Name: Maria Medvedeva
Subject: Russian economic crisis of 2008-2008: monetary and fiscal responses.
As an owner of a manufacturing company in Russia, I have been under tremendous pressure for the past two years
being unable to cover expenses and having to lay off employees, being unable to pay loan installment payments for
machinery bought from UK and having to restructure the debt, and facing a decline in sales 30% year over year. In
the midst of the crisis, our company was downsized from 280 to 160 employees and also deployed “part time” work
and commission only compensation structure for sales and bonuses for lead generation. The Central Bank of Russia
micro-economic decisions of controlled ruble devaluation and increased interest rates impacted our ability to pay
loan installments to creditors, as our income was in ruble and payments in foreign currency. The company
experienced a downturn and at that time the monetary policy of CBR appeared to be counter-productive vs. mature
Central Banks offering support through low interest rates. To understand the Russian government responses to the
economic crisis, this paper will analyze Russian economic situation starting from overheating in 2007, following on
to the double shock of funds outflow and oil price collapse in 2008, government fiscal and monetary responses in
2009 and the recommended short and long term steps for 2010.
1. Economic Situation in Early 2008: Signs of Overheating
After the start of the global crisis in 2007 into the late months of 2008, Russian economy was sustaining a strong
growth with considerable foreign capital inflows, high consumption rates, low unemployment and booming
According to the World Bank, the real GDP growth was climbing steadily from 7.4% in 2006 to 8.1% in 2007 and
expected Q42008 target of 8.7%. These numbers were partially due to the increased consumption through wages and
lowest unemployment since 1994. Various industries reported increases in wages starting from construction, retail
and public sectors. Comparing to the lows of $179 in 2003, the numbers reached $649 in 2008. Unemployment was
lowest since 1994 at 6.1% in 2007 with expected target of 6.9% in 2008. Real estate prices sky-rocketed to a range
of $5,000 to $15,000 per sq meter in Moscow as compared to an average of $1,000 in markets of US.
Banking sector “easy” lending policies and government fiscal policy aimed toward investment in infrastructure led
to the improvements of roads and continuous construction to satisfy population needs. As demand grew in corporate
and public sectors, so did the debt built up from massive consumption. Public debt tripled over 2005 to reach
$275bn in 2007. Banking sector loan portfolios increased to 36% of GDP; and this rapid growth in credit led to high
earnings with average return on equity reaching 26% in 2008 from 18% in 2006. Russian citizens living abroad
started to pour savings into the Central Bank of Russia savings. Oil related revenues not only led to high liquidity
in the financial sector but also in the increase in imports of foreign goods such as bread and bakery products, milk,
meat and fruit/vegetables. High prices of imported food and real estate material caused inflationary pressures with
CPI index rising from 11.9% in 2007 to 13.3% in 2008.
Considering that wage rise did not match productivity growth, real estate prices were outpacing the inflation and
deepened non-oil current account deficit, many economists saw early signs of overheating. The drive behind this
phenomenon were Russian government policies of fiscal and monetary easing and excess liquidity from oil revenues
and foreign direct investments.
The Central Bank of Russia heavily resisted appreciation of ruble with monetary interventions and low interest rates
encouraging capital inflows and foreign borrowing. The policy was set to monetary easing and domestic expansion.
Monetary easing caused money supply to grow to 44% in 2007 and exports to increase by 50% to $108bn from
$71bn in 2007. Government fiscal spending in 2007 was significantly higher with revenue at 38.5 % of GDP and
expenditures at 33.7% in 2008 vs 40.2% , 34.1% respectively in 2007. Since the inflation was on the increase due
to the fiscal and monetary easing, Russian government undertook a tightening in February 2008 by increasing the
refinance rate from 10% to 10.5% and raised reserve requirements on nonresident banks from 5.5% to 7%. As oil
revenues were high, foreign funds poured into finance, infrastructure (electricity, gas, water production and
distribution), extraction of mineral resources, and transportation and communication sectors. Rosstat, a Russian
Government Center for Statistics, announced that per capita FDI rose sevenfold to $369, reaching beyond BRIC
countries average. To compare Brazil had FDI of $182 and India of $22 per capita. FDI flow into Russian economy
was recorded at $27.8 billion in 2007 vs $6.8 billion in 2003.
2. Mid 2008-2009: From Overheating to a Deep Crisis
The crisis hit Russia in the fall of 2008 with a sharp outflow of funds and mounted reserve losses due to the collapse
in the oil prices. The capital outflow was caused by a reverse in exchange rate expectations leading banks to hedge
their foreign currency exposure as foreign investors exited the country. This outflow reached $131bn in Q4 2008
through portfolio withdrawals, holding of foreign currency and rising bank net foreign positions. Nonfinancial sector
experienced withdrawal of $72.5bn while financial faced $58bn of outflows. During mid 2008 oil prices reached the
rates of 2006 and volume drastically declined. This cased current account surplus to contract to (- $45.4)bn in 2008
from a positive $148bn in 2007. Public and government consumption also dropped to 2% of GDP down in Q4 2008
from 7% in Q4 2007. Due to the internal and external exposure from holding of foreign assets, the tinancial system
was on the verge of collapse. As the demand sources of Russian growth consist of net imports, inflows (investments)
and consumption, its economic position become highly vulnerable.
As World Bank report suggests, the Central Bank of Russia deployed a three step process for recovery from these
shocks: accommodation, devaluation and tightening, and gradual easing. During the accommodation stage
significant liquidity was poured into the system starting September 2008. This was accomplished through CBR non-
collateralized lending facility, Ministry of Finance deposit auctions, purchase of toxic assets, injections into the State
Mortgage Agency and bank recapitalizations at the amount of $4,301bn with actual utilization of $2,708bn by mid
2009. Additionally, interbanking lending guarantees and deposit insurance were introduced to bolster confidence in
the banking system. To control the pressure on the currency the CBR spent almost 1/3 of its foreign currency
reserves buying the ruble, but this set expectations of further depreciation and pushed consumers and companies to
start converting their savings into foreign currency. Overall the excess liquidity fueled even further capital outflows
with loss of reserves equating $200mn since August 2008.
The output also sharply contracted in November 2008 with labor productivity growth being at low of 1.4% over the
rest of the 2008 at 5%. Unable to borrow companies started to develop programs for employee dismissal through
unpaid packages that surged unemployment to 7.1% on Q4 2008 vs 6.3% in 2008. Real disposable income also
declined to a negative (- 5.6)%. Corporate and consumer confidence started to erode with small and medium
business going bankrupt. From the financial standpoint, the crisis deepened with credit indicators at negative
nominal growth in foreign lending and drying up deposits. The situation came close to the Russian economic crisis
Facing this fact the CBR started a policy of tightening and “controlled devaluation” in December 2008. It declared
that the ruble would be defended against a unilateral basket of 45% EUR/55% USD with the lower bound of
RUB41. To cut on liquidity interest rates were raised reaching 27% in overnight interbank rates. The economy
entered a spiral as most companies were not able to borrow short term or maintain previous credit lines under the
same conditions. Debt restructuring became important for survival of most businesses. At the same time from
economic standpoint this intervention helped to stabilize ruble velocity, stop outflows and slow down the pace of
reserves loss. In fact, the pressure on exchange rate eased and reserves leveled at $380bn in February 2009.
By June 2009 the CBR deployed the last step of “slow monetary easing” and repo rates came down reaching 8%. As
the oil price rose the ruble appreciated in nominal terms and conditions of interbank lending have improved with
banks repaying uncollateralized loans at faster speed than expected. While the inflows renewed into manufacturing,
extraction, trade and real estate sectors with FDI being at $3.2bn in Q1 2009, the sectors continued to sharply
contract. Decline in transportation and other manufacturing ed to a large contraction of tradables at (-9.80)% in Q1
and (-10.5)% in Q2 2009 ; while non tradable sector inclusive of finance and demand sensitive industries had a
lesser exposure a with a decline to (-6.2)% in Q1 and (-6.5)% in Q2 2009. Despite some turnaround signs, reduction
in sectorial output led to high unemployment at 13% in 2008. The consumption was holding steadily until the Q4
2008 when it grew to 8% but then started to decline sharply amid deterioration in employment and confidence. The
weak consumption, low inflows and collapsed industrial output led to a sharp economic contraction and a decline in
various production sectors in Q1 2009.
3. The Stabilization Period: Mid 2009
While the Q1 of 2009 faced a decline of output, as the world commodity markets and stock market started to
improve, Russian economy cyclically followed the same trend. The CBR continued to reduce interest rates reaching
a repo rate at 6.75% and refinance rate at 9.5%, which lowered CPI inflation to 8.1% for the three quarters. To
maintain a tradeoff between competitive exchange rate and inflation, the CBR invested heavily in buying foreign
currency and topping its reserves to $434bn in Q3 over $384bn in Q1 2009. This helped to keep ruble appreciating
against the dollar and the currency basket.
By Q3 all main areas of real GDP growth including net exports, consumption and investments have shown signs of
recovery and pushed GDP upwards from (-9.8) % in Q1 to (-9.4) %. This modest improvement occurred primarily
from increase in net exports of oil related products. Companies such as TNK BP and Lukoil benefited from
instability and ruble depreciation by selling in foreign currencies and paying their own expenses in rubles. As prices
for oil started to recover, government trade balance also grew to $31.4 in Q3 2009 vs $19.1bn in Q1 2009. The
worldwide demand for oil set the expectations of rising oil prices, which also improved investor appetite for Russia,
and drove investments of $207bn. Comparing to the last years’ inflow of $340bn, current number represents a drop
but it definitely shows an interest in risky emerging markets. The weakest area was household consumption which
dropped significantly adding 3 points to the aggregate contraction of GDP. Contrary to this government
consumption increased as a result of the fiscal stimulus package.
Looking at the real GDP from the sectorial prospective, we are seeing marginal improvement in tradables and
continuous decline in nontradables. The tradables sectors with manufacturing and extraction industries being the
leading have demonstrated the signs of upward progression. On contrary, the nontradables including retail,
transportation and construction have been contracting with prime example being a temporary closure of car parts
manufactures. This is partially due to the tightened lending conditions despite the CBR’s “eased monetary” policy
and decreased interest rates. Banks continue to be risk averse and keep capital slowly available with lending being at
$8bn up to Q3 2009 vs $20bn average in 2006-2008.
On a positive side as the industrial production started to improve, unemployment also lessened to 7.9% in Q3 vs
9.1% in Q1 2009. Composition of employment changed significantly to have reduced working hours and lower
wages, as employees preferred paycut to layoff. The Russian government has also applied fiscal programs to
facilitate introduction of flexible working regimes, on job training and help for employees to transfer to jobs to other
sectors. These programs valued at $1.4bn focused on enterprises that already had employed personnel and needed
support to keep retaining them.
4. Next Steps and Recovery Strategies for 2010
From 2008 through the Q4 2009 the Russian economy contracted due to the fall in oil prices and outflow of foreign
capital. Since the currency is strongly dependant on these components, Russia came under a threat of the currency
devaluation similar to the crisis of 1998 . The CBR applied a twofold technique of increasing interest rates to stop
outflows and pouring the funds to defend the ruble against a bilateral basket of EUR/USD. While both actions
succeeded and stopped capital leakage, the effect of the global financial crisis started to take place with banks unable
to restructure and rollover the debt and various sectors reporting high unemployment. As banks became risk averse,
credit flow stopped and overdue loan numbers started to increase. In mid 2009 the government applied large fiscal
stimulus and eased monetary policy to increase consumption, facilitate lending and invigorate business activity.
While the overall steps of the CBR were reasonable, the next step should be planning of the exit strategies and
control of the government and public expenditures, and reduction of fiscal deficit. Additionally the CBR should
apply the following short term and long term steps to drive strategic sectors upwards and improve consumption:
Short Term Reform Recommendations
1) Include support of Small and Medium businesses with tax reduction in the fiscal stimulus package to
invigorate trade and retail sectors.
2) Help in decreasing poverty through child allowances, pensions and unemployment benefits as a part of
fiscal stimulus to increase consumption
3) Offer direct Central Bank assistance to manufacturing entities through loans and grants to improve export
and reduce unemployment.
Long Term Reform Recommendations
1) Develop a counter-cyclical economic policy without heavy dependence on foreign funds inflows and high
2) Improve the investment laws to strengthen governance, eliminate bureaucracy, paperwork and
inefficiencies that cause corruption.
3) Redesign Russian accounting system to match to GAAP or other international standards to improve
transparency and help banking sector in modernization
While the government actions appeared to be challenging to small businesses during 2008-2009, from the economic
standpoint the CBR took correct steps to overcome the crisis and to avoid total collapse in output. The current fiscal
and monetary policies are properly set for economic recovery and growth. The recommendations above are given to
ensure the future growth and continuous prosperity of the country.