Oil prices, fantastic. Economics, good. Politics, hmmm…

by Simon Pirani

Concern is growing among investors that political infighting ahead of the March 2008 presidential elections could derail Russia’s impressive economic recovery.

The oil boom has made Russia financially impregnable: this summer it has paid off its Paris Club debt and is pouring tens of billions of dollars into its stabilisation fund. But analysts are concerned about inflation on one hand and oil-driven “Dutch disease” on the other, especially as tensions between rival groups in the Kremlin intensify as the election nears.

Aleksei Kudrin, the finance minister credited with highly effective management of Russia’s windfall, has been under constant pressure from various Kremlin factions to loosen budget discipline – and said in an interview with Emerging Markets that he is steeling himself for the special pleading to mount as the election nears.

Kudrin, who along with economy minister German Gref has carried the torch for economic reforms in a government increasingly dominated by statist centralism, said he expected to be put under “a great deal of political pressure” in the run-up to the elections. “We have to keep within definite limits, to prevent any sharp increase in inflation or further strengthening of the ruble.

“It will be hard to explain these things to parliament, on the eve of elections – but, nevertheless, the effectiveness of our budget spending must be improved.”

The elections seem certain to be won by a successor chosen by president Vladimir Putin, whose own popularity ratings remain high. Parliamentary elections in December 2007 are expected to have a similarly predictable outcome: the pro-Kremlin party, United Russia, should trounce an increasingly divided opposition of former communists and keep liberal rightists’ numbers to a minimum. And there is little danger of serious disruption or discontinuity of government.

But that’s both the good news and the bad news, according to Chris Weafer, chief strategist at Alfa Bank in Moscow. “We expect the next president either to be someone with the skill to keep the peace among the Kremlin factions, or a secondary figure who is simply doing Putin’s bidding.

“The critical issue is that the government needs to make some tough choices in the next couple of years. If it avoids doing so – and much decision-making has been avoided in the six years under Putin so far – then we could be in difficulty, whatever the oil price.”

There are two scenarios the government needs to avoid, says Weafer. The first is that, with continuing high oil prices and a burgeoning stabilisation fund, there could be an inflow of speculative capital, a surge of inflation, a downturn of service industries and a sharp fall in consumption. “We could have $75 oil and GDP growth stuttering along at 1-2%.”

The other danger is, with a lower oil price –$55 per barrel in a model Alfa has worked on – that the Central Bank will have no room to increase the monetary surplus, Russia’s creaky banking system would be unable to keep financing consumer spending and growth would be damaged.

Kudrin, acutely aware of these dangers, says in his interview: “We can not call our economy competitive.” Part of the problem, he acknowledges, is “administrative outgoings in industry resulting from bureaucratism and corruption that result from the excessive influence of the state”.

Weafer is hopeful that the government can overcome the dangers and, through its programme of creating “national champion” companies in industry, move the economy away from dependence on oil, gas and metals exports. Analysts at UBS note in a recent piece of research are even more bullish: they see the beginnings of investment-led growth and, in particular, highlight the reversal of capital flight that dogged Russia throughout the 1990s.

The private capital account showed a net inflow of $16.1 billion in the second quarter of 2006, including $7.9 billion worth of foreign direct investment, they point out. “The surplus, combined with the acceleration of investment growth, means Russia’s stability, current account and budget surpluses plus balance sheet strength are finally translating into investment,” they say.

But other critics say that the Putin administration has lost valuable years to break that dependence, during its pursuit of the Yeltsin-era oligarchs, its destruction of Yukos, once Russia’s prime oil company, and its encouragement of the “new oligarchs” who run state-controlled businesses such as Rosneft, the newly-listed oil company and VSMPO, the titanium producer that signed a 30-year, $18 billion supply deal with Boeing over the summer. Russia will pay the price in economics for this type of politics, they warn.

Lilia Shevtsova, senior associate at the Moscow Carnegie centre, a think tank, says that the rise of the “new oligarchs” – alongside Putin’s “managed democracy”, under which the Kremlin has cornered opposition parties by subtle harassment of leaders and overwhelming control of broadcast media – amounts to “a victory of bureaucracy over the market”.

“Until recently the elite considered over-reliance on natural resources exports to be a weakness. Not any more,” she complaints. “Russia is being consigned to a future of obsolescence. Putin talks about investing in high-tech, but nothing happens.”

Among possible presidential candidates, no-one speaks seriously about any except for those supported by Putin. The front runners are first deputy prime minister Dmitry Medvedev, chairman of the state gas firm Gazprom, and defence minister Sergei Ivanov, who has recently started speaking publicly on broader policy issues. A hint from Putin in May that he would back a candidate not considered a front-runner led to speculation about lesser known figures such as Sergei Sobyanin, head of the presidential administration, figures such as Vladimir Yakunin, ceo of Russian Railways.

This article appeared in Emerging Markets, 19 September 2006.
Posted October 2006; © 2006 Simon Pirani

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