PART 4: RUSSIA'S ECONOMY |
46. The Committee's attention was drawn to advances
already apparent in the transformation of the Russian economy.
Nevertheless, witnesses also recognised, as have President Putin
and the reformers, that the Russian economy is growing at too
slow a rate to compensate for chronic under-investment since the
mid-1970's. Indeed, Russia needs to grow at least twice the current
rate (less than 4 per cent) to catch up with the poorer countries
within the EU. Russia is classified by the World Bank as a "lower-middle-income
economy" alongside countries such as Albania, Peru, Guatemala
and Egypt. Its gross national income per capita (GNI), for instance,
now stands at one half that of Portugal.
It is equally apparent that the level of growth pivots precariously
on the production of raw materials (most notably oil and gas),
whose prices are subject to world market volatility, rather than
the more stable axis of manufacturing and services.
47. Moreover, the task of modernising the economy
has been complicated by the need simultaneously to sustain electoral
support among a population sceptical that the sacrifices required
will result in the promised reward. The tension between these
Russian attitudes and the needs of the country creates a major
challenge to the political leadership. The path of reform will
be long and difficult; but a great deal is at stake.
48. A crucial element underpinning the resurgence
of the economy since the financial crisis of 1998 has been the
emergence of political stability under President Putin. The Head
of the Russian Business Unit at BP Mr. Scott Kerr advised: "The
biggest move over the past few years has been to economic and
political stability in Russia, which has allowed people to invest
in very long-lead projects such as oil and gas and be assured
of a return." (Q357) The Director of Sovereigns Group, Fitch
Ratings, Mr. Edward Parker went further: "the consolidation
of the power of President Putin over the Duma, over the regions,
over the business oligarchs, and, perhaps, less encouragingly,
over the media, have been an important factor in improving stability
in Russia and reducing political and economic risk." (Q322)
Russia's Fitch Rating
is currently BB-, this is three notches below investment grade.
49. Much has therefore come to depend upon Putin's
presence and his persistence in accelerating change. In turn his
own continuation in power has come to depend upon the success
of reform. This symbiosis is both reassuring and worrying. Putin's
close identification with change will, we hope, ensure its success.
Nevertheless if the reform process yields mass unemployment and
social deprivation he will become vulnerable to any credible opposition.
The political hurdles of parliamentary elections (due in December
2003) and presidential elections (spring of 2004) have to be overcome
before the more radical elements of the reform programme can attain
their full potential.
50. For the President the present institutional
obstacles to economic progress are critical. In his annual address
in 2002 he railed against "the cumbersome, clumsy and ineffective
state apparatus" which was blocking the "colossal potential
of the country." It was, he argued, "conducive to corruption...Any
administrative barriers are overcome with the help of bribes.
The higher the barrier, the more bribes and the more officials
that take them."
51. President Putin's focus on bribery was echoed
in evidence we heard. Professor Archie Brown of Oxford University
told the Committee that "Business tycoons find it much more
reliable to buy state officials, whether in the presidential administration
or in ministries, than to rely on the law courts." He added
that this was "a huge disincentive to foreign direct investment
because foreign companies do not have the same contacts, they
may have a greater unwillingness to bribe officials, and they
will then see themselves at a disadvantage in the Russian market."
(Q6) Former Deputy Prime Minister and Finance Minister of Russia
Dr. Boris Federov recalled that the Swedish furniture chain IKEA
spent several unrewarding years negotiating for land with the
local authorities in Moscow. "Basically, everybody was asking
for bribes. These people did not want to pay, and that means they
started their shop four years later than they could have done.
I think that is damaging the Russian economy." (Q507)
52. At present bad practice in Russia is easy
to hide. Managing Director of Lazards Mr. John Shakeshaft cited
the "wonderful letter from Anatoly Chubais, who has, after
all, been described by Federov as 'the darling of the West' on
privatisation, refusing to disclose his salary as President of
Unified Energy Systems of Russia (UES)
on the grounds that it is a state secret." (Q329) It was
initially expected that greater integration with the West would
improve standards. Never the less significant problems remain,
as instanced by the gas monopoly, Gazprom. Seven of its companies
(Purgaz, Rospan, Tarkosaleneftegaz, Sibneftegaz, Achimneftegaz,
Vostokogaz and Severneftegaz) accounting for nearly 10 per cent
of its reserves and worth $5,805 million to Gazprom were sold
off for a mere $325 million (a loss of $5,480 million). As a result
investors called for an independent audit. Instead Gazprom requested
a confidential audit from its own auditors, PricewaterhouseCoopers
who, it is reported, remarkably, gave it a clean bill of health.
This was not the only example of doubtful practices highlighted
by concerned Western investors.
53. In calling for the rule of law the Kremlin
is fully aware, after a decade of mixed results from extensive
legislation, that "adopted laws often contradict each other."
Moreover, laws without enforcement are useless. The problem in
Russia, former ambassador to Moscow Sir Rodric Braithwaite told
the Committee, "is that getting good laws is not difficult;
getting good laws implemented is very difficult" (Q88) even
though President Putin has stressed the importance of cracking
down on "racketeering, administrative lawlessness and corruption,
the protection of the rights of owners and manufacturers."
54. A further problem for economic growth has
been the chronic weakness of the banking system. Atomised and
under-capitalised, it is "one of the most disappointing areas
terms of economic reforms." (Q311) Progress has begun, however,
with the resignation of Mr. Viktor Gerashchenko and the appointment
of Mr. Sergei Ignatiev as head of the Central Bank. Ahead lie
the introduction of compulsory International Accounting Standards
in 2004, followed by a mandatory deposit insurance system and
the raising of capital requirements (10 per cent by 2005).
55. Reluctant investors from abroad mostly allude
to the above issues when explaining the low level of inward investment
and the persistence of outflow, including illicit capital flight.
Capital is in short supply in the Russian market. This has mostly
been due to capital flight since the collapse of the Soviet Union
and the breakdown of stringent controls on external trade and
foreign currency movements. Professor Mario Nuti of the London
Business School estimates flight as "of the order of $25
billion a year" since 1994. (Q5) Initially this appeared
to indicate widespread anxiety lest the Communist Party regain
power and drive Russia back into the command economy. Since the
end of the 1990's and with the consolidation of democracy, reforms
had advanced sufficiently to ensure that the route back to Communism
was securely blocked. Dr. Federov assured the Committee that "Since
1996 the chances of really going back have been absolutely nil.
The question is, how quickly and comprehensively and how civilised
the progress will be." (Q489)
56. All in all, it would be a mistake to conclude
that no progress has been made. Larger Western companies like
BP, which can deal at governmental level, are now confident that
they can operate in the new climate. Even smaller companies such
as software producer Delcam Plc, which centres its activities
in Ekaterinburg in the Urals, can work to profit "if one
plays the game right and knows who one is dealing with
according to its Managing Director Mr. Hugh Humphreys. (Q227)
Expert assistance from the embassy in Moscow has played its part.
It is, however, a cause for regret that Britain is less of a presence
among small and medium size enterprises in Russia compared with
Germany and other European competitors.
57. The continuation of capital outflow has logically
to be taken as a lack of confidence in the ability of the economy
to deliver profit rather than fear of reversion to the past. Improvement
here, however, is now noticeable. Professor Philip Hanson of Birmingham
University told the Committee "that at the margin what we
are seeing is a stabilisation or even slight fall in that capital
flight, and a considerable increase in domestic investment."
(Q4) Thus, as reform succeeds, capital will return. The market,
in that sense, rules. The EU, therefore, can do little directly
to help. It is through indirect meansby bolstering the
platform of reformthat the EU and Member States can do
most to facilitate greater inward investment.
29 World Bank Development Indicators Database
(World Bank, August 2002). Back
Fitch Ratings is an international rating agency with a presence
in 75 countries. International credit ratings assess the capacity
of states, for example, to meet foreign currency or local currency
commitments. Investment grade ratings of international long-term
"AAA" to "BBB" categories indicate a relatively
low probability of default, while those in the "speculative"
or "non-investment grade" categories, international
long-term "BB" to "D", either signal a higher
probability of default or that a default has already occurred. Back
Annual Address by President Putin to the Russian Federal Assembly,
Moscow, 18 April 2002. Back
Unified Energy Systems of Russia-Russian joint stock company established
Gazprom Gifts to ITERA "Review of PWC Audit of Itera",
March 2002. William F Browdes, Chief Executive Officer, Hermitage
Capital Management. Back
Meeting Report "Gazprom and Itera: A Case Study in Russian
Corporate Misgovernance" - Carnegie Endowment for International
Peace 22 March 2002. Back
For details: Carnegie Endowment for International Peace, Meeting
Report-Gazprom and Itera: A Case Study in Russian Corporate Misgovernance,
18 March 2002. Available at www.ceip.org. Back
Annual Address to the Duma by President Putin, 18 April 2002. Back
Annual Address to the Duma by President Putin, 18 April 2002. Back
National Investment Council, The Problem of "Capital Flight"
from Russia and Ways to Repatriate it to Russian Economy,
ed. S Glinkina et al. (Moscow 2002). Back
The range of obstacles created by over-regulation remains formidable.
The details of an extensive survey can be found in a recent publication
from the Center for Economic and Financial Research and the World
Bank, Monitoring of Administrative Barriers to Small Business
Development in Russia, Round 1. Back