Eight years ago, on August 8, 1999, Russia’s first president, Boris Yeltsin, nominated Vladimir Putin, head of Russia’s Security Council, as the new acting prime minister, confirmed by the Duma the following week. On December 31 of the same year, Yeltsin resigned, calling for early presidential elections and leaving Prime Minister Putin to come in as acting president.
In evaluating the economic performance of Putin’s administration, we look at whether the majority of the population has benefited from the country’s economic performance over the past eight years; and at key policy steps that, in our view, distinguish Putin’s economic era from those of his predecessors.
Overall, the past eight years represent a period of numerous economic successes. Growth has been strong, unemployment and inflation have fallen and the government has paid off most of its foreign debt.
Strong economic growth
Putin was appointed prime minister just 12 months after August 1998, when the harshest economic crisis in Russia’s recent history occurred. The economy was showing some signs of recovery, owing to the significant impact of currency devaluation, yet the stability of this growth was not strong at the time. Today, we see a very different economic environment. From being the world’s 22nd largest economy in 1999, Russia ranked 11th in 2006, and could even rise to ninth position in 2008, according to IMF forecasts. Dollar GDP in 2007 is projected to reach $1.3 trillion, 6.4 times higher than the reported figure in 1999. The average salary has increased to $540 per month in August 2007, from $65 per month in August 1999, and the population’s real disposable income doubled between 1999 and 2006.
In 1999, Russia was still negotiating with its foreign creditors on restructuring its foreign debt, which then amounted to more than 70 percent of GDP. In August 1999, Russia agreed with the Paris Club of creditors to restructure debt of $8.3bn and in 2000 Russia signed a debt-restructuring deal with the London Club of Creditors. There was talk of the “2003 problem,” when foreign debt payments were set to peak. In 2005 and 2006, Russia paid down $37bn of Paris Club debt ahead of schedule, and as of July 1 this year, Russia’s debt to the Paris Club amounted to just $2.4bn. Today, investors probably wish Russia had borrowed more; total foreign debt is now only $47.8bn – one-third of what it was in 1999 – of which the majority is Russian-traded debt. Reflecting a greatly reduced debt burden, the EMBI + Russia spread (a benchmark spread of Russian external debt instruments over U.S. treasuries) narrowed to just over 100 basis points in early August from more than 3,000 bps in early August 1999.
The Stabilization Fund was set up in 2004 as a tool to sterilize oil inflows into Russia, and to save windfall revenues for future generations. The fund’s revenues are oil-export duties and taxes for the extraction of natural resources when the oil price exceeds $27 per barrel (Urals blend). Today, the fund, which is managed by the Finance Ministry, exceeds $120bn, and continues to grow, as the price of oil remains high. The establishment of the fund was an important achievement of the liberal economists in Putin’s administration. Russia has committed to a discipline of saving oil revenues for the future and reducing its foreign debt. The transparent process of accumulation and management of the Stabilization Fund is a clear indication of Russia’s transition towards prudent fiscal policies, of long-term planning. Accumulated foreign reserves, along with the size of the stabilization fund, very clearly embody the strength potential of the Russian economy.
Fiscal stabilization and tax reform
The reduction of Russia’s budget deficit has become another important feature of the Putin era – something that was not seen in Russia for decades before.
Today, the federal budget is running at a 6 percent surplus, compared with a 1.2 percent deficit in 1999 – an achievement in itself after the 1998 fiasco. The government has introduced a three-year budget planning mechanism, and has adopted a rule directing oil-related tax revenues above a certain oil price to the stabilization fund, to reduce its budgetary dependence on oil. Despite the huge inflow of oil revenues, the budget remains relatively slim – federal budget revenue remains at 21-22 percent of GDP. Only over the past year have the Russian authorities decided to start spending the money to support the national infrastructure, as well as directing funding into the areas of highest social importance.
The campaign to improve tax discipline and fight tax evasion became one of the most distinct features of Putin’s economic policy. Revenues to the enlarged government have grown to 39 percent in 2006 from 34 percent in 1999. The Tax Code, adopted in 2000, represented a major breakthrough in fiscal administration in Russia, reducing the tax burden and establishing a much more streamlined system of budget revenues and expenditures. Indeed, since its adoption, there have been no attempts to revisit any taxes, which has provided a high degree of security and safety for both domestic and international investors, and helped to attract capital to Russia. A 13 percent flat personal income tax rate remains among the lowest in the world.
Significant budget surpluses have allowed the government to start financing its national projects – key areas of public spending that are aimed at producing the greatest long-term effect on the economy and wellbeing of the population. The projects are being implemented in the four key areas of healthcare, education, housing and agriculture. National-projects financing for 2007 is set at $8.7bn. Projects include: the provision of financial assistance to the mothers of newborn children; increased spending on healthcare; the construction of new hospitals; increased pay for a wide range of doctors and nurses; the issuance of mortgage loans; construction of new housing financed by the budget; investment in the upgrade of housing infrastructure; the establishment of two new universities and scholarships for the best students.
Control of strategic industries/oligarchs
When President Putin came to power, the oligarchs constituted a crucial part of the Russian economy and, most importantly, the country’s politics. In fact, Putin’s own rise to power was often attributed to the help of oligarchs close to Yeltsin’s family. Shortly after his inauguration, Putin put forward the motto of “equal distance” to all oligarchs. As a result of a long campaign, three once super-influential moguls – Berezovsky, Gusinsky and Khodorkovsky – have lost their empires and any role in the country’s political and economic life. Others were encouraged to pay taxes, withdraw from politics or cooperate with any large government programs. (The 2014 Winter Olympics in Sochi will, for example, be financed through significant contributions from the largest of the country’s companies.) The state under Putin has also gone a long way in securing government control and improving financial and business discipline over the government-owned monopolies – including Gazprom and Rosneft, which were helped to grow much larger than they had been in 1999. At the same time, the government has moved along with the gradual reform and privatization of key assets in other sectors – including the reform of power utility RAO UES and the IPOs of Sberbank and VTB, as well as Rosneft itself.
Liberalization of current and capital accounts
From July 1, 2006, Russia had fully liberalized its capital accounts, following the liberalization of its current account several years earlier. This, essentially, completed the inclusion of Russia into international capital flows; and was a highly significant reform, in our view, securing Russia’s place among the world’s most open and fastest-growing economies.
We believe the liberalization of foreign-exchange controls was also instrumental in the reversal of capital flows; Putin’s presidency has seen the reversal of capital flight into very strong capital inflows, which has contributed to the major repositioning of Russia in the global financial markets.
Integration into the world economy
Despite Russia still not being a member of the WTO, it has become a much more open economy since the end of 1999. On the consumption side, the availability of foreign-made goods was an important achievement of the Gorbachev and Yeltsin administrations after decades during which consumers were limited to Soviet-made goods. The availability of foreign goods – particularly in the segments of quality and luxury goods – is an attribute of Putin’s rule.
The liberalization of consumption has been a very important component of Putin’s economic revolution, as it has also permitted the restructuring of the economy. For example, despite the government’s efforts to protect domestic automotive producers, Russians increasingly prefer international cars – produced both in Russia and abroad – to domestic brands, which puts binding pressures on producers. Russian companies, on the other hand, increasingly compete on the international markets, and actively seek international expansion.
Inflation down, but remains an issue
Inflation has been reduced dramatically to 8 percent (running) in 2007 from 36 percent at the end of 1999, but still remains a very important concern for monetary authorities. In its latest economic outlook, the Russian Ministry of Economic Development and Trade forecasts a decline of inflation to 3 percent per year over the long term, which today appears an extremely ambitious target. Inflation will remain a difficult beast to tame for the new administration, given expected tariff adjustments and continued strong inflows of foreign currency, coupled with the authorities’ reluctance to move to direct inflation targeting.
Poverty and social reform
Russia under Putin has succeeded in dramatically reducing the level of poverty. The proportion of the population living below subsistence level has fallen to 17 percent in 2007 from 30 percent in 1999. In some regions (Moscow being arguably the strongest example), regional authorities have been playing an important role in raising the living standards of pensioners and other less-wealthy parts of the population. However, with or without the help of the federal centre, poverty is being gradually eradicated in Russia.
Putin’s administration has also conducted key market reforms in the monetization of privileges. The system of privileges existed as a rudiment of Soviet times, and added to the complexity and opacity of a significant proportion of government operations. It was also a system prone to corruption. Reforms conducted in 2005 gave rise to a significant wave of criticism – the scale of the monetary compensation has often been too small to substitute the goods and services previously received in kind, and financing often arrived with delays. However unpopular, we believe the reform was a very important step in simplifying the government’s social expenditures.
The government has also attempted to reform the pension system – moving from a pay-as-you-go system to the fully funded three-pillar system (started in 2002). The reform is far from being an overwhelming success. Most of the population chose not to select the manager for their individual pension accounts, and authorities believe that employees are not encouraging their employers to make contributions to the pension accounts. Yet, pension reform was of paramount importance, and we believe the government will consider further efforts to develop a fully-funded pension system.
In 1999, there were 8.6 million people unemployed in Russia, or an unemployment rate of 13.2 percent. The system was also characterized by significant underemployment (short hours, involuntary unpaid leave). By the end of 2006, the number of unemployed had dropped to 5 million, with the unemployment rate falling to less than 8 percent.
Today, Russia is a large importer of labor, attracting workers from most CIS countries, and this trend is set to continue. This trend counterbalances the nationalistic domestic political mood, which often results in the effective closure of certain professions to foreigners. Over the medium term, Russia will need foreign labor to sustain high growth rates, and cheaper foreign workers should help to maintain flexibility and competitiveness in the domestic labor market.
August 15, 2007 Story Comment
by Katya Malofeeva and Tim Brenton