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  • Russia and Georgia – An Economic Mistake

    Posted by Carl from Chicago on September 1st, 2008 (All posts by )

    Economic Impact of Georgia Invasion

    A recent Wall Street Journal article titled “Borrowing Costs Increase Sharply for Russian Firms” lays out the economic toll that Russia will begin to feel from their invasion of Georgia. Per the article:

    “the Georgian conflict has sparked prohibitively funding costs… conditions have deteriorated significantly for Russian borrowers, as reflected by sovereign and corporate-credit spreads, which have widened sharply, substantially increasing the cost of borrowing… but even then, an attractive premium may not be enough to entice investors to participate in deals… the majority of investors won’t want to participate right now. They will prefer to wait for signs of improvement, and right now there are no clear signs.”

    For Russian companies seeking debt financing, this war comes at a bad time. The world debt markets are already being roiled by a lack of liquidity and losses, making even solid companies with low credit risk scramble for funding. Now add to this the fact that Russia seems to be actively repelling the West, this makes Russian instruments an even bigger risk.

    On top of the difficulty in finding investors to purchase their debt securities, the Russian stock market index (MCX) is down about 20% after scoring big gains over the last few years as Russia prospered due to the commodities boom and the perceived move towards less economic and political risk.

    HISTORY – NOT THE COLD WAR ANYMORE

    In college I studied a lot of economics (although I never got into the heavy detailed mathematics that advanced economics requires) and in particular I focused on the communist countries. GOSPLAN was the Soviet entity in charge of planning, and the failures of this model would be very obvious to the contributors of this blog.

    In particular, the Soviet Union was run as an autarky – it was mostly self-reliant, with little external trade (or external financing). There were certainly exceptions, but this was a general principle.

    Thus while we look at the Georgia episode under our cold-war perspective, we need to recognize that Russia has changed significantly since that era. Many Russian companies are listed on Western stock exchanges, or are at least partially owned by foreigners in the Russian exchanges, and they rely to a significant extent on access to Western capital.

    In addition to autarky, Russian citizens (with a few, minor exceptions) were not allowed to travel to the West. Today, on the other hand, the Russian billionaires are thick on the ground in Europe, particularly in London and Switzerland. While Moscow is the most expensive city in the world and has many attractions, it is not hard to see while their elite mainly locate outside the country and it can be safely presumed that their funds have mainly crossed borders, as well.

    The Russian economy is being buoyed by commodities and rising commodity prices. For the most part they deserve credit for creating semi-modern enterprises and reversing the death spiral that their energy and mining companies were facing after the fall of communism. One positive potential impact for Russia would be a spike in commodity (oil) prices caused by increased tension related to their war with Georgia, but for the most part this impact has been minor.

    All of the other impacts (economically) have been negative. The Russian stock and bond indexes are down and it is unlikely that they will rise any time as long as the bellicose rhetoric continues to course out of Moscow. It is a bad business tactic to berate your business partners, especially when they have other choices and more friendly climates in which to invest.

    To contrast with the Tibet situation, the Chinese did not try to make that uprising into a wider war with the West. They generally muted the protests for fear that they would turn against the government or turn too hard against the west prior to the Olympics.

    From an economic perspective, it is hard to see how this war is beneficial to the Russians. They are pummeling their own markets, driving away capital that they need, and hurting their own business climate, which will take years to repair, after they START to try to repair (i.e. the clock doesn’t even start ticking until they stop the rhetoric). They don’t gain anything economically out of the areas of Georgia that they have taken, and they will likely deter future investment by other neighboring states.

    Cross posted at LITGM

     

    5 Responses to “Russia and Georgia – An Economic Mistake”

    1. toad Says:

      I have been wondering about how the Russian “business men” are going to react when they face travel restrictions, decline of in country asset value, and the possiblity of frozen assets out of Russia. I’ve heard rumour that more than a few of them were/are KGB/Rusian Mafia types. It might get noisy in some of the basements of the Kremlin and Lubyanka.

    2. Anonymous Says:

      There is a price to doing business with criminals. JP Morgan said he lent money on someones character. Marxism, and the autocracy before it, was very destructive of people’s character;we see this in the high rate of criminality among our “russian” immigrants.

    3. renminbi Says:

      Didn’t mean to post anonymously.

    4. Shannon Love Says:

      The free-market forces integrity. When you can’t coerce people into investing or otherwise interacting with you, you have to allay their concerns and establish a reputation in order to succeed.

      Having said that, it is a mistake to think that autocrats will sacrifice their own power for the sake of a national economy. I think that Putin et al still possess a marxist disdain for all things related to business. They will view the injury of the Russian business class as a just fate for those driven by “greed”. They will sacrifice what they see as the short term economic loss of the people in general for the long term benefits of their own rule.

      It’s happened before.

    5. ElemBend Says:

      It’s not just the war with Georgia that is affecting investment in Russia. The shabby treatment of BP over its eastern oil development will soon run the company out of Russia giving it probably pennies on the dollar in compensation for their effort. Obviously, these treatment will serve as a stark warning to any who may want to do business in Russia in the future.
      The NYT had an article on the vast possibilities of commercial farming in Russia, as much of the land (some of the best in the world), is under-utilized, even fallow. Now, apparently foreign investors are being attracted to the possibilities. Were I interested in profiting from such large scale farming, I can think of many countries and continents that have a far more benighted view of property rights in which I’d prefer invest. Such the pity for world food supplies.

      Here’s the article:
      http://www.nytimes.com/2008/08/31/business/worldbusiness/31food.html?partner=rssnyt&emc=rss

      Here is another highlighting the fact that capital is not the only thing Russia is lacking for development:
      http://query.nytimes.com/gst/fullpage.html?res=9B0CE4DB153BF93BA35754C0A9629C8B63