November 13, 2001
A Russian Revival?
The lead editorial in the November 12, 2001, issue of The Wall Street Journal is entitled "A Russian Revival." Russia's revival, according to the Journal, is due largely to its refusing fresh IMF assistance and advice. Russia's recent growth, says the Journal, stems from its rediscovery of the Laffer Curve; in particular, cuts in tax rates with promises of more rate reductions to come, along with the right to buy and sell urban land. "Of course," writes the Journal, "rising oil production, and the resulting tax revenues, have also helped." Russians are beginning to invest in their own country. What remains is to develop a national banking system, dependable rule of law, and surmounting a legacy of default.
Normally, we do not comment on newspaper editorials. The editorial reflects a new consensus that is emerging in the financial press, investment houses, and the academic community. In this case, our disagreement with the Journal on the sources of Russia's revival and what is becoming "the second Russian boom" school of thought warrants a reply.
Our first area of disagreement is with the notion that Russia's recent growth is due to its refusal to accept IMF advice. Nothing could be further from the truth. In fact, the IMF's recent report on Russia's economy was in lockstep agreement with Russia's government. The IMF praised Russia for weakening the ruble to prevent its real appreciation, thereby protecting the recent increase in domestic industrial production (see our article, "The New IMF Orthodoxy for Russia is the Old Protectionism for Africa"). A second area of praise was the easing of capital account exchange control. The Duma enacted legislation that reduced from 75% to 50% the percentage of foreign earnings that exporters must repatriate and convert to rubles, a policy that was imposed by the Central Bank. The IMF and Russian government fully agree on the need to develop a real banking system, improve corporate governance, and so forth. The IMF is not urging Russia to raise tax rates or cut spending, which is the typical "austerity" regime of the IMF that the Journal routinely criticizes.
Our second area of disagreement is with the notion that "Of course, rising oil production, and the resulting tax revenues, have also helped." This is a gross understatement. We have argued in numerous articles that higher energy prices, not higher production, coupled with the Central Bank's policy of mandatory repatriation of export revenue, are the primary causes of Russia's growth. Oil output has indeed risen from the average 295 million metric tons (MMT) (5.9 million barrels per day) in 199599 to 313 MMT (6.26 b/d) in 2000 to an estimated 335 MMT (6.7 b/d) in 2001. This is roughly in line with overall economic growth. But oil accounts for only about 10 percent of Russia's GDP. The indirect impact of rising revenues from oil exports, and hence the indirect impact of high world oil prices, is the key issue. Oil prices shot up from $10 to $30 a barrel in 2000, sharply raising export earnings. Mandated repatriation of oil export revenues accelerated payments in the economy, which fueled economic growth. (This argument, with evidence, was most recently articulated in "Bush and Putin at the Ranch.")
The fiscal significance of high oil prices, in conjunction with mandated repatriation of revenues, is even more apparent. Russia exports about 130 MMT (2.6 b/d) of oil per year. A $1 change in the price of a barrel of oil is worth $1 billion in export revenues (there are 7.3 barrels in one million metric tons). This is about R30 billion—enough to pay off the entire stock of payroll arrears in Russia. The fall in the price of Russian crude oil from $25 per barrel to $15 per barrel is worth R300 billion. This is equivalent to 20 percent of Russia's federal budget revenues, which run about R1.5 trillion in the current and next fiscal year. A loss of a big fraction of this amount is sufficient to reverse a small federal budget surplus into a significant deficit. Servicing external debt payments in 2002 and especially in 2003 becomes tenuous. This is why the Russian government has started recently to make inquiries with the IMF about a possible future loan and with foreign creditors about a possible debt restructuring. Moving in the near future from a temporary revival to a near-default, on the backdrop of a resumed contraction, is just the question of price. The price of oil, that is.
We have, here, two rival policy positions. Our view is that if oil prices decline and remain low, and the new, lower repatriation requirement remains in place, growth will slow or revert to contraction. The other view is that more free-market reforms (e.g., further tax-rate cuts, more privatization) will sustain growth. We invite readers to judge the relative merits of these competing hypotheses.