#12 - JRL 7068
Jamestown Foundation
www.jamestown.org
Russia and Eurasia Review
Volume 2, Issue 4
February 18, 2003
OPENING RUSSIA? CONTEMPORARY FOREIGN TRADE
By Julien Vercueil

Julien Vercuil is an economist at the Institut Universitaire de Technologie Jean Moulin, in Lyons, France.

After a somewhat chaotic seven-year interlude, Russia's international strategy--in terms of diplomacy, defense and politics--has been progressively redefined over the past three years. However, despite the context of ongoing negotiations for the country's accession to the World Trade Organization (WTO), relatively few details are usually given on the current shape of its external economic policy. What is the current situation of Russia's foreign trade? What are the main challenges that must be met in the course of a further opening of the Russian economy? For Western companies, is Russia an emergent market, a promising field of investment or a potential threat?

Russia is currently the seventeenth-largest exportere world (the largest outside the WTO now that China is a member), and twenty-eighth-largest importer. Its share in world trade is comparable to Spain's or Malaysia's. If we take a look at its natural and human resources, we must admit that its economic potential is overwhelming. With a relatively well-educated population of 145 million people, the world's greatest territorial expanse neighboring three continents, and one of the most diversified and impressive stocks of natural resources in the world, Russia seems to be in a particularly good position to respond to international demand--and international competition. Since 1999, the average annual economic growth has reached 5.8 percent, one of the highest among Central and East-European countries.

Russia is now widely open to the global economy: The share of foreign trade in the gross domestic product has been about 50 percent since 2000, measured at the current exchange rate. Moreover, foreign trade is enjoying a structural surplus, which plays a great role in the country's main aggregates: Since 1999 the positive impact of trade surplus has represented 15 to 20 percent of the national economic growth. Excise taxes, import duties and taxes on exports account for about 30 percent of the federal government's revenue. Their contribution to the steady surplus the federal budget now registers has been significant. And the surplus has had a strong impact on the balance of payments, the hard currency reserves of the Central Bank and the ruble exchange rate.

FROM THERE TO HERE

It is therefore vital that we understand precisely the underlying logic of Russian foreign trade's evolution. The geographic orientation of trade has undergone tremendous changes since 1992. Starting with a structure oriented towards former Soviet countries, Russian imports and exports have progressively moved westwards. Nowadays, Russia's main trading partner is the European Union, which accounts for more than 30 percent of the total. Trade with the United States, Japan and South East Asia is also dynamic. But the most interesting re-orientation is towards Central Europe, with which trade is regaining a new momentum after the initial collapse of the Soviet trading bloc COMECON. From a geo-economic point of view, Russian foreign trade's restructuring seems to be altogether rational.

Unfortunately, the positive elements of the picture stop there. The disillusion begins when we study the productive structure of Russian trade. The bulk of exports are made up of raw materials and semi-processed goods. Mineral products, metals and metal products, timber, cellulose, pulp and paper account for more than 75 percent. By comparison, engineering and manufacturing represents barely 10 percent of the exports to non-CIS countries. One striking property of the technical composition of trade is its stability over time: The overall structure has not experienced any fundamental improvement since 1992, even though its geographic orientation has been transformed during the same period. On the contrary, one can even notice signs of impoverishment in the technological composition of exports. In 1993, there were only two technology-intensive industries (cars and ships) among the first fifteen exporting branches. In 2000, both have lost their position. The transition process seems to have locked in the sectoral structure of exports and imports, preventing Russia from integrating into the world economy as an industrialized nation. How can we explain such an unfavorable development?

The main problem lies in the lack of productive investment during the first seven years of transition. Institutional instability and economic crisis virtually discouraged any sound, medium-term project in the industrial sector between 1992 and 1999. Instead of making investments to upgrade their productive capacities, enterprises have tried to find short-term survival solutions in a very hostile context--chaotic disintegration of the Soviet planning system, rising international competition, increasing uncertainty about the legal environment and the enforcement of existing laws, monetary restrictions and the breakdown of payments systems in some regions, and so on. Even in export branches there has been no strategy of modernization in either the public or the private sectors. As a result, investment has shrunk faster than production: At the end of 1998, the volume of capital formation represented less than 25 percent of its 1991 level. At the same time, investment in the European Union was growing at an annual pace of more than 2 percent. The industrial and technological gap between Russia and its Western partners therefore widened rapidly even as Russia integrated with the global economy. The persisting underdeveloped-style of Russia's foreign trade structure reflects this evolution.

Another consequence of the current structure of foreign trade is the asymmetrical evolution of the trade balance. While export earnings primarily depend on trends in international fuel prices--namely, the price of the Urals variety of crude oil sold by Russian companies--imports are mostly sensitive to the evolution of the exchange rate. Obviously, the government cannot always manage those two linkages. The trade balance can change rapidly if external conditions turn to be simultaneously adverse, or favorable. The first instance of such vulnerability of the Russian economy is evident in the 1997-1998 period, when oil prices dwindled after the Asian crisis, while the fact that the authorities tried to maintain the ruble exchange rate pegged to the dollar prevented them from countering the progressive over-evaluation of the national currency. As a result, in April 1998 the foreign trade balance became negative for the first time since 1992, preparing the field for the financial crisis of August. Another example can be found in subsequent developments later that year. After the deep devaluation of the ruble in September, imports shrank dramatically, allowing domestic industry to substitute for them. But in the second quarter of 1999, oil prices began to rise again, leading to a sharp increase in exports. This explains the record surpluses registered by Russian foreign trade in 1999 and 2000 (respectively US$35 and US$59 billion).

POSSIBLE SOLUTIONS

To reduce the international vulnerability of the Russian economy, one basic, long-term strategy is to try to improve the technological and industrial quality of Russian products. This means to create favorable conditions for investment--both inbound and domestic. The stock of foreign direct investment (FDI) accumulated in Russia since 1989 is about US$30 billion, far less than that of China (US$325 billion) or Brazil (US$170 billion). Institutional and legal conditions for investment have recently improved, as the upgrading international credit rating of Russia has acknowledged, but many questions regarding law enforcement, the role of regional authorities in the regulation of property rights and the judiciary system are not clear for Western enterprises. This lack of transparency prevents a real acceleration of FDI flows into Russia.

A second way of boosting investment is to stimulate Russian enterprises themselves. On that point, a profound reform of the banking sector is essential. Banks have never played an orthodox role as financial institutions in the Russian economy. After 1992 and the breakup of the Gosbank monopoly, the new private banks focused on speculative activities--linked at first to the high level of inflation, and then to the high real interest rates provided by the well-known GKO state bonds--instead of building an active intermediary position between savers and borrowers and transforming the quality and the duration of financial resources. The banking sector has undergone several crises since 1992, but the most severe was the crash of 1998. Since then some banks have merged, while others have been closed down or are now under public supervision, but the fundamental reform package necessary to encourage the banking sector to play a genuine role has not yet been worked out. Therefore, most of the recent recovery of productive investment was financed by the enterprises themselves. A comprehensive industrial policy, encompassing a restructuring of the whole financial system, is badly needed in order to reverse these adverse tendencies.

Recent difficulties in the accession negotiations to the WTO, after a two-year "honeymoon" of widespread optimism between 2000 and 2002, are mainly due to the internal problems of the Russian economy. Now coming to the most difficult parts of the negotiation, Russian authorities have been put under pressure by the country's remaining industrial lobbyists--in the auto and aircraft industries, for example--who realized that their factories would not be able to compete with foreign products if import duties were to be alleviated. Given the asymmetrical shape of the WTO negotiations, there is little hope that the outcome of the talks will be what Russian negotiators are hoping for.