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Putin's policies
President Putin's economic reforms are stalling, say the critics. Emerging Markets explores
By Alex Fak
On August 19, a strange cabinet quarrel took place live on Russian TV.
The prime minister, Mikhail Fradkov, grew annoyed that the draft 2005 budget drawn up by the ministers forecast annual growth well below the 7.5% required to achieve President Vladimir Putin's goal of doubling the economy in 10 years.
?I don't understand why we can't simply write in 7.5% as our forecast, as is required in order to double the GDP,? Fradkov was quoted as saying. ?It's not just someone, it's the president who called for the doubling of GDP.?
To their credit, the top reformers would not change the number, even after Fradkov warned that he has ?recurring thoughts about rotating the Cabinet ministers?. Alexei Kudrin, the finance minister, even went on a counter-offensive, telling reporters after the meeting that ?the new Cabinet? ? by which he implied Fradkov, who assumed the post in March ? has ?screwed up? on structural reforms.
The incident raises the same questions investors have been asking since Putin's re-election in March. Why have the structural reforms completely stalled, despite the overwhelming mandate that the president received in the elections? If there are divisions within the Kremlin, who is getting the upper hand? Is the government so concerned with form that its drive to achieve numerical targets might hurt the substance of the economy? More fundamentally, what is it really up to? What are Putin's policies?
Don't know/won't tell?
The problem is, Russia's government has no explicit economic programme, and observers are left reading the proverbial tea leaves. When Putin ran for re-election, he refused to talk about his policies, saying he'd unveil them after the election. Although he never did, his first steps in his new term were encouraging: he retained the liberals in the economics team, and even recruited some fresh faces.
During his State of the Nation speech in May, Putin unexpectedly raised the issue of oil export growth, pledging to build new pipelines. Transneft, the state pipeline monopoly, is unable to transport much oil; private pipelines are banned, and companies resort to shipping oil via railways, which is several times more expensive.
Alas, talk of fresh pipelines has since been dropped, and the liberals have found themselves hemmed in. More ominously, investors have begun talking about creeping state intervention in the economy.
Putin's power grab, announced on September 13, has strengthened these concerns. The president proposed that the national parliament, the Duma, be elected strictly on a party list basis and that regional governors be essentially appointed by the Kremlin.
?They are changing the political system, and that has far-reaching consequences for the reforms,? says Al Breach, an eight-year veteran of the Russian scene and an economist at Brunswick UBS. ?Where one discusses reform, one usually means moving ... towards markets and openness. But there's definitely a sense that this is not about that.?
Litmus test
The litmus test of commitment to reforms, says Breach, would be how hard Russia tries to enter the World Trade Organization, convert the ruble, privatize state monopolies and liberalize tightly-controlled sectors, like the electricity market and UES, the power company. Russia is negotiating with the US about WTO entry, and full convertibility is scheduled for 2007, when the last capital controls are due to be removed.
But on June 25, Fradkov said the government wouldn't go ahead with the restructuring of UES nor the long-awaited sell-off of its generating assets ? at least not this year. The break-up of the behemoth gas company Gazprom has also been forgotten, and the removal of the ?ring fence? that bars foreigners from owning local shares of the company has again been postponed.
Indeed, Gazprom has expressed interest in buying UES's generating capacity (which is meant for privatization), and the authorities have launched investigations into several brokerages for creating schemes to let foreign clients invest in the domestic shares of the gas concern. All this points in the opposite direction to liberalization.
Alexei Moisseev, an analyst at Renaissance Capital, points out that reforms conceived in Putin's first term have continued. Some planned tax cuts have gone ahead, and more of the tax burden is being shifted to the oil sector in pursuit of diversification. Capital controls were eased in June, and a deposit insurance scheme, which financial sector watchers say is essential to rebuild people's trust in banks, has now been grounded in law. But ?we knew three years ago that these things were coming,? says Moisseev. ?There haven't been any bold new initiatives.?
The one measure that was the product of the second term ? replacement of healthcare and transportation benefits for socially disadvantaged groups with cash payments ? was rammed through the parliament without the government bothering to sell it to the people first. As a result, the bill sparked mass protests and marked the first time in a long while that the opposition actually reared its head.
In response, the deputies were given just 24 hours to read the 761-page bill, appointed senators were told to vote or lose their jobs, and members of the ruling United Russia Party were given a brochure instructing them to call the bill's opponents ?political speculators who cheat people?. The authorities turned an opportunity for a policy debate on efficient markets into an ad hoc attempt to get their way.
?The government seems to have lost the clear direction it had during President Putin's first four years in office,? says JPMorgan in its research note to clients.
Gimme back my oil
Some are putting it more ominously. A prevailing view is that the Kremlin wants to reinstate state control over key assets. ?Putin's end game plan is for the state to ?reacquire' or keep control over assets of strategic importance, [such as] natural resources sector, utilities and so on,? wrote researchers at Trust Investment Bank. ?This will mean less opposition to implementing tax reforms, or increases in tax payments in these sectors.?
Close observers of Russia say it is Mikhail Khodorkovsky's successful attempt to derail tax hikes on oil last summer that has attracted the Kremlin's wrath against him and the company he chaired, Yukos. The company expects to be slapped with a total of $14 billion in back taxes and fines, and bailiffs will probably seize its main production facility, Yuganskneftegaz.
?Of course we will not have a re-nationalization as such, but in practice it will amount to the same thing,? wrote one analyst recently. ?The ultimate creation of a state-owned [and] controlled oil giant has been one of the consistent themes in various speeches by the president since 2000. He has always said that there would be no re-nationalization of any privatized assets but he always made the exception for what he referred to as Russia's strategic assets: oil and gas.?
Chris Weafer, chief strategist at Alfa Bank in Moscow, calls it a ?salami slice? expropriation, designed to keep investors from running away. ?With Yukos's shares trading at a 75% discount to previous levels, investors are still waiting for the provocative action that will force them to dump their Russia portfolios. Of course that provocation will not come,? he wrote recently. But it will amount to the same thing. Others say events surrounding Gazprom indicate that the strategy of consolidating ?strategic assets? is not confined to oil.
The Road to Hell...
But is the Kremlin really so deliberate? Even as Fradkov ruled out privatizations of UES and Gazprom, a Kremlin-based free marketer, Arkady Dvorkovich, held out a hope that both issues could be resolved this year. Observers say that divisions between market liberals and those who want the state to play a greater role in the economy almost guarantee contradictions in policy ? or a stalemate.
?It's too early to say without reservation that Russian economic policy has changed course,? writes Evgeny Gavrilenkov, senior economist at Troika Dialog brokerage. ?What we can say, with greater confidence, is that it nowadays lacks consistency.?
Two policy dilemmas exemplify this best ? one monetary, the other fiscal. Until early this year, the central bank has been busy trying to rein in inflation, which has stayed in double digits since the collapse of the USSR. Its goal for 2004 was to bring it down to 10%. But in April, Putin ordered Sergey Ignatyev, central bank chairman, to stem the rise of the ruble, a protectionist measure designed to insulate Russian producers from import competition.
The trouble is that under the Russian conditions, the two goals are contradictory. The central bank cannot issue bonds to mop up the rubles it prints, and due to the importance of dollars in the economy and low levels of financial intermediation, refinancing rates carry no leverage on investment and inflation. So by September, the 12-month CPI reached 11.2%, and the three-month annualized rate soared to 15% ? well above the target, and one of the fastest price surges in the world.
Yet monetary authorities continue to hint that low inflation is their priority. What is less seen, wrote Renaissance Capital in a recent report, is that an artificially weak ruble ?discourages efforts to improve competitiveness [and] freezes the inefficient structure of [the] economy? ? even as Putin continues to stress his commitments to structural reform.
Then there is the famous goal of doubling the GDP. Several economists have said that the target might lead the authorities to implement Keynesian measures, leading to deterioration of its fiscal position. High oil prices have allowed the government to maintain budget surpluses for several years running. Last year, it established a ?stabilization fund? to safeguard the money. But the kitty can be raided once it surpasses 500 million rubles (about $17 billion). This might happen as early as the end of the year, and the government is polling several ministries on how to spend the cash.
The prime minister's insistence on growth targets, coupled with the opening of the fund, ?point to more politics in fiscal policy,? wrote Barclays Capital in a note to clients. ?If Fradkov is displeased with the growth assumptions, he seems that much more likely to support spending from the [stabilization fund].? Such pro-cyclical spending would put further pressure on prices and elbow some borrowers out of the market.
The prime minister's demand that all government bodies meet the macroeconomic forecasts they set for themselves ?is fairly reminiscent of the infamous Soviet Gosplan, and, in our view, will not be long-lived,? wrote Renaissance Capital. ?However, for now at least, Gosplan is back.?