Oil and gas in the capitals

	Vol. 230 No. 1
JACQUES SAPIR, CONTRIBUTING EDITOR, FSU

Russia in the global financial storm

Will late 2008-early 2009 in Russia be a winter of discontent? Reading Russian media may give one the distinct feeling of a very serious crisis, with important social and political ramifications.

There is, no doubt, a season of hardship looming ahead for Russia. However, the situation looks much better than in 1998, which is the country’s most important reference point for a crisis. The worst forecast so far published, as usual the International Monetary Fund’s, predicts a 3% growth rate in the Russian economy for 2009. This is much lower than that experienced in 2007 and 2008. Still, there are plenty of governments in advanced economies, from Paris to Washington, that would dream of such a growth rate.

The global financial crisis has hit the Russian economy in two different ways: one real and one psychological. It is quite easy to assess the first aspect because it is grounded in objective and well-known factors. The second aspect is much harder to assess because collective psychology is not an exact science.

The “real” crisis. The real aspect of the shock is threefold. First, Russian banks and large enterprises have suffered from the collapse of international liquidity markets. Local financial markets are quite narrow. The Russian Trading System stock exchange never traded more than US$100 million on a daily basis. Even on the larger Moscow Interbank Currency Exchange, the volume of shares traded has been pretty low. The Russian banking sector is still underdeveloped. This is why large banks and enterprises were raising funds for their own development in international financial markets.

The near disappearance of liquidity in September 2008 was a tremendous shock. The Russian government had to act as a substitute for financial markets, which had dried up. The Russian state bank for external operations - the VEB - has loaned between $70 billion and $100 billion to banks and enterprises. The intended purpose of the VEB, which receives funds directly from the state budget, is actually to refinance foreign liabilities of Russian banks.

Second, there is the sudden price drop of oil and other commodities, which is clearly related to downward speculation following upward speculation. Commodities markets have became highly speculative because future contracts operators, which are extremely remote to the actual commodity market, now use these contracts as financial tools. For one barrel of crude oil actually delivered, there are now up to 18 future contracts.

Third, the recession in the US economy and in the EU is hitting Russia, cratering demand. This is a cause of serious concern in Russia, and would explain the slowdown in the country’s oil and gas industry. Unemployment is on the rise, which will in turn damage internal consumption.

Low oil prices are clearly a financial problem for Russia, but the country’s situation is nevertheless quite strong, even if the expenditures side of the 2009 budget has been computed based on $50/barrel.

During the summer of 2008, Central Bank foreign exchange reserves were nearing $600 billion. Even if $144 billion has been spent between August and the end of November, the rate of reserve depletion has fallen to $3 billion a week. There is clearly no “catastrophe” here in the making.

Furthermore, the country has been running a huge budget surplus since 2000, and the government debt is very small. The Russian financial situation is stronger than that of many developed countries.

All these combined effects impact the Russian industry. Already, the government and the Central Bank have injected more than $278 billion into the economy. The government’s remaining surplus reserves could be engaged this winter. To some extent, Russia is trying to replace declining foreign demand with stronger internal demand. If adequate actions are taken this winter, the 2009 growth rate will certainly be over 3%.

Russia’s economic prospects for 2009 are actually much better than for Europe or the United States, where a true recession is already underway. So why does such a feeling of gloom pervade the Russian media and the commentary of some Western observers?

The psychological crisis. The reason is the psychological aspect of the crisis. The Russian elite have still not recovered from the trauma of 1998. The current capital outflow raises old fears even if, at the current rate, the Central Bank can sustain the drain for 150 weeks, or nearly 3 years. In August 1998, there were less than 3 weeks of reserves left.

Also, the Russian economic elite have become accustomed to the easy lending atmosphere that pervaded international financial markets until early 2008. Some adjustments are needed, and the current situation looks full of uncertainty.

The psychological aspect of the crisis requires psychological actions as well as real ones. A greater government commitment to the economy is needed, if only to reduce uncertainty to manageable levels. The economic program to 2020 that Prime Minister Vladimir Putin announced in late November is a step in the right direction, but more is needed. A comprehensive public investment program linked to increased social expenditures could stabilize expectations and enhance private investments. This is well within the government’s reach. It is possible that some kind of capital controls, targeting mostly speculative movements, could also be of use; disconnecting trade and the national currency from highly unstable exchange markets also makes sense. With US public and private debt ballooning, the value of the US dollar is in doubt for 2009. Currencies will be caught into a cauldron of speculation as a consequence of the massive debt expansion in the US economy as well as in Europe and Asia.

No matter how sound are the economic measures taken, the most important thing is addressing the psychological aspect. When a storm is rising, the crew needs to see the skipper on watch. It is even more important to see him acting. Russia needs a more aggressively interventionist economic policy, not just for “real” reasons, but also for psychological ones. .

.