Rus­sia risks be­com­ing a se­cond-rate state

▶ Putin has shown lit­tle in­ter­est in chang­ing the eco­nomic model ▶ “It’s not about oil or sanc­tions; it’s about struc­tural weak­ness”

Bloomberg Businessweek (North America) - - Conntents -

For Rus­sia’s bat­tered econ­omy, 2016 al­ready looks mis­er­able. The ru­ble has slumped to record lows as oil prices have fallen 11 per­cent since Jan. 1, to around $30 a bar­rel. The govern­ment, which gets nearly half its rev­enue from oil and gas, is scram­bling to plug a 1.5 tril­lion-ru­ble ($19.2 bil­lion) hole in its bud­get. The In­ter­na­tional Mon­e­tary Fund fore­casts the econ­omy will shrink 1 per­cent this year, af­ter con­tract­ing 3.7 per­cent in 2015. The sit­u­a­tion has cre­ated “an at­mos­phere of ex­treme ner­vous­ness,” Econ­omy Min­is­ter Alexei Ulyukayev told Pres­i­dent Vladimir Putin in a meet­ing on Jan. 26, ac­cord­ing to a tran­script re­leased by the Krem­lin.

As grim as the num­bers are, they may un­der­state the in­creas­ingly dis­mal prospects for a coun­try that only a few years ago was en­joy­ing its great­est pros­per­ity. Econ­o­mists and busi­ness lead­ers, in­clud­ing some with strong Krem­lin ties, are warn­ing that Rus­sia faces long-term stag­na­tion and de­clin­ing com­pet­i­tive­ness. “We find our­selves among the coun­tries that are los­ing, the down­shift­ing coun­tries,” Her­man Gref, head of state-con­trolled Sber­bank, the coun­try’s largest fi­nan­cial in­sti­tu­tion, said at a con­fer­ence in Moscow on Jan. 15.

The sit­u­a­tion re­sem­bles “a stair­case lead­ing down,” says Evgeny Gont­makher, a board mem­ber at Moscow’s In­sti­tute of Con­tem­po­rary De­vel­op­ment, whose chair­man is Prime Min­is­ter Dmitry Medvedev. Gont­makher pre­dicts Rus­sia will prob­a­bly eke out near-zero growth through 2017 and that the govern­ment will re­as­sure cit­i­zens the econ­omy will re­sume climb­ing af­ter the March 2018 pres­i­den­tial elec­tions. In­stead, he says, the econ­omy “will go down­ward af­ter 2018.”

Rus­sia has weath­ered crises be­fore, in­clud­ing a 2008 oil price plunge and a 1998 sov­er­eign debt de­fault. In those cases, ro­bust growth re­turned within a year or two. This re­ces­sion’s dif­fer­ent, says Vladislav Inozemt­sev, a pro­fes­sor at the Na­tional Re­search Univer­sity Higher School of Eco­nom­ics in Moscow. “It’s not about oil or sanc­tions; it’s about struc­tural weak­ness,” he says. There al­ready were signs of malaise in 2012, when oil topped $100 and Western sanc­tions over Rus­sia’s an­nex­a­tion of Crimea were two years off.

The trig­ger for the down­turn, Inozemt­sev says, was Putin’s re­turn to the pres­i­dency in May 2012. He raised taxes on busi­ness and real es­tate to fi­nance mil­i­tary spend­ing and ex­panded the reach of in­ef­fi­cient state-con­trolled com­pa­nies such as oil gi­ant Ros­neft. “Busi­ness­peo­ple be­came dis­il­lu­sioned,” curb­ing in­vest­ment in fac­to­ries and equip­ment, Inozemt­sev says. Pro­duc­tiv­ity slack­ened, cor­rup­tion thrived, and for­eign in­vest­ment slowed as in­vestors fret­ted about the state tak­ing over their as­sets, says Ti­mothy Ash, an emerg­ing-mar­kets strate­gist at No­mura In­ter­na­tional in Lon­don.

When Putin first be­came pres­i­dent, in 2000, he said he would re­duce the govern­ment’s re­liance on oil. In­stead the govern­ment grew even more de­pen­dent on oil rev­enue, and con­sumer spend­ing be­came the main driver of the econ­omy.

No more. House­hold in­comes have de­clined for the past two years, and some 22 mil­lion Rus­sians live in poverty, up 50 per­cent since 2013. Retail sales fell 10 per­cent last year, and auto sales plunged 36 per­cent. Gen­eral Mo­tors, which once counted Rus­sia among its fastest-grow­ing mar­kets, shut most op­er­a­tions there last year, and re­tail­ers in­clud­ing Ger­many’s Adidas and Spain’s Mango have closed stores. Mcdon­ald’s, which has 543 Rus­sian restau­rants, said on Jan. 25 that it still plans to open 60 out­lets this year but is ad­just­ing its menus as more cus­tomers switch from Big Macs to cheaper chicken wings and pork burg­ers.

Omi­nously, in­dus­trial pro­duc­tion and fixed in­vest­ment de­te­ri­o­rated in De­cem­ber, even af­ter Putin de­clared on Dec. 17 that the worst of the cri­sis was over. Oil prices don’t seem likely to re­bound soon.

Re­form ad­vo­cates say there’s still time to re­verse the de­cline by in­vest­ing more in tech­nol­ogy and loos­en­ing the govern­ment’s grip on the pri­vate sec­tor. Even if Rus­sia’s cit­i­zens are hurt­ing, there’s no im­me­di­ate risk of so­cial un­rest, for­mer Fi­nance Min­is­ter Alexei Ku­drin, a Putin ad­viser, told Bloomberg News at the World Eco­nomic Fo­rum in Davos on Jan. 20. “We have two years in re­serve when so­cial sen­ti­ments will be sta­ble,” Ku­drin said.

The govern­ment can’t af­ford ma­jor in­vest­ments, though. It has al­ready dipped heav­ily into for­eign re­serves, and Fi­nance Min­is­ter An­ton Silu­anov said on Jan. 13 that spend­ing on most pro­grams would likely be slashed 10 per­cent to close bud­get deficits. Things are no bet­ter in the pri­vate sec­tor. Sanc­tions have frozen most Rus­sian com­pa­nies out of ma­jor fi­nan­cial mar­kets, and the weak ru­ble makes it dif­fi­cult for busi­nesses to im­port equip­ment to boost ef­fi­ciency.

Putin, whose ap­proval rat­ing re­mains above 80 per­cent, has shown lit­tle in­ter­est in shak­ing up the coun­try’s eco­nomic model. “We have grounds for cau­tious op­ti­mism” in 2016, he told Econ­omy Min­is­ter Ulyukayev on Jan. 26, ac­cord­ing to of­fi­cial re­marks.

The state-run com­pa­nies that dom­i­nate the econ­omy are headed by loyal

Putin friends, while other mem­bers of his in­ner cir­cle have ben­e­fited from big-ticket projects such as the Sochi Olympics that failed to pro­duce last­ing eco­nomic ben­e­fits. Far-reach­ing re­forms, econ­o­mist Gont­makher says, “are con­trary to the in­sti­tu­tional in­ter­ests of the cur­rent govern­ment.”

- Carol Mat­lack, with Anna An­dri­anova The bot­tom line Econ­o­mists pre­dict long-term de­cline for Rus­sia’s econ­omy; the IMF fore­casts it will shrink 1 per­cent this year.

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