shadow economy

Economy of Russia

Russia is a unique emerging market, in the sense that being the nucleus of a former superpower shows more anomalies. On one hand, its exports are primarily resource based, and on the other, it has a pool of technical talent in aerospace, nuclear engineering, and basic sciences. How this peculiar emerging market integrates itself into the world economy over the coming decade is a story as significant in today's world as the reemergence of China and India.

Historical background

For about 60 years, the Russian economy and that of the rest of the Soviet Union operated on the basis of a centrally planned economy, viz. state control over virtually all means of production and over investment, production, and consumption decisions throughout the economy. Economic policy was made according to directives from the Communist Party, which controlled all aspects of economic activity. The central planning system left a number of legacies with which the Russian economy must deal in its transition to a market economy.

Much of the structure of the Soviet economy that operated until 1987 originated under the leadership of Joseph Stalin, with only incidental modifications made between 1953 and 1987. Five-year plan and annual plans were the chief mechanisms the Soviet government used to translate economic policies into programs. According to those policies, the State Planning Committee (Gosudarstvennyy planovyy komitetGosplan) formulated countrywide output targets for stipulated planning periods. Regional planning bodies then refined these targets for economic units such as state industrial enterprises and state farms (sovkhozy; sing., sovkhoz) and collective farms (kolkhozy; sing., kolkhoz), each of which had its own specific output plan. Central planning operated on the assumption that if each unit met or exceeded its plan, then demand and supply would balance.

The government's role was to ensure that the plans were fulfilled. Responsibility for production flowed from the top down. At the national level, some seventy government ministries and state committees, each responsible for a production sector or subsector, supervised the economic production activities of units within their areas of responsibility. Regional ministerial bodies reported to the national-level ministries and controlled economic units in their respective geographical areas.

The plans incorporated output targets for raw materials and intermediate goods as well as final goods and services. In theory, but not in practice, the central planning system ensured a balance among the sectors throughout the economy. Under central planning, the state performed the allocation functions that prices perform in a market system. In the Soviet economy, prices were an accounting mechanism only. The government established prices for all goods and services based on the role of the product in the plan and on other noneconomic criteria. This pricing system produced anomalies. For example, the price of bread, a traditional staple of the Russian diet, was below the cost of the wheat used to produce it. In some cases, farmers fed their livestock bread rather than grain because bread cost less. In another example, rental fees for apartments were set very low to achieve social equity, yet housing was in extremely short supply. Soviet industries obtained raw materials such as oil, natural gas, and coal at prices below world market levels, encouraging waste.

The central planning system allowed Soviet leaders to marshal resources quickly in times of crisis, such as the Nazi invasion, and to reindustrialize the country during the postwar period. The rapid development of its defence and industrial base after the war permitted the Soviet Union to become a superpower.

The record of Russian economic reform through the mid-1990s was mixed. The attempts and failures of reformers during the era of perestroika (restructuring) in the regime of Mikhail Gorbachev (in office 1985-91) attested to the complexity of the challenge. After 1991, under the leadership of Boris Yeltsin, the country made a significant turn toward developing a market economy by implanting basic tenets such as market-determined prices. Critical elements such as privatization of state enterprises and extensive foreign investment were rushed into place in the first few years of the post-Soviet period. But other fundamental parts of the economic infrastructure, such as commercial banking and authoritative, comprehensive commercial laws, were absent or only partly in place by 1996. Although by the mid-1990s a return to Soviet-era central planning seemed unlikely, the configuration of the post-transition economy remained unpredictable.

Although the market now determines most prices, the Government (Russia's cabinet) still fixes prices on some goods and services, such as utilities and energy.

According to official Russian data, in 1994 the national gross domestic product (GDP) was 604 trillion rubles (about US$207 billion according to the 1994 exchange rate), or about 4% of the United States GDP for that year. But this figure underestimates the size of the Russian economy. Adjusted by a purchasing-power parity formula to account for the lower cost of living in Russia, the 1994 Russian GDP was about US$678 billion, making the Russian economy approximately 10% of the United States economy. In 1994 the adjusted Russian GDP was US$4,573 per capita, approximately 19% of that of the United States. A second important measurement factor is the extremely active so-called shadow economy, which yields no taxes or government statistics but which a 1996 government report quantified as accounting for about 51% of the economy and 40% of its cash turnover.

Economic history

Two fundamental and interdependent goals — macroeconomic stabilization and economic restructuring — the transition from central planning to a market-based economy. The former entailed implementing fiscal and monetary policies that promote economic growth in an environment of stable prices and exchange rates. The latter required establishing the commercial, legal, and institutional entities — banks, private property, and commercial legal codes— that permit the economy to operate efficiently. Opening domestic markets to foreign trade and investment, thus linking the economy with the rest of the world, was an important aid in reaching these goals. The Gorbachev regime failed to address these fundamental goals. At the time of the Soviet Union's demise, the Yeltsin government of the Russian Republic had begun to attack the problems of macroeconomic stabilization and economic restructuring. By mid-1996, the results were mixed.

Since the collapse of the Soviet Union in 1991, Russia has tried to develop a market economy and achieve consistent economic growth. In October 1991, Yeltsin announced that Russia would proceed with radical, market-oriented reform along the lines of "shock therapy", as recommended by the United States and IMF. However, this policy resulted in economic collapse, with millions being plunged into poverty and corruption and crime spreading rapidly. Hyperinflation resulted from the removal of Soviet price controls and again following the 1998 Russian financial crisis. Assuming the role as the continuing legal personality of the Soviet Union, Russia took up the responsibility for settling the USSR's external debts, even though its population made up just half of the population of the USSR at the time of its dissolution. When once all enterprises belonged to the state and were supposed to be equally owned amongst all citizens, they fell into the hands of a few, who became immensely rich. Stocks of the state-owned enterprises were issued, and these new publicly traded companies were quickly handed to the members of Nomenklatura or known criminal bosses. For example, the director of a factory during the Soviet regime would often become the owner of the same enterprise. During the same period, violent criminal groups often took over state enterprises, clearing the way by assassinations or extortion. Corruption of government officials became an everyday rule of life. Under the government's cover, outrageous financial manipulations were performed that enriched the narrow group of individuals at key positions of the business and government mafia. Many took billions in cash and assets outside of the country in an enormous capital flight.

The largest state enterprises were controversially privatized by President Boris Yeltsin to insiders for far less than they were worth. Many Russians consider these infamous "oligarchs" to be thieves. Through their immense wealth, the oligarchs wielded significant political influence.

The Yeltsin economic program

In October 1991, two months before the official Collapse of the Soviet Union and two months after the August 1991 coup, Yeltsin and his advisers, including reform economist Yegor Gaidar, established a program of radical economic reforms. The Russian parliament, the Supreme Soviet, also extended decree powers to the president for one year to implement the program. The program was ambitious, and the record to date indicates that the goals for macroeconomic stabilization and economic restructuring programs may have been unrealistically high. Another complication in the Yeltsin reform program is that since 1991 both political and economic authority have devolved significantly from the national to the regional level; in a series of agreements with the majority of Russia's twenty-one republics and several other subnational jurisdictions, Moscow has granted a variety of special rights and powers having important economic overtones.

Macroeconomic stabilization measures

The program laid out a number of macroeconomic policy measures to achieve stabilization. It called for sharp reductions in government spending, targeting outlays for public investment projects, defense, and producer and consumer subsidies. The program aimed at reducing the government budget deficit from its 1991 level of 20% of GDP to 9% of GDP by the second half of 1992 and to 3% by 1993. The government imposed new taxes, and tax collection was to be upgraded to increase state revenues. In the monetary sphere, the economic program required the Russian Central Bank (RCB) to cut subsidized credits to enterprises and to restrict money supply growth. The program called for the shrinkage of inflation from 12% per month in 1991 to 3.5% per month in mid-1993.

Monetary and fiscal policies

In 1992 and 1993, the Government expanded the money supply and available credit at explosive rates that led directly to high inflation and to a deterioration in the exchange rate of the ruble. In January 1992, the government clamped down on money and credit creation at the same time that it lifted price controls. However, beginning in February the Central Bank loosened the reins on the money supply. In the second and third quarters of 1992, the money supply had increased at especially sharp rates of 34% and 30%, respectively. By the end of 1992, the Russian money supply had increased by eighteen times.

The sharp increase in the money supply was influenced by large foreign currency deposits that state-run enterprises and individuals had built up, and by the depreciation of the ruble. Enterprises drew on these deposits to pay wages and other expenses after the Government had tightened restrictions on monetary emissions. Commercial banks monetized enterprise debts by drawing down accounts in foreign banks and drawing on privileged access to accounts in the Central Bank.

1991-1992

Government efforts to take over the credit expansion also proved ephemeral in the early years of the transition. Domestic credit increased about nine times between the end of 1991 and 1992. The credit expansion was caused in part by the buildup of interenterprise arrears and the RCB's subsequent financing of those arrears. The Government restricted financing to state enterprises after it lifted controls on prices in January 1992, but enterprises faced cash shortages because the decontrol of prices cut demand for their products. Instead of curtailing production, most firms chose to build up inventories. To support continued production under these circumstances, enterprises relied on loans from other enterprises. By mid-1992, when the amount of unpaid interenterprise loans had reached 3.2 trillion rubles (about US$20 billion), the government froze interenterprise debts. Shortly thereafter, the government provided 181 billion rubles (about US$1.1 billion) in credits to enterprises that were still holding debt.

The government also failed to constrain its own expenditures in this period, partially under the influence of the post-Soviet Supreme Soviet, which encouraged the Soviet-style financing of favored industries. By the end of 1992, the Russian budget deficit was 20% of GDP, much higher than the 5% projected under the economic program and stipulated under the International Monetary Fund (IMF) conditions for international funding. This budget deficit was financed largely by expanding the money supply. These monetary and fiscal policies were a factor along with price liberalization in an inflation rate of over 2,000% in 1992.

In late 1992, deteriorating economic conditions and a sharp conflict with the parliament led Yeltsin to dismiss neoliberal reform advocate Yegor Gaidar as prime minister. Gaidar's successor was Viktor Chernomyrdin, a former head of the State Natural Gas Company (Gazprom), who was considered less favorable to neoliberal reform.

1993

Chernomyrdin formed a new government with Boris Fedorov, an economic reformer, as deputy prime minister and finance minister. Fedorov considered macroeconomic stabilization a primary goal of Russian economic policy. In January 1993, Fedorov announced a so-called anticrisis program to control inflation through tight monetary and fiscal policies. Under the program, the government would control money and credit emissions by requiring the RCB to increase interest rates on credits by issuing government bonds, by partially financing budget deficits, and by starting to close inefficient state enterprises. Budget deficits were to be brought under control by limiting wage increases for state enterprises, by establishing quarterly budget deficit targets, and by providing a more efficient social safety net for the unemployed and pensioners.

The printing of money and domestic credit expansion moderated somewhat in 1993. In a public confrontation with the parliament, Yeltsin won a referendum on his economic reform policies that may have given the reformers some political clout to curb state expenditures. In May 1993, the Ministry of Finance and the Central Bank agreed to macroeconomic measures, such as reducing subsidies and increasing revenues, to stabilize the economy. The Central Bank was to raise the discount lending rate to reflect inflation. Based on positive early results from this policy, the IMF extended the first payment of US$1.5 billion to Russia from a special Systemic Transformation Facility (STF) the following July.

Fedorov's anticrisis program and the Government's accord with the Central Bank had some effect. In the first three quarters of 1993, the Central Bank held money expansion to a monthly rate of 19%. It also substantially moderated the expansion of credits during that period. The 1993 annual inflation rate was around 1,000%, a sharp improvement over 1992, but still very high. The improvement figures were exaggerated, however, because state expenditures had been delayed from the last quarter of 1993 to the first quarter of 1994. State enterprise arrears, for example, had built up in 1993 to about 15 trillion rubles (about US$13 billion, according to the mid-1993 exchange rate).

1994

In June 1994, Chernomyrdin presented a set of moderate reforms calculated to accommodate the more conservative elements of the Government and parliament while placating reformers and Western creditors. The prime minister pledged to move ahead with restructuring the economy and pursuing fiscal and monetary policies conducive to macroeconomic stabilization. But stabilization was undermined by the Central Bank, which issued credits to enterprises at subsidized rates, and by strong pressure from industrial and agricultural lobbies seeking additional credits.

By October 1994, inflation, which had been reduced by tighter fiscal and monetary policies early in 1994, began to soar once again to dangerous levels. On 11 October, a day that became known as Black Tuesday, the value of the ruble on interbank exchange markets plunged by 27%. Although experts presented a number of theories to explain the drop, including the existence of a conspiracy, the loosening of credit and monetary controls clearly was a significant cause of declining confidence in the Russian economy and its currency.

In late 1994, Yeltsin reasserted his commitment to macroeconomic stabilization by firing Viktor Gerashchenko, head of the Central Bank, and nominating Tat'yana Paramonova as his replacement. Although reformers in the Russian government and the IMF and other Western supporters greeted the appointment with skepticism, Paramonova was able to implement a tight monetary policy that ended cheap credits and restrained interest rates (although the money supply fluctuated in 1995). Furthermore, the parliament passed restrictions on the use of monetary policy to finance the state debt, and the Ministry of Finance began to issue government bonds at market rates to finance the deficits.

The government also began to address the interenterprise debt that had been feeding inflation. The 1995 budget draft, which was proposed in September 1994, included a commitment to reducing inflation and the budget deficit to levels acceptable to the IMF, with the aim of qualifying for additional international funding. In this budget proposal, the Chernomyrdin government sent a signal that it no longer would tolerate soft credits and loose budget constraints, and that stabilization must be a top government priority.

1995

During most of 1995, the government maintained its commitment to tight fiscal constraints, and budget deficits remained within prescribed parameters. However, in 1995 pressures mounted to increase government spending to alleviate wage arrearages, which were becoming a chronic problem within state enterprises, and to improve the increasingly tattered social safety net. In fact, in 1995 and 1996 the state's failure to pay many such obligations (as well as the wages of most state workers) was a major factor in keeping Russia's budget deficit at a moderate level. Conditions changed by the second half of 1995. The members of the State Duma (beginning in 1994, the lower house of the Federal Assembly, Russia's parliament) faced elections in December, and Yeltsin faced dim prospects in his 1996 presidential reelection bid. Therefore, political conditions caused both Duma deputies and the president to make promises to increase spending.

In addition, late in 1995 Yeltsin dismissed Anatoly Chubais, one of the last economic reform advocates remaining in a top Government position, as deputy prime minister in charge of economic policy. In place of Chubais, Yeltsin named Vladimir Kadannikov, a former automobile plant manager whose views were antireform. This move raised concerns in Russia and the West about Yeltsin's commitment to economic reform. Another casualty of the political atmosphere was RCB chairman Paramonova, whose nomination had remained a source of controversy between the State Duma and the Government. In November 1995, Yeltsin was forced to replace her with Sergey Dubinin, a Chernomyrdin protégé who continued the tight-money policy that Paramonova had established.

1996

Inflation

In 1992, the first year of economic reform, retail prices in Russia increased by 2,520%. A major cause of the increase was the deregulation of most of the prices in January 1992, a step that prompted an average price increase of 245% in that month alone. By 1993 the annual rate had declined to 240%, still a very high figure. In 1994 the inflation rate had improved to 224%.

Trends in annual inflation rates mask variations in monthly rates, however. In 1994, for example, the government managed to reduce monthly rates from 21% in January to 4% in August, but rates climbed once again, to 16.4% by December and 18% by January 1995. Instability in Russian monetary policy caused the variations. After tightening the flow of money early in 1994, the Government loosened its restrictions in response to demands for credits by agriculture, industries in the Far North, and some favored large enterprises. In 1995 the pattern was avoided more successfully by maintaining the tight monetary policy adopted early in the year and by passing a relatively stringent budget. Thus, the monthly inflation rate held virtually steady below 5% in the last quarter of the year. For the first half of 1996, the inflation rate was 16.5%. However, experts noted that control of inflation was aided substantially by the failure to pay wages to workers in state enterprises, a policy that kept prices low by depressing demand.(http://www.russiansabroad.com/russian_history_196.html)

Exchange rates

An important symptom of Russian macroeconomic instability has been severe fluctuations in the exchange rate of the ruble. From July 1992, when the ruble first could be legally exchanged for United States dollars, to October 1995, the rate of exchange between the ruble and the dollar declined from 144 rubles per US$1 to around 5,000 per US$1. Prior to July 1992, the ruble's rate was set artificially at a highly overvalued level. But rapid changes in the nominal rate (the rate that does not account for inflation) reflected the overall macroeconomic instability. The most drastic example of such fluctuation was the Black Tuesday (1994) 27% reduction in the ruble's value.

In July 1995, the Central Bank announced its intention to maintain the ruble within a band of 4,300 to 4,900 per US$1 through October 1995, but it later extended the period to June 1996. The announcement reflected strengthened fiscal and monetary policies and the buildup of reserves with which the government could defend the ruble. By the end of October 1995, the ruble had stabilized and actually appreciated in inflation-adjusted terms. It remained stable during the first half of 1996. In May 1996, a "crawling band" exchange rate was introduced to allow the ruble to depreciate gradually through the end of 1996, beginning between 5,000 and 5,600 per US $1 and ending between 5,500 and 6,100.

Another sign of currency stabilization was the announcement that effective June 1996, the ruble would become fully convertible on a current-account basis. This meant that Russian citizens and foreigners would be able to convert rubles to other currencies for trade transactions.

Economic impact

As of mid-1996, four and one-half years after the launching of Russia's post-Soviet economic reform, experts found the results promising but mixed. The Russian economy has passed through a long and wrenching depression. Official Russian economic statistics indicate that from 1990 to the end of 1995, Russian GDP declined by roughly 50%, far greater than the decline that the United States experienced during the Great Depression. (However, alternative estimates by Western analysts described a much less severe decline, taking into account the upward bias of Soviet-era economic data and the downward bias of post-Soviet data. E.g. IMF estimates: ) Much of the decline in production has occurred in the military-industrial complex and other heavy industries that benefited most from the skewed economic priorities of Soviet planners but have much less robust demand in a free market.

But other major sectors such as agriculture, energy, and light industry also suffered from the transition. To enable these sectors to function in a market system, inefficient enterprises had to be closed and workers laid off, with resulting short-term declines in output and consumption. Analysts had expected that Russia's GDP would begin to rise in 1996, but data for the first six months of the year showed a continuing decline, and some Russian experts predicted a new phase of economic crisis in the second half of the year.

The pain of the restructuring has been assuaged somewhat by the emergence of a new private sector. Western experts believe that Russian data overstate the dimensions of Russia's economic collapse by failing to reflect a large portion of the country's private-sector activity. The Russian services sector, especially retail sales, is playing an increasingly vital role in the economy, accounting for nearly half of GDP in 1995. The services sector's activities have not been adequately measured. Data on sector performance are skewed by the underreporting or nonreporting of output that Russia's tax laws encourage. According to Western analysts, by the end of 1995 more than half of GDP and more than 60% of the labor force were based in the private sector.

An important but unconventional service in Russia's economy is "shuttle trading" — the transport and sale of consumer goods by individual entrepreneurs, of whom 5 to 10 million were estimated to be active in 1996. Traders buy goods in foreign countries such as China, Turkey, and the United Arab Emirates and in Russian cities, then sell them on the domestic market where demand is highest. Yevgeniy Yasin, minister of economics, estimated that in 1995 some US$11 billion worth of goods entered Russia in this way. Shuttle traders have been vital in maintaining the standard of living of Russians who cannot afford consumer goods on the conventional market. However, domestic industries such as textiles suffer from this infusion of competing merchandise, whose movement is unmonitored, untaxed, and often mafia -controlled.

The geographical distribution of Russia's wealth has been skewed at least as severely as it was in Soviet times. By the mid-1990s, economic power was being concentrated in Moscow at an even faster rate than the federal government was losing political power in the rest of the country. In Moscow an economic oligarchy, composed of politicians, banks, businesspeople, security forces, and city agencies, controlled a huge percentage of Russia's financial assets under the rule of Moscow's energetic and popular mayor, Yuriy Luzhkov. Unfortunately, organized crime also has played a strong role in the growth of the city. Opposed by a weak police force, Moscow's rate of protection rackets, contract murders, kickbacks, and bribes — all intimately connected with the economic infrastructure — has remained among the highest in Russia. Most businesses have not been able to function without paying for some form of mafia protection, informally called a krysha (the Russian word for roof).

Luzhkov, who has close ties to all legitimate power centers in the city, has overseen the construction of sports stadiums, shopping malls, monuments to Moscow's history, and the ornate Christ the Savior Cathedral. In 1994 Yeltsin gave Luzhkov full control over all state property in Moscow. In the first half of 1996, the city privatized state enterprises at the rate of US$1 billion per year, a faster rate than the entire national privatization process in the same period. Under Luzhkov's leadership, the city government also acquired full or major interests in a wide variety of enterprises — from banking, hotels, and construction to bakeries and beauty salons. Such ownership has allowed Luzhkov's planners to manipulate resources efficiently and with little or no competition. Meanwhile, Moscow also became the center of foreign investment in Russia, often to the exclusion of other regions. For example, the McDonald's fast-food chain, which began operations in Moscow in 1990, enjoyed immediate success but expanded only in Moscow. The concentration of Russia's banking industry in Moscow gave the city a huge advantage in competing for foreign commercial activity.

In mid-1996 the national government appeared to have achieved some degree of macroeconomic stability. However, longer-term stability depends on the ability of policy makers to withstand the inflationary pressures of demands for state subsidies and easier credits for failing enterprises and other special interests. (Chubais estimated that spending promises made during Yeltsin's campaign amounted to US$250 per voter, which if actually spent would approximately double the national budget deficit; most of Yeltsin's pledges seemingly were forgotten shortly after his reelection.)

By 1996 the structure of Russian economic output had shifted far enough that it more closely resembled that of a developed market economy than the distorted Soviet central-planning model. With the decline in demand for defense industry goods, overall production has shifted from heavy industry to consumer production. However, in the mid-1990s the low quality of most domestically produced consumer goods continued to limit enterprises' profits and therefore their ability to modernize production operations. On the other side of the "vicious circle," reliance on an outmoded production system guaranteed that product quality would remain low and uncompetitive.

Most prices are left to the market, although local and regional governments control the prices of some staples. Energy prices remain controlled, but the Government has been shifting these prices upward to close the gap with world market prices.

Economic history, 1996-present

Russia posted gross domestic product growth of 6.4% in 1999, 10% in 2000, 5.1% in 2001, 4.7% in 2002, 7.3% in 2003, 7.2% in 2004, 6.4% in 2005, 7.4% in 2006 and 8.1% in 2007 with industrial sector posting high growth figures as well. Russia is currently the fastest growing economy in the G8.

The Russian GDP, however, contracted an estimated 40% between 1991 and 1998, despite the country's wealth of natural resources, its well-educated population, and its diverse - although increasingly dilapidated - industrial base.

By the end of 1997, Russia had achieved some progress. Inflation had been brought under control, the ruble was stabilized, and an ambitious privatization program had transferred thousands of enterprises to private ownership. Some important market-oriented laws had also been passed, including a commercial code governing business relations and the establishment of an arbitration court for resolving economic disputes.

But in 1998, the Asian financial crisis swept through the country, contributing to a sharp decline in Russia's earnings from oil exports and resulting in an exodus of foreign investors. Matters came to a head in the financial crisis of August 1998 when the government allowed the ruble to fall precipitously and stopped payment on $40 billion in ruble bonds.

In 1999, output increased for only the second time since 1991, by an officially estimated 3.2%, regaining much of the 4.6% drop of 1998. This increase was achieved despite a year of potential turmoil that included the tenure of three premiers and culminated in the New Year's Eve resignation of President Boris Yeltsin. Of great help was the tripling of international oil prices in the second half of 1999, raising the export surplus to $29 billion.

On the negative side, inflation rose to an average 86% in 1999, compared with a 28% average in 1998 and a hoped-for 30% average in 2000. Ordinary persons found their wages falling by roughly 30% and their pensions by 45%. The Vladimir Putin government has given high priority to supplementing low incomes by paying down wage and pension arrears.

Russia has been experiencing a boom in capital investment since the beginning of 2007. Capital investment showed record growth in June, rising 27.2 percent over June of last year in real terms (adjusted for price changes), to 579.8 billion rubles, with construction industry leading the way. That is a rise of 58 percent in nominal terms and a better showing than in China. Modern Russia has never before seen such a growth rate. The rate of investment in Russia rose 22.3 percent in the first half of 2007 compared to the same period the year before. The increase during that period in 2005 was only 11 percent. The statistics significantly exceed both the conservative prognoses of the Ministry of Economic Development and Trade and less conservative independent analyses. According to Interfax, the consensus among analysts at the end of last month 15.3-percent growth compared to last year.

Recovery

The Russian economy underwent tremendous stress 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 decline 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.

Russia, however, appears to have weathered the crisis relatively well. As of 2007 real GDP increased by the highest percentage since the fall of the Soviet Union at 8.1%, the ruble remains stable, inflation has been moderate, and investment began to increase again. In 2007 the World Bank declared that the Russian economy had achieved "unprecedented macroeconomic stability". Russia is making progress in meeting its foreign debts obligations. During 2000-01, Russia not only met its external debt services but also made large advance repayments of principal on IMF loans but also built up Central Bank reserves with government budget, trade, and current account surpluses. The FY 2002 Russian Government budget assumes payment of roughly $14 billion in official debt service payments falling due. Large current account surpluses have brought a rapid appreciation of the ruble over the past several years. This has meant that Russia has given back much of the terms-of-trade advantage that it gained when the ruble fell by 60% during the debt crisis. Oil and gas dominate Russian exports, so Russia remains highly dependent upon the price of energy. Loan and deposit rates at or below the inflation rate inhibit the growth of the banking system and make the allocation of capital and risk much less efficient than it would be otherwise.

In 2003, the debt has risen to $19 billion due to higher Ministry of Finance and Eurobond payments. However, $1 billion of this has been prepaid, and some of the private sector debt may already have been repurchased. Russia continues to explore debt swap/exchange opportunities.

In the June 2002 G8 Summit, leaders of the eight nations signed a statement agreeing to explore cancellation of some of Russia's old Soviet debt to use the savings for safeguarding materials in Russia that could be used by terrorists. Under the proposed deal, $10 billion would come from the United States and $10 billion from other G-8 countries over 10 years.

On January 1, 2004, the Stabilization fund of the Russian Federation was established by the Government of Russia as a part of the federal budget to balance it if oil price falls. Now the Stabilization fund of the Russian Federation is being modernized. The Stabilization Fund will be divided into two parts on February 1, 2008. The first part will become a reserve fund equal to 10 percent of GDP (10% of GDP equals to about $200 billion now), and will be invested in a similar way as the The Stabilization Fund. The second part will be turned into the the National Prosperity Fund of Russian Federation. Deputy Finance Minister Sergei Storchak estimates it will reach 600-700 billion rubles by February 1, 2008. The the National Prosperity Fund is to be invested into more risky instruments, including the shares of foreign companies.

Putin years

Under the Putin administration, Russia's economy saw the nominal Gross Domestic Product (GDP) increase 6 fold, climbing from 22nd to 11th largest in the world. The economy made real gains of an average 7% per year (2000: 10%, 2001: 5.7%, 2002: 4.9%, 2003: 7.3%, 2004: 7.1%, 2005: 6.5%, 2006: 6.7%, 2007: 8.1%), making it the 7th largest economy in the world in purchasing power. In 2007, Russia's GDP exceeded that of 1990, meaning it has overcome the devastating consequences of the 1998 financial crisis and preceding recession in the 1990s.

During Putin's eight years in office, industry grew by 75%, investments increased by 125%, and agricultural production and construction increased as well. Real incomes more than doubled and the average salary increased eightfold from $80 to $640. The volume of consumer credit between 2000–2006 increased 45 times, and during that same time period, the middle class grew from 8 million to 55 million, an increase of 7 times. The number of people living below the poverty line also decreased from 30% in 2000 to 14% in 2008.

Inflation remained a problem however, as the government failed to contain the growth of prices. Between 1999–2007 inflation was kept at the forecast ceiling only twice, and in 2007 the inflation exceeded that of 2006, continuing an upward trend at the beginning of 2008.

The Russian economy is still commodity-driven despite its growth. Payments from the fuel and energy sector in the form of customs duties and taxes accounted for nearly half of the federal budget's revenues. The large majority of Russia's exports are made up by raw materials and fertilizers, although exports as a whole accounted for only 8.7% of the GDP in 2007, compared to 20% in 2000.

There is also a growing gap between rich and poor in Russia. Between 2000–2007 the incomes of the rich grew from approximately 14 times to 17 times larger than the incomes of the poor. The income differentiation ratio shows that the 10% of Russia's rich live increasingly better than the 10% of the poor, amongst whom are mostly pensioners and unskilled workers in depressive regions. (See: Gini Coefficient)

Post Putin years

The Russian economy is on much firmer ground now but instead of resting on their laurels the Russian government is determined to make Russia a modern first world economy. After attaining broad macro economic stability and high growth likely to exceed both India and China in 2008 as per the IMF, the focus is now on using the oil windfall to build and modernize infrastructure and create an environment conducive to business, particularly the non commodities exports.

Arms sales have increased to the point where Russia is first in the world in sale of weapons, the IT industry has recorded a record year of growth concentrating on high end niches like algorithm design and microelectronics, while leaving the lesser end work to India and China; Russia is now the world's third biggest destination for outsourcing software behind India and China. The space launch industry is now the world's second largest behind Arian Space of Europe and nuclear power plant companies are going from strength to strength, selling plants to China and India, and recently signed a joint venture with Toshiba to develop cutting edge power plants.

The civilian aerospace industry has also made a comeback with the Sukhoi Superjet, arguably the most advanced regional jet available, as well as the upcoming MS 21 project to compete with Boeing and Airbus. Russia is well on its way to being a developed country within the 2020-2025 timeframe. To sustain this momentum of high growth in high end manufacturing and services the government has pumped large amounts of money in higher education, resulting in the highest number of student enrollment in higher education at any time in history, including at the zenith of the USSR.

Problems

Asset stripping and barter

As noted in the Washington Consensus, privatization leads to incentives to improve productivity of Soviet-era state enterprises. However, privatized enterprises proved difficult to vitalize, given the high interest rates, lack of financial institutions to provide capital and resistance to foreign investment.

With inflation at double-digit rates per month as a result of instantaneous price liberalization, the macroeconomic stabilization program enacted to curb this trend entailed the tightening the money supply and raising interest rates. During the early 1990s the focus on macrostabilization led to interest rates from 20% to 250%. With interest rates so high, "non-insiders" were left largely incapable of borrowing the capital to invest in Russian enterprises, a major factor leaving privatized industries starved of cash. In addition, shock therapy had wiped out the savings of most Russians, leaving ordinary Russians largely incapable of investing in enterprises left up for auction.

Until around 1996-1997, due partly to the lack of competition, many enterprises did not have enough working capital to pay the wages and taxes on time, and traded with one another using barter. Not able to pay wages, upgrading and modernizing their facilities was out of the question.

The high interest rates and shortage of financial capital forced some industries to barter, leading to a new system of distorted prices (barter creates unreal values). By 1998, at least half of enterprise output was being "sold" through barter or trade. The federal government has effectively allowed them to avoid paying much of their federal taxes in return for keeping key customers, such as military bases and major industrial enterprises, supplied with energy and power.

Institutional problems

Existing institutions were abandoned before the legal structures of a market economy that govern private property, oversee the financial market, and enforce taxation were functional. Yet, the two major components of a macroeconomy are banking system and the state budgetary system. Complicated markets require strong contract enforcement, accepted customs and practices, and financial and regulatory institutions account for the bulk of economic output. Instead, Russia was left with Soviet-era institutions and organizations. Privatized enterprises would thus be difficult to revitalize, given the lack of financial institutions to provide capital.

Several devastating blows were dealt to the potential capital market. First the savings of the people in state-owned Sberbank were frozen and effectively destroyed by hyperinflation. Second, a large number of financial pyramids extracted huge amounts of money from unsuspecting public. Third, the government has successfully repeated the scheme with their short-term government obligations, extracting tens of billions of dollars from unsuspecting investors and then defaulting on domestic obligations.

Capital flight

"Insider privatization", accompanied by the opening of the capital markets, led to incentives for capital flight in addition to barter, leading to movements $2 billion to $3 billion of capital per month. However the situation has greatly changed in 2006, and for the 2007 fiscal year, the net inflow of capital into the Russian economy according to the Russian Central Bank is expected to hit $30-35 billion.

The "brain drain"

Among other things destroyed during the transition to market economy were Soviet educational and science systems. Teachers and scientists, together with doctors, were the hardest hit by the transition. As the government was unwilling to index fixed salaries according to inflation or even to make salary payments on time, education and science incomes quickly dropped below the level of subsistence, ridding the schools, universities and research institutes of qualified specialists in record time. Some scientists fled to the West, attracting some attention to the problem of "brain drain", but nothing was done.

Macro Economy

Gross Domestic Product

This is a chart of trend of gross domestic product of Russia at market prices estimated by the International Monetary Fund with figures in millions of Russian Rubles.

Year Gross Domestic Product US Dollar exchange
1995 1,428,500 4.55 Rubles
2000 7,305,600 28.13 Rubles
2005 21,665,000 28.27 Rubles
2008 39,952,177 23.52 Rubles

For purchasing power parity comparisons, the US Dollar is exchanged at 13.63 Rubles only. Average wages in 2007 hover around $42-51 per day.

Russia's GDP, estimated at $1,250 billion at 2007 exchange rates, increased by 8.1% in 2007 compared to 2006. Continued average inflation of approximately 10% and strict government budget led to the growth, while lower oil prices and ruble appreciation slowed it. As of November 2007, unemployment in Russia was at 5.9%, down from 10.4% in 2000. Combined unemployment and underemployment may exceed those figures. Industrial output in 2007 grew by 6.3% compared to 2006, driven by investment growth and private consumption demand.

As of 2005, oil industry and related services account for at least 40 per cent of the gross domestic product of Russia.

As of April 2008, the International Monetary Fund estimates that Russia's gross domestic product (nominal) will grow from its 2007 value of $1,289,582 million to $3,462,998 million by 2013, a 168% increase. Its GDP PPP is estimated to grow from $2,087,815 to $3,330,623 in the same time, which would make it the second largest economy in Europe in terms of purchasing power.

Monetary policy

The exchange rate stabilized in 1999; after falling from 6.5 rubles/dollar in August 1998 to about 25 rubles/dollar by April 1999, one year later it had further depreciated only to about 28.5 rubles/dollar. As of June 2002, the exchange rate was 31.4 rubles/dollar, down from 29.2 rubles/dollar the year before. After some large spikes in inflation following the August 1998 economic crisis, inflation has declined steadily. Cumulative consumer price inflation for 2001 was 18.6% slightly below the 20.2% inflation rate of the previous year but above the inflation target set in the 2001 budget. The Central Bank's accumulation of foreign reserves drove inflation higher and that trend is expected to continue. The 2002 budget estimates an inflation rate of 12%, but the World Bank predicts inflation will stay above 15% in 2002.

Fiscal Policy

Central and local government expenditures are about equal. Combined they come to about 38% of GDP. Fiscal policy has been very disciplined since the 1998 debt crisis. The overall budget surplus for 2001 was 2.4% of GDP, allowing for the first time in history for the next year's budget to be calculated with a surplus (1.63% of GDP). Much of this growth, which exceeded most expectations for the third consecutive year, was driven by consumption demand. Analysts remain skeptical that high rates of economic growth will continue, particularly since Russia's planned budgets through 2005 assume that oil prices will steadily increase. Low oil prices would mean that the Russian economy would not achieve its projected growth. However, high oil prices also would have negative economic effects, as they would cause the ruble to continue to appreciate and make Russian exports less competitive. The 2007 budget law corporates a 25% increase in spending, much of it for public-sector salary increases, pension increases and social programmes. Spending on education is targeted to increase by 60% relative to the 2006 legislation and spending on healthcare is to increase by 30%. Funding for the four "national projects", undertakings in agriculture, education, housing and healthcare, will increase by 85 billion roubles over the 2006 figure to 230 billion roubles.

Privatization

The essence of economic restructuring, and a critical consideration for foreign loans and investment in Russia's economy, is the privatization program. In most respects, between 1992 and 1995 Russia kept pace with or exceeded the rate established in the original privatization program of October 1991. As deputy prime minister for economic policy, the reformist Chubais was an effective advocate of privatization during its important early stages. In 1992 privatization of small enterprises began through employee buyouts and public auctions. By the end of 1993, more than 85% of Russian small enterprises and more than 82,000 Russian state enterprises, or about one-third of the total in existence, had been privatized.

The task of privatizing the Russian economy was of an enormous scale. As described in Blasiet al. (1997), the Russian economy in the late 1980s was dominated by large and medium-sized industrial enterprises that had more than 200 employees. These firms employed about 95 per cent of the industrial workforce and produced 95 per cent of production. Large firms with more than 1000 employees accounted for 75 per cent of employment and production. At the beginning of 1991 the Russian Federation had approximately 24,000 medium-sized and large industrial enterprises and about 170,000 smaller ones – astonishingly few businesses for such a large and diverse economy. Moreover, virtually all these businesses were in the state’s hands. As OECD (1995) explains, measures taken towards the end of the communist period in Russia had allowed a variety of co-operatives and leasehold enterprises to be established, often using the assets and labour force of existing SOEs to set up these new, quasi-private businesses. These measures gave rise to a wave of spontaneous or nomenklatura privatization. This spontaneous privatization took a variety of forms: from nomenklatura-bureaucratic privatization to managerial privatization and employee lease-buyouts.

The last scheme was especially widespread – the USSR law on leasing enacted in 1989 provided employees (worker collectives) with the opportunity to lease state enterprises with the right of buy-out; the enterprises were then re-established as 100% insider-owned closed corporations. Formally, the lease-buyout privatization was stopped in mid-1991 when the law on privatization was passed; however, it de facto continued through 1991 and even 1992. The incidence of the lease-buyout scheme was particularly large in the retail trade and consumer services sectors, in light industry and some others. By February 1992, 9,451 state enterprises accounting for 8 percent of total employment were leased by their workers and managers.

The 1992 mass privatization programme classified enterprises into three categories: (a) small enterprises, to be sold by competitive bidding orlease buy-out; (b) large enterprises, to be converted to joint stock companies first(corporatization), then privatized through the mass privatization programme; and (c) medium enterprises, which could use either method. Some enterprises, such as most public utilities and firms in the defence sector, were exempted from this round of privatization. However, firms in retailing and consumer services, which had already been transferred to municipal ownership in 1991, were required to take part in the small privatization, and mass privatization was required for about 5000 large enterprises and over 15,000 medium-sized ones.

Mass Privatization

The process referred to as mass privatization in Russia implied, de facto, a combination of two main techniques – management-employee buyouts and the mass privatization itself. Surprisingly, the main role in the process turned out to involve the former rather than the latter technique. Besides, some elements of the competitive sale of enterprise shares for cash– through cash auctions and investment tenders – were also incorporated in this stage of privatization. Associated with the mass privatization, the Russian government distributed to the population, for a nominal fee of 25 Rubles per voucher, around 150 million vouchers, each with a face value of 10,000 Rubles. Since vouchers were freely circulating securities, people could usethem as a means of payment when purchasing shares of enterprises at voucher auctions, could sell them or invest them in specially created voucher investment funds. The management-employee buyout component stemmed from the substantial privileges given by the state to managers and employees of the enterprises offered for privatization. The programme granted these groups the opportunity to receive a significant fraction of shares either for free or with substantial discounts. Privatization of each enterprise started with a development of a privatization plan which determined the procedures for the sale of shares as well as the proportions offered to various groups of potential investors, most importantly, employees and managers within the limits allowed in the privatization regulations. The plan was to be approved by the State Committee for the Management of State Property (GKI) – the main Russian privatization agency – or its regional offices. The next step involved corporatization, which transformed state enterprises into open joint-stock companies wholly owned by the state. At this stage the charter capital of each firm was calculated as the book value of its assets other than land (and net of any outstanding debt), and the board of directors was appointed comprising the general manager with two votes, a representative of rank-and-file employees, and one representative each of the federal and local governments. Shares of newly created companies were transferred to the Federal Property Fund (FPF) and its regional branches, which acted as the sellers of enterprises.

Given the generous entitlements offered to managers and employees in the Russian privatization, these insiders were able to choose from among three options, or privatization methods, at a general meeting of their enterprise:

  • Option 1: Workers and managers were to receive 25% of equity in the form of preference (non-voting) shares for free, plus the right to purchase a further 10% of ordinary(voting) shares using cash or vouchers (at 30% discount on the January 1992 bookvalue). In addition, senior managers of enterprises could purchase an additional 5%of the stock in the form of ordinary shares.
  • Option 2: Workers and managers could buy - for cash or vouchers - 51% of voting shares at 1.7 times the book value of the enterprise on January 1992.
  • Option 3: A managing group (that could include existing management and workers, or anyother physical or legal person) that took responsibility for the execution of the privatization plan and the prevention of enterprise bankruptcy could buy 30% of thevoting shares; a further 20% could be purchased by management and workers (regardless of whether they were part of the managing group) at a 30% discount.

In addition, employee shareholdings could be increased through so-called EmployeePrivatization Funds (Fond Aktsionirovaniya Rabotnikov Predpriyatiya - FARP). Ordinary shares amounting to 10% of a firm’s charter capital (if an enterprise followed the second option of privatization, the limit was 5%) could be assigned to these funds for subsequent sale to employees on preferential terms. These funds could be created only if the application for privatization was submitted before 1 February 1994. Option 1 was first proposed as the main approach, but it met with strong resistance from managers who, through regional leaders and through their representatives in the Federal Assembly were able to put sufficient pressure on the government to have Option 2 included in the programme (Åslund, 1995). Option 3 was also included due to pressure from the managerial lobby, but in practice the government banned its use at large enterprises and by imposing a “no bankruptcy” condition finally made it rather unattractive for the managers. In all three options, given the rapid inflation in Russia during the relevant period, the prices that insiders were asked to pay for enterprise shares were scarcely more than nominal. In this sense, the mass privatization really was a give-away operation.

As for the mass privatization component, the programme envisaged that not less than 29 percent of shares of each firm would be sold at a voucher auction, though in reality the figure was closer to 20 percent. How people disposed of their vouchers was interesting: about half were invested by employees (and, as a rule, their relatives) in their own enterprises, either through closed subscription or through voucher auctions. A quarter of the vouchers weresold, and the remaining quarter were invested in voucher investment funds. These were closed-end funds that issued their own shares in exchange for vouchers invested by people; they were not obliged to repurchase the issued shares. The number of voucher funds peaked in 1994, amounting to 662. About 25 million people – over 16 percent of citizens – became shareholders in these funds which acquired over 10 percent of the assets of the firms offered for privatization.

The last component of privatization – the competitive sale of shares at investment tenders or cash auctions – typically involved 10 to 20 percent of the shares of enterprises. In an investment tender, which was a competition between investors to buy a block of shares, bidders had to agree to provide the company with additional assistance in the form of capital investments or technology. Similarly, cash auctions also produced capital for enterprises.

Despite periodic delays, the inept administration of the program's more recent phases, and allegations of favoritism and corrupt transactions in the enterprise and financial structures, in 1996 international experts judged Russia's privatization effort a qualified success. The movement of capital assets from state to private hands has progressed without serious reversal of direction — despite periodic calls for reestablishing state control of certain assets. And the process has contributed to the creation of a new class of private entrepreneur.

The insider buyout

In hindsight, prominent Sovietologist Marshall Goldman has argued that Yeltsin should have extended property ownership to land, facilitated the formation of new companies, reformed the currency, liberalized prices, scrapped taxes on wages, brought fiscal policy under control, and moved toward convertibility of the ruble before implementing the process of privatization.

Marshall Goldman, Joseph Stiglitz (the winner of the 2001 Nobel Prize in economics), and other critics of Russia's implementation of privatization generally argue that "insider buyout," which allowed state managers to usually wound up with the controlling share of the stock, further accounted for Russia's poor implementation of economic restructuring.

The "insider buyout" supposedly induced 'employee dominant ownership', inevitably leading to the tendency for the stockholders, who are managers or employees themselves, to vote for increased wages, reduced investments, and fewer layoffs, which all disfavor the growth of market economy.

In Russia a far higher share of state-owned assets were sold to managers and workers, or "insiders," compared to the former Czechoslovakia, Hungary, and Poland. In this sense, it is more precise to describe Russia's privatization as "insider privatization" (the first stage) and "oligarch privatization", and thus distinct from the general pattern of privatization in other, more successful countries in Eastern Europe.

Many have therefore argued that it would be more accurate to say that real economic reform was never tried, given that it was quickly subverted by actors outside the government's control, such as the Central Bank, ministries, regional governments, and industrial managers.

Aside from the distortions associated with the lack of competition, employee ownership in general keeps wages and employment at levels that were too high. The impact of "insider buyout" in Russia can be seen from the abnormally low unemployment rates and very high underemployment levels in privatized industries. Generally speaking, large-scale privatization of moribund, money-losing state owned enterprises should increase unemployment. Some Soviet industries, after all, were not even value adding, with cost of inputs exceeding the cost of outputs (though it must be noted that in a planned economy this can sometimes be reasonable). Sixteen percent of the workforce became unemployed in both the former East Germany and Poland.

As a point in comparison, even in Communist China, where organized, large-scale privatization has not been carried out, the unemployment rate in 1998 was conservatively counted at 8 to 9%. But in Russia, in the most radical stage of privatization, 1994, only 6.3% of the economically active population was unemployed (a far larger share of the population is underemployed).

According to major surveys of Russian enterprise directions about whether they would be willing to sell a majority of the shares of their enterprise to an outside investor who would bring in the capital needed to invest in modernizing the firm, two-thirds said they would not be willing. In other words, they would rather remain majority owners of an unprofitable enterprise than minority owners of a much more profitable one. Very few firms have experienced much management turnover.

According to Stiglitz, the key economic mistakes of the transition were the emphasis on privatization over competition and the emphasis on restructuring existing enterprises over creation of new jobs and enterprises. With emphasis on just transferring ownership to private hands in order to create a lobby for private enterprise in order to prevent a communist comeback and push for creation of institutions to govern the market instead of competition, price controls were lifted without dismantling key Soviet-era monopolies. Prices thus were not able to properly equilibrate according to levels dictated by supply and demand since private profit-seeking monopolies lacked the incentives provided by competition to lower prices.

Law

Lack of legislation and, where there is legislation, lack of effective law enforcement, in many areas of economic activity is a pressing issue. During 2000 and 2001, changes in government administration increased the power of the central government to compel localities to enforce laws. Progress has been made on pension reform and reform of the electricity sector. Nonetheless, taxation and business regulations are unpredictable, and legal enforcement of private business agreements is weak. Attitudes left over from the Soviet period will take many years to overcome. Government decisions affecting business have often been arbitrary and inconsistent. Crime has increased costs for both local and foreign businesses. On the positive side, Russian businesses are increasingly turning to the courts to resolve disputes. The passage of an improved bankruptcy code in January 1998 was one of the first steps. In 2001, the Duma passed legislation for positive changes within the business and investment sector; the most critical legislation was a deregulation package. This trend in legislation is continued through 2002, with the new corporate tax code going into effect.

Natural resources

The mineral-packed 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 such resources are located in remote and climatically unfavorable areas that are difficult to develop and far from Russian ports. Oil and gas exports continue to be the main source of hard currency. Russia is a leading producer and exporter of minerals, gold, and all major fuels. The Russian fishing industry is the world's fourth-largest, behind Japan, the United States, and China. Natural resources, especially energy, dominate Russian exports. Ninety percent of Russian exports to the United States are minerals or other raw materials.

Expecting the area to become more accessible as climate change melts Arctic ice, and believing the area contains large reserves of untapped oil and natural gas, on August 2, 2007, Russian explorers, in submersibles, planted the Russian flag on the Arctic seabed, staking a claim to energy sources right up to the North Pole. Reaction to the event was mixed: President Vladimir Putin congratulated the explorers for "the outstanding scientific project", while Canadian officials stated the expedition was just a public show.

Under the Federal Law "On Continental Shelf Development" upon proposal from the federal agency managing the state fund of mineral resources or its territorial offices the Russian government approves the list of some sections of the mineral resources that are passed for development without any contests and auctions, some sections of federal importance of the Russian continental shelf, some sections of the mineral resources of federal importance that are situated in Russia and stretch out on its continental shelf, some gas deposits of federal importance that are handed over for prospecting and developing the mineral resources under a joint license. The Russian government is also empowered to decide on the handover of the foresaid sections of the mineral resources for development without any contests and auctions.

Sectors

Strategic Enterprises

In September 1995, the Russian government adopted Order #949, which classified three thousand enterprises as strategic. Since 1996 the lists of such enterprises immune from privatization have been formed by presidential decrees. As of 2008 there is a list of 1,000 enterprises rated as strategic ones Privatization of such companies, or any reduction of the government-owned stakes is prohibited by law. The strategic enterprise status implies a number of privileges such as a special bankruptcy procedure when a company may apply for aid from state coffers.

Industry

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 machinery. Russia inherited most of the defence industrial base of the Soviet Union, so armaments are the single-largest manufactured goods export category for Russia. Efforts have been made with varying success over the past few years to convert defence industries to civilian use.

Electronics

Russia is experiencing a regrowth of Electronics.. Among Russia's biggest television sets producers is Rolsen.

Telecom

Russia's telecommunications industry is growing in size and maturity. As of 31 December 2007, there were an estimated 4,900,000 broadband lines in Russia. Over 72% of the broadband lines were via cable modems and the rest via DSL.

In 2006, there were more than 300 BWA operator networks, accounting for 5% of market share, with dial-up accounting for 30%, and Broadband Fixed Access accounting for the remaining 65%. In December 2006, Tom Phillips, chief government and regulatory affairs officer of the GSM Association stated:

"Russia has already achieved more than 100% mobile penetration thanks to the huge popularity of wireless communications among Russians and the government's good work in fostering a market driven mobile sector based on strong competition.

While there is a lot of interest in a national broadband network, as of January 2007 there still wasn't one.

Agriculture

Russia comprises roughly three-quarters of the territory of the former Soviet Union but has relatively little area suited for agriculture because of its arid climate and inconsistent rainfall. Northern areas concentrate mainly on livestock, and the southern parts and western Siberia produce grain. Restructuring of former state farms has been an extremely slow process. The new land code passed by the Duma in 2002 should speed restructuring and attract new domestic investment to Russian agriculture. Private farms and garden plots of individuals account for over one-half of all agricultural production.

Trade

In 1999, exports were up slightly, while imports slumped by 30.5%. As a consequence, the trade surplus ballooned to $33.2 billion, more than double the previous year's level. In 2001, the trend shifted, as exports declined while imports increased. World prices continue to have a major effect on export performance, since commodities, particularly oil, natural gas, metals, and timber comprise 80% of Russian exports. Ferrous metals exports suffered the most in 2001, declining 7.5%. On the import side, steel and grains dropped by 11% and 61%, respectively.

Most analysts predicted that these trade trends would continue to some extent in 2002. In the first quarter of 2002, import expenditures were up 12%, increased by goods and a rapid rise of travel expenditure. The combination of import duties, a 20% value-added tax and excise taxes on imported goods (especially automobiles, alcoholic beverages, and aircraft) and an import licensing regime for alcohol still restrain demand for imports. Frequent and unpredictable changes in customs regulations also have created problems for foreign and domestic traders and investors. In March 2002, Russia placed a ban on poultry from the United States. In the first quarter of 2002, exports were down 10% as falling income from goods exports was partly compensated for by rising services exports, a trend since 2000. The trade surplus decreased to $7 billion from well over $11 billion the same period last year.

Foreign trade rose 34% to $151.5 billion in the first half of 2005, mainly due to the increase in oil and gas prices which now form 64% of all exports by value. Trade with CIS countries is up 13.2% to $23.3 billion. Trade with the EU forms 52.9%, with the CIS 15.4%, Eurasian Economic Community 7.8% and Asia-Pacific Economic Community 15.9%

Trade volume between China and Russia reached $29.1 billion in 2005, an increase of 37.1% compared with 2004. China’s export of machinery and electronic goods to Russia grew 70%, which is 24% of China’s total export to Russia in the first 11 months of 2005. During the same time, China’s export of high-tech products to Russia increased by 58%, and that is 7% of China’s total exports to Russia. Also in this time period border trade between the two countries reached $5.13 billion, growing 35% and accounting for nearly 20% of the total trade. Most of China’s exports to Russia remain apparel and footwear.

Russia is China’s eighth largest trade partner and China is now Russia’s fourth largest trade partner.

China now has over 750 investment projects in Russia, involving $1.05 billion. China’s contracted investment in Russia totaled $368 million during January-September 2005, twice that in 2004.

Chinese imports from Russia are mainly those of energy sources, such as crude oil, which is mostly transported by rail, and electricity exports from neighboring Siberian and Far Eastern regions. In the near future, exports of both of these commodities are set to increase, as Russia is building the Eastern Siberia – Pacific Ocean oil pipeline with a branch to Chinese border, and Russian power grid monopoly UES is building some of its hydropower stations with a view of future exports to China.

Information Technology

The IT market is one of the most dynamic sectors of the Russian economy. Russian software exports have risen from just $120 million in 2000 to $1.5 billion in 2006. Since the year 2000 the IT market has demonstrated growth rates of 30-40 percent a year, growing by 54% in 2006 alone. The biggest sector in terms of revenue is system and network integration, which accounts for 28.3% of the total market revenues Meanwhile the fastest growing segment of the IT market is offshore programming. The industry of software development outsourcing crossed the mark of $1 billion of total revenues in 2005 and reached $1.8 billion in 2006 Market analysts predict this indicator to increase tenfold by 2010 Currently Russia controls 3 percent of the offshore software development market and is the third leading country (after India and China) among software exporters. Such growth of software outsourcing in Russia is caused by a number of factors. One of them is the supporting role of the Russian Government. The Government has launched a program promoting construction of IT-oriented technology parks (Technoparks) - special zones that have an established infrastructure and enjoy a favorable tax and customs regime, in seven different places around the country: Moscow, Novosibirsk, Nizhny Novgorod, Kaluga, Tumen, Republic of Tatarstan and St. Peterburg Regions. Another factor stimulating the IT sector growth in Russia is the presence of global technology corporations such as Intel, Motorola, Sun Microsystems, Boeing, Nortel and others, which have intensified their software development activities and opened their R&D centers in Russia.

Nanotechnology

In its push to diversify Russia's research and development in emerging technologies, The Putin government has announced a massive $7 billion investment program in nanotechnology. As part of the program, during 2007, $5 billion is being invested into a new state corporation, Rosnanotech, that will be responsible for overseeing and coordinating research in the area.

In criticism of the initiative, it has been noted that the Russian nanotech program will receive three times more state funding than the rest of Russia's scientists put together.

Apart from public funding, Mikhail Prokhorov, a leading Russian metals and banking tycoon, has announced the creation of a $17 billion holding company that will focus on high-tech investments, including alternative energy and nanotechnology.

Investment

In 1999, investment increased by 4.5%, the first such growth since 1990. Investment growth has continued at high rates from a very low base, with an almost 30% increase in total foreign investments in 2001 compared to the previous year. Higher retained earnings, increased cash transactions, the positive outlook for sales, and political stability have contributed to these favorable trends. Foreign investment in Russia is very low. Cumulative investment from U.S. sources of about $4 billion are about the same as U.S. investment in Costa Rica. Over the medium-to-long term, Russian companies that do not invest to increase their competitiveness will find it harder either to expand exports or protect their recent domestic market gains from higher quality imports.

Foreign direct investment, which includes contributions to starting capital and credits extended by foreign co-owners of enterprises, rose slightly in 1999 and 2000, but decreased in 2001 by about 10%. Foreign portfolio investment, which includes shares and securities, decreased dramatically in 1999, but has experienced significant growth since then. In 2001, foreign portfolio investment was $451 million, more than twice the amount from the previous year. Inward foreign investment during the 1990s was dwarfed by Russian capital flight, estimated at about $15 billion annually. During the years of recovery following the 1998 debt crisis, capital flight seems to have slowed. Inward investment from Cyprus and Gibraltar, two important channels for capital flight from Russia in recent years, suggest that some Russian money is returning home.

A significant drawback for investment is the banking sector, which lacks the resources, the capability, and the trust of the population that it would need to attract substantial savings and direct it toward productive investments. Russia's banks contribute only about 3% of overall investment in Russia. While ruble lending has increased since the August 1998 financial crisis, loans are still only 40% of total bank assets. The Central Bank of Russia reduced its refinancing rate five times in 2000, from 55% to 25%, signaling its interest in lower lending rates. Interest on deposits and loans are often below the inflation rate. The poorly developed banking system makes it difficult for entrepreneurs to raise capital and to diversify risk. Banks still perceive commercial lending as risky, and some banks are inexperienced with assessing credit risk.

Money on deposit with Russian banks represents only 7% of GDP. Sberbank receives preferential treatment from the state and holds 73% of all bank deposits. It also is the only Russian bank that has a federal deposit insurance guarantee. In March 2002, Sergei Ignatiev replaced Viktor Gerashchenko as Chairman of the Russian Central Bank. Under his leadership, necessary banking reforms, including stricter accounting procedures and federal deposit insurance, are likely to be implemented.

Strategic Sectors

In the Russian law, there are sectors of the Economy who are considered to be cruicial for national security and foreign companies are restricted from owning them. Investments in the so-called Strategic Sectors are defined in a law Adopted by the Russian Parliament in 2007 Federal Law "On the Access of Foreigners to Strategic Sectors".

Types of legal entities in Russia

  • IP (Индивидуальный предприниматель) - Russian "Individual entrepreneur"
  • OOO (Общество с ограниченной ответственностью, ООО) - Russian "Limited liability company"
  • ZAO (Закрытое акционерное общество, ЗАО) - Russian "Closed joint-stock company"
  • OAO (Открытое акционерное общество, ОАО) - Russian "Public joint-stock company"
  • ANO (Автономная некоммерческая организация, АНО) - Russian "Autonomous non-profit organization"
  • GP or GUP (Государственное унитарное предприятие, ГП or ГУП) - Russian "Unitary state enterprise"
  • Фонд - Russian "Fund"
  • PK (Производственный кооператив, ПK) - Russian "Production Cooperative"
  • PP (Политические партии, ПП) - Russian "Political party"

See also

Stocks

External links

Russia's Virtual Economy: http://www.brookings.edu/articles/2008/02_virtual_economy_gaddy.aspx

References

Further reading

State and Evolution: Russia's Search for a Free Market by Yegor Gaidar and Jane Ann Miller, ISBN 0-295-98349-3, 2003

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