#4 - JRL 7227
June 18, 2003
Is Another Crisis Looming?
By Rudiger Ahrend
Rudiger Ahrend, who works as Russia economist in the OECD's economics department, contributed this comment to The Moscow Times. The views expressed are the author's and do not necessarily reflect those of the OECD or the governments of its member countries.
Recently, various comparisons have been drawn between Russia's current market conditions and those in 1997, explicitly or implicitly evoking the possibility of an August 1998-style economic breakdown in the near future.
Among the similarities focused on by commentators are that in 1997 as in 2003 a high degree of liquidity led to a booming stock market and corporate credit boom. Then as now the currency was strengthening due to increasing capital inflows, and growth outlooks were being rapidly updated, although many serious structural problems remained unresolved. These similarities are indisputable, and some developments are indeed seriously worrying. However, one should refrain from taking the extra step of concluding that because of the similarities, a 1998-style economic meltdown is just around the corner. To see why this is, it is important to remember the nature and root causes of the 1998 crash.
Though Russia obviously suffered from severe structural problems at the time, the 1998 crisis basically was a standard currency crisis under what was in essence a fixed and overvalued exchange rate. Large budget deficits quickly led to the government amassing a huge amount of short-term domestic debt, much of which was held by foreigners. Strong import growth -- largely driven by the overvalued currency -- together with a negative terms-of-trade shock saw the current account swing into deficit by mid-1998. Admittedly, the deficit was mild compared to other countries that were struck by similar crises, but the large amount of structural capital flight at the time would have required a substantial current account surplus to give the exchange rate regime then in place a chance of survival. In addition, apart from a minor blip in 1997, there wasvbasically no economic growth, so that by mid-1998 the debt dynamics looked increasingly unsustainable.
These days the macroeconomic situation is fundamentally different. There is no evidence that the exchange rate is overvalued. Moreover, as the exchange rate is flexible, it could if need be respond to terms-of-trade shocks without creating large disturbances in the economy. Furthermore, Russia's huge current account surplus provides a sizeable cushion against both falls in the oil price and further increases in imports. In strong contrast to 1997, there is sizeable economic growth, the budget is in surplus, and the Russian government has paid back a significant amount of debt in recent years. In addition, there have been advances in corporate restructuring and structural reform, and the political system has stabilized since 1999.
This is not to say there are no risks. Many Russian stocks and Moscow property look richly valued, and some recent increases indicate that we may already be in bubble territory. But while this raises the risk especially for new entrants in the respective markets, it poses no systemic risk to the Russian economy so far. Major stock market corrections do not by themselves cause grave economic crises -- as witnessed by the world economy in the aftermath of the Internet bubble. Most of the time, stock market bubbles simply boost economic activity while they last, and reduce it to below trend in the years after they burst. Moreover, any such effects would probably be small in Russia, as the importance of the stock market's performance (or the Moscow property market) on real economic developments is limited.
The current boom in corporate borrowing is more worrying from a systemic perspective. While increases in lending to the economy are in principle welcome, the rapid credit expansion currently taking place may be problematic for two reasons. First, very rapid increases in credit are often accompanied by a deterioration in the quality of borrowers. Given that the screening capacities of most Russian banks are poorly developed, there is a concern that ultimately the banking sector may get stuck with large amounts of bad debt, which may cause a banking crisis and in any case would seriously handicap further banking sector development. This would be highly unfortunate, as a reformed and well-functioning banking sector could seriously increase Russia's long-term growth potential. But given current low levels of the sector's development, even a banking crisis at this stage would only have a limited direct negative impact on economic activity.
Second, Russian private sector borrowing is increasingly from abroad and denominated in foreign currency. This, especially for enterprises without large export revenues, leads to a currency mismatch between revenues and debt-related expenditures that could cause large problems if there were a significant depreciation of the ruble. Moreover, once private borrowing abroad reaches significant proportions as a share of GDP, it becomes a potential systemic threat to macroeconomic stability -- as was demonstrated by the Asian crisis. So far the total amount of private sector borrowing from abroad is not a problem, but the Russian authorities should remain alert to prevent it from becoming one. Long overdue banking reform, as well as the further development of a ruble-denominated debt market, could help keep the aforementioned currency mismatch at manageable levels. If, however, as is likely, foreign currency-denominated private borrowing continues growing at the current pace, prudent macroeconomic management may at some point warrant concrete action to prevent the situation from getting into dangerous territory. Chile, for example, levied a special tax on foreign currency borrowing (particularly short-term credits) when it was experiencing strong capital inflows, in order to keep the systemic risk in check.
More structural reforms are obviously needed. However, structural reforms are aimed at, and can be successful in, increasing medium- and long-term growth. With few exceptions, they have little -- if any -- influence on whether or not there will be an economic crisis in the near future. Macroeconomic management, on the other hand, does. In recent years, Russia has been following prudent macroeconomic policies -- running budget surpluses, basing budgets on relatively prudent oil price assumptions, and accumulating reserves for a rainy day. There has been some slippage this year, but so far it appears to be less than one might expect in an election year. For now, everything indicates that Russia will continue responsible economic policies (as witnessed, for example, by the plans to transform the reserve fund into a real stabilization fund) and it will be well rewarded if it does.
The Latin American experience of recent decades may be worth looking at. Chile, having significantly advanced with structural reform, has pursued responsible and prudent economic policies during the past 15 years, and as a result has experienced sustained and rapid growth. At the same time, other Latin American countries that opted for less prudent approaches have experienced boom-and-bust cycles and mediocre average growth performance. If Russia abandons macroeconomic prudence it will inevitably share the same sorry fate. If, however, it maintains responsible macroeconomic policies, including not allowing the aggregate foreign currency indebtedness of the private sector to reach hazardous levels, it will experience reasonable growth rates in the medium term, no matter what happens to the stock market or the oil price. Further structural reforms, if successfully implemented, will facilitate the pursuit of good macro policies. Pension and utility reform, for example, would reduce medium- and long-term pressures on the budget, and hence facilitate the continuation of responsible fiscal policy.
It has become widely accepted that further advances in structural reform are crucial to increasing sustainable long-term growth rates. But it should not be forgotten that sound and prudent macroeconomic management remains the necessary basis without which the fruits of structural reform cannot be reaped.