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Russia: time for political, economic reform

The global crisis has hit Russia much harder than originally expected, putting an abrupt end to a decade-long economic boom driven by high oil prices.

At the outset of the crisis Finance Minister Alexei Kudrin trumpeted Russia as an “island of stability” in the rough seas of the global financial turmoil thanks to its world’s third largest foreign currency reserves of $600 billion. This week the government conceded that the economy was sinking into recession. Industrial production in November shrank a monthly 10.8 per cent compared to growth of 2.8 per cent in the previous month, the statistics board reported, and analysts expect it to plummet a further 20 per cent in December.

The government still insists that the Gross Domestic Product (GDP) will grow between 2 per cent and 3 per cent next year, down from 6 per cent this year, 8.1 per cent in 2007 and 7.4 per cent in 2006. But independent economists are far more pessimistic. The economy may contract between 6 per cent and 15 per cent next year, says Igor Nikolayev of the leading Russian audit and consulting company, FBK. He does not rule out that the slump would be deeper than the crash of 1992 after the break-up of the Soviet Union.

Russia is paying the price for failing to diversify the economy when oil prices were sky-high. If anything, heavy dependence on the commodity sector has only increased over the past decade: exports of oil and gas today contribute 60 per cent of the federal budget revenues. More tax revenues are generated by suppliers to the energy industries and by the sales and services sector boosted by the oil windfall. As the global slowdown reduced demand for commodities, Russian steel, construction, manufacturing and transport sectors slashed their output and investment programmes.

The plummeting oil prices have undercut the basis on which the Russian economy rests. Manufacturing shrank 15.3 per cent in November; the output of coal coke, pulp, fertilizers, rolled metal, and some machine plant declined by more than 30 per cent in November compared with a year ago and is heading for a deeper slump in December, Russia’s leading business daily, Kommersant, reported citing government sources. Rail freight turnover dropped by 20 per cent in November and looks likely to shrink by a further 30 per cent or more in December.

The tax collection tumbled by half in November, the federal tax service reported, while wage arrears nearly doubled. Prime Minister Vladimir Putin, who two months ago said Russia would be able to relatively easily survive the crisis, voiced concern last week over new data showing that the jobless rate rose by 372,000 in October to 4.6 million people, from October 2007.

Unemployment will grow by 10 per cent to 11 per cent in Russia next year, from 6.1 per cent currently, according to a report by VTB Capital, investment branch of Russia’s main state bank.

Mr. Putin, who has taken responsibility for the economy after promoting his chosen successor, Dmitry Medvedev, for President in May, faces the most severe test of his popularity as economic outlook for Russia is getting grimmer by the day.

Most economists believe the Russian economy will keep falling at least till mid-2009, and probably till early 2010 if oil prices do not rise. The Russian oil mix has dropped below $45 a barrel, whereas the 2009 budget is based on the forecast of $70 a barrel.

The country is heading for an “industrial catastrophe” that would eclipse the 1998-1999 crisis when Russia defaulted on its sovereign debt, the Kommersant said.

Anti-crisis measures taken by the government without any public debate or parliamentary scrutiny are coming under mounting criticism from the expert community.

“The government made a strategic mistake in its initial response to the crisis,” said Mr. Nikolayev of the FBK consultancy. “When the stock market collapsed they argued that this would only hit the share holders and brokers, not the real sector. And now it turns out that we are in for a recession.”

Russia’s central bank has spent about $160 billion more than a quarter of its reserves — propping up the currency and increasing market liquidity. The measures have helped prevent a panicky run on bank accounts, but failed to stop the downslide of the rouble, which has lost 15 per cent of its value since a summer peak, or ease the credit crunch for industry.

Analysts have criticised the government for lack of openness in dealing with the crisis. Little is known where the multibillion bailout chest has gone, or why some Russian tycoons, who were reckless enough to pledge big stakes to foreign lenders, have been rescued.

Even parliamentarians from Mr. Putin’s ruling United Russia party, which rubberstamped the government’s the $200-billion bailout plan two months ago now admit that the plan is not working. A group of prominent party members signed an open letter this week saying the government money went mostly to large corporations and banks, which converted it into foreign currency as a hedge against the falling rouble, instead of investing or issuing loans to industry.

The government has now pledged direct financial help to 1,500 companies that account between them for about 85 per cent of gross domestic product. Sociologists register growing popular discontent over the rapidly deteriorating economic situation. A November poll showed that 39 per cent of Russians are increasingly unhappy with the government, and in some industrial regions the anti-government sentiment exceeds 50 per cent.

The Kremlin has banned any coverage of the crisis on national TV channels in an effort to control protest moods. When a Moscow paper carried a story by a well-known economist who painted a disturbing picture of the financial crisis triggering huge protests after massive layoffs next year, the editor was issued a stern warning by a government media watchdog against “inciting extremist feelings.” But media restrictions appear to have the opposite effect.

Thousands of drivers took to the streets in several cities and towns in Russia’s Far East last Sunday to protest higher tariffs the government clamped on imported cars to protect domestic auto makers. The protesters clashed with police and openly called on Mr. Putin to resign.

The government has taken the protests very seriously. Two days later the commander of Russian Interior Ministry troops announced that earlier plans to cut his forces by about 25 per cent had been put on hold.

The current crisis is not only a challenge, but also an opportunity to reform Russia’s economic and political system. “The economic model Russia has developed for the last several years has exhausted itself,” Minister of Economic Development Elvira Nabiullina stated in Parliament last month. She called for diversifying the economy away from over-dependence on oil and gas, cutting production costs and reforming the banking system as a source of easy long credits to producers.

Political analysts say that economic modernisation in Russia is not possible without greater political freedom. In the midst of the financial crisis a Kremlin-linked think tank has called on the Russian political leadership to promote a credible multiparty system and political competition. The Institute of Contemporary Development, formally headed by Mr. Medvedev, issued an updated report this month stating that a “vertical-hierarchical” system of government dominated by an entrenched bureaucracy would not be able to mediate between the state and society “in the event of a deteriorating socioeconomic environment.” If the reforms are not initiated “from above,” the report warned, they will still be “placed on the agenda by the logic of the emerging economy.”

The report reflects the views of the so-called “modernisers” who are locked in a fierce debate with “conservatives,” a Kremlin group that has so far dominated the government. The conservatives’ viewpoint was set out this week in the government newspaper Rossiyskaya Gazeta. Political scientist Leonid Radzikhovsky argues that there is no social demand today for any further democratisation outside a small group of liberal political intellectuals who have no practical impact on public opinion. In an opinion piece titled “A Thaw on the Ice-Floe” Mr. Radzikhovsky warns that unlimited freedom of speech of the kind that existed in the early 1990s can be destructive in conditions of an economic crisis. The writer calls instead for the rearing of a true, independent middle class, which will then create a strong demand for a bigger amount of democracy in Russian society. Some analysts have suggested that this debate points to an emerging rift between “liberal” Medvedev and “conservative” Putin. There is mounting speculation that if the crisis gets out of hand Mr. Putin might return to the presidency next year and stay at the helm for the next 12 years, taking advantage of the just approved constitutional amendments extending the presidential term from four to six years.

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