Russian economy succumbs to the oil curse but Govt gets 80% of IMP as Royalty- Telegraph

Russian economy succumbs to the oil curse - Telegraph

Russian economy succumbs to the oil curse

By Ambrose Evans-Pritchard International Business Editor

Last Updated: 1:44am GMT 05/02/2008

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Moscow is the most expensive city in the world, like Tokyo before the Nikkei bubble burst. A taxi from Domodedovo airport to the Kremlin costs $170 (£86). Property in Ostozhenka trumps Chelsea. Space fetches $30,000 a square metre.

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Nice Tsarist flats fetch $3m to $4m. Even Bolshevik boxes are booming. Moscow boasts 150,000 home millionaires in dollars, says Sergei Polonsky, the Mirax Group tycoon. In a good year, prices double.

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This is the curse of commodity wealth, the "Dutch Disease" that eats at the competitive foundations of an economy and incubates a parasite culture. No doubt Russia's scientists, engineers, and cyber talent, will enrich the country, but first it must overcome the toxic effects of oil at $90 a barrel.

"We can no longer afford to buy Russian equipment," said Yevgeny Ivanov, head of Polyus Gold.

"The prices here are one and a half times higher than abroad so we're having to break our rigid rule and turn to foreign-made machinery. It is bad news for Russian firms. The commodity super-cycle is catching up with us through higher prices. It is a disheartening picture," he said.

"There's no infrastructure, no power, no roads. Electricity costs twice what they pay in Alaska and Canada. We face a Soviet bureaucracy passing decrees that make you weep," he said.

The government has declared an infrastructure emergency. Russia has hit the limits of durable growth on today's rickety foundations. China has built 25,000 miles of highways since 1988, Russia a few hundred.

President Vladimir Putin has ordered a $1 trillion blitz on ports, highways, power grids, and water plants over seven years. Some 2,600 miles of road are planned each year, starting with the St Petersburg "High-Speed Diameter" and the $3bn Helsinki Expressway. Bouygues and Bechtel are battling for the first tender.

Around $200bn is to come from state coffers: the rest from industry and banks. Taken together, the scheme is the biggest project in the world outside China.

Finance minister Alexei Kudrin said the railways alone would need $440bn by 2030. "We are prepared to guarantee foreign investors a high level of return," he said.

Hence the pinstripe and Blackberry brigade descending on Moscow. There were no visible tourists on my BA flight from London. Two thirds of the aircraft was business class, a telling sign.

The infrastructure edict comes late. The economy is already over-heating. Inflation has hit 12pc, despite Soviet price controls on food. Factory gate prices are up 25pc. Yet the all-conquering rouble rises, strapped to oil. This is double strangulation.

"The government must bring down inflation, there is no other way," said Andrew Bosomworth, head of PIMCO in Europe.

"Interest rates [7pc] are negative in real terms. It will encourage borrowing until the cows come home," he said.

Car sales rose 67pc last year to $53bn, imported Audis and Renaults by the look of it. The current account surplus will shrivel to 2.6pc of GDP this year, down from 9.5pc two years ago. The oil bonanza is draining into shopping malls.

"We believe the trade surplus will disappear before the end of 2009," said Danske Bank.

The slippage is ominous with oil, gas, and metals near historic highs. They make up 80pc of exports.

"Russia has all the classical symptoms of the Dutch Disease," said a World Bank report.

"Firms have largely exhausted the productivity gains derived from idle capacity and labour shedding after the 1998 crisis," it said.

This feels like the late phase of the 1970s oil boom, when Mexicans briefly thought they walked on water. The sequel was not happy.

Eighty cents on every dollar above $27 a barrel goes to the state. Energy rents fund 48pc of the budget. Yet the fiscal surplus has halved in two years. Plans are now afoot to lavish funds on long-suffering pensioners. One sympathises, but this is how macro-blunders occur.

Mr Kudrin is chopping his figures as fast as Alistair Darling. The budget surplus will be 2.8pc in 2007, not 4.8pc as expected. If a US-British-Club Med-Japanese recession knocks oil down to $50, Russia faces a crunch.

Ex-premier Yegor Gaidar said Russia is ready this time. "It won't be a catastrophe. We can easily adjust because of our accumulated reserves," he said.

Perhaps, but the credit markets are sniffing Russia-risk. Even Gazprom is paying much higher spreads. "The bond market effectively shut down in October," said Commerzbank.

The Oil Stabilization Fund was supposed to inoculate Russia against the curse by siphoning revenues out the domestic economy. Certainly it helps.

There will be no repeat of 1998 default. Russia has paid off its foreign debt. The oil fund ($157bn) and foreign reserves ($470bn) are enough to deflect anything short of financial cataclysm.

But as Japan learned in the 1990s, being a reserve power does not cure imbalances. It allows ministers to procrastinate for longer.

If Peak Oil drives crude ever higher, Russia may overtake Germany and America in per capita income within a decade, as some predict.

Most likely, this is wishful thinking.

As the adage goes: Russia is never as weak as she looks, Russia is never as strong as she looks.