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. Last Updated: 07/27/2016

The Year Ahead: An Eye on Growth, and Asia

For Russia, 1998 looks like a year for economic growth and a modest stock market rebound. But outside events will shape the country's progress more than ever before. Stephanie Baker-Said reports.

In 1998, for the first time, Russia is threatened not so much by internal chaos as by external instability.

The country's financial markets still look shaky, troubled more by Asia's financial woes than by political instability within Russia. The worldwide financial crisis has jacked up the cost of borrowing for the Russian government, which could spell trouble for the country's battered budget.

And with President Boris Yeltsin out of the public eye once again, there are doubts the government will be able to push through desperately needed economic reforms.

The one bright spot in this otherwise gloomy picture is that the economy, having hit rock bottom last year, looks set to at last record substantial growth in 1998.

Despite the uncertainties, hopes are high that the economy will continue to improve and, if the dust finally settles in Asia, that the markets will recover the losses they suffered since last October's crash.


According to preliminary figures, Russia recorded modest economic growth of 0.4 percent in 1997. Although insignificant by most standards, it would mark the first growth since reforms began and come on the heels of nearly a decade of severe economic decline.

"The most important result of 1997 is the existence of basic prerequisites for economic growth," Prime Minister Viktor Chernomyrdin told a Cabinet meeting last week. "The current year must become a decisive one."

For 1998, the government is predicting at least 2 percent growth in gross domestic product and only 5 to 8 percent inflation. Several economists say Russia could end the year with slightly higher inflation of 8 to 10 percent and growth as high as 3 percent.

"The growth will not be even," said Pavel Teplukhin, an economist with the Russian investment bank Troika Dialog. He said only a few regions, led by Moscow, Samara and Tyumen, will pull Russia out of the economic doldrums in 1998.

Growth is likely to be patchy by sector as well, he said. Dynamic areas to look out for include telecommunications, transport, retail and consumer goods, such as food processing.

These rosy predictions could in part hinge on an expected boom in foreign direct investment, that is, money pumped into production and services rather than stocks and bonds. Chernomyrdin last October predicted that foreign direct investment would surge to $7 billion in 1998, nearly double the estimated $4 billion that flowed into the country last year.

Several high-profile direct investment projects are set to get off the ground this year and are unlikely to be derailed by the global financial turmoil.

"There will be substantial direct investment in the top end of the consumer goods sector, in autos and in the oil sector," said Eric Kraus, chief strategist at Regent European Securities in Moscow.

In one such project, Italy's Fiat recently inked a $850 million joint venture with Russia's automaker GAZ to produce 150,000 Fiat cars annually.

Foreign investors are also expected to pump millions of dollars into the energy industry this year, with alliances formed between British Petroleum and Russian oil major Sidanko and Shell and Russian gas monopoly Gazprom.

But the number of projects in the pipeline is as numerous as the number of joint ventures gone sour. Direct investment is still hampered by widespread corruption and a draconian tax system.

Nonetheless, some predict the real economy will outshine the markets in 1998. "It will be a harder year for the ruble and the markets than '97 was, but the real economy will be better," said Al Breach, an analyst with the Russian-European Center for Economic Policy.


With Asia still in a freefall, most investment banking analysts remain cautious about the Russian market in the short term. Ever since financial turmoil rippled across the globe last October, investors have fled emerging market assets for safe havens in Western markets.

The Russian equity market, down almost 50 percent since its October high, has yet to witness the expected post-New Year's rally, much to the dismay of brokers who cut their vacations short in anticipation of cashing in.

A constant flow of bad news from Asia has kept share prices down. Analysts now say any upturn will depend on a stabilization of the crisis in Asia.

"Russian markets are completely dependent on the international market and foreign flows," said Christopher Granville, head of research at United City Bank in Moscow. Nevertheless, he predicts the equity market will eventually recover its losses and rise 50 percent for the year, as long as the situation in Asia does not deteriorate further.

Others agree the market will remain wobbly for at least the first quarter, but should rebound based on Russia's relatively sound economic fundamentals and stocks that look cheap after the market run-down. Analysts say blue-chip stocks, particularly oil and gas companies and telecoms, will be good buys once the market finds its feet. But international markets need to recover first.

Share prices have been held back in part because yields on treasury bills remain high, drawing investors away from the equity market.

But foreign investors have also stayed away from the T-bill market, fearing a change in rates. For yields to come down, the Central Bank will need to wait for foreign investors to return. As of Jan. 1, the Central Bank stopped requiring foreigners to sign a one-month ruble forward contract to exit the T-bill market, which means Russia will now instantly feel the full force of any new global meltdown. But lifting the restrictions has not, so far, sparked a flood of foreign money.

In the absence of foreign funds, yields are expected to remain high until the autumn. Although the government has said it is aiming to reduce yields to pre-crisis levels by April or May, Troika Dialog's Teplukhin said it will probably take until September or October to bring average yields back down to 17 percent from current levels of about 30 percent.


With the cost of domestic borrowing higher than expected, and foreign borrowing in the form of Eurobonds prohibitively expensive at the moment, several economists say Russia is headed for more budget trouble in 1998.

The budget, which has yet to gain the Duma's final approval, assumes debt servicing costs on T-bills will be quickly brought down this spring. Given the higher cost of borrowing, the government could be forced to scrounge for extra funds or sequester spending as it did last year to keep the deficit in line, economists said.

"Russia could once again face the problem of very high budget arrears," Teplukhin said, even though the 1998 budget is considered more realistic than its predecessors.

Given the anticipated revenue squeeze, many analysts believe the government will speed up privatization to make up for the shortfalls. Already sales of state assets in 1998 are expected to fetch 8.1 billion rubles ($1.4 billion), but the upcoming auction of state oil company Rosneft could bring in that amount alone.

Stakes in several oil companies, including LUKoil, Eastern Oil Co., Tyumen Oil Co. and Slavneft, are to be sold this year, and the sale of another 25 percent stake in telecoms holding company Svyazinvest is scheduled in the next six months. Revenues could be three times higher than originally forecast.

Competition among Russia's powerful banking tycoons is likely to continue, but most investors are confident auctions will go to the highest bidder. "No one is going to get cheap stakes," said Regent's Kraus.

Russia has moved to clean up its messy public finances and boost tax collection, which has been dismally low. From the start of the year, the Finance Ministry will no longer use monetary offsets -- essentially debt cancellation -- for tax payments, a move which is expected to boost collection of tax receipts in cash.

Among other initiatives, the government is trying to move to a treasury system to make budget transfers to the regions, cutting out commercial banks who have handled the funds and been blamed for delaying payments and exacerbating wage arrears. Chernomyrdin said last week that all budget funds will be channeled through the treasury system by June 1.

The government has also been cracking down more vigorously on tax evaders, using methods such as a threat to cut off oil companies from precious pipeline space if they fail to pay their taxes. But tax reform remains in limbo.


By all accounts, the most important legislative challenge in 1998 is a new tax code, and hopes are high once again that some kind of tax reform package will be pushed through the Duma in the first half of the year.

After last year's disastrous failure of the government's draft tax code, which met with stiff opposition in the Duma, the Finance Ministry is expected to present proposals that take into account the complaints of deputies.

Many observers think recently appointed Finance Minister Mikhail Zadornov, a former deputy of the Yabloko faction, which has been the most vocal opponent of the tax code, will be able to persuade the Duma to back his proposals. Chernomyrdin said the government would submit a revised tax code to the Duma by the end of January, but Zadornov is believed to favor a piecemeal approach to reforms.

Other legislative battles, such as land reform, production sharing and introduction of a means-tested system of social benefits, will likely take a back seat to overhauling the tax system.


Some analysts are predicting a year of greater political stability in 1998, pointing to Yeltsin's efforts to meet regularly with opposition leaders from the Duma and draw them into decision-making.

"The pattern of relations between the president and the opposition, the executive and legislative branches, which developed in 1997 is likely to remain in the new year," said Vyacheslav Nikonov, director of the Fond Politika think tank.

Although the Kremlin has moved to pay off all public-sector wage arrears by Jan. 1 and the economy looks like it is recovering, the opposition will undoubtedly be stepping up pressure to help the vast number of Russians who have lost out during reforms.

"Another Cabinet reshuffle is inevitable," said Yevgeny Volk of the Heritage Foundation. "Someone will have to be found responsible for the failures."

First Deputy Prime Minister Anatoly Chubais is unlikely to survive the year unscathed, he predicted.

The health of Yeltsin remains the biggest wild card. Yeltsin, who turns 67 next month, has spent most of the past few weeks recovering from a viral infection.

Although the president made a strong recovery from heart surgery just over a year ago, he remains physically weak and prone to illness. "We can face a new [presidential] election this year or in '99," Volk said. "Russian politics will remain uncertain as long as Yeltsin remains."