Another issue that I have seen mis-covered a lot in the news is the issue of Russia’s oil revenues, and foreign exchange reserves. Particularly, this issue arises in the context of discussions on ‘resource dependency’ (fka ‘resource nationalism’).
Most coverage of Russia’s economy over the course of 2008 falls into one of two categories – (a) Russia is booming, with oil-fueled prosperity; (b) Russia is languishing, with oil-fueled destitution. The only difference is that discussion (a) occurred in the first 3/4 of 2008, whereas discussion (b) occurred in the last 1/4 of 2008, and continues today. The problem is that oil seems to have transformed from a source of wealth to a source of weakness within a few months. To put it simply – if you produce and sell something, and you receive cash which you then either spend or save, the money is still real even after the price at which you sell drops; and you still receive money for what you sell, just less. Thus, resource dependency can be a fundamental weakness if your economy requires an uninterrupted revenue stream at the high price.
So, the first question to ask is what Russia does with its oil revenues while the price is high. One obvious answer is that the Russian Government saved a good portion of the money in the Stabilization Fund, which was split into the Reserve Fund and the National Welfare Fund early last year. The Reserve Fund’s purpose is to allow the government to balance the federal budget in the event that oil falls below a certain level; the National Welfare Fund plays the same role, but with regards to entitlement spending. When they were created in February 2008, the Reserve Fund and National Welfare Fund possessed, respectively, $125.2 billion and $32 billion. The balances now stand at approximately $137.1 billion and $88 billion. You often see people confuse these two funds with Russia’s international reserves (i.e., highly liquid assets consisting mostly of foreign ‘reserve’ currencies and gold). Russia does have massive (the third largest) international reserves – reaching a high of $596.6 billion in July 2008 – and it has spent a large portion of its reserves to deal with the current crisis (about $184 billion, with a planned total of $222 billion).
Still, Russia’s anti-crisis expenditures, though significant, were more than covered by the country’s international reserves, and the Welfare and Stabilization Funds have gone untapped. Indeed, the Russian government could cover 100% of the $300 billion in Russian external corporate debt this year, and it would still have reserves left over, and without having to tap into the two Funds. The government, however, has had to revise the budget and it is possible that it might run a short deficit in 2009.
So, we know that the Russian government saved the vast majority of ‘oil wealth’ over the past few years, and even resisted the temptation to drastically increase the budget with the windfall. Perhaps, then, the problem is with Russian firms, relatively inexperienced as they are, and their inefficient and wasteful use of oil profits. Actually, Russian oil companies did not benefit much from the spike in oil prices over the past few years due to the heavy tax burden on that industry. As this excellent post over at Mmd Russia Blog demonstrates, while oil prices rose, the oil price minus the applicable taxes and export duties remained flat over the same period. So, if Russia’s oil tax regime did not enrich Russian enterprises, and the state wisely saved its proceeds, in what sense was Russia so exposed to the financial crisis?
The answer lies in Putin’s development strategy, which he either chose or was forced to choose, based on the country’s circumstances in 2000. As a recent article in The National Interest explained his “Third Way,” Putin entered office with only $8.5 billion in reserves and $133 billion in external debt. To the extent that this balance of payments situation threatened Russia’s sovereignty, Putin wanted to first and foremost get out of debt. The authors point out that, though Putin benefited from high oil prices in reaching his goal, he also laid the tax framework to generate sufficient revenues from those prices. The downside of this strategy was the negative impact it had on domestic sources of capital – Russia’s major wealth-generating firms were not able to invest their profits, and the state avoided expenditures to prevent excessive inflation. To try and neutralize this problem, Putin eased restrictions on foreign lending in Russia. The result is almost comical: Russian firms sold oil to the West; the Russian state taxed away all of those revenues; the state then lent that money to the same Western governments by purchasing reserves; and banks in those Western countries lent the money to the Russian oil companies.
The strategy was sound so long as Western financial institutions were better at allocating capital efficiently than Russian firms and the Russian government, which is probably true most of the time. In other words, the money generated by rising oil prices in Russia, after being lent to the West, was re-lent to Russian enterprises by Western financial institutions, but in an inefficient way. Thus, Russia’s susceptibility to the Western financial crisis is largely a product of its deliberate choice to substitute the Western financial system for its own, underdeveloped system. At the same time, you could argue that Russia could have attracted more foreign direct investment, rather than foreign portfolio investment and direct loans, if it had created more attractive domestic conditions (but this is a subject for another post). Still, one would expect that, if Western financial institutions do make rational investments, they would not have injected so much capital into Russia if the country lacked adequate conditions for investment.