Download Russian Analytical Digest No 48: Russia and the Financial Crisis

No. 48
17 October 2008
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RUSSIA AND THE FINANCIAL CRISIS
■ ANALYSIS
The Impact of the Global Financial Crisis on Russia
Peter Rutland, Middletown, CT
2
■ STATISTICS
Financial Indicators
5
■ STATISTICS
World Commodity Prices
9
■ OPINION POLL
The Financial Crisis as Perceived by the Russian Population (Late September 2008)
12
■ ANALYSIS
After 10 Years of Growth, the Russian Economy May Be Losing Steam
Vladimir Popov, Moscow
15
■ DIAGRAMS
Economic and Social Indicators
DGO
Research Centre for East
European Studies, Bremen
18
Center for Security
Studies, ETH Zurich
Otto Wolff-Stiftung
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Analysis
The Impact of the Global Financial Crisis on Russia
Peter Rutland, Middletown, CT
Abstract
Russia’s rosy economic development outlook has been thrown into question by the global financial crisis.
The stock market has lost about 60 percent of its value. So far only two banks have fallen into bankruptcy,
but industry has suffered 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
Market
For the first few weeks, as the financial crisis unfolded
in the United States and metastasized around the globe,
the Russian reaction was rather calm. Only a small fraction of Russians, less than two percent of the population, 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 neighborhood. As late as mid-September, a poll reported in
Ekspert magazine found only 42 percent of Russian respondents felt that a crisis was coming.
The government, for its part, was also confident
that the crisis was a “made in the USA” problem. All
Russians remember the devastating impact of the 1998
financial meltdown, which led to a default on foreign
debts, a 75 percent depreciation of the ruble, the collapse of most private banks and the loss of personal savings therein. But the situation in 2008 looked vastly different. Sitting on $560 billion of hard currency reserves,
with low foreign debts and a huge current account surplus, the Russian Central Bank was confident 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 secure 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. The future looked bright.
However, while Russia was insulated from the impact of the US financial 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. The 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 market by 13.1 percent. Then 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 fight for control over
TNK-BP; the outbreak of fighting in Georgia on August
8; and a tiff over the steel-producer Mechel. (On July
24 Putin casually accused the company of price-gouging, causing its stock to fall by one third.)
But the main factor was the plunging price of commodities – 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. (These are
prices for West Texas Intermediate.) Metals prices have
also fallen considerably since the start of the year. The
last time the world oil price fell by half was 1998, and
prior to that 1986 – both of which triggered devastating 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. The Federal Financial Markets Service (FSFR)
introduced a blanket ban on short-selling – one of the
few countries to introduce a blanket ban (most limited the prohibition to financial 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. The
Central Bank and finance ministry would intervene
to buy shares in Russian companies and strengthen
bank balance sheets. The Central Bank and National
Welfare Fund would loan the equivalent of $36.1 billion to Sberbank, VTB (formerly Vneshtorgbank) and
VEB (Development Bank) at 7 percent interest for five
years (later raised to ten). They in turn were to lend the
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money to banks and companies. Ekspert has estimated the total value of the rescue package at 3 trillion rubles, or 10 percent of GDP.
The 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 barrel, 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. The
bill also raises the state guarantee on personal bank deposits to cover the first 700,000 rubles ($26,800, up
from 400,000). There is no sign of organized political opposition to the government’s actions, as even the
Communist Party has refrained from criticism.
The bailout deal included an immediate cut in oil
export tariffs, worth 140 billion rubles for oil producers. Still, on September 24 four Russian oil companies sent a letter to Putin, complaining that they hold
$80 billion in foreign loans and asking for low-interest loans from the state to enable them to continue investment projects. It’s hard to feel sorry for the oil barons, though. On October 10 TNK-BP paid out all of
its first half year’s profits, some $2 billion, in dividends.
Surgutneftgaz, flush 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). The total value of all Russian oil companies on October 6 was $128 billion – while Brazil’s
Petrobras alone was valued at $135 billion.
The 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.
The 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 impact
So far only two banks have fallen into bankruptcy. Svyaz-bank was taken over by the state-owned
Vneshekonombank, and after several weeks of rumors
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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 KITFinans, 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. There is clearly a danger 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 letter 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 country’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 VTB24, 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.
The industrial sectors affected by the crisis can be
divided into two groups. First, there are those suffering
from the slump in global commodity markets. Second,
there are those who were exposed to the credit crunch
– notably, construction and retailing.
The metals sector’s output is expected to contract by
20 percent during the fourth quarter, and some companies (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 longer profitable and Russian customers cannot afford
to pay. The market capitalization of the top six firms
(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 firms 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 immediately 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 firms with a debt/cashflow (EBITDA)
ratio of three to one or less. Although a slump in con-
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struction and retailing will affect GDP growth, labor
economist Vladimir Gimpelson argues that adjustment
will come through wage cuts and not layoffs, so it is unlikely that we will see an increase in the current reported unemployment rate of around 6 percent.
Among manufacturing industries, the hardest hit
is likely to be auto sales – a big ticket item for consumers. 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 experience a decline in sales, in part because they have been
discounting heavily. Some auto producers have cut
hours or temporarily closed production lines, including truck manufacturer Kamaz, hit by the construction
freeze. Daimler may be having second thoughts about
its plan to buy 42 percent of Kamaz.
Even firms with substantial cash flows were not immune if they had borrowed heavily to finance acquisitions. For example, Gazprom needs 400 million euros to buy Serbia’s NIS; Lukoil $2.1 billion to buy the
Italian ISAB refinery and $555 million for the Turkish
distribution company Akret. The 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 collateral. Plunging share prices led lenders to issue margin
calls – requiring the borrowers to increase their collateral. The 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 billion, 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 firsthalf profits 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 maker Magna and his 10 percent stake in the German construction firm Hochtief. The combined assets of the 25
top oligarchs on Forbes magazine’s billionaires list are
estimated to have shrunk by 62 percent, or $230 billion, between May and October.
Implications
The financial crisis may actually help Russia’s re-entry
into the international community after its ostracism following 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
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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 egoism 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 participation, just as the global nature of the economy precludes Russia from resolving all the problems associated with the crisis in financial markets alone.” Russia
was excluded from the G7 finance ministers meeting
in Washington on October 11 – that failed to come up
with a plan – though it was included in the simultaneous consultations with G20 countries.
What of the long-term prospects? The 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. The budget is projected out three years ahead, based on a conservative price estimate of $70 a barrel. However, rising
costs of production mean that some of the new fields
may simply not be profitable 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 capital 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 first 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”). These negative trends in oil output volume and
price may erode the current account surplus, which was
still a healthy $64 billion in the first half of 2008.
There 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 deficit 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 flight
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.
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Third, there is the political dimension. The legitimacy 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 ossified, and discontented citizens have few options other than taking to the streets. There have already been
some unconfirmed reports of panic buying of consumer staples (“salt and matches”). The crisis will clearly in-
crease an already excessively high level of state control
of the Russian economy, which bodes ill for efficiency, growth and the battle with corruption. With wildly gyrating asset values, and vast flows of rescue cash,
one can expect a fresh round of turf wars between newly-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 Indicators
Diagram 1: Indices of the Russian Stock Exchanges 1995–2008
2,500
2,000
RTS
MICEX
1,500
1,000
500
0
3 000 00
3,000.00
RTS
MICEX
2,500.00
2 500 00
2 000 00
2,000.00
1 500 00
1,500.00
1 000 00
1,000.00
500 00
500.00
Sources: http://www.rts.ru/
ru/index/stat/dailyhistory.
html?code=RTSI and http://www.
micex.ru/stockindices/data/
0 00
0.00
Nov Dec Jan Feb Mar Apr May Jun
Jul
Aug Sep Oct
2007 2007 2008 2008 2008 2008 2008 2008 2008 2008 2008 2008
5
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R
us
si
a
(R
TS
)
Diagram 2: The Russian Stock Exchange in a World-Wide Comparison (Change since
Beginning of the Year in %)
0%
-60%
-38
8.2%
-39
9.1%
-44.0%
%
%
-45.6%
-46.6%
-47.0%
-53.1%
--54.8%
-5
56.7%
-59
9.4%
-50%
-65.6%
%
-40%
-5
56.0%
-30%
-44.6%
%
-20%
-31.2%
-10%
-70%
Source: The Economist, 16 October 2008
Diagram 3: Russian Interbank Call Money Rates 2008
7.0%
5.8%
6.0%
5.0%
4.3%
4.3%
4 0%
4.0%
3.0%
4.4%
4.2%
3 7%
3.7%
3 7%
3.7%
May
June
2.8%
2.0%
1.0%
0.0%
January
February
March
April
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
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Diagram 4: The Exchange Rate of the Ruble to US-Dollar and Euro 2005–2008
40 RUR
38 RUR
36 RUR
34 RUR
32 RUR
EUR
30 RUR
USD
28 RUR
26 RUR
24 RUR
22 RUR
Sep 2005
Oct 2005
Nov 2005
Dec 2005
Jan 2006
Feb 2006
Mar 2006
Apr 2006
May 2006
Jun 2006
Jul 2006
Aug 2006
Sep 2006
Oct 2006
Nov 2006
Dec 2006
Jan 2007
Feb 2007
Mar 2007
Apr 2007
May 2007
Jun 2007
Jul 2007
Aug 2007
Sep 2007
Oct 2007
Nov 2007
Dec 2007
Jan 2008
Feb 2008
Mar 2008
Apr 2008
May 2008
Jun 2008
Jul 2008
Aug 2008
Sep 2008
20 RUR
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 banks
42%
Remaining 1105
banks
36%
Source: Central Bank of the Russian Federation, http://www.cbr.ru/analytics/bank_system/obs_ex.pdf
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Diagram 6: Foreign Currency Reserves of the Russian Central Bank and Assets of the State
Stabilization Fund (in bln. US dollars)
600
530.6
476.4
Central Bank
500
Stabilization Fund
400
303
300
168.4
200
189.7
124.5
156.8
156 8
100
18.9
43
89.1
2005
2006
0
2004
2007
2008
700
600
500
564.8
592.3
582.5
562.8
530.6
400
300
200
163.2
162.4
174.5
189.7
June 2008
July 2008
August 2008
September 2008
100
0
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/
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Statistics
World Commodity Prices
Diagram 1: Crude Oil Price 1997–2008 (US dollars, NYMEX Light Sweet Crude, Contract 1)
$160
$140
$120
$100
$80
$60
$40
$20
Jan 1997
May 1997
Sep 1997
Jan 1998
May 1998
Sep 1998
Jan 1999
May 1999
Sep 1999
Jan 2000
May 2000
Sep 2000
Jan 2001
May 2001
Sep 2001
Jan 2002
May 2002
Sep 2002
Jan 2003
May 2003
Sep 2003
Jan 2004
May 2004
Sep 2004
Jan 2005
May 2005
Sep 2005
Jan 2006
May 2006
Sep 2006
Jan 2007
May 2007
Sep 2007
Jan 2008
May 2008
Sep 2008
$0
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
Diagram 2: World Market Price of Steel 2002–2007 (in US-Dollar/t)
$300
$250
$256
$200
$201
$187
$171
$150
$100
$162
$114
$121
2002
2003
$50
$0
2004
2005
2006
2007
2008
Note: value for 2008 is for the period January to August.
Source: Price Indicator WPU101 (Iron and Steel), US Bureau of Labor Statistics, http://www.bls.gov/ro3/ppi_metals.pdf
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Diagram 3: World Market Prices for Important Commodity Groups 1998 – 2008
(Index, 2005=100)
200
180
Food
Metals
Energy
160
140
120
100
80
60
40
20
0
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
Note: value for 2008 is for September
Source: IMF, http://www.imf.org/external/np/res/commod/table1a.pdf
Diagram 4: World Market Prices for Fossil Fuels 2005–2008
$600
Crude oil (West Texas Intermediate $/bbl)
$500
$400
$517
Natural gas (Russian in Germany, $/000 m3)
Coal (Australia, export, $/metric ton)
$296
$300
$213
$293
$200
$100
$0
$161
$56
$51
2005
$66
$72
$53
$70
2006
2007
$86
2008
$600
$517
$500
$428
$370
$400
$308
$300
$200
$91
$122
$
$100
$89
$98
4th quarter
2007
1st quarter 2008
$148
$124
$161
$86
$0
Source: IMF, http://www.imf.org/external/np/
res/commod/table3.pdf
2nd quarter
2008
October 2008
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Diagram 5: World Market Prices for Metals 2005–08
Aluminum ($/metric ton)
Copper ($/metric ton)
Nickel ($/100kg)
$8,000
$6,731
$7,000
$7,132
$6
$6,000
$5,000
$4,000
$4,767
$
,
$3,714
$3,676
$2,573
$3,000
$2,229
$1,901
$2,000
,
$1,000
$2,640
$2,413
$1,478
$1,133
$0
2005
2006
2007
$9 000
$9,000
$8,000
2008
$7,818
$8,454
$7,203
$
,
$7,000
$6 000
$6,000
$4,767
$5,000
$4,000
$2,924
$3,000
$2,000
$2,898
$2,948
$2,229
$2,445
$2,751
$2,567
,
$1 000
$1,000
$1,133
$0
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/
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Opinion Poll
The 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 first
time: “World Financial Crisis”?
I know this
phrase
30%
I have heard it
43%
No answer
2%
I am hearing it
for the first
time
25%
Source: FOM, http://bd.fom.ru/report/map/projects/dominant/dom0839/d083921
Diagram 2: Do your family, friends or colleagues discuss the world financial crisis? If yes, do
you take part in these discussions?
Family, friends
and colleagues
discuss itit, but I do
not take part in
these discussions
14%
No, family,
friends and
colleagues
ll
d
do nott
discuss the crisis
50%
Family, friends
and colleagues
discuss itit, and I
take part in these
discussions
32%
No answer
4%
Source: VTsIOM, http://wciom.ru/novosti/press-vypuski/press-vypusk/single/10787.html
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Diagram 3: Which of the following opinions corresponds most to your own opinion?
The current world
financial crisis is a
long-term affair,
there won't be a
quick solution to
q
the crisis
36%
The current world
financial crisis
won't last long,
the situation will
soon be
b stable
t bl
35%
No answer
29%
Source: VTsIOM, http://wciom.ru/novosti/press-vypuski/press-vypusk/single/10787.html
Diagram 4: In your opinion, does the current world financial crisis affect the Russian economy,
or not? If it does affect the Russian economy, does it exert a negative or a positive influence?
35%
32%
30%
25%
20%
15%
15%
12%
10%
10%
5%
8%
9%
4%
0%
The crisis does It exerts a
not affect the
positive
Russian
influence on
economy
the Russian
economy
It exerts a
negative
influence on
the Russian
economy
Difficult to say Difficult to say There is no
whether it
whether it
crisis
exerts a
affects the
negative or a
Russian
positive
economy or not
influence
Do not know
about the crisis
Source: FOM, http://bd.fom.ru/report/map/projects/dominant/dom0839/d083921
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Diagram 5: Does the world financial crisis affect your and your family’s financial situation? If it
does affect your financial situation, does it affect your situation negatively or positively?
Yes, it affects our
situation positively
6%
No answer
20%
Yes, it affects our
situation
negatively
41%
No, it does not
affect our
situation
32%
Source: VTsIOM, http://wciom.ru/novosti/press-vypuski/press-vypusk/single/10787.html
Diagram 6: Are the Russian authorities doing something or not doing anything to protect the
Russian economy from the effects of the world financial crisis? If they are doing something, are
they doing enough?
30%
25%
25%
20%
16%
15%
15%
12%
10%
10%
7%
5%
4%
0%
They are doing They are not They are not Difficult to say Difficult to say
enough
doing enough doing anything whether they whether they
are doing
d
are doing
d
enough or not anything or not
There is no
crisis
Do not know
about the crisis
Source: FOM, http://bd.fom.ru/report/map/projects/dominant/dom0839/d083921
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Analysis
After 10 Years of Growth, the Russian Economy May Be Losing Steam
Vladimir Popov, Moscow
Abstract
From May to October 2008, Russian stocks, as measured by the RTS index in dollar terms, lost two-thirds
of their value. The decline was driven partly by the world financial 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 outflows drained foreign exchange reserves by approximately $40 billion. The seasonally adjusted index of industrial output has not grown since May 2008. If global recession pushes fuel prices 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?
The Achievement of the Past 10 Years
The 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. The
short-lived stabilization of 1995–98 (when the ruble
was pegged to the dollar and inflation subsided) ended
in the spectacular currency crisis of August 1998 – the
ruble then lost over 60% of its value in several months,
inflation 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. The 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. Inflation 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 government budget moved from deficit to surplus, and government 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 reserves – 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 performance 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 output, 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 improved 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 below 142 million by mid-2008). The number of murders
reached a peak in 2002 and fell in 2003–08; the suicide
rate decreased in 2001–08 (Figure 4); and the mortality 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–
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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 committed because the number of violent crimes (which are
always registered more accurately than others) continued to decline.
Remaining Weaknesses
Unfortunately, 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 performance 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 nearly fivefold increase in average annual oil prices (Figure
6). The answer may be disappointing, but is hardly disputable – Russia did not manage to use its growing resource rents in the best possible way.
The 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. The prosperity 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 official 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.
The difference, $400 billion, is the fuel windfall profit
that literally fell on Russia from the skies.
Few specialists would call the USSR a resource economy, but Russia’s industrial structure changed considerably 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. The output share from major resource industries (fuel, energy, metals) in total industrial 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-resource sector. The 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-
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ports fell from 18% in 1990 (USSR) to 10% in 1995
and to below 6% in 2007. The share of R&D spending 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-abundant 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 investment 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 recovered only partially afterwards – to about 40% of GDP
in 2007 (Figure 7). Wages and incomes in recent years
have been growing systematically faster than productivity.
Tax collection fell dramatically in 1992–98, from
over 50% of GDP to about 30%, whereas GDP itself
nearly halved. The efficiency of the government in the
1990s deteriorated greatly: low spending levels meant
that the state simply could not provide enough public
goods. The shadow economy, which according to the
most generous estimates placed at 10–15% of GDP under 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 establishment of a market economy and the victory of democracy, Russia came in 48th in the same 54-country list,
between India and Venezuela.
Since 1999, state revenues and expenditures increased as a percent of GDP, but by far too little to restore the provision of public goods to the levels of the
late USSR. As a result, provision of education, healthcare, public utilities and law and order continue to be
dramatically underfinanced. Instead of using windfall
petrodollars to repair the weakest link – state capacity to provide public goods – the government, on the
one hand, decreased tax rates, allowing petrodollars to
leak into personal incomes, and, on the other, maintained a budget surplus that expanded to nearly 10%
of GDP and was used to finance the accumulation of
foreign exchange reserves in the Central Bank and the
Stabilization Fund.
The share of investment in GDP increased marginally after 1999, but again, far too little to compensate
for the fall of the 1990s. This share remains at a level of
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25% as compared to 36% in 1990–91 (Figure 7), whereas the real volume of investment in 2007 barely reached
40% of the 1990 level (Figure 8). These figures 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.
Third, in recent years Russia has suffered from the
“Dutch disease” – a dramatic appreciation of the real exchange rate of the ruble (Figure 9) that undermined the
growth of all industries except for those in the resource
sector). The Russian Central Bank was doing the right
thing by going against the grain and accumulating foreign 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 (fivefold in real terms in 1999–2008) greatly outpaced the growth of exports in real terms.
True, Russia maintains low fuel prices in the domestic market via export taxes and direct administrative restrictions on exports, which create stimuli for the manufacturing industries. But such a policy has a high cost
since the Russian economy is one of the most energy intensive 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 economy, and especially in the high tech industries, without
the unfortunate energy waste. However, there are virtually no resource-rich countries with this combination
of policies. Typically, these countries, like Russia, have
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exactly the opposite combination – low domestic fuel
prices and an overvalued exchange rate, usually combined with poor quality institutions.
Finally, income inequalities have increased considerably. The Gini coefficient (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. The decile coefficient – 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 person 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 billionaires 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.
These weaknesses – an overvalued exchange rate,
poorly diversified economy and export structure, low
spending for investment and public goods, and high income 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-oftrade 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 problems rather than their symptoms. The paradox, however, is that the need to deal with these weaknesses becomes more acute with the depletion of the required
financial resources.
About the author:
Vladimir Popov is a professor at the New Economic School in Moscow.
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Diagrams
Economic and Social Indicators
Figure 1: GDP Growth Rates and Inflation (Right Axis, Log Scale) in Russia, %, 1990–2008
10
10000
GDP growth rates
5
1000
0
100
-5
-10
Inflation (CPI, Dec. to Dec.)
2008 (esst.)
2
200
07
200
06
200
05
200
04
200
03
200
02
200
01
200
00
199
99
199
98
199
97
199
96
199
95
199
94
199
93
199
92
199
91
1
199
90
-15
10
Figure 2: Government Budget Revenues and Expenditure, % of GDP, EBRD Data
40
Expenditure
Consolidated budget
35
30
Revenues
25
20
Federal budget
Expenditure
15
Revenues
10
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
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Figure 3: Average Annual GDP Growth Rates in CIS Countries in 2000-07, EBRD Estimates
Azerbaiijan
Turkmenisstan
Armeenia
Kazakhsstan
Tajikisstan
Bela
arus
Ukra
aine
Georrgia
Russsia
Moldo
ova
Kyrgyzsstan
Uzbekisstan
16
14
12
10
8
6
4
2
0
Figure 4: Crime Rate (Left Scale), Murder Rates And Suicide Rate (Right Scale) per 100,000
Inhabitants
August 1998 currency crisis
2900
45
2700
40
2500
35
2300
30
2100
25
1900
20
1700
15
1500
Crime rate
1300
Murder rate (crime statistics)
1100
M d rate
Murder
t (d
(death
th statistics)
t ti ti )
10
5
2008 (esst.)
200
07
200
06
200
05
0
200
04
200
03
02
200
200
00
199
99
199
98
199
97
199
96
95
199
1994
199
93
199
92
1991
199
90
198
89
88
198
1987
198
86
198
85
2001
Suicide rate
900
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Figure 5: Mortality Rate (per 1000, Left Scale) and Average Life Expectancy (Years, Right
Scale)
70
69
14
68
Life expectancy
(right scale)
67
12
66
10
65
Mortality
(left scale)
8
Averag
ge life exp
pectancy, y
years
Moratlity
y rate, per 1000 inha
abitants
16
64
6
63
2007
2004
2001
1998
1995
1992
1989
1986
1983
1980
1977
1974
1971
1968
1965
1962
1959
1956
1953
1950
Figure 6: Oil Prices (Brent, $/bbl, Right Scale) and GDP Growth Rates in Russia (%, Left
Scale), 1990–2008
10
5
100
GDP growth
rates
80
0
60
-5
40
Oil price
10
-10
20
-15
0
2008 (est.)
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
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Figure 7: Structure of Russian GDP, %
Net export
Private consumption
Government consumption
Investment
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
2007
7
2006
6
2005
5
2004
4
2003
3
2002
2
2001
2000
0
1999
9
1998
1997
7
1996
6
1995
5
1994
4
1993
3
2
1992
1991
0%
Figure 8: Growth of Real Investment and Total (Private and Government) Consumption,
1991=100%
160
140
120
100
Consumption
80
60
Investment
40
20
0
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
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Figure 9: Real Effective Exchange Rate, Dec. 1995=100% (Left Scale), and Year End Gross
Foreign Exchange Reserves, Including Gold, Billion $ (Right Log Scale)
160
1000
140
120
REER
100
100
80
60
10
FOREX
40
20
2008 (est.)
2007
2
2006
2
2005
2
2004
2
2003
2
2002
2
2001
2
2000
2
1999
1998
1997
1
1996
1995
1
1994
1992
1993
1
1991
1
0
Figure 10: Goods Export from and Import to Russia, Billion $, Monthly Data
40
August 1998 currency crisis
35
30
Exp
Imp
p
25
20
15
10
5
0
2008 1
6
11
4
9
2
7
12
5
10
3
8
2001 1
6
11
4
9
2
7
12
5
10
3
8
1994 1
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Figure 11: Real Exports and Imports of Goods and Services, National Accounts Statistics,
1995=100%
310
260
210
EXP
IMP
160
110
60
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
Diagrams on pp. 18–23 compiled by Vladimir Popov.
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