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INSTITUTE FOR THE ECONOMY IN TRANSITION RUSSIAN ECONOMY: TRENDS AND PERSPECTIVES October 2005 MONTHLY BULLETIN Moscow 2005 Institute for the Economy in Transition, 1996.

5 Gazetny pereulok, Moscow 103918, Russian Federation Phone: (095) 203-88-16 Fax: (095) 202-42-24 E- Mail: todorov@iet.ru 1 Political and Economic Developments of October 2005........................................................................ 3 Budgetary and Tax Policy....................................................................................................................... 5 Monetary Policy in the Russian Federation............................................................................................. 7 Financial Markets.................................................................................................................................. 10 The Real Sector of the Economy: Major Factors and Trends............................................................... 20 IET Business Survey: Industry in October of 2005............................................................................... 25 Oil and Gas Sector................................................................................................................................. 26 Foreign trade......................................................................................................................................... 31 Prospective provisions of WTO Doha Round Agricultural Agreement and their implications for Russia (the market access aspect)..................................................................................................................... 34 Health Care: New Priorities of the State Policy.................................................................................... 37 Issues Considered at the Sessions of the RF Government of October 6 and 27................................... 39 Review of the economic laws for October 2005................................................................................... A review of regulatory documents concerning taxation issues, which were made public in October of 2005...................................................................................................................... Political and Economic Developments of October In October we once again saw dramatic aggravation of the situation in the Northern Caucasia. On October 13 a large group of militants attacked Nalchik, the capital of Kabardino-Balkaria. The militants, having divided into five groups almost simultaneously attacked the Departments of Internal Affairs, Special Police Force building, the Board of execution of punishment, FSB (Federal Security Service of Russia) Board, Antiterrorist Center of the Ministry of Internal Affairs, the frontier detachment, and the airport. Exchange of fire lasted several hours, and the attack was completely suppressed by evening. It was announced about the death of 90 militants, over 30 law enforcement agency officers, and twenty civilians. A relatively successful result of the operation (last year a considerable number of security officials died during the similar attack on Ingoshetia, whereupon the attackers could safely retire) can be explained by well coordinated work of the law enforcement bodies and the presence of preliminary information (the previous day the large militants detachment was attacked, hiding-place was found with almost half a ton of explosives, etc.).

Nonetheless, coupled with half a year non-interrupted fighting in Makhachkala, it is a question of only a partial stabilization.

Less than a month ago Valery Kokov, one of the most authoritarian rulers of the Northern Caucasia (who governed Kabardino-Balkaria since 1991) retired (it is striking that even at the time of Eltsins rule the Republic had no competitive elections). Last years Valery Kokov was severely ill, the power was actually concentrated in the hands of Kokovs wife Violetta and the head of the Ministry of Internal Affairs H. Shogenov. The power was accused in self-will and corruption, the use of force in suppression of the dissatisfied. The relations were worsened with Muslim leaders, with the result of closing all the mosques, except for the one - official. This cau6sed aggravation of the situation and searching for contacts with terrorist groups in Chechnya, its clear the basis for such state of affairs existed previously. A new head of the Republic was assigned the Moscow big entrepreneur and deputy of the State Duma - A. Kanokov. It remains to be seen to what extent he will be able to build a stable polyarchic system of power, that diminishes the incentives to armed resistance, and establish multinational (there are big diasporas of balkars and russians in the republic) and multiconfessional society.

The draft constitutional act of the future union state of Russia and Byelorussia has been prepared (it will be considered by the High Council until November 15, 2005). However, its principal structure has already been suggested. The union will have a parliament consisting of two houses. The House of Representatives will be formed through direct elections: 28 persons from Byelorussia, 75 - Russia. The House of the Union will include 36 senators and deputies delegated by the states of the Union on a parity basis. The superior body of the executive power will preserve its present structure: it will be headed by the present presidents of the two states on a rotational basis. The State Council assigns a premier now this position is held by joint appointment by Russias prime-minister M. Fradkov. The position of a president is not suggested.

Thus, the so-called union state again demonstrates its fictional character, while the forecasts on its use as an instrument for prolongation of V.Putins powers fail. However, it was also quite clear earlier because such a structure meant a rejection no matter how profitable, but unreliable exchange of absolute power of A. Lukashenko.

Again the debates ran high in the Government of the RF. Early in the month the three federal ministers (the finance minister A. Kudrin, the industry and energy minister V. Khristenko, and the economy development and trade minister G. Gref) all together opposed dominance of the state in the economy. In particular, they were talking about Gazprom and not only about it. Most severe was the criticism of G. Gref who called the policy of expansion of the government participation in the economy Neanderthal and offered the prospects of its quick death. In parallel with that, the premier M. Fradkov, supported by the government office, made a new attack on the so-called economic block.

Late in 2004 it was suggested to reduce the VAT rate from 18% to 13% by 2006., but G.Gref and A.Kudrin did not support the idea. Not without regret Fradkov agreed with the ministers arguments and promised not to reduce the rate until the 2008. Still, late in September of 2005 the idea to reduce the VAT rate (to 13% since 2007) again stood first on the list of measures to speed up the economy, that were prepared by the government office for the session of the Competition Council. Among other measures were - reduction of prices of earth redemption under the privatized enterprises to 2% from their cadastral values (now it is 5%), and the rental rates of such land lots to the size of land tax. As a result, Gref and Kudrin were forced to promise to analyze the possibility of reducing the tax burden in the near future. In parallel with that, the Government Office attacked the already provided for (in the budget law for 2006) investment fund (Rb 70 bn), the selection of projects for which was planned to conduct with the key participation of MERT (the Ministry of Economic Development and Trade of Russia). The government officials criticized that the budget Code of the RF had no respective terminology.

It looks like the political dynamics and the volume of available budgetary funds will make the economic bloc to concede indeed, the reduction of taxes (according to calculations of experts, by Rb 300 billion a year) means a simple and transparent method of stimulating the economic growth. In parallel with that, the power demonstrated its willingness to large-scale investment in the social sphere, which is to be mounted and not reduced in 2008, which is why its hardly that the reduction of taxes will be so radical as it is suggested. As concerns the reduction of tax rates, it is not so principal for business under conditions, when the main threats for its existence are non-fiscal in its nature, but more likely to be associated with the breakdown of the law-governed state institutions, instability and vulnerability of business before the power as a whole and different groups, up to and overt racketeers.

On the other hand, it is unlikely that attempts to reduce the expenditures of the investment fund will be a success, because besides the ministers of the economic bloc it is big business which is interested in its existence. Though, in our opinion, the decision of the question of redemption of the land plots under the industrial enterprise (promised by V.Putin just after the arrest of M. Khodorkovsky) will not be solve positively, it is a very suitable instrument of pressure to give up from it.

On the whole, one should not overestimate the ideological dispute between different wings of the Governments. It is quite a friendly dispute. We cannot expect any or radical decisions. Plus, liberalism of the Government economic bloc is strongly exaggerated.

For example, the Russia's industry and energy ministry prepared a new version of the bill on limitation of the access of foreign investors to strategic branches of the economy. Forty types of activity are considered as strategic, and to deal with them in Russia a foreigner will have to go through the three-step procedure of agreements. By November, the Government is to introduce the respective bill in the State Duma, but this will not happen, first, the bill is not agreed between the departments, and, second, Putins administration made serious remarks to the concept of the bill, suspecting it in the nature of corruption. In any case, its clear that it is a question of making new administrative barriers, no matter what are liberal declarations (or even liberal laws such as the federal law On protection of competition, defining wide and not formalized authorities of FAS (Federal Antimonopoly Service) they were grounded.

October became rather effective as far as advancing on business both institutional and private is concerned. Thus, it is FAS that prescribed Eurocement group to go down the price for cement and repay to the budget over $70 million, as well as within five years deprived it of the right to increase prices for cement without preliminary notification of FAS and reasoning of their changing. FSB (Federal Security Service of Russia) suspended the operations of the subdivisions of Russian-Britain TNK-BP in the Western Siberia because of non-observance of the law on the State secret. FSB offers the oil companies to substitute foreign general directors by local ones according to the law on the State secret, foreigners have no right to see ground maps like that. Because of conflict between the shareholders there were arrested the shares of Verhnyaya Salda metal industrial association, one of the largest world producers of titanium and largest in Povolzhiye operator of cellular communication SMARTS. Because of the above conflict of bureaucrats suffered the director of the known state-controlled distillery Kristall A.Romanov, who was hurled into prison. In parallel the Yukos case is being developed.

We cannot but remember the deal between Gazprom and R. Abramovich on the purchase of Sibneft.

FAS granted a permission to purchase of Sibneft, while the Gazprom Board of Directors approved it. It has been announced that Sibneft will be headed by one of Millers deputies A. Ryazanov, who had already been introduced to the staffers. However, its not yet clear if he retains his functions (control over acquisition and capture of new assets) in GAZPROM. If Ryazanov is to concentrate on administrating Sibneft, its not improbable that the members of Usmanovs team will take his position.

Sergey Zhavoronkov In his May address to the Federal Assembly Putin required from the government to establish well-defined rules of foreigners access to strategic fields No precedents are known are yet that FAS critically reacted to GAZPROM purchases.

Budgetary and Tax Policy In January through August of 2005, the revenues of the RF federal budget made 24.41 per cent of GDP, while the level of expenditures of the federal budget was registered at 16.66 per cent of GDP, and the budget surplus made 7.75 per cent of GDP. In January through August of 2005 the revenues of the RF consolidated budget made 37.0 per cent of GDP, while the expenditures of the RF consolidated budget were registered at 26.6 per cent of GDP, and the budget surplus made 10.5 per cent of GDP.

According to the data as on October 1, 2005, the amount of financial reserves accumulated in the RF Stabilization Fund was registered at Rub. 960.7 billion as compared with Rub. 832.1 billion registered as on September 1 of this year.

The State of the Federal Budget According to the preliminary estimates presented by the RF Finance Ministry, in January through September of 2005 the revenues of the federal budget made Rub. 3 676.45 billion in terms of the execution of the budget on the cash basis (or 24.41 per cent of GDP), the expenditures of the federal budget were registered at Rub. 2 509.46 billion (or 16.66 per cent of GDP). The surplus of the federal budget made Rub. 1 166.98 billion (or 7.75 per cent of GDP). It should be noted that in 2005 the amount of revenues of the federal budget significantly exceeded the value of this indicator registered in the respective period of the preceding year, which at that time made Rub. 2 425.05 billion (or 20.per cent of GDP). In January through September of 2005, the expenditures borne by the RF federal budget also increased in comparison with the figures registered in the respective period of 2004, which at that time made Rub. 1 837.05 billion or 15.2 per cent of GDP. The surplus of the federal budget registered in the period under observation also significantly surpasses the value of this indicator observed in 2004 (Rub. 588.01 billion or 4.9 per cent of GDP).

In August and September of 2005, the amount of the revenues of the RF federal budget made Rub.

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