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Jamestown Foundation
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Eurasia Daily Monitor
Volume 2, Number 90
May 9, 2005
IDLE PETRO-RUBLES ARE A RECIPE FOR STAGFLATION
By Pavel Baev
Russia's economy is growing at a pace that invites envy from most European states. The ruble holds steady against the dollar, and Russia's trade balance for the first quarter of this year shows a record $25.9 billion. Its Central Bank, opting for a euro-shift in the composition of its reserves, which amount to an impressive $140 billion, is now able to influence global currency rates (Vedomosti, April 29). It appears perfectly possible for the Kremlin to ignore those biased pessimists, led by former prime minister Mikhail Kasyanov, who tried to spell disaster at the recent Economic Forum in London (Vedomosti, April 28). Indeed, President Vladimir Putin saw no need to elaborate on the macro-economic analysis in his annual address to parliament, but one remark betrayed his growing worries: "Instead of a breakthrough we could see stagnation" (Polit.ru, April 27). Even a brief look at the current indicators confirms that this possibility is far from hypothetical, but instead of stagnation the looming trouble could be more precisely defined as "stagflation."
This economic phenomenon -- low growth accompanied by high inflation -- was observed in the United States in the late 1970s, and some experts warn about its possible return (New York Times, April 18). This warning is entirely applicable to Russia, where the first quarter GDP increased only by 4.9% against 7.4% in the same period a year ago, while inflation reached 5.3% compared with 3.5%. One plain fact emerging from these figures is that the officially approved plan for 2005, envisaging GDP growth of 6.5% and inflation levels of 8.5%, has to be corrected, probably by half (Gazeta.ru, April 27). Another unpleasant truth is that no simple solutions are available, since measures aimed at stimulating growth immediately add to the money supply, while tightening financial flows drives a recession deeper.
Putin announced his commitment to the high-growth course and sought to impress upon the legislators that he was serious about it, avoiding simplistic slogans like "doubling the GDP" and elaborating on the need to encourage investment. His proposals for legalizing the return of capital from "offshore" accounts and terminating the "terrorism" of the tax authorities earned the unreserved approval of Yevgeny Yasin, the doyen of Russian economists (Ekho Moskvy, April 26). Indeed, many experts subscribe to the argument that the growth potential remains strong, and a series of business-friendly measures could quickly increase the demand for investment capital and that would reduce the inflation pressure (Ekspert, April 25).
The government, nevertheless, meeting the day after the president's address, made curbing inflation a priority (Izvestiya, April 27). This discrepancy cannot be explained away by the Kremlin's obsession with secrecy, so much that the prime minister had been kept in the dark about the key points of Putin's message. The Finance Ministry still must compensate for the emergency "bonuses" that were paid to angry pensioners in order to calm down their protests and to cover the new salary increases in the state sector ordered by Putin. It wants, therefore, to continue repaying Russia's external debt ahead of schedule and is not particularly concerned about the capital flight that in the first quarter reached the record level of $19 billion (Kommersant, April 28).
This figure points to a hole in the very heart of Putin's growth strategy: Russian entrepreneurs cannot trust his words. The deterioration of the investment climate has been caused by a sustained series of attacks on business interests accompanied by a parallel series of reassuring statements from the president. This address may set a new high-water mark of "liberalism" in his rhetoric but Yasin emphasized that the dark "genetic memory" of Russian business needed a more serious treatment. Andrei Illarionov, Putin's independent-minded economic adviser, insists that there is one simple step that could eliminate much doubt and worry: Mikhail Khodorkovsky, who awaits verdict in the thoroughly politicized trial, must be set free (Vedomosti, April 28).
This proposal would hardly restore Illarionov's long-lost popularity in the Kremlin. The destruction of Yukos, Russia's most efficient and transparent oil company, and the imprisonment of its owner are not just episodes in Putin's taming of Yeltsin-era "oligarchs"; they have become the defining moments of his presidency. Back in mid-2003, Khodorkovsky was neither an "enemy of the state" nor a political competitor, but he started to blaze an alternative strategic course – and Putin's "stability" is based on the lack of any alternatives. Yukos began to invest massively not just in the development of oil infrastructure but also in developing human capital, so that Russia would escape from the bottom of the world rating in computerization (Novye izvestiya, April 28). Putin has crushed this alternative and now postpones the verdict only for the sake of the pompous celebrations of the 60th anniversary of the great Soviet victory over Nazi Germany (Novaya gazeta, April 28). He is, however, unable to present any coherent and comprehensible course that would make economic sense and at the same time satisfy his greedy courtiers. The huge inflow of petro-rubles finds therefore no meaningful investment except corrupting Russia's tremendous bureaucracy and pouring money over the flashpoints of social discontent. Stagflation is in the cards and Putin may claim copyright for the original "squeeze-and-sweet-talk" recipe.