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INSTITUTE FOR THE ECONOMY IN TRANSITION RUSSIAN ECONOMY: TRENDS AND PERSPECTIVES December 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 December 2008 S. Zhavoronkov.............................................. 4 Budgetary and Tax Policy N.Luksha.................................................................................................. 7 Financial Markets N. Burkova, E. Khudko....................................................................................... 12 Real economy Sector: Trends and Factors O. Izryadnova................................................................. 23 Business Survey in December 2008 S. Tsukhlo................................................................................ 26 Foreign Trade N. Volovik................................................................................................................. 28 Investments in Real Sector of Economy O. Izryadnova.................................................................... 31 Foreign Investments E. Ilukhina...................................................................................................... 34 Budgetary and Tax Policy . Kirillov.............................................................................................. 39 The crisis will test the financial stability of Russias budget already in the nearest future I. Sokolov............................................................................................ 42 Oil and Gas Sector Yu. Bobylev....................................................................................................... 45 Countryside Development: from National Priority Project to State Program G. Rodionova............ Socio-economic express-analysis of the new federal target program designed to switch the Russian army to a contract recruitment basis V. Tsymbal............................................................................ Meetings of the Government of the Russian Federation in December 2008 M. Goldin...................... Review of Economic Legislation I. Tolmacheva.............................................................................. Review of Regulatory Documents Concerning Taxation over November-December 2008 L.

Anisimova........................................................................................................................................ Review of Budgetary Legislation M. Goldin.................................................................................... Notification of foreign creditors of financial institutions concerning the initiation of insolvency (bankruptcy) proceedings against their debtor E. Velikova.............................................................. Restrictions to economic growth in industry on the eve of crisis (results of polls of industrial enterprises) A. Kaukin, L. Freinkman............................................................................................... Major developments and trends In December, Mr. V. Putin and other Government Heads have clearly stated that the sharp devaluation of the ruble will not happen. That is, smooth devaluation, started since summer, will be continued.

The Government continues to declare the intention to spend considerable sums of money to support domestic enterprises. The list of applicants for public assistance, compiled in December, includes, in fact, all more or less large enterprises. The Parliament has adopted the laws, restricting the powers of several authorities under the Ministry of Internal Affairs to control businesses, but at the same time, it is planned to restrict the jury trial authority. In the Far East, there were massive protests by automobile users, who are disappointed with the decision of the authorities to increase the import duties on second-hand cars. The Head of the Moscow Patriarch Church Alexiy II has passed away, and it is not yet clear how the election of his successor will take place, on a consensus or a competitive way.

In November 2008, for the first time in the past three years, there was recorded a negative trend in virtually all indicators of micro-economic development. This has resulted in reduction of the estimates of GDP growth for the fourth quarter to 102.3 per cent and to 106.0 per cent for 2008 in general. The decline in real incomes of population in November 2008, as compared with preceding month (97.per cent) and with November 2007 (93,8 per cent), has affected the annual rates of living standards growth. In November, the number of unemployed has grown 8.1 per cent as compared with November 2007. By the end of the year a significant growth of the number of unemployed, who applies to public employment service agencies is expected.

The growth of investments in November 2008 amounted to 3.9 per cent as compared with November 2007, and in comparison with the preceding month of 2008, the investments increased by 1.9 per cent, what has offset the decline of investment in October. According to the tentative estimates of the Central Bank of Russia, in the third quarter of 2008, the net outflow of private capital amounted to USD 16.7 billion. The total volume of foreign investments in the Russian economy in 2008 has decreased by 14 per cent, in all kinds of investments. According to the IET estimates, the expected growth rate of investments in fixed assets will account to 109.0 per cent in 2008.

As of the end of November, the CPI in Russia amounted to 0.8 per cent, what is lower than the indicator of the relevant period in 2007 (1.2 per cent). Consumer prices growth in January - November reached 12.5 per cent. Despite the slowdown of the decline in international reserves in November, as well as reduced outflow of capital, it is still too early to speak about the emerging new trend. To stabilize the financial system, the Bank of Russia has increased the refinancing rate by 1 percentage point up to 13 per cent and increased the rates on credits and deposits of the RF Central Bank. Moreover, since mid-November, the Central Bank of Russia is pursuing a policy of ruble soft devaluation.

In December, the deterioration of the economic crisis in the Russian industry has somewhat slowed down. According to the survey, the rate of production output has stabilized. Regardless of seasonal factors, the balance of changes at the end of 2008 has made -41 points, while in summer that indicator was +8 points, and in the spring that indicator was +15 points. More intensive decline in the volume of production was recorded as early as in the first six months of 1994. A massive decline in producer prices is noted, as well as declining satisfaction with the demand level. The stocks of finished products is growing. The availability of credits is getting reduced. For the first time in recent years there observed a decline in oil production.

The aggravating global liquidity crisis, the continuing decline in oil prices, as well as the policy pursued by the Central Bank of Russia on ruble devaluation and upgrading the key interest rates were the main factors, resulting in reducing the Russian stock market indices. Moreover, on December 15, Moody's agency has downgraded the rating of Russia from positive to stable. Besides, on December 8 Standard & Poor's agency has downgraded the forecast for the Russian credit rating due to the sharp decrease of foreign currency reserves and investment inflow. However, a number of anticrisis measures, taken by the Government of Russia, the support of the automotive industry helped to improve the expectations of investors. The effect of divergent factors was observed, on the one hand, in the growth of the blue chips quotations (up to 40 per cent) and increased activity of investors in the short-term market, MICEX and RTS, and on the other hand, in the decline of government securities profitability in the market. MICEX index has grown nearly by 15 per cent within the month. There has been noted an increased level of government bonds, which is the result of higher risks to borrowers and creditors of the debt market.

The deterioration of the external market situation provides an increasing affect on export contracts.

The sharp decline in credit activity, the decrease of real disposable monetary income of the population and dollar strengthening have provoked a reduction of imports.

In November, additional amendments were made to the Law on the federal budget for 2008-2010, which were made for the fourth time. Moreover, the Russian government has adopted a number of new anti-crisis measures to stabilize the Russian economy.

Apparently, the deterioration in the financial status of business entities inevitably entails a decline in budget revenues, and therefore calls into question the financial stability of the entire national budget system. Under such circumstances, it is necessary to pursue a restrained fiscal policy. One should avoid a decrease of the tax rates, that are dependent on the global oil prices to a lesser extent.

Among other important decisions in the field of economic policy are:

- the Russian government has established limits for rented premises to be privatized in the framework of a simplified procedure, available to small and medium-sized enterprises, as well as the deadline for installment payments;

- the maximum amount of unemployment benefit increased, as well as the some other social benefits.

The political and economic results of December S. Zhavoronkov In December, Prime Minister Putin and other leaders of the RF Government unambiguously stated that there would be no any drastic devaluation of the ruble. This means the continuation of its smooth and gradual devaluation, which has been visible since last summer. The RF Government, as before, declares its intentions to spend considerable sums of money on rendering support to enterprises; the December list of candidates earmarked for government assistance includes all more or less largescale enterprises. Parliament adopted laws designed to relatively restrict the ability of the bodies subordinated to the Ministry of Interior Affairs to inspect businesses; however, at the same time, it is planned to limit the jurisdiction of the jury. There were mass protests of car owners in the Far East, who expressed their dissatisfaction with the government decision to increase import duties on second hand cars. Moscow Patriarch Aleksey II died, and it has not become clear so far whether the election of his successor will be held on the basis of consensus or on that of contest.

In early December, the leader of United Russia party, RF Prime Minister V. Putin, appeared live on a TV hot-line and answered a number of questions put to him by citizens. Some of the questions dealt with the drastic deterioration of the living standards of some categories of citizens as it was always emphasized, in connection with the world financial crisis. The most disturbing questions were asked in connection with the issue of unemployment. V. Putin explained that, unlike other countries which were forced to reduce their expenditures because of the crisis, Russia would increase expenditures, including social ones, whereas inflation was planned to be kept at the level of 12 13 %. At the same time, according to Putin, economic growth in 2008 had been planned to be at the level of 7.5 %, while in reality it dropped to 6.8 - 6.9 %. As regards the unemployed, their number amounted to 1.7 million, but would grow, as Putin admitted, to 2 million, and it would be possible for the situation to be made less acute by internal migration, by increasing unemployment benefits and by organizing public works in the sphere of construction dealing with the development of infrastructure. Putin then told the audience about the government measures designed to ensure that budget funds would reach their final recipients, including small and medium businesses.

It is noteworthy that the Prime Minister took a relatively tough stance on one of the most sensitive issues that of sealing the tariffs on housing and utilities services. He motivated his position by saying that the infrastructure was worn up by 80 %, while the natural monopolies rely on the government-approved rates of tariff growth, because these figures are entered into their investment programs. What is on stake is the purchasing of metals and construction materials, the ensuring of functioning of the whole branches of the economy and the preservation of jobs. Putin also found some positive aspects of the crisis, such as increased security of the state housing certificates issued to discharged officers being risen to the level that would be sufficient even for purchasing apartments in major megalopolises - however, with the help of local authorities. It was also mentioned that internal prices of energy carriers were going down in connection with the drop in external prices.

V. Putin and other top-ranking officials stated that there were no plans to drastically devalue the ruble. V. Putin said: I am proceeding from the fact that we will not permit this there will be no acute fluctuations of the exchange rate of the ruble. Naturally, it will be adjusted in one way or another according to the prices of our traditional goods on world markets prices of energy carriers and metals I have already talked about this and of fertilizers. I should repeat again our main inflow of foreign exchange is from [selling] these goods, but we also have to serve out imports, which are still coming into our country in large quantities, and this produces a natural outflow. Putin then assured his audience that the government was not planning to change the existing regime of buying and selling foreign exchange.

More than two weeks later, it was D. Medvedevs turn to talk live on radio and TV. Against the background of Putins hot-line which was relatively rich of certain theses and target indications, Medvedevs message was practically devoid of anything concrete apart from general positive recollections.

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