EXPERT VIEWS: MEDVEDEV'S REFORM PROSPECTS SLIM;

C O N F I D E N T I A L MOSCOW 000866 SIPDIS SIPDIS STATE FOR EUR/RUS, EEB/IFD TREASURY FOR MEYER, TORGERSON DOC FOR 4231/IEP/EUR/JBROUGHER NSC FOR WARLICK E.O. 12958: DECL: 03/28/2018 TAGS: ECON EFIN PGOV RS SUBJECT: EXPERT VIEWS: MEDVEDEV'S REFORM PROSPECTS SLIM; POLICY DEBATE CHANGING REF: MOSCOW 721 Classified By: ECMIN Eric T. Schultz, Reasons 1.4 (b/d). -------------- Summary -------------- ¶1. (C) A swelling number of experts has low expectations that the Medvedev administration will pursue pro-market reforms. In separate conversations the week of March 17, Deputy Director of the Institute for the Economy in Transition (aka the Gaidar Institute) Sergei Sinelnikov and Alfa Bank Chief Economist Natalia Orlova are the latest analysts with whom we have met to add their voices to this chorus. Both cited the country's current prosperity as a major impediment, as well as the government's unwillingness to give up its increasing control over the economy. That said, both gave Medvedev credit for raising the need for reforms. Orlova said Medvedev had identified the right priorities, and Sinelnikov called Medvedev's February 15 speech in Krasnoyarsk a signal to the "siloviki" that Medvedev's administration would not be focused on doling out the spoils of power but rather on a policy debate about how to sustain the country's economic growth. End Summary. -------------- Krasnoyarsk: No "There" There -------------- ¶2. (C) Gaidar Institute Deputy Director Sergei Sinelnikov sharply criticized the conventional wisdom that Medvedev's Krasnoyarsk speech was a first draft of the President-elect's economic policy roadmap. Sinelnikov observed the speech was conspicuously lacking in substance. Medvedev did not shed any light, for instance, on strengthening civil society, even though the development of Russia,s institutions lagged well behind that of other countries with similar GDP per capita measures. According to Sinelnikov, Medvedev had no political motive in the sense of garnering support "because he knew he was going to win the election." Instead, Medvedev used the speech's "extreme populism" as a means of garnering positive sentiment. ¶3. (C) Alfa Bank Chief Economist Orlova echoed Sinelnikov's assessment that the speech offered few details to highlight what policy direction the Medvedev administration might follow. She said she had found the speech itself positive and credited Medvedev for identifying the need to address the shortcomings the "Four I's" represented. The first step on the road to reforms was acknowledging that there were problems. That said, she conceded that the Krasnoyarsk speech as well as Medvedev's other public comments were essentially "encore performances" of Putin's speeches during 2001-03. -------------- Outcomes Uncertain, Reforms Resisted -------------- ¶4. (C) Sinelnikov restated Merill Lynch CEO Aleksashenko's perspective (Reftel) that nothing short of a crisis would spur the incoming administration to undertake broad reforms. Sinelnikov added that not only would the Russian economy's general stability minimize the perceived need for pro-market reforms but the uncertainty of outcomes would also increase the government's reluctance. For instance, encouraging greater investment--one of the Four I's--would be a distinct challenge without tax incentives, especially in the oil and gas sector, which the Finance Ministry would oppose. (Comment: Kudrin has apparently reversed this position. He announced a proposal on March 24 to reduce oil extraction taxes -- septel. End Comment) ¶5. (C) Orlova also said she considered the country's current prosperity to be a hostile environment for reform. Russia was too rich and its people too cynical. Cheap credit, however, had helped fuel Russia's boom, and she thought that credit would begin to dry up as the global financial crisis deepened. Russia had not yet suffered badly from the crisis, but talk that it was "decoupled" from the global economy, including the U.S. economy, was wrong. Orlova also said the first reform was likely to be tax policy. She favored a general cut in taxes along with increased social spending but feared the government would instead cut oil and gas taxes, weakening the country's fiscal position, and would at the same time increase funding to the inefficient and corrupt state corporations. ¶6. (C) Orlova added that the long-term nature of Medvedev's institutional development goals meant that they might suffer from slow and uneven implementation. This was unfortunate, because stronger property rights, especially for small and medium size enterprises, were critical to growing the economy in the right way. Even large companies had questionable control over their assets. She said that Troika Dialog, for instance, one of Russia's largest domestic investment houses, had been denied permission by the government to sell out to a Japanese investment bank. Orlova said that the Yukos affair had had a chilling effect on people's willingness to take risks and come up with new economic initiatives. If this continued, Russia's economic growth would result in low-paying, low-skill jobs in retail trade and the state corporations. And Russia's greatest comparative advantage, its human capital, would be squandered. -------------- Multifront Reform Effort or Else -------------- ¶7. (C) Sinelnikov said the most effective path toward economic reform was a multi-front effort. Referring to the proposal on reducing Russia,s value-added tax (VAT),which the Ministry of Economic Development and Trade (MEDT) had just sent him, he said that some officials and ministries were already vying for priority position among the reforms suggested in Medvedev,s speech. He argued, however, that Russia could not afford to support the development of institutions of civil society to the exclusion of infrastructure improvements, or that building an innovation economy should take precedence over legal reforms such as strengthened property rights. Sinelnikov conceded that the magnitude of resources allotted would vary by area of reform, but he maintained there was no such thing as a "key reform." Addressing reforms one by one threatened a repeat of Putin,s second term, during which the "window of opportunity" to continue reforms was shut tight. ¶8. (C) Orlova speculated that the Medvedev administration would adopt a broad based approach to reforms, but more by inertia rather than by design. She observed that government spending had been on the rise: the 2006 budget surplus equaled 7.6 of GDP; whereas in 2007 it slipped to 5.5 percent of GDP. Budget expenditures in January 2008, furthermore, were double those of January 2007. She anticipated that the incoming administration would cut taxes either generally or for specific sectors as a means of moving toward more value-added production. Orlova said that social spending was likely to increase and that one of Presdident-elect Medvedev,s key challenges would be to refrain from spending the Stabilization Fund too fast. She explained that pressure was mounting to spend the Stabilization Fund on Russia,s wide ranging needs. The banking sector needed the resources to provide liquidity; small businesses needed access to inexpensive financing; funds were needed to shore up the country,s health care system. -------------- The New Face of Policy Debates? -------------- ¶9. (C) According to Sinelnikov, observers would be able to gauge the level of Medvedev,s seriousness about reforms based on his choice of advisors. Keeping Alexey Kudrin in the Finance Ministry would ensure that any fiscal action to stimulate the economy would be thoroughly vetted for adverse effects on the budget and inflation. He noted that the economically liberal, Western-leaning Presidential Administration Experts, Directorate Head Arkadiy Dvorkovich and Deputy Economic Development Minister Stanislav Voskresenskiy were becoming influential advisors to Medvedev. Sinelnikov recounted that during the flight to Krasnoyarsk with Medvedev, Dvorkovich and Voskresenskiy edited the "Four I,s" speech. Sinelnikov attributed the economic portions of the speech, such as cutting the VAT and increasing deductions for research and development spending, to their direct influence: "Medvedev left Moscow with one speech and arrived in Krasnoyarsk with another." ¶10. (C) Despite his critiques of the Krasnoyarsk speech, Sinelnikov said the speech sent a signal to Kremlin factions about the general direction of the future Medvedev administration. The speech implied the focus would gravitate toward systemic changes and away from political favoritism. Medvedev would concentrate on deciding between optimal policy choices rather than doling out political spoils. Sinelnikov said that Medvedev,s current combination of senior economic policy advisors underscored the point: in listening to both the fiscally conservative Kudrin and the more economically progressive Dvorkovich, Medvedev was signaling that the debate within the government had already shifted, away from a division of spoils and toward policy. BURNS