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01.02.08
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Will Russia’s Economic Resurgence Be Disrupted By A U.S. Recession?
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Introduced by Vladimir Frolov
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Contributors: Stephen Blank, Ethan S. Burger, Vlad Ivanenko, Andrei Liakhov
On Jan. 21 and Jan. 22, 2008 Russia’s stock market plunged a combined 14 percent, following the global financial meltdown that tanked stock prices from Japan to Frankfurt.
Global investors are spooked by what now appears to be a near-certain economic slowdown in the United States, bordering on a full-blown recession. Throughout 2007, the U.S. markets struggled under a load of bad news from the banking and housing sectors, which have been seriously hit by a wave of defaults in the sub-prime mortgage market. Venerable U.S. financial institutions like CitiGroup and Merryll Lynch had to write off billions of dollars in bad loans and defaulted securities.
The problem was aptly summed up by Paul Krugman of the New York Times: “for the last decade, Americans have been making a living by selling each other houses bought on borrowed Chinese money.” One day this economic miracle was bound to fizzle out.
The biggest question right now is not whether the U.S. economy is heading for a recession – it is. The $64 million question is whether it will drag emerging markets – like Russia – into a recession as well.
Most economists and market watchers in Moscow continue to say that last week’s financial meltdown had nothing to do with Russia. The country’s financial situation is sound; the economy is growing mostly through the rapid expansion in domestic demand and substantial private and government investments into infrastructure and productive assets in manufacturing, energy and consumer industries. Russia, the popular theory goes, should be a safe haven from the growing economic hurricane that is due to engulf the United States.
There is even a robust “decoupling theory’ that posits that emerging markets in Russia, China, India and Brazil are already “decoupled” from the U.S. slowdown by domestic demand-driven growth. Russia has the world’s largest per capita foreign currency reserves and its Stabilization Fund will exceed $200 billion by the end of this year. Russia will be an ''island of stability,'' Finance Minister Alexei Kudrin boasted at the World Economic Forum in Davos, Switzerland.
So Russia seems to be safe for now. But is it really so?
It is true that Russia’s trade with the United States is relatively small, less than $30 billion a year. And the correlation between the S&P 500 and the RTS Index is tenuous at best. But what if the recession in the U.S. proves to be long – 12 or 18 months? This might drive down world commodity prices, particularly the price of oil. How would this affect the Russian budget and plans for a major expansion in social spending?
Russia is in the midst of a delicate political transition and both President Vladimir Putin and First Deputy Prime Minister Dmitry Medvedev have outlined ambitious plans for modernizing the country, including its dilapidated social sector. The country’s much acclaimed political stability hinges on robust economic growth that boosts disposable income and allows for charitable social programs some of which, like drug insurance or pension insurance, need to be further expanded. An economic slowdown in Russia, much more a recession, might upset the delicate political consensus that provides the foundation for the Putin model.
Were the Russian economy to slow down or even slump, how would this affect Russia’s political transition and the beginning of Medvedev’s presidency? Would Russia’s political stability unravel? How would a Medvedev-Putin tandem work in such a situation? Putin has been extremely lucky not to have had an economic crisis on his hands as president; how would he handle a recession as the country’s prime minister? How would Medvedev and his team handle the crisis? Does the “decoupling theory” hold any water and is Russia sufficiently immune to the financial troubles in the U.S.? Or is it going be dragged into a recession by the stampede of frightened international investors?
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Vlad Ivanenko, Ph.D. economics, Ottawa
The cause and settings of the current financial crisis have been known for long, but the timing of when it will hit in earnest remains a mystery. Assuming that the world is approaching this stage, let’s consider the structure of the global financial system, possible anti-crisis measures and Russian positioning in this situation.
The dual U.S. trade and fiscal deficit is the prime cause of current financial shocks. The deficit creates global instability in the system built on the use of the dollar (USD) as the reserve currency. Within the system, American disturbances spread to other countries that are economically linked to the United States. Up to now, these countries - Japan, China and others - were willing to serve as buffers containing adverse shocks; however, they now realize that they are playing a game of musical chairs and are looking for ways to opt out of the system. International financial organizations are not prepared to handle such a contingency because they proceed on the assumption that the USD will continue to dominate in global trade and offer no "quick fix" solution.
The most likely handling of the impending crisis involves a redistribution of the massive U.S. debt burden among its economic allies. For creditors, this would amount to their bailing out the American economy. They need to get prepared for hard bargaining, because Washington may have to resort to non-market solutions if no consensus about sharing the losses emerges. In this situation, two factors determine how losses will be distributed: the creditor countries' economic dependency on the U.S.-centered system and their bargaining power in relation to the United States.
The BRIC countries have little in common in this situation. Among the four, Russia is in the most favorable position. It is not heavily involved in the global financial system and is distanced from the U.S. in trade, partially because Washington has not been enthusiastic about developing trade with Russia. In retrospect, this supposed punishment has becomes a blessing now that the U.S. economy is entering a period of turbulence.
An interesting historical perspective comes to mind observing the current disposition. When the Western world entered the Great Depression in the 1930s, Russia embarked on the most ambitious industrialization program in its history. The trouble with this analogy is that the downfall of the Western economic model increased the appeal of "all-things-non-Western," including the temptation of autocratic governance. Possibly, the long and unsuccessful communist experiment has injected a healthy dose of anti-totalitarianism into Russia. Still, its continuing economic growth against the background of global stagnation may confuse Russian voters and intensify popular disrespect for struggling Western institutions. To overcome the danger, Moscow needs to develop a model of democracy that envelops main democratic tenets in local, "custom-made" national packaging.
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Andrei Liakhov, associate, Norton Rose Law Firm, London
The Russian economy, although helped by high energy prices, is not only about oil and gas. It is undeniably a commodities-based economy though as metals, chemicals, diamonds and timber along with energy resources constituting some 89 percent of Russian exports.
However, it is important to keep in mind the fact that Russia's exports – particularly those of metals, coal and timber – are not focused on supplying other G8 economies, and the price of Urals blend oil is substantially discounted from Brent. So even if there was a fall in demand from G8 economies, this could be easily offset by increasing exports to China, the Middle East and Southeast Asia.
All of the above will limit the negative impact of a sustained global recession on Russia. However, the other result of such a recession would be a deficit of financial resources for medium- to long- term investment (18-72 months), for which there is a substantial, undiminishing, demand in Russia. Although the state may be able to compensate for the deficit in private investment funds in the short term through various "national" investment programs, the state has priorities other than those of the private investors and its investment program may lead to a long term imbalance in the economy.
All of this must be weighed against the backdrop of a genuinely boisterous Russian domestic market, which is not burdened with consumer credit overexposure and/or complicated stock index related investment products. For once, the archaic nature of the Russian banking and financial services sectors could be a blessing.
Furthermore, we could expect the inflow of short term speculative money into the BRIC economies that investors, fed up with the underperformance of their structured derivative products, could channel into the real economy. Russia has several advantages over other BRIC countries, but as these are the very early days of the recession, it remains to be seen how all of these factors will affect Russia's economic growth.
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Ethan S. Burger, Adjunct Professor, Georgetown University Law Center, Scholar-in-Residence, School of International Service, American University, Washington, D.C.
It is indisputable that Russia plays a prominent role in different aspects of the global economy and that the worldwide credit crunch will have an impact on the performance of its economy. The Russian leadership probably already appreciates some of the implications. I will identify just what I see as the most prominent consequences:
1) Russia's current account's situation is very strong. It does not have to borrow money to service its debt. In addition, whether the situation becomes simply a global slow growth period, Russia is likely to benefit from a reduction of inflationary pressures. Furthermore, I think it likely that the ruble will continue to appreciate, barring a major political crisis in the country in connection with the end of President Putin's term.
2) On the one hand, the cost of borrowing will probably lead to a reduction of foreign direct investment in Russia, but not necessarily portfolio investment. This may have an impact on Russia's ability to undertake the major infrastructure projects it has indicated are needed if foreign technology and expertise are needed. It is also possible that with worldwide demand for services of Western companies in the infrastructure area, Russia may seem like a good market if the government is the customer. The underdevelopment of the Russian banking sector will make it harder on Russia to take full advantage in this environment.
3) While Russian companies and its sovereign fund might have the ability to acquire larger stakes in companies abroad, there may be a political backlash against this. Few "patriots" want to sell off their country on the cheap.
4) With a downturn in the economy, the price of energy and other raw materials should decline. This could have a real impact on the Russian state budget and contribute to more economic stagnation in Russia than one might presume.
In light of the above, Russia is probably better situated to deal with a global economic downturn. It will be interesting to see if cheaper exports from abroad in the form of finished products will have a negative impact on the development of certain Russian domestic industries. Overall, I think most Russian consumers would be better off, with the exception of the wealthiest segment of the population.
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Stephen Blank, The U.S. Army War College, Carlyle Barracks, PA
I believe the United States is in or about to enter a recession in the technical sense of the term – two quarters of negative growth. And I have no doubt that the decoupling theory is nonsense and wishful thinking. In an era of financial globalization, no market is immune to shocks in other markets as global markets' behavior on Jan. 21 indicated. But that does not necessarily mean that Russia will be as affected as other economies. In other words, the impact of this recession or growth slowdown, if that is what we are seeing, will be differentiated across markets. It has already begun to affect the price of oil, driving it down to between $88 and $90 a barrel from previous highs. Russia does have some dangerous vulnerabilities besides its dependence upon energy rents; there is no sign that the government has really adjusted in order to confront the problems of domestic inflation or to guard against the speculative excesses taking place elsewhere. So I expect that Russian growth rates will slow down in 2008, though there may not be a recession in Russia. This also means that the pace of foreign portfolio investment will also slow down, though we cannot say by how much.
Were a recession to occur, it would probably create major squabbles among the elite, whose pie is therefore shrinking, and lead to discontent at home, especially if deflationary remedies – the only ones known to work – are applied. Furthermore, if a Russian recession occurs, it will be due to the prolongation of the American problems and the incidence or consequence of inflation in other major economies like China. Ultimately though, the American crisis and the transfer of power here should lead to new energy policies aiming to reduce the price even as Russia cannot meet the combined demand of its own domestic, Asian and European customers through its own means.
So I would imagine that if economic crisis comes to Russia, it will do so in 2009-10. And as of yet, I see no awareness in the policy community of measures to forestall or avert this outcome, which can only be done by cooling off economic growth. That is a policy that always arouses discontent and we may expect even more truculent rhetoric blaming everything on foreigners. But until then, it is impossible to discern the outlines of a coordinated domestic policy response to current international economic troubles.
Nevertheless, because of its growing financial integration with global markets, Russia cannot remain unaffected by the present challenges, even if their impact will be different and possibly less than in other major centers. |
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