The Change in Command is Russia's Biggest Problem

Russian daily newspaper Moskovskiy Komsomolets (MK) recently published an article by economist Nikita Krichevskiy (professor at Russia's State Social University) on the state of the government-sponsored national projects as well as the pace, structure, and funding of the new initiatives outlined in Putin's state address in April. The Russian economist speaks highly critically of virtually all sides of the way the funding is allocated and the projects are structured, and sees major risks associated with the change in political command and direction expected in 2008.

In his address to the state, President Putin for the first time clearly mapped out the spending amounts and areas where the excess government income will flow. The amount, which has been dubbed "Putin's trillion" (for the 1 trillion rubles or about 40 billion USD of government investments) will be allocated in the following ways:

• 250 billion for reforms of the housing system (the reform itself is set to spread over five years, and given the projections for a reduced budget surplus, this figure will be the bulk of the investment into housing)
• 300 billion for the fund whose aim will be to increase the well-being of the country's residents and sponsor economic initiatives to help current and future generations. As part of the project three new organizations (government-run) will be created: Bank of Development, Investment Fund, Russian Venture Company.
• 100 billion will head toward development of highways and transportation infrastructure, which has been Russia's incurable problem
• 180 billion (!) will be directed to the soon-to-be developed Russian Nanotechnological Corporation
• 56-89 billion will head to the sponsorship of Russian fundamental science development
• 20 billion (!) will be headed toward creation of a chain of libraries and academic information centers in the name of Boris Yeltsin, who recently passed away.

These projects by themselves envision the creation of six new governmental organizations at least, whose sole goal will be to attempt to ensure proper allocation of "Putin's trillion"; another giant leap to increase Russia's already ballooning bureaucratic titan. The Russian economist mentions that the funding for the housing reform (known in Russian as the Zh.K.Kh. (ЖКХ)) will come not from the current surplus but from tighter fiscal discipline, with its excesses and side-effects, as well as with the additional sale of government property or processes similar to the one pulled on YUKOS.

The rest of the funding, according to Mr. Krichevskiy will not come from the budget surplus but will come from unexpected inflows as a result of miscalculations in the budget prognosis. The current surplus of 1.5 trillion rubles for 2007 has already been allocated to either the stabilization fund or to unexpected funding. The head of the Ministry for Economic Development and Trade, Mr. Gref, has argued that the pace of capital spending, salary, and income growth is much higher than that calculated by the Economic Ministry, whose numbers are used in the budget. Mr Gref argues that the actual growth of the GDP in 2007 will likely surpass the forecast by 1.5% at least. If the Russian economist is right this means that the new initiatives will be funded by a best-case scenario of inflows; (aka) money that has not been received so far by the government; such a best-case scenario is also very highly correlated with the the price for a barrel of oil, revenues from which make up close to half of government revenues. Thus even before the problem of who will control the capital disbursement of "Putin's trillion" becomes a problem, the sourcing of the actual capital is unclear in the first place.

Another problem that Russia is facing, along with other developed and emerging economies, is that of the pension system funding. Mr. Krichevskiy argues that despite President Putin's speech not mentioning any real problems with the state-run pension system, the fact that 13% of government income will go toward funding the country's pensioners is an unhealthy sign for the economy. Every year the absolute amount of necessary funding (now at 918 billion rubles, just under 25 billion USD) will continue to grow, and the percentage figure may grow at a higher rate as the current budget's heavy oil revenue windfalls are not guaranteed. The pessimistic scenario is not due to volatile oil prices solely, but also due to the falling level of oil generation in Russia; the massive reallocations of ownership within Russia's oil and gas industry into the government's hands has played its role in reducing the efficiency of oil companies, with high oil prices acting as of a moral hazard.

The final problem highlighted by the Russian economist is ine of responsibility for the reforms and projects. With President Putin set to leave office, his economic staff has begun to slowly question and remove some of the funding initiatives (government pension matching initiatives have been reduced to fulfill the requirements for just 700,000 workers out of the current 67 million people workforce). To mitigate the likelihood of more of these scenarios, President Putin initiated a three-year budget mechanism, which once approved for 2007 will be a strict burden for the next Russian president until 2009.

However, the approaching change in command and the loss of power of the Yelstin clan of business owners and politicians (the structure of which is still a much debated topic among Russian political analysts) is set to see a new and very aggressive battle for Russia's assets. The YUKOS affair in 2003 was just one such example, but several credible sources, including the author of the article, Nikita Krichevskiy, predict that asset wars such as YUKOS will be numerous in the years to come. These processes will trigger, in the worst case scenario, fundamental changes to the "vertical of power" that was the cornerstone of President Putin's bureaucratic reforms. Side-effects of such changes will be either the return to power of regional leaders or a further concentration of economic and political power in the hands of the Moscow or St. Petersburg clans. Economic growth and the competitiveness of Russia's key corporate giants will be severely hampered if continuing arrests, flashy trials, and at worst asset sell-offs and shady restructuring processes occur. Depending on the harshness of such actions, Russian may well see and slip back to its chaotic times of the 1990-s.