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. Last Updated: 07/27/2016

Putin's Russia Needs to Stand and Deliver

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In many respects the Group of Eight summit in St. Petersburg earlier this month marked the end of the first phase of Russia's emergence from the wreckage left by the collapse of the Soviet Union. Russia has put behind it the reputation of being a dangerously unstable and bankrupt country, and -- despite the fact that membership in the World Trade Organization remains elusive -- has been admitted to the top tier of global economic and political powers.

But that admission ticket comes with conditions, or rather with expectations. If history is to judge the economic and political progress made under President Vladimir Putin as the groundwork for a new phase of growth and expansion in the economy and a more important geopolitical role for the country, then over the next few years the government must deliver on the expectations it has given rise to at home and abroad. Otherwise history may regard this period as an opportunity missed, and Russia as another victim of the curse, and complacency, of high oil prices.

Russia was able to defy its critics and assume the G8 presidency in 2006 in part because of the expectation that it would extend its current role as the world's biggest energy supplier -- Russia's combined oil and natural gas exports exceed the total exports of Saudi Arabia -- and that it would become an even bigger, more reliable energy partner for its G8 partners. The G8 countries account for nearly half of the world's daily oil and gas consumption.

Russia also created the expectation, perhaps not overtly but certainly by implication, that it can use its influence in countries like Iran and Syria to contain global instability.

So far, progress in extending the energy partnership has been very limited and mired in political controversy. Poorly handled PR and Russia's lack of a clear strategy for expanding this partnership are probably as much to blame for the slow progress as anything else. But it is clear that progress on issues such as increasing Russia's gas exports to the European Union and initiating the Shtokman project with U.S. participation are important steps toward maintaining the good will built up over the past few years.

Energy importing countries have become used to the OPEC model, in which exporters use oil and gas revenue to purchase consumer goods, military hardware and infrastructure from the importing countries. Russia clearly does not wish to follow that model. It is intent on "bartering" its energy exports to help achieve a number of key economic and political goals. The clear danger is that unless progress can be made on these issues, frustration on both sides will inevitably increase and the idealistic model of energy partnership could soon become a destructive element in Russia's relationship with its G8 partners.

While Russia and the United States failed to reach a compromise on WTO membership at the G8 summit, the comments from both sides suggest that a deal is close. There are undoubtedly a number of political and energy-related issues blocking a deal, and the hope is that these can be resolved in the upcoming weeks or months. If not, then the start of the political campaign season in Russia later this year will only complicate negotiations and limit the Kremlin's ability to compromise. Similarly, the EU will want some hard evidence that last winter's gas shortages can be avoided in early 2007. Gazprom's declared intention to buy as much as 19.9 percent of rival producer Novatek at least suggests that a deal is taking shape.

Another key test of Russia's ability to deliver on increased expectations is the current conflict in the Middle East. Russia has dealings with the Syrian and Iranian governments and was one of the few to offer assistance to the newly elected Hamas government. That is a unique position among the G8 countries. If Russia is unable to help broker a solution to the current conflict, its role within the G8 may diminish -- especially if energy deals also remain elusive.

Probably of much greater importance to investors in Russia, both portfolio and strategic, is how successful the government will be in delivering on expectations that it has raised domestically. Over the past seven years, living standards in the country have grown steadily, and disposable income continues to grow at more than 10 percent in real terms annually. Surveys show that people expect to see economic growth and their own standard of living rising almost indefinitely.

Headlines proclaiming that Russia has the world's fourth-largest financial reserves -- third-largest if the stabilization fund is included -- and is paying off more than $20 billion of Paris Club debt early only serve to reinforce those expectations. The enormous wealth gap in the country is acknowledged as a concern, but it is tempered by the expectation of continued rising living standards. That is also one of the key reasons why public support for the government remains high and why Putin's chosen successor will almost certainly become the next president.

The government is already taking too great a share of oil revenues in taxes, however. And while the country's fiscal health is improving rapidly, the very real danger is that a lack of state investment will soon begin to have a negative impact on growth. The next government could easily be faced with a less favorable and more speculative economic climate, in which current expectations could not be met and the two critical factors for controlling investment risk in any emerging economy -- internal stability and economic predictability -- would surely be eroded.

It is easy to forget, especially after the G8 summit, that Russia is still an emerging economy and that only eight years have passed since it nearly went bankrupt. In the intervening period, the Russia story has been the most compelling financial soap opera in history because of the rapid changes that have taken place on the back of the $600 billion earned from oil and gas exports and the greater stability since the start of Putin's presidency.

In reality, for investors there are two Russias. There is the brash and confident Russia that is the world's most important energy supplier and has all the trappings of wealth to show for it. But there is also the other Russia, where the majority of people earn $400 per month and who expect to see that rising by a steady 10 percent or more above inflation every year.

The important issue for investors looking at Russia as it starts the second phase of its post-Soviet existence is whether all of the current expectations can be met. The critical factor is whether the government can reach consensus, between now and March 2008, on a political and economic model that makes best use of the countries natural and financial resources to sustain growth and to keep Russia in the top tier of the global economy.

Given the rapid improvement in the economy under Putin, it might seem ungracious to be highlighting the potential negatives. But Russia has raised expectations, and these are at the core of why investors are coming to Russia today.

Christopher Weafer is chief strategist at Alfa Bank.