Russia has emerged from recession with rising domestic demand and sound finances, say the optimists, and oil wealth brought onshore will fund investment – including the kick-start to modernization that the government craves.
The trouble is, say the sceptics, that the government’s plan to run a fiscal deficit up to 2015 could crowd out private investment, hold up infrastructure renewal and hobble growth. And with an oil price perhaps as high as $95 a barrel needed for Russia to break even, external factors could upset the whole applecart.
There’s a consensus that Russia’s economy is recovering, albeit with difficulty, and will probably grow by 4–5% this year. But the scale of last year’s slump brought the category Brics (Brazil, Russia, India and China) into sharp relief, raising doubts over whether Russia deserved to be included: its GDP fell by 8%, while Brazil’s growth was flat and China’s (+8.7%) and India’s (+5.7%) roared on.
The recession was a devastating reminder of Russia’s economic dependence on natural resources, mainly oil. And the differing interpretations of the recovery often rest on contrasting views about how easy it will be to escape that dependence.
The enthusiasts focus on the fruit that government efforts to marshal oil funds to diversify the economy will bear. But the doubters worry that oil dependence will not be conquered without stronger policies to ensure sufficient private investment flows, properly targeted.
Clemens Grafe, economist at UBS and firmly in the optimist camp, says fears that Russian domestic demand will fall behind that in the other Brics are “misplaced”. He argues that a structural shift in fiscal policy means that oil revenues were not just used for the 2008–09 crisis rescue package, but will be shifted onshore longer term, boosting domestic demand and investment.
This shift, together with structurally lower inflation rates, means that private-sector savings and domestic leverage are likely to expand rapidly and drive the economy forward, he says. While Russia will continue to be dependent on volatile commodity prices, domestic savings will grow and interest rates can stay low, which will fuel “a trend growth rate significantly higher than that of the world economy”.
Of course oil money coming onshore is itself no guarantee of progress: it depends how much of it is saved and invested. The news on household savings is all good, Grafe says. “Russia is now the highest saving country in Europe – a completely different place in that respect from what it was in the 1990s.”
The volume of individual bank deposits grew by 27% in 2009 and by May 2010 exceeded 8 trillion roubles, according to a recent report by the National Agency of Financial Research. And at least part of the capital account inflows registered in the first half of 2010 was due to Russians changing euros into roubles, many of which then stayed in the banking system. But too much is still saved in other currencies, says Grafe: “Unless you get the money into the system in roubles, you’ll always be dependent on capital inflows.”
The government’s ability to encourage investment – specifically, into innovation and infrastructure – is a key part of the argument. Natalia Orlova, chief economist at Alfa Bank in Moscow, is optimistic on this score. She points to the plans to create an international financial centre in Moscow and the renewed insistence by prime minister Vladimir Putin and president Dmitry Medvedev that Russia welcomes foreign investment.
SELL-OFF
The proposal to sell more than $20 billion of stakes in state-owned companies, made by the finance ministry in July and under discussion in government, is another good sign, Orlova says. “This is not really privatization. The stakes being sold will be under 50% of these companies, some under 20%, and the state will retain control when the free float is increased.
“This is about the management of state companies. They need benchmarks of success and failure, and the market can provide a measure of efficiency.” Russia’s largest company, Gazprom, is 51% state owned and arguably already works like this.
The sceptics do not generally disagree about the government’s aims of modernizing the economy and diversifying it away from natural resources. But they focus on the difficulties of doing so.
Yaroslav Lissovolik, chief economist for Russia at Deutsche Bank, says the preponderance of social spending in last year’s budget – caused mainly by hefty increases in pensions and some public-sector wages that were planned long before the financial crisis – “inevitably comes at a cost”.
Since there is no prospect of social spending being cut – particularly as politicians are already turning their minds to the 2012 elections – the current plans to reduce the budget deficit are bound to impact investment in infrastructure, says Lissovolik.
“Even if the private sector has to do most of the actual work, public spending on infrastructure investment is needed to stimulate it,” he says. Higher fiscal deficits and higher state spending tend to produce higher interest rates, which further undermines the prospects of a private investment boom.
The World Bank’s latest Russian Economic Report, released in June, is also cautious. “Crumbling infrastructure, especially in transport, could hamper the economy’s competitiveness and longer-term growth prospects,” it warns.
And while criticizing governments for improving people’s living standards went out of fashion long ago in Washington, the report does note that the corollary of social spending is “greater rigidity” for the budget and “only modest increases in capital expenditures that will likely limit the impact on growth”.
Zeljko Bogetic, the World Bank’s lead economist for Russia, says: “My own view is guardedly optimistic. If the fiscal adjustment is made, it can bounce back and grow at 3–4% a year after that. The point is: that’s not so great for a country with such tremendous needs in terms of infrastructure development and modernization.
“That is why I worry more about the long term. If Russia wants to unlock sources of long-term growth, it needs to open up more aggressively.”
Assuming that capital, labour and technology are the essentials, Bogetic says, capital “is not being replenished as it should”; Russia’s labour supply problems are well known; and the economy is “still not open enough” to develop technology at the necessary pace.
The government, like many around the world, argues that mobilizing private-sector investment is the key – and its efforts cannot be written off. Lissovolik at Deutsche agrees. He points to impressive commitments by Cisco and Microsoft to put money into Skolkovo, Russia’s would-be silicon valley, and by Siemens both to participate in the high-tech development and to plough billions of dollars into the electricity industry.
But the bottom line is that, while these efforts are being made, Russia remains heavily dependent on oil revenues, Lissovolik says. Medium term, Deutsche forecasts an oil price of $70–80 a barrel, which the Kremlin defines as a “comfort zone”. But “as long as prices are below $95, Russia will be running a budget deficit,” he says – underlining how the world has changed as a result of the crisis.