RUSSIA is back. She is certainly back in the headlines. BP's recent $6.75 billion (£4.2 billion) foray into the country's oil industry was the largest foreign direct investment in Russian history. It was followed by the announcement last week of a $250 million project by Renault to build cars in Russia. Bentley, the luxury carmaker, has even opened a showroom next to the Kremlin.
With such prestigious names putting their faith and their money back into Russia, optimists have been falling over themselves to designate 2003 as the year when investors finally put the disastrous 1998 crash behind them. Economists see good cause for such optimism but caution that all in Russia is not as it seems.
By common consent, Vladimir Putin's management of the Russian economy has been impressive. Although growth slowed to 4.3 per cent last year — the fourth successive year of growth — Russia remained among the most rapidly growing economies in Europe. At $31.7 billion, the current account surplus was almost 10 per cent of gross domestic product (GDP). Russia's budget surplus in January was 4.5 per cent of GDP. In 2002 the benchmark share index, the RTS, rose 38 per cent. If Tony Blair or George Bush could boast such figures they would probably throw a party.
"Macroeconomically, Russia is pretty well managed at the moment," Willem Buiter, chief economist at the European Bank for Reconstruction and Development (EBRD), says.
"It is clear that the situation today is vastly improved compared to early 1999 after the Russia collapse. The BP investment is just a confirmation of that improvement."
The cynics have long argued that the improvement in Russia's economic fortunes is all down to the surge in the oil price in recent years. Few could dispute the significance of oil to the Russian economy. Almost all of Russia's major companies are in the energy sector. And with oil prices hovering about $30 a barrel (the state budget assumed prices per barrel at just over $20) Putin has clearly been blessed with good fortune. Mikhail Kasyanov, Russia's Prime Minister, once estimated that for every $1 drop in the price of oil, the Russian economy risks losing as much as $2 billion.
The International Monetary Fund (IMF) is quick to point out that windfall gains have been squandered by many countries in the past. Responsible economic managment in Russia has ensured that oil money has been wisely used. "If the Government had not in effect saved much of the higher oil revenues by running large fiscal surpluses, the rouble would have been much stronger and this could have choked off the recovery," Poul Thomsen, the IMF's head of mission in Moscow, says.
This kind of praise for the Russian Government's economic management has become the consensus in recent months. But no one underestimates the economy's weaknesses or the challenges that lie ahead. In important respects the core problem is balance, or rather the lack of it. BP's investment itself is illustrative.
Thomsen says: "It is still an economy where a handful of huge companies, almost all in the energy sector, account for most of the growth. So the economy is still extremely vulnerable to a downturn in the oil price. The economy needs to be more diversified and in order to achieve this reforms need to improve the investment climate outside the energy sector.
"Particularly important in this regard are reforms of banking, natural monopolies and the civil service and state administration."
Balance is also lacking between Moscow and the regions across Russia's 11 time zones: "The vast majority of foreign direct investment has been concentrated in the Moscow region. There is a high degree of inequality between average incomes in the Moscow area and the rest of the country," Laza Kekic, director of the East European department at the Economist Intelligence Unit, says.
Official figures show that more than a fifth of Russia's 145 million people live at, or below, the subsistence level. This means that poorer parts of Russia risk being locked into a vicious cycle where low disposable incomes act as a disincentive to foreign investment, particularly in the consumer sector. The poor become poorer, the rich richer.
There have also been signs that Russia's hitherto solid growth rates may be slowing. The IMF last week cautioned that the economy would grow by just 3.5 per cent this year compared with government forecasts for 4.2 per cent. Inflation, currently running at 14 per cent, continues to erode competitiveness and there are fears that the pace of structural reforms has slowed in the run-up to parliamentary elections in December and the presidential elections in March 2004.
"Implementation is of course the Achilles' heel of government reform everywhere and in Russia it is definitely the source of remaining concern that those who look at the country's many opportunities keep in mind before they take decisions," Buiter, at the EBRD, says. "Russia without significant reforms is in danger of becoming an enclave economy. They have high productivity, wealth-oozing islands of prosperity in an otherwise investment starved industrial structure. It must get diversification away from the extractive sectors or I think Russia's longer-term prospects as a modern, mature industrial state will not be realised. It's a critical juncture."
Appraising the Russian economy, its record and its prospects, is largely a question of whether one sees the cup as being half full or half empty. The scale of the BP investment was impressive by any standards. But since the end of communism total foreign direct investment in Russia has amounted to not much more than $20 billion. Last year alone, China drew in $53 billion. The economy has done well in recent years but real GDP still stands at a mere 64 per cent of 1989 levels. Central and Eastern Europe has already surpassed its starting point. Poland's economy stands at 129 per cent of its size in the last year of communism.
Even the oil sector may not save Russia in the long term. It is the world's second largest oil exporter, just behind Saudi Arabia. But unlike Saudi Arabia with proven reserves of more than 250 billion barrels, Russian reserves are estimated at just 50 billion barrels — another reason why international institutions are so keen to see greater economic diversification.
Solid economic management in Russia has also been pushed through at the price of a near emasculation of checks and balances in the political system. The chaotic relationship between the Duma and the presidency which did so much to wreck fiscal discipline in the 1990s may be over. But that is because the Duma is now little more than a talking shop. Few observers of Russian history can fail to see the irony that economic progress has been underpinned by increasingly authoritarian rule.
And not even authoritarianism has so far managed to root out corruption, one of the major obstacles to general economic development and foreign investment in particular. The world's leading anti-corruption agency, Transparency International, last year ranked Russia the 71st most corrupt country among 102 countries surveyed. Russia was given the same overall ranking as Zimbabwe.
More broadly, the Russia problem for foreign and domestic investors alike can be summarised in one simple question: What happens next? As Vaclav Klaus, former Prime Minister of the Czech Republic and Eastern Europe's most loyal disciple of Margaret Thatcher, never tired of saying in the 1990s: the post-communist reform process is historically unique. Many countries have embraced capitalism but, prior to 1989, none had ever taken that route from a socialist starting point. The governing assumption of the 1990s that Russia is inexorably locked on course for transition to Western-style democratic capitalism remains just that, an assumption.
Even in the second decade of reforms, it is by no means clear that the models and methods used by economists in the West are appropriate for countries such as Russia. For foreign investors, humility, caution and in-depth knowledge of the local environment are prerequisites to success.
Russia may have moved far from the dark days of 1998. But much remains to be done and the smarter observers are aware that they cannot be entirely sure how and when it will be accomplished.