With the United States clearly in a recession, Latin America sliding into a deep crisis and Asia feeling the jitters of a global crisis, Russia still stands out on the world economic scene as nearly a success story. The country is paying off its foreign debt on time, plans no new foreign borrowings next year and still expects the economy to grow this year around 4 percent.
But not everything is so bright, economists are saying, pointing to the slowing growth, declining investments and the first signs of fiscal problems. The cure is deeper and faster reform, they say. But with looming parliamentarian and presidential elections in 2003 and 2004 respectively, it appears that there is lack of political will to make the painful decisions needed to push the reforms forward.
"The number of warning lights that have started flashing in the last several months is concerning, despite the apparent health of the basic ratios," Roland Nash, head of research with Renaissance Capital investment bank, said commenting on Russia's latest macroeconomic figures.
"First and most widely recognized, slowing growth. Industrial production growth has fallen from 5.5 percent in the first half of 2001 to 3.1 percent in the first half of 2002. While recovery in the service sector has partly disguised this in the GDP figures, headline growth is down to 3.7 percent in the first half of 2002 from 5.3 percent last year."
Unlike in other emerging markets, in Russia economic growth is fueled mostly by the energy sector, which has been benefiting from relatively high commodity prices on the global market.
"The current growth mechanism is not sustainable in the long term," Troika Dialog investment bank commented in the most recent economic report. "In this regard, Russia is at crossroads: if it can modify the existing growth mechanism, then higher and more sustainable growth rates are perfectly plausible in the long term. If not then growth is likely to continue its decline," the report added.
Most of investments attracted into Russia in the last few years went into the development of mineral resources or came from the energy sector.
With commodity prices volatile and generally falling, it is not surprising to see investments declining as well. While domestic investment rose 18 percent in 2000 and 15 percent in 2001, in the first half of this year investment rose only 2 percent. "The level of direct investments remains appallingly low," Peter Westin, senior economist with Aton investment bank said. "So far Russia has attracted about $22.4 billion in accumulative foreign direct investments, which comes to about $150 per capita, compared to over $2,000 per capita for countries like Hungary, the Czech Republic and Estonia. For many observers this remains somewhat puzzling, as Russia has enjoyed several years of economic and political stability," he added.
Westin also said despite upbeat statements by Russian officials about capital coming back into Russia, capital flight remains high. In the second quarter this year, it amounted to $2.7 billion, which is a reduction from the first quarter's $3.5 billion, but 15 percent above the first quarter 2001 level. According to Westin, since 1994, $114 billion or almost $800 per capita has left Russia. Westin said: "President Putin recently called for the government to consider the implementation of amnesty for individuals bringing money back from foreign held assets. However, amnesty alone will not accomplish this. The indisputable prerequisite for halting capital flight and attracting flight capital back in large numbers is the creation of investment opportunities and an improved investment climate."
The strengthening ruble is also hurting the economy, analysts said. "With real appreciation at 8 percent a year and wage increases at 20 percent – add to this increased utility tariffs – Russian companies either have to sacrifice profits or price themselves out of the market," Peter Lavelle, a Western economist based in Moscow, wrote recently in The Russia Journal. "The latter increases inventories and lowers demand – and eventually lowers industrial output. The incentive to delay payments is obvious." For the first time since the 1998 devaluation, the non-payment and barter deals are again becoming serious problems.
But in many respects Russia is doing better than some of its emerging market peers.
In July, the Standard & Poor's international ratings agency upgraded Russia's sovereign long-term local and foreign currency ratings to BB- from B+. At the same time, Standard & Poor's affirmed its single-B short-term local and foreign currency sovereign credit ratings on Russia. The outlook on the sovereign's ratings has been revised to stable from positive. According to Standard & Poor's, the stable outlook reflects the expectation of sustained prudent fiscal and debt management, and further progress in reform implementation.
Russia is now standing two notches below investment grade and this helps Russian companies to borrow abroad at relatively cheap rates. "A positive development with a negative twist is the increase in capital in the second quarter brought in by non-financial private enterprises, amounting to $4 billion compared to $2.5 billion in the second quarter last year. About half of the inflow was in the form of foreign loans taken by Russian companies," Westin said. "The fact that Russian companies are able to acquire foreign loans is clearly a product of increased transparency and corporate governance.
However, the negative aspect of the increase in foreign loans to Russian companies is the lack of access to domestic financing." Banking reform still has to get off the ground, considering that only 3 percent to 4 percent of capital investments are financed by bank loans. Investors are also concerned about slow progress of structural reforms, the restructuring of gas giant Gazprom and UES power grid monopoly, as well as the full implementation of production sharing agreements.
Reforms have begun in key areas including tax, the natural monopolies, land, labor market and deregulation of economy. But the results may fail to impress, analysts said.
"Certain regulations were found to be inconsistent, requiring a number of amendments to be passed, some of which have and effect of creating instability and hampering the business climate," Troika Dialog said. "The presence of unreformed public administration has also impeded the general reform process.
"The government has been ordered to develop concept for administrative reform by end 2002, but with the 2003 budget already formulated, actual restructuring is unlikely to start before 2004. As a result, progress on reforms through end 2002 and 2003 is likely to be gradual and growth rates moderate."