Kudrin’s warning


Russia's ruling tandem have hung their economic policy high up on a mast: oil prices will hold, they say … and, well, even if they do drop, dwindling reserves should just about cover it. As ex-Finance Minister Kudrin realised, this is a foolish game that runs the risk of total catastrophe, writes Dmitry Travin.

Dmitry Travin
28 October 2011

In Russia there is a romantic legend about so-called Russian roulette. It says that back in Tsarist times officers, holding their lives cheap, would play the following ‘game’ together. They would take a six-chambered revolver, put one bullet in it, twirl the barrel round several times and then each in turn would put the gun to his own head and pull the trigger. Obviously, if there were six players one would always lose.

There are no historical sources that confirm the popularity of this ‘game’  among Russian officers; however, the legend fits well with traditional ideas of Russia as a place where things were always so bad that people were happy to lose their lives.

Today’s Russian ruling tandem, President Dmitry Medvedev and Premier Vladimir Putin (who after the March 2012 elections will swap places) are playing a game with the country’s economy that is very reminiscent of Russian roulette. They intend to conduct a financial policy so risky that economic survival will depend on continuing very high prices for oil, the export of which will guarantee  a large inflow of foreign currency. It was in fact fundamental disagreements about financial policy that led to the recent resignation of Finance Minister  Alexey Kudrin, who for 11 years was Putin’s right hand man in economic matters.

The leading Russian newspaper ‘Kommersant’ recently published  an article (link in Russian) by Kudrin in which he gave a detailed analysis of his disagreements with the tandem. It is no longer possible to claim, as many commentators were still doing quite recently,  that the minister’s resignation was impulsive or emotional, and arose out of pique that Medvedev, and not Kudrin himself, would be offered the post of Prime Minister after the presidential elections. Whatever emotions were present in all this story, the existence of fundamental strategic differences can no longer be concealed. And the future of Russia’s economy depends on the direction taken by its financial policies, and not on anyone’s personal ambitions.

Recent Russian history has already seen one instance of a Finance Minister resigning over policy differences with the President and Premier: Boris Fyodorov in 1994. Fyodorov argued strenuously for budget savings at a time when President Yeltsin was pushing for the simple expedient of printing more money to cover the budget deficit. The result of Russia’s living beyond its means was soaring inflation and the consequent collapse of the country’s entire economy.


President Medvedev's insistence on a programme of increasing social and military expenditure led to a public fall-out with then Finance Minister Alexei Kudrin. Photo: kremlin.ru

Realising that the parliamentary elections of 1993 would not result in a government led by the ‘Russia’s Choice’ reformist bloc, and that there was therefore no hope of a hard line on spending, Fyodorov resigned. Nine months later came the infamous ‘Black Tuesday’, when the rouble lost a third of its value on the exchange market, confirming that the incompetent Prime Minister, Viktor Chernomyrdin, and Victor Gerashchenko, the Head of Tsentrobank, were much mistaken when they imagined that printing money was a panacea against all economic ills. 

The present situation with Kudrin has much in common with that of Fyodorov seventeen years ago. A Finance minister resigns because the country is living beyond its means. He notes that a number of recent bad decisions have led to significant rises in government expenditure.  A case in point is the proposed rapid increase in teachers’ salaries, to bring them up to the level of incomes in the commercial sector, a luxury that only a few of the world’s richest economies can afford. Pensions are also rising steeply, especially given that the retirement age in Russia is one of the lowest in the world (60 for men and 55 for women).  But the rises in teachers’ pay and pensions pale into insignificance beside the huge rearmament programme and increase in officers’ pay, probably a Medvedev initiative, which particularly aroused Kudrin’s antagonism towards his financial policies.  

‘Up until now Putin has in fact been amazingly fortunate, with a favourable economic climate, a weak, splintered opposition and the incredible servility of the Russian population, which tolerates barefaced official corruption. But let’s suppose that Putin’s luck runs out this time. What will harsh budget cuts mean if oil prices do drop and the reserves do not last long?’

There is, however, one crucial difference between the circumstances in which Kudrin and Fyodorov handed in their resignations. Nowadays Tsentrobank, headed by Sergey Ignatiev, acts in a responsible fashion, and so Russia is not about to be reduced to printing money, with the acceleration of inflation rates that can result. If no one listens to Kudrin, and the present growth in expenditure is not curbed, it will once more have disastrous consequences, but not quite on the scale of 1994.

Medvedev and Putin may have spent hours in front of the television cameras in the last couple of months, publicising their policies and answering all manner of questions, but not once have they actually tackled one obvious issue: what will happen to Russia’s public purse if oil prices plummet again. Kudrin notes in his article that if this were to happen, the government’s expenditure would inevitably exceed its income. This is actually what took place during the crisis of 2008-9, when the budget deficit was covered by the reserve fund set up by Kudrin in more prosperous times. As a result recovery was considerably easier than many expected in the summer of 2008.

Putin and Medvedev are probably relying on a similarly easy recovery from any possible future crisis. However, Kudrin reminds us that the residue of the reserve fund will be used up within a year, after which drastic cuts in expenditure will be unavoidable. These cuts will add up to the approximate cost of all government expenditure on education, health and culture, plus half of the present federal government subsidy to the regions.

So it appears that the tandem’s understanding of the future of the Russian economy can be summed up very easily: with any luck, oil prices will hold up, and if they drop, it’ll just be for a year or so, like the last time, and the reserves will just about cover it.

This approach might turn out to be workable. But it does remind one of Russian roulette. There is too great a risk of total catastrophe if the crisis is a serious one.

‘It is fatal to promise the impossible. And if the tandem does not change its financial policy, then, were Russia to be hit by unfavourable developments on the oil market, it might be too late for it to change course.’

In his many years in the cockpit, both alone and in tandem, Putin seems to have come to the conclusion that luck will always be on his side. Up until now he has in fact been amazingly fortunate, with a favourable economic climate, a weak, splintered opposition and the incredible servility of the Russian population, which tolerates barefaced official corruption.  In the course of one televised ‘meeting with the people’ Putin was asked whether he was ‘a jammy bugger’, and answered, only half joking, that he was.  

But let’s suppose that Putin’s luck runs out this time. What will harsh budget cuts mean if oil prices do drop and the reserves do not last long. We know from the experience of the 90s how people react when government handouts, which they have grown to rely on, disappear. When the transition to a market economy led to a significant drop in people’s living standards, the mass of the population refused to believe that this was a result not of the reforms, but of the general deterioration of the Soviet economic system, which prioritised the production of missiles above goods needed by ordinary people. The man and woman in the street had no interest in the objective difficulties connected with reform and came to the conclusion that the reformers were simply stealing the people’s money.

It is fatal to promise the impossible. And if the tandem does not change its financial policy, then, were Russia to be hit by unfavourable developments on the oil market, it might be too late for it to change course. In a crisis situation Putin is unlikely to tell people, ‘The money has run out, so we are cutting teachers’ pay, raising the retirement age and cutting off finance for the construction of warships and fighter jets that are already in production.’  

Putin will be unable to cut his inflated expenditure even in a crisis. But what is the alternative to spending cuts in a crisis situation? Kudrin believes there is only one: an increase in taxation (including the worst possible: an inflation tax). Theoretically, of course, he could have recourse to loans; fortunately Russia’s national debt is much lower in relation to GDP than those of Greece, Italy, Spain and many other western countries.  But two problems could arise here.

Firstly, extending credit to Russia could be considered a too risky, since much of our debt is tied up with large state-owned and quasi state-owned companies which the tandem would probably want to save. So that effectively our national debt (including corporate debt) is sufficiently large for the market to refuse to provide favourable credit facilities.

Secondly, after all that has been happening in the Eurozone, any provision of credit will entail a simultaneous cut in expenditure. Otherwise lending to Russia will again be considered too risky. So going for loans in a crisis situation is not an alternative to cutting spending. Spending will need to be cut in any case, but Putin and Medvedev are unlikely to agree to it.

In other words, if things turn nasty Putin and Medvedev’s present financial course can have only one outcome: higher taxes. Indeed there has recently been a certain reassessment, for the worse, of Kudrin’s own tax policies: ten years ago it was he who was responsible for a considerable easing of tax on businesses. 

Raising taxes is also likely to spark an adverse reaction from Russian business owners, who are already actively moving capital out of Russia, as well as from potential foreign investors, who are unlikely to invest money in Russian business if the financial prospects are unfavourable.  

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