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INSTITUTE FOR THE ECONOMY IN TRANSITION RUSSIAN ECONOMY: TRENDS AND PERSPECTIVES JANUARY 2009 MONTHLY BULLETIN Moscow 2009 Institute for the Economy in Transition, 2009.

5 Gazetny pereulok, Moscow 125993, Russian Federation Phone: (495) 629-67-36 Fax: (495) 203-88-16 E- Mail: lopatina@iet.ru 1 Basic developments and trends........................................................................................................... 3 The political and economic results of January 2009 S. Zhavoronkov.................................................. 4 Inflation and monetary and credit Policy N.Luksha............................................................................. 8 Financial Markets N. Burkova, E. Khudko....................................................................................... 13 Real Economy Sector: Trends and Factors O. Izryadnova................................................................ 22 Russian Industry in January 2009 S. Tsukhlo................................................................................... 26 Foreign Trade N. Volovik................................................................................................................. 28 Budgetary and Tax Policy . Kirillov.............................................................................................. 32 On the new system of money allowances for servicemen of the RF Armed Forces E. Trofimova..... 34 Meetings of the Government of the Russian Federation in January 2009 M. Goldin........................ 38 Review of Economic Legislation I. Tolmacheva.............................................................................. 39 Review of Regulatory Document Concerning Taxation Issues over December 2008 January 2009 L. Anisimova.......................................................................... 42 Review of Budget Legislation M. Goldin........................................................................................ Municipal reform: recent changes in legislation I. Starodubrovskaya, N. Mironova.......................... Some amendments of corporate taxation rules: depreciation assessment amendments . Malinina.. Development of Forecast Research in Sphere of Science and Technology I. Dezhina...................... Important issues of Transfer Pricing Kornienko N., Velokova E....................................................... Carry trading strategy and its impact in the context of financial crisis 2008 . bramov.............. Possibilities of Russias Participation in Preferential Trading Agreements with non-CIS Countries A. Pakhomov............................................................ Basic developments and trends In January the Government of Russia in the person of the Minister of Finance has formally recognized the existence of an acute crisis in the economy, the expected reduction of budget revenues by one third and zero economic growth in 2009. Among the ongoing anti-crisis measures in Russia, one can mention primarily the continuation of ruble devaluation and thereby reduction of the budget commitments. Dmitry Medvedev has for the first time gently rebuked the government for slow actions. In January, it was announced that Dmitry Medvedev has signed the bill, abolishing jury trials for terrorism and extremism crimes. The President has also submitted to the parliament a draft law that gives the right to the designated Heads of the Regions to initiate the resignation of Heads of local governments through the authorized municipal bodies.

The situation in the real sector in late 2008 was characterized by negative dynamics in key indicators. The situation in the mining sector has worsened by decreased demand and falling prices for raw materials and steel products in the world market, decline in the domestic market under the pressure of the production output reduction in the engineering and construction industries. In the IV-th quarter the decline in the output of manufacturing industries has reached 7.7 per cent, production and distribution of electricity, gas and water 5.4 per cent, and mining 1 per cent. At the background of high inflation rates and downgrading of population real income annual growth rate to 2.7 per cent and real wages up to 9.7 per cent, the growth rate of retail trade turnover amounted to 13.0 per cent, i.e., 3.percentage points below the preceding year. In the IV-th quarter of 2008, the number of unemployed increased by 23 per cent against the same period of the last year.

Analysis of the industry, based on IET monthly market surveys reveals the formation of new trends in the economic dynamics. The slowdown in demand has resulted in a stabilization of satisfaction with sales and allowed businesses to adjust the dynamics of output. Changes in price and production policies halted further warehouses overstocking. There are excessive production capacity and personnel in industries, that can provide resources for the post-crisis breakthrough without additional investments.

In late 2008, a sharp decline in key indicators of the Russian foreign trade was observed. The downfall in oil prices in the fourth quarter led to the accelerated reduction of exports. The downfall in the real exchange rate and declining incomes of population have led to a significant reduction in imports.

At the end of December, the CPI in Russia has made 0.7 per cent, i.e., lower than the indicator of the same period of preceding year (1.1 per cent). The consumer prices growth for 2008 amounted to 13.3 per cent and was highest in the last five years. Against the background of large-scale outflow of currency from the country, the ruble real effective exchange rate began to decrease: in December, its decline was 3.6 per cent. The international reserves of Russia fell down to USD 427.1 billion as of January 1, 2009. The Central Bank has pursued a policy of ruble soft devaluation. To avoid a sharp devaluation of ruble, the Bank of Russia has executed a large foreign currency interventions to support the ruble: USD 57.4 billion dollars and Euro 12.6 billion in December. To stabilize the situation in the banking sector, the Central Bank has taken a number of measures; it has increased the upper limit of credits and removed restrictions on the maximum amount of funds, provided by currency swap.

Moreover, the Bank of Russia has informed on postponement for three months the dates of planned upgrading the compulsory reserve rate.

The Ministry of finance announced the reassessment of the federal budget for 2009, based on the new estimates of the Ministry of Economic Development. The most significant amendment is the assessment of the average oil price at the level of USD 41 per barrel and the exchange rate at RUR 35.1.

per USD 1. Budgets for 2010-2011 will be planned after adjustment of the budget for 2009.

In January 2009, a number of significant amendments was introduced to the budget legislation, aimed at simplifying the procedure for the of budgetary funds allocation. It is anticipated, that this measure can accelerate the funding of government programs, implemented in the framework of budget execution and reduce the impact of economic crisis in the country.

Volatile trends were observed at the securities markets, initiated by predominating negative news, as well as positive response of investors to the actions of the governments, implementing anti-crisis programs. MICEX index has decreased by 2 per cent within the month. The positive trend in the mar ket of corporate bonds in January has been an increase in the number and total amount of registered issues, which allows to expect a speedy expansion of the market.

Other important decisions in the field of economic policy are:

the Law has been effected On Amendments to Article 3 of the Law On Customs Tariffs, changing the procedure for estimation export duties on oil.

the Government extended the validity term for import duty on sugar, imported from Ukraine to January 1, 2013.

Federal Law N 305-FZ of December 30, 2008 has amended the corporate tax proceeds allocation (the flat rate of 20 per cent) among the budgetary system levels. 2 per cent of those proceeds shall be addressed to the federal budget and 18 per cent will be allocated to the budgets of the Russian Federation Subjects.

amendments are introduced to the second part of the Tax Code, changing the procedure of depreciation assessment. The major changes are made to non-linear method of depreciation.

The Supreme Council of the Russian Government has reviewed the draft law On amendments of Articles 149 and 162 of the second part of the Tax Code, adjusting the taxation procedure for provision of housing and public utilities to the tenants of blocks of flats.

In late 2008, two federal laws were adopted, which made a wide range of changes in various aspects of local government regulation.

The new federal law provides for the transfer to a new system of auditing activity regulation. In particular, it is foreseen to abolish licensing of this activity with the simultaneous introduction of compulsory membership of auditors in a self-regulating professional organization.

The political and economic results of January S. Zhavoronkov In January, the Russias Government, in the person of RF Minister of Finance A. Kudrin, officially admitted that this countrys economy had been struck by a severe crisis, that budget revenue was expected to shrink by one third, and that there would be zero economic growth in 2009. Prime Minister Putin expressed his belief that the Russian Government bore absolutely no responsibility for the crisis and shifted the blame to the USA and EU member-countries. Among the anti-crisis measures being implemented in Russia, the most noteworthy is the ongoing devaluation of the ruble, which inevitably results in the actual budget obligations decreasing. For the first time ever, D. Medvedev gently rebuked the Government for its working too slow. In January, it was announced that D. Medvedev had signed a law scrapping the right to trial by jury for the individuals accused of terrorist and extremist crimes, and that the President had submitted to parliament a draft law vesting the appointed heads of regions with the right to initiate, via municipal representative bodies, the dismissal of heads of local self-governments. January saw several political murders: of the well - known lawyer S. Markelov; of A. Baburova, journalist of the newspaper Novaia Gazeta; and of S. Israilov, Kadyrovs former bodyguard who had emigrated to Europe.

As it was three years ago, Russia entered the new year without having any signed agreements with Ukraine concerning either the price of Russian gas supplied to that country or Ukraines fee for transporting Russian gas on transit to European consumers. In 2008, the price of Russian gas for Ukraine amounted to 179.5 USD for 1,000 cubic meters (it had been growing rather rapidly: 2007 130 USD;

2006 95 USD), while in 2009 Russian politicians demanded that more than 400 USD be paid for 1,000 cubic meters, while the price of transit be preserved at the same level as before. The Ukrainians said that they could accept the price of 1,000 cubic meters being at the level of 200 250 USD, and considered the future agreement on gas transit to be linked with that on gas supplies. The negotiations ended in a deadlock. Russia began to reduce gas supplies to Ukraine, while the latter did not let it pass to European consumers. By contrast with the 2006 conflict, the new row lasted not one but more than two weeks. European countries did not get enough gas, for which they blamed both Russia and Ukraine.

The gas problem in some of its aspects has not changed since 2006. During the past three years, despite the various PR-declarations of the Russian authorities concerning the construction of new gas pipe lines and the development of new technologies for gas liquefaction, Russias dependence on Ukrainian transit remained at the same high level as before: as in the past, it accounts for more than % of gas exports. Also unchanged are the relative advantages of Russia resulting from the acute competition in Ukrainian politics and the possibility for Russian diplomacy to support one or other group of local politicians. But the other part of the problem has definitely changed in 2006, the hydrocarbon price trend was inexorably going upwards, while nowadays, since summer 2008, oil prices have collapsed, automatically pulling down the price of gas. Therefore the problem of pegging the export price of gas to world prices no longer inspires much optimism in Russia.

In the end, the Prime Ministers of Russia and Ukraine, V. Putin and J. Timoshenko, announced that they had reached the following agreement: their countries would switch over to the European formula of pricing with Ukraine getting a 20-percent discount on condition that the transit tariff in be kept at last years level (1.7 USD per 1,000 cubic meters); starting from 2010, they would fully switch over to the European rules of pricing and tariff forming. As in 2006, this new agreements leave a lot of leeway for manipulations. The 2006 agreement stipulated that Ukraine would pay different prices for Turkmen and Russian gas (although they are technologically identical); this time it remains unclear what is meant by the European price and what would be the period for applying this price. At present1, the price of gas on the European border amounts to approximately 470 USD per 1,000 cubic meters, but as early Q2 it can display a downward change, thus making it difficult to give any precise estimates for the end of 2009. Also, it is far from being absolutely clear as to what is meant by the European transit tariff. The only possible conclusion is that Russia, as it has already been forecasted by Prime Minister Putin, has pinned its hopes on the assumption that period of low prices for hydrocarbons is going to be short. In this case, her bargaining tactics will yield success, otherwise it will become counterproductive.

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