Russian Economy Shows Signs of Life

By David Hoffman, Washington Post, Wednesday 29 March 2000; A16

MOSCOW, March 28 —— Russia's troubled economy has felt a ray of sunshine lately. Soaring oil prices have swelled budget coffers, foreign currency reserves are higher than at any time since the 1998 ruble devaluation, and domestic industry is showing signs of life.

“Not bad at all,” First Deputy Prime Minister Mikhail Krasyanov declared today after meeting with acting President Vladimir Putin, who is also Russia's president-elect. Even if oil prices go down, Krasyanov added, “we have no fears” that Russia will suffer.

But foreign investors and many Russian economists say that beyond the momentary optimism, Russia's economy has not yet resolved the long-term distortions that have characterized its transition from the Soviet command system to a free market. In fact, they said, these structural problems have been languishing and Putin's approach to them will be a major test of his presidency, which begins formally with his inauguration in early May.

The structural problems include an unreformed banking system; long-deferred tax reform; the continuing hemorrhage of capital abroad; and a failure to establish the rule of law—including an effective bankruptcy statute and protection for the rights of investors and property owners. All these are roadblocks to the kind of investment and capital growth that Russia needs to sustain an economic revival. Moreover, the economy is hampered by widespread corruption and dominated by a tribal system of competing financial-industrial clans.

“Putin is aimed at one thing—restoring Russia as a great power,” said Eric Kraus, chief strategist of Nikoil Capital Markets, a brokerage house here. “Now there is a motive, a force to make politically unpopular choices. This is the only way he can salvage Russia.

“Without an economy, Russia is a huge auto chassis without a motor,” Kraus added. “They have got to reestablish a functioning motor. And you can’t have an economy function when everything gets stolen and pumped offshore and the assets are systematically stripped. The reason we expect some changes is that Putin is tough enough to drive this.”

In some respects, Putin is in the midst of a political honeymoon. A boom in the price of oil—Russia's chief export—has eased many of the government's chronic budget woes. A recent deal with the London Club of commercial creditors on restructuring $32 billion in Soviet-era debt is the first step toward Russia's return to global capital markets and may ease upcoming negotiations with the Group of Ten, governments that hold another $40 billion in Soviet-era claims.

Also, the tangled web of wage arrears, debt and barter transactions has been easing. For example, the share of cash income collected by Unified Energy Systems, Russia's electricity grid, has increased from 19 percent to 48 percent. According to a recent World Bank study, the crisis stemming from chaos in the country's payments process was a key factor in undermining Russia's economy in the 1990s. “The overwhelming priority at this point is to dismantle this system,” the study said, a move that could lead to growth and restructuring of many troubled enterprises.

Putin, who was elected Sunday by an overwhelming margin, has urged citizens to be patient, and he declared as the votes were being counted that “miracles don’t occur.” He has signaled his intention to continue market reform, but with stronger government involvement. Still, he has said little about his plans, other than a few slogans and generalities offered during the election campaign, such as his vow to create a “level playing field” for all.

Some of Russia's best and brightest economists—headed by German Gref, a St. Petersburg lawyer—have been working intensively to prepare a program for Putin, but details are being kept under wraps. Yevgeny Yasin, an economic reformer advising the group, told the weekly Moscow News that Putin must quickly demonstrate “whether the market reforms are going to continue” and “that he is capable of acting resolutely and consistently, something that society—tired of the weakness of power—expects of him.”

Whether Putin will adopt Yasin's prescriptions is not known, but the former economics minister laid out a blueprint for the incoming president, declaring he will have to slash government subsidies to inefficient factories; move to protect investors' rights; cut taxes; crack down on corruption; and “separate business from power”—a reference to the influential “oligarchy” of wealthy businessmen who were close to the Kremlin under former president Boris Yeltsin.

Many investors and analysts here agree with those recommendations. Grigory Yavlinsky, leader of the Yabloko bloc in parliament and a longtime advocate of market reform, told a business conference here that Putin must undertake “serious structural and institutional reforms,” including cutting taxes and resolving the impasse over private land ownership, the Interfax news agency reported. Yeltsin tried but failed to overcome Communist Party opposition to a new code allowing the purchase and sale of land.

“Economic reform is unthinkable in Russia without private land ownership,” Yavlinsky said.

Although the recently elected parliament has yet to get down to work, it is expected to be much more cooperative with the president than the last one, and this may open the way for passage of much needed laws, such as revised land and tax codes.

But other, larger problems cannot be solved by laws alone. The banking system has been in disrepair since the 1998 ruble crash, and little has been done to revive it. Capital flight has also been intractable; by some estimates, $15 billion a year is pouring out of Russia—capital desperately needed at home that is being hidden in offshore havens to avoid taxes, customs duties and the risk of instability.

The recent surge in the foreign currency reserves of Russia's Central Bank—to $15 billion, the highest level since August 1998—has led some to conclude that capital flight is slowing. But United Financial Group, a leading brokerage house here, has warned that the leakage of cash continues. “Capital flight may improve if political stability becomes the norm,” said the group's analyst, Alexei Zabotkine, but “the money is still flowing out.”

Kraus, of Nikoil Capital, said: “Putin has to get access to foreign capital expertise and technology. He has got to protect investor rights.” After the painful experiences of the 1997-98 boom and bust in Russia, investors are not going to come to Russia “to get a place in heaven,” he said.

A number of high-profile collisions over share dilutions and corporate governance between Russian companies and foreign investors have shaken confidence, and Putin needs to restore it by “enforcing the letter and spirit of the law,” Kraus said. “They don’t have it yet.”