Rescuing Russia From Collapse

Russia's economy is collapsing, but the situation could be even worse. The global economic crisis has finally forced the government to adopt sensible policies, thereby staving off disaster -- at least for now.

Official forecasts for Russian gross domestic product growth in 2009 remain positive, but most analysts, including government officials, are bracing for a severe recession, which appears to have started in the fourth quarter of 2008. The stock market's collapse -- its 72 percent fall is the worst of all major emerging markets -- is only the most visible sign of this.

Even Russia's oligarchs are pawning their yachts and selling their private jets. Signs of political instability are mounting. The approval ratings for the country's president and prime minister are heading south. Mass street protests have started, and they are led not by opposition political parties but by workers and middle-class families facing job losses and declining wages. More important, protesters are demanding that the government resign, which was unthinkable just a year ago.

With oil prices plummeting 70 percent from their peak, it is no surprise that the country is facing severe economic challenges. Growth is endangered, the ruble is weak, and the government budget is in deficit. Nevertheless, up to now, the government and private sector have weathered the storm reasonably well.

Critics of Prime Minister Vladimir Putin's regime argue that the political system is too centralized and risks collapse in today's economic storm. The regime's ideology, after all, places the state and loyalty to the rulers ahead of private property and merit. When the crisis hits with full force, they argue that the government will nationalize major banks and companies, with the resulting inefficiency then burying the economy, just as it doomed the Soviet Union.

The government has, in fact, made serious mistakes in dealing with the crisis. Taxpayers' money was spent to purchase corporate stocks in a failed attempt to support collapsing stock prices. The government is unlikely to recover its investment anytime soon.

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The government was also too slow in depreciating the ruble. While it can be argued that a one-off devaluation could have triggered a panic, gradual depreciation should have started earlier than it did. In the last two months of 2008, the Central Bank allowed the ruble to weaken at a rate of 1 percent per week, then at 2 percent to 3 percent per week. It probably still needs to fall another 10 percent. In the meantime, the Central Bank hemorrhaged reserves defending this slow correction, while commercial banks have been holding onto dollars in anticipation of the ruble's further decline.

The third mistake was to raise import duties, especially for imported cars. This decision was economically foolish since the automotive industry, as with many other import-competing sectors, will certainly be protected by the weakening ruble. It was also politically dangerous. Car owners are an affluent, socially active and easily organized group. Street protests against the import duties became the first serious popular uprising that Russia has seen in many years.

Yet these mistakes are relatively minor and reversible. In all fairness, the government, unexpectedly, has made resolute and mostly correct economic decisions. First, it prevented the collapse of the banking system. Many Russian banks were heavily exposed in foreign markets and therefore faced severe financial problems once the crisis hit. A massive liquidity injection by the government ensured that no major bank collapsed, and minor bank failures were administered in a surprisingly orderly fashion.

Moreover, the crisis has -- so far -- not resulted in major nationalizations of private companies. The government could have used the crisis to nationalize all banks and companies in financial distress. It has not despite its still large foreign reserves, which give it the means to buy out a significant portion of the economy at fire-sale prices. Instead, the government has mostly been providing high-interest loans rather than engaging in massive equity buyouts.

Nor have the oligarchs been bailed out. Of $50 billion in external debt owed by Russian banks and firms in 2008, the government refinanced only $10 billion. Apparently, the terms offered by the government (LIBOR+5 percent and collateral) have turned out to be right on target.

How did reasonable economic policies prevail in this crisis? The key factor is that for the first time since Putin came to power the Kremlin perceives a genuine threat. The years of easy popularity are over. All the ugly facts that Russians ignored during the years of fast economic growth are bubbling to the surface.

The regime knows that its survival depends on preventing economic collapse. The crisis energized the system and shifted decision-making power to those who know about and can do something for the economy.

But did these policy changes come too late? The ossified, corrupt and inefficient economy built in the fat years of the oil boom may be impossible to save. So the central question that Russia confronts is whether even competent economic policy can prevent economic and political collapse.

Sergei Guriev is rector of the New Economic School in Moscow. Aleh Tsyvinski is professor of economics at Yale University. © Project Syndicate