DOCUMENT OF THE EUROPEAN BANK FOR RECONSTRUCTION AND DEVELOPMENT STRATEGY FOR THE RUSSIAN FEDERATION As approved by the Board of Directors on 16 November 2004 TABLE OF CONTENTS EXECUTIVE SUMMARY..................................................................................................... 1 1. THE BANK’S OPERATIONS TO DATE AND CURRENT PORTFOLIO......... 6 1.1 Overview of Activities to Date...................................................................................... 6 1.2 Implementation of the previous Country Strategy ........................................................ 7 1.2.1 Promoting Restructuring in Infrastructure .................................................................................... 7 1.2.2 Encouraging Restructuring and Attracting Strategic Investors in the Corporate Sector ............. 8 1.2.3 Strengthening Small Business Development and Expanding Regional Coverage ......................... 8 1.2.4 Enhancing Competition and Supporting Financial Sector Reform................................................ 9 1.3 Implementation of the Regional Approach ................................................................. 10 1.4 Transition Impact of the Bank’s Portfolio and Lessons Learnt................................... 10 1.5 Mobilisation and Co-Financing................................................................................... 12 2. OPERATIONAL ENVIRONMENT ....................................................................... 13 2.1 The General Reform Environment.............................................................................. 13 2.1.1 Political Environment .................................................................................................................. 13 2.1.2 Governance and Integrity Issues.................................................................................................. 13 2.1.3 Social Conditions ......................................................................................................................... 14 2.1.4 Legal Environment....................................................................................................................... 15 2.1.5 Physical Environment .................................................................................................................. 16 2.2 Macroeconomic Conditions relevant for Bank Operations......................................... 17 2.3 Progress in Transition and Key Remaining Challenges.............................................. 18 2.4 Access to Capital and Investment Requirements ........................................................ 21 3. STRATEGIC ORIENTATIONS ............................................................................. 23 3.1 Bank’s Priorities for the Strategy Period..................................................................... 23 3.2 Sectoral Challenges and Bank Objectives................................................................... 24 3.2.1 Corporate Sector.......................................................................................................................... 24 3.2.2 Promoting Private Entrepreneurship........................................................................................... 26 3.2.3 Financial Sector........................................................................................................................... 27 3.2.4 Transport Infrastructure .............................................................................................................. 29 3.2.5 Municipal Infrastructure.............................................................................................................. 30 3.2.6 Power & Energy, Natural Resources........................................................................................... 31 3.3 Regional Orientation................................................................................................... 33 4. CO-OPERATION WITH OTHER IFIS AND MULTILATERAL DONORS ... 37 ANNEX 1: POLITICAL ASSESSSMENT..................................................................... 41 ANNEX 2: LEGAL TRANSITION................................................................................. 48 ANNEX 3: MACROECONOMIC CONDITIONS........................................................ 57 ANNEX 4: SELECTED ECONOMIC INDICATORS ................................................. 62 ANNEX 5: ENVIRONMENT .......................................................................................... 63 ANNEX 6: PROFILES OF RUSSIA’S SEVEN FEDERAL DISTRICTS .................. 65 ANNEX 7: CUMULATIVE BUSINESS BY INDUSTRY ............................................ 73 ANNEX 8: CUMULATIVE BUSINESS BY REGIONS............................................... 74 ANNEX 9: TC PROJECTS BY SECTOR...................................................................... 75 LIST OF ABBREVIATIONS ADR American Depository Receipt BBL Barrels BPD Barrels per Day CAS Country Assistance Strategy CBR Central Bank of Russia CIS Commonwealth of Independent States CPI Consumer Price Index EIB European Investment Bank EU European Union EUR Euro FCSM Federal Commission for the Securities Market FDI Foreign Direct Investment FIAS Foreign Investment Advisory Service FIG Financial Industrial Group GDP Gross Domestic Product GDR Global Depository Receipt GRP Gross Regional Product IBRD World Bank ICAO International Civil Aviation Organisation IET International Emission Trading IFC International Finance Corporation IFIs International Financial Institutions ILO International Labour Organisation IMF International Monetary Fund IMO United Nations International Maritime Organisation IOSCO International Organisation of Securities Commissions IPOs Initial Public Offerings JI Joint Implementation JSC Law Law on Joint Stock Companies JV Joint Venture KP Kyoto Protocol LNG Liquid Natural Gas LPR Law on the Protection of Rights and Lawful Interests of Investors on the Securities Market MARPOL International Convention for the Prevention of Pollution from Ships MCI Ministry of Communications and Informatisation MEI Municipal and Environmental Infrastructure MSE Micro and Small Enterprises NATO North Atlantic Treaty Organisation NDEP Northern Dimension Environmental Partnership NGOs Non-governmental Organisations NIB Nordic Investment Bank OCE Office of the Chief Economist (EBRD) ODIHR Office of Democratic and Human Rights OECD Organisation for Economic Co-operation and Development OSCE Organisation for Security and Co-operation in Europe PACE Parliamentary Assembly of the Council of Europe PCA Partnership and Co-operation Agreement PPPs Public Private Partnerships PSP Private Sector Participation RSBF Russia Small Business Fund RUR Rouble RVF Regional Venture Fund S&P Standard and Poor’s SDR Special Drawing Rights SME Small and Medium Enterprises SML Law on the Securities Market SOLAS International Convention for the Safety of Life at Sea TC Technical Co-operation TFP Trade Facilitation Programme TNP Transnefteprodukt UES United Energy Systems UNDP United Nations Development Programme UNESCO United Nations Educational Scientific and Cultural Organisation UNICTRAL United Nations Commission on International Trade Law USD US Dollar VTB Vneshtorgbank WTO World Trade Organisation YOY Year on Year EXECUTIVE SUMMARY The Russian Federation is committed to and applying the principles of multiparty democracy, pluralism and market economics in accordance with the conditions specified in Article 1 of the Agreement Establishing the Bank; however, in the past Strategy period, application of these principles has been uneven. Political stability and consolidation – notably through the confirmation of a reform-minded government, the creation of a strong parliamentary majority and the establishment of a common legal space across the Federation – is an important achievement which can contribute positively to the country’s continued structural reform efforts. Following a wave of terrorist attacks in the North Caucasus and in Moscow, the government has taken steps to reinforce public security and re-establish central political control over the regions. Recent political developments suggest a concentration of power in the hands of the executive and a perceptible drift from democratic practice that has raised concerns in the international community. At the same time, a robust system of checks and balances is the most effective way to guard against potential abuse of power and to encourage policy innovation. In this connection, the Bank welcomes the statement made by the President following his re- election, defining the creation of “a free society of free people” in Russia as the foundation for economic growth and political stability. Russia’s economic performance over the past two years has been robust, with strong GDP growth and a sharp acceleration in domestic investment. Management of public finances has been sound, with the federal budget running a large overall surplus for the fifth consecutive year in 2004. Inflation has gradually declined while the exchange rate has remained firm. Foreign investment into Russia has also accelerated, including in the form of FDI inflows. However, the accumulated stock of FDI amounts to about 6.5 per cent of GDP: only a fifth of the average level of the other European transition economies. The current account has recorded large surpluses in recent years and reserves are at record highs. However, following years of substantial declines, net private capital outflows have increased