beyondbrics

By Timothy Ash, head of emerging markets research, Royal Bank of Scotland

The global financial crisis has stress tested all economies, and some, e.g. Brazil, Poland and Turkey, have come out relatively well, proving their durability and reinforcing the view that emerging market nations are in many respects in better economic shape than their G7 counterparts.

However, one EM economy that has underperformed through the crisis has been Russia. Real GDP declined by 7.9 per cent in 2009, which marks it out against its BRIC peers; China posted 10 per cent plus growth, India over 7 per cent and even Brazil just about managed to achieve positive growth.

Russia bulls claim the country is now shrugging off the crisis and recovering fast. I struggle with this rose-tinted view: first quarter 2010 numbers are weak and the country needs fundamental reforms if it is to fulfill its potential.

Russia’s disappointing performance comes despite its stellar sovereign credit position, the fact that oil prices averaged over US$60 a barrel in 2009 and the government’s aggressive counter-cyclical fiscal policy which saw budget spending rise by around one-third.

Now the Russia bulls would argue that Russia was just hit by the perfect storm in 2009: the Lehman debacle cut off financing for Russian banks/corporates dependent on short-term external financing; the market had been technically long on Russia and the unexpected speed of the correction proved the hammer blow. The bulls contend that growth indicators are now looking much more upbeat, and Russia will rebound quickly in 2010, posting growth of 5 per cent or more.

I have my doubts. First-quarter real GDP growth was anaemic at just 2.9 per cent, considering hugely beneficial base-period effects, a still huge fiscal stimulus (budget spending was up by 26 per cent YOY in Q1 2010) and the fact that oil prices still averaged over US$80 a barrel.

In my view, the global crisis has laid bare deep-seated structural problems in Russia that policy makers need to address.

First, the past decade has seen little real diversification. Around 80 per cent of exports are commodity related, and around 45 per cent of budget revenues are derived from oil.

Second, remarkably, the federal budget now balances at an oil price of over US$90 a barrel, versus just US$25 in 2002, reflecting a huge budget spending spree undertaken over the past decade. An aging and declining population, carrying a pensions time-bomb, suggests great fiscal challenges to come.

Third, high NPLs in the banking sector have exposed the lack of meaningful reform over the past decade and the unseasoned nature of borrowers. Credit expansion will be slow-moving in future as lenders attach higher premiums for credit risk.

Finally, Russia has underperformed its peers in terms of attracting FDI: on a per-capita basis it is one-third the level of China’s, India’s or Brazil’s over the past decade. The business environment remains difficult (in the World Bank’s Doing Business Survey, Russia ranks 120 out of 183). Meanwhile, initiatives over the period 2003 to 2008 to ensure Russian national dominance in strategic sectors sent a signal that foreign direct investors were somewhat surplus to requirements.

What is encouraging is that Russia’s policy elite do finally seem to be getting the message. President Dmitry Medvedev and Vladimir Putin, the prime minister, have both recently underlined the need to do more to attract FDI; that was a focus of Medvedev’s trip to Silicon Valley this week.

In parallel, Russia seems to be rethinking its relations with the west, after Russia’s performance in the global crisis revealed it to be firmly linked now to economic developments in the US and EU. WTO membership is back on the agenda and Russia is playing a central part in the G20, with Russian government officials this week seeking not to exploit the problems in the eurozone, but instead seeking to talk up prospects for the euro. Discussion of the rouble as a reserve currency has quietly been put on the back burner.

Russia is commodity-rich, secular and market-driven. It would seem to be a natural ally of the US/West. After a brief freeze in relations with the west, Russia’s poor performance in the global crisis is forcing it to re-engage. This offers great hope for the future.