The Hindu Business Line : High oil prices and Russia’s problem of indigestion

At a time when India struggles with the soaring crude import bill, Russia’s problem is how to absorb windfall oil revenues and avoid indigestion. Just over a decade ago, oil was trading at around $10 a barrel; last week, it shot through $147 for the first time. Russia pulled ahead of Saudi Arabia in June as the world’s top crude oil producer; it has been for years the second biggest oil exporter and the biggest natural gas exporter. Petrodollars are flowing in at a breathtaking pace: Russia earns over $800 million a day from the export of oil and gas, or $560,000 every minute.

Oil windfall

The mind-boggling oil windfall has driven Russia’s impressive economic growth. Ten years ago, it was a $200-billion economy; this year it has crossed the $1.4-trillion mark. Russia’s per capita gross domestic product has quadrupled to nearly $7,000.

Today, Russia is the eighth largest economy in the world in Purchasing Power Parity (PPP), according to the World Bank. By the end of the year, it will overtake France to become the world’s sixth largest.

Last year, foreign investment surged by a factor of 2.5 to touch $100 billion — a record growth for any of the world’s 15 leading national economies.

Petrodollar glamour

Signs of newly found wealth strike the eye in Russia’s major cities. Moscow is one of the most expensive cities in the world. It is a showcase of petrodollar glamour, with world-class restaurants, nightclubs and super-expensive boutiques. Moscow has knocked off New York as the world’s top city for the number of resident billionaires.

Some analysts say that Russia is now the fourth largest consumer of luxury goods in the world, after the US, Japan and China. Moscow’s congested streets are filled with late-model BMWs, Mercedes and Bentleys. As oil wealth trickled down the other sectors of the economy, about 20 million people have been lifted out of poverty. Average earnings have been growing by around 20 per cent a year, fuelling an unprecedented consumption boom.

Mega-malls crammed with goods from all over the world are mushrooming in Russian cities. Russia has overtaken Germany this year as Europe’s biggest car market, and demand outpaces supply: Russians sometimes have to wait 12 months and more to get a car of their choice.

Energy superpower

The oil boom has brought Russia more than economic prosperity. It has made Russia an energy superpower. Restoring government control over oil and gas privatised by his predecessor, Boris Yeltsin, former President, Vladimir Putin, wielded energy resources as a modern equivalent of military power, rebuilding Russia’s global clout and influence. Moscow has consolidated its hold on oil and gas flows from Central Asia, tied Europe firmly to Russian energy supplies, and won access to Western technologies.

Russia’s economy has been growing at 6-8 per cent a year in the new century, but it has still found it hard to digest gushing cash flows. Four years ago, the government set up a Stabilisation Fund to sop up oil duties and oil extraction taxes levelled above the cut-off price of $20 per barrel.

By the end of last year, the oil fund, designed to save the energy windfall for a rainy day and to prevent it from distorting the rest of the economy, rose to $160 billion. Russia has also built up the world’s third-largest foreign exchange reserves, which have swollen from $12 billion in 2000 to over $500 billion today.

Stabilisation Fund

Even as the Stabilisation Fund helped sterilise excessive cash, it has been widely criticised for failing to address the strategic goal of diversifying Russian economy away from overdependence on oil and gas. More than 60 per cent of federal budget revenues still come from oil and gas taxes.

Over two-thirds of the value of exports is earned from the products of extractive industries, and the share of extractive industries in the nation’s gross domestic product is closer to 25 per cent.

Before stepping down as President and taking over as Prime Minister in May, Mr Putin unveiled an ambitious programme of petrodollar-driven modernisation to transform Russia from a resources-dependent to a science-based economy by 2020.

Russia has split its oil Stabilisation Fund into a Reserve Fund, which will cushion the budget from a fall in oil prices, and a National Wealth Fund (NWF) earmarked for investment.

With the Reserve Fund expected to reach its limit of 10 per cent of the GDP before the end of the year, the bulk of oil revenues, which have jumped 70 per cent this year, will flow into the NWF, opening vast possibilities for investment.

Ambitious programme

Russia is funnelling billions of petrodollars into the establishment of “national champions” — vertically integrated state-controlled holding companies to spearhead growth in hi-tech industries, such as nanotechnologies, aviation, shipbuilding and nuclear energy. The government has launched an ambitious programme to set up a network of technoparks, largely modelled on India’s Silicon Valley in Bangalore Mr Putin visited in 2004.

The government also announced plans to sharply raise its spending in basic infrastructure. In May, it unveiled Russia’s largest spending project since the collapse of the Soviet Union, a $570-billion programme to develop road, rail, air and port facilities until 2015. Outdated transport infrastructure is a “brake on the economy,” Mr Putin said.

Biggest challenge

The biggest challenge is to manage this spending without fuelling the already rapidly rising inflation. Driven by global food and energy prices, the Russian inflation rate rose to a more-than five-year high of 15.1 per cent in May, although the government hopes to bring it down to 10.5 per cent by the end of the year.

The Russian Central Bank has raised key interest rate three times this year in an effort to keep down the inflation. The Finance Minister, Mr Alexei Kudrin, said there were “strong signs” the economy was overheating, and vowed to take a series of measures, including curbs on spending, to bring the inflation rate down to 6 per cent before 2011. However, the Prime Minister, Mr Putin, champions the idea of pouring more money into the economy while the going is good to lay solid foundations for dynamic growth in the future when the oil boom comes to an end.