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Putin Faces 'Unpopular' Decisions to Overhaul Russia's Oil-Reliant Economy

Vladimir PutinVladimir Putin will face obstacles that include a growing budget deficit, continued dependence on oil exports and the potential for social discontent as he reclaims Russia's presidency next year, according to former government officials.

Putin, 58, said Sept. 24 he'll seek to return to the presidency in March elections, pushing aside his protégé, Dmitry Medvedev, who replaced him for four years because of a constitutional ban on three consecutive terms. Medvedev may take the role of prime minister, a move that Finance Minister Alexei Kudrin, an advocate of budget discipline, said would prompt him to quit.

Putin would take the country's job just as the global slowdown threatens to throttle demand for oil, the lifeblood of the Russian economy. The risk is that Putin, an officer in the Soviet-era KGB who says economic-policy makers must avoid "liberal experiments," will struggle to combat challenges that threaten the country's long-term growth prospects, said former Economy Minister Yevgeny Yasin.

Economic changes "will entail political risks, unpopular decisions, and I'm afraid that will stop Putin," Yasin, who was minister between 1994 and 1997 and is now the director of the Higher School of Economics in Moscow, said yesterday by phone. "Russia has yet to reform many institutions which are the legacy of the Soviet era."

Concern over the global economy and Europe's sovereign-debt crisis has roiled markets in Russia, which saw its economy contract 7.8 percent in 2009, its worst recession on record. Russia is vulnerable to swings in oil prices and will have to cut spending, including pensions, to bring its budget into line and its dependency on commodity exports, the International Monetary Fund said on Sept. 21.

Oil Price Falling

The world's largest energy exporter saw the price of its main export, Urals crude oil, fall more than 7 percent last week to $104.93 a barrel, $10 below the level required to balance the budget.

Speculation over who would run for president pushed Russian equities evaluations to the lowest in emerging markets. The Micex index slipped 12 percent last week, dropping valuations on the measure's 30 shares to an average 4.7 times of member companies estimated earnings, the cheapest among 23 emerging markets tracked by Bloomberg.

The ruble has slumped 10 percent against the dollar in September and is poised for its worst month since January 2009, according to Micex prices compiled by Bloomberg. The currency was unchanged at 32.0475 per dollar late on Sept. 23 in Moscow, the lowest level since Aug. 17.

Increased Order

Putin's first two terms as president were marked by order and increased state ownership of the country's biggest companies. Buoyed by a booming global economy, Russia averaged 7 percent growth a year during Putin's 2000-2008 presidency.

Mikhail Kasyanov, a prime minister under Putin until he was fired in 2004 and now an opposition figure, predicts Russia may see its reserves dry up and record a budget deficit of as much as 5 percent of economic output if crude prices fall by a third from their current levels. Putin said on Sept. 21 that there will be no budget shortfall this year.

"If the price of oil falls to $70, that means the ruble will sink, the price of food and medicine will go up 30 percent as most are imported, and there will be a wave of social discontent," Kasyanov said by phone.

While Putin said in April that Russia must avoid liberal "experiments" to ensure stable economic growth, he said at a weekend party congress that tough decisions lay ahead.

'Bitter Medicine'

"The task of the government is not only to pour honey into a cup, but sometimes to give bitter medicine," he said. "This should always be done openly and honestly, and the overwhelming majority of people will understand the government."

Still, the prospect of Putin serving two more six-year terms, which would give him 24 years at the helm, may increase complaints from his critics that the system is authoritarian and make him more vulnerable to unrest.

The ruling United Russia party has seen its support fall to around 40 percent from the two-thirds of the vote it won in 2007. Billionaire Mikhail Prokhorov quit as leader of the pro- business party, Pravoye Delo, last week after the Kremlin withdrew support for his bid to get the party into the lower house of parliament, where 87 percent of seats are held by pro- government forces.

Prokhorov, who had committed $80 million of his money for campaigning in the December elections, said Aug. 26 that Russia is becoming a "farce and parody of the Soviet Union," stifled by bureaucracy and authoritarian rule. On Sept. 25, Medvedev expelled him from a commission on economic modernization.

Platform for Initiatives

The commission, made up of government ministers and top business men, is Medvedev's platform to discuss new initiatives to help develop the Russian economy. Sitting on such commissions is important for Russian businessmen because it gives them access to political leaders and knowledge of economic decisions being made.

Medvedev, 46, a former corporate lawyer from Putin's hometown of St. Petersburg, made the rule of law, the fight against corruption and reversing Putin's policy of increased state ownership to attract greater foreign investment the cornerstones of his time in office.

"Even though everybody knew that Putin de facto led the country during Medvedev's presidency, Medvedev was associated with more liberalism and more investor-friendly rhetoric," said Sergey Dergachev, who helps manage $8.5 billion in emerging- market debt at Union Investment in Frankfurt. "Whether Putin will follow these issues is to be seen."

Capital Flight

Russia, which had $31.2 billion in capital flight in the first half of the year, could see that rise to $100 billion and suffer a sharp increase in the brain drain as educated Russians seek to emigrate, said Boris Nemtsov, an opposition leader and a former deputy prime minister under President Boris Yeltsin.

Russians are becoming increasingly frustrated, said Nemtsov. "When people see they cannot replace the government peacefully through elections, they come out to the streets."

The Russian prime minister made his announcement at a packed congress of his ruling United Russia party, which former Soviet leader Mikhail Gorbachev earlier this year said reminded him of the "Communist Party in its worst years."

Gorbachev was awarded the Nobel Peace Prize in 1990 for helping end the Cold War and introduced a policy of "glasnost," or openness. In July he urged Putin not to run for president, saying if he did so it "will lead to a situation like in Africa where leaders sit and rule for 20 or 30 years."

Putin said his most important priority was the need to show ordinary Russians he was on their side.

"Taxes for people with high incomes, for the rich -- and we have more and more of these people -- should be higher than for the average class, the majority of citizens," he told the United Russia party in Moscow on Sept. 24 where he received a standing ovation. Higher taxes for the wealthy should fall "primarily on consumption, real estate and property," he said.

Article ©2011 BLOOMBERG L.P. ALL RIGHTS RESERVED; article also appeared at www.bloomberg.com/news/2011-09-25/putin-must-overhaul-russia-s-economy-or-risk-brezhnev-style-stagnation.html

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