MOSCOW BLOG: Mercury falling as storm approaches

By bne IntelliNews April 12, 2012

bne -

Metre-deep piles of slush are lying about the streets of Moscow as the weather is having a gender crisis: it can't decide if it wants to remain winter or finally given into nature and become spring. Politics are similarly confused - is a thaw coming or a crop-killing frost? I don't remember things being so confusing since Vladimir Putin took over in 2000.

Superficially, everything is going extremely well. The economy is practically booming (although there is no feel-good factor), so much so that VTB Capital's chief economist Alexey Moiseev warned at the end of March that the economy could be overheating.

All the indicators have jumped. Savings and Ural blend oil prices are at 20-year highs, and the current account surplus also hit a record $45bn in the first quarter. This has all fed through into rapidly accelerating consumption and retail sales. Even the protest movement has died down, leaving a low-key weekly gathering on Pushkin Square and the occasional gaggle of demonstrators on Red Square. But tap the barometer and the mercury is falling fast: a political storm is on its way to Moscow.

Inaugural pains

Rumours are flying ahead of the inauguration of president-elect Vladimir Putin at the start of May. It seems pretty clear that big changes are in the works.

President Dmitry Medvedev's appointment as prime minister is a done deal - for the time being anyway. But in his last weeks as president, Medvedev probably pushed through more laws than at anytime during his entire four-year term. The direct election of governors has been re-introduced, various new graft measures passed and several more governors sacked. The interesting question is whether he is rebelling and shoving through changes before he leaves office that will undermine Putin's authority - because that's what several of these measures will do - or whether he is playing liberal cop to Putin's authoritarian cop in concert with the president-to-be. It's hard to tell. Russia has reverted to its Churchillian bulldogs fighting under the carpet.

However, several things are becoming clear. First, there are going to be sweeping personnel changes. One current rumour is that former Rosneft boss and Siloviki-in-chief (the Kremlin securities forces fraction) Igor Sechin has lost out in a clash with oil trader par excellence and uber-oligarch Gennady Timchenko. Sechin is out, say the little birds, and if true, then a big blow has been struck for the liberal camp. Energy Minister Sergei Shmatko is also expected to go. Together, all this suggests major changes are ahead for the energy sector.

On the other side of the fence, the liberals have ratcheted up their rhetoric and seem to be gaining traction. Minister of Economic Development Elvira Nabiullina issued a stark warning at the start of April that things have to change drastically or Russia faces stagnation. In a positive sign, Nabiullina is expected to be promoted to deputy prime minister in the reshuffle and young Turk, Arkady Dvorkovich, the presidential economic advisor, could replace her. To the liberals, it is patently obvious that Russia needs a new economic model, but they are going to have a hard time convincing the Siloviki who are looking at the oil price and don't see a problem.

Which side Putin comes down on will be the key to resolving this tension, but just as in 2000 he is currently unreadable. When he came to power, we wrote that there are two Putin's: the economic one that pushed through a radical tax reform, and the political one that threw oligarchs in jail and fired the federation council deputies.

Massively increasing spending on the military and his disparaging remarks about condom-wearing protestors suggest the political Putin is in the ascendance. However, his crackdown on corruption in the utilities sector in December, (another) prospective radical reform of the tax code and the possible clipping of the Siloviki's wings (not to mention Medvedev's flurry of activity) all suggest the economic Putin is back. The reality is probably that, like before, we have both. I just wish someone would give him some potassium and he would make up his mind which he wants to be.

Maybe it makes more sense to see the changes in terms of economics, as after all Putin is at core a pragmatist and the Kremlin has started to hunt for more revenue. For most of the last decade Russia has been flush with cash. It didn't matter if everyone was stealing, as there was plenty to go round and still finance the state's pet projects. But now with pensions eating up a third of the budget and some $100bn being spent on both infrastructure and military reform a year, for the first time the government is feeling the pinch. The federal budget is in surplus for the moment - but that won't last for long.

During the recent presidential elections, Putin ignored the fact that he could have won some 53% of the vote without massaging the result, but he still added 10% to the tally using administrative resources. Why? Because his real constituency is still the elite. He needs to show the men in power he is still boss - especially if he plans to push through sweeping changes: an "Orange Revolution" of the elite. The protest movement is still only five months old after all and the people still sheep, although they did manage to reduce Putin's win from the 71% Medvedev won in 2008 to 63% this time round. Having said that, most of the Kremlin insiders are now talking about one more Putin term, not two.

Money matters

Where is this new revenue going to come from? Taxing the voters is a non-starter politically. Cutting spending on state services is also a no-no. That leaves more growth, cutting down on corruption and taxing the raw materials sector. In this light, Putin's assault on the utilities sector has little to do with his dedication to rooting out graft and everything to keeping more state funds in the state's pockets.

A new draft tax plan is being circulated at the moment and according to bne sources it extends the tax-the-crap out of oil to the other big resources sectors, especially metals, which will be used to subsidise low taxes on the rest of the real economy.

In parallel, the state is in effect going launch a Gref 2.0 liberal reform plan (following the original overseen by German Gref in 2000). The main elements of this are still emerging, but agriculture and the capital markets have already got a lot of attention and pensions are about to. At the same time, all this talk of business ombudsmen and transparency suggest the bureaucracy is going to be reformed as part of a systemic crackdown on corruption. The authors of the 2020 strategy have already shown their draft to First Deputy PM Igor Shuvalov (another one that might get sacked and sent to Siberia, according to reports) who sent it back for not being "radical enough," one source close to the debate told bne.

The state clearly intends to continue spending heavily, but a touch of realism is creeping in too. A deal to sell control of Avtovaz to French carmaker Renault is imminent, which would be the death knell for the Kremlin's aspiration to revive the Soviet-era automotive sector. The state will have to give up on other sectors too. It has already said it will allow foreign banks to open branches in Russia - something it has resisted vigorously for years - and the Superjet project is going very badly, as bne counts only six planes sold so far.

In typical Russian style, this plan will give ammo to both the "rah-rah Russia" crowd and Russia's detractors. One economist who has seen the tax plan warned the Ministry of Economic Development and Trade that it would drive investors away and hurt the equity market. The ministry attitude was: "They will come back. They always do."

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