With Vladimir Putin In Power It’s Laughable Russia Is One of The BRICs (RSX, VWO, EPI, FXI, EEM)
Martin Hutchinson: The re-election of Vladimir Vladimirovich Putin last week means even more crony capitalism in Russia (NYSEArca:RSX). With Putin in power nothing will change.
In fact, it’s laughable that Russia is still even considered among the group of the world’s most glamorous emerging markets (NYSEArca:VWO) – otherwise known as the “BRICs.”
The truth is Russian prosperity will last only as long as the price of oil keeps rising by 25% a year, and not one second longer.
Of course, that hasn’t stopped one of Russia’s boosters, Moscow broker Prosperity Capital Management from claiming that Russia is the third fastest growing economy in the world.
But since Russian growth is only expected to be 3.2% in 2012, according to The Economist, Prosperity’s definition of the word “world” is as little suspect.
Presumably Prosperity is only including the wealthy countries, most of which are much richer than Russia and should be expected to grow more slowly.
The Economist actually ranks Russia 18th of the 58 countries it surveys, based on projected 2012 growth rate.
That looks reasonably impressive, until you realize that this modest growth is being achieved in a period of sharply rising oil prices. Oil is Russia’s largest export.
After all, one of the countries that beat Russia, with a 4.2% growth rate, is Venezuela. Needless to say, few people outside Hugo Chavez’ immediate family would claim that country was economically well run.
Apart from corruption and cronyism, Russia’s main problem is its state budget, which depends crucially on oil revenues and hence on the oil price.
Before 2008, its budget was balanced at an oil price of around $90 per barrel, already up from a break-even of $30 per barrel earlier in the decade. Now according to the Finance Ministry as reported in Atlantic Monthly, today the oil price must be $117 per barrel for Russia to balance its budget.
In reality, since Putin announced $260 billion of spending programs during the election, plus a defense program totaling $763 billion, the oil price needed for balancing next year’s budget is likely to be around $140 a barrel, rising continually thereafter.
Needless to say, the rest of the world is likely to be tipped into recession by any oil price that will make Russian budget managers happy.
In terms of oil, Russia is playing a game that will never add up.
What Russia Needs to Do Be One of the BRICs
Russia needs to diversify from energy into high-skill industries; after all it has a relatively well-educated workforce.
However, at present it’s going the other way. Energy exports have risen since 2000 from 45% to 69% of exports, while at the same time equipment and machinery exports have declined.
As well as this imbalance in the economy, Russia suffers badly from its corruption.
Russia ranked an appalling 143rd on Transparency International’s 2011 Corruption Perceptions Index, along with such trustworthy stalwarts as Nigeria and Belarus and well below Syria and Nicaragua.
It’s a long-standing problem, but in 2001 Russia ranked 79th, and in 2005 90th which while not good were considerably more respectable.
While two other BRICs, India (NYSEArca:EPI) and China (NYSEArca:FXI), can manage economic growth with fairly high corruption levels, Russia is currently well beyond the levels compatible with prosperity – except for the oligarchs extorting from the system.
Meanwhile, Russians themselves are voting, if not with their feet then with their rubles. Capital flight from Russia totaled $38 billion in the fourth quarter of 2011, and there is no sign of it slowing.
Putin’s Russian End Game
There is one comfort: Even if Putin wants it to (which he may well) Russia cannot become the global threat the old USSR was; its economic position is far too weak.
Whereas President Reagan had to undertake a very expensive defense buildup to defeat the USSR, taming Russia today is much simpler and cheaper: fire Ben Bernanke, and maybe free up offshore oil drilling and onshore oil fracking.
Once Bernanke is gone, and interest rates revert to a more normal level of around 5%, say 2% above today’s inflation rate of 3% or so (they may have to go higher if we delay) there will no longer be the cheap-money-driven upward pressure on commodity and energy prices.
If interest rates are allowed to move naturally, the price of oil will decline, because with $100 oil over the last few years, we have found gigantic new sources, especially through the development of fracking technology to extract oil and gas from shale.
In a very few years, possibly even within months, the re-imposition of normal interest rates would cause the oil price to decline to $50-60 a barrel, just enough to allow the most efficient tar sands and shale extraction companies to run at a profit.
And a bunch of very unpleasant regimes, notably those of Hugo Chavez and Vladimir Putin, will be left gasping for money, as their state budgets careen into bankruptcy.
Suddenly, $763 billion defense budgets will become completely unaffordable.
If Putin is not thrown out he will have to learn real economics, and allow the superbly educated Russian entrepreneurs (the real ones, not the billionaire crooks) to create engineering export giants.
Once that’s done, Russia will be a much happier and more stable society, and most of its oligarchs would be left only with their Swiss bank accounts.
At that point, and only at that point, will Russia be worth investing in.
Today, Russia remains a threat to the world, and a source of endless criminal activity. Putin’s election changes nothing.
How Russia is still one of the BRICs is mystery to me.
Related: iShares MSCI Emerging Markets Index Fund (NYSEArca:EEM).
Martin is a Contributing Editor to both the Money Map Report and Money Morning. An investment banker with more than 25 years’ experience, Hutchinson has worked on both Wall Street and Fleet Street and is a leading expert on the international financial markets. At Creditanstalt-Bankverein, Hutchinson was a Senior Vice President in charge of the institution’s derivative operations, one of the most challenging units to run. He also served as a director of Gestion Integral de Negocios, a Spanish private-equity firm, and as an advisor to the Korean conglomerate, Sunkyong Corp. In February 2000, as part of the Financial Services Volunteer Corps, Hutchinson became an advisor to the Republic of Macedonia, working directly with Minister of Finance Nikola Gruevski (now that country’s Prime Minister). The nation had been staggered by the breakup of Yugoslavia – in which 800,000 Macedonians lost their life savings – and then the Kosovo War. Under Hutchinson’s guidance, the country issued 12-year bonds, and created a market for the bonds to trade. The bottom line: Macedonians were able to sell their bonds for cash, and many recouped more than three-quarters of what they’d lost – to the tune of about $1 billion. Hutchinson earned his undergraduate degree in mathematics from Cambridge University, and an MBA from Harvard University. He lives near Washington, D.C.
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