Illarionov on the Stock Market and Georgia

Andrei Illarionov, first writing in the Moscow Times on the stock market crash and then via Paul Goble on Georgia:

From its peak on May 19 to its lowest point on Sept. 17, the Russian stock market has fallen by almost 58 percent. This is its largest decline since the crash of 1998. What is the cause of the current cataclysm?

The Kremlin has been quick to blame the West, and primarily the United States, for the country’s troubles. Prime Minister Vladimir Putin blamed Western “speculators” who pulled out their investments en masse at the first sign of trouble. He also denied that Russia’s aggression toward Georgia played any role in the market’s fall. Putin suggested that the crisis is connected “not with the problems of the Russian economy, but with problems of the West’s economy.” In recent comments, he even referred to it as the “American contagion.”

President Dmitry Medvedev concurred, saying, “The United States caused the whole crisis with its own financial market. … Regarding the factors that were responsible for the drops in the Russian stock market, I would estimate it as follows: 75 percent of the fall in the stock market is connected with consequences of the global financial crisis and 25 percent due to our internal problem, including consequences of the war in the Caucasus.”

How accurate are these assessments?

After May 19, stock markets in almost every country of the world started to decline, and Russia followed this downward trend. Therefore, in the first stage of the global crisis, the financial problems were by no means specific to Russia. This global decline continued for almost two months. During this period, the U.S. stock market fell by 11.5 percent, the global market by 12.9 percent and the Russian market by 13.1 percent. Because the Russian market’s decline was slower in comparison to emerging markets, which fell by 17.5 percent overall, this may have confirmed for many observers what Finance Minister Alexei Kudrin claimed in January — that Russia had become an “island of stability.”

But all of that changed on July 18, when the RTS fell by 4.5 percent, while there was little or no change in the markets in the United States, Europe or in emerging markets. What happened on that day? The Federal Migration Service granted TNK-BP chief Robert Dudley a “temporary visa” — valid for 10 days only. This was followed by a prolonged harassment campaign aimed at Dudley and other top managers from the British side of the joint venture. It became clear that the government was favoring the Russian shareholders in the conflict. In 2003, when TNK-BP was formed, the company had been touted as the crown jewel of successful joint ventures between Russian shareholders and a venerable foreign multinational corporation. It had the support at the highest level of both countries, including then-British Prime Minister Tony Blair and Putin. Thus, when this much-celebrated joint venture deteriorated into a nasty, underhanded shareholder battle, many investors drew their own conclusions about the unstable, unpredictable and arbitrary investment climate in the country. They started to pull their money out of Russia.

In the following weeks, Russia’s stock market continued to drop. These declines were deeper than in other emerging markets, and this was because of the following additional events: Putin’s promise to “send a doctor” to Mechel’s director on July 24; the start of Russia’s intervention in Georgia on Aug. 8; the Kremlin’s unilateral recognition of independence for South Ossetia and Abkhazia on Aug. 26; and a whole series of official, inflammatory statements directed against the West from Sept. 3 to Sept. 17, which were accompanied by the decision to send strategic bombers to Venezuela and the announcement of naval maneuvers in the Caribbean Sea.

The authorities managed to achieve the impossible: In less than two months, Russia’s stock market declined by 51.8 percent. To be sure, stock markets in other countries also declined during this period, but it was nothing like what happened in Russia. The U.S. stock market fell by only 8.5 percent, the global market by 12.4 percent and the overall market of developing countries by 25.4 percent.

Given those dynamics, it would be difficult to blame outside influences — especially the United States — for causing Russia’s financial crisis. Had investors appraised the risk-return ratio for their Russian investments to be the same as that in the crisis-stricken United States, then the Russian stock market would have lost no more than the U.S. market did. And even if we were to take seriously what was reported in the Western media — that top Russian officials believed that the U.S. government had instructed U.S. banks not to lend to Russian companies — then why didn’t investors from Europe, Asia and the Arab states happily rush in to snatch up those greatly devalued shares at bargain prices? On the contrary, they stayed far away from the Russian market because they also evaluated it as a high-risk investment.

The drop in world oil prices has also been cited as a contributing factor to the country’s stock market crisis. Indeed, oil prices fell by 38 percent over a two-month period — from July 17 to Sept. 17. But Russia’s market — which includes far more than just oil company shares — fell even further. In fact, the main evidence against the “oil factor” argument is the performance of markets in other leading oil-exporting countries. Even in these countries, where the share of oil production in their gross national product is generally higher than Russia’s, markets fell by only 20 percent.

In the end, only a small portion of the 51.8 percent decline in Russia’s stock market can be attributed to the “American contagion.” In reality, the “U.S. factor” could not have accounted for more than a 17 percent decline. But by insisting on blaming the United States for its financial woes, the Kremlin is trying to trick the Russian people, as well as themselves. Foreigners, however, would never fall for that nonsense.

As it turns out, at least half of the market’s fall is attributable to domestic causes. Foremost among them were the Kremlin’s attacks on Russian and foreign businesses, its aggression against Georgia followed by its recognition of independence for South Ossetia and Abkhazia, and the subsequent fears of investors and the international community as a whole that a new Cold War was about to start. Unlike Russia’s leaders, investors are scared off by any form of war — whether it is “hot” or “cold.”

The total capitalization of Russian companies with shares traded on the stock market has fallen by almost $800 billion since May 19. Capitalization losses since July 17 alone account for more than $600 billion. Half of those losses — more than $300 billion — were the direct result of factors originating from Russia.

The Russian government pretended to be mitigating the effects of the crisis by pumping more than $100 billion of state funds into the stock market, but nearly all of these funds went to state-owned companies and to other businesses that have close ties to the government.

But Russia’s stock market crisis was brought on by more than just superficial causes. The drop in global oil prices to $90 or $100 per barrel — a symptom of the shifting winds of the global economy — was not damaging enough to trigger a crisis of this depth. Neither could the liquidity crisis be the reason, with Russia currently awash in petrodollars. Systemic, institutional problems are the real cause of this crisis. There is a fundamental incompatibility between open global markets and the universal principles of tolerance and respect that govern it in the West, on the one hand, and the paranoia and aggressiveness of Russia’s current leadership, with its cult of isolation and militarism and the modus operandi of street gangsters, on the other hand.

In Korney Chukovsky’s classic children’s poem, “Putanitsa” (“The Muddle”), a crocodile is unable to put out a fire with pirogi and blini. Similarly, the fire of Russia’s deep and long-term institutional crisis cannot be extinguished with the financial “pirogi and blini” offered by Russian leaders — particularly when these goodies are divvied out only to their close friends.

Paul Goble summarizes a recent speech from Illarionov in Russian on the Georgia attack:

The Russian government began preparing for the invasion of Georgia four years ago as part of a more general attack on the West and the West’s democratic, free market, and security ideas in the post-Soviet states, according to former Putin economics advisor and more recently Kremlin critic Andrei Illarionov.
In a speech delivered to the Cato Institute in Ukraine on September 4 but posted online only this week, Illarionov described what Moscow’s political leaders had said about Georgia over that period and what Russian intelligence services had done against Georgia well before the first of August. And he described precisely what Russian forces had been doing in the weeks leading up to the outbreak of hostilities and what they did after that time, actions that in both cases show just how false are all Russian claims that Tbilisi started the war and that Moscow intervened to defend its citizens or the right of nations to self-determination.

If one examines this history, Illarionov said, then it becomes clear why Moscow went to war against Georgia and why it is so critical that everyone understand that “the Russian-Georgian war is part of another, very major war that Russia intends to launch as a responsive strike to the West.” After disposing of Russia’s “propaganda” arguments about its invasion of Georgia – the defense of Russian citizens, the right of nations to self-determination, and the supposed Georgian genocide of Ossetians – Illarionov focused on two things: the reasons Moscow decided to move against Georgia after the “rose” revolution and the specific steps it took.

According to Illarionov, the reasons for the Russian-Georgian war are to be found in Moscow’s reaction to the changes Georgia has undertaken in the last four years and to Mikhail Saakashvili’s success in restoring Tbilisi’s control over the Ajar region which had more often looked to Russia than to Georgia. Over the last four years, Illarionov said, “a contemporary, European, democratic state, responsible to the population, has been created.” And he added that as a specialist on economic reform, he was prepared to assert that there has not been any other country in the world which “has carried out so many reforms in such a short time.” Those reforms, the former Kremlin advisor said, made it possible for Mikhail Saakashvili to turn from Moscow to the West and to indicate that he wanted his country to become a member of NATO and other Western institutions. Such goals were unacceptable to the Russian leadership, and consequently, it set as its “task” the removal of Saakashvili.

After the Georgian president “resolved” the Ajar problem, Moscow “began to think” about replacing him. In December 2005, the Kremlin ordered the heads of Russian energy companies to begin a blockade of Georgia, but when that effort failed, the Russian government turned to other means. Several pipelines and electric power lines passing from Russia to Georgia were blown up, actions that many blamed on Islamic terrorists but which, Illarionov said, investigations showed were in fact the work of Russian special services. And “after that, there was an attempt at the liquidation of the leader of the [Georgian] opposition,” presumably by the same agencies.

In 2006, the Georgian special services arrested several Russian agencies but, Illarionov noted, “Georgia followed diplomatic etiquette and without any noise sent them back to Moscow.” Moscow stepped up its penetration efforts, and in September, Tbilisi announced the arrest of four Russian agents, and Moscow responded with an economic blockade.  Over the same period, Russia “strengthened its military presence in Abkhazia and South Ossetia,” and Russia diplomats told their colleagues quite openly that Moscow would engage in military actions in Georgia before September 2008, statements that many were inclined to dismiss but that proved to be quite true. And then Illarionov details the specific steps from July through mid-August that show that Russia was planning to move well before Saakashvili transferred his forces into South Ossetia, the action that the Russian government continues to insist was the proximate cause of the war.

Most of the details he provided about that period have been reported in the Western media, although they, like Illarionov’s speech in Kyiv itself, have not been given much attention in the mainstream Russian media. (On that failure, see the discussion of Illarionov’s remarks on the Kavkaz Centre website.) But the former Kremlin advisor’s conclusion is if not new at least more clearly articulated than those which have been offered by most others. He pointed out that Russia continues to want a change of leadership in Tbilisi because for the Kremlin, “the western choice of Georgia is unacceptable.” Consequently, Illarionov said, Moscow’s war against Western influence in the post-Soviet states and hence against the West itself has just begun. From the Kremlin’s perspective, Georgia was the weak link, a place where unlike in the Baltic countries or even Ukraine, it could act.

But because it did not achieve its goal in Georgia, Moscow will continue to push there and elsewhere because Illarionov suggests, the Russian leadership knows that if the Western combination of democracy and free markets succeed in these countries, not only will Russia’s influence there decline but the power of Russia’s current leaders will be at risk as well.

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