November 15, 2005

Awash in Petrodollars, Russia Frets About the Paradoxes of Bounty

MOSCOW, Nov. 10 - A few years ago, Russia's finance officials could only dream of the problem Aleksei L. Kudrin described recently.

Thanks to bountiful revenue from oil exports, the Kremlin is in a position to pay $15 billion in sovereign debt ahead of schedule next year.

Russia is the world's second-largest oil exporter behind Saudi Arabia, thanks to places like this Lukoil-owned oil field in the Urals, above.

Russia's oil exports are bringing in $500 million a day, and economists are concerned that the cash is gushing faster than the country can use it without leading to inflation. Above, a Lukoil refinery in Siberia.

"We would be ready to pay the whole sum," Mr. Kudrin, Russia's finance minister, explained recently to a group of investors. Other countries, however, are not permitting Russia to accelerate repayment because of other obligations tied to the debt.

Mr. Kudrin's comments illustrate an economic challenge - and a fierce internal debate - novel for Russia, which only seven years ago defaulted on its debt.

As the world's second-largest oil exporter, behind only Saudi Arabia, Russia is taking in $500 million a day from crude oil exports and the cash is gushing faster than the nation can absorb it without causing inflation.

Russia is still a relatively poor developing country, and with obvious needs to fix decades of accumulated infrastructure problems and pull an estimated 25 million Russians out of poverty, it has no dearth of things to spend money on.

If it does not manage smartly, however, Russia's embarrassment of new riches can turn into a classic paradox of good times, one that economists call the Dutch disease, afflicting energy-exporting countries.

The government is pulled in many directions.

"My pension is tiny," said Lina S. Martinyenko, 76, a widow selling plastic bags of pickled cabbage on a Moscow sidewalk to supplement her pension of $98 a month. "I have to pay for my apartment. Groceries are expensive. What I grow in my garden I haul out here to sell. Life is not simple for us."

The challenge with Dutch disease - the name for what happened in the Netherlands after the discovery of North Sea gas in the 1960's - is that as more and more oil dollars come back to Russia, they are converted to the local currency, raising the value of that currency, along with the threat of inflation.

For Russia, the threat is that its manufacturing will decline as its goods become more expensive overseas, while imports rise as they become cheaper at home, leading to a de-industrialization of the economy. The problem is exactly the reverse of Russia's chronic economic troubles with a weak ruble in the 1990's.

"It always goes badly for Russia," Irina E. Yasina, director of the Open Russia research institute, fretted. "It's bad when we don't have money and bad when we do."

Still, Russia is better off with its current problem than it was a few years ago.

Some of the impact is already surfacing, as Russia is starting to rearm itself. For the first time in a decade, the government is buying more of Russia's arms production for the country's own needs rather than to resell as exports.

Spending on military hardware will rise 50 percent next year, Gen. Yuri N. Baluyevsky, the chief of the general staff, told the government newspaper Rossiskaya Gazeta in an interview published recently. The 2006 budget includes money for everything from new Sukhoi fighter jets to such prestige-enhancing items as lambskin hats for Russia's generals, an accoutrement abandoned by Boris N. Yeltsin when he was president in leaner times, in 1993.

On Nov. 1, Russia's Stabilization Fund reached $38 billion. It is projected to exceed $50 billion by the end of the year. Under the law that created it, the fund can be used only to pay down foreign debt or top off the state pension fund.

The World Bank, in a report released this month, said the appreciation of the ruble had already harmed domestic production. "Many industries are struggling," the report said. The ruble appreciated by 7.3 percent against a basket of currencies in the first nine months of this year, the bank said.

Russia missed its 10 percent inflation target last year, registering growth in prices of 11.7 percent. This year, inflation is running about 11 percent, according to Andrei N. Illarionov, President Vladimir V. Putin's economic adviser. High inflation threatens domestic industry and undermines gains in living standards.

Beginning in 2004, fears of inflation led Mr. Illarionov and other liberals in Russia's government to isolate oil revenue in the Stabilization Fund, modeled on a similar fund in Norway and the Alaska Permanent Fund. The money is kept out of circulation. For a time, that settled the question of what to do with the billions of dollars.

But Russia now intends to begin spending from its specialized oil revenue accounts through the creation of a second fund. The proposed new fund would invest in infrastructure through loan guarantees or co-financing backed by the oil tax income.

Even with inflationary constraints brought by the ruble's floating on international markets, the Kremlin is financially stronger than at any time since a similar spike in oil prices in the early 1980's.

Back then, the Soviet Union threw oil revenue into the final sprint of the cold war arms race, largely ignoring the rest of the economy, and plunging into the reforms begun by Premier Mikhail S. Gorbachev only after the prices came back down.

This time, Mr. Putin has suggested completing the Boguchansk hydroelectric dam in eastern Siberia, which was begun in Soviet times but was abandoned half finished. Russian news media floated the idea of finally completing the Baikal-Amur railway, another epic Soviet-era undertaking left unfinished.

Viktor B. Khristenko, the minister of energy and industry, is pushing a plan to use the new investment fund, expected to reach about $2.4 billion next year, to revive production of the Ruslan cargo jet, a Russian aviation behemoth able to carry 150 tons, the largest such jet in the world.

The government Web site posted a strategy paper on "measures intended to speed up growth and improve the competitiveness of the economy." It encouraged the creation of a government-owned venture capital fund for high- tech companies.

For now, the money from oil-related taxes - which kick in at oil prices above $20 a barrel - has simply been stacking up in an account in the Ministry of Finance. The money has not been invested in stocks or bonds and yields no interest, although it has appreciated along with the ruble's oil-driven rise in value against the dollar.

In a change of policy, the Finance Ministry said last month that it would invest the funds in foreign bonds and currency under a plan developed by Russia's Central Bank, another institution brimming with petroleum cash these days. The bank's foreign currency and gold reserves reached $164 billion on Oct. 28. Mr. Kudrin, whose ministry wants to tame inflation and use the funds mainly to pay down sovereign debt, has his detractors. Just about everybody else in government wants to start spending, either on infrastructure, social needs or re-arming the military, an option favored by a hard-line faction in the Kremlin.

Mr. Putin is moving cautiously. He recently urged restraint in spending, even as Russia faces many problems, and suggested continued commitment to the Stabilization Fund and large foreign debt payments even as domestic spending rises. Mr. Putin's political image is that of the guardian of stability; roller coaster exchange rates or inflation set off by mishandling money from the oil boom would hurt him politically.

Russia could "take advantage of the foreign economic situation which today favors our country and become mired in long-term projects," he said. But "in case the situation changes we would again have to incur debts in order to complete the projects started or cut spending sharply."

But then again, Mr. Putin also knows how to spend. At a Kremlin meeting with lawmakers in September, he also promised an additional $4 billion to raise doctors' salaries and other social spending next year.

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