Russia's economic reformers are winning President Vladimir Putin's backing, against the siloviki (men of force), for key pro-business measures. But observers fear that, in the longer term, Putin's balancing act between the two factions could undermine his economic growth strategy.
Analysts interpreting the mixed messages from Russia's deeply divided leadership reckon that three recent policy developments reflect crucial presidential support for Finance Minister Aleksei Kudrin, Economy Minister German Gref and their allies:
l The government's decision to keep the VAT rate at 18% for the next three
years, as Kudrin and Gref proposed. This contradicts a populist plan by Prime
Minister Mikhail Fradkov, perceived as an ally of the siloviki, to cut the VAT rate
to 13%, and make up the difference from the Stabilization Fund accumulated from extra oil revenues.
l Putin's approval in January of proposals by Kudrin and Deputy Prime Minister Aleksandr Zhukov, another economic liberal, to curb the power of tax auditors – and effectively prevent future strangulation-by-back-tax claims, the method by which the siloviki killed off Yukos, Russia's most profitable oil company.
l Putin's declaration of support, at a meeting with business leaders in March, for amending Russia's statute of limitations to prevent future Yukos-type prosecutions over the 1990s privatizations. This provided reassurance to Russian business and reduced political risk for foreign investors.
Russia's public finances provide further evidence that the reformers are making headway. They have won Putin's approval for using Russia's huge oil windfall to repay Paris Club debt early and reduce interest rates (see box), and for preserving the Stabilization Fund for sterilizing balance-of-payments inflows rather than funding infrastructure projects, as Fradkov has suggested.
Reform Strategy
Michael Marrese, emerging markets strategist at JP Morgan, says the reformers' policy vision – of creating a business-supportive tax and regulatory regime that will help reduce the economy's dependence on extractive industries, of lowering interest rates by paying down sovereign debt, and of reducing inflation by prudent use of the Stabilization Fund – "has become increasingly influential".
"The reformers believe these measures will lead to vigorous investment and, in turn, spur rapid GDP growth," Marrese says. "Yet because they are determined to remain politically influential after Putin ends his second term in March 2008, they may need to bow to populist pressure to use part of the oil price windfall to boost budgetary spending. And that could hinder their attempts to reduce inflation."
The strength of the pressure to boost spending may be judged from Fradkov's recent promise to double pensions and public service pay in three years, which triggered a fresh argument between reformers and siloviki over where to set the reference oil price above which oil revenues go into the Stabilization Fund. And the impetus for such potentially inflationary measures comes from Russia's still-poorly-rewarded population, which showed its capacity for protest in the January demonstrations over botched social benefit reform – and will vote for a new president in three years' time.
The danger is that Putin, in attempting to satisfy reformers, siloviki and voters all at once, will opt for an economic strategy so timid as to heighten long-term dependence on, and vulnerability to, commodity price cycles.
Chris Weafer, head of research at Alfa Bank, Russia's leading privately owned bank, says: "President Putin, having in practice scrapped the ambitious reform plans with which he started his second term in office, will opt instead for a series of state interventions to drive growth in selected industries where there is either existing growth, such as oil and gas, or where he believes Russia has some competitive advantage, such as defence and some key manufacturing and technology sectors.
"Key reforms, including that of the civil service, will again be postponed. It's not what the economists want, but it's practical in the circumstances and suits Putin's primary objective of 'state-controlled growth'. "
The dangers posed by the retreat from larger reforms are clear, though. Russia's economic performance has been sluggish, despite the unprecedented oil revenues: growth slipped from 7.3% in 2003 to an estimated 6.9% in 2004, and is expected by most economists to fall again this year.
Unpredictable element
The wildest card on the Russian scene, though, is the siloviki. Notwithstanding the policy victories scored by their adversaries in the reformist camp, they remain capable of acting independently of a president who is less able to control them than is often supposed.
This year's back tax cases against Japanese-owned tobacco maker JTI and freight company Volgotanker, on top of December's attack on Vimpelcom, the telecoms firm, all reinforced fears that Yukos was not the last victim. Some observers see siloviki influence behind a recent announcement that foreign owners would not be allowed to bid for a series of "strategic" assets.
Olga Kryshtanovskaia, political scientist at the Institute of Sociology of the Russian Academy of Sciences and an expert researcher of the Russian elite, says: "The siloviki retain huge influence on economic policy. They see it as a question of controlling cash flows rather than in terms of the market economy."
She points to the rise to prominence of, among others, two deputy heads of the presidential administration: Igor Sechin, who works closely with Prime Minister Fradkov and chairs the board of Rosneft, the state oil company that swallowed Yukos production assets, and Vladislav Surkov, chairman of the oil products pipeline monopoly Transnefteprodukt. "The president's attempt to find a balance between the siloviki and the liberals is problematic," Kryshtanovskaia adds. "So far, his assurances [on limiting tax auditors' powers and legally ring-fencing privatizations] are just words."
A Kremlinologist's guide to the warring camps
Reformers:
German Gref, minister of
economic development and trade
Viktor Khristenko, minister
of energy and industry
Dmitry Kozak, government
chief of staff
Aleksei Kudrin, minister of finance
Aleksandr Zhukov, deputy prime minister
Those believed to favour
greater state control:
Mikhail Fradkov, prime minister
Sergei Ivanov, defence minister
Leonid Reiman, minister of IT
and communications
Igor Sechin, deputy head of the presidential administration,
chairman of Rosneft
Vladislav Surkov, deputy head of
the presidential administration, chairman of Transnefteprodukt
Paris Club prepayment
By Simon Pirani
Russia's agreement with the Paris Club is hailed as great news for sovereign creditworthiness and for the economy. Last week, Russia struck a deal for early repayment of $15 billion of debt, or just under one-third of the overall $43 billion it owes to its official creditors. The deal is the biggest debt redemption in the Paris Club's history. It will help save Russia $6 billion in interest payments that was otherwise due by the year 2020.
Prepayment is expected at par. When Russia first mooted prepayment last year, it insisted on a discount, but last month presidential spokesman Igor Shuvalov made clear that a deal at par would still be beneficial. Germany, Russia's largest creditor, accounting for 45% of sovereign debt, has reportedly dropped demands for a premium.
On April 21, the Russian government approved a debt management plan, including prepayment of both the Paris Club debt and some other unsecuritized loans, and a novation scheme (swapping high-coupon Eurobonds, such as Russia 2028, for new paper with lower coupons), which would ease a government bond buy-back at a later date. The decision to go ahead with prepayment is seen as welcome confirmation that financial prudence prevails. Suggestions by Russian Prime Minister Mikhail Fradkov and others of spending some accumulated oil wealth on populist, inflationary handouts have been shelved.
The prepayment plan is great economic news, too. Philip Poole, head of emerging market research at HSBC, says: "From the point of view of economic reform and policy, Russia has probably been moving in the wrong direction for a couple of years. But on the positive side, it has been an incredible de-leveraging story."
Russia brought its debt-to-GDP ratio down to 20% at the end of last year from 90% in 1999, Poole points out. "The Russian public sector became a net creditor to the rest of the world in 2004. The question that flows from that is whether the economy as a
whole can attain that net creditor status and,
while we think that unlikely this year, that does not detract from the extraordinary strength of the national balance sheet."
Ed Parker, sovereign debt analyst at Fitch Ratings, says debt repayment will reduce Russia's vulnerability to future oil price shocks. "Paris Club debt repayments could generate net present value savings," he adds. "They could also effectively prevent issuance of quasi-Russian debt, such as the German Aries bond, being repeated, and raise Russia's perceived status with its G8 peers."
A framework agreement with the Paris Club will
be followed by individual negotiations with creditors. In January, the Club agreed to the repayment of €12.3 billion of Polish debt at par, but several creditors, including Italy, Japan and Austria declined to take up the offer.