Back to the 90s - Russia to freeze energy tariffs

By bne IntelliNews September 10, 2013

Ben Aris in Moscow -

In the face of persistently high inflation and capital outflows, the Russian government has decided to freeze energy tariffs, which will give the economy a short-term boost, but will also stymie the long-term development of the economy.

Times are tough in Russia after economic growth dropped to 1.2% in the second quarter, but inflation remains stubbornly above 6%. Forced to choose, the Central Bank of Russia (CBR) has opted to fight inflation ahead of boosting growth, an extremely emotive topic for Russians who lived through years of hyperinflation in the early 1990s.

For almost two decades, the state has held back increases in tariffs for power and gas in an effort to bring inflation down into single digits. And the effort has been successful: inflation fell to a record low of 5.5% in July 2010. However, the slowdown in 2012 has been partly cause by the high cost of borrowing: the CBR has kept interest rates high as the cornerstone of its battle against inflation. This high cost of borrowing has caused investment to tank and that in turn is killing growth. Inflation has fallen slowly from a high of over 7% earlier this year, but the current 6.4% is still too high for the government's taste.

Freezing energy tariffs is one of the most effective tools in the state's armoury for containing inflation. But it comes at a high cost: the decades of underinvestment, especially in the power sector, mean that Russia's utilities, strapped of investment cash, are old and inefficient. The privatisation of the sector at the end of the 1990s was a big step in the right direction, but the sector still needs tariffs to rise to international levels to raise more money for investment.

Yet on September 7, Russian Prime Minister Dmitry Medvedev asked key government entities (including the economy, finance, and transport ministries) to develop scenarios for Russia's development over the medium term assuming that all regulated tariffs are kept stable.

The tariff freeze has been proposed for gas, electricity and rail transportation. And, if implemented, will come into force in July 2014.

"This new proposal goes far beyond the economy ministry's initiative to set the regulated tariff growth in line with last year's consumer inflation for industrial customers and to set last year's inflation plus few extra percentage points for households," says Alexei Devyatov, an analyst with Uralsib. "The tariff freeze proposal shows that the government is concerned about the current state of the economy and is ready to use policy tools to boost fading economic growth, which is bad for key monopolies, but good for the economy."

Uralsib estimates the tariff freeze will add 0.8-1% to growth over the year it is expected to run. The service sector will be the biggest beneficiary thanks to the lower costs. However, manufacturing will be less affected, as any gains won from lower prices will be offset by losses for utilities and the raw materials producers. But it will be worth it if freezing tariffs leads to a general revival in capital investment, which has fallen into torpor over the last year.

But analysts are confident the move will deliver on its main goal. "We also see a very strong positive effect on inflation, which, under the assumption of zero tariff growth in 2014 and average 5% tariff growth in 2015-16, drops from 6.3% year-on-year in 2013 to only 3.4% year-on-year by the end of 2014, but then moderately rises to 4-5% in 2015-16," says Devyatov.

The freeze may have the desired effect, but this is so-1990s as far as policymaking is concerned and smacks of desperation. Russia has been working hard to move into the 21st century and made several significant changes to the way it manages the economy, the introduction of the so-called fiscal rule probably being the most important (oil price assumptions in the budget are based on historical prices rather than future guesses).

Previously, the Ministry of Economic Development intended to increase tariffs by 5% a year, President Vladimir Putin called for keeping the hikes in line with inflation (6-7%), and the energy ministry and gas producers continued to lobby for 15% hikes to close the gap with the rest of the world. In this context a flat out freeze looks fairly drastic by comparison.

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