Swedbank Baltic Sea Analysis No. 31/2012; A president returns – but dated solutions to new economic challenges.

1. Swedbank Baltic Sea Analysis No. 31  1 Mar 2012
Russia
A president returns – but dated solutions to new
economic challenges.
 Vladimir Putin appears to be headed for victory in the first round of
the presidential election on Sunday, March 4). There have been
major demonstrations both for and against, but the opinion polls
indicate that Putin will be returned to the Kremlin. Even if Putin’s
position and mandate are weakened, he is likely to add another six
to the 13 years he has already spent in power. The absence of a
strong opponent is a sign of the Russian democracy’s weakness.
 Continued high oil price, strong private consumption and falling
inflation should generate decent economic growth in the short term.
The extensive election promises have increased the fiscal policy
imbalances, however, and this limits the scope for reform policies.
There is a risk that increases in defence spending and public sector
salaries will be at the expense of important infrastructure
investments, holding back economic growth in the medium term.
 Moreover, the fundamental problems in the Russian economy still
remain. The business structure is still concentrated on natural
resources. The lack of diversification is amplified by low
competitiveness, a poor infrastructure and a weak innovation climate.
Even though membership of WTO will increase competitiveness,
Russian companies lack the resources to take on this competition.
In a number of articles Putin correctly identified these problems, but
his proposals rather point to a state-controlled capitalism, as in
China, than to a well-functioning market economy. Without rule of
law and independent media there is a continued risk of widespread
corruption, and reforms that sustainably raise the welfare of the
general population will be further delayed.
Economic Research Department, Swedbank AB (publ), SE-105 34 Stockholm, tel +46 (0)8-5859 7740
e-mail: ek.sekr@swedbank.se Internet: www.swedbank.se Responsible publishers: Cecilia Hermansson +46 (0)8-5859 7720
Magnus Alvesson +46 (0)8-5859 3341, Jörgen Kennemar +46 (0)8-5859 7730 ISSN 1103-4897

2. Putin on the way to victory – despite resounding
discontent
The latest opinion polls indicate that Vladimir Putin is headed for Putin looks set to win with
outright victory in the Russia presidential election on 4 March, over 50% of the votes in
avoiding a second election round. Even though these polls should be the first election round
taken with a pinch of salt, as many are not independent, Putin’s
election campaign has intensified in recent months. This has among
other things entailed major pledges to important groups of voters,
such as the military and the police, but also doctors and teachers.
Putin has also promised major increases in defence spending. In the
past, pensions have been raised, and planned VAT increases have
been postponed. Putin also has control of the most important media
channels, and despite extensive protests by the middle classes in the
major cities it now seems that Putin will win by more than 50% of the
votes in the first election round, making a second round unnecessary.
Election survey, Russian presidential election, 2012
(Answer to the question: ”Who would you vote for if the presidential election was held
next Sunday?”;%)
60
Putin V.
50
Zhirinovsiky V.
40 Zyuganov G.
30 Mironov S.
Prohorov M.
20
Hard to answer
10 I wouldn't go to
the polls
0
January 21, January 28, February 5, February 12,
2012 2012 2012 2012
Source: Russian Public Opinion Research Center.
Apart from Mikhail Prohorov, the other presidential candidates are Few real contenders
already well-known by the Russian electorate. Gennady Zyuganov is against Putin, apart from
the Communist party leader and is most popular with pensioners and discontent and apathy
poorer groups in rural areas. He has stood in previous presidential
elections, and his party grew in support in the latest elections to the
Duma. The ultra-nationalist populist Vladimir Zhirinovsky is also a
well-known presidential candidate and his party also made gains in
the Duma elections. Sergey Mironov and his centre-left Fair Russia
party is considered to be close to Putin and does not present any
threat to his re-election. As the liberal, independent Yabloko party’s
Grigory Yavlinsky is not allowed to stand due to insufficient approved
signatures for his candidacy, this leaves Prohorov as a relatively
young, well-financed opponent.
Mikhail Prohorov, an oligarch who made his fortune in the nickel Prohorov – wealthy young
industry, has promoted himself as a market-oriented and business- challenger whose
friendly candidate. His independence is also questioned, however, independence is
and speculation that the present government is behind his candidacy questioned
2 Swedbank Baltic Sea Analysis No. 31 • 1 March 2012

3. has generated suspicion and undermined his chances of a successful
campaign. The biggest threat to Putin is, thus, growing dissatisfaction
among the middle class in the larger cities, and thereby a weak
mandate for Putin to tackle the difficult, but necessary reforms.
Putin is back as presidential candidate after four years as prime Putin’s time in power can
minister. Prior to that, he was president for two terms between 2000 be as long as a quarter of
and 2008. An important reason for the escalating protests, especially a century
in Moscow, is the belief that Putin and Dmitry Medvedev, the current
president, who is not standing for re-election, have manipulated the
constitution; and that Medvedev’s election four years ago was merely
a smokescreen to pave the way for Putin’s return. With the present
constitution’s six-year election terms, winning both this and the next
presidential election could put Putin in power until 2024
Putin has presented his election platform in a number of newspaper Putin still puts state control
articles. He points to corruption, insufficient innovation and limited first
competitiveness in the Russian economy as the biggest challenges.
Modernising Russia and its economy was a message previously
promoted by Medvedev when he was president, but these reforms
have proved to be hard to put into practice. Even though Putin speaks
of liberalising the economy, and the importance of reducing corruption
and strengthening property rights, he also makes it clear that there
are limits to how far the state should step back. Referring to Chinese
and South Korean experience, he welcomes foreign direct investment
in selected industries, but also signals that he prefers a state-
controlled investment policy. When companies are privatised the
state will also retain control in strategically important areas, such as
natural resources and the financial sector. Russian reform policy thus
balances between, on the one hand, recent years’ experience that
increasing state control easily leads to growing corruption, and on the
other hand the “shock therapy” after the collapse of the Soviet Union
that led to major losses from the sale of state property.
In his election campaign Putin recently promised major increases in Election promises of the
spending on the military and the police, as well as pay increases for traditional variety can be a
doctors and teachers. These follow on previous increases in pensions threat in the long term
and other social transfers. This may give Putin enough support to
exceed the 50% threshold, but even with sustained high oil prices
public finances will be under pressure, which can undermine Putin’s
position and support, especially if the global economy continues to
falter.
Moderate growth in the short term – stagnation in the
medium term
Strong domestic demand contributed to continued growth in the fourth No cyclical rebound in
quarter of 2011, and in 2011 overall the Russian economy grew by Russia
4.3%. This is marginally higher than our forecast 4.2%. Especially
retail trade expanded, supported by relatively low unemployment, at
6-6.5%, and receding inflation. Together with large election
campaign-related increases in public transfers, this boosted
consumer confidence and purchasing power. Companies are more
hesitant, however, and investments increased more moderately. Net
foreign trade also dampened economic growth in 2011.
Swedbank Baltic Sea Analysis No. 31 • 1 March 2012 3

4. Economic growth and inflation, 2005 - 2011
(Annual percentage change, quarter)
20
GDP
15 Inf lation
10
5
0
-5
-10
-15
2005 2006 2007 2008 2009 2010 2011
Source: Ecowin.
Inflation has continued to drop this year, reaching 4.2% in January, Moderate growth prospects
which is the lowest rate since the collapse of the Soviet Union. To in the short term
some extent declining inflation is a consequence of the authorities not
raising taxes and tariffs, as is otherwise customary at the turn of the
year, which is probably due to the approaching presidential elections.
The world market price for oil rose to 110 dollars per barrel (Ural) and
the rouble strengthened to a degree, after weakening significantly in
mid-2011. This leaves the Russian authorities with some economic
policy room, and the central bank has continued to lower the key
interest rates, while both private and business lending continue to
expand. Together with a rising oil price and rather more positive world
economic outlook, although not in Europe, this implies that our growth
forecast from December 2011 of 3.9 % for 2012 and 3.7% for 2013 is
on the low side
Oil price and exchange rate, Jan 2005 – Jan 2012
45
160 Oil price (Ural, US$/b)
43
140 Ruble basket (EUR, USD, rs)
41
120
39
100 37
80 35
33
60
31
40
29
20 27
0 25
2005 2006 2007 2008 2009 2010 2011 2012
Source: Ecowin.
4 Swedbank Baltic Sea Analysis No. 31 • 1 March 2012

5. At the same time, the fiscal-policy imbalances are becoming more Less scope to dampen
pronounced, and today Russia does not have the same opportunities cyclical fluctuations and
to dampen a cyclical downturn as it did after the 2008-09 crisis. Then, high growth
the Russian government could use major fiscal reserves and a
substantial stimulus package to stabilise the economy, despite a large
drop in oil prices and accelerating capital flight. The stimulus
increased the budget deficit significantly, however, and excluding oil
revenue it has exceeded 10% of GDP since 2008. At the same time,
the reserve fund has shrunk, and the generous election promises will
now also exert further pressure on fiscal policy. Without austerity
measures, the budget deficit (including oil revenue) is expected to
increase from 1.3% in 2011 to approximately 5% in 2016. Even
before the election promises were made an oil price of around 110
dollars per barrel was required in order to balance the federal budget.
This means that fiscal policy must be tightened in coming years,
pushing down growth. Otherwise, Russia again risks rising inflation
and escalating budget deficits. Meanwhile, growth in payroll and
transfer expenses is crowding out other more growth-promoting
expenditure, such as investments in public infrastructure.
Fiscal balances, 2004 - 2011
(Per cent of GDP)
50
40
30
20
10
0
-10
-20
2004 2005 2006 2007 2008 2009 2010 2011
Overall balance Overall balance (excl. oil)
Revenue Expenditures
Source: IMF.
In structural terms, the Russian economy is characterised by high Reforms must be
dependence on raw materials, major state involvement in business strengthened with inde-
and industry, and weak productivity growth at company level. The pendent authorities and
ratio of exports to the overall economy is also significantly lower than media
in other growth economies, especially the BRIC countries. To boost
the Russian economy's growth potential, besides stable economy
policy and public investments, reforms are also needed to strengthen
competitiveness and the investment climate. Even though Putin, and
before him Medvedev, has often pointed to these areas, and as such
gets the analysis right, it is also very important that the advertised
reforms are actually implemented. In these respects it is important to
strengthen the rule of law and to give the courts more independence.
The role of the media is also vital to increasing transparency and
accountability. So far, Putin has not given any clear signals that he is
ready to take this path.
Swedbank Baltic Sea Analysis No. 31 • 1 March 2012 5

6. Gross domestic product, BRIC countries, 2000 - 2011
(Index 2000=100, purchasing power parity)
400
350 China
India
300
Russia
250 Brazil
200
150
100
50
0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Source: IMF.
After a period of major economic fluctuations and political turbulence High oil prices lock Russia
Russia again faces long-term growth challenges. The economic in its dependence on raw
development has lagged behind other growth economies, and without materials
extensive reforms there is a risk of permanent stagnation. Putin
identifies the right problems, but points to solutions that will lead to
continued state control of the economy, rather than more dynamic
private sector development. A major new oil price dive may be
needed in order to release the Russian economy from its dependence
on oil.
Magnus Alvesson
Economic Research Department
SE-105 34 Stockholm Swedbank Baltic Sea Analysis is published as a service to our customers.
Telephone +46-08-5859 7740 We believe that we have used reliable sources and methods in the
ek.sekr@swedbank.se preparation of the analyses reported in this publication. However, we
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ISSN 1103-4897
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