End of Russia's economic boom?
Peter Lavelle
Until the Kremlin's makes some hard political choices about the
economy, Russia is faced with a decade of limited growth and limits allowing the country
to reach its economic potential. With the big business lobby (called the
"oligarchs") vanquished and replaced with competing groups in the Kremlin,
issues such as inflation, investment, and ruble appreciation are not being addressed. This
result could signal the end of Russia's economic boom
In the beginning, Russian President Vladimir Putin had it relatively
easy. The economy was growing a pace that was the envy of the West. The country's oil
production raced to levels not seen since Soviet times. Investment in the oil sector
matched production and international oil prices have soared. State coffers were
replenished, the ruble remained undervalued, pensions paid, and some tough talk on needed
structural reforms to repair or replace aging infrastructure.
Putin announced that Russia would double gross domestic product within
a decade -- a goal many thought attainable at the time.
Then things started to change.
A rigid tax regime aimed to capture a lion share of oil profits and the
attack and destruction of the country's largest private oil company Yukos saw investment
in the oil sector plummet and production drop to levels not seen since before the 1998
financial crisis.
Russia's economy continues to expand, though at a pace that disappoints
most economists. The Kremlin's economic liberals such as Finance Minister Alexei Kudrin
and Economic Development and Trade Minister German Gref have, under severe political
pressure, lowered their growth predictions to 5.5-6 percent for the next couple of years,
less than the average of 6.5-7 percent experienced during 2000-2004. Putin's goal of
doubling Russia's economy within a decade is in tatters.
Realizing that Russia's once shimmering economic progress is losing its
shine, Putin has gone to lengths to reassure domestic and foreign investors. Laws
favorable for investment have been passed into legislation, including decreasing the
statute of limitations on privatization from 10 years to three. Putin has even met with
international business leaders to make it clear, if not indirectly, the Yukos affair was a
one-off event and that Russia was open for foreign investment.
However, it is all that simple. Putin knows this, the competing groups
in the Kremlin fighting for influence (and quite possibly wealth) know this, and, most
importantly, foreign and domestic investors know this. With foreigners now effectively
banned from investing into energy and raw materials and a list of other industries deemed
too "strategic," investors remain highly skeptical.
The problems facing Russia's economy are, for the most part,
self-inflicted. For the present, high consumer spending has supported Russia's recent
growth, but with foreign direct investment at about $70 a head (compared to thousands of
dollars per head for Kazakhstan and Eastern European countries), foreign direct investment
is believed to be necessary to energize Russia's current economic growth and potential.
Not everyone in the Kremlin agrees though. With a stabilization fund
standing at about $30 billion (accrued from high taxes on oil production and exports),
some Kremlin officials claim that Russia can afford to dispense with foreign investment to
fund the state "strategic industries." These same officials do not appear to be
particularly concerned how such a policy would fuel inflation and speed ruble appreciate
-- two issues that threaten the current pace of economic growth.
Add to the mix messages coming out of the Kremlin that Prime Minister
Mikhail Fradkov has demanded that Economic Minister Gref simply draw up a plan to double
Russia's gross domestic product within in a decade, or a plan that would produce the
needed 7.2 percent growth a year. In so many words, Gref replied that he doesn't involve
himself in economic central planning and told the Fradkov what he is demanding is simply
"impossible."
As courageous as Gref and other Kremlin economic liberals have been in
counting the dictatorial demands of the government to increase growth, they too have
compromised -- a compromise that may see inflation eat away at all their hard work.
Gref and others have argued the stabilization fund should be used to
pay off Russia foreign debt of over $100 billion and be held in reserve for an unexpected
economic shock. Fradkov sees the fund as means to please his boss by literally
"buying" economic growth and a source of revenue to purchase popular pork-barrel
projects ahead of Russia's 2007-28 election season.
The two sides compromised. The government will be allowed access to the
excess oil revenues originally destined for the stabilization fund at the cut off level of
$27 a barrel instead of the present $20 a barrel.
Fradkov got the better of the deal. Fiddling with the stabilization
fund will pump an additional $10 billion into social spending. To date, non-monetary
factors such as state-control tariffs for national gas and electricity have fueled
inflation, now government spending is set to add to this.
As a result, the government's own inflation target of 10 percent is
simply illusory. Additionally, increased spending will also mean more petrodollars will
pour into the economy which will inevitably drive the value of the rouble up even faster.
It will take little time before high inflation and an appreciating ruble impact the
economy: Russia's unreformed industrial sector, accounting almost half of all employment,
and paying little in terms of tax revenue will be hit hardest.
Even with the policy differences and compromises cited above, Russia's
economy could go on as it is for decade. With $144 billion in reserves (and an additional
$30 billion in the stabilization fund), a strong trade surplus and external sovereign debt
of a mere 17 percent of GDP, Russia is in no immediate danger. However, what is missing is
the political will to reach Russia's economic potential. Infighting behind Kremlin walls
may be able to compromise to assure the present level of economic growth is sustained or
even accelerated for a short time, but in the longer run what should be the "Russian
economic miracle" is being squandered.
Peter Lavelle, based in Moscow, is a commentator on Russia's
politics and economy.
“The Washington Times”, July 6, 2005
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