Special Market Focus - Russia / The Russian economy (PART II)

April 2004

A decade after the implosion of the Soviet Union in December 1991, Russia is still struggling to establish a modern market economy and achieve strong economic growth. In contrast to its trading partners in Central Europe - which were able within 3 to 5 years to overcome the initial production declines that accompanied the launch of market reforms - Russia saw its economy contract for five years, as the executive and legislature dithered over the implementation of many of the basic foundations of a market economy. Russia achieved a slight recovery in 1997, but the government's stubborn budget deficits and the country's poor business climate made it vulnerable when the global financial crisis swept through in 1998. The crisis culminated in the August depreciation of the rouble, a debt default by the government, and a sharp deterioration in living standards for most of the population. The economy subsequently has rebounded, growing by an average of more than 6% annually in 1999-2002 on the back of higher oil prices and the 60% depreciation of the rouble in 1998. These GDP numbers, along with a renewed government effort to advance lagging structural reforms, have raised business and investor confidence over Russia's prospects in its second decade of transition. Yet serious problems persist. Oil, natural gas, metals, and timber account for more than 80% of exports, leaving the country vulnerable to swings in world prices. Russia's industrial base is increasingly dilapidated and must be replaced or modernized if the country is to maintain vigorous economic growth.’ *
* Source: The CIA World Factbook

2003, just one year after that overview, the Russian economy boomed. Attributed mainly to the dramatic increase in oil prices, many economists believe that President Vladimir Putin’s policies also had a very positive influence.
Russia’s Minister of Economic development, German Gref, recently said that high oil prices had both positive and negative effects on the economy. His explanation for this remark was that the high prices padded Russia’s economic and market indicators, but also created the impression that all was well in the economy and it could consider postponing radical economic reforms a little longer. (In 2003, Russian oil exports outside of the Commonwealth of Independent States were 3.1 million barrels a day, an increase of 12.4% over 2002.)
2003 also saw a positive trend toward increased investment in Russia. For the first time the influx of capital into the country exceeded capital flight, US$ 2.9 billion for 2003 as opposed to US$ 8.1 billion in 2002 and an average of US$ 20 billion a year during the 90s (Central Bank statistics). The cost of domestic credit fell, allowing companies to attract more funds and this activity was felt throughout most sectors of the Russian economy.
According to a recent market survey conducted by the Comcon research institute, citizens on the breadline have diminished by around 30%, although the State Statistics Committee estimate that one in four Russians still live below the poverty line. Galina Karelova, Russia’s Deputy Prime Minister responsible for Social Affairs, recently reported that the number of ‘poor Russians’ fell by 9 million in the first half of 2003, thus putting the official figure for those classified as poor at 33 million. In Moscow, the poverty line is given as 86 euros a month, whereas in the smaller towns it is put at 46 euros a month.
The official unemployment figure for 2003 is given as 8.1%, however, in a throwback to the old Soviet system, registering as an unemployed person requires hours of interminable queuing inducing many to simply abandon the process in an effort to try and find work. Consequently, the real figure is probably a few points higher.
Russians’ real income for the same period however, has grown by an estimated 14% and their purchasing power has also improved. Two years ago, one in ten people were estimated as being able to afford a new washing machine or a refrigerator, now one if five have sufficient
funds to be able to purchase home appliances and most Russian homes now have a TV set with one in four families owning a personal computer.
According to the latest statistics (the State Statistics Committee) the average per capita income in Russia is put at 5,524 roubles a month (approximately 164 euros), but in Moscow the average wage is put at 7,770 roubles (approx. 230 euros). In the rural areas it’s more a question of people making ends meet.

Income tax
A ‘Flat tax’ on personal income of 13% was introduced by Vladimir Putin on January 1 2001. Prior to that a 3-tiered system, introduced by Boris Yeltsin, with a top rate of 30% was in use and was chaotic. The system of ‘the more you earn, the more you pay’ meant tax evasion was rife and many people declared a small percentage of their earnings or simply didn’t bother to make a tax declaration.
The Flat tax system proved to be an instant success. With a rate of 13%, most wage earners felt that it was worthwhile paying in order to avoid any eventual problems. In its first year government revenue from personal taxes increased from $6.2 billion in 2000 to almost $12 billion in 2002.
Part of the success of the Flat tax system is a particularly clever advertising campaign (using sections cut out of apples that compare the old and new systems) aimed at convincing wage earners that because the tax is so low it’s worth paying. The flat rate of 13% with very few deductions also means that the forms are simple to complete. Nevertheless, tax evasion remains a problem. Employers had to pay just over 35% on an employees income, which naturally leads to companies declaring lower wages for their employees.
Corporate tax was also lowered as of January 1 2002 from 35% to 24% and a flat rate business tax came into effect where the tax payer could opt for the lesser of 6% of gross sales or 15% of profits.
On January 1, 2004, the Russian Government abolished the 5% sales tax and lowered VAT 2% to 18% a further indication that the government is actively trying to develop the economy. In their preparation to join the World Trade Organization (WTO) in 2004 and implement tax reforms. The Finance Minister said the reforms were aimed at significantly reducing the tax burden. In particular, the single social tax, the value added tax, the land and water taxes and the personal property tax will be reduced.

In December 2003, Russia’s Finance Minister, Alexey Kudrin, said that the Russian economy grew by 11.2% in 2003 as compared to 2.6% the previous year. According to the ministry, investment not connected to the fuel and energy sector is also growing (9.1%) with the final figures of the growth of industrial production in 2003 expected to achieve 6.7%.
The most important goal facing the Russian Government in the near future, Kudrin stated, is the “diversification of the economy and development of sectors not concerned with fuel and energy, where 65 million people are employed. This will allow for the creation of a new base for a healthy economy.”

State Financing (Dateline 30.1 2004)
Last year, state financing for the development of small business in Russia almost doubled compared with the previous period and amounted to 300 million roubles, Russian Minister for Antimonopoly Policy [and Enterprise Support] Ilya Yuzhanov said at a recent meeting. According to him, for the period after 1998 this figure was a “record” one but “still not enough to guarantee the economic development of small business”. In 2003, the minister recalled, “the government adopted a program of support for small business through a mechanism of state guarantees,” Yuzhanov said. This promising system, the minister said, received an appropriate reflection in the 2004 federal budget which set the state limit of state guarantees at 3 billion roubles. At the same time, the ministry will “attract regional banks to providing credits to small businesses on preferential conditions”. According to the Minister, “the Russian Development Bank has been chosen as a state agent to distribute money to the regions.” According to experts, small business in Russia is not sufficiently developed, amounting to only 5 per cent of Russia's GDP while in Europe the figure is more than 60 per cent.

In the forthcoming days, the rest of this lenghty survey will be added to our europastar website.

Revolution in evolution (PART I)
The Russian economy (PART II)
The Russian watch industry (PART III)
The Russian watch market (PART IV)
Watch companies in Russia (PART V)