On August 4 the Russian government held a meeting to discuss the economic results of the first six months of 2005. They listened to a report by German Gref, Minister of Trade and Economic Development and the main standard bearer for the besieged market-liberal wing of the Putin administration.
The meeting was the usual mixture of surface complacency and thinly disguised anxiety. Prime Minister Mikhail Fradkov said the results were “satisfactory in general but far from those desired.” The government is caught in a trap. The short-term numbers look good, but the long-run sustainability is in doubt. Gref noted, “There are no stable sources of growth outside the extractive industries, with the exception, perhaps, of communications” and argued, “Serious restructuring is required.” But he failed to elaborate a program for such restructuring.
Gref’s performance was rather lackluster. In the subsequent Q&A with government ministers, he was unable to answer such a basic question as the inflow of foreign direct investment in the first half of the year (another ministry official stepped in with the answer — $12 billion). Gref was also flustered by a question about the impact of the social benefits reform on the poverty level. He said that the poverty level had fallen by “about 1 %,” and conceded that the controversial monetization of benefits may unfortunately have slowed the rate of decline.
GDP grew by 5.6% in the first six months of 2005 compared to 7.7% in the first half of 2004, and 7.2% in the second half. The rate of increase was slightly higher in the second quarter of 2005 (6.0%) than in the first. But manufacturing industry only grew 4%, and the only sector that saw a substantial increase was telecommunications, which jumped 20%. Investment rose by only 9.4%, compared to 12.6% a year earlier. Imports grew 16%, covering four-fifths of the rise in domestic demand, but Russia still ran a trade surplus equal to 8.5% of GDP.
Export revenues were boosted by the fact that the average oil price was $46, compared to $34 in 2004. But extraction rose by only 2.7% to 230 million tons — down from a 10.5% surge in output in the same period a year ago. The volume of exports edged up 0.5%, with rail and sea shipments falling by 32%. Gref said the reasons for the slump in non-pipeline exports was unclear, citing factors such as increased rail and port fees.
With a sliding scale of excise and extraction taxes tied to the export price, the government has captured $90 of the $105 increase in the oil price per ton in the first half of the year. Gref argued that this high level of taxation is choking off investment in new wells — hence the leveling off in oil production. (These excise taxes are not currently differentiated by region, to allow for different production costs.) At the meeting Finance Minister Alexei Kudrin defended the current taxation levels, while Central Bank chair Sergei Ignatiev called for a tax cut. It is safe to assume that the government’s assault on Yukos also contributed to the sluggish investment in new production.
Hokkadido University’s Shinchiro Tabata calculates that each $1 increase in the price of oil produces an additional $1.86 billion for the Russian federal budget. Thanks to these petro-dollars, the federal budget surplus is 6.7% of GDP. The government’s stabilization fund, set up to sequester surplus oil taxes, may hit $45 billion by the end of the year — even after $15 billion was spent to pay down Paris Club debts. Central Bank hard currency reserves are at $150 billion. Most of this wealth is sitting in Moscow, either in government or corporate hands. Moscow city, with 7% of the nation’s population, accounts for 21% of national GDP.
The government’s efforts to sterilize the inflow of oil dollars are only partly successful. Inflation was 8% in the first half of 2005, up from 6.1% in the first half of 2004, meaning that the government will again fail to bring annual inflation down to single figures. With inflation running so high, the government will feel obliged to hold down natural gas and utility price increases — further delaying the urgently needed reform of Gazprom and the electricity industry.
So far this year the ruble has gained 3.4% against the U.S. dollar and 15% against the euro. Most analysts agree that this real appreciation has now brought the ruble back to the exchange rate prior to the 1998 financial crash. This has undermined the price advantage that the depreciation had brought to Russian manufacturers. Gref cited the example of the auto industry, which saw domestic output fall 6.5% last year. Russian cars like the VAZ-2112 are $8,000, priced close to the cheapest foreign import, the Daewoo Nexia, at $8,500.
For Western investors, dominated by a short-term perspective, Russian looks in good shape. The market seems to have accepted that the Yukos reprivatization was a one-off case, and Russian stocks have risen 28% this year. The oil revenue makes Russia a good financial risk — Russian bonds are only 131 basis points above the U.S. treasury rate.
So, there is little chance of a financial crisis in the near future. But the economic recovery is increasingly driven by booming oil revenues, while the government seems unable or unwilling to implement a radical program to modernize Russian manufacturing, whether it be a liberal or statist plan. The rivalry between Gazprom and Rosneft for control over the assets of Yukos is just one example of the obstacles Putin faces in trying to come up with such a plan.
(fednews.ru, Vedomosti, Reuters, Kommersant August 5)