No Place in BRIC for Russia's Economic Mess

Op-ed in the Moscow Times

July 29, 2009

First-half results are arriving, presenting many countries with shocking declines, but the record is quite varied. Whatever standard we choose, Russia is underperforming.

The country's natural comparison is with the BRIC countries-Brazil, Russia, India, and China. According to JP Morgan's current forecast, this year the gross domestic product of China is expected to grow by 8.4 percent, India by 6.2 percent, while that of Brazil is expected to shrink by 1.0 percent, and Russia by 8.5 percent. During the first half of 2009, China and India have been forging ahead, while Russia's GDP plunged by 10 percent.

Russia's economy remains dominated by oil and gas, and its overall government policies depend heavily on the global oil price. Three standard scenarios were formulated in the official Strategy 2020 program. The favored "innovation scenario" was supposed to generate an annual growth of 6.5 percent. It presupposed far-reaching reforms and investment in human capital, which is not a plausible option with an oil price above $60 per barrel.

The Kremlin's negative "inertia scenario" assumed no significant reforms and forecasted an average growth of 3.9 percent a year. Such an authoritarian petrostate is likely if the oil price is $75 per barrel. In between, the Kremlin put an "energy and raw materials scenario" with 5.3 percent growth, which could be called status quo with an oil price of $60 to $75 per barrel, but such a policy is not likely to generate a high growth rate.

The critical insight is that the higher the oil price is, the lower Russia's long-term economic growth is likely to be, because the ruling elite will thrive on energy rents rather than pursue reforms or invest in human capital. The greater the corruption is, the more repression the rulers need to defend their fraudulent revenues.

Russia's course is difficult to discern because overt economic policy changes every few months with the oil price. During the period from May to July 2008, the inauguration of President Dmitry Medvedev raised hopes that he would initiate economic and political reforms-particularly as it related to his anti-corruption initiatives-but we saw no significant changes.

Instead, Prime Minister Vladimir Putin intimidated Mechel in late July, threatening to send a "doctor" to clean out the company's problems, and the war in Georgia two weeks later augured a period of darkness and reaction. Russia's attempts to accede to the World Trade Organization (WTO) were suspended and a renationalization of leading companies became a priority.

But the devastation caused by the financial crisis and gradual devaluation allowed reformist ideas to surface again. Russia saw a renewed openness from February until May that could almost be labeled a thaw, but again no legislation was passed.

In early June, the oil price surpassed $70 per barrel, and the reactionaries got into action again. In Pikalyovo, Putin declared the not very market-oriented view that private businessmen have to produce for the sake of producing. Numerous governors threatened private enterprise owners with confiscation if they did not rehire workers and keep decrepit factories alive. Several weeks later, Putin suspended Russia's attempted accession to the WTO, and he even went on a personal tour to control sausage prices. Naturally, rumors are ripe of possible new confiscations of large corporations.

This is no way to run economic policy. In effect, Russia is pursuing the status quo or inertia scenario-but without the benefit of stability. With its quarterly swings in declared economic policy, the government destabilizes the business environment and fails to carry out any economic policy. Both the vagaries and passivity are dangerous to the country's economy as is evident from the drastic decline in GDP. Little surprise that not only China and India but also Brazil are much more successful.

Russia's only sensible policy has been its fiscal policy with a persistent budget surplus in the good times from 2000 until 2008, which allowed it to build huge international reserves that, while reduced, remain at roughly $400 billion today. This means that Russia can safeguard itself from some fluctuations of the global financial market.

But it is not doing so. On the contrary, it is causing unnecessary domestic financial problems. The ultimate folly was Russia's gradual devaluation during the period from November to January. Naturally, everybody speculated against the ruble, which meant that the Kremlin instigated a domestic liquidity freeze. It was probably the main reason for the excessively sharp drop in Russia's industrial output. Amazingly, this operation is officially hailed as a success, making evident that the danger of a repetition persists.

The state-dominated banking system remains a morass. The five dominant state banks are in poor shape. The government pours more and more money into them, but it helps little as the banks lose it in short order on politically motivated, nonperforming loans. The state banks pose a threat of nationalizing big Russian companies, while they provide little credit. In effect, the Kremlin maintains a detrimental liquidity squeeze.

Senior officials interfere arbitrarily in big enterprises, asking them to hire more workers, to reduce prices and to expand production under threat of confiscation, further undermining the country's weak property rights. This is the worst possible policy.

Gazprom appears to be the greatest management failure of them all. It is difficult to fathom how it has succeeded in scaring so many customers away in half a year that it has been forced to cut its output by 35 percent. In any other country, save Congo, such a harmful management would be ousted without delay. There is no reason to expect any significant improvement as long as the managers remain the same.

Russia's ultimate shortcoming is its pervasive top-level corruption. Remember that it has failed to extend its road network since 2000. A country that cannot build roads cannot develop much more.

Undoubtedly, Russia will recover somewhat because of higher oil prices, the global recovery and recovering exports, but nothing has been done about the country's profound structural problems, which have only been aggravated during a year of financial crisis. Worse, Russia's economic policy is in such flux that nothing is being done. Gradually, the question is moving from complaints about how Russia is being governed to criticism that it is not being properly managed. No forthcoming disaster is evident, but no country can be ruled so poorly for so long.