Interview with Clifford Gaddy, a Senior Fellow, Foreign Policy, Global Economy and Development at the Brookings Institution.

Question: How prepared is Russia for the financial crisis compared to other countries?

Gaddy: Well, the simple answer to that is, it has been very well prepared in the sense of having these large foreign exchange reserves, or large reserves in general. First of all, most countries in the world never had that luxury of even thinking about having reserves since they were oil consuming countries and for several years now have been paying very high oil and gas prices which has been a drain on their economies. So the high oil prices, especially the last three years or so, have in effect been a tax on consuming countries to the benefit of producing countries.

So that gave Russia an opportunity that few other countries had and Russia took advantage of that by setting aside a pretty significant portion of that extra revenue, in the form of the foreign exchange reserves and the stabilization fund, which of course is now divided into two parts. The idea behind those was ‘this is a period that’s unusual, it’s an anomalous period with these high oil prices, lets set aside a large part of that extra windfall as a kind of rainy day fund for the situation in which the oil prices go down.’

Now, that having been said, there was nobody in Russia that was thinking in terms of ‘we need to build up reserves for when the entire world economy implodes, the whole financial system implodes.’ So there is not that kind of preparation, but the fact that you do have these large reserves is something that distinguishes Russia from most other countries in the world, and of course you know that Russia’s foreign exchange reserves are still, they were at their peak and they still are the third largest in the world after China and Japan.

Question: The Russian government invested a lot of its oil money in the United States, where was that money invested and what exactly did it buy?

Gaddy: Well, predominantly it bought U.S. government securities of all kinds, like treasury bills. It also bought the securities of Fannie Mae and Freddie Mac, and they were considered very secure, stable and reliable. That’s important to recognize because no one, and least of all the Russian leadership, but certainly no one in the world expected that these most reliable institutions in the world, most secure investments in the world, would suddenly become very fragile. So that reflects the fact that even though the preparation was there in the sense of building up the reserves, there was not the foresight, which would have been basically magical, to be able to see that the global financial system would break down the way it did. And that’s really half of the big problem for Russia today. The collapse of the oil price is one; the collapse of the financial system is the other.

Questions: Some critics question whether investing the money in to the U.S. economy was a prudent decision, what is your opinion on this?

Gaddy: When you are building up reserves like this, there are two things you are looking for. You look for security, something that is not going to loose its value, so you avoid the stock market. You lend the money in the form of loans; that is bonds rather than buying stocks because the stocks can collapse, but you also want to diversify. In other words, ‘if the oil price goes down and the Russian economy suffers from that, we don’t want to have lost the value of the money we saved.’ If it had been for instance invested in Russian companies, you would be sitting there with about a fourth of what you had. As a matter of fact, all of the money that Russia invested abroad in the form of treasury bills, U.S. securities and so forth, has retained its value. In fact, as the dollar has gone up in price in the last months, it’s actually gone up in value. So that criticism is really not very valid today.

Question: How stable is Putin’s economic model and how flexible is it when faced with unforeseen circumstances?

Gaddy: As I describe this model, I try to boil it down to two points. One is Putin does believe in the advantages, the virtues of a market economy and private ownership, contrary to what I think a lot of people assume and think that he wants to nationalize everything. I don’t agree with that. I think from the beginning his preferred alternative is to have private ownership especially of the large companies under competent proven leaders, the so-called oligarchs. However, he needed to control them and make sure that their wealth did not translate into political power. And that’s a very interesting story about how he did that that I explain in the article. This pretty strong commitment to the free market and to private ownership on the one hand, with controls, but the second element, the second pillar, and even more important, more fundamental in the way he has managed the Russian economy is to have the resistance to crisis and especially the resistance to any sort of crisis that would cause Russia to loose its economic independence and its financial sovereignty. Because remember, he inherits an economy that is heavily indebted to the west, and because it’s so indebted to the west it has no freedom politically, it had to sort of accept. He didn’t have to like what was happening in the rest of the world, but when the United States enters the war in the Balkans and bombs Serbia, Russia could only protest. They could not do anything about it. Once the financial sovereignty was achieved by paying off the foreign debt and building up the reserves, Russia could act differently. So these two elements are really important, the question of how do they each survive a financial crisis like we are having right now is the important one.

On its commitment to the market, here Russia is in a bind because these companies have lost a huge amount of their market value. Their stock market value has plunged, on average, to one-fourth of what it was at the peak, and many of the private companies are heavily indebted to foreign lenders. So they have debts they need to roll over, credit markets are frozen and they are in very critical shape. Much like companies in the United States and elsewhere, they are turning to the government for help and Putin has pledged to help them pay off the debts. Let’s assume we agree that George Bush is not a crypto-communist, so he wouldn’t try to nationalize the auto industry, the banking industry or the insurance industry, but in fact the United States is on the verge of some of the largest nationalizations that have happened. That’s necessity. It’s not because that’s an ideological preference. We will see the same thing in Russia. I am quite sure that the government will be taking over more of the Russian economy. I do not, therefore, conclude that this means Putin wants to nationalize everything, to me it’s the same as in the United States. The question is what you really would like to do and what you have to do, at least temporarily, and the crisis is going change that balance.

So what about survival, how important is this notion of having a resistance to crises and avoiding a total crisis that would threaten the very existence of Russian households? Well, I think that the reserves are there, but no one can predict how far this global crisis is going to go and how much it might affect any country in the world, least of all Russia. I think the longer and the deeper the crisis is, the more Putin will feel justified in building up these reserves and having this survivalist, worst-case scenario kind of thinking. And of course there is almost a reservoir of resistance in the Russian society, the experience going back decades and decades, living through World War II, living through the deprivations and crises of the Soviet period, living through the 1990s. People know how to do it, doesn’t make anybody happy, but of all major countries in the world, if I had to say there is one population that will figure out the way to get through it, it will be the Russian population. Whether any of this translates into political tensions and the dissatisfaction with the regime and so on, I think, is anybody’s guess. That’s just from my opinion pure speculation, and science can’t really tell us anything about it.

Question: How well is the Russian economy incorporated into the global economic system?

Gaddy: In a sense that it is highly dependent on it, yes very much. We see this with the oil; Russia rode the amazing good times because it was exporting its oil to the west during the time of high prices, and it’s suffering as the prices go down. Also, despite the fact that the Russian government has paid off its foreign debt and therefore reduced its vulnerability to events outside, the private companies incurred a huge amount of extra debt and they are now suffering as the financial system get worse. Russia has no control over the world oil price, right now that’s being driven mainly by the general state of the recession. When the world economy begins to slow down and when people look forward and think it’s going to slow down even more, demand for oil and other commodities will go down, the price goes down and this is exactly what is affecting Russia.

Question: The Russian government, in conjunction with the private sector, are actively involved in sponsoring a wide variety of social programs. What effect will this financial crisis have on these programs?

Gaddy: It’s unquestionably going to have a major impact on both the government spending on social programs, and what the companies out in the regions can do to support the social spending that they have been doing. One of the basic principles of Putin’s model of working with the oligarchs is that they needed to share their wealth informally. Not only do they need to pay formal taxes we typically think about, in effect they were also being asked to pay informal taxes by building roads, schools, swimming pools and ice hockey arenas. All over the country this kind of spending is going on. Formally it’s voluntary, but people call it “prenuditelno dobrovolno” so it’s kind of like “obligatorily voluntarily,” you knew that you had to do it. That money came from the windfall caused by the high oil prices, so as the windfall disappears, they are not going to have the money to do this anymore. So across the board, projects are going to stop and probably just stay frozen for whatever time it takes, that’s going to effect people. So the ordinary Russian are not only going to be effected by the fact that their salaries won’t grow, they may lose their jobs as plants stop working, they may not be paid their salaries even if they continue to work; the non-payments phenomenon might start up again. But we also find that a lot of the social spending stops and it’s going to have a pretty big effect. 

Question: Not long ago Medvedev and Putin talked about the prospect of Russia becoming one of the world’s leading financial centers, on par with London and New York, and the ruble becoming a global currency. Considering the impact of the global financial crisis on the Russian economy, is this still a realistic perspective and how likely is it that these goals will be realized?

Gaddy: It’s not a realistic prospective given the current crisis. In the long term, had things continued as they were before, and perhaps in the future once the crisis is over, it’s a laudable goal and worth thinking about. In this current crisis, however, it’s very unrealistic, and I must say I am rather surprised that they continue to talk about it. I think it’s not the only statement we heard from both Putin and Medvedev in the last few weeks that reflects to me a very strange detachment from reality. I find it strange also, because it might comeback to bite them. It’s almost as if, “not only is it business as usual, despite the global crisis, but our ambitious plans for the future don’t need to be changed.” Putin is not talking about postponing or freezing the big 2020 development plan and so on, he says no, we will continue with this. This cannot be done, it is unrealistic.

Moreover, Putin is saying “we will keep the ruble stable,” and he is rejecting the idea of any sort of significant devaluation of the ruble. This is completely unrealistic, the ruble has to be devalued and it will be devalued, the problem is that it may devalue in an uncontrolled way. Another thing I worry about, the more promises Putin makes to the population about keeping the ruble stable, the bigger their disappointment will be when the inevitable devaluation occurs, it will be like a crash when it comes. As a political move this is strange to me. Putin seems to have been a person who usually avoids making these sort of promises and commitments that people can hold you to and say “well you told us this but you didn’t do it.”

I understand that as a politician and as the father-of-the-country figure, it’s almost in his job description to keep things calm. Don’t panic people by talking about the horrible situation; you need to instill confidence, that’s the Franklin Roosevelt model, “the only thing we have to fear is fear itself.” So you want to reassure people, but there is a difference between reassuring people while still being realistic about the threats that are out there, and then simply being untruthful to people of what the real threats are and what might happen. I think he is verging over into the latter and that may reassure people today, but it could lead to a worse outcome, a real lack of confidence if it turns out that people say “wait a minute, everything he told us is complete nonsense, and all the things he said wouldn’t happen are happening now.” That’s not a recipe for stability.

Question: Many countries will be affected by the global financial crisis. In your opinion, how much will Russia suffer compared to countries in Europe, Asia and the U.S.?

Gaddy: It’s a good question, but it’s really hard to ask, its not even clear that it’s a meaningful question because if I answered that Russia might not suffer as much as others, that’s not going to be much comfort I don’t think. There is resilience in Russia that may perhaps be of benefit for Russians. They know how to survive crises. If you are talking about physical survival, if it gets down to that I think Russia may well end up better than some countries, but if it’s long term damage to your economy, how much will you be set back along the trajectory towards growth and progress and prosperity, that’s hard to say. I think it could be pretty serious, another one of these episodes of Russia moving forwards and then sliding back, moving forward and sliding back. That’s certainly frustrating because the last time that happened was 1998, and it’s not quite a generation since then, it’s only half a generation, but it’s a whole new wave of young people who graduated, joined the work force, were confident, the economy was booming and growing, and now they see everything go to ruin. And all the projects about increasing the birth rate and forming families and so on, well this suffers too. My opinion is that a lot of the success in those areas was due to the fact that people were better off, they had higher paying jobs, they could get their apartments and their house and now there will be some negative effects.

In some ways Russia may suffer more than the welfare states of Western Europe. Things work there, the roads are new, the schools are new, the water systems and the electricity systems are in good shape, a few years crisis is not going to lead to a total breakdown of all that. So it is a possibility that Russia could suffer more, simply because a lot of Russia is more fragile, some of Russia is inherently more robust, but other parts of the Russian system are pretty fragile.

Question: So part of the blame could be placed on the Russian government for not investing enough into the other sectors of the economy and the infrastructure, perhaps being fiscally over-conservative. So what kind of Russia can we expect to come out of this crisis, not just economically but politically?

Gaddy: Well, first of all let me clarify that I don’t want to be described as someone who criticizes the Russian government for being too conservative, there are those who do that. The reality is that there really was a choice to be made, you could not buildup the reserves the way they did and invest in infrastructure, so you had to make the choice. A year ago it was easy to criticize the Russian government for putting too much into the reserves, “you should be building up the roads, fixing the hospitals, the schools, and so on. Today, frankly it is only thanks to having those large reserves that Russia still has the possibility of managing. So, looking at this from today’s perspective, in the short term that’s what gave Russia the capacity hopefully to survive this crisis.

Like anybody or any country in the world you don’t have enough resources to do all the things you want to do, you have to make the choices. Putin made the choice, and I think he is going to stick to this choice that is he is going to make sure that no matter what else happens Russia keeps some reserves enough to be independent. So they no longer have to go hat in hand to the IMF like Ukraine does or like Russia did ten or fifteen years ago. That is not going to be repeated if he can help it. And if that means that you don’t build that extra road, if that means that you don’t increase wages, if that means even if you have to reduce wages. I think that’s the route he is going to go. Presumably he is going to appeal to the Russian people and say, ‘it’s your choice. Would you rather keep your high living standard that you had over these past couple of years, but we go back to being indebted to the west, Wall Street, the IMF or would you rather stick it out and be independent?” My guess is that the majority of Russians would say ‘we will be independent no matter what, we can stick it out, we have done it in our history, our grandparents and our great-grandparents and so on and so forth. Because when it boils down to it, Putin has made those choices in the past; those choices become even starker today. This is a period of surviving a crisis; this is really not a period for talking a lot about expansion and growth and dreams, that’s why I don’t quite understand what Putin is doing when he talks about the ideas of making Moscow into a financial center, making the ruble into a global currency. At this point, that is simply not realistic, and if it costs money to do this it won’t be done and it’s not going to happen.

I think in the end, as people draw lessons and they already presumably thinking about what could and should we have done differently, because Putin has said by the way that these sorts of things repeat themselves, and he may be right. I mean obviously in a sense the crises will continue to happen. So you think not only about how to survive today, but you’re also thinking ahead what could be done differently. I tend to believe that this whole crisis is simply going to reinforce even more his conviction that we always have to have the reserves to allow us to be independent and not have to relinquish our sovereignty.