Mon | Oct 22, 2018

Walter Molano | Russia: The benefits of discipline

Published:Friday | August 31, 2018 | 12:00 AM
President of Russia, Vladimir Putin. (AP)

Academic economists often debate the merits of dictatorships.

These politically incorrect debates are usually relegated to academic conferences, and often occur behind closed doors. Examples, such as China, Singapore and Pinochet-era Chile, are touted as examples where totalitarian regimes provided the leadership needed to push through painful economic reforms, without pushback from the parts of the society that suffered from the adjustment process.

This is not to say that economists are in favour of dictatorships. In reality, examples of economic success among dictatorships are the exception, not the norm. These regimes are usually plagued with rampant corruption, mismanagement and cronyism. Venezuela, North Korea and Zimbabwe are three very salient examples.

Russia is not a paradigm of democracy. However, it can be commended for its economic discipline and its ability to weather a tough international environment of volatile energy prices and punitive trade sanctions.

The three pillars of Russia's economic stability is fiscal discipline, a floating exchange rate regime and a well-capitalised financial system. This year, the government is expected to post a primary fiscal surplus of 0.6 per cent of GDP. This is a vast improvement from the 1.7 per cent deficit that was posted last year.

Discipline and stability

A good part of the improvement was due to the sharp increase in international oil prices. However, some of the improvement was offset by Russia's decision to trim production levels in order to bolster international prices.

The modification of the government's fiscal rule has added to the degree of discipline and stability across government spending programmes.

Moscow established a fixed oil price target, which allowed the government to save any excess earnings. This prevents wild swings in fiscal expenditures. The current target level is US$50 per barrel. The reason it's so low is, Moscow believes oil prices will trend lower due to the development of alternative energy sources, such as renewables and shale. Another measure to keep a lid on government expenses was last month's announcement that the retirement age was raised from 60 to 65 for men and 55 to 63 for women.

Although unpopular, the measure would have produced a severe public backlash in other democracies, such as Argentina and Brazil, which probably would have brought the governments to their knees. However, it produced only a handful of street protests in Russia.

[On Wednesday, faced with a dip in approval ratings, President Vladimir Putin announced a concession the retirement age for women would move to 60 instead of 63].

There was a second reason for the increase in retirement age. Russia has a negative population growth, and an increase in the retirement age will help boost the shrinking labour force.

The high degree of fiscal discipline is one of the reasons why Russia has been able to reduce its inflation rate, despite a highly volatile exchange rate. Russia's inflation rate has dropped to four per cent, about a third of what it was just a few years ago. The central bank is fully committed to its floating exchange rate regime, as well as its inflation targeting policies.

Unlike Argentina, which reacts hysterically to any devaluation of the peso, the Russian rouble moves up and down without triggering political and social backlashes. Another important factor is the central bank's tight oversight of the domestic banking system.

Over the course of the past decade, Russia has undergone an important consolidation of its financial sector, eliminating weak institutions and forcing mergers of medium-sized banks. The result has been the emergence of a well-capitalised financial system, with strong government support, that has been able to withstand the volatility in oil prices and the withering effects of international sanctions.

The high level of economic discipline has allowed the country to post an impressive array of economic indicators, including a debt-to-GDP ratio of 22 per cent, a current account surplus of 3.6 per cent of GDP and international reserves of US$420 billion.

A recent trip to Russia revealed a buoyant consumer economy, with elegant malls cropping up along the major thoroughfares, a fleet of new cars grazing the highways and recently inaugurated public works to improve quality of life. This is the reason public support for Putin remains relatively high despite his authoritarian approach. Depending on the polling institution, his support ranges between 42 per cent and 70 per cent.

Russia's high level of discipline was instilled through several decades of hard knocks and painful lessons. The crisis of 1998, which found the country high-levered and with a weak financial system, left a set of important lessons that the government took to heart.

Unlike other countries, such as Argentina, which repeat the same mistakes time and time again, Russia was able to pick itself up and not repeat them again. Many economists believe that an economic authoritarian regime can coordinate painful reforms that benefit everyone in the medium and long run.

- Dr Walter T. Molano is a managing partner and the head of research at BCP Securities LLC.

wmolano@bcpsecurities.com