Modernization is Russias buzz word: everyone from president Dmitry Medvedev downwards is talking about it. But it will be a long, hard slog, economists warn and in the meantime the economy remains dependent on oil.
And while the governments post-crisis stimulus package won applause from markets and international institutions alike, dilemmas including industrial strategy and monetary policy remain to be addressed.
Economic growth fuelled by commodities exports, if its potential is not already exhausted, is in any case no longer so relevant, Medvedev told French business leaders last month, echoing warnings made by prime minister Vladimir Putin since the mid-2000s about the need to diversify from oil.
To begin with, the two leaders take modernization to mean intensifying the crusade against corruption in government, kick-starting a high-tech sector, and pushing energy companies to lead the way on energy saving. Analysts say that both Putin and Medvedev mean what they say on modernization in contrast to general sloganizing prior to the economic crisis but that the process is slow.
Chris Weafer, chief strategist at Uralsib Financial Group, says: Putins plans for modernization were completely derailed by the economic crisis. And now there will not be time before the next elections in 2011 (parliamentary) and 2012 (presidential) to make substantial progress. On the other hand, post-crisis, theres a better chance of success.
Alexandra Evtifyeva, senior economist at VTB Capital, speaks approvingly of Medvedevs electronic government initiative. It will put on line, and therefore simplify, such processes as applying for passports, licences and other documents, destroying bribe-taking opportunities abused by corrupt Russian officials for generations.
But Medvedevs headline-grabbing plan to create a high-tech development area at Skolkovo, near Moscow, is not as utopian as its critics think. Russia has quite a competitive edge in IT services, Evtifyeva says, and the country has the ability to attract highly skilled Russian labour back home from the US and elsewhere.
There is a gap between demand and supply in innovative projects. And they are cheaper for the government to do than infrastructure investment such as road construction, she says.
At a meeting of the governments modernization commission on March 23, Medvedev appointed Viktor Vekselberg, billionaire owner of the Renova group and shareholder in TNK-BP oil company, to head the high-tech initiative. He will work with veteran market reformer Anatoly Chubais, who is chief executive of RosNano, the state high-tech corporation.
At the meeting held in Khanty-Mansiysk, western Siberia, Russias largest oil-producing province Medvedev spelled out that Russias energy-saving campaign must embrace the national introduction of LED light bulbs and modernization of housing stock, but also technological upgrades in the oil sector to improve field recovery rates. Surgutneftegaz boss Vladimir Bogdanov and other oil magnates at the meeting were told to present proposals by October.
The key issue for any kind of planning is whether the bounce-back from recession continues. The signs are encouraging: oil prices are above $80/barrel, and economists are forecasting growth of 5% or more this year.
Post-crisis, differences in government about how to modernize, and how to dispose of Russias excess oil wealth put oversimply, between economic reformers and the siloviki (former security services officers brought in during Putins presidency) have largely been pushed into the background. For this year, the issue is to keep the recovery going.
Russias recession was one of the worlds most severe. In 2009, real GDP shrank by 7.9%, industrial production by 10.8% and fixed capital investment by 17%. The proportion of Russians below the poverty line rose during 2009 to about 14%; the average dollar wage fell by $101 to $593; and unemployment (International Labour Organization, ILO, definition) rose to 8.2%, while many millions of employees faced short-time and compulsory unpaid holidays.
Russias recovery began in the third quarter of 2009, driven by a bold fiscal stimulus package and, according to the World Banks Russia Economic Report, published in March, looks robust this year. Russia is gaining from strong oil prices and from the surge of capital flows to emerging markets. Against that, domestic demand is weak, industrial production growth sluggish, and problems with bank debt are persistent.
The Russian fiscal package is notable for support to corporations deemed strategic. The GM-Avtovaz plant at Togliatti, Russias and, indeed, Europes largest car factory, is emblematic of the strategy: it received 28 billion roubles ($955 million) in government aid last year, restructured 25 billion roubles worth of debt, but is still aiming to make an operational profit by next year. Russian families are big recipients, too: pensions will rise by 47% during this year, which some economists see as a useful stimulant to sluggish consumer demand.
Fitch Ratings moved Russias sovereign outlook to stable from negative in January. Ed Parker, a senior director at the agency, says that although industrial output and consumer demand remain flat, while they are rising in other countries, Russia continues to move in a positive direction. He says that news on inflation is better, the trend in capital flows is encouraging the latest figures, for the 4th quarter of 2009, show an $11.6 billion inflow and that while the banking sectors giant cross-border debts remain worrying, downside risks have stabilized.
Those mighty arbiters of developing nations economies, the fund managers who have ploughed such gigantic quantities of money into emerging markets this year, have shown favour to Russia too.
Within Brics-dedicated (Brazil, Russia, India, China) funds, Russia, with its exposure to strong oil prices, has grown as a weighting, while China and India, where interest rates are rising, have fallen. Among equity funds, Emerging Portfolio Fund Research reported that in 2010, up to mid-March, those focused on Russia had attracted $1.47 billion in equity double what had gone to their Brazilian counterparts and three times the comparable flows to China.
Indeed, while Russias oil-based story worries economists, who see the very early stages of Dutch disease whereby increasing exploitation of natural resources results in a decline in manufacturing it gladdens the heart of emerging markets strategists. Michael Harris, head of emerging EMEA (Europe, Middle East and Africa) equity strategy at BofA Merrill Lynch, says: If Russia institutes reforms, kills off inflation and reduces dependence on oil, it is a phenomenal story. But for now Russia has one trick: oil. Its a very good one, though.
SWITCH IN PRIORITIES
The Russian oil lobby, headed by deputy prime minister Igor Sechin, the countrys most powerful silovik, sees this time of high oil prices as one in which to address the issue of under-investment that has plagued the industry throughout post-Soviet times. Sechins formidable lobbying power is concentrated on developing east Siberian oil reserves a key to the governments plan to send up to a quarter of Russias oil, and a fifth of its gas, to China and other Asian markets by 2030.
Rosneft, the national oil company of which Sechin is president, is developing the Vankor field in east Siberia; two other major fields, Talakan and Verkhnechonsk, are being worked on by Surgutneftegaz and TNK-BP respectively. Investment has been partly funded by China, which last year extended $25 billion of loans to Rosneft and the state-owned pipeline company Transneft, but more is needed.
A proposal for export duty from the east Siberian fields to be set at zero, which would cost the budget about 120 billion roubles, has been under discussion in government. Russian newspapers claim that Sechin has suggested to finance minister Alexei Kudrin ways to raise the same amount in tax elsewhere. In late March the zero export duty was extended to the end of the year.
The east Siberia issue could trigger a wider discussion about reforming the tax system, which in 2003 was refocused on output volumes rather than profit, to deal with the tax avoidance schemes of the 1990s. The trouble with this is that there is no incentive for capital expenditure. And decisions taken willy-nilly, such as on the east Siberian export duty, can have unintended consequences, such as drawing investment away from the older fields in western Siberia, where recovery rates are too low, says Chirvani Abdoullaev, oil and gas analyst at Alfa Bank.
The oil lobbys ambitions are in sharp contrast with the travails of Gazprom, Russias biggest company, whose revenues from European sales two-thirds of its turnover fell by $13 billion in 2009 as demand and gas prices sank, and the gas war with Ukraine took its toll.
Oil companies are encroaching on Gazproms domestic market, taking stakes in smaller gas producers and lobbying the government for a greater share in the gas pipeline system for associated gas produced at oil fields. If the trend continues, a shift in Russian politics in favour of the Rosneft party and against the Gazprom party could ensue.
The drive for east Siberian oil sits comfortably in the international markets view of what needs to happen next. Smith at BofA Merrill Lynch says that Russia needs to move beyond redistributing oil windfalls via wages and pensions policy.
The challenge for the government is to move beyond direct populism and to modernize and grow its commodity infrastructure, he says. One possible secular growth accelerator is Russias aim of becoming a big strategic supplier of resources to China, although Smith thinks it is premature to assume that politics will remain conducive to that outcome.
Supplying more raw materials to China is little better for Russias long-term development than supplying them to the West. However, it is a likely stepping stone towards the goal of modernization.
How much progress the Putin-Medvedev team can make towards that goal will remain the big Russian question for some time.