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Toni Schönfelder
A lifetime of innovation

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Toni Schönfelder
A lifetime of innovation

Moscow Budget
2018 GMT, 000421" vspace=4 width=145>Despite bragging about Russia’s “huge growth” in the first quarter and Russia’s current budget surplus, Russian President-elect Vladimir Putin warned the Russian government on April 19 to adopt “a more rigorous budget policy” in light of lower world oil prices. A number of one-shot measures and the windfall of high oil prices in the first quarter will allow Putin to fully fund Russia’s 2000 budget, but this alone will not help Russia develop economically. In 2001 Russia will face the same litany of unaddressed problems.

Following World War II, Japan and Russia never signed a formal peace deal. They" TARGET="_new">">They are now on the verge of doing so. If signed, such a deal will likely return the disputed Kuril Islands to Japan, but at the cost of a hefty loan from Japan. Such a loan, despite Finance Minister Mikhail Kasyanov’s insistence that foreign loans are not necessary, would help fill a glaring $4.5 billion hole in the 2000" TARGET="_new">">2000 budget created by IMF and World Bank loans that never materialized. While a Japanese loan would likely not reach $4.5 billion, it will almost certainly be at least $1.5 billion – the amount that Japan agreed to in 1998 merely to continue talks on a return of the Kurils.

Despite tightening credit terms for Russia internationally, debt forgiveness is in the air. In February the London Club, an organization of 600 banks that lent money to the Soviet Union, agreed to reduce Russia’s debt from $32 to $21.3 billion and extend payments over a longer period. The" TARGET="_new">">The Paris Club is expected to adopt similar plan later this year. Such debt reduction would take a healthy bite out of Russia’s 2000 debt payments of $10.2 billion. The debt will still be huge, but slightly more manageable.

Restructuring of Russia’s energy and aluminum will provide revenues from an expanded tax base. Gazprom," TARGET="_new">">Gazprom, Russia’s single largest source of tax revenue, has been severely hobbled by government intervention, particularly with regard to Moscow’s insistence that Gazprom provide Russia’s electricity provider, Unified Energy Systems (UES) with free gas. But last week Gazprom" TARGET="_new">">Gazprom hammered out a deal with UES that will raise prices for Russian consumers by 15-20 percent. This will have the effect of freeing up more gas for export – a far more profitable prospect than supplying subsidized gas to Russians. No doubt Gazprom’s foreign investors have noticed this switch of priorities. The deal with UES, higher rates and more foreign investment will all help Gazprom expand its export network. More exports means more cash and more cash means more taxes for the Kremlin.

The official merger of Siberian Aluminum and Sibneft on April 17 created a new holding company, Russian Aluminum. The new $8.5 billion giant will control three-quarters of Russia's aluminum production and substantial" TARGET="_new">">substantial portions of the Ukrainian aluminum industry as well. While Russian Aluminum will enjoy a near-monopoly in Russia, it will also discover the downside of being a monopoly in Russia. It will be like Gazprom" TARGET="_new">">Gazprom – a target for nationalization and the tax man.

Speaking of the tax man, on April 19 Putin signed a law that increased the ability of the tax police from being able to investigate two articles of the criminal code to 20. In theory this should increase the tax police’s ability to investigate corruption. Greater expansions of power are certainly needed, but these expansions alone do not address the underlying corruption of the Russian bureaucracy. It is a step in the right direction.

The methods Putin will use to balance this year’s budget will work, but they are largely one-time items. The loan from Japan is just that – a loan. Despite the fact that the loan is from Japan, a lender that tends to offer loans to borrowers that don’t repay them, to Russia, a borrower that doesn’t like to repay loans, Russia does not need more debt.  Even with substantial debt write offs, Russia will still owe well over $100 billion at the end of the year. Russia will not make it a policy to sell islands to other countries as a method of raising revenue – it simply doesn’t have enough islands. Furthermore, Putin is currently the very model of Russian nationalism; repeatedly parceling out chunks of Russia for income is a sure to turn that nationalism against him.

Putin may be able to garner foreign investment for Gazprom this year to help with sorely needed repairs. But after Putin’s" TARGET="_new">">Putin’s nationalization plans begin Gazprom will only be able to get cash for joint projects such as the Blue" TARGET="_new">">Blue Stream line to Turkey being built with Italy’s ENI. There is simply no foreign interest in – or foreign money for – developing a Russian distribution network for a market that won’t pay world prices. Gazprom and Russian Aluminum may be made into stronger institutions that can better serve Moscow’s political interests, but once the oligarchs are purged – and nationalization begins – Putin will only be able to dream dreams of foreign investment. It will all fade away.

Beyond the budget wrangling, Russia’s economy is not performing as well as it seems. Russia, to use Putin’s recently appointed economic advisor Andrei Illarionov’s words, “shall get nowhere in the long-term if it sits on the oil needle.” Energy exports currently account for 58 percent of all Russian exports according to ITAR-TASS – over three times the dependence of OPEC member Indonesia. Petroleum industries do little to develop other sectors of the economy and price fluctuations make oil as much a curse as a gift. As long as Russia’s economy – and budget – are hooked on oil, it will never be able to achieve stable economic growth.

Putin has trumpeted that Russia’s GDP grew by 6 percent in the first quarter – almost all of this can be chalked up to a tripling of oil prices. Russia reported that this year its GDP will grow by 3.0 percent, or about $7.2 billion. But now that the price of oil has plummeted from $34 to $22 a barrel, overall Russian revenues will drop by about $1.2 billion a month – or $10.8 for the last three quarters of this year. Once the growth in oil sales is removed from the equation, Russia’s economy is at best holding steady.

Part of this is a structural issue. Since the August 1998 financial crisis, Russia has worked to substitute imports with locally produced goods. This has improved Russia’s trade balance and granted it a seemingly impressive 11.9 percent growth in industrial production in the first quarter. But it did little to encourage long term growth or efficiency in Russian industry. Since Russia did not concentrate on products it produces well and focused instead a broad range of goods to substitute for imports, it is now much more difficult for Russian industry to compete internationally. Russia produces small amounts of a lot of things that no one outside of Russia wants. As long as Russia does not want to globalize, it can stagger along. But if it wants substantial foreign investment or export markets, it will need to start from scratch – its existing industry simply cannot compete. A functional budget will in and of itself do nothing to solve this problem.

None of Putin’s new steps address the underlying problems in the Russian system: corruption, lack of transparency, warped legal structure, outdated technology, crumbling infrastructure, demographic" TARGET="_new">">demographic decline and government meddling. When 2001 rolls around Putin will have the same problems to address, but fewer tools with which to treat Russia’s sickly economy. If Putin is serious in rooting out the oligarchs, their holdings must come under national control. By definition this will mean delaying reforms.

But one of Putin’s actions will have a long lasting effect: his strengthening of the tax police. Putin’s experience in the intelligence services – and past inter-agency cooperation within Russia – indicates that a more empowered tax authority and a strengthened intelligence service will become de facto partners in Russian society.

Using a series of quick fixes, Putin has successfully established a baseline from which he can salvage the Russian budget. He has not solved Russia’s economic problems. He has merely bought himself another eight months. Considering the depth of Russia’s problems, gaining this reprieve this is no small feat, but the real work – and pain – is yet to come.
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