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Claus Vistesen and I also have a number of country briefings and study papers available for download in PDF format. The latest are:

Bank Rossii Eases Further As Russia's Economy Contracts At A Record Rate

The ECB's Balance Sheet At A Glance.

Monday, November 10, 2008

Massive Foreign Reserves Outflow Puts Russia's Ruble Trading Band Under Threat

Russia's currency reserves, the third-biggest in the world, are falling steadily as tumbling oil prices and an exodus of capital are piling the pressure on the central bank and government policymakers to accept a devaluation in the ruble. Oil prices which are now down 60% from their july peak, slowing economic growth and increasing investor concern are steadily draining Russia's foreign exchange reserves, which fell 19 percent (to $484.6 billion) in the 12 weeks through Oct. 31. This is down from $598.1 billion in the week before the invasion of Southern Ossetia.

Russia had been using the reserves to try and contain the upward movement in the ruble was thought to present a threat to the competitiveness of exports. But resistance is now becoming increasingly difficult in the fact of a 13 percent drop against the dollar since August 1.

Bank Rossii began managing the ruble's exchange rate in February 2005 against a
currency basket comprised of about 55 percent dollars and 45 percent euros.
Policy makers let it trade within a fixed range in mid-May. Since then, it has
dropped 2.1 percent against the basket to 30.4020. Though the central bank
doesn't reveal the limits of the band, BNP Paribas considers 30.40 to be its
weaker end.
Evidently the main responsibility for the drop in the ruble has been a change in the relative values of the currencies in the basket, with the euro falling significantly against the dollar.

The central bank sold a record $40 billion in October, according to Moscow-based Trust Investment Bank, while Troika Dialog, the country's oldest investment bank, have warned that the currency may fall by as much as 30 percent in the event of a devaluation.

The logic behind any impending devaluation would not be too hard to find either. Try looking at the inflation bonfire which has been allowed to rage in Russia over the last eighteen months.

Inflation Drops Back In October, But Is Still At 14.2%


Russia's inflation rate fell to 14.2 percent, the lowest in seven months, in September as grain, legumes and gasoline prices all decreased. The rate dropped from 15 percent in September, according to data from the Moscow- based Federal Statistics Service. Prices were up 0.9 percent on the month, after rising 0.8 percent in September.






Bank Rossii, Russia's central bank, may have to increase the "flexibility'' of the ruble exchange rate, and this will involve a "certain tendency toward weakening'' according to bank Chairman Sergey Ignatiev speaking on state television Vesti-24 last week.

Russia may "gradually'' widen the trading band if the current account falls into a deficit next year, according to Arkady Dvorkovich, an economic adviser to President Dmitry Medvedev, recently.

And Russia's current account, the widest measure of flows in goods and services, seems now to be inexorably headed toward just thatdeficit. Russia's trade surplus narrowed to $16.4 billion in September, from $18.5 billion in August, according to the latest data from Bank Rossii .

Russia's benchmark 30-year government bond has fallen substantially in 2008, pushing the yield to an almost seven-year high of 12.55 percent as of Oct. 27. So far this year, the RTS Index has lost 64 percent, and is headed for its worst performance since 1998.

And Corporate Lending Piles Up And Up

VTB Group, Russia's second-biggest lender, has lent 377 billion rubles ($14 billion) to Russian companies since the beginning of September. The state-run bank provided 120 billion rubles worth of loans in September, 229 billion rubles in October and 28 billion rubles in the first week of November. Most of the money was leant by VTB (94 billion rubles) to metals companies. This was followed by 33 billion rubles for the power industry and 32 billion rubles for retail companies. The bank increased its corporate loan portfolio to 667 billion rubles in the first 10 months of 2008, from 363 billion rubles in the same period last year, according to the bank. The bank has also increased its retail loan portfolio by 183 billion rubles, a 97 percent increase from the first 10 months of 2007.

Russian Services Contract In October

Russia's service industries contracted in October for the first time in more than seven years as the effects of the financial crisis spread into the real economy. VTB Bank Europe's Purchasing Managers' Index of growth in services fell to 47.4 from 55.5 in September. A figure below 50 shows a contraction.



If we put this chart alongside the October manufacturing PMI one, it is clear that something significant happened in October. If things continue this way we are heading straight for recession I would say.




Update Tuesday 11 November 2008


The ruble fell this morning by the most in at least a month against the central bank's dollar-euro basket and stocks fell back as traders speculate policy makers are allowing the currency to weaken. The Micex Stock Exchange halted trading for an hour after the benchmark index sank almost 10 percent. The dollar-denominated RTS Index slipped 8.5 percent to 743.77. The ruble extended its 16 percent drop since August 1 following the statement by central bank Chairman Sergey Ignatiev (see above) that under current conditions the ruble may have a ``certain tendency toward weakening.''

The ruble declined 1 percent to 30.6879 versus the basket as of 1:30 p.m. in Moscow. Against the dollar, it was at 27.3040 having earlier slid by as much as 1.3 percent to 27.3975. It was 1 percent weaker against the euro at 34.8484 per euro.


In other news Fitch Ratings yesterday followed Standard & Poor's and lowered the outlook for Russia's credit rating to negative, while Bank Rossii today set a limit of 10 billion rubles ($366 million) on the amount of so-called currency swaps it offered. The swaps allow traders to bet on the exchange rate without having to sell rubles. The central bank started curbing swaps on Oct. 20 in theory to deter "speculators".

Among the falling stocks were those of OAO Sberbank, which dropped sharply after Vedomosti reported that Russia's largest savings bank had suffered a record $3 billion of withdrawals from retail accounts in October. Sberbank, which is the biggest holder of ruble deposits, fell 3.2 rubles, or 10 percent, to 27.63 rubles on the Micex Stock Exchange. Retail clients of Russia's biggest bank withdrew 80 billion rubles ($3 billion) in October, a record amount for a single month, Vedomosti reported, citing an unidentified person familiar with the bank's accounts. Central bank Chairman Sergey Ignatiev estimated yesterday said net private capital outflows reached $50 billion in October.

Update Wednesday 12 November


Russia's central bank lifted its key policy interest rate to 12 percent from 11 percent after the market closed yesterday. The move is widely interpreted as an attempt to stem the massive outflow of funds. The central bank also widened its trading band target by 30 kopeks (1 cent) yesterday, a move which "achieved almost nothing'' and cost the best part of $7 billion of the nation's foreign-currency reserves, according to analysts at Renaissance Capital. Russia has thus joined central banks in Hungary, Iceland and Pakistan in raising interest rates to stem currency losses while the rest of the world cuts benchmark levels to try to promote lending.


The cost of protecting against a default by Russia also soared after the decisions were announced. Credit-default swaps on Russian government bonds jumped to 7.17 percent of the amount insured from 6.14 percent yesterday, according to CMA Datavision prices. The yield on its 30-year dollar bonds increased to 10.77 percent from 9.1 percent.

The ruble fell back 1 percent yesterday, the biggest daily drop in two months.

23 comments:

Jesse Heath said...

"The logic behind any impending devaluation would not be too hard to find either. Try looking at the inflation bonfire which has been allowed to rage in Russia over the last eighteen months."

-Are you saying that they should devalue the currency to fight inflation?

Edward Hugh said...

Hi again Jesse,

"Are you saying that they should devalue the currency to fight inflation?"

No. The logical chain runs in the other direction. I am saying they should have applied other tried and tested techniques to cool the inflation and overheating problem 2 years ago, raising interest rates, letting the currency rise, running a larger fiscal surplus, restraining public sector wages etc. Controls on credit for mortgages etc.

But they did none of this, and now they just have a big mess, which is what I had more or less been arguing. So now they have no alternative but to devalue if they want to get export competitiveness back in the non energy sectors, and now they need to do this since with the credit crunch domestic demand is going to be lifeless and for some time.

Instead of sending tanks to Georgia the Russian authorities should have been busying themselves watching the Baltics, they were the testing ground - the canaries in the coalmine - for all of this.

But then, they were, now what was it the Economist called them, oh yes, just "pipsqueaks".

Anonymous said...

"Instead of sending tanks to Georgia the Russian authorities should have been busying themselves watching the Baltics"

They should have just let the annihilation of South Ossetia take place? All so some economic numbers could improve a bit? How can you say that with a straight face? The fact is that we now know the war in Georgia saved thousands of people. It wasn't some geopolitical game they were playing, it wasn't some conspiracy to annex land and oust Sakashvilli. The facts have been layed out for us by OECD missionaries and NATO intelligence who were there when the war broke out. They've given detailed accounts of how the war unfolded, and they've debunked most of Georgia's outrageous claims, up to and including their excuse for invading South Ossetia in the first place, as well as their claim that Russia had invaded first.

Please read the articles posted below. I can't help but find your constant comments regarding the war in South Ossetia inflammatory and flat out ignorant, considering the information we now have freely available to us. At some point you're going to have to acknowledge and accept the truth, rather than keep looking back and remembering what you saw on Fox news on August 11th, and making these careless knee-jerk comments.

BBC - Georgia accused of targeting civilians

NYTimes - Georgia Claims on Russia War Called Into Question

Der Spiegal - Did Saakashvili lie?The West Begins to Doubt Georgian Leader

There are plenty more that a quick search in google will find for you. Please, I hate to be rude, but inform yourself. Listen less to the politicians and more to the first-hand intelligence reports.

Edward Hugh said...

Hello,

"They should have just let the annihilation of South Ossetia take place?"

Look I am an economist, and a technician of economic systems. I am really not interested in getting into the politics of all this. I can simply report what happened.

Basically, if you want to be part of a global economic system you have to play by the system rules, which means you need to consult and negotiate before acting. Russia could, I imagine, have taken this to the UN, or Putin could have flown direct to Washington to talk face to face with George Bush if the situation was so critical, and agree a common approach.

What really blew the lid off things was the decision to recognise the two new separatist reasons. You really can't do things like this when you are very dependent on external funding, as they are now finding out to their cost. The US, in its own way, has the same sort of problem with China. Since the Chinese authorities buy considerable chunks of US government debt (and Agencies) there are very definite limits to what the US can and can't do about - eg - the yuan.

I don't say that this is either right or wrong, but simply that it is like this, and I then need to report the consequnces of decisions which are taken.

"All so some economic numbers could improve a bit?"

I think you simply don't understand just how serious the situation which has now been precipitated in Russia actually is. Russia is still a comparatively poor country, a lot of the population have chronic health problems, and the collapse in Russian headline GDP could well produce a humanitarian problem inside Russia of significant proportions. This is what we now await to see.

Just how long, for example, will the $575 billion dollars in FX reserves they had before the went into Georgia actually last? We are still waiting to see.

Sublime Oblivion said...

"Russia could, I imagine, have taken this to the UN, or Putin could have flown direct to Washington to talk face to face with George Bush if the situation was so critical, and agree a common approach."

Actually Russia that. It submitted a UN resolution disavowing the use of force in South Ossetia, which was vetoed by the US. It's hard to negotiate with a country that at the very least implicitly supported the Georgian aggression.

About the economics:

I don't see how the recognition of Ossetia / Abkhazia in any way precipitated the economy crisis. Your projections for reserves are unrealistic. The Baltics face a crisis because their current account deficits were on the order of 10%+ of GDP; Russia's will only go (slightly negative) if the oil price falls and stays low at about 50$ per barrel (although the consensus view AFAIK is that oil will rebound to 70$-80$ or so for 2009).

Nobody said...

In the last years Russia was hit by a massive outbreak of a peculiar form of patriotism based on Emil Coue's method of repeating every morning "Every day, in every way, I am getting better and better." Visits to some Russian blogs and media outlets gave one an impression of being present at self hypnosis sessions. The thing is that not only the common population, but the leadership itself has fallen victim to its own propaganda. They seem to have been completely unprepared to find themselves in the middle of such a mess. Even when it was getting very clear that Russian economy had started crumbling under the impact of this crisis, the Russians still continued fancying themselves with all sorts of weird notions like that they are very special and that this crisis is entirely of Western making and irrelevant to them. In fact, they still do. Not so long ago the president Medvedev has promised them that Russian economy would grow 7% next year.

Nobody said...

The Economist, by the way, has published a superb special report on Russia in its last edition. Among many gems of the report one is:

Russia today has a glass-like quality to it: rigid and fragile at the same time, and liable to develop cracks in unforeseen places.

I guess this should be a very apt description of Russian economy too.

Sublime Oblivion said...

@Nobody,

Medvedev predicted 7% growth this year, not the next. (http://en.rian.ru/russia/20081125/118535320.html)

Unless you can prove otherwise, or have a very unconventional understanding of "Not so long ago", the single fact you give will be considered a blatant lie and as such invalidate the rest of your purely subjective rant.

Nobody said...

Correct, SO. Maybe I was confused by this...

RIO DE JANEIRO, November 25 (RIA Novosti) - Russia's economic growth will reach around 7% in 2008, President Dmitry Medvedev said on Tuesday at a meeting between representatives of Russian and Brazilian businesses.

"Economic growth will remain at a level of 7%, although everybody will face certain difficulties," Medvedev said.


Never mind that economic growth for Russia is already projected at less than 7% this year. Anyway, don't take it too personally. It was just a throwaway comment. It was not intended for Russian patriots.

:D :D

Edward Hugh said...

Hello both of you:

"It's hard to negotiate with a country that at the very least implicitly supported the Georgian aggression."

Well, given the seriousness of the problems which have been produced, you just have to try harder, or stay out of the international financial system, that is all I can say. With power comes responsibility. If you have the future of the Russian people in your hands, I don't think you should allow your actions to be influenced by your own personal feelings about George W Bush, or any other major world leader, for that matter.

More than anything else, I would say the single issue which has caused most problems on the economic front has been the decision to unilaterally recognise the separatist regions. Go it alone-ism simply doesn't work when you depend on others for financing, as we are now seeing.

"The Baltics face a crisis because their current account deficits were on the order of 10%+ of GDP"

I think wording is important here. The Baltics don't face a crisis because of their current account deficit, their crisis will be WORSE becuase of it, and because (unlike Russia) they have little in the way of exportables to compensate for the destruction of internal demand in the future.

The Baltics had a problem since (like Russia) they have a long term low fertility issue which constrains the rate of growth of the young part of the labour force and means it is very difficult to grow rapidly without fuelling up inflation. In the Baltic case the issue is complicated even further by out-migration, while Russia of course has been able to rely on something like a million inward migrants a year to plug the gap.

Still, Russia has had horrendous inflation, and has had no convincing policy from the central bank to address the issue. This would be the big-picture weakener of confidence in underlying institutional quality I think. Fine speeches don't count for a lot in this context, what matters is action and results, and we have seen relatively little on either front here.

Would that Russia's leaders had devoted the same energy to the inflation problem as they did to the "Georgian one".

On the economic growth for 2009 issue, while I would be far from considering myself a first line enthusiast for Dimtry Medvedev, I do think it is very hard for political leaders generally to accept when their economy goes off into tailspin. I live in Spain, and the performance of Spanish prime minister José Luis Zapatero has hardly been exemplary here.

It is very hard to forecast what Russia growth rate in 2009 will be, since there are so many unknowns at this point.

Gary Dugan, who is chief investment officer at Merril Lynch, is suggesting a growth rate of between 1 and 2 percent, based on an average oil price of $42 a barrel in the first half of next year. The World Bank on the other hand is forecasting growth of 3 percent. I have no better suggestion to make. It may well be that growth will not be that far from 7% in 2008 as a whole, since the momentum from the first three quarters will virtually guarantee this. And next year there is certain to be a sharp slowdown, possibly even a recession. After that we will have to see, since so many variables are in play, not the least of them the value of the ruble, which after so much inflation looks like it is in line for a sharp devaluation, possibly of 20%.

Nobody said...

On the economic growth for 2009 issue, while I would be far from considering myself a first line enthusiast for Dimtry Medvedev, I do think it is very hard for political leaders generally to accept when their economy goes off into tailspin. I live in Spain, and the performance of Spanish prime minister José Luis Zapatero has hardly been exemplary here.

I agree with this. Still, one can't be left unimpressed with the debates they were having there about how the crisis means the end of the US hegemony and the beginning of the Russian era. Russians in general see it as a kind of zero sum game: one down (the US) - another one is automatically up (Russia). My family has a business in St. Petersburg and if I believe them there are massive layoffs under way all around since a while ago. There is an astonishing gap between how the Russians perceive their situation and the actual situation itself.

Nobody said...

BTW Eduard

I bet you know that the regulators are raising RFS for the next year to 10.21% while some articles of the EISA regarding the biofuels blend should become mandatory this or next year. Do you expect this to have an impact on the situation of the energy market?

Edward Hugh said...

"There is an astonishing gap between how the Russians perceive their situation and the actual situation itself."

This is unfortunately true all over Central and Eastern Europe - except Hungary, the Baltics and now Ukraine. I have just spend the weekend doing a long piece on Romania. They have all been busy giving themselves pay increases of up to 50%, and have no idea at all of what is now in store for them.

Basically I agree with what you say about zero sum games, but remember European politicians (especially in Germany) were all busying themselves laughing at US sub-prime problems, and now just look where we are. In all of this, if you are part of the global system, you sink or swim together. And of course, the most vulnerable take the biggest hit. Now if you are Myanmar, things may be different, but in very many ways, and most of them not good.

"Do you expect this to have an impact on the situation of the energy market?"

Not my field at all I'm afraid.

Sublime Oblivion said...

@Ed,

Whatever your personal issues about Georgia/Ossetia (on which we'll have to agree to disagree), that still assumes that the conflict there and recognition of Abkhazia/Ossetia actually contributed to the fall in the RTS and reversal of capital flow. And it did - I'm not disputing that. However, both those factors were already secular trends that were well under way, and all they did was speed them up a bit. Take a graph of the RTS's decline from June to October and you get practically a straight line, with a sharp dip around the time of the recognition followed by quick reversion to the dominant trend - which is powered by general things like flight to quality, not one-time events of questionable overall significance.

"The Baltics had a problem since (like Russia) they have a long term low fertility issue which constrains the rate of growth of the young part of the labour force and means it is very difficult to grow rapidly without fuelling up inflation."

I know the fusion of demography and economics is a central part of your work, and I agree that generally speaking it's a neglected area; but I feel you overcompensate. Firstly, if you look at the data (World Bank) the great bulk of economic growth in Russia and EM ECE has been down to productivity improvements; labor has not been a big drain in the latter, and has actually boosted the former (although this is now beginning to go into reverse). Although its tempting to link higher Russian inflation in 2007 to the start of its sharp decrease in new workforce entrants, I think traditional explanations (like the huge monetary expansion in that year, followed by the food price spike in the next) are better.

"Fine speeches don't count for a lot in this context, what matters is action and results, and we have seen relatively little on either front here."

The World Bank would beg to differ, having praised Russia's policy response to the crisis in their latest report.

Re-growth

I agree. 7% growth is assured unless Q4 is truly catastrophic. After that, it depends on how the interrelated world economic/credit situation/oil prices play out, and how long it will take for the fiscal stimuli to filter through to the real economy, and a host of other things.

---

BTW, I still think there is a fundamental difference between Russia and the US. The US has a problem in that in all probability some of its biggest companies are in insolvent, dead but still breathing. Russia had low levels of leverage, company profits high with big net foreign asset holdings, and practically didn't participate in the toxic casinos that were the subprime and US housing and CDS markets. The main problem has been iliquidity and destruction of internal demand due to the credit crisis and falling oil prices. But this is a one-off and reversible problem, whereas the quagmire the US is in - in which a profligate, already grossly indebted state takes on the obligations of a failing financial system, not to mention the prospect of another impending oil crisis after the recovery and Social Security obligations beginning to kick in - is in reality much deeper.

Sublime Oblivion said...

My take on things:

http://www.sublimeoblivion.com/2008/12/07/russia-economic-crisis-iii-on-the-importance-of-self-sufficiency-in-liquids/

Nobody said...

Edward Hugh said...

"Do you expect this to have an impact on the situation of the energy market?"

Not my field at all I'm afraid.


I understand this, but these are some of those unknowns you mentioned that make predicting the price of oil and anything very difficult. The ethanol producers in the US are now pushing for a mandatory E12-E13 blend as the shrinking domestic autofuel consumption is undermining them too.

China seems to have been taking advantage of the current situation by restructuring its energy market at the expense of the consumers. In fact it looks as if Chinese leadership has finally reached a decision that the demand should be deliberately suppressed.

There are big questions about how much the oil market will be able to recover the next year.

Edward Hugh said...

Hello again both of you.

It seems to me if we are sophistocated enough to avoid saying things which we know will simply irritate the other, and respect varying points of view, then we could have an interesting discussion here, especially about the possible future paths of energy prices, which at the end of the day is going to be key for Russia (in my opinion).

"I understand this, but these are some of those unknowns you mentioned that make predicting the price of oil and anything very difficult."

Well, I said I don't know much about the ins and outs of emerging technologies in the energy field, and the likely course of government regulations, this doesn't mean I don't have intuitions about the future path of global growth, and other macro economic aspects which are going to be important. So I do have opinions, but I am aware they are merely that, opinion.

For example, I have no idea how far away we are from having a form of vehicular transport which doesn't depend on petrol. But obviously this is going to be a key policy objective for oil dependent Europe, the US and Japan over the next decade. If someone could say, we will be there by 2025, then just what would that do to the path of petrol prices during the intervening years? I have no idea, but this is surely a very interesting question.

And just how far will people go over the next 15 years with nuclear technology, and (let's say) electric cars. At the moment there seem to be insurmountable difficulties, but will that always be the case? Seeing Larry Summers in as Chief Economic Adviser to Obama suggests to me we may well see some interesting and innovative initiatives here, since the people who ran the US during the internet boom years are now effectively back in charge, and this is going to be a very big change of collective mindset. And my feeling is on all of this, when there is a will, there is a way.

OK, I have to do some work now, but I will try and come back with some thoughts on Sublime Oblivion's post sometime tonight.

Have a nice day,

Edward

Edward Hugh said...

Well, this is a bit off topic, but I don't know if you saw this in Bloomberg:

Deutsche Bank AG expects Germany’s economy to shrink in 2009 more than currently expected by the government, Bild Zeitung said. Deutsche Bank chief economist Norbert Walter said that Germany’s gross domestic product could contract by as much as 4 percent next year, the newspaper said in an article to be published tomorrow. Walter forecast the slump because of a deteriorating economic situation in Russia and in the Middle East, the newspaper reported. Walter is urging Germany’s government to drop its value-added tax to 16 percent for one year to strengthen domestic consumption, the newspaper reported, citing the chief economist.

Personally, I felt from the start that Germany was going to be the worst casualty of the Roki tunnel incident, as the economies of Russia and the CEE went off into melt down mode. Russia may well avoid the IMF, but there won't be many more who can resist (Slovenia possibly, since they are in the euro).

4% contraction for German GDP in 2009 looks a bit high, even for me, but it isn't in the wrong ballpark. Germany was totally export dependent on the CEE, and now has no customers.

Also, with China's economy falling off a cliff itself, and Japan sinking into ever deeper recession, the argument that the large surplus countries were going to soak up the economic slack is starting to look a bit thin. Very thin.

Nobody said...

Edward Hugh said...

Hello again both of you.

It seems to me if we are sophistocated enough to avoid saying things which we know will simply irritate the other, and respect varying points of view, then we could have an interesting discussion here, especially about the possible future paths of energy prices, which at the end of the day is going to be key for Russia (in my opinion).


I actually did not have in mind electric cars or something within the range of 15 years. There are some recent developments that may have an immediate impact on the market. Several bilateral FTAs concluded by the US with Latin American countries are about to take effect. The immediate effect would be that the special tariff with which the US is blocking entry of Brazilian ethanol will be breached. Brazilian ethanol is claimed to be competitive at $40-50 per barrel but that from Peru may happen to be even cheaper. It's of limited significance right now as the US will hit the blending wall next year, even though they may authorize the use of 12%-13% blend for regular engines. Of course if Obama comes up with a massive program of switching car fleet to flex engines this may open wide cracks in the blending wall. And Obama himself and many around him are often claimed to be ethanol hawks.

Another thing is that China seems to have moved to tackle the domestic demand. They were phasing out subsides for quite a while but as far as I can get they are now restructuring the taxation system and introducing fuel tax. Some people are already asking if Obama will follow their suit.

Of course this is not my field just as you say it about yourself. Nevertheless, I would dare to suggest that if it keeps going this way the energy market will not go soon back to where it was a few months ago, if it's ever going to do it at all.

Nobody said...

It's official now: Official warns Russia already in recession.

PS

Did you see the latest trade figures released by China? I would say they are dramatic. But the most weird thing about them as far as I can judge is that it's the imports that seem to have taken most of the hit. According to the US figures too the trade imbalance has actually increased. I am wondering if we should take this as an indication that the internal demand is collapsing in China despite the massive stimulus package.

Sublime Oblivion said...

I think it's more to do with the prices of the commodities they import having collapsed.

Nobody said...

Right. It can be the commodities. Though the Chinese are apparently in a kind of shock. They didn't expect this. By the way, EH. Why did you say that they are falling off the cliff? Because before this data was released everybody was talking as if they are doing relatively fine.

Edward Hugh said...

Hello you two,

I'm sorry I haven't been around lately, I have just been hellishly busy. I have just put up a new post, which really puts the situation as I see it now, and answers some of the questions.

@ Sublime Oblivion

"Firstly, if you look at the data (World Bank) the great bulk of economic growth in Russia and EM ECE has been down to productivity improvements;"

Hmm, hmm. Look at the chart from their most recent report which I put in my latest post, and which comes from the WB, showing the comparison between wage growth and productivity growth.

Basically there seems to be a sort of before and after. Up to 2005 it is quite possible that most of the growth was achieved via substantial improvements in productivity, but post 2005 (more or less) people have been paying themselves whatever price they wanted, and funding this with borrowing and the commodities boom.

I am working up a piece on emerging markets and you may like to take a look at the chart at the top of the post.


This chart shows the Reuters Jeffries commodities index, and basically what I argue is that we had a very nice and smooth EM expansion going on in a lot of countries until the sub prime thing really broke. Then we got a flood of money into EM economies, capacity got spread to the limit, and then we got an inflation bonfire, depending on the ability of the local central bank to handle the situation.

Anyway, the point is, that "mini-bubble" inevitably burst, and we now have the downside correction, which is why prices have fallen so low. The relatively good news for Russia is that at some point we can expect commodities to retake the line of secular rise they were on, before the blow out. The bad news is that we don't know how long it is going to take for all this to correct, or even who is really going to lead the next global charge (although as you will see, my money is on Brazil and China).

However, as we are now about to see, the short term outlook for Russia looks pretty bleak, with things even worse than even I expected. It seems that 7% for 2008 that I was willing to take for good has now gone out of the window, and deputy economy minister Andrei Klepach is talking about 6%, which is based on a 2.8% y-o-y in Q4, which is like, wow, and almost certainly means the Russian economy is actually already contracting and not just slowing, which is also the picture you get from the PMIs.

"The Baltics face a crisis because their current account deficits were on the order of 10%+ of GDP; Russia's will only go (slightly negative) if the oil price falls and stays low at about 50$"

Well, we are already there, and people seem to think the CA is already in deficit, and unless the ruble falls strongly this deficit can grow (if anyone is willing to fund it, which is another problem).

Being dependent on oil makes any economy very vulnerable given the rapid fluctuations in price, which is why it is so important to have good economic management as well as the reserve funds, to stop the imbalances building up so much. Now what we have is unwind. I hope the leaders will learn this time.

Also note the problem with forex borrowing if they have to bring the ruble down. This mess is generalised across Eastern Europe, and could well have serious consequences in Western European countries like Austria and Italy, if the banks from those countries get to take too big a hit.

"I think it's more to do with the prices of the commodities they import having collapsed."

Well there was a 19% drop (y-o-y) in imports in October (remember oil wasn't that high in October 2007), so I think this is more than just commodities. I think it is materials from places like Japan and Singapore coming for processing. If the final customers in the US, Europe and Japan (which are all in recession) aren't buying, then they don't need to do the processing.


@ nobody

"By the way, EH. Why did you say that they are falling off the cliff? Because before this data was released everybody was talking as if they are doing relatively fine."

Because it was obvious to me that they wouldn't be. I closely follow the two most export dependent economies on the globe (japan and Germany) and it is very obvious to me what happens to these economies once the main customers go down, there is simply nothing to fall back on. Why this is in the Chinese case takes us beyond this thread, but it is like that.

If you raise productive capacity by 25% a year (as the Chinese were doing) and then your customers reduce their orders by 5%, you have a hell of a mess. Plus they had a credit and construction boom coming into the Olympics. It all had to go, and it did.

I wouldn't be surprised to see China GDP down at 2% or 3% growth next year - the prices of most of the products just are not geared to the internal market even though many of them seem cheap to us, they are for export. Of course, given China's size we should also see world markets now flooded with some very cheap manufactured products.