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Russia and the Global Economic Crisis – The Causes and Coping With The Crisis

Russia and the Global Economic Crisis – Causes and Coping With The Crisis

Abstract
Nearly after 20 years and the fall of the Soviet Union, the shape of Russia, its principal successor state, remains unsolved. As well as Russia’s relationship with the West. Though the intense U.S.-Soviet competition of the Cold War is over, Russia has not become the permanent partner that many on the outside hoped would emerge after the Cold War’s end. The United States and Europe have taken issue with many elements of Russia’s domestic path, regional and international posture, including its democratic exercise, energy-related activities in Europe, pose on Iran’s nuclear program, and war in the 2008 due to the Russia-Georgia conflict. A principal factor enabling this assertiveness in recent years has been Russia’s strong economic growth. Since 2008, though, Russia, like many other countries, has experienced a deep economic crisis. The main problem here is how the crisis affected Russia and how the Moscow interfered to help Russia stabilize and stand against this crisis and overcome it.

Introduction
Economics is the study of how people choose to use resources. The time and talent people have available, the land, buildings, equipment, and other tools on hand, and the knowledge of how to combine them to create useful products and services are all main type of resources. In short, economics includes the study of labor, land, and investments, of money, income, and production, and of taxes and government expenditures (Macroeconomics). Economists try to measure and to learn how the well-being may rise over time, and to evaluate the well-being of the rich and the poor. Although the practices of individuals are important, economics also study the group behavior of businesses and industries, governments and countries, and the globe as a whole. Microeconomics starts by thinking about how individuals make decisions. Macroeconomics considers aggregate outcomes. The two points of view are essential in understanding most economic phenomena (1). As in any system, there are booming and trough periods, booming happen due to growth and trough due to economic problems, long term troughs may happen due to a financial crisis. The term financial crisis is commonly known to a variety of situations in which some financial institutions or belongings suddenly lose a large part of their money value. In the beginning of the 20th centuries, many financial crises were associated with banking fears, and many recessions coincided with these fears. Other situations that are often called financial crises include stock market collapses and the bursting of other financial bubbles and currency crises. Financial crises directly result in a loss of paper value; they do not directly result in changes in the real economy unless a recession or depression follows (2).

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Russia and the Global Economic Crisis – Causes and Coping With The Crisis

Different countries are affected by any international economic crisis, but those few unlucky ones face a very painful dimension of it. In the current crisis, Russia is confronting virtually all the negatives at once, steeply declining export income from energy and metals, over-leveraged corporate balance sheets and a chorus of bailout appeals, a credit crunch and banking failures, a bursting real-estate bubble and mortgage defaults, speeding capital flight, and unavoidable pressures for devaluation (3). In this report, we discuss the 3 main elements that led to an economic crisis in Russia: it begins with a financial crisis Russian banks and firms hit, a steep decrease in the price of Russia’s principal export commodities, and a recession marked by low domestic demand. We then talk about the crisis’s implications for Russia’s political dynamics and foreign policy. All of this makes Russia less able to compete with the international order and U.S. leadership in particular. Through this paper, we discuss how the government interfered to stabilize and overcome this bad situation. In addition, the paper argues for leaving open the possibility of Russian membership in the World Trade Organization and helping Russia resolve obstacles to its development, including quarrel with Georgia, if Moscow makes progress on relevant reforms. Finally, advocate U.S. and European Union efforts to strengthen domination in the broken soviet union countries in order to reduce their tendency to Russian pressure and discourage Russia from pursuing a dominant regional role (4).

The Reasons and Aftermath
The end to the fall of 2008, by September, the Russian Trading System (RTS) stock index had submerged almost 54 %, making it one of the worst markets performing in the world. On 16th September 2008, the Moscow Interbank Currency Exchange (MICEX), trading in Russia’s most liquid stock exchange and the dollar-denominated RTS was suspended and as well as the next 2 days. 6th October 2008, the Russian stock market faced a quick drop of 18% in a single day. Bank un-success worsened the stock market collapse (5). On September the 15th, KIT Finance, a large financial institution, failed to pay off its debt. Also consequently, the price of oil also faced big problems for Russia. On September the 15th, the oil price dropped below $100 for the first time in seven months. On October 11st, it fell to $78 and on December 21st of 2008, the oil was sold at $33.87/bbl, less than 1/4 the peak price reached four months earlier. Prices did not rise when 2009 started. However, after initially passing over the $48, prices declined by mid-February to below $34. Russia’s other major export, metals, experienced a similar price decline as in figure 1.

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Russia and the Global Economic Crisis – Causes and Coping With The Crisis

Figure 1: Oil, metal, and stock market prices during the 2008–09 crisis. Source: IMF, World Economic Outlook, October 2009. Although Russia’s economic crisis is part of the global recession, its beginning and sequence are different. Russia’s economy began flattering even before the worldwide meltdown of October 2008 set off by the collapse of the U.S. housing bubble. In spite of the claims from Russian responsible and analysts that Russia’s emerging, commodity-dependent economy was decoupled from volatility in global markets, following August 2008 “The Russian invasion of Georgia”; Putin, Russia’s Prime Minister heavy-handed threats against companies over back taxes, triggered big escape of foreign investment from Russia in the second half of 2008, just as global commodity prices were starting to decline. As a result, the Russian stock market crashed; the benchmark RTS index lost almost 90 % of its peak value in May 2008 over the continuous 10 months before rising again (as of early 2010 it was still a third below its peak). Moreover, the heavy dependence of Russia on the export of energy & other commodities became at risk when commodity prices dropped as a result of reduced worldwide demand. The Russian crisis main reason has three components: 1- A serious financial crisis affecting banks and several heavily indebted enterprises, 2- A world wide commodity price crunch that 4|Page

Russia and the Global Economic Crisis – Causes and Coping With The Crisis

slashed prices for Russia’s major exports, 3- A recession described by sharply lowered domestic demand. That decline contributed to a fall in Russia serious even by the standards of the global “Great Recession.” The Russian economy, which had been rising by an average of more than 7 % a year for the previous decade, began falling down; in 2008, output rose by only 2.1%, before falling by 7.9% in 2009. Even as month to month gross domestic product (GDP) began growing again in the third quarter of 2009 on the back of higher commodity prices, investment and consumer expenditure have not recovered. Credit is extremely tight, contributing to sharply lower domestic aggregate demand. And the recovery is likely to be protracted. The crisis and concerns about property rights have increasingly scared off foreign investors; foreign direct investment (FDI) into Russia fell by 45% in the first half of 2009 alone. Moscow also spent $200 billion from the state’s Reserve Fund to prop up the ruble (4). Preventing a run on the currency avoided fear among holders of bank deposits, but moreover fortified the country’s uncompetitive industrial model while enriching privileged banks and currency traders. These steps along with the efforts to soothe the effects of rising unemployment mean that after running a budget deficit of 6.3% of GDP in 2009, yearly deficits will continue until at least 2012. Russia’s heal remains at risk because of its weak banking system, large private sector debt, and continuous unemployment that threaten to keep tax revenue low even as spending on social services rises (4). The impact of the economic crisis on Russian foreign policy is important, since Russia’s crisis-driven foreign policy will shape the chances available for dealing with Russia to western policymakers. At a minimum, the crisis has forced Moscow to reevaluate its self-realization as a rapidly rising power, particularly as other large developing economies (including Russia’s supposed BRIC partners: Brazil, India, and China) have faced the crisis better. The crisis forced officials by exposing structural deficiencies in the Russian economy and highlighting the limits of its post 1998 revival, to pull back from the claims about Russia’s approaching return to great power status and focus attention on problems closer to home. Russian industries were forced to meet the local demand because of their inability to compete, which has plummeted in the course of the crisis. Yet because of their inability to modernize on their own, for the high technology, the Russian companies have increasingly partner with Europe (especially Germany, France, and Italy). In the context of the crisis and President Barack Obama’s promise to return the relations with Moscow, Russia has also appeared more flowering to political planning from the United States and the European Union (EU), like the penalties against Iran, strategic arms cuts, and the war in Afghanistan. The relationship of Russia with its neighbors have gone through many complications, in that Moscow appears less able to provide investment and subsidies as a means of maintaining political influence in the former Soviet Union, creating a parallel opportunity for the West to promote political and economic reform in the other post-Soviet countries (4). 5|Page

Russia and the Global Economic Crisis – Causes and Coping With The Crisis

Not only was the 8 % Russian GDP contraction for 2009 the largest among the G-20 countries but also the change in the growth rate between 2008 & 2009 by far exceeded that in other G-20 members. The impact of the economic crisis on the Russian economy was the strongest relative to any other G-20 economy.

Figure 2: GDP growth in selected G-20 countries, 2008 and 2009. Source: IMF, World Economic Outlook, October 2009. Figure 2 plots GDP in the G-20 countries before and during the crisis (2008 & 2009) based on the International Monetary Fund’s October 2009 data. It shows that all countries performed badly in 2009 than in 2008. However, the difference was the biggest for Russia more than 13 % drop (5). The main suspect is the dramatic fall in oil prices from the peak of $140 per barrel in summer 2008 to the trough of below $40 per barrel just half a year later. There are two approaches to calibrate this effect on pre-crisis data. One can estimate the total rent that Russia generates in oil and gas and then determine the direct effect of the oil price changes. Or one can estimate the co-variation of Russian GDP and oil price (controlling for other factors) in recent years (5).

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Russia and the Global Economic Crisis – Causes and Coping With The Crisis

Government Intervention - Overcoming the Crisis
The Government adopted many Economical and non-Economical ideas to help Russia overcome the crisis, we will mainly focus in this report on the economical approaches and specially from the macroeconomic prespictive that was used to support Russia rise again and regain its previous success in the global market.

1- The Crisis and Foreign Policy
The Russian economic crisis has impacted obviously the relation between Russia and its neighbors. Recent history suggests that Moscow’s international behavior is more assertive when the economy is booming, and more accommodating in recessions. The 1979 invasion of Afghanistan similar to what happened in the 2008 during the invasion of Georgia occurred in the middle of booms and recorded high oil prices. In opposite, Moscow’s withdrawal from Eastern Europe in the late 1980s occurred after oil prices sank. This is assumed to happen again as a pattern during the next boom as well, unless the west encouraged Russia to stop being imprisoned in its border and start dealing with the Europe and the west. In light of Russia’s structural economic problems, President Medvedev has argued that Russia’s current foreign policy should open the borders and should seek to promote modernization by opening the country to foreign capital, technology, and ideas. The importance of the foreign policy as a tool for development has been increasingly mentioned during the crisis, for the moment to acknowledge that it cannot afford an ideologically driven foreign policy. This observation appears based in part on the recognition that the crisis has undermined some of the principal levers Russia has used to exert influence abroad in recent years: energy, the military and financial assistance to neighbors. The crisis has largely discredited the notion, championed by Putin of Russia as an energy superpower (5). Due to decreasing energy prices and a steep decline in its market capitalization, Gazprom has less money available for foreign acquisitions or the construction of new pipelines, weakening its push for greater market power in Europe. Meanwhile, completion of a new oil pipeline to China required a $25 billion loan from the Chinese government to Rosneft and oil pipeline operator Transneft. The loan allowed China to lock in guaranteed supplies for twenty-five years at a net price that will average only about $20/bbl. The deal underscores both Russia’s need for foreign capital and the increasing power disparity between Russia and China (5). The decreased European demand and lack of capital for investment have shared in to a serious decline in Russian gas output (production for 2009 is estimated to have fallen by at least 10%). The shortage of investment capital has also delayed plans to open up new production sites. These problems obviously call into questioning Russia’s ability to meet projected long-term 7|Page

Russia and the Global Economic Crisis – Causes and Coping With The Crisis

demand in Europe because the short-run fall in demand has now been damaged the Russian influence in Central Asia, where Gazprom has had to unilaterally reduce its purchase of gas from Turkmenistan, even as a new oil pipeline from Central Asia to China opened in December 2009, ending Russia’s ability to control the Central Asian countries’ access toward energy markets (4).

2-Foreign investment
The fall has made Russia a much less attractive destination for FDI, which has declined steeply, even as short-term capital flows and the stock market have risen. When commodity prices were skyrocketing, foreign investors were largely willing to examine Russia’s weak investor protection and barriers to foreign ownership, in the addition of the existence of the state monopolies. With the Reserve Fund established to support the economy in time of crisis and to sequester the flow of petrodollars into the country over the past 10 years to prevent inflation set to run out by the end of 2010, Russia will need to turn to international capital markets to raise money and allow the investment capital it needs to restore growth. Given the sharp decrease in foreign borrowing and investment along with the decrease in tax incomes from energy sales, Russia needs to attract important foreign investment to refresh its economy and renovate its aging infrastructure, and to implement Medvedev’s ambitious reform program (4). Russia’s need to continue its foreign borrowing (on the order of $17.8 billion in 2010) represents a great chance to enhance the economic cross dependence with the West. Western governments and companies should use Russia’s need for foreign investment as a lever to press for bigger economic reform, particularly a greater commitment to transparency and the rule of law, as well as reduced tension over energy. The mutual interest in deepening economic ties provides an opportunity to address the structural and institutional barriers to cooperation (4). Therefore the EU should design a way to encourage legal and institutional convergence, may be on the basis of its acquis-communautaire (similar to Europe’s outreach to Turkey). The EU would encourage Moscow to bring its standards and procedures on track with European norms. This way should focus on minimizing the obstacles to foreign investment such as Russian legal and judicial reform and encouraging the free launch of capital. In the Long run, these efforts could lay a foundation for discussions on creating a free-trade zone called the EU-Russia. They should be followed by a push to make it easier for Russians to move and live in the EU. At the same time, Europe’s troubles have encouraged companies like including Opel and Mistral to be more open to Russian investment, and the EU should lower the legal and regulatory barriers to Russian companies which want to buy stakes in European companies. 8|Page

Russia and the Global Economic Crisis – Causes and Coping With The Crisis

3-Tax and state budget policy
On November the 20th, a government package of tax reforms was announced by Vladimir Putin and that the corporate profit tax rate (24% in 2008) is to be reduced to 20%. Profit tax base will decrease for those companies investing in the capital assets as the immediately recoverable depreciation allowance is raised from 10% to be 30% of the asset principle cost. There will be no change in VAT rates (maximum 18%) in 2009, however the government considered changing VAT accrual rules in favor of the taxpayers. Ministry of finance which resisted tax breaks until September concurred with Putin 's proposal as it was expected that they will save the businesses around 500 billion robles annually (6). In November, The ministry of finance announced that the state has accepted the fact of a long term drop in oil prices and that the current state budget plans will stay unchanged if the oil prices stayed constant on 50 $/bbl. Even with tax breaks effective, it was estimated that the 2009 state budget will break even or in worst case bear no more than 1% deficit. The deficit will be covered by Stabilization Fund, without resorting to borrowing. In addition, in December the government eliminated import tariffs on industrial equipment imported by metallurgy, construction, forestry and textile industry, at the same time enforcing increased tariffs on imported cars. On 15 April 2009, Finance Minister Alexei Kudrin said the federal budget will show a deficit of 7.4% of GDP in 2009. In comparison, the US expects a budget deficit of 13.5% of GDP, Britain 9.3%, and France 6.6%. According to Kudrin forecast for the 2010 deficit is 5%. Kudrin warned that Russia must cut down its budget deficit before 2011. "Our vulnerability to the crisis is higher than that of the countries with more diversified economies. This is why 2009 should be a unique year. We must not have a comparable budget deficit in subsequent years. We must work to reduce it to 3% in 2011," he said. On 25 th of May 2009, President Dmitry Medvedev said the budget deficit in 2009 will be "at least 7%" of GDP (6).

4-International cooperation
Russia has agreed to co-operate its finance in the International Monetary Fund emergency loans to other states, initially contributing one billion US dollar. Earlier, in October, Russian ambassador announces to Iceland that Iceland will receive a €4 billion loan from Russia to mitigate the 2008-2011 Icelandic financial crises. The loan will be given across three or four years, and the interest rates will be 30 to 50 points above LIBOR (6).

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Russia and the Global Economic Crisis – Causes and Coping With The Crisis

Conclusion
Russia is still healing to what remains a persistent and serious economic crisis. As in the past, Russia’s recovery will depend to a great degree on the movement of global oil prices. Despite a rise in oil prices from their low of about $35/bbl in winter 2009 to roughly $75–$80/bbl in early 2010, Russia’s economy remains imprisoned, neither enjoying the windfall profits of 2007 and 2008, nor suffering the barring of late 2008 and early 2009. Such stability is beneficial; it allows Moscow to plan for the future. Although Russia appears to have avoided a large-scale social or political crisis for the time being, the failure to push through reforms means that Russia’s recovery is likely to be slower and less complete than that of other major economies, which seemed to be inching toward recovery by the start of 2010. As Russia fights to get its economy back on track, its capacity for foreign adventures will likely remain small for a while. Also Medvedev’s focus on improving Russia’s competitiveness provides an opportunity for curious, economically focused engagement by the West. The United States and its allies have a chance to focus on solid steps that support Russia’s recovery and adhesion to international economic norms. (4). So as a summary: The newborn cure: After its 2009 contraction, the Russian economy is on its way toward recovery, all panelists agreed. This recovery is led by:     Rising oil prices, which have risen from $34/bbl to $80/bbl. Stronger Russian demand for domestic products. The flexibility in the exchange rate helped Russia against the drop of oil price volatility. The moderation of increasing unemployment by an increase in part-time employment and involuntary vacations as a temporary adjustment.

Russia still faces significant barriers to full recovery, however:    Industrial production is still in delay. Despite the easing of monetary conditions, there has not been significant increase in lending. Unemployment also remains high, especially among young urban males.

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Russia and the Global Economic Crisis – Causes and Coping With The Crisis

Prospects for Reform and Growth According to the World Bank 2010–2011 economic outlook, it is suggested that Russia will continue to see positive economic indicators (6):    Russia’s GDP is subject to grow at 3.5% in 2011, which is 3%age points higher than the global average. Russia’s consolidated government balance is likely to return to a neutral balance in 2011, from a previous negative 3% balance. From 2010 to 2011, the current Russia’s account volume is projected to fall by $13 billion, while the capital account would increase by $20 billion in 2012. Growth will consumption. be supervised mainly by the recovery of domestic

 

It is suggested that Russia will see either medium growth, at 3-4% per year, or high growth of 6%. a similar projection, based on possible political

Anders Aslund offered scenarios (5) (6): 

Following the path set out by Putin, Russia could see a growth in authoritarianism, state capitalism, and protectionism, leading to a 4% growth. Following the goals of political and economic liberalization designed out by Medvedev, Russia could see a 6.5% growth.



Moving Forward All panelists agreed that key concerns for the Russian economy going forward include high levels of corruption, highly inefficient state corporations, and future problems with infrastructure and human capital skills. They also suggested ways that a better investment climate and strengthening the financial sector will aid Russia’s long-term recovery. Bogetic concluded that “the crisis has provided an opportunity for reform and impetus to rethink and accelerate public sector, financial sector, and diversification reforms.”

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Acronyms
BRIC bbl CSTO EU FDI GDP G20 IMF NATO START-1 WTO MICEX RTS Brazil, Russia, India, and China barrel Collective Security Treaty Organization European Union Foreign direct investment Gross domestic product Group of Twenty International Monetary Fund North Atlantic Treaty Organization 1st Strategic Arms Reduction Treaty World Trade Organization Moscow Interbank Currency Exchange The Russian Trading System

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Russia and the Global Economic Crisis – Causes and Coping With The Crisis

Bibliography
1. Vanderbilt. [Online] http://www.vanderbilt.edu/AEA/. 2. Wikipedia. [Online] http://en.wikipedia.org/wiki/Financial_crisis. 3. Stephen Sestanovich, George F. Kennan Senior Fellow for Russian and Eurasian Studies. [Online] http://www.cfr.org/economic-development/russia-global-economic-crisis/p17844. 4. Mankoff, Jeffrey. The Russian Economic Crisis. s.l. : Council Special Report No. 53, April 2010. 5. Anders Aslund, Sergei Guriev and Andrew Kuchins. Russia After The Global Economic Crisis. s.l. : Petrson Institute for Internation Economics. 6. Wikipedia. Russian_financial_crisis. [Online] http://en.wikipedia.org/wiki/2008– 2009_Russian_financial_crisis.

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Bibliography: 1. Vanderbilt. [Online] http://www.vanderbilt.edu/AEA/. 2. Wikipedia. [Online] http://en.wikipedia.org/wiki/Financial_crisis. 3. Stephen Sestanovich, George F. Kennan Senior Fellow for Russian and Eurasian Studies. [Online] http://www.cfr.org/economic-development/russia-global-economic-crisis/p17844. 4. Mankoff, Jeffrey. The Russian Economic Crisis. s.l. : Council Special Report No. 53, April 2010. 5. Anders Aslund, Sergei Guriev and Andrew Kuchins. Russia After The Global Economic Crisis. s.l. : Petrson Institute for Internation Economics. 6. Wikipedia. Russian_financial_crisis. [Online] http://en.wikipedia.org/wiki/2008– 2009_Russian_financial_crisis. 13 | P a g e