(Business New Europe – www.bne.eu – Moscow Blog – February 5, 2013)
Russian Prime Minister Dmitry Medvedev called on the government to pick up the pace of economic growth and raise it to 5% in the near future, which might “require some changes in the budget policy.” The battle lines are being drawn for probably one of the most important policy debates in the country’s modern history.
In one camp is President Vladimir Putin, whose popularity is entirely predicated on the fact that he has overseen a decade-long transformational boom. Putin needs fast growth like a glass of vodka needs a pickle to make it more palatable. In the other camp are the boffins in the Ministry of Economic Development and the Central Bank of Russia (CBR) that actually dream up the policies to enable the Russian economy to grow and hold the purse strings.
Put into simple terms, the issue is that the government wants to loosen those purse strings and release more money into the economy to boost growth (by cutting interest rates and tapping the reserve fund), while the CBR wants to keep the purse tied, as the bank has now fully switched to inflation-fighting mode. It is going to be a nasty fight, as these are two fundamentally different points of view when it comes to running a country: quick prosperity vs. prudence.
The problem is the economy hit a soft patch at the end of last year. Russia started 2012 recovering from the crisis nicely with growth running at a little under 5%. But by the fourth quarter it slowed to only 2.2% and is expected to slow further in the first quarter of this year to about 1.9%.
The good news is that much of this slowdown can be attributed to the panic attack that both the Kremlin and business had in the summer when fears grew of another meltdown in Europe. The crisis didn’t materialize, but Russia’s economy still suffered from this “phantom crisis”: the affect is most clearly seen in the fact that companies began to sell off their inventories, rather than making things to sell, and corporate lending tanked despite booming consumer borrowing.
The CBR was also partly to blame for this slowdown with its surprise interest rate hike in September to 8.25%, at a time when pretty much every other central bank in the world was cutting rates to support growth.
The decision highlights the CBR’s new concern with fighting inflation above all else and was meant to establish these credentials six months before Russia’s bond market is hooked into the international financial system and all restrictions on bond trading are removed. Nominally, the CBR’s decision should be welcomed, but the Kremlin is unhappy as it needs more growth.
Russia’s average growth of 3.4% in 2012 and the 3.5% widely predicted for this year looks poor. Moreover, the economy ministry said in January that 5% growth will remain a dream without “accelerated reforms” and a looser monetary policy. Even with reforms, the earliest that Russia can return to 5% growth is 2016 and only if the roadmap reforms being introduced this year are made to work, the ministry said. The ministry has three scenarios for the next decade and none of them will please the Kremlin much.
Under the optimistic scenario, 25m new high-tech jobs are created and investment growth rises to 25% of GDP from the current 7% by 2015 and then again to 27% by 2018. In this case, average GDP growth will be 5.4% through to 2030.
But the economy ministry doesn’t believe this will happen. In its “target” scenario, the ministry expects that the extensive infrastructure reforms and modernization of the power sector on the docket will be carried out, but there will be a lot less progress in developing new high-tech, competitive industries. In this case, average GDP growth will be 4.1% through to 2026, but after that it will fall to an average of 3.8% as Russia gets caught in the “middle income trap.” This also assumes that investment growth remains stuck at current levels of 7.3% of GDP to 2015, and then slows after that.
Finally, the “conservative” scenario (a polite way of saying “total policy failure”) says the energy reforms happen, but no high-tech sector of any sort appears. Investment then falls from 7.0% to 3.6% by 2025 and Russia is doomed to a miserable 3.2% average GDP growth rate to 2026, before it falls even more to 2.5%. In other words, Russia falls into the same sort of stagnation that Latin America suffered in the 1970s.
While the GDP figures are well below the 7-8% Russia enjoyed in the last decade, Ivan Tchakarov, chief economist for the CIS at Renaissance Capital, points out that last year’s poor results are still actually pretty good amongst Russia’s peer group and that the slow growth was not all Russia’s fault. “While the official Rosstat figure for 2012 Russian GDP of 3.4% (4.3% in 2011) may not exactly conjure up images of dizzying heights, we are of the view that this is a solid and respectable performance given the significant headwinds that Russia faced last year,” Tchakarov said in a note. “Russia outperformed [emerging market] peers with similar per capita income levels.”
Russia is best compared with countries in the same per-capita GDP bracket, namely Poland and Brazil. India and China did a lot better than Russia, but they are also a lot poorer, so much earlier in the transition cycle where countries typically put in much higher “catch-up” growth.
Tchakarov concludes that currently the rate of Russian economic growth is being entirely set by external factors and if you buy into the theory that 2012 marks the bottom of the 2008 crisis, then the economy should start gathering momentum from here on in.
Still, the Kremlin is facing a scary outlook and unless it can actually pull off its promises of real change this time, then the “target scenario” does look the most likely. Given the government’s previous form, the prospects for real and meaningful structural reforms are not good.
Most observers (including the economy ministry) are assuming Russia continues the typical “muddle through” progress. In the past, Russia could afford to waste time and money with at best pseudo-reforms thanks to its oil money. But for maybe the first time since 2000, the Kremlin actually has to deliver on its promise as the oil money can no longer deliver such growth. If it does, then this will be a sea change in the way ZAO Kremlin works. Certainly, the rhetoric coming out of the Kremlin not to mention the increasingly serious anti-corruption drive that started in November suggests they are going to make a go of it. Trouble is, after two decades of dithering, investors are going to need a lot more convincing that the Kremlin can actually pull it off.