More than a decade after the collapse of the Soviet Union in 1991, Russia is now trying to further develop a market economy and achieve much° more consistent economic growth. Russia saw its comparatively developed centrally planned economy contract severely for five years, as the executive and the legislature dithered over the implementation of reforms and Russia’s aging industrial base faced a serious decline.

Crash: Russian financial crisis

After the breakup of the Soviet Union, Russia’s first slight recovery, showing signs of open-market influence, occurred in 1997. In 1998, however, the Asian financial crisis culminated in the August depreciation of the ruble. This was followed by a debt default by the government in 1998, and a sharp deterioration in living standards for most of the population. Consequently, 1998 was marked by recession and an intense capital flight.

Recovery

Nevertheless, the economy started recovering in 1999. The recovery was greatly assisted by the weak ruble, which made imports expensive and boosted local production. Then it entered a phase of rapid economic expansion, the GDP growing by an average of 6.7% annually in 1999–2005 on the back of higher petroleum prices, a weaker ruble, and increasing service production and industrial output. The country is presently running a huge trade surplus, which has been helped by protective import barriers, and rampant corruption which ensures that it is almost impossible for foreign and local SMEs (small and medium sized enterprises) to import goods without the help of local specialist import firms, such as the Russia Import Company. Some import barriers are expected to be abolished after Russia’s accession to the WTO.

The recent recovery, made possible due to high world oil prices, along with a renewed government effort in 2000 and 2001 to advance lagging structural reforms, has raised business and investor confidence over Russia’s prospects in its second decade of transition. Russia remains heavily dependent on exports of commodities, particularly oil, natural gas, metals, and timber, which account for about 80% of exports, leaving the country vulnerable to swings in world prices. Industrial military exports, after undergoing sharp contraction, are now the major non-commodity export. In recent years, however, the economy has also been driven by growing internal consumer demand that has increased by over 12% annually in 2000–2005, showing the strengthening of its own internal market.

The economic development of the country has been extremely uneven: the Moscow region contributes one-third of the country’s GDP while having only a tenth of its population. GDP increased by 7.2% in 2004, 6.4% in 2005 and about 7% in 2006.

Recent economy

The country’s GDP (PPP) soared to $1.5 trillion in 2004, making it the ninth largest economy in the world and the fifth largest in Europe. For the year of 2007, Russia’s GDP is projected to grow to about $1.2 trillion nominally (31.2 trillion rubles) that would be about $2.3 trillion PPP and would make Russia the second largest economy in Europe. Russia’s economics ministry has revised forecasts for 2007 GDP growth from 6.2 to 6.5%

According to Russia’s finance minister, investment in Russia’s economy will grow by $44 billion in 2007. Alexei Kudrin said investment increased $37 billion in 2006, to $168 billion. Speaking at a conference on economic modernization, the minister predicted investment would double in 2010, to $357 billion, against 2006. According to the ministry’s forecast, inflation will gradually decrease from 9% in 2006 to 5.6% in 2010, which the minister said would bring loan rates down and boost investment in fixed assets. He said Russia was expected to double its domestic debt by 2010, but that foreign borrowing was not planned. The minister said Russian borrowing from the World Bank would remain at $300-400 million for the next three or four years. Kudrin specified that investment growth would be primarily due to the private sector.

Some experts believe that official statistic underestimates Russian GDP by 28% because of inaccuracy of decades old statistical system (for example, it didn’t count small enterprises and whole sectors of new economy). IMSG estimated that nominal Russian GDP reached $970 billion in 2005. In 2006, GDP grew to $1018 billion nominally (26.31 trillion rubles; 2.04 trillion in PPP dollars).

1000 ruble note, depicting Yaroslavl.In 2005 Russia exported 241.3 billion dollars and imported 98.5 billion dollars. This means that Russia registered a trade surplus of 142.8 billion dollars in 2005, up about 33% from 2004’s foreign trade surplus of $106.1 billion dollars. In 2006, export grew to $304 billion, import to $164 billion; foreign trade surplus grew 19% to $141 billion.

It’s estimated what direct foreign investment reach at least $23 billion in 2006, overall foreign investments reached $55 billion. On May 5, 2007 Russia’s international reserves reached $372.1 billion nominally and projected to grow to $400–450 billion by the end of 2007. Thanks to high oil prices, Russian oil exports totaled $117 billion in 2005 while gas exports totaled $32 billion in the same year. That means that oil and gas made up 60% of total Russian exports in 2005.

Knowing the importance of oil and gas to the economy, the Stabilization Fund of the Russian Federation was formed by the government in January 2004. This fund takes in revenues from oil and gas exports and is designed to help offset oil market volatility. This fund was also set up in order to prevent the ruble from appreciating. The Stabilization Fund (SF) grew to $76.6 billion in November 2006. In October 2006, Russia’s Deputy Prime Minister Alexander Zhukov said the fund will continue to increase over the coming years, and will exceed $149 billion by late 2007 and about $260.4 billion by the end of 2009. Russia is paying off its foreign debt mainly from the Stabilization Fund, which hit $76.9 billion as of July 1. Russia repaid the bulk of its outstanding debt to the Paris Club of Creditor Nations on August 18-21. The debt totaled $1.9 billion as of October 1, compared to $23.7 billion on July 1. According to the Federal State Statistics Service of Russia, the monthly nominal average salary in January 2007 was 11,410 rubles (about $437 nominally; about $793 PPP), 26.6 percent higher than in January 2006.

Challenge

Some perceive the greatest challenge facing the Russian economy to be encouraging the development of Small and Medium-sized Enterprises in a business climate with a young and less-than-sufficiently functional banking system. Many of Russia’s banks are owned by oligarchs, who often use the deposits to lend to their own businesses. The 2005 Milken Institute’s ratings place Russia at the 51st place in the world, out of 121 countries by the availability of capital.

The European Bank for Reconstruction and Development and the World Bank have attempted to kick-start normal banking practices by making equity and debt investments in a number of banks, but with very limited success. However, about twenty-five of the biggest banks of Russia get entry into Top 1000 banks of the world by The Banker. Many more Russian banks have very high international ratings by Moody’s and Fitch, including “investment” level.

Other problems include disproportional economic development of Russia’s own regions. While the huge capital region of Moscow is a bustling, affluent metropolis living on the cutting edge of technology with a per capita income rapidly approaching that of the leading Eurozone economies, much of the country, especially its indigenous and rural communities in Asia, lags significantly behind. Market integration is nonetheless making itself felt in some other sizeable cities such as Saint Petersburg, Kaliningrad, and Ekaterinburg, and recently also in the adjacent rural areas.

The arrest of Russia’s wealthiest businessman Mikhail Khodorkovsky on charges of fraud and corruption in relation to the large-scale privatizations organized under then-President Yeltsin, contrary to some expectations, has not caused most foreign investors to worry about the stability of the Russian economy. Most of the large fortunes currently in evidence in Russia are the product of either acquiring government assets at particularly low costs or gaining concessions from the government. Other countries have expressed concerns and worries at the “selective” application of the law against individual businessmen, though government actions have been received positively in Russia. Russia occupies 122th place among 157 countries in the Index of Economic Freedom.

Prospect

Encouraging foreign investment is also a major challenge due to legal, cultural, linguistic, economic and political peculiarities of the country. Nevertheless, there has been a significant inflow of capital in recent years from many European investors attracted by cheaper land, labor and higher growth rates than in the rest of Europe. Very high levels of education and societal involvement achieved by the majority of the population, including women and minorities, secular attitudes, mobile class structure, and better integration of various minorities into the mainstream culture set Russia far apart from the majority of the so-called developing countries and even some developed nations.

The country is also benefiting from rising oil prices and has been able very substantially to reduce its formerly huge foreign debt. However, equal redistribution of capital gains from the natural resource industries to other sectors is still a problem. Nonetheless, since 2003, exports of natural resources started decreasing in economic importance as the internal market has strengthened considerably, largely stimulated by intense construction, as well as consumption of increasingly diverse goods and services. Yet teaching customers and encouraging consumer spending is a relatively tough task for many provincial areas where consumer demand is primitive. However, some laudable progress has been made in larger cities, especially in the clothing, food, and entertainment industries.

Additionally, some international firms are investing in Russia. According to the International Monetary Fund (IMF), Russia had nearly $26 billion in cumulative foreign direct investment inflows during the period (of which $11.7 billion occurred in 2004). Russia faces considerable income inequalities that hinder Russia’s potential to become a more diversified economy.

While Russia possesses vast mineral and energy wealth, this does not come without some price both to Russia and to the greater globe. Particularly, oil and gas extraction exacts a heavy cost to the health of the land and people. Drilling waste water, mud, and sludges are accumulated, annual volumes have been estimated at 1.7 million tons of chemical reagents contaminating 25 million cubic meters of topsoil. Considerable geomechanical disturbances, contamination of soils and water, and multiple increases of contaminated waste water ejected into suface water streams, is a serious problem offsetting Russia’s profits from the industry. It has been estimated that between 1991-1999 the volume of contaminated waste waters from the Russian oil industry amounted to 200 million cubic meters. Complete utilization of co-extracted gas in oil extraction does not exceed 80% in Russia, it has been variously estimated that five to seventeen billion cubic meters of non-utilized gas extracted alongside oil is burnt annually in “gas torches”, with 400,000 tons or more hazardous substances released into the atmosphere from this each year, creating the double impact of wasted resource and negative environmental effect. 560 million tons of methane is estimated to leak annually into the atmosphere from oil and gas extraction, not counting accidental outbursts and pipe breakage. Other valuable industries also have their costs, such as the coal industry’s release of vast quantities of hazardous, toxic, and radioactive materials. Also the Russian gold industry, with Russia being the only nation for at least a century with high extraction of gold from placer deposits, and having 4000+ large deposits, inevitably creates problems for the river systems. The associated pollution from using mass explosions in mining also can be a problem. Overall, the extensive mineral wealth and riches, brings great benefit to the Russian economy.