Outlook

The Presidential Baton Passes to the Bear

When it comes to economic issues, Russia’s new president will have some big shoes to fill. As chair of state oil giant Gazprom and as first deputy prime minister, he has been a party to Russia’s economic growth. But with clouds looming over the global economic landscape, he’s going to have his work cut out for him if he’s to continue Russia’s economic transformation.

When Dmitri Medvedev is inaugurated as Russia’s new president early in May, the contrast with his predecessor’s elevation — and the business and economic circumstances surrounding it — could not be starker. Back in 2000, Vladimir Putin inherited an economy which was widely viewed as a laughing stock: dilapidated industry, impoverished people, wracked with debts. Since then the economic and business transformation has been little short of miraculous.

If, as critics suggest, it has all been on the back of spiraling energy costs, then Dmitry Medvedev, the new president, has been at the center of making sure Russia maximizes the opportunities that have come its way. As the recent chair of Gazprom he has overseen its rise as a global energy major, and as first deputy prime minister he has been a key part of plans to make sure that Russia gets the best out of its energy-fueled boom and lays down plans for making the country a more significant player on the global business and economic scene.

All this means that the change at the top should be good news for business. In his speech at the Krasnoyarsk Economic Forum just a few weeks before the March 2 election, Medvedev outlined some key economic policy themes. The areas he chose to address, including proposals to beef up Russia’s prominence on world markets by promoting Moscow as a financial center and greater international use of the ruble, augur well for Russia’s economic future.

But it was his emphasis on changes to the way Russia approaches business that attracted the most attention: calls for a culture of greater entrepreneurialism, an emphasis on the business acumen of those appointed to top posts at state corporations, a renewed focus on stimulating Russia’s small-business sector. All if this makes for easy listening, but concrete steps are what the business world is waiting to see.

The macroeconomic world Medvedev is about to enter is also changing rapidly — for the worse. Whereas President Putin was able to reap the benefit of eight years of relatively constant global growth, it is becoming increasingly obvious that the economic future outside of Russia is starting sour, and sour in ways that could hit home in Russia. This isn’t to say that the outlook for Russia is necessarily grim, but it does mean that plans to boost Russia’s economy further need to progress beyond the conceptual stage and start becoming reality.

In the immediate term there’s a credit crunch unfolding across the world, from which Russia isn’t immune. However there is something of an upside here for the domestic economy in that the Central Bank and the government have the capacity to ensure that liquidity isn’t as serious an issue inside the country as it seems to be abroad. Russia doesn’t have a sub-prime crisis, and Russian banks aren’t the ones seeing their investments in collateralized debt obligations evaporate.

That said, some Russian companies are — or may be looking to become — large borrowers on the international scene. Since the cost of this is significantly higher than it was just a short time ago, the flood of Russian companies listing internationally over the next few years is sure to slow.

Possibly the biggest economic issue President Medvedev will have to come to grips with is inflation. After disastrous figures for 2007 (12 percent for the year), the government’s 2008 forecast of 8 percent has effectively been blown out of the water already: January and February alone posted a net 3.5 percent. The pressure comes from a range of sources — vast capital inflows driving demand, which local production and distribution networks simply aren’t coping with, and a society that still largely looks to spend as soon as it can.

In the coming months, increases in the price of domestic gas will start to trickle down, affecting a range of industrial sectors. On top of this, there’s a changed global outlook on food prices and a range of other commodities as well.

In the short term the massive amounts being outlaid by the government to improve infrastructure across the country, from railways and roads, to airports, and sea ports, as well as a massive ramp up of government expenditure in general only add to the extra cash and demand for goods. In the longer term the end results will alleviate critical production and distribution bottlenecks and make for a more efficient economy, as will the large sums being invested in new production capacity across the country.

The new President has an interest in Russia’s agricultural sector, and this in itself may be quite opportune. It’s been a longstanding sector of underinvestment in Russia, meaning that large amounts of productive capacity have not been utilized effectively, while Russian consumers dine out on imports. It has also been a significant factor for Russian inflation and one felt most noticeably at the lower end of the socioeconomic spectrum. Bringing more productive capacity on line will help ease the pressure as well as lighten Russia’s import bill at a time when agricultural produce worldwide is hitting prices not seen in more than a generation.

Of course, the key determinant of Russia’s economic profile at the moment is energy. With oil now having passed the $100 per barrel mark it seems the age of higher energy costs, if not peak oil, is certainly upon us. Economic growth in developing nations (particularly China) is expected to continue, meaning that supply is increasingly strained and that those nations which have it can cash in. It has been the underpinning of Russia’s recent economic boom, but certainly not the whole story, and can be expected to continue. The Medvedev government, however, will face renewed calls for some change to the taxation arrangements applying to the oil majors in order to stimulate further domestic production. They are not getting the headline prices one sees, and this means they are not getting the signals to stimulate further exploration and development. At a time when the focus of Russian energy exploration is increasingly shifting to more difficult locations, and particularly offshore, this could hold the key to keeping the goose laying the golden egg.

The money not going into oil company exploration is going into the budget’s bottom line. The new government will come under renewed pressure to spend more of it than it has under President Putin, who traditionally allowed the liberals in his ministry to run the economic portfolios and a tight budget accordingly.

For the Medvedev government the economic balancing act will be to continue investing in economic productivity while ensuring that the investment does not generate too much inflation and is accountable. If this can be achieved, the new president’s longerterm goals of business cultural change and economic diversification become far more likely, and the investment levels needed to overhaul Russian production more certain.

Ultimately, Dmitri Medvedev, when he takes over the reins from Vladimir Putin, has the task ahead of him. If his government can cement the achievements of its predecessor and bring about the reforms he has pointed to, Russia’s 21st-century golden age can continue, with more ordinary Russians getting a piece of the pie. He has the experience of being part of the success up until now, but from here on in he takes responsibility for it.