tutkimuia

Eastern European Markets

(4/2012)

CEMAT
Russia’s Economic Prospects 1/2012
University of Eastern Finland – CEMAT 2012

The complete report (in Finnish) is available at:
http://cemat.aalto.fi/fi/electronic/prospects/russia/


Oil exports, retail trade and foreign car manufacturers’ investments hastened Russia's economic growth more than expected; Finnish companies' expectations generally positive

Russia's gross domestic product (GDP) grew by 4.3 %, slightly faster than expected. Real GDP growth accelerated at the end of the year due to the stirring up of manufacturing, retail trade and construction. The biggest growth engine was the automotive industry, where production increased by as much as 25 %. In addition, similar to the entire post-crisis period, consumer demand continued to grow which maintained the development of retail sales. The historically low inflation (6.1 %) also contributed to the recovery of the trade primarily due to the more moderate increases in food prices than earlier.

However, economic growth was marred by both internal and external risks, especially by the capital flight - exacerbated by the election campaign in December - as well as the slowdown of export market growth in the turmoil of international financial crisis in spring 2012. All in all, recovery has been slower than after the so-called ruble crisis in 1998: for example, fixed investment is still at a lower level than before the economic slump in 2009.

The Russian economy is highly sensitive to the uncertain global development, and for 2012, the GDP growth forecasts range from 2.3 % to 4.2 %. There is a risk of continuous capital flight, which has resulted in, for instance, the shortage of liquidity in Russia's banking sector. This in turn may adversely affect the companies' access to finance for investments. At the same time, confidence in the Russian banking sector has fallen very low, apart from the largest state banks, which seem to have strengthened the role of government in the local banking sector.

In spite of the low inflation rate, the real growth of public revenues has been slow. The real value of wages fell in 2009 as a result of the economic crisis, and at the same time, cross-industry wage differentials have narrowed along with the raise in the salaries of the public sector. Thanks to the pension reform, pensions in 2008-2010 increased in real terms by almost 80 %, and this year, also a reform of the army payroll will be carried out. Employment has also developed favorably, and estimates suggest that Russia's unemployment rate is about 6.5 % which is almost two percentage points lower than during the crisis. The favorable employment trend has simultaneously caused a more severe competition for skilled labor.

Last year's budget finally showed a small surplus (0.8 % of GDP), far better than expected. The fact that oil prices remained high throughout the year augmented the budget revenue. In addition to oil revenues, the rise of social insurance fees based on employers' wage costs increased the government revenues. In the expenditures, expenses especially in health, road infrastructure, defense and training were on the rise. The growth in pension expenditures, in turn, came to a halt after the earlier dramatic increase for three years.

The value of Russia's foreign trade rose to a significantly higher level than before the crisis, but at the same time, the dependence on energy exports rose almost to the former peak. Various fuel and energy products accounted for as much as 68 % of the export value, although the Russian state aims to increase the degree of oil refinement by raising export duties in products such as heavy fuel oil. Russia's energy sector has also suffered from problems with the export of natural gas to Europe via Belarus and Ukraine because of price disputes. Although China has become Russia's most important trade partner, passing Germany in recent years, Russia has intensified cooperation particularly with the CIS countries to facilitate trade in these important export markets.

Economic integration has also progressed at the multilateral level, when the negotiations for Russia's accession to the WTO were finally completed in December. This will ensure the same treatment for foreign products as local ones during the transition period in Russia, which will improve, in the long term, Finnish companies' competitive advantage. This is truly good news for Finnish exporters, since exports from Finland to Russia have recovered rather slowly after the economic crisis, while the value of imports, in turn, has been growing fast because of the rising of oil prices.

In spite of the good buoyancy of oil exports, Russia's energy sector is in dire need of investments in order to renew the capacity that is becoming outdated. The government wants to strictly control the strategic sector, while at the same time foreign investors are not interested because of Russia's notoriously difficult investment climate. In fact, foreign direct investments in Russia are mainly Russian capital recycled through tax havens, and all in all, very few actual foreign investments are directed to Russia. In an international comparison of investment risks, Russia recently got a score close to Pakistan.

Investments from Finland to Russia, however, have been on the rise. Finnish companies' expectations for 2012 and 2013 are still mostly positive, although last winter’s election riots occasionally increased uncertainty in the investment climate. Operations are now expected to grow at a slightly slower pace.

Attracting foreign investment has been one of Russia's economic policy priorities in recent years. The main objectives of Russia's recent 2020 strategy are the reduction of raw material dependence and the transition to a post-industrial, service and innovation-based economic model. In addition, Russia intends to improve the business environment and to increase the investment attractiveness by reducing regulations and subsidies, as well as to attract high-skilled labor force to facilitate labor market shortages.

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More Information
Professor Riitta Kosonen
Director, Center for Markets in Transition (CEMAT)
riitta.kosonen@aalto.fi
cemat@aalto.fi


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