EDITORIAL: Diagnosing the Russian Economic Malaise


Diagnosing the Russian Economic Malaise

When investors entered this market, there were certain carrots at the end of the stick. All of these carrots either did not materialise at all or came out in some way retarded.”

— Sergei Emdin, the head of EuroSibEnergo, an electricity investment unit of Russia’s richest man, Oleg Deripaska, speaking on investment in Russia’s energy sector at an energy summit on Tuesday in Moscow

Things are getting uglier by the minute on the economic front in Vladimir Putin’s Russia.  The country is in recession, with a 0.4% contraction in GDP last month (industrial production contracted at six times that rate).  Due the Kremlin’s crazed tariff policies, the Moscow Times reports that Russian oil producers, with their costs soaring, lost over $3 billion on oil exports in September and October.  Only now, months too late, has Putin finally cut the export duty, meaning that the Kremlin will finally begin to suffer a massive loss of revenue from the falling market price of oil, placing the state budget at dire risk.

The ripple effects on the oil-dependent Russian economy have been devastating, and angry investors who were stupid enough to trust the Kremlin are demanding answers, and the full brunt of the disaster wrought by Vladimir Putin’s incompetent leadership has yet to be fully felt. Rachel Ziemba, lead analyst for oil-exporting countries for RGE Monitor, has offered an extensive review of Russia economic performance on the organizations’s website.  It highlights several neglected facts that emphasize the increasingly dire economic peril faced by Putin’s Russia.

Ziemba points out that the bleak economic forecast of 3% economic growth for Russia in 2009 put out recently by the World Bank was based on an average oil price of $100/barrel next year.  Even at that price, Russian GDP growth was expected to halve compared to this year, since that price would represent a nearly 50% falloff from the recent record highs.  Thus, if oil prices remain at $50/barrel through 2009, Russia will clearly plunge into a brutal recession and the Kremlin will incur rapidly mounting debt (a deficit of 5% is expected in the 2009 budget if oil prices remain where they are).  Yet, the Kremlin’s recent behavior in repeatedly shutting down the Russian stock markets and invading Georgia hardly make it a prime candidate for lending.  Moreover, Ziemba points out, the Kremlin’s total lack of transparency and trust, combined with Russia’s pandemic corruption, makes it difficult to implement liquidity injections effectively, and may doom such efforts before they begin.

The ruble has lost 17% of its value so far this year, Ziemba says, and the government’s furious attempt to artificially limit the slide is not only costing Russia billions in FOREX reserves, but also “may be exacerbating the outflow from the  banking system (outflows were about 5-7% in October) even as it erodes Russia’s cushion of foreign exchange reserves.  Foreign investment flows have clearly reversed – In 2008, Russia has now had net outflows of investment in contrast to the inflows experienced in recent years.”  The cost to Russia of combatting the economic crisis is truly staggering; some sources are suggesting the price tag will be at least $400 billion, or one-quarter of Russia’s annual GDP and virtually the entire amount of its existing FOREX account.

But that is not the worst of it.

Ziemba explains that Russia is now experiencing an “oil bubble” that is no different from the “housing bubble” that caused havoc in the U.S. economy. So much for Vladimir Putin’s haughty denunciations of the U.S. economy as a troublemaker!  She shows that Russian banks and other financial institutions have leveraged Russia’s oil windfall in exactly the same manner as U.S. homeowners did, and warns that “now the bill is coming due.” 

And the people of Russia have been doing exactly the same thing, leveraging the oil windfall to purchase imported goods that their own market cannot supply.  As the ruble cheapens and the oil windfall disappears, Russians will no longer be able to afford foreign goods and will face shortages because ” Russia may have difficulty sourcing some of the goods at home as productivity in most sectors remains weak.”

Russian industrial growth is contracting rapidly

Russian industrial growth is contracting rapidly

The chart at left shows now Russian industrial production has been contracting rapidly throughout the year, even before the financial crisis began in August, and has now entered recession, a level not seen since the massive economic crisis of 1998 under Borish Yeltisin.  Unemployment in Russia is soaring chiefly because the manufacturing sector is slashing jobs to cut costs as the liquidity crisis deepens and demand slacks off.  Ziemba warns that wages are not falling at an appropriate pace, perhaps due to Kremlin pressure, and this may result in severely worsening inflation as consumers bid up the price of fewer and fewer available goods.  At the same time, she observers:  “Adjusting for inflation, retail sales have returned to mid 2006 levels. High inflation, loss of wealth, difficulty accessing credit may all account for slowing retail sales growth. But evidence suggest further slowing is to come, despite the fiscal stimulus.”

It’s the typical Russian scenario, the worst of all possible worlds. 

But worst of all is that Russia finds itself not only governed by a clan of security police toughs with no knowledge or experience in complex economic systems, but unable to replace that government when it fails (as for instance has happened recently in the United States).  Russian citizens once again find themselves trapped between an authoritarian rock and a dependent economic hard place, without options or much hope for a viable future.  It’s in their living memory how such a situation obliterated the USSR, and there is no reason t think that the same thing cannot happen all over again.

5 responses to “EDITORIAL: Diagnosing the Russian Economic Malaise

  1. And, it is going to get worse.

    This from Gazeta.ru:

    После Нового года из-за финансового кризиса безработных станет еще больше, а зарплаты сократятся до 40%. Впрочем, депутаты Госдумы пообещали помочь уволенным – но для этого придется либо начать свой собственный бизнес, либо переехать в другой город, либо сменить профессию.

    Here, even the State Duma is predicting that unemployment will rise and wages will drop by 40%. Their plan? They will help those people who start businesses (good luck with that given the corruption in Russia); have them move to another city or change profession (not the easiest of things to do in a recession). Muscovites will certainly love the idea of moving to the “provinces” and even if they do move, where exactly will they live? At least in Moscow they likely had an apartment they inherited from babushka.

    Here is the lede from another article:

    Бизнес не смог уговорить власть снизить темпы повышения тарифов естественных монополий. У гигантов тоже кризис, объяснило государство, им нужно финансировать инвестрпроекты. Неубедительно, считают эксперты: во-первых, проекты уже никому не нужны, а во-вторых, все равно они не будут исполнены.

    Here, we have smaller businesses complaining that they can’t convince the government of the need to have the monopolies (state-owned or state controlled) reduce their tariffs, which is hurting them. The government is saying they can’t cut back on what is being charged as the monopolies need the money to “invest” in large projects. The experts say that this is foolish as these investments are not necessary at this time and it is unlikely that the money will ever be invested anyways. In other words, the Russian state is willing to cut some businesses off at the knees in order to protect the interests of the privileged monopolies. Hardly what Adam Smith would have recommended ;)





    Thanks for your wonderful translations and links, most edifying and illuminating as usual. You have a standing invitation if you like to forward us your analysis by e-mail and we will be happy to publish it as actual blog post. Your comments here and on SWP are invaluable and most appreciated.

  2. Dear Michel

    Thanks a lot for your insight and interesting translations, much appreciated

  3. Незачто! My pleasure!

    Another interesting and telling piece of info from grani.ru:

    Свыше 300 граждан Таджикистана, работающих на стройке в Екатеринбурге, в пятницу объявили забастовку, сообщает Уралинформбюро. Председатель организации “Общество таджикской культуры “Сомон” Фарух Мирзоев пояcнил, что гастарбайтеры более четырех месяцев не получали заработную плату.

    So you have 300 guest workers in the construction industry from Tajikistan on strike in Ekaterinburg because they have not been paid for 4 months. This does not bode well for Russia. As the crisis deepens and more people do not get paid–both guest workers and Russian citizens–you are likely to see more people taking to the streets.

    Source: http://www.grani.ru/Economy/m.144679.html

  4. Is the crisis getting this bad in Russia?

    Just a few weeks ago , Putin was bragging about how the economy wouldn’t effect Russia and he seemed to enjoy the turmoil in the U.S.

    Also , this Russian scientist predicted that the crisis would brea the U.S into pieces….Did this guy stated what will happen to Russia since they’re getting hit harder then the United States.

  5. If you like Adam Smith, you should definitely read John Locke.

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