Russia's Increased International Influence - A shift in relations with the West

Russia’s strong macroeconomic fundamentals – which include the second best growth performance in the emerging markets (after China), the largest budget surplus in the post-transition period, and an unusually robust balance of payments– have been the backdrop for a remarkable shift in the country’s relations with the West following 11 September. Because perceptions of a strengthened role in international affairs will have a bearing on credit ratings, eurobond spreads, and investment prospects, it is useful to review some aspects of Russia’s increased international influence.

First, Russia’s relations with Nato seem headed for a potentially systemic change. While the full details remain to be worked out and will the subject of intense consultations, Lord Robertson, Nato’s secretary general, has proposed a formal partnership with Russia that would permit the government to help shape policy in areas of common interest. These might include initiatives aimed at combating terrorism, making more effective use of international peacekeeping operations, monitoring and limiting the proliferation of advanced weapons, and strengthening mechanisms of consultation in a number of trouble spots in the developing world. Although Nato will want to safeguard its prerogatives in certain sensitive areas, such as potential military interventions (`a la Kosovo in 1999) and the expansion of its membership, there is no doubt that an enhanced role for Russia in Nato is likely to allay concerns in Moscow about future alliance expansion plans, particularly to the Baltics.

Russia’s participation with peacekeeping forces in Bosnia and Kosovo, President Putin’s decision not to oppose the use by US forces of airfields in some of the central Asian republics as part of the war on terrorism and the recent announcement by presidents Bush and Putin of plans to carry out deep cuts in nuclear weapons have all served to underscore not only the extent to which the Cold War has ended, but also the extent to which Mr Putin seems intent on showing that Russia can now be seen as a reliable partner with the West. Mr Putin’s decisive response to the 11 September events has resulted in some grumbling among some of his more conventionally minded generals and security personnel, and thus strengthened perceptions of a rising opposition. We would interpret this as signs of increasing self-confidence on his part, rooted in unusually high levels of public support, rather than as evidence of emerging weakness.

Thus, in an unusually brief span of time, President Putin has steered Russia from the strategic ambiguities of the 1990s, when the country’s diminished international standing seemed to be accompanied by at times noisy opposition to various western initiatives – eg, Nato expansion, intervention in the Balkans – to the search for clear avenues of co-operation with western partners on a broad range of political and security issues.

We judge that this is likely to have potentially far-reaching implications for the willingness of investors (other than to the energy sector) to give the country a second look, for perceptions of underlying political stability, for credit agency ratings, for asset prices and, ultimately, for the speed with which the country is likely to make a comeback to the international capital markets. A foretaste of this may have been provided by Moody’s recent two-notch upgrade (and further likely upgrades in 2002), and by Russian eurobonds trading well inside of their corresponding counterparts in other emerging markets such as Brazil (see chart in next page). Also, by the government’s decision to prepay ahead of schedule debts to the International Monetary Fund (which the market takes as a clear positive step, signaling growing self confidence in the underlying strength of the budgetary and reserve position), and by the recent impetus given to WTO accession negotiations, which are now seen as a realistic medium-term objective rather than a long-term ethereal goal.

The emerging oil power

Another strengthening sign of Russia’s growing influence is its emergence as a major power in the international oil markets. Partly reflecting sizeable investments by the oil companies during the last three years, Russian oil output has expanded by some 15% in the period 2000-01 and the country is now the world’s number two oil exporter. If appropriate account is taken of gas exports, total Russian energy exports are broadly similar to those of Saudi Arabia, the world’s largest oil exporter. The government’s initial reluctance to submit to OPEC requests for production cuts in 2002 has reflected a combination of factors. Among them: the setting of ambitious medium-term production targets by private producers, concerns about the establishment of a precedent which could then lead to future OPEC demands on the government and producers, and the fact that the government appears to have made a deliberate strategic choice to present itself to the West as a reliable, alternative supplier.

Other factors which support a relatively non-accommodating stance vis-`a-vis OPEC include large projected inflows of foreign investments linked to the oil sector (eg, Exxon’s oil production agreement signed last October which is expected to provide the Russian budget upwards of $30bn over the life of the project) which are partly predicated on the Russian government placing no artificial constraints on the growth of oil output. In the light of these factors the export cuts announced on 5 December (150kbpd) should be seen as largely a fig leaf to OPEC: a face-saving device that will allow it to proceed with its own export cuts, in collaboration with other non-OPEC producers such as Mexico and Norway. More likely than not, Russia’s “cuts” will be accommodated within the seasonal export slowdown that takes place in the first quarter linked to inclement weather conditions.

Chart 1: Euro bond spreads (basis points over treasuries)		Table 1: Natural gas exports (bn cubic meters, 2000)

We expect no significant deviations with respect to the government’s long-term strategy of boosting oil and gas export, to generate a stable revenue stream to the budget even at low international price levels. It is entirely feasible that within three to four years the federal budget may receive higher revenues at an average price of $15/barrel than it did in 2000, at an average price of $26.6/barrel. If, in addition, discussions within the government and the Duma on the possible creation of a Norwegian-style stabilisation fund were to lead to the creation of such a mechanism in 2002, Russia will have taken a leap forward in terms of reducing its excessive dependence on commodity exports and will have made an important contribution to the creation of a more stable macroeconomic climate that will provide investors larger margins of comfort.

Other encouraging signs

Table 2: Oil production (million tonnes, 2000)		Table 3: Stock market performance (% change from 31 December 2000, in $ terms)

To the extent that the government succeeds in reducing its dependence on commodity exports and that progress continues to be made in the implementation of its ambitious programme of structural reforms, medium-term growth prospects should remain strong. The factors which should make this possible are many:

• A bountiful natural resource base which is attracting rapidly growing levels of foreign investment, initially to the energy companies but, with increasing frequency, to other sectors as well – manufacturing,  construction, retail trade – which support the activities of the energy sector.
• A rich human capital endowment, with a skilled labour force supplying workers at comparatively low dollar wages, when compared with other transition economies in the region.
• Considerably higher levels of political stability than seen at any other time during Russia’s ten-year transition. [1] This is prompting the repatriation of flight capital, a potentially vast source of finance for the economy over the longer-term.
• Reasonably solid commitment on the part of the government and parliament to hard budget constraints and, more generally, the pursuit of macroeconomic stability and cautious budgetary management.

These points should not hide that, in an uncertain global environment, Russia too has its own vulnerabilities. The authorities will, therefore, have to remain vigilant in the pursuit of what the IMF calls “high quality growth.” Nevertheless, they do underscore the extent to which the country has entered a new phase, the key elements of which are rising per capita incomes and a more visible, co-operative profile in the international political arena.[2]

[1] For a review of the achievements and setbacks of Russian economic reforms during the first decade of the post-transition era, see the article by Augusto Lopez-Claros and Mikhail M. Zadornov, Economic Reforms: Steady As She Goes, in the winter 2002 issue of The Washington Quarterly, the journal of the Centre for Strategic and International Studies. The article may be downloaded from www.twq.com.

[2] See Russia: Five Things To Worry About, Global Weekly Economic Monitor, 19 October 2001.