Developments in international financial markets may, at first glance, seem irrelevant to the dynamics of the Russian economy. But, as has been learned the hard way, the link is strong and the causation is one-way. We had a vivid reminder of this fact again at the end of last week when global markets became spooked by concerns about the tepid economic recovery in the United States and the fragility of sovereign debt in the euro zone as a result of Greece’s fiscal prolificacy.
Those debt problems drove the euro down temporarily to below $1.36, bringing the dollar to an eight-month high. Because oil and other commodities are priced in dollars, gains in the dollar usually translate into declines in oil prices. As an indication of how sudden and unexpected market reversals can be, we could recall that just over a week earlier, positive manufacturing data from several economies had driven up energy prices to above $77 a barrel as market participants saw signs of stronger economic recovery. But that gave way to the concerns about a debt contagion in Europe and the impact of austerity measures to bring debt under control. Oil prices duly dropped briefly to just below $70 and capital flows to emerging market economies apparently went into a tailspin as a part of the generalized flight from risk to presumably “safe-haven” assets — notably U.S. Treasury securities. Even the gold price plummeted to about $1,050 an ounce. Contagion spread immediately to Russian financial markets as the RTS Index was down 4.3 percent for the week and declined a further 3 percent on Monday in line with global markets.
Around the world, investors fled from risk. The unwinding of leveraged debt positions by distressed market participants, herd behavior among investors and loss of liquidity giving way to a flight to quality can all lead to heightened correlations between markets. In extreme cases, this can set off a self-fulfilling crisis on a regional and global scale.
For Russia, thus far, this has just been a hiccup, but the real question is what may lie ahead as the world economy steers through a period of uncertainty? With its economy dependent on both oil prices and stable capital flows, the contagious effects from global markets can have real consequences as we discovered at the end of 2008.
Ironically, just as Russia’s economy was finally turning the corner, the global economy may be sputtering after a seeming resurgence in late 2009.
Russia’s recently announced gross domestic product numbers for 2009 imply that fourth quarter output rose by 4.7 percent quarter on quarter and that the momentum continued into last month. Russia’s Purchasing Managers’ Index data came in at 50.8 in January versus 48.8 in December, rail traffic — an important coincident indicator — rose significantly last month, inflation continued to trend downward, and the budget was financed without recourse to the Reserve Fund.
But turning to the outlook in the rest of the world, there is a big question mark as a result of the debt overhang in advanced economies. Ironically most emerging market economies, notably Russia, learned their lessons about debt. In recent years, they have improved their fiscal performance, lowered their stock of public debt-to-GDP ratios and reduced the currency and maturity mismatches in their public debt. As a result, sovereign risk today is a greater problem in advanced economies than in most emerging markets.
There is still a prevailing view that the world will return to precrisis conditions with a stable United States that functions as borrower, lender and consumer of last resort. What this ignores is that precrisis growth in the United States and the global economy was based in part on an unsustainable macroeconomic framework that implied an ever-expanding increase in debt relative to income.
Just like in the United States, the common patterns across the globe now suggest that the unwinding of excess household debt via increased saving or increased default rates could be a significant drag on consumption and bank lending going forward, possibly muting the vigor of the economic recovery. This realization of the long slog ahead has frustrated financial markets that were already pricing in a V-shaped recovery.
In any case, returning to a model that promotes financial bubbles would not be wise. While a relatively high, sustainable growth pattern can be achieved, it will take time. If growth does occur, it will happen in a global economy with fundamentally different structural characteristics. Waiting for the advanced countries to put their economies in order so that we can all go back to the old normal is neither good policy nor a good bet.
What is needed is coordinated restructuring and policy setting. The Group of 20 is well-intended but ineffectual, and the international political climate is hardly propitious to the type of courageous decisions and shared burdens that are called for. This would be especially hard to do when the United States, burdened by domestic problems, and China are seemingly at loggerheads.
In the meantime, with the global economic crisis still unresolved, the potential for policy mistakes grows with every day. Among the kind of conceivable risks, not to mention the other kind, we could imagine that, under political pressure with an election in nine months and employment sluggish, the Obama administration maintains too much stimulus and the bond market loses its patience, or it prematurely withdraws stimulus and the recovery slumps, or Greece does default in the spring also spiking bond yields, or Western consumers decide to save and refuse to spend, or foreigners lose confidence in the United States and a dollar crisis ensues. Each day seems to yield new possibilities.
The implications here are fairly straight?forward. We are not yet out of the debt-crisis woods, and 2010 has the potential to remind us of that. The uncertainty as to what comes next is high, and markets are nervous. As the year proceeds, there is real potential for another economic relapse and even a double dip.
Whatever you might say about Russia, its economy is undoubtedly integrated with the rest of the world. So there is no escape. It helps, of course, that Russia still has substantial foreign exchange reserves of almost $436 billion and two reserve funds with about $150 billion. In this regard, Russia is fortunate that it pursued fiscally conservative policies over the past years. In view of what may lie ahead in the near term, a measured macroeconomic policy will matter.
At this juncture, we don’t know how 2010 will unfold. Our economic models do not handle so many unknowns at the same time very well. The main thing is to be prepared for the worst-case scenario of a double-dip recession in the relatively near term, but without forgetting that history teaches that governments often avail themselves of inflation to resolve their sovereign debt problems.
Martin Gilman, former senior representative of the International Monetary Fund in Russia, is a professor at the Higher School of Economics.