 2008

Apr 2008

May 2008

Jun 2008

Jul 2008

Aug 2008

Sep 2008

Oct 2008

Sources: http://www.rts.ru/ru/index/stat/dailyhistory.html?code=RTSI and http://www.micex.ru/stockindices/data/

6



Diagram 2: Th e Russian Stock Exchange in a World-Wide Comparison (Change since Beginning of the Year in %)

Source: Th e Economist, 16 October 2008

-10%

0%

% % % 9.1% 8.2% -3

1.2%

-30%

-20%

% 9.4%

56.7

%

56.0

%

-54.

8%

-53.

1% -47.

0%

-46.

6%

-45.

6%

-44.

6%

-44.

0% -39 -38

-50%

-40%

-65.

6% -59 -5 -5 -

-70%

-60%

Diagram 3: Russian Interbank Call Money Rates 2008

7.0%

5.8%6.0%

4.3% 4.3% 4.2%

3 7% 3 7%

4.4%

4 0%

5.0%

2.8%

3.7% 3.7%

3.0%

4.0%

2.0%

1.0%

0.0%

January February March April May June July August

Source: Central Bank of the Russian Federation, http://www.cbr.ru/statistics/print.aspx?file=credit_statistics/interest_rates_08.htm&pid=cdps&sid=svodProcStav

Russia

(RTS)

7



Diagram 4: Th e Exchange Rate of the Ruble to US-Dollar and Euro 2005–2008

20 RUR

22 RUR

24 RUR

26 RUR

28 RUR

30 RUR

32 RUR

34 RUR

36 RUR

38 RUR

40 RUR

Sep

2005

Oct

200

5N

ov 2

005

Dec

200

5Ja

n 20

06Fe

b 20

06M

ar 2

006

Apr

200

6M

ay 2

006

Jun

2006

Jul 2

006

Aug

200

6Se

p 20

06O

ct 2

006

Nov

200

6D

ec 2

006

Jan

2007

Feb

2007

Mar

200

7A

pr 2

007

May

200

7Ju

n 20

07Ju

l 200

7A

ug 2

007

Sep

2007

Oct

200

7N

ov 2

007

Dec

200

7Ja

n 20

08Fe

b 20

08M

ar 2

008

Apr

200

8M

ay 2

008

Jun

2008

Jul 2

008

Aug

200

8Se

p 20

08

EUR

USD

Source: Central Bank of the Russian Federation, http://www.cbr.ru/currency_base/dynamics.asp

Diagram 5: Distribution of Assets of the Banking Sector (1 September 2008)

The next 15 largest banks (no. 6 to 20)

22%

5 largest banks42%

Remaining 1105 banks36%

Source: Central Bank of the Russian Federation, http://www.cbr.ru/analytics/bank_system/obs_ex.pdf

8



Diagram 6: Foreign Currency Reserves of the Russian Central Bank and Assets of the State Stabilization Fund (in bln. US dollars)

476.4530.6

500

600

Central Bank

400

500Stabilization Fund

303300

124.5

168.4

156 8189.7

200

18.943 89.1

156.8

0

100

0

2004 2005 2006 2007 2008

600

700

564.8592.3 582.5 562.8

530.6500

300

400

163.2 162.4 174.5 189.7200

0

100

0

June 2008 July 2008 August 2008 September 2008 October 2008

Note: Stabilization Fund: since 2008 Reserve Fund and National Wealth Fund.Sources: Central Bank of Russia, http://www.cbr.ru/Eng/statistics/credit_statistics/print.asp?file=inter_res_08_e.htm#week; Russian Ministry of Finance, http://www.minfin.ru/en/

9



Statistics

World Commodity Prices

Diagram 1: Crude Oil Price 1997–2008 (US dollars, NYMEX Light Sweet Crude, Contract 1)

$0

$20

$40

$60

$80

$100

$120

$140

$160

Jan

1997

May

199

7Se

p 19

97Ja

n 19

98M

ay 1

998

Sep

1998

Jan

1999

May

199

9Se

p 19

99Ja

n 20

00M

ay 2

000

Sep

2000

Jan

2001

May

200

1Se

p 20

01Ja

n 20

02M

ay 2

002

Sep

2002

Jan

2003

May

200

3Se

p 20

03Ja

n 20

04M

ay 2

004

Sep

2004

Jan

2005

May

200

5Se

p 20

05Ja

n 20

06M

ay 2

006

Sep

2006

Jan

2007

May

200

7Se

p 20

07Ja

n 20

08M

ay 2

008

Sep

2008

Diagram 2: World Market Price of Steel 2002–2007 (in US-Dollar/t)

$300

$256

$200

$250

$162$171

$187$201

$150

$200

$114 $121

$162

$100

$50

$0

2002 2003 2004 2005 2006 2007 2008

Source: http://www.eia.doe.gov/emeu/international/prices.html#Crude, 16 October 2008; Source: Reuters News Service as reported in EIA, Weekly Petroleum Status Report, Table 16

Source: Price Indicator WPU101 (Iron and Steel), US Bureau of Labor Statistics, http://www.bls.gov/ro3/ppi_metals.pdf

Note: value for 2008 is for the period January to August.

10



Diagram 3: World Market Prices for Important Commodity Groups 1998 – 2008 (Index, 2005=100)

180

200

Food

140

160FoodMetalsEnergy

120

140

80

100

40

60

20

40

0

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Note: value for 2008 is for SeptemberSource: IMF, http://www.imf.org/external/np/res/commod/table1a.pdf

Diagram 4: World Market Prices for Fossil Fuels 2005–2008

$296

$517

$300

$400

$500

$600Crude oil (West Texas Intermediate $/bbl)

Natural gas (Russian in Germany, $/000 m3)

Coal (Australia, export, $/metric ton)

$56 $66 $72

$86

$213 $293

$51 $53 $70

$161

$0

$100

$200

$300

2005 2006 2007 2008

$600$517

$500

$600

$370

$428

$400

$500

$308$300

$400

$$148 $161$200

$300

$91

$124

$122$148

$100$98

$124 $86$89$0

4th quarter 2007

1st quarter 2008 2nd quarter 2008

October 2008

Source: IMF, http://www.imf.org/external/np/res/commod/table3.pdf

11



$8,000

Aluminum ($/metric ton) Copper ($/metric ton) Nickel ($/100kg)

$6,731

$7,132$6

$7,000

$4,767$5,000

$6,000

$3,676

$ ,

$3,714$4,000

$1,901

$2,573

$2,640$2,229

$2,413$2,000

$3,000

$1,478

$2,413

$1,133$1,000

,

$0

2005 2006 2007 2008

Diagram 5: World Market Prices for Metals 2005–08

$9 000

$7,203$7,818 $8,454

$8,000

$9,000

$ ,

$6 000

$7,000

$4,767$5,000

$6,000

$2,948$2,229

$2,924 $2,898$3,000

$4,000

$2,445 $2,751$2,229

$2,567$1 000

$2,000,

$1,133$0

$1,000

4th quarter 2007

1st quarter 2008

2nd quarter 2008

17 October 2008

Sources: IMF, http://www.imf.org/external/np/res/commod/table3.pdf; for October 2008: http://rohstoffe.wallstreet-online.de/

12



Opinion Poll

Th e Financial Crisis as Perceived by the Russian Population (Late September 2008)

Diagram 1: Do you know, have you heard or are you hearing the following phrase for the fi rst time: “World Financial Crisis”?

I know this phrase30%30%

I have heard it43%

No answer2%

I am hearing it for the first

time25%

Source: FOM, http://bd.fom.ru/report/map/projects/dominant/dom0839/d083921

Diagram 2: Do your family, friends or colleagues discuss the world fi nancial crisis? If yes, do you take part in these discussions?

Family, friends and colleagues discuss it and I

Family, friends and colleagues

discuss it but I do discuss it, and I take part in these

discussions32%

discuss it, but I do not take part in

these discussions14% 32%14%

No answer4%No, family,

friends and ll d tcolleagues do not

discuss the crisis50%

Source: VTsIOM, http://wciom.ru/novosti/press-vypuski/press-vypusk/single/10787.html

13



Diagram 3: Which of the following opinions corresponds most to your own opinion?

The current world financial crisis

The current world financial crisis is a financial crisis

won't last long, the situation will

b t bl

long-term affair, there won't be a quick solution to soon be stable

35%

qthe crisis

36%

No answer29%


Diagram 4: In your opinion, does the current world fi nancial crisis aff ect the Russian economy, or not? If it does aff ect the Russian economy, does it exert a negative or a positive infl uence?

32%

30%

35%

20%

25%

12%

15%15%

20%

4%

8%10% 9%

5%

10%

0%

5%

The crisis does It exerts a It exerts a Difficult to say Difficult to say There is no Do not knowThe crisis does not affect the

Russian economy

It exerts a positive

influence on the Russian

It exerts a negative

influence on the Russian

Difficult to say whether it exerts a

negative or a

Difficult to say whether it affects the

Russian

There is no crisis

Do not know about the crisis

economy economy positive influence

economy or not


14



Diagram 5: Does the world fi nancial crisis aff ect your and your family’s fi nancial situation? If it does aff ect your fi nancial situation, does it aff ect your situation negatively or positively?

Yes, it affects our situation positively

6%No answer

6%20%

Yes, it affects our situation

negatively41%

No, it does not affect ouraffect our situation

32%


Diagram 6: Are the Russian authorities doing something or not doing anything to protect the Russian economy from the eff ects of the world fi nancial crisis? If they are doing something, are they doing enough?

25%25%

30%

20%

25%

16%

12%

15%15%

7%

10%12%

10%

4%5%

0%

They are doing enough

They are not doing enough

They are not doing anything

Difficult to say whether they

d

Difficult to say whether they

d

There is no crisis

Do not know about the crisis

are doing enough or not

are doing anything or not


15



Analysis

After 10 Years of Growth, the Russian Economy May Be Losing SteamVladimir Popov, Moscow

AbstractFrom May to October 2008, Russian stocks, as measured by the RTS index in dollar terms, lost two-thirds of their value. Th e decline was driven partly by the world fi nancial crisis and partly by declining world oil prices, which fell from a maximum of nearly $150 in June to below $100 in October. Between August 1 and October 1, 2008, capital outfl ows drained foreign exchange reserves by approximately $40 billion. Th e sea-sonally adjusted index of industrial output has not grown since May 2008. If global recession pushes fuel pric-es further down, the Russian economic growth of the past 10 years may also come to an end. Is the Russian economy today better suited to survive the coming downturn than it was ten years ago?

Th e Achievement of the Past 10 YearsTh e Russian economy lost 45% of its output during the transformational recession of 1989–1998, income inequalities increased greatly, the crime rate doubled, and life expectancy dropped from 70 to 65 years. Th e short-lived stabilization of 1995–98 (when the ruble was pegged to the dollar and infl ation subsided) ended in the spectacular currency crisis of August 1998 – the ruble then lost over 60% of its value in several months, infl ation spiraled out of control, and crime, suicide and mortality rates increased once more.

However, after the 1998 currency crisis, the Russian economy started to grow. With an average annual growth rate of about 7% in 1999–2007, Russia’s GDP is gradually approaching the pre-recession level of 1989. Real incomes and personal consumption increased even faster – they more than doubled in 1999–2007 – and have already surpassed the pre-recession level of the late 1980s. Th e major push came from the devaluation of the ruble in 1998 and higher world prices for oil and gas in the later years, but the government can at least take credit for not ruining this growth. Infl ation fell from 84% in 1998, when prices jumped after the August 1998 currency crisis and dramatic devaluation of the ruble, to 10–12% in 2004–07 (see Figure 1).

Economic growth and high world fuel prices helped the government collect more tax revenue, so the govern-ment budget moved from defi cit to surplus, and gov-ernment spending as a proportion of GDP increased since 1999 (Figure 2), allowing a partial restoration of the state’s institutional capacity that had been lost in the 1990s. Moreover, high oil and gas prices in the world markets allowed Russia to enjoy large foreign trade surpluses and to accumulate foreign exchange re-serves – they increased from less than $15 billion right after the 1998 currency crisis to nearly $600 billion by August 2008.

True, in comparative perspective, Russian perfor-mance was not that impressive. By 2007, many other former Soviet republics – Armenia, Azerbaijan, Belarus, Estonia, Kazakhstan, Latvia, Lithuania, Turkmenistan, and Uzbekistan, to say nothing of the Central European countries, – had surpassed the pre-recession level of out-put, whereas Russian GDP was still only 99% of the 1989 level. Russian growth rates in 1999–2007 were high (7%), but still lower than other fuel exporters from the former Soviet Union, such as Azerbaijan, Kazakhstan and Turkmenistan (over 10% in 1999–2007). Even some fuel importers, like Armenia and Belarus, showed higher growth rates than Russia (Figure 3).

Russia’s performance on the Human Development Index (HDI), which measures GDP per capita as well as life expectancy and education levels, is still below the USSR level and even below that of Cuba, where the average person lives 77 years, 11 years more than in Russia. China, with a life expectancy of 72 years, is rapidly approaching Russia’s HDI level. Nevertheless, at least there is more stability in Russia today than in the rocky 1990s.

Economic growth and the gradual restoration of the government’s ability to provide public goods led to im-proved conditions in the social sphere – since 2002–03 the murder, suicide and mortality rates started to fall, albeit very slowly, while the birth and marriage rates increased, helping to slow the decline of the Russian population (it fell from 148.6 million in 1993 to be-low 142 million by mid-2008). Th e number of murders reached a peak in 2002 and fell in 2003–08; the suicide rate decreased in 2001–08 (Figure 4); and the mortali-ty rate stabilized and fell in 2004–08 as life expectancy increased slightly (Figure 5). After reaching a 50-year minimum in 1999, the birth rate started to grow. As the marriage rate increased, divorces fell. On the other hand, the over 50% increase in the crime rate in 2002–

16



06 most likely indicates that the police were doing a better job registering crimes reported to them rather than an actual jump in the number of crimes commit-ted because the number of violent crimes (which are always registered more accurately than others) contin-ued to decline.

Remaining WeaknessesUnfortunately, the Russian achievements of recent years are based on weak foundations. Russia was unable to properly cope with the growing stream of petrodollars. In fact, the right question to ask about the recent perfor-mance of the Russian economy is why Russian growth rates lagged behind the growth rates of other countries and were not even higher in 2001–08 despite a near-ly fi vefold increase in average annual oil prices (Figure 6). Th e answer may be disappointing, but is hardly dis-putable – Russia did not manage to use its growing re-source rents in the best possible way.

Th e Russian economy faces several weaknesses. First, the economy is too dependent on the oil and gas exports that account for one-half to two-thirds (depending on world fuel prices) of total Russian exports. Th e prosper-ity of recent years was mostly based on growing world fuel prices. A simple calculation shows the importance of the windfall oil revenues for Russia: Russian GDP at the offi cial exchange rate was about $1 trillion in 2007, whereas the production of the oil and gas sector, which employs less than 1 million workers, is valued at about $500 billion at world oil prices of $80 per barrel. When oil was priced at $15 a barrel in 1999, Russian oil and gas output had a value of less than $100 billion. Th e diff erence, $400 billion, is the fuel windfall profi t that literally fell on Russia from the skies.

Few specialists would call the USSR a resource econ-omy, but Russia’s industrial structure changed consider-ably after the transition to the market began. Basically, the 1990s were the period of rapid deindustrialization and “resourcialization” of the Russian economy and the growth of world fuel prices since 1999 seems to have reinforced this trend. Th e output share from major re-source industries (fuel, energy, metals) in total indus-trial output increased from about 25% to over 50% by the mid-1990s and stayed at this high level thereafter. Partly this shift was the result of changing price ratios (higher price increases in resource industries), but also the real output growth rates were lower in the non-re-source sector. Th e share of mineral products, metals and diamonds in Russian exports increased from 52% in 1990 (USSR) to 67% in 1995 and to 81% in 2007, whereas the share of machinery and equipment in ex-

ports fell from 18% in 1990 (USSR) to 10% in 1995 and to below 6% in 2007. Th e share of R&D spend-ing in GDP amounted to 3.5% in the late 1980s in the USSR, but fell to 1.3% in Russia today (China – 1.3%, US, Korea, Japan – 2–3%, Finland – 4%, Israel – 5%). So today Russia resembles a “normal resource-abun-dant developing country”.

Second, the government failed to channel the stream of petrodollars into repairing the “weakest link” of the national economy – provision of public goods and in-vestment into non-resource industries. Investment and government consumption amounted to about 50% of GDP in the early 1990s, fell to below 30% of GDP in 1999 (right after the 1998 currency crisis), and recov-ered only partially afterwards – to about 40% of GDP in 2007 (Figure 7). Wages and incomes in recent years have been growing systematically faster than produc-tivity.

Tax collection fell dramatically in 1992–98, from over 50% of GDP to about 30%, whereas GDP itself nearly halved. Th e effi ciency of the government in the 1990s deteriorated greatly: low spending levels meant that the state simply could not provide enough public goods. Th e shadow economy, which according to the most generous estimates placed at 10–15% of GDP un-der Brezhnev, grew to 50% of GDP by the mid-1990s. In 1980–85, the Soviet Union ranked in the middle of a list of 54 countries rated according to their level of corruption, with a bureaucracy cleaner than that of Italy, Greece, Portugal, South Korea and practically all the developing countries. In 1996, after the establish-ment of a market economy and the victory of democ-racy, Russia came in 48th in the same 54-country list, between India and Venezuela.

Since 1999, state revenues and expenditures in-creased as a percent of GDP, but by far too little to re-store the provision of public goods to the levels of the late USSR. As a result, provision of education, health-care, public utilities and law and order continue to be dramatically underfi nanced. Instead of using windfall petrodollars to repair the weakest link – state capaci-ty to provide public goods – the government, on the one hand, decreased tax rates, allowing petrodollars to leak into personal incomes, and, on the other, main-tained a budget surplus that expanded to nearly 10% of GDP and was used to fi nance the accumulation of foreign exchange reserves in the Central Bank and the Stabilization Fund.

Th e share of investment in GDP increased margin-ally after 1999, but again, far too little to compensate for the fall of the 1990s. Th is share remains at a level of

17



25% as compared to 36% in 1990–91 (Figure 7), where-as the real volume of investment in 2007 barely reached 40% of the 1990 level (Figure 8). Th ese fi gures mean that Russia was literally “eating up” its capital stock at a time when the stream of petrodollars created better conditions for repairing this stock than ever before.

Th ird, in recent years Russia has suff ered from the “Dutch disease” – a dramatic appreciation of the real ex-change rate of the ruble (Figure 9) that undermined the growth of all industries except for those in the resource sector). Th e Russian Central Bank was doing the right thing by going against the grain and accumulating for-eign exchange reserves to prevent the appreciation of the ruble, but it did not do it fast enough, which resulted in the growing ratio of Russian prices to foreign prices. As a result, Russian non-fuel industries could not compete with foreign producers, so imports in real terms grew faster than anything else in the national economy. As Figures 10 and 11 suggest, the growing trade surplus of recent years is mostly due to constantly increasing fuel prices, whereas the growth of the physical volume of imports (fi vefold in real terms in 1999–2008) great-ly outpaced the growth of exports in real terms.

True, Russia maintains low fuel prices in the domes-tic market via export taxes and direct administrative re-strictions on exports, which create stimuli for the man-ufacturing industries. But such a policy has a high cost since the Russian economy is one of the most energy in-tensive in the world, consuming much more energy per unit of GDP created than other developed countries. It is theoretically possible to switch to a more promising industrial policy – undervaluing the ruble exchange rate and imposing high domestic prices for fuel. Such a policy would stimulate growth for the whole econo-my, and especially in the high tech industries, without the unfortunate energy waste. However, there are vir-tually no resource-rich countries with this combination of policies. Typically, these countries, like Russia, have

exactly the opposite combination – low domestic fuel prices and an overvalued exchange rate, usually com-bined with poor quality institutions.

Finally, income inequalities have increased consider-ably. Th e Gini coeffi cient (which ranges from 0 to 100, with higher numbers representing higher inequalities) increased from 26 in 1986 to 40 in 2000 and 42 in 2007. Th e decile coeffi cient – the ratio of the incomes of the wealthiest 10% of the population to incomes of the poorest 10% – increased from 8 in 1992 to 14 in 2000 to 17 in 2007. But the inequalities at the very top increased much faster: in 1995 there was no per-son in Russia worth over $1 billion, in 2007, according to Forbes, Russia had 53 billionaires, which propelled the country to the second/third place in the world after the US (415) and Germany (55) – Russia had 2 billion-aires fewer than Germany, but they were worth $282 billion ($37 billion more than Germany’s richest). In 2008 the number of billionaires in Russia increased to 86 with a total worth of over $500 billion – one-third of the country’s GDP.

Th ese weaknesses – an overvalued exchange rate, poorly diversifi ed economy and export structure, low spending for investment and public goods, and high in-come inequalities – were partially concealed by high oil and gas prices in 2003–08, but are being revealed now, as oil prices fall. Foreign exchange reserves of over $550 billion (as of early October 2008) provide some room for maneuver and a chance for a “soft landing.” At the current rate of depletion ($20 billion a month), Russia still has more than two years to adjust to the terms-of-trade shock. But even if oil prices do not fall faster, at the end of the day, there is no way to avoid devaluation and real restructuring in order to tackle the root prob-lems rather than their symptoms. Th e paradox, how-ever, is that the need to deal with these weaknesses be-comes more acute with the depletion of the required fi nancial resources.

About the author:Vladimir Popov is a professor at the New Economic School in Moscow.

18



Diagrams

Figure 1: GDP Growth Rates and Infl ation (Right Axis, Log Scale) in Russia, %, 1990–2008

10000

5

10 GDP growth rates

100

1000

0

5

10

100

-10

-5

Inflation (CPI, Dec. to Dec.)

1-15

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 st.)

Inflation (CPI, Dec. to Dec.)

199

199

199

199

199

199

199

199

199

199

200

200

200

200

200

200

200

200

2008

(es

2Figure 2: Government Budget Revenues and Expenditure, % of GDP, EBRD Data

40Expenditure

35Consolidated budget

Expenditure

30Revenues

25

Federal budget

15

20Federal budget

Expenditure

10

15

Revenues

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

Economic and Social Indicators

19



Figure 3: Average Annual GDP Growth Rates in CIS Countries in 2000-07, EBRD Estimates

1416

8101214

468

02

stan

stan

ova

ssia

rgia

aine

arus

stan

stan

enia

stan

ijan

Kyrg

yzs

Uzb

ekis

Mol

do Rus

Geo

r

Ukr

a

Bela

Tajik

is

Kaza

khs

Arm

e

Turk

men

is

Aze

rbai

Figure 4: Crime Rate (Left Scale), Murder Rates And Suicide Rate (Right Scale) per 100,000 Inhabitants

452900 August 1998 currency crisis

35

40

2500

2700

25

302100

2300

15

201700

1900

5

10

15

1100

1300

1500Crime rate

Murder rate (crime statistics)

M d t (d th t ti ti )

0

5

900

1100

85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 st.)

Murder rate (death statistics)

Suicide rate

198

198

19 198

198

199

19 199

199

19 199

199

199

199

199

200

20 200

200

200

200

200

200

2008

(es

20



Figure 5: Mortality Rate (per 1000, Left Scale) and Average Life Expectancy (Years, Right Scale)

70

1669

14

16

year

s

abita

nts

67

68

12

14

pect

ancy

, y

1000

inha Life expectancy

(right scale)

6610

12

ge li

fe e

xp

y ra

te, p

er

65

8

10

Ave

rag

Mor

atlit

y

Mortality(left scale)

63

64

6

8

636

1950

1953

1956

1959

1962

1965

1968

1971

1974

1977

1980

1983

1986

1989

1992

1995

1998

2001

2004

2007

Figure 6: Oil Prices (Brent, $/bbl, Right Scale) and GDP Growth Rates in Russia (%, Left Scale), 1990–2008

80

100

5

10GDP growth

rates

60

80

0

5

20

40

10

-5Oil price

0

20

-15

-10

1990199119921993199419951996199719981999200020012002200320042005200620072008 ((est.)

21



Figure 7: Structure of Russian GDP, %

Net export Private consumption Government consumption Investment

90%

100%

70%

80%

40%

50%

60%

20%

30%

40%

0%

10%

1 2 3 4 5 6 7 8 9 0 1 2 3 4 5 6 7

199

1992

1993

1994

1995

1996

1997

199

199 9

2000

200

200 2

2003

2004

2005

2006

2007

Figure 8: Growth of Real Investment and Total (Private and Government) Consumption, 1991=100%

140

160

120

80

100Consumption

40

60Investment

20

40

0

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

22



Figure 9: Real Eff ective Exchange Rate, Dec. 1995=100% (Left Scale), and Year End Gross Foreign Exchange Reserves, Including Gold, Billion $ (Right Log Scale)

1000

140

160

100100

120REER

1060

80

FOREX 10

20

40FOREX

10

1991

992

993

1994

995

996

1997

998

999

2000

2001

2002

2003

2004

2005

2006

2007

(est.

)

1 1 1 1 1 1 1 1 1 2 2 2 2 2 2 2 2

2008

Figure 10: Goods Export from and Import to Russia, Billion $, Monthly Data

40August 1998 currency crisis

30

35

25

30

ExpImp

15

20

p

10

15

0

5

0 1994 1

8 3 10 5 12 7 2 9 4 11 6 2001 1

8 3 10 5 12 7 2 9 4 11 6 2008 1

23



Figure 11: Real Exports and Imports of Goods and Services, National Accounts Statistics, 1995=100%

310

260

210

EXP IMP

160

EXP IMP

110

60

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Diagrams on pp. 18–23 compiled by Vladimir Popov.

24

russian analytical digest 48/08

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