NATO Economic Colloquium 1997

Russian External Economic Relations: Problems And Prospects Dr. Valery Oknyansky Counsellor, Economic Cooperation Department, Ministry of Foreign Affairs, Moscow Foreign Trade Looking at the Russian economic landscape today one can observe various contradictary trends. Among the most visible signs of progress is the recovery of the external sector. Notwithstanding the dramatic fall in production, the breakdown of past trade ties and the collapse of traditional trade arrangements over the last few years, foreign trade turnover has been steadily increasing mainly due to the implementation of economic reforms which have resulted in Russia's transition to an open market economy, the liberalisation of price and currency exchange systems, and the restoration of financial stability. However, the growth rate of Russian foreign trade fell substantially in 1996, although total volume reported at US$150bn (including private trade) was 7% up against 1995. Exports accounted for US$85.5bn and imports amounted to US$64.5bn. As always, trade statistics must be viewed with some caution, but it is evident that Russia witnessed a strong growth in exports of 8.7% while imports declined by 2% following two years of increase. As a result, the 1996 trade surplus grew to a level much higher than that recorded in 1995. Paradoxically, this trend, which in general looks favorable, is connected with some negative features of the present economic situation in Russia. For example, the appreciation of the rouble made some goods uncompetitive on the World market, but their exports continued to increase mainly because of the depressed domestic market. Regarding energy, high World prices increased the dollar value of what in quantative terms were static exports. Low consumer demand, caused in part by wage arrears, has adversely affected imports despite the strengthening rouble. Indeed, exports represented some 20% of GDP in 1996 against only 4% in 1991, but this is more a reflection of the collapse in domestic production than of any real achievement in the external sector. Regarding the qualitative aspect of Russian foreign trade, there have unfortunately been no essential changes in its commodity structure. Oil, oil products and gas made up the largest input in export value growth, and now account for 46% of Russian exports (1996). About half the oil and more than 30% of the gas produced in Russia in 1996 have been exported. Coal, iron ore and timber, in that order, are the next most prominent items of Russian exports. While the main part of Russian manufacturing industry continues to falter, the World market is encouraging the relatively rapid recovery of some export oriented sectors. This concerns not only mining industries but also non-ferrous metallurgy, the chemical industry and some others. About 70% of the output of the non-ferrous metallurgy industry was exported in 1996. The only sign of real improvement in the structure of exports has been the intensification of Russian activities in the World arms market. In 1996, arms exports increased to US$3.3bn compared to US$2.3bn in 1992, whereas global arms exports declined from US$27bn to US$22bn during the same period. Correspondingly, Russia's share of the World arms trade rose from 8.5% to 15.7%. According to some estimates, it might reach some 25% in 1997 and draw closer to the USA whose share amounted to 36% in 1996. This growth is likely to be stimulated by the fact that there are now 16 entities producing weapons and military equipment in Russia that have the right to operate independently in the foreign market, whereas before 1996, arms sales were the monopoly of just a single firm. Imports, in spite of their fluctuation, accounted for more than 50% of domestic retail commodity circulation in 1996, about the same ratio as in 1995. Food imports are now estimated to be around 35-45% of total consumption. Such a high level of dependence creates some problems of national economic security. Machinery and equipment amounted to 30% of Russian imports in 1996 and rose to 37% in the first five months of 1997, a trend that will probably continue. After decades of isolation from World markets, many specialists now consider Russia to be a tremendous potential market for most goods and services. Demand is emerging in waves. First, in the early 1990s, came demand for food products. Relatively strong demand for consumer products followed. 1995 saw a surge in demand for construction materials, hotel and restaurant equipment, and furniture. The hard currency-earning industries of oil and gas, mining and timber are the most promising sectors in Russia for the exporters of equipment and services. Significant opportunities also exist in long-term equipment sales to the coal industry. Although the quality of Russian building products is substantially lower than in the West, the price is just as high. As a result, Russian firms generally prefer to buy Western products. Demand is strong, driven by urban renovation. Commercial property (offices, banks, department stores, hotels and restaurants) are also a strong source of demand. Virtually all major Russian cities have embarked on urban construction projects to modernise and upgrade both residential and commercial property. These projects supplement private sector initiatives serving the same strong market demand. New large multi-story construction projects along with the renovation or demolition of old buildings are now commonplace in Moscow, St.Petersburg and other cities. Thus trade in self-erecting and mobile cranes, earth moving machinery, concrete trucks and pumping equipment will be much in deficit. In 1997, as Moscow geared up for its 850th anniversary, strong demand for construction equipment continued, although this demand could now shift to regional markets. Over the last few years, the private sector has grown dramatically with a commensurate increase in car ownership. Liberalisation of foreign trade in the 1990s stimulated the flow of imported cars, 80% of which were used vehicles. To protect local automobile manufacturers, the Russian government has levied import duties of approximately 100%. It is likely, however, that these tariffs will be gradually reduced over the coming years, thereby stimulating demand for imported vehicles. The Russian telecommunications market suffers from a lack of installed lines, outmoded switching equipment and inadequate revenues to finance investment. However, the cost of telecommunications equipment imported by Russia in 1995-1996 was over US$2bn. The Russian Ministry of Communications is dedicated to bringing the telecommunications infrastructure up to the international norm as quickly as possible, and many multinational firms are vying for the opportunity to participate in this undertaking. The significant change in the geographic structure of Russian foreign trade which has been visible over the last two years has been the growth of the CIS countries' share to about 25%. Integration within the CIS is essential for Russia. In 1992-1994, Russian foreign trade with these countries nearly halved although it stabilised in 1995. In 1996, trade with the CIS grew by 6% reaching US$34.2bn, including US$16.5bn (+8%) exports from Russia and US$17.7bn (+4%) imports to Russia. This suggests a modest revival of economic ties between former Soviet states. In the past, Russia faced a serious problem of trade imbalance with CIS countries to the tune of about US$20-25bn each year. The resulting accumulated debt owed by CIS states to Russia had become a real obstacle to further trade development. But this imbalance was slightly reduced in 1996. The European Union now dominates Russian foreign trade, amounting to 40% of total turnover. Russia's chief export market is Germany, which imports nearly twice as much as the next largest importer of Russian goods - China. Italy, the United Kingdom, Hungary, Japan and the United States, in descending order of importance, follow Germany and China as markets for Russian goods, predominately energy and raw materials. Official statistics for Q1 of 1997 confirm the above trends. Balance of Payments Situation Russia 's consolidated current account in 1996 was in surplus for the fifth year in a row at US$9.3bn. The 1996 surplus reflected a US$21bn merchandise trade surplus, offset by a US$11.7bn deficit in non-merchandise trade. The Russian Federation is a net importer of services - in 1996 imports more than doubled the value of exports. More than 80% of imported services into Russia were accounted for by three sectors: tourism (US$10bn against US$5.5bn exports), transportation and construction. In 1996 Russia sustained a capital account deficit of US$5.2bn. Capital flight continues to plague the Russian economy although official data suggests that its rate has slowed significantly since the peak year of 1992. Assessments vary greatly, but a realistic figure for net capital outflows from Russia since the start of transition would be between US$60-80bn. It appears that little of this is related to criminal activity. Most represents a desire for safe havens abroad for foreign exchange earnings. Foreign Trade Regulation Regime Custom procedures are constantly being revised in Russia and need to be closely followed by trade partners. Most foreign trade is already regulated according to WTO rules and this has been confirmed by special treaties and agreements with some countries. For example, an agreement (on partnership and cooperation) was signed with the European Union in 1994 and ratified by Moscow in November 1996. But many Russian specialists feel that excessive haste in opening up the domestic market without any corresponding investment in Russian enterprises would create, indeed is creating, tremendous difficulties for the stimulation of economic growth and structural reform. This concerns many industries which are not yet ready for competition without state support because of their obsolete equipment and technology. The Russian authorities have also adopted an "import passport" system whereby an importer has 180 days either to document the entry of goods with the Russian Customs Service or return the hard currency issued in payment. This should help to stem the tide of illegal contracts for imports into Russia which results in capital flight. Foreign Investment Environment The enactment of foreign investment legislation is currently being completed in Russia. Its basic principles are oriented towards international norms and WTO procedures. Treaties relating to the encouragement and protection of investment as well as double taxation avoidance have been signed with more than 40 countries. With certain specific exceptions, the legal regime for foreign investors may not be less favorable than that for Russian legal entities and individuals. Foreign investments on the territory of the Russian Federation may be channeled into any business not prohibited by federal law. Certain types of activity are subject to licensing, such as insurance, banking and certain other services. Government policy towards investment also covers foreign capital participation in the privatisation process and defense conversion, but with a few exemptions. Foreign investments in Russia are not subject to nationalisation, requisition or confiscation, except for cases which are specifically provided for under Russian legislation. After the payment of the appropriate taxes and duties, foreign investors are guaranteed by law unhindered transfer abroad of profits, dividends, interest, license fees and commissions. Because of limited national financial resources, the volume of investments in Russia in 1996 fell by 18% compared with 1995 and amounted to only 30% of such investment in 1991. But the average age of fixed assets in Russia is now 35 years and the Russian economy needs approximately US$350bn just to finance the replacement of obsolete equipment. Russia's large domestic market, its vast supply of national resources, its skilled labour force and finally its proximity to CIS markets should enable it to attract considerable foreign investment. But while foreign direct investment in Russia has by far outpaced investment in other CIS States, the level is still low when compared with foreign direct investment in Eastern Europe. In 1996, per capita total foreign direct investment in Russia amounted to US$14 against about US$200 in neighbouring Poland. Estimates of foreign direct investment in Russia vary widely due mainly to company confidentiality and the relative lack of definitive means to establish actual cash inflows. At the end of 1996, officials estimated total cumulative direct investment in Russia to be US$7bn, with US$2.1bn coming into the country during 1996 itself. About 50% of 1995-1996 foreign investment was accounted for by four sectors: trade, finance, the food industry and energy. In the previous two years, the energy sector held a much more dominant role in investment, accounting for 44% of total foreign investment in 1994. The ascendancy of investment in other industrial sectors can be interpreted as a positive sign that the economy is becoming more diversified and less reliant on the extraction of natural resources. Since the break-up of the Soviet Union, the US is clearly the leading foreign investor in Russia accounting for about 30% of the total. The US is followed by Switzerland with 15% and Germany with 10%. Opinions differ as to which countries are the next most prominent investors, but generally include France, South Korea, Japan, the UK and Italy. Moscow, St.Petersburg and their respective hinterlands are the areas receiving the largest amounts of foreign money. There are more than 15,000 joint ventures in Russia, of which about 45% operate in trade, 22% in industry and 10% in construction. Free Economic Zones Russian customs legislation permits the creation of free customs zones and free warehouses within which foreign goods may be placed without customs duties and taxes being levied and from which goods may be exported to third countries. The territory of free zones and warehouses is considered as being outside the customs territory of the Russian Federation. Between 1990-1996, the federal authorities decided to establish some 20 zones with special regimes for doing business, including foreign trade privileges. However, these privileges granted by various regulations were not always subsequently confirmed by Russian tax, customs and currency legislation. The draft Law of the Russian Federation on Free Economic Zones is under consideration in the State Duma. National debt Russia maintains a substantial foreign debt which amounted to about US$135-140bn at the beginning of 1997. Approximately US$103bn of this debt has been inherited from the Soviet Union while the remainder has accumulated since 1991. Russia's chief creditor is Germany which holds roughly 40% of oustanding foreign debt. In April 1996, the Paris Club of official creditors agreed to reschedule Russia's outstanding stock of sovereign debt (more than US$40bn) over 25 years. This agreement is subject to periodic reviews which are tied to performance under the IMF program. In May 1996, the London Club of commercial bank creditors reached an agreement in principle with the Russian government to reschedule US$32.5bn in debt. The agreement calls for principal to be repaid over 25 years with a seven-year grace period. The corresponding agreements with Germany, the US, France and Switzerland were signed last year. These structural improvements have lightened the re-payment load of outstanding Russian debt and given Russian firms the ability to tap into international capital markets. Some other countries (such as Cuba, Mongolia, Vietnam, India, Syria and Libya) are in debt to Russia. The total amount is estimated to be some US$150bn. Thus, on paper at least, Russia still retains its position as a net creditor and as such could participate in the activities of the Paris Club.