Russia Enters Calmer Waters

Wednesday, February 6th, 2013

Last winter’s demonstrations in Moscow and elsewhere have more or less died out. This is an expected outcome as this non-movement always lacked of a leadership. Neither did it have any common program beyond the goal “Putin out!” But nature and society alike abhor a vacuum: there was no answer to that question. Polls claim that those participants that had any political identity divided quite evenly into nationalists, communist and new leftists and modernizers. The last ones are routinely called liberals in outside media. That is a problematic piece of terminology, because in Russia even self-nominated liberals are often supporters of a strong state.

This is not the end of opposition in Russia. There will be re-births and new declines. Part of the lesson should have been learned already of the Arab Springs. One can call together demonstrations through social media, but nothing compensates repeated face-to-face contact in building a genuine political movement. It has to be an organization. And Russia lacks the Muslim Brotherhoods and traditionally politically active armies in place to fill the organizational vacuum left by the street demonstrations.

The regime in power continues to put out potential bush fires. This and that visible oppositional is put in front of court and very probably condemned in due course. Foreign aid to NGOs is squeezed out and other barriers to cross-border contacts will be established. Some Russians vote with their feet and many more at least consider the possibility. But on the level of large-scale politics the regime sits tight – for the time being at least. At least three large dangers loom.

The first one is complacency. It has economic as well as political roots. The macroeconomic situation of the country is better than perhaps ever before. Economic growth is a multiple of most European levels, unemployment a fraction of some. Inflation is lower than ever in independent Russia, official reserves are as high as they have been. Both investment and consumption grow faster than aggregate production. Both the budget and current account have a surplus.

This is a dangerous situation, as the Russian policy advice consensus is right when it calls for profound but at the same time difficult decisions. The low hanging fruit of systemic change were picked years ago, though they continue to impact the society now and in the future. Neither can one count on continuous growth in export. On the other hand, a collapse of them – even of gas prices – is not in the cards.

Typically the decisions now ahead are difficult, socially divisive and without a ready-made recipe. Russia is not alone in this respect. Pension reforms are nowhere particularly easy. No political regime finds it easy to allocate scarce resources between social needs, much needed infrastructure investment and military outlays. Preparing for demographic change is a common European challenge.

The regime should also be able to control itself. Though statistics are inevitably murky, corruption is widely seen as the big problem faced. There is a fair possibility that Vladimir Putin is finally serious about fighting corruption. He is also ready to call it a systemic feature of his country, and thus also of his own regime. If the former Defense Minister Serdyukov actually goes to court, a leaf in Russia’s history has turned. There was no necessity for doing that: a dismissal with lukewarm thanks would have sufficed.

But if that is the case, the Putin regime has to be able to control the Pandora’s box. In a society where so many people reportedly have files of negative material on so many others, a war of everybody against all would be easy to ignite. And when there is no political opposition or alternative society ready to take and use power that would be a recipe for catastrophe.

Finally, though new goods and services have flooded Russian markets, export-wise Russia remains as dependent on energy and other commodities as before. Being rich in resources is glorious, but they cannot continue maintaining an economy which is growing. Measured – as it should – in constant prices the share of the wide energy sector in Russia’s GDP peaked at about thirty per cent. It has already declined, and may well reach ten per cent in a couple of decades. This at least is what the Russian experts say, and the policy makers seem to concur.

This is a tall order and must imply a new kind of integration in the world economy. The first months of Russia’s membership have shown that Russia tends to be more apt in defensive than offensive measures. The country is testing the limits of what WTO membership allows in terms of protectionism and such. Established members are testing the limits of Russia’s resolve.

But that, naturally, was fully to be expected.





Pekka Sutela
Nonresident Senior Associate Carnegie Endowment, Washington D.C. & Visiting Professor at the School of International Affairs, Paris


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How the Euro Connection could Boost Russian Asset Prices

Wednesday, October 3rd, 2012

One of today’s puzzles is the low valuation of Russian equities. On average, these cost just 6 times the expected profits of 2012, while Canadian stocks trade at 15 times earnings and Norwegian stocks at 12 times, to mention just the two commodity producing countries which lie in the same climate zone. The message from the price-to-book ratios is similar: if a company is attractive for investors, the ratio should be well above 1. But Russian stocks average only 0.85 whereas Canadian and Norwegian stocks trade at 1.85 and 1.58.

Creating conditions that bring valuations on par with those of other stock markets would do wonders for the country’s spending on capital goods, including foreign direct investment, the growth rate of real GDP and thus for the standard of living.

One way to achieve this is to create an institutional framework similar to that of the democracies of Western Europe. This is just as important as broadening Russia’s production base and reducing its dependency on raw materials. Indeed, a comprehensive and state-of-the-art institutional framework is probably the precondition for that sort of structural change. Economists emphasize more and more the role of institutions in development, such as independent courts, media, regulators and central banks, a fair and efficient tax system, genuine opposition parties which have a reasonable chance to oust the existing government in secret ballots, an incorruptible bureaucracy, good and affordable kindergartens, schools and universities, a well-maintained infrastructure, and so on.

Russia has serious deficiencies in all these areas and pays the price in the form of undervalued equities and real estate. In spite of its enviable endowment with natural resources it is an unnecessarily poor country.

One approach to improve things is to use the European Union’s “Acquis communautaire” as a guide for institutional reform. Norway and Turkey, very successful economies for some years now, have done this – without being members of the EU. The Acquis covers the EU Treaty, the whole body of laws, decrees and guidelines passed by EU institutions as well as the judgments of the European courts. These are binding for all 27 countries, and new members have to fully adopt them. Dauntingly, the complete edition of the text comprises 31 volumes and more than 85,000 pages. Cyprus and Malta have been able to do it, so Russia’s civil service could certainly do it as well.

For years, Russians did not care much about institutional reform. They were able to increase their spending at a higher rate than production, as export prices have outpaced import prices. The general feeling is that the standard of life continues to improve. Since this is not accompanied by political and institutional progress, the rising middle classes are getting restive, demanding a bigger say in the country’s decision making process.

To rely on ever higher commodity prices is not a sustainable growth model in any case – prices will certainly not go up all the time. Every so often they crash and cause havoc in the rest of the economy. The 8 per cent decline of Russian GDP in 2009, the 80 per cent fall of stock prices between mid and end-2008, the 36 per cent depreciation of the rouble against the dollar during that time, and the collapse of the real estate market were direct consequences of the crash of raw material prices, in particular the oil price which imploded from $146 to $35 in just half a year. To this day, markets are not yet back to pre-crisis levels.

If Russia had more robust institutions and took the rule of law seriously, investors would demand lower risk premiums for holding shares of companies and government and corporate bonds – which is another way of saying that asset prices could be much higher, and the cost of capital correspondingly lower. A big increase in capital spending is needed to wean the country from its reliance on commodities. China’s impressive growth model has at its core very high saving and investment ratios. Anything that helps to boost these must have top priority for policy makers. Right now, the value of Russia’s firms that are traded at the stock exchange is about 19 trillion roubles (€465bn).

If the government could credibly show that it will launch an institutional reform process on the basis of EU standards, this number could easily double, cutting the cost of capital expenditures by one half. Perhaps more importantly, Russia would become a more normal country where people like to live, rather than trying to emigrate.






Dieter Wermuth
Chief Economist & Partner, Wermuth Asset Management


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Russia – Stirred but not Shaken

Monday, February 6th, 2012

As the March presidential elections approach, Russia is stirred but not shaken.  December demonstrations were the biggest in two decades, but still they gathered only tens of thousands of demonstrators in the capital city, even less elsewhere. There is no atmosphere of fear, but neither are there proper organizations or policy demands. Arab spring has again shown that social media can call many people to the streets, but it takes a split of elites to transform demonstrations into a political movement. The call for honest elections is a fundamental one, but there is not much else to unify the tens of aspiring leaders of the crowd. As a rule they are men in ripe age, scarred by two decades of mutual battles and proven inability to cooperate. The demonstrations will in all probability not evolve into a political movement offering an alternative to the Putin regime.

Therefore Russia is not really shaken. And if it were, we had better beware. At the time of the post-Soviet color revolutions Yegor Gaidar said that he did not wish one in Russia. The color, he feared, would be black and brown like in a cockroach: those of nationalism and reaction. Just before the demonstrations another friend of mine, also somebody with rich experience of high-level positions during the past twenty years, argued that Putin with his attempted power vertical is the only barrier between today’s Russia and a criminal state. This speaker is a ranking member of one of the unregistered opposition movements. His children have vowed not to return to Russia as long as the Putin regime remains.

Vladimir Putin is scarred as well. Twelve years ago he had an evident program though that was not easy to detect in the beginning. Russia had been dependent on outside finance, a nation to which conditions were dictated. Poor Yeltsin, Bill Clinton once noted, we keep tabling demands that he has little possibility of fulfilling. That had to go and it did, not least because soaring oil prices helped Russia to pay back debt, accumulate reserves and start financing the rest of the world. For a few years Russians were high on oil. Still money was cheaper abroad, and the 1998 crisis was repeated ten years later.

Russia also longed for stability, and for years the Putin regime helped deliver it. Inflation and unemployment went down, consumption, foreign travel and life satisfaction up. Putin was repeatedly voted the sexiest Russian man, not so much because of the muscles but because his regime facilitated sexy things. There was also a kind of political stability, maintained by thugs when deemed necessary.  Putin wished Russia and the world to function like a hierarchic bureaucracy. He had after all worked in one for sixteen years, and uses many pages of his dissertation to copy American organization science on how such a hierarchy should handle uncertainty.

But that is not the way the world or Russia actually functions. Not surprisingly Putin has grown frustrated and cynical. That is not a good starting point for a leader who should reinvent himself.

That Putin should do: politically, as there will be a real opposition; policy-wise, as Russia can no longer rely on those drivers of growth that just years ago made it one of the fastest growing major economies in the world.

Needed mental readjustment started in about 2006 when it was understood that Russia cannot rely on energy alone. It needs diversification and modernization. The readjustment continued a year ago when Putin tasked the leading economists to write a policy program for the post-elections. They did write, over 500 pages of program, with more than a thousand specialists contributing. In a little-noted speech just before Christmas Putin seemed to sign the basic message of the program. Russia’s future growth must be based on investment, and a major overhaul of investment climate is needed.

An authoritarian regime faces its biggest challenges when attempting partial democratization. That happened with Gorbachev’s perestroika. Putin is no Brezhnev but he risks becoming a Gorbachev – without Yeltsin as the alternative. The world and Europe in particular must pay great attention. The alternatives are several, and the most positive ones the least probable.




Pekka Sutela
Nonresident Senior Associate Carnegie Endowment, Washington D.C.  &  Visiting Professor at the School of International Affairs, Paris


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