Publication: Prism Volume: 8 Issue: 1

By Elena Chinyaeva

While Russia’s leadership remains optimistic regarding the prospects for the country’s economy, the statistics paint a less certain picture. Last year’s inflation was 18.5 percent rather than the planned 12 percent, growth of the gross domestic product has slowed and the structural reforms launched last year look uncertain. On the whole, the economy is still highly dependent on the world raw materials markets and sensitive to seasonal factors. Meanwhile, the government of Mikhail Kasyanov has to find the right balance between economic tactics and or face being replaced.


During his frequent international visits and high profile public appearances inside Russia, President Vladimir Putin likes to stress the country’s economic successes over the past two years–and rightly so, given that the economy has shown growth for the third consecutive year. In 1999, the GDP rose 5.5 percent. In 2000, the economic results were more impressive, with GDP rising 8.3 percent, industrial production increasing by 9 percent and agriculture showing growth for the first time in many years, rising by 3 percent. The figure for 2001 GDP growth (the official results have not yet been published) is expected to be about 5 percent.

Most important, the economy has grown not just because of the favorable conditions on the world markets for raw materials–mainly oil, gas and metals, which are Russia’s main exports–but because, for the first time since Russia’s transition began, the domestic markets have begun to grow. A real consumer boom began in 2000, driving sales in almost all markets. As the pre-New Year sales showed, the country has finally overcome the devastating consequences of the 1998 financial crisis: The turnover of all producers and traders has reached or exceeded the pre-crisis level. According to Expert, the Russian economic business weekly, the following sectors showed particularly impressive results in 2001: mobile phones, sales of which rose 124 percent; beer consumption (up 17 percent); civil aviation (up 25 percent); property (up 25-30 percent); furniture (up 10 percent); clothes (up 18 percent); home appliances (up 20 percent). Sales of new imported cars doubled.

One of the most important qualitative changes in Russian economy during this period was the rise of internal investment and the population’s real income. In 2000, the investment tempo rose 17.2 percent, and 8.8 percent in 2001. Real incomes for 2001 rose about 15-17 percent as of last autumn. During these two years, Russia has also started a number of long-overdue structural reforms, including an overhaul of the army along with the tax, pension and judicial systems. It also laid plans for reforming the state gas, electricity and railways monopolies.


Inflation, however, has remained a big problem. Although it had been dropping–from 84.4 percent in 1998 to 36.5 percent in 1999 to 20.2 percent in 2000–it was 18.6 percent in 2001 rather than the 12-14 percent envisaged in the 2001 budget, which was considerably higher than 11 percent of pre-crisis 1997. Meanwhile, economic growth began stalling out in October of last year, meaning that the GDP growth target for 2001–5 percent–may have not been reached. While the government has said that seasonal factors accounted for the growth stall, the business daily Kommersant noted that such an explanation only further underscores the fragility of the Russian economy, which continues to depend on factors beyond the government’s control–world oil prices and the weather. As domestic consumption of oil and gas grows in the cold season, oil exports drop, which, along with the drop in world oil prices, directly affects the state’s income and GDP growth.

Tax reform has been heralded as the showcase of Russia’s latest round of economic reforms. With a flat income tax of 13 percent, a consolidated social tax, lowered turnover and customs duties and a 24 percent profit tax, Russia’s tax system promised to emerge as Europe’s most liberal. Yet taxpayers have already found a few traps in the new legislation. For example, companies with high investment levels have found that they have to pay more tax because a tax exemption on profits for such companies was cancelled. Draft legislation voted into a law in late December by the Federation Council, the upper chamber of the parliament, changing the procedure for paying the consolidated social tax, is also a worrying sign that tax reform might go wrong. Half of this tax, 14 percent, constitutes pension payments. Given that the reform of the pension system which came into effect on January 1 of this year–special pension funds have been created to accumulate this 14 percent–it was decided to split the consolidated social tax and to pay the pension tax separately. However, thanks to a loophole in the legislation, the employers will not be able to reduce their consolidated social tax for that amount, but will have to pay this 14 percent as well, in the hope that the state will reimburse them later. Getting the money back from the state is a long and costly procedure. Many employers might consider it a better option to go back into the shadows–meaning revert to tax evasion. Thus, the pension tax trick, which in fact increased the corporate tax burden 14 percent, has undermined the whole of the tax reform.

According to Expert, Russian economy has a number of other significant problems. One is the increasing volume of imports. Given that the positive impact the 1998 ruble devaluation had on Russian producers is vanishing, this underlines a sad fact: Domestic products are still not competitive due to their low quality and high prices. Russian companies also remain relatively unproductive because, despite the increase in domestic investment of late, not all of them have yet modernized their production lines. In addition, the level of capital accumulation in Russia is around 17 percent, while average for growing economies is 30-50 percent.

The plans undertaken last year to reform the state monopolies also look uncertain: Neither the railways nor Gazprom, the state-controlled natural gas giant, have yet adopted detailed restructuring plans. The essence of these reforms is to break these monopolies into several companies by dividing the production facilities–the railways network and gas pipelines, which are to remain state property–from operators, which are supposed to pay taxes just like other law-abiding transparent businesses. Thus far, however, the changes in both monopolies have gone no further than replacing a number of top managers in order to ensure that control of their financial flows is in the “right hands.” Only the state electricity monopoly, headed by one of the most prominent liberals of the transition era, Anatoly Chubais, is still moving in the direction of reform.


The apparent change in Russia’s economic model–from an export-oriented one with an annual growth potential estimated by Expert at about 4 percent, to one oriented towards the domestic market, with a growth potential of 10 percent annually–is very promising. However, the Russian government’s economic policy, as it has been developing so far, does not instill much optimism.

January 2002 marked the start of Prime Minister Mikhail Kasyanov’s third year as head of the Russian government. Kasyanov came to the fore of Russian politics in 1998 after he successfully headed the Russian team negotiating Russia’s debt to the London club of creditors. His ability to negotiate helped him ascend to the second-highest post in the Russian Federation and hold it for over two years. He has, however, been less successful in working out a sound economic strategy, leaving the job of generating ideas to the group of so-called “St Petersburg liberals” in his government, including Aleksei Kudrin, deputy prime minister and finance minister, and German Gref, the minister of economic development.

Upon its appointment, the Kasyanov cabinet clearly stated its allegiance to the ideals of economic liberalism–economic freedom, low taxes, deregulation. Yet it has so far failed to come up with any economic strategy program, having become bogged down in the daily routine of finding money for foreign debt payments, pensions and salaries for state workers. Entry into the World Trade Organization has suddenly become the biggest issue on the government’s agenda, yet the government not actually stated what trade structure Russia will have and which domestic producers WTO membership would assist.

True, there is no unanimous opinion on what such an economic strategy program should be. Is it even possible to identify the main economic directions in the world, whose development becomes faster and more unpredictable every year? How far into the future should such a program look? Or is it perhaps better to leave everything up to the “blind forces of the market”? These arguments notwithstanding, the business community can rightly expect the government to give a clear indication of economic priorities, and to show some consistency in following them up. Will the government encourage further domestic investment? If so, what tax and other measures is it going to undertake to create the right conditions for Russian companies to return capital they have moved offshore and for foreigners to invest in the real sector? How should the banking system develop? What industries could be the locomotive for the national economy and thus be given special attention? How does the government intend to assist small and medium-size businesses?

The Soviet economic model–an economic fortress in which almost everything was produced domestically–has long been declared outdated, but no clear steps have been taken to indicate what role in the world’s division of labor Russia intends to play. Being mainly an exporter of raw material and cheap weaponry no longer satisfies the needs of the country’s development. The Russian economy is at a crossroads and the time is right to make a choice, given that the economic growth of the last three years allows for an informed decision. There is only one problem: who has the courage to make this decision?

The decision has to be made pretty soon, given Russia has entered its last year before the new election cycle begins and the time for bold moves is running out. Electioneering has its own logic and the grand vision needed for strategic plans might be buried under more the pragmatic considerations of winning over the electorate. Mikhail Kasyanov’s government must meet this challenge or go.

Elena Chinyaeva, who holds a doctorate in modern history from Oxford University, is a writer with the leading Russian political weekly Kommersant-Vlast.