UNSTABLE EQUILIBRIUM By Aleksandr Buzgalin Aleksandr Buzgalin is a doctor of economics and a professor at Moscow State University. He is a leader of Russia's Democratic Socialist Movement.
Is Russia's economy expanding or contracting? The indicators point both ways. Today's apparent equilibrium is unstable, and the government, out of caution or fear, hesitates to act.
While President Putin and others demand more ambitious targets than the government's 2002 growth projection of 3.5 percent-4.5 percent [see "Who's Driving the Economy" by Elena Chinyaeva, RER, June 18, 2002], the Russian economy has not been growing at all. GDP fell at the end of 2001 and recorded losses in January, April and May, leaving negative growth over the first five months of this year. Even so, year-on-year, through five months of 2002 industrial production was up 3 percent, investment grew 1.7 percent, and real incomes rose 8.7 percent.
Which trends predominate? Will there be renewed economic growth, or will the domestic market face another squeeze?
TRENDS IN DOMESTIC DEMAND
How can real incomes (and retail trade) grow so much faster than production? Imports are filling the gap.
The fact is that almost all the recent gains in personal income have gone to upper-income individuals, who spent almost all of this increase on imports. For example, a boom in the home-appliance market in 2001 bypassed domestic producers in favor of European, Japanese and South Korean products. Incomes in the lower brackets, where most Russians find themselves, have risen very sluggishly, with no discernable impact on demand for domestic manufactures.
Government attempts to increase demand by increasing the public-sector wages are likely to fail. Regional budgets, which must bear the brunt of the wage-hike costs, are clearly unable to cope. In many regions, salary arrears are growing. In others, paying higher wages means bigger budget deficits or big cuts in non-wage expenditures.
Apart from anything else, this upper-class growth in consumption, satisfied by imported goods, means that export revenues are used increasingly to buy consumer goods, leaving less for investment. At the same time, there is an overall shift away from personal savings toward consumption. But all is not doom and gloom.
INVESTMENT TRENDS
Russia still runs a surplus in foreign trade, though imports are growing faster than exports. Markets for trading oil and other fuels, Russia's main exports, remain favorable. Oil prices have even been rising a little recently, which inspires a certain optimism. Oil-export earnings fund domestic investment, and despite the heavy burden of servicing the foreign debt, there is still investment activity in the Russian economy.
Capital flight is down, and repatriation of capital is gaining ground. Specialists from the Bank of Russia are even predicting Russia will experience net capital inflows of around one billion dollars in the second quarter (when, admittedly, there were no payments due on the foreign debt).
Stock prices for the most popular "blue-chip" companies are trending up. Between January and May the RTS (Russian Trading System) share index rose by 41 percent. This reflects and encourages a growth in the inflow of portfolio investment from abroad. Direct foreign investment is growing at the same time.
Nevertheless, capital is still draining abroad on a fairly large scale, and the positive trends cited here are not strong enough to provide stable economic growth. Government blunders are partly responsible. Most big businessmen are unequivocally critical of the withdrawal of tax incentives for reinvestment of profits in tax legislation backed by the government and recently enacted into law.
SECTOR BY SECTOR
Engineering: Growth in export earnings in oil and gas over the decade of the 1990s supported growth in manufacturing, especially in the engineering sector that supplied equipment to the oil and gas industry. Now oil and gas growth is tailing off, and the engineering sector is expecting a decline.
Food: The food industry seems fairly stable; it has been largely unaffected by the switch in demand to imported manufactured goods. At the current exchange rate, imported foodstuffs cannot compete with Russian produce on price, and as for quality, Russian consumers tend to rate home-grown produce higher. So the continuing growth in real incomes ensures the food industry is a market that is growing steadily if not quickly.
Agriculture: Stability in the food industry has helped the entire farming sector, which has recovered from the near catastrophe of 1996-98. Almost half the enterprises in the agrarian sector are now turning a profit, although farm debt is also growing. Orders for new farm machinery continue to rise. Even so, the rural economy is in poor shape. The level of mechanization is low. Land neglected during the crisis years is still largely uncultivated, often with negative consequences. For example in Irkutsk oblast in southern Siberia neglected arable lands have become a breeding ground for locusts which have ravaged the oblast.
THE GOVERNMENT'S REACTION
The Russian government has remained true to itself: It reacts to any complex problem by putting the brakes on any far-reaching initiatives. Yet perhaps this is the right approach. In the absence of a well thought-out strategy for economic development, the best the presidential administration and the government can do is to avoid any sudden movements. This is one lesson learned from adoption of the new Tax Code, which contained so many ill-thought-out provisions that the government was forced to review tax legislation all over again.
Hesitation marks the drive to restructure the natural monopolies--the fundamental decisions on which were taken two years ago. Drafts of legislation moved through the government in slow and stately fashion, and the extremely complex process of pushing bills through the State Duma has at last begun. Given the complete domination of the current Duma by pro-presidential factions, the fact that the readings of these bills are taking so long indicates that Putin's desire for a liberal reform of the natural monopolies is not quite as uncompromising as it once appeared.
At the same time, the government is not taking the dangers threatening the economy very seriously--particularly the long-term strategic dangers. The impression is that the government hopes that economic growth will continue of its own accord, and that the steps already taken to reform the economic system are enough. Meanwhile, little mistakes (like forecasting 2002 inflation at 12-14 percent, when 16-18 percent is the likely range) do not seem to worry the government at all.
WHAT HAPPENS NEXT?
The threat of decline or even stagnation in Russia's economy over the next few months seem negligible. The upward movement in investment and incomes, and the favorable conditions in foreign trade, should bring at least some growth to the economy. But the original government growth target of 3.4-4.5 percent, which the president criticized as too modest, may not be met. This all means that 2003 promises to be another difficult year.