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October 05, 2008

Requiem For Russia's Middle Class?

by Brian Whitmore

Traders at Moscow Interbank Currency Exchange (MICEX) during a trading session in Moscow on September 17.

Riding the train from Moscow to his native St. Petersburg, Aleksandr Zvyagin ponders the future of his business as the world's financial system spirals deeper into crisis -- and its aftershocks ripple across Russia.

Zvyagin has built a profitable company, Slip Ltd., which constructs custom-made yachts for the super-rich. Business is still good, for now at least. But Russia's oil-fueled economic boom is slowing and global financial markets are in turmoil as the crisis on Wall Street spreads east.

He says he doesn't expect the salad days to last much longer.

"We have long-term contracts. It takes from 18 to 36 months to build a yacht," Zvyagin tells RFE/RL's Russian Service. "So this far, we haven't felt [the financial crisis]. But soon credit will become more expensive and harder to get. Then we will feel it."

Zvyagin adds that inflation is already driving up production costs -- metals prices have risen 25 percent this year -- and will soon begin eating away at his profits.

Struggle To Survive

Stories like Zvyagin's are becoming increasingly common in Russia as small and medium-sized businesses struggle to survive amid declining demand and tightening credit.

And as Mikhail Delyagin, director of the Moscow-based Institute for Globalization Studies explains, it won't be long before the troubles trickle down.

"It is a problem for business because it reduces the possibility to get funds for operating capital and for refinancing. Financial problems are becoming worse," Delyagin says. "This hasn't yet hit ordinary people, but it will soon hit them as well. Not extremely badly -- not like it was in 1998 [during the financial crisis], but there will be unpleasantness. People will have to take lower-paying jobs."

Rarely, if ever, in Russian history has life been so good for so many as it has been in the past several years. Sociologists say the middle class in Russia now comprises between 20 and 25 percent of the country's population. And with the improved living standards came a consumer boom. Shopping malls are full, foreign car sales are brisk, and Russians are ubiquitous in many of the world's tourist destinations.

Russia's leaders point to this fledgling middle class as one of the key accomplishments of former President Vladimir Putin's rule. And this new bourgeoisie has largely acquiesced to the paternalistic and authoritarian rule that has marked the past decade under Putin and that of his handpicked successor, Dmitry Medvedev.

But analysts say that could change if the economy sours.

'Irresponsibility'

"One of the big successes that Putin can point to is the growing middle class in Russia [and] the strength of the economy," says Roland Nash, head of research at Renaissance Capital, a Moscow-based investment bank. "If that's undermined, people will begin questioning that facet of Putin's success story."

Perhaps aware of the political risk, Putin slammed the United States on October 1, saying the crisis on Wall Street shows the "irresponsibility of a system that...had claims to leadership."

Russia's economy, which has grown at around 7 percent a year over the past several years, began been cooling off earlier this year, even before the U.S. financial crisis spread.

Between mid-May and mid-September, the index of the Russian main stock markets -- the MICEX and RTS exchanges -- lost nearly 60 percent of its value. Much of these losses resulted from an exodus of foreign capital following the outbreak of armed conflict between Russia and Georgia in early August.

To stem the bleeding, Russian authorities have twice stopped trading and have also poured massive state funding into the market.

In mid-September, the Russian government announced a multibillion-dollar package to inject liquidity into Russia's banking sector. According to the plan, which is making its way through the State Duma, up to $50 billion would be available to help Russian firms refinance debts taken on or before September 25.

Nash gives the government high marks for responding quickly to the crisis.

"The authorities have been surprisingly proactive. They started providing funding a year ago, before the U.S. did. And they have been talking to the financial sector very closely for the last several weeks," he says. "They've been far more reactive than I thought they would be."

Not As Severe As 1998

The help, however, did not come fast enough for some troubled firms. On October 2, for example, Russia's leading mobile-phone retailer, Yevroset, was sold at bargain-basement prices as it struggled under mounting debts and falling liquidity.

While Russia can expect to take a hit from the global financial crisis, analysts say it will probably not be nearly as severe as in August 1998, when the country defaulted on its debt and devalued the ruble, causing banks to fail and wiping out the savings of ordinary citizens.

Nash points out that although credit has been growing at a clip of about 50 percent a year, Russians are not nearly as "hooked on debt" as their counterparts in the West, meaning that a crisis in the financial sector will not hit ordinary households as hard.

"Financially speaking, Russia is entirely globalized already, so a global financial crisis is bound to have an impact on Russia as well," Nash says. "But for better or worse, the financial sector in Russia is not as integrated into the country as it is in most Western countries. Mortgages as a percentage of GDP are only around 4 percent, compared to around 130 percent in the U.S. and higher in places like the U.K. So the chances of negative equity resulting from this crisis are pretty small."

But for business owners like Zvyagin, concerned about fulfilling orders made before the crisis hit, the financial storm looks anything but small.

"It is hard to guess [what happens next]," Zvyagin says. "I have signed contracts earlier without taking into account the crisis. And for my customers, there is no reason to renegotiate."

Tatyana Voltskaya of RFE/RL's Russian Service contributed to this report from St. Petersburg
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