Russia's ongoing economic crisis has understandably generated some pretty heated coverage, with no small amount of schadenfreude directed towards Vladimir Putin and his ever-shrinking circle of close advisers. Over at the Washington Post, my friend Matt O’Brien (a budding macroeconomic pundit often cited by the likes of Paul Krugman) had a representative take on the situation, mocking Russia for the sudden collapse in its currency and its continued dependence on volatile commodities: “Whether its 1986, 1998, or 2016, Russia's economy is only as strong as the price of a barrel of crude – so not very much.”
I think O’Brien goes a little too far. It’s not that his analysis is wrong (you might have noticed Russia’s economy is not performing terribly well right now!), but that he seems to be projecting the continuation of trends (ie. a collapse in the price of oil) that do not seem likely to run much further. That is to say the oil price has already fallen so far so fast that it seems highly unlikely to keep doing so for any further length of time. And, as O’Brien himself admits, once oil stops falling so will the ruble. When that happens a series of problems that, in the context of a collapsing currency, appear totally unsolvable and cataclysmic suddenly become much less threatening. That’s basically what happened in early and mid-2015 as oil prices (at least temporarily) stabilized and the carnage being inflicted on the ruble (again, at least temporarily) abated.
But as someone who was trained in comparative political science, my urge is always to look at Russia not in isolation but in comparison to other countries. Russia is often described as a “petro-state” – a primitive economy that revolves not around value-added manufacturing, but around pumping dead dinosaurs out of the ground.
So, how is Russia’s economy holding up compared to some of the other petro-states? It’s instructive to examine the issue, because as bad as Russian policy might look in isolation, it looks rather more enlightened in a comparative perspective. Let’s consider two specific examples, Azerbaijan and Saudi Arabia.
First, Azerbaijan. As earlier reported by bne IntelliNews, the Central Bank of Azerbaijan (CBA) has followed a remarkably spendthrift policy since oil prices started to crash at the end of 2014. Rather than floating its currency like Russia and Kazakhstan, where monetary authorities saw the writing on the wall, the CBA instead decided to use most of its accumulated forex reserves to defend a hard currency peg against the dollar – a peg that had been rendered obviously indefensible by the decline in crude prices. By the end of 2015, according to Reuters, the CBA had already spent a full 62% of the reserves it held at the end of 2014. That kind of totally unsustainable spending is why the Azeri government was forced into a massive devaluation.
If Azerbaijan had only wasted its forex reserves on defending a currency peg, that would be one thing. But the bad policy decisions, unfortunately, don't stop there.
Azerbaijan also recently imposed capital controls, coming in the form of a 20% tax on transactions in which money is taken out of the country. These are “soft” controls rather than a blanket prohibition on withdrawals, and the authorities (for the moment) are graciously exempting foreign investors. But placing any kind of restrictions on the movement of capital, even if it is “only” a tax that applies to domestic investors, is a pretty dramatic step, and a bell that can’t really be un-rung. Once the authorities place restrictions on such transactions, they can easily be broadened or strengthened.
Azerbaijan is also running a government budget deficit that is projected to be somewhere between 5.5% and 9.2% of GDP (it depends on whose forecast you trust) and is heading to the bond market trying to sell about half a billion dollars’ worth of debt. Azerbaijan’s strategy, unlike Russia’s, seems to be predicated on delaying macroeconomic adjustment to the greatest extent possible, and on expectations that oil prices will rapidly bounce back.
The Saudis appear to be following a broadly similar playbook. They ran a gargantuan budget deficit during 2015, one that amounted to more than 15% of GDP. This year, according to Bloomberg, the deficit is on pace to be even bigger, up to 20% of GDP. Even for a country with substantial accumulated foreign assets, deficits of this magnitude have resulted in an exceedingly rapid rate of depletion: expectations are that, at the current pace, it could deplete its foreign assets entirely within five years.
There’s also the matter of Saudi Arabia’s foreign exchange reserves which, although still large, remain in freefall (in stark contrast to Russia’s, which are now at roughly the same level as back in March of 2015). So long as oil prices remain low and they maintain a hard peg to the dollar, the Saudis will continue to bleed reserves at a rapid rate. Much like the Azerbaijanis, the Saudis are also contemplating large-scale international bond sales in order to finance their still huge fiscal deficits.
The Azerbaijanis have already used most of their “ammunition” and seem to be belatedly adjusting to the new environment, but could the Saudis' gamble pay off? Yes, it is possible. Although it seems unlikely in today's environment, there's nothing preventing oil prices from rebounding just as quickly as they collapsed (and some analysts are forecasting precisely that). If that happens, the Saudi authorities will look like geniuses, and the Russians will look panicky and over-reactive. But if oil prices don’t “snap back”, the Saudis, and any other oil producer that has tried to defy economic gravity, are going to be badly exposed.
Basically, Saudi maco policy over the pat year and a half only makes sense if the Saudi government is strongly bullish on long-term oil prices. But, simultaneously, its government is actively trying to run other high-cost oil producers out of the market by driving down prices. If that sounds like a fundamentally contradictory approach, it’s because it is.
Russia’s economic policy, particularly the “self-sanctions” imposed on imports of various European foodstuff, hasn’t exactly been enlightened. But the finance ministry and the central bank have been admirably proactive in forcing an adjustment to the “new normal” of cheap energy. Other large oil exporters haven’t been nearly so aggressive, and the longer they try to delay adjustment, the more wrenching that adjustment will eventually be.
Follow @MarkAdomanis – Wharton MBA by day, Russia analyst by night.