Nov. 25 (Bloomberg) -- Vladimir Putin wasn’t having a great day. The Russian president had spent the August morning in a helicopter over Khabarovsk, near the Chinese border, surveying flood damage that had left tens of thousands of people homeless.
Then he met with senior advisers who were on the trip, for a briefing on economic issues. They drew parallels to another brewing storm: The energy-export model Putin had relied on to restore Russia’s economic strength had run its course, he was told, said two officials on the trip. The state-dominated economy needed a shock, and, to prevent stagnation as growth slowed, a reset. Something had to be done.
The solution Putin chose will ripple through the entire Russian economy starting next year: He elected to freeze prices at such state companies as OAO Gazprom and OAO Russian Railways. The plan is to set off a chain reaction that will lead to increased efficiency, more stable costs for companies and tamer inflation.
It came with a hitch. That option, one adviser briefing him said, also would trigger lots of yelling from some of his closest allies. After a moment of reflection, Putin shrugged off the concern. If anyone yelled, so be it, he told the officials. They asked not to be identified as the Aug. 29 talks were private.
Today, with the freezes set for next year, Putin, 61, is signaling he no longer will tolerate surging costs and bloated investment programs at Russia’s largest monopolies. The annual price jumps those companies were allowed to charge for more than a decade will be suspended. Forced to act like businesses, the state-run monopolies probably will lay off workers, cut costs and shrink to become a smaller share of the economy, said the senior official who briefed Putin.
They also will lose money. With no increases for 2014 and future raises capped by inflation, the three largest monopolies, which employ 1.85 million people, or 2.6 percent of the workforce, stand to lose 878 billion rubles ($27 billion) in anticipated revenue over the next three years, according to Economy Ministry projections.
“It was a tough decision for all,” Dmitry Peskov, Putin’s spokesman, said by phone Nov. 15. “Executives always make convincing arguments, but once a decision is made, Putin can’t be pressured.”
The pressure he does face comes from a weakening economy. Third-quarter growth of 1.2 percent was the same as in the second quarter, which in turn was the sixth straight quarter of decline. Those two quarters marked the worst performance of Putin’s nine years in the Kremlin. Putin can’t depend on oil prices, which rose more than fourfold through his first two terms, to drive growth any more, Deputy Finance Minister Alexey Moiseev said in an Oct. 1 interview in Moscow.
Brent crude, the benchmark for more than half the world’s oil, has fallen 3 percent this year after gaining 43 percent in the previous three years. That also compares with an 87 percent increase in the commodity during Putin’s first stint as president, from 2000 to 2008.
The Economy Ministry expects the freeze, announced on Sept. 19, to boost profit at the biggest industrial enterprises by 2.5 percent to 3 percent next year alone as budgeted cost increases disappear. Oil producers should benefit the most, led by state-run OAO Rosneft, as well as miners and steelmakers, which should spend 47 billion rubles less in total than planned in 2014 on power and cargo bills, the ministry said.
Other predicted consequences: a hold on inflation, which is running ahead of the central bank’s target and ranks among the biggest concerns for Russians, according to a poll published Sept. 18 by the state-run All-Russian Center for the Study of Public Opinion. And productivity should rise as the monopolies are forced to get rid of unnecessary workers, said one of the senior officials.
“That’s a hard fact that’s been recognized and the government is pushing reforms on a broad front,” Moiseev said. “It’s called the middle-income trap, when you’re not China anymore but you’re still not Germany. You either let the imbalances keep growing, devalue the ruble and fall lower, or you pull yourself together and jump higher.”
Sergei Kupriyanov, Gazprom’s spokesman, said the price cap on industrial users will affect the gas company’s investment program “one way or another,” declining to elaborate.
Squeezing monopolies isn’t a new idea. Then-President Boris Yeltsin resorted to freezing their prices after the sovereign debt default in 1998 to support cash-strapped companies. The hold-down worked then, adding about 1.5 percent to gross domestic product in 1999 as companies put their cash to more productive use, said Julia Tsepliaeva, head of macroeconomic research at OAO Sberbank, Russia’s largest lender.
Consumer price growth unexpectedly increased to 6.3 percent in October, exceeding the central bank’s target of 5 percent to 6 percent for a 14th month. The rate reached 127 percent in July 1999, half a year before Putin became acting president. It was 3.6 percent in April and May 2012.
“The government didn’t worry about monopolies’ exorbitant expenses and accelerating inflation as long as the economy was booming,” Tsepliaeva said. “Things have changed. Now high price increases act as a deterrent to competition and limit authorities’ ability to diversify the economy.”
Alexey Kudrin, who ran the Finance Ministry for 11 years under Putin, says now what’s he’s been saying since he first became a minister in 2000: the government’s role in business is just too big.
“The state-controlled sector of the economy needs to be drastically reduced and fair competition bolstered,” Kudrin, who was named chairman of state-run Sberbank’s strategy committee in September, said in an interview. “State-run corporations are ineffective.”
Putin’s pressing on the monopolies will probably lead to a short-term jump in unemployment as companies cull their least efficient workers -- a necessary shock therapy needed to stimulate the economy by improving productivity, said one of the senior officials on the Khabarovsk trip. Putin, whose current term ends in 2018, is at the beginning of a fresh political cycle that affords him the chance to gamble on new measures, the official said.
“It’s clear to everyone that Putin had to make a political choice amid a difficult economic situation: either continue feeding companies close to him with high prices or face the threat of popular discontent over inflation,” said Boris Makarenko of the Center of Political Technologies in Moscow.
Putin, who returned to the presidency last year after four years as premier, has identified increasing productivity as a key growth driver in his third term. His protege, Prime Minister Dmitry Medvedev, expanded upon that in an article he published in Vedomosti on Sept. 27.
In “The Time of Simple Solutions Is Gone,” Medvedev, who began his four-year presidency just months before the financial crisis erupted in 2008, said the former communist country must abandon its policy of preserving jobs at any cost. Russia needs to take advantage of its relatively low jobless rate, which has held below 6 percent for 1 1/2 years, to improve worker mobility and efficiency, Medvedev said.
The time of more complicated solutions may be gone, too, said Yaroslav Kuzminov, rector of the Higher School of Economics in Moscow. He also was head of a group that crafted a strategy plan for Putin’s 2012 election campaign. While Russia needs an injection of unemployment to improve productivity, a bigger problem isn’t being addressed: the management of the monopolies themselves.
“The economy is managed by a bunch of tightly knit elites: politicians, lawmakers, law-enforcement agencies and corporations,” Kuzminov said in an interview in Moscow. “Managers of different ranks treat state companies as their own feudal estates rather than as assets they should run in the interests of the country.”
Back in Khabarovsk, at a televised meeting with local officials on how to respond to the worst flooding in more than a century, Putin recommended a course that could have applied to the officials and heads of state companies back in Moscow.
“I don’t expect any heroic deeds,” Putin said. “You just need to do your duty professionally, work hard and be honest. And then we will achieve the desired result. ”
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