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By Vladimir Radyuhin
AFTER A disastrous decade under the former President, Boris Yeltsin, Russia is finally on the way to economic revival, demonstrating in the past four years the highest growth rates in half a century. When Mr. Yeltsin appointed Vladimir Putin Prime Minister in August 1999 before resigning in his favour five months later, the economy began to show signs of revival, but it was still more dead than alive. Mr. Yeltsin's "shock therapy" reforms proved all shock and no therapy. The attempt to leapfrog from the statist socialist economy into the capitalist market relying on the advice of the International Monetary Fund led to economic and social catastrophe. Deregulated prices soared, wiping out savings, the largest privatisation of state assets in world history created a handful of commodity-sector billionaires and a vast majority of impoverished people, and the opening of the domestic market to imports killed off much of the local industry.
The economic devastation Russia suffered in the 1990s was even worse than during World War II. During 1940-46, Soviet industrial production fell 24 per cent. In 1990-99, the fall was almost 60 per cent, while the GDP fell 54 per cent. The crippling financial crisis of 1998 signalled the collapse of a pseudo-market economy Mr. Yeltsin had built on a sand castle of an artificially propped-up rouble, out-of-proportion borrowings inside and outside the country and substitution of domestic production with massive imports financed from energy exports. When the rouble plunged in August 1998, Russian industry for the first time got a chance against imports whose costs soared.
The Government helped promote growth by slashing income taxes to a flat rate of 13 per cent and lowering corporate taxes to below Europe's average level. Mr. Putin put an end to the evil practice of the Yeltsin administration to continuously rewrite corporate legislation, often backdating new rules. He has reined in regional bosses and oligarchs, making them pay taxes and stop meddling in federal politics. Helped by increased oil and other commodity prices, Russia's economy registered a 20 per cent growth in the past three years and surged 7.2 per cent in the first six months of the current year, placing Russia among the world's fastest growing economies. The country's foreign exchange reserves soared from $11 billion three years ago to $64 billion this year. For the first time in decades, Russia has stopped building up foreign debt and managed to slash them by one-fourth over three years. The country is confidently coping with the peak debt repayment of $17.3 billion this year, reducing its debt-to-GDP ratio to 35 per cent, lower than that of Germany, France or Italy.
Russia today enjoys higher credit ratings than at any time since the break-up of the Soviet Union. In the first six months of 2003 foreign investment in Russia grew by more than a half year-on-year, to $12.66 billion.
Real per capita incomes under Mr. Putin have risen 32 per cent and old-age pensions for the first time have caught up with subsistence level. Following almost a decade of steady decline, Russia's birth rates have grown by 18 per cent, even as death rates kept edging up in the aftermath of the past social upheavals.
In his state-of-the-nation address this year Mr. Putin set an ambitious goal of doubling the country's GDP over ten years. This is likely to become Mr. Putin's main concern during his second term, which he is set to win in next year's elections. During his first four years as President, Mr. Putin has concentrated on foreign policy, working to restore Russia's status as a global power, and has done quite well in this job, leaving economic management largely to the Prime Minister, Mikhail Kasyanov. (Many analysts are convinced this was part of the bargain between Mr. Yeltsin and his picked successor, Mr. Putin.) However, the challenging task of rebuilding Russia's economic power will require great political will and personal involvement of the President.
Russia's oil and gas industry has been the locomotive that pulled the economy from the mire of the preceding decade. In the past three years oil and gas exports have increased by 18 per cent, filling Government coffers, strengthening the rouble and helping repay foreign debt. At the same time, the energy production growth has aggravated the one-sided dependence of the Russian economy on the commodity sector. Russia's economic boom has been fuelled to a large extent by oil prices, which have soared nearly three times above the $10-per-barrel low they hit in 1998 precipitating the domestic financial crash.
Russia badly needs diversification to sustain high growth rates in the likely scenario of a dramatic fall in oil prices once oil from Iraq hits the market. Meanwhile, this is one area where the Cabinet led by Mr. Kasyanov has failed. The promised banking reform designed to facilitate the flow of the oil export windfall into the manufacturing sector is yet to take off. The existing taxation system makes investment in the energy sector far more profitable than in other industries.
Bringing about a structural reform of the Russian economy is a political as much as an economic problem. It calls for reforming the bloated and inefficient bureaucracy, corrupted inside out by the free-for-all economic policies of the past decade. The Russian bureaucracy has taken advantage of the chaotic years of the Yeltsin rule to swell its ranks to 2 million, more than the Soviet Union had. Overlapping functions and red tape in Government agencies have become a major obstacle to business activity. The Economic Development and Trade Ministry, for example, has found that the same environmental controls are handled by 18 Government bodies, while five federal bodies oversee the control of biological resources and ground and underground water. In one region, water-quality control for industrial enterprises is conducted by 25 organisations. Last month Mr. Putin set up a Kremlin commission tasked with drawing up proposals to strip Government agencies of redundant powers and cut their staff.
Another major problem is to effect a substantial shift in capital investment from commodity to processing sectors of the economy. At present more than 50 per cent of industrial capital investment is directed towards the privatised fuel sector, while investment spending in non-commodity industries is negligible.
There is growing realisation in the Russian Government that Mr. Yeltsin's policy of dismantling state regulation of the economy and giving free play to market forces was erroneous for Russia, where the bulk of high-end technologies were in the defence sector. "The idea that the market will regulate everything itself is wrong," said the Deputy Prime Minister, Boris Alyoshin, appointed by Mr. Putin earlier this year to draft a new concept of Russia's industrial policy and reform in the defence industry. "In a country where 40 per cent of industrial assets belong to the state, its role in the economy is extremely big." According to Mr. Alyoshin, the Government should work in two main directions: promote vertically-integrated super-corporations capable of competing in world markets and encourage the growth of small and medium businesses ("almost non-existent in Russia today," he admitted), which should manufacture units and components for the big corporations in a highly competitive environment.
Such restructuring will require "redistribution of capital investment" and "direct financing from the state budget," Mr. Alyoshin said. In a country where the wear and tear of equipment in most industries has reached 70 to 80 per cent, the Government will have to mobilise all available resources to carry out the new industrialisation.
One obvious way to accumulate resources is to tax super-profits in the largely privatised commodity sector. These are huge given the relatively low domestic and high international oil prices. In the past two years Russian oil has been sold abroad at triple the domestic price, with the difference ending up in private pockets. A substantial amount of the estimated $160 billions to $300 billions of Russian capital held in foreign bank accounts is under the control of commodity exporters and oligarchs.
So far the commodity-sector tycoons have successfully rebuffed all attempts to deprive them of super-profits by making full use of their cosy relations with the Government and a powerful lobby in Parliament. However, the investigation launched by prosecutors earlier this year into alleged tax evasion and illegal privatisation of state assets by a leading shareholder of Russia's private oil giant, YUKOS, may be the first indication that oligarchs are in trouble. Many analysts have dismissed the investigation as a Kremlin public relations campaign ahead of parliamentary and presidential elections. It may or may not be so, but Mr. Putin will have to curb the power of the oligarchs to achieve sustained economic growth and make good on his promise of making Russia great again and its people prosperous.
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