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   September 30
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Analysis & Opinion
09.06.08 Blending With The Global Economy
By Sergei Balashov

Inward and outward investment has been one of the key indicators of what many see as an economic boom. Russia has seen a sharp hike in foreign direct investment, which jumped from less than $7 billion in 2003 to over $27 billion in 2007, or $396.3 per capita, which is more than twice that of Brazil and six times greater than China’s for the same year.

“I’ve been involved in Russian investment since 2002, and I can say that the situation has dramatically improved since then,” said Rainer Geiger, deputy director for financial and enterprise affairs of the Organization for Economic Cooperation and Development. “At first, the performance was poor, but now Russia has reached the top in both inward and outward investment, which opens new opportunities for partnerships and cooperation. Outperforming China is quite an achievement,” he added.

OECD is another major organization Russia is aspiring to join. Russia has had a cooperation program with OECD since 1996, when it officially requested membership. It has so far produced five surveys of the Russian economy reflecting positive changes, including increased legislation efficiency, state institutions’ accountability, and advancement of property rights. Still, there’s more work to be done. “There is still room for improvement,” continued Geiger. “If you look at the FDI as a percentage of the GDP, Russia has not been as impressive as other countries, and there are a lot of business opportunities which haven’t yet fully developed.”

As Russia is still a few years away from full membership in the OECD, structural reforms are crucial for speeding up this process. “The improved investment figures should not be taken as a reason to stop the reforms,” said Geiger. “We’d like to see information transparency and good administration of sovereign funds, as we’re looking forward to future cooperation. OECD needs Russia as a major partner.”

“Both the WTO and OECD influence foreign investment,” said the deputy director of the Department of Trade Negotiations of the Russian Ministry for Economic Development and Trade Vladimir Tkachenko. “The WTO doesn’t regulate capital movements, but the OECD goes further than that. The OECD has devised a code of liberalization of capital movements, which entails certain obligations in stability and transparency positively viewed by investors, Russian and foreign alike. I think that just as in the case with the WTO, the advantages we’ll gain from joining the OECD will include further improvement of the investment climate, and the increase in investments into the Russian economy in both scale and quality.”
Harnessing the growth
Sovereign funds have been the government’s main instrument aimed at curbing inflation. The Stabilization Fund, which was set up in 2004 to balance the federal budget and accumulate the profits from high oil prices, was split up into the National Welfare Fund of about $32 billion and the Reserve Fund storing over $130 billion. While it has been possible to keep inflation relatively low over the past years, the government has had to deal with arguments that these funds would be of more use if they were spent on various domestic projects, such as improving the infrastructure and building more roads. Yet, as per the finance ministry, such measures would only slow down growth, and have serious macroeconomic consequences.

“We do have plenty of problems that remain unsolved,” said deputy finance minister Alexei Pankin. “We have awful roads, our hospitals and transportation need improvement. All of that is fair, and the poor quality of the infrastructure slows down the economy, but the problem here is that any additional inflow of money will not improve the situation. Any additional spending by the government will cause inflation to grow. If we spend twice more on roads, we will not get twice as many built. And this will also drive out the private sector,” explained Pankin. “It would be possible to consider spending a part of these funds on infrastructure projects, but only in a different macroeconomic situation,” he added.

According to the latest reports of the International Monetary Fund (IMF) and the World Bank, Russia might have to do more than establish the funds to keep inflation in check and balance the economy. While the IMF warned against overheating of the economy, the World Bank issued a report stating that the economy is already overheated, as the GDP growth rate has amounted to eight percent, which is higher than its long term potential, with the producing capacities outmatched by the growing aggregate demand spurring inflation and creating a risk of further growth below the estimated potential. The report states that following eight years of decline, consumer price inflation accelerated to 11.9 percent in 2007, and is projected to reach anywhere from 12 to 14 percent in 2008, according to World Bank’s lead economist for Russia Zeljko Bogetic.

The World Bank recommended balancing inflation and closing in on institutional reforms and infrastructure gaps, to sustain long-term growth. In conclusion of the report, World Bank analysts stated their belief that the government was in the right position to tackle any possible setbacks. “President Medvedev’s policy emphasis on the four I’s – institutions, infrastructure, innovations and investment – outlines important priority areas for the new government that could reinvigorate the structural reform agenda and further productivity gains that form the basis for sustained economic growth in the future,” states the report.
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