Russia 090421 Basic Political Developments

Q1 Jobless Rate Hits 8-Year High Of 9.5%

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Q1 Jobless Rate Hits 8-Year High Of 9.5%
21 April 2009 Reuters
Some 1.8 million Russians lost their jobs in the first three months of 2009, taking the jobless rate to an eight-year high, data showed Monday, in a sign that it may be too soon to talk about the bottoming of the crisis.

The State Statistics Service did not give a monthly breakdown for the jobless data, but according to Reuters calculations unemployment hit 11.9 percent in March, from 8.5 percent in February, assuming that the previous data were unrevised.

Officials had been saying the worst of the crisis may be over for Russia, taking heart from higher global oil prices, a stabilization of the ruble and a recovery in domestic stocks.

But with retail sales, real wages and capital investment all falling sharper than expected in March, the data suggest that Russia's first economic contraction in a decade is still in full swing.

"We see this data as an indication that ... the decline is starting to spread to consumer demand, and it will continue to pressure the economy over the next several quarters at least," said Vladimir Osakovsky, an analyst at UniCredit.

"Overall, I think the data really calls for an interest-rate cut in Russia, and possibly some weakening of the ruble, to help exporters and the domestic economy in general."

The releases come as the Finance Ministry frets that a deeper-than-expected slowdown could slash budget revenues by a further 800 billion rubles ($23.9 billion) this year, taking the budget deficit to 10 percent of gross domestic product.

The government expects a contraction of just 2.2 percent in 2009, but international organizations and think tanks have said the slowdown could be at least twice as sharp.

At 7.1 million, the number of unemployed is already more than a million higher than the Economic Development Ministry forecasts for 2009 as a whole, as companies slash jobs in the face of falling global and domestic demand and the inability to attract fresh financing.

"Unemployment is coming up much sharper than I was expecting, so I am considering revising my forecast of 12 percent for year-end," said Elina Ribakova, an economist at Citi.

Retail sales fell for the second consecutive month year on year in March after slipping into the red for the first time since September 1999 in February.

One glimmer of hope came from housing construction, which recovered sharply from a one-year low in February, traditionally the worst month for the sector. The figures brought completed housing in the first quarter to 10.4 million square meters, a 2.4 percent gain year on year.

A presidential adviser on Monday forecast that the economy could start to recover in six months once demand picks up in China and other countries.

"We are an export-oriented economy. The drivers of growth, the variables, are outside of Russia, which makes it dependent on the global situation more than others," Igor Yurgens, chairman of the Institute of Contemporary Development, said in an interview.

COMMENT: Strengths and weaknesses of Russia's anti-crisis plan
Vladimir Tikhomirov of Uralsib
April 21, 2009

The approval by the Duma of the Russian cabinet's new anti-crisis programme on April 15 marks the end of a lengthy three-month period of debates within the government about the ways and means to tackle the deepening economic crisis. The new anti-crisis programmeme and the revised budget do not imply any immediate gains for the stock market or the investment community. Their strategic importance lies in the preservation of political and social stability - the major objective of both documents. Banks are the only sector of economy set to benefit from increased state funding, at the expense of significant cuts to spending plans in other areas, most notably state investment.

The pros of Russian government policy:
• Big reserves help to soften the negative impact of the crisis;
• Stability is not under threat as the government is firmly in control;
• Drive for reform grows stronger during periods of crisis.

The cons of Russian government policy:

• Russia is still a petro-economy;
• Heavy private debt burden is a major headache in tight credit markets;
• Over-centralization has blocked the development of a competitive economy.

Why the new programmeme?

• This programmeme is part of a political showdown, but is also driven by the need to save state funds;
• Systemic approach replaces initial piecemeal response to the crisis.

The new anti-crisis plan has four priorities: social policy, state companies, SMEs and banks. However, banks are set to get the largest slice of the new funds (48%) followed by social spending (15%) and tax cuts and rebates (14%).

2009 budget – from surplus to deficit

All budget items have been cut, except two. The revised federal budget will provide the bulk (55%) of funding for the new anti-crisis programme. To accommodate new spending needs, budget expenditures have been increased by 7.4% and spending priorities have been changed. Spending on the economy has been boosted by 62% and regional subsidies by 16%. All other budgetary spending items have been cut with the biggest falls recorded for spending on infrastructure, the civil service defence and law enforcement.

The drafting of the new programme and the accompanying revision of the 2009 federal budget law was completed at the end of March and in early April both documents were formally approved by the cabinet. As expected, the Duma made only minor cosmetic changes to these documents.

The upper chamber of the Russian parliament, the Federation Council, will start debating both documents and we expect that by the end of April, the programme and the revised budget will be signed into law by President Dmitry Medvedev.

Pros and cons of the policies

The drivers and dynamics of the economic crisis in Russia and the evolution of government's response to this crisis have once again underlined all the major strengths and weaknesses of the domestic economy. The quick deterioration of the economic situation in Russia between September and December demonstrated that, despite nine years of strong growth, the economy hasn't changed that much: it still remains the same petro-economy that it was before.

The crisis has revealed that all the talk about the decoupling of the Russian economy from its heavy reliance on commodity exports and growing dependence on domestic growth drivers were nothing but wishful thinking. As soon as oil export revenues started to fall, government finances immediately came under pressure, capital outflows increased and the incomes of the general population plunged. What clearly made things worse was the increased reliance of Russian companies and banks on foreign loans: a phenomenon that existed in the past as well (heavy public indebtedness characterized the late Soviet and early post- Soviet governments in Russia).

Dependence on oil revenues, multiplied by swollen private sector foreign debt has shown how small and limited reforms in Russia were. This is perhaps one of the biggest fundamental weaknesses that the crisis has helped to reveal. As the crisis evolved, it became clear that another major setback to the economic policies of the government was the belief that the state is capable of managing the many imbalances within the economy. Over-concentration of economic and financial power in the hands of the state soared when the crisis hit, as virtually all of Russia's largest companies lined up for government aid. It took less than three months for the cabinet to realize that its own resources - no matter how large they seemed in the past - are limited and, in fact, very limited.

Despite these negative features, the crisis has also demonstrated some extremely important positive shifts in Russia's economic policy that took place under Vladimir Putin. Undoubtedly, the key positive factor was the level of government preparedness for the crisis, which was unprecedented in Russian history. All the years spent scrupulously building up state reserves definitely paid off and so far the government has easily managed to retain control over social and economic development without undermining financial or political stability. While it still remains to be seen just how long this fragile balance can be maintained, there is no doubt that this crisis will have a far less detrimental effect on the living standards of the Russian population than any other comparable crisis in modern history.

Another positive development from this crisis is a sincere return to the implementation of the reform agenda by the Russian ruling elite. As during all previous crises, this crisis has given a powerful impetus to reform. Just like 10 or 20 years ago, Russia is once again being given a chance to reform and modernize. And we are confident that this chance is not going to be missed, even if it is unlikely that it will be fully taken advantage of. Hopes are strong that over the next few years we will see the Russian economy become less centralized, better managed, alongside lower levels of state intervention. The levels of trust between the government and the business community are likely to grow and the longstanding hostility to foreign investors should weaken. This crisis opens up a plethora of reform opportunities and even if only a few of these are taken advantage of, in a few years time Russia is likely to emerge as a far better place to live and do business than it is now.

Why the new programme?

Like many similar policy documents drafted in other countries, Russia's anti-crisis package is primarily supposed to have a psychological and political effect, ie. to demonstrate to the electorate that the government has contingency plans and is staying one step ahead of the crisis. However, the economic effectiveness of the anti-crisis programme is a completely different matter, and we do have doubts over the practicality and impact of some of the measures included in the programme.

The main reason why the government decided to come up with a more systematic approach to tackling the crisis - in contrast to the initial piecemeal anti-crisis measures since last autumn - is that it has felt increasingly overwhelmed by rapid growth in the number of requests for aid from various quarters: the regions, businesses, trade unions, political parties, powerful lobbying groups, etc.

This new demand for funds has significantly scaled down the size of available government funds. This realization occurred around early December and, not surprisingly, coincided with a shift in Central Bank of Russia's exchange rate policy when defending of the stability of the ruble was no longer seen as a plausible and practical response to the rise in capital outflows.

The managed devaluation of the ruble, which took place between early December and late January, was no doubt one of the most important components of the new anti-crisis plan. The other component was an introduction of a differentiated approach to the selection of possible recipients of state aid. The shift to this new approach started with the so-called list of strategic enterprises in late December. The practicality of publishing such lists, however, is unclear. By issuing blank cheques for guaranteed state bailouts to Russia's major companies, the government was de facto substituting company management and giving it protection from the mistakes it made in the past.

The above explains why the December strategic list has so far failed to play a significant role in anti-crisis management in Russia and is unlikely to do so in the future. Instead, the cabinet decided to opt for a case-by-case approach and set clear limits on the total aid package available. The need for this was also prompted by the fact that by January-February it had become clear that the crisis was likely to last for months and years rather than weeks, which means that the demand for state support could remain acute over one-two years or perhaps even longer.

The new plan

The result of this evolution in the government's approach to the crisis is a systematic anti-crisis plan that sets caps on state spending and clearly identifies sources of state aid. Uncertainties about the length and depth of the current crisis forced the cabinet to significantly scale-back their initial reliance on spending reserves. A large chunk of funding for the new anti-crisis programme should be covered by the budget by way of reallocation of government spending priorities and the 2009 spending cap for the Cabinet's Reserve Fund has been set at RUB2.7 trillion or 55% of the total volume of the Fund as at March 1, 2009.

The total value of the new anti-crisis programme amounts to RUB2.923 trillion, which is almost the same amount that the government said it had already spent since the start of the crisis last fall (RUB2.937 trillion). In all, 55% of the announced new spending is planned to come from the federal budget (RUB1.611 trillion) while the remainder will either come in financial form from other state agencies (central bank, VEB, etc.) or in the form of non-financial aid, ie. tax reductions, cuts in credit rates, etc.

The priorities have also changed with the adoption of the new programme. During the first stage of the crisis in October-November, the Russian government put the main emphasis on the provision of financial aid to banks and non-financial companies, most of which struggled in rolling over their foreign debts. While no defaults on foreign debt were recorded, this has cost the government and CBR reserves dearly. In the new programme the cabinet has shifted the priority from providing financial packages directly to companies and banks to supporting social spending, state enterprises, small businesses and banks. A big part of the spending will also go towards covering growing deficits in regional budgets, but a lot of this money will be spent on social programmes and state employees anyway. Agriculture, transport (railways and air carriers), housing and car industries are among planned recipients of this new state support.

Financial sector will get half of the new funding. Of the total volume of spending set out in the new programme the largest share (48%) will go to banks. However, in contrast to previously provided state aid, this money will be tied in to certain spending priorities: mortgages, low-rate loans to the agriculture and defence industry, etc. The next largest chunk in the new programme will go to increased social spending on unemployment benefits, job creation programmes and pensions (15%). The government estimates that the combined effect of its tax initiatives will contribute some 14% to the total new anti-crisis spending. These include changes in amortization rules, reduction of profit tax, rebates on new house purchases, etc. Direct spending on the economy comprises some 8% of the new programme while federal support to regional budgets accounts for 10%.

Conclusion – stability likely to be preserved

The new anti-crisis programme and the revised budget do not imply any immediate gains for the stock market or for the investment community. Their strategic importance lies more in the long term rather than short term. We believe that both documents are capable of ensuring that social and economic stability in Russia is maintained: a factor the significance of which is hard to underestimate given Russia's high levels of dependence on the dynamics of external markets (commodities, credit).

We believe that the possibility of a destabilization of the social and/or political situation in Russia remains very low, even though there are clear signs that economic development in some of the country's major industries and regions will continue to remain exceptionally weak.

Another important conclusion that can be drawn from both documents relates to the future of the Russian banking sector. Almost half of the total funds to be provided by the anti-crisis programme will be directed towards stabilizing and supporting the banking system. This makes it abundantly clear that financial stability is still regarded by the government as one of its key priorities. While the across-the-board support to the sector characterized by early anti-crisis measures is now likely be replaced by a more in-depth and selective approach, we remain confident that Russia's banking system will survive the crisis and, moreover, that during the post-crisis period it will emerge more effective, flexible and transparent.

Perhaps the biggest disappointment that some may feel after reviewing the new anti-crisis documents is that they lack any clear-cut statement about the government's plans in the investment and infrastructure areas. Ever since the crisis started to spread last autumn, we were among those who warned that bets on continued high capex spending by the Russian state as a means of weathering the crisis were bound to be short-lived as there will simply not be enough funds in government coffers. To our regret we were proved right, and investment programmes have suffered the largest cuts in the new budget. That said, this seems to be the right choice, as the cabinet was forced to choose between social and political stability and growth and investment. Nonetheless, this factor is certain to make the current slowdown in economic activity deeper and the future recovery more protracted.

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