Russia’s Stock Market Fall: It’s All About Oil

September 16, 2008

It’s great fun to explain a sudden boom or bust in the stock markets after the fact by alluding to some unique event that happened to occur at just that time. Anyone can do it, and no one can refute you, since the experiment cannot be repeated. Normally, it’s also an innocent exercise. In recent days and weeks, however, some people have carried this game into a more serious arena, that of geopolitics, and are using it to draw wrong policy conclusions.

It by now seems to be an article of faith for many people that Russia’s invasion of Georgia on Aug. 8 caused a massive fall in the Russian stock market, as well as a crash of the currency and outflow of foreign capital. The serious misstep is when some people take this as evidence that Western governments don’t have to worry about making tough decisions as to whether and how to react to Russia’s actions in Georgia because “the markets are punishing it.” Implicit in such thinking is that Prime Minister Vladimir Putin obviously did not realize what a penalty he would pay. Now that he does, Putin — or the oligarchs who back him — will be deterred in the future.

Is this at all credible? Let us look at some facts. Yes, the ruble has lost 6.9 percent against the dollar since Aug. 7. Then again, nearly all currencies have lost against the dollar recently. Maybe it would be better to ask how the ruble has fared against the euro. The answer is that the ruble now is stronger against the euro than it was on Aug. 7. And the foreign exchange impact? Again, there’s some reality here. In the week following the invasion, the country’s foreign exchange reserves dropped by $16.4 billion. But that is still less than 3 percent of the total of nearly $600 billion. Since then, the reserves have held more or less steady.

So neither the currency nor the foreign exchange situation seems particularly dire after the Georgia events. The Russian stock market is a different story. The fact that it is collapsing is indisputable. The market value of the country’s main exchange, the RTS, is now down to barely half of what it was earlier this year. A lot of value has been lost, although commentators disagree on just how much. Anders Бslund wrote in The Moscow Times on Sept. 3: “Aug. 8 … marks Prime Minister Vladimir Putin’s greatest strategic blunder. In one blow, he wiped out half a trillion dollars of stock market value.” Gideon Rachman adhered to the same figure in his Sept. 8 column in the Financial Times. But David Ignatius in The Washington Post on Sept. 10 wrote more cautiously that the RTS index lost “about $290 billion in value since Aug. 7.”

To be precise, between Aug. 7 and Sept. 9, the RTS lost $183 billion. What is true, however, is that since its peak on May 19, the RTS has lost about $600 billion, or around 43 percent. The issue is when it lost that value, and why? Did it really happen, as Бslund wrote, “in one blow”? Most important, was it because of Georgia? Consider this: In the four weeks before the invasion, the RTS lost more value than in the four weeks after — $192 billion before and $167 billion after. In fact, the Russian market has been declining since early July.

So if the Georgia events did not cause the decline, what did?

One alternative explanation is the worldwide decline in stock markets, which has had an especially strong impact on emerging markets like Russia. Another suggestion is that the Russian market has suffered from a general climate of distrust that has been growing over a longer period, highlighted first by the acrimonious dispute among the owners of TNK-BP and then by Putin’s July 24 attack on the mining company Mechel and its CEO.

It may well be that all of these various factors, including the Georgia factor, have played into the market’s fall. But if we are looking for a main cause, the best bet is to turn one’s attention to the main driver of economic events in Russia since the 1970s — namely global oil markets. After peaking in mid-summer at over $140 a barrel, the world oil price has steadily declined. From its high on July 14 to Sept. 8, the oil price dropped by 29.8 percent. Over that same period, the value of the Russian stock market fell by 29.3 percent. The extreme closeness of those two numbers is certainly a coincidence. But the stock market’s general dependence on oil prices should not be a surprise.

I suspect that Putin and his advisers are smarter than the Western analysts on this one and are well aware of the oil factor. If so, the lesson for Putin and Co. will be that since the markets have imposed little penalty for the military action in Georgia, there is no reason to be deterred for fear of further such “punishment” in the future.

Meanwhile, Western policymakers would be wise to realize that spurious post hoc, ergo propter hoc explanations for stock market behavior do not take them off the hook. They still need to decide about how to react to Russia with real policy.