May 26, 2017

Is Russia’s Crony Capitalism Really Sustainable?

REUTERS/Sergei Karpukhin/File Photo
A worker checks the valve of an oil pipe at an oil field owned by Russian state-owned oil producer Bashneft near the village of Nikolo-Berezovka, northwest of Ufa, Bashkortostan, Russia January 28, 2015.
A worker checks the valve of an oil pipe at an oil field owned by Russian state-owned oil producer Bashneft near the village of Nikolo-Berezovka, northwest of Ufa, Bashkortostan, Russia January 28, 2015.

Vladimir Putin’s ultimate goal is to remain in power while the economic growth is not seen so essential.

The Russian economy is not doing well, but nor is it collapsing. It is best described as stable and nearly stagnant. But is this sustainable? President Vladimir Putin cares greatly about macroeconomic stability, while neither economic growth nor the standard of living interests him much any longer.
Recently, I gave a lecture in Warsaw on Russia’s crony capitalism, arguing that the Putin system is not sustainable but the Soviet Union taught us that an unsustainable system can last for a long time. Somebody in the audience raised his hand and pointed out that Prime Minister Antonio Salazar was the dictator of Portugal for 36 years in spite of miserable economic performance and colonial wars in Guinea Bissau, Angola, and Mozambique. Even so, Salazar died quietly in his bed in 1970 at the age of 81, and it took four years before the revolution broke out. Often, bad rulers persist for far too long.
The latest test for Russia’s economic stability was the financial crisis starting in the summer of 2014. The Russian economy was hit by a double-whammy. In June 2014, he oil price starting falling and the Western financial sanctions over Russia’s aggression in Ukraine in July 2014. Each produced negative effects reinforcing one another.
In December 2014, the financial panic hit Russia. The Central Bank of Russia (CBR) let the exchange rate float freely, and the exchange rate of the ruble fell almost three times from June. Society was shocked. People ran to the shops to buy whatever they could before new and higher import prices were introduced.
In the midst of the panic, Putin made two major public appearances: his annual address to the Russian Federal Assembly in the Kremlin on December 4 and his annual big press conference on December 18. He said little about economic policy. He reassured his audiences that the economic situation was quite good, blamed external forces for any problems, offered no changes in the government’s approach the economy, and expressed his hope that things would get better.
He avoided the word “crisis,” arguing that “the current situation was obviously provoked primarily by external factors.” He said little about future policy: “What do we intend to do about this? We intend to use the measures we applied, and rather successfully, back in 2008. In this case, we will need to focus on assistance to those people who really need it…. We would certainly be forced to make some cuts.”
Although Putin repeatedly claimed that Russia would repeat its successful policies of 2008-9, he changed policy. The new anti-crisis plan was very different from those measures that had cost Russia far too much in reserves and public expenditures, while GDP had fallen by 7.8 percent in 2009.
First, the Kremlin economized on reserves through the floating exchange rate. Second, the budget cost was much smaller, as Western sanctions stopped all refinancing of Russian foreign debt. Third, the allocation of the government funds was quite different. Yet, Putin has nixed all proposals of structural reforms.
The great improvement from 2009 is the flexible-exchange rate policy, which helped the CBR to economize on reserves. Russian corporates had no choice but to pay off their debt service as it fell due, and they had hardly any possibilities of refinancing. Russia’s total foreign debt fell from $732 billion in June 2014, to $513 billion at the end of 2016. Meanwhile Russia’s international currency reserves declined from $510 billion at the end of 2013, to a low of $356 billion in March 2015. But since then they have gradually recovered and stabilized at almost $400 billion.
The low oil prices have dealt a devastating blow to Russia’s export revenues. Russia’s merchandise exports fell by almost half from 2013-16, from $523 billion to $283 billion, but so did imports because of the falling exchange rate from $341 billion to some $190 billion. As a consequence, Russia incredibly maintained a significant current account surplus.
This anti-crisis plan was supposed to have a total cost of 3 percent of a GDP, compared with the bailout 10 percent of the GDP in 2008–2009. Most of the anti-crisis package was devoted to bank recapitalization, which made sense. The government proposed to recapitalize 27 major banks, which would consume two-thirds of the anti-crisis allocation. Admittedly, 199 “strategic” companies irrespective of ownership or efficiency were singled out for assistance and loan guarantees, but because of the falling exchange rate they did not need much financing.
The large depreciation of the ruble helped the government to limit the budget deficit because although the oil revenues plunged in dollar terms they remained almost constant in ruble terms. The government’s goal was to keep the budget deficit low around 3 percent of GDP, and it did. Public debt stayed minimal at 13 percent of GDP. The Kremlin has responded ruthlessly by slashing expenditures on education and health care and recently even pensions. Russia has maintained practically full employment, with an official unemployment rate vacillating between 5-6 percent.
But something has to give, and that is standard of living, investment, and GDP. In the two years 2015-16, real disposable incomes slumped by 16 percent and retail sales, also reflecting the standard of living by 15 percent, and investment fell by 9 percent in.
At first glance, Russia’s combination of crony capitalism and very conservative macroeconomic policy appears odd, but the big lesson from Russia’s experiences with three financial crises in the last two decades is that a severe financial destabilization is dangerous for political stability and must be avoided.
But macroeconomic stability does not warrant sound economic policies in other regards. Under Putin, Russia has reinforced an iron triangle of the old KGB, state corporations, and Putin’s cronies. In a debate between liberal market economists and statists, the liberals have won on macroeconomic policy, while the statists have obtained the expansion of the state sector and protectionism. This system delivers macroeconomic stability but little or no growth.
Putin has relied heavily on a group of contemporary KGB officers that he came to know in his youth in St. Petersburg and Dresden. They dominate the state, law enforcement system and state corporations.
A major trend in Putin’s Russia has been the development of large state monopolies and the renationalization of major companies. Its started with the arrest of Mikhail Khodorkovsky, the CEO and main owner of the Yukos oil company, in October 2003, and the ensuing confiscation of Yukos and its absorption into Rosneft. The formation of several of the main state corporations occurred in 2007. The most important company has been Gazprom. The state corporations have expanded because of privileges granted by the state but not because of economic efficiency. As a consequence, the Russian Antimonopoly Committee claims that the state share of Russia’s GDP has increased from 35 percent in 2005 to 70 percent in 2015.
The large state corporations let public funds flow to the private corporations of the cronies, a few close personal friends of Putin from St. Petersburg. The three prime cronies are Gennady Timchenko, Arkady Rotenberg, and Yuri Kovalchuk, all sanctioned by the United States since March 2014. They have all become multi-billionaire, and they have largely made their money on the state, primarily on Gazprom, either through privileged public procurement of pipelines and other infrastructure projects, or through asset stripping.
The ultimate goal of the Putin regime is its maintenance of power, while economic growth is not seen as essential. Crony capitalism helps the Kremlin to maintain political power. As domestic politics dwindle and the economy stagnates, foreign policy is becoming ever more important as a means of legitimacy. The century-old Russian urge for “small, victorious wars” is vital for our understanding of how Russia’s economic system and political regime can provoke Russian aggression abroad. The Kremlin’s propensity to take risks is rising. A regime collapse is one possibility, while reform appears less likely.

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