Moving Away From Distrust

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The relationship between Russia and the West has been rocky in 2008 in terms of diplomatic relations and foreign investment. The Russia-Georgia war, disagreement over deploying elements of an anti-missile system in Poland and the Czech Republic, the TNK-BP oil company dispute and the freefall of Russia's stock market have all created mutual resentment and frayed relations. Yet there are reasons to believe that the situation will change in the near future, and Prime Minister Vladimir Putin's speech in Davos on Wednesday may just be the first step.

Just six months ago, many felt that Russia was economically invincible. Riding on a decade of 7 percent average annual growth, almost $600 billion in foreign currency reserves (about 40 percent of gross domestic product) and what then appeared an endless boom in commodity prices, Russia seemed to be an island of prosperity, despite the oncoming waves of the global financial crisis.

This economic muscle fueled the often-arrogant stance of Russian officials toward the rest of the world, and investors flocked to the booming economy regardless of the harsh political rhetoric coming out of Moscow. The West wanted Russia, but the Kremlin was convinced that Russia did not need the West.

That confidence has now been shaken. Before the crisis hit, Russia had underestimated how financially and economically integrated it had become with the rest of the world. First, it came as a surprise that such a large part of its stock market was owned by foreigners. When foreigners started dumping Russian stocks, the market collapsed.

The second surprise came after Russian companies and their owners took on huge debt from Western creditors. During the boom years, these companies had borrowed aggressively to fund acquisitions, using skyrocketing stock prices as collateral. When the stock market collapsed, margin calls followed, and shareholders scrambled for cash. Finally, oil and metals prices -- the catalyst of the country's growth -- are being hit hard by the worldwide recession and growth slowdown.

Such a dramatic reversal of economic fortunes will undoubtedly threaten political stability in Russia. To sustain growth and avoid social unrest, the Kremlin must undertake internal economic reforms, attract foreign investment and improve relations with the West. And it must do so now.

Fortunately, the crisis offers an opportunity for Russia to play a significant role in reforming the global financial system and to strengthen its reputation and relationship with the West. The Kremlin can achieve these goals by capitalizing on several strong points of its economy. First, Russia still has substantial financial reserves, and its economy remains very large.

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Second, in the midterm the ruble may emerge as a key regional reserve currency -- a goal that is very dear to the Kremlin. If Russia finally floats its currency and finally brings inflation down, the ruble will undoubtedly become an important instrument for hedging oil prices -- at least for neighboring countries -- once the commodity prices begin to recover.

If Moscow is able to play a larger role in reforming international economic institutions, this will help Moscow improve its relationship with the West. True, the bitterness that has accrued over the past several years will not disappear overnight. The average Russian perceives the United States as an enemy, and this feeling is widespread. The polls administered in the wake of the Georgian war showed that 75 percent of Russians believe that the United States is hostile rather than friendly to Russia. The Russian public also believes that the United States is largely to blame for the current economic troubles, and this negative baggage will be difficult to dispel.

The expected change in U.S. foreign policy from the administration of President Barack Obama offers a lot of hope that U.S.-Russian relations will improve significantly. But better times also require change within Russia itself. The Kremlin must switch from confrontation to cooperation and from belligerence to assistance.

By recognizing that Russian economic power depends not only on internal reform but also improved collaboration with international partners, relations with the West can evolve from distrustful solitude to mutual strength.

Sergei Guriev is Morgan Stanley professor of economics and rector at the New Economic School. Aleh Tsyvinski is professor of economics at Yale University and the New Economic School.