Streetwise Professor

April 7, 2009

Will This Make Certain SWP Readers Revise Their Bet?

Filed under: Commodities,Economics,Energy,Politics,Russia — The Professor @ 9:51 pm

Michel and DR have a bet on the performance of the Russian economy in 2009.  I’m Shocked! Shocked! to see gambling at Craig’s Cafe SWP!

Russia Economy Watch has a very thorough description analysis of the subject of the bet.  Some highlights (lowlights?):

According to Deputy Economic Development Minister Andrei Klepach last week, Russia’s economy shrank by 7 percent year on year in the first quarter of 2009, a staggering turnaround for an economy which has just enjoyed eight years of solid oil-fueled growth.

“These figures are worse than we expected,” Klepach said at a press conference in Kiev,citing preliminary figures. Klepach also stated that net capital outflows reached $33 billion in the first quarter of 2009, following record outflows of $130 billion in the second half of last year.

. . . .

The Russian State Statistics Service have also released official gross domestic product figures for the fourth quarter of 2008. GDP was up 1.2 percent year on year, the worst reading for any quarter since the first quarter of 1999, and down from a revised 6 percent in the previous three months. The World bank are now suggesting that the present slump may be deeper than the one that followed the government debt default and ruble devaluation in 1998.

Certainly the data are bleak. Industrial production contracted for a fourth consecutive month in February – falling by 13.2% year on year – as the credit squeeze and falling incomes eroded demand for metals, cars and consumer goods. Retail sales contracted in February for the first time since February 1999. Unemployment was also up, at 8.5 percent in February, the highest level since January 2005.

Manufacturing output plunged with the collapse in demand in the last two months of 2008, and it is likely to contract further in 2009. According to Rosstat five of 14 major manufacturing industries reported outright output declines in 2008, with electronics, electrical, and optical equipment hardest hit (-7.9 percent), followed by textile and sewing (-4.5 percent) and by chemicals (-4.2 percent). Most of the dislocation took place in November and December 2008, when total manufacturing output respectively fell 10.3 and 13.2 percent (year-on-year). As credit continues to tighten and demand to fall, manufacturing is likely to contract further in 2009. According to recent statistics, manufacturing output dropped 24.1 percent in January 2009, compared with January 2008, and 18.3 percent in February 2009, compared with February 2008. In February 2009 the most significant declines were registered in the production of electro-technical and optical equipment (-46.6%), other non-metal products (-33.3%), and transport and transportation equipment (-31%).

. . . .
The latest data we have to hand confirm the ongoing character of the contraction. The Russian economy is thought to have declined by 5.4 percent in March compared with March 2008, according to the latest GDP indicator estimate provided by VTB Capital. The VTB GDP indicator also registered an average 4.4 percent contraction for the first three months of 2009, which would be the worst decline since the economy shrank 5.1 percent in the fourth quarter of 1998. The difference between the VTB estimate and the 7% estimate put forward by Klepach would lie in the fact that the VTB indicator does not include contstruction, and construction activity has declined sharply in recent months, so the two pieces of data are consistent with one another.

. . . .

As a result of this contraction in output and weakening in the labour market real incomes have declined substantially in Russia since the autumn of 2008. Rising unemployment and worsening enterprise finances (wage arrears have increased considerably) have meant that in the fourth quarter of 2008 alone, real disposable income dropped 5.8 percent year on year, and by 10.2 percent in January 2009 (again year-on-year). And unpaid wages as a share of total enterprise turnover tripled to 0.12 percent in December 2008, compared with August 2008. The stock of wage arrears as of March 1, 2009 (8 billion rubles or about USD 240 million) remains small but is likely to increase as the crisis grows. At the present time such arrears are thought to affect up to 450,000 people, significantly less than 1 percent of total employment. Growth in real wages came to a complete halt in January-February 2009, following double-digit increases in previous years.

. . . .

Inflation was spurred at the start of the year by the weakening ruble, which pushed up import prices, helping the annual rate jump to 13.9 percent in February from 13.4 the month before. The ruble has now lost 29 percent against the dollar since August. The most recent spike in inflation is evidently producing quite a headache for the Central Bank, since chairman Sergei Ignatiev last week that if April’s inflation is “significantly less” than it was a year ago, the central bank may consider cutting interest rates for the first time since 2007, giving some kind of monetary relief to an economy which is badly in need of it. Russia’s inflation rate went as high as 15.1 percent last June, and has since come down somewhat from that peak, but really the record of the central bank in containing inflation has been pretty abysmal.

Bank Rossii has been forced to raise its refinancing rate twice since last November, to the current level of 13 percent, in an attempt to limit the amount of rubles available to banks and companies and to slow the decline of the ruble against the dollar. On the other hand the central bank may be in danger of excessive optimism at this point, with Ignatiev telling journalists that his expectation was that the economy may pick up within “several months,” thus trying to offer hope that Russia’s banks won’t suffer that “second wave” of crisis that Finance Minister Alexei Kudrin said may hit as bad loans eat up capital. I am of the opinion that Kudrin is right to be cautious here.

Rising delinquency “is a serious problem, but I don’t share the opinion that a second phase of the crisis is unavoidable,” is Ignatiev’s view. Overdue retail loans rose to 4.4 percent as of 1 March from 3.2 percent on 1 September. “I believe the most serious phase of the economic crisis is over,” Ignatiev told journalists. Would that he were right, unfortunately I think he is wrong, the worst is still ahead.

Obviously the continuing inflation is a problem for Russia’s central bank since they would obviously like to offer monetary easing to the economy, just as the U.S. Federal Reserve, the European Central Bank and the Bank of England are doing by bringing their benchmark rates close to zero to bolster banks and pull their economies out of recessions. Bank Rossii last cut the refinancing rate in June 2007, and it has now increased the repurchase rate charged on central bank loans four times since November.

REW does note that various measures indicate that the rate of contraction in the Russian economy slowed in March; the economy was still contracting, but not as rapidly as in February, which in turn exhibited a lower rate of contraction than January.

To me, the most interesting aspect of all this is the policy dilemma.  The inflation issue mentioned above is a serious issue.  As I’ve mentioned before, Russia is in a stagflationary situation, which makes it very difficult to use an expansive monetary policy.  (Not that I think that US or UK policy is to be emulated.  We’re just facing a stagflation down the road.)  

A more severe contraction than forecast by the government also puts Russian government finances in a serious bind:

While the Organization for Economic Cooperation and Development and the World Bank are forecasting that the Russian economy will decline by 5.6 percent and a 4.5 percent, respectively, in 2009, the Russian government is still stubbornly holding fast to its official forecast of a 2.2 percent fall. Publicly government officials are sticking to their view, and diiging in around the idea that they expect a recovery in the final quarter. Deputy Economic Development Minister Klepach said that the government forecast takes into account a package of anti-crisis measures currently being debated by lawmakers that should bolster domestic demand and help boost GDP. Without it, the economy could contract by 4 percent to 5 percent, Klepach noted.

The Central Bank, on the other hand, continues to forecast a 4.5 percent contraction for the current year.

The Russian Cabinet approved last month a revised budget containing the first deficit in 10 years. The budget anticipates a deficit of 7.4 percent of projected gross domestic product, but since the current forecast is for a GDP contraction of only 2.2%, the final deficit may be considerably larger. The Finance Ministry is now transfering money from the Reserve Fund to cover the deficit, and anticipates using some 2.7 trillion rubles this year to help fund the budget gap.  

The Ministry of Finance has released the main parameters of its revised federal budget for 2009 which is based on lower oil prices (USD 41 a barrel, Urals) and a drop in budget revenues from the original 21.2 percent of GDP (under the old assumption of USD 95 a barrel) to 16.6 percent, or RUB 6.72 trillion. At the same time, expenditures will be increased by RUB 667.3 billion to RUB 9.69 trillion, to produce a deficit of RUB 2.98 trillion (about 7.4 percent of GDP), a massive reversal of the fiscal position from the 4.1 percent surplus in 2008.  

The total consolidated general government deficit is expected to be around 8 percent in 2009 deficit and will be financed largely from the Reserve Fund (7 percent of GDP) with modest domestic borrowing (up to 1 percent of GDP). With a large fiscal deficit, however, and the need to preserve some reserve fund resources for the uncertainty likely to extend into 2010, the space for more fiscal stimulus this year appears limited.

So the level of the contraction which the Russian economy undergoes in 2009 really is rather big beer, since it will condition the size of the eventual fiscal deficit, and the percentage of the Reserve Fund which will need to be used this year. If there is no rebound in oil prices in 2010 then Russia’s position can complicate on a number of fronts, since the Central Bank Reserves will be significantly depleted, the Reserve fund also, and there may be less room for fiscal easing in the face of potential credit rating downgrades, while monetary easing may also prove difficult given the need to support the currency, and protect Central Bank Reserves. All in all, 2010 could be a very hard year for Russia and its citizens.

Putin is touting the efficacy of his fiscal policy measures;

Prime Minister Vladimir Putin defended his handling of Russia’s economic crisis on Monday, telling lawmakers a 3 trillion-rouble ($90 billion) aid package would ensure the country survived a “very difficult 2009”.

“What should — and must — be said with all certainty is that Russia will overcome the crisis,” a confident Putin said in a 65-minute report to the State Duma (lower house), his first as prime minister.

“The country will beyond all doubt keep its position as one of the largest economies of the world.”

Amazingly, Putin also forecast that inflation would fall soon.  Right.  

I think a more realistic appraisal is that the likely prolonged economic downturn will put tremendous pressure on the Russian budget, thus draining the reserve funds, and putting tremendous pressure on the Central Bank to inflate.  

Russia’s fate depends now, more than ever, on a worldwide recovery.  Russia is a high beta country, due to its dependence on raw material exports.  The US Fed’s unprecedented loose monetary policy may also provide help to Russia by helping to prop up the prices of Russian exports.  But Russian policymakers have very few levers to pull.  They are at the mercy of the world economy.  And therefore, so are the betting men on SWP;-)

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  1. “I believe the most serious phase of the economic crisis is over,” Yeah right! I woud add that this high Beta Russian economy needs to start developing a high beta Russian foreign policy if it wants to have a less volatile economy.


    Comment by AlanE — April 8, 2009 @ 3:35 am

  2. Reported today, US oil inventories are at a 16 year high. The trend for oil globally is flat to down for a long time. Natural gas demand is very dependent on manufacturing levels. No recovery coming there either for a long time.

    Putin is going to have his hands full keeping Russia “one of the largest economies of the world” when the reality is subtracting arms sales to other increasingly bankrupted fellow thug regimes it hasn’t got much more going on than so many of the commodities only failed African states when you scratch below the bluster.

    Political murders and assaults are increasing in Russia which is my measurement of the Kremlin’s real confidence in the economy.

    Comment by penny — April 8, 2009 @ 12:08 pm

  3. As I said, the key question is where this is an L shaped or a V shaped recession.

    I believe it is more likely the latter, since growth is likely to come from import substitution eased by a weaker ruble (as in 1998). The two most common problems affected other countries, high debt levels that will require prolonged deleveraging or dependency on manufactured exports for economic growth, aren’t as prevalent. In fact there are already many tentative signs of a turnaround in manufacturing expectations.

    Anyway I’m going to write another post on this today with graphs and stuff. Adios 4 now.

    Comment by Sublime Oblivion — April 8, 2009 @ 8:52 pm

  4. DR–

    Quick responses. 1. L-shaped much more likely. World recession looks very L-shaped, and there is no way in hell Russia is going to flash the V sign when the world is (in the words of a Lit song) “looking kinda dumb with [its] finger and thumb in the shape of an L on [its] forehead.” 2. That’s partly why comparisons with 1998 are out of place. 98 was largely a Russia-specific event, in which a currency correction was needed to equilibrate the economy. 2009 is a world-wide thing. Completely different kettle of fish. 3. Not high gov’t debt levels in Russia, but high levels of external corporate debt are problematic. Also, high private indebtedness, with associated defaults loom. Kudrin and others in the gov’t have raised alarms about spreading non-performance on loans owed to Russian banks. 4. Uhm, you’re right that there is absolutely no dependence in Russia on “manufactured” exports, b/c there’s little if anything that Russia manufactures that anybody wants to buy. (Bug or feature?) But, dependency on raw material exports, esp. energy, is undeniable. (Though, I will not be surprised if you try to deny it;-) Will be interested to see your creative way of doing so.) These link Russia’s economic fate to the world economy–and that’s not a good place to be right now. Budget is especially dependent on revenues from export taxes. 5. “tentative sings of a turnaround in expectations” ? ? ? ? That’s a pretty slender reed to lean on my friend, especially given the manufacturing holocaust in 1Q09 documented in the post. I presume you mean that the PMI is increasing (but still well below 50). You have to squint really, really hard to glimpse any silver lining in this data.

    The ProfessorComment by The Professor — April 8, 2009 @ 9:25 pm

  5. From Bloomberg. Apparently Sberbank CEO German Gref hasn’t imbibed the same happy sauce as you, DR;-):

    Russian overdue bank loans are increasing by 20 percent a month, a pace that will bankrupt weak lenders as the financial crisis deepens, OAO Sberbank Chief Executive Officer German Gref said.

    Businesses and consumers are still struggling to repay loans, more than half a year after the crisis started, paving the way for a new round of problems, Gref, a former economy minister, said at a conference in Moscow today.

    Russian companies and individuals owe 18.4 trillion rubles ($549 billion) to domestic banks, according to central bank data. Prime Minister Vladimir Putin’s government plans to spend 1.4 trillion rubles this year to bolster banks and stimulate the economy, which is contracting for the first time in a decade.

    “The crisis is just beginning for the banking industry,” said Gref, who has run Russia’s largest lender for 18 months. “The crisis will arrive from the real sector of the economy.”

    Note: “The crisis is just beginning for the banking industry.” Doesn’t sound V-shaped to me. Sounds pear-shaped. Gref noted overdue loans are growing at 20 pct/month.

    The ProfessorComment by The Professor — April 8, 2009 @ 11:11 pm

  6. From FT. Sounds L-shaped/pear-shaped to me:

    The Federal Reserve sharply downgraded its economic outlook at its latest meeting only three weeks ago, minutes released on Wednesday revealed, challenging the view that green shoots of recovery are now plain to see.

    “The staff’s projections for real GDP in the second half of 2009 and 2010 were revised down,” the minutes say. Fed staff no longer expected growth would recover this year, and instead forecast that output would “flatten out gradually” in the second half and then “expand slowly next year”.

    The ProfessorComment by The Professor — April 8, 2009 @ 11:30 pm

  7. 1. You say “world” is going to be L-shaped, whereas in fact you must refer to “advanced world”. India is practically out of the abyss and China looks like following it soon. Same for much of the rest of emerging Asia, and I don’t think Latin America is doing too badly either.
    2. Re-dependency. Russia’s budget surplus depends on energy exports, its GDP growth – not anywhere near so much. In fact to some extent its a drag because it helped overappreciate the ruble.
    3. Re-Tentative signs. Since we all like the Moscow Times so much here…
    4. Re-corporate indebtedness. I know about this of course, but what I think I’ve pointed out in the past here is that their c.500bn $ liabilities are counterbalanced by c.500bn $ of foreign assets. The problem in Q4 was that a lot of payments were coming due and many companies couldn’t sell assets far enough to meet those margin calls, now the situation is much less stressed in that regard.

    Comment by Sublime Oblivion — April 8, 2009 @ 11:52 pm

  8. Let’s all give a big ATTABOY to German Gref for standing up to Putin on the banking crisis,

    As a “silent tsunami” of bank defaults is about to sweep over the country

    all Russia’s so-called “leader” can do is lie about it and help protect North Korea.

    Comment by La Russophobe — April 9, 2009 @ 12:41 pm

  9. The people of Russia are not fooled by Putin’s ridiculous neo-Soviet lies

    even if certain of his sycophants repeat his drivel, as in this very thread, just as they did in Stalin’s time.

    They are, of course, Russia’s true enemies.

    Comment by La Russophobe — April 9, 2009 @ 1:11 pm

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