However, the effect may not last long, as measures announced by European leaders on Friday might temporarily stabilize markets, but there is little chance that mantras on the need to stimulate growth will go beyond rhetoric. Money can be printed in unlimited amounts, but, as the saying goes, "you can lead a horse to water, but you can't make it drink". One cannot call enormous distortions created by the US Federal Reserve via quantitative easing and Operation Twist on the bond market a success - although the government can borrow cheaply, economic growth in the US remains slow and unemployment is still high. Over EUR1 trln in loans extended by the ECB to banks since last year have not encouraged banks to lend money more actively to the real economy - banks used these facilities to purchase less-risky government bonds (and pulled yields lower) or deposited the money with the ECB. So far, unconventional monetary policy has not helped stimulate growth, but has allowed some governments (e.g. the US, Germany, UK and Switzerland) to borrow for less, and rates turned negative in real terms.
There is no guarantee that more monetary and fiscal easing will encourage the horse to start drinking any time soon. In some sense, the current situation in the advanced economies resembles what happened in Russia at end 2008 - early 2009, when the Central Bank extended sizable unsecured credits to "systemically important" banks (mostly state-owned) and encouraged them to lend money to the real economy, but this did not happen. Those loans moved immediately to the forex market until the Central Bank abandoned its policy of exchange rate targeting, which at the time meant gradual and predicable ruble devaluation. The Russian currency weakened by around 40% at that time, overnight rates surged to over 20%, and money in fact stopped moving (apart from one direction - to the forex market). The forex market was and still is the most important for the Russian economy, while the bond market plays a crucial role in developed countries. Unsurprisingly, in times of uncertainty and elevated risks, money mostly moves in one direction, i.e. toward safe havens, such as gilts, bunds and USTs. A scared horse will not drink.
That said, it looks as though global economic uncertainty will remain high and markets will be nervous for some time. As the situation is rather new, past experience cannot necessarily be applied. Macroeconomic imbalances in several developed economies are only getting stronger, and most available macroeconomic policy tools have already been exhausted. Hence, we can expect a continued trial-and-error approach.
How is Russia positioned in the current environment? We have broached this in the past, suggesting that the economy looks better prepared for external shocks than it was in 2008. Indeed, the economy is less overheated these days, but more importantly, the exchange rate policy is different, as the Central Bank no longer targets the exchange rate. This has made the budget and current account balance more resilient to external shocks. When the oil price falls, the ruble automatically weakens (and people have grown accustomed to this, so it does not create a panic comparable with the 2008 crisis), which somehow compensates ruble-based oil tax flow to the federal budget. A weaker ruble also limits import growth, leaving more room for import substitution by domestic producers. We broached these issues in recent issues of our Russia Economic Monthly.
One of our findings was that the so-called breakeven oil prices (i.e. the theoretical oil price at which the federal budget of some particular year would be in balance) should be a function of the current oil price. The breakeven price is not a function of expenditures alone, but also of revenues. That said, if the oil price declines, and the ruble consequently weakens, then the effect of a lower oil price on oil-related taxes is somehow offset by a weaker national currency. Thus, if the oil price goes down, then the breakeven oil price will also go down. We introduced this dependence in our April Russia Economic Monthly.
Since then, the oil price has fallen sharply (Urals was temporarily well under $90/bbl). The ruble initially weakened, but it bounced back a bit. The effect of the weaker ruble on inflation seems to be rather limited - w-o-w inflation temporarily accelerated to 0.2% from the "usual" 0.1%, but it returned to this level at end June. In early June, inflation largely accelerated amid higher prices for imported fruits and vegetables, so there is a good chance that some prices may actually fall once locally produced fruits and vegetables appear on the market. The budget was in surplus in 5m12. Economic growth continues - domestic demand was rather strong in May, and domestic manufacturing was up 7.0% y-o-y that month. According to the State Statistics Service, business confidence improved further in June, meaning there is a chance that the overall economic performance should be decent in 2Q12. A weaker ruble combined with relatively low inflation may indeed support local manufacturing this year.
Things now look completely different from what we saw at end 2008 and early 2009. As mentioned above, money stopped moving then, overnight rates soared (thus moving lending rates to prohibitively high levels) and economic activity was disrupted for months during which the Central Bank exercised gradual devaluation. These days, the economy seems to have successfully passed the test - money markets remained relatively calm (with overnight rates fluctuating between 5% and 6%) as the regulator supplied the system with liquidity in sufficient volume via short-term refinancing, thus limiting the scope for speculative pressure on the ruble. The economy was also little affected despite the fact that the ruble plunged as the oil price fell. It looks as though domestic lending has continued to expand in recent months, which stands in stark contrast to what happened at end 2008 and 2009, when domestic lending shrank in nominal terms amid rising NPLs and rumors about a second wave of the crisis. Since then, Russia has faced several such waves, including one in August-September 2011, but the economy demonstrated its resilience and was not impacted greatly.
The current turbulence on global markets is very timely for Russia. A lower oil price will force the government to remain less generous on the fiscal side, meaning budget expenditures should not rise faster than was most recently announced. Moreover, it looks as though President Vladimir Putin and Prime Minister Dmitri Medvedev's earlier election promises, such as a massive increase in defense spending, may be postponed. Putin recently mentioned that the budget deficit should not exceed 1.5% of GDP going forward, which is rather encouraging news. So far, Russia does not look that bad compared with many other countries. It may be one of the few large economies that will now carry out traditional macroeconomic policy: the budget deficit will be contained, no unorthodox monetary policy is being discussed, inflation remains relatively low and real rates are positive, while economic growth continues.
After the 2008 crisis, the Russian economy resumed m-o-m growth in March-April 2009, i.e. right after the Central Bank stopped tossing out money in almost unlimited amounts and halted forex interventions, which sent the wrong signals to the economy and distorted the forex and money markets. That is when the Russian horse started to drink. Regulators in the developed countries continue to generate macroeconomic distortions by intervening on the bond market and promising an even "bigger bazooka". Hence, the chances of stronger economic growth are limited - private money will simply watch what the regulators are doing, and they are highly unlikely to move away from safe assets.