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According to the data of the statistical service, 88% of entities bought new Russian made equipment and machinery, while 60% of entities, import equipment; on the secondary market 22% of entities bought Russian made equipment, while 5%, import equipment. In January September 2004, investment in purchase of import equipment amounted to 23% of the total volume of investment in machinery, equipment and means of transportation.

A shift from investment into fixed capital financed at entities and enterprises own account to a greater use of borrowed funds was a principally new factor behind economic growth. The above points to quality changes in mechanism of investment development aimed at ensuring greater efficiency of flows of investment resources. In 2004, the share of own funds accounted for 47.2% of the total investment in fixed capital, which corre sponded to the 2000 level (the record high demand in investment during the entire period of recovery growth). There were also changes in the structure of borrowing: the share of bank loans and borrowed funds of other institutions increased, while that of budgetary fi nancing went down by 1.9%. In the past few years, the share of federal budget funds in in vestment financing gradually decreased in a situation of growth in the share of budgets of constituent entities of the Russian Federation. In 2004, the share of the federal budget in the structure of budgetary funds decreased by 3.8% on the 2003 figure.

By estimation, in 2004 growth in lending to enterprises and entities amounted to nearly 31.6%. In 2004, the share of bank loans in investment rose to 7.7%, as against 5.2% in 2003 and 2.9% in 2000. With high economic growth rates in the 2003 2004 period, posi tive growth dynamics of direct foreign investments in Russian economy were registered.

According to the results of the three quarters of 2004, an increase in foreign investment amounted to 39.1%, while the share of foreign investment in the total volume of invest ments in national economy, to 5.4%. Industry was getting more and more attractive to for eign investors, followed by commerce, public catering and general commercial market services (Table 22).

De dollarization of households savings was a factor behind greater role of banks and other entities in advancement of loans. Drop in cash foreign currency holdings by households and conversion thereof into rubles were accompanied by growth in bank deposits. With the ex isting average level of profitability in the economy, low real value of credit resources contributed to growth in the number of domestic market oriented borrower enterprises. With a decrease in the lending rate of refinancing of the Bank of Russia from 16% in 2003 to 13% in June 2004 and an increase in the share of medium and long term funds accumulated by the banking system, the money market became more attractive.

At the same time, in a situation of economic growth it became clear that investment management was not in line with restructuring processes taking place in Russian econ omy. Lack of investment financial institutions, underdevelopment of the stock market and legal irregularities made borrowing rather complicated. Also, due to a lack of mechanisms of intersectorial flow of capital, investment at the level of enterprises, branches and re RUSSIAN ECONOMY in trends and outlooks gions was complicated. As known from experience, in making of reserve savings taking of investment decisions requires both prudence and efficient management of investment flows. Lack of long term development strategy and business priorities was a factor behind reduced investment motivation.

Table Structure of investment in fixed capital by the source of financing (%) 1998 1999 2000 2001 2002 2003 2004* Investment in fixed capital total 100 100 100 100 100 100 Including by the source of financing:

Own funds 53.2 52.4 47.7 49.4 48.0 46.2 47.Including:

profit 13.2 15.9 23.4 24.0 20.5 17.2 17.Borrowed funds 46.8 47.6 52.5 50.6 52.0 53.8 52.Including :

Bank loans 4.8 4.2 2.9 4.4 4.8 5.2 7. Including loans by foreign banks 0.6 0.9 0.5 0.8 1. Borrowed funds of other entities 4.3 5.6 7.2 4.9 6.0 8.6 7.Budgetary funds: 19.1 17.0 22.0 20.4 19.6 18.8 16.federal budget funds 6.5 6.4 6.0 5.8 6.0 6.5 4. funds out of budgets of constituent enti ties of the Russian Federation and local 12.6 10.6 16.0 14.6 13.6 11.5 11.budgets foreign investment in the total volume of 3.5 6.6 4.7 4.5 4.1 4.7 5.investment in fixed capital * According to the data of January November 2004.

Source: The Federal Service of State Statistics.

In 2004, dynamics of demand in investment were determined by an aggregate im pact of factors behind changes in sectorial, technological and reproduction structures of national economy. Reallocation of flows of investments was accompanied by an increase in the share of the services sector. In the 19992004 period, the share of transport, com munication and commerce accounted for 25% of the total volume of investments in fixed capital, as against 15% on average in the 19921996 period. Growth in investment activi ties in service industries and an increase in demand in such services became an indicator of the potential of economic growth, all the more so investment activities in the above sec tor were primarily aimed at attainment of long term objectives.

In analyzing of investment inflow by the sector of the economy, it was important to take into account the specifics of dynamics and structure of investment in housing con struction. Analysis of the structure of new commissioned housing showed that non public investors (which accounted for nearly 80% of new commissioned housing) had a greater role to play in that sector. At the same time, in the last decade there was growth in the share of housing financing by households.

There were also changes in the sectorial structure of investment in fixed capital. The total volumes and dynamics of investment were determined to a great extent by natural monopolies industries and branches of oil industry. With transport, communication indus try and fuel industry accounting for 45% of the volume of investment in national economy it was obvious that business activities in the above industries had a significant effect on dy namics and structure of demand in investment. In the 2003 2004 period, growth rates of investment in transport development were positive, which factor permitted to overcome negative implications related to a drop in investments in 2002. In January September 2004, the share of investment in the transport sector amounted to 20%, as against 21.6% Section 3.

The real sector in 2003. In the past four years, branches of the services sector were characterized by faster growth in investment in fixed capital of communication industry and commerce.

From 2001, positive investment growth rates were registered in healthcare, education, cul ture and science. In the 20022004 period, the aggregate unit weight of investment in the above sectors of the economy amounted to nearly 5.8%, which factor permitted stabiliza tion of the rates of service rendering.

In 2004, the share of investment in fixed capital of branches of the physical produc tion sector remained at the previous years level and amounted to 48.5%, which situation was caused by a low key growth in investment in industry. Also, a slow down of investment activities was registered both in the export oriented sector and domestic market oriented industries.

Investment industries accounted for 9.0% of the total volume of investment in in dustry, while branches of the consumers sector, for 7.7%. With the existing age, techno logical and reproduction structure of fixed capital, low investment rates of branches of manufacturing industry were a factor behind a slow down of economic growth rates (Fig. 42).

Food-processing Light Building materials Forestry Machine engineering Chemicals Non-ferrous Ferrous metallurgy metallurgy Fuel Electricity -8,0 -6,02001-2002-4,0 -2,0 2002-2003 2,0 2003-2004 6,0,0 4,Fig. 42. Change in the structure of investment in fixed capital by the branch of industry in the 20012004 period (% of the previous year figure) Fuel industry kept dominating in the structure of investment; it accounted for over 45% of the investment in industry with over 50% of such investment made in oil industry. However, in the 2003 2004 period the oil sector of the economy was characterized by low key investment dynamics. In January September 2004, a share of the fuel sector in the total volume of invest ment in industry decreased by 2.9% as compared to the same period in 2003.

Prospects for further economic growth depend to a great extent on intensive changes in the structure of investment in favor of domestic market oriented industries.

Implementation of the above suggests coordination of decision making in fiscal, tax, tariff, customs and monetary policies. A tax system reform and budgetary reform are to promote RUSSIAN ECONOMY in trends and outlooks diversification processes in the economy and make manufacturing branches more attrac tive to investors.

For the purpose of ensuring investment into the economy, financial infrastructure and the system of financial intermediation are currently reformed. In September 2004, the Russian Government approved a plan of actions for development of financial markets. The plan included amendment of the legislation on financial markets and was aimed at ensur ing of a greater use of derivative financial instruments, further application of self regulation principles and harmonization of requirements in respect of formation of own capital, placement of funds and composition and structure of assets of financial institutions.

In 2004, the President of the RF signed a number of laws concerning the stock mar ket, including amendments to the Federal Law on Execution Proceeding aimed at protec tion of funds of client participants in the securities market and the Federal Law on Joint Stock Companies aimed at upgrading of investment activities by joint stock companies through implementation of effective dividend policy and ensuring of financial and business transparency. Also passed were statutory acts dealing with regulation (risk reduction) of activities by professional participants in the securities market, development of new finan cial instruments (which would help attract foreign and domestic investors), simplification of the securities registration system and development of the system of provision of informa tion by issuers to investors.

In July 2004, the President of RF signed a law on amendment of the Federal Law on Prevention of Legalization (Money Laundering) of Income Received from Criminal Activities and Financing of Terrorism which permitted to control activities by banks and institutional investors, as well as operations with real estate, cash funds and securities.

In August 2004, the Federal Law on Amendment of the Federal Law on Insolvency of Credit Institutions (aimed at upgrading of legal regulation in respect of bankruptcy preven tion and bankruptcy proceedings of credit institutions) was passed.

In July 2004, the Government of the RF approved in principle the draft Strategy of Development of the Banking Sector in the RF.

The Federal Law on Amendment of the Federal Law on Insurance Operations in the Russian Federation (aimed at ensuring of a higher share [up to 25%] of foreign capital in the charter capital of Russian insurance companies and removal of a number of limitations imposed on insurance companies in which foreign investment accounted for 49% of the charter capital) contributed to a greater transparency of the insurance market. In addition to the above, within restructuring of the banking sector and implementation of the strategy of development of the banking sector it was planned to ensure a nondiscriminatory access for foreign capital to the Russian banking sector.

Standard&Poor's (an international rating agency) raised Russias long term sover eign credit rating in foreign currency from + to . The last level according to the S&P methods was considered the first one in the so called investment category. As other inter national rating agencies, such as Moodys and Fitch Rating raised Russias rating to the above level, it can be stated that the three leading rating agencies included Russia into the investment category. However, recognizing positive changes in dynamics of economic growth, foreign economic activities and fiscal policy S&P experts pointed to existing high political risks, non transparency of business and slow progress in institutional reforms.

With upgrading of Russias rating to the investment level, Russia can expect better borrowing terms on international capital markets. Such a situation can permit to a certain extent relieve strain of temporary high foreign debt payments on dynamics of economic growth and adjust a mechanism of investment regulation. Concurrently, real prospects will arise for growth in capital flows in Russia by portfolio institutional investors, which are re Section 3.

The real sector quired to invest only in instruments having an investment rating. With growth rates within a range of 7% a year, the Russian market is attractive enough to foreign investors. At the same time, with Russia assigned the investment rating new problems may arise. In a situa tion of a better investment climate (judging by formal factors), the Russian financial market may become dependent to a greater extent on fluctuations on international foreign ex change and securities markets.

Foreign investments in Russian economy The economic development in the recent four (4) years is characterized by growing volumes of foreign investments into the Russian economy with regard to the GDP dynam ics and the business activity indicators of domestic investors. As compared against the year of 2003, the volume of foreign investments experienced a 36.4% growth thus com prising 40.5 bln US dollars (Table 23). Positive influence on increasing the investment at tractiveness degree of the Russian economy in 2004 was exerted due to raising by the re spective international rating agencies of the sovereign crediting rating of Russia up to the level of investing.

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