by Anders Aslund, Peterson Institute for International Economics
Op-ed in the Moscow Times,
March 26, 2008
© Moscow Times
See related article: "A Frightful Wake-up Call" September 24, 2008, Moscow Times
As the 10th anniversary of Russia's financial crash approaches in August, Russians can take heart from the US financial crisis. "Have you not learned what you taught us?" many are asking.
An American who used to work in the International Monetary Fund told me the other day how deeply embarrassed he was that his country had conducted itself as the worst emerging country. But what does the US financial crisis mean for Russia today?
The United States has been caught in its own financial hubris, much like Russia of 1997. For too long, Washington maintained a large current account deficit, claiming that the country was just irresistible to foreign investors. President George W. Bush did not finance his war in Iraq with taxes but with a steady budget deficit. Legendary Federal Reserve Chairman Alan Greenspan maintained a very loose monetary policy. This made him quite popular, but it led to a bubble in technology stocks and another in housing. Lending standards fell to a new low, as banking regulation eased.
Two different scenarios prevail. Until recently, the dominant view was that the United States might get a recession—a decline in gross domestic product for at least half a year—but then GDP would swing up again in the second half of 2008. The alternative view was that the United States was approaching a 1929-like depression.
The US government's response is evident: Its main concern is to maintain liquidity. The Federal Reserve is going to cut its interest rate as much as it has to and much faster than ever before. A federal funds rate of as little as 1 percent later in 2008 would be extreme, considering that the rate in September was 5.25 percent, but it is quite possible. At the same time, the federal government is increasing its fiscal deficit to stimulate demand. Reassuringly, the Federal Reserve has facilitated the purchase by JPMorgan Chase of the failing investment bank Bear Stearns in no time, trying to stop financial panic and making sure that the banking and payment system does not freeze because of fear.
Russia, by contrast, has learned its lessons from 1998, and it has been buttressed by its large oil revenues. With its huge current account and budget surpluses as well as international reserves, Russia is not very vulnerable. Nonetheless, it will be affected in several different ways because it is highly integrated into the world economy. In fact, Russia's main problem might be an abundance of capital inflows.
What will happen with the abundant liquidity that is being poured into the US economy through the Federal Reserve's loose monetary policy? Americans are certainly not going to buy more houses, as price declines are predicted to last until 2010. Nor are they going to purchase commercial bonds, whose reputation has suffered badly. And why acquire US equities when the economy is slowing or declining and profits must be falling? Instead, shell-shocked Americans are likely to boost their minimal personal savings, which will further reduce demand. Indeed, why keep money in the United States? The US dollar is currently falling like a stone, and such falls are not easily halted. Even "safe" treasury bonds are losing value as the currency plummets.
Americans with a choice are likely to transfer their excess liquidity abroad to currencies that are likely to appreciate, and the ruble is a prime candidate for appreciation. This is particularly true since Russia is keeping the ruble exchange rate artificially low, meaning that the ruble can only appreciate. The euro has already risen so high that it might be close to its peak. As a consequence, European exports are likely to suffer, causing the European economy to slow down. In this case, investment in European stocks and bonds will not appear very attractive.
What better safe haven for investors is there than Russia? First, the ruble is undervalued. Second, Russian equities rose moderately last year and are quite cheap by any comparison. Third, commodities are scarce and their prices have surged for long. As they have become securitized, they can easily be purchased by ordinary people. They are likely to be a prime object of speculation or just safekeeping. As a consequence, Russia's export revenues might soar even more and the economy will flourish, rendering all kinds of Russian assets—real estate, stocks and bonds—attractive to foreign investors. At the same time, the country's macroeconomic indicators will continue to ride and further attract investors.
The stock prices of many big Western corporations, ranging from Citigroup to General Motors, have already fallen to a fraction of their prior values. Meanwhile, Russian asset prices are set to rise, and the government coffers will be filled with cash. This means that both Russian businessmen and the government are likely to purchase distressed Western assets on a grand scale. Is the West ready for this and will it even allow it? It should, but the government needs to reassure Western countries that its intentions are benign.
But Russia is also facing risks. No Russian bank seems to have bought US subprime mortgages because Russian mortgages are so much more profitable and safer. But many Russian banks have borrowed abroad at current interest rates that have now surged. Some significant banks are likely to end up in trouble. The big state corporations, such as Rosneft, VTB, and Gazprom, have been the biggest lenders. The energy companies will be compensated by higher energy prices, but some banks may suffer. The Central Bank has been surprisingly concerned about lacking liquidity in the banking sector.
The country's main worry, however, should be an artificial and excessive capital inflow that leads to more corruption and even less reform, as the country experienced during the oil booms in the 1970s and now. An abundance of short-term capital inflows is one form of resource curse. If commodity prices are boosted by speculation, consumers will save energy by all means, and prices will fall even deeper after the Western financial crisis abates.
The government can do many things to avert such a future crisis. First, it should let the exchange rate float upwards, so that a bet on the ruble does not become a risk-free gain. Second, Russia should try to contain an unsustainable rise in commodity prices—for example, by privatizing oil and gas fields so that production can increase again. No country will suffer more from a temporary, unsustainable peak in energy prices than Russia, because soon demand—and thus prices—will plummet. Once that happens, Russia will lose its footing. Third, the government should even consider taxing short-term capital inflows—especially given the likelihood that they will move out as soon as the worst aspects of the financial crisis have passed.
Although Russia will most likely suffer the least from the US financial crisis, it will be a test for all of us.
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