Russian Economy in Distress - What Investors Need To Know
Russia has emerged as a political threat – from invading Georgia to stopping natural gas deliveries to the Ukraine and the rest of Eastern Europe. Russia is the world’s biggest producer of oil and gas. It has a seat on the U.N. Security Council and, of course, a nuclear arsenal.
However, now Russia’s economy is in despair and most analysts suggest it will take a long time to recover. Russia’s economy shrank by 9.5% in the first quarter, the worst performance in the G20 after Japan.
In fact, according to the Russian Economic Report No. 19, “the impacts on the real economy and the social sector on Russia were larger than anticipated.” Russia's real GDP in 2009 is likely to contract to about 7.9% in 2009. Unemployment could rise to 13% and poverty to 17.4% by year’s end.
The financial crisis has significantly worsened not only poverty, but also the entire income distribution in Russia. A deeper-than-expected drop in real GDP of 7.9% in 2009 is causing huge changes in the composition of wealth and the overall income distribution across the country. For example, per the report, “Russia’s middle-class, measured by household consumption, is likely to shrink – by about 10 percent – from 55.6 percent to 51.2 percent (a decline of 6.2 million people).”
Bank Troubles… Big Surprise
Russia’s banks are in trouble. They have been plagued by more and more overdue loans. The Russian economy is shrinking for the fist time in about 10 years. Over the last 12 months, around 30 banks have lost their licenses.
Reuters reported, “Alexander Turbanov, who heads the agency charged by the state with bailing out troubled banks, told a banking conference that his agency would likely take control of another 15-20 banks this year, in addition to those set to lose their licenses.”
Russian banks have been consolidating their reserves. But, reserves rules, which have been lowered of late, are set to snap back early in 2010. The central bank demonstrated that banks might need to move 500 billion rubles into extra provisions by that 2010 deadline, according to Reuters.
It is possible that regulators will extend the deadline.
Is Stability Coming?
In attempting to adjust for Russia’s first recession since 1998, the central bank has cut interest rates four times since April. Bloomberg reported, “Bank Rossii cut the refinancing rate to 11 percent from 11.5 percent and the repurchase rate charged on central bank loans to 10 percent from 10.5 percent effective July 13.”
The Moscow Times reported that banks need to be assured that there will soon be stability in Russia’s economy.
Nikolai Podlevskikh, head of the analytical department at Zerich Capital Management, told The Moscow Times, “Despite government measures, the economy is still suffering from monetary hunger, as money is being disbursed in slow mode and banks continue consolidating their reserves.”
However, there is some soothing news for the troubled banks. Russia’s finance minister, Alexei Kudrin, who typically lacks optimism, said in The Moscow Times the economy might grow slightly next year. “We expect – in a conservative, very cautious scenario – economic growth of about 1 percent in 2010.”
From BRIC to G8
Over the years, Russia gained its economic might with its oil and natural gas supplies.
It was a powerful emerging market, and was lumped in with the quickly growing economies of Brazil, India and China. BRIC exchange-traded funds popped up everywhere, and Russia’s investment markets soared.
From September 2003 up to the global economic crisis, Russia’s RTS index climbed 360%. And throughout these years, Russia has been buying up U.S. debt like crazy. It’s the fifth largest holder of U.S. Treasuries in the world.
These factors have catapulted Russia into a world power, and it now has a seat at the Group of Eight Summit.
But it’s no wonder, with all its economic problems, that Russia is flailing a little bit, and trying to throw its weight around at the Summit.
Welcome to Italy…
The 2009 G8 Summit was held July 8-10 in Italy.
Among those who appeared in Italy are Russian President Dmitri Medvedev and President Barack Obama. The two first had their own talks in Russia. The major topic between them was the Strategic Arms Reduction Treaty, which ends this year. But President Obama wants to address another issue as well.
Voice of America quoted Obama, who said, “I think that it's important even as we move forward with President Medvedev that Putin understands that the old Cold War approaches to U.S.-Russian relations are outdated.”
When the two finished discussions in Russia, they made their way to L’Aquila, Italy, for the G8 Summit. There, one of the topics was the dominance of the U.S. dollar, even though it wasn’t on the official agenda. With a U.S.-led recession and risk of U.S. inflation, many have begun to claim that it’s time for the dollar to be replaced as the global currency of choice.
Russia and China have been among those leading the discussion to replace the dollar.
Down With the Dollar!
President Medvedev said, “The dollar system or the system based on the dollar and euro have shown that they are flawed.”
Bloomberg reported, “While Medvedev said he sees ‘no alternative’ to the dollar or euro now, he repeated his proposal that ‘regional reserve currencies’ be developed and again questioned the wisdom of relying on the dollar.”
China has echoed this opinion, and is concerned for the safety of its investment in the dollar. China has made some steps to move away from the risky dollar. On Monday, China allowed a cross-border transaction to be conducted in yuan, reported The Wall Street Journal. This was the first yuan transaction of that kind.
India has now sided with Russia and China in declaring that it may be time to replace the dollar. According to Bloomberg, Suresh Tendulkar, one of Indian Prime Minister Manmohan Singh’s economic advisors, said, “The major part of Indian reserves is in dollars – that is something that’s a problem for us.”
Reuters reported that, while the dollar was discussed, nothing very definitive about it should come out of this year’s G8 Summit.
So is Russia’s dollar rhetoric falling on deaf ears? Not if the G5 can help it…
The New G5
The Wall Street Journal reported, “The so-called Group of Five, making their fifth straight appearance at the annual summit, albeit as invited guests, [discussed] climate change, development aid, global economic growth and international trade with their Group of Eight counterparts – all topics touched on by G-8 leaders [who met] on their own Wednesday.”
The new G5, the Group of Five, can’t be ignored anymore, and that means their voice about the U.S. dollar is certainly going to be heard.
Pierre Briancon, an editor with BreakingViews.com on CNNMoney, wrote, “The G8 leaders should do more. To start, they might listen to the leaders from China, India, Brazil, Mexico and South Africa, who [met] next door. Following a new tradition, the rich world summit has de facto widened to include that up-and-coming G5. Obama, Medvedev, Merkel, Brown and their colleagues can learn that their problems won't be solved unless the rest of the world’s are too.”
What hope does the G5 have of making a quick change a new world currency? Not much…
Bloomberg reported, “Brazil’s President Luiz Inacio Lula da Silva wants the biggest developing nations to use their own currencies in settling trade accounts, India’s Foreign Secretary Shivshankar Menon told reporters yesterday.”
But Menon also said that the process of transitioning to a new reserve currency is a long-term goal for the G5.
Where’s the Dollar Headed?
Harinder Singh, currency expert and editor of Currency Profits Trader, an exclusive service of the Taipan Publishing Group, told his readers, “Before the G8 meeting, the issue of the world reserve currency was put on the G8 agenda by China; and now during the meeting it has been taken off.”
The reason given is that concern is “long term” but not an immediate issue, said Harinder.
“Even during Obama’s visit, Russia indicated no concern for the U.S. dollar, but ‘desired’ more than one world reserve currency on a longer-term basis,” he said.
So what has that done to the greenback’s value?
Harinder said:
That helped long U.S. dollar or short euro positions… along with the benefit from the bearish outlook for the world economy, which can encourage investments to move to “perceived” safer havens like the U.S. dollar and Japanese yen. That bearish outlook for the world economy has hurt commodities, which in turn are impacting equities. And it seems the old relation of equities weakness benefiting the U.S. dollar in the wake of risk aversion is still intact.
For now, at least. Dollar-denominated assets – including commodities – can fluctuate relative to the dollar. But it’s a two-way street.
“Any weakness in … commodities could further hurt equities and benefit the U.S. dollar,” said Harinder.
The Commodity Question
According to an article in The Economist, “Over the past ten years, under Vladimir Putin’s leadership, Russia has become more nationalistic, corrupt and corporatist. Its economy, although much bigger than a decade ago, is even more dependent on oil and gas, an industry now controlled by a small group of kleptocratic courtiers and former spies.”
In fact, most European Union countries are dependent on Gazprom for natural gas. But now those countries are hopeful for alternatives.
According to BBC News, Nigeria, Niger and Algeria have signed an agreement to build a multi-billion dollar gas pipeline to take Nigerian gas across the Sahara to the Mediterranean. “The giant project, which will cost an estimated $13bn, aims to deliver up to 30 billion cubic meters of gas per year for the European market.”
The Problem of Over-reliance
The report continues, “European Union nations now hope it will enable them to diversify their gas supplies – and most pressingly, reduce their reliance upon Russian gas… European Union states are keen to reduce their reliance upon Russian gas because of Gazprom's numerous price disputes in recent years with Ukraine.”
In the past Gazprom has temporarily cut supplies to Ukraine, “which in turn has reduced Russian gas deliveries to western Europe that are piped through Russia’s neighbor.”
Oil and international investment expert, Chris DeHaemer, who spearheads Crisis Trader, has been following Gazprom for years. “Don’t count Russia out on this one just yet,” says DeHaemer. “Gazprom signed a separate $2.5 billion deal with Nigeria’s state-owned gas firm NNPC to build new gas refineries, pipelines and power stations in Nigeria.”
Conflicting Signals
These conflicting signals of poor economic data and big energy deals could confuse some investors.
Russia’s story is evolving, and neither view can be ignored, but it’s important to look at specific timeframes for each philosophy.
The poor economic data is going to be the main investment factor in the near-term.
That means buy-and-hold investors looking at specific companies or ETFs will need to be extremely diligent in their homework, and even then, they can see red. But traders might see some short-side opportunities.
The long-term bullish scenario includes the commodity-based argument. And Russia’s vast natural resources will certainly come into play as it economy improves with the global recovery.
In other words, investors in Russia should see more downside in the near term, but great potential for growth in the long term.
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written by Armando Monteiro,
July 28, 2009
