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#2 - JRL 7239
New York Times
June 25, 2003
Russia's Economy Building on 3 Years of Solid Growth
By JAMES BROOKE

MOSCOW, June 24 President Vladimir V. Putin appears to be off to a strong start on his newly announced capitalist plan to double Russia's economy in a decade.

In the first five months of this year, Russia's gross domestic product rose 7.1 percent, about double the rate of the comparable period last year. Oil and gas production, the locomotive of modern Russia's economy, is up 11.5 percent. Russia, which exports more oil than any nation except Saudi Arabia, is increasing its oil output this year for the fifth consecutive year.

The Russian Central Bank is forecasting a reversal of years of capital flight, with a net capital inflow of $2 billion in the second quarter.

Top government and World Trade Organization officials have predicted to reporters here in recent days that Russia will join the organization next year, joining the world's economic mainstream. The pro-Western shift seems to have considerable public support: in a poll of Russians that was conducted this month by the Public Opinion Foundation, 73 percent of respondents said they wanted to see Russia join the European Union.

Today, Mr. Putin started the first state visit by a Russian leader to Britain since 1874. The visit highlights Britain's having become the largest foreign investor in Russia, with two oil deals announced this year that amount to nearly $17 billion. During his four days in London, Mr. Putin is expected to preside over the signing of documents sealing the petroleum producer BP's investment of $6.75 billion to create Russia's third-largest oil company.

The recent economic numbers follow three years of solid growth, making Russia a confirmed member of a group of three major developing countries that are showing high growth. India is expecting to grow by 5 percent this year, Russia by 5.4 percent and China by 7 percent, as growth in Japan, the United States and Western Europe is expected to be marginal. Partly because of anemic growth opportunities in the world money centers, an influx of foreign capital has made Russia's RTS stock index jump by about one-third so far this year.

But beneath Russia's encouraging numbers, many analysts say, is an overdependence on oil and gas income.

"On first sight, everything is good," Christof H. Ruhl, the World Bank's chief economist in Russia, said in an interview. "But that does not mean that they will double in 10 years. There is a lack of diversification. This high growth is still tied to high oil prices."

With oil and gas sales accounting for about half of exports and about half the national budget, oil and gas contributed to a 23 percent jump in Russia's world trade in the first five months of this year, compared with the similar period in 2002. Because of high oil prices, Russia now exports almost double what it imports.

"The economy remains vulnerable to a downturn of oil prices," Anne O. Krueger, first deputy managing director of the International Monetary Fund, said Friday in a news conference here. While saying that Mr. Putin's goal of doubling the economy was realistic, she warned of "excessive regulation and corruption" and its "drag on private sector development."

James A. Baker III, the Reagan-era secretary of state, expressed similar sentiments in a speech here last week to American and Russian business leaders. "Russia, in short, has come far," he said. "But huge challenges remain. Russia's core manufacturing sector remains in decline, with much of its infrastructure obsolete."

Russia's monopolies often give the country the look of a place where mediocrity is protected. According to research by the Brunswick UBS investment bank, eight conglomerates control 85 percent of Russia's largest 64 privatized companies.

"Despite Putin's reassuring words, the fact of the matter is that Russia's business world, under the surface, is still eyeball-deep in organized crime," The Russia Journal, an English-language daily read by foreigners here, warned last week in an editorial headlined "Killing With Impunity."

Changes in laws have created 40 million landowners. But Russia's farm production remains stagnant, millions of acres of arable land lie fallow, and Russia imports about 40 percent of its food.

While the country's leaders have accepted a central concept of supply economics, that lower tax rates can result in greater tax collection, a huge amount of the economy remains off the books. To encourage Russians to pay their taxes, the nation two years ago adopted a flat income tax of 13 percent.

With lowered taxes and four years of economic growth, Russians now have more money to spend, which has drawn the attention of foreign investors.

As food consumption increases, Tyson Foods Inc., the Arkansas meat producer, is considering buying a Russian poultry farm, and Metro, Germany's largest retailer, plans to invest $1.2 billion here. With Russians using their savings to remodel their Soviet-era apartments, Ikea, the Swedish furniture group, is spending $44 million to build two new furniture stores.

After personal incomes officially expanded by 14 percent last year, the General Electric Corporation set an ambitious goal to increase its Russian sales tenfold, to $3 billion, by 2010. With three million Muscovites owning cars, Goodyear is studying the purchase of a Russian tire manufacturer.

While stuck in traffic jams, Moscow's middle class can study billboards that confirm Moscow has become a standard stop on the world tours of major North American musicians. In large Cyrillic characters, advertisements announce concerts here this month by Julio Iglesias, Elton John, Diana Kroll and Engelbert Humperdinck.

With elections in December to decide control of the Parliament, Mr. Putin is working hard to push the new oil revenues through the state system into the pockets of the people. Unpaid state salaries are being paid up, and in October, 33 percent increases in state salaries are to take effect.

Last week the Duma, the lower house of Parliament, voted to abolish the 5 percent national sales tax and reduced the value-added tax by 10 percent.

With oil revenues high, economists predict that these measures will not knock the government off course in its efforts to reduce inflation to 12 percent, down from 15 percent last year. But the government could crank up public spending this fall to earn good will for the parliamentary elections.

All polls indicate that Mr. Putin will easily win another four-year term next March. But the December parliamentary elections remain a question mark, and the Communists have a chance of once again becoming Russia's dominant party. And Mr. Putin has been able to push through the Duma a series of free market economic changes because he has enjoyed a coalition majority that his predecessor never had.

Will Russia rise to meet the challenge of his 10-year plan? Mr. Putin responded Friday in a nationally televised news conference, "This won't be an easy task for Russia."

Speaking only days after meeting with President Bush in St. Petersburg, Mr. Putin sounded like a Russian Republican. He called for lower taxes, and for a program to "deregulate the economy and get the state out of areas where its presence is not justified and stifles economic activity."

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