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. Last Updated: 07/27/2016

Economists Call Trends Worrying

Is there an economic crisis brewing like the one that brought the country to a halt in August 1998?

There is growing concern among economists that the answer to that question is more likely yes than no.

They say that against the backdrop of a depressed world economy, Russia's basic macroeconomic indicators may look healthy, but beneath the gloss, several trends have emerged recently that give cause for alarm and suggest that the positive effects of the 1998 ruble devaluation have been exhausted: Growth is slowing; investment is falling; corporate profits have halved; public-sector wage arrears are on the rise; the ruble is rising in real terms against the dollar, making domestic producers less competitive; and barter appears to be making a comeback.

"The number of warning lights that have started flashing in the last several months is concerning despite the apparent health of the basic ratios," said Roland Nash, head of research at Renaissance Capital. "First, and most widely recognized, is slowing growth," he said.

After posting record gross domestic product growth of 9 percent in 2000, the pace slowed to 5 percent last year and the government now expects 3.8 percent growth this year. The official forecast for the year was originally 3.6 percent, which led President Vladimir Putin to publicly chastise his government for not being ambitious enough. Last week, the Economic Development and Trade Ministry announced a rosier outlook, saying that the new number was based on higher-than-expected growth of 3.8 percent in the first half of the year, up from 3.2 percent in the first quarter.

"[This] allows us to say that the economy has broken the negative trend of the first quarter," the ministry said in a statement, claiming, without elaboration, that real sector companies now "feel more secure" than earlier in the year, despite external pressures such as a stronger ruble, rising labor costs and higher tariffs.

Even so, assuming Russia can maintain 3.5 percent annual growth, it will take 100 years to achieve the average per capita income level enjoyed by the European Union if the EU grows at an average of 2 percent a year, according to a recent Economist Intelligence Unit study.

However, even 3.5 percent may not be sustainable, economists say, without further structural reforms and a radical overhaul of the banking system.

If Russia continues to evolve the way it is now, "a new crisis will be inevitable," said Yevgeny Gavrilenkov, chief economist with investment bank Troika Dialog. Gavrilenkov characterized that evolution as one along the lines of the ill-fated South Korean chaebols -- huge, vertically integrated conglomerates that emerged in the absence of a strong financial sector. He said Russia is now developing an "Asian economic model and an administratively driven system."

Another worrying sign is industrial production, which is slowing faster than overall economic growth. After growing 5.1 percent in the first six months of 2001, industrial production slowed to 3.1 percent in the first half of 2002.

Marcin Wiszniewski, an economist who tracks Russia for Morgan Stanley in London, said the current slowdown did not come as a surprise, because the pace of industrial production and GDP growth were expected to slow after the initial boost from ruble devaluation and high oil prices was exhausted and spare capacity in the economy was largely utilized.

"But even if we devalue the ruble now, it won't help to support growth because production capacities are full," Gavrilenkov said. "So in the end, economic growth is driven by consumption demand and investments."

Part of the slowdown can be attributed to shrinking levels of investment -- both foreign and domestic. While the level of domestic investment grew 18 percent in 2000 and 15 percent last year, it grew by only 2 percent in the first six months of 2002. Furthermore, foreign direct investment actually shrank, reaching $1.4 billion in the first half of 2002, down $500 million from the same period last year.

More worrying still is that corporate profits are down nearly 50 percent year on year, from 501 billion rubles ($16.7 billion) in the first half of 2001 to 316 billion rubles in the same period this year.

"A combination of real ruble appreciation of around 8 percent per annum, real wage growth of nearly 20 percent per annum and rising utility tariffs are rapidly increasing firm costs," Nash said.

These negative factors, combined with tax changes and increased expenditure obligations, have left regional budgets struggling to make ends meet.

"In May, the federal budget was forced to bail out regional budgets, a transfer that pushed the federation into its first cash deficit since 2000," Nash said.

This, in turn, has led to an increase in arrears for the first time since the 1998 crisis.

Tax arrears to the federal budget increased by 11.9 percent during the first half of 2002 to 530.8 billion rubles ($17 billion), a Tax Ministry official told Prime-Tass on Friday, without elaborating. And Putin last week criticized the Cabinet for not paying state wages on time and failing to meet budget targets in the social sphere.

"People are going on vacation and they are not being paid money to spend," Interfax quoted Putin as saying. Putin stressed that, despite pledges by the government to cut wage arrears by the summer, they "have grown, and considerably so."

On Friday, Deputy Prime Minister Valentina Matviyenko said that wage arrears increased by 1 billion rubles in June to about 3 billion rubles. Especially hard-hit are the nation's poorly paid teachers, who have yet to receive their yearly summer bonuses. Finance Minister Alexei Kudrin said Monday that the government would do so by Sept. 1.

Similar problems are facing the largest state-controlled companies. Natural monopolies Unified Energy Systems and Gazprom are both having problems getting customers to pay -- suggesting that the old days of barter payments may be making a comeback.

UES said Friday that its level of cash collections has fallen from 100 percent to 98 percent in the first quarter of 2002. "Two percent is a very huge number for us, taking into account the payment volumes," UES spokesman Yury Melikhov said.

And gas giant Gazprom said the debts of its customers in the same period rose by 1.6 billion rubles ($50.8 million) to 45.1 billion rubles, equal to roughly a third of its investment budget this year.

"For the first time since the devaluation there are the first signs that nonpayments and barter may again be on the rise," said Nash.

So what does the future hold?

Nash said Russia is going through the transition that all emerging markets go through at one stage or another -- the redistribution of resources from those firms that cannot survive to those that can.

"We all know that Russia has only started down the path of genuine structural transformation after macroeconomic stability was established," Wiszniewski said. "As always in transition economies, problems are deep and everything boils down to political commitment and the government's political ability to tackle those problems."

But even here the government is not doing as much as it can, according to the Economist Intelligence Unit.

"The state's ability to implement its legislative program will remain constrained by institutional weakness, including corruption, crime, excessive bureaucracy and weak rule of law," the EIU wrote in its study. It also concluded that economic reform has been hampered because it "has not been accompanied by efforts to build up democratic institutions."

Gavrilenkov said Russia's future lies not in the further exploration of its natural resources but in developing new export-oriented sectors.

Russia is again at a fork in the road where one option is to reduce the entry barriers for business and develop the private financial sector, Gavrilenkov said. "This could bring about a resumption of high, sustainable growth rates," he said.

"The other is the road to a further strengthening of the chaebols as substitute intermediaries between savings and investments," Gavrilenkov said. "This would be building the foundation for a new crisis."