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Economic hurdles for new Russian president

March 03, 2008 | “BBC News"

With Dmitry Medvedev poised to win Russia's presidential election, BBC reporter Konstantin Rozhnov looks at the economic challenges he faces.

Vladimir Putin's presidential campaign in 2000 was very different to the latest pre-election winter in Russia.

While eight years ago Mr Putin was positioned as a person capable of improving security situation in Russia in light of the Chechen war, this time Mr Putin himself and his favourite candidate Dmitry Medvedev have been highlighting the rapid expansion of the country's economy.

A continuous surge in global oil and gas prices, a rise in Russian consumer spending and foreign capital have been helpful.

According to the preliminary data, Russia's economic growth in 2007 exceeded 8% in comparison with 7.4% in 2006.

And most economists think that the emerging economies, including Russia, will survive the global financial crisis much better than the Western world.

Yet, 2008 won't be free of economic problems.

Furthermore, some new problems have added recently to the list of unsolved ones such as corruption and a lack of successful structural reforms.

In pursue of prices

Economists agree that inflation must be solved as soon as possible.

Prices have been rising around the world - mostly due to food and fuel becoming more expensive.

But in Russia there is one more huge inflationary factor: pre-election rises in state pensions and salaries.

The official statistics says that prices in Russia went up more than 12% in 2007, which is 1.5 times faster than the government planned initially.

Mr Putin has said that high inflation rates are not a catastrophe but they have affected people's real incomes and welfare.

Besides, it can lead to further exchange rate appreciation.

This could "further squeeze exporters that are already suffering from weaker global demand", says Neil Shearing, Emerging Europe economist at Capital Economics.

Christopher Granville, managing director at Trusted Sources investment online magazine, believes that "tightening monetary policy and the very least avoiding further loosening in fiscal policy will be essential" for the Russian government in 2008.

Sergei Guriev, rector of the New Economic School in Moscow, agrees.

He said: "I think that at some point the new Cabinet will have to abandon populist promises to increase budgetary expenditures".

Internal and external factors

The Russian government will also have to consider the state of the world economy in light of the recent global financial crisis.

Mr Guriev says that if problems connected with inflation and the global crisis are not addressed, the Russian financial system could suffer.

He believes the problems will have to be solved "one way or another".

Meanwhile, most economists think that Russia's economy has entered the period of the global financial crisis in a relatively good shape.

"We expect only a gradual slowdown in GDP growth to around 7% this year," Mr Shearing says.

Furthermore, Mr Granville believes that the Russian central bank and the authorities in general "are clearly hoping that the global slowdown will help them".

As a result of the global problems in credit market the scale of inflows of private capital into Russia this year will be much less than the $82bn recorded in 2007, he estimates.

Already in January 2008 there was a net outflow of private capital.

"However the approach of just waiting for the outside world to help will not be sufficient because the inflationary expectations have now become entrenched inside the country," says Mr Granville.

Bureaucracy and effectiveness

There are problems in the Russian economy which have been handicapping its development for a very long time, but it is unlikely they will be solved soon.

"They are problems connected with corruption and ineffectiveness of the economy, lack of competition, dominance of state corporations and unequal rules of the game," says Mr Guriev.

In his opinion, tasks of increasing the effectiveness of the economy, such as reducing its dependence on oil and gas exports, will have to be solved "when oil prices fall in two or three years".

As for weeding out corruption and increasing quality of people's lives via investments into education, health system and demography policy, Mr Guriev doubts it will happen soon.

"The task of solving the problems can be postponed quite successfully year after year," he said.

Mr Granville believes that structural reforms, including increasing the bureaucracy's effectiveness, will be one of the main tasks in the longer term.

"Improving the effectiveness means reducing its powers and improving the regulatory framework - especially by removing regulations," he says.

Sacrificing ratings

High oil prices and a robust global economy have allowed the Russian government to avoid implementing unpopular reforms and measures for several years.

But now, experts believe, the changed economic reality will make the new president and his government risk their popularity ratings for the sake of strengthening the economy.

For example, in the next several years the new government will have to bring to life the previous Cabinet's decision to raise internal gas prices.

"Gas prices will be several times higher - at least, twice higher in three years.

"It will lead to a huge and painful restructuring - at least, in industry, but most probably in housing and public utilities sector as well", says Mr Guriev.

Other tasks include introducing the new pension system reform after the previous attempt failed dramatically.

Besides, officials will have to find the best ways to invest abroad the capital from so called Reserve fund, which was created after splitting Russia's Stabilisation fund - $160bn of oil revenues.

So to solve a lot of economic problems the new president and government will have to find answers to political questions: whether to risk and try to secure the sustainable development of the economy or avoid taking risky steps and hope for the favourable global picture to help the Russian economy.

By Konstantin Rozhnov
Business reporter, BBC News


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