Paul Krugman's Notes on Russia Debt Are Upside Down

The debt is small. Krugman makes a host of schoolboy errors to "prove" the opposite

Fri, Dec 19, 2014
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Indian name: 'Often Wrong'

In his recent opinion piece in The New York Times – Notes on Russian Debt - Paul Krugman admitted that he had difficulties in understanding the Russian debt situation. Nevertheless, he gave it a try. But failed. Let’s see how.

Krugman reasons that Russia has a debt problem, which is supposedly more severe than it seems on first glance. We should factor in the purchasing power parity (PPP) of the dollar, he argues, and concludes that therefore the size of Russia’s external debt would in actual fact be bigger in proportion to the GDP than it is when only the nominal value of the ruble is considered.

The problem with this reasoning is that precisely the contrary is true. By PPP the Russian economy was in 2013 1.65 times bigger than it was by the nominal measure, 3.46 trillion versus 2.1 trillion. This means that the purchasing power parity yielded an exchange rate of 19.3 rubles for the dollar while the nominal figure corresponded to an exchange rate of 31.8.

But Krugman reasoned to the other way and multiplied the nominal rate by the PPP adjustment coefficient (1.65) to yield the rates he pictured in this chart:

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Krugman’s arithmetic yielded a PPP rate of about 45 rubles. He then argues that the size of the Russian economy would have to be considered correspondingly lesser by the measure 45/32 (divided by) when in fact it would have to be consider bigger by the measure 19/32.

With the ruble devaluations of last few months, nothing much will happen to the PPP calculated size of the Russian economy which will remain at the level of 3.5 trillion.

Unfortunately, Krugman’s errors do not stop here, so I must drag on with this article a bit.

Next Krugman confuses public and private liabilities. He refers to the figure of Russia’s external debt without acknowledging the fact that what is called “Russia’s external debt” actually consist of both government debt (public) and private (corporate) debt.

The legal point here is that the government is not liable for corporate debt. Krugman should therefore before he rushes Russia into the folds of IMF correct his calculations by separating public and corporate debt.

Acknowledging this we realize that the Russian government’s external debt indeed was very small. (Figures can be verified here).

As per June 2014, the total public external debt stood at $377 billion.  But that figure includes both the general government and government controlled corporations. The risk of Russia, as the state, defaulting is limited to the general government debt, which was a mere $57 billion.

This can be compared with the more than 400 billion foreign exchange and gold reserves Russia holds. The rest of the public debt is what state owned banks ($131 bln) and other corporations ($114 bln) own. These are well hedged and do not carry any default risk.

But let’s allow for the sake of argument that there would be such a risk. Nevertheless, this would not entail a government liability; if the corporations failed, the government would have no obligation to bail them out.

That’s how it goes in a market economy. The problem would be with the Western creditors and not the Russian government. Indeed Russian investors could pick up some of the assets at bargain prices from a possible estate.

The same applies for the private sector external debt, which was $353. The Russian government bears no liability for it. The problem if any would be with the Western creditors that should come to Russia to look after the collateral in case of default.

Moreover, it should be noted that a big portion of this debt is intercompany debt of Russian subsidiaries to Western parent companies and other affiliates; and also debt of Russian companies to their ultimate Russian beneficiaries registered abroad.

Both of these categories of debt do not in reality affect the Russian debt position in any way. As much as half of the private sector external debt could possibly be referred to such type of debt, that is, about $170 billion of the total $353.

After partaking of this small review of facts and method, we hope that Mr. Krugman could calm his liberal conscience and rest assured that Russia will not default.

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