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. Last Updated: 07/27/2016

The Economics Of War

As major global economies struggle to ward off recession following the terrorist attacks in the United States, Russia is shaping up to show the world that it will not only emerge unscathed but perhaps come out on top. Valeria Korchagina reports.



As global stock markets were reeling, airlines were laying off hundreds of thousands of employees and consumers were staying away from stores in droves, Prime Minister Mikhail Kasyanov made a prediction that no other leader in a leading industrial power would dare utter.

He upgraded Russia's economic forecast. Kasyanov said Sept. 20 that the economy would grow this year by 5.5 percent, a figure slightly higher than previous government forecasts.

President Vladimir Putin backed up that optimism late last week at a conference in Dresden aimed at winning over German investors.

"We know there is currently a big fall in the world economy. We hope it won't lead to serious consequences, but Russia's economy is still growing," Putin said without a trace of pride in his voice.

The mood in Moscow is drastically different from elsewhere in the world. In Asia, Europe and across the Atlantic in North America, stock brokers have long written off scrumptious year-end bonuses, and investors are hoping that once the seesawing markets stabilize there will be enough money left for retirement. Economists have been hastily revising their colorful graphs to account for depressed economic expectations.

But those same market watchers say Kasyanov and Putin could well be on the mark. Russia, thanks to its insulation from other global economies, has a good chance of outperforming not only other emerging markets this year, but also showing relatively healthier growth than economic heavyweights such as the United States, Britain, Germany and Japan.

However, the key to this growth could well hang on two factors -- global oil prices and Russian diplomacy, economists say.

And even if oil prices hit barrel bottom, diplomacy could pull Russia through. Russia, which is steadily warming up to the United States' call to fight terrorism, could be on track toward cutting a deal with the West in which it trades its war support for a restructuring or write-off of its staggering foreign debt, accelerated entry into the World Trade Organization or even, perhaps, membership in NATO.

A Pattern of Growth



The optimistic economic expectations voiced by the government this month are hardly surprising. Russia's economy has been showing improved year-on-year growth every year since the devastating 1998 financial crisis. Last year, gross domestic product growth topped a stunning 8 percent, the highest growth ever in post-Soviet history.

The 5.5 percent GDP growth planned for this year is 1.5 percent above initial forecasts made in January. Furthermore, Russia is expecting to see 4 percent growth in 2002.

Putin and his economic-minded government have been working around the clock to keep that locomotive of growth roaring at full steam. The Kremlin pushed legislation through the State Duma last year that simplified a mind-boggling web of often-contradictory tax legislation which suffocated investment. He also slashed income tax to 13 percent, the lowest in Europe.

The government this year has continued to keep up a frantic pace of reform aimed at improving the investment climate, drawing up crucial land, labor and judicial laws. Just last week the Cabinet began taking steps to tame the banking sector.

At the same time, the Central Bank has maintained a tight monetary policy that has kept the ruble stable.

These changes have helped convince foreign investors that Russia is worthy of their attention and, perhaps even more importantly, given Russian businessmen a good reason to bring hundreds of millions of dollars back home.

The Best Laid Plans ...



But despite all the effort Putin and the government put into building a robust economy, the one thing they probably did not count on was a possible U.S.-mounted war in Russia's backyard.

U.S. President George W. Bush has named Osama bin Laden, the exiled Saudi millionaire believed to be hiding in Afghanistan, as the No. 1 suspect for the terrorist attacks. And even as Putin extolled the virtues of Russia's economy to German investors last Wednesday, Bush was building up U.S. forces in the Middle East in anticipation of an assault on Afghanistan.

The initial fallout of the potential war was seen in Moscow within hours of the Sept. 11 terrorist attacks. On the street, the value of the U.S. dollar plummeted from the official rate of about 29.3 rubles to as low as 15 as currency exchange operators hoped to cash in on jitters about a looming U.S. crisis. However, the Central Bank rate ended up holding steady and exchange rates on the street quickly returned to official levels.

Central Bank head Viktor Gerashchenko breathed confidence into the country by expressing unconcern that a considerable portion of the bank's reserves were in dollars.

Longer term prospects for the stability of the dollar are unclear. Central banks around the world -- including Russia's Central Bank --worked with the U.S. Federal Reserve after the attacks to keep the dollar stable. In a country like Russia, where billions of dollars in personal savings are kept under mattresses, the strength of the dollar remains of paramount importance.

In the days that followed the attacks, trade thinned out on the Russian stock market as investors waited to see what would happen when the New York Stock Exchange reopened. After opening Sept. 17, the Dow plunged and the benchmark RTS index in Moscow quickly followed suit. Although it is still down, the RTS has since shown more stability than other major indices.

Significantly, the Russian stock market, while seen as a good bet compared to other emerging markets, has never been a major factor in influencing the health of the Russian economy. Thus, any ups and downs would do little to shake up the economy.

"Most economic growth is currently due to local factors, and we believe that Russia has enormous potential for internally driven growth, rebuilding infrastructure, industry, distribution and the entire economic apparatus," said Eric Kraus, chief strategist with NIKoil investment bank.

The Petrodollar Economy



The attacks only managed to shoot a first shockwave through Russia when global oil prices plummeted 13 percent last Monday. Oil tried to clawed back its losses throughout the week but to little avail.

Kasyanov dourly noted that Russia saw the value of its Urals blend drop in one month by almost $10 a barrel. The government estimates that the federal budget loses $1 billion for every $1 drop in the price of oil.

As such, there was little the country could do but sit up and take notice.

"Despite positive [economic] trends [this year], there are a series of uncertainties that the government must take into account," Kasyanov told a government meeting last Tuesday.

Despite Kasyanov's remarks, the meeting went on to approve a draft 2002 budget that set the average oil price at $23 per barrel. The State Duma, while expressing jitters about the price level, passed the budget at a first hearing Friday.

Kasyanov and the Duma have good reason to be worried. Russia's economic growth is linked almost entirely to oil prices. The country has enjoyed a sweeping ride over past two years because of high oil prices. They have enabled the government not only to meet foreign debt obligations, but also provide extra funding for activities such as the war in Chechnya and building up Central Bank reserves.

A Worst-Case Scenario



If worst came to worst, oil prices could fall to unexpected and prolonged lows as the world economy sinks into a deep recession. Russia would be unlikely to have enough revenues to meet its debt obligations -- which come to $19 billion in 2003 -- and would find it difficult if not impossible to borrow more in order to keep up payments.

To ease its Soviet-era debt repayments, the government this month said it intends to issue $2 billion worth of Eurobonds. Even if the float goes ahead as planned, with volatility in oil prices and uncertainty over how long and deep a global recession might be, there is a risk that Russia won't be able to find enough buyers for the debt.

The government will most likely refrain from issuing Eurobonds if the price of oil falls below $16 a barrel, said Troika Dialog equity strategist James Fenkner. Although Russia is currently in good shape politically and economically, there is still strong residual doubt over the country's credibility rooted in the 1998 crisis.

"The problem is that the investors have so much doubt following the August 1998 crisis that it is impossible to see major investors coming back to Russia yet in any meaningful way," Fenkner said. "Russia is better than other countries, but it's still not so attractive. The risk factor is still quite high."

The negative aftermath of 1998 would become particularly acute if Russia is hit by the world economic turmoil in the near future, Fenkner said.

"Russia no longer has the benefit of the doubt," he said. "It lost the benefit of the doubt on Aug. 17, 1998. And, unfortunately, although the later achievements are very good, no one is going to care about them over the next couple of months."

Even if oil prices collapse, Russia should be able to get by in the short term, said Keith Rowden, senior energy partner at PricewaterhouseCoopers Russia.

"The government is building credibility in the world markets by publicly focusing on debt repayment and maintaining a surplus in the federal budget despite the significant temptation to spend money on needed domestic issues, such as salaries for government workers and infrastructure costs," Rowden said.

Russia's dependence on oil could prove to be a blessing of sorts in disguise.

When the Organization of the Petroleum Exporting Countries hastily met late last week to discuss falling oil prices, nonmember Russia found itself with an invitation to join.

Russia is not thought to have any interest in teaming up with the cartel, but the invitation from Saudi Oil Minister Ali al-Naimi in itself is a sign that Moscow is being considered a force -- albeit small -- to be reckoned with on the world oil stage, analysts said.

Russia produces about 6.5 million barrels of oil per day, and exports, nearly 3 million bpd -- an amount equal to about 12 percent of all OPEC's daily output on the market.

Other Economic Movers



A saying has it that war is the grease that gets an economy going. Despite the rations and blackouts, the United States certainly saw its economy come out of the doldrums of the Great Depression during World War II as factories worked overtime pumping out weapons, planes and other military hardware.

As a potential conflict looms in Central Asia, Russia has the potential to see a rebirth of sorts in the defense industry. While a Russia that wants the West to see it as an ally would not be able to sell arms to Mideast countries like Iran and Iraq, there could be a clamoring for additional defense goods from former Soviet republics in the region such as Kazakhstan, Tajikistan, and Uzbekistan. Furthermore, longtime customer India -- which is seeing rival Pakistan getting Western concessions for its assistance in bargaining for bin Laden -- may decide its wants to bolster its forces. Pakistan, which was just allowed last week to once again buy arms on the world market, has expressed interest in shopping for hardware at an upcoming arms bazaar in Turkey.

Even before the attacks in the United States, arms sales -- like Russia's economy -- were expected to grow rapidly this year. The government says Russia will sell up to $4 billion in arms in 2001, more money than the industry has earned since 1991.

Deputy Prime Minister Ilya Klebanov, who oversees the defense sector, said earlier this year that the country will be selling $6 billion worth of arms annually in the near future.

Theoretically, an increase in arms sales could be tied to a need for an increase in metals production and, perhaps, an increase in jobs.

While the entire scenario is purely hypothetical, the fact remains that a boost in one Russian industry could bode well for the economy as a whole.

One other factor that could tip the balance for the economy is gas. Revenues from the export of natural gas account for a fourth of the country's GDP. However, with the price of gas stable and its shipment from Russia practically bypassing the Central Asia region (except for imports from Turkmenistan), gas is not seen by analysts as a wild card at this point.

Cutting a Deal



What could turn out to be the wild card in the stack is how Russia deals diplomatically with the West in the war on terrorism.

After initially saying little about Russia's stance, Putin last week backed the U.S. initiative to fight terror and offered Washington anti-terrorist support that included providing Russian airspace for relief missions, participating in search and rescue operations and arming the anti-Taliban opposition.

Almost immediately, Russia began to bear the first fruits of its decision. The United States and Western Europe toned down -- for the first time -- their criticism of Moscow for its ongoing campaign in Chechnya. Bush said he believed there were rebels in Chechnya funded by international terrorist groups -- echoing statements made by Moscow for years.

Speculation is already swirling that the terrorism war will allow Russia to fulfill a 50-year-old dream of becoming a member of NATO. Putin is to visit Brussels, Belgium, early this week to meet for talks with NATO members on terrorism. Some reports have said he will become the first Russian leader to visit NATO's headquarters there.

Putin mentioned Russia's interest in joining NATO when he met Bush for the first time in Slovenia in June. He said a request to Washington to discuss the issue had been rebuffed late last year. He also said the Soviet Union had made such a request in the 1950s.

Whether NATO membership will be used as a bargaining chip remains to be seen. But Russian politicians are already looking for an economically rewarding payoff for Moscow's support of America's fight against terrorism -- a debt deal.

"Pakistan had its debts quickly forgiven. Such a window of opportunity for Russia has also opened," Boris Nemtsov, leader of the Union of Right Forces, said at parliamentary hearings Friday.

After Pakistan offered its support to the U.S. campaign, international lenders quickly agreed to drop sanctions and rescheduled hundreds of millions dollars in maturing debt.

At the start of the year, the government tried to convince its creditors in the Paris Club to rollover or revamp 2001 payments, claiming the country lacked the money to make good on its obligations.

When the club balked, the government was forced to rewrite the federal budget to take the debt into account. Since then, the government has repeatedly dropped hints about getting some debt relief while faithfully paying off its dues.

"Russia is the only post-communist country that is still paying 100 percent of its communist debt, and not only for itself but for the other 14 former Soviet republics," said Vyacheslav Nikonov, head of the Politika think tank.

Russia also has its eye on one other goal -- winning entry into the WTO. Putin has named WTO entry as a top priority and has ordered bundles of legislation passed that would make Russia's laws conform with that of WTO member states.

Seven years of negotiations with those member states appeared to have made little progress.

However, U.S. Trade Representative Robert Zoellick met with Russian officials in Moscow over the weekend to discuss the bid and emerged saying Russia could be in the final stage for WTO ascension by early 2002.

Previously, WTO members had said Russia had little chance of joining before 2003-04.

While Zoellick conceded that Russia had a lot of work to do before it obtained membership, he said, "Serious progress has recently been achieved by Russia in reforming its economy and developing its social sphere."

He added that he had spoken with EU officials about speeding up the WTO bid.