RUSSIA’S PROSPECTS FOR ECONOMIC GROWTH

By A. V. Buzgalin

THE SUDDEN SHIFT

To determine how the factors governing Russia’s economic growth will change in the near future, it is important to understand how this economic growth arose in the first place. After the destructive crisis of 1992-1994, a period followed in which the Russian economy gradually adapted to the new conditions established by market reforms. This could be seen in the substantial slowing of the downturn in 1995 and the transition to a sluggish, scarcely visible upturn in 1996 and 1997. This process of adaptation, however, was only achieved at the cost of a series of aftereffects that had an extremely negative impact on the development of the economy. These included a far-reaching demonetarization of the economy, reflected in the high proportion of nonmonetary transactions. No less that two-thirds of the turnover of goods in this period involved no real money at all, and was based instead on either barter transactions, extended deferment of payment (which produced an unprecedented increase in company debts), or the use of money substitutes. The phrase “debt economy” was even used.

Financial transactions split into two strands: The more substantial one serviced operations inside the financial market and the other, thinner, strand was intended to meet the needs of the real sector. The situation was exacerbated by decisions taken on economic policy. To cover the budget deficit, the government resorted to a massive issue of very high yield short-term state bonds (GKO), as a result of which the banks concentrated the bulk of their operations on speculative dealings in these bonds. In such conditions, the profound shortage of working capital available to most companies was not going to be compensated by bank loans. In order to keep up their operating payments, companies were therefore obliged to steer clear of any long-term investment. And long-term credit was practically nonexistent: With most companies experiencing low profit margins (almost half of them were effectively unprofitable), and with dealings in short-term bonds proving highly profitable, the banks made the obvious choice.

All of this led to a tight squeeze on the investment in fixed capital and so to its progressive deterioration, which made it impossible to guarantee a technical level of production that was up to modern standards. In the unregulated economy, Russian goods, which had in any case never been noted for their competitiveness, were gradually squeezed out of the domestic market by their foreign competitors.

As a result, the whole of the first half of 1998 was marked by a renewed economic downturn. The financial crisis of August 1998 and the macroeconomic shock which followed permitted at least a partial resolution of these problems.

First, the four-fold devaluation of the ruble against the dollar immediately produced a sharp reduction in the effectiveness of the import trade. With imports down by almost a half, domestic producers found that the market they had lost was opening up to them once more, and this brought about an almost immediate economic upturn (as early as November 1998).

Second, the devaluation of the ruble led to a fall in wages of about 40 percent in real terms, and this, along with the rise in production output, meant businesses became more profitable. This both increased the scope for firms to undertake investments based on their own resources, and made it easier for them to secure bank loans (though these were still predominantly short-term).

Third, the ruble’s devaluation created a more favorable climate for the export of Russian fuel products and raw materials. Added to this, in early 1999 there was a considerable rise in the prices of the major Russian export goods (oil, gas, timber products) on the global market.

Last, the measures introduced by Primakov’s by no means liberal government–the obligation for exporters to sell their hard currency takings on the internal financial market, a cautious monetary expansion, a taxation clamp-down, and a number of others–contributed to a growth in the monetarization of the economy, dealt with the shortage of working capital available to businesses and made it possible to liquidate the budget deficit. As a result, the outbreak of inflation was nipped in the bud, and at the same time the economy could be re-saturated with money.

LIMITATIONS ON EFFECT OF FACTORS

The favorable macroeconomic situation which evolved was the basis of the relatively rapid economic growth in Russia in 1999-2001. In 1999 the increase in GDP amounted to approximately 5 percent, in 2000 it was over 8 percent and in the first nine months of 2001–5.2 percent. A rapid rise in the earnings of the oil and gas sector brought a considerable growth in investment in fixed capital and a corresponding increase in demand for the output of the engineering industry. However, as predicted by economists in early 1999, this growth has its limits, which are related to the dwindling influence of the growth factors.

The process by which imported goods retreated from the domestic market and were substituted by domestically produced goods had already gone in to reverse by the end of 2000. Imports are now growing considerably faster than exports and the increase in consumer demand on the domestic market is shifting ever more towards foreign-made goods.

The high level of oil prices on the global market could not last forever. In summer of 2001 there were the first signs of a fall, and in November the collapse came, with prices falling dangerously close to Russia’s oil production costs. We cannot reasonably expect high prices to be restored in the course of the forthcoming year, as the unfavorable economic conditions in the USA, Western Europe and Japan continue to militate against this.

The rise in real incomes has contradictory effects on the growth of the economy as a whole. On the one hand, it ensures increased demand for goods and services. But as noted above, Russians prefer to use their pay rises to purchase higher quality goods of foreign origin. In addition, the growth in real incomes (although it has yet to reach precrisis levels) means that businesses see their profitability shrinking, albeit not yet too severely. Does this mean that we are facing a new economic downturn?

WILL THE ECONOMY GROW IN 2002?

The answer is yes. Although the influence of many of the factors that stimulated economic growth in late 1998 has diminished, several other factors remain in play. One such factor is the increase in internal demand. The workforce in Russia has been a significantly undervalued factor in production and until major production cutbacks are foreseen, wages will continue to rise throughout 2002. At the same time, there will be some reduction in the level of unemployment. The growth rate for production investment in the first nine months of 2001, as before, has outstripped the growth in GDP, creating the conditions for economic growth in the coming year.

Another factor is the multiplicative effect of capital investments made in the industrial engineering sector in 1999-2001, which has ensured an increase in production in that sector considerably higher than the growth rate of the economy as a whole.

The momentum of the economic growth stimulated by these capital investments will remain effective throughout 2002.

It is also worth noting that import volumes are increasing significantly faster than exports, but a positive trade surplus is nevertheless being maintained, since the volume of exports remains considerable, while imports are still far short of their precrisis level. It should be noted, however, that all of these factors contributing to further economic growth are closely linked with the high level of export earnings achieved in the oil and gas sector. Depending on the depth of the fall in world oil prices, the situation may change dramatically.

NEGATIVE EFFECT OF LONG-TERM FACTORS

It is quite probable that by the end of 2002 the influence of the various factors affecting economic growth will gradually decline. In fact, both the rise in real incomes and the state of the federal budget depend directly on export earnings and their investment in Russian manufacturing, agriculture, construction and transport. Once the effect of long-term contracts on the sale of oil and other unprocessed goods loses momentum, the drop in export earnings will severely restrict the tax revenues available for the budget, as well as the scope for increasing real wages and investment activities.

Even before the fall in world oil prices, the growth in investments was beginning to show a clear downward tendency. After a growth rate in 2000 of almost 18 percent, in the first nine months of 2001 it was down to 7.8 percent. Furthermore, the surge in investment activity in 1999-2001 has had almost no effect on the problem of the country’s extremely outdated fixed assets. A large proportion of the capital investment undertaken in this period was earmarked for restoring Russia’s tired old production capacity to a serviceable working standard. No significant projects for the technical modernization of fixed assets have even come up for discussion.

This is an extremely worrying situation, since Russia faces ever more pressing problems not only with the technical obsolescence of its fixed assets, but also with the physical loss of production capacity. A significant proportion of the country’s fixed assets is now so antiquated that it will soon become totally unserviceable.

In 2003-2005 (during which period, according to the experts, the problem of the loss of fixed assets will reach a peak), will Russia’s economy be in a position to mobilize sufficient investment resources to prevent the disintegration of her normal production cycles?

There are no grounds yet to expect this problem to be successfully resolved, and the current economic policy of the Putin administration is directed towards the solution of quite different problems.

REFORMS AND PROSPECTS

At first sight, the reforms being drawn up by the Putin administration appear to be aimed at dealing with problems arising from the lack of the capital investment needed to upgrade a number of sectors of the Russian economy. Of all the declared objectives of the reforms in the energy sector, rail transport, land ownership, housing, utilities, pensions and education, arguably the foremost is the creation of a climate which will attract private investment in these sectors.

Whether economic experts consider these reforms to be heading in the right direction, however, it is still impossible to see them having any marked effect in the next few years. The reforms have prompted heated debate not only across society, but within government circles. It is still unclear what form the reforms that are on the table will finally take. And in any case, no firm decisions about how to implement them will be taken before 2002.

What is more, there are variations in the degree to which these reforms are actually ready for launch. While energy and rail transport reforms may be more or less complete, the reform of the housing and utilities sector is still very sketchy.

Nevertheless, even a successful development and implementation of these reforms will not solve the problem of how to attract private investment, if the economy as a whole is not a favorable investment climate. The reforms cannot in themselves create any new mechanisms for attracting investment; all they can do is open up a number of new sectors to private investors. And this is wholly inadequate. Even in conditions of economic growth in Russia, there is an increasing seepage of private capital abroad. And even the private capital investments secured while the climate has been wholly favorable have failed to make any progress at all with the problem of technical modernization.

Besides, all the reforms detailed above entail a further diversion of people’s incomes towards paying for the appropriate services. This will either mean a squeeze on demand for goods and services in other sectors (which will not be conducive to economic growth), or require a considerable rise in nominal wages, which will strengthen the inflationary trends which will already be encouraged by price rises for services in the sectors undergoing reform.

So, can the planned reforms change the economic situation for the better No, since they are based on the same liberal economic theories which the Yeltsin administration applied before with such crushing effect. An intelligent approach to the application of such a strategy might, of course, remove the threat of economic catastrophe. But such a strategy is still manifestly not up to boosting the competitiveness of the Russian economy.

Aleksandr Buzgalin is a doctor of economics and a professor at Moscow State University. He is a leader of Russia’s Democratic Socialist Movement.