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11 June, 2014

Feigned Triumph or Concealed Capitulation

Russian leaders are certain their country will easily weather Western sanctions. Business disagrees

The XVIII St. Petersburg International Economic Forum (SPIEF), which closed on 24 May 2014, was not a great success. SPIEF has become a widely recognized platform for discussing regional and world trends and has welcomed 20 heads of state (some on multiple occasions) over 18 years. In 2013, Vladimir Putin was joined by German Chancellor Angela Merkel and Dutch Prime Minister Mark Rutte, while this year he had to go it alone trying to convince the world business community that Western sanctions will not have much effect on Russia and that his country had bright prospects of rapid growth. Ultimately, he was unconvincing. SPIEF was lower-profile than last year – not only because Putin was the only head of state in attendance but also because 20% of foreign guests did not come. This is according to guest lists. Journalists working for the Dozhd TV channel claimed that, in fact, some 40% of foreign invitees declined. At the same time, the forum attracted slightly more foreigners who work in subsidiary companies that Western businesses have in Russia, but since their businesses already operate in Russia, they were likely more interested in the geopolitical, rather than economic, prospects and scenarios for the Russian Federation.  Together with Russian businessmen and an army of officials who were invited in order to fill all the empty seats, they hoped that Putin’s address would answer many questions. However, it made an ambiguous impression, polarizing the audience.

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Putin’s address

This was the key event at the forum. Putin was his usual self. He expounded his “truth” about the current geopolitical process, on multiple occasions pointing out that the global community ignored Russia’s “legitimate interests”. In his opinion, a unipolar model of the world has exhausted itself. In this, China’s Vice President Li Yuanchao supported him, saying in his address that a transition to a multipolar model was necessary. Indeed, it seems inevitable that several political centres will emerge across the globe, but they are likely to be formed around countries that themselves have good prospects for the growth of the economy, society and individuals and will create similar opportunities for others. If the world order was in the slightest degree dependent on an authoritarian country which curtails the rights and freedoms even of its own citizens, this would lead to a global uprising of free people, eventually turning into the Third World War. The events in Ukraine, where the Kremlin is trying to influence citizens who have liberated themselves, are a prime case in point. Thus, Russia’s aspirations to geopolitical leadership, something Putin hinted at, appear to be unnatural and unconvincing, especially to the business community which knows for certain everything there is to know about how developed Russia’s economy really is.

Commenting on the events in Ukraine, Putin stressed several times that a state coup took place there to overthrow and possibly eliminate the “legitimate” president, Viktor Yanukovych. And not a word on the people who stood for two months, regularly booing proposals voiced by opposition leaders, before events took a radical turn. Not a word about Russia’s FSB men who whispered into Yanukovych’s ear trying to sway him in favour of bloody suppression of the Maidan. Not a word about other aspects of the Ukrainian revolution that are unpleasant to the Kremlin. This is what Putin’s “truth” is – complete disregard for ordinary people, whose individual development defines the power of any state and lays the foundation for geopolitical aspirations.

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Speaking on economic issues, the Russian president acknowledged that the sanctions imposed by the developed world did affect Russia’s economy. However, he pretended not to understand the rationale behind them, suggesting that the Kremlin only wanted its interests to be taken into consideration. In Putin’s opinion, the impact of the sanctions will be temporary, while the proposed measures to stimulate the economy will completely eliminate the adverse effect and will secure rapid growth for Russian business in the medium-term perspective. Putin even attempted a joke about how the restrictions were applied against his friends, “two Jews and one Ukrainian”, who allegedly had nothing to do with the events in Ukraine and Crimea and “transferred all their money to Russia even before the sanctions were introduced” anyway. These jokes came across as grotesque against the backdrop of weak tools suggested for economic growth which, as Russian analysts observed, have been copied from one address to another for three years now.

Putin clearly identified the key economic problem today – the deficit of financing resulting from the sanctions. His recipe for dealing with it appeared adequate and multifaceted. It included the introduction of project financing in industry at a rate one per cent above the inflation rate, greater capitalization of systemically important Russian banks, budget financing of a technological upgrade of the economy, channelling money from the National Wealth Fund into the construction of infrastructure objects and government-backed loans for selected investment projects. However, all these elements converge on the federal budget, and it remains an open question where Putin is going to obtain money from if developed countries limit the purchases of Russian oil and gas, protected budget articles continue to account for a large part of Russia’s budget and the agreement signed with China absorbs a sky-high USD 55bn in investments. Tested standard answers to this question – simplifying the launching and management of businesses and import replacement policy, which seems to suggest Moscow is gearing up for isolation – were not convincing.

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Economic realities

In general, the audience reacted with scepticism to Putin’s courting address but turned out to be polarized. According to some forum participants, Putin was applauded about a dozen times in 2013 but only once or twice this year. Even though Russian officials were, as always, ecstatic about his statements and constantly beamed with joy behind the scenes, businessmen were more pessimistically minded.

Their gloomy sentiments are justified by macroeconomic trends. The money deficit is ubiquitous in Russia. First, the interbank rate grew from 6.7-7% last year to nearly 9% in May 2014. In the meantime, the Bank of Russia raised its interest rate twice – from 5.5 to 7.0 and then to 7.5%. The yield of ten-year federal bonds also jumped from 6.5-7% last year to 8.5-9% in March-May 2014. Second, in March month-on-month money supply fell for the first time since 1998. Given the devaluation of the rouble, this means that deposits are shrinking in Russian banks – the Russians are withdrawing their money from banks, possibly converting it into hard currency. This leads to increasing requirements that banks set before businesses and the population (mostly when issuing loans). Third, capital is fleeing from Russia in large amounts (see Capital flight from Russia). According to an estimate of the central bank, net capital outflow from Russia in Q1’2014 was nearly USD 64bn, which is more than in all of 2013. The events in Crimea and the Donbas erupted only in late February 2014. If this trend persists, some USD 200bn may leave Russia, according to Russian experts over the year 2014, causing its foreign-exchange reserves to fall 40%. Even the strict government-imposed limitations on dubious transactions used to transfer money to offshore accounts will not be of much help. Coupled with third-stage sectoral sanctions against Russia, this kind of capital flight may hamstring the federal budget so much that it will have a hard time making social payments to the population, to say nothing of large-scale investment projects like building the infrastructure to export natural gas to China.

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It is not surprising that a number of investment bankers were reported by Russian journalists as comparing that SPIEF 2014 to SPIEF 2008 when large business had misgivings of an imminent economic crisis. Their gut feelings are likely to come true to a larger or smaller extent this time around.

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