Streetwise Professor

Vladimir Putin has sharply criticized businesses and individuals that have taken capital out of Russia. Central Bank head Sergei Ignatyev seconds that emotion.

Central Bank Chairman Sergei Ignatyev backed Prime Minister Vladimir Putin’s call for stricter banking oversight by government, law-enforcement and financial authorities amid capital outflow.

“When there is a significant capital outflow, a more effective, tighter oversight of the situation is needed,” Ignatyev said Monday in comments broadcast on Vesti-24. Net private capital outflow reached $50 billion in October, he said, citing preliminary estimates.

Lenders that have received government funds meant to boost liquidity in Russian markets are increasingly transferring money abroad, Putin said during a government meeting Monday, according to Vesti’s web site.

He also on Monday warned against “corporate egoism,” saying that emergency funding must work “within Russia, as intended,” he said, Interfax reported.

Putin and Medvedev clearly desire to step capital flight, and various ideas have been mooted to achieve that objective in the aftermath of the $50 billion outflow in October. All of these ideas involve the employment of state power in one way or another.

Rather than attempting to stop the flow through capital controls, or by exerting pressure on Russian businesses and banks, Putin, Medvedev, and Ignatyev would be better served by stepping back and asking: “Why is capital fleeing the country at such a rapid clip?” But then again, they probably wouldn’t like the answer. It is a vote of no confidence in the security of capital from the predations of the state, in the the government’s policies, and the country’s investment prospects.

After a week of relative quiescence in both Russia and the West, economic tremors are being felt again. We are not through the woods yet. In this environment, the relative vulnerability of Russia to investor yips and the resulting capital flight are pronounced. Putin can attempt to command the capital to stop, but it won’t. Indeed, the more he attempts to impose additional controls, the more he will frighten investors about the security of capital, and the more desperate and creative they will become in their efforts to get their money out. Putin will have no more success in stemming capital flight than King Canute did in commanding the tides to cease. (And I am aware that there are alternative interpretations of the Canute myth, one being that he issued his famous command to rebuke flattering courtiers. That’s definitely not Putin’s motivation.)

In other, related news, Ignatyev also conceded that the Ruble is likely to fall:

“I do not rule out more flexibility in the ruble exchange rate with some tendency toward a weakening of the ruble against some foreign currencies in the current conditions,” Ignatyev said.

That’s central banker-speak for “Going Down!” And the market reacted, right on cue, with the Ruble selling off almost 4 percent (for December delivery) on the CME, and the Ruble spot down about 1.8 percent.

Here’s my interpretation, FWIW. The currency is the most visible indicator of economic conditions and confidence in the Russian economy and the government’s management thereof. Regardless of what Russians see on TV, they will know things are not going well if the Ruble continues to depreciate. From an internal political management perspective, I doubt the government wants to see a substantial decline in the Ruble. Such a decline would alert people to the severity of the economic situation, give the lie to the soothing “it’s not our problem” rhetoric coming from the Kremlin, and represent a repudiation of the government’s management of the economy.

But macroeconomic considerations, capital flight, and especially the decline in the price of oil will make it extremely difficult to defend the Ruble. The fundamentals are not auspicious. Moreover, Russian corporations and oligarchs, including those near and dear to the Kremlin and the White House (on the Moskva, not the Potomac) owe substantial amounts–in hard currency–to Western banks. Margin calls and debt repayments will force Russia to choose between dipping into hard currency reserves to pay off the debt, or letting the companies fall into foreign hands.

Russia has large currency reserves compared to 1998, but the demands on those reserves are much greater too; state debts are much more modest, but private and corporate debt is massively greater, and is secured by assets that the Kremlin is loath to lose control of. I see the willingness to let the Ruble decline despite the political dangers this entails as an admission the $500+ billion in reserves is insufficient to defend the currency and pay off foreign creditors, especially in the face of a likely extended slump in oil prices. Given this Hobson’s choice, Putin and Medvedev have chosen to keep Russian companies in Russian hands, and to let the currency take care of itself; the political fallout will be managed by, uhhmmm, other means, most likely.

As I said some time back, the financial crisis is showing that “$570 billion can evaporate in a trice.” It may not evaporate in Russia, but it will decline steadily and perhaps precipitously in the coming weeks and months. And it is coming pretty clear that it will go primarily to Western banks to keep them from obtaining big stakes in Russian corporations, rather than to defending the currency. Ordinary Russians will pay a price, in terms of higher prices for imported consumption goods, and domestic substitutes.