South Africa’s need for a new direction


Harry Jones

The S&P shook South Africa on Friday 24th November when it announced the downgrading of South African ratings. The local currency credit rating was demoted from BB+ to BBB-, sending the Rand sliding. However, the currency rallied after Moody’s decision to place the country on review for downgrade. Despite the fact that this still presents a negative outlook for the future of the South African economy, the fact that Moody’s did not actually downgrade the country at the same time as the S&P has been seen as a positive. The country will be under review for a 90-day period before a decision is made on its rating. Following the decision from the S&P, Zuma directed his Finance Minister to identify various concrete measures which could be used to address the economic challenges facing South Africa.

The future is not looking positive for the South African economy. In September, the World Bank cut the growth outlook for 2017 to 0.6% from their previous estimate of 1.1%. Although the estimates for the next few years are slightly more positive, 1.1% and 1.7% in 2018 and 2019 respectively, this would be a poor performance for any economy, let alone a developing one such as South Africa.

South Africa has experienced weak economic growth and high unemployment which has led to a huge amount of poverty in the region. Unemployment has also dampened growth in the consumer sectors. These are not the only reasons for the downgrade, however. The country is also experiencing political and budgetary issues. President Zuma could potentially come under the same problems that Mugabe suffered recently in Zimbabwe. Mugabe’s attempt to put his wife in power was not popular and led to the soft coup, culminating in his resignation. Zuma is pursuing a similar idea and is trying to ease the way for his ex-wife to take power in the 2019 elections. However, the potential for military intervention is a lot lower than in Zimbabwe, and so it would be much harder to settle the dispute. One of the main points that South Africa can learn from Zimbabwe is that disputes are resolved much more easily within the ruling parties than out on the streets.

South Africa has not had a huge amount of luck in recent times. They have attempted to gain a major sporting event in an attempt to boost economic growth. However, they have had numerous setbacks over the years, with failed bids for the 2011, 2015 and 2019 Rugby World Cups. They recently failed to gain the 2023 Rugby World Cup as well suggesting the sport is becoming more and more dominated by money, especially due to the fact that South Africa was initially named as the favourite to host the event in 2023. This has just added to South Africa’s economic woes.

Zuma must now be extremely careful when making plans to deal with the dire economic situation. The country has had a lucky escape with Moody’s decision to only place the country under review. A downgrade from Moody’s could lead to South Africa falling out of the Citi World Global Aggregate Bond Index. This would lead to further outflows from the bond market. Therefore, Zuma’s next steps have the potential to either raise the country to new heights or lead to deeper economic problems. However, Zuma focuses on staying in power rather than using his power to the country’s advantage. Therefore, there could be a need for change in South Africa to prevent further problems down the line.

South Africa’s shaky economy – the power of rating agencies demonstrated

Oliver Dyson

South Africa’s economic outlook looks dire for the coming months. On October 25th, Malusi Gigaba -South Africa’s Finance Minister – revised GDP growth estimates down from 1.3% to 0.7% in the Medium-Term Budget Policy Statement (MTBPS), firmly placing the nation as the third worst-growing economy, behind Brazil and Switzerland. This is not a developing market issue; South Africa is not following the current trend rate of growth in emerging markets, currently standing at around 3.4%. Unemployment rates of 28% also pose an issue on how to improve government finances in a situation where next year’s budget deficit is forecast to stand at 4.3% of GDP. More troubling are the recent S&P downgrades of Rand-denominated bonds to ‘junk’ grades which has worsened the options for South Africa going forward.

Slack demand for the country’s exports, along with political turmoil have culminated in an economic recession over the past few quarters, ending in September of this year. Investor confidence has remained low in the nation, spurred by several scandals involving President Jacob Zuma. The first family’s close involvement with the Gupta family, a cohort of rich Delhi-born businessmen, has created anti-corruption outcry with many suggesting that the family has been using their influence to achieve policy changes. Indeed, the anti-corruption minded former Finance minister Pravin Gordhan was one of the largest critics of the family, stating that the Guptas had bee involved in ‘suspicious’ transactions worth some $490m. Several downgrades by rating agencies were unsurprisingly made when pro-reform Gordhan was ousted by the ruling party. Zuma’s African National Congress (ANC) party has been under increasingly close scrutiny going forward; investor trust has suffered as a result.

Zuma’s economic policies going forward are also giving cause for concern in markets. The President told his Presidential Fiscal Committee to reduce spending by 25 billion rand ($1.8 billion) in next year’s budget and to find ways to add 15 billion rand to the nation’s revenue. This is likely to lead to tax increases, which may dampen economic expansion for a country that just exited its second recession in a decade. Ratings agencies have severely downgraded their outlook for the economy as well; S&P stated last week that “South Africa’s economy has stagnated and external competitiveness has eroded”. The institution downgraded Rand-denominated debt to one-level below investment grade at BB-, with Fitch following suit. This move has contributed to the nation’s economic woes by ensuring that SA bonds have been expelled from the Barclays Capital Global Aggregate Bond Index (which only trades S&P investment-grade bonds). With access to $2tn of capital now cut off, the government’s borrowing costs are set to rise, as a rise in issued debt is expected in the near future to plug the deficit gap. As evidence of this issue, yields on 10-year bonds have increased from 8.4% to 9.4% since October, reflecting investors’ waning confidence in the economic performance of the nation. The rand also fell by 2% after the announcement.

However, the rating agency Moody’s has decided to keep local-currency bonds on its rating of Baa3 (the lowest investment-grade rung above ‘junk’) for the next 90-days as it revises its decisions. This decision has enabled SA bonds to remain in the Citi World Government Bond Index (with access to a much larger $8tn of foreign capital), while Citigroup economist Gina Schoeman has estimated outflows of 100 billion rand ($7 billion) from the bonds if they are allowed to fall to ‘junk’ grade. Clearly, the government has been thrown a lifeline from Moody’s decision, which has given it the opportunity to turn the economy around in the next 90 days. Indeed, this took the rand’s year-to-date carry return against the dollar to 5.7 percent (up from a negative rate in early November), meaning more investors performed carry trades (borrowing in rand to buy more dollars) following this announcement. Reinforcing the gravity of this decision, previous Finance Minister Gordhan stated that if Moody’s downgrades the country to sub-investment grade, it could take up to 10 years to recover.

Going forward, both ratings agencies and investors will be looking at the ANC party conference in December, which will pick Zuma’s successor. Many argue that the role is only truly contested between Zuma’s ex-wife Nkosazana Dlamini-Zuma, who argues for a more equitable distribution of wealth in the economy, and Cyril Ramaphosa arguing for reigniting growth and restoring investor confidence. Investors may have several opportunities present with this conference. Firstly, prices of options for dollar-rand volatility remain around the highest in a year for one-month contracts. That suggests that traders are anticipating big market swings when the ANC decides who will replace Zuma as party leader. Moreover, Toronto-based bank Toronto-Dominion says the Rand may rally by almost 10 percent to 12.55 next year if Ramaphosa or another candidate outside Zuma’s faction wins the vote, especially if they push the president to resign from his role of as head of state before the end of his term in 2019. This would be a great improvement for the economic outlook of South Africa, as growth-based policies would be put in place once more. This party conference on 16th -20th December should therefore be watched closely by FOREX traders.

Yet it is hard not to forget about the fundamentals of the economy. The same issues of low growth, large inequalities, high unemployment and low investment still remain and it is unlikely that these will be resolved soon. Low growth and poor credit/bond ratings may be here to stay for Africa’s largest economy, which is why a favourable Moody’s rating on rand-bonds in the next few months is vital to lifting the economy out of a low-confidence malaise.

Venezuela: “defying economic gravity”?

Oliver Dyson

Venezuela’s economic outlook is looking bleaker by the day. On Monday 13th November, the struggling nation officially defaulted on the first of its government bonds, after missing $200m in interest payments, according to ratings agency S&P. These are expected to be the first in a long string of defaults in the next few days and months, with Venezuela owing international debts worth upwards of $60bn. Indeed, S&P recently downgraded the sovereign bonds to ‘CC’ level (the second-lowest rung possible) and stated there being a 50% chance of default within the next 3 months.

This also comes a few days after the PDVSA (Venezuela’s national oil company) made a $1.1m payment 3 days late, after fears it would miss the payment altogether. The International Swaps and Derivatives Association (ISDA) has scheduled a (now delayed) meeting as a result, in which it will decide whether to declare ‘failure to pay’ on PDVSA debts. This would have the implication of Credit Default Swaps (a derivative acting as effective insurance for a debt or transaction) on these debts being paid out, which would then send the market into further shock.

Venezuela has been struggling to pay its creditors since 2014, when global oil prices fell dramatically and put a squeeze on the OPEC nation, where 95% of export revenues come from oil. Under President Nicolás Maduro the country has been in a recession and humanitarian crisis ever since, with food shortages, population outflows, and high inflation placing huge strain on the economy; thus making it increasingly impossible for the government to find funds to pay creditors. US-imposed sanctions on the nation August have further contributed to the problem. After Maduro created a ‘sham’ new legislative body to redraft the country’s constitution, through allegedly rigged elections, the US froze the President’s foreign assets and banned all US banks from purchasing any new Venezuelan bonds. This had the immediate effect of bringing any trading of previously owned bonds to a stop in the US. As expected, Venezuela has blamed most of its financial issues on this move. A bondholder meeting on Monday had Venezuelan Vice President Tareck El Aissami allegedly using most of his speech to rail against President Trump who had ‘conspired’ against the country.

These sanctions will halt any attempt of a restructuring, one of which is being attempted now. On the 3rd November, Maduro announced his ‘plan’ to restructure the debt after the last PDVSA payment was made, yet no details were announced. At the time of this announcement, bond prices dropped to a record low, with yields on the benchmark 2027 bond shooting up to 36.8%.

However, the main development this week is the role of Russia. The country has agreed to restructure $3.15bn of debt over the next 10 years, with ‘minimal’ payments to be made over the next 6 years, according to the Russian Finance Minister. In addition, the Russian national oil exporter Rosneft provided $6bn in advance payments for Venezuelan crude oil, a huge lifeline for the nation. The funds opened up here may then be used by Maduro to alleviate the current ongoing humanitarian crisis affecting the 31 million-strong population. Of course, some analysts argue that this move has just put off the inevitable defaults on other bonds; Venezuela’s future depends on how well it can negotiate with other creditors for debt extensions, such as with China, to whom it owes $16bn. Again of course, the US-imposed sanctions will make it nearly impossible for further debt-restructuring to take place on an international scale, given the importance of the big US banks.

These developments all have implications for the wider global economy, with the main impact being on oil markets. Venezuela currently exports 2 million barrels of oil a day, is an OPEC member, and is one of the largest producers in the world. With there already being tight supply conditions in OPEC currently, a default on the $27bn worth of PDVSA bonds may result in creditors seizing their oil cargos, further contributing to a reduction in new investment in the sector. The number of oil rig in Venezuela has nearly halved since 2013.  Many in the oil sector are already expecting a fall in production soon, with the BP CEO stating that Venezuela is currently “defying economic gravity” by holding off defaults for as long as it has. Oil exports would likely fall in this event as well, cutting world supply and forcing up prices in an already tight market. The current tensions in the Middle East between Iran and Saudi Arabia may further add to the speculative assumption that an oil price rise is likely in the near future.

Turning vulnerability into an opportunity in Brazil

Harry Jones

Brazil has been attempting to undertake a number of reforms in order to transform its economy and drive economic growth. However, this reform agenda may have suffered a major setback following claims that the Brazilian government has thrown in the towel on its pension reforms, causing a 2.7% fall in the Bovespa stock market index on Tuesday 7th November. Despite these claims, Michel Temer, the Brazilian President, has said that he is still fighting for these reforms. This still has not prevented Temer from having an approval rating of 3% – the lowest of any Brazilian president on record.

Politicians have set out on a number of reforms in recent years, aiming to further open up the Brazilian economy. Tax reforms, labour market reforms and higher investment in infrastructure are just a few of the policies which are being implemented. Having hosted the 2016 Olympic Games and the 2014 FIFA World Cup, investment in infrastructure seems to have risen. However, the venues now appear to be falling apart without any sign of maintenance. Unlike the London 2012 legacy, which aimed to provide a long-term benefit to the economy and sporting nature of the country, Brazil does not appear to have any long-term goal following these major sporting events. For these policies to be successful, there needs to be a strategy set out clearly so to ensure they have their desired impact on the Brazilian economy.

However, Brazil has risen from its recent economic crisis and there now seem to be opportunities in the economy. The IMF forecasts growth in Brazil at 0.7% in 2017 and 1.5% in 2018. This is seen by many as overly pessimistic, as there is potential for growth to be much greater than 1.5%. Many investors have turned to places such as Brazil for investment opportunities following two years of deep recession. Nowhere is this more prominent than with Chinese investors. Since the start of the year, Chinese foreign investment has been fallen by 40%. However, it has remained constant in Brazil, highlighting the opportunities present there.

Despite this, Brazil still needs to emerge from its recent corruption scandal which saw Temer charged with receiving money from the boss of meatpacking firm JBS. With claims from Marcelo Odebrect that he donated $48m illegally to the 2014 campaign, Temer could be brought into disrepute. This could potentially lead to political polarisation in Brazil, creating huge political challenges. This alongside the potential failure of reforms presents a major risk in Brazil. There are opportunities as well as problems surrounding the 2018 election, but if it goes the right way it could trigger the rebirth of Brazil and push the country towards a brighter future.



India, its demonetisation and the banking sector

Danielle Cuaycong

Ranked as the fourth fastest growing economy in the world, keeping up with India is no easy feat. With the IMF predicting that the Indian economy will achieve growth of 7.2% in 2017-18, the Indian banking sector’s potential and ability to uphold this high value of GDP has raised questions. Despite India’s demonetisation act, which resulted in the removal of $239.5bn of Indian Rupees out of circulation, leading to a short-term credit crunch and a decrease in consumer demand, the IMF has also predicted 7.7% growth in 2018-19 and 8% the following year. Alongside this, the Goods and Service Tax (GST), which was implemented on July 1, 2017, has evidently had an effect on the financial services sector due to the decrease in profits.

In November 2016, Narendra Modi’s decision to remove bank notes with denominations of 500 and 1000 rupees as legal tender led to an 86% fall in M1 circulation. The aim here was to abolish black money, remove money laundering, destroy counterfeit currency and promote the digitalisation of Indians finances. However, the news of this impelled fear and anxiety in India, prompting consumers to save and accumulate all of their money, dampening consumer demand and business confidence. Annualised GDP growth fell to 6.1% in Q1 2017 and credit growth decreased staggeringly from 12.1% to 5.4% (from a previous 10-year average of 12.3%). Furthermore, the advanced tax collections during this time period increased by 41.8% over the 1-year period, as a larger number of individuals filed their tax returns post demonetization. Although the economy undeniably experienced negative effects, black money still remains in the system, indicating the failure of the banking system to cure this issue.

However, there are evidently benefits of this demonetization. Firstly, the push for a digital economy seems to be materialising, as India’s internet penetration is expected to grow by 40% over the next five years. With over 1 billion mobile phones in India, e-commerce and mobile transactions are deemed to be of the utmost priority. This is evident in the spike in usage of debit and credit cards post-demonetisation. As for banks, the deposits of large sums of notes has led to an accumulation in bank’s asset bases, compelling further loan growth. Thus, the increase in credit will decrease the cost of capital, leading to more businesses borrowing and investing in factors of production. On the other hand, observing the asset quality will be key for the banking sector. Despite a large amount of credit being returned into the system, India’s non-performing asset (NPA) issue has placed a great pressure on GDP growth and will impact the financial stability of the banking sector in a negative light.

It is palpable that the Indian banking sector will be able to maintain this momentum of increasing economic growth in the medium to long term. However, the extent to which the Indian economy will be able to maintain this is dependent on the digitalisation that banks will encounter, particularly in private sector banks.


The lasting impact of Michel Temer

Danielle Cuaycong

With a weak 3.4% approval rating and corruption charges, the President of Brazil, Michel Temer, seems to have a limited period of time left in office as the head of state. However, his impact may be felt for a longer time, as the policies he has implemented may leave an indelible impact on Brazil’s economic development.

Last December, the Brazilian Senate passed a 20-year public spending ceiling to mitigate the increasing budget deficit, in an attempt to save Brazil’s hindered economy which had been left severely damaged by the economic recession. With the obvious expectation that this is affecting those at the lower end of the pay scale, Temer implemented a series of privatisations to effectively address the budget deficit and bring about an increase in productivity. By selling a large stake in Electrobas, Latin America’s largest utility company, and having future plans to sell airport licenses in Salvador and Porto Alegre, oil and power rights and toll roads, Temer’s attempt to plug the budget deficit may seem rather genuine. In increasing the level of privatisation in Brazil, there are potential benefits of improved efficiency and increased competition, alongside the increase in revenue from the sale of the state assets. This adds to the image of Temer actually having the right of authority due to the enhancement of Brazil as an investment destination for international investors.

However, one must note that although the considerable privatisation in Brazil may lead to increases in efficiency and higher tax revenues, the severe corruption in Brazil may prompt issues regarding the regulation of the private monopolies and the fragmentation of industries.  Furthermore, if Brazil does not see higher tax revenues, the country will be forced to sell off more state assets, worsening the situation entirely due to a widening budget deficit which stands at 157.7 billion Brazilian Reals (c. £36.8bn).

With the election looming and Temer having decreasing approval ratings, the fundamental issue is that the left-wing opposition to Temer’s PMDB may be the ones to take control of Brazil.  Previously, Luiz Inacio Lila Da Silva, the Brazilian President between 2003 and 2011, had a different, market-friendly approach, albeit with significant corruption allegations.  Whilst he may not return, it is evident that there is a significant gap in the market that whoever chooses to oppose Temer will use an anti-privatisation and anti-austerity approach will appeal to the masses.

China’s indebted economy

Oliver Dyson

Following the 19th Communist Party Congress, there are rising concerns about the sustainability of the Chinese economy, based on fears of China’s increasing dependence on debt. Zhou Xiaochuan, governor of the People’s Bank of China (PBOC), has warned of a potential ‘Minsky Moment’ in the near future, a term used to describe a sudden market correction following periods of exuberance and optimism. Indeed, total Chinese debt stands at around $28 trillion, or 260% of Chinese GDP (debt was only 148% of GDP at the end of 2007). To explain this ‘debt explosion’, we need to look back to the 2008 global financial crisis.

The PBOC’s response to the 2008 crash was to supply a wave of cheap loans channelled through the state-owned banking system, which worked by propping up the economy, holding growth rates steady at 7-9%. Now, however, the level of corporate debt is reaching a 5-year high, with consumer debt rising quickly. The IMF called on China to reduce this “dangerous” level of debt, while credit-rating agencies such as Moody’s and Standard & Poor’s both downgraded Chinese sovereign bonds earlier this year, citing excessive debt growth as the primary reason.

Deleveraging and tighter regulations were two key themes in Xi Jinping’s message to the Congress; the PBOC is expected to increase borrowing costs, or roll out more deleveraging measures by the end of this year. Indeed, Chinese state news agency, Xinhua, has described recent reforms as a ‘regulatory windshear’, with policies focused on targeting complex high-yield products from the shadow banking sector. The China Banking Regulatory Commission (CBRC) has stated that it will “thoroughly examine and rectify the problem of transactions with too many participants, complex structures and excessively long chains, which causes funds to ‘take leave of the real and enter the virtual’.”

At the same time, corporate bond yields have been on a steady, dizzying climb. The yield on AAA bonds has risen to 4.9% on 30th October, their highest level since 2014, while the spread between these notes and sovereign debt is looking increasingly high (with 10-year sovereign bonds on a yield of 3.93% at the time of writing). Markets have been reflecting this anxiety increasingly, shown by Zhou Xiaochuan’s concerns about high corporate borrowing on 15 October sparking a 16 basis-point rise in the yield on corporate securities this month.

As a result of rising corporate bond yields, Chinese companies are seeing costs rise, triggering mounting concerns over defaults across the commercial sectors. Just on Monday ‘Dandong Port Group Co.’ failed to pay some of the principle on its bonds due to rising borrowing costs, forcing rates and worries higher still.

An interest rate rise is also looking plausible as the economy reaches 6.8% growth (exceeding Beijing’s target) and a potential property bubble looms. House prices last year grew at a rate of 8.3%. Yet, regulators have also been cutting back on mortgage lending while forcing tougher regulations on borrowing, such as the PBOC banning down payments being funded through peer-to-peer lending. This may have cooled off the house price boom in the short term, but there are still many doubts about the wider financial risk in the economy. A potential interest rate hike – up from the current bank rate of 4.35% – could in fact be a triggering factor needed to deflate the housing and lending boom.

Of course, while the next few months and perhaps years will involve deleveraging and reduced lending, there may not be an ugly market correction. On Monday the PBOC eased some fears by injecting Rmb300bn ($45bn) into the banking system through reverse repos. Sovereign 10-year bond yields fell from 3.98% to 3.92% as a result. Clearly the central bank is looking for an easy deleveraging to not spook investors against the gloomy backdrop of a property boom, high indebtedness, high borrowing costs and stronger financial regulation.

The short-term forecast for China is not looking good, but all depends on the PBOC’s ability to deleverage the economy whilst maintaining growth and confidence. Of course, investors may need to factor in higher market and systemic risk for the coming months.

The rise of the Asian Billionaire

Harry Jones

Asian billionaires now outnumber US billionaires for the first time in history. The UBS Billionaires Insight Report has revealed that a new billionaire is created in Asia every 3 days. This growth has been led mainly by China, with Hong Kong and India following closely behind. The US has recently witnessed slow growth in billionaires with the billionaire population only growing by 1% in 2015, signalling a major slowdown.

This growth in the number of billionaires comes from the emergence of growing markets within Asia. Young business-people have moved into industries such as technology, consumer retail, and real estate in order to make their new wealth. In 2014 and 2015 China accounted for 69% and 71% respectively of Asia’s new billionaires. China’s rapid growth, increasing urbanisation and consumer spending created a business-friendly environment, allowing businesses to grow rapidly.

However, as always, there is a risk in Asia that this growth could come crashing down. Political uncertainty, asset price volatility and government scrutiny represent the greatest threats to this new wealth.

There are three main factors behind the growth of Asian billionaires. Firstly, political and economic uncertainty in Europe has meant that Asia has been seen as a safer environment for new businesses. Asian entrepreneurs have been able to use this stable environment to rapidly grow and develop new businesses. As aforementioned, another key factor has been the emergence of new growing markets where wealth can be generated quickly. Capital and labour-intensive industries are no longer the main drivers of wealth; industries such as technology have provided key opportunities for entrepreneurs. Finally, Asia’s views on new businesses give them a greater chance of success. The overall preference to publically list young companies means that they can ascend much more quickly than businesses in the US or Europe.

One place where the presence of new Asian billionaires has become increasingly obvious is within the football industry. The emergence of a growing number of Asian owners of various football clubs in as an example of the growth in Asian billionaires. Owners such as Vichai Srivaddhanaprabha at Leicester City show how Asian billionaires are having an increasingly large influence on today’s society.

Despite having a lower number of billionaires, the US still controls a higher proportion of the world’s wealth. However, if the growth in Asia continues at the same rate, the US could be overtaken in as little as 4 years. This could show the swing in power from West to East that we are witnessing with the ascension of China. All that remains to be seen is whether this growth continues and if China becomes the world’s leading economy.

Russia finally back on track

Jan Globisz

On March 17th, Moody became the last of the “Big Three” credit rating agencies — alongside S&P and Fitch Ratings — to improve Russia’s short-term credit rating, upgrading it from ‘negative’ to ‘stable’, mentioning both a fiscal strategy — that is expected to lower the country’s dependence on energy and replenish its savings — and the gradual economic recovery.

Last year, both Fitch and S&P credit agencies upgraded the Russian bond ratings from “junk” to an “investment” grade. Generally, they are bonds that are judged by the rating agency as likely enough to meet payment obligations that banks are allowed to invest in them. Ratings play a critical role in determining how much companies and other entities that issue debt, including sovereign governments, have to pay to access credit markets, i.e., the amount of interest they pay on their issued debt.

Russia’s deficit-to-GDP ratio is now forecast to narrow by roughly one percentage point per year between 2017 and 2019 and Moody’s said this new target was “achievable” because the government’s “oil price and revenue assumptions are sufficiently conservative”. In December, Russia’s Finance Minister Anton Siluanov said that the economy could surprise next year by accelerating growth to 1.5%, a small but at last a positive result.

Yet this recovery is linked almost entirely to short-term external factors rather than long-term fundamentals. Oil prices, Russia’s economic lifeblood, are up about 50 per cent from a year ago. Little surprise, then, that equities and the rouble should have strengthened.

Russia overtook Saudi Arabia as the world’s largest crude producer in December, when both countries started restricting supplies ahead of agreed cuts with other global producers to curb the worst glut in decades. Russia pumped 10.49 million barrels a day in December, down 29,000 barrels a day from November, while Saudi Arabia’s output declined to 10.46 million barrels a day from 10.72 million barrels a day in November, according to data published Monday on the website of the Joint Organisations Data Initiative in Riyadh. That was the first time Russia beat Saudi Arabia since March. The U.S. was the third-largest producer, at 8.8 million barrels a day in December compared with 8.9 million barrels a day in November.

At the same time, the Top South Korean refiner SK Innovation Co. is set to receive about 1 million barrels of Urals crude in its first purchase of the Russian blend oil in a decade. The shipment was made viable because of rising costs for rival supply from the Middle East, as nations such as Saudi Arabia curb output to comply with a deal between global producers. It is said that the new economic environment will see a change to the oil trade patterns, with more and more shipments from Russia going to the South-East Asia region.

The fundamental problem. however, is that domestic and foreign investors, uncertain about Russia’s prospects and protection of property rights, are not putting sufficient capital in new capacity or productivity improvements. Investment is running at about 20 per cent of output. Mr Putin pledged in 2012 to lift it to 27 per cent.  To address the investment problem, Russia needs not just long-delayed structural reforms, but sweeping institutional changes to boost political competition and rule of law, and to establish an independent judiciary. Perhaps the ratings will help to reshape that landscape in the future as well.


The Russian Bear Awakens

Matthew Evans

Russia seems to be finally emerging from the severe two-year recession that began amid the collapsing oil price and Western sanctions imposed in 2014. According to Russia’s statistics service, GDP contracted by just 0.2% in 2016, lower than anticipated. Economists at Citi have added to the more upbeat mood, saying that the Russian economy is entering 2017 with strong momentum, and have predicted GDP could rise by 2% this year, which compares favourably to the government’s baseline forecast of 0.6%.

These signs of economic recovery strengthen the hand of President Vladimir Putin in the lead up to next year’s presidential election. Also, there appear to be signs that the Russian state has weaned itself off dependence on a high oil price. The Central Bank of Russia has predicted that the economy will be on the positive side of growth even if the price of crude oil falls to $40 per barrel. In the meanwhile, Putin has said that the national budget for 2017 was pegged on oil priced at around $40 per barrel.

Despite the improving economic situation, any euphoria from Mr Putin would be misplaced. The World Bank is currently projecting growth rates of 1.5% to 1.8% over the next three years – well below the global average, and nowhere close to the 7-8% growth that was typical of Putin’s first two terms in office. This will limit his ability to restore the domestic bargain by which Russians accepted the loss of political freedom in exchange for a rapid expansion of living standards.

Although Western sanctions and the collapse in oil prices sparked the recent recession, the deep underlying issues with the Russian economy are home-grown. Russia has a business environment that stifles enterprise and deters investment, due to the weakness of property rights and uncertainty over the rule of law. For example, business people are reluctant to start new businesses or expand existing ones in case they catch the attention of criminals who use powerful connections to seize businesses. This has become a widespread practice called ‘reiderstvo’. This is in stark contrast to the Western corporate raiding, whereby hostile takeovers are pursued by legal means; reiderstvo relies on a mix of corruption and criminality.

Recently, President Putin has appointed Alexi Kudrin to come up with a new economic strategy. Mr Kudrin is a former finance minister who oversaw strong economic growth in the early 2000s before resigning in 2011. His verdict has been harsh; he has pointed out that Russia is at a low pace of economic growth even compared with the stagnation of the 1980s that led to the break-up of the Soviet Union.

Rather than blame the Western sanctions, he identified the cause of this poor economic performance as structural and institutional. Mr Kudrin has argued that deep reforms are needed, particularly to the judiciary. Courts must provide justice even when that requires ruling against the state or security services. He has presented the government with a choice. If it does nothing, assuming oil prices do not fall, he estimates the economy will grow at around 2% per year between now and 2035, resulting in almost no convergence with Western countries. However, if it implements his reforms, growth rates could top 4%, which would be enough to gradually close the income gap with the Western world.

Despite this assessment, Mr Putin’s government is unlikely to adopt liberal reforms when its elite believes that liberalism is on the retreat and a new Russian model is on the rise. The election of Donald Trump, and the possibility of nationalists such as Geert Wilders and Marine Le Pen gaining power in Europe, has convinced many in the Kremlin that things are going their way. The President is confident that he has that he has earned the unwavering support of his people, and no longer needs to reinforce his standing through a strong economic performance. Sadly, with barely any opposition in Russia, the people don’t have much chance to prove him wrong at the ballot box.