DOCUMENT OF THE EUROPEAN BANK FOR RECONSTRUCTION AND DEVELOPMENT STRATEGY FOR THE RUSSIAN FEDERATION Approved by the Board of Directors on 21 October 2002 TABLE OF CONTENTS EXECUTIVE SUMMARY .............................................................................................. 4 ABBREVIATIONS........................................................................................................... 8 1. THE BANK’S OPERATIONS TO DATE AND CURRENT PORTFOLIO ........ 10 1.1 OVERVIEW OF BANK ACTIVITIES TO DATE ................................................................. 10 1.2 MAIN CHARACTERISTICS OF THE PORTFOLIO............................................................ 11 1.3 FINANCIAL PERFORMANCE OF THE EXISTING PORTFOLIO ....................................... 13 1.4 TRANSITION IMPACT OF THE BANK'S PORTFOLIO ..................................................... 14 2. OPERATIONAL ENVIRONMENT......................................................................... 18 2.1 THE GENERAL REFORM ENVIRONMENT ..................................................................... 18 2.1.1 Political Developments..........................................................................................................18 2.1.2 Centre-Region Relations........................................................................................................18 2.1.3 Social Conditions...................................................................................................................19 2.1.4 Legal Environment ................................................................................................................20 2.1.5 Governance and Integrity Issues............................................................................................20 2.1.6 Environmental Dimension .....................................................................................................21 2.2 MACROECONOMIC CONDITIONS RELEVANT FOR BANK OPERATIONS ..................... 22 2.2.1 The Real Sector .....................................................................................................................22 2.2.2 Fiscal Policy ..........................................................................................................................23 2.2.3 Monetary Policy, Inflation and the Exchange Rate ...............................................................24 2.2.4 External Debt and Debt Service.............................................................................................25 2.3 ACCESS TO CAPITAL...................................................................................................... 25 2.4 PROGRESS IN TRANSITION AND REMAINING CHALLENGES ....................................... 27 3. STRATEGIC ORIENTATIONS............................................................................... 30 3.1 BANK PRIORITIES FOR THE STRATEGY PERIOD.......................................................... 30 3.2 SECTORAL CHALLENGES AND BANK OBJECTIVES...................................................... 32 3.2.1 Corporate Sector....................................................................................................................32 3.2.2 Small and Medium-Sized Enterprises....................................................................................34 3.2.3 Financial Sector .....................................................................................................................36 3.2.4 Transport Sector ....................................................................................................................40 3.2.5 Municipal Finance and Infrastructure....................................................................................43 3.2.6 Energy....................................................................................................................................45 3.2.7 Energy Efficiency, Environment and Nuclear Safety............................................................49 3.3 REGIONAL ORIENTATION ............................................................................................. 50 4. CO-OPERATION WITH OTHER IFIs AND MULTILATERAL DONORS ..... 56 4.1 EUROPEAN UNION (EU) ................................................................................................ 56 4.2 INTERNATIONAL MONETARY FUND (IMF).................................................................. 57 4.3 INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT (IBRD) ......... 57 4.4 INTERNATIONAL FINANCE CORPORATION (IFC)........................................................ 58 4.5 MULTILATERAL INVESTMENT GUARANTEE AGENCY (MIGA) ................................. 58 4.6 EUROPEAN INVESTMENT BANK (EIB).......................................................................... 58 4.7 BLACK SEA TRADE & DEVELOPMENT BANK (BSTDB).............................................. 59 4.8 UNITED NATIONS DEVELOPMENT PROGRAMME (UNDP).......................................... 59 4.9 BILATERAL ASSISTANCE ............................................................................................... 59 ANNEX 1 – POLITICAL ASSESSMENT ................................................................... 61 ANNEX 2 – LEGAL TRANSITION............................................................................. 67 ANNEX 3 – ECONOMIC INDICATORS.................................................................... 74 ANNEX 4 – REGIONAL INDICATORS..................................................................... 75 ANNEX 5 - PORTFOLIO BY REGIONS.................................................................... 81 ANNEX 6 - NET CUMULATIVE BUSINESS VOLUME BY INDUSTRY ............. 96 ANNEX 7 - TC PROJECTS........................................................................................... 97 3 PRESIDENT’S RECOMMENDATION The Russian Federation remains committed to the principles of multiparty democracy, pluralism and market economics in accordance with the conditions specified in Article 1 of the Agreement Establishing the Bank. Since the previous Strategy was adopted, Russia’s political and economic stabilisation has improved and further progress is expected. Over the ten years EBRD has been working in the Russian Federation the Bank has become a well established partner for the Russian authorities, foreign investors and Russian companies. The Bank's local presence through its offices in Moscow and in the regions has allowed the Bank to accumulate specific expertise and has helped to gain the trust of its partners. The EBRD's portfolio now covers a diverse range of industrial sectors with projects located in the majority of the Russian regions, utilising a wide variety of financial products. The EBRD will share its unique expertise in Russia with other international institutions to the benefit of the country and according to its mandate. A key driver of the recent reforms is the political will of the current administration and constructive working relations with a more reform-minded Duma. On the political front, the authorities have pushed through important reforms on strengthening the federal system, restoring rule of law, and consolidating the political party system. The current administration has sought to create a common political, legal, and economic space and to put centre-region relations on a sounder, more predictable basis. This has given way to successive waves of economic and legal reforms, but improved efforts to crack down on corruption and improve corporate and public governance, are still needed to further improve the investment climate. A key to reform success in the future is “deep” democratisation – meaning the consistent and sustained implementation of the principles of pluralism, and open society, including media freedom and human rights. The country’s macroeconomic performance over the past two years has been impressive, with GDP and domestic investment growing consistently. Macroeconomic stability and growth, together with positive changes in debt management policies, have improved Russia’s creditworthiness significantly. The pace of output recovery, albeit not evenly across all regions, remained robust despite a deterioration in the external economic environment over the last year, as domestic demand replaced import substitution as the main driver of growth. However, strong real wage increases together with a real appreciation of the rouble are eroding Russia’s competitive advantage. Investments have so far been concentrated in the natural resources sectors. The consolidation of public finances continues to be the single most important stabilisation achievement. The period of high oil prices has been used, prudently, to establish sizeable fiscal reserves. Large current account surpluses, together with a fairly stable exchange rate allowed a dynamic accumulation of international reserves. Although inflation has been on a declining trend, the rate of decline has recently slowed. Reducing inflation further will be a key condition for future macroeconomic stability. Following the adoption of the government reform programme in mid-2000, structural and institutional reforms have accelerated. This has already led to a major overhaul of the tax regime, a reduced scope for bureaucratic interventions in the economy, the start of pension reform and the reform of the judiciary, the adoption of new labour and land codes and stronger legal defences for investors. 4 The implementation capacity of the authorities, especially at the regional and local levels, will be seriously