I went to the World Bank website to see if their November report on the Russian economy was up. It wasn’t, so I took another look at the report issued in June. It looks prescient in some ways, although I doubt that the WB folks thought that this danger would be realized so soon:
Issue 1: Oil revenues, booming today, could become a drag on economic
The strong recovery of oil prices since 2000 increased Russia’s dependence on oil and gas revenue, making it more vulnerable to price declines.
The share of oil revenue in total fiscal revenue increased substantiallyâ€”from 10 percent of GDP to about 30 percent. Instead of diversifying, Russia has specialized in oil, which now accounts for about 60 percent of exports (figures 2.1 and 2.2). Higher oil revenues create more room for spending, but they also complicate macroeconomic management and foster dependence on a volatile, uncertain source of income. This has not been a problem in the face of high oil prices, but it could become a major vulnerability if oil prices begin a rapid descent.
The report also notes:
External debt stock and external vulnerability remain within a comfortable range, but Russia’s private corporate and banking debt is growing fast (figure 1.13). A rapid buildup of corporate and banking debt partly financed the massive consumption and investment spree of recent years. With general government external debt modest and declining, this banking and corporate debtâ€”public and privateâ€”explains almost all the buildup of external debt (figure 1.13, left panel). External private debt almost tripled, from $106 billion at the end of 2005 to $275 billion at the end of 2007. External public debt, which includes the general government and public financial and nonfinancial organizations, has also grown thanks to borrowing in large state companiesâ€”but not nearly as fast as private sector debt. Although overall debt appears low compared with the economy’s size and its massive international reserves, it has become a concern at the central bank. That exuberant private borrowing, if continuing at the same pace during a prolonged global credit crunch, could undermine corporate liquidity and repayments, spilling over into the banking system, which faces its own risks.
The report mentions the real estate financing issue too:
Russian banking has weathered global financial turbulence, but credit, liquidity,
and market risks require monitoring.
The credit portfolio may face strains from the rapid credit expansion over the last decade, the entry of new and inexperienced borrowers, and banks’ uncertain ability to manage the risks. The brisk growth in mortgage lending could become a concern. Mortgage loans increased fivefold during 2000-06 and by at least 70 percent in 2007, though the consumer segment remains small (13 percent). The following issues are worth noting.
- The retail deposit base is concentrated in Sberbank, forcing large and medium-size banks to rely more on international funding.
- Household deposits represent 30 percent of bank liabilities on average, but they are concentrated in the state-owned banks, which hold more than 40 percent of bank assets (Sberbank, VTB, Gazprombank, Bank of Moscow, and the Russian AgriculturalBank).
- The concentration of corporate deposits â€¢ remains a concern for smaller banks. Withdrawals by a few large customers could reduceliquidity. For some smaller banks, the 20 largest depositors account for more than half of customer funding.
- Banks relying on external funding risk a contraction in global credit. Benefiting from abundant global liquidity, banks operating in Russia have borrowed significantly from abroad over the last few years. This may pose refinancing risks for some banks.
- Banks’ exposure to market risk has grown with deeper capital markets and banks’ greater sophistication. Securities portfolios, about 20 percent of assets at the end of 2007, are dominated by corporate bonds, though equity holdings are also significant for some banks. These securities expose banks to potential equity or bond prices.losses from adverse movements in equity or bond prices. sustained strong earnings, but profits are coming under pressure.
The continuing global credit crunch is straining banks’ funding model. If the global credit crunch is prolonged, the system could face funding problems. With Russia’s thin domestic capital markets and its retail deposits concentrated in the largest state banks, some banks must depend on foreign funding. Sustained, restricted access to foreign borrowing could increase funding costs, slow credit growth, reduce profitability and capital, and expose banks to refinancing difficulties. Rapid credit growth has so far sustained strong earnings, but profits are coming under pressure.
In sum, most of the major vulnerabilities that the World Bank identified are being tested, and far sooner and far more severely than pretty much anybody had anticipated at the time the report was written.
The report also details Russia’s investment-led growth, and notes that this investment was heavily-oriented to the resource extraction sector, and largely ignored manufacturing. These investments are not looking to good now, with resource prices down hard across the board. The report further notes that although Russia’s investment rate (investment/GDP) has ticked up in recent years, it is still far below (barely half) the rate in other rapid growth emerging economies (21 percent vs. 38-42 percent.) The report’s data shows that growth has been heavily driven by non-tradeables, notably construction. So much for that.
In other words, the WB painted a picture of a nation with its private economy and government finances highly dependent on natural resource prices, largely funded by hot money, and dependent on a fragile banking system. Oil prices (and the prices of other natural resources) are the lynchpins of such an economic system. It is pretty clear what the implications of a collapse in these prices are. And we are seeing them unfold before our very eyes.
The WB mentions the outstanding institutional issues facing the country, but doesn’t place tremendous emphasis on them. The problem is that the very institutional weakenesses that the Bank acknowledges will exacerbate these problems, and make it very difficult for Russia to surmount them.