Falling capital outflow suggests deleveraging is ending and with it dependence on Western financial markets
This post first appeared on Russia Insider
As confidence grows that the Russian economy has turned the corner, the Russians have been taking an increasingly hard line on sanctions.
Economics Minister Ulyukaev has said - echoing what Putin’s Chief of Staff Sergei Ivanov has also said - that Russia is not asking for the sanctions to be lifted. That is purely a decision for the Europeans.
More to the pont Ulyukaev twisted the knife a little but saying that the longer the sanctions remain in place the less effective they become.
That is true.
The major consequence of the sanctions - the only one that in economic terms matters - is that Russian companies have been unable to borrow in Western financial markets.
The result of that was that during the recession caused by the oil price fall Russian companies were unable to roll over their foreign debts, or increase their debts. Instead they were forced to go on paying them.
One important company - the airline company Transaero - which had over borrowed in Western financial markets - has been forced to close.
As I predicted a year ago, the government has however refused to bail out private companies like Transaero that have found themselves in this position - and neither it should it do so.
The great majority of companies have managed to pay their debts.
The result is that whereas the fall in oil prices would normally lead to a rise in the foreign currency debts of Russian companies, we have actually seen a sharp fall.
Total foreign debt has fallen by around a third, from $730 billion at the time sanctions were imposed in July 2014, to less than $500 billion now.
Meanwhile the sanctions are having a transformative effect on Russia’s financial system.
Certain much needed technical steps have been taken.
An alternative interbank payment to SWIFT has been created. A Russian credit agency is being set up. MasterCard and Visa have been obliged to locate transfer hubs in Russia and an alternative Russian card system is being created.
Even more important, the sanctions are changing the financial situation inside Russia.
The sharp fall in indebtedness means that money is increasingly staying within Russia.
The Central Bank says that total capital outflow will be only $70 billion this year (half the level of last year).
The bulk of capital outflow - around $50 billion - took place in the first two quarters. It seems in the third quarter there was even a small capital inflow.
The fall in capital outflow is a result of the fall in the level of foreign debt.
What is called “capital outflow” in Russia’s case is mostly debt payment.
The popular image of rich Russians dashing for the exits with suitcases full of money is a myth. That did happen in Russia during the 1990s. However what was different about the crises of 2008 and 2014 is that such capital flight - which should not be confused with normal capital outflow - did not happen to any great degree.
A lot of people converted their roubles into dollars. However they kept their money in Russia in dollar and euro accounts.
There will be more capital outflow in the last quarter as companies have to pay more foreign debts during the traditional debt payment period at the end of the year. However the fact the rate of capital outflow is declining is a further sign that the period of the economy’s deleveraging on its foreign debt is drawing to a close.
What that means is that the Russian economy’s long period of dependence on foreign capital is finally drawing to a close.
Russian companies are awash with cash. Instead of having to use this cash to pay foreign debt, they will increasingly keep it in Russia. Not only will that cause the rouble to strengthen, but it will cause the financial system to strengthen as well.
The Russian authorities meanwhile are taking more steps to strengthen the financial system.
The Russian banking system is seriously unbalanced.
At the top end it is heavily concentrated in a small number of giant largely state owned banks like VTB and Sberbank. These traditionally - and unsurprisingly - find it easier to work with big companies than medium sized or smaller ones.
It is however precisely more medium sized and smaller companies that Russia needs.
The trouble is that it is precisely the kind of banks needed to support such companies that Russia most lacks. Whilst Russia does have many private banks, not all of them are financially sound or well run.
Steps are now being taken to sort out this problem and to plug this gap.
Ever since Nabiullina was appointed Chairman, the Central Bank has been cleaning up the banking system by revoking the licences of weaker banks. Hopefully those that survive the cull will be better able to do their job properly.
At the same time the Russian Post is developing a project to offer the population banking services.
This was originally launched in 2013 as part of a plan to reorganise and increase the efficiency of the Russian Post, which has until recently been beset with problems.
If done intelligently this should however also provide Russians with a safe publicly owned banking service alongside VTB and Sberbank .
Since it would be a lot more decentralised than VTB and Sberbank are, it could in time become - and is probably intended to become - something like the public banking service, which exists in Germany and which is a key provider of credit to the Mittelstand - the small and medium sized businesses that form the core of Germany’s economy.
That is for the long term. In the nearer term the improving financial conditions in Russia make it less likely Russian companies will turn to European financial markets once sanctions are lifted to anything like the extent they did before.
Already European financial markets are worrying about a loss of international business. A report just issued frets that the City of London is losing out to New York and to the new financial centres in Asia.
For that the Europeans - and the British especially - have no-one to blame but themselves.
Whilst Russian business is only a very small part of their business, using financial centres as weapons of economic warfare is a guaranteed way of harming their reputation. In Britain especially it contradicts the City’s key principle: that it is always open for business.
As Ulyukaev says, the longer the sanctions remain, the less effective they become. Over time they will be so ineffective they will not matter any more.
At that point there may even be some hard-bitten old siloviki in Russia who will say they have in fact done their work very well, and that they were imposed on the country just when they were most needed.
This post first appeared on Russia Insider
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