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Financial Times (UK)
30 November 2001
The promise of capitalism has yet to be realised: A decade of painful reforms is now paying off and the economy has been expanding fast for the last three years
By ROBERT COTTRELL

Almost 10 years after the fall of the Soviet Union and the rise of the market economy, Russians still argue whether their country is worse or better off in material terms now than it was under central planning.

The early experiences of economic reform were painful. But there are strong signs now that things are getting better. Russia is into its third successive year of economic expansion, and confident of a fourth - albeit from a very low base. Per capita GDP in Russia is scarcely more than Dollars 2,000, and the average annual wage is about half that.

The current recovery was triggered by the collapse of the rouble in 1998. It slid from six to more than 20 against the dollar when the government defaulted on domestic bonds and froze foreign commercial debt. That gave Russia a much lower rouble cost-base, at a time when dollar prices for its main export, oil, were rising sharply.

The ministry of economic development and trade says economic growth this year should be above 5 per cent and around 4 per cent next year. That scarcely compares with the boom of last year, when the economy grew 8.3 per cent. But sustainable growth of 4 per cent would make the government happy indeed.

It may be achievable, but it will depend on at least one crucial factor outside Russia's control - the price of oil. A price of about Dollars 22 a barrel for Urals blend oil will suit Russia nicely. But much more than Dollars 22, and capital inflows will force Russia's inflation rate even higher, push up the real exchange rate of the rouble even faster and choke off growth in the rest of the economy.

On the other hand, with the oil price falling below Dollars 22, as it has since September 11, the international capital markets will begin to doubt Russia's capacity to service its foreign debt obligations, which peak at Dollars 18bn in 2003. Russia says it can manage debt servicing unaided with an oil price as low as Dollars 17. But if worries set in among lenders, Russian companies will have little hope of raising the long-term international finance they need for investment.

Even with the oil price in the optimal band for much of this year, however, inflation has remained obstinately high. Most analysts forecast a rate of about 18 per cent for 2001.

The rouble's nominal exchange rate has held firm, meaning a strong appreciation in real terms against the dollar. That appreciation has already halved the competitive advantage Russian industry gained in 1998.

So far, however, manufacturing has been holding up surprisingly well. A composite index of Russian manufacturing performance compiled by Moscow Narodny Bank showed growth in July at its strongest in nine months. The relative isolation of the Russian market has helped insulate industry against the world downturn.

Russian heavy-engineering companies sell their tractors to Russian farms, and their pipelines to Russian oil firms. Russian light engineering companies sell their consumer durables to Russian families, or families in other ex-Soviet countries, who cannot afford western imports. Russia's only big long-distance exports are oil and gas to Europe, and weaponry to countries such as China and India.

In policy terms, President Vladimir Putin and his government have steered the economy well enough within the many obvious limitations. Russia still lacks an efficient judicial system and a reliable commercial banking system. The bureaucracy is plagued by laziness, corruption and in-fighting that turns almost any reform into a power-struggle.

Mr Putin's first big decision was an economically sensible but a socially difficult one - to let most of Russia's new tycoons, the "oligarchs", hang on to the wealth they grabbed from the state in rigged privatisation deals in the 1990s. He has told them instead to pay their taxes and stop bossing the government around.

Contestable as the origins of the oligarchs' wealth have been, to leave them untouched has spared Russia another round of economic convulsions that would have set the economy back another year or two at best. And the oligarchs - some of them, at any rate - are turning into much more responsible managers, with investment programmes instead of asset-stripping programmes, now that they feel relatively secure as long-term owners.

Mr Putin has started canvassing business views on economic policy. Business support contributed to his decision to introduce a flat-rate income tax of 13 per cent. Corporate profits tax will soon fall to 25 per cent (from 34 per cent), giving Russia one of most benign tax environments in Europe.

Legal reform, crucial to a well-run economy as well as an orderly society, is under way, but will take years if not decades. There are schemes afoot, too, to reform national monopolies - introducing more competition into the gas and electricity markets, and introducing more transparency into rail tariffs.

The big dilemma here is whether the government can take the political risk of letting gas and electricity prices move closer to market levels. That may bring prices down for industrial consumers, and a free market should encourage private investment.

But it will mean much higher heating bills for households, where consumption has been heavily subsidised from municipal budgets and industrial tariffs.

Mr Putin is pushing, too, for Russia to join the World Trade Organisation, so opening its economy much more to the world at large. But that remains a doubly controversial aim. Other WTO countries think it may be a long time before Russia can match the international standards and practices required in the WTO. And many Russian companies want to put off WTO accession for fear that imports will wipe them out if tariff barriers are lowered.

Still, Russia's problems today pale beside those of five years ago. Then people despaired that the economy could ever get back on its feet. It is limping heavily even now, but at least it is moving.