Suddenly, Russia stands out as one of the countries likely to be worst hit by the international financial crisis, although it entered the crisis with huge budget and current account surpluses since 2000 and the third-largest currency reserves in the world. It would be unfair to blame only international markets, as Prime Minister Vladimir Putin does, considering how flawed his own economic policy is.
Apart from Russia's excellent fiscal policy, just about everything has been wrong with the country's economic policy since authorities arrested former Yukos CEO Mikhail Khodorkovsky in October 2003. Shortly after this, Yukos was confiscated. The only significant short-term relief is to free the ruble so it can depreciate. Apart from the fall in oil and other commodity prices and the international liquidity squeeze, Putin has caused the lion's share of the country's current economic problems.
Initially, Russia was hit with a huge exogenous shock when its terms of trade deteriorated sharply because of the sudden fall of oil, gas, metals, and other global commodity prices. With current commodity prices, the country's exports next year could plummet by some 40 percent in current dollars, or by $200 billion. Budget and current account surpluses will quickly turn into deficits.
Russia is praised for its large currency reserves and its limited domestic leverage, but it suffers from minimal domestic financial intermediation because inept state banks dominate the financial market. The state takes money out of the country, while its big corporations are forced to borrow abroad, maximizing their currency risk. If Russia had privatized its banking system as most other post-Soviet countries, its companies would suffer from fewer currency risks.
Putin's chief project has been to develop huge, unmanageable, state-owned mastodons, considered "national champions." They have stalemated large parts of the economy through their inertia and corruption while impeding diversification. In addition, they have financed themselves with foreign loans rather than equity, and this has aggravated the country's currency risks.
Russia's nationalistic energy policy after 2003 has stalled the development of major new energy investments (apart from the Sakhalin projects, which date back to the Boris Yeltsin era). Gazprom and Rosneft have financed themselves with foreign debt rather than with equity capital, accounting for almost one-fifth of Russia's corporate foreign debt of $490 billion. Gazprom's aggressive pricing and delivery disruptions have scared away customers, reducing the demand for its gas.
Huge public funds are being diverted to state corporations, which either hoard the money or siphon it off. In their new book, Putin and Gazprom, Boris Nemtsov and Vladimir Milov have offered a staggering and credible account of how Putin and his friends pilfered assets of $80 billion from Gazprom during his second term as president. Investors have taken notice, slashing Gazprom's market capitalization from $350 billion last spring to $70 billion at its nadir. Although Russia is the 46th-richest country in the world in per capita terms, it is ranked 147 out of 180 countries on Transparency International's corruption perception index for 2008. Only Equatorial Guinea is both richer and more corrupt than Russia.
Under Putin, transparency has systematically been reduced, and we no longer dare to trust the government's public statements on its currency reserves. Officially, they have declined by $163 billion, or 28 percent, from $598 billion in early August to $435 billion in early December. But when Vneshekonombank was given $50 billion of state reserves to help Russian oligarchs with refinancing, nothing was deducted from the official reserves as it should have been. In an article on Gazeta.ru on October 24, Alexei Mikhailov plausibly claimed that another $100 billion or $110 billion of "other reserves" had been transferred to the banking system and were nothing but rubles. To my knowledge, no official denial has been issued. If that is correct, the reserves have fallen by more than half to less than $300 billion, but the government sheds no light on this.
Russia's largest corporations have turned out to be much more leveraged than anybody had thought. The government has made clear that it will refinance their foreign loans to secure "strategic" ownership. So far, $13 billion has been paid, out of which United Company RusAl has received $4.5 billion and Altima $2 billion, but such private pledges are huge. Vneshekonombank has $37 billion left to spend, but it has already asked for $30 billion more from the government, and more is likely. Thus, Russia can swiftly lose more than $100 billion of reserves.
Putin has persistently denied that anything is wrong with the country's economic policy, while everything but its fiscal policy has been wrong. Domestic and foreign businesspeople realize that he does not talk about reality, which undermines confidence in the Russian market. Without free public debate, rational policy decisions are unlikely.
Incredibly, the government is repeating its mistake from 1998 to maintain a pegged exchange rate in the face of falling commodity prices. Until this summer, this policy provoked speculative capital inflows that boosted the money supply excessively and propelled inflation to 15 percent. Now, the pegged exchange rate, which is probably overvalued by up to 25 percent, promotes speculative capital outflows, quickly reducing the currency reserves. Devaluations in very small steps only convince the market that a major depreciation is inevitable. The coming combination of loose fiscal policy, negative real interest rates, current and capital account deficits, and an overvalued ruble is unsustainable. The incentives for capital flight are overwhelming.
The global economic crisis is testing Putin's system. He has undermined the ground under the house Yeltsin built, transforming the country into a house of cards ready to tumble. He has wasted the oil wealth rather than investing it in infrastructure, health care, education, and law enforcement reform. Russia needs fundamental change; above all, it needs to uproot-or at the very least contain-the country's pervasive corruption, which has gotten markedly worse under Putin. Nothing would serve the country better than the retirement of the failed prime minister, but that is evidently not in the cards.
One of the few policy measures that can be undertaken with Putin still in power is to let the ruble float freely, move to inflation targeting, and boost interest rates to positive real interest rates. A commodity-exporting country needs to let its exchange rate float up and down with global raw material prices to balance its foreign payments. At present, all speculators sensibly bet on a ruble devaluation, just like in 1998, which quickly depletes the country's currency reserves. When the ruble is allowed to float, it is likely to plummet. But after that, nobody knows whether it will rise or fall, and this will reduce speculation and losses of currency reserves.
Does anybody still believe that Russia's economy will grow in 2009?