Reform of Russia’s ailing economy cannot wait - FT View

Reform of Russia’s ailing economy cannot wait

Sunday December 6th, 2015 at 6:34 PM

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Russian president Vladimir Putin

President Vladimir Putin’s annual address to Russia’s parliament last week began with the expected rallying call to fight Islamist terrorism, and praise for the country’s military in Syria. He threatened to make Turkey “regret more than once” shooting down a Russian bomber last month. But then Mr Putin devoted much of his speech to domestic issues — above all, Russia’s growing economic difficulties.

Such attention is welcome, though words are not enough. The Kremlin’s obsession with projecting military resurgence in the face of supposed external threats has long trumped economic issues. Now the impact of low oil prices, western sanctions and failure to modernise is too harmful to ignore.

Russia’s economy has proved somewhat more resilient than expected. Output will contract by 4 per cent this year, less than many initial forecasts, and seems set to stabilise next year.

But if oil prices continue where they are now, the Kremlin’s economic policies look dangerously unsustainable. Military and social spending — above all, on pensions — have grown sharply in recent years. To compensate, vital spending on education, health and infrastructure will be cut next year.

Next year’s budget foresees a 3 per cent deficit even assuming oil at $50 a barrel — well above Friday’s price. Without measures such as curbing social spending increases and spreading rearmament over a longer period, Russia could hit serious financing difficulties within two or three years.

More broadly, capacity constraints, over-dependence on natural resources, excessive state domination and feeble investment have limited Russia’s estimated potential growth to 1.5 per cent to 2 per cent a year. Structural reforms to boost investment and raise productivity are ever more overdue.

Perhaps most significantly, real household incomes are falling for the first time in Mr Putin’s rule. Inflation is still above 15 per cent, boosted by rouble devaluation and a Russian ban on western food imports. Average real incomes will fall 5 per cent this year.

That undermines the unspoken social contract with Russians that underpinned Mr Putin’s first two terms as president: give up some democratic freedoms and we will deliver higher living standards. Mr Putin’s annexation of Crimea and Syrian intervention constitute a new compact that many Russians, for now, seem ready to accept: tighten your belts and we will restore Russian glory. Yet further military escapades carry great costs, and risks.

Associates says Mr Putin recognises the need for reform, but plans to postpone critical measures, such as pension reforms, until after the 2018 presidential election to avoid risks to stability. But delays leave Russia lagging further behind advanced economies, and raise the cost of investment. Interim measures to curb predatory attacks on business by law enforcement bodies, flagged by Mr Putin last week, are welcome if they happen, but insufficient.

Glimmers of discontent can, meanwhile, be seen. Long-distance truck drivers protesting over a national road toll blocked Moscow’s ring road on Friday. Without careful handling, economists warn protests could spread.

Mr Putin should recognise military power is only one component of greatness. Economic clout matters at least as much. The time when Russia, along with other Brics economies, was seen as increasing its weight in the global economy in coming decades has long passed. Instead, even its own government forecasts its share of output is set to fall. Without fundamental economic reforms soon — not postponed until after 2018 — Russia’s future is not one of resurgence, but long-term decline.

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