Will Putin reinvent himself - and the economy?

Source: Reuters

Source: Reuters

Russian financial experts believe Putin will embrace economic reform, because it is logical, but logic has never been the driving force in Russian politics.

After announcing his plans to return to the Kremlin in next year’s elections, Prime Minister Vladimir Putin gave a speech highlighting Russia’s economic strengths as a way of supporting the notion that his return to the presidency was necessary to maintain economic and financial stability. The country’s GDP is now the sixth largest in the world, and Putin made what amounted to a pre-election pledge to lift it into fifth place by 2015. Inflation in 2011 is lower than for many years, and Russia has the third-largest gold and foreign currency reserves in the world.

But look beyond the headline figures, and things are very far from rosy. Budget expenditures are increasing by more than 10 percent per year and will rise further as the elections approach. The political elite constantly talks of reducing corruption and bureaucracy, but both have risen dramatically since 2000, while both international and domestic investors remain very wary, despite constant promises to improve the country’s investment climate.

Productivity remains low by international standards since there is little investment – quite the opposite, capital flight remains considerable, amounting to $34 billion in 2010.  So paradoxically, the country is operating at near full capacity, one reason why imports are very high and increasing at a rate of 40 percent per year. People are now better off than in the 1990s and are consuming, but public goods such as health, social care, education and property rights remain at low levels. Energy exports have increased as a proportion of total exports, making the country even more dependent on the vagaries of global oil and gas prices, which are totally beyond Russia’s control, as are international interest rates and thus Russia’s cost of capital.

The resignation-cum-sacking on Sept. 26 of Russia’s highly respected finance minister Alexei Kudrin merely highlighted these underlying problems.

Kudrin, a fiscal hawk and economic liberal, rejects the political elite’s intention to boost military and social spending, rightly arguing it is a risky step for the economy as a whole.

Most serious Russian and international observers have also argued that the country cannot keep spending its way out of problems and must implement thoroughgoing reform to cure its energy dependence and diversify its economy. Earlier this year, for example, a widely discussed report by The Institute of Contemporary Development (INSOR), at which President Dmitry Medvedev is a trustee, rightly stated that all of the country’s modernization was imported and warned that, without major reform, Russia would lose any chance whatsoever of catching up with the rest of the world technologically.

Since Putin’s announcement, Russian investment banks have been arguing that he will embrace reform, since that is what the country needs.

But that view is based on based on common sense and economic rationality. The problem is that economic rationality is rarely the driving force in Russian politics. During Putin’s presidency, many problems dating from the Soviet period and the 1990s not only remained unresolved, but actually got worse as a direct result of government policies.

The economic and political stability Putin brought to the country came at the huge cost of greatly increased corruption and bureaucracy. That now has the twin effects of hindering economic development and business, while at the same time preventing the implementation of laws and government policies.

This desire for stability and the status quo within very tight limits set by the government means that it cannot pluck the low-hanging fruit and institute simple reforms, such as calling on Russians to become far more entrepreneurial and slashing bureaucracy, which could easily add a few percentage points to annual GDP growth.

Instead, the government remains fixated on supposedly prestigious mega-projects and large companies. Small and medium-sized enterprises account for around 20 percent of Russian GDP, compared to around 60-70 percent in advanced countries, so there is potentially huge scope for improvement here. But the small business organization OPORA complains that the government constantly ignores its requests to reduce bureaucracy, corruption and taxes.

Under Putin’s presidency, Russia ignored countless warnings to reduce the country’s energy dependence and diversify the economy. Nor did he implement the “dictatorship of the law” that he promised. Russia was far too complacent during the commodity boom up to 2008 and thus missed the best chance it had had, literally for decades, to develop a more balanced economy. Now it must try to do so under much more difficult circumstances and a far less favorable global economic environment. It remains to be seen whether Putin can really “reinvent” himself.

Ian Pryde is Founder and C.E.O. of Eurasia Strategy & Communications in Moscow.

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