Russia: Where Has All the Money Gone?

Nov 25, 2013
By

Russian President Vladimir Putin has had a good run over the past few months.

Edward Snowden, the former NSA contractor, landed on his doorstep, a gift from the PR gods. Agreement on Syria went from no chance to golden opportunity in the course of one afternoon. Forbes dubbed Putin the most powerful man in the world. Yet all these successes obscure a basic fact: Russia is running out of money.

To be fair, Russia is far from broke. Revenues continue to stream in from oil and gas sales, and Moscow maintains healthy financial reserves for future rainy days. Russia also dislikes budget deficits and keeps its foreign debt down — a model of fiscal rectitude that most Western countries can only dream about.

Yet despite these accomplishments, the Russian government submitted an austere budget to the Duma in September that contemplated freezing government salaries and significant across-the-board cuts for most government agencies. Although the Duma restored some social spending in its budget amendments, Russia will be working under tight financial constraints for several years to come.

Where has all the money gone? Much of it left the country due to catastrophic rates of capital flight and corruption. So much money gets siphoned off the top that Russian economic growth has fallen to below 2 percent this year, with no prospects for any dramatic improvement in the immediate future.

Alternative sources of revenue have also dried up. Putin returned to office in 2012 with ambitious plans to privatize numerous state-owned enterprises, in the process raising billions of dollars for the Treasury. His subsequent demand, however, that all such privatizations take place on the Moscow Exchange (to encourage domestic investment and limit capital flight) means that these assets remain underpriced and subject to limited demand.

The diamond producer ALROSA, for example, recently sold 16 percent of its shares on the Moscow Exchange for just $1.3 billion — significantly below expectations.

Small- and medium-sized enterprises represent another obvious source of tax revenue. But this group has been regulated, taxed and prosecuted almost to the point of collapse. The number of people contemplating going into business remains miniscule. Meanwhile, higher taxes and excessive bureaucratic interference have prompted some 500,000 small business owners to de-register from state rolls over the past year. Some went out of business but others shifted into the shadow economy.

Yet Putin still needs to feed the bureaucracy and fund his grand projects — hosting the Winter Olympics in Sochi, hosting the World Cup, Far East development. So his government has been busy picking the pockets of Russia’s big state-owned corporations.

The Russian government is now trying to recover $4.9 billion that Rosneft’s state-owned holding company received from BP as part of the Russian company’s acquisition of TNK-BP. Essentially, the government wants the proceeds of this sale to cover budget shortfalls, instead of letting the company invest its own money.

An even more ambitious Putin program concerns the government’s plan to demand that state companies pay upwards of 35 percent of profits in dividends. Such fixed payments will no doubt be welcomed by those lucky private investors who own shares in Russian state companies. The Russian state is the majority owner or controlling shareholder in all these companies, however, and thus the primary beneficiary of this new policy. So these mandatory dividends simply represent a tax by another name.

State companies are grumbling as to what sort of burdens these increased dividend payments will place on their operations. Sberbank, Russia’s largest financial institution, has already complained that it can either pay dividends or fund economic growth — not both.

The Russian government is busy casting around for other potential sources of revenue as well. Russian land-holdings appear particularly enticing. A new market-based real estate tax seems to be on hold, but the Duma recently approved a major tax increase on the value of commercial property. This has already produced howls of protest from small- and medium- sized enterprises.  Increased excise taxes are also in the offing for gas, alcohol and cigarette sales.

But will any of this be enough? The International Monetary Fund has concluded that Russia’s economic growth model is exhausted. Indeed, Moscow has dramatically slashed its long-term growth forecasts, and any sudden drop in oil prices would place impossible pressures on Russia’s future budget calculations.

Some Russian government officials seem to understand, at least intellectually, that the current economic course is unsustainable and major liberal reforms are necessary to change the country’s economic fortunes. Prime Minister Dmitry Medvedev recently admitted that Russia must turn to the non-state sector as the source of new investment and growth.

But such statements carry no concrete actions behind them — and clearly go against Putin’s desires. Instead of opening up the business sector, he continues to put the squeeze on it.

Putin recently proposed that Russian criminal investigators again be granted the power to initiate tax prosecutions without a request from tax officials. Medvedev had withdrawn this authority in 2011 — largely because it had been frequently misused for extortion and the arbitrary arrests of businessmen.

Putin has openly criticized Medvedev’s previous efforts to “humanize” the most severe aspects of Russian criminal law — especially as it relates to economic offenses. There appears little prospect that the legal environment for Russian enterprise will improve anytime soon.

Russian corporate law has become so distorted that the Russian corporation, the institutional backbone of a market economy, seemingly exists solely for the state’s financial benefit, not as the means to spur private-sector development.

Russia clearly needs new sources of revenue, yet it appears unwilling to make the hard economic and political choices to make this happen. The clock is ticking — both for the Russian economy and Putin’s place atop the world leader board.

This article first appeared on Reuter's The Great Debate.

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