Russia Has One Year for Reform Before Effects of Iraq War Bite
2 April 2003
Article by Prof Andrey Nechayev, president of Russian Financial Corporation:
"Iraq Index for Russian Economy. Government Has One-Year Margin"
If we leave aside the geopolitical, military, and humanitarian aspects of the war in Iraq, which certainly worry us, and focus on its economic consequences for Russia, they boil down to two points. First, will the occupation authorities and Iraq's future government recognize the country's debts in respect of Russia and also the contracts Iraq has concluded with Russian companies? Second, how will Iraqi oil influence the world market -- can we expect prices to fall, or will they remain at the previous level?
As far as the debts are concerned, a possible refusal to recognize them would be a serious blow to Russia's image, but, strange though it may seem, would have little impact on our economic situation. Iraq has not paid its debts for the last 15 years.
The rupture of contracts, which, according to unofficial information, exceed $40 billion, would be a more tangible loss. However, this would affect a few major oil companies that have not exactly been poverty-stricken in recent years and again would not particularly affect the economy of the whole country.
That leaves the price of oil. Experts are unanimous that world oil prices will drop as a result of the Gulf war. The only question is when and how much. At the moment there is no clarity even regarding when the military operations will end or what damage they will cause to oil wells and Iraq's entire export infrastructure. It is also totally unclear who is going to trade in the oil, although politicians-cum-businessmen like Dick Cheney, Donald Rumsfeld, and Condoleezza Rice will scarcely entrust this to UN officials or the future Iraqi leadership in the next few years. Unlike our oligarchs, US oligarchs do not attend receptions at the White House, they work there.
One thing is clear: The longer the war drags on, the longer the stage when Iraqi oil will actively reach the world market and consequently the decline in oil prices will be delayed Therefore the latest Russian Government scenario, which is that oil prices will not drop below $25-26 per barrel for the whole of 2003, can be deemed very realistic.
But whether this is a boon for the Russian economy is a big question. The supply of petrodollars helped Russia to overcome the consequences of the 1998 crisis, though the main locomotive for growth in the Russian economy was the multiple devaluation of the ruble Unfortunately, most of our state economists think in the following terms: What's good for the budget is good for the economy. Alas, this thesis is by no means indisputable gospel truth Certainly when oil prices are high we can be relatively calm with regard to the budget, especially if a decision is made to seriously get to grips with oil companies' excessive profits. However, our experience shows that a budget posting a surplus is by no means a guarantee of high, stable economic growth rates. Moreover, the strengthening of the ruble means that the rate of increase in imports is outstripping not only the growth rate in GDP but also the growth of exports Furthermore, 80 percent of imports are goods that compete directly with Russian goods. Without a protective barrier in the form of a depreciating ruble, most sectors of our industry are hopelessly losing this competition. Moreover, there is virtually no pumping of capital from the oil industry into other sectors of the economy. The "Dutch disease" -- previously unknown in our country -- where a significant proportion of sectors of industrial, especially processing industry, lapse into a state of stagnation as a result of the large-scale influx of currency into the country has become a grim reality. Both common sense and the desire to make Russia a WTO member prohibit the government from introducing prohibitive import duties for most goods, as was done for imported used cars. We must also bear in mind the modesty of the Central Bank's successes in sterilizing the surplus money supply entering the economy via the purchase of hard currency, which means that the inflation rate constantly exceeds the budget projections. Thank goodness the population still believes in the stability of the dollar. The mass dumping by citizens of their dollar savings, which are estimated at $50 billion, would lead to chaos in the currency market and to a jump in the ruble exchange rate. A decline in the dollar exchange rate to below R25 would put an end to all ambitions for economic growth in the country. The prevention of this via the now-traditional purchase of currency by the Central Bank would increase annual inflation enormously in a couple of months.
Thus the preservation of high oil prices is by no means an unconditional stroke of luck. A fall to $19-20 per barrel, on the one hand, would not be an irreparable blow to the budget and, on the other, by alleviating the problem of the excessive strengthening of the ruble, would give Russian commodity producers the necessary respite in the fight against imports. Unfortunately there is another danger here. As the experience of the nineties shows, OPEC operates quite well when oil prices are relatively high and stable. Quite a rapid decline in them could destroy the unity among oil exporters, which would be fraught with the danger of an uncontrollable fall in prices Analysis shows that in the last 10-15 years the price of oil has generally not spent long at around $15 per barrel. It has either consistently exceeded the $20 mark, or has fallen for a long time to the $10-12 level. So we can only put our trust in the fact that the present incumbents of the US White House are Texans, and Texas too does not want excessively low oil prices.
Judging by the events of recent years, including those in Iraq, corporate and regional interests matter to Bush and his team.
In my assessment, all these conflicts are not a problem for the current year. We definitely have in hand at least a year when the budget situation will be calm and the situation with regard to the competitiveness of Russian industry will not yet be dramatic. The conclusion is simple to the point of banality. We must urgently accelerate the structural and tax reforms. We will not have another year for genial contemplation and conceptual debates.