The Financial Times (Great Britain): "Russian economy: The Putin defence"
By Catherine Belton
When a top economic adviser to Vladimir Putin approached his boss in September to argue that the rapid fall in the oil price meant he would have to devalue the rouble, the answer was a firm nyet. "He said he would not be the prime minister of devaluation," one insider said.
Mr Putin had staked his political credibility for the past eight years - first as Russia's president and then as an equally powerful prime minister - on breaking with the financial turmoil of the 1990s. Even though any likely devaluation this time around would be far less severe than the disastrous August 1998 collapse that wiped 70 per cent off the rouble and obliterated Russians' savings overnight, the word had a political stigma and could sow panic. The currency - like everything else in Russia - was to be tightly controlled.
But even before the oil price failed to recover on output cuts by the Opec producers' cartel earlier this month, Mr Putin's room for manoeuvre was running out. As crude has fallen from $147 a barrel this summer to less than $40, Russia's oil-fuelled economic boom has come abruptly to an end. A country that was growing at a rate of 7 per cent only six months ago now faces a looming recession - and Mr Putin, almost exactly nine years since Boris Yeltsin handed him the presidency on New Year's Eve, is stalked by the same prospect of economic failure as his ill-fated predecessor.
He must also contend with growing unrest. This month has seen thousands of Russians protest against the government's handling of the crisis in a series of demonstrations across the country. With some 400,000 losing their jobs in November alone and around 2 per cent of those in work facing wage arrears, tensions are likely to rise further.
As well as suffering from a marked drop in demand for commodities, Russia's economy is also being choked by Mr Putin's rouble policy. His decision to stave off a sharp devaluation is starting to look to some economists as ill-advised as Yeltsin's similar attempt in 1998. The central bank has already lost more than a quarter of its foreign currency reserves as a result of its efforts to stem the rouble exodus that began in August, when foreign investors fled Russia in the wake of the war with neighbouring Georgia.
Russia's reserves of some $451bn (€321bn, £309bn) may still be the third largest in the world, but the sharp drop in the oil price is limiting its ability to replenish them. Propping up the rouble is currently costing the government $6bn to $10bn a week; if this continues, Mr Putin may be unable to assuage popular unrest as he did in 2003, when he defused a row over social benefits by spending freely.
Also at risk is the country's ability to refinance the foreign debt held by Russian companies. With international credit markets closed, the government has so far pledged $50bn for this purpose. But with up to $170bn due next year, analysts say, the reserves could be quickly exhausted.
The size of these commitments is one reason Mr Putin is wary of letting the rouble go. He has ordered the central bank to oversee a very slow slide - a twice-weekly reduction of 30 kopecks - against a euro-dollar basket. Altogether, the rouble has declined 15 per cent against the dollar and 12 per cent against the euro this year.
But many economists say the slow rate of decline is only fuelling expectations of further depreciation, accelerating the exodus from the currency. Russians withdrew 6 per cent of their rouble deposits in October, converting them into dollars. Banks are also shifting out of the rouble. Worse still, expectations of devaluation mean they have stopped lending in roubles, putting further stress on the economy.
"The situation is starting to look like 1998 when, in anticipation of devaluation, the credit market is frozen and there is an enormous contraction of the economy," says Anton Strouchenevsky, an economist at Troika Dialog, the Moscow investment bank.
Industrial output in November fell 8.7 per cent year on year, the steepest drop since August 1998. But because of the lending freeze and the expectations of devaluation, "the whole payments system is suffering from indigestion," says one western banker. "Businesses are not getting paid by customers and they are not paying suppliers."
Mr Putin's rouble strategy is beginning to look like one of the riskiest moves of his political career. A 20 per cent drop in the rouble - the amount many analysts think necessary to boost the economy and curb the rise in imports - would not wipe out consumer spending power as in 1998, when the economy was more dependent on im¬ports. It could even boost revenues in Russia's critical raw materials export sec¬¬tor, source of many recent layoffs.
For Mr Putin, however, the political consequences of a considerable devaluation are of a greater concern. Officials fear that a sharp fall could cause more depositors to panic and withdraw savings, potentially fuelling a run on Russia's already fragile banking system. Instead, the prime minister is hoping that this month's Opec production cuts will eventually push the oil price back towards $75, while the dollar is starting to weaken on President-elect Barack Obama's massive spending plans, helping Russia boost reserves last week.
But any Opec cuts could take at least six months to catch up with plummeting demand, while economists warn the dollar weakening could be premature. One senior Moscow official warns that Russia's reserves could fall to $300bn by February if the central bank continues to support the rouble and the oil price remains depressed, making a steeper devaluation unavoidable. "It is basic economics. They have to devalue," the official says.
The problems with the economy appear to be denting the air of invincibility that Mr Putin has taken on since 2000. In a recent nationwide call-in show, the prime minister broke with tradition and did not make one joke. He looked tense as he insisted on his government's ability to spend its way through the crisis. A week later, one of his officials caused embarrassment when he broke ranks to warn that Russia was indeed heading towards recession.
The turnround is a sharp reminder that wealth creation under Mr Putin has been largely fuelled by the rising oil price. "The growth we had for the past eight years was propelled by $1.3 trillion in oil and gas revenues but this was not matched by any changes in the institutional infrastructure. This is the reason why it has all collapsed so quickly. We didn't have any foundations," says Chris Weafer from Uralsib, an investment bank.
The Kremlin is steeling itself for a social backlash. Boris Dubin, an analyst at the independent Levada polling centre, says 15 to 20 per cent of the population have already been hit by the crisis - either through sackings, wage arrears or cuts and difficulties finding new jobs. The continuing exodus from the currency could make things worse. "A combination of a rouble devaluation and increasing job cuts is explosive material," he says.
Already, cracks are starting to show. In an almost unprecedented incident, Dmitry Medvedev, who succeeded Mr Putin as president this year, was recently heckled as he gave a speech in the Kremlin. Meanwhile, in Vladivostok on the Pacific coast, thousands demonstrated this month over plans to increase import duties on used foreign cars, with some carrying placards calling on Mr Putin to resign. "It is like an epidemic," says Olga Kryshtanovskaya, of the Academy of Sciences. "People start to feel the weakness of the reg¬ime. It's only the bravest first. But then others join in."
The Kremlin has so far kept a tight grip on media coverage of bad economic news and protests. Mr Putin is also trying to calm any discontent with promises of greater spending, including shipping Russian cars to the disaffected motorists of Vladivostok.
For now, opinion polls show support for the premier remains high. Mr Dubin says most Russians are still "half-passive". But, he adds: "I can't rule out that by spring they will take to the streets."
THE BALTIC ECONOMIES: EUROPE'S WILD NORTH-EAST PAYS THE PRICE FOR LIVING BEYOND ITS MEANS
The fall from grace has been swift. Once lauded as free-market beacons for sclerotic "Old Europe", the Baltic states are now seen as tinderboxes that could set off wildfires across the continent's eastern half, writes Robert Anderson.
Latvia this month agreed a €75bn ($105bn, £72bn) stabilisation package led by the International Monetary Fund and the European Union to bolster confidence in its currency peg. There are fears that, were it forced to devalue, Lithuania and Estonia would have to follow and the repercussions would be felt in many other countries with fixed exchange-rate regimes.
In recent years the Baltic states have been among the EU's best-performing economies, enjoying double-digit growth since joining the EU in 2004. But next year there will be contractions of between 3.5 per cent for Estonia and 5 per cent for Latvia and Lithuania, according to finance ministry projections - the worst outlooks in the 27-member bloc. The sudden change in the fortunes of the former Soviet republics raises the question of whether the Baltic "miracle" was just a mirage all along.
After a rocky transition from communism, the Baltic states restored economic stability by the end of the 1990s through fixed exchange rates and sound public finances. Free-market reforms stimulated entrepreneurship and a wave of foreign investment, unlocking the advantages of being low-wage economies on the EU's borders.
EU accession then unleashed a credit boom as foreign banks battled for market share by offering cheap euro loans to satisfy the pent-up demand for consumer durables, foreign cars and new apartments. House price inflation in Riga, Latvia's elegant capital, peaked at nearly 60 per cent during 2006, while wages soared by 30 per cent as companies sought workers from a labour pool that was being depleted by migration to western Europe. At the same time, surging imports of consumer goods and weakening export competitiveness generated current account deficits of more than 20 per cent of gross domestic product.
When banks reacted to the deteriorating domestic and global environment last year by restraining credit growth, they pricked housing bubbles and pushed the Baltic economies into a sharp downturn. This accelerated as the global credit crunch worsened and the Baltics' main export markets in the eurozone and Russia began to suffer.
Latvia was the weakest link because it had the highest current account deficit and external debt, and its public finances were in the worst shape. Crucially, unlike its neighbours, a quarter of its banking assets were also domestic-owned. When depositors lost confidence that Parex Banka, Latvia's second-largest bank, would survive, the currency came under pressure and the government was forced to follow Hungary and seek IMF help.
Lithuania and Estonia are now cutting spending and resuscitating privatisation programmes to avoid having to knock on the IMF's door.
Lithuania looks the most vulnerable because Estonia can draw on a budget reserve fund equal to 10 per cent of GDP. Lithuania's new centre-right government has announced tough austerity plans but some analysts doubt it will be enough. "It would make a lot of sense for Lithuania to have a deal with the IMF and EU as part of a larger fiscal consolidation package," says Lars Christensen of Danske Bank.
All three Balts are firming up plans to adopt the euro but are unlikely to be able to enter before 2012. All are desperate to avoid devaluation, which would increase the burden of euro-denominated debts and destroy confidence painstakingly built up over more than a decade.
Nevertheless, there will be a temptation to devalue as the recessions deepen. Growth in the Baltic states is not expected to revive strongly until 2011, which will delay their efforts to catch up with the rest of the EU and hurt foreign companies, notably Swedish banks, that have made sizeable investments there. How quickly the economies recover will depend on how much of the Baltic miracle survives - in particular, how swiftly industry adapts and whether governments can regain their reforming drive.
Baltic companies that have already come through two recessions are quietly confident that they can endure another. "We are survivors," says Norman Bergs, chief executive of the Latvian company SAF, a niche player in microwave radio equipment. "We've survived 50 years of Soviet occupation so we can survive some turbulence in these years."
There is also anecdotal evidence that the construction slump and returning migrant workers are easing tight labour markets and enabling companies to agree wage cuts. But too many companies, particularly in wood products and textiles, still rely on low wages to be competitive and need to move up to higher value-added production.
Governments have also neglected investment in education and research. This year all three countries slipped in the World Economic Forum global competitiveness ranking. "They were on an automatic convergence conveyer belt," says Christian Ketels of Harvard Business School. "They didn't build new competitive advantages, new strengths. Now they need to do this in a much less favourable environment."
Yet the coming recession may now help focus minds. "It's very difficult to get people to agree to deep reforms when the economy is growing 10 per cent a year," says Andrius Kubilius, the new Lithuanian premier. "It's really an opportunity to make these reforms that are really needed."
