ECONOMY
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 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.
Still, Russia has weathered the crisis well. In the nine years following the financial crisis, GDP growth averaged 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 have both grown by about 10 percent per year since 1999 and have replaced net exports as the main drivers of demand growth. Inflation and exchange rates have stabilized due to a prudent fiscal policy (Russia has run a budget surplus since 2003). The government created a stabilization/rainy day fund ($156 billion at the end of 2007), and has the third-largest foreign exchange reserves in the world (close to $476 billion at the end of 2007) which should shelter it from commodity price shocks.
Russia's balance of payments continues to show dynamic growth. The current account balance fell slightly, from $95.3 billion in 2006 to $78.3 billion in 2007, as imports increased rapidly. Large amounts of capital moved into Russia in 2007. The capital account balance was $84.3 billion, compared to $6.1 billion in 2006. In addition, net private capital flows continued to increase in 2007 to $81.2 billion from $40.9 billion in 2006. Foreign direct investment (FDI) flows continued to improve in 2007 to $52.5 billion compared to $32.4 billion in 2006. As of July 1, 2006, the ruble is convertible for both current and capital transactions. Russia prepaid its entire Soviet-era Paris Club debt of $22 billion in late 2006. Russia maintains relatively small amounts of sovereign debt. In 2007, total sovereign foreign debt was $36 billion, or about 3% of GDP, down from $45 billion at the end of 2006. Russia's total public and private foreign debt at the end of 2007 was $460 billion, or 34% of GDP. Russia currently has a sovereign investment-grade rating from Standard and Poor's of BBB+.
Although the economy has begun to diversify, the government budget remains dependent on oil and gas revenues; consumption and investment are, however, contributing to an increasing share to GDP growth. While currently sheltered from external price shocks, the government realizes the need to intensify reforms that will promote new investment in aging infrastructure and continued productivity gains. The government believes it can do this by creating state-sponsored investment funds, special economic zones, and by exercising control of strategic enterprises (a law defining strategic sectors was passed by the Duma in March 2008). Although investors are returning to Russia, excessive bureaucracy, corruption, insufficient and insufficiently enforced legislation, selective interpretation of laws (particularly tax laws), unclear limits and conditions on foreign investment, obsolete infrastructure, and stalled economic reforms still remain a problem. In 2005, the government announced reform programs in four priority areas (health, education, housing, and agriculture), but further work is needed on them as well as in financial regulation, civil service reform, and reform of government monopolies, such as railroads, gas, and electricity.
Gross
Domestic Product
A strong expansion in domestic demand continues to drive GDP growth, despite a slowdown in manufacturing. GDP growth and industrial production for 2007 were 8.1% and 6.3%, respectively, relative to 6.7% and 4.8% in 2006. GDP growth is currently derived from non-tradable sectors, but investment remains concentrated in tradables (oil and gas). Construction continued to be the fastest-growing sector of the economy, expanding by 22% in 2007. The main private sector services--wholesale and retail trade, banking and insurance, and transportation and communications--showed strong growth of about 10%. In contrast, public sector services lagged behind in 2007 with only 1.6%-2.4% growth in education and health care, although public administration increased to 7.5%. Recent productivity growth has still been strong in some parts of domestic manufacturing. Real disposable incomes grew by 10.4% in 2007 spurring considerable growth in private consumption.
Monetary
Policy
Large balance of payments surpluses have complicated monetary policy for Russia. The Central Bank has followed a policy of managed appreciation to ease the impact on domestic producers and has sterilized capital inflows with its large budget surpluses. However, the Central Bank also has been buying back dollars, pumping additional ruble liquidity into the system. Given the rising demand for money, this has softened the inflationary impact, but these policy choices have complicated the government's efforts to lower inflation to the single digits. Consumer Price Index (CPI) inflation rose to 11.9% in 2007.
Government
Spending/Taxation
The Russian federal budget has run growing surpluses since 2001, as the government has taxed and saved much of the rapidly increasing oil revenues. In 2007 the federal budget surplus was 5.5% of GDP. Despite strong pressures to relax spending ahead of elections, the government has loosened its spending gradually, as the economy is running at near capacity and there are dangers of increasing inflation and rapid exchange rate appreciation. Spending increases to date have mostly been for increased salaries of government employees and pensions, but some money is also being dedicated to special investment funds and tax breaks to develop new industries in special economic zones. The government overhauled its tax system for both corporations and individuals in 2000-01, introducing a 13% flat tax for individuals and a unified tax for corporations, which improved overall collection. Business has put pressure on the government to reduce value added taxes (VAT) on oil and gas, but the government has postponed this discussion. Tax enforcement of disputes continues to be uneven and unpredictable.
Population
Russia's population was 142 million as of January 1, 2008. It declined at a lower rate in 2007 than in 2006 and previous years due to a significant (8%) increase in the birth rate and a 5% reduction in the death rate. The improvements may in part be attributed to the implementation of a National Priority Health Project and financial incentives to mothers having two or more children. Life expectancy remains low compared to developed countries but rose to 60.37 years for men and 73.23 for women in 2006. 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. 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 have had short-term success; Russia's population declined by 0.14% compared to 0.42% in 2006. It is unknown if such programs offer a long-term solution. 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.
HIV/AIDS
At the end of 2007, there were 403,000 HIV cases officially registered in Russia, though many experts believe the actual number of cases may be two to three times higher (1 million to 1.3 million HIV cases). Prevalence of HIV cases was 270.1 per 100,000 people in 2007, higher than the 2006 indicator of 243 per 100,000. The chief form of transmission continued to be intravenous drug use, which accounted for 65% of new HIV cases in 2007. More than 44% of new HIV cases are identified in females, and transmission through heterosexual sex has grown rapidly. The number of secondary, AIDS-associated diseases has increased more than twofold in 2007. As a result, the number of deaths from AIDS has grown by 10% compared to 2006. 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 will spend over $42 million over the next five years to support HIV/AIDS vaccine research. At the September 2003 Camp David Summit, and again at the Bratislava meeting in February 2005, Presidents Bush and Putin pledged to deepen ongoing cooperation between the two countries to fight HIV/AIDS.
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-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. Nevertheless, Russia is a leading producer and exporter of minerals, gold, and all major fuels. Natural resources, especially energy, dominate Russian exports. Ninety percent of Russian exports to the United States are minerals or other raw materials.
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 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.
Agriculture
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.
Investment
Russia attracted $52.5 billion in foreign direct investment (FDI) in 2007 (4.1% of GDP), up from $32.4 billion in FDI in 2006. Russia's annual FDI figures are now in line with those of China, India, and Brazil. However, Russia's per capita cumulative FDI still lags far behind such countries as Hungary, Poland, and the Czech Republic. The paradox is that Russia's challenging business climate, lack of transparency, and weak rule of law/corruption has taken a back seat to Russia's extraordinary macroeconomic fundamentals and the consumer and retail boom, which is providing double digit returns to investors and attracting new flows. Russian domestic investment is also returning home, as the foreign investment coming into Russia from havens like Cyprus and Gibraltar, is actually returning Russian capital. Retail loans amounted to $132.1 billion at the end of 2007, up from $78.4 billion at the end of 2006. Retail deposits increased to $209.3 billion from $144.1 billion from $95.7 billion over the same period. Also, currently deposits are fully insured up to $4,000 and an additional $12,000 is insured at 90%.
Although still small by international standards, the Russian banking sector is
growing fast and is 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, accounting for 57% of
the private-sector capital inflows in that year. 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. Fewer Russians prefer to keep their money outside the banking sector, the
recent appreciation of the ruble against the dollar has persuaded many Russians
to keep their money in rubles or other currencies such as the euro, and retail
deposits grew by 35% in 2007. Despite recent growth, the poorly developed
banking system, along with contradictory regulations across banking, bond, and
equity markets, still makes it difficult for entrepreneurs to raise capital as
well as to permit capital transfer from a capital-rich sector such as energy to
capital-poor sectors such as agriculture and manufacturing and to diversify
risk. Banks still perceive small and medium commercial lending as risky, and
some banks are inexperienced with assessing credit risk, though the situation is
improving. In 2004, Russia enacted a deposit insurance law to protect deposits
up to 100,000 rubles (about $3,700) per depositor. Subsequent amendments to the
law increased the Deposit Insurance Agency's coverage for deposits up to 400,000
rubles.
Trade
The U.S. exported $7.4 billion in goods to Russia in 2007, a 57% increase from the previous year. Corresponding U.S. imports from Russia were $19.4 billion, down a slight 2%. Russia is currently the 20th-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 2007 was $132 billion, roughly equal to the $139 billion surplus in 2006. World prices continue to have a major effect on export performance, since commodities--particularly oil, natural gas, metals, and timber--comprise most 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 continued in 2007 on meeting WTO
requirements for accession. Russia reports that it has yet to conclude bilateral
agreements with Saudi Arabia and Georgia.
According to the 2005 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, large losses to U.S. audiovisual and other companies in Russia owing to poor enforcement of intellectual property rights in Russia are 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.
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GDP (2007 estimate): $1.34 trillion.
Growth rate (2007 estimate): 8.1%.
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 (2007): Exports--$355 billion: petroleum and petroleum products, natural gas, woods and wood products, metals, chemicals. Major markets--EU, CIS, China, Japan. Imports--$223 billion: machinery and equipment, chemicals, consumer goods, medicines, meat, sugar, semi-finished metal products. Major partners--EU, U.S., NIS, Japan, China. U.S. exports--$7.4 billion. Principal U.S. exports (2007)--oil/gas equipment, autos/parts, meat, aircraft, electrical machinery, medical equipment, plastics, cosmetics, and chemicals. U.S. imports--$19.4 billion. Principal U.S. imports (2006)--oil, chemicals, aluminum, iron/steel, precious stones, nickel, fish and crustaceans, copper, base metals, and wood.
