Back in September, First Deputy Prime Minister Igor Shuvalov nailed it, perhaps more than he’d wanted to. The economy was slowing and foreign investors – tripping over political risks, judicial nightmares, legal bogs, and corruption – were bailing out. Demand for Russian metals, oil, and gas “is what it is,” he told Reuters. Russia had some potential export products, but “we haven’t yet entered the global market with them.” Then there were “good projects,” like building nuclear power plants, but not enough “to get us out of that noose, that over-dependence on oil and gas.”
So was the government to blame for the slowdown? Nope. “In any country, the government is evil to a certain extent,” he said. But the Russian government understood it “should bring as little evil as possible to the business community.” And to attract foreign investors, Russia would simply have to show them “very responsible macroeconomic policies for 2014,” he said.
So Russia annexed Crimea.
Russia’s economy doesn’t need to be hit with sanctions. It’s already in trouble. Last year, growth slowed to 1.3%, the worst in four years. This year started out even shakier. Private sector output contracted in March at the fastest pace since May 2009, according to Markit’s PMI report. Services activity in March dropped at the fastest rate since August 2010, when a terrible heat wave had disrupted business activity. The March nosedive pushed the index for the first quarter into contraction. It was the lowest quarterly average since Q2 2009.
Job destruction in services and manufacturing, now in its ninth month, was the worst since October 2009. And business expectations in the service sector deteriorated to the worst level since December 2008, the depth of the financial crisis. “Respondents referred to unstable economic, political, and currency conditions” – and there were reports, as Markit put it, “of a growing economic crisis in the country.”
But it’s not just the annexation of Crimea and the threat of sanctions, or even actual sanctions, that are causing the tremors, but the fallout from Russia’s state-run business model. Take Gazprom, Russia’s natural-gas export monopoly. It’s publically traded but run by the state, as Bloomberg notes, for the Kremlin’s own purposes:
No company among the world’s top 5,000 has suffered a bigger collapse in market capitalization [since April 2007] than Gazprom, a $154 billion plunge that’s become emblematic of the malaise that has overtaken President Vladimir Putin’s economy. The state-run company has tumbled three straight years in the stock market as it stepped up spending on everything from the Olympic Games in Sochi to projects in Siberia.
Gazprom is under pressure. The Kremlin froze domestic gas prizes to keep the people happy and increased taxes on the company. The Ukraine owes Gazprom about $2 billion for gas it burned while its oligarchs and politicians syphoned off the country’s wealth. International competitive pressures are building, with global LNG capacity and Norwegian gas production trampling on Gazprom’s bailiwick in Europe. Meanwhile, under irresistible encouragement from the Kremlin, Gazprom spent about $3 billion on the Olympics and plowed a pile of dough into the Nord Stream pipeline system to Germany that bypasses the Ukraine. And suddenly it doesn’t have, it confessed, any funds left to distribute to shareholders.
“A champion in value destruction” is what Firebird Management founding partner Ian Hague called the company. “It’s Russia who failed,” he told Bloomberg. “It failed to create an environment where state-owned companies would function as shareholder-owned entities.”
The Kremlin uses Gazprom to do some heavy political arm-twisting in other countries, pay for social projects at home, cover the cost of subsidizing domestic gas deliveries, and execute various other political agendas, such as funding parts of the most expensive Winter Olympics ever. In this elegant manner, the costs are shifted from the government’s squeezed budget to Gazprom’s financial statement. Shareholders end up with the short end of the stick.
“This is an issue of any Russian state company,” lamented Oleg Popov of Allianz Investments in Moscow. And there are many of them, and they dominate many sectors of the economy. Joseph Dresen of the Kennan Institute of the Woodrow Wilson International Center for Scholars observed:
Russia’s prime minister during much of the 1990s, Viktor Chernomyrdin, came from Gazprom, and he worked to keep the gas industry a state monopoly under his control. The oil industry experienced a significant return to state control with the 2004 confiscation of Yukos assets and their subsequent transfer to state-controlled Rosneft. Russia’s 1998 financial crisis, which caused the collapse of several large private banks, led to a great increase in the state controlled financial institutions.
These state-run banks, benefiting from cheap credit and state guarantees, outgun more efficient private banks. The transportation and defense sectors were never privatized. Nor were some of the major media outlets. Formerly private media companies have now been consolidated under the Kremlin’s control. And what little is left of the independent media is constantly under attack.
State-run companies don’t face real competition. Some of them are monopolies. They have access to cheap credit via the state-run banks and the implicit government guarantee on their debt. The commodity boom provided the grease. And these companies, Dresen writes, “function as a mechanism of political control and rent extraction in Putin’s system of vertical power by enriching allies and neutralizing any opposition (such as Yukos’ former owner, Mikhail Khodorkovsky).” There isn’t even any pretense of generating economic benefits.
It works. Or at least it does for the state-run corporations, Putin’s political system, and the ruling elites. Where it falls apart is in the private sector that can’t get enough air and in the inconvenient situation when state-run mastodons like Gazprom have to compete internationally: they suffocate under the Russian state-run business model and the Kremlin’s costly political agendas.