Readers of Risk Watchdog will know of my long-held bearish outlook on Russia and I thought I’d take the opportunity to reassert my position seeing as Business Monitor International just revised down its 2009 Russian economic growth forecast to -4.0% (yes, that’s a minus sign). Without going into a 1,500 word expose on all things wrong with Russia, I thought it would be better to highlight three key indicators (other than oil and the rouble) which have helped to underpin my view.

1) Money Supply Growth:

Both M2 and M0 money supply growth has effectively fallen to zero in December, after recording double-digit year-on-year expansions for the previous 123 consecutive months. Tightening monetary conditions at a time when businesses are already slashing capital expenditures and contracting output to reflect a sharp decline in aggregate demand is hardly a positive sign, and indicates that a recession is all but unavoidable. Certainly, it rules out any potential for a recovery in 2009 driven by loosening monetary conditions.

Indeed, nominal declines in both M2 and M0 in the fourth quarter are reflective of wider systemic problems with the economy. For M2, it is suggestive of a crisis of confidence in the banking system, indicative of deposit outflows. As for M0, this has fallen due to a crisis of confidence in the rouble and the concomitant dollarisation of the economy as people pull out of their rouble holdings.

2) Interbank Markets:

Dollarisation will accentuate the significant challenges already facing the domestic credit markets by reducing the liquidity available within the banking system as well as the ability of the government and the central bank to control monetary conditions. Indeed, the seizure of the interbank markets is the second big indicator which underlines my negative outlook. We saw how the spike in interbank rates in the UK, US and eurozone back in the first half of 2008 helped to wreak havoc with the capital markets in each of those respective countries.

At least in the developed world though, the rates came back. In Russia, any interbank rate beyond the overnight tenure has remained at its record highs, since initially spiking in September (that’s five months and counting). Three-month and six-month prime rates are currently above 20% and anecdotal evidence suggests that these numbers are effectively meaningless anyway since Moscow banks are now only lending within tightly knit personal networks. Without liquidity in short-term money markets, the ability of corporates to efficiently manage cash flow has been severely hamstrung and there has been a subsequent increase in default risks. This in turn results in a vicious cycle where the tightening of credit markets is further accentuated and capital investments wound down.

3) Net Capital Flows:

The final factor to consider are net capital flows. Here, both the high foreign investor risk perception of Russia, as well as the global deleveraging process underpinning BMI’s bearish global outlook are clearly on display. In the fourth quarter, the net capital deficit totalled a record US$130.5bn, or roughly 10% of total gross domestic product in 2008. Certainly, Russia has experienced capital deficits in previous quarters, but this figure trumped the previous record by five fold.

Of course, these three factors (money supply, interbank markets and net capital flows) cannot be viewed in isolation and feed into each other as macroeconomic indicators. Ultimately, what they all signify is that the Russian economic downturn goes beyond just a demand slowdown tied to weaker commodities markets, but is rather indicative of a much greater problem of a capital shortage. Indeed, when capital shortage meets large external financing requirements, the outcome, especially for emerging markets is not just a recession but a full-blown economic and financial market crisis.

Tags: capital outflows, Capital Shortage, Economy, gdp growth, Interbank, Money Market, money supply, recession, Russia
Posted in: Emerging Europe, Financials, General
RSSFree email updates