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Economics

Greece’s financial meltdown sounds all too familiar to Russia’s experience in 1998. Yet differences between the two show how far Moscow has come in 12 years.

BEN ARIS

RUSSIA NOW

The crisis Greece is facing looks all too familiar to Russia. It went through more or less the same thing in the run up to the Au- gust 1998 financial meltdown that ended with the ruble cut to a quarter of its value, repay- ment on its foreign debt frozen for five years and its banking sector destroyed. However, this time around Russia will prob- ably only be affected for about four months if Greece defaults on its debt before returning to a path of strong growth and recovery. The European Central Bank

(ECB) was forced to act on May 9 to prevent another meltdown of the continent’s financial sys- tem. While the ECB’s $1 trillion rescue package floods the mar- kets with money and staved off disaster, it has left the funda- mental problem untouched: All of Europe’s economies are weighed down by debt and high deficits. As confidence evaporated in

the first week of May, equity markets around the world, in- cluding Russia’s, tanked as the possibility of a Greek default loomed large. But unlike the global crisis that burned the world’s economy 18 months ago, this new crisis looks a lot like the run up to Russia’s 1998 financial crisis; that one was bad for Russia but had a very short- lived impact on the rest of the world. This time around, rather than being infected by a po- tential Greek collapse, Russia is on the other side of the fence as one of the strong coun- tries. This will be little more than a bump on the path that leads back to strong growth. At the start of 1998, Russia

had just experienced its first-ev- er positive growth, and the spreads on the government’s Treasury bills had fallen into the low teens, making the 8 per- cent deficit easier to finance. Russia was starting to look like it had turned the corner after almost a decade of chaos. But it was brought to its knees

by contagion from the Asian cri- sis the year before. By the sum- mer of 1998, the collapse of the so-called Asian Tigers final- ly fed through into commodity prices, bringing the cost of a barrel of oil down to $10. Rus- sia’s economy promptly col- lapsed despite a huge Interna- tional Monetary Fund bailout loan. Yields on the state’s bonds soared to over 200 percent and cash fled the country, leaving the state with a pathetic $9.1 billion at the start of August. The crisis came to a head on

August 17, 1998, when the gov- ernment called it quits. The ruble was cut to a quarter of its previous value and the govern- ment put a five-year moratori- um on all international debt re- payment. Now history is repeating it-

self with Greece. The bailout deal struck with Germany and the other European Union mem- bers (despite the ban on bail- outs in the E.U. treaty) was not enough to convince bond in- vestors that Greece’s problems are behind it. Fears of conta- gion quickly spread to neigh- boring markets, threatening to bring the entire European edi- fice down. Some observers ques- tioned the lack of a single fiscal policy across the Eurozone. Investors are afraid of a re-

peat of Argenitina’s collapse in 2001, when the country was unable to swallow the bitter

medicine of the austerity pack- age imposed to fix the collaps- ing public finance. Greek is close to going the same way after people took to the streets on May 5 to demonstrate against the deep cuts in public spend- ing that will hit almost every- one in the pocket. However, things are not quite

as bad as they seem for coun- tries like Russia, which saw heavy selling of its stocks and bonds in the first week of May. It is notable this time that, unlike the crash in 2008, the problems are regional and not global. The Asian collapse in 1997 spread to Russia via the fall in oil pric- es, but for the rest of the world it was business as usual. Indeed, the developed world was en- joying the heady excesses of the dot-com bubble, which didn’t pop until 2000. While Russia’s meltdown caused a sell off in

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Macroeconomics Russia’s monetary and fiscal policies have come a long way since 1998, when it defaulted on government debt

Russia 2010: No Greek Tragedy

MOSCOW

A global financial hub between East and West?

President Dmitry Medvedev’s plan to promote Moscow as an international financial center is part of his agenda to transform Russia into a more modern, liberal society. “When you bor- der western Europe and China and have a massive natural re- source base wanted by both, you can become a financial li- aison between the two,” said Steven Meehan, chief executive for Russia/CIS at Swiss banking titan UBS.

However, if Moscow is to be taken seriously as an interna- tional financial center, it needs to shed its image as the font of so-called Wild East capital- ism, characterized by a lack of legal safeguards to protect in- vestors’ rights, he added.

INDICATORS

$447 billion

Russia’s gold and foreign currency re- serves as of March 2010; they are cur- rently the third larg- est in the world.

$2.1 trillion

Russia’s gross do- mestic product in purchasing power parity; Russia has the world’s 7th largest economy.

BRIC countries are a new factor in the global balance of power, and all four are continuing to grow very strongly.

“On the whole, Russia’s busi-

Greek protests in 2010 vs. Rus- sian railroad workers’ strike, which blocked off the Trans-Si- berian railway, in 1998.

the west, VTB Capital points out that it took the western mar- kets to absorb the shock and return to its growth bubble. And Russia wasn’t part of the E.U., which has a vested interest in bailing Athens out, as no one wants to see the Euro project wrecked. “The Greek situation is evolv-

ing along the lines of Russia’s 1998 economic crisis; indeed, the fiscal parameters of Greece’s situation are worse than that, but they also have a greater po- litical imperative of financial aid from the Eurozone playing to their benefit, at least for now,” Wiktor Bielski, an analyst with VTB Capital said. “And the end- game might be very similar, i.e. an eventual default on Greece’s sovereign debt triggered by the country’s inability to meet the conditionality attached to the package. That said, the experi-

ence of the 1998 Russian crisis suggests that the contagion from such a credit event, while significant, would be short- lived.” While growth in western Eu-

rope and America is sluggish, the rest of the world is doing better than expected. The Eu- rozone manufacturing index is at a 46-month high of 57.5 (vs. 56.6 in March, while 50 repre- sents no change) and the U.S. manufacturing index is back over 60 again (at 60.4) for the first time since June 2004, said VTB Capital. Likewise, car sales in the United States, China and Japan are all up by 65-75 percent over the first quarter; housing starts stateside are up 20 percent; and both of these have been feeding a surge in production in commodities like steel, which is now at a record high.

ness is just taking shape. It should not be forgotten that Russia’s active financial and property markets only emerged some 20 years ago, while in the West such markets are centu- ries old,” commented Andrei Kostin, president of VTB. “Looking at the system as a

whole, we see that we have in- deed turned the corner. Bad debt levels have dropped mark- edly, and reserve levels vary among banks. Some banks proved very responsible and built their reserves last year, as required, and some are still doing this now. Generally, it is obvious that the system has turned this corner,” Kostin said. In general, the United States

is expected to grow by about 3 percent and Europe by about 1.1 percent this year, accord- ing to the IMF, whereas Russia’s economic recovery is gathering momentum fast. The Russian Ministry of Economic Develop- ment upgraded its forecast of end-of-year growth to 4 per- cent (it grew 4.5 percent in the first quarter and is still gather-

Expected GDP growth of the Rus- sian economy in 2010, following an 8 percent drop the previous year.

3-4%

While growth in America is sluggish, much of the world, including Russia, is doing better than expected.

ing speed), and the investment banks are talking about 8 per- cent of growth in the second half of this year. “Another pos- itive factor is that markets have grown, too, rising from the bot- tom and thus raising collateral values and improving client creditworthiness,” Kostin added. On top of this, the BRIC coun-

tries are a new factor in the global balance of power, and all four of these countries are continuing to grow very strong- ly, which will provide important support to commodity prices, the key consideration for Rus- sia’s ability to weather the po- tential storm. If Greece collapses, the con-

sequences are unthinkable, yet it is not enough to make really big waves on the market: Greek GDP was about a fifth of Russia’s economy and a tiny fraction of the European Union’s total GDP in 2009. There will be some contagion to the other countries on Europe’s periph- ery, but Greece alone is not big enough to bring the likes of Rus- sia down, let alone France and Germany.

Banking In a far cry from 1998, Russia’s financial system withstood the crisis

True grit: Russia’s banks prove their mettle

Pumping liquidity into banks during the crisis averted a major catastrophe, but can the banks restore enough confidence to revive mortgages?

GUY NORTON

BUSINESS NEW EUROPE

It’s a world turned upside down.

Last time Russia faced a se-

rious economic crisis, in August 1998, both the government and the banking sector proved to be the weakest links, collec- tively defaulting on tens of bil- lions of dollars worth of debt.

In 1998, Russians lost their

life savings to banks under water while international inves- tors suffered massive losses from the Kremlin’s decision to renege on repaying its debts. Predictably, bank customers and international creditors feared the worst when U.S. bank Lehman Bros. entered bankruptcy in 2008 and eco- nomic growth ground to a halt. Yet this time around, the Rus-

sian government and banking sector proved to be the cor- nerstones of a much stronger infrastructure when the global

credit crunch and economic downturn hit. Mid-2010, there is consensus that both the Kremlin and the banks have passed the latest crisis test, if not quite with flying colors, then at least with their credi- bility vastly enhanced. Ironically, Russia’s lack of ac-

cess to international capital after 1998 turned into one of its strengths in 2008. Unlike Ka- zakhstan and Ukraine, Russian banks could not go overboard on borrowing in the interna- tional bond and loan markets, and they were far less affected when the spigot of cheap in-

ternational funding was abrupt- ly turned off, according to Peter Ghavami, head of global mar- kets for Russian investment bank Troika Dialog. Rich in petrodollars, the Kremlin pumped in liquidity before lending confidence evaporated. A managed ruble devaluation accomplished the feat of restoring Russia’s export competitiveness, while avoid- ing a run on the country’s banks. There were many who questioned the wisdom of the Russian central bank’s step-by- step devaluation—some called it a death of the ruble by a

thousand cuts—but it ultimate- ly stabilized both the economy and the banking sector. There has been no need for govern- ment bailouts that have been a feature of the U.S. and Euro- pean economies. From the start of the year,

Russian banks have been able to refinance existing debts and raise fresh capital abroad. “All the Russian banks that bor- rowed one-year money in 2008 repaid it in full and on time in 2009, which gave comfort to international lenders. So there’s positive market sentiment to- wards Russia and Russian banks at the moment,” said Thomas Sommer, director, loan syndi- cation for financial institutions in central and eastern Europe at UniCredit in Vienna. Problems remain, of course,

not least in relatively underde- veloped sectors of the banking sector such as mortgage lend- ing. “Foreign-currency-denom- inated loans showed significant- ly higher default rates than local-currency-denominated

loans as a result of local cur- rency evaluation,” said Olga Ulyanova, an analyst at Moody’s Investors Service. Yet housing default rates stabilized from the second half of 2009 after surging in the previous 12 months. Mortgage rates are falling, said Jeppe de Boer, head of real

estate at investment bank Ren- aissance Capital in Moscow. Russian Prime Minister Vladimir Putin has said he wants to see rates at 10 percent, which would help make home own- ership a realistic hope for mil- lions of Russians and provide income for the country’s banks.

Assets rising in Russian banking

SOURCE: CBR, RENAISSANCE CAPITAL ESTIMATES

MILITARY REFORM

CAN RUSSIA’S ARMED FORCES ADAPT TO 21ST-CENTURY THREATS?

VLADIMIR SAYAPIN_ ITAR-TASS

ALEXANDROS STAMATIOU_ ITAR-TASS

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