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Medicine or poison?

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Moscow.(Yelena Korop for RIA Novosti) - World oil prices are high and the Russian economy is oversaturated with money. Gold and foreign exchange reserves have grown by 50% since early 2006 amounting to about $270 billion and placing Russia third in the world after China and Japan.

Federal budget revenues are 25% higher than planned. The Stabilization Fund in which the Russian government accumulates its surplus profits from oil exports will reach $93.3 billion by the end of the year (8.5% of the country's GDP), twice as much as the Finance Ministry had projected.

The government is at a loss: It had not expected such enormous profits. So far, the state has been the main beneficiary of the favorable situation on the raw materials markets, since a considerable part of oil exporting companies' revenues goes to the federal budget in taxes. Thus, the government is responsible for the proper use of Russian oil bonanza.

A cautious conservative approach to the use of oil superprofits, as advocated by the Finance Minister Alexei Kudrin, prevailed among members of the Russian government until recently. The minister tried to persuade the president and the prime minister that budget revenues received from high oil prices exceeding analysts' forecasts should be regarded as a "windfall", and should not be used in the economy but stockpiled in the Stabilization Fund instead.

The finance minister fears that when the petrodollars enter the economy from the state budget, they will lead to higher living standards unsupported by an adequate rise in labor productivity and thus provoke inflation. Inflation has been gradually brought down in Russia but is still very high (10.7% in 2005). Public opinion polls name price rises as one of the major problems facing the country.

Meanwhile, monetarism Kudrin-style is no longer in fashion. Advocates of an active budget and the guiding role of the state in the economy have gained the upper hand in the Kremlin and the government. In their opinion, the state budget is not only a mechanism for redistributing tax revenues and maintaining financial stability, but also an instrument for reaching the key goal of Russia's economic policy - to reduce the economy's dependence on raw materials exports.

Experts say that in three years the stabilization of world oil prices and lower growth rates of raw materials exports will reduce the contribution of the external factor to Russia's GDP growth from the present 14% to zero. The country's economy needs an internal growth impetus. Preoccupied with its search for new "growth points," the government has focused on industry.

Despite the years of oil bonanza, Russian industry is in a sorrowful state, with its growth rates lagging far behind the general economic dynamics. Only companies servicing raw materials sectors and those aimed at meeting consumer demand are going strong.

Large-scale investment into equipment and modern technologies is needed to develop engineering and other sectors manufacturing high added value products.

In terms of direct foreign investment, Russia is ahead of Japan and Canada ($20 billion over the first nine months of this year). However, the money attracted by the Russian economy due to high oil prices and a stronger ruble is not channelled to the sectors the Russian government would like to. Both foreign and Russian investors prefer the fuel and energy sector with its high profits. Capital owners are not interested in small iron and steel works beyond the Urals. One of the reasons is that they are too far away and difficult of access.

The government, eager to show to the world that Russia is capable of producing more than crude, has decided to take the investment initiative into its own hands. The 2007 federal budget increases investment spending by 50%, with its share in GDP to rise from 2.2% to 2.7%. The funds will be used to develop the infrastructure and provide targeted support to industrial enterprises.

This work is in full swing now. The State Investment Fund has been set up to finance road and airport construction by the government in partnership with private businesses. The first budget allocations have been made for infrastructure development in special economic zones (SEZ). Within the next few months, a Russian Venture Company will be established to provide government support to high technologies development. A State Development Corporation will be set up to give financial backing to promising industrial projects.

Russia is on the threshold of a state investment boom and opinions are divided on this issue. Russian economists continue their debates on the expediency and justification for the state's active involvement in the economy. The majority of experts share the Finance Minister's point of view that the economic function of the state must be limited to curbing inflation and promoting a favorable economic environment for business. In keeping with this logic, the government's additional investment creates a threat of inflation and prevents the natural market selection of competitive sectors. Analysts question the efficiency of the state as the investment process manager. Numerous studies, including those done by Transparency International, the Berlin-based non-profit organization founded to combat corruption, testify to the growth of corruption in Russian government bodies.

However, the situation at present is not in favor of the liberals. In the run-up to the forthcoming parliamentary and presidential elections, the Russian authorities cannot afford stocking the oil billions in the Stabilization Fund, when 60% of the country's roads do not comply with standards, the public utilities inherited from the Soviet times are in a deplorable state, and 20% of the voters, who live below the poverty line, resent the affluence of oil and gas companies.

Advocates of an active budget policy point out that the share of state investment in Russia's GDP is among the world's lowest. They say that the effort will be worth the trouble if at least two world-class highways are built with the Investment Fund money.

The Russian Economic Development Ministry estimates that at least three years will have to pass before budget investment yields the first tangible results. Only then will it become evident whose approach to economic policy - that of the liberals or advocates of government interference in the economy - is more productive.

Yelena Korop, deputy editor-in-chief of the Business Week Russia.

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