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. Last Updated: 07/27/2016

Gref Says It's Time to Squeeze Big Oil

Main Macroeconomic Indicators
200020012002
GDP9%5%4.3%
Inflation20.2%18.6%15.1%
FDI$4.4 bln$4 bln$4 bln
Trade surplus$60.1 bln$47.8 bln$45.8 bln
2003*2004*2005*
GDP3.5-4.4%4.2-5.5%4.5-5.7%
Inflation10-12%8-10%6-8%
FDI$5-6.5 bln$6-7.8 bln$7.5-8.5 bln
Trade surplus $36-42 bln$33-44 bln$31-44 bln
*Projected Figures
Source: Economic Development and Trade Ministry
Is the government ready to bite the hand that feeds it?

German Gref says it ought to be if it wants strong and sustainable economic growth, although "bite" might be a little strong. Nibble would be more like it.

After three years of broad-scale reforms and general economic liberalization, Gref is asking the government to approve a development plan he says will produce a robust 5 percent growth annually over the next three years -- but only if it tackles head on its overdependence on oil.

On Thursday, Gref will submit his Economic Development and Trade Ministry's medium-term strategy to the Cabinet for its approval. If accepted, it will become the blueprint for bureaucratic behavior toward business through 2005.

The main objective of Gref's 127-page plan, made available earlier this week, is to diversify the economy away from the energy sector by, among other things, shifting the tax burden from manufacturers to extractors by hiking taxes on energy exports.

"If Russia fails to change the structure of its economy, we will see growth rates slow down to 2 percent to 3 percent by 2005," the document says. "If Russia fails to compete on world markets, it will not only lose a significant amount of economic resources, but also political weight, international influence and potential for sustainable growth."

But if the government sticks to this program, Russia will achieve sustainable annual GDP growth of 5 percent from 2004 and 7 percent to 8 percent growth in 2007-15, up from 4.3 percent last year, the document says. It also says the plan will reduce inflation from the current 12 percent to between 6 percent and 8 percent by 2005.

More important, however, the plan envisions a strategic shift in the structure of Russian exports -- from commodities to finished goods.

The numbers, say economists, are alarming: While oil and gas accounted for about 40 percent of all exports five years ago, they now account for more than half. Fuel is also now the source of every third ruble of fiscal revenues and 30 percent of industrial production.

There is growing consensus among economists that something must be done quickly to prevent, as Yukos chief Mikhail Khodorkovsky recently said, "the Saudi Arabia-ization of Russia."

Gref's plan may help do just that.

"The main difference between the new program and the 2000-02 program, which was a general reform plan that established a framework and set political guidelines, is that the new one looks like a concrete action plan," said Christof Ruhl, the World Bank's chief economist for Russia.

It is difficult to gauge how many of the objectives called for in the 2000-02 plan were actually implemented.

Although progress has been made in many areas, such as the introduction of new Tax, Labor and Land codes and the start of pension and administrative reforms, major structural reforms have stalled and the government has failed to make the economy more competitive on world markets.

"This is something that has appeared on the government's agenda, that has become obvious over the last three years," Ruhl said.

In addition to recalibrating the current tax system -- which is more burdensome for the manufacturing sector than it is for the fuel sector and fails to provide enough incentives to stimulate investment activity or scientific research -- Gref's plan stresses the importance of state support for innovative technologies and high-tech industries, including the organization of exhibitions for private companies abroad.

It also calls for liberalizing the labor market by abolishing the much-maligned propiska, or permanent domicile registration. The current system hinders economic potential and prevents the creation of a unified labor market, the plan says.

The plan also calls for Russia to join the World Trade Organization during the current round of negotiations, which ends in 2005, and for the ruble to become a fully convertible, or hard, currency "in the near future."

Even more important, according to the ministry, is developing the small-business sector, which it calls the key to sustainable growth.

The country needs new institutions for micro-lending, such as credit bureaus or mutual lending societies, which "will help to provide financing to small businesses which do not meet banks' lending requirements," the document says.

Gref's ministry also confirms its commitment to further liberalizing the economy and reducing the role of the state. "The introduction of any new government regulations in any sector of the economy requires a thorough analysis and serious justification," it says.

Although most economists applauded the program, some found the main goal of diversification questionable.

Christopher Granville, senior political analyst and equity strategist at UFG, for example, said the government is limited in what it can do.

"The government might improve the investment climate, provide a stable macroeconomic background, lower inflation and interest rates to generate lending, and investments may find their way to interesting projects," he said. "But even if the government does deliver on every promise it makes in this document, the great unknown is the response of the private sector and individuals."

Ruhl agreed, saying the problem now is how to enforce the process.

"They want to give the right incentives without directly interfering with the market," he said. "But if the shift in the tax burden will be adjusted to oil prices, it will have a positive affect on the economy, as we have seen in other successful oil-exporting countries, like Canada or Norway, for example."

Most analysts called Gref's program very idealistic and extremely ambitious, but they saw nothing wrong in this because people want the government to aspire to the highest performance possible. In reality, however, it is no secret that in Russia implementation is extremely difficult.

"This is not something that should be trusted or not, and this is not a document that we expect to be implemented 100 percent," said Marcin Wisznewski, Russia analyst at Morgan Stanley in London.

Wisznewski said there has been a lot of talk in the government and economic circles about the need for diversification for quite some time.

"But in fact Russia became even more dependent on oil in 2002. So, on this account, they have yet to achieve success," he said. "There are a lot of issues that are not under government control -- like oil prices, for example."

The upcoming elections are also likely to hinder Gref's plan. With parliamentary elections in December and the presidential election three months later, most economists have given up hope of progress on any major reforms until after President Vladimir Putin's likely second term starts.

"The period between 2003-04 will play a decisive role in defining the pace of future reform," Alfa Bank said Wednesday in a report on post-election reform.

"In 2003 the reform process will largely remain on hold because of the upcoming elections," Alfa said.