Vladimir Putin and the curse of Siberian oil

On the face of it, the Russian economy is booming. Growth in 2005 slowed a bit but still hit more than 6.0%. The current account surplus surged to $90 billion (EUR 75bn), 12% of gross domestic product (GDP).

As the oil price has surged to more than $60 a barrel, oil-rich Russia has prospered as never before in the post-Communist era. But, says one official economist anxiously, "in some ways the situation is quite reminiscent of Mexico". What happened to Mexico was a classic oil fuelled boom-and-bust. It triggered the almost disastrous Latin American debt crisis of the 1980s.

When the Netherlands had a similar brush with economic peril as a result of its 1980s natural gas boom economists tagged the phenomenon 'Dutch disease'. Now, in organisations such as the World Bank and the Organisation for Economic Co-operation and Development (OECD), economists are looking at whether Russia is catching the virus, too.

With its soaring foreign exchange reserves, estimated by Deutsche Bank to hit more than $200bn (EUR 168bn) this year, and an external debt ratio of 25% of GDP, Russia today, unlike in 1998 when it was forced into a partial default, looks well insulated from a foreign-creditor panic. But the domestic economic picture is looking increasingly unstable.

In December this drew a sharp rebuke from the OECD which, in its Economic Outlook, warned of an "explosive growth in consumer credit". It expressed unease about the difficulty the authorities were having in bringing inflation down from more than 11% last year. And it warned about an adverse inflationary impact from the way a larger share of oil windfall gains are once more being spent in spite of capacity constraints. Critically, it complained that "structural reform has largely stalled".

Eric Berglof, who this month took over as chief economist at the European Bank for Reconstruction and Development (EBRD), is no less blunt.

"It is the combination of too good an economic situation and some kind of political limbo looking forward to the presidential election in 2008 which is causing the reform movement to stall," he says. In its 2005 Transition Report, the EBRD identified Russia as one of the countries exhibiting high levels of financial sector systemic risk indicators.

"Today," says one expert in Brussels, "Russia should be attracting high levels of foreign direct investment and importing a broad range of capital equipment. Neither is happening." In fact, EU exports to Russia are concentrated on the energy and transport fields and Russia remains one of the least attractive of the more advanced transition economies in terms of the willingness of foreigners to invest there. This contrasts sharply with China.

Russia is the EU's third biggest trading partner with around EUR 162bn of bilateral trade. Around half of Russian exports go to the EU, 60% of them in the form of oil and raw materials. EU exports to Russia surged 22% to EUR 56bn last year. The trade deficit, however, widened to EUR 50bn.

Brussels has supported Moscow's application to join the World Trade Organization (WTO). It is in Europe's interests to foster the integration of the Russian economy into the EU's and, in time, try to achieve a broad range of regulatory convergence which would deepen the integration of their economies. Behind the scenes, work has already started on thinking about a bilateral free trade agreement once Russia's WTO entry is complete.

The hope is that the deepening trade relationship will not only be good for growth, but that trade negotiations will foster economic reforms across a broad range of sectors. One of the risks is that Russia will be tempted to try to cherry-pick the parts of an agreement it likes and ignore the reforms. Currently the deepening Russian state influence in strategic sectors, not just energy, is a source of concern.

In the medium term, however, the biggest worries are how Russia would cope if its domestic economic imbalances were allowed to grow and whether Russia's oil wealth turned into a curse, discouraging reforms and facilitating the inflation of an economic bubble, which, when it bursts, could have unpredictable economic and political repercussions.

Stewart Fleming is a freelance journalist based in Brussels.

Author gives an assessment of the state of Russia's economy. In spite of substantial economic growth and an oil boom, foreign direct investment was modest and some voices were warning of an imminent crisis.
Article is part of a European Voice Special Report, 'EU-Russia'.

OECD: OECD Economic Outlook No. 78, December 2005: Developments in selected Non-member Economies http://www.ingentaconnect.com/content/oecd/04745574/2005/00002005/00000002/1205021e

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