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Russia's belated entry to WTO will help consumers but subsidized industries will suffer

Moscow - After 18 years of negotiation, Russia on Wednesday entered the World Trade Organization, which restricts import duties and subsidies in an attempt to create a level playing field for international trade.

Analysts and politicians hope that Russia, which has long proven a formidable market to foreign investors because of its byzantine bureaucracy and protectionist tariffs, would be transformed by its entry into the WTO. Russia is one of the last major global economies to enter the group, which has long included other developing nations like China.

While consumers here will benefit from the lower cost of imported goods, some worry that struggling industries long coddled by state subsidies, such as agriculture or the automobile industry, will suffer from foreign competition.

Russians often complain about the burdensome cost of Western-imported consumer products, which range from refrigerators to jeans. With its entry into the WTO, the country will cut its average import tariff by 5.9 per cent, making those imports cheaper.

M. Video, one of Russia's largest electronics retailers whose shelves are packed with foreign-made CD players and American movies, said Russia's entry into the WTO would bring more customers into their stores.

"We believe that (entry into the WTO) is going to be a very good decision for our customers in the future, because they will be able to purchase goods with prices harmonized with other economies," said Enrique Fernandez, chief commercial officer of the company.

But uncompetitive domestic goods, which have long been propped up by Soviet-style subsidies, could be threatened by the invasion of higher-quality imports. Nearly 100 major business leaders and industry groups including dairy and meat producers signed a petition earlier this summer addressed to the ruling United Russia party, asking that its deputies vote against ratification of the WTO treaty.

Agriculture, the automobile industry, and Soviet-style "Monogorods," or towns which revolve around a single factory or industry, are bound to suffer next to foreign competition unless they can reform quickly. These industries are based in regions that have often displayed the most support for President Vladimir Putin, but could easily turn into a hotbed for protest if already fragile industries were to collapse.

At a car dealership in Moscow, 63-year-old engineer Alexei Tarakanov said he doubted that low-quality Russian cars could win on an open market.

"I already have a negative attitude towards our (Russian) cars," said Tarakanov, who was buying a Renault. "I doubt that they can win the preference of the modern buyer."

Because state-subsidized industries proved such a pivotal issue in Russia's WTO negotiations, financial aid to struggling sectors will be gradually phased out, rather than abruptly cut off, over the course of seven years.

"The industry will not collapse immediately, (major Russian car-maker) AvtoVaz is going to continue steadily producing its 700,000 cars per year," said Ovanes Oganisyan, an analyst at the Moscow-based investment bank Troika Dialog. "But eventually there's going to be more competition, and if AvtoVaz doesn't change in seven years it will have to go out of business."

In addition to the challenges faced by unreformed industries, the Russian government expects to take a short-term financial hit from the loss of income from import duties and taxes. But the government emphasizes long-term gains, and the World Bank has estimated that WTO membership could increase Russia's GDP by an extra 3.3 per cent a year in the next three years.

While the WTO will significantly open up the Russian market to foreign producers, the U.S. faces the threat of paying higher tariff rates than other WTO members to sell goods in Russia, leaving American producers at a competitive disadvantage compared to European or Asian industries.

The reason for the disparity is the Jackson-Vanik Amendment, a law passed by Congress during Soviet times that denies Russia normal trade relations with the U.S.

The U.S. president has been granting Russia annual waivers since 1992, but Moscow insists it will not lower its tariffs for the U.S. as much as for other countries until the law is scrapped.

"The last thing that America needs right now is for foreign companies to have lower tariff rates than American companies," said Andrew Somers, President and CEO of the American Chamber of Commerce.

Vice-President Joe Biden lobbied for the repeal of Jackson-Vanik in 2011, as have previous presidential administrations, but Congress has so far proven intransigent to executive pleas.

Congress has increasingly taken fire at the Russian administration for its human rights record. In June, the U.S. House of Representatives passed the Justice for Sergei Magnitsky Act, a bill named for a Russian lawyer who died in a Russian prison last year after allegedly being abused at the hands of Russian authorities.

This week, President Barack Obama expressed his disappointment after the three participants of Pussy Riot, a punk band who sang an anti-Putin prayer in Moscow's Cathedral of Christ the Savior, were convicted to two years in prison.

"Business hates uncertainty," said Somers, "If the Jackson-Vanik Amendment remains on the books and the U.S. continues not to have normal trade relations with Russia, who knows what will happen."

Russia’s economy: Unsustainable support
The oil-fuelled surpluses may vanish – forcing the Kremlin to borrow, devalue or spend less

Cash and carry: backers of Vladimir Putin with a mocked-up Rbs1,000 note. If Russia’s trade surplus falls as forecast, the president-elect’s ability to fulfil spending pledges made during his campaign will be curbed

Once Vladimir Putin is back as Russia’s president in May, he will again face pressure for change. But with the street demonstrations that began in December now showing signs of ebbing, those could be the least of his worries in the six-year term that is to come.

Instead, it is a tectonic shift in the economy that may preoccupy him. According to analysts, growing imports will gradually outpace exports of oil and gas; the oil-fuelled trade surpluses that have buttressed his leadership for more than a decade could vanish.

That would be dramatic, given that the surpluses totalled $785bn between 2000 and 2011, an amount equivalent to well over 40 per cent of last year’s gross domestic product. During those 11 years, oil prices quadrupled, budget expenditure rose nine times in real terms and real wages almost trebled.

But unless oil prices nearly double again, which most economists say is unlikely as it would tip the global economy deep into recession, this era of easy money that has buoyed incomes and social spending will be finite. “Halfway through Putin’s term the economy may hit the wall,” says Ivan Tchakarov of Renaissance Capital, a Moscow investment bank.

Mr Tchakarov predicts that the current account, which includes goods trade plus services and transfers, will turn negative in 2015. He calls this “the great transition” from a time in which both the fiscal and current account surpluses were huge to one in which the country is forced to borrow, devalue, or spend less. “Russia will become a classic twin-deficit economy,” he adds, with both a federal budget deficit and a current account deficit.

Already the signs are apparent. While budget spending grew 31 per cent in real terms in 2007 alone, at the peak of the nation’s energy-driven exuberance, in 2010 and 2011 expenditures were almost flat in real terms. Only an uptick in oil prices allowed the government last year to end up with a modest surplus on the federal budget, which since 2009 had been running small deficits for the first time since Mr Putin came to power at the turn of the millennium.

The end of massive trade surpluses is not necessarily a disaster waiting to happen – many countries, including the US, run both budget and current account deficits, which are made up for by attracting capital from abroad. While pointing out the risks such a scenario entails, analysts say somewhat counter-intuitively that the removal of the pillow of petrodollars may even be a good thing – one that could finally force the government to reform its economy and legal system in an effort to become an attractive destination for foreign investment.

“I think Putin doesn’t have any choice but to change. We hope he understands that if he doesn’t, the economy could experience severe difficulties in three years’ time,” says Mr Tchakarov. “If you don’t do anything no one is going to come to you and help finance these deficits.”

Rather than attracting capital, Russia at the moment is doing the opposite: partly because of political uncertainty, capital outflows totalled a net $84bn in 2011, equivalent to 5 per cent of GDP. That drain in funds was barely noticed because the country was running a big trade surplus. But if the cushion of petrodollar surpluses were to vanish, such outflows would cost Russia its reserves and could force a devaluation of the rouble.

Mr Putin himself has repeatedly declared that his chief economic goals as president will be to improve the investment climate and limit federal expenditure so as not to crowd out private sector investment. During his election campaign, however, he paradoxically pledged to spend an additional Rbs5tn ($171bn) to Rbs10tn on wage rises for federal workers, a sum equivalent to about 1 per cent of GDP. That will put additional pressure on the budget.

Such largesse is the reason why the trade surplus is evaporating. Throughout the decade of Putin rule, domestic consumption and imports outpaced GDP growth as Russians made up for the deprivations of Soviet life by splurging on everything from cars to fur coats and holidays. These habits have been buoyed by anti-crisis spending since 2009, when GDP fell by 8 per cent amid a drop in oil prices. Budget funds earmarked for infrastructure were diverted to the state’s social safety net in an effort to prevent political unrest.

Assuming oil prices of about $100 a barrel, the International Monetary Fund predicts that rising imports will overtake exports and Russia will show a small current account deficit in 2016. If the country cannot attract the foreign capital to finance a deficit, it will have to allow the rouble to devalue until imports fall enough to stay in balance. Ksenia Yudaeva, chief economist at Sberbank, is a believer in this scenario, predicting that once the current account surplus shrinks to 2 per cent of GDP, from its current level of about 5.5 per cent, the rouble will begin an orderly devaluation. That would “bring the system back into equilibrium” and head off a deficit.

If the forecast twin deficits do come to pass, they will bring a sea change in economic management for the Kremlin. For most of the past decade, government spending was limited not by how much money it had but by the economy’s capacity to absorb it. Russia parked much of its oil wealth abroad in sovereign wealth funds and reserve deposits because the finance ministry believed it would be counterproductive and inflationary to spend it.

Soon, however, the Kremlin may face a real scarcity of revenues and be forced to cut back on politically popular election pledges and/or on its ambitious defence spending programme designed to return Russia’s military to its former pride of place on the Eurasian landmass, which Mr Putin announced in February. The modernisation plan is scheduled to cost Rbs23tn, in effect doubling defence expenditure as a percentage of GDP for the next decade.

Pressing ahead with spending plans is likely to require borrowing, which for a limited time would not be hard for the government – external debt levels, a key indicator of international creditworthiness, are minuscule at less than 15 per cent of GDP. “There is much more room to borrow,” says Ms Yudaeva. “In fact, I don’t think we have been borrowing enough, and it’s time we started.”

The finance ministry has even taken the step of making Russian treasury bills euro-clearable, partly in an attempt to promote Moscow as an international financial centre but also as an unmistakable preparation to borrow more. ‘The domestic pool of savings is too small to finance large budget deficits, so they’ll be needing foreign investors to come here,” says Mr Tchakarov. “But to do that, Russia will have to think seriously about how to make itself a more attractive destination for foreign investment.”

Yet Elina Ribakova, chief Russia economist at Citibank, says hopes for increased investment may be misplaced. “We have not seen investors bullish on the rouble or Russia when the current account surplus is small or close to zero. When the current account surplus disappears, the quality of policymaking becomes the key focus of investors and they are not yet willing to give the authorities the benefit of the doubt in this area,” she says. A zero current account surplus may even be possible on a monthly basis as early as the end of this year if oil is at $110 a barrel.

The economy would be more vulnerable to downward swings in the price of crude: the IMF has repeatedly warned that Russia is becoming more rather than less vulnerable to such shocks. The non-oil budget deficit, which has ballooned since the 2008-09 crisis, remains a crucial indicator of how well the country can manage the volatility of oil revenues.

“When you look at the standard vulnerability indicators, Russia doesn’t look bad on the budget side or on the external side,” says Odd Per Brekk, the IMF representative in Moscow. “However, the government budget deficit before oil revenue has increased substantially compared with the pre-crisis situation.” The imminent depletion of rainy-day reserve funds “means that Russia now has much less scope for a budget response to any adverse spillovers from external developments than it had in 2008”.

The last time the current account swung into negative territory on a quarterly basis was in late 1997; it is a shift widely seen as a main reason for the collapse of the rouble in August 1998.

Today, many things are different. In 1998, foreign reserves were less than $20bn, while now they are about $500bn, the third largest in the world. Economic management, while still far from perfect, is nowhere near as chaotic as in the post-communist 1990s.

But Russia minus its current account surplus will be a very different economy to orchestrate. “The foreign investors will get a vote in how Russia is run,” says one banker. “That is an encouraging sign.” It is a change that would put more pressure on Mr Putin for privatisation – a process in any event resuming with the planned sale next month of a stake of Sberbank, the largest state lender.

Privatisation and pension reform are liberal economists’ two most sought-after reforms. Both, however, are politically difficult. Many special interests stand in the way of a wide-ranging sell-off of public assets, while Mr Putin’s new dependence on pensioners and other federal budget dependent voters as his main electoral base has led him repeatedly to rule out raising the pension age. While the 2018 election is far off, few in the Kremlin will want to be contesting it in the midst of an economic tumble brought about by bad planning.

Ms Yudaeva says that despite problems with the investment climate, Russia compares favourably with other emerging markets. With its low debt levels, “I don’t think we would have a major problem attracting money”. But on what the Putin team faces, she adds: “It is clear that they are going to be forced into some reforms – and few of us economists think this is a bad thing.” 

WTO forecasts big rise in global trade
World trade will rebound in 2010 as international commerce continues its rapid recovery from the falls during the financial crisis, the World Trade Organisation said on Friday.

The WTO predicted that the volume of global trade would expand by 9.5 per cent this year, undoing most of an estimated 12 per cent drop in 2009. Patrick Low, the WTO’s chief economist, said that while a rise of 14 per cent would be needed to return trade to the highs it reached in 2008, at current rates of growth it would take two years. “The story is of a recovery in global demand,” he said. “Those countries which suffered from a fall in demand, particularly the Asians, are now recovering.”

The unprecedented speed of the collapse in world trade volumes in late 2008 and early 2009 was attributed by some economists to a sudden shortage of the trade credit which finances transactions, and some wondered whether a rise in blocks on trade by governments was to blame. On Friday, Ron Kirk, US trade representative, said the US was considering the latest in a stream of WTO cases against Beijing, this one for restrictions on credit and debit cards being processed in China.

But economists have coalesced around the explanation that it was a simple drop in demand that caused the fall, exacerbated by the synchronised nature of the downturn and the prevalence of highly cyclical products such as consumer goods and investment goods in international commerce.

The WTO said that emerging market exports would lead the recovery, predicting a rise of 11 per cent this year compared with 7.5 per cent for the developed economies. The forecasts assumed that the global economy would grow at 2.9 per cent.

Mr Low said that there was no clear evidence yet whether the sharp fall had inflicted any lasting damage to trade by making producers less willing to extend supply chains around the globe.

“There were some reports of concern before the crisis that people had extended supply chains too far and that long-distance transport was vulnerable to pressure from environmentalists, but it is not obvious that the crisis as such has made any difference,” he said.