by Timothy Ash
Dec. 18, 2014
Russian President Vladimir Putin during his Dec. 18 press conference.
Timothy Ash is head of emerging market research for Standard Bank in London.
I think that the U.S. warming in relations with Cuba could somehow be an attempt by U.S. President Barack Obama's administration to send out an olive branch also to Moscow – “look, we, the U.S, can live in peace with our neighbors, surely you (Russia) can live with yours (Ukraine). And that we should not view our neighbors as threats, but work to build bridges (but not to Crimea, that is)."
Listening to Russian President Vladimir Putin’s session with journalists, I did not hear anything that hinted of compromise from Russia with respect to the crisis in Ukraine.
Putin evaded the question as to how many Russian troops are in Ukraine, and all the blame was again heaped on the authorities in Kyiv – albeit he repeated the line that he believed President Petro Poroshenko wanted peace.
I am never quite sure if Putin actually believes this – i.e. Poroshenko is the man that Moscow thinks it can do business with – or that by “bigging-up” Poroshenko as the man that Moscow respects the aim in fact is to sow division and disharmony in the Ukrainian camp.
Putin must know by now that no Ukrainian politician can now deliver a peace agreement which is in line with Russia’s demands – no NATO, No European Union and No Maidan (revolution) and no Crimea for Ukraine. It would simply be political suicide, and risk a Maidan II, or III, if you count the first Orange Revolution as the first Maidan-style protest.
Overall listening to Putin this morning, the impression was that this is not a man who is looking to back down over Ukraine, or indeed change course that much in terms of the domestic economy.
The message was for the population to brace itself for two years of hardship, and it was also an appeal to the national spirit, against an unjust, unfair and what Putin’s views as an aggressive, expansionist West.
There were no big ideas today on the economy – a hint of some moves to diversification, but we have been hearing these from Russia for the past 15 years, with little progress, so nothing substantive to make me think that this time around things will change.
Worryingly, in identifying the causes of Russia’s current economic woes, Putin blamed “external” factors, of which sanctions he claimed account for around 35 percent of the problems. But presumably this was mostly about falling oil prices, which he later concluded was about the U.S. and Saudi Arabia colluding to punish Russia and Iran. This is disappointing, as Russia’s problems are much deeper than this, and as I wrote yesterday are a reflection in my mind of:
First, yes it is about falling oil/commodity prices, and the fact that half of budget revenues and 68 percent of export receipts are oil/energy related. But it is also about years of neglecting the need for diversification. People like former Finance Minister Alexei Kudrin have long warned about this - but were ignored, and indeed forced out.
Second, it is about years of Dutch-disease and over-appreciation of the currency. By my reckoning, by early this year, the ruble had doubled in real effective terms since 2002. In effect the rest of the economy had been squeezed out by the oil/energy sector and the lack of any other efforts at diversification. There is now focus on import substitution, but there is not much left to build on - there are no quick fixes here and any such strategies will only work in the medium to long term. Russia essentially has oil/energy/commodities, and the military industrial complex. I guess arms are not that price sensitive - unlikely to be elastic in demand to ruble weakness - Russian kit is already the cheapest on the market.
Third, sanctions/geopolitics, yes. Western sanctions have gradually sucked the dollar liquidity and life out the Russian economy - they have been like a boa constrictor. Indeed, as oil prices have dropped they have multiplied the impact. Interestingly, they have also forced the Russian administration into making basic mistakes - the food import ban hit Russian consumers/inflation, and sends a very negative signal to foreign real investors, who likely slowed inward investment as a result which will impact on growth. Also the decision not to use FX reserves in defence of the rouble accelerated the demise of the rouble this week - a basic 101 central banking mistake, i.e. when you face a currency crash, deploy all resources you have available, bully the market, and do not tie your hands behind your back. Watching the CBR over recent weeks has been like watching a slow motion train crash about to happen - simple, basic stuff, you just would not expect from the CBR and not for a central bank with a wall of FX reserves. But ultimately what we learned this week is that the CBR is not independent, but has been constrained in its decision function by the Kremlin - don't use reserves as they are strategic in the context of the long run battle now with the West (sanctions working there), and don’t raise policy rates if can get away with it, as we are worried about recession and the impact on Putin's poll ratings.
Fourth, underlying deep structural problems - poor business environment, inadequate protection of property rights, lack of rule of law, corruption red tape and bureaucracy. In the end local and foreign investors do not trust the regime that their cash/assets is safe from "acquisition" by the state. So when risks rise, the temptation is not to invest in Russia, and indeed actually to pull assets out. Capital flight is hence an enduring problem - likely doubling this year to $130 billion+.
Fifth, broader competitiveness issues and the lack of real growth drivers, beyond commodities. Basic question - how come when oil prices were elevated, i.e. over $100 per barrel, and with the Fed pumping ample liquidity in global markets and to Russia, was Russia only growing at a trend rate of 1 percent. Because - the regime had run out of ideas - and there was no reform momentum. Putin's big reform idea was the CIS CU/Eurasian Union and that has been at the core of the crisis in Ukraine, and ultimately the kick back of sanctions on Russia. Putin's big vision essentially failed, and he is now falling back on petty nationalism at home/blaming the West and foreigners, and attempts at expansion in the near abroad.
Reviewing the above what should be important is Putin accepting the problems at home, and working to resolve them – not blaming external factors and forces, and instead encouraging the population to build the defences and brace for difficult times, but with no reform ideas.
Putin’s comments on the ongoing ruble crisis were interesting, as he implied disquiet that the Central Bank of Russia had not acted soon enough – and if they had then perhaps interest rates would not have been hiked to 17 percent.
But at the same time he appeared a bit inconsistent, in suggesting that the central bank should not have wasted foreign-exchange reserves defending the ruble. The message therein still was that the bank should conserve scarce reserves and if oil prices fall further then the ruble will also have to fall. I sensed herein divisions within the administration over the policy response. I also think that his defense of the team was not that wholehearted and after listening to him I would still expect significant changes to follow in the government and even the central bank – he will first likely wait until an easing of market tensions. This could prove to be a major cabinet reshuffle, and could be key in determining Russia’s course, and whether it will be able to bounce back successfully.
It is interesting how the foreign exchange market have taken Putin’s comments – flat on the day, perhaps with the help there of some official management.
Timothy Ash is head of emerging market researchf or Standard Bank in London.
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