How sound is Russia's economic growth?

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MOSCOW. (RIA Novosti economic commentator Nina Kulikova) - An important factor in Russia's economic growth last year was the unprecedented scale of investment.

According to official statistics, the increase in investment in fixed assets hit a six-year high of 13.5% against 10.7% in 2005. The government views the rise as a sign of a healthy economy. Yet the country's stagnating industry makes talk of sound economic growth seem premature.

The fact that investment grew almost twice as fast as gross domestic product (up 6.7%) is really a positive development for the Russian economy. Combined with the generally favorable macroeconomic situation and stable growth on the domestic market, it even prompted Finance Minister Alexei Kudrin to describe the current investment boom in Russia as "the beginning of an economic miracle." This boom was encouraged, among other things, by an influx of private capital into the country and by growing state investment.

According to the Central Bank's estimates, net private capital inflow into Russia in 2006 reached an all-time high of $41.6 billion against $1.1 billion the year before. This was to a large extent due to the government's move to fully liberalize the currency regime on July 1, 2006. This made operations on Russian financial markets more attractive for foreigners and investment companies, while Russia became one of the most open countries in terms of capital movement.

The Russian government also boosted investment last year. It not only increased state capital investment, but also appropriated large sums for developing such investment instruments as partnership between private businesses and the government and special economic zones with tax relief. The government also set up an Investment Fund to help finance projects outside the energy sector and the Russian Venture Company was set up to sponsor innovation projects.

Although investment in fixed assets is growing, it remains on too small a scale. This is primarily reflected in Russia's industrial growth, which has been slowing for the past three years, down to 3.9% last year from 4% in 2005.

A major problem is that equipment at Russian industrial plants is becoming obsolete faster than it can be replaced. There are various estimates of the depreciation of Russian fixed assets, but the rate exceeds 50% in such key industries as metallurgy, oil refining and mechanical engineering.

This, combined with high production costs in many industries and growing competition from imports, which increased by some 30% in 2006, is seriously weakening the competitiveness of Russian products. Much larger investment is evidently needed to achieve sustainable long-term economic growth in Russia.

Although the share of processing industries in total investment volume is gradually growing, a considerable part of fixed asset investment is going, as before, to the fuel industry, especially extraction, and metallurgy. Industries producing high value-added goods remain less profitable and are less popular with investors than the raw materials sector. So while Russia's overall economic growth rate is high, it is not the right type of growth needed to build an innovative economy, although the government has frequently declared this a priority.

The government has been talking about economic diversification for a long time. Dmitry Medvedev, first deputy prime minister, was the latest to do so. Speaking at the recent world economic summit of top business and political leaders in Davos, he said that considerable economic restructuring was the only way to ensure fast and sustainable growth in Russia. "Today we are focusing on certain sectors like advanced processing of all types of mineral resources, the aerospace sector and the export of intellectual services," he said. "In some of those areas we are looking at forming big Russian corporations and we will support them in every way."

But how realistic is it to change the structure of the economy by state financing? We need colossal investments for the wholesale modernization of the Russian industry. Considering forthcoming presidential and parliamentary elections, the growth rate of foreign investment may slow down over this year. In that case despite a good macroeconomic performance, it will become even harder to call Russia's economic growth sound.

The opinions expressed in this article are those of the author and do not necessarily represent those of RIA Novosti.

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