BEAR MARKET BRIEF: Can IT revive Russia’s economy?

BEAR MARKET BRIEF: Can IT revive Russia’s economy?
President Vladimir Putin did not offer much clarity in his discussion of IT at SPIEF.
By Aaron Schwartzbaum in Washington DC June 19, 2017

According to Russian Vice Premier Igor Shuvalov, Vladimir Putin is sick. Not with a disease, Shuvalov clarified, but with a desire to develop Russia’s digital economy.

The development of a high-tech economy, so officials hope, will be the engine that propels Russia out of stagnation and pushes its growth rate above the global average. That hope was prominently on display at this year’s Saint Petersburg International Economic Forum (SPIEF), a pageant of business deals and tired pronouncements by well-meaning officials of the need for yet-undelivered ‘structural reform’. Notably, Putin appeared with Russian-born developer Vitalik Buterin, founder of a Bitcoin-competitor Etherium. The forum also featured a panel on blockchain implementation, moderated by Sergei Gorkov, head of Vnesheconombank (VEB), that included the participation of ministers and foreign business representatives alike.

But how realistic are the hopes of a robust digital economy in Russia? Could IT prove a much-needed economic shot in the arm?

The Russian government’s plan to date is embodied in a draft programme entitled “Tsifrovaya Ekonomika” – the digital economy. For now it remains vague, encompassing a plethora of sectors and concepts including state management, IT infrastructure, R&D, personnel, education, information security, public policy, “smart cities,” and digital insurance.

Putin himself unfortunately did not offer much clarity in his discussion of the topic at SPIEF: “The digital economy is not a separate sector per se, but a framework that will allow the formation of quantitative models for business, trade, logistics, production, will change the format of education, healthcare, public policy, communication between people, and in turn, will create a new paradigm for the development of the state, economy, and society as a whole.”

Vagaries like the above aside, top officials are genuinely interested in the plan, evidenced by the presence of Arkadiy Dvorkovich and Andrei Belousov – influential officials with the political gravity to deliver on plans – at a meeting on the topic on May 30th.

Local experts have little illusion about the plan’s lack of focus: in late May they heavily criticized the plan, calling for it to be “systematically reworked”. Why? For one, they noted that the plan appears at present more a collection of highlights from a number of state strategic initiatives . A presentation from the Russian government’s policy think tank lists digital economy plans in no fewer than three projections, seven road maps, four strategies, and two concepts. A local joke that strategic planning, much like baseball to America, is Russia’s national pastime, seems apt.

The experts also complained that the plan lacks both a means of measuring progress on the development of a digital economy (much like Putin’s infamous May Decrees), as well as a baseline measure of where it stands today. While many of Russia’s strategic plans have failed to take root in reality, this one seems deficient on paper, too.

The Good

Russia’s technical know-how is undoubtedly a strength as it seeks to build a digital economy. The IMD World Digital Competitiveness Ranking for 2017 places Russia 42nd in overall performance – but an impressive 24th in the knowledge category.  The country retains competitive technical education capacity – one of several beneficial Soviet holdovers – and Russians have grown both famous and perhaps infamous as well as of late for their technological and computer abilities.

This is visible in the case of Buterin, but even better in the case of Pavel Durov, developer of social network vkontakte and the popular messenger app Telegram. Keeping this talent at home is another matter (Buterin resides in Singapore and Durov fled Russia several years ago), but Russia still has the brainpower to deliver growth in the tech sector and economy overall.

Worth noting as well is that there is significant marginal gain to be had from the implementation of technologies such as blockchain and other crypto currencies in Russia. Why? Russia has issues with corruption, particularly in state procurement, limited trust in the rule of law, an oversized state burden on business. Blockchain, which in short involves the decentralized recording of transactions, would be hugely beneficial to market regulators looking to eliminate corruption and embezzlement by cutting out the seemingly ubiquitous middle men – posredniki – involved in state procurement. The implementation of such technology seems quite feasible as authorities forge ahead on an electronic procurement system.

For a sense of the potential savings, last year Deloitte found that Russia’s state railroad monopoly could save some $2.2bn. In the private sector, firms and individuals that trust neither each other nor courts may be more eager to do business knowing essentially ‘un-fudgeable,’ common records exist – trust, in essence, is rendered obsolete. And for business owners, the implementation of better state IT systems means relief from a large administrative burden: some 172 separate forms of documentation for individual entrepreneurs by one count.

The Bad

However grand in its scope, the Kremlin’s plans to turn the IT sector into an engine of growth face what is in essence a chicken-and-egg problem. A report on the local venture capital market by the Russian Venture Capital Association (RVCA) found that while interest in IT among venture capital investors remains high, investments in terms of overall volume fell by 85% versus 2015, reaching only $128mn. An earlier report by AT Kearney and VimpelCom found investment in local startups beginning to flag in 2014.

Authorities, in short, are waiting for the digital economy to boost overall growth rates, while at the same time, the digital economy is waiting for overall growth rates to boost investment. One of those has to happen first, and it may fall on the state to provide that impetus with private investors still skittish on Russia’s real economy.

A second issue concerns whether the establishment of a robust digital economy can benefit most Russians. A recent report cites the case of farmer Mikhail Shlyapnikov, who started his own crypto currency called Kolion, which saw $500,000 in investor purchases. For a country short on capital, the ability of Russians like Shlyapnikov (or the town of Magnitogorsk, which recently earned $5.6mn in an ‘initial coin offering’) to raise money matters.

However, despite interest in crypto currency by both individuals and officials, the number of Russians who actually know of or use digital currencies is “between 10,000 – 20,000 people”, according to that story. The geography of investment is telling as well: per the RVCA, some 83% of total venture capital investments went to the Central Federal District, most probably to Moscow and the surrounding area, and not to poorer regions.

On a broader level, it would be highly optimistic to expect a population that has yet to fully adopt credit cards in daily use to rapidly embrace technology such as contactless payment, let alone crypto currencies.  In other words, it seems more likely that large corporations, including or primarily those owned by the state, would be those who ultimately integrate the technology.

The Ugly

Despite the Bank of Russia’s recent softening on crypto  currency issues, Russian authorities have by and large held a sceptical view towards new technologies, tending to view them through a security lens as opposed to as an economic opportunity.  The ‘securitisation of IT,’ as it might be termed, is perhaps best exemplified in the Yarovaya Laws, which mandate that telecom providers – some 10,000 in Russia – save metadata from communications for up to three years. The cost of this legislation for operators has been calculated anywhere from 3-10 trillion rubles ($50bn-170bln). Given that that overall sector revenue (not profit!) for 2016 was 1.675 trillion rubles, the scale of the burden becomes apparent. Though implementation – one that will involve state subsidies that add to the challenge of reducing the local deficit – remains a work in progress, the regulatory risk of future acts such as the Yarovaya Laws will not simply evaporate. For every new technology, there arises a new risk of its securitisation.

Ultimately, the digital economy may prove beneficial especially for state procurement and a number of large firms. But there’s no sign yet that nascent digital technologies have the capacity to revolutionise the Russian economy, or that the state has the institutional flexibility to provide fertile soil for its taking root. The risk is that the benefits of a digital economy may both start and end with the state, leaving only indirect benefits for households apt to grow increasingly impatient with stagnation.

Aaron Schwartzbaum is the publisher of Bear Market Brief