The government channeled $50 billion in bailout money to both state-owned and private companies through VEB. In total, it spent $104 billion from the Reserve Fund on budget support from September 2008 until June 2010. Its greatest support, however, was spending $200 billion of its international currency reserves. The Central Bank maintained an overvalued exchange rate, pursuing a gradual devaluation for three months from November 2008 to February 2009. This policy was evident, but not explicit, effectively allowing the wealthy and well connected to profit on speculating against the ruble. The Russian government thus bailed out big companies.40
While this Keynesian stimulus might have seemed sensible, its outcome was miserable. Russia’s GDP plunged by 7.8 percent in 2009, more than in any other G-20 economy, and its future productivity had been aggravated. Much of the capital injection flew out of the country. The IMF assessed Russia’s capital flight in 2008 at a record $119 billion (table 6.1, p. 166).41
The government pursued the opposite course of the creative destruction of 1998. It bailed out big, inefficient companies owned either by the state or by oligarchs, which crowded out more efficient enterprises. Of 481 state-owned firms deemed “strategic,” 79 received state support. Enterprises with low profitability that had quickly increased their debt before the crisis were likelier to receive government assistance during the crisis. The “average productivity . . . declined among the treated firms, while it grew among the control firms in the post-bailout period.” In short, “firms that received government assistance performed worse than matched firms that did not receive such assistance.” Not only did the government spend money on the worst enterprises, but its help further aggravated their performance. Still, by supporting the old, big companies, the government kept up real wages, which was a major objective.42
The Russian government had freedom of action with its ample funds, and it made this deliberate policy choice, which was widely celebrated as a wise stimulus until the poor economic outcome became apparent. In 1998, the government had fewer options, but the crash delivered a catharsis. During 2010–2012, Russia’s economic growth looked good in comparison with the stagnant eurozone, and its macroeconomic stability remained stellar, but with a deteriorating economic structure and minimal reforms, economic growth was set to gradually decline, even if oil prices stayed high.
By 2014, Putin’s policy of state and crony capitalism had eliminated economic growth. Then, two big blows hit the Russian economy. The price of oil fell by half from June 2014 to February 2015, and in July 2014, the West imposed financial sanctions on Russia because of its aggression in Ukraine. Each produced negative effects, and they reinforced each other.
The conventional wisdom was that Russia would manage well since its total foreign debt was not large—$732 billion in June 2014, about one-third of GDP. Its share of GDP rose with the depreciation of the ruble, whereas Russia’s problem was not solvency but liquidity. Western sanctions caused a “sudden stop” of all refinancing of Russian foreign debt.43
In December 2014, a monetary crisis hit Russia with a furor. The CBR decided to let the exchange rate float freely, suddenly moving to inflation targeting. An obvious aim was to conserve currency reserves that had been sharply reduced in 2014. Traditionally, the ruble-dollar rate and the oil price in dollars have followed each other closely, but now the ruble plummeted much further. Society was shocked. Panic erupted. People ran to the shops to buy whatever they could before new, higher import prices were introduced and many imports had become prohibitively expensive.
As a consequence, inflation shot up. With the exchange rate plunge, inflation surged from 7 percent to 16.9 percent on a year-over-year basis in March 2015. The CBR refused to intervene with currency sales. Instead, it hiked the interest rate to 17 percent and waited for the panic to recede. The alarm eased after a couple of weeks, and the inflation rate declined gradually. The CBR maintained high nominal interest rates, tightening actual monetary policy. By mid-2017, inflation had sunk to the target rate of 4 percent, and it continued to fall to 2.2 percent in early 2018.
During the financial panic of December 2014, Putin made two major public appearances, but he said a minimum about economic policy, reassuring his audiences that the economic situation was quite good. Putin avoided the word “crisis,” blaming the outside world while avoiding any analysis of the effect of falling oil prices and sanctions, respectively. He argued that “the current situation was obviously provoked primarily by external factors,” expressing a bland hope that things would get better, as if Russian policy was irrelevant. He was vague about future policy: “What do we intend to do about this? We intend to use the measures we applied, and rather successfully, back in 2008. In this case, we will need to focus on assistance to those people who really need it. . . . We would certainly be forced to make some cuts.”44
In early 2015, Putin held meetings with senior economic officials, resulting in the government adopting a package of sixty anticrisis measures. Still avoiding the word “crisis,” the program was called the Plan for Sustainable Economic Development and Social Stability in 2015 (though it was popularly called the anticrisis plan). Again, Putin claimed that the government should repeat its anticrisis policy of 2008–2009:
This is not the first situation of this kind that we are going through. In 2008–2009 we went through the same thing. Then it was also a crisis that came from outside. Let me remind you that it started with the collapse of the mortgage system in the United States and then it touched other countries, including ours. Now as well, one of the main causes of the situation in the economy is the situation on foreign markets, in this case for raw materials, which is seriously reflected also here.45
In mid-February, Putin clarified his policy: “Overall, the agenda is clear. . . . Our tasks include diversifying the economy, creating conditions for faster growth, creating the right environment, improving management at every level of power . . . stabilizing the currency and of course keeping our macroeconomic indicators on course.” He avoided the tough questions of allocation of resources and said nothing about reform.46
Although Putin insisted that Russia would repeat its policies of 2008–2009, he did not do so. Instead, in its new anticrisis plan the Kremlin economized on reserves through a floating exchange rate, and the budget cost was small, focusing on the recapitalization of banks. Yet Putin has nixed all proposals of structural reform.
A great improvement was the altered exchange rate policy, moving Russia from a pegged exchange rate to a floating exchange rate policy with inflation targeting. This has helped the CBR to save reserves. Russia’s reserves have gradually recovered and stabilized around $400 billion, which seems to be the Kremlin’s target. That corresponds to 30 percent of the current GDP, or two years of current imports. After the month of panic in December 2014, the ruble exchange rate recovered. It floats freely but has stabilized at about half the dollar value of June 2014.47
This anticrisis plan was supposed to have a total cost of $38 billion, or 3 percent of a GDP of $1.2 trillion, compared with the bailout of $200 billion in 2008–2009, which was then 10 percent of the GDP of $1.9 trillion. This drop reflected the tighter fiscal situation. Two-thirds of the anticrisis package was sensibly devoted to the recapitalization of twenty-seven big banks. Admittedly, 199 “strategic” companies, irrespective of ownership or efficiency, were singled out for assistance and loan guarantees, similar to 2008–2009, but because of the falling exchange rate they did not need much financing.
The large depreciation of the ruble also helped the government to limit the budget deficit because oil revenues remained almost constant in ruble terms, whereas they plunged in dollar terms. The government’s goal was to keep the budget deficit low, around 3 percent of GDP, and it did. Federal government debt has stayed minimal, at 13 percent of GDP. The Kremlin has responded ruthlessly by slashing expenditures on education and health care and, in 2016, even pensions. Russia has maintained practically full employment, with an offi
cial unemployment rate vacillating between 5 percent and 6 percent.
In the aftermath of the 2014 crisis, Russia went through a new bank crisis. In three years, more than three hundred banks were closed down, leaving more than five hundred banks. The CBR has been widely lauded for cleaning up the Russian banking system, but the results are dubious. The Russian banking system is not developing but shrinking, and its structure is not improving but turning worse. The big state banks have become more dominant than ever. The five biggest state banks, led by Sberbank and VTB, account for almost 60 percent of banking assets.
In the second half of 2017, three of the five biggest private Russian-owned banks, Bank Otkritie, Binbank, and Promsvyazbank, went under with horrendous losses, raising doubts about the sustainability of most of the private banking sector as well as the quality of the central bank supervision. They were taken over by the Central Bank after having been outcompeted by the large state banks, which benefited from cheap funding while becoming ever more monopolistic, focusing on big, mainly publicly owned clients. The few foreign banks primarily serve foreign companies, and Russian medium-sized and small private companies are now left with little access to credit. The Central Bank had used Bank Otkritie and Binbank as consolidators of multiple smaller failing banks, raising doubts about the quality of bank inspections. Moreover, banking requires strong property rights and a well-functioning judicial system, which Russia lacks. Russia’s malfunctioning banking system is a serious bottleneck for the development of the economy.48
The falling oil prices sharply reduced Russia’s export revenues. Russia’s merchandise exports fell by almost half from 2013 to 2016, from $522 billion to $282 billion, but so did imports, because of the falling exchange rate, from $341 billion to $192 billion (fig. 3.9). As a consequence, Russia managed to maintain a significant current account surplus even at the worst of times (fig. 3.10). Both exports and imports recovered significantly with rebounding oil prices in 2017.
Something had to give, and that was the standard of living, investment, and GDP. In the two years 2015–2016, real disposable incomes slumped by 16 percent, and retail sales, also reflecting the standard of living, plummeted by 15 percent; investment fell by 9 percent. Real disposable incomes continued to fall in 2016–2017.49
Fig. 3.9 Merchandise exports and imports, 2000–2017. Source: BOFIT (2018)
Fig. 3.10 Current account balance, 1992–2017. Source: IMF (2018)
Social scientists have argued that Putin established a social contract with the Russian people, granting them stability and a steadily increasing standard of living, while he took care of politics. Since 2014, Putin has abandoned this social contract. The question is how long the Russian people will accept a lower or even falling standard of living.50
For the future, one of Russia’s big negatives is its demography. Russia’s working-age population peaked at 90 million in 2003–2006, and it is now falling continuously. By 2016, it had dropped to 83 million, and it is expected to shrink by about 700,000 a year, or almost 1 percent of the labor force, until 2030. This implies a corresponding decline in GDP, all other things being equal.51
The Russian government does little to the benefit of its human capital. The two key health statistics are life expectancy and infant mortality. Life expectancy for men has been remarkably low in Russia for decades, and it decreased further during the collapse of the Soviet Union and the early transition period, hitting a low of 58 years in 1994. The main cause was increased mortality in cardiovascular diseases, suggesting that Russian men found it exceedingly difficult to live through the stress of the postcommunist transition. Many of the deaths reflected increased drinking. Male life expectancy started rising steadily from 2006, but it remains very low by international standards at 66 (fig. 3.11). By contrast, Russian women live eleven years longer than their men. In 2016, the overall life expectancy in Russia was just 71.6 years, according to the World Bank World Development Indicators, putting Russia in the worst half, at number 108, of 186 countries in the world.52
Russia’s infant mortality rate was mediocre until the late 1990s, but then it started to improve every year. Even so, Russia’s infant mortality remains twice the EU average and is three times as high as in the Czech Republic, which is the best-performing postcommunist country (fig. 3.12). The far greater improvement of infant mortality in the Central European countries is best explained by their democracy, which forces the authorities to take better care of their citizens.
Fig. 3.11 Male life expectancy at birth, Russia and the Visegrad Group, 1989–2016. Source: World Bank (2018)
Fig. 3.12 Infant mortality, Russia and the Czech Republic, 1989–2016. Source: World Bank (2018)
Socially, Russia is underperforming badly according to all relevant international comparisons. The situation was far worse in the Soviet Union, but the Russian government devotes strikingly little attention and resources to the improvement of social conditions.
At first glance, Russia’s combination of crony capitalism and very conservative macroeconomic policy may appear odd, but it makes a lot of sense. The Kremlin’s big lesson from the crash of 1998 was that a severe financial destabilization is dangerous for political stability so it must be avoided. Therefore, it has shunned large budget deficits and substantial public debt. The Kremlin sees large international reserves as a matter of sovereignty.
From 2000 to 2008, Russia maintained significant budget surpluses, almost eliminating its public debt. After public finances had stabilized, Russia could carry out major tax reforms, taking its cue from Estonia, reducing the number of taxes sharply, cutting tax rates, and adopting sensible rules for deductions. The most popular policy was the flat income tax of 13 percent. Value-added taxes and the unified social taxes have varied slightly, but the new tax system has been quite stable.
As Russia’s public debt dwindled and its international reserves rose, the idea arose of strengthening the country’s financial stance further with sovereign wealth funds. The first fund was introduced in 2004. The Reserve Fund and the National Welfare Fund grew until the crises of 2008 and 2014. They have served as buffers, but they have also reduced the urgency for reform. At the end of 2017, their combined size had shrunk to 5 percent of GDP. The government made the logical decision to abolish the Reserve Fund in February 2018. The sovereign wealth funds have attracted more attention than they deserve. It is more important that Russia’s public debt is minimal and that its international currency reserves are substantial. The Russian Ministry of Finance can easily borrow from the Central Bank reserves when the sovereign wealth funds have been depleted without expanding the money supply.
In 2008–2009, when ten years of high growth had bred a sense of hubris, the Kremlin did the opposite of 1998. Rather than cutting expenditures, it opted for the largest fiscal stimulus package of any G-20 country. It rescued large and inefficient companies regardless of ownership, crowding out more efficient enterprises. It used $200 billion of currency reserves to bail out the establishment through a gradual devaluation during three months. The outcome was a decline in GDP of almost 8 percent, a less efficient enterprise structure, large capital outflows, and much smaller reserves, but the standard of living was maintained even in 2009.
Although the Kremlin did not admit that this policy was a failure, its response to the crisis of 2014 showed that it had learned its lesson. Russia at last adopted a floating exchange rate and opted for inflation targeting, saving its reserves and quickly reducing inflation after a large depreciation in a textbook fashion. The budget deficit was kept below 3 percent of GDP. Russia had arrived at a macroeconomic policy that is likely to stick, and highly professional systemic liberals maintain it. However, the Kremlin ignores any growth-oriented policies.
In an article on Russia after the global financial crisis, the eminent economists Sergei Guriev and Aleh Tsyvinski concluded that if “economic reforms are not implemented, Russia is likely to enter a new decade of Brezhnev-style stagnation.” They foresaw a “‘lost
decade’ as in the 1990s Japan, when the acute phase of the crisis was mostly over but the economy grew very slowly for more than 10 years.” After its financial crash in 1990, Japan got zombie banks encumbered with excessive nonperforming loans, and today Russia has got zombie companies. Guriev and Tsyvinski observe that “Russia still has an ossified, corrupt, and inefficient economy built during the fat years of the oil boom.” Their prediction of stagnation and zombie companies has been remarkably accurate, and current forecasts suggest that their words will stay true.53
F • O • U • R
The Rise of State Capitalism
A major trend under Putin has been the renationalization of large private companies. Renationalization started with the arrest of Mikhail Khodorkovsky on October 25, 2003, and was soon followed by the state company Rosneft seizure of Khodor-kovsky’s oil company, Yukos. Big state enterprises have expanded, mainly by purchasing good private companies on the market, but also through corporate raiding, in which private enterprises have been seized with the unlawful assistance of law enforcement agencies. The state sector has expanded because of privileges granted by the state, including cheap and plentiful state funding, as well as the unique right to buy big companies, and not because of economic efficiency.
This chapter shows how state capitalism has developed and functions in Russia, showcasing four key state enterprises in four major industries: gas (Gazprom), oil (Rosneft), banking (VEB), and armaments (Rostec).1
Russia lacks accurate statistics on the size of the private and public sectors, and assessments of the state sector vary to an amazing degree. According to analysis by the European Bank for Reconstruction and Development (EBRD), the private sector peaked in 2003, when it generated 70 percent of GDP. It fell to 65 percent of GDP in 2005, but soon afterward the EBRD stopped publishing these statistics because there was no reliable methodology behind that or any other assessment.2
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