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Analysis & Opinion
25.09.08 Down With The Money
By Sergei Balashov

“The crisis hasn’t passed yet. We’re just past the critical stage and it doesn’t look like we’re going to hit it again in the mid-term,” said Pavel Medvedev, a member of the State Duma committee on financial markets. “I don’t know how it is going to be in ten years, but then I don’t even know what will happen tomorrow.”

With its heavy dependence on energy exports and on the reserve fund, the Russian economy is far from fully independent. Oil and gas trade, which makes up the bulk of Russian exports, produces revenue in U.S. dollars. This currency composes almost half of the funds accumulated in the Russian Reserve and National Welfare funds, underscoring these funds’ dependence not only on oil prices, but on the overall U.S. economy as well. And the latter hasn’t been doing so well.

In fact, the dollar has been plummeting, and the subprime mortgage crisis has ravaged the U.S. economy, bringing Wall Street into turmoil. “Right now, we’re seeing structural changes in the U.S. economy. We’ll get more unpleasant surprises from the United States, which we should be expecting,” said Andrei Shemetov, the general director of the ATON investment company. “If the United States starts getting out of its crisis, we’ll get some stability.”

Regardless, some damage has already been done, and it goes far beyond the stock market fluctuations. “The financial crisis can’t but affect the non-financial sector,” said Julia Tseplyaeva, Merrill Lynch’s chief economist for Russia and the CIS. The crisis took a heavy toll on the amount of money available for loans, which thus became more expensive. Less money means less investment and a general decline in economic development.
“The current situation affects investment more than it affects demand; investment programs that don’t have their own strong financial backing will undergo adjustments,” said Tseplyaeva. “We’re expecting a slowdown in the financial sector.”

This slowdown will have palpable consequences, which are already surfacing and will only become more evident as time passes. Construction is one sector that will go into decline. Major projects in this field are already being halted, translating into higher mortgage rates and less housing available. The Korston Group alone has suspended construction of eleven residential estates all over Russia, worth over $1.5 billion. The reason was the same—an inability to acquire any loans from the banks. According to the Vedomosti daily, the average interest rate jumped from 12 percent to at least 18 percent. “Many developers have frozen their construction projects, and the supply will be curtailed considerably,” said Tseplyaeva.

The trends suggest that the demand will decline as well, as it will become no less difficult to get a mortgage. “We can feel the American housing crisis reverberate around Russia,” said the General Director of Fosbourne Home mortgage brokering Vasily Belov. “It affected the loan rates, leading to a sharp decline of the mortgage market.”
Mortgages are even less available than they were before. Data from Fosbourne Home shows that the rates have grown by an average of 1.8 percent since the beginning of the year. The requirements for borrowers are also rising, as is the down payment. “There are fewer potential borrowers now,” Belov added.

Lower real estate prices could be one positive outcome of the decreased demand; however, experts suggest that there will hardly be any decline in prices, which could actually grow rather than fall, making housing even less affordable. “If the crisis continues, the real estate prices will go down by no more than five percent,” said Belov. “There will most likely be a three percent decline, or even a three percent growth by the end of the year.”
The real estate market is quite rigid, with the supply growing by no more than 0.75 percent daily. “It’s not enough to turn the corner on the prices,” Belov said.

The other setback is that salaries, which have been growing by 33.1 percent since August of last year, will remain at the current level for the foreseeable future. “This fast growth of salaries will come to an end,” said Tsepelyaeva. “Today, people are becoming less mobile, they have a more careful approach to changing jobs,” she added.

The small businesses, which bring in about 16 percent of Russia’s GDP and were supposed to turn into the top supplier of new jobs, will be hit the hardest by the loan shortage, doing the most long-term damage to the economy. “It was hard to provide loans for small businesses even before the crisis,” said Belov. “Today, we can hardly talk about any development of the small businesses in the near-term.”

Fewer jobs, less money and expensive loans spell trouble for Russia at least until the end of this year, even taking the relative stabilization that has taken place since the crisis peaked in mid September into account. Experts say that the current situation could be compared to last year’s financial crisis in Kazakhstan, where people’s incomes fell, as did construction, trade, and production all over the country as a result of a liquidity crisis, when banks failed to refund their debts and didn’t have enough funds to provide loans inside the country.

“The trends are the same, but the magnitude won’t be anywhere near the one in Kazakhstan, where residential real estate prices fell by a third,” said Tseplyaeva. “Nobody is expecting an eight percent GDP growth next year. If there is a slight cooling of the economy, the growth will most likely be around six percent.”
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