Why is Vladimir Putin not following the example the West’s example and pumping cheap money into the failing Russian economy? Because he fears the fall of the ruble more than he does his political opponents.
At the end of July, Vladimir Putin made an unusual move in his economic policy. He criticized Russian bankers harshly for providing loans to entrepreneurs at excessively expensive rates, and even indicated a specific interest rate that the Russian government considers normal for modern conditions.
The obliging bankers immediately responded to the criticism. Two of the country’s major financial institutions - Sberbank and Vneshtorgbank (VTB) - announced that they were prepared to reduce their interest rates. At least, for borrowers they described as strategic.
In economic terms, this was an extremely debatable decision. Banks had been keeping interest rates high not only out of greed, but because the crisis makes it very difficult to distinguish between good and bad borrowers, i.e. those who are able to pay back their loans and those who will soon go bankrupt. So if the interest rate on loans is kept high, the inevitable losses from unpaid debts are to some extent covered.
In theory, these losses could be covered by selling mortgaged property on the market. But in practice this gives rise to serious problems. For example, property prices have fallen drastically during the crisis: at current prices it is impossible to sell anything, as potential buyers are waiting for houses and apartments to become even cheaper. So when property is transferred from a debtor to a bank, it is practically impossible to convert it into money.
Second phase of the crisis?
Experts are currently talking more and more about the imminent so-called second phase of the crisis, when bad debts on a massive scale will lead to the collapse of the banking system. And on top of this bankers are being asked to give favourable interest rates to industry and construction projects. Might the major banks who have decided to please Putin by being so obliging not actually collapse as a result?
No, unlike the small banks, they will not collapse. The Russian economy has one little trick up its sleeve. The government always helps its chosen few. It supports Sberbank, VTB and Gazprombank. It finds money for Gazprom, Rosneft, the Volga Car Works and a few other companies. So in responding to Putin’s call for them to reduce their interest rates, the bankers are sure to know that the Central Bank is prepared to provide them with the necessary liquidity in the event of a second phase of the crisis.
Sberbank holds the savings of tens of millions of Russians. If it were to collapse, Vladimir Putin would have far greater problems with angry depositors than with the head of the bank, German Gref. So Sberbank will not collapse. If it gets into difficulties, it will be "fed" using Central Bank loans or budget funds. And until that moment comes, it will be asked to "feed" borrowers.
In general, the actions of leading bankers are not mysterious . Their motives are clear, although if one is not aware of the little tricks of the Russian economy, it may seem that they are acting against their own interests.
Putin’s pressure on banks is interesting for another reason. It shows what the Russian leader most fears today. However, in order to understand the logic of Putin’s actions, one must take a look at the general state of affairs in the Russian economy.
The end of the era of prosperity
The economic crisis in Russia has proved much more serious than was expected in the autumn of 2008, when the first signs of a serious downturn became apparent. At that time officials only talked about a slowing down in growth rates. Later they began to predict a small slip. But in the end, the situation has proved to be truly catastrophic. According to a recent assessment by the Ministry of Economic Development, GDP dropped by 10.1% in the first half of 2009 compared with the first half of 2008.
Russia has not seen a slump like this since the early 1990s, when radical economic reforms were under way. However, that was a so-called transformation slump. It was unavoidable, as the country was having to abandon a whole range of goods which were manufactured before under the state plan, and which proved to be completely unnecessary in a market environment.
Russia has no need of such extensive reforms today. On the contrary, the oil and gas markets have brought in so much money in recent years that this could be used to strengthen the Russian economy significantly. But alas, the scale of the slump shows that the economy is still weak. The period of the so-called Putin prosperity has been replaced by one of even deeper crisis.
Can the Russian government headed by Vladimir Putin carry out an effective anti-crisis policy? Economists are discussing this all the time, but perhaps it is only now that the logic of the government’s actions has become clear. It is clear what Putin is afraid of, and what he is prepared to do to save the country’s economy.
The ruble doesn’t obey the government
Many Russian experts and political figures advise Putin to pump money into the economy more energetically. For example, to reduce the Central Bank’s discount rate and thus expand the credit facilities of commercial banks. The logic of these proposals is quite clear. The Central Bank, by giving out money left right and centre, will compensate for the lack of funds in the economy caused by the drastic reduction in the petrodollar revenue. By creating money, the Russian authorities will create a real demand for goods. Supply will inevitably react to this demand. Enterprises will begin to expand their production that was closed down after the crisis began. And as a result, the Russian economy will begin to emerge from the crisis.
Supporters of this approach point to foreign experience. They say that in the United States and in European countries, the state spends large sums supporting the economy. Accordingly, Russia should also take this path.
But Putin does not want to do so. Although the Central Bank is gradually lowering the bank rate, the government is avoiding a sharp increase in money supply. Many are surprised by this. Putin is known as a populist politician. During the period of prosperity he regularly increased the incomes of the public sector and pensioners. In the 00s real incomes have grown faster than GDP, and GDP itself increased significantly (6-8% per year on average). Why is the Russian Prime Minster now refusing to pursue a policy of pumping cheap money into the economy?
No faith in the ruble
The problem is that in Russia, even after a decade of economic growth, there is no faith in the national currency, the ruble. In the autumn of 2008, faced with the growing crisis, banks and individuals began actively offloading rubles and investing in dollars and euros, which meant that the Central Bank was forced to resort to a slow devaluation of the national currency. And this devaluation in its turn provoked a further flight from the ruble.
By the spring there had been some growth in international oil prices which stabilised the Russian currency. But in Russia everyone understands full well that at any moment organizations and individuals may once more be forced by unpropitious circumstances to start offloading their rubles.
What might trigger a new round of panic buying of dollars and euros? It might happen if oil prices fall. For this will mean another reduction in the flow of foreign currency into Russia. Everyone realizes that if Russia did not have oil and gas, the American dollar would be as rare in Russia as the Australian kangaroo.
Alternatively, it might happen if the Central Bank starts pumping money into the economy. Russians are used to cataclysms and will immediately fear devaluation. To put it simply, everyone will start buying currency simply because they will expect others to do the same. They will understand that when everyone invests in foreign currency, the ruble falls, and so they should also hurry to buy dollars and euros to avoid being caught out.
Thus, in Russia today, the policy of actively pumping money into the economy is more likely to have different consequences than in countries with a strong national currency. Instead of stimulating the work of the economy, this money will descend on the currency market and undermine the ruble’s position. And if the ruble falls, banks will stop lending money to industry, construction and retail, as it will be much easier for them to make money from currency speculation.
Putin is very afraid of this. He is far more afraid of a disobedient ruble than a disobedient opposition. For the political opposition in Russia does not yet have the support of the people, while Russians like their savings very much, and will not keep them in rubles, even if the Russian national leader Vladimir Putin would like them to.
The corruption effect
A similar scenario applies to the possibility of using budget funds to prop up the economy. Recent months have shown that the government actively spends money on pursuing social policy, ignoring major state investments, which some experts and politicians think could create a demand for goods and stimulate the economy.
The fact is that every ruble spent on paying public sector salaries, or pensions to the elderly, probably does create a demand: for groceries, clothes and medicine. But a ruble spent on state investments will probably not reach its goal and will go to the currency market, where it will be spent on buying dollars or euros. This can be explained by the high level of Russian corruption. The government is incapable of controlling how the money it allocates is spent. Even if after some time it really is spent on building roads or supporting industrial enterprises, in the short-term perspective banks will probably play with money on the currency market. And this will become a serious threat to the stability of the ruble.
So all in all, Vladimir Putin is just not in a position to pursue an anti-crisis policy. He can only hope that as the world economy emerges from the crisis demand for oil will rise, restoring the flow of petrodollars into Russia and strengthening the ruble. If this happens, the Russian economy will gradually recover.
But so far all Putin can do is order bankers to give loans to the economy, and not play the currency market. Who knows, Sberbank and VTB loans might just be able to give a bit of a boost to production.