The Russian economic machine has gathered speed it cannot control, the World Bank said in its Russian Economic Report #16 presented on June 2. Given the high growth rate of federal expenses and a dangerous macroeconomic policy, the Russian economy could stumble even if oil prices do not plunge, the Bank warns.
These conclusions are in stark contrast to the Bank's November 2007 report, which was quite optimistic about "rising domestic demand, in particular, buoyant household consumption and business investment."
"Sectors servicing the domestic demand (construction and retail trade) continued to boom," the Bank said in November 2007, predicting that inflation would be contained to 7.5% in 2008.
At the same time, it warned that since the Russian economy was "growing close to potential, reducing inflationary pressures is becoming exceedingly a difficult task."
The World Bank's lead economist for Russia, Zeljko Bogetic, said on June 2 that the Bank estimates inflation for 2008 at between 12% and 14%, and the growth of the gross domestic product between 7.5% and 8.0% this year.
This does not sound menacing either. However, "rising inflation and capacity and labor utilization, tightening infrastructure constraints, and real wage increases outpacing productivity gains... suggest that the economy is overheating, i.e., aggregate demand is outpacing long-term productive capacity of the economy," the Bank's report says.
In plain English, "overheating" means that the economy cannot satisfy the demand for its output. Demand depends on growing incomes, including wages in the public sector, pensions and other social payments. However, supply cannot grow overnight alongside a manifold increase in wages and payments. This only increases inflationary pressure, with prices growing at an accelerated pace.
At the same time, the demand for imported goods grows in this situation, as it is now doing in Russia. The country's exports are growing more slowly than imports, despite sky-high energy prices. In a year or two, Russia will enter a period of a negative current account balance even without plummeting oil prices. In other words, its imports will be larger than exports.
This is how the World Bank writes about this possibility in its report: "At the end of the planning horizon in 2040, with passive continuation on this path, Russia could eat up its oil fund assets and other foreign exchange assets it started out with, and could reach a zero net debt position. After that, Russia could get into debt again as gross debt continues to increase while the oil fund begins to shrink since the budget transfers by that time exceed oil revenues."
Heedless of this danger, the government is strengthening its influence in all sectors and increasing federal expenses. Taken together with the planned reduction of taxes on business, this spells catastrophe for the economy, because its revenues are shrinking steadily.
The Bank's recipe is simple: contain inflation while restructuring the institutional and infrastructure spheres.
Strangely, this is also what Russia's current economic authorities are advocating.
They have proposed measures to contain inflation, and are even implementing some of them, raising the interest rate and obligatory reservation norms, and leveling off the exchange rate policy.
They are considering ways to improve the investment climate and environment for small businesses, as well as to urge innovation. Taken together, these are the institutional reforms the World Bank is talking about.
Russia's leaders are also urging the development of the transportation and financial infrastructure.
Why, then, are we moving in the wrong direction?
Unfortunately, Russian macroeconomic policy rests on the mutually exclusive precepts of increasing federal expenditures while lowering taxes.
Global practice shows that state expenditures can be high in socially oriented countries, like Sweden, but in this event the tax burden on the economy must be substantial. And, vice versa, lowered taxes produce a positive economic effect - but only if state expenditures are cut accordingly.
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