Putin needs to put things right while the going is good

Since 1998 Russia’s economy has been growing at well over 6% a year.

But few foreign economists believe that, without dramatic reforms, it can sustain this rapid expansion.

Much of the growth has been associated with increasing energy (oil and gas) and minerals prices, rather than increased output in the energy sector, and prices have almost certainly peaked. High world energy prices have fuelled domestic consumption, driving up real wages, thereby fuelling demand and intensifying inflationary pressures.

Across industry, heavy capital investment is now needed to increase capacity to support further expansion. The World Bank says that "absolute investment levels remain low in Russia relative to (other) emerging market economies that have sustained growth over a number of years."

The Bank worries about the implications of a slowdown in the manufacturing sector. A strengthening exchange rate and an industrial base too focused on the energy sector mean that Russia is prone to sucking in imports to meet its domestic needs and is failing to develop globally competitive exporters in other sectors.

The policy tools needed to maintain economic stability may be compromised. It requires a well developed financial sector for monetary policy to be effective in containing inflation and Russia does not have one. So tax and budget policy should be the main instrument for economic stabilisation. But, as the International Monetary Fund said in June, "we are concerned about plans for further fiscal relaxation", which risk adding to demand pressures.

One bright spot, surprising given the government’s assault on private property rights in the energy sector and its determination to bring the sector under government control and keep foreigners out, has been the rapid increase in foreign direct investment (FDI) going into Russia. This is up from around 1% of gross domestic product in the aftermath of the debt crisis of 1998 to nearer 3% now. But, as the World Bank points out, much of this FDI is focused on the energy and minerals sectors and on retailing rather than on sectors which would broaden Russia’s economic and technological base.

But perhaps the most worrying development has been the evidence that economic reforms, which gathered pace in the wake of the currency crisis of 1998, have stalled. This at least is the common judgement of the government-owned international financial institutions such as the IMF, the Organisation for Economic Co-operation and Development (OECD) and the European Bank for Reconstruction and Development (EBRD).

Specialists who know Russia well say that top Russian policymakers are now deeply divided between those who argue Russia is performing just fine as things are, and those who worry about the longer term outlook.

A key question is, to which faction does President Vladimir Putin belong ?

Russia - vital statistics

GDP (Billion $)

Growth %

Inflation %

2006 (forecast)

EU GDP 2005 $10,008bn.

Source: Deutsche Bank

• Stewart Fleming is a freelance journalist based in Brussels.

Since 1998 Russia’s economy has been growing at well over 6% a year.