BISNIS RUSSIA OVERVIEW Chapter 1: Economic Profile February 2000
* Note: Unless otherwise noted, all ruble figures for 1997 are indicated at their pre-redenomination face value. All 1998 and later ruble values are presented in accordance with the redenomination value.
Population: 145.7 million (November 1999, declining), the sixth largest national population after China, India, the United States, Indonesia, and Brazil; 81.5 percent are ethnic Russian; 73.9 percent urban; population of Moscow - 9 million; population of St. Petersburg - 4.8 million. Russia has a 98 percent literacy rate.
Territory: 17,075,200 square kilometers/6.6 million square miles. Russia, covering one-eighth of the world's land surface, is the largest country in the world. Its territory is almost twice the size of the United States. Russia is divided into 89 administrative regions, including provinces (oblasts and krais), metropolitan cities (Moscow and St. Petersburg), 16 autonomous republics with their own independent governments, 5 autonomous regions, and 10 national regions. The autonomous and national regions have less autonomy than the republics.
Economic Significance: Russia is well endowed with natural resources and raw materials such as petroleum, diamonds, gold, copper, rare metals, manganese, bauxite, uranium, silver, graphite, and platinum, all of which are a source of hard currency because of worldwide demand. The country ranks as either the largest or one of the largest worldwide producers of several of the above commodities and products. Although Russia has been a leading international player in select manufacturing sectors, such as chemicals and military aerospace, the country's manufacturing base remains greatly diminished.
Russia manufactures approximately 62 percent of all the machinery made in the Newly Independent States of the former Soviet Union (NIS) and nearly 60 percent of the NIS' crude steel (Russia is the world's largest steel producer after Japan).
Industrial Profile: Steady growth over the last three years in the trade and service sectors, which were underdeveloped during the years of the USSR=s central planning, has been an increasingly important contributor to Russian GDP. Since the mid-to-late 1990s, services have accounted for more than 50 percent of GDP, with manufacturing contributing just under 40 percent, and agricultural output accounting for just under 10 percent. Overall trends indicate that the portion of GDP accounted for by services and taxes is increasing, while production is decreasing in importance as a contributor to GDP.
Aside from output related to the above-mentioned petroleum products and minerals/metals, other key Russian industries are chemicals, timber and wood products, including paper, and nonferrous metals. Nearly 15 percent of Russia's industries are defense related.
MACROECONOMIC INDICATORS
In many areas, Russia showed better performance in 1999 than expected, and improved results compared to 1998. Higher world prices for fuels and metals facilitated improvements, as did the devalued ruble, which rendered Russian products relatively cheaper than imports and contributed to increased domestic purchases and exports. Given Russia’s extremely poor performance in 1998, however, a comparison of 1999 performance to 1997 results can provide a useful frame of reference. On many fronts, a comparison of Russian performance in 1999 vs. 1997 shows small declines in 1999 results.
GDP Russian authorities report that in real terms, Russian GDP is still only at 59 percent of 1990's GDP. Table 1 indicates the annual real change in GDP compared to the previous year.
TABLE 1: CHANGE IN RUSSIAN GDP (1995 - 1999)
Year Change (real GDP, over previous year) 1999 +3.2% (down 0.2 percent compared to 1997) 1998 -5.0% 1997 +0.8% 1996 - 5.0% 1995 - 4.0%
Goskomstat, the Russian State Statistics Committee (www.gks.ru), is the organization that provides many of Russia's official statistics. Official Russian statistics indicate improving economic performance in 1999 following initial declines in the first quarter of 1999, with particularly strong recovery in the third quarter.
GDP per capita: According to the European Bank for Reconstruction and Development (EBRD). GDP per capita in Russia climbed steadily from 1991 to 1997 (1995: $1,868; 1996: $2,910; 1997 $3,056), but then dropped sharply in 1998, to $1,867 per capita. For 1999, early estimates suggest that per capita GDP fell to levels on par with the early 1990s.
Industrial production "Free fall" is a phrase some used to describe industrial output immediately following the breakup of the Soviet Union. According to the Russian State Statistics Committee (Goskomstat), industrial production has fallen nearly 55 percent since 1990; larger declines are suggested by other sources. The military- industrial complex, suppliers of goods to the state sector, and light industry have been among the hardest hit. However, depending on world prices and ruble stability, some export- oriented industries have fared relatively well during Russia's transition. One of the effects of the August 1998 crisis was to facilitate, at least temporarily and for some sectors, progress at stimulating local production and import substitution.
The rate of decline in real industrial output slowed markedly beginning in August 1994. Table 2 shows the year-on-year change in total Russian industrial output for 1995-1998.
TABLE 2: YEAR-ON-YEAR CHANGE IN INDUSTRIAL OUTPUT (1995 - 1998) Year Change in Industrial Output (over previous year) 1999 +8.1% 1998 - 5.7% 1997 +1.9% 1996 - 4.0% 1995 - 3.3%
Initial Russian government estimates report 8.1 percent growth in industrial output during 1999 over the previous year, reportedly the strongest growth since the early 1990s, but perhaps unsurprising given the challenges and declines of 1998. The finish to the year marks a significant improvement from performance in early 1999—during the first quarter of 1999, industrial output dropped 1.6 percent compared to the same period of 1998. Third quarter performance was particularly strong with year-on-year growth in industrial output of 16.5 percent. Analysts within Russia and abroad assert that Russia achieved this growth as a result of the August 1998 crisis and will not be able to maintain this growth in 2000 without higher levels of consumer spending and investment.
According to official Russian data, most major industry sectors showed an increase in output in 1999 over 1998, as well as compared to 1997 (exception: agribusiness and the power and fuel sectors, which showed improvements over 1998, but declines compared to 1997). Specific sub sectors showing declines in output in 1999 over 1998 include heat/oil, machine tools, television, and sausage production. Certain sectors that have otherwise fared poorly in the mid and late 1990s--such as light industry and the pulp/paper, chemical, and building materials sector--showed increased output in 1999 over 1998. Sectors that fared the worst in 1998 included light industry, metallurgy, chemicals, and agribusiness.
Despite improvements in 1999, some experts note that a majority of Russian companies remain uncompetitive. Meanwhile, according to Goskomstat, output continues to fall at medium and large Russian enterprises, while small companies and joint ventures are largely responsible for increased output.
Russian production levels face monthly and seasonal fluctuations, as well as wide disparities between industry sectors. Secondary indicators such as freight haulage and energy output can suggest a slightly different scenario than that indicated by official statistics. This mystery is somewhat accounted for by the informal, or shadow, economy, as well as by ongoing tremendous tax avoidance by Russia=s enterprises, despite efforts to improve tax collection. The Russian Federal Security Service has estimated that the shadow economy may account for as much as 40-50 percent of GDP, compared with less than 10 percent in most developed economies. In early 1999, the State Statistics Committee reported that on average 20 percent of incomes are concealed from the government, with much higher rates in trade and during the summer months, when individuals are harvesting food from their summer homes.
Inflation Inflation levels in Russia dropped drastically between 1992, when the annual inflation rate surpassed 2,000 percent, and July 1998, when annualized inflation in Russia dropped to a low of 5- 6 percent. The Russian Government was aiming for 5-7 percent inflation in 1998, but the eruption of financial crisis and related developments on and after August 17, 1998 (ruble devaluation, etc.) resulted in a dramatic climb in monthly inflation. Monthly inflation was just 0.2 percent in July 1998, but jumped to 15 percent in August 1998 and 38 percent for September 1998, closing at 84 percent for the year.
Despite concerns that inflation might reach 100 percent in 1999, Russian inflation rates generally showed decline in 1999 over 1998, ending the year at 36.5 percent. The following chart shows the progression of Russian inflation rates between 1994 and early 1999.
TABLE 3: RUSSIAN INFLATION: 1994-1999
Year January August December Annual Total 1999 8.5% 1.2% 1.3% 36.5% 1998 1.5% 0.2% 11.6% 84.4% 1997 2.3% -0.1% 1.0% 11% 1996 4.1% -0.2% 1.4% 21.8% 1995 18.0% 4.6% 3.0% 131% 1994 22.0% 4.0% 18.0% 215%
Monthly inflation rates have varied depending the time of year under consideration, with recent years indicating a general pattern of relatively higher levels at the beginning and end of the year but lower rates during the summer months. Although inflation rates are usually reported for Russia as a whole, regional variations do occur.
RUBLE / EXCHANGE RATES
Russia has undertaken a number of different approaches to exchange rate policy over the past few years, including a currency corridor in 1995 and a crawling band mechanism from 1995-1997. For the most part, these measures were viewed as part of an effort to establish a more "natural" ruble-to-foreign currency rate and have generally been positively received for their perceived contribution to Russian macroeconomic stability. Falling inflation, slow money supply growth, and the effective functioning of Russia=s ruble-dollar mechanisms also contributed to a period of relative ruble stability through early 1998.
In January 1998, with the ruble trading at just over 6 to the dollar, Russia replaced the crawling band mechanism with a more freely floating but still semi-managed ruble. The exchange rate policy allowed the ruble to fluctuate within 15 percent around a central exchange rate, which Russia intended to maintain at between 6.1-6.2 rubles to the U.S. dollar in 1998-2000. In July 1998, the ruble was trading at R6.2 to the dollar. On August 17, 1998, Russia widened the band within which the ruble was allowed to fluctuate, resulting in a de facto devaluation of the ruble. In total, the ruble lost 71 percent of its value in 1998, closing the year at R20.65 to the dollar.
The ruble fell to R25 and lower to the dollar in April 1999, mildly appreciated in value through early summer, but began to decline again at the height of summer. The ruble ended 1999 at R27 to the dollar.
Ruble redenomination: On January 1, 1998, Russia redenominated its ruble, introducing new bills with three fewer zeros than pre- 1998 rubles. At the same time, Russia re-introduced the kopek, valued at 1/100th of a ruble.
DEBT / DEFICIT
According to the Russian Government, payments to service domestic and foreign debt accounted for nearly 30 percent of federal budget spending in 1998. Among the measures introduced on August 17, 1998, in response to the growing financial crisis, the Russian Government announced a 90-day moratorium on some foreign debt payments. Lacking specific guideline regarding the implementation of the moratorium, banks applied their own interpretation to the measure, with some continuing payments and others stopping them all together.
Budget Deficit Russia has initially reported a budget deficit for 1999 of 1.4 percent of GDP, which is lower than the 2.5 percent projected for the year’s budget. Revised Russian 1998 figures report a budget deficit of 5.5 percent for 1998. Russian estimates of the country’s budget deficit, however, tend to be at least a few percentage points lower than international estimates. In 1997, for example, the Russian Government reported a budget deficit of 3.3 percent of GDP, but other sources, such as the International Monetary Fund (IMF), estimated Russia's budget deficit to be closer to 7.7 percent; in 1996 Russia reported a 3 percent deficit, while many other sources estimated the deficit to be 5 percent. One source of the variance is differing methods used to calculate deficit figures--Russian Government methods do not include debt service payments (interest on debt).
Wage and Pension Arrears The Russian government continues to name as a top priority paying arrears to state workers, students, and military personnel. Russian wage arrears have reportedly fallen steadily each month since October 1998. Between January 1999 and November 1999, total wage arrears fell from nearly R77 billion to R53 billion. Regional governments are said to account for more than 80% of those wage arrears. According to the Ministry of Economy, in November 1998 pension arrears totaled R30 billion, roughly equal to $1.7 billion at the time.
Foreign Debt The Russian Government maintains substantial foreign debt. Approximately $100 billion of Russia=s foreign debt was inherited from the Soviet Union -- Russia assumed all of the foreign debt of the Soviet Union in exchange for the other NIS countries abrogating any claims to the FSU=s foreign assets. The remaining amount of foreign debt has accumulated since the break- up. Russian total foreign debt grew approximately $20 billion between 1996 and 1998, to roughly $144 billion. Of the total debt, approximately two-thirds is principal, while the remaining amount constitutes interest and payment arrears accumulation.
In June 1996 the Russian Government reached a settlement on rescheduling $38.7 billion in old Russian sovereign debt to the Paris Club of creditor countries, and in October 1997 Russia was admitted to the Paris Club. In December 1997 Russia signed a closing agreement with the London Club of commercial creditors for a program to restructure nearly $32 billion of mostly Soviet- era debt over a period of 25 years.
Russia missed a number of foreign debt payments following the onset of the August 1998 financial crisis and pursued a rescheduling of its foreign debt throughout 1999. The Paris Club agreed to a 20-year restructuring plan in August 1999; enactment of this plan is contingent upon Russia’s signing of agreements with each Paris Club member. In February 2000, the London Club agreed to write off $10.6 billion in debt and to restructure the remaining debt over 30 years. Russia is expected to pay roughly $10 billion in foreign debt payments in 2000.
Resolution of the outstanding bad debt between Western government and Russian commercial creditors under the Paris and London clubs opened up the possibility of resolving the estimated $7 billion of unsecured debt owed foreign companies, as well as the recovery by 2004 of up to $12 billion from developing countries with debts to Russia. In 2000, Russia estimated that 51 countries owed Russia a combined total of $30 billion.
In late July 1999, Russia was able to meet the pre-conditions set by the International Monetary Fund (IMF), including the passage of a number of laws by the Duma, and the IMF agreed to provide a $4.5 billion credit. These funds, to be disbursed in several loan tranches, are to be used to facilitate repayment of the IMF for other funds provided. The release of the loan tranches, however, is contingent upon Russia meeting IMF requirements on structural reform; of three loan tranches to be received in 1999, Russia received only one. The IMF is not expected to release any new funds until after the March 2000 presidential elections. As of early 2000, Russia, the IMF’s largest borrower, owed the international lender more than $15 billion.
INCOME AND LABOR
Income/Wages: Developments in 1998 interrupted growth trends for nominal and real income in Russia. Russia's financial crisis had a severe effect on wages in the country. Many employees were helpless as ruble devaluation and price increases eroded the buying power of their salaries. Meanwhile, both foreign and Russian companies, faced with their own challenges stemming from the crisis, resorted to pay cuts in order to maintain what staff they felt able to keep.
Although nominal wages in Russia continue to climb, real wages in the country continue to fall. The average nominal monthly wage in January 1999 was approximately R1,200; in January 2000, the nominal wage was roughly R1,575 (about $58 at the January 1 exchange rate). According to official figures, real wages and real disposable income had fallen roughly 30 percent by the end of 1999 compared to 1997. Many mid-1999 estimates placed real incomes down 35-40 percent or more from August of 1998.
The minimum wage is currently R83 (equivalent to roughly $3 in early 2000). In December 1999, the average monthly subsistence minimum was R943 (approximately $36 according to the exchange rate in effect at the time); 30 percent or more of Russia's population is believed to be living below the subsistence level. As of February 1, 2000, Russian pensions increased 20 percent; the minimum Russian pension is R410 per month, but the average pension is R650, still below the subsistence minimum.
Russia’s well educated but relatively inexpensive labor force has been a leading attraction for foreign firms. While in the early 1990s many Western firms initially found it challenging to find employees educated in Western business concepts and practices, there is a growing pool in Russia of individuals with Western business exposure, education, and experience. Russian law requires that wages be paid in rubles. Information on salary levels for various positions in Russia is available in the regional reports on Opening an Office that are available via BISNIS Online (www.bisnis.doc.gov, click on Country Reports, Russia, and the particular region of interest).
Unemployment: Although the Russian Government has been using International Labor Organization (United Nations) statistical methods to determine unemployment, officially reported unemployment levels in Russia, as with other official statistics, have often been lower than figures determined by the international community. Russia reported several years of very slowly growing unemployment, which temporarily peaked at 9.6 percent in the spring of 1997 before dropping to a low of 9 percent at the end of 1997. During this time, alternative estimates of unemployment suggested a combined unemployment and underemployment rate of between 12 and 15 percent.
In 1998, unemployment levels resumed their climb. In the wake of Russia's financial crisis, both Russian and foreign companies resorted to layoffs and salary cuts. In November 1998, when the official unemployment rate was 11.6 percent, the Russian Ministry of Economy predicted that unemployment would grow 70 percent by 2001. In early June 1999, the Russian government reported that unemployment had reached 14.2% of the country's work force, or 10.4 million people, the highest level ever officially reported by Russia. For much of 1999, the unemployment rate hovered at 12.4 percent, or 9.12 million people. Russia closed 1999 with an official unemployment level of 11.7 percent.
A challenge in determining Russian unemployment is that many of Russia's underemployed have kept their official jobs but have worked reduced hours or have stayed on unpaid leave in order to receive social benefits and also to establish a cover for tax purposes, that is, to conceal income made in the informal sector.
ECONOMIC REFORM
Throughout the Yeltsin presidency doubt continued to rise and fall about the speed at which economic reform would proceed in Russia. Key elements of President Yeltsin's reform program were price liberalization, financial stabilization, and privatization. Yeltsin also cited additional economic goals and plans, including: a stronger government role in promoting economic growth, greater transparency in government transactions, and creation of a federal treasury, as well as improved tax collection, decreasing capital flight, and adopting economic legislation necessary to obtain further IMF funding. Four government shuffles, differences between the President's government and the Russian duma, and Yeltsin=s periodic sidelining due to health problems are among the factors perceived as slowing economic policy developments during his administration.
When Vladimir Putin assumed the position of acting president on December 31, 1999 following Boris Yeltsin’s resignation, he had not yet elaborated a precise economic agenda. In subsequent January 2000 statements, he advocated a “moderately liberal” economic policy, involving the strengthening of legal institutions, maintaining state regulation of certain portions of the economy, nonpreferential treatment of organizations, and caution in formulating policy.
Multilateral institutions continue to consult with Russia on the country=s economic reform measures. Lack of progress at implementing structural reforms has been an ongoing sticking point between Russia and groups such as the International Monetary Fund (IMF) and the World Trade Organization (WTO).
Tax collection remains a major priority, and challenge, of the Russian Government, although the country improved its collections in 1999. In 1998 tax collection reached only 78 percent of original target levels for the federal budget, and in 1997 the tax collection rate was only 70 percent of targeted levels. Tax revenues exceeded targets in 1999 and accounted for 8 percent of GDP. According to the Russian State Tax Police, five Russian regions--Moscow City, Moscow Oblast, Khanty-Mansii Autonomous Okrug (4.6 percent), Kemerovo Oblast (4.5 percent), and St. Petersburg City--account for more than 50 percent of Russian tax payments.
Price controls have been lifted on almost 90 percent of wholesale and retail goods. Although there are still price controls on certain sectors, such as housing and telephone services, and some prices remain artificially low, generally these controls are being lifted. Energy costs, for instance, have risen from between 7 and 10 percent of the world energy market price to 75 percent (wholesale domestic fuel oil only). In March 1997, the Russian Government announced that corporate energy rates would be lowered 13 percent, while consumer rates would be allowed to grow. Tariffs on railroad transportation were lowered in 1998 and again in 1999. In the aftermath of the August events, a number of regions established price ceilings for foodstuffs, but enforcing these ceilings proved difficult. In early 2000, Moscow city announced energy prices would rise 20- 25 percent.
In mid February 2000, the Russian government approved a 40 percent hike in the minimum price of vodka.
Privatization As of January 1994, 75 percent of medium- and large-scale enterprises in Russia and approximately 80 percent of small shops and restaurants (establishments with under 200 employees) had been privatized. Since January 1996, the Russian Government has reported that at least 70 percent of Russian GDP is composed of goods and services accounted for by the private sector. Early 1997 Russian Government figures reported that the private sector accounted for 75 percent of manufacturing enterprises, 85 percent of manufacturing, and more than 80 percent of the Russian workforce.
Russia has moved through four phases of privatization. Phase one began on October 1, 1992, and involved the distribution of privatization vouchers to every citizen (a voucher was roughly equivalent to the value of six weeks' worth of wages) and holding voucher auctions. The second phase of privatization, initiated in July 1994, involved the sale of vouchers of Russian companies for cash and privatization of some of the largest Russian enterprises. The third phase, starting in the second half of 1995, involved the controversial "equity-for-loans auctions." The concept behind this model was to raise long-term loans from major Russian banks in exchange for granting bankers controlling stakes in the largest Russian enterprises as collateral, together with voting and management rights. Lastly, since late 1995, Russia has been selling shares--primarily to domestic investors--of approximately 136 enterprises considered the "crown jewels" of Russian industry.
In 1997, President Yeltsin signed a decree on plans for privatization of Russia=s natural monopolies, including power and gas enterprises as well as Russian railroads. Privatization of the natural monopolies continues to be a disputed issue. During 1998 the Russian Government planned to begin the process of selling unused Russian military assets and to offer shares in a number of key companies, including Svyazinvest, Lukoil, Rosneft, and Slavneft. However, due to failed tenders, financial turmoil that postponed privatization auctions, and other factors revenues from privatization in both 1998 and 1999 were far less than expected. In 2000 Russia plans to proceed with a number of privatizations, including selling shares of Gazprom, Rosneft, Slavneft, Svyazinvest and others.
Land Reform: Russia does not yet have a land code establishing the framework for overall land reform and sale, and progress in this arena has been slow. In particular, the Russian Duma has resisted passing land reform laws, with many duma members intending to significantly restrict the sale of land, especially agricultural land. Since Vladimir Putin became Acting President, there has been speculation and mention of land reform as a Russian reform priority for 2000.
A decree on land privatization was issued in January 1992, but it was not until October 1992 that the first private plots were sold at auction. Yeltsin's decree #1767 on land of October 1993 allowed, on paper, the free sale and purchase of land to Russians as well as to joint ventures with foreign participation. Fully foreign-owned companies are not allowed to purchase land outright. In practice, however, 49 to 99 year leases are allowed on land abundant in natural resources (e.g., forestry). In May 1996 the Communist-led duma attempted to enact a land code that included measures prohibiting the sale of privately held agricultural lands or shares in private farm enterprises (preferential allowances were made for collective farms), but the Federation Council (upper house) vetoed the code. A resolution committee has been negotiating differences over the land code since that time, leaving the Presidential Decree still in effect.
Russian legislation is somewhat clearer over the ability of companies to own buildings than it is on allowing buildings' tenants to own the land upon which those buildings rest. In May 1997, Yeltsin signed a land ownership decree for urban real estate (non-agricultural lands), which was designed to make it easier for building owners to buy the land on which their real estate rests.
Russia established the basic foundation for a mortgage system though the abovementioned Decree 1767, which enabled banks to lend money to farmers. The land/property purchase/sales process has moved slowly because the real estate sector remains undeveloped. The actors that normally play an integral roll in land/home purchasing and sales in the West, i.e., real estate agents, title companies, and law firms, are in their infancy. The lack of a central land registry, which would guarantee title to a land/property purchaser, is another obstacle to the natural development of the real estate sector.