MOSCOW BLOG: Crisis #3

By bne IntelliNews April 23, 2010

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"The recession is over." So Prime Minister Vladimir Putin announced at his annual progress report to the Duma on April 20.

"Recession" is putting it rather mildly. Russia's progress towards normality has been plagued by calamity. The economy's performance over the last 18 months would be better described as "meltdown." And this is not the first time either: since becoming "independent" (as the Kremlin describes it), Russia's economy has collapsed three times. But the good news is that each time the collapse does less damage.

The first was the biggest in 1991 when the Soviet Union imploded and threw the entire country into disarray. The 1990s were a write-off, with almost no reform as the late president Boris Yeltsin's energy was almost entirely spent on preventing a Yugoslavian-style disintegration.

Russia was beginning to grapple with reform when it was hit by the second crisis in 1998. That one destroyed the nascent banking sector and wrecked the country's creditworthiness after it defaulted on its debt. The average Russian was also hammered after the value of the ruble was cut to a quarter of its value against the dollar overnight.

After a decade of misery, 2000 finally brought Russia's first year of growth (a record 10% that year) as the newly elected president Vladimir Putin was gifted steadily rising oil prices. During his first term in office, much of Putin's energy was taken up with battling the oligarchic interests that riddled the Duma, which ended with the jailing of Mikhail Khodorkovsky, owner of the now-bankrupt oil company Yukos.

It was not until Putin's second term, starting in 2004, that real reform appeared for the first time ever. The next three years saw much (but not enough) progress that fuelled an economic boom.


Russia's overriding problem since the start has been to bring inflation down from the 1,400% it hit at the start of the 1990s. Although the country piled up massive currency reserves in Putin's second term (topping $600bn until the recent crisis hit), it couldn't spend any of this money on badly needed infrastructure investment without pushing up inflation and killing what growth there was appearing.

2008 should have been a game-changing year: inflation dipped below 10% for the first time ever and the Kremlin immediately announced a long-delayed massive $1-trillion investment programme into pretty much everything (but power and transport in particular). And then the economy collapsed for a third time that September.

It must be incredibly frustrating. Each time things start to look a bit better, the economy collapses in spectacular fashion. In the last two decades, Russia has had only three years when it managed to carry out any real reforms - and most of that was preparatory work, putting basic laws on the books etc.

The trillion-dollar investment programme would have lifted investment over the magical 25% growth in investment year on year that sparks the virtuous circle of spending-profits-investment-growth that leads to "Asian Tiger" catch-up growth rates. But the latest crisis hit before the programme could start and places like China (which has an investment rate of over 40%) left Russia in the dust.

However, progress has been made. This crisis has been extremely painful (and cost the state some $200bn in a controlled 30% devaluation of the ruble last year), but it has done a lot less damage than the previous two.

None of the significant banks went bust, all the big companies are still standing (albeit several have been badly wounded), most Russians still have their job, real incomes have actually risen 7% in the last year and, crucially, it has killed inflation dead (at least for the meantime). The economy is now clearly bouncing back faster than anyone expected and could return to strong growth as soon as the second half of this year.

But most importantly, the Kremlin has been jolted into making the missing reforms, the lack of which exacerbates these recurring crises. For example, the state spent $32bn on upgrading the railways in 2009 in the depths of the crisis and this year is already ramping up investment on a slew of infrastructure projects to even higher levels. At the same time, a storm of legislation is being launched to deal with everything from the capital markets to corruption.

The jury is still out on whether the Kremlin can actually kick-start the virtuous circle into turning. Under Yeltsin the game was wielding power, but under Putin it has become forming policy - big progress. But where the Kremlin has always fallen down is on its inability to implement good ideas. If the pattern continues as in the past, Russia now has some five years grace in which to make very deep changes before the next crisis hits - which analysts say is an almost certainty.

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