Russia's coming financial crash
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Today, the whole world is being hit by a tremendous financial crisis,
but Russia is facing a perfect storm. The Russian stock market is in
free fall, plummeting by 60 per cent since May 19, a loss of $900
billion. And the plunge is accelerating. As a result, Russia's
economic growth is likely to fall sharply and suddenly.
One problem is that, after a long period of fiscal prudence, Russia's
government has shown extraordinary ineptitude. Russia has enjoyed
average annual economic growth of 7 per cent since 1999. With huge
current-account and budget surpluses, it had accumulated international
reserves of $600 billion by July. Its public debt was almost
eliminated. But the open economy that has bred Russia's economic
success requires the maintenance of sensible policies to succeed.
The initial American financial crisis barely touched Russia, but the
global economic slowdown brought about a decline in oil and other
commodity prices by more than one-third since July, which was a big
blow. All the other hits, however, have been self-inflicted. The
Russian financial crisis is high drama, best described as a tragedy in
five acts.
On July 24, Prime Minister Vladimir Putin initiated the first act by
fiercely attacking, without evidence, the timid owner of the giant
coal and steel company Mechel for price-gouging and tax evasion. In
three days, Mechel's shares lost half their value, triggering the
Russian stock market's decline.
Then, on August 8, Putin launched the second act of this Russian
tragedy, his long-planned attack on Georgia. Shockingly, Russia argued
that it had the right to attack a country that harboured people to
whom it had just issued passports, scaring all countries with Russian
minorities. By recognising the "independence" of the two occupied
territories, Abkhazia and South Ossetia, Russia turned the whole world
against it.
Russia's leaders have earned a reputation for being unreliable,
quixotic, and unpredictable, but markets like trustworthiness,
stability, and predictability. Not surprisingly, foreign investors no
longer favour Putin's Russia.
Within a week of its attack on Georgia, Russia recorded a capital
outflow of $16 billion, which has since increased to $30 billion. This
is a small sum relative to Russia's currency reserves, but plenty for
the underdeveloped banking system, which experienced a severe credit
squeeze.
Putin continues to deny that Russia's financial problems were caused
by his war in Georgia, and it took the Central Bank more than a month
to provide substantial liquidity injections. But it was already too
late, as the liquidity problem had become a matter of solidity.
Overtly, Russian stock valuations look attractive, but by heaping
abuse on foreigners, Putin has scared them away, while Russian
investors have no money at hand. With every statement, Putin erodes
Russia's political risk profile.
As is customary, many Russian businessmen pledged their shares to
borrow money for stock purchases. As the stock market dives, they
receive margin calls and are being forced to sell their shares at ever-
lower prices, causing the stock market's downward spiral to
accelerate. In Soviet fashion, the Moscow stock exchanges closed for
four days in a row in the week of September 15, because stocks plunged
too fast. By denying the problem, the authorities have aggravated the
lack of confidence.
On international financial markets, the war in Georgia has rendered
Russian debt and bonds toxic. Interest rates on Russia's bonds have
risen by 2-3 percentage points, and many Russian creditors no longer
have access to international capital markets.
Turmoil
Russia is just about to enter the third act of this tragedy, a banking
crisis. Numerous medium-sized banks, and some large ones, are set to
go under in the stock-market turmoil. Too many big investors can no
longer meet their margin calls, while borrowing costs have risen
sharply. The recent appreciation of the dollar adds to their hardship.
In the fourth act, the real estate bubble will burst. A reasonable
guess would be that Moscow's astronomic real-estate prices will fall
by at least two-thirds. That will exacerbate the banking crisis.
In the fifth act, investment will seize up. Why continue building when
you can neither finance your investment nor sell real estate? Russian
consumers are already scared and will cut their consumption, causing
aggregate demand to contract.
In the end, real economic growth will come to a screeching halt,
perhaps as early as next year. Other factors are likely to aggravate
the situation. High-level corruption is so rampant that Russia appears
unable to build major public infrastructure projects. Oil and other
commodity prices are likely to fall further, and oil and gas
production have already stagnated. Putin has turned his back on the
World Trade Organisation and is promoting protectionism, which will
also harm growth.
Strangely, the most solid parts of the Russian financial system are
the state budget and the currency reserves, but it is too late for
them to prevent this tragedy. Neither arbitrary state intervention nor
brutality will restore investor confidence.
The villain in this drama is Vladimir Putin, who has thrived on eight
years of rapid growth generated by the market reforms of his
predecessor, Boris Yeltsin. Russia had a good chance to escape this
international financial crisis, but, through his ruthlessness and
ineptitude, Putin has rendered his poor country a prime victim. How
long Russia can afford such an expensive prime minister?
full news
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