In recent years the Russian authorities have taken advantage of the favorable external environment to reinforce the achievements of macroeconomic policy. Substantial export revenues have allowed the Central Bank to increase reserves up to a level of $84 bln, which places Russia second behind Japan in coverage of months of imports. Starting this year the government has launched a stabilization fund, which will help reduce fiscal dependence on oil revenues; the fiscal reserve will cover one year of foreign debt payments by 2005. Foreign state debt is now only 22% of GDP and is almost entirely covered by reserves. This is a remarkable improvement compared to 1997, when state debt was seven times the level of reserves.
While Russia achieved a very high growth rate of 7.3% in 2003, upon closer inspection this figure is not as impressive. First, it was largely based on greater commodity exports, as confirmed by the strong correlation between GDP growth and the current account dynamic. Second, countries such as Ukraine and China, which are negatively affected by high commodity prices, managed to post even higher growth rates, which indicates that Russias growth potential can be expanded by implementing appropriate structural reforms.
Meanwhile, several structural weaknesses must be addressed. First, the role of final consumption can be substantially increased through a more equal redistribution of income. In 2003 the wealthiest 20% of the population accumulated 46% of total revenues versus 45% in 2002, which is far from a healthy dynamic. Given such unfair income allocation, it is unsurprising that Russia suffers from shallow penetration of retail lending: 89% of Russians have never borrowed from a bank, according to the latest polls.
There is no way to diversify the Russian economy without stimulating activity among small and mid-sized enterprises (SMEs). In order to maintain competitiveness of production, large Russian companies have reduced staff levels by 7% since 2001. This excess labor force was partly absorbed by the state, which raised its employment by 10% during the period. Thus, it seems clear that as long as the SME sector remains weak, reducing the involvement of the state in the economy will remain problematic.
Another area of concern is that the banking sector continues to play a weak role in promoting growth. Granted, the assets to GDP ratio reached 42% by 2004, but this is still below the level of developed countries. Russian banks contribute no more than 5% of total fixed investment.
The very gradual change in the investment climate has created a situation in which Russia is facing too much liquidity and too few projects in which to invest. Many Russian companies continue to operate Soviet-era equipment: post-crisis growth actually took place aided by a substantial increase in existing capacity utilization, from 55% in 1998 to 73% in 2003. Even worse, no more than 10% of Russian companies are renovating their industrial capacity, compared to as much as two-thirds in developed countries.
Thus, in order to prevent investors from concluding that in terms of Russias investment climate the glass is half empty, stimulating private business activity must be a key priority for state policy in the future.