[SERI COLUMN]Russian economy showing vulnerability

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[SERI COLUMN]Russian economy showing vulnerability

The Russian economy, after years of strong growth on the back of high oil prices, slowed in the first half of this year.

A slew of economic indicators highlight trouble that shows no signs of abating soon; second quarter inflation rose to its highest rate since December 2002; unemployment is rising; and the Russian ruble is depreciating.

The real estate market also has cooled rapidly with prices and transaction falling conspicuously. Property developers have pulled back, freezing projects already in the works.

Economic growth in 2009 is forecast to fall below 6 percent. While that would likely exceed growth in many industrialized nations, it is far off the galloping rate that Russia has enjoyed in the past several years.

To be sure, Russia cannot escape the pinch of the global financial turmoil that first reared up in the U.S. subprime mortgage crisis.

It is notable that the Russian stock market has fallen the most among those of other emerging economies that have been affected by the recent global credit crunch woes.

The causes of the downward spiral lie with an underdeveloped economic structure and flight of foreign investors. The risk factors could make the Russian economy considerably more vulnerable to the global economic downturn than other countries.

The economy is narrowly based on natural resources, which account for 80 percent of Russia’s total exports. The energy industry alone represents more than 25 percent of the country’s GDP, and energy companies account for over 70 percent of Russia’s total market capitalization.

Among the four Russian companies listed at the top 100 list of Financial Times’ FT500, three are oil and gas companies.

Naturally the over-dependence on energy exports makes the Russian economy highly sensitive to price fluctuations.

The slowdown in global economic growth and retreat of market speculators has toppled energy prices well off their record highs since July.

An inevitable global slowdown, if not recession, in 2009 would make worsening economic conditions in Russia inescapable.

A second structural determinant is Russia’s underdeveloped financial industry, which is characterized by more than 1,000 small banks.

Many of them are beset with underperforming assets and depend largely on overseas borrowing. The global credit crisis and the resultant stricter lending against Russia could worsen already strained liquidity, which have slammed these small banks.

The payment trouble of companies that have borrowed money from overseas also is problematic.

The amount that Russian companies need to pay off is $300 billion to $400 billion.

The housing, construction, real estate and retail businesses that have been depending largely on bank loans will be hit particularly hard.

The third factor making Russia vulnerable to the global economic turmoil is the loss of trust by foreign investors.

The Russian government surprised the industrialized countries by nationalizing oil company Yukos in 2004. A series of recent events, conflict over oil company TNK-BP with the U.K., inspection into mining company Mechel on tax evasion, and the Russian invasion of Georgia, have also dented foreign investors’ confidence.

In particular, the spread of resource nationalism seems to be the major factor that has weakened confidence of foreign investors in Russia. During the past two months, an estimated $50 billion has been withdrawn from the country, according to the Russian government.

Nevertheless, there is little possibility that the Russian economy would face a currency crisis like the moratorium it suffered in 1998.

The overall situation is favorable, including foreign currency reserves, the composition of foreign assets, and stable domestic politics. The problem here is that the Russian economy could be more affected than other countries from the global credit crisis.

For Korea, Russia’s economic predicament serves as a lesson in several aspects. The financial markets of both countries are showing similar reactions to the global credit crisis.

Both countries boast ample foreign currency reserves, and yet not only foreign investors but also local investors are losing confidence in their financial markets.

The ample foreign currency reserves could be of no use if the market loses confidence. While risk sentiment grows, demand for dollars is also increasing in both markets considerably weighing down on the foreign exchange markets.

Second, although the degree of anti-sentiment against foreign capital and efforts to attract foreign investors is different between the two countries, similarities can also be found. Korea, after securing enough foreign currency reserves after the currency crisis in 1997, slowed its efforts to attract foreign capital.

Thus, looking at the Russian situation, Korea should raise consistency and transparency in its economic policy overall, while re-examining its foreign capital inducement efforts.

Another crucial need is stabilization of consumer and business sentiment toward the economy.

*The writer a research fellow at Samsung Economic Research Institute. For more SERI reports, please visit www.seriworld.org.

By Lee Jong-kyu
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