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#11 - JRL 7213
June 2, 2003
Investment Climate
Julian Schweitzer: It is unlikely that Russia Will Manage to Achieve 10-Percent GDP Growth

The annual investment conference of the Renaissance Capital Group will be launched today. Deputy Prime Minister Alexei Kudrin will be the first to take the floor at the conference. He will certainly be asked whether the goal set by Vladimir Putin in his message to the Federal Assembly to double GDP by 2010 is achievable. On the eve of the conference, JULIAN SCHWEITZER, Resident Representative of the World Bank in Moscow, talked on this topic in his interview to Kommersant observer KONSTANTIN SMIRNOV.

- You recently noted that the main objective of the World Bank is to achieve a situation where Russia would not make old mistakes (committed by other countries) but rather make new ones to teach others. How do you separate old mistakes from new ones?

- I thought it would be opportune to joke a bit. But speaking seriously, Russia has a rich and diverse record. However, the record of other countries is also rich. Therefore, your ideas should be verified against the ideas that have been already in circulation in other countries, so as not to repeat mistakes that were made by others and are well known.

- Do you believe that GDP will be doubled in Russia by 2010?

- Of course, there is nothing bad in looking optimistically into the future. But to accomplish this goal would require about ten percent growth annually. This is a lot. Given the structure of economic growth, it is unlikely that such rates are achievable.

- More accurate calculations will show that even the growth of about 8% may be enough because Vladimir Putin suggested that GDP be doubled in comparison with 2001, not 2003. But this is also a lot. What should be done to accelerate the growth in Russia?

- First, investments should be increased. And this is already taking place. Incidentally, this means that the Russian money that took flight outside the country has begun to come back, and this is good news. But it is important that the investments are funneled into the real sector of the economy. In other words, the investment climate should be made more favorable for long-term investments. I emphasize the notion of "long-term investments" since there is a certain danger that the "hot"money which is fast to enter the country is also fast to exit it. Therefore, there should be a focus on the tax regime. It should be appropriate, rational, and, at the same time, sustainable. Investors become nervous if the tax regime experiences continuous changes.

- Do you think the Russian Government recently showed recently excessive zeal with its tax reform?

- I think that good progress has been achieved. I mean the introduction of a flat income tax rate, change in the taxation on natural resources and hydrocarbon exports. But in principal, the overall tax burden in Russia remains rather high and the tax system is still complex and cumbersome. Small businesses complain they have to spend a lot of time and funds to meet all tax legislation requirements. Investors are also concerned about frequent changes in the system of taxation. Numerous tax consultants have to be employed. In addition, the existing tax system is designed more to meet tax collection targets, rather than encourage business and investment activities.

- The Government proposes to reduce VAT next year and UST by 2005. What is your assessment of such sequence?

- This is a difficult question. One should find a proper balance to ensure a necessary amount of public revenues and to meet commitments in the social area. On the other hand, one should not forget that the level of tax evasion in Russia is too high.

- In addition to taxes, what else can improve the investment climate?

- Despite tangible successes, I do not think anyone would argue about the fact that the range and scope of administrative interventions in the economy remain very wide. There is still not an even playing field for all market participants and this applies not only to foreign but also to Russian businessmen. Our studies show that manipulations with laws on land and land management, particularly at the local level, may prove to be quite ruinous for the small business.

- Nevertheless, the Goskomstat data show that during the first four months of the current year a fresh inflow of foreign investment into Russia was observed reaching $3.1 billion. Despite a cold investment climate in Russia, can one forecast an imminent investment boom?

- This is correct, but it is necessary to look into the structure of this investment boom. If one reviews various growth constituents, then during the last year the volume of direct investments remained approximately at the 2000 level or even lower in terms of the GDP percentage share. What was really on the rise was portfolio investment between 2000 and 2002, while so-called other investments, which basically included commercial credits, bonds, etc., were growing at still higher rates. This, of course, is well correlated with the reduction of capital flight from Russia.

- Recently the euro has sharply appreciated against the dollar. Can Russia somehow benefit from this situation? For example, by resuming borrowing on external markets?

- Russia is already making gains through the deceleration of the real ruble exchange rate appreciation. Since oil prices remained high over the last year, the real ruble exchange rate would have been much higher by now than it actually is, imposing problems on Russian producers. But from this perspective the dollar depreciation against the euro by 35% has already helped Russia and, more specifically, Russian exporters. I do not think that the availability or lack of access to cash can be viewed as a major issue for Russia now. I think that the real issue is to ensure the efficient use of cash that is already available.

- In the recent time, relations between the Russian Government and the World Bank were not as productive as in 90s. How do you assess Bank's recent projects in Russia?

- It is of interest to note that we have been requested to focus more on the investment sphere. For instance, in the housing and communal services sector, the condition of the housing stock and services have degraded, this doesn't need much discussion. In addition we have been requested to consider preparation of investment projects in the highway sector. Incidentally, we have already talked about the improvement in the investment climate, but when this issue is on the table, it rarely comes to one's mind that the status and development of infrastructure are of immense significance. Of course, this should be highlighted much more often. It is still more important to review the status of ports, highways and other infrastructure elements. Also, we are working on a very interesting project in the banking sector and preparing several education projects, as well as others.

- The word "port" leads to a train of thought to the future of St. Petersburg. How do you asses the Bank's project aimed to develop the city which is celebrating its anniversary?

- As a matter of fact, the project was approved by the Board of Executive Directors only a couple of weeks ago. Now we are waiting for signature of the relevant loan agreement with the Russian Government. We hope it will soon take place. The project has two components. The first component is an adjustment loan provided to the City Administration. But again, among other things, it is designed to improve the business climate in the city. The second part of the project is an investment component basically designed to preserve the cultural and historical heritage of St. Petersburg. Experience gained in very many cities demonstrate the following. It becomes evident that when you do not merely create a favorable investment climate but also make a city attractive for tourists, appealing to other people to visit it, then it is beneficial not only for tourism but, inter alia, helps generate jobs. On the other hand, this is in principle an area for activities because it is just here that the things that concern a lot of people are going on.

- What is the cost of the project?

- In total, the loan amounts to $161.1 million. Of these, $100 million is a city component, $46 million will be provided to preserve the cultural and historical heritage of St. Petersburg. The remaining portion will be used for other purposes related to project implementation.

- What were the difficulties that had to be overcome during project preparation? Is the WB satisfied about the extent of transparency with respect to the future use of these funds?

- It took about two years to prepare the project because we, together with the city authorities, had to further improve a plan for St. Petersburg strategic development. As a rule, we try to be very careful when selecting areas for development that we support. One of the conclusions we made on the basis of the experience accumulated by us over the last ten years of our operations in Russia is as follows. A concept to select 100 strategic areas or objectives and an attempt to try to provide support to all of them does not look bad. But, on the other side, it would be extremely difficult to check what is actually going on in each of those 100 areas and see whether the objectives established are met or not. This time, we attempted to limit ourselves to a narrow range of specific objectives.

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