As EU crisis unfolds, Russia bracing for the worst
Russia’s most important neighbor is facing some dark times. The last time a Western super economy went belly up, Russia nearly collapsed. And while it’s collapses are better managed than they were during the 1991 break up of the Soviet Union, memories of the 2008 crisis echoes like a wailing ghost between the old Stalin inspired buildings of old Moscow and the new sky scrapers going up across the Moscow River.
Russia has learned to be more cautious. It’s fiscal balances depend mostly on the price of hydrocarbons — oil and gas; a problem for the country because they have no control over the direction of global oil prices. A weaker Europe and U.S. means lower oil prices. That tends to put an end to Russia’s current budget surplus.
“We’ve cut our global growth forecast to just 4% and expect only 2% growth in the advanced economies. They’ll be engaging in fiscal austerity for many years to come,” says Elvira Nabiullina, Russia’s Minister of Economic Development.
She may need to cut her country’s official forecast even more. As it stands, it’s not all that conservative. Afterall, on Sept. 20, the International Monetary Fund also forecast global growth of 4%.
From May 2008 to the lows of February 24, 2009, the Market Vectors Russia (RSX) exchange traded fund declined by more than 80%, making it the worst performing big emerging market around. This year, between the Aug. 5 credit downgrade of the U.S. by Standard & Poor’s to the lows of Sept. 30, 2011, Russian equities are down just over 35%.
Could things get worse? Of course they can. But Russia seems to be fairly inoculated at this point. It has over $540 billion foreign exchange reserves. The country’s debt to GDP ratio doesn’t exceed 10% while the average in the advanced economies is 90%. Less debt, gives Russia more breathing room when markets turn against them. If oil goes to $90, Russia’s GDP will likely grow by 2.2% next year instead of around 4% this year, says Nabiullina. Brent crude oil prices are already below $90, closing at $84.23 on Thursday. If oil prices average below $60, as it did in 2008, Russia could fall into a mild recession.
“Oil at $80 would probably mean a much lower exchange rate, perhaps of USD/RUB of around 36 to one,” says Alexey Moiseev, a macroeconomist at VTB Capital in Moscow. A weaker rouble might be a boost to local industry who can better compete with products on the international market. A weaker rouble would also mean less imports, so Russian’s would have to buy the Russian made equivalent.
The government taxes away most of oil companies’ revenues at high oil prices, which deprives the private sector of most incremental revenues. But this also means that when oil prices fall, the biggest loser is also the government. So for a relatively short period of 18-24 months, the government will substitute revenue fall-out from weak oil prices with their reserve fund cash. But if oil prices stayed low for longer, there will have to be a fiscal adjustment, maybe cutting back on expenditures by as much as 3% of GDP. As it is now, the reserve fund is nearly spent. It’s down to just $26 billion after the government burned through it in 2008 and 2009, cutting it from its January 2009 peak of $186 billion.
“We have room for stimulus support in that case,” says Nabiullina. “We can support the banking sector. We will support society and the most vulnerable people in our society in that instance.”
As for the corporate sector, the Central Bank of Russia has said that the deleveraging of 2009-10 has made Russia companies more resilient to external shocks that trigger higher foreign borrowing costs. A weaker rouble, for instances, means companies with U.S. dollar and Euro debt have to use more of those roubles to convert into the foreign currency to pay down debts. Risk aversion also adds to interest rate costs on short term bank loans, and with Russia considered a risk investment, loan costs inevitably rise. Experts stress that Russian companies remain less sensitive to forex shocks — their dollar debt is just 20% of total debt, according to Nabiullina. The banking sector is no longer taking on unhedged risk en masse like it was in 2008. They have a strong cash position, Central Bank officials said during the Russia Calling conference in Moscow last week. Outside of corporate Russia, household debt is just 15% of total income. As much as Russia may like to consider itself a Western nation, the economic culture of its people are not Western. Right now, that’s a good thing.
“Comparing 2008 Russia to 2011 Russia is like comparing a dolphin to a shark. They may look alike from the surface, but one is a mammal and the other one is a fish,” says Alexey Ulyukaev, First Deputy Chairman of the Bank of Russia. Ulyukaev is in charge of the country’s monetary policy.
“The problem in 2011 is different than the problems in 2008 because of prudent fiscal and monetary plans. Russia is not in a crisis and I don’t think we will have a recession. But we will definitely see a correction in world growth that will affect Russia. We have to live with less certainty and lower rates of economic growth. We won’t be able to produce economic growth of 5% here like we did prior to 2008. I don’t see this as a lost decade. I see it as opening up the opportunity for new technical and political reforms which will be fundamental for the future,” Ulyukaev says.
He expects the country to end the year with a budget surplus of around 2% of GDP. Balance of payments will also have a minor surplus this year, with foreign exchange reserves ending the year over the current level of $516 billion, already the second largest emerging market forex reserves after China. Money supply growth is seen rising by 20% and credit growth for the nation’s banking sector is seen rising between 15% and 16% this year. Inflation is coming down, too. It is expected to end the year at 7%, and come down to 4% to 5% within the next three years, Ulyukaev says. That would put Russian inflation on par with the advanced economies, only Russia would be in better shape fiscally.
It seems that Russia has become less vulnerable to financial and currency shocks and that it is still highly exposed in the event of an adverse oil price shock, writes Tatiana Orlova, a Russian strategist at Nomura in London. In 2008-09, the country’s ample cash and fiscal cushions were used to cope with the crisis. This time around, it seems that the more flexible — and much weaker rouble — will be used as a main shock absorber if the world crisis deepens, and should provide a mechanism for a rapid balance-of-payments adjustment.
“The range of tools developed by the Central Bank and the Finance Ministry during 2008-09 should help alleviate any liquidity shortages,” Orlova says. However, should the global gloom lead to a drop in world commodity prices in the months ahead, market bearishness towards Russian assets should justifiably rise, driving equities into deeper into a hole they have been stuck in all year.