SUTELA, Pekka June 0611

The Russian economy Pekka Sutela 6 June 2011 www.pekkasutela.fi Pekka Sutela

1

Back to pessimism • Russia – as we know it – – i.e. liberal mostly Moscow intelligentsia • Always subject to shifts of mood

• Is back to pessimism – Disappointment in Medvedev – Frustration with seeming immobility and authoritarianism of the regime – Absence of meaningful opposition – Perceived increase in corruption, lack of long-term incentives – Outmigration of middle class, capital outflow – Expected growth about 4% in spite of high oil price

• But is this justified?

Pekka Sutela

2

Before the crisis Russia was...

•

About 8th largest economy globally – On PPP terms, comparable to Britain and France – On current exchange rates, comparable to Spain, Mexico and India

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Very fast growing market – Imports of consumer and investment goods paid for by energy and minerals exports. For Russia, resources are a blessing – Imports growing by 20-30% USD annually – Russian consumption-driven growth implied that e.g. Germany, Sweden and Finland lost market share; China the big winner

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A major target for foreign direct investment – In 2006-2008 inward FDI/GDP comparable to Brazil, Mexico – Probably majority of this was Russian money roundtripping; still a portfolio choice

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Still, a very low-ranked business environment – Since 2004 perceptions turned worse – Though some reforms continued (reserve funds, capital account liberalisation, financial sector, power sector, military reform)

Pekka Sutela

3

Growth drivers in the 2000’s • Estimates: 2/3 domestic factors – Structural change • Birth of modern services • New enterprise entry • Monetisation and early financial deepening

– Recovery growth • Capacity utilisation • Relatively low investment

– Low-priced inputs • Labor, energy

– Twin regime goals: Stability and sovereignty

• 1/3 external factors – Oil price – Finance

Pekka Sutela

4

... And in the crisis • GDP drop was deep – y/y 7.9%; largest in G20; identical with Finland – Peak to bottom 14%

• And not all that simple to explain – Energy dependence, bad institutions do not explain – Lack of domestic funding does – A massive inventory cycle?

• Policies mattered as well – Preference for stability – Victory of tactics over strategy • • • •

Stepwise devaluation Protection of existing jobs Maintenence of incomes Huge hikes in pensions

Pekka Sutela

5

A good crisis lost?

• For Russia, the crisis was steep and short – GDP drop three quarters – Oil price back to historical heights – Gazprom: the winner of the Game Changer

• The great disconnect – Any number of strategy papers: Russia thinks of the long term - but where do you see that in practice?

• Return of self-assertion – Victims of outside shocks – Yes, we were prepared – and (as IMF, IBRD tell) did the right things Pekka Sutela

6

Back to a (lower) potential growth rate • Consensus 1 – Russia’s post-crisis growth potential about 4% y/y – Why lower: demography!

– But also many low-hanging fruit picked already

• Consensus 2 – Oil price an upside risk – Capital flows a question mark

• Consensus 3 – 2011/2012 elections not a watershed

• Consensus 4 – Basically, policies remain responsible Pekka Sutela

7

The true demographic issue • Russia’s population will decline but that is not the true issue – No decline in past five years

• Echo of Great Patriotic War – Few elderly to have grandchildren in the early 1990’s – Transition did not help – Peculiar policy mistakes

• The 18-year-young cohorts – Close to one half of recent ones – Labour markets, education, military...

• And the older ones – Life expectation does increase – Pension system unsustainable – 40% of those voting in current pension age

Old growth drivers no longer remain • Transient factors are – well – transient – Productive capacity in full use – Labor scarcer and more expensive – Higher energy prices needed

• Decline in labor force – In-migration?

• Little growth in energy production • Time for creative destruction – Military and dual-use industries – Soviet location patterns Pekka Sutela

9

Badly needed: • Investment-based growth, but – Much of the capital stock is from the 1970’s, and beyond modernisation – Investment environment remains in the lowest one third to one fourth in rankings • Can it really be that bad?

– Finance and its intermediation • The great lesson of the crisis • Moscow –a financial center?

– Where are the relative advantages • ”Russia between low-cost Asia and hi-tec Europe” • But recent European catching up success stories need not be hi-tec: Estonia, Poland, Slovakia...

• Much enhanced infrastructure • Modernisation of market structure – From plant autarchy, provision of public goods, to value chains

Pekka Sutela

10

Revising the 2020 program • Putin: this is the 2012 government program – 2020 Program written in 2006-2008 needs revision – HSE, ANE tasked to ”write program for the 2012 government” – 21 working groups chaired by ”Gaidarians”

• The priorities – – – – – –

Fiscal policy Pension system ”Modernization” ”Diversification” Integration or not ...and everything else Pekka Sutela

11

Example: Energy efficiency is a structural issue 3500

3500

3000

2920

2770

Structural energy saving potential

Energy consumption

Total primary energy demand with 2005 efficiency

2500 2250

2100

2000 1700

1520

1500 1190 954

1000

1120

1240

Source: ГУ ИЭС

2010

1395

Energy consumption with improved

500 2005

1565

1107

990

2000

1250

Technic al energy

4000

2015

2020

2025

2030

2035