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INSTITUTE FOR THE ECONOMY IN TRANSITION RUSSIAN ECONOMY: TRENDS AND PERSPECTIVES December 2006 MONTHLY BULLETIN Moscow 2006 Institute for the Economy in Transition, 1996.

5 Gazetny pereulok, Moscow 103918, Russian Federation Phone: (495) 203-88-16 Fax: (495) 202-42-24 E- Mail: todorov@iet.ru 1 December 2006: Political and Economic Outcomes..................................................................................... 3 Budgetary and Tax Policy............................................................................................................................ 5 Monetary and Credit Policy......................................................................................................................... 9 Financial Markets..................................................................................................................................... 11 Investments in Real Sector of Economy..................................................................................................... 20 Foreign Investments in Russian Economy.................................................................................................. 23 Real economy sector: trends and factors..................................................................................................... 28 Business Survey in December 2006........................................................................................................... 31 The Oil and Gas Sector.............................................................................................................................. 32 Foreign Trade............................................................................................................................................ 37 New Trends of the Federal Government Staffing Policy in the Area of Science......................................... 40 New Amendments to the Legislation on Delineation of Powers Between Local Authorities....................... Issues discussed at the RF Government meetings of November 7, 14 and 21, 2006..................................... Review of Budget Legislation: December 2006.......................................................................................... Review of the Budget Laws for December 2006......................................................................................... December 2006: Political and Economic Outcomes In December 2006 a story of fight of the Russian officials, Procurators Office and Ministry of Natural Resources for the Sakhalin ecology was over approximately 6 months after the whole thing started. In a Kremlin meeting which left no doubt about the source of Sakhalin Energy problems, President V. Putin convened the leadership of all the companies participating in the deal: Mitsubishi, Mitsui, Royal Dutch Shell and Gazprom. It was announced that according to the terms of the agreement Gazprom would pay $7.45 bio for 50% plus 1 share in the Project operator who is Sakhalin Energy (the sharehoplders would give Gazprom half of their current stock, and the payments would be distributed on a pro rata basis). Thus, Shell will retain 27.5% shares of Sakhalin Energy, while Mitsui and Mitsubishi 12.5% and 10%, accordingly. President V. Putin appreciated the partners for their flexible approach and stated that in principle the ecological claims might be considered settled.

Several important facts may be mentioned in this connection. Mr. V. Putin and the Russian authorities do not make a secret any more of that they believe it acceptable to directly regulate the ownership structure of the profitable projects at least in the fuel and energy sector even when they talk about major internationals and not the Russian business. Secondly, Russia demonstrates its willingness to re-consider the game rules in those projects where th government took over certain obligations before the strategic investors. Thirdly, the actions of the Russian authorities are motivated not by economic strategy (and, obviously, not the ecological strategy) or protection of the Russian budgetary interests, that have been constantly urged by the advocates of the said considerations but solely by the reasons of re-distribution of property. At the current stage the business may be offered a dumping factor as compensation. Transnational companies are not confident they can protect their interests via courts or diplomatic mechanisms, and this may encourage the Russian authorities to escalate their demands.

Indeed, after the successful attack at Sakhalin-2 the same month a new attack was launched at the second of the three fields developed under PSA terms. Rosnedra announced the beginning of the license revocation procedure for Khariaginskoye field in the Nenetsk okrug (the operator is Total, a French-Belgium company, owning 50%, while another 40% belongs to Norvegian Hydro and 10% to the Nenetsk oil company). The formal pretext is a low production level and the field development rates that do not meet the Feasibility Study requirements1. Procuracy supervision bodies notified the Caspian Pipeline Consortium (CPC) on the expiration of the license term for crude shipment from Novorossiysk (earlier CPC was notified of tax claims worth RUR4.5 billion). CPC connects Tengiz field in Kazakhstan with a marine terminal close to Novorossiysk; the system is operated by the Consortium where Russia owns 24%, Kazakhstan 19%, and Oman CPC 7%. The other 50% are distributed among a large investors consortium led by Chevron. In case of Khariaga an attempt should be made to enter the project of Rosneft operating in the okrug while in case of CPC to increase the government stock managed by Transneft up to the control stake.

In terms of the Russian investment climate all these events are believed to result in a mid-term to a considerable cut down of the foreign investments in the fuel and energy complex that seem to be defenseless before the Russian executive power (indeed, also shrink the stimuli to invest by the remaining partners in the public companies that tend to look at their equity capital as portfolio investments). On the other hand further dissemination of the practice of the enforced buy-out of the assets from the owners and in other profitable sectors in addition to the fuel and energy complex may be expected.

The Unified Russia (UR) had its ordinary convention on the 2nd of December. Though formally the topic of the convention was the Urals industrial development, several important events were expected to happen. First, a final draft of the party program was to be adopted; the half-year long debates around the party program ceased to be academic and began to reflect the attitudes to some of the Russias leaders.

Second, a sizable enrollment to the party ranks of the celebrities was expected. And third, at the eve of the convention the party leadership had a meeting with President V. Putin in order to discuss a number of issues among which the most urgent (though not public) was the attitude to S. Mironovs Fair Russia (FP).

A certain compromise was reached on the first issue. The term sovereign democracy launched by V.

Surkov and used as grounds for criticism of the Deputy Head of Putin Administration (B. Gryzlov and other official party bodies avoided using this term till October) secured its position in the party documents. As for the rest, the ideas nourished by the Center of Social and Liberal Policies, 4th November Club and oth Even the authorities recognize that 80% of the volume stated in the Feasibility Study have been produced; and the Project operator is absolutely correct saying that it would have been strange to produce more than the established oil throughput quota via Transneft system.

ers were adopted: re-distribution of roles between the executive and legislative authorities (the parliamentary majority is to be involved in strategic planning of economy and the supervision of the strategy implementation). However the national projects were also supported by way of demanding that their funding be sharply increased.

B. Gryzlov somewhat reinforced his positions by adding to the Presidium of the General Council his fellows-in arms Y. Shuvalov and A. Turchak. At the same time no weakening of the the clients base of V.

Surkov - primarily the Presidium Secretary V. Volodin and Head of the Executive Committee A. Vorobiev was observed. At the eve of the convention a sensational information was announced: two major oligarchs joined the Presidium V. Yakunin, Leader of RZD, and S. Chemezov, Leader of Rosoboronexport;

they are sometimes called pretenders to the role of the successor. This information was confirmed but partially for S. Chemezov; V. Yakunin refused to join the party (at the end of the month Prime Minister S.

Ivanov made a statement of not joining the party). S. Chemezov, however, addressed the convention with a number of

Abstract

demands for support to the defense industry. How serious were his demands will become clear in the period till the probable UR convention next spring. A key and ambiguous issue is the attitude to the Unified Russia of V. Putin environment and a shaping trend to keep a certain distance at the eve of the election cycle.

The results of the meetings of V. Putin with the party officials (in addition to the meetings with the UR and FR Leaders President talked to the Leaders of 10 registered parties) confirmed that the Unified Russia informally is Number 1 Party. Mr. V. Putin linked this with the UR success at the regional elections that, according to President, could be regarded as evidence of the UR being most influential and established political power in the country. The Unified Russia, however, can not use against the Fair Russia the traditional set of tools of enforcement and banning from participation in the elections which, when used, for instance in Tuva, resulted in the creation of the anti UR majority this fall. V. Putin also curbed the recent abundant flow of democratic initiatives from S. Mironov, Federation Council Speaker (S. Mironov went as far as condemnation of the amendments to the election legislation, drafting a new agreement on the delimitation of jurisdictions with Tatarstan and the demand to elect the Federation Council). During the meetings it was proposed to seek the electivity of the Federation Council in a certain reform of the current system2, and not in general elections;

the commitment to fight with extremism was reaffirmed. S. Mironov had to refuse to nominate himself as a Leader of the party list at the coming elections to the Legislative Assembly in St.-Petersburg in order to balance the terms of the campaign with the Unified Russia that failed to find a powerful engine.

In December the elections took place for the Perm Regional Legislative Assembly3. In this traditionally democratic region the voting results of the Unified Russia were the least in this fall run 34.5%, SPS took the second place (16.3%); the threshold was overcome by LDPR (13.8%), the Pensioners Party (11.6%) which will be absorbed by the Fair Russia and KPRF (Communist Party) (8.6%). Some commentators began to talk about the revival of the rightists, and the SPS convention nominated their party list Leader N.

Belykh as Number One in all the regions where SPS is going to participate in March elections (St. Petersburg and Moscow region are the key areas). However, the Perm situation can hardly happen again. First, the Apple list was absent in Perm. Second, the list was led by the most popular person in the region (it is not easy to find such leaders in other regions). Third, large financial costs (estimated at above $1 per each regional voter) could not be copied. There are some positive outcomes, however: a democratic list has chances in regions where there are no other party lists; where the democrats criticize the Unified Russia and have populist and re-distribution slogans (e.g. in the Perm agitation campaign the promise to raise pensions by 2.5 was a key stake).

At the eve of the New Year the relations with the CIS republics has become strain by tradition around Gazprom attempts to increase prices. If the Ukrainian government led by V. Yanukovich burdened by post election political commitments easily agreed with the price increase up to $160/thousand cu. m., and Georgia and Azerbaijan tried to minimize the supplies, the old ally of Russia A. Lukashenko consistently rejected, as in 2004, any price increase (actually the price of $46 is lower than that in Russia) likewise any compromise (sale of Beltransgas at the expense of the reduced price, etc.). Where around 10% of the European transit depends on Byelorus, even this volume, under condition of the Lukashenkos firm position and actual impossibility to influence the Byelorussian Leadership (neither by election procedures that are actually annulled, nor by foreign asset sanctions that are non existent) beats the Russian Federation.

S. Zhavoronkov This allegedly provides for electivity of the governors who nominate senators under the threat of dismissal of the sole source elected ones by the legislation makers as advised by V. Putin.

As the region was consolidated, the date is an exception from the single date of elections.

Budgetary and Tax Policy According to the tentative performance of the budget in terms of revenues as of November 2006, the level of revenue of the RF federal budget made 23.2 per cent of GDP; the expenditures of the federal budget accounted to 15.21 per cent of GDP, budget surplus has come up to 8.0 per cent of GDP. Within January October of 2006 the RF consolidated budget revenues made 35.1 per cent of GDP, consolidated budget expenditures made 24.7 per cent of GDP, and consolidated budget surplus accounted to 10.6 per cent of GDP.

As of December 1, 2006 the volume of financial reserves of the RF Stabilization Fund made RUR 2189.bln, as compared with RUR 1894.09 bln on November 1 of the current year, which makes 8.2 per cent of GDP and 7.8 per cent of GDP accordingly.

The State of the Federal Budget According to the tentative estimates of the federal budget execution on cash basis, made by the RF Ministry of Finance, the federal budget was executed within January-November 2006 in terms of revenue in the amount of RUR 5 651.9 billion (23.2 per cent of GDP), in terms of expenditures in the amount of RUR 3 703.7 billion (15.21 per cent of GDP). The budget surplus made RUR 1 948.2 bln (8.0 per cent of GDP).

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