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INSTITUTE FOR THE ECONOMY IN TRANSITION RUSSIAN ECONOMY: TRENDS AND PERSPECTIVES October 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 1 Major developments and trends.......................................................................................................... 3 The political and economic results of October 2008 S. Zhavoronkov.................................................. 4 Inflation, Monetary and Credit Policy P. Trunin................................................................................ 7 Financial Markets N. Burkova, E. Khudko....................................................................................... 11 Real Economy Sector: Trends and Factors O. Izryadnova................................................................ 22 Russian industry in October 2008 S. Tsukhlo................................................................................... 25 Foreign trade N. Volovik.................................................................................................................. 27 Budgetary and Tax Policy . Kirillov.............................................................................................. 30 Meetings of the Government of the Russian Federation in October 2008 M. Goldin......................... 34 An overview of economic legislation I. Tolmacheva........................................................................ 36 An overview of the normative documents on the issues of taxation adopted in September October 2008 L Anisimova......................................................................... 38 An overview of budget legislation M. Goldin................................................................................... 41 The 2008 financial crisis: a new round of state expansion A. Radygin.............................................. The new Concept of the public health care systems development S. Shishkin.................................. Small and medium business in Russian agriculture: problems of identification N. Shagaida............ An overall assessment of the military-economic potential of regular forces and of the mobilization reserve (resource) V. Tsymbal............................................................................ The RF Governments policy of aimed at improving the performance of state academic establishments I. Dezhina................................................................................................. The foreign economic strategy of the Russian Federation until 2020 A. Pakhomov........................... Major developments and trends In October, a slowdown in economic growth, aggravated situation in financial sector, capital outflow, downfall in the stock market and the overall significant deterioration in economic expectations were registered in the Russian economy.

Estimated GDP growth as of 2008 results should make 7.0-7.2 per cent versus 8.2 per cent in 2007.

Significant impact on economic performance provides the slowdown in the growth of investment in fixed assets to 13.1 per cent in January-September 2008 against 21.3 per cent in the relevant period of 2007, as well as slower expansion in consumer demand at the background of constrained growth of real income. Russian foreign trade turnover, as estimated with the help of the methodology of balance of payments, has fell down by 5 per cent in August, as compared with the level of July 2008. In August - October the ruble rate has declined against the two-currency basket.

As of the month result, the main Russian stock indices have fallen down beyond 50 per cent, the decline in corporate bonds indices was sustained, as well as the volume of trades, the number of canceled bond issues has increased. Strengthened negative expectations of investors was provoked by the aggravated global financial crisis, the collapse of major world stock indices, the increased liquidity crisis, continued significant decline in oil prices and further strengthening of the US dollar. Moreover, on October 23, the Standard & Poor's agency has downgraded the sovereign rating of Russia from stable to negative.

The Government of the Russian Federation identified the major trends of the anti-crisis policy: the extended credit support to private business, including avoiding ownership restructuring through the pledged shares, the use of budget reserves to maintain the existing level of public expenditures. The RF draft federal budget for 2009-2011 is estimated on the basis on the oil price at USD 95 per barrel, despite the prevailing trend in recent months to a substantial decline in oil prices. To maintain the stability of the Russian financial system, the Bank of Russia has taken a number of measures to extensive refinancing of the banks, including unsecured credits to credit organizations.

As of September results, CPI made 0.8 per cent, having been unchanged against the relevant period of preceding year. Growth in consumer prices within January - September has reached 10.7 per cent, what significantly exceeds the growth rate of price in 2007.

According to the surveys results, the situation of the Russian industrial enterprises is getting deteriorated. The indicators of the dynamics of supply and demand have fallen down to the level, never registered since 1998. The structure of industrial limitations is getting changed: the insufficient domestic effective demand comes out to the first place, the lack of operating assets are at the second place, the first signs of the emergence of insolvency are registered. But enterprises still manage to avoid the excessive growth of finished products stocks, and they do not plan to massive employment layoffs.

The financial crisis provokes a significant intensification of the two linked processes in the field of property relations: 1) the overall process of redistribution of property throughout the economy gets a new incentive, 2) unlike the crisis of 1997-1998, the government and publicly controlled businesses are taking an active part in the process of property redistribution. This leads to a significant expansion of government control. According to the estimates, the proportion of shares of the Russian government-owned companies in 2006 was 29.6 per cent, in early 2007 - 35.1 per cent. By early 2008, this share was about 40-45 per cent, and the possibility of further increase of that share until the end of 2009 as about at 9-10 p.p.

At the last regional elections the United Russia has received some less votes than during the preceding year Duma election campaign. There was no significant strengthening of the other three parliamentary parties - the CPRF, LDPR and Fair Russia. The law, requiring the allocation of at least half of the mandates on party lists, even at the municipal level elections was adopted in first reading.

The Federal Center has replaced M. Zyazikov, the Head of Ingushetia, thereby recognizing the deteriorating of political situation in the Republic.

Among the major developments in the legislative and regulatory framework, attention should be given to:

Discussion by the Government the project on long-term socio-economic development of Russia to 2020 and action plan for its implementation.

Amendments to the procedure of the Fund of National Welfare assets allocation.

Increase of the amount of compensation for the individuals deposits in the Russian banks.

Permission to the Central Bank to bid at the RF stock exchanges.

The right of taxpayers to pay VAT by instalments within 3 months.

Recognition of the possibility for the municipal unitary enterprises to shift to the simplified taxation system.

Clarifying the rules of taxation upon the receipt and transfer of grants.

In addition, the survey provides comments to the following government decisions:

contents of Development of Health Concept for a long-term socio-economic development of Russia for the period up to 2020;

project for Foreign Economic Strategy of Russia until 2020, developed by the Ministry of Economic Development;

methods and approaches of assessment the impact of public research organizations and universities, developed by the Government;

Target Program (Federal Program), aimed at the transfer of all sergeants and a contract crew Navy until The political and economic results of October S. Zhavoronkov The RF Government mapped the basic contours of its anti-crisis policy: credits to private businesses, which are designed, among other things, to prevent changes in their ownership structure through mortgaging shares, the use of budget reserves to maintain the existing level of expenditures, somewhat increased taxes preferably through higher rates of social deductions. At the recent regional elections United Russia received fewer votes than during last years elections to the Duma.

However, there was no significant rise in the standing of the other three parliamentary parties - the Communist Party of the Russian Federation (CPRF), the Liberal Democratic Party of Russia (LDPR), and Fair Russia. A law was adopted in the first reading, which envisaged that no less than a half of all the mandates should be distributed by party lists even at municipal-level elections. Deputy Minister of Finance S. Storchak and some other eminent detainees were released from custody on recognizance not to leave, which may be interpreted as evidence of the weakened position of the Investigation Committee under the RF Office of Public Prosecutor. Minister for Regional Development D. Kozak lost much of his former status by being appointed Vice Prime Minister for Sochi. The federal center replaced Ingushetias leader M. Ziazikov, thus having recognized the grave situation in that republic.

Russias economic troubles in October were the target for active comments voiced by the states top officials. , Prime Minister V. Putin declared that Russia had turned out to be well-prepared for the global financial crisis thanks to the governments conservative policy (comparing the situation in this country to that in other countries that had been left unprepared by their own governments). According to Putin, the impact of the falling oil prices was counterbalanced by the Reserve Fund, the positive balance of trade, and substantial gold and foreign currency reserves, and the small external government debt. At the same time, despite the actual absence of any discussion of the Russian crisis in the official mass media1, the authorities could not ignore and leave without any comments several obvious challenges. These are the budget problems the budget being very nearly displaying deficit in view of the current level of hydrocarbon prices which previously seemed to be very conservative ($ 60 per barrel of Urals), as well as the problems faced by big companies and banks, which are overburdened with debts. Of no less importance are the trends of capital outflow, rapid shrinkage of the. gold and foreign currency reserves, and the onset of large-scale buying-up of foreign currencies, all these phenomena being the upshot of low trust in the government, rather than behavior of macroeconomic indices. Thus, First Vice Prime Minister I. Shuvalov and the Presidents assistant A. Dvorkovich made declarations to the effect that there is going to be no devaluation of the ruble, which echoed the declarations voiced by Russian authorities a decade ago.

Having criticized the US administration (as D. Medvedev put it) for socialism, Russian authorities, nevertheless, undertook similar, and even grander in scope, measures of state intervention: while The term crisis is applied only in respect of other countries, and even in the sense of global crisis, irrespective of any specific indices.

the federal authorities in the USA make attempt to save big companies on the brink of bankruptcy, in Russia a sufficient reason for providing financial support can be the fact of a companys own stock being used as collateral and the unfeasibility, from a political point of view, of its transfer to creditors, mostly represented by foreign banks. In regard to socially important issues the authorities took different approaches: thus, guaranteed private deposits with banks were increased from 300,000 to 700,rubles, while fuel operators received and implemented2 the Federal Antimonopoly Services order to lower the retail prices of petrol due to the decline in international oil prices. At the same time, the State declared the impending large-scale buyouts of housing products from the market, thus openly siding with construction corporations at the expense of the population.

Importantly (and this is a rather bad sign), the government says nothing about reducing its expenditures, which would have been a very natural measure to resort to in a situation of crisis. On the contrary, in early October the government declared of its conceptual decision to increase social taxes and payments from 2010 onwards. In fact, so far there has been no mention of any adjustment of the previously adopted course towards preserving the obviously high level of expenditures and not only in the social sphere.

In October, elections to the legislatures of five Russian regions, synchronized with municipal elections, were held within the framework of a single election day. The specific feature of this campaign was that there were only four parties nearly nowhere any of the other still registered parties were allowed access to the elections beside the four parliamentary ones. In Chechnya and Kemerovo Oblast is was announced that United Russia got 88 % and 85 % of votes respectively, followed by Fair Russia (9 % and 5 %). However, election results in these two regions have for a long time been doubtful because of the impossibility for any parties other than United Russia to electioneer there3. In three other regions where election campaigns were competitive the results achieved by United Russia amounted to about 50 % in Trans-Baikal Krai, to slightly more in Sakhalin Oblast, and to slightly less in Irkutsk Oblast. This is approximately by 10 p.p. lower than the results of the elections to the Duma.

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