24 June 2003
Is Russia Suffering From 'Dutch Disease'? First Half-Year Demonstrated Almost Uniquely High Growth Rates for Russian Economy and Capital Inflows
By Doctor of Economic Sciences Professor Andrey Nechayev of the Russian Economics Academy
It is interesting that this (reference to headline) has happened against the backdrop of a notable strengthening in the ruble's real exchange rate. Moreover, there has even been a rise in the nominal exchange rate against the dollar. The skeptics who had claimed that Russian industry would be unable to withstand the competition posed by imports without the protection of a permanent ruble devaluation have seemingly been completely discredited. And, unlike SARS, "Dutch disease" (we would recall that this is when an economy's processing sectors stagnate as a result of large inflows of foreign-exchange earnings into a country from raw-materials exports) has been completely conquered. A more in-depth analysis on the whole does not remove the grounds for optimism, but shows that the situation is not that simple.
High economic growth continues to be profoundly based on raw materials. Thus, the fuel and energy complex is responsible for around 48 percent of total industrial production growth, whereas all the sectors producing output for end users -- that is, consumer and investment goods -- account for just 23 percent. As a result, the fuel and energy complex has grown to represent 35.6 percent of industry. The relatively modest 5.7-percent growth in machine building was to a decisive extent determined by equipment purchases by the metallurgical industry and major orders for rail cars and locomotives from the Ministry of Railways. Production of most other types of machinery and equipment has gone up very modestly, while production of cars has fallen sharply altogether. Exports of raw materials account for 89 percent of aggregate exports, and shipments of energy sources account for more than 64 percent.
Economic axioms are now true of the Russian economy as well. One of these -- and something from which the US economy suffered for many years -- is that a rise in the exchange rate of the national currency leads to increased imports. We have seen this picture in full this year in Russia as well. Imports accounted for 70 percent of the total growth in demand from our fellow citizens and represented 43 percent of all commodity resources. Admittedly, it is gratifying that the growth in imports of machinery and equipment has outstripped the rise in imports of consumer goods. This means that our manufacturers are taking advantage of the favorable situation as regards the ruble exchange rate to accelerate the renewal of their technological base.
The situation regarding investment, according to figures from the State Committee for Statistics, looks generally impressive. Over the past couple of years we have grown accustomed to capital investment growth rates of 11 percent. If things continue in this vein, it can be said that the "investment timeout" that was caused as a result of the very controversial abolition of profits tax investment relief is over. In this area the strengthening of the ruble has undoubtedly had a positive role to play. The point is not even that imported equipment has become relatively less expensive. The banks, having lost their usual ability to effectively speculate on a rising dollar, have been forced to, if not face up to, at least half-face up to the real economy. Levels of lending to the real economy have increased notably. The swift introduction of changes to the legislation on collateral with a simultaneous cautious expansion of bank access to "long-term" pension monies would undoubtedly accelerateThe fall in the dollar has made it possible to noticeably mobilize one other very important source of investment funding -- funds from the population. Our people, who are rapidly learning the basics of the market economy, have realized that holding funds in dollars is unprofitable, to put it mildly. It will not even provide a hedge against inflation. Whereas our citizens had grown accustomed to keeping cash in the form of foreign currency under their pillows, doing the same thing with rubles strikes them as not being sensible. And those savings have been put in the banks. Thus, in the first quarter of this year alone Russians' ruble deposits increased by almost 13 percent. Moreover, the length of time money is being placed on deposit has started rising noticeably as well. It can even be claimed that it is the population's money that has forced the banks to look toward the real economy. It is no accident that the rise in bank loans to nonfinancial enterprises has roughly coincided this
The saying "foreign countries will help us" is also very appropriate for explaining the rapid growth in investment this year. The growth in foreign investment is characterized by almost phenomenal figures -- 65.4 percent in the first quarter of 2003 (last year the figure was 39.4 percent). Unfortunately, there is a fly in the ointment. More than 83 percent of the foreign investment is so-called "other investment," the bulk of which is made up of loans. The proportion of direct investment is declining year-on-year, even though more than 40 percent of it is made up of loans from foreign co-owners of enterprises. So why do foreigners like lending money to Russian enterprises so much? There is a simple explanation. This is Russian money coming home under a foreign flag -- as a rule, an offshore flag. It is no accident that the modest offshore center for Russian capital abroad -- Cyprus -- firmly occupies the number-two spot in terms of total foreign investment in Russia, ahead of all the GThe conclusions are both simple and complicated. The Russian economy's ability to adapt to any conditions is both surprising and worthy of respect at the same time. In the space of just a few years Russian entrepreneurs learnt to live with a convertible national currency that was falling. Now they learning even more rapidly to live with a rising exchange rate. But we should not nonetheless pin our hopes solely on the heightened ability of our businessmen to survive. The state authorities must, finally, make a serious breakthrough in creating a truly favorable business climate in Russia. Then our entrepreneurs will be able to solve the ruble exchange rate problem one way or the other.