Ben Aris in Moscow -
The ruble's crash on December 15 from RUB53 to nearly RUB80 vs the dollar has caused many commentators to compare this crisis to Russia's financial collapse in 1998. Is Russia really going into a full-scale meltdown for the fourth time in two decades?
Crashing oil prices are driving this crisis as they did in 1998. Oil prices have unexpectedly and dramatically tumbled over the last two months from over $100 to around $59 at the time of writing. The same thing happened in 1998 when oil prices more than halved from a long-term average of $25 per barrel to $10 a barrel, in effect bankrupting the government.
However, looking more closely, the 1998 crisis was a lot more severe. As a young freelancer I was embarrassed by how much money I made in August 1998 as my phone rang off the hook with calls from newspaper after newspaper asking for stories. At the height of the crisis I walked past the closed stalls in the Dorogomilovskaya market opposite the Hotel Ukraine and wrote a piece that started: "It may be August but the cold winds of crisis are sweeping through the open air markets of Moscow…"
Not only did the ruble lose more than three quarters of its value in a matter of months, tumbling from RUB6 to the dollar to about RUB30 by the end of the year, but the entire top tier of the banking sector went bust after runs on deposits, the payment and settlement system collapsed, and the economy ground to a halt.
Shop shelves emptied simply because it became impossible to pay people, even if you had the money. Traders who had been making fortunes in a matter of months suddenly found almost their entire wealth was tied up in inventory they couldn’t move.
The banking system was destroyed as the top tier of oligarch-owned commercial banks, which had been speculating against hyperinflation on the FX market, found themselves on the wrong side of the trade. Queues formed outside most branches as people desperately tried to withdraw their savings. Household names like SBS Agro, Uneximbank and Most Bank, which had made fortunes as the "authorised" banks to make federal payments, simply closed their doors and disappeared. Alfa Bank is the only survivor from that era.
And the stock market crashed. Thanks to a benign 1997 and a stable ruble/dollar exchange rate, the RTS had soared to reach a peak of 500 in that summer before starting a long sell-off that culminated in October 2008 when the index dropped to an astonishing 38. On August 19, two days after the crash, I remember being told by George Kogan, then head of equity sales at UFG (now the investment arm of Deutsche Bank), who had made a killing selling Russian equity to international investors: "You can't image what just happened. We are totally f*cked."
Symbolic of the change that Russia had just gone through was that The Hungry Duck, a legendary hedonistic bar that was rammed full of expats spending fast-made fortunes during the trading boom years of the mid 1990s, was almost empty of foreigners by the autumn. The party was over.
The big difference between 1998 and now is simply the scale which things are operating on. In the midst of the 1998 meltdown Russia's capital flight was running at $4bn a year and that was enough to cause the collapse, whereas today's capital flight is expected to be $120bn but that is considered manageable under normal circumstances.
What has stayed the same is that Russia's budget revenues have always been heavily dependent on oil prices, although the absolute numbers have increased enormously in the last decade and half: in 1998 the break-even price of oil for the Russian budget was about $14 a barrel and this time round it was about $103, according to economists.
This dependence on oil means that in both crises the value of the ruble has to fall if oil prices fall. But in general the value of a currency is predicated on a country's hard currency reserves, its balance of payments account, its federal budget account and it GDP. When you take all these factors into account the two pictures start to look very different.
Hard currency reserves: In 1998 Russia had no hard currency reserves to speak of: enough to cover just under two months of imports for all of the 1990s.
President Boris Yeltsin had been sending Anatoly Chubais, head of the presidential administration, off to the IMF cap in hand to raise bailout cash, and in the run up to August 17, 1998 - the day the ruble devalued and Russia defaulted on its external debt - it had some $10bn in reserves. On July 20 the IMF transferred an emergency $4.8bn to bail out the banking sector, much of which the then governor of the Central Bank of Russia (CBR) Sergei Dubinin lent to the leading commercial banks, which promptly whisked it offshore.
By contrast, today Russia has approximately $416bn of currency reserves (although the CBR has clearly stepped into the market on December 17 and will almost certainly spend several billions of dollars or more on propping up the ruble this week). That is equivalent to 1.7 years of import cover – well over the three months that economists recommend. On this point the ruble should be rock solid.
Balance of payments: in the 1990s the ruble was overvalued, driven up by oil exports as the only real economic activity in the country at the time, which led to a large trade deficit and current account deficit that the Kremlin struggled to finance.
Russia remains heavily dependent on oil exports (and to a much lesser extent gas exports), and is now the biggest exporter of crude oil on a daily basis. This was until recently expected to help it enjoy a $200bn-plus trade surplus and a $60bn current account surplus. The dramatic fall of the oil price will reduce the value of Russia's exports, but the devaluation will also kill off imports, so the balance of payments should remain positive and continue to feed dollars into the budget.
Federal budget: The contrast with the federal budget now and then is also like night and day. Russia had been running a budget deficit of between 7% of GDP and 12% for most of the 1990s and the state was constantly desperate for cash. Gazprom was pretty much the only company in Russia earning hard currency but, as a "state within the state" controlled by a clique headed by former CEO Rem Vyakhirev, it had organised special tax exemptions. The game was that Yeltsin would go and bludgeon the state-owned company into making special payments to bail out the state budget. Even this was not enough. The government's lack of funds led it to organise the now infamous loans-for-shares deal in 1995-96, where it borrowed hundreds of millions of dollars from the oligarch-owned commercial banks using shares of Russia's best companies as collateral, thus facilitating the takeover of Russia's industrial crown jewels by the oligarchs.
Today Russia's federal budget has defied all predictions of going into deficit. While the recession that is bound to follow the interest rate hikes to 17% imposed this week will inevitably lead to a deep recession in 2015 and a fiscal deficit next year, the irony of the current devaluation is that it actually increases the rubles the government receives; the oil prices' assumption in Russia's budget is priced in dollars, but spending is denominated in nominal rubles, so the state is one of the biggest winners from devaluation when it converts its oil tax dollars to budget spending rubles.
Currently Russia has a 2.1% surplus, but the fall of oil prices from around $80 to $60 in this crisis will change that too, but the deficit will not be on the order of those that characterised the 1990s. The rule of thumb is each $10 fall in oil prices cuts $15bn from the federal budget revenues.
GDP: Russia's formal economy was contracting for almost all of the 1990s, bar a few months in 1997 when it put in anaemic growth of less than 1% that nevertheless fuelled the stock market boom ahead of the 1998 crash. The economy was incapable of making money and lived hand to mouth off Gazprom's cash and IMF handouts.
But all that changed when Russian President Vladimir Putin took over in 2000. He was enormously lucky as oil prices began to rally, gifting him with soaring revenues. But he also introduced a set of radical economic reforms, dubbed the Gref Plan, after the young and insecure academic German Gref, now CEO of Sberbank, who was appointed economics minister. New flat extremely low flat taxes were introduced, a new labour code was written, a federal treasury system introduced that stopped the most egregious stealing by the regions and Vyakhirev was ousted and control over Gazprom returned to the state.
The beneficial effects of devaluation also played an important role: the barter system known as Russia's "virtual economy" was killed by devaluation, which forced everyone to make payments in cash. With a pump primed by petrodollars flowing into the economy and with revenues in dollars, but costs in rubles, the oil companies invested more into the sector in 1999 than had been invested in total in the preceding decade. Russia's economy exploded; growth in 2000 was 10%, a record yet to be surpassed and defying IMF predictions of a return of hyperinflation and a deep decade-long depression.
Will Russia boom again thanks to devaluation? It is unlikely as the nature of the economy has changed. Most of the fast growth of the last decade was simply catch up – taking Soviet-era productive assets and putting them to work. But this easy-to-do growth potential has been used up. Going forward Russia needs to make deep structural reforms to improve the productivity of the workforce if it is to return to strong growth – something the Kremlin has consistently failed to do.
What next for Russia?
Currently the story being reported is all about the ruble's collapse, but like in the 1990s it is the collapse of oil prices that is actually doing the damage. Russia's ruble is merely following the price of Brent down.
Much has been written about US pressure on the Middle East to reduce the cost of oil specifically to hurt Russia. An alternative conspiracy theory is that the House of Saud has decided to take out America's marginal shale producers by making them unprofitable and so regain some of the market share lost to the "shale revolution" in the US.
However, a far simpler explanation is that what is going on is exactly the same as in 1997, when the "Asian Tiger" crisis caused demand for oil to fall, lowering prices and exporting their problems to Eastern Europe. Again today Japan has fallen back into deep recession and China's extraordinary growth has come off the boil, reducing demand and now this is infecting Russia.
But the economy is far more robust today than it was then. Despite the brouhaha, the payment system is continuing to function, banks remain well capitalised and there have been no runs on banks.
Indeed, as bne reported, food distributors were turning their trucks around on December 16 and refusing to supply Moscow's supermarkets at the "old prices". However, this morning German-owned wholesaler Metro announced it would reset prices every two days to account for the ruble's fall, according to bne's sources.
Russia's debt profile has also vastly improved. In 1998 Russia's debt was the equivalent of 75% of GDP, and more damagingly, the budget was funded almost entirely by short-term three-month GKOs. At the start of 1998 the outlook for the year was extremely rosy. Inflation had fallen from 131% in 1995 to 22% in 1996 and 11% in 1997. Likewise the yields on the GKOs fell into the low teens for the first time and talk turned to mega-deals such as the merger of Yukos and Sibneft to form Yuksi. But things rapidly span out of control by the summer as yields on the GKOs spiked to 160% in June 1998 as export revenues collapsed. In a desperate attempt to stave off disaster, the CBR hiked rates to 150% in May 1998, compared to the 17% CBR governor Elvira Nabiullina imposed this week.
This time round Russia's external sovereign debt is only 13% of GDP, about $53bn, or 33% if you include corporate debt, while maturities, because of the 2008 crisis, are now much longer; half the corporate debt has a maturity of two years or more. The government has increased its borrowing plan from RUB450bn to RUB1 trillion but cut its foreign borrowing plans for $7bn entirely. And as the domestic bond market has been hooked into the international financial system since February 2013, it can borrow in rubles, negating the currency risk if it can find buyers.
Still, this is a delicate period as bank runs remain a real danger; FX conversations by the population are currently running at least four times above the average daily volumes. But as the ruble has been sliding all year from RUB32 to the dollar in January to RUB53 before the panic started, a large proportion of the crisis-hardened and exchange rate-savvy Russian population has already bought cars, apartments or converted their savings into dollars and moved them to deposit boxes in banks, rather than leave cash on account, as bne has reported. Provided the CBR takes back control of the exchange rate and quells the obvious panic this week, there is a good chance that its reserves will be enough to prevent a full-blown meltdown.
At the end of the day the biggest difference between 1998 and 2014 is that fact that the CBR chose to float the ruble at the start of November, a month before the ruble devaluation, and so has preserved its hard currency reserve powder, whereas in 1998 the CBR was forced to float the ruble only after the ruble collapsed.
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