Posted: Jan 26, 2017
Author: Pavel Koshkin
RD Interview: Kendrick White of Marchmont Capital Partners discusses the potential obstacles ahead for Russia’s economic growth, including factors that might weaken global energy prices
During the first weeks of 2017, economists continue to have mixed reactions about the fundamental health of Russia’s economy. On the one hand, some economists point to the upward trend in oil prices and Russia’s successful monetary policy — especially polices carried out by the Central Bank to stabilize the ruble. On the other hand, skeptics continue to fret about the lack of diversification in the Russian economy and the continued drawdown of the nation’s reserve funds.
To make sense of Russia’s economic direction in the months ahead, Russia Direct recently sat down with Kendrick White, the director of Marchmont Capital Partners, a U.S.-Russian investment advisory firm, as well as an advisor to the Rector of Lobachevsky State University of Nizhny Novgorod (UNN), to discuss Russia’s economic challenges.
As White points out, Western-led sanctions have done little thus far to change the Kremlin’s policy calculus. Instead, it is the short-term outlook for oil prices that matter. And it’s here that U.S. President Donald Trump’s efforts to turn the U.S. into an energy superpower — a move that could put downward pressure on global energy prices — might most directly impact Russia.
Russia Direct: A number of economists and politicians argue that Russia successfully overcame the recession in 2016 and hope for further economic growth. Could this just be wishful thinking? What is your take?
Kendrick White: The sanctions certainly have had a negative effect, but the falling oil prices have had a far more detrimental effect on Russia’s economy – and in spite of this, I think that Russia actually did a very good job of adjusting its budget to these various economic shocks.
Many people think that Elvira Nabiullina [head of the Central Bank of Russia] is one of the best central bankers in the world, because they’ve managed the complex situation much more effectively than many other commodity-driven economies. You can easily compare Russia, for example, to Venezuela – another oil-based country, and see the dramatic mistakes made in its macroeconomic and political policies and see the difference.
Other countries have severe budget problems because they are over-reliant on oil. Actually, Russia, in spite of its reliance on oil and gas, has done relatively well by slashing its budgets, cutting its expenses and adjusting its strategy. And putting up barriers to the sanctions on European food imports has actually increased food and agricultural output here in Russia. And so, domestic investors have ultimately supported that segment.
So, there are some real results. I mean I am not overly optimistic that Russia is going to return quickly to very fast growth. As Mr. [Alexei] Kudrin pointed out here at the Gaidar Economic Forum, there is going to be a long process required of serious structural reforms, which are required to return the economy to 3-4 percent annual growth in GDP [Alexei Kudrin is Russia’s former Finance Minister – Editor’s note].
Right now Russia has actually done much better than many people expected. And it should be applauded that Russia is not in a desperate situation despite the U.S. sanctions. Many people have concluded that U.S. sanctions were a failure. They really didn’t have the impact on Russia that the Obama administration wanted. In this case, Russia succeeded in surviving through the sanctions and is now expected to grow positively during the next 2-3 years.
RD: Are there any reasons to believe that this trend will persist in 2017?
K.W.: There are reasons. I hope the sanctions will be loosened and I hope the Europeans will loosen sanctions as well. I honestly hope that the Trump administration will find some common ground with the Putin administration. I think the tensions will be lessened between Russia and the European Union as well as between Russia and the U.S. And this will certainly help. Most importantly, it will free up imports of Western technologies that Russia would need, and it will free up the ability for Russian banks to tap into European and American financial markets.
And I think this is critical because Russia does suffer from a lack of global liquidity for its banks and large corporations. Being able to access international financial markets is the single most important thing that Russia needs right now. It is surviving without that, but I think that these tensions will go down and this will certainly bring a lot of liquidity to Russia’s small business and entrepreneurial sector, which has actually suffered the worst under the sanctions.
My position on sanctions is that they were wrong-headed from the beginning, because the most important segment of the society to support the country’s long-run development consists of small and medium-size businesses and entrepreneurs — and they require liquidity to get their businesses started and to keep them growing. And the people that have been most negatively impacted by all of these sanctions have been small businesses, the private entrepreneurs, the innovation entrepreneurs, and the students.
You know, the private sector people have been hurt by sanctions more than anyone else. So, it didn’t have a really desired effect on the top oligarchy or the Presidential administration. But it certainly had a devastating effect on private sector business in Russia, which is the most keen to reach out and work with international partners.
RD: What are the odds of Trump being able to lift the sanctions imposed on the Kremlin, given his tensions with the Washington establishment, which remains intransigent toward Russia?
K.W.: I think that President Trump is going to find common ground with President Putin by finding some compromise position regarding Syria, Ukraine and other areas including fighting international terrorism. He will use that and he will use the majority of the Republican Party in the House of Representatives and the Senate to begin to reduce pressure on Russia, because it will show that Russia will be supporting the U.S. in some important areas.
I think there will be serious and thoughtful negotiations between the Trump administration and the Putin administration. They might come up with some agreements. Trump is a dealmaker and he is going to find the way out with Russia as he promised his supporters. Many in the GOP [the Republican Party] may or may not like this, but thus far, if nothing else, President Trump does seem to be keeping his campaign promises and one of his most consistent promises was to return the U.S. to a more friendly relationship with Russia.
RD: Russia spent half of its National Reserve Fund in December 2016. How can you account for this? Does it mean that something is fundamentally wrong in the Kremlin’s response to the crisis? Did this huge spending contribute to the ruble rebound?
K.W.: There are a lot of factors in the ruble rebound. It was expected that Russia was going to use its National Reserve Fund in 2016. This was obvious. It still has the other welfare reserve funds. This drawdown was more or less expected. At the end of the year, Russian authorities finally sold the shares of the country’s largest state-run oil company Rosneft. And this sale — the privatization of Rosneft — really helped the Russian government. I think that the possible privatization of other assets in Russia, such as perhaps Sberbank, in 2017 will be key events for the year for the Russian budget, which is obviously under pressure.
But this current crisis is exactly the sort of crisis for which Mr. Kudrin had been saving funds – a time when oil prices would fall and put the federal budget under pressure. What is most important to know is that commodity prices are always cyclical — they rise and they fall. The time to enact saving policies is when oil prices are high, that’s when the government needs to establish savings funds. Then when oil prices eventually fall again, that’s when you need the stabilizing funds the most. This is all Macroeconomics 101.
RD: Yet the authorities spent half of the budget in just one month (December 2016).
K.W.: This country has always had a huge amount of expenditures exactly in the fourth quarter — right at the end of the year. There is cyclicality if you look at that over 30 years of Russia’s budget spending habits. Now the question is at what point will the sanctions be rolled back from the European Union and the United States, regarding Russia’s access to international financial markets.
I would like to see the sanctions lifted as soon as possible, because they will bring more liquidity back into Russian banks and put less pressure on the Russian budget. And it will mean that the national savings funds would be drawn down not as fast, although it is probably still going to have to run out in 2017. And the authorities might tap into other welfare funds for Russia.
Actually, the key issue in solving this question for Russia is what happens with oil prices. Right now there are expectations that oil prices will be strengthening. Russia has already reduced its output. It is already exceeding the expectations on the agreement with the Saudi Arabia-led OPEC regarding how much oil Russia will reduce its output by. And this is going to have a positive effect on the price of oil. I don’t think it will have a great impact — oil prices are not going to go back to some $80-90 per barrel but we could see oil stabilize in the $50- $60 range for some time.
RD: Yet Trump makes no bones about his intentions to make the U.S. the number one energy superpower of the world. This means that he is going to export even more oil to external markets and this, in turn, could lead to another decline in oil prices.
K.W.: In fact, as a dealmaker, he might be very interested to partner with Russia in that sphere. If you look at all the people that Mr. Trump has picked, that makes sense. You know, he has picked people that are going to reduce environmental protection legislation; they are going to expand licensing for oil and LNG exports; they are going to expand the oil and gas pipeline and distribution network.
Trump has picked a surprisingly interesting choice in the Department of Energy, with Rick Perry, the former governor of Texas, because he is actually interested in wind power and alternative energy power. This might mean that the U.S. is going to continue to pursue a policy of developing alternative energy for domestic consumption, so that it could expand its exports of oil and gas. That might be why Trump might seek to form a more friendly partnership with Russia, because it is going to emphasize oil and gas partners in exploration, storage and distribution.
RD: So, you don’t believe that Trump’s attempt to turn the U.S. into a new energy superpower will dampen oil prices, do you?
K.W.: I don’t really think that Trump is going to push the oil prices down. I think he wants to see a compromise at about $70 per barrel. After all, he is interested in big profits from oil exports and low oil prices won’t be in his interests. Likewise, he is not going to support alternative energies so much by allowing oil to go back up above $80 per barrel.
In fact, by having higher oil process, he could help alternative energy development. So, I do believe that he is going to find a compromise with Russia and Saudi Arabia, but at the same time he is going to emphasize that the U.S. will be a strong competitor or partner to OPEC and with Russia.
He wants the U.S. to play a leading role in setting that oil price. This means that if the United States wants, it would be in a position to rapidly increase output and sales. And that will give the United States better negotiating leverage – that’s what President Trump will always be looking for in his international political and economic dealings. What he wants is he wants to put the United States into having a greater leverage on international oil markets by expanding oil production, LNG exports, storage and access pipelines.
RD: As many pundits assume, there might a sort of trade war or economic confrontation between China and the U.S. under Trump, given the fact that he overly puts himself into opposition with Beijing. Could Russia be interested in such a confrontation and actually profit from it?
K.W.: Trump’s thinking is that he is going to create conflicts with China and, therefore, he needs allies and Russia would be a very good ally. I don’t think that Russia is going to lose from that and, moreover, Russia could gain from that by developing more normal, business-like relations with the United States. Russia very much needs Western technologies to modernize and access global markets for its commodity products as well as markets for its emerging technology-driven businesses. Russia cannot possibly be against globalization and international economic development, but what’s important for Russia is respect and the formation of equal partnerships.
RD: What is the key challenge for Russia in 2017?
K.W.: I think that Russia should use low oil prices as a chance to modernize its economy and promote the development of innovation-driven universities. Russia need to encourage small entrepreneurship and drive Russian large-scale state enterprises to buy Russian technology and innovation in order to support the development of regional innovation ecosystems and technology clusters, and this is critical. Once oil prices head back up, then the pressure to support these modernization programs will fall.
So, as long as oil prices are still relatively low, Russian reformers need to continue to use this time to press forward with modernization and specific structural reforms that will encourage entrepreneurship and the development of the innovation-driven economy. That will be Russia’s key challenge in the coming two years.