Streetwise Professor

Russia’s economic position remains parlous. The ruble has continued to weaken, and although the price of oil rallied somewhat late last week, it still remains far below levels necessary to permit growth. The World Bank is predicting a 2.9 percent decline in GDP in 2015. 9.2 percent is more likely.

So what is Putin/Russia going to do? The options are limited. Given the weak economic conditions, and the lack of access of the banking and corporate sectors to international funding, there appears to be only one option. As a lawyer friend sagely put it, the government will essentially have to move massive amounts of liabilities from big banks and large state enterprises onto the government balance sheet. Formally, it will be done through the banks. The banks will extend credit to the corporate sector (including most notably big state firms) and the government will capitalize or guarantee/backstop the banks.

This is certainly the view of Sberbank’s Chairman, German Gref (one of the last liberals-as Russians go-in the power structure):

The head of Russia’s largest bank, German Gref, offered a bleak picture of the fate awaiting the country’s banking sector in 2015 during the set piece Gaidar economic forum in Moscow this week.

“It’s obvious that the banking crisis will be massive,” the Sberbank chief told reporters.

“The state will capitalize the banks and increase its stake in them, and the banks will buy industrial enterprises and become financial-industrial groups,” Gref said Wednesday. “All our economy will be state-run.”

The result will be a simulacrum of the Soviet economy.

Two things are worth noting. The first is that this gives the lie to those who are sanguine about the prospects of a sovereign default in Russia. These optimists downplay the impending downgrades by the rating agencies, and the  fact that Russian CDS are trading well into the junk range by pointing out that Russia’s government debt is relatively small compared to GDP. But one always needs to pay attention to the contingent liabilities, and in the current circumstances these contingent liabilities include a large fraction of the liabilities of the banking and corporate sectors. That’s why Russian 5 year CDS are trading at implied default probabilities of around 10 percent despite modest levels of government indebtedness.

The second notable fact is that once things move onto the government balance sheet, it’s hard to move them off. Companies get quite comfortable with government support and the avoidance of capital market discipline: soft budget constraints-or no budget constraints at all-have their attractions. It’s easier for managers in the elite to influence the members of the elite in government than it is to persuade investors, especially foreign ones. The managers can muster 1000 excuses: think of all the justifications Sechin pushed to stave off privatization of a large stake in Rosneft. Even more excuses will be forthcoming in the midst or even the aftermath of a crisis. What’s more, appeals to patriotism-chauvinism and paranoia, really-will be quite effective. And perhaps most importantly, Putin and his clique will relish exercising even greater control over big firms than they do now. For reasons of power and personal profit.

This means that the prospects for any real structural change in Russia will be even more doubtful than they ever were, and they were never very good, especially in the mature stages of Putinism. Thus, the consequences of the immediate crisis will be severe, but the consequences of the likely response to the crisis will be enduring and quite negative. An even more statist economy even more thoroughly dominated by Putin and his cronies is doomed to stagnation.

We have already seen that to some degree in the aftermath of the last crisis: Russia’s post-2009 growth has been a fraction of its pre-crisis growth. I expect that post-2015, long run growth will ratchet down yet again, as the dead hand of the state and the dying hand of Putin weigh heavily upon the economy.

The geopolitical consequences of this are hard to discern, because there are conflicting forces at work. An economically moribund Russia will have less capacity for adventurism. But a resentful Russia that will blame the crisis and its dreary aftermath on its enemies abroad, and a Putin who will be looking to stoke these resentments for domestic political gain, will be more likely to provoke conflict.

Some years ago Andrei Shleifer said that Russia was becoming a normal,  middle income country. I always thought that was doubtful, especially once Putinism really took hold. I think it is utterly fantastical now. A combination of economic and political factors accentuated by a crisis brought on by sanctions and especially low oil prices will defer indefinitely Russia’s convergence to western-style normalcy.