Streetwise Professor

November 1, 2007

Milov, Again

Filed under: Economics,Energy,Politics,Russia — The Professor @ 10:45 am

The previous post quoted Vladimir Milov. This guy knows what he is talking about (from Kommersant via Johnson’s Russia List):

As to Russia’s participant of the discussion, Vladimir Milov, he recalled more than three-fold growth of government’s interest in private energy companies, which widened from 11.5 percent in 2004 to 38.9 percent today.

Asked to comment on results of the conference, Milov told Kommersant that there was no one to pursue common energy policy in Europe, as “this calls for the people with muscles.” “Today’s strategy of the Germans, Frenchmen, Italians and Austrians will make them bankrupt, if Gazprom has problems with supplies. As to the relations of the U.S. and Europe with Russia, they proved unprepared and overslept emergence of undemocratic regime in the RF,” Milov pointed out.

There’s really nothing to add.

February 27, 2015

Putin Reenacts the Kirov Assassination

Filed under: Military,Politics,Russia — The Professor @ 6:15 pm

Russian opposition figure Boris Nemtsov has been gunned down literally in the dark shadows of the Kremlin’s spires.

Just when you thought that Russia could not become more twisted and disturbing, something like this happens.

With a chutzpah that puts  OJ Simpson’s pledge to track down the real killers to shame, Putin announced that he is putting his Chekist skilz to work and taking personal charge of the investigation. This is to ensure that no mistakes are made that could result in the identification of the real executioners. There are frames to be fitted.

Through his creature Peskov, Putin denounced the crime as a “provocation,” fulfilling a prediction I had made on Twitter only moments before that he would use this killing to eliminate many enemies, not just one. This assassination will not be a two-fer. It will be an N-fer. Nemtsov will not be the only enemy eliminated: his death will be the pretext for eliminating many more, on the model of “for my friends, everything: for my enemies, the law!”

The narrative will be that this was part of a plot to blacken Putin’s name, and every-and I mean every-perceived enemy foreign and domestic will be implicated. Numerous, mutually contradictory conspiracy theories will be advanced and pursued simultaneously. These will permit the investigation, arrest, and prosecution of myriad Putin enemies, and the intimidation of many more.

In other words, we are going to see a reprise of the Kirov murder, which Stalin exploited to justify the purges that began soon thereafter. Note the similarity:

“Comrade Stalin personally directed the investigation of Kirov’s assassination. He questioned Nikolayev at length. The leaders of the Opposition placed the gun in Nikolayev’s hand!” (Barmine, Alexander, One Who Survived, New York: G.P. Putnam’s Sons, 1945.)

Why Nemtsov? He had long been a thorn in Putin’s side, authoring (along with Vladimir Milov) several white papers accusing Putin of gargantuan corruption. Recently, he had been an outspoken opponent of the war in Ukraine. He was organizing a peace rally to take place Sunday, and was allegedly on the verge of releasing another white paper documenting Russian participation in the Ukraine war.

Perhaps the anti-war activities and revelations about Putin’s lies about Ukraine were the proximate cause of Nemtsov’s killing. But I think that the murder serves a far larger purpose for Putin. It eliminates a gadfly, yes, but Nemtsov was hardly a threat. But a la Stalin and Kirov, the murder gives Putin a pretext to unleash a full-scale repression.

Will Obama, Merkel, and the other assorted cringers finally be forced to face up to the reality of what they are dealing with in the Kremlin? Call me a cynic, but I seriously doubt it.

Do not underestimate how bad things can get in Russia. And consider this happy thought. Stalin wasn’t embroiled in an international confrontation, and didn’t have nukes, when Kirov was killed (likely on his orders). Putin is, and does.

March 20, 2014

Obama Sanctions Timchenko: Will FUD Kill Gunvor?

Filed under: Commodities,Politics,Russia — The Professor @ 2:44 pm

Obama finally did something halfway serious about Putin.  The Treasury Department added several prominent names in Putin’s inner circle to the sanctions list.  Prominently featured were several judo buddies, the Rotenberg brothers and Gennady Timchenko of Gunvor and Novatek.  Also sanctioned were Ivanov and Yakunin.

Timchenko is of particular interest.  The Treasury Department specifically alleged that Putin is a part owner of Gunvor, and might have access to Gunvor funds.  I don’t know, but would love to know, whether this is based on information that UST has developed, or is just a repeat of the allegations from Milov and others that have been made in the past.  If the former . . . that would be a bombshell.

This puts Gunvor in a very delicate position.  Some of its contracts likely have illegality clauses which could conceivably permit counterparties to void the contracts.  Gunvor would no doubt fight this.  But the main threat is that no company is likely to want to deal with Gunvor going forward, and more importantly, that banks are very like to cut or pull altogether credit lines.  These lines are the lifeblood of any commodity trader.  It cannot finance inventories and trades without access to credit.

The fading away of counterparties and banks can set off a death spiral that causes the rapid demise of a trading firm.

The market is already hammering the firm.  Yield on its bond rose 340 basis points to 10.91 percent.

Meaning that we may soon get a live test of an argument that I’ve been making for over a year now, and which I made today at a conference in Brussels (and made to various European regulators yesterday): namely, that commodity trading firms are not systemically important like banks are.  Commodity trading firms can die, without fear of contagion that affects the broader economy.

Gunvor announced that Timchenko has sold his shares to co-founder Törnqvist (a Swede).  I doubt this will clear the serious doubts now swirling around Gunvor.  Banks and potential counterparties will wonder whether there is an explicit or tacit option for Timchenko to repurchase his shares.

Trading firms depend very heavily on reputation, and the trust of counterparties and lenders.  Gunvor is so closely associated with Timchenko-and Putin-that it is hard to see how counterparties and banks would be willing to take the risk of dealing with the firm.   How can they be sure that the firm is out of any threat from action by the US (or the EU, if it follows suit)?  Will they really trust this claim of a miraculous sale that severs all ties between Timchenko and Gunvor?  (If the bond price doesn’t rebound tomorrow, we’ll have our answer.)

There is no doubt that Fear, Uncertainty, and Doubt are swirling around Gunvor right now, and there is little that Timchenko or the company can do to dispel it.  And FUD is often more than enough to kill a trading firm.

The US government can feed the FUD by opening an investigation, not just of the alleged sale, but of other Gunvor activities.  I am sure there is more than enough grounds: the hint,hint; nudge, nudge about the connection between Gunvor and Putin is alone sufficient to give those thinking of dealing with Gunvor the yips.  And the announcement of an investigation, particularly in this environment, is likely to be as fatal as a conviction would be.

I will note that in the aftermath of the Georgia War I specifically called out Gunvor as a firm that deserved special scrutiny as a way of pressuring Putin.  It’s about damn time.

The storm that is brewing around Gunvor will be a gentle spring breeze by comparison to the tempest that would occur if the administration moves to add a name conspicuously absent from today’s list: Igor Sechin.  Again, illegality clauses are likely to come into play, which could permit the banks to pull the prefinancing that was provided in conjunction with prepay contracts between Rosneft and Glencore, Vitol, and Trafigura.  Invocation of these clauses would require Rosneft to repay the loans immediately.  The sums involved are immense, totaling around $12 billion.  Rosneft had announced it was looking to go to the capital markets to raise funds.  Those plans would likely have to be scuppered if Sechin gets named to the Treasury list.

But that’s for another day.  For the immediate future, all eyes on Gunvor.  Let’s see if it can find some legal maneuver to convince lenders and counterparties that it has severed all ties with Timchenko, and therefore has no exposure to punitive actions by the Treasury.  I suspect that many will argue that the downside exposure is so great, that they are unwilling to run that risk.  If that happens, Gunvor will soon implode.  The question is: will much of Putin’s wealth implode with it?

Finally, a personal note. I have had several excellent students in the Masters Program in Commodity Trading and Finance at the University of Geneva who work for Gunvor.  I feel very badly for them.  I know that being young, and bright, and having general human capital  they will wind up on their feet.  But I do sincerely regret what they must be going through now.

December 21, 2011

This Would Explain a Lot

Filed under: Economics,Energy,Politics,Russia — The Professor @ 2:58 pm

From #1 SWP daughter: Young Vladimir Putin Looks Totally Like Tom Riddle (a/k/a Voldemort):

Speaking of Putin.  He is reaching new levels of chutzpah in his campaign.

A couple of examples.  First, Russia to Be a Top Country for Business in 10 Years:

“We need to outline a quite clear goal – to become one of the world’s leading countries with the best conditions for entrepreneurial activity within ten years,” Putin said at a congress of Business Russia, a national association of businesses.

“This is a very difficult task, because it is rather hard to eradicate and wipe out corruption, which, unfortunately, is part of the culture, or its absence,” the premier said.

Vladimir Putin, anti-corruption campaigner.  Mind boggling.

Second, another related piece: “Business must return from off-shore ‘shadows‘”.  This story included this bit:

“There should be absolute clarity concerning the structure of ownership, with real shareholders and beneficiaries,” said Putin.

“This is a key indicator of how civilised the business climate is, the maturity of the economy and the level of responsibility of the business community,” he added, saying his comments did not only refer to the energy sector.

Hey.  Speaking of the energy sector and clarity regarding “real shareholders and beneficiaries”, how about shining some light on Gunvor!  I’m sure that would be quite interesting.

And for an extended treatment as to why Putin lecturing about corruption as anything but a practitioner, see the new Milov, Nemtsov, Ryzhkov, and Shorina paper.  (Five, four, three . . . )

December 9, 2008

Ruble Rumblings

Filed under: Commodities,Economics,Energy,Politics,Russia — The Professor @ 9:44 pm

Much news on the Russian economic front.

One of my favorite Russian commentors, Vladimir Milov, said this on Ekho Moskvy:

According to Kiselev’s next guest, Vladimir Milov, president of the Energy Policy Institute, compared with his previous annual question and answer sessions with the nation, this year “the president did not look confident”. Milov continued: “I would put it this way: there was less of the aplomb which we could observe in the previous years and more apologies and attempts to explain the situation.” “It was as if he (Putin) was apologizing for what is happening and, in my view, he was not very successful in this,” he said.

According to Milov, Putin is not suitable for the role of a crisis manager: “Putin is so used to the idea that everything is growing, that mentally it is very difficult for him to adjust.   One can see that he has a very inertial mentality and hence it is very difficult for him, in the conditions of the crisis, to respond to the current major and sweeping changes. He is definitely not suitable for the role of a crisis manager.”

Asked whether he approved of the government’s current strategy of “ensuring economic growth and GDP growth at any cost”, Milov replied: “To be honest with you, I can’t see the government acting in a coordinated manner, not to mention having a clear strategy or aim.” “It is evident that they (the government) have got into a muddle and are not ready to get together as a single team and draw up a coordinated anticrisis plan,” Milov said.

He went back to elaborate on the idea of the “inertia” prevailing in Putin’s and other leaders’ approach: “They are used to the situation of the past few years when everything was improving all the time owing to various external factors which they had nothing to do with, and they are simply not ready, they simply do not know and do not understand what to do in a situation when the economy is functioning in entirely different mode and when very difficult problems have emerged and the essence of which they do not understand either.”

“It is a question of fundamental incompetence and inability to assess the scale of the problems that have appeared very suddenly and are of rather an unexpected nature,” he added.

Asked how he would have dealt with the current crisis, Milov replied: “There are ways, but first of all we still need a competent leadership that would indeed understand the essence of the economic problems we are facing. Judging by what Putin said yesterday (4 December), he is a long way from having even a basic understanding of the nature of these crisis phenomena. He was still blaming America for everything. But soon, incidentally, most people will realize that America is America but jobs are being cut here, in Russia.”

Asked about the possible political consequences of the current economic crisis, Milov said: “It is a very difficult question because there are two opposite theories. According to one, the growing economic difficulties will undoubtedly start affecting a wider circle of people and very quickly push these people towards a realization that something needs to change in the political system and they (these people) will demand this.”

“But there is another theory”, Milov continued, “which says society can be rather adaptable –
people will be getting used to having slightly worse living standards and will start saying, as Putin did yesterday, that in its one-thousand-year history Russia has been through much worse times. At present it is very difficult to say what will happen in society and how this will affect the political system.”

And, in conclusion, he added: “Even if they want to, these authorities, which have only the most primitive tools at their disposal, will not be able to respond because they can’t provide any serious crisis management. Hence, if there is a significant public protest, I think they will simply have to go. There are no other options here.”

It’s easy to look like a genius when the prices of your main products go through the roof.   When oil was $140/bbl, Putin strutted about like the cock who thought his crowing made the sun rise.   Too often, people confuse luck for skill.   Happens with traders all the time.   Now, things are a little bit more difficult, and Vlad is not looking quite so good. Maybe Time should reconsider that Man of the Year thing.

The main issue is the ruble.   Due to concerns about the ruble, S&P has downgraded Russia’s sovereign debt rating, with a negative outlook (meaning that further downgrades are likely.)     Another first! (Russia is the first emerging market to have its rating cut by S&P.) S&P emphasized both macroeconomic and political risks in making its judgment. The political risks are especially important in my view.

In one rather (black) humorous moment, A S&P analyst opined:

“On the other hand, passage of measures to improve the legal and institutional framework for foreign direct investment and enhance competitiveness of the broader economy, as well as implementation of monetary policies to preserve the government’s still substantial liquid assets, could lay the foundations for greater resistance of the balance of payments to external shocks, and lead to a stabilization of the sovereign rating,” S&P’s Frank Gill was quoted as saying.

Good luck with the “passage of measures to improve the legal and institutional framework,” Frank.   That’s a very weak reed upon which to lean. In fact, if that’s the key to creating a firm foundation for future investment and growth–and I believe it is–then going short the ruble is a very good trade.

The increasing consensus is that (a) Russia is making a serious mistake by delaying the adjustment of the ruble to reflect the new bearish fundamentals (most notably the oil price), and (b) political considerations are driving this policy error.   Nouriel Roubini has an excellent analysis:

Given this sudden change in the Russian fortunes there are several key policy issues that the policy authorities need to deal with: of course given the external shocks (terms of trade worsening and sudden stop of capital and credit) it was important to use the buffer of foreign reserves to avoid a bank run by providing liquidity and capital to banks and by providing a fiscal stimulus to a country that is sharply slowing down. But the key unresolved policy issue is what to do with the exchange rate. Until recently Russia was on an effective basket peg (with 55% for the dollar and 45% weight for the euro). But with oil prices now down over 60% from the peak of the summer and with incipient current account deficits and fiscal deficits and a likely recession in 2009 the currency is obviously overvalued. A reasonable estimate of the needed exchange rate depreciation – with oil at about $50 a barrel in 2009 – is 25%. But until recently the authorities resisted the needed depreciation through aggressive forex intervention.

The reasons for resisting such necessary depreciation were varied: the banks and the corporate sector had massive foreign currency liabilities and a sharp movement of the currency would have led to nasty balance sheet effects and severe financial distress; the incipient bank run of retail depositors could accelerate if the currency were to fall sharply (Russian depositors were wiped out already twice in the transition period in the early 1990s and again in 1998 and they tend to be trigger happy); Putin staked part of his reputation and his view of a strong Russia on maintaining a strong rouble.

But the forex intervention that financed the capital flight out of Russia (a flight initially triggered by the increase in political risk given the Georgia conflict and then exacerbated by the global sudden stop of capital given the US financial turmoil in October-November) exacerbated the flight. Indeed, a good part of the forex intervention was sterilized thus preventing a significant stabilizing increase in domestic interest rates that an unsterilized intervention would have triggered. But, as a perfect case study of Triffin’s “inconsistent trinity”, a country cannot maintain a peg, have no capital controls and, at the same time, maintain monetary independence and avoid an increase in domestic interest rates that an expected depreciation triggers. The sterilized intervention thus led to a persistent bleeding of forex reserves that could continue unless such intervention is allowed to be unsterilized and thus force a rise in interest rates that would however be seriously costly in growth terms.

For a while the Russian authorities tried to skirt this inconsistent trinity inconsistency by introducing capital controls on capital outflows (taking the form of reading the riot act to local and foreign banks and financial institutions and telling them not to speculate against the trouble). But even such controls are leaky as many banks – faced with retail depositors converting roubles into dollars – needed to hedge such currency risk to avoid exacerbating their open currency positions mismatch. So the authorities cannot be too heavy handed against banks that are just hedging rather than speculating”. And unless capital controls are imposed in retail depositors their demand for currency hedging drives the financial institutions need to hedge in turn this currency exposure. So the conundrum of the inconsistent trinity still holds as there are limits to regaining monetary independence under fixed rates when such capital controls are effectively leaky and implemented partially.

The more appropriate way to regain a modicum of monetary independence and prevent a sharp increase in domestic interest rates that expectations of a rouble depreciation trigger is to let the currency peg go and flexibilize the exchange rate regime. Only after the currency has moved down enough expectations of further depreciation would quiet down. So, the right policy move would be one of a one-step large depreciation of the currency value that reduces significantly the amount of actual overvaluation of the currency. Instead, for the time being, the authorities have reacted by allowing only a gradual and modest depreciation, in a series of four 1% downward steps in the last month. But such small step depreciations exacerbate the capital flight incentives (and ensuing bleeding of reserves) as they lead to further expected depreciation expectations that triggers further flight. Only a relatively large unexpected step depreciation can stop such expectations and reduce the amount of the capital flight and forex reserve depletion.

But so far authorities had resisted such large step move for three reasons: losing face politically; worrying about a run on banks by depositors; and the large foreign currency exposure of financial institutions and corporate firms. These three reasons to resist a larger currency move are now becoming less important for several reasons. First, a continued bleeding of a large stock of reserves could cause a much bigger problem down the line – a real currency crash that would be politically even more damaging – if continued sterilized intervention leads to a sharp fall in reserves at the time when the current account and the fiscal account are likely to move into a deficit in 2009. Second, the risk of a bank run can be better managed via a controlled devaluation when reserves are still high rather than when reserves have been mostly depleted via a self-defeating defense of an indefensible peg.

Third, and most important, by now a significant part of the foreign currency exposure of the financial and corporate has been reduced by using the forex reserve intervention to effectively allow banks and corporate firms to reduce their exposure to foreign currency liabilities and thus avoid severe balance sheet effects when the currency moves by a larger amount. Effectively Russia has been doing what Brazil did in 1998-99 – i.e. bailing out ex-ante its banks and corporates by allowing them to cover their forex currency exposure via purchase of a large fraction of the reserves of the central bank.   This Brazilian “ex-ante bail-out” prevented the “ex-post bail-out” that would have been necessary if banks and corporates with a massive amount of foreign currency debt had experienced a large currency depreciation before they had the time to hedge such exposure. So now that the forex reserves of Russia have been run down enough to reduce the foreign currency exposure of the private sector the central bank can allow a faster rate of rouble depreciation without worrying about the banks and corporate going bust via the balance sheet effects of a large currency move on the value of their previous large foreign currency exposure.

All these factors suggests that the Russian authorities are now ready to let the currency fall at a faster rate than it the past. They have already moved in that direction by surprising markets with their weekly 1% moves. But since a much larger depreciation is needed and since further expected 1% moves will trigger even greater amounts of capital flight and reserve depletion a broader and large one-step move is now necessary and viable. The rouble may need to fall by about 25% before reaching a new equilibrium value. It is thus better to make a good chunk of that adjustment faster and in an unexpected way rather than keep on bleeding a large stock of forex reserves if small step movements trigger expectations of further depreciation. Now that banks and corporate firms are more hedged than before and the war chest of reserves has not yet fallen to alarming levels it is time to let the currency level take a larger burden of the necessary adjustment that the country needs to cope with lower oil prices, the sudden stop of capital, the increase in investors’ risk aversion and a global economic outlook that signals a sharp recession in advanced economies and a very likely recession in Russia too.

Roubini does endorse one argument that DR has made–namely, that defending the ruble has effectively bailed out those banks and corporations who have borrowed in foreign currencies. But Roubini argues that the time for that is over. The other deleterious effects of maintaining the peg which I have focused on are becoming too big to ignore. But Russia seems to be ignoring them, and primarily for political reasons, or, as Roubini puts it, “losing political face.” Putin’s ego is a very expensive proposition, indeed.

Roubini’s best point is that by burning through its reserves to prop up the ruble at levels completely inconsistent with the currently low price of oil, Russia is depriving itself of the means to manage the currency at a more realistic level when the real fiscal crunch begins to kick in sometime in 2009.

The incoherence of the Russian policy is becoming more widely acknowledged. One thing I had noted (in a reply to DR in the comments, I think) is that there was a certain dog-chasing-its-tail aspect to Russian policy, with the central bank printing rubles to try to provide liquidity to the domestic economy, and then sopping them up by buying them with dollars and euros. The ruble printing tends to drive the ruble down, so the bank has to sell more dollars to keep up the exchange rate. This can work, after a fashion, if, as Roubini notes, three are effective capital controls that effectively segment the domestic and FX markets, but these controls are not in place. As one Russian economist noted:

Yevgeny Gavrilenkov, economist at Troika Dialog, argues this has accelerated the exodus from the rouble.

“The expectation there will be a devaluation is present and . . delaying this is only making it worse,” he says. “The [central bank] is printing roubles to support liquidity and half of that . . is going to the dollar market. This is a bit absurd.”

Hence, Russia is blowing through its reserves in a thoughtless way that is impeding its adjustment to the new reality of a $40 oil price and depriving itself of the policy flexibility it will need down the road if world economic conditions–and hence the price of oil–continue to be weak well into next year.

All of which just goes to demonstrate the justice of Milov’s rather damning judgment on Russian economic policy and Putin’s crisis management acumen.

December 1, 2008


Filed under: Commodities,Economics,Energy,Politics,Russia — The Professor @ 9:45 pm

Like a spoiled child who has lost a game at his birthday party, Vladimir Putin cries: “It’s NOT FAIR!“:

Prime Minister Vladimir Putin described the effect foreign markets have on domestic share prices as “unfair” during a government meeting Monday, saying the values of the securities do not accurately reflect those of the companies themselves.

Putin also spoke out against insider trading and again blamed the West for the country’s economic difficulties, adding that those trading on domestic exchanges would be compensated for financial losses, Interfax reported.

“Decisions concerning which securities to buy or sell on Russian markets are, for the most part, made abroad,” Putin said, the news agency reported. “Moreover, the criteria by which these decisions are made have very little connection to the actual state of our economy or Russian companies.”

At the same time, he was careful to point out that the country did not want to exclude foreign investors.

“No one is preparing to limit the activities of foreign capital in the Russian stock market — we welcome foreign investors,” Putin said. “But at the same time, the task lies in properly building a large class of domestic investors as a powerful and capable financial institution of its own.”

While the lack of domestic investors is clearly a problem and shares in Russian companies trade at levels below what might be expected given their fundamentals, said James Beadle, director of Pilgrim Asset Management, the blame for their performance should be shared around.

“On the face of it, Putin is completely correct — I think a lot of the market’s reaction has had nothing to do with the Russian economy,” Beadle said. “But Russia’s situation has been, as we know, worse than most emerging markets. I put that down to the weak economic environment, the political risk and a lack of domestic investors.”

While lashing out at the West, Putin said the government remained committed to turning Moscow into an international financial center.

“In the very near future, the government will examine a comprehensive plan regarding the financial center’s creation,” he said, adding that the financial crisis would perhaps change the global economic pecking order, affording Russia greater opportunity to achieve its goal.

Vladimir Milovidov, head of the Federal Financial Markets Service, followed Putin’s comments at the meeting by elaborating on the state’s plans for compensating investors for market losses, Interfax reported.

Milovidov explained that this would be achieved through a mechanism based on the Deposit Insurance Agency, which is designed to insure individual bank deposits.

“I don’t see any clear obstacles to the creation of such a system of compensation based on the idea of the Deposit Insurance Agency,” Milovidov said, although he added that the question would require further consultation with various ministries and departments.

There was skepticism over whether such a plan could work.

“It seems a little unrealistic to me,” said Tom Mundy, an analyst at Renaissance Capital. “Maybe it would be better to think about how Russia can restructure its financial institutions.”

While saying there was some truth to the charges Putin made, Mundy also said not all of the blame for weak domestic markets should be placed elsewhere.

“Russia’s financial institution did break down. The banks didn’t lend,” he said. “[The crisis] is an inherited problem, and I can understand why the market is frustrated. But it does not mean that Russia is completely blameless.

“There is a little bit of blame to be passed overseas, and there is some internal blame as well with these oligarchs who had [overleveraged their companies],” said Ronald Smith, chief strategist at Alfa Bank. “There’s blame all the way around.”

In line with Putin’s comments, the Presidium approved a strategic development project for Russia’s financial markets through 2020, Milovidov reported. He added that the Presidium also approved a draft law designed to combat insider trading.

Mundy said the Kremlin’s focus on a global financial center pointed to a healthy desire for economic integration and that, in the end, the crisis might actually help push along Russia’s economic development.

“‘The next stage in Russia’s development is probably creating more transparency,” he said.

I especially like the part about insider trading.   I’m sure no silovik ever does that.

The prattle about Russia as a financial center is simply delusional.   No secure property rights, no credible policy commitments, no rule of law, corporate raiding, expropriation of foreign investors–yeah, that’s the foundation for a world financial center.   You betcha!

And what’s the deal about compensating those trading on domestic exchanges for their losses?   That’s the ticket, give investors a put paid for with government money.   No better way to encourage wild risk taking–private gains, socialized losses.   The proposal also smacks of a scheme to tunnel state assets and direct them to the pockets of political favorites.   We are repeatedly told that individual investors don’t play the Russian stock market–that it is the playground of a limited set of connected players, the oligarchs prominent among them.   So this seems like just another bailout.

Tom Mundy gets a nomination for the Understatement of the Year Award:

“It seems a little unrealistic to me,” said Tom Mundy, an analyst at Renaissance Capital. “Maybe it would be better to think about how Russia can restructure its financial institutions.”

Ya think?

November 1, 2007

Competitiveness Rankings

Filed under: Economics,Politics,Russia — The Professor @ 9:09 am

Newly released competitiveness rankings place the US first. This year’s rankings are different than those from years prior, because they place greater emphasis on institutional factors, and less on green-eyeshade fiscal/macroeconomic factors:

However, the U.S.’s sharp climb was due to a change in methodology that gives more weight to market-related factors in the survey, relative to macroeconomic criteria on which the U.S. is weak. Under the new methodology, the U.S. would have topped the rankings last year, too.

“The U.S. does amazingly well on innovation and markets, but on the macroeconomic-stability pillar it ranks 75th” out of 131 countries included in the survey, said Jennifer Blanke, the forum’s chief economist and a co-author of the report. “This still reflects a very serious problem that could hurt the U.S. in the future.”

The U.S. scores badly for high levels of government debt and deficits and a low savings rate that reflects overextension among U.S. households. The recent credit crunch, triggered by problems in the subprime-mortgage market, is an example of the risks these weaknesses hold for the U.S. and global economies, according to the survey’s authors.

This greater emphasis on institutional factors–“market factors” in the lingo of the report–is entirely warranted, but based on descriptions of the methodology in the press, I have my doubts about the overall reliability of the methodology, and the conclusions based thereon. Specifically:

Among surprising performers are countries from the Middle East and Central Asia, many rich in oil and natural gas and several new to the survey this year. Kuwait, Qatar and Tunisia ranked 30th to 32nd, respectively, beating all but one of the dozen countries that recently joined the European Union, as well as China and India.

Saudi Arabia, the United Arab Emirates, Oman and Bahrain followed close behind. They also beat several EU countries, including Italy, Hungary and Poland. Russia, at 58th, and Uzbekistan, a natural-gas-producing dictatorship in Central Asia, rank ahead of EU laggards Greece, Romania and Bulgaria.

Those rankings reflect a revenue windfall from high energy prices that has given these countries strong macroeconomic stability. It has also provided the means to fix basic productivity drags on their economies, such as poor education, rampant unemployment and minimal female work-force participation, Ms. Blanke noted.

“Right now they have so much potential,” Ms. Blanke said. “The question is what they do with it.” If they don’t use the windfall wisely, then a sharp drop in commodity prices could see their competitiveness drop quickly, she added. [Emphasis mine.]

“If they don’t use the windfall wisely” indeed. Err, ever heard of the “resource curse,” Ms. Blanke? It is well documented that countries with resource windfalls–particularly, dramatic improvements in their terms of trade attributable to spikes in prices of primary commodities they produce–tend to perform very badly economically. There are many competing hypotheses regarding the channels through which the curse manifests itself. The earliest hypothesis is the “Dutch Disease” channel, whereby the resource boom causes an appreciation in the commodity producer’s currency, placing its tradeables sector (primarily manufacturing) at a competitive disadvantage, leading to a flow of resources into non-tradeables production. If there are positive spillovers (e.g., learning by doing) in the tradeables sector, but not in the non-tradeables sector, this can lead to poor future growth performance.

Other theories focus on the political economy effects of resource booms. I consider these theories much more plausible, and they speak directly to the wisdom of public expenditures in countries reaping a resource windfall, and the chimerical nature of “macroeconomic stability” in these nations. The basic idea behind these theories is that the commodity price boom leads to a diversion of resources into non-productive uses primarily because the windfall is distributed by politicians according to political, rather than efficiency, criteria.

These types of theory also come in many flavors, but the Robinson-Torvik-Verdier article published in the Journal of Development Economics in 2006 is a good example with some interesting implications of direct relevance to the competitiveness analysis. In their model, politicians use the windfall to direct goodies to their political supporters. Because politicians’ promises of delivering checks to supporters in the future are not credible, efficient transfers are not possible. Instead, politicians must buy votes with inefficient mechanisms–such as increased public employment–that are credible. (Read the paper to see why public employment is a credible way to shower benefits on supporters.) [NB. This is actually a variant on Stigler’s old theory of why politicians/regulators use inefficient mechanisms like entry barriers rather than distribution of cash.] Thus, in the Robinson et al model, political considerations lead to the direction of the commodity boom windfall to unproductive sectors of the economy, dampening future economic growth.

This model, and other political economy resource boom models, predict that “spending the windfall wisely” is the exception rather than the rule, and both cross country and case study evidence is strongly supportive of this view. Thus, the “potential” of resource boom countries is likely a mirage, and “macroeconomic stability” too often disappears in a splurge of wasteful public spending.

The Robinson et al article also predicts that the effects of a resource boom depend on the institutional framework of the country receiving the windfall. Countries with weak political institutions–those that do not “promote accountability and state competence”–will tend to suffer from resource booms, while those with strong institutions will benefit. (A paper by Durnev and Guriev provides another model of a different mechanism by which institutional quality affects the severity of the resource curse.) Thus, the countries named in the competitive rankings as potential beneficiaries of the commodity price boom–Saudi Arabia, the United Arab Emirates, Oman, Bahrain, Russia, and Uzbekistan–are in fact unlikely to thrive despite high oil prices because each is plagued by weak institutions.

As an interesting contrast, historically Australia, Canada, and the US had natural resource intensive economies, but did not suffer from resource curses. The most reasonable explanation; these nations inherited a strong legal and property rights framework from Britain that antedated the development of natural resources. Moreover, these resources were largely privately owned.

Indeed, the resource booms can actually corrode already weak institutions even further. In this regard, an article by former Russian Deputy Energy Minister Vladimir Milov is particularly illuminating in this regard:

After several years, the phrases related to the creation of the rule of law and the dictatorship of law have disappeared from the official lexicon. The YUKOS case has become the apotheosis of the destruction and discrediting of the Russian legal system. The case has launched the odious “tax terror”, (which, in practice, is based on a replacement of the presumption of a lawful conduct of a taxpayer with the presumption of guilt). The case also showed full dependency of the courts on the executive. As soon as YUKOS assets passed from one owner to the other, the courts at once reconsidered their previous decisions on “tax debts”. . . .

A special law limiting access of foreign investors to strategic areas of economy has still not been adopted. Despite this fact, the authorities have been limiting the foreign access at will. They simply do not need the law, since in reality informal mechanisms determine everything.

The natural resource sector–and the oil and gas sector in particular–has been the primary target of the assault on the rule of law and the security of property rights within Russia, but Mirov suggests that the damage resulting from this assault is not limited to this sector alone, but instead has undermined property rights and the rule of law in Russia generally. This is not conducive to good future economic performance, and indeed, will likely cripple future growth prospects.

So, despite the salutary changes in the computation of the competitiveness rankings, the compilers of the rankings are missing a major part of the competitiveness picture. By viewing the resource boom primarily through the filter of government budgetary considerations, and failing to recognize that resource booms can undermine the very institutions that they rightly acknowledge are major contributors to economic growth, they exaggerate the potential of the resource boom countries. ” If they spend the windfall wisely they will do well.” This is a conditional statement, and the condition under which it holds is highly unlikely to be true. My uncle liked to quote a Chief Petty Officer who was wont to say: “If . Yeah, if frogs had wings they wouldn’t bump along on their butts.” The authors of the competitiveness rankings imagine that resource boom countries have wings to fly, but in reality, they are likely to bump along frog-like because of the deleterious effects of commodity price booms on the allocation of resources in countries with weak institutions.

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