Overview: Eastern Promises

On the eve of the credit crunch, the former Soviet states were best positioned to weather the international storm. Russia, with its huge current account surplus and treasure trove of international reserves, was the one with the best position. Its geographic proximity to China was an additional competitive advantage, as the principal provider of natural resources to Asia, against far-flung outposts in Latin America and Australia. It was true that some of the other former-Soviet states had a variety of problems, such as Kazakhstan’s overleveraged financial system and the Ukraine’s balance of payment problems. However, their abundance of natural resources and proximity to the Far East compensated for their short-falls. Or, so it seemed. At the same time, some of the other Eurasian countries, principally Turkey, did not look as strong. Its large current account deficit and dependence on light manufacturing destined for the European market made it a candidate for disaster. Moreover, political constraints at home prevented the Turkish government from accessing the multilateral resources that were available at the IMF. However, there were many surprises in the convulsions that shook the world in 2008 and 2009. Many of the most promising regions of the planet turned out to be bitter disappointments. Meanwhile, some of our suspicions were mislaid.

Russia was a blow. To use Churchill’s famous phrase, “Russia is a riddle, wrapped in a mystery, inside an enigma,” always seemed to be a capitulation of logic. All humans react on the basis of reason. Therefore, the behaviour of Russians should not be mysterious. However, a country’s geography and history shapes the institutions and incentives that direct people’s actions. Unfortunately, we failed to account for this when we were assessing how Russia would respond to the global meltdown. Russia is clearly massive. It has the largest landmass on the planet, almost twice the size of Canada, which is the second largest country in the world. Despite the advances in telecommunications and transportation technology, such vast distances complicates communication between towns and cities. At the end of last year, for example, one hundred Russian riot police were flown 6,000 miles from Moscow to Vladivostok to put down protests against an increase in import tariffs. These vast distances inculcated a history of fierce independence. While the rest of the planet is conditioned through notions of law and honor, brute force is what shapes Russian behaviour. The fact that Russian political or business leaders lie or act immorally has no adverse social consequences. On the contrary, it is a testament to the figure’s favourable social standing as an indicator of their enormous bravado and brawn. Given such social references, it is not surprising to have witnessed the rogue type of behaviour that came out of the East during the past year.

At the same time that the Russians and former Soviet states took the low road, the Turks took the high road by rapidly adjusting to the international crisis. The trade numbers said it all. Turkey’s trade deficit declined 57% y/y to $3.4 billion in July. Exports contracted 28% y/y to $9.03 billion while imports decreased 40% y/y to $12.4 billion. The June 2009 deficit narrowed 46% y/y to $4.2 billion. The rapid reaction of the trade accounts allowed Ankara to quickly narrow its current account gap by 65% y/y to $1.9 billion in June. More importantly, Turkey’s current account deficit contracted 75.7% y/y to $6.7 billion during the first half of the year. The government forecasts the current account shortfall to be near $10 billion in 2009, which is vastly lower than the 2008 level of $41.4 billion, and it will bring the current account deficit below 2% of GDP. This is setting Turkey on the road to a rapid recovery. Industrial soared 7.3% on a month to month basis in June, generating optimism in that the economy was on the mend. Although Turkey’s GDP is expected to contract 5.1% y/y in 2009, a solid expansion is expected in 2010. Many people were surprised by the ability of the Turkish economy to respond, but the real surprise was the action by local firms to repatriate $18 billion in order to pay down corporate debt. Such noble behaviour will go far in distinguishing Turkey from its Central Asian rivals. More importantly, the rapid adjustment of the current account and the repatriation of capital allowed Ankara to avoid tapping the IMF. Therefore, Turkey was the sweet and pleasant surprise. Perhaps, the country’s long history of integration with the West ingrained a spirit that was vastly different than the isolationist traditions that blew across the steppes. Unfortunately, the broken promises of the East will make it costly for it to attract the foreign investment needed to spur economic development.