Nov 15, 2008

World - Russia coping with financial crisis

Vladimir Radyuhin

The global crisis is adding a new urgency to reforms towards political pluralism and competition in Russia.

When the financial crisis broke out in September, the Russian government quickly moved to reassure the business community that it had enough resources to prevent a meltdown. Announcing a multi-billion rescue package, Prime Minister Vladimir Putin remarked rather sarcastically: “We have been often asked in recent years: what do we need such large currency reserves for? To feel confident [in this crisis].”

Russia set up the so-called “stabilisation fund” in 2004 to sop up excessive oil-generated cash from the market and save it for a rainy day. As of August 1, the country had the world’s third biggest currency reserves — $595.9 billion. It is out of that pot that the government has promised to dish out more than $210 billion to support the banking sector and industry.

Many economists and industrialists agree that the injection of billions of dollars into the economy may ease the debt and liquidity crunch but they say the government strategy of building up such huge reserve funds instead of promoting growth was wrong and will aggravate the fallout of the current crisis on the economy. Deputy Prime Minister and Finance Minister Alexei Kudrin, the architect of the safety cushion policy, once compared himself to the biblical Joseph, who stocked up grain during seven fat years to feed his people over the next seven lean years.

Critics counter that while Joseph stored grain thereby encouraging production, Mr. Kudrin has been hoarding money taking it out of the economy and thereby slowing growth. As the government invested its currency reserves in the West in low-yield securities, Russian companies were forced to borrow from western lenders at a much higher rate. When the global crisis struck, Russian businesses owned close to $550 billion in foreign debts, which almost equalled the country’s hard currency reserves.

According to the critics, the government should have instead poured money into Russia’s still underdeveloped banking system to increase its capitalisation, which currently stands at just over 60 per cent of the country’s GDP, and enable banks to offer long-term credits at affordable interest. Had the oil windfall been used for investment to diversify away from over-dependence on oil and gas, it would have made the Russian economy more reliant on long-term Russian money, encouraged sustainable growth in non-oil industries and insulated the country from the U.S. contagion.

Penny wise and pound foolish

Mr. Kudrin’s penny wise and pound foolish policy meant Russia forfeiting a chance to build a robust manufacturing sector during the fat years and prepare the country better for the lean years ahead, independent economists say. Its 2009 budget will be in the red if oil prices dip below $70 a barrel as they did recently. The massive bailout effort now threatens to deplete the oil funds. This will jeopardise an ambitious programme of economic modernisation unveiled earlier this year when the government finally agreed to invest part of the oil money in infrastructure and high-tech sectors.

The crisis is bound to have a strong negative impact in the long term, the economists warn. Russian stocks have lost more than 70 per cent of their value since spring; the GDP growth plummeted from 7.6 per cent in January-August to 0.4 per cent in September. Net private capital outflows are expected to reach $20 billion this year, in stark contrast to the previous forecast of $40 billion in net inflow. Industries have started cutting jobs and people are spending less. The crisis threatens to wipe out the impressive economic gains of the past 10 years.

Russia’s leading economists and business lobby groups, including the Association of Russian Banks, the Russian Chamber of Trade and Industry and the Russian Union of Industrialists and Entrepreneurs, have been urging drastic changes in monetary strategies for years. But Mr. Kudrin successfully fended off all attacks. He is the longest serving Cabinet Minister who has not only survived three Prime Ministers — he was appointed Finance Minister in 2000 — but also exerted decisive influence on shaping the economic strategy in the last eight years.

Mr. Kudrin owes his fantastic survival, in the face of massive criticism, to one man, then President and now Prime Minister Putin, who firmly believes in the financial acumen of his long-time friend and ally. Mr. Kudrin’s story points to critical flaws in the system of “managed democracy” Mr. Putin set up during his eight-year presidency. He calls it “manual control.”

When Mr. Putin became President in 2000 after a decade of post-Soviet meltdown, he faced the Herculean task of pulling the country together, reasserting Central control and rebuilding the economy. The chaotic transition from the Soviet Communist system to a market democracy under his predecessor Boris Yeltsin had all but destroyed the institutional capacity of the state to govern. This convinced Mr. Putin that law and order must be restored before democracy was introduced step by step.

Mr. Putin brought the electronic media under the Kremlin’s control, cancelled elections of regional leaders, and marginalised opposition parties by tightening election laws and controlling financial contributions to parties from businesses. The Kremlin effectively removed political parties from the sphere of state governance. Centralisation of power helped Mr. Putin establish political stability and carry out painful reforms, and set the economy on the path of revival.

But as Russia moved from economic recovery to modernisation, the lack of political competition, absence of strong opposition parties and the presence of an obedient Parliament emerged as major hurdles to faster growth. The costs of “manual control” began to outweigh the gains. Corruption has grown to staggering proportions in recent years in the absence of effective parliamentary oversight and accountability of government officials.

Experts say Russians pay a 30-50 per cent “corruption tax” added to the price of all goods and services. President Dmitry Medvedev has just unveiled a new plan to combat corruption, but sceptics say the plan is likely to fail because its implementation has been entrusted to the law enforcement agencies, which are also deeply steeped in corruption. “These methods are useless when there are no external institutional checks and balances, such as a critical and independent media, independent courts, transparent government and fierce competition from political opponents,” said Georgy Satarov, a leading anti-corruption expert. Monopoly on power has stifled the contest of ideas and led to costly mistakes, analysts say. A sweeping reform of the Soviet-era social security net undertaken three years ago was necessary but was so badly prepared that it provoked large-scale protests, forcing the government to increase social expenditure, instead of trimming it. A pension reform launched in 2001 fell through and is being overhauled again.

Several years ago, the Moscow government decided to build a new ring road to cope with the growing traffic in the capital. Experts then warned that the road would not solve the problem of congested streets fanning out from the city centre to the outskirts in a star-like pattern, but the docile city legislature approved the project backed by Moscow’s powerful Mayor Yuri Luzhkov. The new road was laid at a cost of over $4 billion but it failed to unclog city streets. Notwithstanding this, the Moscow government is about to launch the construction of yet another ring road which, the experts predict, will be just as useless.

The Kremlin’s chief ideologist, Vladislav Surkov, compared Russia’s political system in which the main pro-government party, United Russia, dominates Parliament to a one-legged man and called for the establishment of another major party, “a second leg to which society can shift its weight when the first leg goes numb.”

Towards two-party system

Two years ago, the Kremlin started building a new two-party system with the establishment of a left-of-the-centre party, Fair Russia, to compete for power with the ruling right-of-the-centre United Russia. However, the effort to promote political competition suffered a setback when Mr. Putin threw his weight behind United Russia last year. This enhanced the monopolisation of power helping United Russia win a huge constitutional majority in the parliamentary elections in December 2007, while Fair Russia captured a mere 8 per cent of the vote, just enough to cross the 7-per cent threshold. In his first state-of-the-nation address this week, Mr. Medvedev called for liberalising political life, stating democracy “on orders from above” must give way to grass-roots democracy.

“I believe that the citizens of Russia today are far more ready for freedom in professional, social and political activity than they were at the start of the reforms,” Mr. Medvedev said proposing a raft of measures to encourage the “broad involvement of citizens, political parties and other civic institutions” in dealing with the challenges of “a new phase in the country’s development.”

The global crisis is indeed adding a new urgency to reforms towards political pluralism and competition in Russia, as the wasteful system of “managed democracy” becomes too costly to maintain when oil prices are falling.

A study commissioned by Mr. Medvedev’s think tank, the Institute of Contemporary Development, earlier this year showed that the Russian political and business elites think “managed democracy” no longer meets the challenges of modernisation and must be replaced with a full-fledged democratic system.

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