Why Russian bears should become bullish

When things look truly dreadful, the wise look for signs of the turn. It is just possible that the plunge (and recovery) of the rouble this week will be seen as a signal that the long decline of the Russian economy is over and a more-or-less secure recovery has begun.

That is not to say that the rouble itself will necessarily recover for long - given high inflation, rather the reverse. Nor that progress for the next five years will be anything other than chaotic. Nor that the lurch of the rouble itself has much impact on the progress or otherwise of the economy.

The proposition is much more simple. It is that, 10 or 20 years from now when it will be possible to see the transformation of Russia from a planned to a market economy in perspective, the autumn of 1994 will come to be seen as the moment when things started to get better.

Why so? Start with Boris Federov. He was the reforming finance minister and deputy prime minister of Russia until January this year and is now a member of the Duma, or parliament, where he is chairman of its banking and finance sub-committee.

Yesterday, by coincidence, he was at the London School of Economics, which is running a course on finance for 30 Russian students - and speaking with wit, wisdom and eloquence on the mess that Russia is making of its public finances.

In some ways his message was one of gloom. Most of the so-called reformers knew little of what they should be doing so that, unlike the rest of central and eastern Europe, there had been no clear break with the past. The result was that, while a lot of the measures which had been taken were in the right direction, there were large sectors of the economy where nothing was happening.

In agriculture, for example, productivity was very low and efficiency was never mentioned. In social security the unemployment benefit system had become 'a financial casino'. Bureaucrats still lived on the fat of the land, and there were more people servicing their dachas than were employed in foreign banks in London. People did not understand that the job of a government in a market economy was to regulate, not to manage.

The most serious problem of all was that no one considered that the budget should fix what was spent by government, so budgets were often overridden. It was difficult to explain to people who thought governments could do whatever they wanted that 'you can't spend money as though you were a monarch'.

Some of the scams were quite funny. There were subsidies for growing grain - so people grew it in flower pots. The government would pay half the cost of building a cowshed if it housed more than six cows - so people built them, got the money and then converted the sheds to something else. For a government that could not collect much of its taxes the effect was disastrous.

As for the present problem of the rouble, Mr Federov felt that instead of looking for scapegoats they had to look at policies. Sacking a couple of people suggested that the real lessons were not being learnt.

Yet, despite this tale of woe, there were cheerful signs. One was the eagerness of foreign companies to invest in Russia, another the inflow of risk capital, something like dollars 2bn so far this year. Russians were repatriating some of their foreign funds, finding that they could only earn 5 per cent a year abroad but 5 per cent a month in Russia.

'The country is very rich,' he declared. 'Everyone will not emigrate. We have very undervalued assets. Everything will have to rise by hundreds of times.'

That may take a while, but there are signs on the ground that the long retreat is over. The LSE has been monitoring the Russian economy on a monthly basis. It reckons real incomes have risen steadily since February and, though they are still only three-quarters of the level in 1990, they are up 18 per cent over the year.

Industrial production is still falling, though at a slower rate than before. But the figures do not pick up the expansion taking place in the service sector, and the LSE says that taken together the evidence is that Russia's GDP has stopped falling.

This sort of timescale - three or so years of decline since the reform process began in earnest - seems to square with the experience of countries such as the Czech Republic, Hungary and Poland, all of which saw quite sharp falls in living standards before recovery was secure.

The fall has almost certainly been sharper in Russia, but you would expect that given the lack of folk-memory of running a market system that still existed in central Europe. In the 1920s and 1930s the central European economy was still linked to western Europe, whereas Russia's was not.

Surely the surprising thing is not that the Russian economy has been dreadfully managed but rather that, despite such damaging economic policies, the thing can recover at all. Imagine what might happen were half-decent economic management in place.

Remember, too, that during the first decade of this century Russia was the fastest growing economy in the world. As Mr Federov pointed out, the fundamental conditions for wealth creation still exist, and there are a lot of grossly undervalued assets. He could have added: Just as there were 100 years ago.