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. Last Updated: 07/27/2016

Bull or Bear, 2002 Is Worth a Toast

To hear the bulls tell it, 2002 was a winner, but the bears say it was a toss-up at best.

Both have a point, economists say, and either way it's OK to pop the champagne, as long as the toasts are worded carefully.

The bulls can raise their glasses to a fourth-consecutive year of solid economic growth; sound budget management that produced another surplus; a stable currency; reasonable inflation; a world-leading stock market; recognition (at last) from the world's two largest powerhouses as a market economy; and, of course, a booming oil sector, which is cranking out 8 million barrels per day for the first time in a decade, meaning Russia's most important industry is back where it started.

Once the backslapping is over and the bottle half emptied, however, the bears tell a different story: The oligarchs have increased their hold on the economy; corruption is still widespread; foreign investment remains laughably low; the banking sector, as always, is acutely anemic; no end is in sight for restructuring the natural monopolies; World Trade Organization membership looks an increasingly distant dream; and the year's two biggest privatization projects were blotted by failure and farce.

"If you were looking for one word to sum up Russia today it would have to be 'frustration,'" says Chris Weafer, chief strategist at Alfa Bank.

"Just when we thought we had it figured out and everything seemed to be sliding nicely into place, a series of unconnected events occurs over a few hours and sends us off scratching our heads again."

If for no other reason, 2002 could be considered a success for putting August 1998 12 months further away, but much more had been hoped for.

In fact, in many ways, economists say, it seems as if nothing much has changed at all -- Russia remains a country of contradictions, high risks and good intentions, with a government that is at times unwilling and at times unable to push through reforms that virtually everyone agrees are needed.

One case in point is Monday's decision by the agenda-setting council of the State Duma to postpone indefinitely the second and crucial reading of a raft of bills needed to begin the breakup of the national power monopoly. Without the bills, there will be no competition and investment in the sector and the government will continue to set electricity prices artificially low, which is a main hurdle to joining the WTO.

It is widely believed that a small number of very powerful businessmen opposed to the reform has managed to trump the liberal-minded government and the predominantly pro-Kremlin parliament. Delaying such reforms, economists say, jeopardizes current and future economic growth and makes the nation, already considered overdependent on oil, even more so.

This same group, which is uninterested in competition of any kind, therefore naturally opposes joining the WTO.

Just 11 months ago, outgoing WTO chief Mike Moore said he was confident that Russia could become a member of the organization within 12 months. But though both sides expressed readiness, most recently last week, to intensify negotiations, Russia's membership seems no closer today than it did a year ago.

In fact, there has been no progress to speak of on any of the major sticking points, which center on protectionist policies on energy prices, agriculture, financial services and telecommunications. The general consensus now is that it could take Russia, the last major economy outside the WTO, as long as five years to join the global trade body.

Protecting domestic producers has certain immediate advantages but in the long term is seen as detrimental to the economy, as it discourages investment and removes the incentive to become more efficient.

In June, for example, the government, in an effort to support the auto industry, decided to increase tariffs on seven-year-old used cars by 30 percent beginning in October. The government's view was that it had to do something to protect AvtoVAZ and GAZ, whose new cars were losing market share to foreign cars made in the mid-1990s.

Not surprisingly, Russians rushed to buy the used cars before the price hike. That, combined with growing demand for new foreign cars, forced AvtoVAZ and GAZ to either shut down or curtail production and lay off workers for the first time in four decades.

Government efforts to protect the devastated aviation industry -- once the world's most prolific -- didn't help either. The sector produced just a handful of civil craft this year and is on the verge of total collapse.

Economic Development and Trade Minister German Gref has said he feels a sense of "hopelessness" about it. "Today we don't have answers for problems in several key areas," Gref said Tuesday in summing up his ministry's work this year, singling out aviation. "Before it is too late we need to take measures to revive our potential in the sector," Gref was quoted by Interfax as saying. "Russia with aviation and Russia without aviation are two different countries."

In a feud that would last for months, the Agriculture Ministry in March took the bold step of banning U.S. poultry imports, ostensibly over health concerns, but the move came at about the same time that Washington erected barriers to steel imports, including those from Russia.

The trade scuffle, which eventually drew in both presidents, didn't end until August. Nor did it prevent the United States from officially declaring Russia a market economy in June. The European Union followed with an upgrade of its own in November, but these moves were considered more of a political payback for Russia's support for the war on terror than for any substantial economic achievement.

So, too, was the decision in October by the Financial Action Task Force, the money-laundering watchdog of the Organization for Economic Cooperation and Development, a club of 30 rich nations, to remove Russia from its blacklist of countries not doing enough to fight financial crimes.

The growing coziness with the West had its benefits, but it also came at a price, paid most recently by LUKoil, the nation's largest crude producer. Earlier this month, Iraq, citing Russia's support for the UN campaign to disarm Saddam Hussein's regime, unexpectedly announced that it had canceled LUKoil's multibillion-dollar contract to develop its massive West Qurna oil field.

But while the Kremlin demonstrated its political strength on international economic issues, the story was different at home. Most notably, the government failed, despite its political will, to make major headway on major reforms, including Gazprom, Unified Energy Systems and the banking sector, all of which will remain focal points for domestic and foreign investors who have seen the Kremlin's political power tested and found wanting.

The wait could be a long one. With parliamentary elections slated for December followed by presidential elections three months later, many economists fear little if any major reforms will be undertaken in the next 18 months.

Even the two largest sell-offs of the year, which were supposed to showcase President Vladimir Putin's cleaner and leaner Russia, were not without scandal.

The government tried and failed to sell 5.9 percent of LUKoil in London in August, although it succeeded earlier this month, fetching a not insubstantial $775 million.

And last week's sale of 75 percent of Slavneft was far from the open auction advertised, as just two bidders, TNK and Sibneft, ended up in the competition and they had agreed beforehand to split the stake 50-50, paying a collective $1.86 billion, just 10 percent above the starting price and a far cry from the $3 billion many in the government felt was deserved.

"Had Slavneft been sold in the good old days of Yeltsin-era privatizations, it would have fetched maybe $150 million, with half of even that paid in overdue veksels and old shoes," says Eric Kraus, head of research at investment bank Sovlink.

"Basically we have gone from discounts of over 95 percent to 'only' 20 to 25 percent, which is quite a substantial improvement, but not quite what we had hoped for."

Even seemingly trivial issues important to foreign investors failed to get resolved.

In January, for example, the European Business Club, the American Chamber of Commerce and the German Business Association, which represent some 2,000 companies doing business in Russia, sent a letter to Prime Minister Mikhail Kasyanov with two simple complaints that they hoped would be resolved in 2002.

The first was for Sheremetyevo Airport to be cleaned up, and the second was to end the annoying rule for foreigners that requires them to get special permission from the Central Bank to leave the country with any amount of hard currency.

In July, Sheremetyevo's board of directors postponed for another year a $20 million plan to spruce up its international terminal, and in November the director of the airport was fired for failing to make any progress on a new, third terminal that has been in the works for years.

It appeared that a ray of light had shone on the currency issue last week when the Duma passed amendments that would have scrapped the Central Bank requirement for foreigners and raise from $1,500 to $10,000 the limit everyone can legally take out of the country without special permission -- but Putin's representative in the Duma said it would be vetoed.

The government took its time fulfilling other promises, too.

More than year ago, in a move eagerly awaited by the foreign investment community, Kasyanov said the government would privatize its second-largest bank, Vneshtorgbank, and attract the European Bank for Reconstruction and Development as a strategic partner. To do that, the government needed to first buy out the Central Bank's 99 percent stake, which it did not do until November, and no deal has yet been struck with the EBRD.

The government has, however, handled well its external debt problem, which was due to balloon to more than $17 billion next year. Over the course of the year it managed to reduce next year's load to $15 billion, which, buffered by privatization revenues, is not now seen as a problem.

The conservative debt policy paid off. Two of the three major international credit agencies -- Moody's and Standard & Poor's -- boosted their ratings for Russia to just two notches below investment grade, which is great for the country's image and will make future borrowing cheaper.

The positive debt news also helped boost the stock market. The benchmark RTS index, which has been one of the world's best-performing stock markets over the last several years, continued the trend in 2002, rising 30 percent in dollar terms.

Oil major Sibneft and state savings bank Sberbank led the way, rising 195 percent and 154 percent, respectively, while the biggest losers of the blue chips were UES and its subsidiary Mosenergo, which lost 22 percent and 28.4 percent on concerns over the pace and shape of sector reforms.

Roland Nash, head of research at Renaissance Capital, says how the restructuring of UES, Gazprom and Sberbank unfolds will largely determine how the market performs next year.

"As it was in 2002, a major theme for the equity market in 2003 will be the ongoing, and often painful, saga of state monopoly restructuring," he says.

Developments around these three companies will also prove to be the single greatest source of rumors and misinformation for investors, according to Nash.

"Hard experience tells us that there will be enormous gains for those close to the process, and enormous heartache for those who do not have the time and patience to sit through the politics."

And for those who have neither the time nor the patience to figure out how Russia ranks in the world, 2002, like every year, offered a plethora of rankings, reports and studies to do it for them.

Russia remains one of the world's most unfriendly places, for example, if measured by the World Economic Freedom Index. It also remains one of the most uncompetitive nations, if the World Economic Forum's competitiveness study is to be believed.

Russia rises to the top, however, when it is judged by how effective its companies are at bribing officials in other countries. According to Transparency International's Bribe Payers Index, Russian firms are second to none among the 21 leading exporting nations. Several studies done by Moscow think tanks this year seem to back up that claim: One study says Russian citizens and corporations pass $36 billion under the table each year, or about 12 percent of the country's gross domestic product.

Most important, at least to some, Russia is No. 2 in what really counts -- oil and arms exports -- after Saudi Arabia and the United States.

Perhaps that is partly why Moscow is the world's second-most expensive city after Hong Kong and the costliest in Europe, according to Geneva-based Mercer Human Resource Consulting. For many Muscovites this is an unwelcome distinction, but it isn't likely to make a dent in the personal incomes of the five who made Fortune magazine's list of the world's richest people under 40, which was topped by Yukos CEO Mikhail Khodorkovsky.

The rising standard of living in the capital is evidenced in the booming retail sector, which enjoyed its greatest year of growth ever, with new supermarkets and hypermarkets opening up seemingly every week.

Two leading local chains, Perekryostok and Sedmoi Kontinent, for example, opened 37 and 30 new supermarkets each in the last 12 months, while Turkey's Ramstore unveiled two new hypermarkets and global French giant Auchan undercut everyone with its first mega-mart on the Moscow Ring Road.

Not to be outdone, Swedish furniture king IKEA, which already considers Moscow the largest potential market in Europe, this month opened the largest mall in Eastern Europe, the 150,000-square-meter MEGA mall, which is anchored by IKEA's third outlet in Russia and Auchan's second.

The first American-style shopping center in the nation is expected to entice 25 million shoppers -- most of whom will likely be blissfully unaware of the government's economic reform adventure -- to spend $675 million in 2003.

IKEA is already raising its glass.