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Russia has crises regularly. They happen for a variety of reasons: poor regulations, the lack of institutional checks and balances, rank corruption, heavy debt, no money in reserve, shallow capital markets, weak banking sectors and external shocks. And they cause havoc when they happen.
There have been five really big crises: in 1991 when the Soviet Union collapsed; in 1998 when the ruble collapsed and Russia defaulted on its debt; in 2008 when the collapse of the US housing market caused a global financial crisis; in 2014 following Russia’s annexation of the Crimea; and most recently in 2020 with a double whammy of the collapse in oil prices and the start of the global coronavirus (COVID-19) pandemic.
However, after three decades each successive crisis does less damage. Russia remains an emerging market and so while it still has not brought its economy up to the level of the more developed nations, in the last 30 years it has made constant progress, making it better able to weather the storms each time they happen.
In 1991 the entire economy collapsed. The centrally planned five-year plans were shown up for the fakes they were and with the borders thrown open to imports no one wanted to buy the shoddy consumer goods the state-owned dinosaurs were putting out. Almost everything went bust.
The ruble also completely collapsed. With hyperinflation soaring to 1,400% the value of a lifetime’s worth of savings were reduced to pennies in a matter of months. People looked for alternative value stores and a favourite tactic was to buy a washing machine, as they were easy to turn back into cash by selling them again second hand. Unemployment doubled over the next ten years.
In 1998 the entire top tier of the banking sector went bust, with the household names like Uneximbank, SBS Agro and Most Bank disappearing overnight, taking people’s savings with them. The ruble devalued by 75%. Unemployment had been falling as new companies came into being, but it soared again rising from 5.1% in 1991 to its all-time post-Soviet peak of 13.3% in 1998.
The crash in 1998 was actually caused by a currency crisis in Asia in 1997 that took almost a year to reach Russia. The Asian crisis fed through into pulling down commodity prices and that began to hurt Russia’s economy. The state had been issuing the now notorious GKOs (the precursor to the new Russian Ministry of Finance ruble-denominated OFZ treasury bills used now) to cover the budget deficits and the maturities of these bills had been getting longer while the interest rates they paid had been getting lower. However, from about May that year investors began to panic and on August 19, 1998 then Prime Minister Sergei Kiriyenko admitted defeat and defaulted on some $40bn worth of GKOs, sending the economy into a tail spin.
The devaluation in 1998 turned out to be a blessing in disguise. It made the ruble so cheap it suddenly became competitive. The “virtual economy” based on barter, as no one had any cash, gave way to a cash-based economy and oil prices, which had fallen to circa $14 a barrel, began their inexorable rise from about 2001 onwards. But the recovery had begun well before oil revenues started to pour in: in 1999 the economy grew by 10%, a record that has never been beaten.
The oil sector was the biggest beneficiary and invested more into production in 1999 than it had invested in all of the proceeding seven years. Labour costs were still priced in rubles, which had been cut by three quarters, but their revenue was in dollars, making them money-making machines. Profits from the oil sector primed the pump and started off an almost decade-long boom as a virtuous cycle of profits-investment-wage rises-spending kicked in. At the same time the government, awash in petrodollars, started increasing state wages by around 10% a year to close the gap between the private and public sectors and kept that up for almost a decade. Consumption became the driving force of the economy, which doubled in size.
It looked like Russia had turned the corner, with GDP growth running at 6%-8% a year in 2006 and 2007 capital flight having reversed as Russian businessmen brought about $130bn of capital home and started investing in domestic businesses. Everyone was making money hand over fist.
Then the world collapsed again in September 2008. This time it was not Russia’s fault. The US financial regulator’s failure to head off the sub-prime mortgage disaster saw the entire US housing market collapse, which sent shock waves around the world. Russian capital turned tail and fled as all that $130bn left the country again. The Russian economy went from a 7% growth rate to a 7% contraction in about six months.
But this time the crisis did a lot less damage. In 1991 pretty much every Russian company went bankrupt. In 1998 the entire top tier of the banking sector went bust. In 2008 only one bank, Finance Invest Bank, went bust. And that was bailed out and taken over by Russian Railways (RZD) by lunch time the same day it announced it was pulling the plug.
The ruble devalued yet again but this time by only about 30% – still very painful, but people didn't see their entire savings wiped out, just cut by a third. Unemployment jumped too, but only by a limited percentage, as most companies could stay open, even if they did cut wages and tighten belts.
With oil still at $100 a barrel in 2009 Russia’s economy bounced back relatively quickly, but the boom years were over.
Between 2008 and 2013 Russia faced a new problem. Oil prices were still high, but the economy began to slow anyway. But 2013 GDP growth had fallen to zero despite the $100 oil. The problem was the Kremlin had ignored the deep structural reforms needed to modernise the economy and the petro-driven model had simply run out of steam, knocking up against increasingly hard structural limitations.
The 2008 crisis has a lot to answer for, as if that Russian capital had stayed a few more years then a whole new class of businesses could have been created that would have made the economy more robust. 2008 was also the high point of the Kremlin’s flirtation with the “Washington Consensus” free market economic model.
After inflation fell into single digits for the first time in two decades, the Kremlin announced a massive $1 trillion infrastructure investment programme to modernise the economy – twice the size of the current 12 national projects programme that is supposed to do more or less the same thing.
In the summer of 2008 the newly elected president, Dmitry Medvedev, announced a far-reaching and radical privatisation programme at the St Petersburg International Economic Forum (SPIEF) that was packed with foreign investors. The programme had been written by Sergei Guriev, a famous professor of economics at the Higher Economic School, and adopted wholesale by the Kremlin. But by the end of that year the government was in crisis mode yet again and all the grand plans for change were unceremoniously dumped as everyone simply tried to keep their head above water.
Already weakened by the onset of stagnation due to the lack of reform, 2014 brought yet another collapse in oil prices as the Kingdom of Saudi Arabia tried to kill the burgeoning US shale oil business by flooding the market with crude.
The ruble crashed again, but this time falling by more than the 35% in 1998, as it dropped by more than half. The ruble went from about RUB35 to the dollar to RUB80 during the worst of the crisis because as part of the Central Bank of Russia (CBR) emergency actions it freed the exchange rate and the ruble became a freely floating currency, which allows the exchange rate to partly cushion the shock. The exchange rate eventually recovered to about RUB65 but that still meant a 50% devaluation.
But this time round the battle-hardened CBR and government rolled out a rescue plan and pumped money into the economy. The CBR introduced a 17% emergency rate hike that stopped the devaluation rot. Some $200bn of Russia’s reserves were spent on supporting industry and no one significant went bust. Retail sales and SMEs suffered and unemployment ticked up but it was still only 5.5% by the start of 2015 – a post-Soviet low. Growth slumped but the economy quickly stabilised.
The problem that Russia faced after the 2014 crash was not the aftermath of the crash itself, but the stagnations caused by the exhausted petro-model of growth. Real income growth has flatlined since 2014 and consumption play almost no role in growth. Oil prices have been stuck around $40, so that didn't help either. And to add to Russia’s woes it annexed the Crimea that year, so the sanctions regime imposed killed off any inbound investment. By 2016 Russia had another near-miss crisis when the Ministry of Finance found itself with a RUB2 trillion ($30bn) hole in the budget that it couldn't fill. In the end that crisis was averted by the “privatisation” of a 19% stake in state-owned oil company Rosneft that later turned out to be a loan from the UAE.
Like in 1998, the crisis had some beneficial effects. The Ministry of Finance was so shaken by the almost-crisis in 2016 that it launched a massive reform campaign to clean up Russia’s tax system. The service was entirely revamped by Mikhail Mishustin, and was so successful that he was promoted to Prime Minister at the start of this year. The tax-take increased by 20%, although the tax burden only went up by 2pp in the same period. As an even better indicator of how radical and far-reaching these reforms have been, in 2008 the federal budget needed oil prices to be $115 to break even; by this year oil prices only need to be $42 for the budget to break even. Russia Inc. is now a much more profitable business.
That brings us to the current crisis that began in March, when Russia walked out of the OPEC+ production cut deal on March 6 and oil prices crashed yet again, falling from an average of $63.5 in December 2019 to a low of $21.2 in April this year – the nadir of the oil price crisis. Since then they have recovered to between $40 and $45 – the breakeven price for the Russian budget.
And then the coronacrisis came on top of an oil price crash in March. With oil prices already back in Russia’s comfort zone by June it is the total lockdown of the economy that started in May that will do the real damage this year; and not just to Russia.
Russia’s federal budget will still go into deficit in 2020 from a 1.8% GDP surplus last year as a result of the extra stimulus spending and reduced industrial production and consumption. The deficit was already at circa 2% in the first half of this year and is expected to end 2020 at -4.4%.
Growth will also hurt. Russia will go from 1.3% growth in 2019 – that stagnation problem hasn't gone away – to an estimated 8.5% contraction for 2020 before returning to growth in 2021. But this is actually a good result. It is less the full-year contractions in all the previous major crises’ contractions and it is also better than those in many of the developed markets.
Inflation too has not been effected. Consumer price inflation was a mere 3.6% in August, still below the CBR target rate of 4%, so instead of the massive 17% interest rate hike the CBR was forced to make in 2014 the CBR actually cut rates this year in order to stimulate more growth. Cutting rates in the midst of a nasty economic crisis is something that developed markets do, not emerging markets.
Unemployment has also escaped largely unhurt. The jobless rate was running at record lows of around 4.3% before the two shocks hit in March (also a developed market level) but has ticked up to 6.4% as of August – again the mildest increase in any of the previous crises.
And finally the ruble has also escaped with very little pain. As bne IntelliNews reported in “Russia’s amazing levitating ruble”, the currency lost about 17% in the first half of this year when oil prices were halved over the same period. Inflows into Russia’s OFZ by foreign investors have offset the fall in oil taxes and held the value of the currency up. If you remember, in 1998 foreign investors fled the GKO market causing it, and the Russian economy, to collapse.
Perhaps most remarkably of all, Russia has managed to continue to accumulate hard currency reserves throughout this year, with gross international reserves topping the $600bn mark this summer – the fifth largest reserves of any country on the planet. It is this huge war chest that gives the bond investors confidence and the Kremlin a lot of options.
The Russian economy is coping better with the coronavirus (COVID-19) pandemic than it did after the global financial crisis, the head of Russia's Accounts Chamber and ex-finance minister, Alexei Kudrin, said on September 28.
"The current economic situation is certainly better than predicted at the beginning of the pandemic," Kudrin told RT. "For a number of reasons, Russia now looks much better than in 2009, when the economy fell by 8%."
What is the silver lining this time round? Russia gained benefits from the previous crises. The collapse in 1998 killed off the virtual economy and remonetarised the country. The crisis of 2014 forced a radical fiscal reform on the Ministry of Finance. So what will happen this time?
The answer has to be the adaptation of a new economic model. The Russian economy has been stagnating since about 2011 and little has been done to fix it. The Kremlin has been well aware of the problem and Russian President Vladimir Putin has attempted to deal with the issue with his so-called May Decrees that were last updated in 2018 and have since grown into the 12 national projects. However, the programme got off a poor start in 2019 and has now been delayed after the crises of 2020 broke. This crisis made be the goad that the government needs to finally see these changes through.
But the geopolitics will hamper the kind of spending Russia needs to do to modernise its economy. With its huge fiscal reserves and extremely low debt – Russia could pay off its entire external and public debt tomorrow and still have $100bn left over, which would still be sufficient to ensure the stability of the ruble – the Kremlin could massively ramp up spending just by using the money in the National Welfare Fund (NWF). In addition, it could borrow heavily and still not be under pressure. Russia currently has public debts of about 15% of GDP and the Ministry of Finance intends to increase that to 20% under the new 2021-2023 budget, but the Maastricht recommended maximum borrowing level is 60% of GDP and almost all the EU countries are already well beyond that level.
The Kremlin won’t go down this road. With geopolitical tensions rising again thanks to the Belarus revolution and poisoning of anti-corruption blogger and opposition activist Alexei Navalny there is new talk of sanctions. On top of that, with Joe Biden looking increasingly likely to win the US November presidential elections, relations with the America will probably get worse over the next four years.
For the Kremlin all that money and the low debt is a strategic weapon in its fight with the US and gives it impunity from sanctions. It's not an economic resource that can be actually used to promote growth. In effect the Ministry of Finance has been running austerity budgets to preserve these reserves, when it doesn't really need to. The Kremlin is clearly hoping to continue this policy and generate the extra money it needs from recovering oil prices and even more efficiency gains. And given how prone Russia is to crises maybe that is not a bad plan.
GDP USDbn PPP
GDP per capita USDbn PP
GDP growth real
Government debt % GDP
Reflections from our correspondents on the ground in the Russian capital.
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