The political future of the Russian administration has become an implicit question mark as the fall in the price of oil entrains a Russian ruble decline.

The currencies of countries that are heavily dependent on producing natural resources are always affected by a fall-off in demand for those commodities because it weakens their own economies even more than others. Thus the Russian ruble decline has taken the currency to nearly the level it held two-and-a-half years ago, almost 28 to the dollar, as the Russian central bank has begun to allow the ruble to depreciate.

Public opinion, the stock market and the Russian ruble decline

The citizens of the country have implicitly accepted a curtailment of their liberties over the past decade in exchange for some economic improvement (although conditions in the provinces away from the major cities remain always difficult).
There may be no popular revolt, but a shrinking economic pie imposes hardship on the oligarchs and their state, and on the urbanized social strata that had until recently handsomely profited from the rise in the Russian stock market.

Today, however, the principal indices of the RTS and MICEX exchanges are both down by three quarters from their highs just six months ago. Consumer spending is growing much more slowly, and the country’s industrial production looks ready to decline as a slowdown proliferates in the construction sector, with knock-on effects for electricity demand. Production in the metals and mining sector is already down by half.

Comparable national equities markets, heavy in natural resources and banking, are Canada and Australia. Their currencies have also been hit by the collapse of marginal demand for primary materials; yet Canada’s S&P/TSX index, by contrast, is down by “only” slightly more than 50 per cent since its all-time high also in May, while the Australia All Ordinaries Index slightly less than that.

Of Russia’s major stock benchmarks, the RTS index has now fallen to 618 and the MICEX index to 580, respectively about 7 and 3 per cent below the tops of the bands of technical support that I identified a little less than three months ago (see Russian equity flight accelerates, Asia Times Online, September 11, 2008), as defined by their charts in 2004-2005 but still within those bands. (For more background, see Georgian invasion makes Russian downturn worse, 22 August 2008.)

Russian banks and the Russian ruble decline

Responding to this fall in Russian equities as well as to the depreciation of the ruble, private banks as well as individuals have been seeking to send their capital out of the country and otherwise convert it into foreign currencies. These flows produce further Russian ruble decline through decreased demand for the currency; and as that occurs, so also, following the law of supply and demand, the value of the ruble itself continues to decline.

Trying to sustain the falling currency against a too-rapid depreciation, the Russian central bank has slowly widened its permitted trading band against its dollar/euro (55-45 weighted) benchmark twice in a week and three times in a month. To support the ruble against a catastrophic decline, it has foreign exchange reserves of about US$450 billion, the world’s third-largest according to Bloomberg; but it is not clear that expending even these sums would be sufficient, let alone advisable. In August, those reserves were $600 billion, so it has since then spent a quarter of that sum merely to restrain the Russian ruble decline to a 16 per cent slide.

Western financial commentators are already suggesting that the central bank should widen the trading band of the ruble, that is, allow it to depreciate faster. Goldman Sachs estimates that it may be desirable for the Russian ruble decline to continue steadily another 18 per cent over the next three quarters. Bloomberg News quotes a strategist at Moscow’s Alfa Bank as saying that market behavior indicates an expectation of a decline of between 15 and 20 per cent from the present level.

Just as central bank intervention has been required until now so as to put brakes on the recent decline, so it would still be required to prevent a further decline from snowballing into a massive devaluation. Both Russian and European financial services, however, are warning that the Russian central bank could end up spending reserves with nothing to show for it. They estimate that a snowball is inevitable and the devaluation could reach 30 per cent, attained in one or more big drops rather than small progressive declines, whether the central bank intervenes in the short term or not.

Russian energy and the Russian ruble decline

As for oil production in Russia, this continues to grow but less dramatically than before, such that the rate of growth itself has turned negative. Meanwhile, the Yukos affair (state expropriation of the company following highly disputed criminal charges against its owner Mikhail Khodorkovsky) and the BP-TNK affair (effective nationalization of a joint venture by slow judicial procedure) have done nothing to encourage foreign investment.

On the domestic-investment side, exploration for new resources has stagnated. Much of the recovery of production levels during the present decade has come from old fields that were “mothballed” in the 1990s. It is unclear that even a return of the price of oil to US$80 per barrel would benefit Russia in the long run. Oil has plunged 67 per cent from a record $147.27 a barrel in early July.

Russia has stated that it will not join the Organization of Petroleum Exporting Countries (OPEC) but may cooperate with it in order to ensure stable prices. Yet OPEC has decided to put off for several weeks any decision on production cutbacks for price support. Since OPEC members tend more and more to see Russia as a free rider, that may be because leading oil producer Saudi Arabia, which often takes the brunt of reductions in output, no longer wishes to do so, or at least to do so alone.

Already in Russia, and increasingly in the world at large, the falling price of oil diminishes incentives for capital investment in future production, beyond the financing and debt problems separately evident from the global financial crisis. This actually sets the stage for the possibility of an explosive spike later, as demand returns to levels supply is unable to match.

However, even if that comes to pass, it may then be too late for the Kremlin and Russia’s currency. Under conditions of increasing economic hardship all around, Russia looks to be on the road to a still more authoritarian state. With even regime-friendly political dissidence effectively eliminated from the public airwaves and print media, it is difficult to see how the citizenry might organize itself so as to oppose such a trend.

The chances for real democracy in Russia appear to have died with the still-unsolved murder of the reformer Galina Starovoitova (who would probably have stood for election as president) in her St Petersburg apartment building 10 years ago.
The current oligarchs, whose fortunes are in metals, energy and banking, have learned the lessons of the past and do not challenge the power of those who wield the state’s (relative) monopoly on the means of physical coercion. At the same time, public statements notwithstanding, they hardly seek to absorb by themselves the brunt of the fiscal and financial consequences of the present downturn.

A political analogy from the Soviet past

In the current political constellation in the Kremlin, it is hard to escape the parallel, that President Dmitry Medvedev is increasingly looking like playing Aleksei Kosygin to Premier Vladimir Putin’s Leonid Brezhnev. When Nikita Khrushchev was deposed by the Communist Party’s Central Committee in 1964, Kosygin became prime minister while Brezhnev was installed as the party’s general secretary. The new regime was denoted by linking the two together, much as Lenin and Trotsky almost were a hyphenated single name before Josef Stalin’s ascendance.

The “Brezhnev regime” properly speaking actually dates only from 1973, when the heads of the KGB, the armed forces and the Foreign Ministry were co-opted into full Politburo membership. This event, presaged by Brezhnev’s dominance of the preceding Communist Party general congress in 1971, represented the compromise and consolidation of the “power ministries” around Brezhnev as head of the party.

By the early 1970s, the reform-minded Kosygin had been politically shunted aside, although he continued to occupy his formal government post. Medvedev, although a post-Soviet rather than a Soviet technocrat, had no real political experience before becoming president. His election represented only the defeat of the Kremlin faction that, for its own reasons, at all costs never wanted Putin to leave power.

Yet there is no guarantee that even Putin’s return to the presidency, a possibility widely bruited in light of a constitutional amendment now permitting this, would resolve the matter. Indeed, such a development would likely upset the balance that political forces around the Kremlin have been attempting to re-establish since his departure from the office. So long as the present oligarchs continue to receive the support of the state in return for their support of the state, the ruble’s situation will not change for the better any time soon.

[First published in Asia Times Online.]