Guiding Lines: Economy of Contradictions

The prospects of Russia’s joining the WTO as early as this year are just as ambiguous. Somber predictions run counter to optimistic macroeconomic reports and data provided by international rating agencies, who see no preconditions for market default.

For example, the Word Bank’s “Russian Economic Report” presented to the Association of European Businesses in late 2006, states that “the pace of economic growth has accelerated since the second quarter of the year”. Construction holds the lead in the real sector; Rosstat, Russia’s State Statistics Service, reports that in 2006 that sector grew by 13.2% from 2005, which is almost thrice as high as the overall industrial growth (4.6%).

Equity and direct foreign investments, too, have been growing at an impressive rate.

In the first three quarters of 2006 alone the inflow of foreign direct investment increased by 55% to $10.3 billion.Remarkably, the share of foreign direct investment in real estate in total investment received last year is quite high, 15.8%, which constitutes a double increase from 2005.

The total real estate investment including construction is comparable to investment in processing industries (metallurgy, coke and oil products excluded), which stands at 17.1%.

A joint survey by PriceWaterhouseCoopers and Urban Land Institute “Emerging Trends in Real Estate Europe 2007” states that buying real properties in Moscow is worthwhile.

Admittedly, the Russian capital ranked only 27th on the list of 27 cities across the globe where real estate investment is deemed least risky. But in terms of equity income prospects Moscow ranked 2nd. 72% of respondents polled by the authors of the survey recommended acquisition of retail space in Moscow, which could be brought about by growing individual incomes and consumption.

Meanwhile, Standard & Poor’s last year upgraded Russia’s sovereign rating to BBB+ (or "Stable"). Interestingly, over the past seven years Russia’s S&P rating was upgraded as many as 10 times!

Foreign investors take keen interest in real estate markets across Russia, examine general urban development plans and take measures to establish contacts with authorities in the regions with best prospects.

A 2005 survey of 822 large corporations in 52 Russian regions carried out by the Moscow Higher School of Economics and Hitotsubashi University revealed that 40 percent of these corporations characterize themselves as having special bilateral relationships based on mutual favors (two-way support) with regional and local authorities.

83 percent of enterprises claimed to give special support to regional and local authorities. 44 percent admitted to also receiving such support. Thus, Russia remains a country whose market is dominated largely by a handful of companies who enjoy support of regional or municipal governments in exchange for social and other services.

“This phenomenon is not just a product of corruption or rent-seeking," the World Bank states in its report. "Given low explicit budgetary (especially tax) autonomy at lower levels of government in Russia, regions and municipalities realize many of their social objectives through shadow budgets that employ the quasi-fiscal services of larger incumbent enterprises on their territories. “This creates a natural bias against outside competition from other businesses or entrepreneurs.”

The lion’s share of investment in Russia is still going to energy and real estate.

Over the first nine months of 2006, 10.8% of total fixed capital investment went to real estate operations, leasing and services provision, while 3.6% went to construction, Rosstat reports. Taken together, that is twice as high as the amount of investment in manufacturing, electricity, gas and water production and distribution (7%).

That is why strengthening of the investment climate remains a priority task for Russia. Strong and stable banking system is necessary to ensure further economic growth. Sadly, Russian banks’ ratings still fall behind the country’s sovereign rating.

John Gibling, head of Russian bank ratings at Standard & Poor's, believes that favorable macroeconomic climate and good potential for financial mediation are the key positive factors for Russia's banking sector. Negative factors, Gibling says, are weak bank regulations and surveillance, concentrated structure of the economy and domination of state-controlled banks. In medium term banks controlled by the government are expected to strengthen their influence in finance, whereas privately-owned banks will be gradually forced out.

Confronted with the threat of being ousted from the market, private banks will be forced to streamline their operations, Standard & Poor’s believes.

Seeking to withstand the increasingly tense competition the banks whose shareholders prove unable to provide resources for maintaining sufficient capitalization will be forced to look for strategic investors, including foreigners.

Over the past two years the share of foreign capital in Russia's banking sector has more than doubled, having increased from 6 to 14%. Nowadays, Russian banks enjoy support of major international banks Societe Generale with stakes in Rosbank and Rusfinansbank, Raiffeisenbank (Impeksbank), Commerzbank AG (Promsvyazbank), Banka Intesa (KMB Bank) and others.

The shortage of labor force is another challenge Russia is likely to face as soon as within the next fifteen years. Domestic real estate sector is likely to be one of the hardest-hit, as last year as many as 72,782 licenses for construction were issued in this country, the Federal Construction and Municipal Economy Agency (Rosstroi) reports. Those works require high-skilled labor force, the supply of which is low in Russia. "It should be noted that Russia’s needs in migration are even greater than those of Western Europe,” the WB report says. The long-term forecasts by Standard & Poor’s also confirm the trend. Moriz Kramer, managing director for sovereign ratings service Europe, notes that as soon as by 2020 Russia’s demographic situation will deteriorate, with population expected to drop by 3 million.

Nowadays, Russia faces serious demographic problems and suffers an acute shortage of high-skilled workforce. A joint study on Russia’s investment climate by the World Bank and the Higher School of Economics reveals that the number of companies who complain about the lack of workforce is nearly twice as high as those who spoke of the excess of human resources (27 vs 13%). 72% of companies who reported the shortage pointed out to the lack of skilled workers on the local market. Although half of all enterprises operating in Russia provide professional training, only 7.7% of high-skilled and only 1.4% of unskilled workers are involved in such training. In Brazil and China those figures stand at 53% and 45%, and 44% and 28% respectively. Meanwhile, for each dollar of his pay a Russian worker produces half as much as an Indian or a Chinese worker. That is a food for thought, indeed.