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This article explains how Russia has undergone a transformation from socialist economy to a modern capitalist system market economy and how Russia could maintain a stable rise since the economic destabilization in early 90's. The research has taken economic social political factors into account along with the fact that Russia being a major global actor which has natural resource dominated economy. It also explores the possibility of developing and shaping Russian economy for the challenges of the future.
This article explains how Russia has undergone a transformation from socialist economy to a modern capitalist system market economy and how Russia could maintain a stable rise since the economic destabilization in early 90's. The research has taken economic social political factors into account along with the fact that Russia being a major global actor which has natural resource dominated economy. It also explores the possibility of developing and shaping Russian economy for the challenges of the future.
This article explains how Russia has undergone a transformation from socialist economy to a modern capitalist system market economy and how Russia could maintain a stable rise since the economic destabilization in early 90's. The research has taken economic social political factors into account along with the fact that Russia being a major global actor which has natural resource dominated economy. It also explores the possibility of developing and shaping Russian economy for the challenges of the future.
Course Instructor: Syeda Rozana Rashid, PhD Assistant Professor Department of International Relations University of Dhaka
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Contents Executive Summary and Findings03 Introduction...05 Transformation Prerequisite..05 Immediate Post USSR Years (1991-1998)..09 10 Years of Economic Growth11 Russian Economic Policies....................................................................................................13 The Role of Oil and Other Natural Resources16 Present Russian Economic Overview..19 Future Challenges to Russian Economy..20 Conclusion24 Bibliography25
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Executive Summary and Findings Seven decades of Socialist economic system comes to an end when USSR breaks down and the economic system had to go through a period of massive transformation along with socio economic change, initially it was hard for Russia to adapt with the new system of. After few years of economic downturn and hiccups Russia got themselves under control and a fast growing and very promising economy in the world until today. Transformation of economy is a gradual process. Transition is the phase between the form of economy Socialism and Capitalism or Market Economy. Successful transformation needs Economic stabilization, Market infrastructure, Property ownership, Change in mentality and Public support along with legal environment of business and Foreign Investments. 1992 Russia's first post-communist government launched a comprehensive economic program to transform the Soviet command system into a market economy. Privatization was and remains the heart of this plan .Neo liberal shock therapy notion views liberalization as a necessary evil, a fast--as well as nasty--way to achieve economic stabilization. But Russia lost 30% of its real gross domestic product and suffered very high rates of inflation, because of weak Governance, incapable of dealing with the socio economic and political transformation.
With Stabilized Growth From 1999 to mid-2008, Russias economic luck reversed. Inflation came under control. GDP has increased 6.9% on average per. Wages increased Unemployment declined Russian exports grew where oil, natural gas, and other fuels accounted for 64.8% of total exports, on the other hand Russian imports rose.
The economic growth that Russia experienced from 1999 to 2008 was largely driven by favorable trends in the Russias international economic interactions. The Russian economy began to grow because of the severe depreciation of the ruble which boosted exports.
Russian government national accounts data show that it improved budget balances and maintained tight control over fiscal policy. Rationalizing Government Expenditures and Revenues was remarkable in the 10 years of economic growth. Russian government had consistently earned budget surpluses and manager state expense never exceeded revenue. The Putin government introduced regulatory reforms 3 | P a g e
by which 13% flat tax replaced graduated personal income tax that peaked at 30% and introduced reform on pension and judiciary sector and cutting the number of mandatory licenses for easing up business opportunities for small and medium enterprise. Present Russian economic overview where GDP $ 2.022 Trillion and Unemployment rate 5.4% and Trade organizations affiliation with WTO, G-20, G-8.
Present Economic outcome is very much focused on energy market. Government policy till 2020 suggests that Russia has focused on one sector heavily. The stability of the economy is heavily interlinked with oil and gas price globally. Russia has huge investments in the energy pipeline projects.
Future Challenges to Russian Economy is that the economy is highly dependent on energy sector strong and relationship between oil price and GDP. Quality of Russias institutional environment regulates the interaction among economic actor and Russia got access in WTO. Excessive inequality becomes threat for maintaining stability of different societal group.
Research Findings
A transformation has taken place towards capitalism and liberal market economy however it is obvious Government holds significant portion of the market control in Russia especially the most lucrative sector energy sector and other strategic sectors as well. One third of the market share belongs to the government which was roughly over 90% in the Soviet Union.
The success of the economy is largely dependent on the energy sector and oil price.
Russia needs to focus on legal standard better infrastructure and corruption free business environment along with Foreign Investment in other sector of their industries and services if they want not to be too much energy reliant.
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Introduction The transition to a market economy was inevitable, as night follows day, and is the only way to economic revitalization for this country. We have no current alternative. ANATOLY SHOVCHAK Seven decades of Socialist economic system comes to an end when USSR breaks down. The economic system had to go through a period of massive transformation along with socio economic change which were obvious political economic consequences of the end of cold war. Initially it was hard for Russia to adapt with the new system of capitalism which they detested for long and fought against. After few years of economic downturn and hiccups Russia got themselves under control and so their economy got stabilized under the strong leadership of Putin since 1999. Despite initial setbacks after USSR collapse, Russia has a fast growing and very promising economy in the world until today. Although its influence has been greatly diminished since the Soviet period, Russia remains a formidable force on the global stage, and its influence seems to be growing. Russias economy is large enough to influence global economic conditions. Many European countries and former Soviet states are highly dependent on Russian natural gas.
Transformation Prerequisite Transformation of economy is a gradual process. Transition is the phase between the the form of economy Socialism and Capitalism or Market Economy. According to Anatoly A. Sobchak five conditions along with proper legislation and Foreign Investment are essential for a successful transition to a market economy. 1. Economic stabilization 2. Market infrastructure, 3. Property ownership 4. Change in mentality and 5. Public support 5 | P a g e
Economic stability can be assured through activation of administration and economic drivers. In Russia it could be done by spending certain government reserved and stockpiles and also by controlling governments both domestic expenditure and expenditures to maintain the governments offices abroad, revise foreign aid policies, stop government spending on large- scale economic projects that do not yield immediate benefits, sell off frozen uncompleted units to private owners, and so forth. In other words, it can be described as comprehensive program of economic action whose content is fairly well known. Creating market infrastructure was essential because Russias economy was primitive and represented by huge monopolistic state enterprise and amalgamations but it did not have the infrastructure required for a market economy to function. What Anatoly A. Sobchak had in mind is a labor market, a capital market, and, as a necessary condition, numerous small and midsize enterprises that will fill the gaps in the economy and create the possibility of competition among producers and, most importantly, the possibility of economic maneuvering. Moreover creation of a market infrastructure requires efficient transportation and well- developed information networks with adequate means of communication, which Russia did not have on a sufficient scale or on a modern level. Transition to a market economy needs a well-developed stratum of commodity producers who own property in different forms. Ownership right of property is a basic need for market economy to develop and flourish the business by empowering and motivating the commodity producers of community. Privatization of trade, grocery, eateries, household services agriculture and major part of the state run industry was required to de-monopolized and get rid from fully state run economy. As can be seen from the experience of the Moscow and Leningrad City Councils when they attempted to privatize trade and household services, such a program of privatization could not be carried out quickly for a number of reasons and one of the reason was need of credit resources to encourage small entrepreneurs and workers collectives. But Russia did not control such 6 | P a g e
resources so its only hope was establishment of investment banks, which would attract foreign investment and allow to secure the credits needed for privatization People needed a change in mentality in Russia. A profound, fundamental revolution in more than just the industrial and economic conditions of Russia was necessary for a change in the structure of life in Russia. People was long accustomed with in a way of life, in thinking, and in the way they see their place in the system of social production. For decades Russian people fostered beggar and parasitic mentality indicates that the state will provide and decide everything for you. Poorly, perhapsbut it will provide equally for everyone and supply all the basic necessities. In contrast market economy creates a different type of responsible mentality where every person must be responsible and solve his or her own problems. Governments interference in economic life will be limited and drastically reduced and this change requires a revolutionary transformation in the minds of people, in their psychology. Transition to a market economy can be accomplished only when it is carried out by a government that enjoys the full support and confidence of its people. Without public support, one can say in advance that any program of transition to a market economyno matter how good it may look in theory and in the abstractis doomed to failure. More than once in our recent history and during perestroika, we have found that the most logically correct, theoretically well-grounded and seemingly impeccable projects turned out to be absurd in practice and led to absurd results. The failure of all these efforts was largely due not only to the methods or means by which they were pursued but also to the lack of necessary trust and support by the people. Russia legal conditions were needed for the transition to a market economy. To create the legal foundation for the functioning of the market requires a fundamentally different approach to the legislative regulation of the economy than Russia had in legislation up to 19 th century. Economy of Russia on that time was dominated by legal-administrative regulation but it was needed relations of a civil and legal nature. The transition to a market economy will require a fundamental change not only in civil and economic legislation but also in labor laws. This transition will be from a system of blind universal guarantees for any worker, even a lazy one, 7 | P a g e
to a contractual system under which a worker who does his job poorly or sloppily will lose his job. There is also a need to overhaul financial, tax, and land legislation. . These laws should comprise all necessary regulations to protect the environment and to balance the interests of producers and entrepreneurs with those of the city, the region, and the republicthat is to say, of society as a whole Anatoly A. Sobchak found that it needed to work on legal mechanisms for attracting foreign investors and for creating joint ventures, as well as foreign-owned firms, on Russian territory. Several options are there to attract funds of Western investors into Russian economy which allow ensuring that they would get adequate returns. One option is to create an investment bank or get Westerners to invest in joint-stock companies that buy back enterprises and their properties from the state. As investors channeled money into enterprises, there would be funds to rebuild and to change product lines to goods that are in demand and are competitive in domestic and foreign markets alike. Another option is for Western investors, through Russian banks or investment banks created with the help of investors, to give loans to small enterprises and to workers collectives that want to set up new enterprises or buy back existing ones from the state. Investors do not acquire shares in these enterprises but rather extend loans at interest rates that would be attractive to investors and would not be prohibitive to small enterprises. A third option is also The Western investor gives the necessary funds to Soviet banks or to a government body, such as a municipal council. The latter uses these funds to invest in privatization and repays the Western investor on a barter basis.
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Immediate Post USSR Years (1991-1998) 1992 Russia's first post-communist government launched a comprehensive economic program to transform the Soviet command system into a market economy. Privatization was and remains the heart of this plan. Russian market and economy has gone through a period of transition after the breakdown of USSR and the socialist economy. During the period, Russia lost close to 30% of its real gross domestic product (GDP), a decline reminiscent of the Great Depression of the 1930s in the United States1 In this period the Russian citizens saw a sharp decline in their standard of living. The key factor was inflation, which is said to be the robber of the Russian people. The first seven years of Russias transition from the Soviet central planned economy from 1991 and 1998 were not easy. This period coincided with most of the regime of President Boris Yeltsin. This 8 years most accounts for a time of economic chaos, if not near collapse and failure. Russia suffered very high rates of inflation over 2,000% in 1992 and over 800% in 1993 before it declined to more tolerable, but still high, levels of around 20% by the end of the 1990s. The inflation robbed Russian citizens of their savings as the value of the ruble collapsed, eventually forcing the Russian government to sharply devalue the ruble on January 1, 1998, with 1 new ruble equaling 1,000 old rubles. As a hedge against inflation, some residents, who were in a position to do so, invested in hard assets such as art works, foreign currencies, and real estate. But the greater portion of the population saw their savings evaporate. The disposable income available after taxes of the average Russian declined 25% in real terms between 1993 and 1999. Foreign direct investments (FDI) flows were very low given the size and needs of the Russian economy. Furthermore, Russia was incurring serious capital flight some $150 billion worth between 1992 and 1999 by estimate. Russian foreign debt soared in part because Russia had taken on the foreign debts of the entire former Soviet Union in an arrangement made with the other former Soviet states. 1 CRS calculations based on official Russian data collected by the Economist Intelligence Unit (EIU) 9 | P a g e
Weak governance added more negative impacts to this situation of sharp economic decline. Problems were also the product of poorly executed, if not poorly conceived, economic policies of the Yeltsin regime. The regime failed to rein in government spending as it tried to deal with the Soviet legacy of massive subsidies for industry and the population. Russian government ran up large budget deficits that reached as high as 9.8% of GDP, forcing the government to finance debt at very high interest rates. The Yeltsin regime was also criticized for employing shock therapy or radical macroeconomic measures, as part of its economic reform program. Critics claimed that the measures unnecessarily created inflation and destabilized the economy because market prices were introduced too early in the reform process. The most controversial aspect of the early post-Soviet economic transition was the effort to privatize state-owned and operated production facilities, in particular, the so-called loans for shares program. In 1995, the government auctioned off to local banks shares in 29 of the most potentially lucrative firms, including major oil companies and mineral producers eg. Yukos, Lukoil, Sufgutneftegas, Novolietsk Iron and Steel etc. 2 They obtained the shares at a fraction of their market value and were able to keep them when the government failed to pay back the loans. The government did not challenge their control of these assets because their owners, who became known as OLIGARCH financed Yeltsins reelection as president in 1996.These new directors were called as RED DIRECTORS. Despite the setbacks, Russia made some strides toward economic reform during this period. Russia became vulnerable because of more fundamental problems associated with its economic policy and economic structure. These included the failure to institute tax reform, property rights, and bankruptcy laws and procedures, according to William Cooper in his CRS published report. At the same time, the downturn was exacerbated by bad policies.
2 OECD report. The Investment Environment in the Russian Federation. 2001. 10 | P a g e
10 Years of Economic Growth From 1999 to mid-2008, Russias economic luck reversed on many accounts. At the same time, robust developed economic conditions contributed a significant level of economic stability to Russia. Economic growth of this time-frame can be understood from two perspectives one is Internal Economic Conditions and Trends and the other is Foreign Trade and Investment Trends. Internal Economic Condition During this time line Russias real GDP has increased 6.9% on average per. The positive GDP trends are reflected in other measurements that point to an improved Russian standard of living throughout the period. Average real wages in Russia increased 10.5% per year from 1999- 2008. In addition, real disposable income (the income that the average Russian resident has available from all sources after taxes) grew 7.9% from 1999 to 2008. The Russian unemployment rate also declined during the 1999-2008 period, from 12.6% to 6.3%. Economic data indicate also that, with the growth of Russian economy the distribution of income within Russia has become increasingly unequal during the post-Soviet period. A standard measure of income distribution is the Gini coefficient (or index) which is on a 0.00 to 1.00 scale. The lower the number, the more equal the income distribution. Thus, 0.00 is perfectly equal income distribution, while 1.00 is totally unequal. In 1992, Russias Gini-coefficient 3 was 0.289 by 2007, it had increased to 0.422 4 The income distribution trends might also be explained by the large role played by exports, especially oil and natural gas, in Russian GDP growth as owners of energy-related assets until recently reaped the benefits of the surge in world energy prices.
3 The Gini coefficient (also known as the Gini index or Gini ratio) is a measure of statistical dispersion intended to represent the income distribution of a nation's residents. 4 WB CIA factbook and Russias Economic Performance and Policies and Their Implications for the United States by William H. Cooper , Specialist in International Trade and Finance 2009 11 | P a g e
Foreign Trade and Investment Trends During the 10years time-frame the roots of Russias increased economy are reflected in the surge in Russian trade and capital flows. Russia foreign trade has increased sharply and during that period Russian exports grew close to 525%, from $75.5 billion to $471.6 billion and Russian imports rose close to 640%, from $39.5 billion to $291.6 billion. As a result, Russia has experienced rapidly increasing trade surpluses. Its merchandise trade surplus rose from $36.0 billion in 1999 to $179.7 billion in 2008. Russias current account balance which includes balances on merchandise trade, trade in services, investment income and unilateral transfers increased substantially, from $24.6 billion in 1999 to $102.3 billion in 2008. As a result, Russia accumulated one of the worlds largest foreign reserve holdings that have skyrocketed from $12.5 billion in 1999 to $427.1 billion at the end of 2008. In 2008, oil, natural gas, and other fuels accounted for 64.8% of Russian exports
Figure 01: Russian GDP since 1992 to 2012 (IMF) 12 | P a g e
This IMF figure suggests that Russian Economy has gone through a disaster in the immediate postcommunist era in 1992 to 1999 and then it has revived under Putins command and later on Putin-Medvedev partnership in Russian premier leadership era. The GDP of Russian Federation shows it has overcome and moved to a stable growth rate.
Russian Economic Policy The economic growth that Russia experienced from 1999 to 2008 was largely driven by favorable trends in the Russias international economic interactions. By the end of 1999, the Russian government had achieved a degree of financial stabilization as then Prime Minister Primakov instituted measures to cut government spending and increase tax revenues. The Russian economy began to grow because of the severe depreciation of the ruble as a result of the 1998 financial crisis which boosted exports. A key objective of the Putin regime was to maintain stability, especially after the effects of the depreciated ruble had disappeared. Rationalizing Government Expenditures and Revenues Russian government national accounts data show that it improved budget balances and maintained tight control over fiscal policy. At the end of 1998, the Russian federal government had a budget deficit equal to 6.0% of Russian GDP, with revenues equal to 11.4% of GDP and expenditures equal to 17.4%. In 1999, the budget deficit declined slightly to 4.2% GDP. During the ensuing years, Russian government revenues soared from 12.6% of GDP in 2000 to 22.6% of GDP in 2008, largely because of tax revenues generated by the surge in oil revenues. 5 At the same time, the government managed to resist expanding expenditures, keeping them far below revenues with expenditures equal to 18.2% GDP in 2008. As a result, the Russian government had consistently earned budget surpluses, at least until recently, and had a surplus of 4.1% which equaled GDP in 2008. 6
5 William H Cooper ,Russias Economic Performance and Policies and Their Implications for the United States Federation of American Scientists Report 6 ibid 13 | P a g e
Implementing Structural Economic Reforms During Putins first presidential term (2000-2004), his government initiated some critical economic reforms that helped Russia emerge from the post-1998 financial crisis period more stable and stronger. One of the factors that had harmed business environment in Russia for both foreign and domestic investors was a plethora of high and overlapping taxes. By 2004, the government had reduced the number of taxes to 16, 10 of which were federal and the remainder regional and local. Among the changes was an introduction of a 13% flat tax to replace a graduated personal income tax that peaked at 30%.30 Four social taxes were compressed into one. Tax collection was centralized into the tax ministry, which eliminated tax collection competition among several collection agencies that bred corruption and abuse. During the early post-Soviet period, the business climate was also hampered by a large number of licensing requirements, inspections, and other regulations, often promulgated and implemented by different local, regional, and federal government entities in conflict with one another. The burden and the capricious manner that the regulations were implemented made the system ripe for corruption and avoidance and also impeded the development of new business. The Putin government introduced regulatory reform by cutting the number of mandatory licenses and inspections to encourage the development of new small and medium sized enterprises. These reforms have largely improved the business climate, although some authorities still conduct inspections contrary to the new regulations. The Russian government also addressed the issue of corporate governance, particularly the protection of the rights of minority shareholders that were notoriously subjected to abuse in the 1990s. Integrating Russia with the Global Economy Russia first applied to accede to the General Agreement on Tariffs and Trade (GATT) in 1993. The application was converted to one for the World Trade Organization (WTO) in 1995 when that organization was formed and became the administrative body for the GATT and other multilateral trade agreements. The process slowed down during the Yeltsin period as the leadership was pre- occupied with other political and economic issues. Putin adopted WTO membership as part of Russian economic reform and a way to integrate Russia into the world 14 | P a g e
economy. Despite the declared policies, the results in integrating with the world economy have been mixed. From 1994 to 2000, Russian exports as a percentage of GDP increased from 27.7% to 44.1% but declined to 31.3% in 2008. Russian imports as a percentage of GDP have declined from 22.9% in 1994 to 22.0% in 2008. On the other hand, trends in Russian foreign investment show clearer signs of economic integration. The stock of FDI in Russia as a percent of GDP rose from 0.1% in 1993 to 12.0% in 2008 and Russian foreign direct investment abroad has increased from 1.3% of GDP in 1993 to 10.6% of GDP 2008. 7
Implementing Other Reforms In 2002, the Putin government instituted pension reform to increase the level of retirement funds and reduce poverty among retirees. In addition, the reform was to move the responsibility for pensions from the government to employers. In 2003, the Russian government implemented a government deposit insurance program, to partially level the playing field for private sector banks that had no such insurance, and the state banks that were backed by state funds. The deposit insurance program also was a way to introduce tighter supervision over the private sector banks that were required to meet financial health criteria by the Russian central bank before being eligible for the insurance. Beginning in 2004, the Russian government also began phasing in the use of internationally accepted financial standards to improve the transparency of Russian bank operations. In 2005, the regime launched national projects to strengthen education, health care, and housing. The Russian government also undertook reform of its judiciary to establish clear lines of responsibility for the levels of courts and to root out corruption by increasing the salaries of judges. Reasserting State Control of Strategic Sectors If President Putins first term of office was marked by achieving economic stability and launching some critical reforms, the second term (2004-2008) was largely characterized by the governments re-establishing control over critical sectors of the Russian economy. It has done so by acquiring the assets of companies that had been privatized during the Yeltsin regime and 7 ibid 15 | P a g e
taken over by so-called oligarchs via questionable transactions. The Putin Administration has been re- nationalizing companies directly by taking control of assets or indirectly through ostensibly private sector companies in which the Russian government has substantial ownership. From 2004 to 2006, the government took control of formally privatized companies in certain strategic sectors e.g. oil, aviation, power generation equipment, machine-building and finance. According to the European Bank for Reconstruction and Development (EBRD), in 1991, just prior to the collapse of the Soviet Union, 5% of Russian GDP was accounted for by the private sector. By 1997, that share had grown to 70%, but decreased to 65% in 2005 . 8 The EBRD monitors the progress of former communist states transition to market economies. One of the elements the bank examines is the degree to which the country has privatized state- enterprises. It does so using a scale of 1.00-4.00 with 1.00 indicating little private ownership and 4.00 indicating more than 50% private ownership. According to the EBRD, the status of Russias privatization of large-scale enterprises fell from 3.33 in 2004 to 3.00 in 2008. EBRD indices of small-enterprise privatization indicated that Russia has done better at 4.00 where it has been since 1995. 9
The Role of Oil and Other Natural Resources Russia is by far the world's largest natural gas exporter. Most, but not all authorities believe that Russia has the world's largest proven reserves of natural gas. Sources that consider that Russia has by far the largest proven reserves include the US CIA (47.6 trillion cubic meters) The Russian oil industry is in need of huge investment Strong growth in the Russian economy means that local demand for energy of all types (oil, gas, nuclear, coal, hydro, electricity) is continuing to grow. 10
8 ibid 9 ibid 10 BBC: 'Threat' to future of Russia oil http://news.bbc.co.uk/2/hi/business/7348463.stm 16 | P a g e
The Energy strategy was changed under the presidency of Vladimir Putin. On 23 November 2000, the Russian government approved main provisions of the Russian energy strategy to 2020. On 28 May 2002, the Russian Ministry of Energy gave an elaboration on the main provisions. Based on these documents, the new Russian energy strategy up to 2020 was approved in 2003 and confirmed by the government in 2003. 11
Russian Government has invested a lot in Energy sector and energy pipelines. Fair share of the recent accomplishments is tied to high oil prices. Boosted by supply constraints rather than strong global demand, the price of Urals crossed US$125/barrel in early March 2012, the first time since July 2008. High oil prices have translated into strong export receipts, buoyant fiscal revenues, and a bullish stock market.
Figure 02: Russian Energy Pipelines Russian government owns most of the shares in Energy sector, for an instance Rusian energy ginat Gazprom is a jointstock company most shares held by Government which generates revenue of 150 billion and over which is in relative figure quarter of Russian export earnings. In 2011, the company produced 513.2 billion cubic metres of natural gas, amounting to 17% of 11 THE SUMMARY OF THE ENERGY STRATEGY OF RUSSIA FOR THE PERIOD OF UP TO 2020 Report:Ministry of Energy http://ec.europa.eu/energy/russia/events/doc/2003_strategy_2020_en.pdf 17 | P a g e
worldwide gas production. In addition, Gazprom produced 32.3 million tons of crude oil and 12.1 million tons of gas condensate. Gazprom's activities accounted for 8% of Russia's gross domestic product in 2011. 12
Figure 03: Global Oil prices from 1994 to 2008 (OPEC) A closer look at the economic situation reveals a number of weaknesses. The growth of the manufacturing industries slowed in the second half of 2011. Fixed investment has started picking up only recently, foreign direct investment stays sluggish, and capital outflows are elevated. The non-oil current account deficit reached a record 13 percent of GDP in 2011, underlying the oil dependence of Russias export sector. The non-oil fiscal deficit remained close to 10 percent of GDP, and is projected to increase further this year. Inflation is set to pick up later in the year, as delayed increases in utility and gasoline prices kick in and prices pressures increase as enterprises find it more difficult to fill job vacancies. 13
12 www.gazprom.com 13 Russian Economic Report Moderating Risks, Bolstering Growth, The World Bank in Russia ,2012
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Present Russian Economic Overview Russia has undergone significant changes since the collapse of the Soviet Union, moving from a globally-isolated, centrally-planned economy to a more market-based and globally-integrated economy. Economic reforms in the 1990s privatized most industry, with notable exceptions in the energy and defense-related sectors. The protection of property rights is still weak and the private sector remains subject to heavy state interference. In 2011, Russia became the world's leading oil producer, surpassing Saudi Arabia. 14
Figure 04: Russian Economy at a Glance 14 CIA Fact Book :Russian Federation https://www.cia.gov/library/publications/the-world-factbook/geos/rs.html 19 | P a g e
The government since 2007 has embarked on an ambitious program to reduce this dependency and build up the country's high technology sectors, but with few visible results so far. The economy had averaged 7% growth in the decade following the 1998 Russian financial crisis, resulting in a doubling of real disposable incomes and the emergence of a middle class. The Russian economy, however, was one of the hardest hit by the 2008-09 global economic crisis as oil prices plummeted and the foreign credits that Russian banks and firms relied on dried up. According to the World Bank the government's anti-crisis package in 2008-09 amounted to roughly 6.7% of GDP. The economic decline bottomed out in mid-2009 and the economy began to grow again in the third quarter of 2009. High oil prices buoyed Russian growth in 2011-12 and helped Russia reduce the budget deficit inherited from 2008-09. Russia has reduced unemployment to a record low and has lowered inflation below double digit rates. Russia joined the World Trade Organization in 2012, which will reduce trade barriers in Russia for foreign goods and services and help open foreign markets to Russian goods and services. Russia has had difficulty attracting foreign direct investment and has experienced large capital outflows in the past several years, leading to official programs to improve Russia's international rankings for its investment climate. Russia's adoption of a new oil-price-based fiscal rule in 2012 and a more flexible exchange rate policy have improved its ability to deal with external shocks, including volatile oil prices. Russia's long-term challenges also include a shrinking workforce, rampant corruption, and underinvestment in infrastructure.
Future Challenges to Russian Economy It is obviously an unmanageable task to predict economic future of a state, especially an emerging economy like Russian Federation however I have tried to look through the futuristic analysis on Russian economy based on the sources of World Economic Forum Report on Scenarios for the Russian Federation. The report forecasts the future uncertainty factors. Russias future economic development is affected by three identified uncertainties in different directions. 20 | P a g e
1. Evolutions in the global energy landscape 2. Quality of Russias institutional environment 3. Dynamics of domestic social cohesion Evolutions in the global energy landscape Russias economy is highly dependent on energy sector where there remains a strong relationship between oil price and countrys GDP. Russia has no power to determine global environment and price of energy which makes countrys future economic growth critical. It has significant impacts which begin with supporting strong GDP growth through global energy landscape which allowed Russia to benefit from high oil prices. Second impact is drawback for non-resource sector which shows Russia has no motivation to invest in other sector except energy sector. This makes difficulties to change the fiscal policies, institutional reforms and adjusting the unbalanced economic nature. The last impact is the Russias fiscal fragility. Russia has grown fast and also fragile because its future success is uncertain for the downward dynamics in energy prices, given that financial spending has become adjusted to surging energy revenues. In future Russia will face challenges because of the changing global energy landscape. The first challenge will be increased oil supply sources from the USA to Iraq. Second challenge will rise from the threat of unconventional gas of Russia which gives the potential prospects to Shale gas exploitation, one force already revolutionizing the global energy landscape, and Russias place in it. The United States is already competing with Russia in natural gas production, and its production prices are comparatively lower. Natural gas in the United States is about 60% cheaper than in Europe, and there are prospects for the United States to become a major Liquefied Natural Gas (LNG) exporter in the years to come, possibly changing the global gas landscape in a fundamental way. 15 The third shift Russia will need to master is in response to a changing demand landscape where, according to all major projections, non-OECD economies will account for the largest share of future fossil fuel demand. 15 Scenarios for the Russian Federation, World Economic Forum ,2013 21 | P a g e
According to the latest forecasts from the International Energy Agency (IEA), by 2020 the United States is set to overtake Saudi Arabia and Russia as the worlds largest oil producer. 16 It may decline oil and gas price globally and Russia would be affected with this global evolutions and may have a great impact on future development. Also future demand for oil and gas of Russia will influence not only by competing supplies but also by the prospects of global energy demand. According to some estimates, gas will be the fastest-growing fossil fuel globally to 2030, with non-OECD countries accounting for 80% of the global rise in gas consumption against a backdrop of limited European demand. This may put pressure on Russia to redefine its distribution networks and adjust its infrastructure investments to continue benefiting from strong global demand. Finally, the International Energy Agency recently reiterated the significance of energy efficiency measures to ensuring energy security, saying such measures could help reduce global needs by a factor larger than the level of Russias energy production. Whether such measures are implemented will be critical to Russias energy future. Institutional environment The effective and properly running institutions consider as essential factor for economic growth which regulate the interaction among economic actors. Russias institutional environment ranking 133 out of 144 countries in the World Economic Forums Global Competitiveness Index 201213. 17 It caused great impacts on the Economy of Russia. Russia is one of the most corrupt major economies in the world. According to Transparency International, public officials and civil servants, including the police, are seen as the most corrupt institutions in Russia, followed by the education system and parliament. This causes direct costs to well- functioning of economic transaction. Russias Infrastructure stands at a very low level. In 2012, the overall quality of Russias infrastructure ranked 101 out of 144 in the Global Competitiveness Index. 18 The quality of the education of Russia is on a downward trend because of poor institutional environment. 16 IEA report http://www.iea.org/publications/freepublications/publication/English.pdf 17 Report: Scenarios for the Russian Federation, World Economic Forum ,2013 18 PWC report - Russia: A Snapshot http://www.pwc.com/gx/en/capital-projects-infrastructure/assets/russia-snapshot.pdf 22 | P a g e
The public health system is facing difficulties. Poor levels of infrastructure, along with a mismatched and unhealthy workforce represent inadequate health facilities. So because of this weak institutional environment capital of Russia uses only in the energy revenues not in other sector for economic development. State is growing, centralizing political and administrative power is taking place and the expenditure of public service is increasing in Russia but bureaucratic apparatus has simultaneously remained low. These situations put pressure not only on socio-political system and business environment of Russia but also on its budgetary health. Centralization of power was considered as an attempt to reduce corruption. But corruption has become a path for wealth creation to maintain stability over productive process in the economy. Russia is the sixth largest economy worldwide in GDP yet corruption levels are higher than in countries such as Togo or Uganda, according to Transparency International data In 2012 finally Russia got access in WTO (World Trade Organization) with the expectation to regulate the change in economic sector and increase and enhance opportunities for foreign investments in several sectors including banking, finance, business, telecommunications and distribution. 19 But the effect of this achievement in the context of institutional environment remains unclear. Social Cohesion Social cohesion is the last driver which creates uncertainties through discontent and weak social integrity in Russias future economic development. Trust in social relations, decision making process and in social institutions provide the opportunity to develop potentiality production but lack of social cohesion makes Russias economic growth uncertain. Impacts are heavy if there is a constant social disintegration. Law regulatory mechanisms, police force can support social cohesion or can bring social reform to make trust worthy trade- offs easier to achieve. So absence of social cohesion undermines the functions of legitimate 19 WTO press release WTO membership rises to 157 with the entry of Russia http://www.wto.org/english/news_e/pres12_e/pr671_e.htm 23 | P a g e
political and institutional consequences. Excessive inequality becomes threat for maintaining stability of different societal group. Protests riots of different social and political group and social unrest and strong deficiencies also provide political and financial stagnation. These situations develop investors negative perception and undermine potential development. In-between this situation middle class of Russia has grown significantly and wealth inequality also increased as well. This rise in wealth has been came with in recent years by growth in diverse forms of popular discontent, including frustrations with the delivery of public services, perceived impediments to pursuing professional aspirations and restraints on political freedoms. The skilled and talented young generation requires changing environment and positive motivation to make a productive role in future economy of Russia but when they fail to get these within home country they seek opportunities in abroad. Further, Russias ageing population may also affect the dynamics of social cohesion within the country. Environmental degradation, religious diversity may affect Russias future social cohesion.
Conclusion A transformation has taken place towards capitalism and liberal market economy however it is obvious Government holds significant portion of the market control in Russia especially the most lucrative sector energy sector and other strategic sectors as well. One third of the market share belongs to the government which was roughly over 90% in the Soviet Union.
The success of the economy is largely dependent on the energy sector and oil price.
Russia needs to focus on legal standard better infrastructure and corruption free business environment along with Foreign Investment in other sector of their industries and services if they want not to be too much energy reliant.
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Bibliography 1. World Economic Forum, Scenarios for the Russian Federation, 2013 2. Copenhagen Institute for Future Studies, Russian Prospects and political Scenario, 2005, on www.cifs.dk accesed on December 2013 3. World Bank in Russia Report : Moderating Risk and Bolstering Growth, 2012, Moscow, Russia on www.worldbank.org.russia 4. William H. Cooper, Russias Economic Performance and Policies and Their Implications for the United States, CRS report , USA, 2009 5. Growing Beyond Survey Report : Russia 2013- Shaping Russias future, Ernst & Youngs, Moscow, Russia 2013 6. Report: Russias Economy:After Transformation,Before Modernization, Moscow, January 2013 on www.valdaiclub.com accesed on December 2013 7. Vladimir Mau, The role of State and creation of Market economy in Russia, Bank of Finland, Institute for ECONOMIES in Transition,Helsinki, 2011 http://www.bof.fi/bofit accesed on December 2013 8. Michael Burawoy,Transition without transformation : Russias Involuntary Road to capitalism, Berkerly, California University, USA, 2001 www.publicsociology.berkerly.edu/publications/producing/Burawoy.pdf accesed on December 2013 9. Michael McFaul, State Power, Institutional Change, and the Politics of Privatization in Russia, Cambridge University Press, 1995, http://www.jstor.org/stable/2950651 accesed on December 2013 10. European Economic Review (1997),Joseph Schumpeter Lecture on Government in Transition edited by Andrei Shleifer ,Department of Economics, Harvard University, USA 11. Anatoly A. Sobchak, Transition to a Market Economy, CATO journal,1991 http://www.unz.org/pub/catojournal-1991q2-00195 accesed on December 2013