COUNTRY REPORT
Russia At a glance: 2000-01
OVERVIEW The president, Vladimir Putin, is not yet strong enough to alienate too many vested interests at a time. He will have to find a compromise with the regions and tread carefully with regard to Russia’s powerful business barons. Expectations that the pace of economic reform will accelerate considerably should probably be discounted. The business environment will remain flawed and investment will not pick up fast enough to sustain the current pace of the economic expansion. Real GDP growth is forecast to average 3.7% in 2000 but to slow to 3% in 2001. Falling oil prices will have a noticeable but not critical impact on the budget and the current account. Key changes from last month Political forecast • Mr Putin may be forced to backtrack on his centralisation plans as the regions have finally taken up the gauntlet thrown down by the Kremlin. Mikhail Kasyanov’s cabinet is now complete. It represents a fragile balance between opposing political and economic groupings. Tensions can be expected. The imposition of presidential rule on Chechnya will not pacify the region. Economic policy outlook • The government will preserve most key points of German Gref’s liberal economic programme but many will be watered down in the implementation phase. The State Duma has passed the tax reform bill, introducing a flat income tax rate of 13%, simplifying the social security system and raising the rate of profit tax. Economic forecast • Unexpectedly high inflation in May could already be the consequence of large capital inflows. The EIU expects disinflation to be sluggish and the rouble to remain strong in 2000. • The slowdown in industrial output growth in May confirms our view that the current pace of GDP growth will not be sustained.
June 2000
The Economist Intelligence Unit 15 Regent St, London SW1Y 4LR United Kingdom The Economist Intelligence Unit The Economist Intelligence Unit is a specialist publisher serving companies establishing and managing operations across national borders. For over 50 years it has been a source of information on business developments, economic and political trends, government regulations and corporate practice worldwide. The EIU delivers its information in four ways: through our digital portfolio, where our latest analysis is updated daily; through printed subscription products ranging from newsletters to annual reference works; through research reports; and by organising conferences and roundtables. The firm is a member of The Economist Group.
London New York Hong Kong The Economist Intelligence Unit The Economist Intelligence Unit The Economist Intelligence Unit 15 Regent St The Economist Building 25/F, Dah Sing Financial Centre London 111 West 57th Street 108 Gloucester Road SW1Y 4LR New York Wanchai United Kingdom NY 10019, US Hong Kong Tel: (44.20) 7830 1000 Tel: (1.212) 554 0600 Tel: (852) 2802 7288 Fax: (44.20) 7499 9767 Fax: (1.212) 586 1181/2 Fax: (852) 2802 7638 E-mail: [email protected] E-mail: [email protected] E-mail: [email protected]
Website: http://www.eiu.com
Electronic delivery This publication can be viewed by subscribing online at http://store.eiu.com/brdes.html Reports are also available in various other electronic formats, such as CD-ROM, Lotus Notes, on-line databases and as direct feeds to corporate intranets. For further information, please contact your nearest Economist Intelligence Unit office London: Jan Frost Tel: (44.20) 7830 1183 Fax: (44.20) 7830 1023 New York: Alexander Bateman Tel: (1.212) 554 0600 Fax: (1.212) 586 1181 Hong Kong: Amy Ha Tel: (852) 2802 7288/2585 3888 Fax: (852) 2802 7720/7638
Copyright © 2000 The Economist Intelligence Unit Limited. All rights reserved. Neither this publication nor any part of it may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior permission of The Economist Intelligence Unit Limited. All information in this report is verified to the best of the author's and the publisher's ability. However, the EIU does not accept responsibility for any loss arising from reliance on it.
ISSN 1350-7184
Symbols for tables “n/a” means not available; “–” means not applicable
Printed and distributed by Redhouse Press Ltd, Unit 151, Dartford Trade Park, Dartford, Kent DA1 1QB, UK Russia 1
Contents
3 Summary
4 Political structure
5 Economic structure 5 Annual indicators 6 Quarterly indicators
7 Outlook for 2000-01 7 Political forecast 8 Economic policy outlook 9 Economic forecast
12 The political scene
20 Economic policy
30 The domestic economy 30 Output and demand 33 Employment, wages and prices 34 Financial indicators 35 Sectoral trends
39 Foreign trade and payments
List of tables
9 International assumptions summary 11 Forecast summary 23 Federal budget execution 24 Federal budget 26 Payroll taxes 29 Main economic policy indicators 31 Production growth indicators, 2000 32 Industrial output by sector, 2000 36 Drilling volumes (production and exploration) 38 Main macroeconomic indicators 40 Balance of payments, 1999 42 External debt outstanding, Jan 1st 43 Oil export duties 44 Main external indicators
EIU Country Report June 2000 © The Economist Intelligence Unit Limited 2000 2 Russia
List of figures
12 Gross domestic product 12 Rouble exchange rates 24 Federal budget balance 28 Money supply 32 Domestic demand 34 Inflation 39 Trade balance 41 Investment inflows
EIU Country Report June 2000 © The Economist Intelligence Unit Limited 2000 Russia 3
June 13th 2000 Summary
June 2000
Outlook for 2000-01 The president, Vladimir Putin, is not yet strong enough to alienate too many vested interests at a time. He will have to find a compromise with the regions and tread carefully with regard to Russia’s powerful business barons. Expecta- tions that the pace of economic reform will accelerate considerably should probably be discounted. The business environment will remain flawed and investment will not pick up fast enough to sustain the current pace of the economic expansion. Real GDP growth is forecast to average 3.7% in 2000 but to slow to 3% in 2001. Disinflation will be sluggish, with average inflation in 2001 still well above the government’s forecast of 11-12%. Falling oil prices will have a noticeable but not critical impact on the budget and the current account.
The political scene Mikhail Kasyanov’s cabinet represents a fragile balance between opposing political and economic interests, and tensions are looming over economic policy. Mr Putin may yet have to backtrack on his regional reform plans. A police raid on the Media Most group has reinforced concerns about press freedom. The imposition of presidential rule on Chechnya does not solve any of the underlying problems of the region.
Economic policy German Gref has submitted his economic policy programme to the government but many key proposals may be watered down in the implementation phase. The strong fiscal performance in early 2000 has encouraged the government to plan for a balanced budget in 2001. The Duma has passed tax legislation that reduces income tax to a flat rate of 13% and shifts all social security payments into the federal budget.
The domestic economy Real GDP grew by an estimated 6.8% year on year in the first quarter of 2000, but there were signs of a slowdown in the industrial sector in April. Rising real wage and employment trends are pushing up consumer confidence. Consumer prices jumped by 1.8% in May as large capital inflows continue to push up the money supply. The large oil companies are planning to increase spending on new exploration to prevent a decline in overall output in coming years.
External sector The trade surplus reached US$19.1bn in January-April 2000, mainly as a result of high commodity prices. The current-account surplus for 1999 was US$25bn. Capital outflows may have slowed and foreign direct investment is set to pick up. Russia continues to seek debt forgiveness from the Paris Club.
Editor: Katinka Barysch Editorial closing date: June 13th 2000 All queries: Tel: (44.20) 7830 1007 E-mail: [email protected] Next report: Full schedule on www.eiu.com/schedule
EIU Country Report June 2000 © The Economist Intelligence Unit Limited 2000 4 Russia
Political structure
Official name The Russian Federation
Legal system Federal state with republican form of government. A new constitution was adopted after a national vote on December 12th 1993
National legislature The constitution created a two-chamber legislature: the lower house, the State Duma, with 450 deputies elected on a territorial basis; and the upper house, the Federation Council, with 178 deputies, 2 from each of Russia’s 89 republics and regions
Electoral system Universal direct suffrage over the age of 18. Half of the State Duma members are elected from party lists, and the other half in a simple majority contest. The Federation Council is composed of heads of regional executive and legislative bodies
National elections December 19th 1999 (parliamentary), March 26th 2000 (presidential); next elections due in December 2003 (parliamentary), March 2004 (presidential)
Head of state The president, elected for a four-year term; currently Vladimir Putin, elected March 26th 2000 and inaugurated May 7th 2000
National government The government is appointed by the prime minister, currently Mikhail Kasyanov
Main political parties The Russian party political scene has been fluid, with a large number of parties and organisations. The most important parties are: Communist Party of the Russian Federation (CPRF); Fatherland; All Russia; Unity; Liberal Democratic Party (LDP); Yabloko; Union of Right Forces (URF)
Key cabinet positions Prime minister Mikhail Kasyanov Deputy prime minister & finance minister Aleksei Kudrin Deputy prime minister for natural monopolies & fiscal federalism Viktor Khristenko Deputy prime minister & minister of food & agriculture Aleksei Gordeyev Deputy prime minister for the military industrial complex Ilya Klebanov Deputy prime minister for social affairs Valentina Matviyenko
Key ministers Anti-monopoly policy Ilya Yuzhanov Defence Igor Sergeyev Economic development & trade German Gref Emergency situations Sergei Shoigu Energy Aleksandr Gavrin Foreign affairs Igor Ivanov Industry, science & technology Aleksandr Dondukov Internal affairs Vladimir Rushailo Justice Yuri Chaika Labour & social development Aleksandr Pochinok Natural resources Boris Yatskevich Property relations Farit Gazizullin Railways Nikolai Aksyonenko Regional policy & nationalities Aleksandr Blokhin Taxes & duties Gennady Bukayev Transport Sergei Frank
Central Bank governor Viktor Gerashchenko
EIU Country Report June 2000 © The Economist Intelligence Unit Limited 2000 Russia 5
Economic structure
Annual indicators
1995 1996 1997 1998 1999 GDP at market prices (Rb bn) 1,540 2,146 2,522 2,696 4,545 GDP (US$ bn) 337.9 419.0 436.0 277.8 184.6 Real GDP growth (%) –4.2 –3.5 0.9 –4.9 3.2 Consumer price inflation (av; %) 197.4 47.6 14.6 27.8 85.8 Population (m) 148.1 147.7 147.1 146.5 146.0 Exports of goods fob (US$ m) 82,913 90,564 89,008 74,888 74,663 Imports of goods fob (US$ m) 62,188 67,630 71,645 57,791 39,361 Current-account balance (US$ m) 8,026 12,450 3,542 1,034 24,990 Foreign-exchange reserves excl gold (US$ m) 14,383 11,276 12,895 7,801 8,457 Total external debt (US$ bn) 120.3 124.9 126.0 183.6 174.3a Debt-service ratio, paid (%) 6.0 6.5 6.2 11.8 13.9a Exchange rate (av; Rb:US$) 4.56 5.12 5.78 9.71 24.62
June 13th 2000 Rb28.43:US$1; Rb27.1:¤1
Origins of gross domestic product 1999 % of total Components of gross domestic product 1999 % of total Agriculture 6.7 Private consumption 55.6 Industry 38.4 Public consumption 15.3 Services 54.9 Stockbuilding 0.3 Total 100.0 Fixed investment 15.3 Net exports of goods & services 17.0 Total 100.0b
Principal exports 1998 % of total Principal imports 1998 % of total Fuels & energy 40.1 Machinery & equipment 35.4 Metals 15.7 Food & agricultural raw materials 9.8 Machinery & equipment 10.5 Industrial goods 5.9 Timber 3.4 Clothing & household items 5.5 Total incl others 100.0 Total incl others 100.0
Main destinations of exports 1999 % of total Main origins of imports 1999 % of total US 8.8 Germany 13.8 Germany 8.5 Belarus 10.7 Ukraine 6.5 Ukraine 8.3 Belarus 5.1 US 7.9 Italy 5.0 Kazakhstan 4.6 Netherlands 4.8 Italy 3.9 a EIU estimate. b Includes statistical discrepancy between production-side and expenditure-side.
EIU Country Report June 2000 © The Economist Intelligence Unit Limited 2000 6 Russia
Quarterly indicators
1998 1999 2000 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr Government finance (Rb m) Revenue 64,400 55,700 90,700 88,600 136,900 160,200 227,900 211,800 Expenditure 99,100 76,700 141,500 127,100 162,100 154,900 234,900 173,700 Balance –34,700 –21,000 –50,800 –38,500 –25,200 5,300 –7,000 38,100 Output Industrial production index (1996=100) 95.4 85.3 96.8 102.4 100.1 99.1 107.8 112.3 % change, year on year –1.5 –11.9 –9.3 –1.8 4.9 16.2 11.3 9.7 Employment, wages and prices Employment (m) 63.7 63.5 63.3 63.3 64.5 65.1 64.9 64.9 % change, year on year –1.4 –1.6 –1.7 –1.0 1.3 2.5 2.5 2.5 Unemployment rate (% of the labour force) 11.5 11.6 12.8 13.8 12.5 11.8 12.2 12.3 Average nominal monthly wages (Rb) 1,069.7 1,091.3 1,256.3 1,250.3 1,507.0 1,636.7 1,929.3 1,897.3 % change, year on year 14.0 8.9 17.1 23.1 40.9 50.0 53.6 51.7 Consumer prices (Dec 1997=100) 103.8 120.6 168.6 207.3 225.1 239.0 248.6 260.0 % change, year on year 7.2 22.4 70.0 102.6 116.9 98.1 47.4 25.4 Producer prices (Dec 1997=100) 100.8 101.3 117.6 138.4 155.2 174.6 200.7 221.7 % change, year on year 2.6 1.9 17.7 36.8 54.1 72.3 70.6 60.2 Financial indicators Exchange rate Rb:US$ (av) 6.151 9.164 17.461 22.890 24.494 24.824 26.272 28.458 Rb:US$ (end-period) 6.198 16.065 20.650 24.180 24.220 25.080 27.000 28.460 Interest rates (av; %) Deposit 12.6 18.8 25.1 22.0 13.4 10.4 9.0 9.6 Lending 42.4 46.8 45.2 45.1 39.8 38.4 35.5 31.7 Money market 44.4 81.3 49.8 23.1 10.2 12.2 13.7 9.9 M2 (end-period; Rb bn) 368.6 365.8 452.5 473.8 567.7 597.4 704.7 751.4 % change, year on year 4.7 0.8 21.0 31.5 54.0 63.3 55.7 58.6 MTa US$ stockmarket index (end-period; Aug 1994=100) 111.8 28.7 38.4 61.0 96.5 63.8 114.6 178.0 % change, year on year –64.5 –92.4 –87.3 –75.0 –13.7 122.3 198.4 191.8 Sectoral trends Crude oil output & NGL (m tonnes)7374747273757575 % change, year on year –2.2 –1.9 –0.4 –1.6 0.7 1.2 0.8 4.3 Natural gas output (bn cu metres) 137 129 162 161 143 130 158 159 % change, year on year 2.7 11.2 1.4 –2.3 4.3 0.5 –2.5 –0.9 Foreign trade (US$ bn) Exports fob 18.7 17.8 19.3 15.5 17.0 18.7 23.5 23.4 Imports fob –17.7 –13.7 –9.4 –9.0 –10.1 –9.4 –10.8 –9.2 Trade balance 1.0 4.1 9.9 6.5 6.9 9.2 12.7 14.2 Foreign payments (US$ m) Merchandise trade balance 1,584 4,814 10,009 6,531 6,886 9,204 12,681 n/a Services balance –1,293 –653 –490 –681 –757 –890 –1,014 n/a Income balance –3,734 –3,234 –2,713 –1,085 –1,799 –2,892 –1,728 n/a Current-account balance –3,587 900 6,755 4,716 4,406 5,628 10,239 n/a Reserves excl gold (end-period) 11,161 8,840 7,801 6,679 8,190 6,634 8,457 11,456 a Moscow Times. Sources: Russian Economic Trends; Goskomstat; IMF, International Financial Statistics; Moscow Times.
EIU Country Report June 2000 © The Economist Intelligence Unit Limited 2000 Russia 7
Outlook for 2000-01
Political forecast
Domestic politics Vladimir Putin is likely to use his constitutional powers to turn Russia into a truly presidential republic. His involvement in the day-to-day management of the government will be much more active than Boris Yeltsin’s ever was, and he will try to suppress all opposition to his government. However, Mr Putin does not (yet) have the political strength to take on all autonomous sources of power simultaneously. He will therefore stagger his attempts to bring regional governments, business tycoons, the media and the political parties in line with his policies. The West is likely to accept the gradual erosion of democracy that this centralisation of power will probably entail in exchange for Mr Putin’s commitment to economic reform and pragmatism in foreign policy.
Given his centralising agenda, it was no surprise that Mr Putin’s first major policy initiative on taking office was an assault on regional power. Initially, the president encountered little active opposition from the regions. However, Russia’s regional leaders will not simply give way. They will negotiate and delay, waiting for signs of conflict at the centre or weakness in the Kremlin that would allow them to claw back what they may lose. Regional reforms will not be the only source of conflict between Moscow and the regions. Federal policies in a number of other areas directly challenge regional interests, including fiscal reform and the restructuring of the natural monopolies.
Through the Federation Council (the upper house of parliament) the regions still have considerable influence on federal policymaking. Mr Putin may have to backtrack on some of his regional reforms in exchange for the approval by the Federation Council of his tax and other economic reforms. In the first sign of a forthcoming compromise, Mr Putin announced on June 10th that a conciliation council would be set up to resolve differences between the Kremlin and the regional leaders. Mr Putin has also encountered signs of opposition from semi-independent state agencies and from the State Duma (the lower house of parliament). The Communist Party of the Russian Federation, which the president hoped to tie to the pro-Putin Unity party, opposes many of his fiscal reforms, thereby denying the legislation the quorum necessary to rule out a veto by the upper house. Mr Putin will probably be forced to follow in the footsteps of his predecessor, Mr Yeltsin, who became a veritable master in holding Russia’s quarrelling elites and interest groups in a fragile equilibrium. He has already taken a step in this direction by including representatives of opposing groupings in his government, most notably the “Family” (the powerful circle ruling the Kremlin during the later stages of the Yeltsin era) and the liberal reformers with whom he became acquainted during his St Petersburg days.
Election watch With the presidential and Duma elections over, Russia is now entering a period of political consolidation during which the power struggle between different political factions and economic interests will mainly take place within Mr Putin’s administration. Mr Putin, who won the presidential election in
EIU Country Report June 2000 © The Economist Intelligence Unit Limited 2000 8 Russia
March by an extremely narrow majority, has indicated that he would like to extend the duration of the presidential term from four to seven years. Assuming that he will seek re-election in 2004, this could potentially leave him in power until 2011. Attention will now shift to the regional governors, 40 of whom are coming up for re-election in 2000. Following the recent election for the governorship of St Petersburg, in which Mr Putin was forced to withdraw his preferred candidate, future regional elections will be watched closely as barometers of Mr Putin’s political strength.
International relations Relations between Russia and the West will remain on an even keel, even if not necessarily cordial. There is potential for tension in relations with the US, in particular over US plans to build a limited anti-ballistic missile (ABM) system in contravention of the 1972 ABM treaty. Europe is siding with Russia in its opposition to the plan.
As expected, the summit meeting in June between Mr Putin and the US president, Bill Clinton, did not yield any concrete results. However, it clarified the issues that Russia and the US will have to resolve over the coming years. After the ratification of the START-II treaty by the Duma in April, preliminary talks have started on START-III. Russia wants substantial cuts in strategic nuclear arsenals to be made by both sides, but the US is likely to link its preparedness for further arms reductions to Russia dropping its veto of the ABM plans. With his second visit to an EU country (Mr Putin has visited the UK and Italy), the president has confirmed that he regards the EU as an important strategic partner. Whereas disarmament is not an issue in Russo-EU relations, potential for tension does exist. The EU has taken a somewhat more critical stance on Russia’s brutal war in Chechnya than the US. Moreover, Russia will start to regard the eastward enlargement of the EU with more scepticism, given increasing concern about its economic implications for an isolated Russia.
Economic policy outlook
Policy trends The new prime minister, Mikhail Kasyanov, initially dissociated himself from the liberal programme worked out by German Gref’s Centre for Strategic Studies. Nevertheless, the government’s economic programme, due to be published in late June, is expected to retain most of the main points of Mr Gref’s programme, notably tax reform, restructuring of the utilities sector and a clean-up of the banking sector. However, some reforms are likely to be watered down in the implementation stage.
Mr Putin has appointed a number of liberal economists to important positions in the new cabinet, most notably Mr Gref as minister for economic develop- ment and trade, and Aleksei Kudrin as deputy prime minister for finance. The removal of the interventionist Viktor Kalyuzhny from the oil ministry was also hailed as a positive sign. However, the cabinet still contains a large number of ministers associated with Russia’s business tycoons, as well as other powerful groupings. So far, the indication is that Mr Putin will be careful not to alienate too many vested interests and that he will give preference to those parts of Mr Gref’s programme that accord with his centralising instincts. Opposition
EIU Country Report June 2000 © The Economist Intelligence Unit Limited 2000 Russia 9
from the left-wing parties and the powerful off-budget funds initially forced the government to backtrack on its tax reform plans, although the Duma passed the original reform plans on June 9th, probably expecting them to be watered down by the Federation Council, with which the Kremlin is currently battling.
Fiscal policy Fiscal performance continues to be strong, with the federal budget surplus reaching 3.7% of GDP in April. High oil prices, improved profitability in the enterprise sector and efforts to strengthen tax collection will keep revenue high for the rest of 2000. However, expenditure will also increase later in the year. The EIU therefore expects a full-year deficit of around 1% of GDP.
The government is aiming for a balanced budget in 2001. Tax revenue is expected to rise further as a result of current tax reform plans. However, part of the reforms had to be postponed because of political opposition, while the introduction of a flat income tax rate is unlikely to lead to the boost in revenue that the government is expecting. The federal budget will therefore probably remain in deficit, at 1.6% of GDP.
Monetary policy Large-scale capital inflows—the result of the massive trade surplus, combined with greater confidence in political and economic stability—are posing a dilemma for the Russian Central Bank. In the absence of financial instruments for sterilisation, the Central Bank can either allow the rouble to appreciate, which could threaten the economic recovery, or let the inflows feed through into inflation. This, in turn, would also lead to a real appreciation of the rouble, with similar effects on growth. Interest-rate cuts will have only a neg- ligible impact on the economy, given the dearth of financial intermediation.
Economic forecast
International assumptions summary (% unless otherwise indicated) 1998 1999 2000 2001 GDP growth US 4.3 4.2 5.1 3.1 OECD 2.4 2.9 3.7 2.8 EU 2.7 2.2 3.1 2.8 Exchange rates (av) US$ effective (1990=100) 119.3 116.3 118.9 114.5 ¥:US$ 130.9 113.9 107.5 105.0 US$:ea 1.12 1.07 0.93 1.00 Financial indicators US$ 3-month commercial paper rate 5.34 5.18 6.50 6.63 ¥ 2-month private bill rate 0.72 0.27 0.05 0.64 Commodity prices Oil (Brent; US$/b) 12.8 17.9 24.5 20.0 Gold (US$/troy oz) 294.1 278.8 290.0 300.0 Food, feedstuffs & beverages (% change in US$ terms) –13.9 –18.6 –2.1 4.9 Industrial raw materials (% change in US$ terms) –19.6 –4.3 16.2 9.9 a Ecu before 1999.
EIU Country Report June 2000 © The Economist Intelligence Unit Limited 2000 10 Russia
International assumptions The international business environment remains basically favourable to Russia. Oil prices are set to decline gently in the second half of 2000 and 2001, but not by enough to threaten the underlying financial viability of the Russian oil and gas industries, or seriously to undermine the new-found strength of the Russian budget. Metal prices will rise sharply throughout 2000 and 2001, and prices of foodstuffs, of which Russia is a net importer, are forecast to fall in 2000 before rising slightly in 2001.
The gradual recovery of the euro against the dollar, should it prove sustainable, will have unfavourable implications for Russia as an oil exporter, as will the ongoing rise in global interest rates. However, none of these trends will be strong enough to derail Russia’s recovery. The only development that could do that is a sharp recession in the US. Although we continue to forecast a soft landing for the US economy, the downside risk of a hard landing has recently increased, at the same time as our baseline scenario for the world economy has become even more favourable.
Economic growth First-quarter GDP growth was estimated at 6.8% year on year, compared with full-year growth of 3.2% in 1999. The expansion is forecast to slow in the course of 2000, partly because of base effects and the appreciating rouble, but also because many industries will hit capacity constraints as investment has not kept pace with industrial output growth.
In April growth in the transport and retail sectors accelerated, but these sectors are expected to follow the industrial sector into a slowdown once base-period effects start to affect year-on-year calculations. More importantly, although investment grew by 5.9% year on year in the first quarter, imports of investment goods are still falling, raising doubts about the sustainability of current growth rates. We expect GDP growth to falter in the second half of 2000, bringing the full-year rate down to around 3.7% in 2000 and to 3% in 2001, when a slowing world economy, commodity supply constraints and slow restructuring will constrain the expansion.
Inflation Consumer price inflation continued to decelerate in the first quarter of 2000 but picked up again in May when prices jumped by 1.8% month on month. This could already be the first sign of inflationary pressure created by large unsterilised capital inflows since late 1999. We forecast that inflation will remain roughly at current levels and end the year at around 18%.
Continued high producer price inflation indicates that there is still con- siderable inflationary pressure in the economy. Prices will also be pushed up by the recovery in wages and by the government’s tax reform plans, in particular the planned sixfold increase in excise duties on petrol and the ongoing adjustment of utilities prices (which were kept far below inflation in 1999). Disinflation will therefore be slow in 2000 and 2001, with average inflation forecast at around 16% in 2001, above the government’s target of 11%.
Exchange rates The rouble remained strong in May and the first half of June, at around Rb28.3:US$1, which, given the large inflation differential between Russia and its main trading partners, resulted in a gradual appreciation of the real
EIU Country Report June 2000 © The Economist Intelligence Unit Limited 2000 Russia 11
exchange rate. Nevertheless, in real terms the rouble is still about 38% below its pre-crisis level of July 1998 (based on consumer price inflation). Although the strong external position and improving economic performance will place continued upward pressure on the rouble in the second half of 2000, we expect the rouble to have depreciated marginally in nominal terms by the end of the year. This reflects the Central Bank’s priority of maintaining the profitability of exports, and not allowing the economic recovery to be threatened by an excessively strong rouble.
External sector Imports have remained stagnant, despite the recovery in real incomes and the real appreciation of the rouble. A mild strengthening of import demand— expected for later in 2000—will not have a significant impact on the trade balance as export receipts are still growing at record levels. The trade surplus in 2000 will be even higher than in 1999, at a projected US$40bn. The current- account surplus in 2000 is forecast at about US$26bn, before declining to US$21bn in 2001.
In January-April the trade surplus reached US$19.1bn, almost twice as high as in the same period of 1999. The surplus is the result of high oil prices, the rouble devaluation of 1998 and the continuing import compression. Exports in January-April stood at US$31.5bn, some 43% higher than in the same period of 1999. The rise in export values is attributable exclusively to higher oil, gas and metals prices. Export volumes are estimated to have remained flat. According to preliminary official estimates, the current-account surplus more than doubled to US$10.1bn in the first quarter of 2000 from US$4.7bn in the same period of 1999.
Forecast summary (% unless otherwise indicated) 1998a 1999a 2000b 2001b Real GDP growth –4.9 3.2 3.7 3.0 Industrial production growth –5.2 8.1 6.0 5.0 Unemployment rate (av) 11.9 12.5 11.4 11.2 Consumer price inflation Average 27.8 85.8 19.5 16.0 Year-end 84.5 36.5 18.0 15.0 Government balance (% of GDP) –5.0 –1.6 –1.0 –1.6 Exports of goods fob (US$ bn) 74.9 74.7 82.6 81.9 Imports of goods fob (US$ bn) 57.8 39.4 43.0 47.6 Current-account balance (US$ bn) 1.0 25.0 26.1 21.1 % of GDP 0.4 13.5 13.4 9.9 Total foreign debt (year-end; US$ bn) 183.6 174.3 c 164.9 170.7 Exchange rates (av) Rb:US$ 9.71 24.62 28.62 31.00 Rb:€ 10.87 26.34 26.62 34.65
a Actual. b EIU forecasts. c EIU estimate.
EIU Country Report June 2000 © The Economist Intelligence Unit Limited 2000 12 Russia
The political scene
The new government yields As expected, the president, Vladimir Putin, confirmed his former finance few surprises minister, Mikhail Kasyanov, as prime minister on May 17th. Mr Kasyanov’s promotion to head of the government is widely regarded as a compromise. On the one hand, his relatively orthodox fiscal management and his experience in negotiating with Western creditors have given him the image of a mild reformer. On the other hand, he is said to be close to the political and econ- omic elite that ruled the Kremlin during the presidency of Boris Yeltsin, widely referred to as the “Family”. This implies that although Mr Kasyanov may be an ardent supporter of fiscal prudence and tax reforms, he is unlikely to undertake drastic structural reforms that could harm powerful vested interests.
The new cabinet is similar to the previous one, which was put together by Mr Yeltsin. The controversial minister for fuel and energy, Viktor Kalyuzhny, was demoted rather than sacked. There were few other changes of note and no major demotion of individuals closely identified with any of the politico- business clans that formed in the Yeltsin era. Given that Mr Putin is in the process of picking a fight with regional governors, this continuity may well have been the most prudent strategy. It suggests that a more substantial cabinet reshuffle is likely later in 2000, although this need not involve the replacement of Mr Kasyanov, who is likely to be given at least a year or two to prove himself. In the meantime Mr Putin will continue to install his own people in second-tier positions, thereby preparing them for advancement, and begin to get a grip on the levers of power in a way far less visible—but also far less disruptive—than replacing large numbers of cabinet ministers overnight.
Tensions loom in the Kremlin officials have been keen to emphasise that Mr Putin wants a united new cabinet cabinet and does not favour the system of checks and balances that Mr Yeltsin used to keep his subordinates divided, jealous of one another and dependent on him. Mr Putin’s willingness to accept Mr Kasyanov’s proposal that there be no first deputy prime minister reflected this attitude. There is no legal or con- stitutional basis for such a post, but Mr Yeltsin liked to keep first deputy prime
EIU Country Report June 2000 © The Economist Intelligence Unit Limited 2000 Russia 13
ministers as counterweights—and potential rivals—to his premiers. Mr Putin neither needs nor wishes to put Mr Kasyanov in such a position. Nevertheless, his choice of ministers has not made for cabinet unity. Apart from the fact that its members have close ties to antagonistic clans, they also represent a wide range of positions on the ideological spectrum, from the highly statist attitudes of the railways minister, Nikolai Aksyonenko, to the liberalism of the new minister for economic development and trade, German Gref.
Moreover, some of the newly appointed deputy prime ministers have overlapping responsibilities, which may become a source of tension, given that they belong to different political camps. Aleksei Kudrin, an ally of Mr Putin from his St Petersburg days, now holds the powerful position of deputy prime minister for finance. His wide-ranging powers might clash not only with the portfolios of other ministers and deputy prime ministers but also with the role of the prime minister.
Viktor Kalyuzhny moves Many oil executives will have welcomed the announcement by Mr Putin on into Caspian politics May 20th that Viktor Kalyuzhny would lose his post as fuel and energy minister. Mr Kalyuzhny’s highly controversial policies had resembled Soviet- style economic management rather than the regulatory regime of a market economy. The oil companies complained heavily about the export restrictions that Mr Kalyuzhny imposed on them. Nor did they like the minister’s plan to create a “national champion” out of the remaining stakes that the government holds in several oil companies. However, rather than being ousted from the government, Mr Kalyuzhny moved sideways into another powerful position, that of deputy foreign minister with special responsibility for the Caspian Sea region. Mr Putin has declared that strengthening Russia’s influence in the Caspian is one of his priorities and has already undertaken extensive talks with the other countries in the region. The increased importance of the Caspian has been highlighted by the recent formation of a joint venture between Gazprom, the natural gas monopoly, and the two largest oil companies, LUKoil and Yukos, to exploit the natural resources in the Russian part of the Caspian Sea.
Mr Kalyuzhny’s replacement as fuel and energy minister is the former mayor of Kogalym, Aleksandr Gavrin, who is widely regarded as a compromise figure. Although he has long-standing ties to LUKoil (LUKoil-Kogalymneftegaz is one of the company’s principal production subsidiaries), he is expected to reduce state intervention in the oil sector and has promised to let market forces rule. However, it is disturbing that Mr Gavrin appears to cling to Mr Kalyuzhny’s plan of creating a national oil company. In any case, he will not inherit all of Mr Kalyuzhny’s functions. The task of handling relations with the major oil companies will reportedly be transferred from the Ministry of Fuel and Energy, now renamed the Ministry of Energy, to the Ministry of Industry, Science and Technology under Aleksandr Dondukov; the slimmed-down energy ministry will principally be concerned with electricity restructuring, managing relations with Gazprom and restructuring the coal sector.
EIU Country Report June 2000 © The Economist Intelligence Unit Limited 2000 14 Russia
The presidential election
The acting president, Vladimir Putin, won the presidential election on March 26th 2000 in the first round when, according to official data, he polled just over 52% of the popular vote. There was considerable doubt about the accuracy of the results, and the count in many regions might not have withstood close external scrutiny. However, as there was no doubt that Mr Putin had led the field and that he would have prevailed over Gennady Zyuganov, the leader of the Communist Party of the Russian Federation (CPRF), in a second-round run-off, there was no serious attempt to challenge the results.
The slim margin of Mr Putin’s victory (coupled with allegations that fraud was needed to push his share of the vote over the 50% barrier in the first round) highlights that the rush by the political class to join the Putin bandwagon was not matched by public opinion. Although Mr Putin’s popularity is greater than that of any of his potential rivals, he appears unable to mobilise a majority of voters in his favour—despite enjoying the almost universal support of the mass media, having all the resources of the state backing his candidacy and having managed to deter his most serious potential rivals from entering the contest.
Mr Putin’s closest rival, Mr Zyuganov, did better at the polls than expected, with 29.34% of the vote, only slightly below his 1996 first-round total of 31.95%. Although some traditional “red belt” regions voted for Mr Putin, the Communist vote in a number of regions, especially in the Far East, rose markedly. The good result helped Mr Zyuganov to fend off a possible leader- ship challenge, which would have been likely in the case of a poor showing.
In part, Mr Zyuganov and the CPRF owe their strong showing in the election to the Kremlin, which since 1999 has regarded the CPRF as its opposition of choice. Unlike the Fatherland-All Russia movement, the CPRF’s support base is solid but limited. It is anathema for much of the electorate and it has generally proved unable to co-operate with other political forces, apart from those that are clearly its satellites. Therefore, in contrast to 1996, when the “red menace” was at the centre of Boris Yeltsin’s campaign, the Kremlin and its supporters more or less left the Communists alone in the more recent election.
In the run-up to the election to the State Duma (the lower house of parliament) in December 1999, they concentrated their fire on the non-Communist left as represented by Fatherland-All Russia, thereby doing serious damage to two potential presidential contenders—the mayor of Moscow, Yuri Luzhkov, and the former prime minister Yevgeny Primakov—and increasing the likelihood that the unelectable Mr Zyuganov would be Mr Putin’s main opponent.
Power reverts back to the Mr Putin’s first major initiative on taking office was a decree on May 13th federal government replacing the 89 presidential representatives to the regions (“subjects of the federation”) with seven plenipotentiary representatives (polpredy) overseeing new so-called federal districts. The decree is intended to create the basis for a much broader recentralisation of power. Even before the election, the govern- ment had begun to curtail the fiscal and personnel powers of the governors. Although the powers of the new polpredy do not, so far, go beyond those of
EIU Country Report June 2000 © The Economist Intelligence Unit Limited 2000 Russia 15
their predecessors, the decree must be considered against the backdrop of plans to amalgamate the regional branches of a number of federal institutions, including the Russian Central Bank (RCB), the tax inspectorate, the State Customs Committee, the interior ministry, the tax police and the Federal Security Service (FSB, one of the successors of the KGB). These changes would remove the main security and financial organs from the influence of regional bosses. Moreover, Mr Putin’s seven “viceroys” will sit on the influential Security Council. They will therefore be able to influence federal policymaking directly, which will further strengthen their position vis-à-vis the regional governors.
Mr Putin has submitted to the State Duma (the lower house of parliament) a number of legislative proposals designed to curb regional power. These include measures to curtail the power of regional authorities to appoint and remove key officials, and to enable the Supreme Court to remove governors for repeated violations of federal law. As the justice ministry estimates that 25-35% of regional legislation does not conform to federal law and/or the constitution, this could be used against almost any regional governor. Mr Putin’s reforms would also eliminate the role of local administrations in financing the courts, which would, it is hoped, greatly reduce their ability to influence judges.
Mr Putin also wants to change the mechanism for forming the Federation Council, the upper chamber of the Federal Assembly (parliament). The Federation Council currently consists of the heads of the executive and legislative branches of the subjects of the federation, but the constitution only stipulates that each subject of the federation has two representatives, one each from its executive and legislative branches. The Kremlin and the Duma are set to change the law on the formation of the upper house to eliminate this ex officio approach and thereby expel regional governors from the chamber. This has resulted in considerable disquiet in many regional capitals, as it would in effect strip the governors of their parliamentary immunity and make them vulnerable to prosecution for alleged corruption and other misdeeds.
Implementing federal A substantial recentralisation of power has in effect already occurred without reforms will be difficult any legal or constitutional change, purely through Mr Putin’s own rise to power. This is evident in the continuing endorsement by the regional elite of Mr Putin’s every move—a support that is born of fear rather than enthusiasm. The “authority leakage” of the 1990s was a direct consequence of the weakness of the Kremlin, of the unpopularity of first Mikhail Gorbachev and then Boris Yeltsin, and of Mr Yeltsin’s need for regional support in his battles with parliament. The political conjuncture is now reversed, with Mr Putin and the Duma acting together against the regions. The Duma has already passed the proposed reforms in the first reading, with a majority of more than 300 votes, which rules out a veto by the Federation Council of the new laws.
However, two further readings are required before the new system comes into effect, and it is widely expected that regional lobbies within the Duma will try to water down the reforms before they pass into law. The regional representatives have a certain amount of leverage through their potential veto of Mr Putin’s tax and fiscal reform plans, which do not have the required support in the Duma to override a veto from the Federation Council. On
EIU Country Report June 2000 © The Economist Intelligence Unit Limited 2000 16 Russia
June 7th the Federation Council passed a harshly worded resolution in which Mr Putin was asked to put his regional reform plans on hold until a compromise could be found between the centre and the regions. Mr Putin reacted by promising a conciliation commission, bringing together representatives of the regions, the Duma and the Kremlin to sort out differences. Even if the changes pass into law, the region’s most effective strategy may yet be a form of passive resistance, combining verbal support for Mr Putin with stalling tactics.
Centralisation may Even if Mr Putin is able to implement all of these proposals, it is not certain even backfire that they will give him the authority that he seeks. Some institutions, such as the tax service, will still require local structures in order to implement policy, even if their regional administrations are amalgamated. The new federal districts may in many cases simply add a layer of bureaucracy between Moscow and the regions. If the new polpredy are given extensive powers over federal bodies in their districts, they will soon come into conflict with the ministries and departments in Moscow over lines of authority.
The problem of territorial governance in Russia has been on the agenda for centuries; no ruler has ever found a simple, effective solution. There is little reason therefore to believe that Mr Putin has done so. The aim is not simply to reduce the power of regional bosses but to ensure that government officials at “street level” implement the president’s policies. This is much more difficult. Even under the centralised system of the Stalinist era, the centre remained unable to monitor local elites fully. Moreover, with Mr Putin riding high politically, it is easy to forget that the regions have been a major prop maintaining political and social stability over the past decade. A recentralised Russian political system could prove less robust in a crisis than the ramshackle federalism of the Yeltsin years.
A raid on Media Most Concern about possible authoritarian tendencies on Mr Putin’s part extends causes concerns beyond his centralisation drive and his penchant for promoting veterans of the country’s secret services and security organs. In particular, the pressure brought to bear on media outlets hostile to, or merely independent of, the Kremlin has caused concern. The clampdown on media outlets airing the views of Chechen political and military figures has highlighted the sensitivity of the authorities to criticism of the Chechen war. A number of individual cases have prompted criticism, such as the temporary disappearance of the Radio Liberty journalist Andrei Babitsky, whose frank coverage of the war annoyed the government.
Most recently, intense financial and police pressure has been exerted on the Media Most group, which is controlled by the tycoon Vladimir Gusinsky. In May the Russian Central Bank imposed a temporary administration on Most- bank, which has faced an intense financial squeeze in recent months, while Media Most’s own offices were raided on May 12th by heavily armed and masked officers of the tax police and the FSB. The official explanation for the raid was changed a number of times before the FSB settled on allegations that Media Most had infringed privacy laws by tapping telephone lines. Although Most’s security service may have been guilty of at least some of the charges made against it—as are many other private security services in Russia—the
EIU Country Report June 2000 © The Economist Intelligence Unit Limited 2000 Russia 17
general impression was that the raid was prompted by critical coverage of the Kremlin on NTV, Russia’s only private national television station, and in the weekly Itogi and the daily Segodnya. All are majority owned by Media Most.
Furthermore, less high-profile incidents of intimidation of the press have become commonplace. The Glasnost Defence Fund, a local democracy watchdog, records dozen of incidents of threats against journalists every month. The journalists’ union has published a number of public appeals, drawing attention to their increasingly difficult working environment.
Mr Putin’s commitment to Faced with increasing criticism, Mr Putin has emphasised his commitment to press freedom is in doubt press freedom. Although the raid on Media Most and other attempts to intimidate the independent media make this statement sound hollow, there have also been some positive developments. In particular, recent management changes at the two main state-owned television channels appear to have weakened Boris Berezovsky’s hold over Russian Public Television (ORT), while placing Russian State Television and Radio (VGTRK) under a less politicised management. In parallel with the change at VGTRK, the Moscow city govern- ment replaced the head of TV-Centre, a station which, although controlled by the city, reaches 40% of the Russian population, with a well-respected journalist. However, it is doubtful whether either Mr Putin or the mayor of Moscow, Yuri Luzhkov, are inclined to relinquish control of their respective television stations. The depoliticisation of these outlets will therefore depend on their decisions rather than on legislative guarantees or commercial independence.
The president avoids With the exception of Mr Gusinsky’s Media Most empire, the politically antagonising the oligarchs influential businessmen known colloquially as the oligarchs have survived the first stage of the Putin presidency more or less unscathed. Mr Putin did not react to, let alone prevent, the carve-up of the aluminium sector by the oligarchs in February-April, and the appointment of Mr Kasyanov’s cabinet did not present the major oligarchs with any unpleasant surprises. This may be a side effect of the president’s offensive against the regions. Even a politician riding as high in the polls as Mr Putin would think twice before initiating conflicts with both the regional bosses and the business barons simultaneously.
The averted aluminium war
One of the surest signs that the president, Vladimir Putin, will tread carefully with regard to the oligarchs was his inactivity in the face of a major shake-up in the aluminium sector. In February shareholders in the oil company Sibneft, led by the tycoons Roman Abramovich and Boris Berezovsky, purchased controlling stakes in the Krasnoyarsk, Bratsk and Novokuznetsk aluminium plants, which together account for around 65% of Russian and 20% of world aluminium output. At the same time their principal rival in the sector, the Siberian Aluminium Group (Sibal), headed by Oleg Deripaska, secured control of the Mikolayiv Alumina Plant in Ukraine, while Russia’s other major alumina supplier, the Achinsk Alumina Combine, was controlled by the rivalling Alfa group. The two major raw materials suppliers were reportedly curtailing supplies to Krasnoyarsk and Bratsk.
EIU Country Report June 2000 © The Economist Intelligence Unit Limited 2000 18 Russia
Moreover, Sibal was waging a bankruptcy battle for control of the Novokuznetsk plant, while the electricity monopoly United Energy Systems (UES), headed by Mr Deripaska’s ally, Anatoly Chubais, was putting pressure on the Krasnoyarsk plant. Given the electricity-intensive nature of aluminium production, Mr Deripaska’s links to UES gave him a crucial advantage.
However, the bitter conflict that many expected was averted when Mr Abramovich and Mr Deripaska announced the formation of a new grouping, Russian Aluminium, encompassing both aluminium empires. The form that Russian Aluminium will ultimately take is still unclear, and there are signs that the Deripaska-Abramovich alliance is a fragile one. However, the accommodation reached appears to reflect a realistic assessment of the parties’ interests as it helps to avoid a conflict that would inflict heavy costs on both sides. Moreover, the new grouping can expect official support—possibly including cheap electricity—now that it can claim the role of “national champion” in this leading export sector.
Mr Putin’s real attitude towards the oligarchs is likely to become clearer only after he has secured his grip on the Kremlin and constructed his own political base. It is, however, unlikely that he will launch an all-out war against Russia’s business tycoons as the costs of doing so may be prohibitively high, not least in terms of the risks to political and economic stability. Instead, Mr Putin will probably try to curb the oligarchs’ power gradually and to influence their behaviour.
However, greater stability Much will depend on the success of Mr Putin’s planned economic and will affect their behaviour institutional reforms. The predatory behaviour of Russia’s post-Soviet elite is largely a product of the weakness of political and legal structures. In such an environment, rational actors heavily discount the potential future benefits of any long-term undertaking and focus on short-term gains. They therefore prefer asset-stripping to investment, rent-seeking to entrepreneurship and speculation to restructuring. Corruption and capital flight are rational, if unattractive, strategies in such circumstances.
Greater stability is a necessary condition for civilising Russian capitalism, although it is not sufficient on its own. There are already signs that the behaviour of businessmen and officials is changing, with notoriously murky companies now emphasising transparency and shareholder values, not because Russian elites have undergone a moral conversion but because they have greater confidence in the future. Russia’s oligarchic class will not suddenly become law- abiding citizens and believers in free-market forces, but, to the extent that Mr Putin is able to preserve economic and political stability, they will have a greater interest in a more orderly, stable and predictable business environment.
Chechnya remains a Almost six months after the Kremlin officially declared victory in the second political liability Chechen war, the pacification of Chechnya is far from complete. The rebels’ ability to strike at federal forces both within Chechnya and outside it—and to inflict serious casualties—confirms that the low-intensity phase of the conflict will be, in many respects, as difficult for the Kremlin as the fully fledged war that preceded it. Russia notionally occupies all of Chechnya except some parts of the
EIU Country Report June 2000 © The Economist Intelligence Unit Limited 2000 Russia 19
southern highlands, but the military position has nevertheless worsened. Morale is falling and comparisons to Afghanistan are becoming more frequent.
The government seems to have given up all hope of concluding a peace deal with the Chechens, or with any of their representatives. On June 8th Mr Putin announced the imposition of direct presidential rule in Chechnya. His decree set up an interim administration headed by a presidential envoy. The decree contravenes the federal constitution, which states that regional governors are elected representatives, and sets an unhappy precedent that is regarded with suspicion by other regional leaders. The political future of Chechnya remains as unclear as ever. The appointed presidential envoy will be either an ethnic Russian or an ethnic Chechen who stands firmly on the Russian side in the ongoing conflict. In either case he will be unable to represent the local people, let alone the warring factions, which rules out a negotiated peace deal. The main task of Mr Putin’s envoy will therefore be to supervise the reconstruction of the destroyed capital, Grozny, and the region’s infrastructure and institutions. So far only Rb700m (US$25m) out of a total of Rb7.8bn planned for 2000 have been made available for reconstruction.
Potential tensions in East- Mr Putin attaches a high priority to good relations with the West, but he also West relations has a clear sense of Russian national interests, which he does not intend to sacrifice in order to win Western goodwill. With the war in Chechnya provoking criticism in France and Germany—the two European states to which Mr Yeltsin traditionally looked for support—Mr Putin has focused his attention on the UK while taking the first steps to repair the damage caused to Russia’s relations with NATO by the Kosovo conflict. Mr Putin shares the Russian security establishment’s dislike of NATO, whose aims and activities are regarded as a threat to Russia, but he appears to have concluded that Russian interests are better served by engagement with the alliance than by isolation from it. However, NATO plans for a second round of eastward enlargement could trigger renewed tensions, in particular as these encompass the Baltic states, which Mr Putin has regards as “off limits” for NATO membership.
Mr Putin has put particular emphasis on mending relations with the US, but there remains ample scope for tension, in particular over arms control. In April he secured the long-delayed ratification by the Duma of the START-II arms control treaty, thereby clearing the way for negotiations on a START-III treaty, with a view to using the talks to press for US concessions on the issue of anti- ballistic missile (ABM) defences. During the visit of the US president, Bill Clinton, to Moscow in early June, Mr Putin reiterated his staunch opposition to US plans to build a limited ABM system, and discounted the US argument that such a system would only serve as protection against potential missile launches from “rogue” states such as Iran and North Korea. Although Mr Putin has threatened to pull out of all existing arms control agreements should the US go ahead with its plans, he is more likely to seek an agreement with the US than to endanger East-West relations. Mr Putin may try to harness the support of western Europe, which partly shares his concerns about the US’s ABM plans.
EIU Country Report June 2000 © The Economist Intelligence Unit Limited 2000 20 Russia
Relations with the EU may Under Mr Yeltsin, Russia was generally favourably disposed towards the EU, grow more problematic even if relations with the US remained paramount. Russia saw the EU as bringing economic benefits to Russia and the east European region, and regarded it as a model of integration that the Commonwealth of Independent States could follow. Until NATO admitted its first new members, Russia took the view that EU enlargement would be an acceptable alternative to the expansion of the trans-Atlantic alliance. Beyond that, the Russian foreign policy elite and public remained fairly indifferent about the EU.
This attitude is changing, and under Mr Putin Russia may find its relations with the EU coming under strain. First, there is a growing awareness that EU enlargement could impose substantial economic costs on Russia as a result of restrictions on Russian exports and border controls that EU aspirant members will have to impose on their relations with their eastern neighbours. Second, Russia is becoming more ambivalent about a possible EU defence identity. As a result, the long-standing distinction among the Russian elite between the “good West” of western Europe and the “bad West” of the US and NATO is becoming blurred.
Asia policy is likely to Like Mr Yeltsin before him, Mr Putin has moved quickly to emphasise Russia’s focus on Japan role as a Pacific power. Russia’s existing ties with China and India—with which the Yeltsin administration carefully cultivated relations as counterweights to the US—are unlikely to be undermined. However, Mr Putin appears set to attach a much higher priority to Japan, despite the unresolved territorial dispute over the southern Kurile islands. This shift in emphasis reflects both security and economic concerns. Although Mr Putin will seek to maintain close relations with China, underpinned by arms sales, it is understood in Moscow that, in the long term, China is as likely to be a rival as a partner, and that the arms trade with China is likely to decline anyway, as it imports the technology needed to increase its self-sufficiency in arms production.
Moreover, China cannot rival Japan as a potential source of aid, trade and investment. Sino-Russian trade has not developed as the two states once hoped and it will not do so in the absence of significant third-party finance. Japan, by contrast, has been a major source of aid—it is the only country still engaged in large-scale bilateral lending to Russia—and of investment capital. Both official Japanese agencies and Japanese commercial banks are involved in financing Gazprom’s Blue Stream pipeline under the Black Sea.
Economic policy
The future of the Gref In late 1999 the then prime minister, Vladimir Putin, appointed an ally from his programme is uncertain St Petersburg days, German Gref, to work out an economic policy programme. Although the programme was submitted to the government in May, its future is far from certain. The new prime minister, Mikhail Kasyanov, has yet to show that he is committed to Mr Gref’s policy vision. On his confirmation, Mr Kasyanov declared that he had not read the programme but was willing to take it into consideration when drawing up the government’s economic
EIU Country Report June 2000 © The Economist Intelligence Unit Limited 2000 Russia 21
policies. As minister for economic development and trade, Mr Gref will have influence on policymaking in the cabinet. However, he would have found it easier to push through his programme had he been made a deputy prime minister, which would have entitled him to co-ordinate the activities of several ministers. He may be able to do so indirectly, as one of his former colleagues from St Petersburg, Aleksei Kudrin, has been appointed deputy prime minister for finance. He will therefore be in charge not only of Mr Gref’s ministry, but also of the tax and anti-monopoly ministries and the revenue services.
Will Mr Putin push Although the programme has not yet been published, enough has already been through reforms? leaked to highlight its liberal, radical content. However, Russia is no stranger to ambitious policy programmes. Many of the reform proposals included in Mr Gref’s programme have already formed part of previous government programmes without ever making it to the implementation stage. The important question is therefore whether Mr Putin can, and will, use his political strength to push through controversial reforms.
The fact that Mr Putin assembled a number of liberal economic advisers—in addition to Mr Gref and Mr Kudrin, he has also appointed the radical liberal Illarinov as his personal adviser—has encouraged many observers to predict that the president will take the issue of economic reform seriously. However, his caution not to alienate the oligarchs and other vested interests suggests that his approach will be a gradual and eclectic one. Although Mr Putin has eagerly taken up the part of the programme that foresees a large-scale shift of power from the regions to the centre, other proposals, such as drastic cuts in industrial and consumer subsidies, or the restructuring of natural monopolies, have made little headway. Many of the reform proposals are likely to be watered down in the implementation stage.
Vladimir Putin’s ten-year plan
Based on preliminary and unconfirmed information about the economic policy programme worked out by German Gref’s Centre for Strategic Studies, the government’s plans are as follows.
Tax and fiscal reforms: introduce a flat rate of income tax of 13%; abolish turnover tax, raise corporate profit tax to 35% and align taxes on banks with those on enterprises; rationalise budgetary planning by bringing all budget funds under the remit of the state Treasury; streamline social security payments to reduce total payroll taxes to around 35% of the wage bill; gradually reduce total state spending to 30% of GDP; phase out subsidies and non-cash support for industry, utilities and workers, which together could be as high as 30% of GDP; bring social benefit entitlements in line with what the government can afford to pay and introduce means testing; increase state spending on education, health and defence; move from the current sector-based pay-as-you- go pension system to individual fully funded accounts and increase the pensionable age for both men and women to 65; cut the number of state employees and double their salaries to make them less amenable to bribery.
Structural reforms: restructure the large “natural monopolies”, notably separate the railway infrastructure from rolling stock and introduce
EIU Country Report June 2000 © The Economist Intelligence Unit Limited 2000 22 Russia
competition in railway services; split the electricity monopoly, United Energy Systems (UES), into separate generation, transmission and distribution units, and reduce the influence of local authorities on the electricity market; make the gas giant, Gazprom, more transparent; improve competition policy and the regulatory system for the utilities; introduce international accounting standards for all large and medium-sized corporations by 2002; strengthen the court system and increase judges’ salaries manifold; establish a land market as a precondition for agricultural reform and the build-up of a mortgage system; simplify the process of setting up a business.
Financial sector reforms: liquidate insolvent banks; open the domestic banking market to foreign competition; improve the regulation and supervision of the banking sector; establish a universal system of deposit insurance; build up a mortgage system.
Fiscal performance Fiscal performance continued to improve in the early months of 2000. The continues to improve better than expected outcome in 1999 was mainly attributable to high oil prices and the devaluation of the rouble, which boosted profitability in the industrial sector. Both factors are likely to persist in 2000. In April the government achieved a primary surplus (budget balance minus debt-servicing costs) on the federal budget of 6.4% of GDP and an overall surplus of 3.7% of GDP. The first-quarter primary surplus was 5.6% of GDP, with an overall surplus of 2.4% of GDP. In the first quarter of 1999 the federal budget recorded a deficit of 2.5% of GDP, with a primary surplus of 1.4%.
The January-April figures mainly reflected a drive in the first quarter to reduce tax arrears and an expected seasonal spike in revenue in April. Companies close their financial accounts from the previous year and pay their deferred taxes (chiefly value-added tax—VAT—and profit tax) in April, which is also the month in which individuals file income declarations and pay income tax. Income tax collection has grown impressively in 2000, with the first-quarter figure reaching Rb30.1bn (US$1.1bn), compared with Rb19.7bn in January-March 1999. Half of this increase is accounted for by inflation, while the rest can be attributed to the recovery of real incomes and improved tax administration.
Spending will increase The second quarter of 2000 will be tighter than the first, largely because of later in 2000 higher debt-servicing expenditure. According to Mr Kasyanov, Russia paid US$1bn in April, with US$1.25bn in payments due in May and around US$850m in June. Moreover, the government faces increased spending commit- ments in the form of wage and pension indexation. Public-sector wages rose by 20% on April 1st and pensions by 7% on May 1st. Together, these increases will raise non-interest expenditure by around Rb10.6bn, or 0.2% of anticipated GDP. There will be a seasonal rise in spending on agriculture in the third quarter, and the government will have to pay for the delivery of fuel and other necessities to remote northern territories before winter sets in. The figures for the second quarter as a whole, and for the rest of the year, are therefore likely to be less impressive than either the April data or the figures for the first quarter.
The government is likely to manage the first half of the year without recourse to borrowing from the Russian Central Bank (RCB). Although some financing
EIU Country Report June 2000 © The Economist Intelligence Unit Limited 2000 Russia 23
will be required in the second quarter, the government can now resort to the relaunched Treasury-bill (GKO) market, where demand continues to be ensured through massive excess liquidity in the banking sector.
Revenue collection is Federal budget revenue in the first quarter was up by almost 7% of GDP improving compared with the same period in 1999. The fact that arrears to the budget remain high indicates that much of this was attributable to a rapidly growing tax base rather than improved revenue collection. At the end of 1999 tax arrears reached Rb378.2bn (8.4% of 1999 GDP), which, when adjusted for inflation, amounts to an increase of more than 100% in four years—and this figure excludes around Rb327bn of fines and penalties outstanding at the end of 1999. The Ministry of Taxes and Duties is maintaining the pressure on tax debtors to restructure their debts. Progress is, however, painfully slow, as so far agreement has been reached with only 36 companies owing taxes, which account for a mere Rb6bn in arrears.
The government is continuing its drive to improve revenue collection. In March- April it increased the fiscal organs’ first-half revenue target of Rb349.6bn by Rb74bn, or more than 20%. Moscow also stepped up the pressure on subnational governments to repay Rb12bn owed for loans extended in 1999 to pay budget sector wage arrears, as well as Rb9bn owed to the centre on other grounds. The MNS, the Federal Tax Police (FSNP) and the State Customs Committee also increased administrative pressure on delinquent taxpayers, and the use of short- term expedients such as the delayed refunding of VAT on exports (an estimated Rb27bn in unrefunded VAT had accumulated by mid-April).
Companies believed to be using transfer pricing to evade taxation and shift profits offshore have become particular targets, as are those in sectors such as alcohol production, where unrecorded production is believed to take place on an exceptionally large scale. The FSNP’s powers to initiate and conduct investi- gations on its own authority have been greatly extended. Since the beginning of 2000 it has acquired the right to tap telephones and read taxpayers’ post, and it is now allowed to investigate taxpayers under 26 articles of the criminal code, compared with two previously.
Federal budget execution (% of GDPa) 1999 2000 Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr Revenue 12.9 12.5 14.9 14.9 12.1 11.3 12.8 14.8 18.2 17.1 18.1 18.0 19.8 of which: tax 12.5 11.7 13.4 14.1 11.6 10.3 12.2 12.7 14.8 15.0 16.8 15.3 n/a Expenditure 13.5 17.3 15.9 14.6 12.5 11.5 12.3 14.4 21.3 13.9 14.5 20.0 16.1 of which: interest n/a 6.1 5.5 5.4 1.4 1.7 1.9 3.3 4.8 4.1 3.1 2.8 2.7 Balance –0.6 –4.8 –0.9 0.4 –0.4 –0.1 –0.4 0.4 –3.1 3.2 3.6 –2.0 3.7 Primary balance n/a 1.3 4.6 5.8 1.0 1.5 2.3 3.7 1.7 7.3 6.7 0.8 6.4 a Local definition. Based on estimated GDP; Goskomstat no longer publishes monthly GDP figures. Sources: Ministry of Finance; United Financial Group; press reports.
EIU Country Report June 2000 © The Economist Intelligence Unit Limited 2000 24 Russia
The government wants to In line with the conservative fiscal reforms envisaged in the Gref programme, balance the budget in 2001 the government is planning to eliminate the budget deficit in 2001. This would be Russia’s first balanced budget in post-Soviet times, after an average federal budget deficit of more than 6% of GDP in 1991-99. Although the full budget draft will not be ready for submission to the cabinet before August 2000, Mr Kasyanov has already outlined the budget’s basic macroeconomic parameters, notably average inflation of 11%, real GDP growth of 4.5% and an average exchange rate of Rb35:US$1. The assumption for oil prices remains unchanged from the 1999 budget, at US$18/barrel.
Federal budget (% of GDP unless otherwise indicated) 1999 2000 2001 Outturn Budget draft Draft 1 Draft 2 Revenue 13.4 14.9 17.0 15.5 Expenditure 15.0 16.0 17.0 17.0 Interest expenditure 3.6 4.1 3.9 3.9 Non-interest expenditure 11.4 11.9 13.1 13.1 Balance –1.6 –1.1 0.0 –1.5 Primary balance 2.0 3.0 3.9 2.4 Macroeconomic assumptions Inflation (av; %) 36.5 18-20 11 11 Real GDP growth (%) 3.2 1.5 4.5 4.5 Nominal GDP (Rb bn) 4,476 5,350 6,800 6,800 Average exchange rate (Rb:US$) 24.6 32.0 41.3a n/a
Note: Draft 1 assumes that the government’s tax reforms are passed by the State Duma and are in force by January 2001. Draft 2 is based on the existing tax system.
a Year-end rate. Sources: Ministry of Finance; IMF; United Financial Group; press reports; EIU.
In order to highlight the importance of tax reform for its budget plans, the finance ministry has drawn up two alternative scenarios. The ministry’s preferred alternative is a budget that already incorporates the tax reforms that are currently being discussed in the State Duma (the lower house of parliament). On the assumption that the most important changes would be in force by the beginning of 2001, the ministry calculates that revenue would amount to Rb1.155trn, with tax revenue of Rb770bn. If the Duma fails to pass the tax changes, revenue is expected to fall short by almost 9%, with the result that the budget would have a gross deficit of Rb101bn, equivalent to1.5% of GDP.
Although the Duma has already accepted most of the government’s tax package in time for it to come into force in 2001, the EIU doubts that the impact on revenue collection will be large, despite the finance ministry’s predictions. Given that the effective tax rate in Russia is far below official rates, it is doubtful whether cutting the rate of income tax will have an immediate impact on revenue generation. The tax administration remains weak and inefficient in many places, and Russians will be loath to start declaring their full income before they have convinced themselves that tax rates are not scheduled to rise in the near future.
EIU Country Report June 2000 © The Economist Intelligence Unit Limited 2000 Russia 25
Moreover, Mr Gref’s original blueprint foresees the abolition of a number of economic and income subsidies, such as housing benefits and free transport, which is likely to be much more difficult to push through than tax changes. This implies that spending pressure could remain substantial. Finally, we believe that the ministry’s macroeconomic assumption are on the optimistic side. Based on our own forecast of real GDP growth of 3% in 2001, we calculate that federal budget revenue will be around 16.2% of GDP, leaving an overall deficit of 1.6% and a primary surplus of 2.7% of GDP.
The government has The government’s tax reform package consists of two parts: the passage of Part 2 ambitious tax plans of the new tax code, and amendments to Part 1, which was adopted in 1998 but only partly superseded the umbrella law on taxation (Law 2118-1) enacted in 1992. On the whole, the proposed reforms are intended to ease the overall tax burden by around 2% of GDP in 2000 and by more than 5% in the medium term (from 41% of GDP to 35% of GDP). The core provisions of the new tax law are the replacement of the three income tax brackets (12%, 20% and 30%) by a single income tax rate of 13%; a unified social tax that is to replace the current levies administered by the extra-budgetary pension, health, employment and social security funds, together with an overall reduction in payroll taxes from 38.5% to 35%; and the reduction and eventual abolition of turnover tax, which is currently levied at 4%. The tax—a relic of central planning—has for years been cited as one of the major burdens on Russian enterprises.
To compensate for the expected revenue shortfall, the government is planning to raise excise duties on high-octane fuel (the most widely used in Russia) sixfold; double excise taxes on tobacco; raise sales taxes on alcohol; and replace the flat tax on cars with a system that increases taxes on expensive vehicles. The government is also planning to raise the rate of profit tax from 30% to 35%, with the higher revenue accruing to local budgets. Improved deductibility of business expenses, such as travel, will compensate for this to some extent. The standard VAT rate is to remain at the current level of 20%, but more items are to be moved from the lower 10% band to the standard rate. Moreover, various measures are planned to plug tax loopholes, abolish tax privileges and reinforce tax collection.
The Duma accepts income On June 9th the Duma passed in its second reading the part of the tax code that and social tax reforms introduces a flat income tax rate of 13%. The proposal was initially met by hefty protests from the labour union, as well as the members of the Communist Party of the Russian Federation in the Duma. On paper, the government’s tax plans are highly regressive, as the tax burden appears to shift further from the rich to the poor. Currently, around 85-90% of the population pay the lowest income tax rate of 12%, while less than 1% pay the top rate of 30%. However, low-wage earners will be compensated for the 1-percentage-point rise in the income tax rate by the abolition of the 1% levy that they currently pay to the employment fund. Some relief will come from a rise in the tax-free minimum income from Rb166/month to Rb300/month, and annual allowances for medical and training costs of up to Rb50,000. However, low-income earners will be particularly hard hit by the planned rises in excise duties for petrol and cigarettes, so the net impact on the overall tax burden is difficult to gauge.
EIU Country Report June 2000 © The Economist Intelligence Unit Limited 2000 26 Russia
Most high-income earners manage to avoid paying the full tax rate by exploiting various tax loopholes or by coming to special arrangements with the tax authorities. The effective tax burden for this group of the population is therefore unlikely to change greatly. More important than the tax cuts are the government’s plans to reinforce tax collection and slowly abolish the “personalised” system of tax collection. There is ample room for improvement, as income tax in Russia accounts for less than 15% of state revenue, which is only one-quarter of the level in western Europe.
The Duma also passed the other linchpin of the government’s tax plans—the abolition of the four different social levies and their inclusion in the state budget—in its original form, although the government had already accepted the necessity for a compromise. The plans triggered opposition not only from trade unions, who fear that the reduction in the “social” levy will endanger subsidised holiday resorts and sanatoriums for workers, but from the powerful social funds. The funds—especially the pension fund—have hitherto blocked attempts even to allow the tax inspectorate to collect payments to them, let alone to surrender the autonomy of “their” charges.
Payroll taxes (% of wages) Current system Reform plans Pension Fund 28.0 28.0 Social Security Fund 5.4 4.0 Health Insurance Fund 3.6 3.6 Employment Fund 1.5 n/a Total 38.5 35.6
Note: Unemployment benefits would be paid out of the federal budget under the reformed system. Source: Press reports.
The regions are opposed to The Federation Council (the upper house of parliament) may reject a number some tax changes of the government’s tax proposals. The most obvious is Mr Gref’s suggestion to abolish the complicated system of shared taxes, at least for VAT, which is the most important revenue-earner for the federal budget. The regions would lose some Rb60bn if all VAT revenue accrued to the centre. They will be equally unenthusiastic about the abolition of the turnover tax, the proceeds of which currently feed into the State Road Fund, an extra-budgetary fund that is supposed to fund infrastructure investment, but has instead developed into a fungible subsidy for regional governments. The regions would lose more than Rb130bn if the turnover tax was abolished. Most importantly, the regions may threaten to veto the changes to the income and payroll tax system that have already been adopted by the Duma. At present, this is the only leverage that they have to force Mr Putin to tone down the radical regional reforms that he is currently trying to implement (see The political scene).
Tax collection is to be The other part of the government’s tax package consists of amendments to improved Part 1 of the tax code, most of which are designed to plug loopholes and reinforce tax collection. Many of these are directed at blatant, long-standing abuses, for example the use of loan and insurance schemes to pay salaries or
EIU Country Report June 2000 © The Economist Intelligence Unit Limited 2000 Russia 27
the use of insolvent banks to reduce tax liabilities. The latter was facilitated by a decision of the Constitutional Court in October 1998 that stipulates that taxpayers who instruct their banks to make tax payments and who have sufficient funds in their accounts to cover those payments are deemed to have paid their taxes. The ruling has allowed clients of failed banks to order tax payments from these accounts, and has created an active black market for frozen bank accounts.
Others proposals, however, have generated criticism, as they might leave the tax authorities with considerable arbitrary powers. For example, under the amended law, the tax organs would have the right to draft the normative acts implementing the tax legislation. Another part of the amended code would require banks to notify the tax inspectorate within one working day of the opening or closing of any account by a taxpayer, and to respond within a fortnight to any enquiry from the inspectorate about the operation of any account. Tax inspectors would not be required to demonstrate the basis for their enquiries.
The government also wants to extend the use of expenditure monitoring by allowing tax inspectors to investigate claims that large purchases (which already need to be declared to the authorities) have been funded by loans. The tax organs would be empowered to demand an account of all expenditure over a three-year period and to require citizens to demonstrate the source of funds if their expenditure exceed their reported incomes by more than 10% a year. In other words, tax inspectors would be granted the right to estimate taxpayers’ incomes on the basis of their expenditure. Finally, in a move to combat transfer pricing, the authorities would have considerable flexibility in defining what constitutes mutually interconnected entities, as well as estimating the appropriate prices as the basis for taxation.
These legislative changes are to be supplemented by a complete overhaul of the tax administration over several years. The project, whose costs are estimated at US$1bn, would rationalise and computerise the tax offices. Most importantly, it would do away with the personalised relationships between tax debtor and tax collector that currently lead to much abuse of the system.
The Russian Central Bank Under pressure from the Duma, which wants to curtail its autonomy, the RCB shuns responsibility has recently made a number of announcements that would shift responsibility for monetary policy to the government. In April the governor of the RCB, Viktor Gerashchenko, announced that it did not intend to use its newly won right to issue its own bonds—a right for which it had fought for several years. Mr Gerashchenko’s explanation—that he did not wish to hinder the finance ministry’s efforts to re-establish the GKO market—sounded hollow, given the volume of excess liquidity in the system. Moreover, he stated that the question of the desirability of RCB financing for the budget should now be exclusively within the competence of the government. Mr Gerashchenko’s deputy, Tatyana Paramonova, spoke publicly of the need to lift restrictions on the foreign-exchange market—a statement which marked a near-complete volte- face for the RCB, given that as recently as March Mr Gerashchenko had been pressing for tighter controls.
EIU Country Report June 2000 © The Economist Intelligence Unit Limited 2000 28 Russia
If the RCB sticks to its current line, the effects of government policies would have a more direct impact on inflation and the external value of the rouble. If the government fails to control the budget or to create suitable investment opportunities to soak up excess liquidity in the financial system, its failure is likely to be felt quickly in terms of pressure on the exchange rate and the price level. This position suits many liberals in the executive branch, who believe that the collapse of August 1998 was in no small measure the product of the RCB’s effectiveness at relieving the government of responsibility. The Central Bank succeeded in reducing inflation and stabilising the exchange rate for a considerable period in 1995-98 through more or less exclusive reliance on monetary instruments, thereby reducing the pressure on the government to implement structural and fiscal reforms.
The RCB plays tough on The RCB has so far been slow to remove licences from banks that failed in the banking reform aftermath of the 1998 crisis. Recently, however, it has toughened its stance on banking sector restructuring, which probably reflects its determination to fend off attempts to strip it of its bank supervisory functions and transfer them to a new, independent regulatory organ. The RCB believes that, despite the improved health of the banking sector (see The domestic economy: Sectoral trends), about 200 banks will lose their licences in the near term. The RCB is also pressing for an expanded definition of the terms under which it can intervene in banks’ affairs under the law on the bankruptcy of credit institutions. The amendment now before the Duma would allow the RCB to intervene if a bank’s capital adequacy ratio fell below 2% and to conduct its own evaluation of a bank’s capital.
The RCB’s sudden enthusiasm for banking sector reform may also be related to the strengthened role of the Agency for Restructuring Credit Organisations (ARKO), which is, in theory, responsible for cleaning up the banking sector. In practice ARKO has had only limited impact, largely because it is severely underfunded and because it has to rely on the RCB’s initiative for its work. This may now change. ARKO hopes to raise an additional Rb4bn by selling three- year bonds to foreign investors later in 2000. It also acquired additional authority when Mr Kasyanov, who was finance minister at the time, took over as chairman of the agency in February.
Capital inflows start to The large current-account surplus has resulted in considerable capital inflows cause problems in the first five months of 2000, pushing up the exchange rate of the rouble as well as the domestic money supply. The continued stockmarket rally in the first four months of the year (the market eased in May) and high demand for the finance ministry’s sporadic GKO issues also reveal the excess liquidity in the system. In real trade-weighted terms the rouble strengthened by more than 8% between the end of 1999 and April 2000 (based on the producer price index; by 3.7% if based on the consumer price index), despite the repeated intervention by the RCB in the foreign-exchange market to keep rouble appreciation under control. The RCB’s international reserves rose by around US$7.5bn between December 1999 and June 2000.
EIU Country Report June 2000 © The Economist Intelligence Unit Limited 2000 Russia 29
As there are hardly any financial instruments available for sterilisation, this is quickly feeding through into the domestic money supply. Between January and April broad money supply (M2) rose by 11.8%, which translates into year- on-year growth of an average of 56.6%, or more than 32% in real terms. This growth was mainly a result of the growth of non-cash funds, as real M0 grew by a much more modest 14% year on year in January-April.
Land reform slips down the Mr Kasyanov’s failure to mention the draft land code in listing his government’s agenda again priorities was symptomatic of a broader retreat on that front. Having focused on fiscal issues and reform of the federation, the Kremlin and the government do not seem inclined at present to enter into conflict with opponents of land reform. The centrist factions in the new Duma have shown little enthusiasm for allowing the sale of farmland, Mr Putin has avoided taking a clear stance on the issue, and the brief surge of government interest in creating a framework for the purchase and sale of land that was evident in late 1999 has faded since March. It remains to be seen whether proponents of the liberalisation of the land market can push it back up the political agenda this year.
Main economic policy indicators
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Federal government budget revenue (Rb bn) 1998 21.8 18.0 22.4 22.1 22.2 20.1 21.0 17.7 17.0 22.0 26.4 42.3 1999 27.8 26.5 34.3 44.8 40.3 51.8 55.3 53.5 51.4 59.9 69.1 98.9 2000 64.9 73.4 73.5 ––––––––– of which: tax revenue (Rb bn) 1998 15.8 15.4 18.7 18.9 19.0 17.4 18.4 15.5 15.4 19.3 23.9 38.1 1999 24.6 24.1 31.4 39.2 33.6 42.3 47.7 42.9 40.2 49.6 57.5 76.4 2000 56.1 66.6 73.5 – – ––––––– Federal government budget expenditure (Rb bn) 1998 29.3 24.4 36.2 30.5 33.3 35.3 32.3 21.6 22.8 32.6 36.2 72.7 1999 39.3 33.1 54.7 53.6 53.5 55.0 56.5 49.4 49.0 54.0 67.2 113.7 2000 44.1 59.0 70.6 – – ––––––– of which: interest payments (Rb bn) 1998 5.1 6.9 16.5 9.3 13.8 10.4 13.3 7.1 2.7 2.5 9.0 10.2 1999 10.6 7.5 12.7 10.7 19.5 19.3 19.1 10.0 8.1 6.7 14.7 23.7 2000 15.7 11.5 12.9 – – ––––––– Federal government budget balance (Rb bn) 1998 –7.5 –6.4 –13.8 –8.4 –11.1 –15.2 –11.3 –3.9 –5.8 –10.6 –9.8 –30.4 1999 –11.5 –6.6 –20.4 –8.8 –13.2 –3.2 –1.2 4.1 2.4 5.9 1.9 –14.8 2000 20.8 14.4 2.9 – – ––––––– Exchange rate (av; Rb:US$) 1998 5.995 6.050 6.090 6.124 6.149 6.180 6.216 6.750 14.526 15.923 16.470 19.990 1999 22.288 22.902 23.479 24.742 24.455 24.286 24.305 24.697 25.470 25.714 26.303 26.800 2000 28.189 28.728 28.458 28.592 – ––––––– Real effective exchange-rate index (CPI-based; 1995=100) 1998 151.5 151.1 151.4 150.2 147.9 148.3 148.0 140.9 86.4 79.3 83.3 76.1 1999 75.0 78.5 80.7 80.0 83.3 87.4 89.9 87.3 86.7 85.4 87.3 88.5 2000 85.7 87.1 89.9 91.9 – ––––––– Real effective exchange-rate index (PPI-based; 1995=100) 1998 157.8 157.0 156.4 154.4 150.5 151.0 149.6 135.9 64.9 60.6 63.4 54.5 1999 53.0 56.5 58.7 58.5 61.2 64.8 66.3 66.0 67.8 68.9 71.7 72.9 2000 71.2 74.0 77.4 78.9 – ––––––– continued
EIU Country Report June 2000 © The Economist Intelligence Unit Limited 2000 30 Russia
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec M2 (Rb bn) 1998 361.2 362.9 360.4 368.0 370.0 368.6 360.0 343.6 365.8 377.6 396.9 452.5 1999 444.2 463.9 473.8 509.6 542.4 567.7 583.2 590.8 597.4 625.1 646.6 704.7 2000 695.0 726.6 751.4 787.9 –––––––– M2 (% change, year on year) 1998 24.6 21.2 17.9 15.8 12.7 4.7 –0.8 –5.8 0.8 2.4 11.1 21.0 1999 23.0 27.8 31.5 38.5 46.6 54.0 62.0 71.9 63.3 65.5 62.9 55.7 2000 56.5 56.6 58.6 54.6 – ––––––– Commercial bank lending rate (%) 1998 29.8 30.4 38.3 38.8 40.4 48.0 44.9 48.6 46.8 49.0 44.8 41.7 1999 45.5 44.1 45.7 43.8 43.5 32.2 38.9 38.5 37.8 37.0 38.3 31.3 2000 34.0 31.3 29.8 – – ––––––– Commercial bank deposit rate (%) 1998 11.6 12.2 11.2 11.0 12.9 14.0 15.1 17.5 23.8 27.3 22.3 25.7 1999 24.2 22.8 18.9 14.6 14.7 11.0 12.6 8.8 9.7 9.0 9.4 8.5 2000 13.4 7.9 7.6 – – ––––––– Money market rate (%) 1998 24.1 30.3 25.9 29.5 47.6 56.1 58.8 45.3 139.7 84.9 36.7 27.8 1999 28.1 20.4 20.7 15.2 7.1 8.4 9.0 9.3 18.2 16.1 13.2 11.8 2000 11.8 11.3 6.5 11.1 – –––––––
Note: Federal budget data are calculated in accordance with IMF definitions. Commercial bank lending rates are weighted average rates on rouble-denominated bank loans to legal entities with a maturity of up to one year. Commercial bank deposit rates are weighted average interest rates on rouble-denominated household deposits with a remaining maturity of up to one year. Sources: Ministry of Finance; Russian Economic Trends; IMF, International Financial Statistics; Russian Central Bank, Monthly Bulletin.
The domestic economy
Output and demand
Growth picks up again in Economic growth picked up again in the first quarter of 2000, having slowed the first quarter in late 1999. The upturn appears to have begun in November, when estimates of seasonally adjusted GDP and of Goskomstat’s five-sector indicator, which had been fairly flat for six months, turned sharply upwards. There was a marked pause in January, when both indicators (seasonally adjusted) slipped from their December levels, followed by a sharp upsurge in February. The finance ministry’s Economic Expert Group, which calculates its own monthly GDP estimates (Goskomstat no longer produces a monthly GDP figure), concluded that in February seasonally adjusted GDP was 2.6% higher than in January, and 8% higher than in February 1999.
The industrial sector shows In late April the president, Vladimir Putin, cited a preliminary figure for real signs of a slowdown GDP growth in the first quarter of 8% year on year. Goskomstat’s estimate is somewhat lower, at 6.8%, year on year. It is unlikely that growth will continue at this rapid pace in the second quarter. There were already signs of a slowdown in April and May, particularly in the industrial sector as the effects of the post-crisis surge abated. Seasonally adjusted year-on-year growth in the industrial sector in April 2000 slowed markedly, to 5.5%, compared with an average of 11.9% in the first quarter and almost 14% in the second half of 1999. (If seasonal factors are
EIU Country Report June 2000 © The Economist Intelligence Unit Limited 2000 Russia 31
ignored, the slowdown was less marked, with April output still up by 8.9% year on year, compared with 10.5% growth in the first quarter.) Industry surveys, taken in April and May, confirm that the slowdown in April is unlikely to be a monthly anomaly.
Whereas industrial output has slowed, growth in other sectors has picked up. Much of this uneven growth performance is attributable to different base effects. The industrial sector was the first to recover after the 1998 crisis, with year-on-year output growth turning positive in April 1999 and surging to double-digit growth from mid-year. Other sectors, such as retail and construction, also returned to growth in April 1999, albeit at a slower pace. Base effects can be expected to slow year-on-year growth in all other sectors in the course of 2000.
Production growth indicators, 2000 (% change, year on year; seasonally adjusted) 1 Qtr Apr Industrial output 11.9 5.5 Freight transport 6.5 3.2 Construction 9.9 13.1 Retail 6.9 8.4 Agriculture 1.1 1.2 Sources: Goskomstat; Russian Economic Trends; press reports.
Energy continues to The slowdown in output in April was evident in all major industrial sectors, underperform import-substituting as well as export-oriented. In addition to base effects, the real appreciation of the rouble is likely to have had an impact on the industrial sector, as did the emergence of capacity constraints. Among the import- substituting branches, the sharpest downturn was in food-processing, where year-on-year growth slowed to 1.9% in April, compared with 12.8% growth in January-April. Light industry (mainly textiles), pharmaceuticals, and glass and ceramics also experienced noticeable slowdowns. Growth in the machine- building sector held steady, at 12.1% year on year in April, reflecting companies’ attempts to avoid hitting capacity constraints. Among the export sectors, the largest drop in output growth was in the chemicals sector, while production growth in the metals industry also slowed.
The energy sector continues to underperform industry as a whole, with oil and fuel output up by 4.7% year on year in January-April and electricity by 1.3%. Given the rapid expansion in industrial output, it is hard to explain the lack of growth in the electricity sector. It is not plausible to assume that Russian industry has suddenly made great progress in terms of energy efficiency. What is more likely is that large parts of industry are so energy-inefficient that increased production does not have an immediate effect on their energy consumption.
However, the year-on-year slowdown in energy production in April may also reveal a different phenomenon. As the government is now insisting on collecting taxes from utilities in the form of real money rather than surrogates, the utilities have addressed the issue of non-paying customers. Anecdotal evidence suggests that many regional energos disconnected non-paying
EIU Country Report June 2000 © The Economist Intelligence Unit Limited 2000 32 Russia
customers in April. The government may therefore be achieving through the utilities sector what it has refused to do through direct policy: weeding out inefficient and insolvent enterprises. However, if this trend spreads, the energy sector could put a considerable dampener on the current expansion.
Industrial output by sector, 2000 (% change, year on year) Jan-Apr Apr Import-substituting branches Food-processing 12.8 1.9 Light industry 38.1 23.1 Glass & ceramics 15.1 5.3 Machinery 14.1 13.1 Animal feeds –2.1 –3.8 Pharmaceuticals 23.4 12.2 Export-oriented sectors Ferrous metals 25.6 21.3 Chemicals 21.1 9.5 Wood & paper 17.8 11.5 Energy Fuel 4.7 4.0 Electricity 1.3 –1.5 Total industry 10.3 5.5 Source: Goskomstat.
Surveys confirm the Data from the April managerial survey of the Institute for Transition slowdown Economics also point to a slowdown in growth rates. Demand remained reasonably strong, but it was being satisfied by reducing stocks rather than increasing output. Moreover, although managerial expectations concerning output and prices remained relatively upbeat, they were markedly less optimistic than in March. The share of managers expecting to reduce output in the coming months was relatively low—only 13%—but this was a substantial increase since March, and was the highest figure since April 1999. This may to some extent reflect a seasonal effect (anticipation of the May holidays), but it was the third consecutive month in which managerial forecasts had shifted in a more pessimistic direction. The survey of purchasing managers, which is compiled by one of the Russian Central Bank’s subsidiaries, paints a similar picture. The seasonally adjusted index fell from 56.1 in April to 55.5 in May, its weakest level since November 1999.
Investment will have Revised data on investment in fixed assets in 1999 show an increase of 4.5% in to pick up real terms, rather than the 1% previously estimated. However, many observers were disappointed by Goskomstat’s first-quarter 2000 figure for investment. At 5.9% year on year, it suggests that the revival of investment is continuing, but it must be seen against the backdrop of a drop of 12.8% in the first quarter of 1999. Investment in the first quarter of 2000 was still 7.7% below the levels of January-March 1998 and 14% lower than in the fourth quarter of 1999. Seasonally adjusted data for expenditure on capital equipment (a proxy for investment) paint an even bleaker picture. In the first quarter of 2000 these
EIU Country Report June 2000 © The Economist Intelligence Unit Limited 2000 Russia 33
outlays were only 0.3% higher in real terms than in the same period of 1999 and they were 6.2% lower than in the fourth quarter of 1999.
If the current recovery is to be sustained, investment will have to increase robustly in the coming quarters. The structure of investment will also have to change. Owing to the financial constraints under which companies operate, some 45% of investment in equipment was devoted to replacement of worn- out equipment or parts; only 15% was devoted to upgrading the technology of production lines; and only 5% was directed at the development of new lines of production. In short, the investment revival has so far served mainly to preserve existing production profiles and technologies, many of which need to change if long-term rapid growth is to be achieved.
Employment, wages and prices
Real incomes continue According to Goskomstat, real money incomes rose by 7.2% year on year in to recover January-April 2000, although the rate of growth slowed in April after rising sharply in March. The rise in real wages was even more striking—average wages were up by 24.8% year on year in real terms compared with January-April 1999. This reflects the fact that real wages fell far more sharply than other components of income in the months following the August 1998 financial crisis, and it is a result of the repayment of back wages that picked up strongly in early 2000. Between the end of January and the beginning of May wage arrears fell by almost 14%. The impact of the pending presidential election was particularly evident in March, when total wage arrears fell by 8.5% month on month, owing to a 25% reduction in budget sector arrears.
The income increases in the first quarter marked a return to trend: after recovering modestly but steadily in month-on-month terms in the first three quarters of 1999, seasonally adjusted real incomes jumped sharply in December, only to fall even more sharply in January. Extrapolating on the trend that now appears to have re-established itself suggests that the first- quarter figure is likely to be typical of the year as a whole, and that real incomes are likely to grow by around 7.5% in 2000.
Consumer confidence is up The recovery in incomes was reflected in consumers’ outlook as shown in both purchases (real retail trade turnover rose by 7.3% year on year in January-April) and surveys: the index of consumer confidence reached 83.5 in March, the highest level recorded since the monthly consumer confidence survey was instituted in January 1993. This result was particularly striking, because the index normally shows a marked decline in March, for seasonal reasons. Moreover, the index has been rising without interruption since July 1999 and is now around 40 points above the low level of October 1998. Recent improvements in living standards were the most commonly cited reason for optimism about the near-term future.
Poverty may be less severe Revised data for 1999 present a less gloomy picture of overall poverty levels than feared than earlier estimates. According to Goskomstat, the proportion of the population receiving less than the officially defined minimum subsistence
EIU Country Report June 2000 © The Economist Intelligence Unit Limited 2000 34 Russia
income peaked in the first quarter of 1999 at 37.7% (around 55.2m people) and declined steadily thereafter, to a level of 26.3% (38.5m) in the fourth quarter. This was still well above the first-half 1998 level of 22.5%, but far below the post-crisis peak. However, the income gap is still widening. According to Goskomstat’s preliminary estimates, the decile ratio—the ratio of the aggregate income of the top 10% of the population to the bottom 10%— was 15.1 in March, up from 13.1 before the August 1998 collapse and 14.5 at the end of 1999. The top decile received 40.7% of the country’s total income in 2000, while the bottom 10% received 2.7%.
Unemployment remains The rate of unemployment (according to International Labour Organisation steady methodology) remained unchanged in the first quarter of 2000, at 12.3% of the workforce. Using Goskomstat’s current data, the unemployment rate has therefore held steady since the third quarter of 1999; earlier estimates suggested a lower level of 11.7%, but these have been revised upwards.
Producer price rises Monthly consumer price inflation jumped to 1.8% in May, after rising to 0.9% continue to outstrip CPI in April and 0.6% in March. The spike may be a result of the inflationary pressure created by large-scale capital inflows that have boosted Russian Central Bank reserves and the money supply (see Economic policy). Nevertheless, the speed of disinflation in Russia remains impressive. Year-on-year inflation in January-May was 23.2%, compared with 107.4% in the same period of 1999. The price of Goskomstat’s 25-item basket of basic necessities rose by just 2.3% in January-March, thanks largely to subdued food price inflation, which continues to run well below consumer price inflation as a whole.
Producer price inflation continues to outpace consumer price inflation, as it has done since February 1999, mainly as a result of rising oil and fuel prices. Since the beginning of 1999 monthly producer price inflation has oscillated around an average of 4%, but in year-on-year terms producer price inflation has edged upwards to average 58.8% in January-April 2000, compared with 39.5% a year earlier. However, the gap that opened up in the months immediately following the August 1998 collapse, when consumer price inflation soared and producer price inflation was relatively subdued, has yet to be offset: the consumer price index rose by 145% between August 1998 and April 2000, while the corresponding figure for the producer price index was 135%. The fastest rates of producer price inflation continue to be recorded in the fuel and metallurgical sectors. Rising electricity tariffs are now an increasingly important source of price increases, which suggests that the government is finally passing on higher energy costs to industry. Electricity tariffs in 1999 rose at roughly one-quarter of the rate of producer price inflation, and electricity producers, led by the national monopoly, United Energy Systems (UES), are determined to make up lost ground.
Financial indicators
Major banks increase assets Apart from a handful of large, bankrupt institutions left over from the collapse capital and profits of 1998 and still not wound up, Russia’s largest commercial banks are in better shape than they have been for years. The total assets of the largest 100 banks
EIU Country Report June 2000 © The Economist Intelligence Unit Limited 2000 Russia 35
(excluding Uneximbank, Rossiskii Kredit and SBS-Agro, which remain in financial limbo) rose by 17% in the first quarter of 2000, and they recorded an aggregate profit of Rb9.1bn (US$318m), compared with Rb25.7bn in 1999 as a whole. However, the real state of the sector could be less impressive than the data suggest. Russian banks are still prone to understate their non-performing assets, and much of the capital raising that takes place is more virtual than real—its purpose is to allow the banks to expand their operations and to circumvent Russian Central Bank (RCB) norms regulating lending to shareholders and other insiders.
However, they are still Despite their apparently healthier state, banks are still not fulfilling their major not lending functions. Lending to the non-financial private sector actually declined as a share of the total assets for two-thirds of the 100 largest banks (although it increased somewhat in absolute terms). The vast majority of banks are still intent on minimising risk and maximising liquidity. Around two-thirds of total assets take the form of liquid reserves, such as correspondent accounts or short- term deposits with foreign banks, government securities, funds held with the RCB, foreign currency and other highly liquid assets. Many Russian banks are therefore de facto providers of payment and settlement services rather than financial intermediaries.
This is arguably a rational strategy, given the obstacles to real intermediation. Poor creditor protection, defective bankruptcy legislation, the lack of an effective mechanism for registering and realising collateral, and the enormous information and monitoring problems presented by Russian corporate borrowers are just a few of the many deterrents to lending.
The authorities’ preferred solution to the reluctance of commercial banks to lend to the non-financial sector is to increase the role of the state in credit allocation rather than to address the problems that prevent the development of a market-based system of financial intermediation. The creation of the Russian Development Bank and the new state agricultural bank, Rosselkhozbank, reflects this approach, as does the protection of Sberbank’s privileged regulatory regime, which helps it to maintain its monopoly in the retail market. This approach will not lead to the efficient allocation of investment finance, but will instead create opportunities for political rent- seeking and corruption.
Sectoral trends
Output of crude oil and oil Crude oil production in the first quarter of 2000 rose by 5.4% compared with products rises the first quarter of 1999, and export volumes increased by around 2% year on year in January-February (the rise was more than 100% in value terms because of the strong recovery in oil prices). The production increase is the result of higher capital expenditure in July-December 1999, which allowed oil companies to continue to raise output in response to price incentives. It represents an acceleration of the modest pick-up in crude oil output that began in 1999. Crude oil production in 1999 was 304.8m tonnes (or around 6.18m barrels/day), slightly up on the 303m tonnes recorded in 1998 but still
EIU Country Report June 2000 © The Economist Intelligence Unit Limited 2000 36 Russia
below the level of 1997, and not much more than half of the 11.4m b/d recorded in 1987-88. Refinery throughput was up by 11% in 1999, at 168.6m tonnes (or around 3.65m b/d).
The oil sector urgently Russia currently produces around 100m tonnes a year more than it is needs more investment discovering in new reserves. The volume of exploratory drilling fell from a level of about 1.4m metres a year in 1994-98 to just 1.16m metres in 1999, a reflection of the cuts in capital expenditure adopted by Russian oil companies in the wake of the August 1998 financial collapse. These cuts have since been partly reversed, but the larger problem remains. Drilling data released by the Ministry of Fuel and Energy at the end of February highlight the wide divergence among producers. The 22% rise in total drilling therefore represents a decline of around 20% in exploratory drilling offset by an increase of roughly 35% in production drilling.
With the government now making the lack of exploration a political issue, the large oil companies have devised impressive investment plans. These appear to be affordable, after the rouble devaluation and the hike in international oil prices led to record profits in the Russian oil business in 1999. Russia’s largest oil company, LUKoil, has announced that it is planning to invest some US$20bn over the next ten years, of which US$600m-800m a year will go into the exploration of new fields in Russia and abroad. Yukos, the second largest oil company, is planning to plough more than US$400m into its oil refineries and production facilities in 2000, while Sibneft is seeking to triple upstream investment this year, to more than US$200m.
Drilling volumes (production and exploration) (‘000 metres unless otherwise indicated) 1999 Jan-Jun Jun-Dec % change 1998 1999 % change LUKoil 347 365 5.2 623 712 14.3 Surgutneftegaz 963 1,040 8.0 1,581 2,003 26.7 Sibneft 140 200 42.9 564 340 –39.7 Tatneft 224 189 –15.6 523 413 –21.0 Total incl others 2,882 3,344 16.0 5,100 6,226 22.1 Sources: Ministry of Fuel and Energy; United Financial Group.
Construction of the Baltic The start of construction of an oil terminal in Primorsk, in Leningrad Oblast Pipeline System begins (region), in mid-April marked the beginning of construction of the Baltic Pipeline System (BPS). The BPS project has long been controversial, mainly because several of the major oil companies have no interest in it but have been required to finance it through an investment tariff on oil exports of US$1.43/tonne. Moreover, important questions remain unanswered. It is still not clear who will participate in the project, how long it will take, how much it will cost (estimates put the cost of the first stage at US$400m-500m, with the second stage bringing the cost up to US$1.5bn-2bn) or who will own the new company created by the state-owned oil pipeline monopoly, Transneft, to manage the project. What is known is that the pipeline is to run for 2,718 km, of which 1,885 km will consist of the existing Usinsk-Ukhta-Yaroslavl-Kirishi
EIU Country Report June 2000 © The Economist Intelligence Unit Limited 2000 Russia 37
line, which is to be renovated. The new segments will include a line running from Kharyaga (Yamalo-Nenets Autonomous Okrug) to Usinsk (Republic of Komi) and a 100-km line from Kirishi to Primorsk. The total annual capacity of the BPS is planned at 12m tonnes initially, rising to 30m tonnes later.
The BPS is intended to reduce Russia’s reliance on oil export routes through the Baltic states, mainly Latvia, which is accused by Russia of mistreating its large Russian minority, and to make it easier to negotiate lower transit tariffs for oil crossing not only Latvia and Lithuania but also Ukraine. Russia insists that these tariffs are grossly overinflated. Primorsk will be only the second specialised oil terminal in Russia and will be located far closer to the attractive EU markets than the Black Sea terminal at Novorossisk. The Russian oil industry stands to benefit from both a 10% expansion in overall export capacity and a direct route to northern-tier EU markets. Nevertheless, LUKoil remains more interested in its planned Arctic Ocean evacuation route from the Timan-Pechora Basin, while Surgutneftegaz fears that the BPS may lead to the export of crude that would otherwise supply its Kirishi refinery.
Large pipeline projects are The energy co-operation pact agreed between Russia and China in late March agreed with China envisages the construction of oil and gas pipelines from Russia to China. If these projects go ahead, they will provide a major boost to the economies of several Siberian regions. The projects have already led to a sharp increase in interest in the Kovykta gasfield in Irkutsk Oblast, which has an estimated 1.2trn cu metres of natural gas reserves and which would be the principal source of gas exports to China. Given the keen interest of the two governments in developing Russian energy export routes to China, the projects stand a good chance of progressing relatively quickly. The competition among Russian and foreign companies for control of the fields involved—especially Kovykta— suggests that they share this assessment.
The spring sowing lags As of May 1st only 9m hectares had been sown to spring wheat, a 27% decline compared with the same period in 1999, while unseasonably cold weather in early May led to predictions of crop damage in a number of regions, including the Volga region, the North Caucasus, Central Russia and the Central Black Earth region.
This is unwelcome news at a time when the grain market is still tight as a result of the disastrous 1998 harvest and the mediocre one in 1999. The amount of grain stored on farms and in granaries was 15.8m tonnes as of April 1st, according to official sources. This compares with 16.2m tonnes as of the same date in 1999. Moreover, the administrative controls on grain flows imposed at regional level in response to the poor harvests of recent years have begun to have an effect. In some regions where there is a grain surplus, food-quality grain is being used for livestock feed, while elsewhere supplies are tight. Further Western food aid is unlikely to be forthcoming in 2000, and therefore any shortfalls that arise as a result of market distortions will probably be covered by commercial imports from Kazakhstan. Russia should be able to get through the end of this crop cycle without undue difficulty.
EIU Country Report June 2000 © The Economist Intelligence Unit Limited 2000 38 Russia
Farm finances show the Data on the performance of the agricultural sector in 1999 highlight the benefits of devaluation beneficial impact of the August 1998 rouble devaluation, which gave the agricultural sector a tremendous opportunity for import substitution. The sharp rise in the cost of imported foodstuffs, along with the disappearance of the domestic government securities market and the tightening of capital controls, made sectors with relatively short cycles of capital turnover, such as the food industry, extremely attractive to investors. Rising demand for domestic food products has shifted the agricultural sector’s terms of trade in its favour: food prices rose by 91% and the volume of sales by 30% in 1999, whereas the prices of industrial inputs needed by agricultural producers rose by just 58%. As a result, the sector as a whole finished the agricultural year in profit for the first time in four years.
Main macroeconomic indicators
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Industrial output (% change, month on month) 1998 –7.4 7.0 –1.2 –3.8 –7.6 –3.6 –6.3 1.8 –2.1 9.4 5.1 3.5 1999 –1.6 4.7 0.7 –2.2 –2.6 –0.8 –1.6 1.6 3.0 1.9 4.3 3.5 2000 –2.0 3.3 1.0 –2.9 – ––––––– Industrial output (% change, year on year) 1998 4.5 1.2 1.0 1.1 –1.2 –4.6 –9.0 –11.6 –5.0 –10.3 –10.9 –6.7 1999 –0.9 –3.0 –1.1 0.6 6.0 9.0 14.5 14.2 20.2 12.0 11.2 11.1 2000 10.7 9.3 9.6 8.9 – ––––––– Retail sales (% change, year on year) 1998 –1.9 0.2 0.1 –1.7 0.2 0.2 1.0 3.3 –3.6 –9.4 –9.5 –12.2 1999 –15.0 –11.4 –9.0 –10.9 –9.9 –7.8 –8.7 –10.6 –7.6 0.9 0.3 2.6 2000 6.6 7.2 6.7 7.6 – ––––––– Unemployment (m) 1998 8.3 8.4 8.5 8.5 8.3 8.1 8.1 8.3 8.6 8.9 9.4 9.7 1999 10.1 10.4 10.0 9.6 9.1 9.1 9.1 8.6 8.7 8.7 9.1 9.1 2000 9.1 9.1 9.1 – – ––––––– Unemployment rate (%) 1998 11.4 11.6 11.7 11.7 11.5 11.3 11.3 11.6 11.9 12.3 12.9 13.3 1999 13.8 14.1 13.6 13.0 12.4 12.4 12.4 12.4 11.7 11.7 12.3 12.3 2000 12.3 12.3 12.3 – – ––––––– Consumer prices (% change, month on month) 1998 1.5 0.9 0.6 0.4 0.5 0.1 0.2 3.7 38.4 4.5 5.7 11.6 1999 8.4 4.1 2.8 3.0 2.2 1.9 2.8 1.2 1.5 1.4 1.2 1.3 2000 2.3 1.0 0.6 0.9 – ––––––– Consumer prices (% change, year on year) 1998 10.1 9.4 8.5 8.0 7.5 6.4 5.6 9.6 52.2 58.8 66.8 84.4 1999 96.9 103.2 107.6 112.9 116.6 120.6 126.5 120.9 62.0 57.0 50.4 36.5 2000 28.9 25.1 22.5 20.0 – ––––––– Producer prices (% change, month on month) 1998 0.9 0.5 –0.1 0.0 –0.9 0.0 –0.8 –1.2 7.4 5.9 5.0 4.8 1999 6.9 5.6 3.8 3.7 3.6 3.7 3.1 4.7 5.9 5.5 3.9 2.2 2000 4.0 3.7 2.6 1.5 – ––––––– Producer prices (% change, year on year) 1998 7.3 6.0 4.6 3.8 2.5 1.6 0.6 –1.0 6.1 12.2 17.6 23.2 1999 30.5 37.2 42.5 47.7 54.4 60.1 66.4 76.3 73.9 73.2 71.5 67.3 2000 62.7 59.8 57.9 54.6 – ––––––– continued
EIU Country Report June 2000 © The Economist Intelligence Unit Limited 2000 Russia 39
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Average monthly nominal wage (% change, year on year) 1998 21.6 21.8 17.3 15.4 13.8 13.0 11.1 7.1 8.4 11.6 16.7 22.0 1999 18.1 19.9 30.8 36.8 40.6 44.9 58.3 52.9 51.4 52.8 39.3 54.0 2000 56.8 53.4 46.1 ––––––––– Average monthly real wage (% change, year on year) 1998 10.5 11.3 8.1 6.9 5.9 6.2 5.2 –2.3 –28.8 –29.7 –30.1 –33.8 1999 –40.0 –41.0 –37.0 –35.7 –35.1 –34.3 –30.1 –30.8 –6.5 –2.7 –32.3 12.9 2000 21.7 22.6 19.3 – – ––––––– Average monthly wage (US$) 1998 165 165 174 170 170 182 179 156 77 71 71 74 1999 52 52 59 58 60 67 72 65 66 67 68 85 2000 65 64 71 – – –––––––
Note. Unemployment figures are as of the end of the month and are calculated according to International Labour Organisation (ILO) methodology, which relies on surveys of the number of job-seekers rather than registration at unemployment offices. Sources: Goskomstat; Russian Economic Trends.
Foreign trade and payments
The trade surplus reaches The merchandise trade surplus (balance-of-payments methodology) in January- US$19.1bn April 2000 totalled US$19.1bn, which is almost twice as high as in the same period of 1999. Exports in the first four months amounted to US$31.5bn, some 43% on the year-earlier period. The large increase in exports was principally the result of the rise in oil and gas prices rather than increases in volumes. The contribution of oil price increases to the first-quarter trade surplus of US$12bn (this estimate includes unofficial border trade) has been estimated at US$4.2bn, and that of gas price rises at around US$1bn; the remaining US$800m was mainly a reflection of higher metals prices. There is little sign in the preliminary data that Russia’s underlying export performance is improving or that the commodity structure of exports is changing greatly. Although the external environment has been favourable over the past year or so, the data highlight Russia’s continuing reliance on a narrow range of exports and its vulnerability to external shocks.
Imports are still stagnant, at US$12.4bn in January-April 2000, compared with US$12.3bn a year earlier. Import demand appeared to recover in the second half of 1999, with the three-month moving average of import growth peaking at 15.4% in October, before trailing off to less than 2% in January. In March import growth turned negative again, despite the real appreciation of the rouble and the beginnings of a recovery in real disposable incomes, which were up by 7.6% year on year in the first quarter. The import data suggest that Russian domestic producers are still benefiting from an import-substitution effect. However, when viewed together with data suggesting sluggish investment growth, they also imply that Russian companies are not increasing imports of capital goods, which does not bode well for future growth.
EIU Country Report June 2000 © The Economist Intelligence Unit Limited 2000 40 Russia
The 1999 current-account Full-year payments data for 1999 show a US$25bn surplus on the current surplus was US$25bn account, 25 times greater than in 1998. This was chiefly the result of a US$35.3bn merchandise trade surplus (more than double the figure for 1998), which more than offset deficits on most other items in the current account. The trade surplus was almost entirely the result of the collapse in imports, as total exports remained at more or less the level of 1998—although the full-year export figures mask a sharp first-half contraction offset by rapid second-half growth, as a result of changes in the world prices of Russia’s major export commodities. Oil exports in fact fell by 2% in volume terms in 1999 but jumped by 37.4% in value terms.
The only other development of note on the current account was the substantial reduction in the deficit recorded on investment income, which fell from US$11.4bn to US$7.5bn, mainly as a result of the sharp drop in the dollar value of payments to non-resident holders of Treasury bills (GKOs) and federal loan bonds (OFZs) in the wake of the financial collapse. Imports and exports of services both fell, with the deficit on trade in services remaining constant at around US$3.3bn.
Balance of payments, 1999 (US$ bn) 1 Qtr 2 Qtr 3 Qtr 4 Qtr Year Goods: exports 15.5 17.0 18.7 23.5 74.7 Goods: imports –9.0 –10.1 –9.4 –10.8 –39.4 Goods balance 6.5 6.9 9.2 12.7 35.3 Services balance –0.7 –0.8 –0.9 –1.0 –3.3 Net income –1.1 –1.8 –2.9 –1.7 –7.5 Net transfers 0.0 0.1 0.2 0.3 0.5 Current-account balance 4.7 4.4 5.6 10.2 25.0 Capital account balance –0.1 0.0 –0.1 –0.1 –0.3 Net direct investment 0.2 0.2 0.1 0.3 0.7 Net portfolio investment 0.1 –0.6 0.1 0.1 –0.6 Net other investment –5.3 –0.7 –5.5 –4.4 –15.9 Change in international reserves 1.0 –1.6 1.1 –2.2 –1.8 Capital & financial account balance 4.0 –2.9 –4.6 –6.5 –18.0 Net errors & omissions –0.7 –1.5 –1.0 –3.7 –7.0
Note. Figures do not sum owing to rounding. Source: Russian Central Bank.
Capital outflows may The current-account surplus in 1999 was roughly matched by a deficit of have slowed US$18bn on the capital and financial account and an outflow of US$7bn recorded under net errors and omissions. According to the Economic Expert Group (EEG) of the Ministry of Finance, the net outflow of capital (Russian and foreign) on the basis of the payments data appears to have been around US$22.9bn (including errors and omissions). This compares with a 1998 net outflow of US$7bn. The EEG estimates that there was a net inflow of foreign capital in 1999 of around US$1.3bn, down from US$20.1bn in 1998. Russian capital flows, however, were deeply negative, at around US$24.2bn. If outflows
EIU Country Report June 2000 © The Economist Intelligence Unit Limited 2000 Russia 41
are measured relative to GDP, it appears that capital flight in 1999 reached its highest level in the post-Soviet period, rising from about 9% of GDP in 1998 to around 13% in 1999.
In 1999 Russia’s massive external surpluses did not lead to any substantial increase in official reserves, as export proceeds were mainly shifted abroad. With the election for the State Duma (the lower house of parliament) over and the presidential succession resolved, there is now reason to expect investor sentiment to improve and capital flight to decrease. Although payments data for the first half of 2000 are not yet available, the rapid build-up of reserves by the Russian Central Bank (RCB) suggests that sentiment has indeed changed. International reserves rose from US$12.5bn in January to almost US$20bn in the first week of June, with the rate of build-up clearly accelerating in recent months. Although most of this is attributable to the large current-account surplus, it also indicates that capital flight is slowing or that some of the capital that fled the country in 1999 is now being repatriated. Although this is a good sign for the economy, it poses a dilemma for the RCB in terms of monetary policy, as the capital inflows are pushing up the money supply and inflation (see Economic policy).
FDI picks up as portfolio According to Goskomstat, total foreign investment inflows in 1999 were down by inflows evaporate 28.8% on the previous year, at US$9.6bn, but foreign direct investment (FDI) inflows rose by more than one-quarter, to US$4.3bn. The Central Bank gives much lower figures for FDI inflows, at around US$2.9bn, which is only marginally higher than the US$2.8bn recorded in 1998. Portfolio investment all but disappeared and loans made up the balance of the US$9.6bn in inflows. According to Goskomstat, the fuel and energy complex and the food industry received 28% and 23% of FDI inflows respectively in 1999. The economy ministry estimates that, barring major economic and political upheavals, FDI inflows in 2000 should reach US$5bn, rising to US$6bn in 2001. The EIU’s own predictions are somewhat more cautious, predicting inflows of US$3.5bn this year and US$5bn in 2001, on the assumption that the government’s reform agenda is making gradual but steady progress. However, outward FDI picked up substantially in 1999, to US$2.1bn, and is expected to remain at between US$1bn and US$2bn in coming years, thereby considerably reducing the amount of net FDI.
Russia has received around US$16bn-19bn in FDI inflows since the beginning of the 1990s (with our estimate on the higher end of the scale). Given the country’s size and potential, these are extremely low figures, not only by comparison with other countries in eastern Europe, but also relative to Russia’s investment needs. Political and economic stabilisation, although necessary, will not be enough to make Russia an attractive destination for FDI. Creating a more favourable environment for both foreign and local investors will require a host of changes to the legislative framework for investment and the tax system, as well as improvements in investor protection and corporate governance, and measures to improve the administration of law.
Russia continues to seek The deputy finance minister, Sergei Kolotukhin, was quoted on May 12th as Paris Club forgiveness claiming that Russia had reached agreement with Germany on terms for rescheduling payments for 1999 and 2000 on Russia’s Paris Club debts. Russia
EIU Country Report June 2000 © The Economist Intelligence Unit Limited 2000 42 Russia
has already reached separate agreements with five of the club’s 18 members on its 1999-2000 payments, but agreement with Germany is of particular significance, given that it holds by far the largest portion of the debt. However, the Russian government still appears to be a long way from its ambition of securing a restructuring of the Paris Club debt along similar lines to what was agreed with the London Club (1st quarter 2000, pages 38-39), including the write-off of a substantial portion of the debt, something that both Germany and the IMF, now under its new German managing director, oppose. Russia’s strengthening external payments situation has weakened its negotiating position as more and more Paris Club member states are coming to the opinion that Russia’s debt-servicing position can be made sustainable without any write-offs.
The finance ministry might Mr Kolotukhin has indicated that the government might also restructure restructure MinFins tranches four and five of its internal hard-currency loan bonds (otherwise known as MinFins or Taiga bonds) if it proved necessary to do so in order to reach agreement with the Paris Club. However, the restructuring of tranche three set a bad precedent. It has been more than a year since Russia defaulted on MinFin tranche three, six months since the restructuring terms were announced and three months since the exchange of paper began. However, less than half of the outstanding US$1.3bn in tranche three bonds have been swapped. The status of the bonds is still much under dispute (4th quarter 1999, page 41), with many investors adopting a wait-and-see attitude, while a few of them are challenging the government’s actions in the courts.
External debt outstanding, Jan 1st (US$ bn) 1999 2000 Federal government 149.8 142.2 Post-Soviet Russian Federation debt 51.7 44.5 of which: owed to the IMF 15.3 12.2 owed to the World Bank 6.3 6.7 Inherited Soviet debt 98.1 97.7 Regional authorities 2.3 2.0 Loans 0.9 0.9 Eurobonds 1.4 1.2 Russian Central Bank 4.1 3.4 Owed to the IMF 4.0 3.0 Other 0.1 0.5 Banking sector 10.0 7.7 Other private sector 19.8 20.2 Total 186.1 175.6 Source: Russian Central Bank.
Regional borrowing may The ability of Russia’s regions to borrow money has been limited since the be constrained August financial collapse but may soon be restricted even more. One of the government’s proposals for imposing tighter financial discipline on the regions involves the amendment of the budget code to prohibit subnational govern- ments from borrowing abroad to finance their budget deficits. Moreover, the
EIU Country Report June 2000 © The Economist Intelligence Unit Limited 2000 Russia 43
proposed amendments would allow the finance ministry to take direct control of the finances of any regional government that could not service its debts. The Duma budget committee has recommended passage of the measure to the full chamber. If the government cannot muster a substantial majority (more than 300 votes) in the Duma, however, it is likely to find it difficult to force the amendments through the Federation Council (the upper house of parliament).
The oil export regime In March the government unveiled a system of floating export duties for crude is revised oil, which link the duties to oil prices. The scale rises from a level of zero for prices of less than US$12.50/barrel to a maximum of ¤48/tonne (US$45/t) when the price exceeds US$32.50/b. As a result of the new scheme, duties were raised from ¤15/t to ¤20/t, but the scale offers producers a lower tax burden in the event of further declines in oil prices. The new system was widely welcomed for its predictability and its capacity to protect companies from price declines, even by those who disagreed with the scales set. Frequent and arbitrary changes to export duties have been a major grievance of the oil companies.
Oil export duties
Crude price (US$/b) Export duty (e/tonne) <12.50 0 12.51-15.00 2 15.01-17.50 5 17.51-20.00 9 20.01-22.50 14 22.51-25.00 20 25.01-27.50 27 27.51-30.00 34 30.01-32.50 41 >32.51 48 Source: United Financial Group.
In April the Ministry of Fuel and Energy approved new product export quotas stipulating that 80% of gasoil, 50-60% of fuel oil and 75% of petrol would be designated for domestic consumption in May. The gasoil and petrol restrictions are in part imposed with the agricultural sector in mind, but the fuel oil restriction makes little sense, as there is virtually no domestic demand for it in the late spring and producers will now lose the opportunity to export it to western Europe, where it would be refined into lighter products. The removal of Viktor Kalyuzhny as fuel and energy minister had nourished hopes that the authorities would adopt a less restrictive stance with regards to fuel exports. However, in May the deputy prime minister for natural monopolies and energy, Viktor Khristenko, indicated that the new government would like to maintain a regulated regime for oil and fuel exports.
Steel producers face new The US International Trade Commission ruled in early March that Russian EU restrictions exports of cold-rolled coil (CRC) were not injurious to US producers and therefore should not be subjected to punitive anti-dumping duties. This decision had no immediate effect—Russia’s CRC exports to the US will remain minimal in 2000—but it should strengthen Russia’s hand in future market
EIU Country Report June 2000 © The Economist Intelligence Unit Limited 2000 44 Russia
access negotiations. The EU, by contrast, cut Russia’s steel import quota by 12% (a reduction of roughly 100,000 tonnes) in response to the 15% duty imposed on ferrous scrap exports by the Russian government, which was introduced to cut raw materials prices for Russian companies, but which simultaneously raised production costs in a number of EU industries that had purchased Russian scrap. As the 2001 quota will be calculated partly with reference to imports in 2000, the cut will affect Russian exporters next year as well.
Main external indicators
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Exports fob (US$ bn) 1998 5.9 5.8 6.7 6.2 6.0 6.5 6.2 5.7 5.9 6.1 5.9 7.3 1999 4.6 5.0 5.9 6.5 5.1 5.3 6.3 6.1 6.3 6.7 7.4 9.4 2000 6.8 7.9 8.7 8.1 –––––––– Imports fob (US$ bn) 1998 5.7 6.1 6.5 6.2 5.8 5.7 5.7 5.0 3.0 2.9 3.0 3.5 1999 2.6 2.9 3.4 3.3 2.9 3.9 3.2 3.1 3.1 3.4 3.5 4.0 2000 2.5 3.3 3.4 3.2 – ––––––– Trade balance (US$ bn) 1998 0.2 –0.3 0.2 0.0 0.2 0.8 0.5 0.7 2.9 3.2 2.9 3.8 1999 2.0 2.1 2.5 3.3 2.2 1.4 3.1 3.0 3.1 3.4 3.9 5.4 2000 4.3 4.6 5.3 4.9 – ––––––– International reserves (US$ m) 1998 15,375 15,034 16,859 15,952 14,627 16,169 18,409 12,459 12,709 13,572 12,480 12,223 1999 11,621 11,437 10,765 11,168 11,937 12,153 11,921 11,231 11,212 11,752 11,504 12,456 2000 12,948 13,657 15,532 17,091 – ––––––– of which: gold (US$ m) 1998 4,895 4,822 4,948 4,996 5,002 5,009 4,604 4,262 3,869 3,916 4,305 4,422 1999 4,543 4,153 4,086 4,094 3,903 3,964 4,094 4,407 4,579 4,671 3,906 3,998 2000 4,035 4,051 4,076 3,682 – ––––––– Sources: Russian Economic Trends; Russian Central Bank.
EIU Country Report June 2000 © The Economist Intelligence Unit Limited 2000