k2kapital.com (Site news), February 27, 2008

EXPERT FOR RUSSIA ADVISES MOSCOW TO ACT TO COOL ITS ECONOMY

 

Russia needs to take measures to cool its economy in the near future to slow down the speed of inflation growth and to prevent problems that are more serious. Anders Aslund, a senior fellow of the Peterson Institute for International Economics, a specialist in Russia, expressed such opinion in his article published by The Financial Times.

According to Aslund, an extraordinary global boom is ending and the world faces the twin specters of declining growth and rising inflation. In the US and Europe, recession is the dominant worry, as economic growth dwindles and the credit squeeze bites. Emerging markets, by contrast, are still enjoying high growth rates and their main concern is inflation.

Aslund mentions Russia as the main example. According to Aslund, last year Russia had a healthy growth rate of 8.1%. That rate continues and has not been much harmed by the subprime crisis, even if a fear of a liquidity squeeze lingers. However, Russia’s annual inflation surged from 7.4% last March to 12.6% last month and it continues to rise.

The well-known economist presumed that the price level has become quite high by international standards, with Moscow rated as one of the three most expensive cities in the world, and inflation is edging up. According to him, Russia’s inflation is mainly generated by vast current account surpluses, which have boosted its international reserves to $480 billion, the third largest in the world after China and Japan. When Russia introduced full convertibility of its currency in July 2006, large volumes of capital flew in.

According to Aslund, until last year, President Vladimir Putin could pride himself on fiscal responsibility. But last October he suddenly abandoned that policy. Russia had a budget surplus of 8% of GDP during the first 10 months of 2007, but in November the government pumped up public expenditure before the elections. Initially the Kremlin reacted in an equally populist way to the surging inflation. It introduced export tariffs and quotas on foodstuffs to keep domestic prices down. Yet those actions had a knock-on effect, further delaying Russia’s entry into the World Trade Organization. Last October it imposed price controls of numerous foods. Fortunately the Kremlin has now acknowledged that more serious economic measures are needed, and it has authorized Alexei Kudrin, minister of finance, to combat inflation.

Aslund presumes that Russia needs to restore its conservative fiscal policies quickly to cool the economy. The best choice would be to prohibit the borrowing spree by Russian state corporations in the west, which reached $60bn last year. Not only is this the main source of capital inflows, but these funds are being wasted on the harmful renationalization of good private companies.

Aslund also believes that the main cure, however, must be to allow the ruble to appreciate more. Russia’s real effective exchange rate has admittedly increased by about 7% in each of the past two years, but that is not enough. The Russian government has long envisaged a floating exchange rate aiming at inflation-targeting in the medium term. This is the right time to make that transition. Then, the central bank could adopt an active monetary policy with positive real interest rates. Its refinancing rate is now only 10.25% cent a year, significantly less than inflation.

Russia is not alone in this dilemma: several other countries in the region suffer from similar ailments with renewed double-digit inflation, notably Kazakhstan, Ukraine and Latvia. Yet Russia must act soon to cool its overheated economy and combat its inflation before more serious financial problems arise.

Anders Aslund is a doctor of economics of the Oxford University, graduate of the Stockholm School of Economics, former employee of the diplomatic representative offices of Sweden in Kuwait, Poland, Switzerland and Russia. In the middle of the 1990s, he was economic advisor to the governments of Ukraine and Russia. He is director of the Russian and Eurasian program of the Carnegie Endowment. He is author of the book entitled Russia’s Capitalist Revolution: Why Market Reform Succeeded and Democracy Failed