The document summarizes economic forecasts and key issues for Russia from 2008-2013. Real GDP growth is expected to be moderate, with consumer price inflation decreasing annually. The budget and current account deficits are projected to shrink over time. Challenges include reducing political uncertainty to attract more foreign direct investment and developing market-oriented legal and political institutions.

1. The Economist forecast for Russia Russia Today: Current Issues Key indicators 2008 2009 2010 2011 2012 2013 Real GDP growth (%) 5.6 -3.0 2.0 4.0 4.4 4.6 Consumer price inflation (av; %) 14.1 13.5 10.4 8.5 7.4 7.0 Budget balance (% of GDP) 3.6 -8.0 -3.0 -1.3 -0.8 -0.7 Current-account balance (% of GDP) 5.9 -2.2 -0.6 -0.5 -1.0 -1.5 Central bank refinancing rate (end-period; %) 13.0 12.0 11.0 9.0 8.5 8.0 Exchange rate Rb:US$ (av) 24.9 36.0 36.7 36.8 36.9 37.1 Exchange rate Rb:€(av) 36.5 48.1 50.8 52.1 53.4 54.5

2. Real Currency Appreciation Productivity growth in exporting sector (oil) leads to higher wages in the whole economy and to higher prices for non-tradables (hair-dressers)  inflation 2) Diffusion of rents from productivity gains in exporting sector to the rest of economy  higher living standards ( Balassa-Samuelson effect ) Real appreciation of ruble 2000-08: Ruble inflation 12% Dollar inflation 3% Stable exchange rate, Rb 28 = $1 till 2008 Consequences: Imported goods more affordable Export industries hurt by lower international demand Loss of terms-of-trade advantage May slow down economic growth

3. “ After the big bang” by Hoff and Stiglitz “ Rule of law”: enforcement of property rights in a reasonably neutral and predictable way In 6 economies where property rights are most insecure, official GDP contracted by > 30%

4. How to Exploit Energy Energy (and resources) key to Russia’s role Russia should focus on its abundance, but how? Two approaches Top-down Oil is a strategic asset Secrecy, government direction, control of pipelines View of energy as rent to be exploited Energy as foreign policy resource Useful for propping up dinosaurs Bottom Up Market driven, private ownership Maximize number of actors involved Competition Share in world technology Develop complementary industries Rule of law, functioning institutions, less corruption

5. Russia’s Future Role in the World Economy Strong commodity demand is good for Russia Russia needs FDI to exploit its energy resources But political uncertainty needs to be reduced Russia needs to choose the correct approach Putin’s dilemma State control of energy provides state power Market control can double GDP

6. Legal system Democratic market-oriented laws exist Institutions to enforce them are weak No good guarantees of ownership 1990s: contracts enforced by thugs with guns 2000s: more businesses turn to courts to resolve disputes Police: under-funded, under-staffed, corrupt Crime and corruption is costly for businesses Inhibits investment, domestic & foreign Judges and lawyers poorly paid, vulnerable to corruption no independent judiciary system - prosecutor's office, courts & police are subordinate to Kremlin Merger of businesses and authorities Every bureaucrat represents business interests No public control over secret services and law enforcement http://www.transparency.org/news_room/in_focus/2008/cpi2008/cpi_2008_table Russia’s 2005 corruption ranking by Transparency International: 126 of 159 countries

7. Russian Trade Share of CIS countries in trade: 17% Share of EU in trade: 52% Main exports 2007 % of total Main imports 2007 % of total Oil, fuel&gas 65.2 Machinery&equipment 43.9 Metals 13.5 Chemicals 12.0 Chemicals 5.5 Food/agricul prod 11.7 Machinery/equipment 5.0 Metals 6.6 Major markets 2007 % of total Major suppliers 2007 % of total Netherlands 12.1 Germany 11.9 Germany 9.6 China 10.9 Italy 7.8 Ukraine 6.0 China 5.0 US 4.2

8. Factors that restrain demand for imports: import duties , 18% value-added tax and excise taxes on automobiles, alcoholic beverages, aircraft import licensing regime (alcohol) frequent unpredictable changes in customs regulations unofficial transit payments Getting a lorry-load of goods from Armenia to Russia means paying $2,000 for “security”. Half of the price of shipping a container from Rotterdam to Georgia = unofficial transit payments through Georgia. Clearing customs in Tajikistan requires 18 bits of paper from different government agencies.

9. "BRIC“ emerging markets preferred markets for growth in the 21st century meant to grow faster turned out to be more volatile, less liquid, dangerous 250 Russian stocks are listed locally or abroad significant premiums for the country political risk, corporate governance, size and currency risks http://www.rts.ru/en/ IPOs: Russian companies prefer to list in London insurance against political risks or unauthorized claims from state officials authorities less willing to pursue companies with foreign investors hard to raise more than $500m in Russia shortage of institutional investors, - private pension funds & insurance companies - able and willing to buy long-term instruments savings rate among Russians 13% of income greater recognition and visibility desire obtain a market valuation of their worth

11. 20% starting 2009

13. Intellectual property rights Copyrights Pirated are 80% DVDs, 60% of CDs 2008: allofMP3.com shut down, US companies dropped charges Trade mark violations Counterfeiting Consumer goods, tobacco, alcohol Smirnoff vodka owned by US United Distillers and Vintners Phillip Morris >25% products are counterfeits

14. Intellectual property rights http://www.wipo.int http://www.cipr.org “ Underrated public policy priority” Weak laws and penalties, no criminal convictions Need stricter standards for WTO membership Deliberate inaction by Russian government Crackdown is costly Benefits? who is hurt? foreign firms, Russian firms, consumers, government?

15. Demographic Crisis Fertility rate 1986-7: 2.19 births per woman 2001-2: 1.3 births per woman 1981 – 2001: 30% drop in marriage rates 30% increase in divorce rates Challenge of shrinking population: post-war “baby boom” generation retires - workforce drops – firms need employers – GDP falls Measures: plan $140bn spending over 20 years on financial support for families with > 1 child education programs to reduce abortions and alcohol-induced deaths, car accidents and unhealthy lifestyles Low life expectancy Tobacco, vodka, poor diet Environmental pollution HIV/Aids Poor health care Stress of transition – unemployment, loss of status Road accidents

16. Male Life Expectancy: Russia vs LDC’s

17. Moscow vs. Rest: Life Expectancy

18. Foreign Direct Investment in Russian Industry

19. Investment FDI in Russia $16.7 bn in 2005, 3% of GDP Poland: 5% of GDP Coca-Cola: purchased St.Petesburg juice company for $600 mil Heineken: purchased Russian companies, $750 mil Toyota and Volkswagen Nestle, total investment in Russia $500 mil Russian companies increased foreign investments Lukoil owns >2,000 gasoline outlets in US 2005: net capital inflow $300 mil Net outflow by individuals and private non-financial companies Inflow by banks and state-owned companies Domestic investment financed not through bank loans but from retained profits  slower investment growth Problem: Weak banking system

20. Problems foreign direct investors in Russia Starting with the most pressing: Inadequate and ever changing tax law Property and creditor rights Customs Risk of political change Macroeconomic instability Weak banking sector Russian accounting system Corruption Risk of expropriation Harassment from federal and local government Payment arrears from clients Problems with workforce or management Russian suppliers Crime, racket Barter

21. Investment Rates in Selected Economies, International Prices

22. Chechnya: separatist rebellion, 1994-2006 Putin’s tough line popular among Russians Support US-led campaign against international terrorism Opposed US action against Iraq and Iran Xenophobic nationalism Racism against Caucasians, Central Asians and Africans Other Concerns

23. Climate Change Rising Sea Levels Melting Permafrost Increased Precipitation Rising Sea Levels Russia’s total coastline = 37,653km Northeast corner of Russia is losing 15 – 18km a year. Will require villages and settlements to move.

24. Impact of Climate Change: Melting Permafrost More than ½ permafrost area can thaw by 2050 Melting permafrost released methane and greenhouse gases. Houses and building collapse Roads and infrastructure more expensive to maintain. Arctic Permafrost boundary will move north. May have big implications for oil, gas, and other investment projects. Tundra Tundra will gradually shrink. As a result, millions of animals will loose up to 50% of their habitat. Taiga Warmer. Less energy costs for habitants.

25. Impact of Climate Change: More Precipitation 20% increase in the winter. 10% increase in the summer. Floods could happen Greater climate instability will cause more rains near Caspian deserts, and more drought years strong winds and dust storms.

26. Climate Impacts Industries - Oil Pros Easier to drill for oil with melting permafrost. Cons Expensive underpinning of refineries. Increase costs of pipeline construction because extensive trenching needed to combat the effects of coastal instability and erosion. Increase costs of oil extraction.

27. Industries - Timber Pros Easier to get to forests with warming temperatures. Extended seasons will allow for additional harvesting. Cons Ecosystems will not have time to adapt to the changes causing outbursts of forest diseases.

28. Services - Transportation Pros Melting of the Arctic will prolong both the Northern Sea and Siberian river navigation seasons. New opportunities for shipping of resources. Cons Improved navigational aids will be needed. Harbor facilities will have to be developed. New road infrastructure will need to be constructed. Maritime laws will need to be adapted to increased shipping.

29. Services - Tourism Pros With the increase in temperatures Russia could see an 30% increase in tourists. Cons Will require adequate infrastructure to be developed. Runways Roads Buildings

30. Regional Income Disparities Real Incomes in Some Russian Regions

31. Internal Migration in Russia and the U.S. Percentage of total population that moved from one oblast/state to another each year Problem is lack of labor mobility Too much industry in the wrong places Very important due to lack of capital mobility

32. Economic Priorities Vulnerable to swings in world prices of oil, natural gas, metals, timber High-technology & consumer goods = small part of economy Diversifying the economy away from commodity dependence Innovation Need more investment Massive lending of foreign banks to large oil and gas companies Smaller companies and other industries short of cash Poor infrastructure in regions South Russia has better climate but high corruption Poor medical care Bad roads International business Forbes Best Countries for Business Rank Reducing political uncertainty Reducing the state's role in the economy Travel restrictions for foreigners Poverty: 20% of population monthly income under 1,000 rubles ($35)