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INSTITUTE FOR THE ECONOMY IN TRANSITION RUSSIAN ECONOMY: TRENDS AND PERSPECTIVES July 2008 MONTHLY BULLETIN Moscow 2008 Institute for the Economy in Transition, 2008.

5 Gazetny pereulok, Moscow 125993, Russian Federation Phone: (495) 629-67-36 Fax: (495) 203-88-16 E- Mail: lopatina@iet.ru Major developments and trends.................................................................................................................... 3 Political and Economic Situation in July 2008 (S. Zhavoronkov)................................................................ 4 Real Economy: Trends and Factors (O. Izryadnova)................................................................................... 6 Russian Industry in July 2008 (S. Tsukhlo).................................................................................................. 8 Foreign Trade (N. Volovik).......................................................................................................................... 9 Monetary Policy and Inflation (P. Trunin)................................................................................................. 12 Budgetary and Tax Policy (O. Kirillov)..................................................................................................... 17 Financial markets (N. Burkova)................................................................................................................. 20 Review of Most Important Issues Considered at the Meetings of the Government of the Russian Federation in July 2008 (M. Goldin)....................................................... 28 Review of Economic Legislation (I. Tolmacheva)..................................................................................... 30 Review of the Budgetary Legislation (M. Goldin)..................................................................................... 32 Review of Regulatory Documents Concerning Taxation over June-July 2008 (L. Amisimova)............................................................................................... Bankruptcy Legislation: Some Trends of 20042008 (E. Apevalova)....................................................... Estimation of the Possible Inflation Decrease in the RF in Short-term Prospect (S.Drobyshevsky)....................................................................................................... Estimations of Software Piracy Level and Rightholders Losses in Russia (A. Pakhomov, Yu.Potanina).............................................................................................. Legal Basis for Exchange of Information on Taxes (N. Kornienko)......................................................... Budget Address 2008 and Plans for Military Reform: Analysis of Consistency (V. Tsymbal).......................................................................................................................... Major developments and trends In July Prime Minister V. Putin subjected to sharp criticism a big mining and metallurgical company Mechel and its owner I. Zyuzin. According to the Prime Minister, the company sold its production to foreign companies at prices that made half of the world ones. Taking into account that about one third of the companys shares are quoted at the exchange, the company suffered a considerable damage immediately. As to the foreign policy the major event of July was the first G8 summit with D. Medvedevs participation. The RF Supreme court refused to answer to the claim of the Communist Party and the Union of Right Forces union on abrogation of election to the State Duma results in December 2007.

According to the preliminary data, over the first half of 2008 increase in the GDP was equal to 8.0% against 7.8% in the corresponding period of the previous year. The specific features of macroeconomic situation of the first half of the current year revealed in the slackening of the growth dynamics by quarters. The GDP growth slowdown from 108.5% in the 1st quarter to 107.6% in the 2nd quarter is mainly accounted for by the slow-down of investment infixed assets dynamics, industrial production and retail trade turnover.

Slight slackening of the development dynamics in the 2nd quarter of the current year against the background of continuing growth of consumer prices and industrial producers prices. Though investments in fixed assets growth rates remained at high level and were equal to 116.9% on the same period of 2007, but as compared with the previous year they reduced by 6.8 percentage points. The trend being for investments rates slow-down in the 2nd quarter of the current year decrease in growth-rates of workload in construction was observed from 18.3% against 28.9% in the 1st quarter.

The surveys of industrial enterprises on demand and output dynamics, on the estimation of finished goods stocks also testify intensification of negative trends in the Russian industry.

As a result of June CPI in the Russian Federation was equal to 1%, not exceeding the CPI over the corresponding period of the previous year for the first time this year. However, the growth of consumer prices was equal to 8.7% over January-June and exceeds considerably the rates of prices growth in 2007. It was the increase of foodstuffs in price (+ 1.1%) that had the biggest effect on prices growth in June, as well as in February-May. Thus, prices for main foodstuff goods continued to grow quite rapidly.

Against the background of fast inflow of currency in the country, real effective ruble exchange rate went up by 0.2% and international reserves of the Bank of Russia by 4.2%. To decrease growth rates of monetary supply and inflation the Bank of Russia increased interest rates on RF Central bank credits and deposits by 0.25 percentage points from July, 14.

The RF State Duma and the RF Government started discussion on the priorities of the middle-term budget for 2009-2011. The decision on raising the expenses for three next years at the rate of 0.5% of the 2008 GDP expected has already been adopted. Against the background of low earnings of federal budget in terms of GDP proportion this year, there are ongoing discussion about the necessity of tax load on economics decreasing in the Government. It is not planned to cash the means of the Reserve Fund and the Fund for national welfare invested in the obligations of American hypothecary corporations before maturity date.

The dynamics of the Russian financial market was defined by the situation at the world financial markets, which was reflected in the reaction of investors for negative news, connected with the dramatic drop of quotations of two leading American hypothecary agencies shares, publication of new financial losses by the biggest financial companies as well as the economic growth slow-down in the USA. There was an additional negative factor for Russian securities trend for the oil prices correction at the world market in the second half of the month. Internal news also contributed in the drop at the Russian stock market tense situation with Mechel company as a result of its criticism by Prime Minister V. Putin, Sberbanks accounting not coming up to expectations as well as Federal State Statistics Service on slow-down of industrial production in June. These negative trends revealed most evidently at the drop of the Russian stock market (decrease of blue chips shares quotations by up to 28%), as well as the reduction in the main Russian stock indices MICEX and RTS- by more than 15% as a result of July.

In May 2008 Russian foreign trade turnover, calculated on the basis of balance-of-payments methodology, was equal to USD 67.2 bln, which is by 42.5% more than in May 2007 and export value volume reached the level which is the maximum over 17 years USD 42.8 bln, increasing by 44.3% as compared with May 2007.

Russian import growth rates also remained at high level. In May 2008 import value index increased as compared with May 2007 by 39.4% and was equal to USD 24.3 bln. Situation in the world on the whole is considered to be favorable for Russia, despite the slow-down of the world economy rates.

The most important issues considered at the meetings of the Presidium of the Government of the Russian Federation in July 2008 were the draft laws aimed at reduction of administrative barriers when conducting entrepreneurial activity.

Political and Economic Situation in July S. Zhavoronkov In July V. Putin, Prime Minister, expressed sharp criticism of a big metallurgic company Mechel and its owner I. Zyuzin.. According to the Prime Minister, the company sold its production to foreign companies at prices that made half of world ones. Taking into account that about one third of the companys shares are quoted at the exchange, the company suffered a considerable damage immediately. As to the foreign policy the major event of July was the first G8 summit with D. Medvedevs participation. The RF Supreme court refused to answer to the claim of the Communist party and the Union of Right Forces on abrogation of the election to the State Duma results in December 2007.

In July the main news item was V. Putins statements about one of a big businessmen, the main owner of Mechel Company. V. Putin accused Mechel of coking oil sale abroad at underestimated prices. In several days V. Putin repeated the claim, stating that the coke is being sold to Switzerland companies at underestimated prices. A number of Russian Authorities, I. Shuvalov, First Vice Prime Minister, A. Dvorkovich, Presidents assistant, and even Yu. Chaika, attorney-general, made calming announcements following V.

Putins statement, saying that it is the issue of the anti-monopoly investigation (which according to I. Artemenko, the head of the Federal Antimonopoly Service, will also be conducted in connection with other metallurgical companies), that the inspection has been started, but there are no radical measures that are necessary to follow etc. Taking into account the fact that about one third of the companys shares are quoted at the exchange, the company suffered a considerable damage immediately.

There are a lot of big companies in Russia, including governmental ones, that trade with various offshores and a part of their incomes remain in the off-shores. But when the issue concerns a good company, for example Swiss trader Gunvor, which was created after V. Putin came to the power, the practice does not draw criticism. In case of a bad trader the authorities remind that the government has not received all the taxes, which together with fines and penalty fees can be collected at will, calculating the right prices for the company, which was chosen as a target, also at will. All the talks about order establishment, necessity of legislative acts adoption, which link the definition of market prices of the leading export goods hydrocarbons and metals to the world exchange prices for the main natural resources, were started more than once, but finished before time. The similar accusations were also officially urged in connection with some other companies (in YUKOS case they were Sibneft and TNK-BP), but they were than stopped by the courts or withdrawn by authorities.

The time will show what are the reasons for accusations towards I. Zyuzin and Mechel Company, but political context in this issue cannot be forgotten. First, there were no comments by D. Medvedev concerning such a big issue. Meanwhile, it is his clear statement that could stop panic at the market. This fact does not ensure anybody in his independence and reality of the well-intended declarations expressed earlier. Second, this reminds once again that Russia is a country characterized by huge problems in private property institution.

Against the background of Mechel, the situation in another company TNK-BP- is by far less worrying.

This company, established on the official approval by the authorities the ceremony of deal signing between the British Petroleum and the group of the Russian oligarchs M. Fridman, G. Khan, V. Vekselberg was attended by the heads of Russia and the Great Britain of that time V. Putin and T. Blair started the corporate war this year, and it is becoming ever more heated. There is no obvious legal solution for the conflict, since the BP has precisely 50% of the stocks and according to the agreement on shares it appoints the president, who is the main executive of the company, and conflicts among shareholders should be settled in Stockholm arbitrary court, which is far from the Russian government. This is why quite a special way was chosen the Russian authorities did not prolong the working visas for a large group of non-resident managers, including the president, R. Dudley. R. Dudley declared that he will fulfill the duties of the head of the company from abroad, which can be very unpleasant for M. Fridman and others, who persistently strived to purchase assets in jural states. It is interesting, by the way, that Mr. Dudley was not refused a standard visa, that is he was not subjected to all the functions. The most effective tool, which Russian authorities dispose sanctions against the property of the British Petroleum itself (a net of filling stations and shares in Sakhalin-and Sakhalin-5 projects belong to it) has not been used so far. The possible solution for the situation is purchase of BP share in the company by some Russian company. Besides, it is obvious that the BP enjoys wide diplomatic support and may not be afraid of expropriation. But for the Russian economy this conflict signifies that there is a threat of further government expansion in the fuel and energy complex.

There were few important appointments. V. Putin appointed A. Drozdov, the secretary of the financial and economic department of the government machinery, to the post of the head of the RF Pension Fund. And former Drozdovs place was taken by A. Belousov, Vice Minister for Trade and economic Development and a famous economist. Besides, V. Putin transferred the supervision functions over the foreign investments to Federal Antimonopoly Service (FAS), and V. Putin himself was approved as a chairman of the government commission on the control over execution of foreign investments in Russia, I. Shuvalov, First Vice Prime Minister, being appointed as his substitute, and the head of FAS, I. Artemiev, - executive secretary, that is works coordinator, in fact. Taking into account FAS commissions concerning Mechel case and Artemievs career growth one can assume that antimonopoly activity in Russia is becoming a branch of security services and is not to be filled with the content that was expected of it.

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