Putin’s Reality Check

realitycheck102408.jpgIt was another rough day for Russian markets, as the RTS slumped 14 percent to 549.43 and the Micex down to to 513.62, which is the tenth consecutive weekly decline. Our devaluation prediction from Sunday did not pan out, but it certainly feels close. Anders Aslund explains why in the St. Petersburg Times:

Putin is correct when he claims “that our economy is rather well prepared for lengthy external shocks.” But that is not enough. Thanks to Finance Minister Alexei Kudrin’s extraordinary steadfastness, Russia has maintained a large budget surplus and held huge reserves at the outset of this crisis. But $70 billion of the reserves have already fled the country and more will follow. A crucial shortfall is that the government exploited the 1998 financial crisis to establish a dominance over the banking system by strengthening the position of five state banks, which still hold 45 percent of Russia’s banking assets. The problem with state banks is that they are inefficient. Therefore, the country suffers from very poor financial intermediation. Putin seems set to aggravate this problem.

The first large state support went to big state banks, which acted in their own interests rather than in the national interest. The money was not passed on to other banks. Businesspeople and newspapers tell stories about a number of “red lists” of favored businesspeople who are supposed to get certain amounts of money from the state because they have the right connections.So far, everything suggests that Putin is intent on using this financial crisis to carry out a huge renationalization program. Bad cases from Britain and the United States are certainly helpful for him. To his credit, Alexander Shokhin, chairman of the Union of Industrialists and Entrepreneurs, has sharply criticized the state-oriented, ineffective government support.Yet, I doubt that Putin can repeat the large bank nationalization of 1998 under then-Central Bank Chairman Viktor Gerashchenko. The amounts needed to prop up the economy and recapitalize the banks are truly monumental. Russia’s stock market losses have reached $1 trillion, while the stabilization fund is only $180 billion. That money will be too badly needed to be used for harmful renationalization.But here is another way of trying to solve the crisis. It is called liberal market reform. As Russia’s veteran reformers Yegor Gaidar and Yevgeny Yasin long have explained, low oil prices are good for reform. The same is true of financial crises.Russia’s economic problems are so severe that the country cannot survive the crisis without profound structural reforms.

A man walks past a currency exchange point in Moscow on October 24, 2008. Both of Russia’s main stock markets plummeted more than 13 percent on October 24 prompting the government to suspend trading on them until October 28, the exchanges said. (AFP/Getty Images)