Oecd, World Bank Evaluate Russian Economy

Publication: Eurasia Daily Monitor Volume: 1 Issue: 52

The World Bank and Organization for Economic Cooperation and Development have just released their latest reports on the state of the Russian economy. Both reports are surprisingly bullish about Russia’s long-term prospects. Surprising, that is, given the daily stream of news about the bankrupting of Yukos and the run on private banks. (worldbank.org.ru, .oecd.org).

Russian GDP growth has averaged 6.8% a year since 1998. Real wages are now 28% above pre-1998 levels, and the number living in poverty has fallen by a third. The recovery was helped by the revival of world oil prices, with Urals crude going from $12 in 1997 to an average of $28 this spring. But oil only accounts for about one-third of the growth. The 75% devaluation of the ruble in 1998 enabled Russian manufacturing and food processing to regain market share from imports, which became more expensive.

Domestic production continued to expand after 2000, even as inflation caused the ruble to appreciate against the dollar in real terms. This was driven by improvements in competitiveness and productivity, thanks to what the OECD report calls “passive restructuring” — that is, gradually shedding labor, as opposed to mergers and plant closures.

For the first time since 2001 manufacturing is growing faster than energy and minerals: 8% versus 6.8% in the first five months of this year, the World Bank reports. Telecom grew 57% and railcar manufacturing (serving oil exports) rose 51%, but even automobiles and farm and construction machinery rose by 14-16%. Manufacturing exports grew 27%, much of it driven by increased demand from CIS partners, whose economies are now growing faster than Russia.

Also the service sector, which the World Bank estimates at 46% of GDP, accounts for one-third of the growth — and it is relatively immune to exchange-rate appreciation. Improved revenue collection from oil exports allowed the government to lower taxes on the rest of industry, which helps improve their profitability and protect them against the “Dutch disease” (energy revenues undermining the competitiveness of manufacturing).

The OECD study finds that just about the only sectors that did not see productivity growth were gas, oil, and electricity. Natural gas saw employment grow by 90%, while labor productivity fell by 40% 1997-2002. This astonishingly poor performance casts doubt on the argument that corporations like Gazprom, which monopolized gas production, can lead the Russian economy to a better future.

Another crucial factor in the recovery has been sound fiscal policy. In 1996 the federal government spent 22.3% of GDP, but only raised 13.4% in taxes. By 2003 spending was cut back to 15.0% of GDP, while revenue rose to 16.7%, of which the oil windfall was only 1.7%. (OECD data) This remarkable fiscal turnaround is the main economic achievement of the Putin administration.

Still, the OECD is worried that the government may raid the windfall oil revenues to pay for its unpopular and mismanaged pension and social benefits reforms. The report urges the government to maintain fiscal restraint through the whole price cycle, and not relax spending controls while the oil price is high.

In contrast to fiscal policy, monetary policy is in trouble. The government seems unable to prevent the influx of export revenues from leaking into the domestic money supply, in part because of the sorry state of the banking system. It is unlikely to keep inflation below its target of 10% this year, and in trying to achieve this goal it is holding down administrative prices on electricity, gas, and utilities, which delays the structural reforms those sectors need.

The OECD suggests that the ruble be allowed to appreciate in real terms, which would boost consumer purchasing power, lower debt service, limit inflation, and increase pressure on industry to restructure. However, such a policy would cut into the profits of Russian exporters and increase import competition for farmers and manufacturers. It seems unlikely that the Kremlin will follow their advice, though it will be hard for the government to keep ruble appreciation to the target of 7% for this year.

Oil and gas is the leading sector, but not the only sector. The official Goskomstat agency has oil and gas accounting for 8% of GDP. Correcting for transfer pricing, the World Bank puts it at 19%. The World Bank estimates that a 10% rise in oil price produces 0.7% growth in GDP, which means that GDP would grow even if oil slipped to $19 a barrel.

Russia was not only benefiting from high world oil prices. It also increased the volume of oil production and especially oil exports, which rose 60% 2000-03. Most of this growth came from the independent private companies Yukos, Sibneft, and TNK. Investment has also started growing, with oil taking 27% of investment, followed by electricity (17%) and gas (12%).

The two reports are quite similar in their analysis and conclusions, and borrow from each other. Russia is not a member of the OECD, but it has borrowed $13 billion from the World Bank, and Moscow had some quarrels with the organization in the past. (The World Bank itself concluded that one-third of the loans to Russia had failed to meet the loan conditions.) But even the OECD report ducks some politically sensitive issues. For example, they coyly observe in a footnote that “Russia may have a comparative advantage in arms production, the data to assess this are not available.”

Both reports called for more aggressive structural reforms. The OECD urges the government to press ahead with administrative reform and dismantling the natural gas and electricity monopolies. The World Bank report includes an update of its study of ownership released in April, which found that 23 firms control about 30% of Russian GDP, a remarkably high degree of industrial concentration by international standards. It also notes the presence of a vast “hidden” sector of defense and other plants, which continue to receive state subsidies.