Tuesday, 27 September 2011

Russian Federation economic review

The Russian economy underwent tremendous stress in the 1990s as it moved from a centrally planned economy to a free market system. Difficulties in implementing fiscal reforms aimed at raising government revenues and a dependence on short-term borrowing to finance budget deficits led to a serious financial crisis in 1998. Lower prices for Russia's major export earners (oil and minerals) and a loss of investor confidence due to the Asian financial crisis exacerbated financial problems. The result was a rapid and steep decline (60%) in the value of the ruble, flight of foreign investment, delayed payments on sovereign and private debts, a breakdown of commercial transactions through the banking system, and the threat of runaway inflation.

The Russian economy bounced back quickly from the 1998 crisis and enjoyed over 9 years of sustained growth averaging about 7% due to a devalued ruble, implementation of key economic reforms (tax, banking, labor and land codes), tight fiscal policy, and favorable commodities prices. Household consumption and fixed capital investments both grew by about 10% per year during this period and replaced net exports as the main drivers of demand. Inflation and exchange rates stabilized due to a prudent fiscal policy (Russia ran a budget surplus from 2001-2008). Foreign exchange reserves grew to almost $600 billion by mid-2008, the third-largest in the world, of which more than $200 billion were classified as stabilization funds designed to shelter the budget from commodity price shocks. The balance of payments experienced twin surpluses until mid-2008 in the current and capital accounts, which accounted for the phenomenal growth of reserves. As of July 1, 2006, the ruble became convertible for both current and capital transactions. Russia repaid its entire Soviet-era Paris Club debt of $22 billion in late 2006, but by October 2008 foreign external debt totaled $540 billion, of which $500 billion was owed by banks and corporations, including state-owned enterprises.

The global economic crisis hit Russia hard, starting with heavy capital flight in September 2008, which caused a crisis in its stock market. Several high-profile business disputes earlier in 2008, such as TNK-BP and Mechel, as well as the Georgian war helped drive capital out of Russia. By mid-September, Russia’s stock market had collapsed, as businesses sold shares to raise collateral for margin calls required by international lending institutions. As the global financial crisis gathered steam in the fall of 2008, the accompanying steep fall in global demand, commodity prices, and tightening of credit served to almost bring Russia’s economic growth to a halt in the fourth quarter of 2008, to 1.1% down from 9.5% during the same period in 2007. The Central Bank of Russia responded by pumping liquidity into Russian banks, which helped avert a banking crisis. At the same time, the government attempted a managed devaluation, which successfully avoided a run on the ruble and bank deposits but at the cost of a steep decline in foreign exchange reserves to $387 billion by mid-February 2009. This in turn prompted the S&P and Fitch rating agencies to downgrade Russia’s sovereign debt to the lowest investment grade. By 2010, however, the Russian economy had begun a modest recovery, bolstered by government anti-crisis policies, the global rebound, and a rise in oil prices. Russia’s leaders put renewed emphasis on promoting innovation as key to economic modernization as well as on the need to diversify the economy away from oil and gas.

Gross Domestic Product
Tighter credit, collapsing global demand, global uncertainty, and rising unemployment hurt investment and consumption, and led Russia to have -7.9% GDP growth in 2009--a sharp contrast to the pre-crisis performance of 8.1% in 2007. However, 2010 saw Russia’s economy return to growth with a 3.8% increase in GDP. Russia’s Economic Development Ministry predicts that the nation’s GDP will grow 4.2% in 2011.

Monetary Policy
For most of the past decade, Russia experienced persistent inflation, gradually declining from 85% in late 1998 to 9% by end-2006. However, a combination of surging international food and energy prices and looser monetary and fiscal policy pushed the Consumer Price Index (CPI) to 11.9% by the end of 2007, and up to 15% in early 2008. The Central Bank of Russia (CBR) monetary policy tended to be limited to managing the ruble’s exchange rate against a bi-currency basket of dollars and euros. The CBR intervened to keep the ruble stable during times of volatile international commodity prices and to manage inflation. In years of record high oil prices, the Central Bank typically purchased dollars to prevent real appreciation of the ruble. These interventions initially had limited effect on inflation, as they were mostly sterilized by budget surpluses and demand for rubles grew in a robust era of economic growth. By 2007, fiscal policy and the balance of payments were the actual drivers of monetary policy, particularly as large capital inflows due to increased borrowing by Russian banks and corporations caused the money supply to swell and added to inflationary pressures. Inflationary pressures eased in late 2008 as energy and commodity prices collapsed and international credit flows virtually stopped, causing money supply growth to halt. Inflation decelerated in 2009 to about 8.9% compared with 13.3% the previous year, owing to residual effects of the economic downturn, and continued to fall to 6.7% in 2010. Some forecasters predict this inflation rate will remain throughout 2011, though others believe the accelerated inflation Russia experienced in the first 2 months of the year could persist, leading to inflation in the 9%-10% range during the first half of 2011.

Government Spending/Taxation
The Russian federal budget ran growing surpluses from 2001-2007, as the government taxed and saved much of the rapidly increasing oil revenues. The government overhauled its tax system for both corporations and individuals in 2000-2001, introducing a 13% flat tax for individuals and a unified tax for corporations, which improved overall collection. Responding to demands from the oil sector, the government reduced the tax burden on oil production and exports, but only marginally. Tax enforcement of disputes continues to be uneven and unpredictable. In 2007 the federal budget surplus was 5.5% of GDP, and in 2008 the government ended the year with a surplus of 4.1% of GDP. Although the government revised its budget projections during 2009 to reflect lower oil prices and the effects of the economic crisis, it ended the year with a budget deficit amounting to 7.9% of GDP, which it financed from the Reserve Fund, one of the government’s two stabilization funds. The government’s anti-crisis package in 2008 and 2009 amounted to about 6.7% of GDP, according to World Bank estimates. The package provided support to the financial sector and enterprises--through liquidity injections to banks and tax cuts/fiscal support to enterprises--as well as modest support for households and small and medium enterprises (SMEs) and increased unemployment benefits. By the end of 2010, due to improving economic conditions, Russia had lowered its budget deficit to 3.9% of GDP. The government hoped to lower it to 3.6% in 2011 and admitted that deficits may be in place through 2015 and beyond.

Russia's population was 139.39 million as of July 2010, a decrease from the previous year according to the government statistics service and the Ministry of Public Health. The birth rate in 2010 was 11.11 live births for every 1,000 people, a statistic which ranked Russia 176th out of 224 countries. Life expectancy remains low compared to developed countries, averaging 59.54 years for men and 73.17 years for women in 2010. Cardiovascular diseases, cancer, traffic accidents, and violence continue to be major causes of death among working age men. Many premature deaths are attributed to excessive alcohol consumption and smoking. A truly healthy Russia will require serious improvements in the health sector and some major changes in current cultural norms. To combat the looming demographic crisis, in October 2007 then-President Putin approved the concept of demographic policy for the years 2008-2025. The program aims to increase life expectancy, reduce mortality, increase the birth rate, improve the population's health, and develop a sound migration policy. The government instituted the National Priority Health Project and "mother's capital" in order to slow the population decline. These programs had short-term success; Russia's population declined by 0.25% in 2008, compared to 0.4% in 2007. It is unknown if such programs offer a long-term solution. Russian statistics show a slight increase in the population in 2009; inward migration is the primary cause. In April 2008, the government approved joining the World Health Organization's Framework Convention on Tobacco Control, which is expected eventually to reduce extremely high smoking rates, and the government put significant amounts of money into prevention of smoking and alcohol abuse in the 2009-2011 budget.

As of the end of October 2009, there were 516,167 HIV cases officially registered in Russia, though some experts believe the actual number may be as many as 1 million HIV cases. According to UNAIDS, 60,000 new HIV cases were documented in Russia in 2009, an 8% increase from 2008. The prevalence of HIV cases was 300 per 100,000 people in 2008, higher than the 2007 indicator of 270.1 per 100,000. The chief form of transmission continues to be intravenous drug use, which accounted for over 60% of new HIV cases in 2009; among HIV-positive injecting drug users, about 85%-90% are Hepatitis C positive. More than 44% of new HIV cases are identified in females, and transmission through heterosexual sex has grown rapidly. The Government of Russia implements HIV treatment and prevention programs through its National Priority Health Project, Federal Targeted Program, and Global Fund Grants. The government currently spends over $250 million per year on HIV/AIDS treatment programs and allocated over $42 million for the period of 2007-2010 to support HIV/AIDS vaccine research. Approximately 68,000 patients are receiving antiretroviral therapy, and the government hopes that number will exceed 100,000 patients by 2012. Russia and the United States cooperate closely to fight HIV/AIDS, including in third countries. For instance, American and Russian experts have collaborated to develop and introduce in Russian medical schools a new curriculum on HIV infection. The materials, which are based on national and international experience, standards and best practices, will be used to train the estimated 25,000 foreign students that attend Russian medical schools each year.

Commercial Law
Russia has a body of conflicting, overlapping and rapidly changing laws, decrees and regulations, which has resulted in an ad hoc and unpredictable approach to doing business. In this environment, negotiations and contracts from commercial transactions are complex and protracted. Uneven implementation of laws creates further complications. Regional and local courts are often subject to political pressure, and corruption is widespread. However, more and more small and medium businesses in recent years have reported fewer difficulties in this regard, especially in the Moscow region. In addition, Russian businesses are increasingly turning to the courts to resolve disputes. Russia's World Trade Organization (WTO) accession process is also helping to bring the country's legal and regulatory regime in line with internationally accepted practices.

Natural Resources
The mineral-rich Ural Mountains and the vast oil, gas, coal, and timber reserves of Siberia and the Russian Far East make Russia rich in natural resources. However, most resources are located in remote and climatically unfavorable areas that are difficult to develop and far from Russian ports. Nevertheless, Russia is a leading producer and exporter of minerals, gold, and all major fuels. Natural resources, especially energy, dominate Russian exports. Over two-thirds of Russian exports to the United States are fuels, mineral oil, or metals.

Russia is one of the most industrialized of the former Soviet republics. However, years of very low investment have left much of Russian industry antiquated and highly inefficient. Besides its resource-based industries, it has developed large manufacturing capacities, notably in metals, food products, and transport equipment. Russia is now the world's third-largest exporter of steel and primary aluminum. Russia inherited most of the defense industrial base of the Soviet Union, so armaments remain an important export category for Russia. Efforts have been made with varying success over the past few years to convert defense industries to civilian use, and the Russian Government is engaged in an ongoing process to privatize many of the state-owned enterprises.

Russia has relatively little area for agriculture, but given its massive expanses, the country still accounts for about 9% of the world's arable land. Grain production for export is concentrated in the south of European Russia, with additional grain for domestic consumption grown throughout the rest of non-Arctic Russia west of the Urals as well as western Siberia. Livestock production was in decline from 1990 to 2006, when new government support policies were instituted to stimulate cattle and hog raising. Poultry production has rebounded and is rising at 17% per year. Small plots averaging one acre in size, urban and suburban gardens, and gardening cooperatives produce over half of Russia's food output. Former state and collective farms have been largely privatized, but management quality is uneven and profitability is highly dependent on proximity to major urban markets. Foreigners are not allowed to own farmland, although long-term leases are permitted.

Foreign direct investment (FDI) in 2009 fell to less than $40 billion after reaching an all-time high of $75 billion in 2008. Much of the FDI in recent years was Russian capital “returning home,” from havens like Cyprus and Gibraltar, and these flows reversed during the economic downturn. Moreover, although the annual flow of FDI into Russia was in line with those of China, India, and Brazil, Russia's per capita cumulative FDI lagged far behind such countries as Hungary, Poland, and the Czech Republic. Most foreign mergers and acquisitions in 2009 were in the politically sensitive energy sector, largely because of the huge capital requirements required relative to other sectors. By the end of 2010, analysts predicted that the total FDI for the year would again top $40 billion, but not reach the levels seen in 2008.

Although still small by international standards, the Russian banking sector before the crisis was growing fast and becoming a larger source of investment funds. To meet a growing demand for loans, which they were unable to cover with domestic deposits, Russian banks borrowed heavily abroad in 2007-2008, accounting for 57% of the private-sector capital inflows in 2007. Ruble lending has increased since the October 1998 financial crisis, and in 2007 loans were 66% of total bank assets, with consumer loans posting the fastest growth at 57% that same year. In 2004, Russia enacted a deposit insurance law to protect deposits up to 100,000 rubles (about $3,700) per depositor. Amendments to the law in the fall of 2008 increased the Deposit Insurance Agency's 100%-coverage for deposits up to 700,000 rubles. The vast majority of Russians keep their money in the banking sector. The combination of liberalized capital controls and ruble appreciation against the dollar in 2005-2008 persuaded many Russians to keep their money in ruble- or other currency-denominated bank deposits. In 2007, total retail deposits grew by 35%, with foreign currency deposits accounting for 13% of the total. Despite the onset of the crisis, deposits rose by 14% in 2008 and 27% in 2009.

Even with the banking sector’s recent growth, financial intermediation in the overall economy remains underdeveloped. Contradictory regulations across the banking and securities markets have hindered efforts to transfer resources from capital-rich sectors, such as energy, to capital-poor sectors, such as agriculture and manufacturing. The sector is dominated by large state banks, and concentrated geographically in Moscow and the Moscow region. Thus financial service providers face little competition for resources and charge relatively high interest rates for favored, large corporate borrowers.

This state of affairs makes it difficult for entrepreneurs to raise capital, and banks generally perceive small and medium commercial lending as risky. Most of the country’s financial institutions are inexperienced with assessing credit risk, though the situation is improving. The low level of trust, both between the general public and banks as well as among banks, makes the system highly susceptible to crises. After an uncertain year in 2009, by spring 2010 Russian officials announced an end to anti-crisis bank support, and a World Bank report said that “a systemic banking crisis had been averted, the liquidity crunch eased and depositor confidence reestablished.” The report cautioned, however, that systemic weaknesses exposed during the crisis--especially excessive dependence on foreign borrowing and non-performing loans--still needed to be addressed.

After hitting lows in 2009, trade between the U.S. and Russia grew to $31.7 billion in 2010, an increase of 35% from 2009. U.S. imports from Russia grew 41% year over year to $25.7 billion while exports to Russia increased just 13% to $6.0 billion. The rapid increase in U.S. imports from Russia from 2009 to 2010 can be attributed to the low base year and nascent economic recovery in the United States, but also to the rising price of oil and other commodities. Oil and oil products represent over two-thirds of the value of all U.S. imports from Russia. Russia is currently the 32nd-largest export market for U.S. goods. Russian exports to the U.S. were fuel oil, inorganic chemicals, aluminum, and precious stones. U.S. exports to Russia were machinery, vehicles, meat (mostly poultry), aircraft, electrical equipment, and high-tech products.

Russia's overall trade surplus in 2009 was approximately $100 billion--compared with $180 billion in 2008 and $129 billion in 2007--a reflection of the slower growth in exports and severe contraction of imports. World prices continue to have a major effect on export performance, since commodities--particularly oil, natural gas, metals, and timber--comprise nearly 90% of Russian exports. Russian GDP growth and the surplus/deficit in the Russian Federation state budget are closely linked to world oil prices.

Russia is in the process of negotiating terms of accession to the World Trade Organization (WTO). The U.S. and Russia concluded a bilateral WTO accession agreement in late 2006, and negotiations continue on meeting WTO requirements for accession. Both Prime Minister Vladimir Putin and the General Director of the WTO, Pascal Lamy, stated in early 2011 that they felt Russia would join within the year.

According to the 2010 U.S. Trade Representative's National Trade Estimate, Russia continues to maintain a number of barriers with respect to imports, including tariffs and tariff-rate quotas; discriminatory and prohibitive charges and fees; and discriminatory licensing, registration, and certification regimes. Discussions continue within the context of Russia's WTO accession to eliminate these measures or modify them to be consistent with internationally accepted trade policy practices. Non-tariff barriers are frequently used to restrict foreign access to the market and are also a significant topic in Russia's WTO negotiations. In addition, Russia’s lax enforcement of intellectual property rights had led to large losses for U.S. audiovisual and other companies and is an ongoing irritant in U.S.-Russia trade relations. Russia continues to work to bring its technical regulations, including those related to product and food safety, into conformity with international standards.

GDP (2010): $1.477 trillion.
Growth rate (2010): 3.8%.
Natural resources: Petroleum, natural gas, timber, furs, precious and nonferrous metals.
Agriculture: Products--Grain, sugar beets, sunflower seeds, meat, dairy products.
Industry: Types--Complete range of manufactures: automobiles, trucks, trains, agricultural equipment, advanced aircraft, aerospace, machine and equipment products; mining and extractive industry; medical and scientific instruments; construction equipment.
Trade (2010): Exports--$376.7 billion: petroleum and petroleum products, natural gas, woods and wood products, metals, chemicals. Major markets--EU, CIS, China, Japan. Imports--$191.8 billion: machinery and equipment, chemicals, consumer goods, medicines, meat, sugar, semi-finished metal products. Major partners--EU, CIS, Japan, China, U.S. U.S. exports--$6.0 billion. Principal U.S. exports (2010)--oil/gas equipment, meat, motor vehicles and parts, aircraft, electrical machinery, automatic data processing machines and parts, medical equipment, plastics, cosmetics, and chemicals. U.S. imports--$25.7 billion. Principal U.S. imports (2010)--oil, chemicals (including fertilizer), radioactive materials, iron/steel, precious stones, nickel, aluminum, fish and crustaceans, alcoholic beverages, and base metals.

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