Russia's Top Economist Needs to Face Reality
- By Anders Aslund
- Oct. 22 2008 00:00
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On Sept. 3, I wrote in this column, "A sudden zero growth would not be surprising, and leaders like Putin are not prepared to face reality." Now zero growth has already been achieved, but Putin remains in denial, even though as prime minister he is the chief economist in the country.
In fact, Russia would be lucky if it faces nothing worse than stagnation. A substantial decline in GDP next year is an acute possibility. Do not believe all these forecasts that as recently as a month ago predicted 6 percent or 7 percent growth next year. Each forecast is lower than its predecessor. Let us instead discuss the forces at hand.
As elsewhere in the world, the Russian banking system has frozen up because of rising international interest rates and an elimination of trust. Central Bank Chairman Sergei Ignatyev said two weeks ago that he expected 50 to 70 banks to go under. Others fear more than 200 banks might collapse. That would keep the credit market frozen for quite some time and lead to a contraction of loans, regardless of whatever the Central Bank does.
The second blow has already hit real estate development, a sector that is particularly dependent on credit. Investment is still increasing, but the growth rate has declined to 8 percent from 24 percent over the same month a year ago in September. You can see for yourselves how many cranes are standing still at construction sites in Moscow, and most large real estate and construction companies are considered to be on the verge of bankruptcy. Their stock prices have fallen 82 percent this year. If construction is halved, construction alone would reduce GDP next year by nearly 3 percent.
The third strike has hit commodity prices. Since their admittedly brief, sharp peak in July, both steel and oil prices have halved because of the sudden slowdown in the world economy. In addition, energy production is already stagnant, and export volumes are declining. Russia's crude oil exports fell by 5.9 percent during the first eight months this year. Steel exports are set to plummet, as China has turned from a steel importer to a major exporter. Domestic demand will decline with construction. Commodities, which represent roughly a quarter of Russia's GDP, cannot possibly expand next year, but they may contract somewhat, especially steel production and construction materials.
But what will grow? Retail sales have already been hit. Transportation will stagnate with the commodity sector. Public services can hardly expand because the state budget will go into a deficit with the falling oil revenues. Some import-substituting manufacturing -- notably car production -- and modern services, such as mobile communications, may continue to grow, but these are likely to be the exceptions.
This year, Russian exports are expected to reach $500 billion, of which slightly over 80 percent consists of commodities. If next year the average export prices of commodities are little more than half of this year's prices and volumes are only moderately smaller, Russia's exports would shrink by no less than 40 percent, or $200 billion, which amounts to a staggering 12 percent of GDP. JPMorgan is already predicting a decline in Russia's exports by $89 billion, which is surely only the beginning.
Naturally, this is nothing but a tentative picture painted with a broad brush, but who thinks that the bank sector will not seize up again or that commodity prices will recover? If anything like this were to happen, Russia's GDP would fall by 5 percent or more next year. The outcome might not be that bad, but it is much more likely than 6 percent growth, which most forecasters still predict.
A recent International Monetary Fund study shows that the average cumulative GDP decline in a combined banking and housing crisis is 5 percent. For example, Finland lost 11 percent of its GDP from 1991 to 1993. Moreover, a serious financial crisis usually lasts three or four years. But the current crisis is the worst the world has seen since 1929, and its reach is truly global. If anything, we should expect a substantially larger fall in output and, as is usually the case, commodity producers get hit much harder than other sectors in a downturn. It is highly likely that Russia's total decline over the next two or three years will exceed 10 percent.
Putin is correct when he claims "that our economy is rather well prepared for lengthy external shocks," but that is not enough. Thanks to Finance Minister Alexei Kudrin's extraordinary steadfastness, Russia has maintained a large budget surplus and held huge reserves at the outset of this crisis, but $70 billion of the reserves have already fled the country and more will follow.
A crucial shortfall is that the government exploited the 1998 financial crisis to establish a dominance over the banking system by strengthening the position of five state banks, which still hold 45 percent of Russia's banking assets. The problem with state banks is that they are inefficient. Therefore, the country suffers from very poor financial intermediation.
Putin seems set to aggravate this problem. The first large state support went to big state banks, which acted in their own interests rather than in the national interest. The money was not passed on to other banks. Businessmen and newspapers tell stories about a number of "red lists" of favored businessmen who are supposed to get certain amounts of money from the state because they have the right connections.
So far, everything suggests that Putin is intent on using this financial crisis to carry out a huge renationalization program. Bad cases from Britain and the United States are certainly helpful for him. To his credit, Alexander Shokhin, the chairman of the Union of Industrialists and Entrepreneurs, has sharply criticized the state-oriented, ineffective government support.
Yet, I doubt that Putin can repeat the large bank nationalization of 1998 under then-Central Bank Chairman Viktor Gerashchenko. The amounts needed to prop up the economy and recapitalize the banks are truly monumental. Russia's stock market losses have reached $1 trillion, while the stabilization fund is only $180 billion. It will be too badly needed to be used for harmful renationalization.
But here is another way of trying to solve the crisis. It is called liberal market reform. As Russia's veteran reformers Yegor Gaidar and Yevgeny Yasin long have explained, low oil prices are good for reform. The same is true of financial crises.
Russia's economic problems are so severe that the country cannot survive the crisis without profound structural reforms.
Anders Aslund, a senior fellow of the Peterson Institute for International Economics, is the author of "Russia's Capitalist Revolution: Why Market Reform Succeeded and Democracy Failed."