An Indispensable Lesson in Macroeconomics
- By Martin Gilman
- May. 12 2010 00:00
The turmoil last week in global financial markets, presumably precipitated by Greece’s unsustainable debt problems, reminded me of why I studied macroeconomics. As interesting as it may be to study how individuals and families make their choices of what to buy, how much to save and when to borrow, the scale at the level of an entire country is truly fascinating.
Of course, in macroeconomics, the policy choices of governments play a central role in the determination of economic performance. It seems that the Greek government, as well as others in the southern part of the euro zone, allowed themselves to be lulled by the benign borrowing conditions in the euro, their domestic currency, to jump-start growth through debt financing.
Professor Yevgeny Yasin, founder of the Higher School of Economics, five years ago bemoaned about the tendency of students to ignore macroeconomics. He assumed that students considered “macro” as something that happened in Russia in the 1990s and would now only be of relevance to economic historians. Ignoring the study of macroeconomics, he felt, was myopic and ahistorical. How right Yasin was!
At the beginning of last year, macroeconomics suddenly became topical again as Russia was plunged into a temporary crisis by capital outflows and a global flight fr om risky assets.
After the massive injections of Central Bank liquidity and government spending to fill the hole left by the retrenchment of overindebted banks and households in the advanced economies, the global environment has been slowly recovering in the past couple quarters. But now bond holders are increasingly worried about whether sovereign borrowers can really repay, and for good reason. Seemingly isolated cases like Iceland, Ireland and now Greece seem to conflate into more of a systemic crisis, much like how Thailand’s economic problems in July 1997 spread to others in Asia and then eventually to Russia and later to Brazil.
Even if you haven’t studied macroeconomics, the basic problem — as any household that spends too much with borrowed money can tell you — is that growing indebtedness raises the floor for the level of income needed and increases vulnerability should unanticipated costs rise or revenue decline. For countries like Greece — or Russia 12 years ago — the situation is analogous.
This will not end well. With or without support fr om the International Monetary Fund and partner countries, the austerity required will be politically challenging at best. The markets may remain skeptical as they did in the case of Russia during spring and early summer 1998, despite a $22 billion IMF bailout package announced in July 1998.
Russia had its sovereign debt crisis 12 years ago. The similarities to Greece, for all of the differences, are chilling — especially as the exit strategy beyond the inevitable default itself is not obvious. At least after Russia defaulted on its ruble-denominated debt on Aug. 17, 1998, the ruble was forced into a free float within weeks and lost more than two-thirds of its value by the end of the year. Greece does not have this recourse unless it leaves the euro — a dramatic step with severe and wide-reaching implications.
Unlike most other countries, Russia is now in a sweet spot. Whether it lasts depends in good part on decisions of the government as it formulates its draft 2011 budget and spending plan through 2013.
Russia’s inflation continued to decelerate to a 6.2 percent annual rate in April, wh ereas China and India worried about accelerating prices. Foreign exchange reserves are rising. Even with last month’s eurobond issue, the first sovereign issue since 1998, Russia’s sovereign debt is now the lowest among the Group of 20 countries as a percentage of gross domestic product.
Can this continue? Of course, there are the usual problems with external forces over which Russia has no control such as oil prices and capital flows. The drop of oil prices by about $10 per barrel last week underscored Russia’s vulnerability in this regard. Even so, compared with the highly indebted advanced economies of Europe, Japan and the United States, many emerging market economies, including Russia, appear to be more attractive. Russia’s external current account surplus may stay at about 4.5 percent of GDP this year. Although this is somewhat less than is expected in China, both Brazil and India are expected to register deficits. And while all of the BRIC countries will run budget deficits in 2010, these will be a fraction of the numbers touted in the United States, Britain, Japan and southern Europe. Meanwhile, Russia’s budget deficit may be a relatively modest 2 percent or 3 percent of GDP.
If the political class in Russia can stick to its original plan for no growth in nominal budget spending this year and a small reduction in 2011, the country’s financial future should be more serene than implied by the difficult environment for countries in general. Moreover, its relatively robust growth will serve as a modest driver of the global economy and distinguish Russia from many other countries.
At the same time, politicians in Russia may succumb to the usual temptation to raise spending as if high oil prices were a permanent and stable feature of the global economy. Finance Minister Alexei Kudrin will have an uphill battle to resist such temptations in the face of higher oil prices and economic growth and hence revenues assumed in the 2010 budget. But this excessive budgetary dependence on oil prices is also wh ere Russia differs from most other countries. Understandably, global markets view the country as riskier from a macroeconomic standpoint — not to mention issues such as the rule of law, the protection of property rights and the general legal framework, which are clearly not among Russia’s competitive advantages.
Russia’s low-debt economy is an important legacy of its 1998 sovereign debt default. But its ability to avoid future debt problems that are crippling other nations is tightly linked to the oil price that sustains the budget. A few years ago, when oil prices were lower, this did not seem to be such a problem. Now, the so-called break-even oil price for the budget is estimated by Troika Dialog at almost $100 per barrel. Clearly, this is not sustainable and sets the country up for a shock at some time in the future. Some tough political decisions are needed to rein in budgetary spending, even if they appear as a cakewalk compared with austerity measures weighing on Greece and other heavily indebted countries.
Like a family, Russia has to decide what is best for the long term. The upside is a country with solid economic growth, a balanced budget and a slightly positive current account in the years to come. Hopefully, a new generation trained in macroeconomics will take its lessons to heart.