The reversal of Russia’s fortunes is nothing short of a Chekhov drama. A seven-year economic boom fueled by cheap credit and soaring commodity prices has come to an abrupt end, plunging the country into the worst financial crisis since its 1998 debt default.
Russia’s economy is expected to contract by at least 2% in 2009 after growing at an average rate of 7% in recent years. Stocks have fallen 18% this year, after losing three-quarters of their value last year, cementing Russia’s place as one of the worst performing emerging markets. The ruble has lost nearly a third against the U.S. dollar since July.
"We’re quite worried about the macroeconomic picture in Russia," said Lars Christensen, chief analyst at Denmark’s Danske Bank.
This sprawling country of 140 million people owes its past success, and its current woes, to this decade’s wild ride in commodities. Its economy heavily depends on revenue from oil, natural gas and metals. Prices in these commodity exports have plunged amid the global economic slowdown. Oil has lost 73% since hitting a record high above $147 a barrel in July.
As a member of the once-mighty BRIC club of large emerging markets - along with Brazil, India and China - Russia exemplifies the fragility of growth built on commodities as well as the sharp reversal of fortunes in the emerging world. What is particularly alarming about Russia’s troubles is that they come at a time when its overleveraged neighbors in Eastern Europe - from Ukraine and Latvia to Hungary and Bulgaria - are struggling to contain their own economic meltdown.
"We have two parallel stories - there’s a Central and Eastern Europe crisis that’s really going on at the moment, which is not really a Russia crisis, but those two things are connected," Christensen said. "Then, there’s the deleveraging in Russia, the pressure on the currency, the fact that Russia has burned more than $200 billion in reserves - all that’s putting significant pressure on consumption and investment."
Putin: Not Another Default, Please
The commodities collapse is starting to hurt ordinary Russians.
The unemployment rate jumped to 8.1% last month, with 6.1 million Russians currently out of work. Overdue wages increased by 50% in January compared to December.
The country’s reserves are rapidly being depleted in an attempt to stem the slide in the ruble. The currency has stabilized in recent days, but downward pressure is likely to resume. That is a worry for Russians who saw their savings wiped out when the country devalued the ruble in 1998.
Although the economic slump hasn’t resulted in major social unrest, more economic pain may motivate Russians to demand more accountability from their political leaders and challenge their unspoken bargain of economic prosperity in exchange for political quiescence.
Russian President Vladimir Putin, at the helm of Russia after it clawed its way out of the 1998 crisis and the icon of this decade’s commodities-led expansion, is set on avoiding any unfavorable comparisons with his political predecessors.
"Putin’s big picture vision is for Russia to avoid a return to the devaluation-cum-default of 1998-2000 when Russia was forced to go cap in hand to foreign G7 creditors," said Timothy Ash, head of CEEMEA research at Royal Bank of Scotland.
In 2000, Putin succeeded former Russian president Boris Yeltsin, who ran Russia when it defaulted on its debt and presided over the country’s controversial privatization programs that concentrated Russia’s wealth in the hands of a few politically connected oligarchs.
"The Putinistas absolutely detest the Yeltsin era, it is their nemesis, and will do everything possible to avoid a re-run of the absolute humiliation of 1998," Ash said in a recent research note.
In sharp contrast to the chaos and economic collapse of the Yeltsin years, Putin presided over strong growth, marginalized the opposition and expanded the state’s role in strategic economic sectors, such as oil and gas. Abroad, he reasserted Russia’s standing, often taking a combative stance toward western nations and moving to expand Russian influence in Eastern Europe and Central Asia.
Russia dramatically demonstrated its geopolitical ambitions last August, when it fought a brief, vicious war with neighboring Georgia. This January, Europe got a chilly reminder of just how dependent it is on Russian gas, when state-controlled gas monopoly Gazprom (OGZPY) turned off the taps to most of Europe following a bitter dispute with Ukraine.
Now, the Russian government is focused on containing the economic crisis at home and avoiding any social unrest. Public disagreements over economic policy are starting to surface.
This week, a close associate of Putin called for the imposition of capital controls to make sure that funds spent to support the ruble stay in Russia. The comments were seen as a thinly veiled attack against the finance minister.
The government is "trying to prevent speculation in the ruble and essentially limit ruble liquidity," said Tim Steinle, co-manager of the Eastern European Fund (EUROX) at U.S. Global Investors. About 46% of his fund was invested in Russia as of Dec. 31, with its biggest holdings in Gazprom, oil giant Lukoil (LUKOY) and state-controlled Sberbank (AKSJF).
"I’d think that the government would be reluctant to spook minority investors" by imposing capital controls, Steinle said. "It’s a delicate line they have to walk between defending the currency and protecting the rights of minority investors."
Battered stock market
Investors in stocks are already nursing their bruises from the past year’s battering.
The MSCI Russia Index tumbled 74% in 2008, dragged down by heavily weighted resources stocks, and making Russia the worst performer among emerging markets. This year, it is down 15% compared with a 9% decline in the MSCI Emerging Markets Index.
The dollar-denominated RTS stock index is down 18% year-to-date and is currently trading near 520 points.
"For Russia, oil and [the] currency are key," said James Fenkner, principal and portfolio manager of Red Star Asset Management, a hedge fund that invests primarily in Russian assets.
"Assuming that world markets stabilize, Russia will only recover once the government’s awful monetary policy results in a very weak ruble and growing, not falling, foreign exchange reserves," he said.
Also, oil prices would need to remain in the $40-a-barrel or higher range.
"Russia remains troubled over the next few months," Fenkner said.
Steep declines in share prices this week prompted trading suspensions on both the RTS and the Micex stock exchanges in Moscow, reminding investors of last October when trading halts were a near-daily occurrence.
Deteriorating economy
The past year’s sharp sell-off in Russia stocks has mirrored a stream of dismal economic news.
The Russian economics ministry has revised downward its forecast for GDP growth and it now expects the economy to contract by 2.2% compared with its earlier estimate of a 0.2% fall.
Russia’s industrial output plunged 16% in January, driven by a large decline in manufacturing.
On top of that, Russia’s central bank has spent more than $200 billion of its international reserves, largely in an attempt to defend the ruble exchange rate. Reserves currently stand at $386.6 billion.
Chris Osborne, chief executive of Troika Dialog USA, the U.S. branch of the Russian investment bank, said the recent stabilization in the ruble is a good sign that the economy will avoid the worst.
Fitch Ratings cut Russia’s sovereign credit ratings to only two notches above non-in
