IHS| http://wwwold.ihs.ac.at/index.php3?in=http://www.ihs.ac.at/secti... ANDREAS WÖRGÖTTER, IHS Russia Regional Risk Rating Presentation Salzburg, June 22, 1998 Bank Austria CEEC and Russia Investment Risk Rating The macroeconomic stabilization of the Russian economy stimulated the interest of both academics and business circles resulting in more knowledge on economic development and opportunities in this country. The issue of foreign investments in the Russian Regions and the related legal and logistic frameworks has become a prominent subject of worldwide interest. However, the vast environmental, demographic, political, economic, financial and cultural diversity of the country, arising from its wide geographic spread, make it difficult to consider the Federation as a single entity. The Russian Federation is the largest country in the world and extending over 9 time zones. The Russian Federation is home to a variety of different peoples and religions of all main European, Arab and Asian beliefs. Russia is combining its wealth of resources and high technological sophistication with the struggles to overcome the distortions of its central planning legacies. The Russian Federation exemplifies diversity, which is unique among all economies. Therefore, the regional approach seems to be relevant and appropriate. This approach allows us to delineate the obstacles and risks for investment at the level of more homogeneous subjects of the Federation. The characterization of the 89 RF subjects by the use of a large number of various indicators is a challenging undertaking, and the presentation of its results needs special techniques. Despite the fact that some information could be lost for the reader, or is indistinguishably couched in technical procedures, our method of rating remains one of the most vivid ways to display investment risks. We see our task to condense available information in a similar way as a road map and to offer report a compass, which is showing the directions. We invite the reader of our study to accompany us on our adventurous travels through the world of information on the Russian Regions and share the results of a "beauty contest" of the Russian Regions from the point of view of an outside investor. Russia Russia experienced substantial changes after the breakdown of central planning; some of which lead to positive developments and some can be identified as negative outcomes. POSITIVE DEVELOPMENTS According to the official economic statistics, the recession of the RF seems to have bottomed out in 1997. Inflation in the beginning of 1998 dropped below 1% per month. The RUR/US$ exchange rate has kept its value despite the heavy speculative attacks, now its volatility is under control of the Central Bank with the price of excessive interest rates. The discount rate was reduced nearly ten times, but it had to be increased temporarily to 150% at the peak of the recent financial crisis. Russian regions started to issue ADR and Euro-bonds, promoting the development of a full-fledged financial market in Russia. These and other steps have led to international recognition of the Russian security market. Now, several Russian stocks are quoted and traded internationally. The Russian banking system is gradually improving its performance and efficiency. Some banks have begun to invest in productive assets. Large banks moved their operations to the regions and established branches throughout the country. So called financial-industrial groups were established with a potential for improving the financial basis of important Russian enterprise conglomerates. Finally, absolute individual savings have started to grow. International trade activities were characterized by an impressive (and for transition economies unusual) positive export-import balance. Going hand in hand with increasing international trade, foreign investments have markedly increased although starting from an insufficient level and foreign and joint 1 of 8 11.03.2010 15:37 IHS| http://wwwold.ihs.ac.at/index.php3?in=http://www.ihs.ac.at/secti... ventures activities expanded. Foreign activities were no longer confined to the RF capital, but have also occurred in the Russian regions and were often financed from abroad. The Russian market is no longer characterized by supply and goods shortages ("deficits"), but in many regions starts to resemble Western markets for the consumer with enough purchasing power. In addition, the quality of domestic products has generally improved. Business services and utilities are now widely available. The quality of communication facilities has improved remarkably and modern communication services such as the Internet or cellular phone services are available today in most cities. The state sector's share in the economy is gradual declining, and privatization is generally heading towards a successful direction. Today Russia is among the economies with the smallest share of GDP commanded by government. Center-region relations are more and more based on a legal framework, regulating the interactions between the entities of the RF. At the same time, the legal system more and more reflects market realities. The government oversees business activities, but refrains from direct interventions, and started to initiate anti-monopolistic policies. All these factors, in the eyes of the population, lend more creditability to the economic and political reforms in the country. Finally, 20 months of war in the Chechen Republic have stopped. NEGATIVE OUTCOMES With the growth of the budget deficit, the instability of tax collection has increased. Many enterprises efficiently delay tax payments and the amount of collected taxes has decreased. There is generally a money shortage in the economy due to the tight monetary policy of the CBR and the insufficient financial intermediation capacities of the Russian banking system. Barter or money surrogates settlements are still common practice. The number of donor-regions to the Federal budget is decreasing, and federal-regional financial relations are generally unclear or not efficiently regulated. Recently the consequences of investor withdrawal scared by fears of regional and federal bankruptcy has been shaking the Russian financial markets. This battle is not yet over and Russian federal and local authorities will have to come up with actions demonstrating their willingness to refrain from playing games with outside investors. International investors become increasingly aware of the risks of inadequate policies. This has also a positive side effect: governments cannot wait as long as in the past, until distortionary policies are changed. Another major shock for the Russian economy has been caused by sharply decreasing energy export prices. Export revenues depend very much on energy and raw material export. Labor productivity (GDP per employed) is generally declining countrywide. The technological and physical depreciation of the productive assets continues. Branch and regional developments are characterized by growing disparities. There are strong concentration tendencies, where specific branches are exclusively concentrated in single regions. The construction of a competitive, market oriented processing industry is still far from satisfactory. There is a polarization of the population regarding an increasing range in net incomes. Wage, pension and social benefits arrears are growing. The number of poor people has become larger. Even homelessness is becoming a widespread phenomenon. Strikes have become a common feature of work life. The regional and Federal government cuts social support programs and social services, and the quality of these state-provided services has deteriorated. At the same time, an increasing share of the population is looking for social assistance. Hidden employment is flourishing, and the official and non-registered unemployment rates continue to rise. On the other side, there is a continuous decline of the life expectancy of the Russian population. The shadow economy prospers criminal activities and financial frauds are on the rise. The population lacks an efficient protection from crime by official law enforcement bodies. The withdrawal of the state has generated a vacuum into which numerous organizations invaded by illegally exercising the state privilege to tax and apply force. The transport sector has generally deteriorated. Custom barriers between the CIS states, and complicated custom procedures are impeding trade activities between the RF and the former Soviet republics. Russia's reputation in the political and economic sphere has suffered in Eastern Europe and in its previous sphere of influence. 2 of 8 11.03.2010 15:37 IHS| http://wwwold.ihs.ac.at/index.php3?in=http://www.ihs.ac.at/secti... The Russian State, the parliament (Duma) and some of its leading figures have lost authority among the population. The Russian population has demonstrated an astonishing amount of patience and ability to tolerate the burden of adjustment to market principles. Currently the confidence in market principles to favor the interests of "the man in the street" rarely can be delivered by the politicians, but has to be provided by the outcomes of economic development. Regions The 89 objects of the Russian Federation differ in terms of their degree of independence granted by the constitution. The constitution mentions 49 Oblasts, 21 Republics, 6 Territories (Krais), 10 autonomous districts, 2 Metropolitan Areas and one Autonomous Oblast. As explained already before, the regions differ vastly