Mark Adomanis in Philadelphia -
Russia has been giving everyone fits recently. The speed of the collapse in the ruble in late 2014 caught many experts by surprise. Its almost equally rapid rebound through the first four months of 2015 did too.
Professional prognosticators have been admirably honest about the limits of their insight and about the positively enormous uncertainty currently hanging over Russia’s economy: many will openly admit that they genuinely have no idea what’s going to happen next and that “wait and see” is the only responsible option.
Some predictions call for a modest recession (around a 1-2% loss in output) followed by a swift return to growth. Business as usual, in other words. Other predictions expect an economic downturn that will be far more harrowing than the one which struck Russia in the aftermath of the global financial crisis: a devastated and devalued currency, a bond market in ruins and an up to 10% loss in overall output.
It being Russia there are several good arguments in favour of both of these schools of thought, which, for simplicity and clarity’s sake, I will call the optimistic and pessimistic. It’s worth presenting them in as fair and balanced a manner as possible, and allowing readers to subscribe to whichever theory they find more plausible.
Reasons for pessimism
Foreign trade is getting clobbered
According to the latest data from Rosstat, which cover January-February, Russian exports fell by 25.4%. Imports fared even worse, declining by a whopping 38% year over year. Altogether Russia’s total foreign trade turnover decreased by a full 30.1% in comparison to 2014.
To place that -30% performance in comparative context, in 2009, the year during which Russia was most significantly impacted by the global financial crisis, international trade experienced a 35% decrease.
The ruble crisis, then, has initially exerted a negative impact on Russia’s foreign trade that was of roughly equal magnitude. That, in turn, would suggest that the ultimate impact on Russian output will also be of a roughly equal order of magnitude. Since Russia’s GDP declined by 7.2% in 2009, the 2015 performance should be in the same ballpark.
This oil price collapse is supply driven (and therefore longer in duration)
While the oil price declines of late 2008 and 2009 were of almost exactly the same magnitude as those of 2014-15 (and, inflation-adjusted terms were probably even more severe) the reasons underlying the collapses in prices were very different.
2008-09 was about the sudden popping of a commodities bubble that, by virtually any reckoning, had grown wildly out of step with global fundamentals. Supply hadn’t suddenly changed, there weren’t any noticeable changes to the global oil supply, but as the bottom fell out of the global financial system there was a sudden shock to demand. As this shock dissipated, prices rebounded reasonably quickly: the price of Brent crude more than doubled over the course of 2009.
The 2014-15 situation is very different. Even as prices marched relentlessly downward production of US crude has continued to grow. The world oil market is currently awash in excess oil. According to the Energy Information Administration (EIA), world oil inventories have been exploding, growing by 1mn barrels a day (b/d) throughout 2014 and with projected average growth of more than 1.7mn b/d through the first half of 2015.
The EIA doesn't expect consumption to match supply until early 2016, and only at that point will prices start to grow.
The government has less “dry powder”
At the end of September 2008, as oil prices began to crash and the economy began first to decelerate and then lapse into crisis, Russia's total foreign reserves amounted to $557bn, of which $542bn were highly liquid foreign currency. In nominal dollar terms Russia’s economy at the time was roughly $1.66 trillion, so its reserves were about 33% of its total GDP. This sizable financial cushion enabled the Russian government to defend the ruble and to engage in substantial anti-crisis measures.
This time around, Russia has substantially less room for maneuver. At the end of September 2014 Russia's foreign reserves amounted to $454bn of which $409bn were foreign currency: they were thus both smaller in absolute terms and marginally less liquid. However the most important fact is that the reserves now amounted to only about 20% of Russia’s $2.2 trillion economy.
This suggests that, unlike in 2008-09, the Russian government won’t be able to throw as much money at the problem: it will have to be a bit more careful about picking and choosing which industries get assistance.
Reasons for optimism
The initial hit to industrial production has been quite modest
Through the first two months of the year (the latest for which data is currently available) Russia’s industrial production was a mere 0.4% lower than it had been during the same period in 2014. A 0.4% decrease is, to be sure, still a decrease, but it was more muted than many analysts had predicted and much less severe than the decline which took place during the worst of the 2008-09 financial crisis.
When you also consider the unexpected growth that the economy experienced in the fourth quarter of 2014, it’s not even clear that Russia has technically entered a recession yet. Yes, a recession is at this point inevitable, but it’s been late in coming and modest in its early impact. It suggests that the overall decline to total output will be on the lower end of the spectrum, or somewhere between 2.5% and 3.5%.
Inflation might have already peaked (and interest are starting to come down)
Due in large part to the extraordinary sensitivity of Russians to inflation, the Russian central bank keeps a very close eye on prices. Fears over excessive inflation in the aftermath of the ruble’s collapse were what inspired the central Bank of Russia (CBR) to hike interest rates so massively: regulators were more afraid of run-away price growth than they were the downturn that would inevitably result from having credit become so ruinously expensive.
Well it took a while for the rate hike to really "bite," but recent data indicate that year-over-year inflation has finally started to decrease: between April 7 and April 13, inflation fell by a modest 0.1% to 16.8%. The CBR, then, seems likely to continue its modest ratcheting-down of interest rates.
Inflation is obviously still high, as are interest rates, but for the first time in many months they are heading in the right direction. This won’t magically propel the Russian economy into rapid growth, but it will have a positive impact on output in the second half of 2015.
The ruble has leveled off (for the moment)
The ruble’s sudden collapse (driven in large part by declines in the world price of oil) was what really kick-started Russia’s crisis. As the ruble weakened, foreign borrowing became more expensive, as did imports of foreign goods. The ruble’s swoon also spiked inflation, and, as noted previously, forced the Central Bank to engage in a potentially output-crushing hike in the interest rate. Currency crises have a way of spinning out of control, and so long as the ruble was nose-diving it was hard to see how Russia’s economy was going to stabilize.
Well the ruble pulled off a rate feat, moving from "worst to first" in the blink of an eye and clawing back many (but by no means all) of its earlier losses. Could the ruble resume its downward slide? Yes it very well could. Forecasting the ruble has been a dangerous game lately, and given the persistent supply gut in oil another tumble in prices is far from impossible.
But the more dire economic forecasts all had the ruble substantially cheaper than its current level of RUB53 per dollar, a level that would spark further inflation and prevent the CBR from cutting rates. If the ruble holds roughly at its current level, there will be a modest boost to exports (as Russian goods become more cost-competitive) and the central bank will have sufficient flexibility to gradually cut interest rates down to their previous level. A return to normalcy, in other words.
At the present time I would argue that the preponderance of evidence supports a relatively optimistic view. But over the past year the situation has changed at such a rapid pace that the only responsible course of action is to constantly incorporate new information.
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