#13 - JRL 7232
The Economist (UK)
June 21-27, 2003
Spend, spend, spend
Russia is booming again, inviting comparisons with the heady days before its 1998 crash. Bust coming?
WHY do Russians who earn one-fifth as much as The Economist's Moscow correspondent buy clothes and mobile phones that are twice as expensive as his? The answer is that Russians prefer spending to saving. The fancy shirts and flashy ring-tones on the streets of Russia's bigger cities are a sign of the economy's boom; but they also attest to its basic weakness.
To some, it all seems eerily familiar. The stockmarket index, the RTS, has risen by 30% this year in dollar terms; domestic demand is expanding by nearly 9% a year; the rouble is strengthening; and interest rates are falling. Last year, say recently revised figures, investment grew by a healthy 9%. Corporate borrowing is soaring (see chart on next page). Cuts in tax rates and bureaucracy have increased tax revenues and made it a bit easier to start a business.
Economists have been upgrading their forecasts of this year's GDP growth to 6% or more--rough guesses, admittedly, given the amount of activity hidden from the tax authorities and the limitations of a statistical bureau that recently recalculated the 2000 growth figure for the third time. Last month Fitch, a rating agency, pushed Russia up to only a notch below investment grade. This week the hope that Moody's and S&P might do likewise sent the stockmarket sharply upwards again.
In short, Russia is roaring, just as it did in 1998, before its government defaulted on its domestic debt, triggering a systemic collapse. Happily, this is not a rerun. Five years ago Russia had a big budget deficit, a fixed exchange rate and a lot of high-coupon debt. Today oil revenues have filled state coffers. The relative stability brought by over three years under President Vladimir Putin has attracted foreign investment and reduced capital flight. "There is a totally different philosophy towards corporate governance in Russia today, as compared with pre-1998," says Peter Weinberg, European chief executive of Goldman Sachs. "Some of the best companies' corporate-governance standards here even exceed some of those in the United States."
Most of the incoming investment, it is true, has been of the twitchier portfolio variety rather than the more stable direct kind, and how much stays in Russia surely depends on oil prices. But the signs are encouraging. Metro, Germany's biggest retailer, has said it will invest euro1 billion ($1.2 billion) in the country; Danone, a French food company, is thinking of increasing its shareholding in Russia's Wimm-Bill-Dann; and Deutsche Bank, which set its face against Russia after the 1998 crash, is said to be eyeing a stake in UFG, an investment bank.
For all that, optimism may be running ahead of the economy's performance. The money supply has been rising by more than 40% a year since 1999. In theory, the financial system should channel this money into its most profitable uses, allowing for risk. But the available cash is being poorly directed. Most of Russia's 1,300 banks are the "pocket banks" of large companies, in effect corporate treasuries. The system is inefficient, poorly supervised and still inexperienced at lending. As a consequence, it is still widely mistrusted. Richard Hainsworth of Renaissance Capital, a Moscow investment house, estimates that Russians still keep anywhere from half to nearly twice as much money under their mattresses as they do in the bank.
The banks' lending patterns are looking increasingly hopeful--or, put another way, increasingly risky. Exporters who borrowed $50m for 18 months in 2000 and 2001 are now taking on debts ten times as big for two or three times as long, says Mark Kirsh of Linklaters, a law firm. With the biggest firms already swamped with credit, foreign banks are starting to look at second-tier, usually less solid companies. Consumer lending, though still tiny, is shooting up. This is a risky business in a country where nobody has a credit history and legal ways of recovering bad loans (ie, without baseball bats) are weak.
Optimism and easy money are pushing up asset prices. Shares are a case in point, driven by foreign investors, oligarchs on strategic buying sprees and the fortunes of a few big firms, not ordinary Russians taking a sudden interest in the stockmarket. Another is property: rents and house prices in Moscow are approaching London-like levels. Analysts and investors who were caught out in 1998, worried by careless lending and over-zealous buying of shares and property, are warily predicting another bust, albeit smaller and without a government default.
This could be just excessive caution. But there would be less cause for concern if Russia's economic structure were better developed. Although credit is easy for big companies, it can still be tight for smaller firms outside the large cities. Straightforward reforms, such as tax cuts, are almost completed, but the harder tasks, such as seriously trimming the bureaucracy that stifles entrepreneurship, are stuck. Russia is diversifying too slowly away from oil and other natural resources with volatile prices.
For now oil is comfortably expensive; and with money in the treasury, and an oil stabilisation fund due to be created next year, Russia could cope with an oil-price fall for a while, especially if it were gradual. Still, a drop in oil prices would hurt the budget, says Evgeny Gavrilenkov of Troika Dialog, an investment bank, because to break even the government is banking on $19-20 a barrel in this year's budget, as against $15-16 last year. A sudden fall would remove the reason for many foreign investors' interest in the country, push up borrowing costs for the government and everybody else, and bring the boom to a sudden stop.
Is a bust inevitable? Not necessarily, says Christof Ruhl, the World Bank's chief economist in Moscow. Banking reforms now before parliament would allow regulators to focus on deposit-taking banks and not waste their resources on the pocket banks. This should rein in the more careless lenders, reducing the risk of a credit bubble. The reforms would also create a deposit-insurance scheme: at the moment only deposits at Sberbank, the country's biggest bank, enjoy an implicit guarantee, because it is owned by the state. Such a scheme might increase trust in banks and take some pressure off asset markets.
However, the reforms have been held up for a while. First the spoiler was Sberbank, because as the biggest it would pay most towards deposit insurance, in effect covering other banks. But now, says Mr Hainsworth, a couple of commercial banks are blocking it, maybe because they fear new regulation, maybe because they want to spend money building up their brands before they pay for insurance. If they get their way Russia's economy, like its fashion-victim shoppers, will go on looking richer than it really is.