Streetwise Professor

October 21, 2008

Russia Is Not the Only Natural State

Filed under: Uncategorized — The Professor @ 8:08 pm

Today’s New York Times discusses the challenges posed by falling oil prices to Venezuela, Iran, and Russia. Here is an excellent, one sentence description of a natural state dependent on natural resource rents to maintain political stability: “At home, oil money allowed Iran’s ideological hard-liners to preserve their monopoly on power, to buy political allegiances and to offset the fiscal damage of their economic policies.” When resource rents fall, it is much harder for authoritarian (and worse) natural states to maintain cohesion.

Of the three states, Venezuela is probably the most vulnerable. Although the oil industries in Russia and Iran have faced problems maintaining output, Chavez has done an especially good job at kneecapping his country’s oil business, by politicizing the operations of national oil company PDVSA (including the firing of many of the most knowledgeable and skilled employees, whom Chavez considered a political threat) and seizing four private oil projects in the Orinoco River region. Venezuela also faces challenges because its heavy crude is notoriously hard to process, so the know-how of the BPs and Exxons and Chevrons is especially vital.

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  1. I am curious as to what you think of the Aslund piece in today’s Moscow Times entitled “Russia’s Top Economist Needs to Face Reality.”

    Here is a passage from the opinion piece:

    In fact, Russia would be lucky if it faces nothing worse than stagnation. A substantial decline in GDP next year is an acute possibility. Do not believe all these forecasts that as recently as a month ago predicted 6 percent or 7 percent growth next year. Each forecast is lower than its predecessor. Let us instead discuss the forces at hand.

    As elsewhere in the world, the Russian banking system has frozen up because of rising international interest rates and an elimination of trust. Central Bank Chairman Sergei Ignatyev said two weeks ago that he expected 50 to 70 banks to go under. Others fear more than 200 banks might collapse. That would keep the credit market frozen for quite some time and lead to a contraction of loans, regardless of whatever the Central Bank does.

    The second blow has already hit real estate development, a sector that is particularly dependent on credit. Investment is still increasing, but the growth rate has declined to 8 percent from 24 percent over the same month a year ago in September. You can see for yourselves how many cranes are standing still at construction sites in Moscow, and most large real estate and construction companies are considered to be on the verge of bankruptcy. Their stock prices have fallen 82 percent this year. If construction is halved, construction alone would reduce GDP next year by nearly 3 percent.

    The third strike has hit commodity prices. Since their admittedly brief, sharp peak in July, both steel and oil prices have halved because of the sudden slowdown in the world economy. In addition, energy production is already stagnant, and export volumes are declining. Russia’s crude oil exports fell by 5.9 percent during the first eight months this year. Steel exports are set to plummet, as China has turned from a steel importer to a major exporter. Domestic demand will decline with construction. Commodities, which represent roughly a quarter of Russia’s GDP, cannot possibly expand next year, but they may contract somewhat, especially steel production and construction materials.

    But what will grow? Retail sales have already been hit. Transportation will stagnate with the commodity sector. Public services can hardly expand because the state budget will go into a deficit with the falling oil revenues. Some import-substituting manufacturing — notably car production — and modern services, such as mobile communications, may continue to grow, but these are likely to be the exceptions.

    This year, Russian exports are expected to reach $500 billion, of which slightly over 80 percent consists of commodities. If next year the average export prices of commodities are little more than half of this year’s prices and volumes are only moderately smaller, Russia’s exports would shrink by no less than 40 percent, or $200 billion, which amounts to a staggering 12 percent of GDP. JPMorgan is already predicting a decline in Russia’s exports by $89 billion, which is surely only the beginning.

    Naturally, this is nothing but a tentative picture painted with a broad brush, but who thinks that the bank sector will not seize up again or that commodity prices will recover? If anything like this were to happen, Russia’s GDP would fall by 5 percent or more next year. The outcome might not be that bad, but it is much more likely than 6 percent growth, which most forecasters still predict.

    Comment by Michel — October 22, 2008 @ 12:07 pm

  2. I definitely agree that there has been a distinct air of unreality in the public pronouncements of Medvedev & Putin, and the state controlled or influenced media’s complete failure to report anything on the financial situation in Russia suggests is telling in its own way; at the very least, officialdom fears a broadly-based panic, and wants to minimize the probability of its occurring by stifling information flows. (This could actually have perverse effects, as people will rely on noisier signals, and information cascades are more likely.)

    Re Aslund’s specific analysis. It is a piece with his writing for some time now. He has always been an extreme pessimist, and coming from me, that’s saying something. I think he tends towards hyperbole (same comment applies), so I would say directionally he is right–Russian growth is likely to be substantially less than forecast. As for a 5 percent decline, that’s possible I guess, but I would be reluctant to make such a forecast (which is essentially a 11 pct difference with the until recently forecast 6 pct growth). Put differently, if RF GDP falls 5 percent, I think it would decline a lot more than that as I doubt the system could sustain such a drop for reasons I’ve stated in previous posts, and the resulting chaos would put the economy in a freefall.

    My main issues with his piece (I read it first thing this morning) are (a) that it relies too heavily on anecdote rather than hard data (e.g., “retail sales have been hit”–supporting data?), (b) it relies too much on hypotheticals (e.g., “If construction is halved, construction alone would reduce GDP next year by nearly 3 percent.” What is the likelihood of a 50 percent fall in construction?)

    In sum, I think he has identified the key vulnerabilities of the Russian economy–and there are several–but is being more than a little sensationalist in his specific predictions.

    A key indicator to keep an eye on is the ruble. It is down about 2 percent today against the dollar (not so bad against the Euro b/c the Euro is down about 2 pct too.) A weakening export picture (even less dire than the $200 billion decline Aslund mentions) definitely pressures the Ruble, as do problems in the banking sector. It is also worthwhile to follow how much the government spends to prop up the currency. It is between the devil and the deep blue sea–if it lets the ruble drop, then (a) that might feed popular panic, as that is a very visible signal, and (b) will feed inflation, but if it supports the ruble, it can blow through the financial cushion pretty quickly.

    The ProfessorComment by The Professor — October 22, 2008 @ 1:53 pm

  3. BTW, Brent is currently trading at $64 and change–which means that Urals will be around $62.

    The ProfessorComment by The Professor — October 22, 2008 @ 1:54 pm

  4. In essence, the Russian state is being undermined by the refusal of the government to even acknowledge there is a crisis. It highlights the problems with “managed” democracies. The fact that the Russian government has not been openly discussing what problems facing Russia feeds the possibility of a panic, which leaves them in a damned-if-they-do, damned-if-they-don’t position vis-à-vis the ruble.

    Comment by Michel — October 22, 2008 @ 2:05 pm

  5. Putin is now doing what Putin does best: meeting with underlings and scolding them for not doing what the state tells them to do. In today’s an article commenting on Putin’s meeting with the head of Alfa-Bank:

    The article writes:

    Владимир Путин отчитал главу Альфа-банка за то, что крупные банкиры, получая дешевые деньги от государства, не двигают их дальше в экономику. Они дожны чувствовать себя не коммерческими структурами, а “агентами правительства”, объяснил премьер. Но одни призывы здесь вряд ли помогут.”

    My rough translation:

    “Vladimir Putin criticized the head of Alfa-Bank because the big bankers are getting cheap money from the state and not moving along in the economy. They should consider themselves not commercial structures, but “state agents” explained the Prime Minister. But calls [to action] alone are unlikely to help.”


    Comment by Michel — October 22, 2008 @ 2:35 pm

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