COMMENT: Valdai Club highlights Russia's modernization dilemma

By bne IntelliNews September 15, 2008

Ariel Cohen in Sochi and Moscow -

The fifth annual Valdai Club meeting took place against the backdrop of the conflict in the Caucasus and Russia's recognition of the secessionist republics Abkhazia and South Ossetia. The Valdai Club, of which this author is a member, brings together policy experts and journalists from Russia and the world for discussions with the Russian leadership.

Five days of meetings with Prime Minister Vladimir Putin, President Dmitry Medvedev, Foreign Minister Sergey Lavrov, and First Deputy Prime Minister Igor Shuvalov, among others, indicate that the Russian leadership finds itself on the horns of a dilemma: its ambitious and confrontational foreign policy clashes with its declared domestic modernizing priorities.

Putin, tanned and relaxed, spent over three hours over lunch in Sochi with the Valdai membership. He said that he came to the conclusion that further social and economic reforms are necessary and that state modernization, innovation-based growth, pension and health systems reforms, will define the nature of Russia's development for the next 15-20 years.

Putin expressed satisfaction with the 8% growth of the Russian economy in the first six months of this year, and the 14% increase of foreign investment year-on-year. Putin said that foreign investment for the first six months of this year was $46bn while last year it was $81bn in total. Even if foreign investment will be somewhat less than in 2007, the real income grew by more than 7% and salaries by 13%.

Despite the global mortgage crisis and VAT payments due, Putin said, Russia has avoided a liquidity crisis and is continuing its anti-inflationary strategy. The state has almost $700bn in reserves and an additional $140bn in government funds, including the Next Generation Fund. There is so much money in the treasury that the commercial banks could not digest or invest surplus funds deposited by the state - there was no sufficient intermediation capacity.

Putin criticized the US repeatedly, albeit less than his Foreign Minister Lavrov. Yet, he mentioned that George W. Bush is a "decent man, in politics and in his private life." The Russian Premier blasted Secretary of State Condoleezza Rice for trying to "convince other countries not to trade with us." A senior Russian official mentioned later that the US Ambassador has advised businesses not to start certain projects in Russia.

Yet, Putin pointed out that even after the TNK-BP spat, foreign investors aren't scared, and that "too strong a national currency is damaging for the export sector" as it inflates costs of production.

Putin criticized the Bush administration for failing to lift the Jackson-Vanick Amendment, preventing the US from granting Russia the Most Favored Nation Status. The amendment got stuck in the US Congress because of the pressure of the poultry exporters who were trying to put pressure on Russia to increase the quota on chicken imports. Putin quoted Nathan Sharansky, the former Israeli Deputy Prime Minister, who said that he "did not spend 12 years in the Soviet Gulag to promote (US) chicken exports to Russia."

Asia and especially China figured prominently in the prime minister's presentation. He said that Russia recognizes that for now 55% of its trade is with Europe and does not want to change it. Yet, "someone is trying to push us east" by advancing unacceptable demands. "If Europeans don't want this resource (gas), we will remove it from the market", Putin said. "If they don't want cooperation," he said in reference to the stalled negotiations of the Russia-EU Cooperation Agreement, "we will not give in, and will shift east."

Putin recognizes that China and Asia are growing, and this dictates the need to build the oil pipeline, terminal, and refinery on the Pacific, and eventually develop East Siberian gas fields.

Putin demonstrated a mix of reverence and seniority towards President Medvedev, calling him, at different points "the senior guy on the block" and a "decent man and a nice guy." The PM said he was sorry Medvedev had to deal with the Caucasus war so early on his job. Yet, these were his decisions, Putin said. "I do not believe in two czars."

Finally, Putin said that Russia has suffered enough in the 20th century, and has no territorial claims. Russia's military expenses as a percentage of GDP will remain the same, while its military gets new high-tech, high-precision weapons. The military budget will grow only as the overall budget grows.

Mr nice guy

The meeting with President Dmitry Medvedev somewhat unexpectedly took place in a dining room in the GUM Department Store across the Red Square from the Kremlin. Medvedev acted accessible and "democratic," mingling with the participants after lunch, although he remained on message at all times and did not show any light between his position and that of his mentor and former boss Putin.

When asked about the decline of the Russian stock market in the context of the war, Medvedev said that, "all conflicts create problems for the economy... We had a choice between life and economic values. We chose defense of life and dignity of the Russian citizens."

Medvedev said that Russia will always be an investment-intensive country due to its location and nature of its resources. It will take much more to destroy the existing investment mechanisms and create a new Iron Curtain (than what is currently suggested by Russia's critics). So far, he said, the RTS decline was "75% due to consequences of the global economic crisis, and only 25% due to the war... I am moderately optimistic."

Medvedev, a law professor and self-described "businessman with 10 years experience, unlike previous presidents," unsurprisingly believes that "throughout the 20th century, Russia lacked property rights and institutions. We need to create those and give them protection and regulation," he said.

What is happening in the world and in Russia is not something extraordinary and will not derail economic expansion, "even if the global economic decline has not reached the lowest point". The Russian blue-chips, he said, are still undervalued, and the emerging markets have higher volatility than the established ones.

Medvedev promised that developing Moscow - and Russia - as one of the global financial centres, and the ruble as one of the world's reserve currencies, would be a great priority of his presidency.

The Russian president doesn't believe that Russia is at a breaking point in its relations with the outside world, and that foreign policy is only the means to accomplish the economic development agenda. This is an admirable position, but it is unclear if everyone in the Russian leadership shares it. Unfortunately, the majority of both Russian and Western members of the Valdai Club believe that Russia's relations with the West, especially with the US and UK, are on the downward spiral, despite both Putin and Medvedev statements that Russia cannot be isolated and that even the USSR was involved in international business.

The recent flight of investor capital and the slide of the Moscow stock market indicate that investors are jittery. The Russian leadership may do their country a favor if it did more to reassure the world of their intention to return to the status quo ante bellum.

Ariel Cohen, Ph.D., is Senior Research Fellow at The Heritage Foundation and the author of 500 articles and three books, including Kazakhstan: The Road to Independence (School of Advanced International Studies, Johns Hopkins, 2008)


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