Russia's morbid addiction to resource politics

Last Friday Vladimir Putin, the Russian prime minister, addressed the Finance and Economic Development ministries calling for a “complete revision of our current obligations and a cut in ineffective and secondary spending” over the next three years.

What many Russians will be asking, however, is how in the teeth of such brutal spending cuts, Putin’s government felt able to offer a 30% discount in gas prices to the Ukraine last month.

From its low in July last year, the MSCI Russia stock index has rallied sharply, suggesting sentiment has markedly improved on the country’s prospects. It also indicates that fears over structural problems revealed by the collapse of the oil price in 2008 have been largely assuaged.

The economic picture, however, does not appear to reflect this bullish outlook. Over 2009 Russia’s GDP shrank 7.9%, its largest fall since the Soviet Union collapsed in 1991, and while it rebounded a little in the first three months of this year, the growth has so far undershot analysts’ expectations.

Despite the return to growth Alexei Kudrin, Russia’s finance minister, urged attendees at last Friday’s meeting that tackling the country’s budget deficit, which he claims will be between 5.2% and 5.4% of GDP this year, must be prioritised.

There are sound reasons for his concern. Over the crisis it is estimated that actual government spending increased 27.4% while revenues fell by 29%. Much of this reflected the collapse in the oil price, which dropped from around $140 per barrel to $35.58 in the last six months of 2008. Oil and natural gas sales account for around one quarter of the country’s total GDP.

Thus far, spending has been propped up by burning through Russia’s foreign currency reserves with a return to economic health resting predominantly on the resilience of current oil prices. Such a policy, Kudrin appeared to acknowledge, is an unsustainable one.

But what do the figures mean? Well, according to Kudrin the government should be looking to cut spending by as much as 20% by 2015, significantly reducing its social welfare commitments. In practice this will mean further reductions to programs for transportation infrastructure and spending on rural development, which were both cut by 30% at the last budget. It may also mean that the planned 36% rise in pensions may have to be scaled back.

The deal with the Ukraine, aimed at least in part to secure the position of pro-Kremlin president Viktor Yanukovich and his government, was therefore bound to prove controversial. Yanukovich claims the savings will amount to $40 billion for Ukraine’s economy over the next decade, savings that might otherwise have gone to Russia’s chronically underfunded welfare system.

To put that into context, in 2007 the average pension in Russia was 3,084 rubles per month, which amounts to some £70 in today’s terms. On these levels the discount being given to the Ukraine would amount to the equivalent of an extra month’s income for Russia’s 38.7 million pensioners.

Although in absolute terms the deal will not make a huge impact on Russia’s finances, many Russians will feel that they are being asked to shoulder a disproportionate burden for their government’s inability to wean the country off the fuel markets. While the old east/west divides may have sufficed to silence internal opposition to resource politics in the past, the Kremlin may find this time that a populace worried about their future will be harder to appease.

Events in Greece should provide a stark warning.