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#10 - JRL 7033
Financial Times (UK)
January 24, 2003
Russia's core challenges
From Mr Abdur Chowdhury.

Sir, I read with keen interest your editorial "Glimmers of light in the east"
(January 16) on the need for economic reform in eastern Europe, specifically
Russia. While the economies in the US, Japan and western Europe have been
slow recovering, what explains the recent impressive performance in Russia?
It is a combination of good luck and good policy. The good luck comes mainly
from the international scene. High international oil prices and import
substitution following the 1998 rouble devaluation have financed recent
spectacular growth. Both trade in merchandise and the current account have
recorded huge surpluses. The Putin administration has also followed prudent
macroeconomic policy in using this surplus fund judiciously and reinvesting
it in the economy. All this suggests that Russia will be able to maintain an
economic growth rate of about 4-5 per cent in the next few years. Whether the
country will be able to sustain this is questionable.

Russia faces structural issues. First, the average age of plant and equipment
in the manufacturing industry is roughly three times higher than the
Organisation for Economic Co-operation and Development average of six years.
To update or replace the aged plant and equipment and the infrastructure will
require about Dollars 2,000bn-Dollars 3,000bn during the next two decades, of
which at least a quarter will have to come from abroad. Second, the role of
small and medium-size enterprises in the Russian economy has been quite
small. Third, future demographic trends and the nation's health suggest a
downward pressure on productivity and output. Alcohol abuse, Aids and poverty
are creating havoc in the health sector.

Even leaving out the implications of the shocking demographic and health
indicators, the scale of capital required for the massive re-equipping and
replacement of manufacturing industry and infrastructure is not in sight.
Russia is attracting less than half of 1 per cent of the world's foreign
direct investment, owing to exorbitant taxes, political instability, lack of
corporate governance, lack of commercial infrastructure, corruption and poor
protection of property rights. This will take years to correct.

Whether Russia will be able to continue on a favourable growth path depends
on the government's willingness and ability to restructure and liberalise
crucial sectors including banking, finance and energy. Moreover, a prudent
tax policy, establishing the rule of law and corporate governance, tackling
corruption and establishing respect for property rights are vital for
continued resurgence of the economy.

Abdur Chowdhury, Senior Researcher, Institute for Economies in Transition,
Bank of Finland, Helsinki 00101, Finland

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