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'Worst Is Yet To Come' For Russian Financial Sector

Moscow traders have seen worse -- so far.
Moscow traders have seen worse -- so far.
The dismal financial news out of Wall Street is being felt not just in the United States but across the world as nervous global markets absorb the aftershocks of failing financial institutions with tens of billions of dollars in assets.

Perhaps nowhere is it being felt more acutely than in Russia, which has seen its benchmark stock index drop by half since May. Anders Aslund is a senior fellow at the Peterson Institute for International Economics in Washington who has served as an economic adviser to the governments of Russia, Ukraine, and Kyrgyzstan. He is also founding director of the Stockholm Institute of East European Economics.

RFE/RL correspondent Heather Maher asked Aslund what's behind Russia's financial woes and how the U.S. market crisis might compound them.

(Editor's note: Since this interview was conducted and posted, trading was suspended on Moscow's stock exchange amid sharp declines and furious efforts to boost Russia's banking sector.)

RFE/RL: Writing in "The Moscow Times," you said on August 8 that Russian Prime Minister Vladimir Putin "made his greatest strategic blunder" and single-handedly "wiped out a half a trillion dollars of stock market value, stalled all domestic reforms, and isolated Russia from the outside world." Explain that stock-market loss part.

Anders Aslund: Well, what happens when you start an aggressive foreign policy is that you also start an aggressive foreign trade policy. And you block domestic economic reforms. And you sharply increase the political risk in your country. And UBS [United Bank of Switzerland] has assessed that this increase in the political risk means that stock prices should be 20 percent lower -- that's $300 billion right off there, off the stock market. The bond yields that are demanded now for loans to Russia are 2-3 percent higher than a month ago.

RFE/RL: You also write that, despite what happened in Georgia, the Russian economy has been headed for a slowdown for some time. Why?

Aslund: Well, it's at the end of a business cycle, the oil price has fallen by one-third, and the Russia economy suffers from massive overheating. So that's the time when you really need reform, and then Putin is turning his back on it.

RFE/RL: Russia has made it an official goal to reach half the U.S. per capita GDP by 2020. You don't think this is going to happen. Why not?

Aslund: I would say that I think that the most important [factor] is the combination of massive corruption and [the] inability to build infrastructure when the need is at its greatest. Russia today can't build motorways; they can't build pipelines. And they need some of them very badly. The traffic chaos in Moscow is just characteristic of the main problem in Russia today.

RFE/RL: Russian President Dmitry Medvedev and Prime Minister Putin have differed publicly about what they blame for the Russian financial crisis. Medvedev has connected it more strongly to the invasion of Georgia, but said, in effect, it was worth it. Both men, though, have also blamed the international financial crisis for Russia's problems. What's the biggest cause in your opinion?

Aslund: Of course, you have a multiple impact. So you can say that the overall causes of the decline in Russia that we have seen on the stock market is first the general economic slowdown, including the [global] financial crisis; the second is the falling oil price; the third is Putin's attack on [mining and metals company] Mechel, which sharply took down the Russian stock market; and then the war in Georgia. These are the four direct causes if you look at the stock market specifically.

RFE/RL: The last 36 hours in the United States have brought very bad news from Wall Street about two major financial securities firms: Lehman Brothers declared bankruptcy and Merrill Lynch was sold to Bank of America. By the end of trading on September 15, the U.S. stock market was down more than 500 points, its worst daily loss in seven years. How is this turmoil going to affect the rest of the world's markets?

Aslund: Well, it's the old [saying] that when New York has a cough, more vulnerable parts of the world get pneumonia. Russia is far more vulnerable than it thinks it is. Or the government thinks it is.

RFE/RL: What do you think Putin and Medvedev will do to reassure nervous investors and try and stabilize financial conditions internally?

Aslund: The question is [whether] they start doing any reforms or not? That's the big question.

RFE/RL: And you don't think they will?

Aslund: At least not for the time being. So the question is if they would really seriously rethink what they are doing because to say no to the World Trade Organization [WTO], as Russia has done now, is a serious blunder and if you look upon the three biggest problems with Russia entering the WTO today, two of them are Georgia and Ukraine. So Russia is not prepared, for political reasons, to resolve that.

Russia's isolating itself politically and you see this, this extraordinary crudeness [with which] Putin and [Foreign Minister Sergei] Lavrov talk to everybody. And that of course means that people are less inclined to deal with them. Each crude statement by Putin and Lavrov now increases the political risk for Russia. And also that Russia now repeatedly promises things and doesn't do [them]. It means that Russia's word is today considered to be worth nothing whatsoever. And that's Russia's problem, rather than anybody else's problem.

RFE/RL: What about in the former Soviet region -- do you see Russia's financial problems reverberating throughout those countries?

Aslund: The big problem in the region is inflation, which is on average 15 percent and to a considerable extent, with a poor exchange-rate policy. In fact several countries have fixed exchange rates, and thereby they are importing inflation, which there is no reason for them to do.

RFE/RL: How will the average person in these countries feel the impact of the financial turmoil?

Aslund: Well, the big question is how much growth will fall, when the two phenomena come together -- the economic slowdown in the world and inflation? And so far we have seen the Central Europeans are going through this splendidly. But the Baltic countries are suffering quite badly. And Kazakhstan is suffering a substantial decline in growth after having seriously mismanaged its macroeconomics in the last couple of years.

And the question -- what will happen to Russia and Ukraine? -- is still up in the air. When a big boom is ending, that's when the quality of your economic policy is being proved. And any serious mistake costs a lot.

RFE/RL: Finally, where do you see things going from here? Will they get worse before they get better?

Aslund: Oh certainly, they will get much worse. We have hardly seen the growth slow down in the CIS countries as yet. Russia and Ukraine are still at top growth rates. I think that we will see a substantial decline in Russia's growth rate pretty soon. And how big depends on how bad the economic policy is.