A wounded economy

It is closer to crisis than the West or Vladimir Putin realise

Nov 22nd 2014 | From the print edition The Economist

VLADIMIR PUTIN is not short of problems, many of his own creation. There is the carnage in eastern Ukraine, where he is continuing to stir things up. There are his fraught relations with the West, with even Germany turning against him now.  There is an Islamist insurgency on his borders and at home there is grumbling among the growing numbers who doubt the wisdom of his Ukraine policy. But one problem could yet eclipse all these: Russia’s wounded economy could fall into a crisis.

Some of Russia’s ailments are well known. Its oil-fired economy surged upward on rising energy prices; now that oil has tumbled, from an average of almost $110 a barrel in the first half of the year to below $80, Russia is hurting. More than two-thirds of exports come from energy. The rouble has fallen by 23% in three months. Western sanctions have also caused pain, as bankers have applied the restrictions not just to Mr Putin’s cronies, but to a much longer tally of Russian businesses. More generally, years of kleptocracy have had a corrosive effect on the place. Much of the country’s wealth has been divided among Mr. Putin’s friends.

Everybody expects continued stagnation, but the conventional wisdom is that Mr. Putin is strong enough to withstand this. The falling rouble has made some export industries like farming more competitive. These exports combined with Mr. Putin’s import-blocking counter-sanctions mean Russia still has a small trade surplus. It has a stash of foreign-exchange reserves, some $370 billion according to the central bank’s figures. Add in the resilience of the Russian people, who are also inclined to blame deprivation on foreigners, and the view from Moscow is that Mr Putin has time to manoeuvre. People talk loosely about two years or so.

In fact, a crisis could happen a lot sooner. Russia’s defences are weaker than they first appear and they could be tested by any one of a succession of possibilities—another dip in the oil price, a bungled debt rescheduling by Russian firms, further Western sanctions. When economies are on an unsustainable course, international finance often acts as a fast-forward button, pushing countries over the edge more quickly than politicians or investors expect.

Putin a good man down

The immediate worry is the oil price. Mr Putin is confident it will recover. But supply seems set to increase, with OPEC keen to defend its market share.  American government agencies predict oil prices could average $83 a barrel in 2015, well below the $90 level Russia needs to avoid recession (and to keep its budget in balance). If global demand weakens—Japan has slipped into recession since the latest round of forecasts—the oil price could fall further. That would immediately prompt investors to reassess Russia’s prospects.  Then there are the debt repayments. Russia’s firms have over $500 billion in external debt outstanding, with $130 billion of it payable before the end of 2015, at a time when few Western banks want to increase their exposure to Russia.  Even firms that earn dollar revenues may struggle to pay their debts. Rosneft, an oil giant, recently asked the Kremlin to lend it $44 billion. Mr Putin has so far resisted, but he cannot let a company that is 70% state-owned and employs 160,000 people fail. There is a lengthening queue of troubled Russian firms.

Non-performing loans were rising even before interest rates were raised to 9.5% to defend the rouble. Meanwhile Russian banks are reliant on the central bank to replace deposits that their customers are understandably spiriting into dollars.  Directly or indirectly, many of these bills will end up with the Kremlin, which is why its reserves will be vital. They are evaporating: down $100 billion in the past year, following failed attempts to defend the rouble. And the book-keeping is dodgy. Of the reported $370 billion reserve pile, more than $170 billion sits in the country’s two wealth funds. Some of their assets are iffy, including various stakes in Russia’s state-owned banks and debt issued by Ukraine that Mr Putin’s own aggression is fast rendering worthless. One of the funds is earmarked for pensions. In reality, Russia’s government has perhaps $270 billion of hard cash that is accessible and usable without massive cuts elsewhere—less than its external obligations due over the next two years.

All this spells trouble for Russia, but Mr Putin’s marauding foreign policy could accelerate things. This after all is a man who has invaded other countries and lied about it. A deeper foray into Ukraine would lead to stronger sanctions by Western countries. Some of them, such as barring Russia’s banks from the SWIFT international payments system, could halt Russian trade altogether. A partial block on oil exports would fell the economy, as it did Iran’s. And the more trouble he faces, the more likely Mr Putin is to play the nationalist card—and that means more foreign forays, and yet more sanctions.

From Russia to Rio, without much love

Russia’s biggest recent economic crisis, in 1998, led to a government default.  This time a string of bank failures, corporate defaults and a deep recession look likelier. Even so the pain from these could spread abroad quickly, both to countries that rely on Russian trade (exports to Russia account for fully 5% of GDP in the Baltics and Belarus) and through financial ripple effects. Banks in both Austria and Sweden are exposed. And if firms in one badly run commodity-driven country start to default on their dollar debts, then investors will worry about others—such as Brazil.

If Russia’s economy looks likely to collapse, there will be inevitable calls in the West for sanctions to be cut back. This week Mr Putin pointed out that 300,000 German jobs depend on trade with his country. But Angela Merkel rightly stood firm. Actions, Mr Putin must finally learn, have consequences. Invade another country, and the world will act against you. And the same goes for the economy, too. Had Mr Putin spent more of his time strengthening Russia’s economy than enriching his friends, he would not find himself so vulnerable now.

8 Responses

  1. Scott – what is SWIFT and would barring Russian banks from it actually cripple Russia, as the article suggests? Are Iranian banks in SWIFT? Who runs SWIFT?

    I think the irony that a significant fraction of Russian wealth is held in Ukrainian debt, of which Putin is systematically destroying the value, is delicious.


    • Mark:

      SWIFT stands for the Society for Worldwide Interbank Financial Transactions, and it issues Swift Codes to all banks that are then used to wire money between banks. Yes, Iranian banks have Swift codes and use the system, although that has apparently been a matter of dispute between the US and SWIFT, and as a result Swift has denied certain Iranian banks with access.

      It would certainly be highly inconvenient to be denied access to SWIFT, but I am sure there are other existing methods by which Russian banks could move funds around, so I doubt it would be entirely debilitating.


      • A good article – and strong words – from Kevin Williamson.

        What stops a defensive tackle from intentionally injuring a halfback even if he thinks he can get away with it — even if he is willing to suffer the consequences of the foul — is sportsmanship. What stops a politician from adopting a what-you-can-get-away-with strategy is, under normal circumstances, patriotism. Congress forgoes impeaching the president every time it would be convenient for the legislative majority to do so not merely out of narrow self-interest, but because doing so would violate our constitutional principles even if the letter of the law could be interpreted to permit that course of action. It would be bad for the country. In an elected official, patriotism means, among other things, elevating the interests of the country above the interests of party and career. President Obama has failed to do that, seems personally incapable of doing that, and in fact has done the opposite. He might be reminded, at the very least, that his presidential duty is to the citizens of the United States, not to citizens of other countries, regardless of where they happen to be located at any given moment. But the very idea of taking that seriously seems foreign to him.

        We already knew that Barack Obama is a coward – a man who, to take one obvious example, pronounced himself opposed to gay marriage right up until the millisecond that political calculation demanded he do otherwise, and who now believes that it is mandated by the Constitution. His putting off his amnesty announcement until after the election – and his dishonest refusal to acknowledge that it is an amnesty – is another example. We already knew that he is a liar (“If you like your coverage . . . ”) and have some reason to suspect that he is a fool. But the fundamental problem is that he is a lawyer, one without the intellectual or moral equipment to be anything more than a litigator of the picayune. For President Obama and his enablers, the law is a species of magic: He is entitled to do whatever he pleases, even when it plainly violates both the national interest and our longstanding habits of government, if he can simply think of a way to say the right words in the right order as he acts. That isn’t governance – that’s alchemical hokum, transforming the dross of Democratic political ambition into pure gold.

        There are many defects with that model of government, but the largest one is that the words “illegal” and “legal” no longer have any meaning. If a sufficiently powerful person or faction demands that the illegal should be the legal, then it is so. Never mind the law – and certainly never mind the lawmakers, who are increasingly irrelevant in our emerging Gaullist, strongman form of government. Charles de Gaulle and his supporters at least had the intellectual honesty to call that form of government what it is: rule by decree.

        And he may yet get away with it. But a wiser and better man would not try to.


  2. Hagel was on Charlie Rose for the hour last Wednesday, I think. It’s available on line. I thought he was pretty clear and cogent.


  3. These aren’t Hagel’s failures. They are the result of the administration’s intentional polices.

    “The first kind are policy failures, and they’re not insignificant. In Afghanistan, Hagel failed to gain enough ground against the Taliban to force them to accept some kind of peace deal; instead, the Taliban sees itself as winning outright and is largely ignoring American negotiators. In Egypt, Hagel took the lead in trying to convince defense minister Abdel Fatah el-Sisi not to depose Egypt’s first-ever democratically elected president in a coup; Hagel failed and the coup went ahead. In Iraq and Syria, Hagel failed to devise a strategy that would prevent the rise of ISIS or that would roll it back. In Ukraine, Hagel has not contributed to the effort to roll back or deter Russia’s still-ongoing invasion. In Hagel’s defense, he is not the lead on Russia and the Afghanistan policy was failing before he took office, but ISIS and Egypt are definitely under his purview.”


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