Crashed
Page 60
The crucial question was whether Europe would throw its weight behind America’s sanctions. Russia-EU trade was ten times larger than Russia-US trade. The EU received 41 percent of all Russia’s exports. This gave the EU considerable leverage, but also meant it had more to lose. German corporate leaders and senior politicians, such as ex-chancellor Gerhard Schröder, continued to cultivate friendly relations with Putin even as Russia’s troops made incursions into Ukraine. France had two big aircraft carriers on order from Russia. Italy’s energy corporations were deeply entangled in Black Sea projects. London, the playground of the oligarchs, was the place to make sanctions tell. The Cameron government talked a good game, but was less quick to act. Nor was it merely economic interests that were at stake. In Germany there was deep skepticism about any overhasty alignment with the United States.52 Since the summer of 2013 the NSA spying scandal had cast a deep shadow over German-US relations. A year later, the percentage of Germans who saw the United States as a “trustworthy partner” was down to 38 percent, numbers last seen in the Bush era.53 Whereas 68 percent of Americans favored extending NATO to Ukraine, 67 percent of Germans were against it. Likewise, 63 percent of Germans rejected EU membership for Ukraine.
To the indignation of right-wingers in Congress, all that the EU could agree to were individualized sanctions against eighteen leading Russian figures. Senator John McCain was moved to declare, “If the Europeans decide that the economic considerations are too important to impose severe sanctions on Vladimir Putin . . . then they are ignoring the lessons of history.”54 Appeasement had failed against Hitler in 1938. It would fail against Mr. Putin. In May transatlantic tensions were mounting to such a pitch that Merkel and Obama hastily convened talks in the White House. Merkel had no doubt about the need for action, but she could not ignore European public opinion, and McCain’s outbursts were not helpful. The two agreed that Obama would restrain the American hawks while Merkel moved to build a consensus in Europe around tougher measures.
In the meantime, if no military aid was forthcoming and only minimal sanctions were applied to Russia, would the West at least provide generous financial support to Ukraine? Just to meet its outstanding obligations, the new government in Kiev estimated that it needed $35 billion over two years. That was not far off the estimates presented by Yanukovych’s regime six months earlier, which had been rejected out of hand. In March 2014 Kiev put in a request for $15 billion from the IMF. The Obama administration backed the appeal and sought to leverage it to break the deadlock in Congress over IMF reform. The administration linked a $1 billion loan guarantee for Ukraine that was popular with the Republican right wing to a proposal to unblock IMF funding.55 The Ukraine crisis was a clear demonstration, the White House insisted, of the IMF’s strategic importance to the United States. Globalist critics of the IMF pounced on the pronouncement.56 The subservience of the IMF as a tool of US policy stood starkly revealed. Except that the Republicans in Congress did not agree. They cut out the IMF funding proposal.
Lagarde and the IMF soldiered on without America’s full backing.57 For a well-run country, at peace and with the institutions to make the most of its ample endowments, Ukraine’s debt burden would have been far from excessive. But Ukraine was none of those things. Given the huge political uncertainty, the insecurity produced by Russian intervention and its weak institutions, there was, in fact, a strong case to be made that Ukraine’s debts were insupportable. Ukraine was insolvent and its debt should be written down. That would have been IMF protocol. But Ukraine was no ordinary case. In 2010 Greece had been funded under the “systemic exemption.” The risk of financial contagion justified an unsustainable bailout. In April 2014 in Ukraine, systemic risk was recast in geopolitical terms. The IMF’s main shareholders did not want to see the embattled pro-Western regime in Kiev declared bankrupt within weeks of an anti-Putin revolution. So despite the obvious risks and despite Ukraine’s appalling track record of program compliance, the IMF plunged in once again. Out of enthusiastic talk of reform and overoptimistic assumptions about economic recovery, the IMF concocted a scenario that allowed it to lend Ukraine $17 billion over two years. A further 11 billion euros would come from the EU and $1 billion in loan guarantees from the United States. Japan chipped in too. In addition, the EU agreed to take 98 percent of Ukraine’s exports tariff free. Visa-free travel was envisioned for 2015. For the winter, the EU promised to backstop Ukraine’s energy supplies by providing a flow of gas through Slovakia, Poland and Hungary.
It was a substantial commitment. But it fell well short of what Ukraine needed. The aid from Europe would be stretched over seven years. The IMF loan, as always, came with tough conditions. Gas prices were to be raised by 56 percent and the government payroll cut by 10 percent.58 The foreign exchanges were to be liberalized to allow the exchange rate to adjust to a competitive level, a high-risk operation that was likely to put huge pressure on Ukraine’s banks. The largest risk of all were the military operations in eastern Ukraine. The IMF had never previously lent to a country at war. So in putting together the April 2014 package, the Fund simply ignored the evidence of the escalating conflict. As Lagarde admitted in a press statement, this put the entire program in jeopardy from the start.59 Within days of the conclusion of the financial package it became clear that Ukraine did indeed face the worst-case scenario. Rather than calming, the conflict in eastern Ukraine intensified.60 In early May, scrambling to raise an army, Kiev was forced to reintroduce conscription. As the oligarch Petro Poroshenko took office as Ukraine’s president in the last week of May 2014, he faced the impossible challenge of implementing an IMF austerity program while fighting a war; a war, moreover, that Russia would not let Ukraine win. Kiev’s only hope was that while military escalation placed ever greater stress on Ukraine’s fragile economy, it would also clarify the political stakes of the conflict and suck in the West.
In July a vigorous offensive by Ukraine’s forces was on the point of overwhelming the Donbass rebels. Moscow’s response was to resupply the breakaway militia with heavy weapons. A conflict of small-scale skirmishes was escalating into a more or less openly declared war involving the mobilization of tens of thousands of men, mass displacement and thousands of casualties. On July 17 a rebel antiaircraft battery armed with new Russian missiles jubilantly reported that they had shot down a heavy transport plane. It turned out to be Malaysian Airlines flight MH17, with 298 passengers and crew on board. It was the moral indignation in the aftermath of that outrage that enabled Merkel to push through a much stronger sanctions regime. The EU blocked the export to Russia of any military equipment, oil industry equipment and the issuance of long-term debt in the EU by Russia’s state-owned banks and energy corporations. The United States doubled down by restricting access to capital markets for Sberbank and pressuring ExxonMobil and BP to drop their collaborations with Russian energy partners. But the real thrust of twenty-first-century sanctions was financial. By September 2014 Rosneft, Transneft, Gazprom, Novatek, Sberbank, VTB, Gazprombank and Bank of Moscow, along with arms makers United Aircraft Corporation and Kalashnikov, were all locked out of Western financial markets. Two of the banks most closely linked to Putin and his entourage had hundreds of millions of dollars frozen in US accounts.61
Moscow, for its part, resorted to more classic retaliation. It did not cut off gas supplies. But it issued a blanket ban against agricultural imports from Europe while increasing its military support for the Donbass rebels, who mounted a bloody counteroffensive on August 23–24. With the front line frozen, Kiev was forced to accept a ceasefire brokered in Minsk by Germany and France on September 5. With the new cold war between Russia and the West having escalated into a comprehensive and violent confrontation, it now came down to a trial of strength.
III
Since the shock of 2008, Russia’s official financial position had been rebuilt. In early 2014 Moscow’s foreign currency reserves stood at $510 billion. As in 2008, it was not the state but Russia’s g
lobalized private sector that was vulnerable. Though the oligarchs of course toed Putin’s line, the markets did not lie. The escalation of tensions over Ukraine caused an immediate capital outflow. When the Russian Federation Council, on Saturday, March 1, 2014, gave a patriotic vote of approval for the deployment of Russian troops on Ukrainian territory, it was followed on “Black Monday,” March 3, by a spectacular 11–12 percent market slump.62 For internationalized Russian banks like Sberbank—a giant that controlled 28 percent of Russian bank assets—sanctions created a truly schizophrenic situation. As its CEO, Herman Gref, mused, 50 percent of Sberbank’s freely marketable shares were held by US and British investors, but the bank was now barred from raising funds in the West.63 Perforce, over the course of 2014, Russian companies paid down their foreign debt from $729 billion to $599 billion, with the central bank deploying its reserves to enable the repayment.64 Tension was building, but it was not until autumn that the crisis broke.
The third round of sanctions in the wake of the downing of MH17 bit deep. At the same moment, Janet Yellen’s Fed finally ended QE3, tightening credit conditions around the world. And then cooperation in OPEC broke down. Saudi Arabia ended its production restraint and oil prices collapsed. With or without sanctions, by the autumn of 2014 Russia would have been in serious financial difficulty. The combination of sanctions, Fed monetary tightening and a plunge in commodity prices was devastating. So devastating, in fact, that it has raised the question of whether this conjunction was entirely coincidental, or whether the United States and the Saudis were collaborating to launch a strike against Russia.65
Oil politics are a rich field for conspiracy theory. There certainly are back channels between Washington and Riyadh. Secretary of State Kerry was in the gulf in the fall of 2014. The Saudis had every reason to act, if not over Ukraine then over Syria.66 Along with Iran, Russia was the main backer of Assad’s die-hard regime. Saudi Arabia was its sworn enemy. There is no conclusive proof. Nor is a conspiracy necessary to explain these concurrent events. The oil market was under stress. America’s new fracking technology had opened up a new source of supply that was cheap and highly elastic. From the point of view of the Russian economy, in any case, the ultimate motivation was irrelevant. Oil prices plunged from $112 per barrel in June to around $60 per barrel by December 2014 and kept on falling. On top of sanctions and tightening credit conditions, it was a body blow.
Ruble-Dollar Exchange Rate and Oil Prices
Source: Bloomberg, Global Investors.
In October the Russian central bank intervened heavily to prevent an immediate ruble collapse. But it needed to husband its reserves, and in November it exited the market. Starting at 33 to the dollar before the Ukraine crisis began, by December 1, 2014, the ruble had fallen to 49 against the dollar. This was terrifying for Russian corporate borrowers, who owed $35 billion in debt repayments by the end of the year. There was a scramble for survival. Rosneft, which had $10 billion to pay, was in the market hoovering up euros and dollars.67 The strain on weaker Russian businesses was unbearable. In December, Trust Bank, a high street lender, and UTair, Russia’s third-largest airline, failed, and the central bank was forced to offer guarantees for the entire banking sector.68 On the morning of Monday, December 15, the ruble began to plunge, ending the day down by 8 percent. That night, after a long evening of debate involving Putin himself, the central bank decided that it would hike interest rates from 6.5 percent to 17 percent. The announcement was made at one a.m. It was intended to reassure investors and punish speculators. It didn’t work. It was read not as reassurance but as a sign of panic. As markets opened on the morning of Russia’s “Black Tuesday,” December 16, the foreign exchange market went into free fall. By the end of the day the ruble had fallen to 80 against the dollar. The following day Sberbank came under concerted attack. A million of its customers received text messages from addresses outside Russia warning that the bank was about to be cut off altogether from external liquidity. On December 18, $6 billion were withdrawn. Over the following week the total came to $20 billion.69,70 It was a spectacular bank run even by the standards of 2007–2008.
The oligarchs were once again exposed. Estimates vary, but the combination of the Ukraine imbroglio, the oil price shock and the December 2014 turmoil cost the twenty richest Russians between $62 billion and $73.4 billion.71 Once again Putin called in favors and demanded action. Measures were passed calling for the end to the offshore hoarding of wealth. An amnesty was offered to those who would bring their cash home. Meanwhile, the central bank attempted to get a grip on the situation with an increase in deposit insurance and the recapitalization of ailing banks. President Putin called for the authorities to abandon general principles of policy. They would need to be in “manual override” to see the country through. But there was one general principle that would not be abandoned. Russia did not want to ruin its reputation in the eyes of foreign investors by resorting to capital controls. Instead, to provide the necessary foreign exchange, the central bank ran down its reserves, which dipped as low as $388.5 billion on December 26. This cushioned the collapse of the ruble, but the pressure continued. The Western ratings agencies started by downgrading Gazprom. In January they lowered the rating of Rosneft, Transneft and Lukoil. Then the ruble slumped by 7 percent, giving up much of the ground it had recovered since the end of 2014.72 That, in turn, posed the question of the central bank’s reserves. What Russia was struggling to contain was something akin to the bank-sovereign doom loop that had menaced the eurozone until 2012. But what was now at stake was not just financial solvency but victory in a geopolitical tug of war.
In his first period as president, Putin’s legitimacy had been based in large part on a sustained recovery in living standards. That easy narrative was broken by the crisis of 2008. From 2014 onward economic expectations were further diminished. Over the winter of 2014–2015 GDP was falling by more than 10 percent per annum. It would not stabilize until the second half of 2015. For ordinary Russians the crisis of 2014–2015 was considerably worse than that of 2008–2009. Real wages fell more sharply and rebounded less vigorously. The Russia that emerged from the Ukraine clash was above all a nationalist regime whose citizens were called upon to pay whatever price was necessary for their nation’s reemergence on the global stage. It was tough, but it was a role that came easily. And, indeed, in some respects one might even say it was convenient.73 As prime minister during the 2008 crisis Putin had thrown himself into hands-on domestic crisis fighting.74 Since his return to the presidency in 2012, the Kremlin had been inciting nationalism to offset disappointing economic growth and disappointing poll ratings. Given the collapse in oil prices in 2014–2015, some campaign of nationalist incitement was only to be expected. The crisis in Ukraine was perfectly timed. Even with the economy languishing, Putin’s personal popularity surged from a low in 2013 in the mid-40s to a record 89 percent approval in June 2015.75
Russia suffered, but if the economy was a weapon, it cut both ways. You could not damage Russia without damaging its neigbors. The much-feared emerging market crisis hit the post-Soviet world with a vengeance.76 Between the end of 2013 and early 2015 the currencies of Kazakhstan, Azerbaijan and Belarus devalued by 50 percent against the dollar. The Kyrgyz, Moldovan and Tajik currencies lost between 30 and 35 percent of their value. Across Central Asia, the effect was to force sudden and sharp increases in interest rates and to place enormous pressure on the balance sheets of those banks and businesses that had globalized and borrowed abroad.77 Meanwhile, family incomes were squeezed as remittances from migrant workers in Russia plunged.78 In Tajikistan, the most remittance-dependent country of the world, where approximately one half of its working-age males earned their living in Russia, it threatened a catastrophic fall in household income and foreign exchange earnings. Kyrgyzstan, the world’s second-most remittance-dependent country, was also badly affected.79
But if the crisis took its toll on the entire region,
the epicenter of the shock was Ukraine. In the emergency bailout of April 2014, the IMF had started its estimate of Ukraine’s economic situation from an exchange rate of 12.5 hryvnia to the dollar. The IMF had called on Kiev to impose currency controls to prevent capital flight, while letting its currency float and allowing domestic prices to adjust to whatever level would ensure the viability of government-owned gas firms. If this program had been adopted, it would have squeezed both ordinary Ukrainians and wealthy Ukrainians, who would see their funds trapped in a depreciating currency. Instead, the Ukrainian central bank did the reverse.80 It permitted billions of dollars to flee the Ukrainian banking system while using its precious exchange reserves to stem the decline in the exchange rate. While prices surged by 50 percent, the result was to favor the most wealthy Ukrainians, who swapped their assets into dollars at favorable exchange rates. All told $8 billion drained from the currency reserves. Whatever money was pumped into Ukraine simply bled out. With exchange reserves depleted to as little as $4.7 billion by February 2015, the central bank finally abandoned the exchange rate. As the European powers struggled to make diplomacy work and the hawks in Washington and at NATO headquarters were urging ramped-up military support, between February 5 and February 6 the currency plunged by 50 percent in twenty-four hours.81 Prices were adjusted on a daily basis, and to combat hoarding, a system of de facto rationing was introduced, which limited each consumer to buying fixed quantities of flour, oil, rice and buckwheat. Meanwhile, GDP fell by almost 18 percent year on year, making Ukraine’s debts progressively less and less sustainable.