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#9 - JRL 7024
Russian enclave's future hangs in the air as EU enlarges
January 19, 2003

A pristine BMW plant tucked in the corner of a Soviet-era naval base is proof to a few optimists that Russia's struggling Baltic enclave of Kaliningrad can shed its shady reputation and become Moscow's bridge to the Europe.

"This factory runs like a Swiss watch -- tick, tock, tick, tock -- every day. It just takes training," boasts Rolf Bottner, the German luxury car maker's local representative, as a group of visiting children eyes a shiny production line that assembles 10 cars daily for the Russian market. Amid post-Soviet chaos, the plant is a model of reliability the enclave's administration has seized upon ahead of May 1, 2004, when Poland and Lithuania -- which block Kaliningrad off from the rest of Russia -- are to join the European Union.

The administration is eager to counter recent European fears that this Russian "island's" crime and corruption problems could spill into the enlarged European Union.

"Everything here was oriented towards the military but now Kaliningrad can be a bridge for the integration of Europe and Russia," says Alexander Koretsky, the administration's spokesman.

There are some positive signs for the enclave and its population of approximately 950,000.

At 8.7 percent, inflation was around three percentage points lower than the Russian average in the first 11 months of 2002.

Despite its problems the enclave has many well-run small- and medium-sized enterprises, says Susanne Decker, chief operating officer at KMB, a bank owned mainly by Western governments that aims to foster small businesses in Russia.

"We have to watch out, but (Kaliningraders) are very open minded, you see a higher level of education in business terms," Decker says.

Observers are divided on the role played by Russian oil-giant LUKoil, for whom Kaliningrad is a source of oil and a stepping stone to the West.

But the depth of the enclave's difficulties is evident from Kaliningrad city's run-down housing and abandoned munitions factories, which have effaced the grandeur of what was the Prussian capital Konigsberg until World War II, when Germany lost the region to the Soviet Union.

Salaries average less than 100 dollars (euros) per month. Per capita productivity lags behind the rest of northwestern Russia and the EU candidates, a study by Denmark's foreign ministry showed recently.

Particularly worrying is that foreign investment in the enclave stagnated in 2002 at a little under the 2001 level of 24 million dollars.

The administration attributes this to uncertainty over future border-crossing arrangements once Lithuania and Poland end visa-free travel for Russians.

But with all sides expressing a will to solve the visa issue a greater problem may be that investors are unimpressed by the enclave's status as Russia's low-tax "special economic zone."

"It is extremely important for the administration to change. There is a lack of fiscal accountability and transparency and virtually no demand for good practices -- good practices are often punished," says Jesper Pedersen, an EU-appointed advisor to the administration.

Part of the problem is a Moscow fear that economic success could breed separatist sentiment in the enclave, argues Igor Rostov, general director of privately owned broadcaster Kaskad.

He accuses Moscow of dragging its feet over a new law intended to govern special economic zones, and introduce equal rules for all.

As a result potential investors cannot be sure of receiving the kind of treatment enjoyed by Avtotur, the Moscow-based company which owns the BMW assembly plant and also builds vehicles for South Korea's KIA.

"Moscow does not have a policy -- foreign businesses need stability and predictability, not just low taxes," Rostov said. "The region's status is up in the air."

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