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INSTITUTE FOR THE ECONOMY IN TRANSITION RUSSIAN ECONOMY: TRENDS AND PERSPECTIVES August 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) 202-88-16 E- Mail: lopatina@iet.ru 1 Major Developments and Trends........................................................................................................ 3 Real Economy Sector: Trends and Factors (O. Izryadnova)............................................................... 3 Foreign Trade (N. Volovik)................................................................................................................ 8 Budgetary and Tax Policy (. Kirillov)........................................................................................... 11 Monetary and Credit Policy (P. Trunin)........................................................................................... 14 Financial Markets (N. Burkova)....................................................................................................... 17 Review of the Most Important Issues Considered at the Meetings of the Government of the Russian Federation in August 2008 (M. Goldin)....................................... 24 Review of Economic Legislation (I. Tolmacheva)............................................................................ 25 Review of Budgetary Legislation (M. Goldin)................................................................................. 27 Review of Regulatory Documents Concerning Taxation over July-August 2008 (L. Anisimova)..... 28 The discussion of the financial aspects of municipal reform by the Council for Local Self-Government (I. Starodubrovskaya)........................................................................... 31 Investments of pension savings in the system of mandatory pension insurance in Q I 2008 (L. Mikhailov, L. Sychiova).............................................................. Factors of GDP Economic Growth and Volume of Industrial Production in First Half of 2008 (E. Astafieva).................................................................................................. A military-economic express analysis of the military actions in the Caucasus (V. Tsymbal)............. Major Developments and Trends The Russian economy in 2008 is characterized by high business activity in virtually all economic spheres, though in May-July the dynamics has somewhat declined. With sustained high rates of investments growth, fast growth in the construction of industrial capacities and infrastructure against the background of slower housing facilities is typical in the current situation. The main factors in the dynamics of public demand are inflation, slower growth of real income and real wages, as well as tighter terms for consumer credits. In the first six months of 2008 foreign trade indicators have reached its historical peak as in the volume of imports and exports, as in their growth rate.

In the 1st half of 2008, according to preliminary estimates, an expressed reduction in growth rates of total factor productivity (TFP) was observed, whereas in the mining sector TFP was declining.

As of July results, CPI made 0.5 per cent, lower than the CPI over the same period of 2007 for the first time this year. However, the growth of consumer prices within January - July reached 9.3 per cent, which far exceeded the rate of price growth in 2007. As a result of quarterly tax payments, the surplus reserves of commercial banks with the RF Central Bank have been reduced in July to RUR 235 billion. For further reduction of the rate of growth of monetary offer and inflation, the Bank of Russia increased the threshold of deductions to mandatory reserve fund from September 1, while the highest rate is applied to the standard of mandatory reserve for the debts of Russian banks to nonresidents.

In August, the dynamics of the Russian financial market was negative, which was based as on the global situation, as well as on domestic news background. In particular, the significant negative factors were the tense geopolitical situation in view of the Russian-Georgian conflict, investors wait-an-see position in the situation with Mechel company, as well as ruble weakening against the US dollar.

Negative trends are clearly evident in the Russian stock market (stock quotes of the blue chips went down to 25 per cent), as well as the main Russian stock indices MICEX and RTS (over 12 per cent on average) as of the month results. Upgrading of the Russian banking system rating by Standard & Poor agency from Group 8 a higher Group 7 did not make an expressed effect on the market.

During the 1st quarter of 2008 the value of the assets in the mandatory pension reserve system, regardless the funds of pension insurance deductions to the RF Pension Fund, has increased only by 0.per cent. The profitability of pension fund remained low. The state pension fund yield in the 1st quarter was noticeably lower than interest rates of GKO-OFZ market.

In accordance with the transition to a three-year budget planning, the Ministry of Economic Development has presented an amended plan of socio-economic development for 2009 and period for 20092011. Herewith, estimates are upgraded for virtually all macroeconomic indicators.

Russian Government has approved the draft federal budget and the Pension Fund of Russia for 2009-2011. Revenues of the budget from the oil and gas sector of the economy in 2008 are expected to reach the historical peak. But by 2011 they should get reduced almost by half (in per cent of GDP).

The RF Ministry of Finance is still against reduction of VAT rate and is taking the initiative to apply index to the unified social tax, as well as tothe tax on mineral extraction.

The Russian government announced on its intention to withdraw from the agreements with partners in the WTO, which are conflicting with the interests of the Russian Federation. In particular, it concerns agricultural issues. For the purpose of gradual substitution of imports for domestic products, the government increases agricultural subsidies.

An extended meeting of the Committee on self-government under the State Duma Chairman was held on the problems of financing the municipalities. The discussion revealed a lack of consensus on the key issues of financing local budgets.

The RF Government has approved the order and procedures for grants allocation to subjects of the Russian Federation, executive bodies of which have reached the best performance indicators.

Real Economy Sector: Trends and Factors O. Izryadnova In 2008 the Russian economy is characterized by high business activity in nearly all kinds of economic activity, though in May-June there was some slackening of the development dynamics observed.

The main factors of the populations demand dynamics are inflation growth rates, deceleration of real incomes and real wages growth, as well as restricting of the conditions for consumer crediting. In compliance with the transfer to the three-year budget planning the Ministry for Economic Development and Trade published a specified forecast for socio-economic development of the Russian Federation in 2009 and in the planning period of 2010-2011. The forecast information base having changed, nearly all the macroindices estimations were increased.

In 2008 the Russian economy is characterized by high business activity in nearly all kinds of economic activity, though in May-June there was some slackening of the development dynamics observed. According to the preliminary data, the increase in the GDP in January-June 2008 as compared with the corresponding period of the previous year was equal to 8.0%, being 8.5% in the first quarter and 8.0% in the second. The situation in the Russian economy was defined, on the one hand, by the sustention of favorable foreign trade situation, which accounts for high growth rates of economic incomes, consumer and investment demand, and on the other hand by the anticipating import growth rates and strengthening of the internal demand dependence on it. The development of theses trends proceeds against the background of growth acceleration of prices for the raw materials and the production of the processing industries, as well as toughening of the banks credit policy.

Over January-July 2008 the increase in the industrial production was equal to 5.4%, which is by 2.percentage points below the corresponding figure of the previous year. The specific feature of the current year is the decrease in the intensity of the development of nearly all the kinds of processing industries. The processing industries growth rates have slowed down to 7.8% as compared with 12.0% in January-July 2007. The existing trend for the decrease in the oil production volumes and the unsteady dynamics of the raw material for the metallurgy extraction on the whole over the first seven months of 2008 determined stagnation in the rates of the minerals extraction activity.

The structure of the economic growth in 2008 was still influenced by the high growth rates of the investments in the fixed assets and retail trade turnover, though these indices start to slow down gradually.

In January-July 2008 investments in foxed assets growth rates were equal to 114.4% against 123.9% in January-July 2007. The increase in the workload in the construction continued to anticipate the investments growth (120.4% as compared with January-July 2007). It is characteristic for the current situation that the construction of the production and infrastructure objects continued to grow faster, while rates of putting into commission of the total square of the housing slowed down dramatically (5.5% over January-July 2008 as compared with 35.5% over the corresponding period of the previous year).

In the first half of 2008 the Russian economy received USD 46.5 bln of foreign investments, which is by 22.9% less than in the first half of 2007. The biggest proportion in the aggregated foreign capital is accounted for by the credits of international financial organization, trading credits (48.7%), the share of the direct investments being 48.4% and of portfolio investments 2.9%.

In contrast to the investment sphere, the consumer market demonstrated the growth by 15.2%, which roughly corresponds to the figure of January-July 2007. It should be noted that the growth rates of the retail trade decreasing for foodstuffs to 108.9% in January-July 2008 as compared with 112.9% in the corresponding figure of the previous year, for non-food goods the growth rates in contrast increased up to 120.6% as compared with 117.6%. Against the background of high inflation expectations the share of expenses for the goods purchase in the structure of the populations incomes increased by 2.5 percentage points as compared with the first half of 2007 and was equal to 56.9%.

Structural shifts in the consumer expenses were accompanied with the decrease in the populations saving norm by 0.8 percentage point and the growth of currency purchase by 0.5 percentage point.

It is the inflation rates, slow-down of the real incomes and real wages growth as well as toughening of the consumer crediting conditions that are the main factors for the changes in the populations demand dynamics and structure.

In January-July the growth of the real disposable populations incomes was equal to 107.4% against 109.9% in the corresponding period of the previous year. Since the beginning of the year the consumer prices have increased by 9.3% against 6.6% in January-July 2007. Anticipating growth of solvent demand for goods and services as compared with their supply and the dynamics of the domestic production, trend for rapprochement of the domestic and the world prices (primarily for foodstuffs and fuel), low level of competition at the local and regional goods market, increase in the costs inflation influence because of continuous rise in the labor remuneration and high growth of industrial producers (123.2%) act as an internal factor for sustention of high inflation. Prices for foodstuffs increased by 11.7% over seven months of the current year, for foodstuffs by 5.2% and paid services rendered to the population by 11.9%.

Taking into account the existing dynamics the Ministry for Economic Development and Trade corrected the estimations of the main macroindices in 2008 and used them as a base for the development of Forecast for socio-economic development of the Russian Federation in 2009 and in the planning period of 2010 and 2011. This resulted in the correction of the forecast indices for the budget development for the planning period of three years.

On the whole the GDP growth rates estimations were raised by 1.7 percentage points, which determined the higher indices level for the planning period. In the nominal terms the increase in the GDP estimations was defined rather by the considerable deflator growth than by the dynamics of the physical volumes. Inflation index for 2008 was raised by 4.8 percentage points and will be equal to 111.8%, according to the estimation, but in the following years the inflation is supposed decrease down to 105106.8% to 2011.

According to the data of Ministry for Economic Development and Trade the expected growth of GDP in 2008 will be equal to 107.8% investments in the fixed assets increasing by 16.5% and retail trade turnover by 14.8%. The growth of oil prices accelerating, the expected export volume by value will be equal to approximately 148%, and by physical volumes by 103%. Import value went up by 38% and import physical volumes by 23% in 2008. Anticipating import growth as compared with the domestic production remains one of the factors supporting the balance at the investment and consumer market, while the growth of export earnings is the condition for fulfillment of the investment programs and social liabilities of the government. The norm of the fixed assets accumulation will be equal approximately to 21.1% of the GDP, which is connected both with the investments growth and with the decrease of the net export share in the GDP structure.

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