Russia’s Contraction Eases But Knife-edge Risks Remain For 2010

The Russian ruble strengthened the most in more than three months against the dollar this morning (gaining 1.7 percent to 32.2247 per dollar at one point) as oil rebounded above $60 a barrel and OAO Sberbank reported better-than-expected earnings. Sberbank shares jumped 5.1 percent after first-quarter net income turned out to be above analyst estimates. But the rise was also helped by the fact that Russia’s central bank spent approximately $2 billion from reserves to try to stop the ruble from falling yesterday, taking central bank reserve spending over the two working days since they lowered interest rates half a percantage point on Friday to around $4 billion, according to reports in the newspaper Kommersant.

Russia’s central bank cut its main interest rates for the fourth time in less than three months at the end of last week after the government estimated the economy contracted an annual 10.2 percent in the January-May period. Bank Rossii lowered the refinancing rate to 11 percent from 11.5 percent following on initial reduction on April 24 and two further cuts on May 13 and June 5.

But the striking thing here is that today’s ruble surge followed seven consecutive days when it fell – including yesterday when it dropped 0.5 percent against the euro and 0.1 percent against the dollar to hit the lowest close against the central bank’s currency basket since May 4. Indeed only last week the ruble posted its steepest slide against the euro and dollar since January as oil prices fell and Russia’s budget deficit contined towiden. And to top it all, as I say, the central bank reduced interest rates for the fourth time in less than three months.

Indeed just after the rate cut Alfa Bank’s Chief Economist Natalia Orlova commented that she was seeing a “very fragile trend” in the ruble, with a lot of downside potential: and I completely agree with her. What we have is a lot of volatility and a lot of market nervousness. Just this morning Bloomberg cited a research report from the ING Group warning that “the ruble may drop as much as 5.8 percent to the weakest end of Russia’s target exchange-rate basket as the central bank aims to revive credit by lowering key interest rates by up to 4 percentage points.” (research note here).

My feeling is that a 400 basis-point reduction would have an even bigger impact than even ING expect. Basically central banks in a number of central and east European countries are caught in a kind of trap, where the high level of forex borrowing both households and companies have engaged in makes local monetary policy rather impotent, and worse, this impotence itself becomes a self perpetuating situation. The trap perpetuates itself since people become reluctant to take out local currency denominated loans due to the high interest rate they carry, so they take out either dollar- or euro-denominated ones and thus make matters even worse, making the possibly erroneous assumtion that end game of all this will be either a dollar collapse (the Russian view) or eventual euro membership (in places like Hungary and Romania). Those doing the borrowing thus feel themselves to be completely covered, and fail to take into account the capital loss that could follow a large correction in their own local currency.

Slowly monetary policy makers in the most affected countries are coming to recognise that they need to address the issue, and somehow or other to get rates down, since the problem is not going to simply go away, and the meanwhile the respective economies keep on shrinking, with no positive boost from local monetary policy. But it is just when they start to lower rates that things start to turn nasty on them, since the whole situation is non-linear. Supporting a currency with high interest rates works for as long as it does on the win-win dynamic of yield differential AND a rising currency, but once the so called carry trade “punters” get the idea that political pressures to address the economic contraction may force substantial rate cuts on the government and the monetary authorities, and that the expectation of such rate cuts may lead the other “punters” to sell local instruments and exit the market, then the “thinking punter” finds he or she also needs to sell, and this is how we get to see that “will the last one out of the door please turn the lights off” type of self fulfilling herd behaviour.

I would say Serbia, Ukraine, Hungary, Romania and Russia are all vulnerable to this kind of outcome. Of course, from a macro economic viewpoint they can all start to bring interest rates down as inflation steadily drops, but I’m not sure that the inflation element is an important consideration for the short term carry-trade people, since it is the absolute yield differential, and the currency dynamics that would seem to matter most.

Sharp GDP Contraction

Evidently the background to all this nervousness is last week’s announcement from the economy Ministry that Russia’s economy may shrink by as much as 8 to 8.5 percent this year. Gross domestic product probably contracted by an annual 10.2 percent in the first six months and may slump at a 6.8 percent annual rate in the second half, according to the latest Ministry forecast.

Behind this drop in GDP lies the fact that Rusia’s exports were down by 47.4 year on year in the January to May period, largely due to falling prices for oil and raw materials. The economy ministry also said it expected capital investment to fall by around 21 percent this year as utility and energy companies, which account for about a third of total investment, cut spending programs. The ministry forecast is based on an oil prices scenario of an average $54 a barrel in 2009.

Further, industrial production is expected to shrink between 11 percent and 13 percent as manufacturing falls by as much as 17 percent. Inflation of between 12 percent and 12.5 percent is forecast, down from last year’s 13.3 percent. And retail sales are expected to suffer an annual contraction of 5.8 percent.

For the 2010 to 2012 period the ministry currently predicts a 1 percent expansion next year, followed by a 2.6 percent one in 2011 and 3.8 percent one in 2012. This “moderately optimistic” scenario would produce a deficit of 6.5 percent in 2010, followed by further deficits of 4 percent and 3 percent over the following two years. Government officials have recently stated they expect Russia to have a budget deficit of around 9% of GDP in 2009, up from an earlier 7.4% estimate.

Short Term Indicators Show Continuing Contraction

Industrial production shrank a record annual pace of 17.1 percent in May, while capital investment fell the most since December 1998, dropping an annual 23.1 percent.

Russian unemployment fell back for the first time in 10 months in May, but despite the positive effect this may produce on confidence the rate is sure to rise further in the months to come.

Retail sales fell the most in almost a decade in May, sliding an annual 5.6 percent, the fourth consecutive decline and the biggest since September 1999. The average monthly wage decreased an annual 3.3 percent in May, while real disposable incomes dropped 1.3 percent.

From Inflation To Deflation?

After all the inflation which seems to have become endemic in Russia, deflation would seem to be the most unlikely of scenarios, and indeed it is not the most likely of out comes, given the capacity of the authorities to allow the value of the ruble to fall. However, downward pressure on producer prices is evident at this point, and the cost of goods leaving Russian factories and mines dropped an annual 6.5 percent in May after falling 4.1 percent in April, according to the Federal Statistics Service. Prices rose 0.6 percent from April.

Russia’s inflation rate – which fell to an 18-month low in June – is still far too high. The rate dropped to 11.9 percent from 12.3 percent in May. Consumer prices rose 0.6 percent in the month, the same rise as registered in May. Russia’s inflation rate has averaged more than 14 percent a year since the country’s 1998 default and is certainly one of the biggest headaches facing the country.

Some Rebound In June

Russia’s manufacturing industry shrank last month at the slowest pace since September, and VTB’s Purchasing Managers’ Index advanced to 47.3 from 45.3 in May. So the rate of contraction is easing.

Further Russia’s service industries shrank in June at the slowest pace since the contraction began in October, according to the VTB Capital Purchasing Managers’ Index which rose to 49.7 from 46.6 in May.

As a result the VTB Capital GDP indicator showed an annual 6.4 percent rate of contraction in the second quarter following a 5.4 percent decline in the first three months of the year. But output was shown shrinking at a 4.8 percent rate in June (from a year earlier) as compared with 6.8 percent contraction rate in May.

“The GDP indicator suggests that the economic decline in the second quarter of 2009 is likely to be similar to, or slightly worse, than in the first quarter,” Aleksandra Evtifyeva, an economist at VTB Capital, said in the report. “However, the prospects for the second half look brighter.” The pace of Russia’s economic contraction eased to a 5-month high of 4.8 percent year-on-year in June, compared with a 6.8 percent shrinkage in the previous month, VTB bank’s GDP indicator showed on Monday. The June reading “suggests that the economic decline in the second quarter is likely to be similar to or slightly worse than in the first one,” VTB Capital senior economist Aleksandra Yevtifyeva said in the report.

2009 Contraction In Double Figures?

According to the latest report from the World Bank collapsing industrial production, rising unemployment and ongoing capital flight will reduce Russia’s gross domestic product by 7.5 percent this year and restrain “intraregional trade flows and transfers,”. The Bank also highlighted that “Remittances to the broader CIS region are expected to decline for the first time in a decade, by 25 percent”.

Neil Shearing of Capital Economics forecasts a contraction of 10% this year, zero growth in 2010 and fears that Russia may be facing a kind of “lost decade”, since it may well not recover the 2008 level of output till 2014, and there are still clear downside risks attaced even to this estimate.

Shearing identifies three main factors which may contribute to the lost decade. First and foremost, he notes, the banking sector remains under enormous strain. While official estimates put bad debt at around 12% of total loans this year, Shearing thinks the true figure is likely to hit something closer to 20%. On this basis, he estimates that the banking sector could require up to $60bn in additional capital – far more than the $30bn that has so far been allocated by the government.

Second, by using so much ammunition this year, authorities leave little scope for further policy stimulus. Monetary policy is somewhat hamstrung as we have seen earlier, and fiscal policy will have to be tightened over the coming years in order to rein in a ballooning budget deficit. Indeed, Laura Solanko of the Finnish Central Bank’s Transition Economies Centre calls this “the largest fiscal stimulus ever” in the Russian context.

As Solanko points out, the current crisis has hit oil and gas exports particularly hard, leading to a 47% decline in export duties and a 53% decline in proceeds from taxes on natural resource extraction during the first four months of 2009. The drop in general economic activity has further reduced proceeds from all revenue sources. General government revenues in January–April were 20% lower than a year earlier. If current trends continue, Solanko estimates that general government revenues may drop to close to 35% of GDP this year – down from around 50% in 2008.

Meanwhile, government expenditure has increased dramatically at all levels. In January–April this year, enlarged government expenditure increased by 23% to RUB 4,140 billion. The expenditure at the core of the Russian fiscal system, the federal budget, increased by an astonishing 37% compared with the same period a year earlier. Even taking the fairly high inflation into account, this equals a 20% increase in federal expenditure in real terms. Relative to GDP, general government expenditure has risen to 37% and federal expenditure to 23% of GDP, against 28% and 16%, respectively, a year earlier.

To sum up, public sector expenditure has nominally increased by 23%, and relative to GDP by a whopping 9 percentage points compared with the first four months of 2008. The sheer magnitude of such a fiscal stimulus is huge. During the 1990s, Russia’s public sector shrank dramatically, its GDP share decreasing by 12 percen-tage points to 26% of GDP in 1999. The current fiscal stimulus has shot public expenditure back to the level of the early 1990s.

As the automatic stabilisers in the Russian fiscal system are small, the expenditure increase largely reflects expenditure on anti-crisis measures and advance transfers to the regions by the federal government. The government’s anti-crisis measures announced by mid-March 2008 alone would increase federal expenditure by some RUB 2,000 billion, or 15%, in 2009. Roughly half of that is directed to strengthening the financial system, and the other half to supporting the real sector.

The current federal budget foresees a deficit of 7% of GDP, a figure only slightly larger than last year’s surplus – and only slightly smaller than the total assets of the Reserve Fund. This im-plies that most of the Reserve Fund will be exhausted by year end and the Russian government will have to reenter the domestic and external bond markets in 2010 at the latest.

And we should never forget that Russia remains in the grip of a pretty vicious credit squeeze. Bank lending to companies fell 1.5 percent in May compared with April, while retail loans dropped 1.9 percent. Overdue bank loans reached 4.6 percent of the total in May, versus 4.2 percent a month earlier. And while many Russian corporates may be restructuring their debt, the only deepening their longer term exposure to currency correction risk. As in the case of Moscow-based steelmaker OAO Mechel, who, according to Bloomberg, just agreed to refinance $2.6 billion of loans in the biggest foreign-debt restructuring by a Russian company since the credit crisis began. Such refinancing is not coming cheap – the rate was 6 percentage points over the London interbank offered rate – but even more to the point this type of restructuring may only to a certain extent postpone the inevitable, since the new debt now becomes due in December 2012. This is fine if everything is all hunky-dory come 2012, but if it isn’t…..

As the OECD put it in their latest report on Russia

“The main threat to credit growth now appears to be solvency problems, arising from the declining capacity of borrowers to repay bank loans,” the bank said in an economic report released today. “The challenge is to maintain capital adequacy and prevent a sharp curtailing of lending flows.”

Lastly, Neil Shearing points out there remains little external support for the economy. With the global recovery likely to disappoint, export demand will remain weak. Oil could fall to $50pb by early-2010. As ING say:

“Oil price dynamics pose additional risks to RUB. Last week, oil prices plunged below the technically important EMA-200 level of US$63/bbl, indicating a potential further drop to US$47-54/bbl. If this happens, the RUB looks destined to weaken as well, given its greatly strengthened correlation with oil prices over the past two quarters”.

And if oil does drop back to this range, and the ruble does weaken, and non performing loans rise above the 20% mark (pushed by that very same ruble weakening, and the rising unemployment), and the Russian Federal Government has to start issuing bonds in 2010, well watch out, is all I can say, since trouble will surely be in store. This is very much knife edge touch and go stuff from here on in. Grit your teeth everyone.

This entry was posted in A Fistful Of Euros, Economics: Country briefings, Economics: Currencies by Edward Hugh. Bookmark the permalink.

About Edward Hugh

Edward 'the bonobo is a Catalan economist of British extraction. After being born, brought-up and educated in the United Kingdom, Edward subsequently settled in Barcelona where he has now lived for over 15 years. As a consequence Edward considers himself to be "Catalan by adoption". He has also to some extent been "adopted by Catalonia", since throughout the current economic crisis he has been a constant voice on TV, radio and in the press arguing in favor of the need for some kind of internal devaluation if Spain wants to stay inside the Euro. By inclination he is a macro economist, but his obsession with trying to understand the economic impact of demographic changes has often taken him far from home, off and away from the more tranquil and placid pastures of the dismal science, into the bracken and thicket of demography, anthropology, biology, sociology and systems theory. All of which has lead him to ask himself whether Thomas Wolfe was not in fact right when he asserted that the fact of the matter is "you can never go home again".

7 thoughts on “Russia’s Contraction Eases But Knife-edge Risks Remain For 2010

  1. I thought this was a very good survey of the data that’s out there – I’m currently doing a similar exercise, but my conclusion would not be so gloomy.

    First point – much of the contraction in industrial output is driven by the lack of credit – banks have shrunk their lending rapidly this year, which led to the famous meeting a few weeks ago when Putin ordered them to start lending ago, and not to go on holiday until they had fulfilled their quotas. Presumably when this money hits the system, you should see some restocking at least, and some stalled projects will start again.

    Second – the massive fiscal stimulus has also yet to hit the economy. The Russian government is slow and bureaucratic, especially when it comes to spending money on big projects, and a large amount of the cash, especially from the capital budget, has not yet been disbursed. If past form is anything to go by, it will not go until the fourth quarter, when there will be a panic rush, and the usual seasonal rouble weakness, as the money is banked and immediately converted to hard currency. But the potential is there, and this is why the VTB leading indicators are pointing up – the managers in the survey are expecting orders, once the government has signed off on everything.

    Third: the fall in exports has been matched by a corresponding fall in imports, so this contraction has not been so disastrous. Plus there has been a real pickup in this respect in the second quarter.

    Fourth: The Russian hard currency debt situation is not like the other EE countries. There’s very little household hard currency debt – it’s almost all imprudent borrowing by corporates. This was addressed late last year, when the rouble was devalued by about 25% (from 27 to 35 to the dollar) and most of the big corporates got refinancing terms from the government, or were able to renegotiate new loans from Western lenders. There are still problems, but most of the big debtors have confronted these problems and have restructured. There is still a huge threat if commodity prices crash again, but thanks to Kudrin, Russia did put away reserves in these fat years, and the net economic benefit of lending them to indebted local companies is quite high.

    I’m expecting investment and net exports to pull back significantly in the second half, and high government current spending will keep consumption level, with maybe a small fall. Net net this should come to about a 4-5% fall this year, and a rebound next year, mainly because of the base effect from this year. Naturally a lot depends on oil and commodities, and sadly Russia is doing nothing to address its structural issues or its Dutch disease, but on a macro level things could be a lot worse.

  2. Hello Sleeper,

    Thanks for the lengthy and thoughtful input. Actually in the longer term we may not be that far apart, since the structural issues you mention at the end are massive. Indeed one of the main thing that worries me about the data I am looking at is the extent of the decline in investment, and the reluctance of foreign capital to get involved again.

    Actually, the whole Nabucco issue in recent days only serves to highlight the general problem Russia is going to face being seen as a partner you can’t rely on. My feeling is Germany is still dithering – one of the consequences of Europe going the Nabucco route would of course be more reliance on Turkey, which I personally feel is a better long run bet, but electorally this may not be popular with German voters.

    Actually I am mainly focused on demographic issues, although I note looking back over the piece that I don’t even mention them. Basically, even if the theoretical argument is long and tortuous, the conclusion is simple: domestic demand is done (cooked) as a future driver of Russian growth. Now it is all about exports, whether energy and commodities or general industrial products.

    But Russian manufacturing has been the main victim (as you suggest) of the high energy prices, and is rather uncompetitive, and starved of investment (a situation which is only going to get worse in the short term).

    Basically I am pessimistic for reasons which go well beyond Russia. Everything hangs, I think on whether you think there are green shoots out there or not. I think there are some, in Sweden for example, or India, or Turkey, but far fewer than people imagine.

    I think a large part of the developed world (including nearly all of the CEE) is busy trying to close current account deficits (lead by the US), while the other half (who were running the surpluses) is running at 80% industrial capacity or less becuase they can’t find the exports.

    The world is short of customers, not credit. Once people can work out who the cutomers will be, then there is plenty of liquidity there (we are in fact awash in it) to lend. But people are not going to lend to those who are already seen as overleveraged, and are seen as having difficulty paying.

    “First point – much of the contraction in industrial output is driven by the lack of credit – banks have shrunk their lending rapidly this year, which led to the famous meeting a few weeks ago when Putin ordered them to start lending ago, and not to go on holiday until they had fulfilled their quotas.”

    Indeed, I agree. In fact, any weakening on local interst rates and the ruble front and the banks will go back to buying dollars and making money from devaluation again.

    But the thing is, you can’t force banks to lend to insolvent clients, and just generate more and more non performing loans (at least, you can’t unless your name is “China”, and we will see how all this ends up). I am in Spain, and we have a very similar situation here. The banks are brim full of liquidity, but cannot take the risk of lending to anyone they don’t have to becuase of the underlying negative dynamic. So they just keep piling on the loans to those who they know are “too big to fall”, since the government will eventually step up to the plate and carry the can.

    This must be happening in Russia right now.

    “There is still a huge threat if commodity prices crash again, but thanks to Kudrin, Russia did put away reserves in these fat years, and the net economic benefit of lending them to indebted local companies is quite high.”

    But isn’t the whole point that this is almost all spent. If the contraction continues apace into 2010 (as I feel it may well do) and we have oil prices below $50 dollars, then they are going to have to do some more “bailouts” and they are going to have to go to the international finance markets to sell bonds. It is then that I think the real action starts in Russia.

    Basically, I am gloomy because the current inflation rate (with a 10% annual contraction in place) is sysmptomatic of very deep problems, monetary policy is caught in a bind which will make it difficult to lower rates too far. Restructuring of debt only works if you turn the situation round, if you don’t then the issue simply resurfaces again, one, or two years later. Few, if any of the restructured syndicated loans will have been in rubles due to the high local rates, which is where monetary policy enters double bind.And I think you are too optimistic on fiscal policy. In a situation like this, where the transition is structural, not cyclical, fiscal policy can at best serve as a stop gap while you refocus on exports. As we can see clearly in Spain, if you don’t use the opportunity to restore competitiveness, then you just keep going down the plughole. This is where Russia is now. Some of the devaluation has already been recovered via carry trade upward pressure on the ruble, while more has been lost by the ongoing inflation. Russia’s export industries are still not competitive, and by the end of this year the fiscal setting will turn negative. I think we are in for a bumpy ride in 2010.

  3. There’s another problem here Sleeper. You mention debt restructuring, but this simply postpones, rather then removing the problem, unless there is some element of implicit default.

    The problem is, when do the rengotiated loans become due? If the Spanish example is anything to go by, they will be displacing forward to around 2011/12 in the hope that improvement will come by then. But if it doiesn’t?

    Assuming they have still gone for $ denominated syndicated stull (this is where the local monetary policy trap gets really vicious) then there could be more serious currency adjustment risk out ther 12 to 18 months from now. I am only guessing, but it may be a hunch worth following. Certainly, I have 2011 pencilled in as crunch year for Spain.

    And looking at this piece in Bloomberg on Mechel, they have just refinanced $2.6 billion of loans in what is descibed as “the biggest foreign-debt restructuring by a Russian company since the credit crisis began”.

    And the thing now becomes due in December 2012. So this works, if it works. And if it doesn’t, then the blowout is even bigger than it would have been. This is just sitting at the casino table and upping the stake.

  4. Indeed, only this morning the OECD seem to have come down more on my side of the fence:

    The Russian banking system’s stability is of “prime importance” as the government seeks to spur lending in the face of rising delinquent debts, the Organization for Economic Cooperation and Development said.

    “The main threat to credit growth now appears to be solvency problems, arising from the declining capacity of borrowers to repay bank loans,” the bank said in an economic report released today. “The challenge is to maintain capital adequacy and prevent a sharp curtailing of lending flows.”

    I absolutely agree.

  5. I think that the main point of contention here is that I can see ways in which Russia’s GDP numbers might not be as bad as people are predicting, but I don’t think we disagree about the long term problems of the underlying economy. (I’ve always had philosophical problems with the whole notion of GDP, to be honest.)

    But everyone tracks GDP, and the Russian government has set itself the task of trying to boost GDP performance, and my belief is that they are addressing the problems well. The reserve funds will finance deficits that can hopefully prime the pump, and don’t forget that the Russian capital markets have been crying out for more government paper – capital markets development has been stunted by the lack of blue chip instruments, which has made it harder for the more conservative end of the money management business, like pension funds and insurance companies. So there is room to borrow, and the reserve funds were created for a rainy day like this. Yes, they will be used up (as yesterday’s Vedomosti suggested) but there should be a multiplier effect (albeit less than if they had actually done any structural reform). But the next effect, numerically, at least, will be that year end GDP growth looks better than the mid-year number, because a lot of this spending just hasn’t hit the markets.

    Second, on banks and lending. Some of the banks, especially Alfa, are crying blue murder about the quality of their loan books. This is as much political as anything else – Alfa, for instance, is the only holdout in the GAZ debt restructuring. They want all their money back, so they are bleating about problems in their overall loan book. And they are saying that this is rife in the system, because they don’t want to look like incompetents. I’m not a bank specialist but Sberbanks NPLs are still below 5%, and I think that VTB’s are not much worse, and none of the big banks seems to be having solvency problems.

    In fact what’s amazing is that there really hasn’t been any sort of run on the banks, as in 1998. I was thinking about this, and wondering if I should worry about the money for my daughter’s next year’s school fees, which is sitting in Euro in Raiffeisen, but I don’t feel any panic, and so far this year I haven’t heard any of the crazy rumours, or currency reform rumours that the dealing desks used to send around once a month last year.

    The banks are important, and are a source of risk. I don’t deny this. But you have to understand that when the banks protest publicly about the quality of their loans, they have an agenda. Putin is holding a gun to their heads, telling them to make loans, and they don’t want to. And part of the reason for this is that most of them aren’t real bankers. They don’t want to make long term loans to long term customers. They want short term loans backed by high quality security. Or they want short term low risk currency speculation. Very few banks really want to be lending bankers in the traditional style. Sberbank is happiest on the interbank markets. Alfa is just trying to build a retail banking network that they can sell to HSBC – no problem building up liabilities, but they are as skittish as debutantes when it comes to committing themselves to assets. One of the big problems now is that too many banks are placing money on deposit at the CBR, which pays 8%, and they would rather do this, than actually lend to anyone.

    You could argue that this is because the economy is so weak. My (and the government’s) argument is that on the macro level, this then becomes a self-fulfilling prophecy. But a primary reason for the banks’ fear is that they just don’t know, because they are not real banks – they’re not out there feeling the real economy, because they have done everything in their power to distance themselves from it. Of course, a major reason for this is that the government itself has been happily abusing property rights for a long time, and there is no Mittelstand that can sustain and grow with a proper banking system.

    What I really want to emphasise, though, is that the situation is very different from the Baltics and Central Europe and Kazakhstan – you don’t have a massively over-extended banking system that got carried away on animal spirits and cheap financing from abroad. The problem here is that the banks never really lent enough, and part of the reason for that was that entrepreneurs really didn’t like being too leveraged (except for the oligarchs). And public confidence in the banks is surprisingly high, at least from where I stand in Moscow.

    The way out of this, of course, is for the government to borrow from the banks, and spend itself. And I think they will be happy to do this, because it’s not really that different from what the Obama administration is doing.

  6. Hi again Sleeper,

    First off sorry for the delay, I’ve been away. Also, I really appreciate your perspective as someone living in Russia. Also I appreciate the difficulties your country is having. On your children and money in bank etc, I don’t expect any big panic. Russia has huge resources, and everyone knows this, so you are unlikely to see any sudden meltdown.

    What I am saying is that the situation is definitely improving moderately, for the reasons you mention, and becuase the global situation has stabilised. That was the theme of this article really, and the point that in the absence of a pick up in the global economy, serious risks exist for 2010.

    (I’ve always had philosophical problems with the whole notion of GDP, to be honest.)

    well this is another whole problem. But for what it is worth, Capital economics compile their own quarter on quarter seasonally adjusted GDP data (thanks to Neil’s kindness). This data is not published by anyone in Russia to my knowledge, yet it is vital to following an economy.

    Anyway, according to Capital Economics calculations, GDP dropped 9.1% over Q4 2008. This is massive, but it is clear there was something like this from the year on year data they did publish. Now, from here on in the statistical issues get complicated, but my feeling is that it is only possible to get less than around 8% contraction this year if you get small but positive growth in Q2, Q3 and Q4.

    I think this is very hard to do. Maybe in Q2 there was some slight growth, but this is unlikely to be repeated, since it is largely to do with falling imports, and my guess is still at least a 10% fall in GDP this year. Well, it remains to be seen if I am right or not.

    “But everyone tracks GDP”

    Well, GDP is important for one single and simple reason, in ageing societies, GDP growth gives us a measure of the sustainability of public finanace (and hence default risk) in the face of rising health and pension costs.

    Take Italy, as a good example. We can all readily agree that Italian GDP severely underestimates the level of output in Italy, due to the very large informal economy. Fine.

    But Italian gross government debt to GDP is now about to hit 110% of GDP, and long run economic trend growth is struggling around zero. In the long run Italy is bankrupt.

    The reason. There is simply no way that the government can get the resources to pay for all those people who appear around 60 looking for pensions and health care after year and years in the informal economy on the limited GDP tax base they have. So short term gain for some has created a huge long term problem for all Italians here.

    From what I have been seeing, a number of societies in the East (Hungary, for exmple) now have created the same sort of problem.

    Well, this is not directly to do with the current situation in Russia, but still.

    “The reserve funds will finance deficits that can hopefully prime the pump”

    Well, this is just what I have my doubts about. I’m not sure – whithout a resurgence in oil prices – that this economy can be “primed”, that is my judgement, and basically I’m sticking with it till I see proof to the contrary.

    “and don’t forget that the Russian capital markets have been crying out for more government paper”

    Of course, but with base interest rates at 11% it is the Russian government that can’t afford to borrow money at these prices, not without also guaranteeing inflation to make real interest rates manageable, and that also would be madness.

    So they need to try to raise dollar denominated debt, and this is where they have a problem if the value of the ruble has to slide, which it will have to to get interest rates down, which is where I started this piece, with their monetary policy double bind.

    “I’m not a bank specialist but Sberbanks NPLs are still below 5%, and I think that VTB’s are not much worse, and none of the big banks seems to be having solvency problems.”

    No, but they are rising at a lively clip, and remember not all NPLs are being declared at this point, for obvious funding difficulty reasons – banks have a built in interest in massaging their bad loan numbers. Gennady Melikyan, one of the first deputy chairmen at the central bank, estimated last week that non-performing loans although slowing, still rose by a monthly 5.9 percent in June, after gaining 10 percent and 12 percent in the previous months. So while excluding Sberbank, delinquent debt only reached 4.8 percent of the total banking system portfolio (Melikyan estimate) the rate of increase means that by the middle of next year problems can be significant. Sberbank’s bad loans were 3.5% of their total in Q1, and they must have risen since then. So they are also probably around 4.5% at the end of H1.

    Neil Shearing reckons we could see bad loans reaching around 20% of total by the end of the year, and this seems to me a reasonable estimate.

    “They don’t want to make long term loans to long term customers. ”

    Well quite. This is what the credit crunch means. This situation is replicated in one country after another. And this is the aspect I fear you may not be seeing, just how extensive and just how vicious this credit crunch is proving to be in one country after another.

    “One of the big problems now is that too many banks are placing money on deposit at the CBR, which pays 8%, and they would rather do this, than actually lend to anyone.”

    This situation is not that different in many eurozone countries, since the ECB just did a massive 450 billion euro lending operation, and the majority of the money went straight back to sit in interest earning deposits at the ECB. Noone wants to lend to people who may be unemployed tomorrow, or companies who may be bankrupt next month.

    “The way out of this, of course, is for the government to borrow from the banks, and spend itself. And I think they will be happy to do this, because it’s not really that different from what the Obama administration is doing.”

    I think you are missing the huge structural and institutional difference between the two countries here. The US still runs its own monetary policy, and borrows in its own currency. Russia is completely unable to do that due to the totally ridiculous monetary policy and inflation tolerance we have seen in recent years.

    Don’t you remember when Putin was justifying all those 20% wages increases? Now all of this has ended in tragedy. The Russian government cannot borrow in its ow currency without fueling huge inflation, since the whole system is out of control, and the underlying issues – about the competitiveness and investment in Russian manufacturing industry – mean that pump priming won’t work.

    You need substantial default on corporate loans in 2010- 2012, not simply forward displacement, and a modern institutional and monetary policy to get things under some control. Frankly I have little confidence that any of this is going to happen, so I expect problems.

    Anyway, we cannot resolve any of this here and now, we will only see going forward. In the meantime, why not join my facebook for an ongoing, blow by blow, discussion as the news arrives.

  7. Pingback: Of Oligarchs, French Banks, and a Whole Pile of Problem Loans | Western Europe

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