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INSTITUTE FOR THE ECONOMY IN TRANSITION RUSSIAN ECONOMY: TRENDS AND PERSPECTIVES June 2004 MONTHLY BULLETIN Moscow 2004 Institute for the Economy in Transition, 1996. Licence, 02079 19 2000 .

5 Gazetny pereulok, Moscow 103918, Russian Federation Phone: (095) 203-88-16 Fax: (095) 202-42-24 E- Mail: todorov@iet.ru 1 June of 2004: Political and economic outcomes..................................................................................... 3 The State of the Federal Budget.............................................................................................................. 5 Taxation of organizations proceeds: key changes in the first six months of 2004................................ 9 Monetary policy.................................................................................................................................... 11 Financial Markets.................................................................................................................................. 13 The Market for Corporate Securities..................................................................................................... 15 Investment in the real sector of the economy........................................................................................ 23 Choice of instruments meant for investing pension savings funds....................................................... 25 Foreign investment in the Russia's economy........................................................................................ 30 The Real Sector: Factors and Trends..................................................................................................... 34 Oil-and-gas sector................................................................................................................................. 37 IET Business Survey: Industry in June of 2004.................................................................................... Foreign trade......................................................................................................................................... Outcomes of applying variable import tariff on sugar market.............................................................. Russia and the Bologna Process: the current state of the problem........................................................ Scenario based macroeconomic forecast for 2004 and 2005................................................................ Issues discussed at the meetings held by the Government of the Russian Federation held on June 10 and 17 of 2004..................................................................................................................... Review of economic legislation: June of 2004...................................................................................... June of 2004: Political and economic outcomes June of 2004 witnessed the second tragedy in the North Caucasus in two months. On June 22, a large group of guerillas (up to 200 fighters) suddenly attacked checkpoints and the building of the Republican office of the Internal Ministry in the Ingush Republic. Guerillas posted at the captured checkpoints their masked sentries (due to the fact that masks are a constant attribute of the Russian troops, this trick had worked and there were numerous casualties). The fighters shot all officers of military and paramilitary units with the exception of officers of traffic police and the Ministry of Emergencies, as well as people they suspected to support Ingush President Zyazikov. The number of casualties made not less than 80 people, the building of the regional office of the Internal Ministry was burnt down; the guerillas disappeared without trace and practically without casualties. It should be noted that the terrorists used a principally different approach in stead of attacking military units on the territory of the Chechen Republic and neighboring regions and civilian population in Russia, the attack on Ingushetia was primarily aimed at officials of the Republican administration loyal to the federal center. The official propaganda materials of fighters declared this attack to be a punitive action carried out in revenge for persecution of Chechen refugees and mass disappearances of people in the Republic of Ingushetia.

The Ingush tragedy demonstrated both the overall weakness of the Russian law enforcement system, and the persistence of a serious terrorist threat in the North Caucasus. The objectives of this terrorist raid, as well as the recent terrorist attack in the town of Grozny clearly demonstrate that guerillas see local police and military officers loyal to Russia as the major threat and use the abuses conducted by different Russian military and paramilitary units as a pretext for declaring local officers to be collaborationists. The illusion that the Constitutional field exists in the North Caucasus prevents the implementation of efficient measures aimed at the legislative imposition of the state of emergency, which may include certain components of the martial law. These measures might be tough, but they will create a predictable and clearly defined situation in the North Caucasus.

In June, the situation in the neighboring Chechnya somewhat stabilized. Different groups of the proRussian administration could nominate A. Alkhanov, the head of the Republican office of the Interior Ministry as the single Presidential candidate. Alkhanov, who presumably fought on the side of federal troops during the first Chechen war, became a key figure in the Kadyrovs administration during the second war. Therefore, there could be prevented a potential split, which could become inevitable in the case of appointment of an official not connected to the pro-Russian Chechen administration. Naturally, it is too early to judge about policy changes in the Chechen Republic before the official elections of the new President of Chechnya.

As concerns the federal political developments, in June the key events were the unfolding YUKOS affair and the statement made by the former Prime Minister M. Kasyanov about his plans for the future.

At the background of the started trial of M. Khodorkovsky and his colleagues, the emigrated shareholders of YUKOS stated that they have no information about terms and conditions offered by the official authorities, however, they were ready to negotiate, what Russian officials had earlier indicated as an alternative to the court proceedings.

On June 17, 2004, V. Putin in his speech held in Tashkent pointed out that the official authorities of the RF and the economic authorities of the country are not interested in the bankruptcy of a company like YUKOS. Debt is the issue to be considered by courts and another issue is how they are being assessed. While these activities are unfolding, the government will try to prevent the company from collapsing, the Russian President emphasized. However, the enthusiastic response on the part of the stock market seems to be not substantiated V. Putin had made similar statements earlier (for instance, he expressed his doubts in the feasibility of the arrest of the companys assets in November of 2003), but these statements had no real consequences. Other facts are of greater importance: first, the court proceedings were practically suspended under pretexts, which courts earlier refused to take into account, like the illness of the Khodorkovskys lawyer, his necessity to familiarize himself with the facts of the case, etc.), and, second, the statement made by V. Rusakova, the head of the Gazprom department of strategic development, which was disavowed the next day, that Gazprom is ready to participate in a tender for YUKOS property in the case the company went bankrupt, third, the personal changes in the top management of the company (S. Kukes was replaced by V. Gerashchenko as the Chairman of YUKOS, what was a logical consequence of the statements made by the former, including hostile remarks addressed to the companys shareholders, involvement of B. Iordan in the affair, etc.), as well as probable personal changes in the Gazprom management. It can not be excluded that there is prepared a large deal aimed at the creation of a new super-company on the basis of Gazprom, which already owns chemical, metallurgical, and growing energy assets. It is still unclear what form of squeezing major YUKOS shareholders out of Russia may be chosen and what are the limits of their possible resistance.

At the end of June, Mikhail Kasyanov made public his proposals to create a bank on the basis of the International Investment Bank (IIB) and the International Bank for economic cooperation (IBEC) and increase their authorized capitals at the expense of Euro 2 billion to be allocated from the reserves of the Russian Central Bank. Mr. Kasyanov announced that he was ready to head such a bank and, according to Kasyanov, he had discussed this issue with President Putin. The new bank should invest in infrastructure projects, which could help to meet growing EU demand for Russian energy resources and, according to M. Kasyanov, the necessary amount of investment was at about Euro 30 to 40 billion. It should be reminded that all suggestions about the new job for the former Prime Minister published earlier were not confirmed. Observers surmised that M. Kasyanov might be really going to engage in public activities as he hinted in February. Nevertheless, the former Prime Minister did not exclude this possibility, although not earlier than in 2007 (the year of the next Parliamentary elections). These intentions of M. Kasyanov may be related to the numerous problems faced by his new project, since neither EU, nor CIS seem to be ready to finance it, and there exist a number of legal and international difficulties. However, a successful implementation of this process does not preclude future political activities.

On June 25, 2004, the Board of Directors of the RAO UES of Russia failed to take the expected decision concerning the key issue of the reform in the sphere of electrical power engineering, i.e. the method of sale of shares in the wholesale generating companies (WGC). According to M. Fradkov, the settlement of this problem is delayed till the end of the year. Earlier, M. Fradkov had promised to resolve the issue personally before July 1, 2004. It should be noted that Gazprom failed to fulfill its numerous promises (made not only by the company managers, but also by President Putin) to liberalize the stock market in the nearest future. Therefore, it may be asserted that the reform of natural monopolies has been fully stopped and there were renewed consultations for the purposes of consultation often accompanied by buying up of falling shares, what was the case of the securities of the RAO UES in 2001 and 2002.

As it had been predicted by many experts, in June there occurred the first open conflict between the governmental officials and the United Russia party controlling the Duma in relation to the draft law on monetization of allowances. It was envisaged that the federal budget should pay compensations in stead of allowances (this measure should concern 14.27 million disabled persons, participants of wars, people participated in the liquidation of the Chernobyl catastrophe consequences, etc.), while certain cash expenditures would be devolved to the regional level (i.e. the respective compensations would depend on the financial well-being of regions). At the same time, certain benefits and privileges mostly related to non-funded mandates should be abolished. In fact, the reform envisages not only overall diminishing of the social burden on the state, but also redistribution of resources in favor of allowance recipients residing in rural areas and small towns at the expense of the beneficiaries living in large cities (monetization of privileges is unfavorable for residents of large cities, while population of rural areas and small towns, where benefits can not be used or their costs are low will be the better for it). As a result, the Duma group of the United Russia party approved the general principles including the maintenance of in kind allowances with respect to public transport tickets, free medicines, and medical treatment at resorts, as well as not to exclude the concept of the minimal wage as the basis of calculation of the unified tariff schedule from the Labor Code. In fact, these decisions mean the rejection of the key principles of the reform. Experts also predict that due to the first serious failure of the Government the influence of A. Zhukov, who formally represents the United Russia party in the Government, delegated for negotiations with deputies.

As concerns parties activities, an important event in June was the SPS congress. The congress not only failed to elect a new leader, but even set the date of such elections (it should be noted that the SPS congress deputies could not agree on other issues as well, including the agenda and counting of the votes). It seems that SPS becomes a classical non-Parliamentary party, the influence of which is in inverse ratio to the internal struggle for leadership and control over the party machinery.

The preparation of the KPRF congress to be held in early July also encountered difficulties. At present, the group of G. Zyuganovs supporters (it should be noted that it is a rather mixed group) intensifies its activities in regions aimed at the condemnation of the positions taken by G. Semigin, who was expelled from the party as a dissenter under the pretext of his participation in the new project Patriots of Russia. In the course of political struggle, the Zyuganovs group could consolidate support of regions. At the same time, there may be observed surprising developments, since G. Semigin has the possibility to invest in the party. On the whole, it is expected that G. Zyuganov will retain his post as the KPRF Chairman; however, the Semigins opposition will also survive.

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