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Moscow Times
November 2, 2001
Some Advice You Can Bank On

With the World Economic Forum in Moscow and the Russian Investment Symposium at Harvard, bad business news has been hard to find this week. And, for the most part, we think there is good reason for that. So now that Russia is, as one U.S. trade mission put it recently, "the flavor of the month" in international business circles, we feel we should offer a couple words of advice:

Caveat emptor.

The famous Russian pyramid that collapsed the economy in 1998 is being reconstructed.

True, this time around the masons are more skilled; the foundation is more solid, and it looks more like an obelisk than a pyramid.

But, as in the pre-crisis years, most of the nation's economy is concentrated in the hands of a very small group of people. And these people's assets are growing much faster than the economy as a whole. The diversity of some these holdings, like Alfa Group, Interros and Millhouse, for example, is staggering, leaving us wondering just how well they've studied the experience of the South Korean chaebol.

Yes, economic growth over the past two years has been unprecedented and considerable headway on a number of fronts, including tax reform, land reform, de-bureaucratization and general political stability, provide grounds for optimism. However, the impressive achievements should not encourage complacency and obscure the fact that there is still much to be done. As in the pre-crisis years, there still is no banking system to speak of or judicial system that can ensure a level playing field.

Banks have a crucial role to play in fueling economic growth by acting as intermediaries, taking household savings and lending them on to business, yet little progress has been made in the sector since 1998. At present only a piffling 3 percent of total domestic investment funds come from the banking sector. This, in part, explains why the Russian economy has developed in such a lopsided fashion with major industrial assets being concentrated in the hands of those who have secured their natural resource turf.

Absent a functioning banking system, companies must rely mainly on their own earnings to fund restructuring and expansion. The above-mentioned conglomerates, with their substantial natural resource export revenue streams, have the cash to invest in themselves and in new acquisitions. The rest -- whether they be Soviet-era dinosaurs or de novo small and medium-sized businesses struggling to develop -- are by and large starved of investment funds.

A key concern is that much of the sound banking legislation that has been passed or is on its way through the State Duma will simply not be implemented. The Central Bank's track record on sector regulation under Viktor Gerashchenko, to put it mildly, has been poor.

The problem, however, runs much deeper. A healthy banking sector requires further progress in a number of interlinked areas, but particularly in judicial reform. Bank lending will remain insignificant until there is a functioning legal system in place which ensures that contracts can be enforced and that there is legal recourse for banks if creditors do not repay their loans.

President Vladimir Putin's reform record deserves praise and we applaud him, but at the end of the day, the truth is that oil has, to a large extent been keeping the country afloat.

However, as a Moscow investment bank observed in a research note this week, "If necessity is the mother of invention, then a low oil price plays midwife in Russia." While high oil prices encourage the government to pursue a muddle-through approach, falling oil prices should encourage the government to run a tighter ship and muster the political will to push through much-needed reforms, even in the face of stiff opposition.

Former Economics Minister Yevgeny Yasin provided a different perspective on the same issue when he recently commented that, "No matter what oil prices are in two years time, there will be no economic growth if there is no banking reform." Wise words.

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