Russia's plan to build an alternative financial system and seek out new sources of financing for domestic companies might backfire. It is unnecessarily expensive and risky.
Russian Prime Minister Dmitry Medvedev, center, chairs a meeting with his deputies at the Gorki residence near Moscow. Photo: RIA Novosti
Of all the sanctions imposed by the international community in response to the actions of the Russian government in regard to Ukraine, the most painful, without a doubt, have been financial.
Events this year irrefutably confirm that Russia, despite its status as a net exporter of capital, is chronically dependent on raising funds in the international markets. Whether we like it or not, the national financial system is unable to effectively channel a steady flow of income from foreign trade into the investment process, whereupon major banks and corporations are forced to turn to foreign investors to meet their capital and borrowing requirements.
Having negatively assessed the events in Crimea, these investors began to revise Russia's risk profile. This, in turn, caused a sharp drop in price quotations for securities and effectively closed off the international markets to most Russian issuers and borrowers even before the imposition of sanctions by foreign governments.
Starting in March of this year, deals to secure financial resources from overseas became sporadic before coming a complete standstill in the wake of the restrictions imposed by the United States and the European Union, which directly impacted leading credit institutions under state ownership. As a result, Sberbank President German Gref admits that even Russia’s largest and most stable bank is currently unable to obtain financing in the foreign markets for any period of maturity.
The move to starve Russian borrowers of external sources is having an adverse affect on the domestic financial market, too, which is experiencing a funding deficit no less painful.
Suffice it to recall that due to "unfavorable market conditions" the Russian Ministry of Finance canceled its weekly issue of federal bonds for the ninth time in a row, while the interest rate on ruble-denominated loans to corporate borrowers has climbed by at least 2 percentage points since the start of the year. All this, coupled with the ongoing risk of tougher sanctions, is undoubtedly contributing to the pouring out of private capital, which this year topped $100 billion. It is also undermining domestic investments, pushing the Russian economy into recession.
The Kremlin's response to the financial sanctions is comprised of several key steps.
First, it announced plans to build its own financial infrastructure, independent of external players. That would involve phasing out the domestic use of Visa and MasterCard, the SWIFT interbank payments system, international credit ratings, and so forth. Although some steps have been taken in this direction, the whole process is generally considered to be prohibitively expensive and futile.
Above all, the idea of creating a self-sufficient Russian financial market in the current climate is pie in the sky. On one hand, even if the enormous costs of a parallel "sovereign" infrastructure were overcome, demand for it would largely depend on "bridges" with the established international systems. On the other hand, any tightening in this area or attempts to erect barriers to cross-border cash flows would, in the first instance, raise the cost of financing for Russian business and undermine the competitiveness of domestic financial institutions, encouraging them to move offshore.
Second, the Kremlin started seeking out alternative sources of financing to the Western markets. But it soon became clear that rumors of the financial cornucopia on Asia's trading platforms and the ready availability of resources for Russian companies from Chinese, Arab, and other less sophisticated investors were greatly exaggerated.
Asian private investors' assessment of Russia's risk profile is often no different to that of their Western counterparts, while sovereign and government-orchestrated funds tend to see lending as a vehicle to promote national interests. Even if one leaves aside the issue of whether such deals would be in Russia's own interests, replacing the Western markets even partially would require considerable time.
Third, measures are being taken to mitigate the effects of sanctions on domestic financial and corporate structures. Some of them have already been promised direct cash injections from the National Welfare Fund. Meanwhile, the Bank of Russia is launching a currency refinancing program, and the government is setting up a special fund to help companies in trouble that will tap pension reserves (at the same time the industry of non-government pension funds with “long money” has been put to rest). The resources available to the government and the Bank of Russia will certainly last for some time, but they are not limitless.
Meanwhile, amid the ongoing capital flight, plans to float the ruble are fraught with the risk of devaluation. The acute shortage of currency in the country could lead to measures to control the movement of capital. In such financially turbulent conditions, any talk of sustainable economic development and improving public welfare is wishful thinking.
Let's wrap up. The financial sanctions have hit the Russian economy hard, both now and looking forward. The reactive measures taken by the Russian government and the Bank of Russia do not look convincing. Creating an autarkic financial infrastructure in an era of global markets is costly and pointless.
The lack of an obvious alternative to external sources of financing has caused dozens of private investment projects, especially in the manufacturing sector, to be terminated or frozen. Drawing upon the reserve of centralized financial resources will temporarily stabilize the situation at best, but cannot rid Russia of its economic woes, which are threatening to break into a full-fledged crisis at any moment.
It is all strongly reminiscent of the situation that Russia found itself in during the global financial crisis of 2008-2009 — but with two important distinctions. First, six years ago, the difficulties affected nearly every country in the world, whereas this time around we are suffering alone, losing ground on our competitors with every passing month.
Second, whereas then there was hope of weathering the economic storm through cooperation with other governments back in 2008-2009, now there is no reason to imagine that the time of troubles will end soon.
The opinion of the author may not necessarily reflect the position of Russia Direct or its staff.