Injections Prevent Crisis for Now, but Russians Worry About Long-Term Financial Future

Sources: Russia Profile Weekly Experts Panel: Immunizing Russia from U.S. Economic Contagion; Business Week, Russia Couldn't Escape Gravity; RTT News, IMF Slashes Russian Growth Forecasts; Moscow Times, Economic Aide Sees Russia at the Top; Moscow Times, Moody's Downgrades Banks

After the two-day suspension of trading on the Russian stock market last week, the government’s massive injection of money into the market averted a major crisis in the short term. When the market re-opened, in fact, buyers moved in so quickly that the market had to close again. The government considers this move not a bailout but an investment, as stocks are expected to rise significantly in the next several years. Either way, it remains to be seen how effective this strategy will be in the long term.

Medvedev and the rest of the Russian government blame Russian economic troubles principally on the U.S. government’s economic policies and the resulting financial crisis in this country. Since speculative money from foreign investors makes up nearly 70% of the Russian stock market, and hedge funds were forced to quickly sell Russian assets to cover huge losses in the U.S. subprime mortgage market, it is easy to see a connection between the financial climate in the two countries. Though the Russian economy at first seemed insulated from global troubles, it now appears that this is not the case, with an obvious tie between the AIG bailout and the Russian stock market crash.

However, there are other reasons for Russia to be having a difficult year that do not depend on U.S. successes or failures. Analysts have long warned that Russia’s dependence on oil and gas revenues would eventually become dangerous, and it seems that they were right, as a significant drop in oil prices is clearly responsible for a large part of slowing growth. The Georgia conflict is another important factor, with about 30% of losses on the RTS index occurring after hostilities began, and $30 billion in investor pullouts in six weeks following the conflict.

The Russian government has reacted by trying to reduce the importance of foreign investors in its markets and encourage long-term domestic investments, including investments of the National Wealth Fund in Russian markets. The liquidity injections are part of this plan, as is a change in tax structure that makes stock and mutual fund earnings tax-free for private Russian citizens after one year. The government hopes that this will encourage Russians to invest in their own economy and loosen dependence on volatile Western markets.

Aside from the stock market, capital outflows and troubles in the banking system are major issues that need to be addressed if Russia is to continue on a trend of long-term growth. In a speech on Thursday, economic aide Arkady Dvorkovich espoused high hopes for Moscow as a possible financial center and Russia as a world financial leader, but also noted drastic changes in the way the banking system operates worldwide. Russia, like the U.S., has been forced to think about bailouts, starting with Svyaz Bank on Tuesday. There is also a possibility that the government will create more state-owned banks, on the theory that they are less vulnerable.

Though Russians are looking to the future and hoping that a world economic realignment would be beneficial, two international indicators were cautious this week in assessing the Russian situation. Moody’s Investor Service on Friday issued a report that rated the banking system overall rather poorly based on failure to apply best practices, failure to obtain more liquid assets and curb expansion of lending, and dependence on the interbank market. The IMF also reduced its 2008 growth forecast for Russia from 7.7 to 7.1% and for 2009 from 7.3% to 6 or 6.5%. The IMF does, however, still expect strong growth long-term as long as appropriate policy responses materialize.

Questions:
1) Do you think Russia has the potential to become a major world financial leader in the next five to ten years, and the ruble one of the principle reserve currencies?
2) Is the government right to blame U.S. policies for the recent downturn, or are internal problems such as corruption and dependence on oil exports to blame?