Vladislav Inozemtsev: The Calm before the Storm

The Calm before the Storm: Can We Avoid Economic Collapse in 2018?
Vladislav Inozemtsev
Slon.ru
August 1, 2016

Last week, Tatyana Nesterenko, one of Russia’s most experienced financiers and a person distant from politics, a person who has held the post of deputy finance minister and head of the Federal Treasury for almost twenty years, said the Russian economy should expect serious financial problems as early as next year, comparing the current situation with the “eye of a storm, [meaning] a condition in which everything [merely] looks quiet and safe.”

In my view, Nesterenko is undoubtedly right. The government has recently appeared to be the epitome of tranquility. It has even been drafting a new three-year budget, although in terms of revenues for 2016, the previous such plan (for 2014–2016) was off by 42%! Revenues were projected at 15.9 trillion rubles, but actual revenues in the first six months of the year were 4.6 trillion rubles. I don’t think the new draft budget will prove more accurate, if only because no sources of income for covering the deficit are envisioned after 2017. The president, who from time to time meets with economists and recommends developing a new development strategy for the country “roughly within a year,” meaning when the Finance Ministry’s reserves will run out and the budget’s huge social commitments will prove impracticable, has mainly been busy reshuffling the security forces, believing, apparently, that a sum changes by rearranging its components.

Today, Russia’s economy, to invoke Economic Development Minister Alexei Ulyukayev‘s maxim, really has hit rock bottom. The authorities are elated that the rate at which the GDP has been falling fell to 0.6% in the second quarter, but we should note this reduction took place in conjunction with an accelerating reduction of real incomes (by 6.2% in May, and 4.8% in June) and a considerable increase in inflationary expectations. Annual inflation was 7.5% as of June and showed no tendency toward decreasing.

Moreover, oil prices have fallen considerably. Brent fell by 15.2% during July, and, apparently, black gold is near a new equilibrium price ranging between 38.5 and 43 dollars a barrel. A 15–16% fall in the oil price will cost the Russian budget 430 to 460 billion rubles in the remaining five months of 2016, which is also no cause for optimism. Responding to it by “managing” the descent of the ruble will not be easy. Devaluing the national currency will no longer lead to a growth in exports, which this year has lagged behind last year’s figures by 30.5%. On the other hand, imports, which have basically not shrunk (they are down by only 10.4%) will inevitably become more expensive, dragging along with them the prices for a wide range of goods, thereby causing inflation and setting the tone for high interest rates.

In mid 2016, the Russian economy really is situated in the eye of a kind of storm. It is quite calm there at the moment: the authorities have become accustomed to the new circumstances. They have no hesitation in spending reserve funds. Generally, fears of popular discontent over lowing living standards have been overcome. Seemingly, a certain reduction in the degree of hostility toward western countries might do the trick of restoring relations with them.  There has been a glimmer of hope the EU’s problems will deepen with the UK’s exit. The possibility of Donald Trump winning the presidential race in the US has been taken seriously. Putin feels like a winner in his confrontation with Turkey. It is no wonder officials have dubbed the situation the “new normal.” It really is the new normal, so as long we take into account two factors: oil at 50 dollars a barrel and spending accumulated reserves at the rate of 600 billion rubles a quarter. That is around 8% of the overall amount in both sovereign wealth funds, the Reserve Fund and the National Wealth Fund.

However, the problem is not so much that sooner or later we will have to break back into the open sea through the hurricane’s eye wall, but the fact that the eye of the storm might move, and it would appear we have no instruments for tracking it. The country has not been trying to find the best place in this “quiet corner.” It has simply been drifting, humbling waiting for what happens next.

Evaluating the numerous programs and strategies that experts affiliated with one or another wing of the government are now trying to draft, one cannot help thinking that none of them is capable of boosting the Russian economy in view of two circumstances.

On the one hand, anti-crisis measures should have been implemented yesterday, rather than postponing their preliminary discussion to 2017. By the way, Russian Finance Minister Anton Siluanov warned in early 2016 that, at current oil prices, the Russian budget would be short 3 trillion rubles, which in turn would lead to spending the greater part of the National Wealth Fund. Little has changed since then. In the absence of reserve funds, the hole in the budget cannot be closed in 2018 either by raising funds on the international capital market (in this case, we would have to raise considerably more money than all the central government’s current international obligations) or by privatizing. (One year’s deficit could be papered over only by selling off the lion’s share of the state’s holdings in Gazprom and Rosneft.) Whatever economic development strategy the Kremlin approves a year from now, it will not prevent a large-scale collapse in 2018, with all the attendant consequences.

On the other hand, all the existing programs, however much Alexei Kudrin and Boris Titov stress their differences, are generally focused on the same thing: relaunching the economy on behalf of manufacturers. There is in fact only one difference between them. Titov’s Stolypin Club has suggested priming major enterprises with money through the earmarked and regulated distribution of cheap loans, subsidized by the Central Bank, while Kudrin’s Center for Strategic Research favors institutional reforms that could include reducing taxes on business and limiting the rights and opportunities of security services and the bureaucracy for extracting additional income from business. The assumption is that either by getting its hands on cheap money or ridding itself of the unbearable pressure of regulators, business will be reanimated, sparking life-saving economic growth.

I would love to be wrong, but I don’t think these measures will produce any meaningful outcomes, because the most important factor in the economic slowdown of 2014–2016 has been the crisis in consumer demand. The state has diligently performed its investment obligations, saturating heavy industry with funds via defense sector orders. It has not halted its sometimes pointless but expensive infrastructure projects. It has been encouraging state companies to build new pipelines and railways, but none of it can compensate the effect of declining consumer demand. Moreover, this demand has increasingly shifted towards the continuing flow of imports, while the share of domestic goods on the market has stopped growing. As I understand it, none of the economic development programs has so far offered a solution to this problem.

Therefore, in my opinion, we should introduce as least three new story lines into the ongoing debates.

First, we should stop regarding increases in wages for low-paid earners, pensions, allowances, and other payments to low-income Russians as “costly measures.” Saving money by reducing the incomes of doctors, teachers or pensioners is much more destructive than reducing costs at Gazprom or expenditures in the program for rearming the Russian army. These segments of the populace are most focused on purchasing domestic goods and services, and investing in them produces a multiplier effect in the sales and production of consumer goods. The crisis of 2008–2009 was negotiated much more successfully than the current crisis not only due to the relatively radical reversal in oil prices but also because the government considerably increased people’s incomes at the time, despite budget problems, whereas 41% of the population now say they lack money for food and clothing.

Second, we should think hard about a one-time credit and debt amnesty for people whose indebtedness to banks, the tax authorities or housing and utilities sector companies does not exceed, say, 30 thousand rubles.  Obligations of this amount now account for around 20% of the population’s entire debt burden, and a measure like this would affect 10 to 12 million people. The state would have to allocate up to 2 trillion rubles to implement the program, but both the social and political (why deny it) effect of such a measure would be incomparable with a Stolypin Club-style emission of a similar scale, which would completely vanish in the offshore accounts of executives of major companies in bed with the state and sympathetic officials. In my view, we cannot do without this measure now, but none of the people involved in the current discussion has deigned to mention it in their programs.

Third, direct measures for stimulating demand are necessary. They were adopted by all the governments of developed countries hit by the crisis of  2008–2009, but our officials were quite reluctant to copy them. I have in mind not only programs for encouraging purchases of new automobiles but also a system of issuing food stamps, analogous to the American one, to poor people. For example, pensioners could buy stamps nominally worth four to six thousand rubles for two to three thousand rubles at welfare offices. The stamps would be accepted in shops as payment for domestic food products only, with the exception of cigarettes and alcohol, and commercial outlets would then turn them in at banks at face value and have the amount credited to their accounts. This could be a powerful stimulus both to domestic manufacturers and commerce, not to mention the popularity of such a step among socially vulnerable groups themselves.

In other words, now it is not enough to say that Russia has sailed into a perfect storm. It must be understand that not only the captain and his mates will have to fight for our ship’s survival but absolutely all the passengers as well, and so the basis of an anti-crisis program should be attention to the general population, not to state corporations. And, of course, to be at least relatively prepared to fend off the mighty blows of the elements, we must stop postponing actual steps until tomorrow, and begin taking them today.

Source of original text: Worldcrisis.ru. Translated by the Russian Reader.