Although the next presidential election in Russia is not scheduled to take place for another four months, the outcome has been clear since September: Vladimir Putin will return to the Kremlin. The only question that remains is whether he will stay there for six years or for twelve. Or maybe even longer.
In 2012, Putin will find himself at the helm of a very different economy than the one he presided over before. When Putin first came to the Kremlin in 2000, the economy was growing and increasingly dynamic after a tough transformation in the 1990’s. Public finances had suffered in the 1998 crisis but appeared balanced by the time Putin came to power, and it seemed that many lessons had been learned.
Next year, however, Putin will face a very different landscape. The economy has lost its momentum and is approaching stagnation. Oil and gas revenues, which have guaranteed macroeconomic stability for several years, appear insufficient now that oil prices have stopped climbing. Moreover, new potential shocks in the balance of payments are visible on the horizon. The budget is still balanced, but if all the expenditure decisions that have been made are actually implemented, they will inevitably lead to a severe imbalance in the future. In addition, Russia’s population is slowly growing older. In the coming decades, the country will see its labor force shrink. Moreover, many factors—red tape, corruption, and poor enforcement of property rights—have made the Russian economy unattractive for foreign direct investment, which has contributed to the nation’s technological backwardness.
Political Castling
Putin has an uneven track record on economic policy. From liberal reforms in the early 2000s, he shifted towards nationalization, greater state control over many businesses, and formal and informal involvement of the state on many economic issues. Additionally, his team isn’t getting younger and has not attracted newcomers for a long time.
The current staff, meanwhile, seems to have exhausted its appetite and political will for reform. Tensions within the leadership erupted in finance minister Alexey Kudrin’s resignation in September. Kudrin was one of the former president’s closest advisors and personal friends and had served as finance minister throughout Putin’s tenure. It is clear who the future Russian president and prime minister will be, but uncertainty over other key players in the next government has hampered new state activity.
Moving forward, the outlook for reform is murky. Putin and the ruling party will hesitate to embark on any program that could destabilize their grip on power, even as reform and rational economic policy is badly needed for true modernization.
An Economy Overly Dependent on External Factors
Slow growth
When the new government takes power, it will find Russia’s economic footing to be tenuous. While the main risks are external—a slow global recovery, financial turmoil in Europe, and falling prices for raw materials—they have contributed to a loss of momentum and unstable growth.
Economic growth in Russia was essentially negligible in the second quarter—less than 0.7 percent (quarter-over-quarter, annualized, seasonally adjusted). As a result, year-over-year growth fell from 3.7 percent in the first quarter to 3.4 percent in the second quarter of 2011. Taking into account the likelihood of a much better harvest, however, and a large increase in spending for the election campaigns, annual GDP growth may reach 3.7 or 3.8 percent.
Still, the main driver of post-crisis growth—the rebuilding of inventories—will be exhausted. According to Rosstat, inventory building accounted for 2.7 percentage points of GDP growth (quarter-over-quarter, annualized) in the second quarter, down from 5.3 percentage points of GDP growth in the first quarter.
There is a new statistical mystery, however. For the first time since the crisis, Rosstat’s data showed sharp growth in internal demand for domestically produced goods in the second quarter (3.5 percent quarter-over-quarter, annualized). But this data may not be reliable given that this category of overall demand grew very slowly at best (and, as a rule, didn't grow or even fell after the crisis). Also, Rosstat’s estimate for import growth was at odds with the Bank of Russia’s estimate for the first time in 15 years.
A stable budget
Conservative revenue and oil price projections ($79/barrel) led to a deficit forecast equal to 3.6 percent of GDP. But a large increase in oil prices (to $109.5/barrel for the first eight months of the year) pushed revenues well above the planned level (21.8 percent of GDP compared to 18.6 percent a year before). The health of the budget, troublingly, depends almost completely on external factors. 70 percent of the increase in revenues is due to larger proceeds from the taxation of oil and gas exports. Revenues from these taxes account for almost half of total revenue. Another 20 percent of the increase in revenue is due to tariffs on imports, which have grown rapidly.
Federal revenue for the whole year is expected to reach 21.2 percent of GDP (above the 19.3 percent forecast), and a small surplus may be recorded (equal to 0.6 percent of GDP). The government understands that external factors will not always be favorable and has therefore decided to put windfall revenues equal to 2 percent of GDP in a reserve fund.
The resignation of finance minister Alexey Kudrin has not yet led to any changes in budget policy. Next year’s budget was submitted to the parliament before his departure, and it will likely be approved without any serious changes. But for the budget to balance, oil prices will need to be $115-116/barrel.
Vulnerable balance of payments
In the third quarter, Russia’s balance of payments was under strong pressure, mainly due to continuing capital outflows and a lack of external financing. As a result, the Russian ruble devalued by 10 percent vis-à-vis the Bank of Russia’s bi-currency basket.
The devaluation has occurred despite the fact that the current account surplus remains large. Although it has nearly halved since the first quarter (falling from $32.3 billion to $17.3 billion), its relative size remains impressive (3.7 to 3.8 percent of GDP). The trade balance was supported by high export proceeds and some delay in the growth of imports.
In the third quarter, net capital outflows from Russia totaled $21.6 billion, twice as large as in the previous quarter. All in all in 2011, capital outflows exceeded $50 billion, as compared to $14 billion dollars the year before. The main driver was not the sale of Russian assets by investors but lack of external financing. The real sector was unable to refinance its maturing debt and had to pay it down. This means that the European financial sector, which is facing more and more limitations in its activities, cannot consider Russia as a buffer against global instability.
If current oil prices are stable and import growth continues, the current account surplus may shrink in the fourth quarter to a little less than 2 percent of GDP. Based on historical experience, a current account surplus equal to 1 percent of GDP is necessary to maintain stability in the balance of payments. This means that there may be little cushion room in the event that imports grow further, capital outflows continue, or oil prices fall by between 8 and 10 percent. The Bank of Russia should respond preemptively by spending from its reserves and enabling the revaluation of the ruble.
Frozen household incomes
Real household incomes continued to stagnate in the third quarter of 2011, as government spending tightened (expenditures for the past eight months were lower as a percentage of GDP than they were a year ago) and pension indexations were postponed due to lower inflation in the summer.
Consumer spending still grew, however. Even as the Russian financial system came under pressure and the ruble lost 10 percent of its value, households reacted by decreasing their propensity to save and spending more. This small consumer boom was also promoted by banks, which extended more credit to households during the summer. As a result, approximately half of the increase in consumer expenditures is leveraged.
In conclusion, the Russian economy is not in great shape, but it is not in bad shape either. The main concern is a strong dependence on external factors that make Russia’s economic growth, budget, and balance of payments vulnerable. As long as the investment climate does not significantly improve, potential investors will be wary, and Russia’s economy will have to fall back on old pillars if and when new crises emerge.
Sergei Aleksashenko, former deputy minister of finance of the Russian Federation and former deputy governor of the Russian central bank, is a scholar-in-residence in the Carnegie Moscow Center’s Economic Policy Program.
