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Financial Times (UK)
June 18, 2003
Putin's sceptical view of Russia's success
By Mark Medish
The writer was senior director of the National Security Council and US deputy assistant Treasury secretary, 1997-2001, and is a partner at Akin Gump Strauss Hauer & Feld LLP

It was John Maynard Keynes who observed that Russia's economy provided ample evidence to support contradictory theories. In this respect, things in Russia today are not much different from the 1920s.

Recent business headlines from Russia point to a flourishing scene, with galloping bond issuances, surging equities and big oil mergers. Macroeconomic performance is also strong. The federal budget is in surplus; inflation is in single digits; the current account is surging; and central bank reserves exceed $60bn. Real annual gross domestic product growth is about 4 per cent. Gone are the days of Russia's International Monetary Fund tutelage. The 1998 financial collapse is a distant memory.

Yet President Vladimir Putin's recent address to parliament on the state of the country was downbeat. He told his countrymen that Russia's "economic foundation, although it has become considerably sounder, is nevertheless unreliable and very weak". Mr Putin's strength is his candour.

What does he know that investors do not? Could Russia be heading towards another crash or a serious slowdown, as some analysts are now suggesting?

A possible answer is that Mr Putin and his advisers are convinced that real rouble appreciation, caused by capital inflows fuelled mostly by the oil and gas sector, is a potential risk. Left unchecked, it would undermine the economy's new-found dynamism and competitiveness. Over-reliance on oil revenues will also damp the reformist zeal that is the key to long-run growth.

The deeper reason for his gloominess may be that Mr Putin distinguishes between headline news and what is happening below the surface. Perhaps the impending parliamentary elections in December and the presidential ballot next March have sharpened his sensitivity to the realities facing the vast majority of Russia's people.

As Mr Putin noted in his speech, a quarter of Russians survive on incomes below subsistence, as officially defined. Clearly, abundant natural resource wealth is not a sufficient condition for durable, equitable national prosperity. Without a strategic approach to reform, Russia's growth spurt will dissipate and windfall profits will once more retreat offshore.

Opinion polls favour Mr Putin for a second term. But whether he will be able to refocus his economic programme is an open question. Several crucial tests will determine whether Mr Putin's legacy is that of a moderniser.

The first test is diversification. Russia must master its hydrocarbons, or they will master Russia. It needs to upgrade, diversify and privatise its pipelines to boost export capacity. The emerging government strategy to develop new exit routes to the Barents Sea and the Far East bodes well.

At the same time Russia must diversify its productive base away from energy and defence towards higher value-added civilian manufacturing, services and the "new economy". Another test, therefore, is whether the authorities find the wisdom to promote small and medium-sized enterprises. Some gains have been made in tax reform, but generally the state is overbearing through its regulation.

The third test is banking reform. Here the shadow of 1998 is long. Will Mr Putin be able to break the liquidity bottleneck by nurturing a network of financial institutions that actually mediate credit to the real economy? Without this, domestic investment in Russia will remain the domain of industrial heavyweights and oligarchs.

Fourth, Russia needs better infrastructure. The new Russian economy is being hampered by the crumbling Soviet legacy. Again, banks and capital markets should be the conduit for investment.

Finally, a second Putin term will be judged by what it does for social services, including education, pensions, and health. Mr Putin made clear that Russia is undergoing unprecedented demographic woes in terms of morbidity and life expectancy. An economy can only be as strong as its people.

The international community could do much to help, by ensuring speedier accession to the World Trade Organisation, predicated on deeper liberalisation and market-oriented structural reforms. But ultimately meeting the challenge will require powerful leadership from Mr Putin - provided the beleaguered Russian population gives him the opportunity in the forthcoming ballot cycle.

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