Gross Domestic Product

Tighter credit, collapsing global demand, global uncertainty, and rising unemployment have hurt investment and consumption in Russia (which have been the main drivers of GDP growth in recent years). GDP growth and industrial production for 2008 were 5.6% and 2.1%, respectively, compared to 8.1% and 6.3% in 2007, according to the World Bank. However, GDP growth in the first seven months of 2008 was 7.7% on average before collapsing in the fourth quarter. GDP in the first quarter of 2009 contracted by over 7% and growth estimates for the year range from the Russian Government’s -2.2 % to the IMF’s -6%. GDP growth is currently derived from non-tradable sectors, but investment remains concentrated in tradables (oil and gas). Over the course of 2008, tradables, including manufacturing, showed lower growth rates than non-tradables, such as retail and construction. Manufacturing was hit severely in the last two months of 2008, contracting by 10.3% in November and 24.1% in January 2009, compared to the prior year, due to tight credit and free fall of demand. By January 2009, construction experienced an 18% year-on-year decline. Real disposable incomes, which grew by 10.4% in 2007, dropped 6.7% in January 2009, which led to negative 2.4% retail trade growth in February.

Government Spending/Taxation

The Russian federal budget ran growing surpluses from 2001-2007, as the government taxed and saved much of the rapidly increasing oil revenues. The government overhauled its tax system for both corporations and individuals in 2000-2001, introducing a 13% flat tax for individuals and a unified tax for corporations, which improved overall collection. Responding to demands from the oil sector, the government reduced the tax burden on oil production and exports, but only marginally. Tax enforcement of disputes continues to be uneven and unpredictable. In 2007 the federal budget surplus was 5.5% of GDP, and in 2008 the government ended the year with a surplus of 4.1% of GDP. However, the 2009 budget was revised with an oil price assumption of $41 per barrel Urals, and the government expects a 7.5% deficit, which will be financed from the Reserve Fund, the larger of the government’s two stabilization funds. The government’s anti-crisis package in 2008 and 2009 are worth about 6.7% of GDP, according to World Bank estimates. Measures focus on supporting the financial sector and enterprises, through liquidity injections to banks and tax cuts/fiscal support to enterprises, entities that were hit first by the crisis, with modest support for households, small and medium enterprises (SMEs), and increased unemployment benefits. More expenditures will be likely if the crisis deepens or is prolonged.

Investment/Banking

Russia attracted $58.7 billion in foreign direct investment (FDI) in 2008 (4.1% of GDP), up from $47.1 billion in FDI in 2007. Although much of the FDI in recent years was Russian capital “returning home,” from havens like Cyprus and Gibraltar, these flows have now reversed in the wake of the economic crisis. Moreover, although the annual flow of FDI into Russia was in line with those of China, India, and Brazil, Russia’s per capita cumulative FDI lagged far behind such countries as Hungary, Poland, and the Czech Republic. Investment in manufacturing sectors accounted for 22% of the total. Real estate, extraction of raw materials, and trade were also high FDI growth sectors, accounting for 18%, 17%, and 15% of the new FDI, respectively. With the weakening global investment climate, Russian political risk (challenging business climate, lack of transparency, and weak rule of law/corruption) is now a significant consideration for investors’ allocation of scarce capital, even though the country’s markets remain largely untapped.

Although still small by international standards, the Russian banking sector before the crisis was growing fast and becoming a larger source of investment funds. To meet a growing demand for loans, which they were unable to cover with domestic deposits, Russian banks borrowed heavily abroad in 2007-2008, accounting for 57% of the private-sector capital inflows in 2007. Ruble lending has increased since the October 1998 financial crisis, and in 2007 loans were 66% of total bank assets, with consumer loans posting the fastest growth at 57% that same year. In 2004, Russia enacted a deposit insurance law to protect deposits up to 100,000 rubles (about $3,700) per depositor. Amendments to the law in the fall of 2008 increased the Deposit Insurance Agency’s 100%-coverage for deposits up to 700,000 rubles. The vast majority of Russians keep their money in the banking sector. The combination of liberalized capital controls and ruble appreciation against the dollar in 2005-2008 persuaded many Russians to keep their money in ruble- or other currency-denominated bank deposits. In 2007, total retail deposits grew by 35%, with foreign currency deposits accounting for 13% of the total. In 2008, despite the onset of the crisis, deposits rose more than 14%, with foreign currency deposits exceeding 26% of the total.

Despite the banking sector’s recent growth, financial intermediation in the overall economy remains underdeveloped. Contradictory regulations across the banking and securities markets have hindered efforts to transfer resources from capital-rich sectors, such as energy, to capital-poor sectors, such as agriculture and manufacturing. The sector is dominated by large state banks, and concentrated geographically in Moscow and the Moscow region. Thus financial service providers face little competition for resources and charge relatively high interest rates for favored, large corporate borrowers.

This state of affairs makes it difficult for entrepreneurs to raise capital, and banks generally perceive small and medium commercial lending as risky. Most of the country’s financial institutions are inexperienced with assessing credit risk, though the situation is improving. The low level of trust, both between the general public and banks as well as among banks, makes the system highly susceptible to crises. As of early 2009, the sector had not emerged from its current crisis and the outcome was uncertain. Although the banking sector was not exposed to excessive leverage and structured products like in the West, a potentially serious problem of non-performing loans could cause future bank failures, especially those banks with concentrated lending to one adversely affected sector/client. Banks had repaid much of their short-term foreign debt obligations as of end-March 2009.