Russia's regions suffer setback

By bne IntelliNews November 10, 2009

Ben Aris and Clare Nuttall -

Read the research reports from the last year and they will tell you that Russia has been badly hurt by the crisis. Read the more recent reports and they will tell you that the country seems to be bouncing back more strongly than anyone dared to hope.

All true, but these reports skip over where the real damage has been done: Russia's economy as a whole is faring pretty well, but its regions have been set back years. And even if the widely cited macroeconomic numbers return to 2008 levels in the next two years - as seems the case - many of Russia's regions will take a lot longer to recover than that.

Russia was once described as a "tale of two economies," to cite the title of a seminal paper written by Renaissance Capital's head of research, Roland Nash: one Russia was Moscow and the other was everything else. Moscow was a cornucopia of plenty, awash with oil money and the scene of some of the most conspicuous consumption on the planet. The regions were mired in grinding misery with the man in the street trying to exist on $50 a month and function with dilapidated infrastructure or lead a normal life in the face of an almost total lack of services.

The growth of the boom years started to change all that. By 2006, the regions began overtaking the centre in terms of everything - retailers were marching out to the regions and loudly proclaiming their latest hypermarket store in Samara or Rostov-on-Don; the internet penetrated deeply into the snow bound wastes of Siberia (as parents want to connect their children to the rest of the world); mobile phone Sim card penetration passed 100% in cities that most westerns couldn't even pronounce; and, most impressively, the volume of retail loans and deposits with banks in the regions overtook that in Moscow. "To the people!" became the rallying cry of commerce, in an echo of the fin de siecle Narodnik movement of the 19th century where proto-revolutionary Russian intellectuals, such as writer Anton Chekov rushed off to the interior in search of the "real Russia" only to find it brutal, alcoholic and ignorant.

Given the growing importance of the regions, surprisingly little research has been done by analysts on Russia's hinterland. Most fixate on Moscow and St Petersburg, which are respectively the largest and second largest cities in Europe (and both are counted as regions in their own right in Russia's federal structure). Both cities are larger in terms of population than almost all of the countries of the former Soviet Union and Central Europe.

Add to this that some 80% of Russia's population live in the European part of the country, bounded by the low lying Ural mountains, and it is no surprise that amongst the other cities mentioned by investors are names from this part of the country like Rostov, Samara and Nizhny Novgorod, which come up all the time.

The economic structure of Russia is also dominated by a few names, but a couple of these regions lie outside of Europe in Russia's sparsely populated Asian territory: of Russia's 83 regions (down from 89 following Vladimir Putin's administrative reforms), some 14 regions were net contributors to the federal budget at their peak of tax revenues collected, while the rest needed help from the centre.

This has led to political problems: while the contribution of retail in European Russia is significant, the really big money earners are the Siberian oil producing regions like Timan Pechora, Tymen and the semi-autonomous regions like Tatarstan and Bashkortostan, which at the end of the 1990s came close to splitting away from the federation along with the Far East until Putin put his foot down.

Regions sent backwards

The crisis has hurt the regional development of Russia far more than the country as a whole, and driven a new wedge between the centre-periphery divide. "The crisis has put a brake on consumer and investment demand across all regions," says Deutsche Bank in a rare report on the Russia's regions released in September. For example, while things like real estate prices have held up reasonable well in Moscow, falling between 10% and 20%, they have completely collapsed in some of the more off-the-beaten-track regions.

Analysts at Uralsib also note that the fall hasn't been uniform across the country. "The crisis has significantly increased regional disparities between various parts of the social, financial and economic spheres in Russia." Real incomes increased in 31 of Russia's 83 regions in the first four months of 2009 (in the depths of the crisis), and fell in the remaining 52 regions.

Two sets of regions were hardest hit by the crisis: those that were lagging behind already, and the manufacturing and non-energy commodity producing regions. "Areas that traditionally were among the least developed in the country - such as the small ethnic republics in the Caucasus or Volga region - have experienced further declines in the living standards of their population. At the same time, in Russia's wealthiest regions these falls were less severe," the Uralsib report says.

Those regions, such as Chechnya and Ingushetia, already had the highest levels of unemployment and lowest standard of living in Russia. Tuva, another small ethnic republic, on the border with Mongolia is ranked lowest according to the UN's Human Development Index.

The largest falls in real income were recorded in the manufacturing and non-energy commodity producing regions. "The global financial crisis has had a devastating effect on the industrial dynamics in some large industrialized regions, particularly those where the concentration of coal and metals industries is high," says Uralsib.

The impact was particularly severe in regions with large metallurgy production plants - such as the Chelyabinsk and Lipetsk regions, as well as regions dependent on a single industry or group of related industries. A substantial drop in real incomes was also seen in manufacturing centres such as Kaliningrad and Ryazan. The highest unemployment growth rates were observed in the Volga, Urals and Northwest Federal regions.

The regions have also been exposed by the make-up of the local economy, which is a legacy of Stalin's central planning. In the 2010 budget, Putin earmarked special financial support for Russia's 400-odd "monotowns," or towns where the local economy is dominated by a single giant factory. The most obvious example is the city of Tolyatti in the Samara region, home to Lada-maker Avtovaz, which announced it would lay off over 21,000 workers in the new year. Social tensions are also running high in Magnitogorsk in the Chelyabinsk region, which is home to a giant steel mill.

State to the rescue

The complexity of the Kremlin's problem isn't well appreciated. Putin summed it nicely in one of his state of the nation speeches as president: "Our country is rich, but our people are poor."

To this, he should have added the qualifier that the poverty of the average Russian depends to a large extent on where they live. The Kremlin elite remain terrified of the population radicalising and so have been quick to pour money into the more backward regions to keep them going. According to Deutsche Bank, the economic downturn has increased pressure on regional budgets since tax revenues have fallen. "Total regional revenues including transfers decreased by 14% in the first half of this year compared to the year previously while expenditures increased by 20% over this period," the report says.

Uralsib notes that unemployment and social tensions are much worse in the south and distant northern regions than in central Russia, where many of the wealthiest regions are located. One upshot is the increase in terrorist attacks in the Caucasus recently. "The worsening social situation has created fertile ground for the growth in extremism in the Caucasus, which explains the recent rise in the number of terrorist attacks in Ingushetia and Chechnya," it says. "The extremely high concentration of wealth and political economic power in Russia is potentially dangerous."

Supporting the regions is draining money away from the Kremlin's stated $1-trillion infrastructure programme, which is now on hold, and other long-term development projects. Social spending "has increased pressure on the strained finances of the federal government, forcing the Cabinet to divert a large amount of funding from infrastructure programs to social and employment programs," says Uralsib. And with some success - while unemployment is rising in most countries of the world, in Russia joblessness is already falling.

Regional winners

Still the news isn't entirely bad: some regions will come through the crisis as winners.

Moscow and the oil-rich Tyumen region are Russia's two richest regions with per capita income of more than twice the national average - this was also true in Soviet-days. Moscow accounted for 24% of Russia's GDP in 2007, with GRP (gross regional product) of $274bn, according to Deutsche Bank. Moscow is Russia's financial centre, and the bulk of Russia's imports, exports and investments are channelled through Moscow. Tyumen is the centre of oil and gas production in Russia. Thanks to its rich endowment of natural resources and low population, its per capita GRP reached $27,000 in 2007, far above the national average of just $6,300.

In all, Deutsche Bank identifies nine regions as having the best investment climate, based on calculations of their above average investment potential and below average investment risk: the city of Moscow and Moscow region, St Petersburg, Samara region, Krasnodar territory, Nizhni Novgorod region, Republic of Tatarstan, Rostov region, and Republic of Bashkortostan. Together, these regions account for 45% of Russia's GDP and achieved GRP growth of between 5.8% and 10.3% between 2000 and 2007. The nine regions have some things in common; they are all located in European Russia, and host 7 of the 11 Russian cities with over 1m inhabitants. However, their economic strength is derived from very different sectors - agriculture, the extractive industries, retail trade and manufacturing.

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