Why Rus­sia’s econ­omy will not col­lapse

Financial Mirror (Cyprus) - - FRONT PAGE -

The rapid de­pre­ci­a­tion of the ru­ble, de­spite a dra­matic – and seem­ingly des­per­ate – late-night in­ter­est-rate hike by the Cen­tral Bank of Rus­sia (CBR) last month, has raised the spec­tre of Rus­sia’s eco­nomic melt­down in 1998. In­deed, the West has sought to an­i­mate that spec­tre in its on­go­ing con­fronta­tion with Rus­sian Pres­i­dent Vladimir Putin. But, though Rus­sia’s econ­omy is un­doubt­edly in trou­ble, a full-blown col­lapse is un­likely.

Oil and gas ac­count for more than 60% of Rus­sia’s ex­ports; other pri­mary com­modi­ties make up much of the rest. Given this, the re­cent sharp decline in world oil prices ob­vi­ously rep­re­sents a ma­jor shock – large enough, when com­bined with the ef­fect of in­creas­ingly strict West­ern sanc­tions – to pro­voke a size­able re­ces­sion. To make mat­ters worse, com­mod­ity prices are ex­pected to re­main low for some time. In that case, the in­come loss would be­come much more than a tem­po­rary set­back.

But Rus­sia is no eco­nomic bas­ket-case-in-wait­ing – at least not yet. The sit­u­a­tion to­day is very dif­fer­ent from that in 1998, when Rus­sia was run­ning twin fis­cal and cur­rent-ac­count deficits. Rus­sia needed to bor­row, and it was bor­row­ing heav­ily in for­eign cur­rency. This meant that as the ru­ble de­pre­ci­ated, Rus­sia’s debts rose. Even­tu­ally, de­fault be­came in­evitable.

By con­trast, in re­cent years, Rus­sia has en­joyed a size­able bud­get sur­plus, and public debt is be­low 20% of GDP. It is true that in­come from oil and gas, which rep­re­sents the bulk of gov­ern­ment rev­enues, has been halved when mea­sured in dol­lars. But the Rus­sian cur­rency has fallen by about the same per­cent­age, mean­ing that the gov­ern­ment’s in­come in rou­bles re­mains ap­prox­i­mately un­changed.

Sim­i­larly, Rus­sia’s cur­rent-ac­count bal­ance has been mostly in sur­plus in re­cent years. Gross public and pri­vate ex­ter­nal debt is be­low 40% of GDP, and much of it is de­nom­i­nated in rou­bles. The sharp fall in ex­port in­come is rapidly chang­ing the sit­u­a­tion, but Rus­sia is start­ing from a com­fort­able po­si­tion. To panic would be pre­ma­ture.

The rou­ble’s free-fall has been driven mainly by cap­i­tal out­flows. Rus­sia’s fa­mous oli­garchs have al­ready stashed most of their wealth abroad, but they re­tain sig­nif­i­cant sav­ings at home. As the eco­nomic and po­lit­i­cal sit­u­a­tion de­te­ri­o­rates, they are most likely pulling more money out. Small savers have ev­ery rea­son to switch into for­eign cur­rency as well.

This has put the CBR in a chal­leng­ing po­si­tion. The rou­ble’s de­pre­ci­a­tion is bound to fuel in­fla­tion, al­ready around 11% and far above the CBR’s 5% tar­get. In that con­text, rais­ing the in­ter­est rate sharply makes sense, and of­fi­cials may be hop­ing that the hike will stem cap­i­tal out­flows – de­spite the risk that the de­ci­sion, if in­ter­preted as be­ing aimed at de­fend­ing the cur­rency, could have the op­po­site ef­fect.

The trou­ble is that the higher in­ter­est rates are bound to deepen Rus­sia’s eco­nomic down­turn, mak­ing the CBR an easy scape­goat. Never mind that the cen­tral bank is not re­spon­si­ble for Rus­sia’s trou­bles – the run on the ru­ble, the re­ces­sion, and the flare-up of in­fla­tion – and that us­ing in­ter­est rates to pre­vent cap­i­tal out­flows al­ways fails. Em­bat­tled politi­cians can be counted on to point the fin­ger.

The threat to Putin is clear. He risks the fate of his pre­de­ces­sor, Boris Yeltsin, who presided dur­ing a pe­riod of un­usu­ally low oil prices. Un­til now, Putin has been lucky, com­ing to power just as oil prices started to rise. Most Rus­sian cit­i­zens credit him with two decades of ris­ing living stan­dards, fol­low­ing decades of decline.

Putin’s de­ci­sion not to im­ple­ment the un­pop­u­lar re­forms that would have cre­ated a strong non-oil ex­port sec­tor may have been bad for the econ­omy’s long-term health, but it has al­lowed him to main­tain wide­spread public sup­port. His eco­nomic good for­tune, com­bined with his readi­ness to stand up to the West, has cre­ated a mis­guided im­pres­sion in Rus­sia that the coun­try is, once again, a world power.

Many in the United States and Europe be­lieve that ratch­et­ing up eco­nomic pres­sure on Rus­sia will help drive Putin out. This is an enor­mously danger­ous gam­ble. As Rus­sian living stan­dards decline, Putin’s only vi­able strat­egy to re­main in power will be an ag­gres­sive in­ter­na­tional pos­ture. For­eign mil­i­tary ad­ven­tures, af­ter all, are most ap­peal­ing when the do­mes­tic front is on fire.

None of this means that the West should bow and for­sake its prin­ci­ples. But it does mean that the time has come for a diplo­matic ap­proach that does not de­pend on the prospect of Rus­sia’s eco­nomic col­lapse.

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