by Stephen O'Sullivan, February 2002
Russia Under Putin
There are three areas worth addressing in an analysis of Russia under President Vladimir Putin. The first is the change wrought in the crucial US-Russian relationship by the events of September 11th, the second is a political analysis and the third is an assessment of the very strong economic performance in Russia.
I have long held the view that, while the Cold War was over, there should remain a considerable degree of scepticism and even mistrust in the West of what Russian governments said and did. However, I think the events of September 11th changed that: that was the day the Cold War ended, a point that President Vladimir Putin himself made when addressing the Bundestag. Subsequently Putin decided which side he was on in the world, and that was the side of the industrialised and democratic West rather than any other. There might have been disquiet in Russia about this shift but it ended fairly quickly when it became clear that the President himself was committed to it.
But there is more to the consequences of September 11th than just the discovery of a common interest in fighting Osama bin Laden and the like. The events in New York were merely the catalyst for Russia’s graduation from being a candidate member of the western “politburo” to becoming a more normal partner with the world’s major countries. The ability to make this transition stems from the progress of Russia’s exit from the Soviet system and the faster progress that has been made under President Putin.
America’s withdrawal from the ABM treaty and Russian troops racing to Kabul without provoking serious US concerns are symptomatic of the change that the US-Russia relationship has undergone. While it will not all be plain sailing – the recent issue of detailed arms reduction proposals shows that – the outlook for co-operation is markedly better in the post September 11th world.
Russia’s problems are immense and despite everything that Putin is doing on internal reform and all the promise that it holds out for future improvements in Russia, the country still has a mountain to climb. To his credit, Boris Yeltsin prevented Russia from slipping back into the kind of bastard Sovietism which is the fate of today’s Belarus and could easily have been Russia’s too. But, whether by accident or design, Yeltsin allowed poisons from the old system to emerge in the new and almost drown the new democratic and law-based order in an orgy of rent-seeking by greedy and selfish elites which not only grabbed the country’s natural resource assets but also succeeded in privatising the state itself. Russia’s transition risked going from Soviet state to failed state.
Against this background Mr Putin has taken commendable action in three key areas. First, to reinforce confidence and stability he has given a de facto amnesty for the 1990s asset grab. This has reduced capital flight, with the so-called oligarchs starting to invest in their businesses instead of looting them as before – the result, in the oil sector at least, is the 7% increase in oil production for the second year in a row which is putting pressure on OPEC. Secondly, he has sought to reassert state power. Given Russia’s history, this is bound to raise concerns about a lurch back to the opposite extreme of authoritarianism or worse. In reality, however, this is a liberal programme: because if the state is too weak to enforce the law, curb regional barons, ensure a level playing-field for a market economy and provide basic public goods, there can be no freedom or prosperity.
Finally, Mr Putin has launched a programme of radical supply-side reforms embracing taxation, deregulation, the judiciary, land and employment. This programme, which in a more normal political environment would mark down its author as a typical centre-right politician, is enhancing the effect of the strong oil price during 1999 2001 and the cheap rouble in driving Russia’s remarkable economic recovery.
Still more remarkably, Mr Putin has forged a national consensus in support of these reforms. The same elites that have shown themselves indifferent to the hardships of the mass of the Russian people have learned – especially from the financial debacle of 1998 – that there can be no national recovery and much-craved international respectability without liberal, growth-orientated economic reform. The ambition of President Putin’s Russia is reflected in its pride in restored public finances, and demonstrative refusal to hold out the begging bowl for more debt relief and IMF loans. On the contrary, Mr Putin offered to accelerate repayments to the IMF to help the Fund’s liquidity position at a time of global economic downturn.
Most countries come to a point when they have to live with the consequences of their mistakes. The financial crisis of 1998 was the turning point for Russia in this regard. It turned the country into a pauper state, it removed it from the ranks of the investible emerging markets and it embarrassed ordinary Russians and the elite alike.
However, with a little help from the oil price, which started rising in March 1999, devaluation helped make the economy competitive again, Yeltsin departed the scene in December 1999 and was replaced by Vladimir Putin. In 2000 the latter laid the groundwork for his reform programme, cautiously at first because for his initial period in office he was somewhat beholden to the interest groups that had placed him in power. He did rather seem to lose momentum in August 2000 after the Kursk sinking but he bounced back so that in 2001 he delivered a considerable number of changes to the substance of power in Russia.
The results of the crisis and Putin’s ascension to power have been extraordinary for anyone who has watched Russia over the past decade. GDP growth was 5.4% in 1999, 8.3% in 2000 and looks to have been 5% in 2001 with 2002 also looking solid.
The financial crisis helped weaken or even destroy the three groups who had under Yeltsin blocked the reforms that Putin has now undertaken. The oligarchs who lived on the state, the regional elites who thrived on corruption and the communists who blocked reform on principle. The issue now is not whether reform and change but which reform and how fast.
Things that have changed markedly over the past three years include:
- the budget deficit has gone and been replaced by a slight surplus that is here to stay, assuming oil prices remain at even moderate levels and if they do not, then the economic orthodoxy of cutting government spending looks set to be implemented
- the arbitrary tax system has been replaced by a flat income tax of 13% from 2001 and a corporate profit tax of 24% from this year
- barter and offsets, which have fallen dramatically and are down by two-thirds over the past three years. They were 54% of all transactions in August 1998 and are just 16% now.
There are those who claim that Mr Putin is a persistent economic reformer. I am not sure I would agree with that. I think he is sufficiently clever to understand that nobody was going to take him or his country seriously again until it began to fix its problems. The debate around Washington in autumn 1998 was “who lost Russia”. Well, the Russians lost Russia. They were offered the same economic aid and advice as their former colonies in Eastern Europe but chose to reject it and head down the path of least resistance. For a while, 1994 to 1997, it looked the right decision. But the problems stored up by the failure to take tough decisions sooner proved too much for the economy to withstand and the 1998 crisis was the result.
I believe that Mr Putin understands the need for reform to create a strong economy so that a strong economy can underpin a wider role for Russia in the world. Russians are in many ways like the post-Imperial British: their world has changed and many are still coming to terms with it. Mr Putin sees this quite clearly I think and has therefore set off down the path of economic reform tempered, as any good politician would appreciate, by the necessities of re- election. In this process of reform, the government adopted a substantial reform programme in the middle of 2000. It now has the technical skills to develop a sensible and effective programme of reform laws and the parliament is passing one reform law after another. These legislative changes have included tax legislation, a land code legalising the private ownership of urban land, five laws on deregulation (bitterly opposed by the bureaucracy, which sees its ability to collect bribes disappearing), pension reform, a labour code, a unified tariff agency and serious structural changes at Unified Energy Systems the national electricity utility and the country’s second-largest company.
From my point of view as a securities analyst, we scored a major success when we had the Chief Executive of Gazprom, Russia’s largest company, replaced in May. It is fair to say that as a firm UFG is very far out in front on corporate governance and this was a crucial test for Putin, which he passed with flying colours. Much of the rest of the former senior management has also been weeded out and we can start valuing Gazprom as a normal business. Of course if it were a normal business, valued under normal rules, it would be worth ten times the value of BP rather than one-fiftieth of BP.
Overall I believe there are grounds for moderate optimism about Russia and its future. My opinion of Vladimir Putin is that he is a very serious leader and that Russia has become an altogether different place since he took charge. Of course there are many issues that still need to be addressed and there are aspects of Putin’s government that cause us to question his commitment to the same values that we hold in the West. But these cannot detract from his essential achievement: making Russia a serious country once again, worthy of respect from both its domestic population and its international neighbours.
This paper is based on a talk given at the Willis Partnership in November 2001.
About the Author
Stephen is the Head of Research at United Financial Group, Moscow's leading independent investment bank. Prior to joining UFG, he was Head of Research for Eastern Europe at MC Securities in London and a consultant specialising in the energy sector of global emerging markets. He is a frequent contributor to the Financial Times and other international publications.