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#14
Financial Times (UK)
November 13, 2001
Investors fear Russia reform may soon run out of steam
By ANDREW JACK

As Russia's President Vladimir Putin heads to the US to meet President George W. Bush today in an atmosphere of new-found friendship, some fear the west's enthusiasm towards Russia is too optimistic and too soon.

After a long period when Russia was seen as dangerous for foreign investors to do business in, the recent rhetoric from high-profile visitors, such as Donald Evans, the US commerce secretary, has been far more positive. Mr Putin looked confident this month when he addressed corporate leaders at a special meeting of the World Economic Forum in Moscow, and joked as he responded to unprepared questions.

He had a lot to be proud of: a substantial simplification of the tax system and cuts in rates which have been matched by a rise in collection figures; a budget in substantial surplus; the start of a programme of liberalising the country's natural monopolies; and legislative reforms under way to restructure the legal and pensions systems, to privatise land and reduce state bureaucracy.

But while the short-term macro-economic picture looks positive, there are more serious questions about the implementation of reforms in the longer term, and about how the issues of outstanding concern to business are being tackled at the micro-level.

An analysis by the World Bank last month warned that the Russian economy remained heavily reliant on volatile natural resource prices, and that productivity growth was lagging behind the appreciation of the real exchange rate.

While high oil prices over the past two years have helped swell government revenues and contribute to higher profits for the production companies, they have also pushed up the value of the rouble, making other companies less internationally competitive.

At the same time, Russian politicians have resisted the creation of a formal ring-fenced "stabilisation fund", which could be used to earmark oil revenue windfall gains for more difficult times in the future.

There are also some signs that the pace of economic reform is slowing down as policymakers become nervous about taking unpopular measures in the build-up to elections. While the parliament can sit until 2003, and the presidential race is set for 2004, some of the most delicate elements of reform are already being pushed back after these dates.

In spite of a commitment to liberalise the natural monopolies - gas, electricity and railways - there are signs that the government is resisting sharp increases of the heavily subsidised levels of tariffs. In doing so, it risks delaying reforms until a period of lower economic growth, when the popular reaction is likely to be greater.

One outstanding and important issue is banking reform. Sberbank, the state-controlled savings bank, dominates the market, and its rivals accuse it of unfair practices. The central bank has done little to close under-capitalised institutions or push through restructuring. The result is a risk of a "credit crunch", which is stifling the growth of small and medium-sized enterprises.

Yegor Gaidar, former President Boris Yeltsin's first deputy prime minister in 1991, who spearheaded the first post-communist economic reforms, argues that Mr Putin's administration has been right not to attempt to tackle too many issues at once.

But in the foreign and domestic arena, some additional efforts, notably in the legal system, remain necessary. A growing number of corporate lawyers say they now have sufficient faith in judges to advise clients to seek redress through the Russian courts. Yet there are still concerns that even if rulings are unbiased, they are not always fairly imple mented.

For large companies with political and commercial clout, solutions can often be found. For smaller investors, the dangers of being caught in the bureaucracy remain considerable. So do questions of minority shareholders' rights.

"The key decision on whether to invest should be based on whether legal institutions are capable of protecting your rights," says Gary Johnson, head of Sawyer, a US-based quartz company which risks losing more than Dollars 8m in a dispute it has been fighting since 1997 over a factory it leased in the town of Vladimir.

The acid test is the level of foreign direct investment, which remains modest.

Nevertheless, after a period of excessive enthusiasm in the mid 1990s, followed by a strong backlash in the aftermath of the 1998 default, investors in Russia may now be feeling their way back towards a new, more reasoned, equilibrium.

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