Russia: Beware falling BRICs

Russian stock exchange shut on three occasions – economic crisis pending

The collapse of US banks is grabbing the headlines worldwide. But the consequences on the current crisis are also starting to hit the so-called BRIC countries – Brazil, Russia, India and China – the supposed new ‘miracle economies’ that were touted by pro-capitalist commentators as potential new motor for driving the world’s economy forward. Indeed, since 2001, when they accounted for less than 10% of world GDP (with over a third of the population), now they account for almost 15%.

Yet in each of the four countries, the effects of the crisis are beginning to bite. While New York and London have been racked by “volatility”, loosing over a sixth of their value since May, the falls in the BRIC countries have been phenomenal. The MSCI BRIC index has fallen by 37% since January, the Brasilian Bovespa by 15% since January, and 38% from its high in May, India’s Bombay exchange has fallen by over 32% since January. The Shanghai stock exchange is in freefall. Since its high point of 6124, in October 2007, it has fallen now to 2154 – an incredible drop of over 60%. Already in China, 67,000 companies have gone bankrupt, adding an extra 2 million to the list of unemployed.

Apart from the general credit crunch, these countries have suffered from the falls in world commodity prices. So volatile has been the Russian stock exchange, the authorities shut it down on three different occasions, in early September. But it has proved impossible to stem the general trend. The Russian stock exchange has plummeted, from its high, in May, of 2,500 to 1,340 today – a drop of 45%, in just 4 months.

The Chinese and Russian stock markets were two of the world’s best performing in 2007, but in 2008 they are the worst. These drops are significant in more ways than one. Ten years ago, these stock exchanges did not play a big role in the world economy. However, the combined value of the four exchanges is now 7 trillion US dollars, nearly twice the size of the London Stock exchange (4 trillion). The share turnover is 5 trillion, per year, compared to London’s 9 trillion.

Although the Chinese and Indian governments say that Foreign Direct Investment (FDI) is still flowing into their countries, in Russia it was drying up before the war in Georgia. Finance Minister, Alexei Kudrin, reported that during the five days of the war another 16 billion euros fled Russia. In the past three months, emerging-market funds have seen an outflow of $26 billion, compared with an inflow of $100 billion in the previous five years. In other words, more has flown out of the emerging markets in the past three months than came in during an average year!

The reaction of the governments has been to a large degree predictable. The Indian government pumped 7 billion USD of its reserves into supporting the rupee. The Chinese government has used its still considerable state holdings to assist the commercial banks. China’s main driving force for growth has been exports, but export volume growth has halved in the past year. The property boom bubble is also under pressure. Property sales in the big cities have dropped by 40-50% in the past year, according to one of Hong Kong’s property companies.

Pending crisis

The clearest signs of a pending crisis are to be seen in Russia. Having closed the stock market to prevent a further collapse, the government has done everything possible to try to calm the situation.

President Medvedev attempts to convince everyone that the Russian economy is in a sound position and any temporary difficulties caused by the US crisis will quickly be overcome. In television news programmes the problems faced in Russia are mentioned as a mere footnote to reports on the American crisis.

Yet “small temporary difficulties” are proving to be quite big. After the collapse of Freddie Mac and Fanny Mae, it turned out that the Russian state-owned Sberbank, Russia’s largest bank had been helping the US to solve its debt problem by investing over 100 billion dollars into the two American banks. By August, this figure had dropped to 30 billion, partly as a result of Sberbank selling the shares, partly as a result in the general drop in value of the US companies. This was the first sign that Russia was not the safe haven that Putin had advertised earlier in the year.

After the collapse of Lehman Brothers, the real problems started. On the first day of the crisis, the Russian government pumped 20 billion dollars into the market. At the time of writing, it has now allocated 127 billion US dollars, which includes 20 billion to support two of the biggest banks and the Rosneft Oil Company. Considering that the GDP of the US is almost 10 times the size of the Russian economy, this sum would be equivalent to the US government handing out 1.27 trillion dollars.

In proportional terms, the hand out to big business in Russia is probably twice the size of the US handout, and yet it is barely mentioned in the business pages of the Russian press. This, of course, may be due to the way in which the support is given; usually by buying up shares in the offshore companies, which nominally own the banks. Needless to say, there are often links between these companies and government ministers.

Despite this, there have still been bank crises. The State Investment Bank, whose chairman happens to be Vladimir Putin, was forced, this week, to step in to buy 95% of the Svyaz bank, the 20th largest private bank in Russia. This bank is important, as it handles all the money transfers to pay pensions throughout Russia, and it could no longer guarantee the free flow of money. At the same time, two other investment banks, Renaissance Capital and KIT Finance have been forced into urgent restructuring. Renaissance Capital is Russia’s largest investment house. Half of its shares were purchased by one of Russia’s oligarchs for half a billion dollars, in what is described as “not a rescue but a preemptive strike”. But the money paid underlines the scale of the crisis; 2 years ago, this bank was worth 4 billion. It is now expected that a wave of second and third level banks will either collapse or be forced to sell themselves to one of the state banks.

The crash of the ruble, in 1998, in conjunction with the South East Asian economic crisis, rocked the world’s economies. Paradoxically, the resulting 30% devaluation of the ruble, which took place practically overnight, helped prepare a decade of economic growth. It meant imports to Russia were expensive and, therefore, Russians started to buy more locally produced goods, boosting local producers. But the other factor behind recent years of growth was, of course, the price of oil and gas. During the nineties, oil prices never went above 22 dollars a barrel. From about 2000, coinciding with Putin’s election as president, oil prices started to rocket. This gave a huge cash injection into the Russian economy and, at least until 2005-2006, acted as a major boost to economic growth. Last year, the economy grew by about 8%.

Uneven investment

But even before the credit and banking crisis in the US broke, signs of developing problems were appearing in the Russian economy. Notwithstanding the huge amount of oil cash flooding the economy, investment was very uneven. As a result of the oil and gas prices windfall, the ruble has been very strong. This has meant that it was very expensive to finance investment in non oil and gas sectors. At best, companies were able to replace only broken down equipment and did not develop new potential. Even the oil sector suffered from this problem. Over the past ten years, Russia has not succeeded in significantly expanding its oil production potential. Indeed, this year, oil production has actually declined slightly. Now the oil bosses say they have no money for investment. Lukoil, for example, is about to cancel its investment programme, arguing it was based on an oil price of $105 dollars per barrel and not $95 which is more realistic.

Now some companies are complaining that it is almost impossible to find any credit, or even to maintain day to day operations. This resulted in a crisis at one of Moscow’s airports, where 6 regional airline flights were cancelled when the companies concerned could not pay for fuel. Passengers were left stranded for one week, until the government bailed out the airlines by allowing one of the new “State corporations” (‘Russian Technology’) to take them over.

There are contradictory reports, as far as industrial production is concerned. One survey conducted by a leading research institute, at the end of August, indicated that industrial production growth was grinding to a halt. This is contradicted by government statistics, which talk of a year-on-year growth rate of 5% (although, last year, it was 7%). What is not disputed is that industrial growth is slowing down. This is a reflection of the rate of investment. In the years 2005, 2006 and 2007, capital investment grew by 10.7, 13.7 and 21.1%, respectively. This year it will be lucky to grow by 9%.

Also, for the first time for a number of years, the phenomenon of wage arrears has appeared again – in August, wage arrears grew by 14%, although the absolute level of arrears is considerable lower than during the nightmare years of the 1990s.

But perhaps the most immediate threat is posed by the property market. Headlines have started to appear in papers, asking: “What does it mean when the country’s largest developers announce they are freezing building projects?” One of the largest companies has frozen, for at least 1 year, and maybe 2 or 3, a project to build 10 million square metres new flats. Another company has announced it is selling off half a billion dollars worth of building sites. One analyst revealed that because the developers can no longer find the money to finance current building, most projects are now delayed by at least 6 months. He explains that “developers” are complaining because they took money out of less profitable and more risky sectors to enter the construction market, believing it would continue to grow rapidly. But following the stock market crash, on average the shares of development companies have fallen by 15-25%, and so they cannot keep up with their commitments. Now that the first outlines of a crisis are appearing, rumours are circulating that add fuel to the problem. The talk is of apartment flat prices dropping by at least 20% in the next few months. Even without the current crisis, it would only be a matter of time before this happened, as there is clearly over-capacity in the construction industry, at least in the big cities. But now that potential buyers are aware of talk of a drop in prices, they hesitate before going ahead with new purchases. This will also affect the industrial sector. It is estimated that up to 15% of industrial production in Russia is account for by the construction market.

But the other factor that is compounding problems is government expenditure. At the start of the oil boom, the Russian government managed to turn the budget deficit into a surplus. This was done by, on the one hand, a sharp cutting of expenditure and, on the other hand, by increasing revenues from the oil and gas sector. The first surplus budget was calculated on an oil price of 24 dollars a barrel. Since then, thee government has used the huge increase in revenues to create a “stabilization” of 500 billion dollars and to launch a number of “national projects”, for example in education, housing and healthcare. While these projects have created some superficial improvements, the main consequence has been to boost inflation (now officially expected to hit 15%, this year) and to create a massive increase in corruption. But it is no longer possible to run a budget surplus if the oil price goes below 85 dollars a barrel. And as can be seen, the stability fund is not that large – at the current time, the 127 billion that has been promised to stabilize the stock market is to come out of federal budget sources. But the pressures on the stabilization fund are already growing, as the government has already announced it will be used to bail out the pension funds, suffering as a result of the demographic crisis.

Consequences of economic downturn

Growth rates are still relatively high in the BRIC countries, but it is clear that the storm clouds are gathering. While it is as yet not clear exactly how the economic crisis will develop further, the only thing that can be said, with certainty, is that the last period of growth has come to an end.

This has big consequences for millions of Russian workers and the rural poor. Following the collapse of the USSR and the disastrous Yeltsin years, the oil and gas-led boom meant sections of the middle classes and skilled workers were able to improve their living standards, to a limited degree, albeit at the cost of long working hours, few rights and often poor workplace conditions. Millions of others, however, particularly in the countryside and regions, still struggled to meet the most basic human needs. Now the country faces economic volatility, uncertainty and possible sharp economic downturn. Putin and Medvedev will find their limited social base of support seriously eroded and will no longer be able to point to economic boom as the necessary ‘trade-off’ for their authoritarian rule. More working people and youth will be forced to look for an alternative to the pro-Putin, pro-market ‘parties’. The populist chauvinism and nationalism engendered by the regime, which reached a peak over the short war with Georgia, will increasingly sound hollow to millions of Russians faced with joblessness and struggling to make ends meet. In this situation, a clear class alternative can gain a wide echo from workers and youth. Genuine independent unions are needed to defend workers’ jobs and conditions and to fight for a living wage. A new mass workers’ party is essential to articulate the real interests of workers and youth; opposing the pro-market and reactionary chauvinistic Putin parties, and offering an alternative of genuine workers’ international solidarity and opposition to capitalism.

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September 2008