Gas and oil revenues helped lift the economy out of crisis

 

Russia's well-being hinges on energy. It accounts for a fifth of Russia's GDP, which grew 8.1% in 2007. Oil and gas generated 65% of export revenues and made up 30% of all foreign direct investment in the country last year, according to the World Bank and IMF.

There are three main types of financial models in the world: Western, Asian and Russian. The Western financial model is economically based, with gaining money and profit as the end goal; such a model tends to crush inefficiency and protect the system as a whole. The Asian model is socially based. This model’s goal is maximum employment and social stability, where money is used as a political resource for nonfinancial ends despite all inefficiencies. The Russian model is politically based. In Russia, finance is a political tool to control the country and operates much like money for loan sharks or organized crime. The system is highly inefficient, but it allows a very small few to hold all the power in an enormous country.

There is a dark side of the boom of commodity exports of 2004-2008. The Russian economy is showing significant signs of illness. Its symptoms include near-complete crowding out of investments in manufacturing and other lucrative export-oriented sectors and the unsustainable trend of a strengthening currency driven by excess petrodollars. Real-estate prices in central Moscow are higher than those in any of the largest cities in the world, and this is in a country with a GDP per capita just one-fourth that of the United States.

Significant inflationary pressures are becoming more visible with the headline inflation rate of 15%. Salaries are growing at double-digit rates, making even some of the most-promising industries, like high technology, uncompetitive very rapidly.

Combined with near-complete nationalization of the main driver of the boom, the oil and gas sector, investors in the private sector have plenty to fear. With so much capital flowing into less-productive government-driven sectors and inflation inhibiting the long-term success of the many of the other most-promising export-oriented investments, it is hard to see how the Russian economy could avoid a meltdown if oil prices continue to decline significantly.

Commodity producers account for a huge share of profits, and thus the Russian market's P/E could rapidly swing into double digits once the double whammy of declining commodity revenues and rampant inflation hits in 2009.