russian economic crises _15343

7/25/2019 Russian Economic Crises _15343

1/11

2015

15343-MEX

Farrukh Junani

RUSSIAN ECONOMIC CRISIS[ ][Why Russian Currency De-valued? What was the reason behind decline? What measure did Russia

take to Recover? Time Line : Last 7-8 Years]


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RUSSIAN ECONOMIC CRISIS

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There is no trait of modern Russia that has changed more rapidly and unexpectedly than its

economic condition. When Mr. Vladimir Putin became President, Russia was actually bankrupt

as it was owing more money to the International Monetary Fund (IMF) than it had in foreign

currency reserves. Since then, Russia achieved a virtual macroeconomic revolution to the point

where it became one of the largest creditors of U.S. debt in the world. The Ministry of

Economic Trade and Development, in early 2009, published an ambitious plan outlining Russian

economic goals to the year 2020. If these goals were reached, Russia would have become the

largest economy in Europe and the fifth largest in the world following the United States, China,

Japan, and India. However these tendencies are also very relevant when considering the

economic future of the Russian Federation. After a remarkable economic growth, driven by

escalating commodity prices and an inexpensive foreign credit, the Russian economy

demonstrated itself for a very favorable seat for foreign investment. Russian foreign currency

reserves, by July 2008, totaling to more than $588.9 billion and oil prices broke new records byreaching more than $147.27 per barrel, while Russian banks acquired foreign debt amounting

$500 billion. After months of financial volatility following the capriciousness that rocked U.S.

financial markets in 2008, Russia appeared to be surviving the financial storm better than most.

However, as the crisis escalated, it became obvious that Russia would not be exempt from the

economic meltdown. Frozen credit markets, rapidly declining energy prices, and major investor

withdrawal began having an effect on the economy of Russia. Initial reaction from the Kremlin

softened the impact of the crisis on Russia.

The Kremlin hopes to outride the crisis, as it did in 2008-09 when GDP declined by 7.5%. By the

end of 2008, the ruble stood considerably weakened against the dollar and the main Russian

stock index collapsed. As industrial production slowed, unemployment increased and isolated

occurrences of civil unrest began to appear across the country. These factors forced the

government to act by passing a broad economic spur package and injecting more than $200

billion into the economy of Russia. In 2009, oil prices climbed back from the low point they

reached earlier in the year and the global impact of the crisis alleviated. Experts prophesy

Russia will continue to feel the effects of the crisis in the years ahead with economic

contraction of between 7 and 8 percent expected in 2009 and only a modest growth inconsecutive years.

Evaluating by the lack of economic news in Russian media, a crisis has been reached. Just as in

Soviet days, media influenced by the state was not reporting facts, it hides them. The official

picture is dominated by the war in Ukraine and Ukraines economic collapse. While ordinary


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Russians have been busily changing rubles into dollars, buying everything that has not gone up

in price and making contingency plans, whereas television was not mentioning the economy.

In the first two weeks of the previous year, during holidays in Russia, the ruble fell by 17.5%

against the dollar. Inflation doubled, the price of oil, Russias main export, slid below $50 a

barrel GDP diminished by 3% to 5%. Russias credit rating moved inevitably towards junk.

The governments calms lack of strategy. Yet the fall in oil prices to below $50 a barrel costs the

state budget, which was calculated on the basis of $100 a barrel, 3 trillion rubles ($45 billion),

or 20% of planned revenues. Even if pensions and salaries were raised by 5%, double-digit

inflation means that real incomes will decline for the first time since Mr. Vladimir Putin came to

power in 2000.

Then the government was able to stimulate demand by increasing public spending and saving

indebted firms. Russian reserves are lower than they were four years ago and may last only for

six quarters, at best. Regretful, the government has lost credibility. An increase in interest rates

to 17% in December 2014 was intended to protect the ruble, but it has not worked. Russians

have lost confidence in the currency and are beginning to withdraw deposits.

The ruble might have fallen even greater had it not been for the Kremlin influencing exporters

to sell foreign-currency revenues while also warning large firms not to buy. But whatever

liquidity the Central Bank supplies to Russian banks, somehow the money manages its way into

the foreign-currency market, putting more stress on the ruble. Any addition of liquidity may

thus end up not boosting domestic demand but merely mounting capital outflows. The only

way to sustain the ruble is to limit the provision of liquidity to banks; but that in turn would put

banks under pressure. The head of Russias largest state owned bank, is reportedly warning that

a currency crisis could become a massive banking crisis. Russia's crumpling currency and

swiftly rising interest rates have been front page news in the media over the past month. The

yield on ten year bonds is in addition of 16.5% related to 10.2% during the last week in

November 2014. The ruble has fallen to the U.S. dollar from 45 during the end of November

2014 to as low as 77.5 to the U.S. dollar in mid-December 2014.

The depreciation of the ruble, which closely tracks the oil price, has helped Russia cushion its.

When the oil price falls, so does the ruble; thus in ruble terms the amount of money the oil

brings in stays almost the same. But it cannot buy as much as it used to. Russian imports are

quiet high, the total value of imported goods in 2000 was $45 billion, and in 2013 it jumped to

$341 billion, and so a devalued ruble quickly fuels inflation. It is predicted to reach 9% by the

end of this year. A weak ruble also makes servicing foreign debt more expensive. Russias


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sovereign debt is just $57 billion, but its corporate debt is ten times as high. And by the end of

2015 Russian firms will have to repay about $130 billion of foreign debt.

Mr. Vladimir Putin, who came to power in 1998, knows the value of money and believes

enough of it solves everything. He started off sturdily averse to low reserves and high debt, and

built up the countrys reservesaccordingly. In approach to the global financial crisis Russia had

reserves of $570 billion, nearly tierce of GDP. This aided the country well after the crisis hit; the

government spent $220 billion refinancing banks and defending the ruble.

Russias exceptional growth between 1998 and 2008 was essentially imported; it was down to

easy money, resulting from rising oil prices and cheap credit. This drove consumption that was

gratified by imports and an increase in domestic output. The government was busy reallocating

rents rather than reorganization or updating the economy. Private firms and the Kremlin opted

for quick profits rather than durable investments. The governments goal in 2009 was to

understate the political fallout of the financial crisis, than to make the economy more

economical and competitive.

Russias only way out now is to reorganize the economy in order to restore the role of markets.

This transition was made possible, twenty-five years ago, by the collapse of the Soviet Union

and change in the Kremlin. Right now, many are speculating that Russia's current crisis has been

brought about by sanctions imposed over the Ukrainian issue and by falling oil prices since oil

forms a key part of Russia's revenues. In the budget of 2014, it called for total revenues of

$409.6 billion and spending of $419.6 for a deficit of 0.4 percent of GDP or $10 billion, a tinyfraction of the deficits run in most developed nations ($2.5 trillion). According to calculations,

at that point in time, if oil prices of $111.76 per barrel for crude oil (the year-end price in 2013)

and natural gas prices of $4 per mmBTU (million British Thermal Unit). If oil price goes down to

$80 per barrel, Russia would experience its oil and natural gas revenues decline by $120 billion.

In 2007, when oil was $72 a barrel, the economy managed to grow at 8.5%; in 2012 oil at $111

a barrel bought growth of just 3.4%. Between 2010 and 2013, when oil prices were high, the

countrys net outflow of capital was $232 billion20 times what it was between 2004 and 2008.

Russian economists are now discussing, how long before the economy faces falls. Most think it

can stumble on for two years or so. But there is a real chance things could get a lot worse a lot

sooner.


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Russias economy is on the verge of recession. The central bank says it expects the next two

years to bring no growth. Inflation is on the rise. The ruble has lost 30% of its value since 2014.

Banks have been cut off from Western capital markets, and the price of oil has fallen sharply.

Money and people are leaving the country. Russias total foreign debt is just 35% of GDP; it has

a private sector which can be surprisingly agile and flexible and is contributing some growth by

substituting things made at home for imported goods; most importantly, it has a floating

exchange rate that alleviates some of the oil-price shock.

But the oil-backed consumption-led economy which has provided nearly 15 years of growth (it

took a stumble in 2008-09, during the global financial crisis) has hit the buffers. It was already

slowing before the oil price began to fall and adventurism in Ukraine was met by Western

sanctions. Some realize the Ukrainian conflict as a response to the countrys economic

distresses. President Vladimir Putin can no longer buy by enhancing living standards.

The drop in oil prices in 2008-09 was met with a 40% increase in government spending. With

reserves lower, and the government needing to either keep those reserves available for bail-

outs or to risk some big companies and banks going broke, that is not an option this time.

Instead the country faces a period of stagflation. Renewed growth will require new investment

and, most significantly, reforms. What Russia needs most is more competition.

In 2011, despite the high oil price, Russias reserves stopped increasing. Money was spentinstead on raising salaries and pensions and financing the armed forces. The increase in military

spending, up 30% since 2008, was the main reason Alexei Kudrin, Russias prudent finance

minister, chose to resign in 2011.


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At the same time Russian firms went on a borrowing extravaganza. They increased their

foreign-currency debt by some $170 billion in the next two years. Most of this money settled

offshore; only a very small part was invested in the Russian economy.

Mr Vladimir Putins restrictions on food imports, presented as a payback for counter-sanctions,

and a way of preserving currency reserves and stimulating farms as Russia imports half its food.

Food production is now rising somewhere between 6% and 10%, even though from a very low

base. Other imports, such as medicines, are not so quickly substituted.

But as someone who believes that the state must keep checks on everything, including the free

market, Mr Vladimir Putin remains mistrustful of open competition. The Kremlin distributes oil

rent via state owned banks to firms and projects which it selects on the basis of their political

importance and their pro-Putin stance. Most of the contractors for the Sochi Olympics, which

cost Russia a staggering $50 billion, were firms run by Mr Vladimir Putins friends, most of the

money took the form of loans from state owned banks. A number of these loans are unlikely to

be paid back. Such loans are one of the reasons why the central bank has been forced to triple

its provision of liquidity to the banks since the middle of 2013.

Most of this money provided by the central bank ended up on the foreign-exchange market,

putting pressure on the ruble. Since the central bank was known to interfere regularly to keep

the ruble within a currency corridor, the banks could place one-way bets on the devaluation of

the ruble. As a result the Russian financial sector expanded by 11.5% in 2013, although GDP

grew by only 1.3%.

The energy sector, which accounts for 20% of GDP, grew by a meagre 1% on average over the

past decade. The industry has not been cutting costs or developing new production; it has been

busy in being nationalized instead. While the state still had money, it could afford to buy out

private owners.

During the initial years, Mr Vladimir Putin had an easy job satisfying all. Now he will face a

tough decision whether to support the incompetent energy sector and the military-industrial

complex with public money or rely on the more dynamic flexible small and medium-sized

companies to pull Russia out of the crisis.

In 2013 the Russian people were better off than at any previous point in history. Their priorities

switched from economic survival to imperial revival. While people still support Mr Vladimir

Putin and Russias annexation of Crimea, they are starting to calculate the costs.


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Protests driven by economic and also social issues have already started. Even in Moscow where

the mood for protest is low, teachers and doctors have come out onto the streets to protest

against pay cuts and restructuring. Opinion polls show that most people neither support a real

war in Ukraine nor are prepared for their children to fight in it.

An unexpected meeting of the European Union Council on 3rd

March 2014 condemned the clear

violation of Ukrainian sovereignty and territorial integrity by acts of hostility by the Russian

armed forces as well as the approval given by the Federation Council of Russia on 1st

March for

the use of the armed forces on the territory of Ukraine. The EU called on Russia to

instantaneously withdraw its armed forces to the areas of their permanent stationing, in

accordance with the Agreement on the Status and Conditions of the Black Sea Fleet stationing

on the territory of Ukraine of 1997. In a statement of the Heads of State or Government

following an unusual meeting on 6th

March, the EU underlined that a solution to the crisis must

be found through dialogues between the Governments of Ukraine and the Russian Federation,

including through potential mutual mechanisms. Having first suspended mutual talks with the

Russian Federation on visa matters and discussions on the New (EU-Russia) Agreement as well

as preparations for participation in the G8 Summit in Sochi, the EU also set out a second stage

of further measures in the absence of de-escalatory steps and additional far-reaching

consequences for EU-Russia relations in case of further destabilization of the situation in

Ukraine.

In the absence of de-escalatory steps by the Russian Federation, on 17th

March 2014 the EU

enacted the first travel bans and asset freezes against Russian and Ukrainian officials following

Russias illegal occupation of Crimea. The EU strongly condemned Russias absurd violation of

Ukrainian sovereignty and territorial integrity. The EU considers a peaceful solution to the crisis

should be found through negotiations between the Governments of Ukraine and the Russian

Federation, including through potential mutual mechanisms. The EU also remains ready to

reverse its decisions and re-engage with Russia when it starts contributing actively and without

uncertainties to finding a solution to the Ukrainian crisis.

The EU is a vital customer for Russia, making up 49% of its exports and imports, while trade

with China amounts to little more than 10%. Moving exports to Asia requires many billions of

dollars of investment and time, therefore the tiff with Europe will hurt the Russian economy.

The financial and technological embargo will put a lid on any potential increase in fuel

production. Not straight away, since that could destabilize the Eurozone, but year after year

Russias share (currently one third) of the European energy market will diminish. Since this is

the official policy of the EU and the U.S., 2015 could see fuel exports to Europe decline in


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physical terms. All this will exaggerate Russias economic griefs and cause a further weakening

of the ruble, taking into a range of 60-75 to the dollar. Double-digit inflation up to 15-20% is

predictable, and the lending rate will float at around 20-27%. There will be continuing capital

flight and a 20-30% decrease in direct and portfolio investments in the economy. The financial

situation could worsen further as a result of the monetary authorities' uncertain decision to

float the ruble during the currency crisis and attempt to keep it in check through ultra-high

interest rates and a contraction of the ruble money supply. For a weak economy on the edge of

crisis, these measures are oppressive.

As Russia's exporters were hurt by rising prices in 2014, so too were they helped by the ruble

fall. No doubt, Mr Vladimir Putin and his pals in the energy sector were content to let the ruble

find its bottom in time. However, The New York Times reported in December that 81% of

Russians still supported him, nevertheless the public is suspicious of rising prices. In the same

month, shoppers hurried to stores to buy imported goods whose prices they feared would soon

rise. Irrespective of what the poll numbers might suggest, it will become difficult for Mr

Vladimir Putin to sell a strong Russia to the public at large if her citizens can't afford to buy

many of the things to which they have become accustomed.

Mr Vladimir Putin's popularity and ruble policy have also been marked by an altogether mixed

policy from the Central Bank of Russia (CBR). In November, the CBR announced that they had

"Abolished the exchange rate policy mechanism through cancelling the permissible range of the

dual-currency basket". Essentially, the bank gave up trying to protect the ruble by keeping it

within a traded "band" of two prices, and resolved to let the currency find its floor. In

December 2014, however, the CBR increased the key lending rate by 6.5 percentage points to

17 percent in an effort to avoid inflation and strengthen the ruble. In January 2015, they

dropped the rate back to 15 percent "due to the shift in the balance of risks of accelerated

consumer price growth and cooling economy." It seems like the CBR is adjusting policy on the

fly, and the February 2015 ruble rally in the face of such mixed messages is all the more

impressive.

The conditions that led to the fall of the ruble in 2014 will continue to determine its potential

rise in 2015. Crisis in the Ukraine has continued into this year, a February 15th ceasefire has

been altogether ineffective. However, the rise in the ruble this year in the face of continuing

violence in Ukraine and previously enacted sanctions is a positive. It doesn't seem like lasting

peace will come to the region anytime soon, negotiations have stalled, and Western

governments seem reluctant to enact new sanctions. The situation in Ukraine is entrenched,

demonstrating a "new normal" to which the ruble is now accustomed.


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The price of crude oil, on the other hand, can still influence the Russian currency. The rise in

value of the ruble this year has almost mirrored an identical rise in crude. April Brent crude

futures closed above $60 a barrel on February 25, at $61.25, a 15 percent gain since February 1.

Russia's crude oil export intensive economy, long tied to the fate of oil prices, stands to gain

from a rise in such prices and we should expect the ruble to continue to as well.

The ruble (black) and April Brent Crude futures (blue), since February 1, 2015

To say that the currency's fate depends solely on the crisis in Ukraine or on the price of crude

oil is a generalization, at best, however such a claim does probe into some of the countless

factors influencing the value of the ruble and other exchange rates around the world. What's

more, a strong ruble doesn't necessarily imply a strong Russia, and it seems that Mr Vladimir

Putin (together with many of his counterparts around the world) doesn't buy into the fallacy

that a strengthened currency belies a strengthened country.

Today's modern financial markets are complicated and volatile. Currency shocks and negative

interest rates, mixed with crisis in the Eurozone and crude oil swings, seem to mark a new

status quo to which global foreign exchange investors must now adapt. In 2014, these investors

around the world watched as the Russian ruble fell nearly 70 percent over the course of the

year in response to the ongoing Ukrainian political crisis and slumping crude oil prices. The

dollar/ruble pair closed on January 1, 2015 at 68.735 - a significant value considering that the

ruble had roughly traded between 25 and 35 since the late 1990s until 2014. This February,

however, the ruble has rallied 13 percent against the dollar, and the currency has been the

best-performing of the emerging markets' so far this year.

Faced with its own demographic problems and falling oil prices, lack of access to foreign

markets and capital outflows, Russia is unlikely to come out of this crisis soon. Russias

economy cannot be repaired by monetary or fiscal measures. The main reason of Russias

economic disease is the weakening of market forces and stifling of competition, which means
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there is no longer much of a market economy. Corruption and a lack of property rights have

forced the most efficient companies out of the market, strengthening the position of parasitic

and badly managed state firms. Falling oil prices have revealed these defects, not caused them.

What is being ignored is the interconnectedness of the world's economy. As became apparent

during the Asian crisis and the Great Depression, when one part of the world's economy suffers,

the suffering has a strong tendency to spread to the most unexpected quarters. In the current

case, while low oil prices will have a strong impact on Russia's economy, they will also have an

impact on any nation that relies heavily on oil revenues to achieve some semblance of fiscal

balance and any nation that trades with Russia. The global financial downturn has highlighted

serious deficiencies in the economic policies of the Kremlin and the Russian economy itself. The

speed and trajectory of Russia's recovery is highly contingent on the willingness of Russian

policymakers to diversify their revenue streams and make much needed economic and

monetary reforms. This mean that Russia has prepared a crisis for itself.

But there are good news for Russia. Before 2014, the ruble was roughly 1.5 times overvalued.

Devaluation was already on the cards. When in early 2014 the ruble has begun to weaken

against the U.S. dollar and the euro, it has sharply enhanced Russias trade balance. In the first

three quarters of 2014, the country accumulated an unusually large surplus on its trade balance

of more than $150 billion. Although some key sectors of the domestic economy are 50-90%

dependent on imports, it seems that local businesses are trying to take an opportunity to

substitute them.


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CITATIONS Dorning, Mike, and Kutz, Ian. U.S. Wont Ease Sanctions to Stem Russias Economic Crisis :

Bloomberg Business, 2014. Print.

Ellman, Michael and Scharrenborg, Robert. The Russian Economic Crisis: Economic and Political

Weekly Vol. 33, 1999. Print.

How We Know Russia's Economic Crisis Has Officially Arrived. The Economist: News Cred

publisher network. 2015. Print.

Russias Rouble crisis: The Economist, 2014. Web. Spence, Peter. Russian economic crisis: as ithappened: The Telegraph, 2014. Print

fortune.com/2014/12/16/russian-ruble-currency-collapse

www.cfr.org/economic-development/russia-global-economic-crisis/p17844

www.themoscowtimes.com/business/article/russia-s-ruble-battered-by-sanctions-likely-to-sink-

Other Online sources

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