Medvedev's Oil Curse

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The emergence of First Deputy Prime Minister Dmitry Medvedev as the long-awaited successor puts to rest ominous speculation about President Vladimir Putin's real intensions. The consensus in Moscow seems to have been accurate. Even though he probably has few scruples about changing the country's Constitution and could have easily won a third term in office, Putin is determined to step down and take on a still-visible -- but less responsible -- role, such as the head of Gazprom or a high-level international envoy in the mold of former British Prime Minister Tony Blair.

Putin's problem has been to ensure stability and continuity after he is gone. In other words, he wanted to prevent one faction within his immediate entourage from gaining the upper edge at the expense of other factions. This is why the elusive Putin's Plan has been a palimpsest, with rules of transition written in an on-the-fly, ad hoc manner. This is also why Medvedev has been anointed so late in the game and will now have less than 90 days to conduct a supposedly crucial election campaign.

Based on his background and public pronouncements, Medvedev is thought to belong to a "liberal" faction within the Kremlin -- or at least less hawkish than the other would-be successor, Sergei Ivanov, a former KGB general and defense minister. But whether he will be more liberal on the economic front is an open question, even though the economy may prove to be his greatest challenge in the coming years.

During his time in office, Putin benefited from a remarkably favorable economic situation. Around the time he became prime minister, oil prices bottomed out at $10 per barrel, rising tenfold over the next eight years. Painful financial and economic reforms, effected during the bad old 1990s, allowed the country to increase oil output and boost investment into the natural resources sector. The distribution and retail network, also built up in the 1990s, delivered consumer goods to millions of people once oil and gas revenues began trickling down to them.

It has also been a period of plentiful liquidity, remarkably low interest rates and subdued consumer price inflation in the world economy. Russian companies and banks funded themselves in global capital markets easily and cheaply. A domestic lending boom fed a spectacular rise in real estate prices not only in Moscow, but in many other cities, as well.

This economic environment gave Putin's government a wide margin for error. Despite glaring inefficiencies in the economy and a plethora of easy liquidity, inflation, albeit elevated by international standards, was declining steadily. Even though economic reforms were neglected, small business languished and the role of the inefficient state sector was enhanced at the expense of private enterprise, the economy continued to flourish.

The good times are now coming to an end, however. There are two scenarios for the country's economy, based on two scenarios for oil prices. Both suggest a hard landing ahead.

The first possibility envisions the global economy recovering from uncertainty and oil prices staying at elevated levels. This will probably mean an inflationary explosion. Domestic food prices rocketed 19 percent in the first 11 months of the year, creating strains within society and leading to more strikes and heightened discontent. The situation will worsen if consumer prices continue to accelerate, belying the sham political consensus displayed in the Dec. 2 elections to the State Duma.

The second scenario is much worse. Rising volatility in financial markets indicates that the liquidity bubble, created by the U.S. Federal Reserve over the past decade, is starting to burst. Surfeit liquidity has pushed global asset prices to unsustainable levels and created a bubble in the oil market, as well, where prices no longer reflect the long-term supply-demand relationship. In early December, oil lost over 10 percent of its value in just a few trading sessions, suggesting that even a modest slowdown in the world economy could lead to a collapse in oil prices. For Russia, the consequences of $50 per barrel of oil, or even lower, can be unpredictable.

Either way, the new president is not likely to face such a glowing economic landscape when he assumes office. Whether Medvedev harbors liberal economic views will not matter, since an economic downturn is not the time to introduce reforms -- especially not in Russia. His most likely response will be price controls and greater government interference in the private sector, which has already been done to combat inflationary pressures this year.

And second, Medvedev will probably start accusing Putin of wasting the oil windfall and allowing top officials and bureaucrats to enrich themselves in an obscene fashion at the expense of the people. If this sounds familiar, it is because dumping on one's predecessor has been a tradition in recent Russian history, and Putin's government was certainly no exception.

Alexei Bayer, a native Muscovite, is a New York-based economist.