Russian Economy is Roaring Again

President Dmitry Medvedev is coming to India in early December on his first visit to this country after being elected the Russian head of state. The following article is being reproduced from New Dawn in Russia (a journal published by the Diplomatist magazine in association with the Information Department of the Russian Embassy) to present a glimpse of the rise of Russia in the economic field after the disintegration of the USSR

seventeen years ago.

When the then Soviet economy collapsed in the late 1980s, the growth rate of the country’s economy curved down into negative territory. Even in the following decade, the economy lurched from one crisis to another. Despite signs of a bit of recovery in 1998, the fragile post-Communist government could not boost the economy to stability, as the emerging markets got caught in financial melt-down.

But in a swift change, the Russian economy has grown at a real term average of seven per cent since the early 2000s. The country’s reserves have swollen from practically zero in 1998 to US$ 480 billion today. With its budget surplus of six per cent GDP along the trade surplus almost twice as much again, Russia is totally debt-free. Russia is now the world’s ninth largest economy and is still growing in rapid pace.

Dynamic Growth

Russia’s economic transformation over the last few years has been quite impressive. The country, which was almost bust around a decade ago, is now proud of being a US$ 1.3-trillion economy having foreign-currency reserves of nearly US$ 480 billion and a US$ 144-billion stabilisation fund for surplus oil and gas revenue. With vigorous exports and imports figures of US$ 365 billion and US$ 260.4 billion in 2007, the country’s trade has been in forward movement.

The GDP per capita has risen from less than US$ 2000 in 1998 to US$ 9000 today. Despite criticism from the West, the country’s entry into the World Trade Organisation (WTO), which is likely happen this year or by 2009, is being hailed widely. The Economist Intelligence Unit expects FDI inflows to remain buoyant till 2012. And the stock of inward FDI will remain 13 per cent of the country’s total GDP. The GDP growth will nevertheless continue to be boosted by high oil prices and is expected to average more than five per cent per year in real terms in 2008-12.

GDP Expansion

The robust growth of the Russian economy in the first half of 2007 was driven by the rising domestic demand. The GDP expanded by 7.9 per cent as compared to 6.7 per cent recorded in the same period of 2006. The growth continued to be driven by buoyant household consumption and business activity. Domestic consumption, which increased by 9.8 per cent in the same period, contributed around 6.7 percentage points to the GDP growth.

The country’s gross capital formation, which expanded by 28.5 per cent in the first half of 2007, contributed 4.4 percentage points to the aggregate growth, compared to only 1.8 percentage points in the same period of 2006. The booming demand combined with the real appreciation of the rouble fuelled import growth. At the same time, the real appreciation of the exchange rate is eroding competitiveness of most tradable sectors in manufacturing except resources and metals.

Investment Zone

The first half of 2007 witnssed a surging FDI that touched five per cent of the GDP. It was estimated that FDI inflow at US$ 15.8 million was recorded in 2007 as compared with the figure of US$ 6.4 million in the previous year—a doublefold increase. Segments like resource extraction, metal and trade remained the most promising areas for FDI in Russia. Mineral resource extraction industries received US$ 11.2 billion in FDI in the first half of 2007.

According to a recent estimate, Russia’s FDI will reach US$ 55-58 billion in 2008. Subsequently, the growth is expected to attain US$ 56-62 billion in 2009, US$ 60-67 billion 2010 and US$ 65-73 billion in 2011 respectively. And in a report by the Economics Ministry, it was forecast that net capital inflow into the country would increase from US$ 52 billion in 2009 to US$ 105 billion in 2011.

Oil and Gas

According to the Institute of Economic Analysis, the share of oil and gas in Russia’s GDP rate increased 12.7 per cent in 1999 to 31.6 per cent in 2007. Natural rsources account for 80 per cent of exports. Like a powerful drug, oil money has masked the pain caused to the Russian economy by the Kremlin. Oil would now be way above US$ 150 a barrel, rather than close to US$ 100.

Rory MacFarquhar of Goldman Sachs estimated the Russian economy growing on average at 27 per cent a year, the fastest of any big economy since 2000. In this respect, the flow of petrodollars is fanning a massive consumption boom, making Russia the sixth largest market in Europe. The country’s disposable incomes have been growing twice as fast as the GDP.

Manufacturing Sector

Russia is now far more than ‘just an oil and gas economy’. The country’s manufacturing sector is booming at large. For instance, the retail sector is growing tremendously at an averae rate of 13 per cent a year in real terms. In the period January-September 2007, growth in the manufacturing sector recorded a healthy rate of 10 per cent as compared to just 4.4 per cent over the same period in the previous year. However, the magnificent growth record of 12.5 per cent achieved in the first four months of 2007 was not sustained in the rest of the year.

The steep growth in the country’s manufacturing segment was accelerated by temporary factors, including particularly low level of manufacturing in the first quarter of 2006 and an exceptionally large increase in infrastructure orders for machine-building. Even an unusually warm winter also contributed to explain the strong growth in the sector in early 2007.

Power Industry

The country’s power sector is enticing as it is one of the world’s fastest growing industries. In some parts of the country, including the areas where OGK-5 has power plants, the annual power demand increased by six per cent over the last few years. And most of all, Russia is the world’s fourth-largest power market.

Until recently, most of the country’s power plants were in the hands of state-owned Unified Energy System (UES). But the government has separated generation from transmission and retailing. UES power plants have been divided among six competing wholesalers and 14 regional generators. These OGKs and TGKs are all being sold to private investors to finance an overhaul of the country’s rickety grid that will remain in the hands of the state.

IT Sector

The information technology (IT) sector, swaggering with an annual growth rate of 25 per cent, is still considered to be a small market but multinational players like SAP, T-System and TietoEnator have all beefed up their Russian presence. And the Russian enterprises are quickly improving their attitudes to IT.

The domestic IT services market is dominated by large local systems integrators, namely, IBS, Croc, TechnoServ and LANIT. In terms of scale, among the top 20 IT companies in Russia, just three companies are non-Russian (HP, SAP and IBM Global Services).

The Russian ICT market is still playing a catch-up game with Western Europe. But it appears that Russian enterprises are quickly improving their attitudes to IT. Boris Volpe, Marketing Director at SAP Russia, reveals that business in the first nine months of 2007 grew considerably, and that the combined Russia and CIS region now stands as SAP’s third largest market behind the US and Germany.

Software and Hardware Markets

Though Russia has the fifth-highest software piracy rate in the world (87 per cent), BMI expects that government efforts to strengthen IP protection as part of the WTO entry will see this decrease closer to average Eastern European levels, boosting the market to US$ 2.6 billion by 2010. The software and implementation service share of the Russian IT market is growing steadily having exceeded 44 per cent in 2007, according to the MITC.

According to the Ministry, in 2007, the software market value reached 80 billion roubles (US$ 3.232 billion), which is a 40 per cent increase as compared to 2006. The significant increase in demand for software and implementation services inside Russia recorded in 2007 relates to a large extent to the initial market saturation and development of projects on implementing management systems in the medium and small business.

Computer sales grew strongly in 2007; the true numbers are hard to ascertain because around 20 per cent of PCs sold in Russia are self-assembled. The hardware market grew from around US$ 5.5 billion in 2006 to US$ 6.9 billion in 2007, according to BMI’s estimates.

In February 2007, the MITC launched a new ‘computer for every home’ programme. With average monthly earnings at around the US$ 400 level, people in remote regions will be able to order computers at a set price of around $ 300 at least 10 per cent below the lowest market prices. Russian as well as foreign manufacturers may participate in the scheme, and schools are also permitted to take advantage of the programme to acquire computer equipment.

Fiscal Policy

The government spent 3483.7 billion roubles (15.4 per cent of the GDP on cash basis) compared to 14.8 per cent during the same period in the previous year’s stipulated budget low for 2007.

Effective progress was achieved in budgetary management reforms in 2007. Russia introduced many fiscal management innovations, including treasury management of the budget; medium-term (three-year budget) fiscal framework; and, oil revenue management funds (Oil Stabilisation Fund and a National Welfare Fund that will accumulate oil revenues beyond a ‘reserve fund’ of 10 per cent of the GDP).

The measures were discussed in detail in the previous RER (June 2007). In turn, the fiscal stance has become increasingly relaxed. Medium-term fiscal framework entails a fiscal relaxation that under the current oil price outlook envisages a balanced budget in 2009-10.