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Can Russia’s economy be saved?

by Sergei Guriev and Aleh Tsyvinski

MOSCOW — Russia’s economy is collapsing, but the situation could be worse. The economic crisis has finally forced the government to adopt sensible policies, thereby staving off disaster — at least for now.

Official forecasts for Russian gross domestic product growth in 2009 remain positive, but most analysts, including government officials, are bracing for a severe recession — which, indeed, appears to have started in the fourth quarter of 2008. The stock market’s collapse — its 72 percent fall is the largest of all major emerging markets — is only the most visible sign of this.

Even Russia’s oligarchs are pawning their yachts and selling their jets. Signs of political instability are mounting. The approval ratings for Russia’s president and prime minister are heading south.

Mass street protests have started — not led by opposition political parties but by workers and middle-class families facing job losses and declining wages. More importantly, protesters are demanding that the government resign — unthinkable just a year ago.

With oil prices plummeting 70 percent from their peak (and similar price declines for metals, Russia’s other major export), it is no surprise that Russia is facing severe economic challenges. Growth is endangered, the ruble is weak, and the government budget is in deficit. Nevertheless, up to now, Russia’s government and private sector have weathered the storm reasonably well.

Critics of Vladimir Putin’s regime argue that Russia’s political system is too centralized and risks collapse in today’s economic storm. The regime’s ideology, after all, places the state and loyalty to the rulers ahead of private property and merit. When the crisis hits with full force, the government would nationalize major banks and companies, with the resulting inefficiency then burying the Russian economy, just as it doomed the Soviet Union.

Russia’s government has, in fact, made serious mistakes in dealing with the crisis. Taxpayers’ money was spent to purchase corporate stocks in a failed attempt to support collapsing stock prices. The government is unlikely to recover its investment anytime soon.

The government was also too slow in depreciating the ruble. While one can argue that one-off devaluation was risky — as it could have triggered a panic — gradual depreciation should have started earlier than it did. In the last two months of 2008, the central bank allowed the ruble to weaken at a rate of 1 percent per week, then at 2-3 percent per week. It probably still needs to fall another 10 percent. In the meantime, the central bank hemorrhaged reserves defending this slow correction, while commercial banks have been holding on to dollars in anticipation of the ruble’s further decline.

The third mistake was to raise import duties, especially for imported cars. This was not only economically foolish (as with many other import-competing sectors, the automotive industry will certainly be protected by the weakening ruble), but also politically dangerous. Car owners are an affluent, socially active, and easily organized group. Street protests against the import duties became the first serious popular uprising that Russia has seen in many years.

Yet these mistakes are relatively minor and reversible. Indeed, Russia’s government, unexpectedly, has taken resolute and mostly correct economic decisions. First, it prevented the collapse of the banking system. Many Russian banks were heavily exposed in foreign markets, and therefore faced severe financial problems once the crisis hit. A massive liquidity injection by the government ensured that no major bank collapsed, and minor bank failures were administered in a surprisingly orderly fashion.

Moreover, the crisis has — so far — not resulted in major nationalizations of private companies. The government could have used the crisis to nationalize all banks and companies in financial distress. It has not, despite its still awesome foreign reserves, which give it the wherewithal to buy out a significant portion of the economy at fire-sale prices. Instead, up to now at least, the government has mostly been providing (high-interest) loans rather than engaging in massive equity buyouts.

Nor have the oligarchs been bailed out. Of $50 billion in external debt owed by Russian banks and firms in 2008, the government refinanced only $10 billion. Apparently, the terms offered by the government (London Interbank Offered Rate plus 5 percent and collateral) have turned out to be right on target.

How did reasonable economic policies prevail in this crisis? The key factor is that, for the first time since Putin came to power, the Kremlin perceives a genuine threat. The years of easy popularity are over. All the ugly facts that Russians ignored during the years of fast economic growth are bubbling to the surface.

The regime knows that its survival depends on preventing economic collapse. The crisis energized the system and shifted decision-making power to those who know about and can do something for the economy.

But did these policy changes come too late? The ossified, corrupt, inefficient economy built in the fat years of the oil boom may be impossible to save. So the question that Russia confronts is whether even competent economic policy can prevent economic and political collapse.

Sergei Guriev is rector of New Economic School in Moscow. Aleh Tsyvinski is a professor of economics at Yale University. © 2009 Project Syndicate