The Economist forecast for RussiaKey indicators 2008 2009 2010 2011 2012 2013

Real GDP growth (%) 5.6 -3.0 2.0 4.0 4.4 4.6Consumer price inflation (av; %) 14.1 13.5 10.4 8.5 7.4 7.0Budget balance (% of GDP) 3.6 -8.0 -3.0 -1.3 -0.8 -0.7Current-account balance (% of GDP) 5.9 -2.2 -0.6 -0.5 -1.0 -1.5Central bank refinancing rate (end-period; %)

13.0 12.0 11.0 9.0 8.5 8.0

Exchange rate Rb:US$ (av) 24.9 36.0 36.7 36.8 36.9 37.1Exchange rate Rb:€(av) 36.5 48.1 50.8 52.1 53.4 54.5

Real Currency Appreciation Productivity growth in exporting sector (oil) leads

to 1)higher wages in the whole economy and to

higher prices for non-tradables (hair-dressers) inflation

2) Diffusion of rents from productivity gains in exporting sector to the rest of economy higher living standards

(Balassa-Samuelson effect )

• Real appreciation of ruble 2000-08:– Ruble inflation 12% – Dollar inflation 3%– Stable exchange rate, Rb 28 = $1 till 2008

• Consequences:– Imported goods more affordable– Export industries hurt by

lower international demand– Loss of terms-of-trade advantage– May slow down economic growth

“After the big bang” by Hoff and Stiglitz

• “Rule of law”: • enforcement of property

rights in a reasonably neutral and predictable way

• In 6 economies where property rights are most insecure, official GDP contracted by > 30%

How to Exploit Energy• Energy (and resources) key to Russia’s role

– Russia should focus on its abundance, but how?• Two approaches

Top-down• Oil is a strategic asset• Secrecy, government direction, control of

pipelines• View of energy as rent to be exploited• Energy as foreign policy resource• Useful for propping up dinosaurs

Bottom Up• Market driven, private ownership• Maximize number of actors involved• Competition• Share in world technology • Develop complementary industries • Rule of law, functioning institutions, less

corruption

Russia’s Future Role in the World Economy

• Strong commodity demand is good for Russia

• Russia needs FDI to exploit its energy resources– But political uncertainty needs to be

reduced

• Russia needs to choose the correct approach

• Putin’s dilemma– State control of energy provides state power– Market control can double GDP

Legal system•Democratic market-oriented laws exist• Institutions to enforce them are weak

– No good guarantees of ownership • 1990s: contracts enforced by thugs with guns• 2000s: more businesses turn to courts to

resolve disputes– Police: under-funded, under-staffed, corrupt– Crime and corruption is costly for businesses– Inhibits investment, domestic & foreign

•Judges and lawyers – poorly paid, vulnerable to corruption– no independent judiciary system - prosecutor's

office, courts & police are subordinate to Kremlin •Merger of businesses and authorities

– Every bureaucrat represents business interests•No public control over secret services and

law enforcement• http://www.transparency.org/news_roo

m/in_focus/2008/cpi2008/cpi_2008_table

Russia’s 2005 corruption ranking by Transparency International: 126 of 159 countries

Russian Trade

Main exports 2007 % of total

Main imports 2007

% of total

Oil, fuel&gas 65.2 Machinery&equipment 43.9 Metals 13.5 Chemicals 12.0 Chemicals 5.5 Food/agricul prod 11.7

Machinery/equipment 5.0 Metals 6.6

Major markets 2007

% of total

Major suppliers 2007

% of total

Netherlands 12.1 Germany 11.9 Germany 9.6 China 10.9 Italy 7.8 Ukraine 6.0 China 5.0 US 4.2

Share of CIS countries in trade: 17% Share of EU in trade: 52%

•Factors that restrain demand for imports:

– import duties, 18% value-added tax and excise taxes on automobiles, alcoholic beverages, aircraft

– import licensing regime (alcohol) –frequent unpredictable changes in customs

regulations–unofficial transit payments• Getting a lorry-load of goods from Armenia to Russia

means paying $2,000 for “security”. • Half of the price of shipping a container from Rotterdam

to Georgia = unofficial transit payments through Georgia.

• Clearing customs in Tajikistan requires 18 bits of paper from different government agencies.

"BRIC“ emerging markets• preferred markets for growth in the 21st century

– meant to grow faster– turned out to be more volatile, less liquid, dangerous

• 250 Russian stocks are listed locally or abroad– significant premiums for the country political risk, corporate

governance, size and– currency risks– http://www.rts.ru/en/

• IPOs: Russian companies prefer to list in London– insurance against political risks or unauthorized claims from

state officials• authorities less willing to pursue companies with foreign

investors– hard to raise more than $500m in Russia

• shortage of institutional investors, - private pension funds & insurance companies - able and willing to buy long-term instruments

• savings rate among Russians 13% of income– greater recognition and visibility – desire obtain a market valuation of their worth

20% starting 2009

Intellectual property rights• Copyrights

– Pirated are 80% DVDs, 60% of CDs– 2008: allofMP3.com shut down, US companies dropped

charges

• Trade mark violations• Counterfeiting

– Consumer goods, tobacco, alcohol• Smirnoff vodka owned by US United Distillers and Vintners• Phillip Morris

– >25% products are counterfeits

Intellectual property rights• http://www.wipo.int• http://www.cipr.org• “Underrated public policy priority”

– Weak laws and penalties, no criminal convictions– Need stricter standards for WTO membership

• Deliberate inaction by Russian government– Crackdown is costly – Benefits? – who is hurt?

• foreign firms, Russian firms, consumers, government?

Demographic Crisis• Fertility rate

– 1986-7: 2.19 births per woman – 2001-2: 1.3 births per woman

• 1981 – 2001: • 30% drop in marriage rates • 30% increase in divorce rates

• Challenge of shrinking population:– post-war “baby boom” generation retires - workforce

drops – firms need employers – GDP falls

• Measures: plan $140bn spending over 20 years on

– financial support for families with > 1 child– education programs to reduce abortions and alcohol-

induced deaths, car accidents and unhealthy lifestyles

• Low life expectancy– Tobacco, vodka, poor diet – Environmental pollution – HIV/Aids – Poor health care – Stress of transition – unemployment, loss of status – Road accidents

Male Life Expectancy: Russia vs LDC’s

Moscow vs. Rest: Life Expectancy

55.0

57.0

59.0

61.0

63.0

65.0

67.0

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

Moscow Rest of Russia Karelia

A male child born as a legal resident of Moscow in 2001 could expect to live 7.2 years longer than a male born elsewhere in Russia, and 9.1 years longer than one born in Karelia

Foreign Direct Investment in Russian Industry

0

1,000

2,000

3,000

4,000

5,000

1997 1998 1999 2000 2001 2002 2003 2004*

USD millions each year

Oil

Machine-Building

All other industry

* 2004 figures are an extrapolation of J an.-J une results.

Investment• FDI in Russia $16.7 bn in 2005, 3% of GDP

– Poland: 5% of GDP– Coca-Cola: purchased St.Petesburg juice

company for $600 mil– Heineken: purchased Russian companies, $750

mil– Toyota and Volkswagen– Nestle, total investment in Russia $500 mil

• Russian companies increased foreign investments– Lukoil owns >2,000 gasoline outlets in US

• 2005: net capital inflow $300 mil– Net outflow by individuals and private non-

financial companies – Inflow by banks and state-owned companies

• Domestic investment financed not through bank loans but from retained profits slower investment growth– Problem: Weak banking system

Problems foreign direct investors in Russia

Starting with the most pressing:• Inadequate and ever changing tax law• Property and creditor rights• Customs• Risk of political change• Macroeconomic instability• Weak banking sector• Russian accounting system• Corruption • Risk of expropriation• Harassment from federal and local government• Payment arrears from clients • Problems with workforce or management• Russian suppliers• Crime, racket • Barter

Investment Rates in Selected Economies, International Prices

10

20

30

40

1970 1975 1980 1985 1990 1995 2000

CHINACZECHJAPAN

KOREARUSSIA

Shar

e of

GD

P

• Chechnya: separatist rebellion, 1994-2006 – Putin’s tough line

popular among Russians

• Support US-led campaign against international terrorism

• Opposed US action against Iraq and Iran

• Xenophobic nationalism– Racism against

Caucasians, Central Asians and Africans

Other Concerns

Climate Change

• Rising Sea Levels• Melting Permafrost• Increased Precipitation

Rising Sea Levels

• Russia’s total coastline = 37,653km

• Northeast corner of Russia is losing 15 – 18km a year.

• Will require villages and settlements to move.

Impact of Climate Change: Melting Permafrost

• More than ½ permafrost area can thaw by 2050

• Melting permafrost released methane and greenhouse gases.

• Houses and building collapse

• Roads and infrastructure more expensive to maintain.

Arctic Permafrost boundary will move north. May have big implications for oil, gas, and other investment projects.

TundraTundra will gradually shrink. As a result, millions of animals will loose up to 50% of their habitat.

TaigaWarmer. Less energy costs for habitants.

Impact of Climate Change: More Precipitation

• 20% increase in the winter.

• 10% increase in the summer.

• Floods could happen

• Greater climate instability will cause more rains near Caspian deserts, and more drought years strong winds and dust storms.

Climate Impacts Industries - Oil

Pros

• Easier to drill for oil with melting permafrost.

Cons

• Expensive underpinning of refineries.

• Increase costs of pipeline construction because extensive trenching needed to combat the effects of coastal instability and erosion.

• Increase costs of oil extraction.

Industries - Timber

Pros

• Easier to get to forests with warming temperatures.

• Extended seasons will allow for additional harvesting.

Cons

• Ecosystems will not have time to adapt to the changes causing outbursts of forest diseases.

Services - Transportation

Pros

• Melting of the Arctic will prolong both the Northern Sea and Siberian river navigation seasons.

• New opportunities for shipping of resources.

Cons• Improved navigational

aids will be needed.• Harbor facilities will

have to be developed.• New road

infrastructure will need to be constructed.

• Maritime laws will need to be adapted to increased shipping.

Services - Tourism

Pros

• With the increase in temperatures Russia could see an 30% increase in tourists.

Cons

• Will require adequate infrastructure to be developed.– Runways– Roads– Buildings

Regional Income Disparities

Real Incomes in Some Russian Regions

Internal Migration in Russia and the U.S. Percentage of total population that moved from one oblast/state to another each year

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

1992 1994 1996 1998 2000 2002 2004

United States

Russia

• Problem is lack of labor mobility– Too much industry in the wrong places– Very important due to lack of capital

mobility

Economic Priorities• Vulnerable to swings in world prices of oil, natural gas,

metals, timber– High-technology & consumer goods = small part of economy– Diversifying the economy away from commodity dependence– Innovation

• Need more investment– Massive lending of foreign banks to large oil and gas companies– Smaller companies and other industries short of cash

• Poor infrastructure in regions– South Russia has better climate but high corruption– Poor medical care– Bad roads

• International business– Forbes Best Countries for Business Rank – Reducing political uncertainty – Reducing the state's role in the economy

• Travel restrictions for foreigners• Poverty: 20% of population

– monthly income under 1,000 rubles ($35)