Dima Deliberates on Debt-Induced Disaster [or Depression?]

Pres. Medvedev released his second vlog yesterday, this time addressing the state of Russia’s economy and what steps are being taken to address the problems:

Specifically, Medvedev spoke of the ‘opportunities’ for Russia that could emerge from the crisis, if the government takes advantage of them:

  1. Support M&A in certain sectors (banking, retail, construction), leading to new competitive companies that will create jobs; Russia government will finance where necessary
  2. Financial institutions should become more efficient and pay attention to indicators of reliability, increasing stability and attractiveness to investors; not clear if this foreshadows more stringent lending requirements[?]
  3. Russian firms must reduce costs of production through modernization of production, technology and management, allowing them to compete at a global level; government will support establishment of efficient workplaces and give tax incentives for innovation and retraining of staff
  4. Russia must modernize in neglected areas – education, health, judicial reform, technical regulations, and the transition to digital technology

Significantly, Medvedev also stated that Russia is currently not caught up in the cycle of contracting credit —> contracting demand —> contracting production/employment —> contracting demand. And even though much is being made of the economic malaise’s impact on Russia, Medvedev may be right. Sure, Russia’s GDP forecasts are steadily dropping and its credit rating was cut yesterday, and it today decided to close its stock market (again) until October 28. Obviously, the sharp drop in oil prices has hit Russia hard, which relies on oil and gas exports for about 40% of its export revenue. Also, the domestic oligarchs and firms who foolishly over-leveraged their companies with short-term foreign loans have lost an enormous amount of money, and now are turning to the government for a bailout.

Russia has also been stricken with a bad case of capital flight – prompting the constant closures of the RTS. This is mostly because 70-80% of the RTS is made up of foreign capital, and in a crisis, investors have preferred to have their assets in cash rather than leave them on the purported ‘island of stability’ that is Russia. But, for the real economy, the exodus of foreign investors from Russia’s stock market is significant only in a psychological/perception sense. The reason is that foreign portfolio investment is a tiny fraction of foreign investment in Russia (approx. 3%); foreign direct investment and other foreign investment (e.g., direct lending) about equally make up the remainder. And even FDI inflows are not that significant, relatively, only amounting to 3% of GDP. Indeed, it seems the main problem stems from Russian corporate foreign debt. Back in 2004 – before the recent ramp-up in FDI into the country – total corporate foreign debt grew 56% to $75.1 billion and made headlines. Since then, foreign ownership of corporate debt has grown to $272 billion (15% of GDP), out of a total of $400 billion (22% GDP). Thus, those firms with overly high debt/equity ratios will likely fail, as they should. Medvedev is correct to say that this will encourage the formation of new, stronger companies.

So, where is the silver lining? Well, while corporate foreign debt is around 17% of GDP, state foreign debt is only 2% of GDP, it has a $192 billion stabilization fund, a current account that is still in surplus (though maybe not for long). Most important, is that Russia’s household debt is around 3% of GDP, while U.S. household debt is 100% of GDP! And this brings us back to Dima’s assertion that what is happening in the United States and, arguably, the UK, is not going on in Russia – because the U.S. is at such a high level of indebtedness, a crisis like the subprime crash is not contained as it should be (though Mortgage Backed Securities had a lot to do with this too). Still, the fundamental problem is that credit has disproportionately fueled U.S. economic growth for quite a long time now. In contrast, the percentage of Russia’s growth that has depended on credit is smaller and likely limited to certain ‘sophisticated’ firms that have access to international credit markets. Ironically, the ultra-concentrated nature of wealth in Russia to a small group of oligarchs might actually shield the rest of the country from the crisis. Thus, the crisis in Russia will scare away speculative portfolio investment and kill off inefficient firms that made bad decisions. In the United States, however, a vicious circle of falling asset values will lead to panic selling, which in turn lowers asset values and leads to losses and reduced spending, ultimately leading to recession. This will most certainly lead to a deep recession if, as is predicted, the U.S. corporate debt default rate hits 10% or 23% [yikes].

Therefore, as for Russia, this crisis has reaffirmed what we [and the Russians] already know – Russia is too dependent on the export of oil and gas; Russia’s economic resources are overly concentrated in the hands of the state and a few oligarchs; good thing Russia has the stabilization fund; the same long-view problems persist – demographics/health, infrastructure, rule of law, etc. If this crisis sufficiently weakens the oligarchs, it opens up the opportunity for two paths – one towards increasing state consolidation and redistributing wealth to bureaucrats; or, increased state involvement in necessary areas like infrastructure and health, but the promotion of private (domestic/foreign) actors and public-private partnerships in other areas of the economy.

Update: here is an excellently long article by BusinessWeek Moscow Editor Jason Bush, which makes the counterargument that Russia’s economy will be substantially and negatively affected by the crisis. There is, however, one misleading statement I found. Bush says that one major problem with Russia’s economy is the “dearth of long-term private savings.” But when comparing the U.S. and Russia, he cites the % of household deposits to GDP. Of course, deposits do not equal savings. Bush should have cited the savings rate of each country. In that respect, both Russia and the United States are in poor shape, though Russia is somewhat better off.

Update II: another good piece on this crisis by the Economist Intelligence Unit (EIU).  The general conclusion – Russia has sufficient reserves to weather the crisis, despite the alarming rate at which they have recently declined, and [hopefully] this crisis will prompt positive reactions from Russia’s leadership regarding sources of capital and political risk.  On a side note, it is always striking how the EIU’s coverage of Russia is so different from the magazine itself.

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2 Responses to Dima Deliberates on Debt-Induced Disaster [or Depression?]

  1. Anonymous says:

    Belive as they say= russia should nuke the rest of the world and then biochemically
    in one moment in time

  2. Anonymous says:

    Belive as they say= russia should nuke the rest of the world and then biochemically in one moment in time

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