Putin's Limited Options to Restore Growth

Russia's Putin fears pumping money into the economy will weaken the ruble, restrict bank lending, and crimp economic growth

By Dmitri Travin

At the end of July, Vladimir Putin made an unusual move in his economic policy. He criticized Russian bankers harshly for providing loans to entrepreneurs at excessively expensive rates, and even indicated a specific interest rate that the Russian government considers normal for modern conditions.

The obliging bankers immediately responded to the criticism. Two of the country’s major financial institutions, Sberbank and Vneshtorgbank (VTB), announced that they were prepared to reduce their interest rates. At least, for borrowers they described as strategic.

In economic terms, this was an extremely debatable decision. Banks had been keeping interest rates high not only out of greed, but because the crisis makes it very difficult to distinguish between good and bad borrowers, i.e. those who are able to pay back their loans and those who will soon go bankrupt. So if the interest rate on loans is kept high, the inevitable losses from unpaid debts are to some extent covered.

In theory, these losses could be covered by selling mortgaged property on the market. But in practice this gives rise to serious problems. For example, property prices have fallen drastically during the crisis; at current prices it is impossible to sell anything, as potential buyers are waiting for houses and apartments to become even cheaper. So when property is transferred from a debtor to a bank, it is practically impossible to convert it into money.

SECOND PHASE OF THE CRISIS?

Experts are currently talking more and more about the imminent so-called second phase of the crisis, when bad debts on a massive scale will lead to the collapse of the banking system. And on top of this bankers are being asked to give favorable interest rates to industry and construction projects. Might the major banks who have decided to please Putin by being so obliging not actually collapse as a result?

No, unlike the small banks, they will not collapse. The Russian economy has one little trick up its sleeve. The government always helps its chosen few. It supports Sberbank, VTB, and Gazprombank. It finds money for Gazprom, Rosneft, the Volga Car Works, and a few other companies. So in responding to Putin’s call for them to reduce their interest rates, the bankers are sure to know that the Central Bank is prepared to provide them with the necessary liquidity in the event of a second phase of the crisis.

Sberbank holds the savings of tens of millions of Russians. If it were to collapse, Vladimir Putin would have far greater problems with angry depositors than with the head of the bank, German Gref. So Sberbank will not collapse. If it gets into difficulties, it will be “fed” using Central Bank loans or budget funds. And until that moment comes, it will be asked to “feed” borrowers.

In general, the actions of leading bankers are not mysterious. Their motives are clear, although if one is not aware of the little tricks of the Russian economy, it may seem that they are acting against their own interests.

Putin’s pressure on banks is interesting for another reason. It shows what the Russian leader most fears today. However, in order to understand the logic of Putin’s actions, one must take a look at the general state of affairs in the Russian economy.

THE END OF THE ERA OF PROSPERITY

The economic crisis in Russia has proved much more serious than was expected in the autumn of 2008, when the first signs of a serious downturn became apparent. At that time officials only talked about a slowing down of growth rates. Later they began to predict a small slip. But in the end, the situation has proved to be truly catastrophic. According to a recent assessment by the Ministry of Economic Development, GDP dropped by 10.1 percent in the first half of 2009 compared with the first half of 2008.

Russia has not seen a slump like this since the early 1990s, when radical economic reforms were under way. However, that was a so-called transformation slump.

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