Russia’s leaders have so much money that they don’t know what to do with it. Literally. The state has successfully taken charge of much of the country’s multi-billion-dollar oil windfall; applying it to human and economic development problems is a greater challenge.
Economists, development experts and international agencies are debating, first, how much of Russia’s foreign exchange reserves can be brought onshore, and how they can be spent without producing a bureaucratic nightmare or inflationary havoc. A second headache is to manage Russia’s uneven economic boom, to stop disparities between regions and social classes widening further and to tackle the legacy of poverty and poor health left by the 1990s slump.
The third, and probably toughest, problem, is how – or whether – the oil money can help address Russia’s historically unique demographic disaster.
Fiscal and macroeconomic management
Russia’s first challenge is wise management of the oil windfall. The government’s share is largely locked up offshore, in $369 million of foreign exchange and gold reserves, and $114 million in the “stabilization fund” of surplus oil revenues.
From next year the “stabilization fund” will be split into two: a Reserve Fund into which revenues from both oil and gas (instead of just oil), up to 10% of GDP, will accrue, and a Fund for Future Generations, to invest in riskier assets with higher returns. While the international financial institutions and most economists have praised Russia’s stewardship of reserves up to now, concerns are mounting that parliament, which will discuss the Fund for Future Generations in the autumn session, could open the door to short-term populist decisions.
Elections loom – to parliament in December, and for the presidency in March next year – and some lawmakers have already made suggestions for spending the money that have greater appeal to the electorate than economic sense. John Litwack, the World Bank’s chief economist for Russia, says that finance minister Aleksei Kudrin has been “working very hard” to enshrine in law the principle that the Fund for Future Generations should remain offshore, possibly invested in equity instruments. “But suddenly there has been an outbreak of populism, and people started saying ‘spend it now, in Russia’ – which would defeat the whole purpose of the fund,” he says.
There are compromise suggestions, such as using some of the fund to plug a gigantic hole in the Russian state pension system. This deficit will grow in coming decades due to there being fewer people of working age and more pensioners – a problem common to many developed countries, but exacerbated in Russia by the demographic crisis.Even if Russia manages its wealth wisely and maintains growth into the next presidential term, that does not insulate it from external factors. A reminder came in August, when the international market turmoil triggered an outflow of speculative capital in long-term rouble instruments, reversing the unprecedented level of capital inflows ($53.7 billion in the second quarter of 2007 alone, more than the 2006 total of $40.9 billion).
The central bank responded robustly, selling $3 billion of its reserves on August 21 to strengthen the rouble, and following up by buying securities under repurchase agreements. The rouble quickly recovered, reaching its strongest point for the year in October. But it was a sober reminder that Russia, with its strong fundamentals, is not an island.
Evgeny Gavrilenkov, chief economist at Troika Dialog investment house in Moscow, says that although budget expenditure is expanding “too rapidly”, he is “much more concerned” about the impact of external factors on the balance of payments. He calculates that the “break-even oil price” at which the budget is safely balanced has risen from $17–18 in 2002 to $37–38 this year and $47-48 next year.
“The oil price will not go up indefinitely. We will see a shrinking fiscal surplus and a shrinking current account surplus,” he tells Emerging Markets. “You can always manage your internal account, but you cannot directly manage your balance of payments. If something happens with capital flows and with commodities prices, this will bring problems in years to come.”
Gavrilenkov also believes that, while Russia has turned the corner and started investing, there remains a huge long-term question mark over investment efficiency. “Investment plans this year – mainly by state-owned companies such as Gazprom, Rosneft and Russian Railways rather than from the budget – will support growth. But it is difficult to check whether this investment is efficient long term,” he warns.
He points out that the Soviet Union doubled investment during its last 25 years, but growth decelerated, and the economy reached “deadlock”. In Korea, the Philippines and other Asian countries where investment is spearheaded by a small group of companies close to the state, there was similar investment growth for two decades up to the 1997 crisis, but it proved “unsustainable”. “Now, Russia has a much more open economy [than in Soviet times]. But it’s too early to judge the long-term results.”
Addressing inequality
President Vladimir Putin and the Russian government have declared poverty reduction and infrastructure investment to boost regional economic development, to be key policy aims. A three-year budget to stabilize spending and encourage medium-term planning has been adopted, with priority funds earmarked for “national projects” to develop health, education, new housing and agriculture.
The trouble is that Russia’s lopsided boom fosters, and sometimes exacerbates, inequalities. The economy remains heavily reliant on oil, gas and metals and the consumer and property booms in Moscow and other rich areas, while manufacturing and processing sectors are reviving, but too slowly.
A report by the UN Development Programme issued this year showed that, in development terms (i.e. judging by regional domestic product per head, access to education, demographic and health factors), the disparity between rich and poor regions continues to grow. And a recent World Bank report concludes that, while in strictly economic terms divergence between regions is declining, this is mainly due to some sections of the European part of Russia catching up on the very richest – and “regional disparities will very likely become more severe over the medium and longer term.”
Professor Natalia Zubarevich of Moscow State University, the UNDP report’s lead author, says that the government’s spending plans comprised nothing more than a first step. “First, there will be more money, but in many regions it will scarcely be noticed,” she says. “Second, more money will be spent on social problems, but many of the decisions about how it is distributed will be taken on a political, that is non-economic and irrational, basis. And third, the inequality between regions will continue to grow, notwithstanding the growth of federal spending.”
The much-vaunted “national projects” will make little difference to the deep institutional and funding problems facing Russian education and health, Zubarevich warns.
On health, the “national project” money comprises only 13% of total health spending, and is poorly directed, Zubarevich believes. About one-third will be swallowed up by a pay rise for general practitioners, while surgeons and other specialists will receive nothing; another quarter will go on flagship medical centres. The fundamental under funding and institutional problems of the sector will be untouched, she warns.
The outlook for education, where the “national project” money will only make up 5% of total spending, is no better. And in housing reform, the single most important potential step will be legislation underpinning individual ownership of dwellings – although even that will not overcome “a monopolized market, a grand bureaucracy and corruption on a colossal scale” in municipal housing.
Litwack at the World Bank agrees that institutional development is central. “The budgetary institutions that developed in the 1990s were, and could only be, very myopic,” he says. “They dealt with one short-term crisis after another, and there were no multi-year programmes to speak of. Now Russia has the money for such programmes but doesn’t yet have the institutions to make them work.”
Matters of life and death
In development terms, Russia’s toughest problem is certainly its demographic one. The population declined from 149 million in 1992 to 143 million in 2003 – and most demographers agree with the UN’s forecast of a further decline of at least 30% over the next 50 years.
Life expectancy is now 58 years for men and 72 for women, on average 14 years behind the European Union’s. It plummeted in the early 1990s, with heart disease, accidents, suicides and alcoholism exacerbating the situation, and after a brief improvement in 1995-98 has turned down again.
Moreover, the population is aging, and the birth rate is lower than that of most rich developed countries. The fertility rate (number of live births per woman of child-bearing age) fell below the replacement rate (about 2.1) in the early 1990s and is now little more than half the replacement rate, about 1.1.
Five years of economic recovery have made little difference. As the labour force shrinks, the government has set its face against the solution embraced by many rich countries – i.e. immigration – and is concentrating instead on a programme of financial incentives (payments of about $10,000 upwards) to families who have two or more children. Demographers have strong doubts about this approach. A five-year study of young families, just completed by the Independent Institute of Social Policy in Moscow, shows that a wide variety of factors – such as the availability and quality of various types of child care and education, employment among young mothers, poverty rates, family structures, etc. – influenced the birth rate.
Ultimately, Russia’s demographic decline is a legacy of the Soviet Union’s decline and fall, the collapse of the economy that followed, and the one-sided recovery. Only when demographic numbers start to change will Russia really be able to claim it has turned the corner.
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