Section 3. The real sector Текст научной статьи по специальности «Экономика и бизнес»

Section 3. The real sector

3.1. Macrostructure of Production

3.1.1. The GDP: Trends and Factors behind Change in Ultimate Demand

The 1999-2004 period was characterized by dynamic development of nearly all the sectors and branches of the economy. In the past six years, the GDP increased by 48.0%, actual ultimate consumption by households, by 48.1% and investments in fixed capital, by 72.0%. Growth in business activities (based on higher growth rates of investment than those of production and consumption) had a considerable effect on structural changes in formation and allocation of the GDP. In 2004, industrial output and agricultural output increased by 53.4% and 26.4%, respectively, on the 1998 figure. Growth in output of goods was maintained by infrastructure of the services market, which was developed during the period of the reforms. With an increase of 57.5% in output of the physical production sector in the 1998-2004 period, growth in output of market services amounted to 43.3%. Commercial cargo turn-over increased by 37.8% on the 1998 figure, while the output of communication services and retail trade, by 238.7% and 49.3%, respectively (Table 1).

Table 1

Major macroeconomic indices in the 1999-2004 period. (% of the previous year figure)

1999 2000 2001 2002 2003 2004

Gross domestic product 106.4 110.0 105.1 104.7 107.3 107.1

Actual ultimate consumption by households 97.1 107.3 109.5 108.5 107.5 111.3

Investments in fixed assets 105.3 117.4 108.7 102.6 112.5 110.9

Industrial output 111.0 111.9 104.9 103.7 107.0 106.1

Agricultural output 104.1 107.7 107.5 101.7 101.5 101.6

Cargo carriage turnover 105.8 104.8 103.2 105.6 107.4 106.2

Communication services 133.1 113.8 119.1 115.6 127.5 127.3

Retail trade turnover 93.9 108.8 110.7 109.1 108.0 112.1

Paid services to households 107.0 105.0 102.8 100.4 105.1 107.1

Foreign-trade turnover 86.7 129.7 105.4 108.1 124.6 131.1

Real cash income 86.4 109.1 108.5 108.8 114.5 107.8

Real wages and salaries 78.0 121.0 119.9 116.6 110.4 110.8

Annual average number of employed persons in the economy 100.5 100.6 100.6 101.0 99.2 101.8

Number of unemployed persons (as of the year end) 102 77 90.0 98.0 106.0 96.4

Price indices:

Consumer prices 136.5 120.2 118.6 115.1 112.0 111.7

Prices of manufacturers of industrial products 167.3 131.6 110.7 117.1 113.1 128.3

Source: The State Committee for Statistics of Russia; the Federal Service of State Statistics.

In the past few years, a favorable situation on international markets of energy and primary resources definitely had a positive effect on economic development. In the 19992004 period, recovery growth was characterized by simultaneous expansion of both the domestic and foreign market. With an increase of 70% in the aggregate demand in the 1999-2004 period, the external demand grew by 78%, while domestic demand, by 55%. It is to be noted that in the 2000-2001 period dominating growth in the domestic market (in a situation where domestic production was aimed at active import substitution) was a key factor behind successful recovery after the 1998 financial crisis. However, in the following

period growth structure was determined by external factors, which started to play a greater role (though some increase in growth rates of domestic demand was observed in the 2003-2004 period).

Source: Data of The Federal Service of State Statistics.

Fig. 1. Rates of growth in domestic and external demand in the 1992-2004 period

(% of the previous year figure)

In 2004, unit weight of exports in the GDP amounted to 34.2%, as against 30.7% in the pre-crisis 1997. Impact of exports on recovery growth was determined by a sustained increase in incomes received from hydrocarbon exports.

In 2004, as compared to the 2002-2003 period conditions of trade with other countries improved thanks to higher rates of growth in prices on export commodities and expansion of the demand. According to estimations by the Bank of Russia, in 2004 an increase in international prices on Russia's principal exports amounted to 22.8% on the December 2003 figure. In the above period, prices on energy resources grew on average by 20%, while those on non-energy commodities, by 23.2%, including prices on non-ferrous metals which increased by 29.5%. In 2004, prices on principal raw materials, semifinished products and products of ferrous industry increased by 100 percent. External factors related to high prices on oil and metals and a considerable increase in exports volumes accounted for over 50% of economic growth in the 2003-2004 period. With a revival of the international economy and growth in demand, there was an increase in export volumes of oil, petroleum, fuel oil, natural gas, aluminum, nickel, wood products, some sorts of ferrous metals, chemical raw materials and mineral fertilizers.

In 2004, Russian export volumes increased by 34.8% on the 2003 figure, while those of imports, by 24.7%. In 2004, in export commodities structure a share of energy products grew by 0.1% on the 2003 figure, while that of ferrous and non-ferrous metals, by 3.1% in a situation where the share of machinery, equipment and transportation vehicles decreased by 1.5%. In the 2003-2004 period, dynamic growth in exports income helped overcome a slow-down of the rates of economic growth. A cumulative effect of dynamic growth in incomes of the export-oriented sector was seen in growing dynamics of related industries and had a dominating effect on changes in conditions and factors behind development of the domestic market.

In 2003-2004 period, growing economic income received from foreign economic activities had a stimulating effect on business. Rates of growth in foreign-trade turnover increased from 108.3% in 2002 to 130.6% in 2004. Foreign-trade balance amounted on average to USD six billion a month. In the past two years, annual average growth rates of the GDP amounted to 7.2%, while those of investments in fixed capital, to 11.7% (in the 19992004 period, those indices amounted to 6.7% and 9.5%, respectively) (Fig.2).

Fig. 2. Change in rates of growth in exports of commodities (including hydrocarbons), ultimate consumption by households and investment in fixed capital in the 1995-2004 period (as a percentage of the previous year figure)

An extremely favorable combination of high business activities at home with high prices on raw materials in international markets contributed to intensive growth in gross savings. In the past six years, the share of gross savings amounted to 31.1%-38.7% of the GDP, as against 24.0% in the pre-crisis 1997. In 2004, thanks to growth in incomes of the economy received from exports and increase in foreign investments, on one hand, and a slow-down of growth in ultimate consumption by households in a situation of prevailing savings trends, on the other hand, national savings amounted to 35.2% of the GDP, as against 31.8% in 2003. It is to be noted that the effect of growing incomes received from

foreign trade operations was limited to a great extent by sectorial priorities of export-oriented industries. As a result, in the 1999-2004 period the share of investments in fixed capital in the GDP remained on average at the level of 16.2% (a decrease of 1.3% on the 1997 figure). The above trends can be explained by lack of both matured investment institutions (which could attract investments to the real sector of the economy) and mechanisms of transformation of savings.

In the past few years, correlation between demand in investment and ultimate consumption were rather sensitive to changes in incomes received from exports and determined the specifics of the domestic market. Dramatic changes in investment expenditure on reproduction of fixed capital were neutralized by smooth dynamics of ultimate consumption. It is to be noted that in 2004 there was less impact on dynamics of ultimate demand of an investment component by the quarter (Fig. 3).

Gross Domestic Product — * - - Households' final consumption —A—Investment in capital assets

Fig. 3. Change in dynamics of the GDP by the component of ultimate demand in the 1999-2004 period (percentage of the previous year figure)

The phenomenon of economic recovery in Russia is such that with growth in actual export volumes, export-related incomes and investment an increase in centralized accumulation of capital is observed. Analysis of capital accounts also points to growing asymmetry of gross savings, resources of gross savings and investments in fixed capital. As of the beginning of 2005, the Stabilization Fund amounted to approximately 4.4% of the GDP (Fig. 4). It permitted Russia to fulfill ahead of schedule its obligations to the International Monetary Fund (Russia paid USD 3.7 billion to the IMF). In addition to the above, in 2005 it is planned to spend another RUR 160 billion out of the Stabilization Fund to repay debts to the Paris Club. According to calculations by the Ministry of Finance of the RF, if resources of the Stabilization Fund were spent in Russia the rate of inflation in 2004 would have grown by another 1.5-2% a year, while the effective rate of RUR, by 1.5%.

Investment in capital assets

60,0

50,040,0 30,0 20,0 10,0 0,0

1994 1995 1996

2001

2002

■ Investment in capital assets

1999 2000

............ 2003 2004

I Gross accumulation □ Gross savings

Fig. 4. Share of gross savings and investments in fixed capital in the GDP in 1992-2004 period (% of the GDP)

With an increase in accumulation of "available funds" in the Stabilization Fund, in the past five years investments in fixed capital amounted to less than 50 % of national savings. As a result, with a decrease in extent of transformation of incomes of the economy into investments, in 2004 issues related to redemption of Russia's foreign debts and fulfillment of social programs started to prevail.

In the 2000-2004 period, positive dynamics of ultimate consumption was a key factor behind development of the domestic market; it is to be noted that in the 2003-2004 period correlation between consumption by households and social transfers received from public institutions and non-profit organizations remained at the same level. However, in 2004 in the structure of allocation of the GDP the share of expenditure on ultimate consumption, including that by households decreased by 2.4% and 1.2%, respectively, on the 2003 figure. Structural changes in allocation of the GDP were caused by high rates of growth in total accumulation (an increase of 1.0% on the 2003 figure) (Table 2).

Table 2

Structure of utilization of the Gross Domestic Product in the 1998-2004 period (percentage of the total)

1998 1999 2000 2001 2002 2003 2004

Gross domestic product 100 100 100 100 100 100.0 100

Expenditure on ultimate consumption 76.2 68.1 61.3 65.8 68.9 68.1 65.7

Including:

by households 55.6 52.3 45.1 48.3 50.0 49.7 48.5

by public institutions 18.7 14.6 15.1 16.4 17.6 17.5 16.4

Gross savings 14.9 14.8 18.7 22.0 20.1 20.6 21.6

Including gross accumulation of fixed capital 16.5 14.4 16.9 18.9 17.9 18.3 18.3

Net export of goods and services 6.8 17.1 20.0 12.7 11.8 11.4 12.7

Source: The State Committee for Statistics of Russia; the Federal Service of State Statistics.

Despite an increase in the share of gross savings and accumulation in the GDP, in the past three years no growth was registered in unit weight of investments in fixed capital. A policy aimed at ensuring competitiveness of the economy through allocation of potential investment resources to the Reserve Fund limited prospects for modernization of production and, eventually, made the economy dependent to a greater extent on a situation which prevailed in international markets. Insufficient volumes of investments in the real sector of the economy (considering the existing age, technological and sectorial structure of fixed capital) had a negative effect on the structure of economic growth. It is to be noted that aggregate domestic factors were insufficient to neutralize the impact of the external demand on the rates of economic growth. Whereas in the 2000-2004 period inputs of the domestic demand accounted for 75% of the increase in the GDP, in the 2003-2004 period domestic factors' impact decreased by 20%. In a situation where incomes of businesses and households kept growing, unstable growth in output of goods of final demand stimulated demand in import goods. In 2004, growth in imports amounted to 24.9% as against 24.2% in 2003 and 13.4% in 2002. That trend was also maintained by higher efficiency of imports in a situation of a gradual appreciation of the ruble exchange rate.

In 2004, in the structure of commodity resources of the retail trade, the share of imports stabilized at the 2003 level and amounted to 44%. Rates of mainline imports were hindered by strong competitive positions of Russian food manufacturers. Whereas in the 202-2003 period the share of imports in the volume of food commodity resources amounted to 34%, in 2004 it went down by 2%. The market of consumer goods was under greater pressure from imports. With such a slow-down of the rates of growth in industries of the consumer's sector as was caused by a permanent recession in light industry, in 2004 the share of domestic production in retail trade in non-food products went down to 46.4%, as against 50.0% in the 2002-2002 period.

A relative decrease in value of import raw materials and material and technical resources had a considerable effect on changes in competitive environment and identified problem zones. Unit weight of imports in the total volume of industrial commodity resources increased by 7.6%, as compared to the beginning of 2004 and amounted to 29.8%. In particular, dynamic growth in investment imports as compared to that in output of domestic engineering industry was accompanied by removal of Russian manufacturers from the market. In 2004, the share of machinery and equipment in the total volume of imports amounted to 41.6%, as against 37.3% in 2003. In the 2002-2003 period, the share of expenditure on purchase of import machinery accounted for nearly 25% of the total volume of investments in machinery, equipment and transportation vehicles. So, as regards general competitive advantages (taking into account a positive impact of growth in production, on one hand, and a negative effect of appreciation of the RUR exchange rate and worsening of correlation ratios between domestic prices and imports, on the other hand) Russian manufacturers backtracked to the pre-crisis 1997 level. (Fig. 5).

Fig. 5. Change in unit weight of imports (in resources) and exports (in sales volumes) in the 2003-2004 period in prices prevailing in respective months (%)

The principal factor behind a decrease in competitive advantages of Russian commodities is lower efficiency in utilization of production factors. Higher rates of growth in wages and salaries, as compared to those in labor efficiency had a negative effect on quality parameters of economic dynamics. In the 2002-2003 period, real wages increased by 42.8%, while labor efficiency, by 17.7%. Such growth in wages and salaries took place in a situation where the gross profit of the economy in the GDP went down from 42.7% in 2000 to 40.2% in 2004 (Fig. 6).

Fig. 6. Dynamics of labor efficiency and real wages and salaries in the 1999-2004 period (% of the 1998 figure)

In 2003, there was narrowing between the rates of labor efficiency and those of real wages. However, it did not have a significant effect on efficiency indices of enterprises and entities. Dynamics of the domestic market was maintained by growth in real wages and salaries and households' income and was accompanied by reallocation of incomes from industries to households, which situation eventually resulted in growth in production costs and a decrease in profitability. In 2004, growth rates of wages and salaries exceeded those of labor efficiency by four percent. However, further growth in expenditures on wages and salaries was limited by changes in competitive environment on commodities markets due to appreciation of the ruble exchange rate and growing pressures from imports. As a result, in 2004 the share of hired workers' wages in the GDP decreased by 1.0% on the 2003 figure.

Table 3

Structure of formation of the GDP by the income in the 1999-2004 period

(% of the total)

1999 2000 2001 2002 2003 2004*

Gross domestic product Including: wages (including unofficial labor remuneration) of hired workers Net taxes on production and imports Gross profit of the economy and gross mixed incomes 100 40.1 15.7 44.2 1 00 40.2 17.1 42.7 100 43.0 15.7 41.3 100 46.7 14.1 39.3 100 46.9 13.5 39.6 100 45.9 13.9 40.2

* Preliminary data.

Source: the Federal Service of State Statistics.

The specifics of formation of the structure of households' income and the GDP was determined by the structure of the gainfully occupied population: 92.1% of the gainfully employed, as against 7.9% of the self-employed. The share of labor remuneration of hired workers accounted for over 63.3% of households' incomes and 45.9% of the GDP (Table 3). Transformation changes in business environment contributed to growth in activities of small businesses. The number of workers employed by small businesses accounted for 11.3% of the total number of workers gainfully occupied in the economy. In 2004, in the structure of households' cash incomes, the share of income received from business and property grew to 21.0%, which is an increase of 1.2% and 3.9% on the 2003 figure and the 2002 figure, respectively.

High differentiation of average wages and salaries by the branch of the economy and industry was preserved. Dynamic growth in wages and salaries in services industries, financial sector and regulatory bodies was accompanied by smooth slowing of growth rates of accrued wages in the physical production sector as compared to the average level across the economy. The above trend was initiated by moderate growth in average wages in industry as compared to that in building industry. In industry, the extent of differentiation of wages was determined by a growing gap between the rates of labor remuneration in export-oriented industries and those in branches of manufacturing industry. Nominal wages and salaries in oil industry exceeded the average industry-wide level by 120%, in natural gas industry, by 260%, in nonferrous industry, by 70%, while in engineering industry and food industry, they fell below that level by nearly 15%. Sectorial specifics of labor remuneration had a significant effect on employment of labor resources in the economy and formation of the structure of households' incomes and expenditures.

With regaining of social development parameters, significant changes took place on the labor market. In 2004, the annual average number of employed persons in the economy amounted to 67.4 million, as against 65.8 million in 2003 and 63.8 million in 1998. It is to be noted that change in demand in labor was determined by a shift of work force from the physical production sector to the market services sector. At the initial stage of recovery growth, that trend had a powerful effect on quality of life and gave an impetus to rapid development of the services sector. However, in a situation where rates of industrial growth slowed down (while those of imports increased) the annual average number of industrial personnel tended to decline. In the past three years, a drop in the rate of employment was observed with all the branches of industry; the highest redundancy rates were registered in branches of manufacturing industry. Due to low efficiency in use of labor force and fixed capital in the investment sector and consumer's sector, the gap between the rates of growth in manufacturing industry and extracting industry increased and, eventually, resulted in a slow-down of growth rates of the economy.

As a predominant portion of households' income is received from labor remuneration, employment-related issues have become a priority (Table 4). The total number of unemployed persons calculated using ILO methods fell from 8.9 million (13.2% of gainfully occupied population) in 1998 to 6.2 million (8.6%) in 2003 and to 5.9 million (7.4%) in 2004. A tension ratio (the number of unemployed persons registered with the employment service per a vacant job) amounted to 2.7 million, as against 2.3 million at the beginning of 2003 (Fig. 6). At the same time, with changes in demand in work force working time was used more effectively. In the first six months of 2004, length of a working day across the economy rose by 1.8%, while in industry, by 2.3%. The number of workers employed parttime or being on forced unpaid administrative leaves fell by nearly 33.3%. In addition to the above, the length of workers' unpaid holidays was reduced in compliance with norms of the effective legislation.

Table 4

Structure of households' cash incomes in the 1999-2004 period (%)

1999 2000 2001 2002 2003 2004

Cash incomes- Total 100 100 100 100 100 100

Labor remuneration, including 66.5 62.8 64.6 65.8 63.9 63.0

unofficial pay

Business income 12.4 15.4 12.6 11.9 12.0 11.8

Property income 7.1 6.8 5.7 5.2 7.8 9.2

Social payments 13.1 13.8 15.2 15.2 14.1 13.8

Other income 0.9 1.2 1.9 1.9 2.2 2.2

Source: The State Committee for Statistics of Russia; the Federal Service of State Statistics.

Fig. 7. Change in growth rates of the GDP, real households' income and unit weight of unemployed persons in the 1998-2004 period (%)

In the past four years, there was sustained growth in households' real income, real wages and real accrued pensions. In 2001, ultimate consumption by households regained the pre-crisis 1997 level, while in the past three years it increased by 30.5%. In 2004, growth in households' real income, real wages and real accrued pensions amounted to 7.8%, 10.8% and 5.5%, respectively.

Growth in income has resulted in a substantial reduction in the rate of poverty. The share of persons with incomes below the minimum subsistence level fell to 24.9 million and accounted for 17.3% of the total number of the population, as against 34.6 million (24.2%) in 2002.

There has been a radical change in distribution of households by the value of average per capita income. In 2004, with average per capita income and real wages growing by 122.4% and 125.3%, respectively, on the 2003 figure, the share of households with income over RUR 7000 and the share of households with income between RUR 4000- RUR 7000 increased by 8.6% and 1.7%, respectively, while that of households with income below RUR 4000 fell by more than 10.0%. However, it did not weaken socioeconomic differentiation of households by the income. By estimate, in 2004 the ratio of funds (which characterizes correlation between the value of the highest income and the value of the lowest income of respective decile groups of the population) increased by 1380%, as against 1330% in 2003 and 1300% in the 2001-2002 period, while Gini coefficient (which characterizes the extent of income concentration) rose to 0.406 in 2004, as against 0.400 in 2003 and 0.398 in the 2002-2002 period.

Distribution of income determined dynamics of current expenditures and savings in the households sector. In the past six years, changes in the structure of consumer's expenditure were determined by growth in unit weight of expenses on non-food products and services in a situation where the share of expenses on food products was declining. It is to be noted that with the existing level of income there was a gradual shift towards more expansive food products in food sales and towards better quality import products in nonfood sales. As compared to the previous period, in the 2003-2004 period there was a narrowing between growth rates of the volume of paid services rendered to households and those of retail trade turnover despite the fact that there was higher growth in prices and tariffs on paid services than on goods. It is to be noted that in the 2002-2004 period there was sustained higher growth in nonfood sales, than in food sales, as well as an increase in the share of sales carried out by commercial entities. Change in consumer behavior can be explained to a certain extent by slowing of the rate of inflation, as well as structural changes in pricing in respect of principal groups of commodities.

Growth in purchase power of households' incomes ensured high growth rates of retail trade turnover. In 2004, households spent RUR7567.2 billion on goods and services, (an increase of 23.4% on the 2003 figure). In 2004, the retail trade turnover increased by 12.1%, as against 8.4% in 2003. Change in the structure of households' demand and increase in the share of non-food durable goods sales gave an impetus to intensive development of consumer lending. Within a year, the volume of lending to individuals increased by 91% and amounted to RUR573.3 billion as of early December 2004. As of December 1, 2004, the share of loans extended to individuals accounted for 14.4% of the total sum of loans advanced by credit institutions (9.8% a year ago).

In the past few years, there was a shift in gross savings from the non-financial sector to households. With an increase in the share of households' savings and restoration of confidence in savings institutions, growth in deposits by individuals in credit institutions was registered. In 2004, the volume of households' cash income amounted to RUR10,779.5 billion, including savings and purchase of foreign currency which amounted to RUR1983.4 billion (an increase of 11.6% on the 2003 figure). The volume of ruble and foreign currency deposits by individuals in credit institutions amounted to RUR1894.7 billion as of December 1, 2004 (which is an increase of 23.0% as compared to the beginning of 2004, including growth in ruble deposits and foreign-currency deposits by 22.1% and 9.4%, respectively). With growth in a savings portion of households' income, the issue of transformation of savings into investments became of particular importance. From 1999, in the structure of households' cash expenditure sustained growth in the share of expenditure on purchase of real estate was observed. It gave a boost to business activities in housing development and on the secondary housing market. In the 2000-2004 period, the share of housing built by households at their own account and with use of loans amounted on average to 40.5%. In 2004, unit weight of expenditure on purchase of real estate grew by 1.0% on the 2000 figure and accounted for 2.2% of the total value of households' cash income (Table 5).

On the basis of analysis of changes in the share of gross profit and entrepreneurial income in the GDP, it can be asserted that average profitability of Russian economy tended to grow. An increase in the share of gross profit of the economy in the GDP was determined by growing efficiency in financial activities of enterprises and entities and a decrease in tax burden on production and imports starting from 2002. In the past five years, balance financial result accounted on average for nearly 12% of the GDP. In January-November 2004, balance financial result of entities of the main branches of the economy amounted to RUR1952.6 billion (an increase of 54% on the same period figure in 2003). It is to be noted that balance financial re-

suit was formed in equal portions through production of goods and rendering of services. However, within sectors there were branches, which had a dominating effect on generation and disposition of profits in national economy.

Table 5

Structure of households' cash incomes in the 1997-2004 period (%)

1997 1998 1999 2000 2001 2002 2003 2004

Cash expenditure and savings -total 100 100 100 100 100 100 100 100

Including :

Purchase of goods and payment of services 68.7 77.7 78.5 75.5 74.6 73.2 69.0 69.8

Mandatory payments and contributions 6.3 6.2 6.6 7.8 8.9 8.6 8.3 8.6

Purchase of real estate 0.8 1.3 1.3 1.2 1.4 1.8 2.0 2.2

Growth in financial assets 24.2 1 4.8 13.6 15.5 15.1 16.4 20.7 19.4

Including increase, decrease (-) in households' cash funds 1.6 1.7 1.8 2.8 2.0 1.7 2.7 0.6

Source: The State Committee for Statistics of Russia; the Federal Service of State Statistics.

Industry preserved its leading positions as regards growth rates of financial performances, which factor was primarily related to an increase in incomes of export-oriented branches of fuel industry and metallurgical sector. According to the preliminary data of the Ministry of Economic Development and Trade, in 2004 balance financial result of oil industry, ferrous industry, non-ferrous industry and chemical industry increased by 140%, 150%, 50% and 70%, respectively, on the 2003 figure. Aggregate unit weight of export-oriented branches in the total financial result of industry rose by 5% on the 2003 figure. Growth in incomes of the export sector had a significant effect on related services industries, such as transport, communications and commerce, while domestic market-oriented branches were left almost unaffected. The situation was less favorable in domestic market-oriented branches of manufacturing industry. Though dynamics of balance result of the investment sector (due to growth in production costs as a result of an increase in expenditure on labor and high domestic prices on energy sources and engineering materials) remained within the domain of positive values, unit weight of engineering industry and building materials industry decreased by 3.2% in industry's financial performance. In a situation of slowing rates of growth in food industry and recession in light industry, income of the consumer's sector of industry fell by nearly 9.0% on the 2003 figure.

Comparison analysis of dynamics and structures of formation and allocation of the GDP has shown that in conditions where growth in external demand exceeds the rates of development of the domestic market there is large scale reallocation of financial, investment and labor resources to a small number of export-oriented branches of extracting industry, processing industry and service industries.

3.1.2. Dynamic and Structure of Production of the GDP

Bellow are factors which had a significant impact on development of Russian economy:

• a higher role of the external demand and export-oriented branches of industry;

• speed-up of growth rates of industries producing capital goods;

• higher growth in investment in fixed capital as compared to dynamics of the GDP and ultimate consumption;

• speed-up of growth in imports of goods of ultimate consumption as compared to that in the domestic demand;

• intensive growth in services sector;

• growing gap between rates of real wages and salaries and those of labor efficiency;

• prevalence of high consumer demand in a situation where households tend to saving;

• speed-up of growth in prices of manufactures of industrial products and tariffs on services.

Services Sector

In the 2002-2004 period, speed-up of rates of growth in market services was observed in Russian economy (Fig. 8). With added value in goods-manufacturing sector increasing by 6.3% in 2004, market services rose by 8.7%. Growing indices of the sector closely correlated with the level of business activities and structural changes in the economy. High growth in transportation services, communications, commerce and business activities aimed at ensuring operation of the market and fulfillment of transactions with real estate had a dominating effect on the services market.

Fig. 8. Change in the rates of production of goods and services by the sector of the economy in the 1994-2004 period (% of the previous year figure)

In 2004, commercial cargo turnover grew by 6.2% with industrial output increasing by 6.1%. Export-oriented industries contributed to a greater extent to growth in demand in transportation services. Growth in cargo turnover of pipeline industry amounted to 6.2% on the 2003 figure. Oil and oil products, ferrous and non-ferrous metals, chemical and mineral fertilizers and wood products were still leaders as regards cargo transportation volumes.

Change in the structure of transportation services was determined by a general economic situation, as well as handling of practical issues of coordination of transport infrastructure. In 2004, volumes of carriage by car, rail and water inside the country increased by 100%, 30% and 4%, respectively, on the 1998 figure. The period of recovery growth was characterized by a decrease in the share of investments in development of rail transport in a situation where in the same period the share of investment expenditure on devel-

opment of highways increased by 13.5% and that of motor transport, by 1.3%. In the period of the reforms, operational length of hard-surface motor roads increased by nearly 200 thousand km with density of motor roads increasing from 23 km per 1000 sq. km in 1990 to 31.7 km per 1000 sq. km in 2003. Motor transport accounted for 75% of cargo carriage volumes and 73% of out of town passenger carriage volumes. Though the condition of Russia's transportation system does not hinder economic growth, its low efficiency leads to higher transportation costs and a loss of incomes from transit carriage.

Communications industry is one of promising and rapidly developing industries of the economy. In 2004, volume of gross added value of communication services increased by 24.7% and amounted to 2.0% of the GDP. In the 2003-2004 period, annual average rates of growth in volumes of communication services amounted to 27.5% and exceeded by 17.2% the 2002 level. New communications operators accounted for nearly 60% of the total volume of communication services and over 50% of services rendered to the population. Telephone service is one of the most widespread services of electrical communication. It accounted for 75% of all the income received from communication services, including mobile communications services (40%). As of January 1, 2005, the total number of cellular phone users amounted to nearly 70 million and increased by 34.5 million (or 97.2%) as compared to the beginning of 2004.

The phenomenon of Russian economy consists in sustained increase in the share of commerce in the structure of national economy. Development of commerce was accompanied by intensive development of its material and technical base and change in the structure of services. Growing role of organized forms of commerce in the structure of goods turnover contributed to intensive growth in sales premises, warehouses and services. Commerce promoted growing demand in equipment, information services, communications services and transport. In 2004, the share of commerce in the GDP amounted to 22%, which corresponded to an average index in the past five years. It is to be noted that development of commerce was characterized by dynamic structural changes. Firstly, favorable changes in demand on international markets contributed to higher growth and increase in unit weight of foreign trade in the structure of sales turnover. Secondly, wholesale trade volumes exceeded by nearly 100% those of retail trade. With increase in business activities, intensive growth in wholesale trade was maintained through expansion of demand in material and technical resources in the domestic market.

In 2004, the situation in retail trade can be characterized as follows:

• small business started to play a greater role in retail trade: it ensured nearly 50% of the retail trade volume, as against 48.7% in 2001 and 46.1% in 2000;

• in 2004, the share of non-food products in the retail trade turnover (an indicator of a quality of life) amounted to 54.4% with an average index amounting to 53.6% in the 2001-2003 period;

• commodity stocks were stable and remained at the level of 34-35 days;

• share of import commodities in the retail trade turnover amounted to 43% and increased by 2% on the 2001 figure;

In 2004, growth rates of prices on consumer goods amounted to 111.7%, as against 112% in 2003. It is to be noted that growth in trade volumes took place in a situation where growth in prices on non-food commodities amounted to 107.4%, as against 109.2, while that in prices on food products, to 112.3%, as against 110.2%.

As a result of the aggregate effect of the above factors, the index of growth in retail trade turnover amounted to 112.1% on the previous year figure with unit weight in the GDP rising to 8.2%. In a situation where rates of economic growth slowed down late in 2004,

speed-up of dynamics of retail trade turnover had a favorable effect on the economic situation in general (Fig. 9).

Industrial sector I I Construction I—¡Transport Output of goods and services by basic sectors

Fig. 9. Change in growth rates by the branch of the economy in the 2001-2004 period (% of the corresponding period figure of the previous year)

Physical Production Sector

In the physical production sector, a ratio between volumes of output in industry and building industry had a significant effect on changes in the structure of production. Sustained growth in incomes of the economy gave an additional impetus to growth in demand in building works. In the 2000-2004 period, annual average growth rates of building works amounted to 10.7%, while those of output of building materials industry, to 6.6%. In the past few years, dynamics of building pointed to strong dependence of the level of business activities in building industry and economic income on foreign economic activities. In 2002, economic income went down due to a drop in prices in international markets; in the same period growth in output of building industry was the lowest during recovery growth and amounted to 2.7%. In the 2003-2004 period, growing economic income gave an additional impetus to growth in building industry. In the past two years, annual average rates of building works amounted to 12.2%. Growth in investment contributed to changes in the structure of recovery growth in the economy.

In conditions of economic recovery, Russian-made equipment was in high demand as a result of upgrading and modernization of production facilities and introduction of competitive capacities.

With annual average growth rates of the investment sector and consumer's sector being at the level of 9.4% and 7.1%, respectively, in the 2000-2004 period, the above in-

dex in the primary sector (which is oriented primarily at foreign markets) amounted to 6.5%. Though in the period under review there were significant fluctuations in correlation between growth rates of industries, a gradual shift from growth (based on natural-resources potential) to formation of the system of investment development was observed (Fig. 10).

Fig. 10. Growth rates of production by the sector in the 1999-2004 period.

(% of the previous year figure)

In the past six years, low-key dynamics of the output of capital goods as compared to the rates of industrial growth was registered in 2002 where growth in output of the investment sector hit its minimum level and amounted to 2.2% against 6.8% in 2001 and 18.9% in 2000. However, as early as 2003 the situation changed radically. As in the 2000-2001 period, the investment sector responded to speed-up of growth in output and income of the export-oriented sector by an intensive increase in production of capital goods. In 2003, output volumes in engineering industry grew by 9.2%, as against 1.9% in 2002, while in building materials industry, by 6.4%, as against 3.0%. Better conditions of trade in Russian-made high-tech products on international markets were an additional factor behind growth in engineering industry.

In 2004, growth in output of the investment sector amounted to 11.7% (an increase of 1.9%) on the 2003 figure. As regards growth in output, engineering industry preserved its leading positions among other branches of industry. At the same time, there were considerable fluctuations in outputs of individual branches of engineering industry. Negative factors which affected the dynamics of engineering industry in the 1999-2004 period included sporadic crises of overproduction in auto industry and fuel industry's unstable investment demand in Russian-made equipment in a situation of growth in import volumes of

machinery and equipment and higher income from exports. High growth rates of machinery and equipment were primarily ensured through expansion of demand in products meant for the domestic market (railway engineering, instrument-making industry and communication industry). In addition to the above, in the past few years there was sustained expansion of demand in machinery and equipment for branches of the consumer's sector.

Analysis of the specifics of formation of the capital goods market is of principal importance, since in the past two years growth in investments in fixed capital was faster than that in ultimate consumption. That factor had a considerable effect on structural changes in the GDP. As regards the rates of output of capital goods, in engineering industry they were faster than those of growth in investment in fixed capital, however, as regards structure and volumes of such output engineering was behind changes in reproduction and technological structures of capital investments in production. In addition to the above, faster growth rates of imports as compared to those of domestic production still had a considerable effect on development of engineering industry. It can be explained by the fact that many types of machinery and equipment were noncompetitive as compared to their foreign analogs (as regards the "price/quality" criterion) and lack of production capacities needed for manufacturing of modern machinery limited to a great extent the market of domestic engineering. With an increase of 11.7% in output of engineering industry, growth in imports of machinery and equipment amounted to 46.2% (Table 6).

Table 6

Dynamics of production by the branch of engineering in the 1999-2004 period

(% of the previous year figure)

1999 2000 2001 2002 2003 2004

Industry - total 108.1 109.0 104.9 103.7 107.1 106.1

Engineering 115.9 115.5 107.2 101.9 109.2 111.7

Including :

Railway engineering 108.9 107.4 126.0 121.7 135.8 122.8

Metallurgical engineering 91.8 130.2 86.1 82.6 94.0 123.9

Electrical engineering industry 127.0 130.1 112.6 93.8 105.5 106.7

Chemical and oil engineering 120.7 119.5 121.6 96 93.0 105.9

Machine-tool industry and toolmaking industry 99.6 111.5 99.4 81.7 100.5 95.1

Instrument making industry 140.8 118.4 98.0 90.9 144.8 112.7

Auto industry 114.7 103.3 101.7 97.8 106.0 109.3

Communications industry 95.7 330.0 90.0 174.6 118.0 193.0

Tractor and agriculture engineering 159.3 148.4 129.1 77.6 76.4 130.5

Engineering for light industry, food industry and household appliances 115.8 109.5 107.1 115.9 106.6 119.0

Source: the Federal Service of State Statistics.

The condition of branches of investment engineering is a key technological factor, which hinders modernization and upgrading of production on a new technical base. Due to prolonged recession trends in machine-tool industry and low rates of renewal of capital in engineering industry, in particular, servicing of the investment process was carried out on the basis of traditional standard technologies. Though in the 1999-2004 period an increase in investment in engineering industry amounted to nearly 41.8% on the 1998 figure, it did not have a significant effect on technical and economic parameters of fixed capital of engineering industry and industry as a whole. With the average norm of renewal of capital funds in the past three years in engineering industry at the level of 0.9% and in industry, at

1.8%, in the structure of machinery and equipment fleet there was a drop in the share of equipment under the age of ten years old.

Engineering industry is characterized by high fluctuation of workers. In the 1998-2004 period, the number of industrial personnel went down by 8.4%. The industry badly needed skilled workers. With average wages and salaries in engineering industry amounting to 80% of the average level of labor remuneration across industry, engineering industry was not seen on the labor market as an attractive employment opportunity.

Dynamics of building materials industry closely correlated with the volume of building works. In the 2001-2004, commissioning of new housing increased by nearly 35.3%. In 2004, with an increase in building works by 10.1% on the 2003 figure, growth in output of building materials amounted to 5.3%. An increase of 11.3% in growth rates of cement industry was accompanied by higher energy saving; per unit weight of cement production on the basis of energy saving technologies in the total output of industry grew from 13% in 1998 to 14.3% in 2003 and 14.7% in 2004. Intensive growth in output of building ceramic (an increase of 115% on the 2003 figure) and building materials produced out of polymer resources (109.9%) was maintained thanks to modernization and upgrading of production. In 2004, the volume of investment in building materials industry increased by 140% on the 1998 figure.

Industries producing consumer goods were unable to maintain high rates of growth during a long period, which factor was related to a great extent to lack of quality changes in technologies and the structure of production. In 2004, growth in the consumer's sector hit the minimum level in six years and amounted to 2.9%, as against 4.3% in 2003. A recession trend in light industry (registered in 2003) affected to a great extent the structure of production of consumer goods (a decrease of 4% a year). In 2004, investments in the consumer's sector kept going down.

It is to be noted that branches of manufacturing industry (including light industry) are all characterized by a high wear ratio of capital funds. The ratio of disposal of capital funds due dilapidation exceeded by 300% that of renewal of capital funds. In light industry, absolute decrease in the volume of capital funds was registered. The crisis in light industry resulted in a radical drop in demand in labor force. In the past three years, annual average number of industrial personnel in light industry decreased by more than 12%. Light industry became less attractive due to a low level of labor remuneration. Wages and salaries in light industry amounted to nearly 40-45% of the average level of labor remuneration across industry in general. Due to incompatibility of a technical base and labor skills with market criteria, domestic products of light industry were getting less competitive and in a situation of appreciation of the RUR exchange rate more niches opened up for foreign goods. As a result, removal of domestic products from the market intensified.

Factors which neutralized a negative effect of light industry on formation of the market of domestic non-food products included a speed-up of rates of growth in output of household appliances, furniture and other goods for home. Growth in output of furniture and building materials correlated with intensive growth in housing construction. Introduction of new technologies and growth in output of assembly unit products on the basis of import accessory parts had a positive effect on the above industries and their competitive advantages.

No doubt, sound positions of food industry on the domestic consumer's market was a positive factor. In the volume of food products resources, the share of domestic products in the 1st-quarter, 2nd-quarter and 3rd-quarter of 2004 amounted to 66%, 67% and 68%, respectively. At the same time, there was a number of factors which had a negative effect on development of the industry. In the 1999-2004 period, there was a gradual decline in 168

growth rates of food industry (Fig 11). In the 2001-2003 period, intensive flow of investments in fixed capital and creation of new jobs contributed to strengthening of positions of food industry on the Russian market. In the above period, investments in fixed capital in food industry increased by nearly one third. With growth in the ratio of renewal of machinery and equipment up to 4.2% in 2003, as against 2.4% in 1998, in the above period the wear ratio of funds decreased by more than 10% and amounted to 35.7%. However, the created potential was insufficient. In 2004, due to reduction in investment support growth rates of production in food industry fell to 3.7%.

Unfortunately, investment programs on modernization and upgrading of production failed to ensure sustained growth in labor efficiency and effective use of material resources. In a situation of growth in material and labor costs in food industry, profitability decreased by nearly 1.5% on the 2003 figure. In food industry, the index of output growth was somewhat lower than that across industry. In 2004, growth in output of food industry amounted to 4.0%, as against 5.1% in 2003 and 6.5% in 2002. Slow-down of growth rates of food industry as compared to those of retail trade turnover was also registered.

□ 2000 B2001 02002 B2003 «2004

Fig. 11. Change in dynamics of production by the branch of industry in the 2000-2004 period (% of the same period figure in the previous year)

The year 2004 was characterized by growing rates of inflation due to faster growth in producer prices in the industrial sector and building industry. According to the 2004 results, producer price index amounted to 128.3% (an increase of 15.2% on the 2003 figure), while in building industry, to 114.9%, as against 110.3%.

Changes in the price structure of the domestic market had a considerable effect on rates of industrial growth and outputs of financial activities. Though in 2003 growth rates of producer prices were higher than those of consumer prices, the gap was insignificant, since there was administrative regulation of prices and tariffs on products and services by natural monopolies. In 2002, the above factor helped overcome inflationary pressures,

which were caused by growth in natural monopolies' prices and tariffs. In 2003, the price index in electric power industry exceeded by a mere 0.8% prices of manufacturers of industrial products, while in 2002 the gap amounted to 10%. In natural gas industry, a drop of 22.9% in producer prices was registered for the first time since the beginning of the reforms.

In 2004, changes in price ratios in industry were related to intensive growth in prices on products of fuel industry and ferrous industry. In 2004, price index in fuel industry amounted to 164.7%, as against 101.4% in the same period in 2003. Growth in prices on products of fuel industry took place in a situation of a change in the structure of pricing on energy resources. With an increase of 65.4% in oil prices since the beginning of the year, prices on the produce of natural gas industry increased by 90%. Change in gas prices was aimed to a certain extent at equation of price ratio in respect of hydrocarbons (with dynamics of prices in domestic and international oil markets taken into account). In 2003, average gas prices amounted to 6.3% of oil prices, as against 8.5% in 2004 (which corresponded to the ratios in the 2001-2002 period). Growth in gas prices stimulated increase in tariffs on electric power which is one of principal consumers of that fuel. However, in 2004 prices on electric power energy increased by 11.5%. A radical change took place in the ratio between prices on natural gas and electric power. In 2004, tariffs on electric power used by consumers exceeded average prices on gas by 190%, while in 2003 that ratio amounted to 480% and in the period of recovery growth, to 270% on average (Fig. 12).

Fig. 12. Dynamics of prices of natural monopolies in the 2002-2004 period as compared to that of prices of manufacturers of industrial products (% of the December figure of the previous year) (industry = 1)

The year 2004 was also characterized by growth in prices on ferrous metals and investment goods. Higher growth in prices in ferrous metallurgy as compared to that in principal consumer-industries was observed since 2002. Extraordinary high demand in ferrous metals, as well as high international prices on such commodities gave an additional impetus to growth in

prices in 2004. Equation of domestic and international prices resulted in growth in producer's prices in ferrous metallurgy by 65.8% in 2004, as against 28.8% in 2003.

The investment sector was the first to respond to growth in prices on metals, since it was the principal consumer of engineering materials. Growth in prices in engineering industry amounted to 15.0% in 2004, as against 11.2% in 2003, in building materials industry, to 16.2% and in building industry, to 14.9%.

In 2004, in consumer's sector a slow-down of rates of growth in prices was observed. In 2004, the producer price index in light industry amounted to 108.1%, as against 115.2% in 2003, while in food industry, to 111.4%, as against 114.8%. Smooth dynamics of growth in prices on consumer foods could be explained by changes in a market situation and decrease in popularity of domestic goods in a situation of appreciation of the RUR and growth in demand in import goods (Table 7).

Table 7

Producer price indexes by the branch of industry in the 1999-2004 period (December to December of the previous year, %)

1999 2000 2001 2002 2003 2004

Industry - total 167.3 131.6 110.7 117.1 113.1 128.3

Electric power industry 114.4 139.9 130.2 127.3 113.9 111.5

Fuel industry 234.9 155.2 102.2 124.3 101.4 164.7

Oil industry 249.2 158.0 97.1 125.6 101.6 165.4

Petroleum refining industry 342.3 147.5 84.5 119.9 114.8 148.9

Natural gas industry 122.1 163.1 141.5 130.2 77.1 188.5

Coal industry 132.2 144.3 122.4 109.1 110.1 151.4

Ferrous industry 189.2 129.2 103.5 123.3 128.8 165.8

Non-ferrous industry 215.8 108.7 89.4 130.1 127.2 113.7

Chemical industry 143.8 126.8 119.8 108.3 115.1 129.4

Petrochemical industry 166.5 135.8 101.2 108.7 111.3 117.4

Engineering industry 149.6 128.0 116.5 110.6 111.2 115.0

Wood industry, woodworking industry 167.7 124.6 107.7 108.2 107.9 111.1

and pulp and paper industry

Building materials industry 137.3 136.6 119.5 117.4 117.0 116.2

Light industry 156.0 122.3 110.9 105.3 115.2 108.1

Food industry 162.6 118.6 115.0 105.8 114.8 111.4

Source: the Federal Service of State Statistics.

Export-Oriented Branches of Industry

Both the extent of demand in primary goods and allocation of income from foreign-economic activities are of principal importance to Russian economy. Analysis of post-crisis development of Russian economy suggests that a slow-down of industrial growth (106.1%, as against 107.3% in 2003 and 111.0% in 2000) is caused by slowing rates of development of the primary sector. In formation by fuel and primary industries of nearly 40 % of balance financial result of the economy and 75% of that of industry, both income of economic agents and the situation on the domestic market depended on fluctuations in international markets. Fuel and primary industries produced over 40% of industrial output, used 60% of investments in fixed capital of industry and ensured employment of 20% of industrial personnel. In the 2000-2004 period, the share of added value received from export of primary goods amounted to nearly 20% of the GDP and 40% of output of goods.

Such limitations of primary resources production as were related to the condition of the export infrastructure, decrease in reserve capacities and depletion of competitive advantages (which appeared as a result of the 1998 RUR devaluation) started to affect devel-

171

opment of the primary sector. With the existing structure of capital funds, further increase in capacity utilization would result in capital intensity of production and decrease in efficiency of utilization of labor and financial resources. A low rate of processing in metallurgy and chemical and wood sectors prevented successful diversification of the structure of production and export. Due to the above factor, the structure of industrial production and changes in demand on the domestic market depended to a great extent on dynamics of output volumes of the export-oriented sector.

In the 2003-2004 period, non-ferrous metallurgy lost its dominating influence on growth dynamics of the metallurgical sector. In 2004, in non-ferrous industry an increase in output amounted to 3.6%, as against 6.2% in 2003. Change in the volume of demand in principal export commodities resulted in a slow-down of growth rates of non-ferrous industry. According to the results of the three-quarters of 2004, growth in export volumes was registered only in respect of unprocessed aluminum. At the same time, in a situation of favorable dynamics of prices on non-ferrous metals manufacturers aimed their efforts at preserving stability on a traditionally volatile and cyclic market of non-ferrous metals, rather than expanding the supply.

With growth rates at the level of 105.0%, ferrous metallurgy occupied leading positions in the sector as a result of simultaneous growth both in domestic and foreign demand. With increase in investment activities in national economy, there was growth both in demand in engineering materials and their sales volumes on the domestic market. A favorable change in a business climate and global market situation gave an additional impetus to growth in ferrous metallurgy. Export of ferrous metals increased by 76.6% on the January-November 2003 figure, while that of ferrous-based alloys, by 24.4%. According to the results of three-quarters of 2004, balance profit in ferrous metallurgy increased by 130%. In the past two years, specifics of ferrous metallurgy were determined by dynamic growth in investment in fixed capital. Though higher rates of renewal of production facilities and removal from service of obsolete equipment resulted in a slow-down of rates of output as compared to 2003, they predetermined future development of ferrous industry.

The Oil and Gas Sector

The oil and gas sector forms a basic sector of Russia's economy and plays a leading role in forming the federal budget revenues and the nation's active balance of payments. In 2004, the oil and gas sector has found itself under the impact of the price situation on the world market for oil. As over 70% of the domestic oil output is exported in the form of crude or refined oil, while domestic sale prices are substantially lower than international, the world price levels form the main factor that determines the national oil sector's proceeds and financial state. Due to high growth rates of the world economy, OPEC's efforts1 to limit oil production and the fall in Iraqi oil output, the oil prices have been extremely high in 2004. As well, the prices remained high because of the fall in oil output in the Mexico Bay due to a hurricane in September, the unrest in the delta of the Niger, and strikes that had hit the oil sector in Nigeria, Brazil and Norway. As a result, in October 2004 Brent oil hit the level of USD 49.6/barrel, while Russian Urals sky-rocketed up to 42.3 USD/barrel. In 2004, the prices for the OPEC's oil basket has been considerably above the ceiling of the targeted price range of the Organization (USD 22-28/barrel) and made up USD 36.05/barrel on average. The price for Russian Urals on the world 9European) market in 2004 reached on average USD 34.45/barrel, or up by 27.4% vis-a-vis its respective level in 2003 (Table 8).

1 According to the decision made by the 2003 (September) OPEC conference, since November 1, 2003 the quota of oil output was reduced by 900,000 barrels a day (from 25.4 to 24.5 mln. barrels), while the February and March 2004 conferences ruled that since April 1, 2004 the quota should be reduced by another 1 mln. barrels a day (to 23.5 mln. barrels).

At the end of 2004 the prices slid slightly, which can be explained by the rise in the OPEC countries' oil output2, restoration of the volume of oil output in the Mexico Bay and the growth in oil supplies from the NIS.

Table 8

World Oil Prices in 1997-2004 (USD/barr.)

1997 1998 1999 2000 2001 2002

Brent, UK Urals, Russia OPEC's oil basket 19.12 18.33 18.68 12.72 11.83 12.28 17.97 17.30 17.47 28.50 26.63 27.60 24.44 22.97 23.12 25.02 23.73 24.34

Table 8 (cont'd)

2003 2004 Ist Q. 2004 lind Q. 2004 lllrd Q. 2004 Ivth Q. 2004

Brent, UK Urals, Russia OPEC's oil basket 28.83 27.04 28.13 31.95 28.94 30.80 35.36 32.54 34.41 41.54 37.41 38.97 44.00 38.92 40.01 38.21 34.45 36.05

Source: OECD International Energy Agency, OPEC.

In 2004, the oil and gas sector has seen the trend to a further rise in production of oil, oil products and natural gas that had emerged between 2000-03. In 2004, the oil output, including gas condensate, nearly reached the 1991 level and accounted for 458.8 t. In 2004, the increment in the volume of oil output grew by 8.9% vs. 2003, while the increment in the volume of primary oil refining grew by 2.6%. So, over the past 5 years, i.e. between 2000 through 2004, Russia's oil output rose by 50.4%. In a longer retrospective, the dynamics of Russian oil output in 2004 was at 19.4% lower the pre-crisis maximum of 1987, when the volume of oil output accounted for 569.4 mln.t., while it appeared to be at 52% greater vs. the 1996 minimum level when it was 301.3 mln.t. Interestingly, the output in the oil sector was growing against some decrease in investment activity. While in 2004 the volume of operational oil drilling was close to the prior year's level (the increment was 0.4%), the placement of new oil wells in operation slid by 1.1%, while prospecting drilling dropped by 18.3 (which can be explained by a fairly high sufficiency of the existing reserves). In the oil-refining sector, the production of petroleum derivatives with the use of intensive technologies grew by 1.8%, while the intensity of oil refining grew from 70.3% in 2003 up to 71.5% in 2004. The share of high-octane gasoline in the overall output of automobile gas grew from 53.1% in 2003 to 55.3% in 2004. The rise in the output of natural gas which had started in 2002 made up 1.6% in 2004. (Table 9).

The list of the biggest oil producers in 2004 included YUKOS, LUKOIL, TNK-BP, and Surgutneftegas. The late 2004 saw substantial changes in the structure of the oil sector: more specifically, YUKOS' main oil asset - Yganskneftegas, with its 50 mln.t. plus output was sold at an auction and acquired by Rosneft. Consequently, the latter considerably rose its share in the Russian oil market (from 4.7 up to 16%), while YUKOS' share fell drastically (from 18.7 to 7.4%). So, the proportion of the state-owned companies (Rosneft, including Yuganskneftegas, and Gasprom in the national oil output grew up to 18.6%. By contrast, as long as a company's individual oil production is concerned, Tatneft and Bash-neft that operate old oil deposits demonstrated the minimum growth rates, which resulted in their shrinking shares in the market.

2 According to decision made by the June (2004) OPEC conference, since July 1, 2004 the quota was increased up to 25.5 mln. barrels a day and consequently to 26.0 mln. barrels a day. The September (2004) conference increased the quota up to 27,0 mln. barrels a day, i.e. by another 1 mln. barrels, effective as of November 1, 2004.

Table 9

The Output of Oil, Oil Products and Natural Gas in 2000-2004 (as % vs. the Prior Year)

2000 2001 2002 2003 2004

Oil, including gas condensate 106.0 107.7 109.0 111.0 108.9

Oil 105.9 107.7 108.7 111.1 108.6

Gas condensate 103.8 106.7 112.8 108.7 116.9

Primary oil refining 102.7 103.2 103.3 102.7 102.6

Automobile gas 103.6 100.6 104.9 101.2 103.8

Diesel fuel 104.9 102.0 104.7 102.0 102.7

Black oil 98.3 104.2 107.1 100.3 97.8

Natural gas, cub.m. bln 98.5 99.2 101.9 103.4 101.6

Oil gas, cub.m. bln 102.5 105.0 110.5 119.3 106.4

Source: the Federal State Statistics Service

Gasprom traditionally dominated over the gas sector. In 2004, according to the RF Ministry of Fuel and Energy, its share in gas production accounted for 85.9%. Russian oil companies showed high growth rates of their gas production, but their overall share in this sector has remained fairly small. The greatest volumes of gas production among oil companies were reported by Surgutnetegas, Rosneft and TNK-BP.

Table 10

The Structure of Oil and Gas Output in 2004*

Oil, mln.t. The share in the total output, as % Gas output, as cub.m. bln. The share in the total output, as %

Russia, total 458.81 100.0 633.95 100.0

LUKOIL 84.07 18.3 5.02 0.8

Rosneft + Yuganskneftegas 73.39 16.0 10.80 1.7

TNK-BP 70.26 15.3 8.00 1.3

Including: Tymenskaya OC 49.49 10.8 5.86 0.9

SIDANCO 20.77 4.5 2.14 0.3

Surgutnetegas 59.62 13.0 14.31 2.3

Sibneft 33.9855.99 7.412.2 1.952.87 0.30.4

YUKOS- Yuganskneftegas 33.89 7.4 2.01 0.3

Tatneft 25.10 5.5 0.74 0.1

Slavneft 22.01 4.8 0.92 0.1

Bashneft 12.07 2.6 0.36 0.1

Gasprom 11.96 2.6 544.42 85.9

Russneft 6.60 1.4 0.77 0.1

Other producers 25.86 5.6 44.65 7.0

For reference:

YUKOS, including 85.68 18.7 3.43 0.5

Yuganskneftegas

Yuganskneftegas 51.79 11.3 1.42 0.2

Rosneft 21.60 4.7 9.38 1.5

Gasprom + Rosneft 33.56 7.3 553.80 87.4

Gasprom + Rosneft + Yuganskneftegas 85.35 18.6 555.22 87.6

* By the organizational structure of the sector as of December 31, 2004. Source: The RF Ministry of Fuel and Energy, authors' calculations.

The companies operating on the production-sharing agreement basis produced 2.37 mln. t. of oil, or just meager 0.5% of Russia's total oil output, while 150 other minor producers' share accounts for just 5.1% (Table 10). The 2004 list of the biggest producers of oil products is overtopped by LUKOIL, followed by YUKOS and TNK-BP. As concerns other companies, Surgutnetegas and Sibneft clearly dominate the market for oil products.

In 2004, the domestic prices for oil and oil products have grown drastically, which to a great extent was related to the expanding oil export opportunities. Thanks to high world oil prices, even very costly export transportation arrangements with the use of railroad transport have become efficient. In December 2004, the domestic average price for oil (producer price) in USD equivalent hit USD123.5/t., while the average price for petrol exceeded USD 350/t in November 2004, thus breaking an ever record price level for oil and petrol over the post-reform period. However, there still existed a considerable gap between the domestic and world prices for oil: in 2004 the respective correlation did not exceed 40-50%. In December 2004, there emerged the trend to decrease in the domestic prices for oil products (the prices of oil refineries slid by 5.5% on average vs. the prior month). By contrast, in 2004 the gas prices, for the first time ever, exceeded the pre-devaluation level and reached USD 105/ 1,000 cub.m. by the end of the year (Table 11).

Table 11

Domestic Prices for Oil, Oil Products and Natural Gas in USD Equivalent in 1997-2004 (average producer prices, USD/t.)

1997 1998 1999 2000 2001

(December) (December) (December) (December) (December)

Oil 63.1 16.4 37.0 54.9 49.9

Automobile petrol 169.6 63.4 171.9 199.3 151.5

Diesel fuel 170.0 52.9 125.0 185.0 158.5

Black oil 73.8 22.0 46.1 79.7 47.1

Gas,,USD./Thos. cub.m. 6.6 2.1 2.2 3.1 4.8

Table 11 (cont'd)

2002 2003 2004 2004 2004

(December) (December) (June) (September) (December)

Oil 60.7 70.1 87.5 103.0 123.5

Automobile petrol 168.8 236.9 275.1 318.8 333.1

Diesel fuel 153.8 214.3 244.6 300.3 364.3

Black oil 66.1 66.0 94.9 93.2 69.4

Gas,,USD./Thos. cub.m. 5.9 4.4 9.7 9.8 10.5

Source: Computed basing on the data by the Federal State Statistics Service

Between January through November 2004 Russia's oil export grew by 13.3%, while that of oil products - by 5.3% vs. the respective period of the prior year (Table 12). The share of export in the production of black oil accounted for 70%, diesel fuel - 54.2, petrol-14% (for reference: in 1999, the share of export in the production of petrol accounted just for 7.2%). High world process for oil generated a considerable rise in export proceeds. The oil export in value equivalent reached USD 52.9 bln., or grew by 47.7% between January through November 2004 vs. the respective period of the prior year, thus being 3 times greater than the increment in the physical volume of oil export. The proportional weight of oil export in the total volume of Russian exports over the period in question accounted for 32.6% (vs. 29.7% reported over the respective period of 2003).

Because of the rise in domestic prices for oil products and the Rb. appreciation in real terms, import of oil products showed a notable rise. Overall, over the period in question the respective rate grew 3.3 times vs. the respective period of the prior year, while im-

port of automobile petrol alone grew 7.6 times, with the share of import in petrol resources growing from 0.2 up to 1.7%. The proportional weight of import has remained very low, nevertheless. For instance, in the first half 1998, i.e. prior to the Rb. depreciation, the proportional weight of import in petrol resources was 8.7%.

Natural gas export rates grew vs. the prior year, which can be explained by the growing supplies to the CIS countries (they grew by 19.2% over the period in question).

Table 12

Export of Oil, Petroleum Derivatives and Natural Gas from Russia (as % to the Respective Period of the Prior Year)

2002 2003 2004 (January-November)

Oil, total 113.9 117.8 113.3

Including: to the non-CIS countries 109.9 118.9 114.4

To the CIS countries 137.3 112.4 107.7

Oil products, total 118.5 103.6 105.3

Including: to the non-CIS countries 119.1 102.6 104.4

To the CIS countries 102.8 132.3 126.1

Gas, total 102.4 102.0 106.1

Source: the Federal State Statistics Service.

As the analysis of the data on output and export of oil and oil products (Table 13) shows, most (over 95%) of extra output of oil was exported (either directly, or in the form of petroleum derivatives). In 2004, according to preliminary assessments, the net export of oil and oil products accounted for 327.7 mln.t., i.e. at 32.3 mln. t. thanks to the rise in the export of oil and 3.8 mln.t. - at the expense of the export of oil products). In other words, as in 2000-03, it was once again the boost of export that determined a considerable rise in the 2004 oil output. As a result, the proportional weight of the net export of oil and oil products in the oil output reached 71.4%, while the net export of oil exceeded 53% of its output. Because of the rise in both domestic and external demand for gas, 2004 saw a continuous boom in the the natural gas output, with the proportional weight of its net export in the output being over 30%.

Table 13

Correlation between Output, Consumption and Export of Energy Sources

in 1997-2004

1997 1 998 1 999 2000 2001 2002 2003 2004 (estimated)

Oil, mln.t.

Production 305.6 303.4 305.0 323.2 348.1 379.6 421.4 458.8

Export, total 126.9 137.1 134.5 144.5 159.7 187.5 223.5 253.2

Export to the non-CIS countries 109.8 117.9 115.7 127.6 137.1 154.8 186.4 213.2

Export to the CIS countries 17.1 19.2 18.8 16.9 22.7 32.7 37.1 40.0

Net export 119.0 129.2 128.5 138.7 154.7 181.3 213.4 245.7

Domestic consumption 132.2 125.1 120.5 123.0 122.9 123.5 129.8 131.1

Net export, as % to outputy 38.8 42.4 42.1 42.9 44.4 47.8 50.6 53.6

Oil products, mln.t.

Export, total 60.6 53.8 56.9 61.9 70.8 75.0 78.4 82.6

Export to the non-CIS countries 58.4 51.2 53.9 58.4 68.3 72.5 74.9 78.2

Export to the CIS countries 2.2 2.6 3.0 3.5 2.5 2.6 3.5 4.4

Net export 56.6 51.0 50.3 61.5 70.5 74.8 78.2 82.0

1997 1998 1 999 2000 2001 2002 2003 2004 (estimated)

Oil and oil products, mln.t.

Net export of oil and oil products 173.4 178.3 184.5 200.2 225.2 256.1 291.6 327.7

Net export of oil and oil 56.7 58.8 60.5 61.9 64.7 67.5 69.2 71.4

products, as % to oil output

Natural gas, cub.m. billion

Production 571.1 591.0 590.7 584.2 581.5 594.5 620.3 634.0

Export, total 200.9 200.6 205.4 193.8 180.9 185.5 189.3 200.8

Export to the non-CIS countries 120.9 125.0 131.1 133.8 131.9 134.2 142.0 144.4

Export to the CIS countries 80.0 75.6 74.3 60.0 48.9 51.3 47.3 56.4

Net export 196.4 197.6 201.3 189.7 176.8 178.3 180.5 192.0

Domestic consumption 374.7 393.4 389.4 394.5 404.7 416.2 439.8 442.0

Net export, as % to outputy 34.4 33.4 34.1 32.5 30.4 30.0 29.1 30.3

Aggregate indicators

Oil and gas output, as mln. 819.6 835.3 836.6 849.0 871.5 914.7 979.7 1029.4

t. of oil equivalent

Net export of oil, oil prod-

ucts and gas, as mln. t. of 350.2 356.1 365.7 370.9 384.3 416.6 454.1 500.5

oil equivalent

Domestic consumption of

oil and gas, as mln. t. of oil 469.4 479.2 470.9 478.1 487.2 498.1 525.6 528.9

equivalent

Net export of oil, oil prod-

ucts and gas, as % to the oil 42.7 42.6 43.7 43.7 44.1 45.5 46.4 48.6

and gas output

Source: the Federal State Statistics Service; the RF Ministry of Fuel and Energy, the Federal Customs Service, the authors' calculations.

The total export of oil and oil products grew from 301.9 mln.t. up to 335.8 mln.t. in 2004 (preliminary assessment), or at 11.2%. The structure of the oil export is still dominated by the export of crude oil that accounts for sof the overall export of oil and oil products. The export of oil products is consequently dominated by fuel oil, which Europe uses for further refining, and diesel fuel. Between January to November 2004 vs. The respective period of the prior year the export of natural gas grew by 6.1%. Notably, most energy sources (84% of oil, 95% of oil products and 72% of natural gas) was exported to the non-CIS countries.

As the analysis of the dynamics of Russia's oil export over a long period of time shows, the 2004 aggregate net export of oil and oil products has for the first time ever exceeded the 1998 record -breaking level of oil export (291.6 mln.t.). In parallel with the rise in oil export, that of oil products has grown steadily since 1996. As a result, the proportional weight of oil refining products in oil export grew from 18.2% in 1990 up to 25.0% in 2004 (Table 14). Because of the drastic fall in the domestic oil consumption (our computations show it fell from 269.9 mln.t. in 1990 to 131. 1 mln.t. in 2004, i.e. more than twice), the proportional weight of export of oil and oil products in the oil output grew from 47.7 up to 71.4% over the period in question. By contrast to the export of oil and oil products, the net export of natural gas and its share in the output has recently remained by the level of late 1990s, while the proportional weight of the net export of natural gas in the respective output has been slightly over the pre-reform level (30.3% in 2004 vs. 28% in 1990).

Structure of Net Export of Oil and Oil products

Table 14

Oil and oil products Oil

Oil products

1990 2002 2003 (estimated)

Mln.t. % Mln.t. % Mln.t. % Mln.t. %

246.3 100.0 256.1 100.0 291.6 100.0 327.7 100.0

201.5 44.8 81.8 18.2 181.3 74.8 70.8 29.2 213.4 78.2 73.2 26.8 245.7 82.0 75.0 25.0

Source: the Federal State Statistics Service; the RF Ministry of Fuel and Energy, the International Energy Agency, the authors' calculations

In 2004, the aggregate net export of oil, oil products and natural gas for the second year in line exceeded the 1998 pre-crisis maximum. We estimate its rise from 407.6 mln. t. of oil equivalent in 1990 up to 500.5 mln.t. of oil equivalent in 2004, i.e. at 22.8%, while the proportional weight of the net export in the aggregate oil and gas output grew from 37.3 up to 48.6%. These data evidence a greater orientation of the sector towards export vis-avis the pre-reform period. However, it should be noted that this is explained not solely by the rise in absolute volume of export, but a considerable decline of the domestic consumption of oil and gas.

The high oil prices noted through the whole 2004 have fueled a considerable price rise in the oil sector. The nation's aggregate revenues from the export of oil and main kinds of oil products between January through November 2004 reached USD 67.63 bln., while their proportional weight in Russia's export accounted for 41.6%. The oil sector's (including the oil and oil-refining subsectors) aggregate profit (balance sheet financial results) between January through October 2004 accounted for USD 11.17 bln., accounting, at the same time, for 34.4% of the overall profit of the national industrial sector and 18.6% of the economy as a whole (the peak value was reached in 2001, with these particular indicators accounting for 39.4$ and 20.7%, respectively). Overall, the revenues of the oil sector secured a high level of tax revenues to the state budget and enabled oil companies to run a relatively low level of accounts payable before their suppliers and the budgets of all levels (Table 15).

Table 15

Financial Indicators of the Oil Sector's Performance in 1997-2004 (USD Bln.)

Sale proceeds form export of oil and main kinds of oil products Profit (balance sheet financial result) Outstanding accounts payable (as of end-year) Including: to suppliers To the budget

1997 1998 1999 2000 2001 2002 2003 2004*

21.09 13.96 18.82 34.89 33.43 38.72 51.13 67.63

3.52 0.60 6.32 10.42 8.14 4.32 6.70 11.17

6.79 2.41 1.61 1.35 1.01 0.90 1.07 1.55

2.38 0.94 0.72 0.55 0.52 0.59 0.85 1.03

2.53 0.66 0.43 0.27 0.15 0.10 0.07 0.07

* The data on export -over the period January - November; on profit - January - October; accounts payable -as of late October.

Source: computed basing on the data of the Federal State Statistics Service.

The year 2004 saw the introduction of a number of substantial changes to the system of taxation of the oil and gas sector. They have notably increased the tax burden on the sector, especially under high world prices for oil. Federal law No. 33-FZ of May 7, 2004, "On introduction of amendments to Art. 5 of the law of the Russian Federation "On cus-

toms tariff" and Art. 5 of the federal law "On introduction of amendments to Section II of the Tax Code of the Russian Federation and some other legal statutes of the Russian Federation, as well as on recognition of invalidity of some single legal statutes of the Russian Federation" has modified the order of computation of the marginal (maximum) oil export duty rate. A new, more progressive scale for computation of the oil export duty marginal rate oriented towards withdrawal of an extra profit resulting from exportation of oil under high world prices for oil became effective as of August 1, 2004 (Table 16). The amount of the oil export duty reached USD 101/t. by late 2004.

Table 16

Oil Export Duty Rates

World prices for Urals, USD/barrel.

Duty rate, as USD/t.

Earlier effective scale (2002 - 31 July 2004)

New scale (effective as of 1 August 2004)

Up to 15 15 - 20 20 - 25 Over 25

0

0.35x(P-15)x7.3 25.53+0.4x(P-25)x7.3

0

0.35x(P-15)x7.3 12.78+0.45x(P-20)x7.3 29.2+0.65x(P-25)x7.3

Source: Federal law No. 33-FZ of May 7, 2004, No. 126-FZ of August 8, 2001

Federal law No. 33 FZ of 7 May 2004 has also introduced new rates of the mineral production tax (MPT) for oil and natural gas, effective as of January 1, 2005, and modifications of the formula of computation of the coefficient that characterizes the dynamics of he world oil prices and applied to the basic rate of the tax. As of January 1, 2005, the basic rate of MPT has made up Rb. 419/t. (i.e. 20.7% up vs. 2004), while the coefficient that characterizes the dynamics of the world oil prices is computed according to the following formula:

Cp = (P - 9) x R / 261,

where P - the price level for Urals, as USD/barrel averaged over a given tax period;

R - the average Rb/USD exchange rate set by CBR (Table 17).

As of January 1, 2005, the MPT rate for natural gas has been increased to Rb. 135/1 thos. cub.m. (from Rb. 107 in 2004, i.e. by 26.2%)

Table 17

MPT Rate on Oil

2002-2003

2004

2005

MPT basic rate, Rb./t

the coefficient that characterizes the

dynamics of the world oil prices (Cp)

340

347

(P-8)xR/252

419 (P-9)xR/261

Source: Federal law No. 33-FZ of May 7, 2004, No. 126-FZ of August 8, 2001

The change in main indicators of the oil and gas sector's development that characterize production, domestic and external sales, prices, investment activity, and the state of payments and settlements is depicted on Fig. 13-20.

Source: the Federal State Statistics Service; the Federal Customs Service; International Energy Agency; the authors' calculations.

Fig.13. Production, Consumption and Export of Oil in 1990-2004 (as mln. t.)

Source: the Federal State Statistics Service; the Federal Customs Service; International Energy Agency; the authors' calculations.

Fig.14. Production, Consumption and Export of Natural Gas in 1990-2004

(as cub. m. bln.)

Oil -Diesel fuel

Source: computed basing on data of the Federal State Statistics Service.

Fig. 15. The average Export prices for Oil and Diesel Fuel in 1996-2004 (USD/t)

Mln. t. (left scale) USD mln. (right scale)

Source: computed basing on data of the Federal State Statistics Service

Fig. 16. Export of Oil and Oil Products in Natural and Value Equivalent in 1997-2004

Source: computed basing on data of the Federal State Statistics Service.

Fig.17. Average Producer Prices for Oil and Gas in USD Equivalent in 1992-2004

as USD/t., USD/Thos. cub.m.

360 330 300 270 240 210 180 150 120 90 60 30

0

Source: computed basing on data of the Federal State Statistics Service.

Fig. 18. Average Producer Prices for Petrol and Black Oil in USD equivalent in 1992-2004 (USD/t.)

Fig. 19. Operational Drilling for Oil and Placement of Oil Wells in Operation in 1996-2004

To suppliers budgets

Source: computed basing on data of the Federal State Statistics Service

Fig.20. Outstanding Arrears of the Oil Sector before Suppliers and Budgets of All Levels

in 1996-2004 (USD bln.)

3.2. The IET Business Surveys3

3.2.1.The Dynamics of Demand or Industrial Produce

Late 2003 traditionally became the period of decline in the demand for the domestic industrial produce. The sales growth rates (by balance) had begun to fall since October and by December they dropped to 6%. That meant that enterprises reporting the fall in their output began to dominate over the industrial sector. All the industry branches reported an absolute fall in sales or, at least, a deceleration of growth at the end of the year. The only exception was the food-processing sector that, by contrast, reported, one of the highest growth rates. So, in 2004 the national industrial sector found itself far from the best shape.

The early 2004 likewise did not predict a rapid rise in demand. The January slump proved to be most intense over the past 5 years (Fig. 21). All the industries reported negative balances, except for the one for electricity (again, due to seasonality).

%

Fig. 21. The Monthly Dynamics of demand in 2000-2004 (Balance = % of Growth - % of Fall)

But as early as in February our surveys registered a rise in sales of industrial produce, which had not happened over the prior 3 years. Notably, it took place (or, at least, the respective decline decelerated) in all the industry branches. It was only the sector for electricity that was undergoing problems with the cash sales, which is an annual phenomenon in the sector, nonetheless. The national industrial sector had been maintaining high rates of sales until the end of the 1st half-year, with balances of changes in demand over this particular period being superior to their respective indices of 2001-2003. It was

3 This section is based upon surveys on heads of industrial enterprises that IET has conducted monthly since September 1992. The surveys cover the whole territory of Russian Federation, with the panel comprising a. 1,200 enterprises with the number of employees accounting for over 20% of those employed in the industrial sector. The panel is biased towards large enterprises by each of 61 singled out subsectors, while the questionnaire return rate is a. 70%.

enterprises of ferrous metallurgy, chemical and petrochemical sectors, and the construction materials industry that reported the most intense growth in demand for their output, while, by contrast, the demand for the light industry produce almost always declined and the intensity of fall in sales would reach very big values (-38...-43% by the balance). Our reports have not registered such high rates of decline in demand for the light industry output since August 1998. (Fig. 22). By contrast, the machine-engineering sector demonstrated absolutely different dynamics of demand - after the seasonal decline in January, it did not fall over the period in question. Even the May (not adjusted) balance proved to be positive, which did not happen both in 2002 and 2003.

%

Fig. 22. Change in Effective Demand in the Industry Branches (Balance = % of Growth - % of Fall)

In the 2nd half-year, the demand growth rates lost their record-breaking momentum vis-avis the preceding years (Fig. 21). The 2004 August growth rates in demand were lower than those of the 4 prior years, while in July - 3 prior years. Once in October, November and December the national economy manifested clear signs of deceleration of its growth (at, least, as evidenced by the official data on the dynamics of output), the growth rates of demand for industrial output were inferior to just the respective index of 2000. So, the monthly dynamics of demand for industrial output does not provide any grounds for pessimistic assessments of sales of industrial output in the 2nd half 2004. This conclusion is back-upped by balances of change in the demand computed by half-years (Table 18). The intensity of change in demand in the 2nd half-year roved to be the greatest one over the last 4 years, while the aggregate result of the 1st half-year also proved to be the best one over the period in question. The demand for its output basically fully enabled Russia's industrial sector to maintain high growth rates of production, at least, not lower than in the preceding years.

Table 18

Changes in Effective Demand by Half-Years in 2000-2004

Year Half-year Growth No change Decline No reply Balance

2000 1 22 65 12 2 9

2 22 65 11 2 11

2001 1 18 61 18 3 0

2 19 65 14 2 4

2002 1 15 58 25 1 -9

2 20 62 18 1 1

2003 1 21 58 20 1 1

2 22 62 14 2 7

2004 1 22 59 18 1 3

2 21 66 13 1 8

This thesis is also proved by the dynamics of the frequency of enterprises referring to a low domestic effective demand as an obstacle to production growth. This particular index dropped to 38% by the 4th quarter, which makes up the minimum value since October 1993, while yet in early 2004 it had been 50%. In 2004, it impeded output at just 46% of enterprises on average, which is the best value over the period 2000-04, except for the year of 2000 (Table 19). It was metal producers that had the least problems with domestic sales in 2004 (31%). When compared with 2003, the domestic demand formed a 2-fold lesser impediment to their output. The forestry held the second position in this regard (38%), followed by the light (39%) and food (40%) industries. Thus, an insufficient domestic demand posed a problem to just 39% of Russian textile and sewing enterprises. By contrast, most other industry branches have found themselves in a far worse position. These results compel one to question the thesis of the domestic market being completely lost by the national light industry. Should it be able to solve its other problems (primarily, the lack of liquid assets and qualified staff), its produce would enjoy the domestic demand. Interestingly, the food-processing industry was likewise challenged by the domestic demand roughly to the same extent as the light industry did. The aggregate 2000-2004 results evidence that the domestic demand hampered 46% of food-processing and 43% of textile and sewing companies on average to boost their output. The dynamics of output in these sectors were different though - while the food-processing sector was progressing more or les successfully, the textile industry went downhill. Notwithstanding that, the domestic demand did not appear the most cited cause for the fall in output in the domestic light industry - in their post-default growth stage, other sectors more often suffered from an insufficient domestic effective demand. For instance, in the machine-engineering and metallurgical sectors, over the period in question the domestic demand on average hampered output at 55% enterprises, in the sector for chemicals and petrochemicals - 53%, and in the construction materials industry - 50%.

But high growth rates in demand in the 1st half-year had nearly zero effect on the enterprises satisfaction with their production volumes. The average balance of assessments (above or below norm) proved to be lower than its analogous indicator over the 2nd half 2003. Enterprises either expect greater results, or have failed to adjust their assessments to recent trends. This thesis is proved by the dynamics of satisfaction with demand (its assessment as being normal). In the first 6 months 2004, across the industrial sector 49% of enterprises on average were satisfied with sales of their produce, while the respective index in the 2nd half-year 2003 was 52. In terms of specific industries, the satisfaction with demand in the first half-year 2004 ranged from 75% in the non-ferrous metallurgy to 37%

in the industry of construction materials and the light industry, while in the machineengineering sector the respective index accounted for 42% and 57% - in the food-processing industry. It should be noted, however, that our survey data evidenced some "revaluation of values" (or demand) in the national industrial sector in 2003 - the balance grew from -65% to -39%, while the proportion of responses "normal" from - c 32 to 55% over the year. There were no such trends in early 2004, albeit a more accurate comparison, following the "a period of one year to the respective period of the prior year" principle shows the presence of positive tendencies in the dynamics of demand assessments, too.

Table 19

The Frequency of Citation of Domestic Effective Demand as an Impediment to Growth in Output in Industry Branches (as % to the Number of Responded Enterprises, the Average Annual Data)

Industry branches 1995 1996 1997 1998 1 999 2000 2001 2002 2003 2004

All industries 56 64 61 63 51 45 47 62 58 46

Metallurgy 64 66 57 63 38 35 64 81 61 31

Chemicals and petrochemicals 50 71 69 63 51 47 46 65 54 52

Machine engineering 62 63 62 66 59 54 51 60 62 49

Forestry 49 70 55 45 22 26 32 39 29 38

Construction 55 67 66 73 65 45 44 59 53 50

Light industry 54 58 49 53 42 40 37 53 47 39

Food processing 52 51 62 62 56 52 41 46 49 40

The averaged balances of assessments of the 1st half-year 2004 appear at 10 balance points greater than their 2003respective values and have proved to be the best ones since 1994. But negative values of the balance of assessments evidence that the enterprises that do not consider the demand for their produce normal mostly are inclined to opt for "below norm" assessments. As the proportion of the "above norm" answers, as a rule, accounts for several per cent, the enterprises' satisfaction is most visibly characterized by the correlation between the "normal" and "below norm" assessments (Fig.23).

Fig. 23. The Dynamics of Main Assessments of Effective Demand

The excess of the "normal" answers over those "below norm" was first received in mid-2003. In other words, by that time the volumes of cash sales of industrial produce had reached such a volume that the national industrial sector found itself dominated by the enterprises that believed the demand for their produce was normal, rather than by those being not satisfied with the demand. It took the economy 5 years of the post-default rise in effective demand to reach that critical point. This domination had still been in place by late 2003, despite, first, the deceleration of growth rates, followed by their absolute decline in December. It was consequently lost only in January 2004, with the surveys registering a drastic (even for January) fall in sales volumes, and in February, when the restoration of sales proved to be insufficient. In March, once again, there were more enterprises satisfied with the demand for their produce than those dissatisfied with that. This domination remained through the year and by October it reached 22 p.p. already, which became a record value for the whole period of monitoring. But a slowdown of growth rates in demand between November to December compelled enterprises to consequently adjust their demand estimates: the rate of "normal" assessments slid by 2 p.p. in November and by another 7 p.p. - in December, albeit the respective excess over the "below norm" assessments was still there. (Fig. 24).

Fig. 24. The Balance of Changes in Effective Demand and Difference between

Its Main Assessments

However not all the sectors proved to be capable to reach the volume of sales satisfactory to most enterprises in 2004 (Table. 20). More specifically, the "below norm" assessments were still prevalent in such sectors as machine engineering, construction materials industry and light industry, The greatest demand challenges still face the light industry, where over half of enterprises still consider the demand for their produce "below norm". It was just in single months when our surveys noted the prevalence of the "normal" assessments in this particular sector. This happened once in 2003 and four times in 2004. So, the positive trends are also present in the light industry - an increasingly greater number of enterprises find a satisfactory balance between heir production capacity and market opportunities.

Table 20

Main Assessments of Volumes of Effective Demand in 2004 Across Sectors (as % to the Number of Responded Enterprises, the Averaged Annual Data)

Industry branches "Normal" "Below Norm" Difference between assessments

Fuel 83 14 69

Ferrous metallurgy 71 23 47

Non-ferrous metallurgy 76 24 52

Chemicals and petrochemicals 65 33 32

Machine engineering 45 53 -7

Forestry 62 36 26

Construction 47 50 -3

Light 39 57 -1 8

Food processing 59 38 21

In the fuel and metallurgical sectors enterprises reached the highest level of satisfaction with effective demand, primarily, thanks to export in the condition of an extremely favorable sate of affairs on the world markets. The sector for chemicals and petrochemicals likewise has demonstrated successful performance in 2004, however, it succeeded in becoming "in the black" only in mid-2003, while the forestry and food-processing industries had demonstrated positive results yet in 2002.

Speaking of enterprises of different property forms, it was joint-stock companies that proved to be most successful in their adjustment to market conditions in 2004. While in the prior years both public enterprises and JSC=s mostly shared the "below norm" assessments (albeit, the latter enjoyed a bit better correlation), last year JSC=s managed to quit "the red zone" -they mostly assessed demand as "normal" (Fig.25), with the difference between the assessments changing over the year form-5 to + 12 p.p., while public companies over the period in question managed only to decrease the lack of their adjustment to market conditions from -13 to -9 p.p. Most public enterprises (54%) are still dissatisfied with the demand for their output. This indicator peaked its maximum in 1996-1997, when not less than 90% of public companies on average considered the demand for their output insufficient. Post-default, the public segment of the industrial sector succeeded in loosing over 30 p.pof its non-adjustment to market, but it failed to come "into the red", i.e. to ensure the prevalence of the "normal" answers. In the worst for JSC=s 1996, their dissatisfaction with demand likewise accounted for more than 90%, but post-default, this segment of the sector decreased its dissatisfaction with demand (alias market) at 46 p.p., with just 43% of JSC=s currently considering the demand for their produce "below norm".

Computations of the dynamics of enterprises of different size adjusting to Russian market realities displayed the existence of specific paths and non-coinciding final (by 2004) results (Fig. 26). In mid-1990s, while assessing demand, enterprises of all sizes mostly opted for the "below norm" response. It was large enterprises that suffered to a far greater extent than the others from the lack of effective demand. In early 1996 through early 1997 and prior to the default the level of adjustment to market of ll enterprises was minimum. N the aftermath of the crisis, with the growth in demand, the share of enterprises satisfied with the demand for their produce began to grow, too, albeit gradually and following different paths.

Fig. 25. The Difference between main Assessments of Effective Demand by Property Forms (normal-below norm)

The large enterprises' satisfaction with effective demand was growing at a pace faster than that of medium-size companies and much faster than that of small businesses. In 2001, with the demand growth rates decelerating, enterprises of all sizes sensed the slowdown of their adjustment to market. In 2003, the process was back on track and in July, for the first time ever, the group of big enterprises reported positive values in this regard. They were maintaining the excess of the "normal" assessments (with a sole exception) through late 2004. Interestingly, the excess was growing and reached its historical maximum in October 2004 +38 p.p.).At the time, 68% of large enterprises were content with effective demand for their output - the results the other groups so far have failed to beat.

Medium-size companies managed to reach just the 50-52% of satisfaction with deand. It happened in August to October 2003. In 2004, their adjustment rate has never been "in the black", with a prevalence, albeit an insignificant one, of the "below norm" replies. The enterprises with up to 500 employees find themselves in a far more unfavorable position. The small (by Russian standards) producers have so far failed to reach an excess of positive assessmsnts of demand. The best result was registered in October 2003 and accounted for - 10 p.p. At the time 43% of the enterprises assessed the demand for ther output as "normal" vs. 53% of the "below norm" assessments. In 2004 the adjustment rate to demand in this particular group grew by 3 p. vs. 2003 (from -26 to -23 p.p.), while in the group of medium- size companies - by 4 p. (from -13 to -9 p.p.) and in the group of large companies - by 21 p. (from -2 up to +19 p.p.). In our view, the most probable cause for such differences in satisfaction with demand is a low competitiveness of the national economy in the segment of large enterprises.

1/94 1/95 1/96 1/97 1/98 1/99 1/00 1/01 1/02 1/03 1/04 1/05

Fig. 26. The Difference between Main Assessments of Effective Demand By Enterprises' Sizes (normal-below norm)

Results of computations with the use of a binary logistical regression that describes the correlation between the dichotomic variable (the assessment of demand by a two-level scale -"normal -"below norm") and enterprises' "generic" features in 2000-04 proved the preceding conclusions. The effect of an enterprise' size has been steadily positive and always significant: with the number of employees growing, the probability of having the "normal" assessments grows. The public property form has almost always decreased the probability of reaching normal volumes of demand. The only exception became 2002, when our surveys registered both an absolute decline in demand volumes and a drop in satisfaction with it. At the time, negative trends were likely to batter to a greater extent privatized enterprises vs. The others. Attaining normal volumes of demand has always posed a problem for electric companies. This is evidenced by coefficients that have always been negative, great by module and almost always appeared significant. The analogous situation is noted both in the machine engineering, construction materials and light industries. By contrast, coefficients of the variable "the survey number" that depicts the dynamics have always been positive and statistically significant, i.e. the probability of formation of the "normal" assessments was growing through all the years in question and particularly in 2003. However, the values of the Nagelk-erke Pseudo R-Square (proportion of the explained dispersion) appear relatively small, which testifies to the fact that "generic" features do not appear major ones, as long as the explanation of satisfaction with demand is concerned.

Once the variables that assess the level of domestic competition and the one with overseas rivals was introduced to the model, it was found that competition did not exert a substantial influence on the formation of normal assessments of demand in the national industrial sector. The respective coefficients appeared positive, which speaks in favor of our hypothesis on a low competition level enabling enterprises easier (simpler, faster) attaining acceptable volumes of demand.

The introduction of independent variables, which assess an actual change in main indicators of a given enterprise, to the model allowed to ensure a fundamental increase in the Nagelkerke Pseudo R-Square. The regression equilibrium employed assessments of an actual change in output, employment, demand, finished produce in stock, costs and profit. A given sector's features, size and property form of an enterprise and the survey number were kept in the equilibrium, while assessments of competition were excluded from it. The signs of coefficients of a new model appeared quite correspondent to an intuitional idea of the impact the employed variables have on the probability of formation of a normal satisfaction with demand at a given enterprise. It was only the 2003 and 2004 regressions that have been assessed, as the data on actual changes in employment and profit had been collected only since 2003.

As expected, the actual changes in demand had the strongest impact on the formation of satisfaction with demand. With the demand growing, there exists an increasingly greater probability of the "normal" assessment. It has always been followed by the level of influence by the actual change in employment, i.e. the national industrial sector considers the rise in the number of employees at a given enterprise to be the second critical economic indicator that determines the normality of its position on the market. By contrast, the change in output does not have a substantial impact on the formation of normal assessments of demand. We believe, this particular result may have more than positive interpretation, for it means that domestic enterprises are no longer in favor of focusing on once very popular purely volume-based indicators (gross output). The impact of profit obviously appeared inferior to the influence employment exercises on the formation of satisfactory assessments of demand. The former is substantial and positive, i.e. with the profit rising, the probability of satisfaction with demand grows, too. The satisfaction with demand grows against the fall in the volume of finished produce in stock. This also appears logical, for a fall in the finished goods in stock means that a given enterprise receives spontaneous (not planned) orders that were satisfied by means of shipping the stored stock. The impact of price changes on the formation of satisfactory assessments of demand is contradictory. In 2003, the probability of satisfactory assessments of demand appeared positively correlated with changes in prices (with account of the specificity of the coding of responses), i.e. the possibility for a given enterprise to raise its sale prices resulted in a rise in normal assessments of demand. This correlation was substantial. In 2004, the correlation vector changed and its lost its substantiality.

At the next step of the analysis the regression equilibrium was complemented by assessments of the enterprise's current state - the assessment of finished produce in stock, capacity loading rate, the assessment of excessive (insufficient) capacities and employment, the assessment of the enterprise's economic state. The insertion method that accounts all the variables was replaced by the reverse selection method that step by step excludes from a given model the variables that display a non-substantial correlation with a given dependable variable without a substantial loss of the quality of adjustment of the model As a result, we received the 2003 and 2004 models that comprised only the variables that had a substantial effect on the formation of satisfactory assessments of demand.

The formation of demand assessments found itself under the strongest impact of the dynamics of sales, assessments of an enterprise' s economic state and those of finished products in stock vs. other factors. All these factors are associated with demand, in one way or another, which is why their effect on assessments of its volume appears quite logical. Let us note that the dynamics of finished products in stock does not affect the demand assessments, which evidences that Russian enterprises are developing quite market approach to management of their reserves, with their assessments associated with demand, 192

rather than the volume of the reserves. The dynamics of output likewise does not affect the demand assessments, which should also be recognized as a positive development, as well as small values of production capacities loading rates - an increase in the use of production equipment has a positive effect on satisfaction with demand, but appears inferior to the other factors. The absence of excessive capacities due to an envisaged demand appears of a far greater importance to the enterprise. The effect of these assessments on satisfaction with demand is greater than the effect form the dynamics of profit. The absence of an excessive staff was important, so long as satisfaction with demand is concerned, in 2003 and lost in significance in 2004, when the industrial sector has already nearly got rid of the excessive workforce and began to increasingly sense its shortage. As usual, an enterprise's size has a positive effect on the probability of the unfolding of normal assessments of demand.

3.2.2. Constraints to the industrial growth in 2004

While the 2004 dynamics of demand bore both positive and negative trends, but overall its impact on the national domestic enterprises was positive (for the time the proportion of enterprises satisfied with demand was over that of dissatisfied with it), the dynamics of output were rather negative. Particularly between May through December (Fig. 27). In the first months of the year, the balance of change in output (less seasonality and other random factors) by changing from 21 to 23 balance points, demonstrated stability, rather than growth. The balance consequently fell to 14 points between June to December, which formed the worst value since early 2003. A long period of the slide or, at least, failure to rise, of the output growth rates evidences that the national industrial sector has encountered new obstacles to the growth in output, with effective demand apparently not being a major challenge in this regard. Indeed, upon stabilization of growth rates in demand between July and August at rather a low level (+3 after clearing from seasonality and random fluctuations), it consequently began to gain its momentum and reached +7 by December, while production at that time was loosing its growth rates.

30 %

I I I I I I I I I I I I I I I I I I I I I I I I 11

1/93 1/94 1/95 1/96 1/97 1/98 1/99 1/00 1/01 1/02 1/03 1/04 1/05

Fig. 27. Change in Demand and Output, Cleared from Seasonality and Random Fluctuations (Balance= % of growth - % of decline)

The quarterly monitoring of constraints to the production growth shows that the Russian industrial sector sees the mergence of a new structure of constraining factors. While the frequency of quotation of most traditional obstacles continues to decline and some of them have reached record-breaking low values, other ones, on the contrary, begin to pose problems to an increasingly greater number of enterprises (Fig. 28). Interestingly, such a seldom referring to some impediments that were not so widespread before, can be explained by a certain inertia in assessing their constraining effect. Perhaps, management still finds it hard to get used to the idea that in the upcoming years their enterprise would lack capacities (which have always been in abundance) an qualified staff (that earlier have not left their jobs even being paid poorly and with delays), rather than solvent consumers and accessible credits.

An insufficient domestic effective demand in the 4th quarter 2004 hampers the output at just 38% of enterprises, which forms the best (minimum) value since early 1994. At the time, the respective index was 84%. The most cited constrain in late 2004 was the lack of liquidity (42%), but this particular value also appears nearly minimum for all the surveys (with the absolute 39% minimum registered in January 2004). This impediment is most outspread in machine engineering (in 2004 it was cited by 50% of enterprises on average), followed by the light industry (49%), and the sector for chemicals and petrochemicals (47%). The best sufficiency rate in this regard is demonstrated by metallurgical plants, with just 26% of enterprises tending to believe the lack of liquidity poses a problem to their growth.

Fig. 28. Impediments to Production Growth

In late 2004, only 16 of enterprises referred to nonpayment's, once the greatest peril to the economy. Last year, the constraining effect of this particular factor slid over 1.5 times: given that in 2003 nonpayment's hampered 26% enterprises' performance, in 2004 -only 17% ones on average. It is the industry of construction materials that currently experiences the greatest settlements problems (29%). Its enterprises have managed to reduce the constraining effect of nonpayment's just by 5 p.p. over the year. The best results in the

timely effecting of settlements were demonstrated by metallurgical and forestry enterprises, with just 6% of them citing nonpayment's. For reference, in 1995 nonpayment's were referred to on average by 74-77% of producers across the national industrial sector.

Against the background of the constraining effect generated by such obstacles as the domestic demand, lack of liquidity and nonpayment's more and more Russian industrial enterprises refer to impediments associated with the resource provision of output and competition on the part of imports.

In 2004, 20% of Russian producers on average consider competing imports to be an obstacle, which is the peak (i.e. worst) annual result. In the 3rd quarter, the reference to it climbed up as high as 26%, which forms an absolute record value through the whole period of monitoring. Imports has not practically posed a problem only to forestry producers and those of the construction material industry (Fig. 9) - only 8 and 4% of enterprises on average in these particular sectors referred to this impediment in 2004. By contrast, the light, chemical and petrochemical industries form the opposite pole. For instance, 29% of enterprises in the light industry considered import to be an obstacle in 2004, while immediately after the default (1999) the respective index in the sector accounted for 5%, while the post-default maximum (1996) was 26%. So, the default lowered the pressure of imports on the sectoral output 5-fold, but the pressure consequently grew nearly 6-fold over the 5 post-default years. Accordingly, presently the national light industry experiences the greatest constraining effect on the part of imports.

Post-default, chemical and petrochemical companies likewise were experiencing a growing pressure of competing imports, albeit the range of fluctuations of the pressure was less intense. The pre-default maximum in the sector accounted for 18% and appeared superior to those noted in two sectors (namely, the food-processing - 30% and light -20% ones). Post-default, the import pressure slid to 8%, but bounced back up to 27% by 2003, thus exceeding its pre-default level. In 2004, import competition affected performance of slightly less number of enterprises (25%).

The default gave Russia's machine engineering a double fall in the import pressure. While in 1998 it had affected 11% of enterprises (notably low level vs. other sectors), in 1999, only 5% of them referred to the import competition. The import pressure on the sector began to grow then and in 2004 as many as 22% of enterprises believed imports hampered their output. So, in the machine-engineering sector, the pressure on the part of competing import has also exceeded the pre-default maximum level.

Light

Chemicals and petrochemicals

Machine engineering

Food

Metallurgy

Forestry

Construction

0 5 10 15 20 25 30 35

□ 2004 r. □ Pre-default maximum

Fig. 29 Frequency of References to Competing Import as an Obstacle to Rise in Output across Industries

According to enterprises' estimates, the pre-default strongest (more precisely, the most widespread) constraining effect of imports was noted in the food-processing sector. In 1997, a. 30% of food-processing companies on average believed imports hampered the growth in their output. In 1999, this index dropped 10 times - down to 3%, but consequently began to gradually regain its position and reached 20% in 2004. This is nearly the 7-fold rise, which none of other Russian industries has ever experienced. The pre-default maximum has not yet been reached, nonetheless, and the industry still enjoys the Rb. depreciation effect. Yet two other industries fin themselves in an analogous position: those are the forestry sector and the construction material industry that have not yet "overshot" the pre-default level of the import pressure.

Results of the regression analysis with the employment of logistical regression showed that in 2000-2004 only the reference to the staff and equipment shortages was in fact associated with an actual production decline. Referring to other causes underlying the decline in output that were significantly correlated with the production dynamics had an opposite effect - they lowered the probability of the production contraction. Such a situation, in our view, may be explained as follows: the equipment shortages and lack of qualified staff form very unusual challenges to Russia's transition economy. Traditionally, it is believed that until recently the domestic industrial sector has had an unlimited supply of these production factors and did not consider that they would ever seriously constrain the rise in output. The economic information sources available to industrial enterprises have not tackled the issue either. In other words, there was no "spinning" of these obstacles by the media, government agencies or the enterprises themselves. This allows to assume that the enterprises referred to the noted obstacles only when they actually constrain the rise in their output. Plus, the enterprises did not do that from the very beginning, as they first had to break stereotype and realize that staff and equipment could also form constrains to their

output. By contrast, the situation with such impediments as a low demand, import competition and lack of liquidity was different. These particular problems were "in the air" and, thanks to the media and the limited official statistics, the interest in them (sometimes, perhaps, not so sound one) is still there. This could not help affecting the enterprises' responses: they traditionally referred to these obstacles, while objectively their constraining affect had faded.

3.2.3. Impediments to rise in output formed by staff problems

While analysts have long kept their watchful eye on the pressure of competing imports on the national industry, the constraining effect of the lack of qualified staff an competitive capacities have not yet moved to the forefront of their debate. The ET surveys evidence, however, that post-default, the lack of qualified staff has always constrained production growth more often than the competition with imports, while the shortage of equipment was referred to more often than imports in 1999-2002 and in 2003-2004 it was just at 1 p. down vs. the import competition in this regard. As a prompt elimination of these obstacles (like a default liquidates the problem of import pressure on the domestic market) is unlikely an hardly possible technically, the analysis of resource constraints is worse a greater attention.

Fig. 30. Resource Obstacles to production Growth

Even in the early 1990s (Fig. 30), the national industrial sector perceived it was falling short of qualified staff. In 1993, this reason was referred to by 23% enterprise on average. The need in employment of qualified staff began to decrease in parallel with the decline in effective demand and, accordingly, output and hit the bottom -7% by 1998. However, prior to the default some industries experienced a minimum need for qualified staff to boost their output. Thus, in 1993 maximum 7% of the food industry enterprises reported such a need, while it dropped to 1% by 1998. A relatively stable demand, "live cash" for produce and wages payable in cash enabled the industry to a maximum extent avoid the "hunger for staff" in 1993-1998. Post-default, the food-processing enterprises also experienced the need in staff to boost their output to a minimum extent. In 2001 and 2004, only 9% of them believed they fell short of staff (Fig. 31).

50

%

40 --

30 --

20 --

10 -■>

0

1/93 1/94 1/95 1/96 1/97 1/98 1/99 1/00 1/01 1/02 1/03 1/04 1/05

Fig. 31. Frequency of References to Staff Shortages as an Obstacle to Production Growth in Some Sectors, as %

The light industry displayed absolutely different dynamics of the need for staff to boost its output. In 1993 the need for staff was reported by 24% of its enterprises, albeit it was not the greatest 1993 value - the maximum one (40%) was reported by the construction materials industry. The need for staff had been declining, following in the wake of the fall in demand and output, by default. In July 1998, only 5% of enterprises reported the shortage of staff, and during the next 12 months the need for qualified staff had been on the utmost low level. For instance, in January 1999 it fell to 2% and grew back to 16% only in July 1999. The indicator has begun to grow since then (except for 2002) and reached 40% (2003 and 2004). none of other industry branches experienced such a great need in qualified staff in 2003-2004. As concerns the light industry itself, the highest need for qualified staff is presently noted in the cotton (55%) and sewing (40%) subsectors. This situation is unquestionably explained primarily by a hard situation in the sector and, accordingly, poor wages, rather than by an absolute lack of necessary workforce on the labor market.

Yet two another sectors likewise demonstrated in 2004 the maximal over the whole period of monitoring need for staff: those were the construction materials industry and machine engineering - 29 and 34%, respectively. Machine engineering has almost always experienced the greatest need for staff in annualized terms to ensure a boost of its output, and it was only in 2003-04 when the light industry outran it. Presently the following machine- engineering subsectors fall short of staff: shipbuilding (84% of enterprises); power engineering (74%), repair plants (84%). The forestry complex passed through the peak of the need in qualified personnel in 2003, when every third enterprise on average reported the lack of specialists to boost its output. In 2004, the need slid to 31% and it is generated mostly by the timber (44%) and sawing (28%) subsectors.

80

%

60

40

More than enough

20

ent

-20

Insifficient

-30

0 lililililililililililililililililililililililil.il -40

1/93 1/94 1/95 1/96 1/97 1/98 1/99 1/00 1/01 1/02 1/03 1/04 1/05

Fig. 32. Respondents' Assessment of an Excessive Number of Employees at an Enterprise and the Balance of Assessments

The need in staff to boost output is combined with an excessive employment in the national industrial sector. According to the IET surveys, prior to the default, the proportion of enterprises that had more than sufficient , due to expected changes in demand, number of staff reached 42%, given that the number of employees in the sector had been declining intensively over the 1990s. Post-default, with the rise in effective demand and the secured by cash output, there started a decline in the share of enterprises whose employment proved to be excessive to output. By the 3rd quarter 2000 an excessive number of employees had been noted at just 11% of national industrial enterprises. This index hits its bottom (9%) in the 4th quarter 2001. In 2004, only 15% of enterprises on average still believed the number of their employees was excessive, with the greatest proportion of such enterprises (18%) noted in the machine-engineering industry.

Most enterprises have always had a sufficient number of employees. The default undoubtedly extended the segment of the industrial sector where employment was sufficient due to envisaged changes, but the extension was not intense, as one could have assume. While in the pre-default period the minimum value of the indicator had been 49%, the post-default maximum sky-rocketed to 74%, i.e. the gap amounted to 25%. Post-default, some industries reported a complete satisfaction with the number of their personnel, and our surveys registered such a situation in the sectors for electricity, fuel and metallurgy, while the machine-engineering and light industry displayed the most modest results over the period in question (74%).

The dynamics of excessiveness of personnel in the industrial sector demonstrates a certain dependence on the size of an enterprise. Large plants have always maintained a greater excessiveness of their personnel vs. medium- and small-size ones. Even post-default the balance of their assessments more often appears positive than negative. Their monopolistic position and a great social significance enabled them both to increase the output and sales volumes at a faster pace pay higher salaries vis-a-vis medium- and small-sized companies, and maintain a certain excess of staff (most likely, with acceptable wages), which could be used in the event of demand and production expansion. In the pe-

riod of the post-default "re-galvanization" that allowed large enterprises to easily solve their problems with staff and experience a smaller need for employing new personnel. In such a situation, an excess of the workforce on hand can be likened to finished products, the immediate availability of which in the storage allows to promptly meet new (unexpected) customers, for a relatively low wages level in the industrial sector makes the associated costs not a heavy burden for the company.

Medium- and small-size enterprises faced an absolutely opposite situation. A more intense competition has not and still does not enable them to achieve satisfactory performance and, accordingly, salaries, which contributed for a faster "washing away" of their personnel. Prior to the default they somehow had been managing to keep "the stock" of workforce to promptly boost their output, but its size rapidly exhausted after 1998. Such enterprise have now experienced a stable shortage of workforce.

Fig. 33. Balances of Assessments of Staff Numbers due to the Enterprise's Size

(Balance = Excessive - Insufficient)

But ultimately in 2004 the national industrial sector saw zero balance of assessments of the number of employees, with enterprises with a sufficient employment dominating over the sector (Table. 21). As the question on the assessment of employment has been asked to enterprises for 9 years already, while the Russian industrial sector experienced drastic changes in demand over this period of time and the balance of assessment has fluctuated recently over zero value, it can be argued that at the macrolevel the problem of provision of enterprises appears resolved. To equally solve it on the microlevel requires a greater territorial mobility of workforce.

The combination of assessments of sufficiency of the exiting personnel and the question about the shortage of staff as an obstacle to growth in output allows to assess the correlation between different enterprises' positions from the perspective of staff sufficiency and possibility for solving the problem with personnel by means of labor market (Fig. 34). As our computations show, the national industrial sector has always been dominated by the enterprises that assess their personnel as sufficient in relation to expected

changes in demand and consider that staffing do not pose a problem to them, as far as the boosting of their output is concerned. It would be logical to assume that this particular group of enterprises finds itself in the state of static equilibrium between their personnel and expected changes in demand and output. They did not suffer from an excessive employment, nor they were in need for additional stuff to boost their output to match the dynamics of demand. Prior to the demand this group comprised on average up to 52% of enterprises, while in 2004 - 58%. In other words, the national industrial sector was anyway dominated by enterprises with a number of employees optimal to ensure their production expansion

Table 21

Assessment of Personnel Sufficiency (as%)

Year More than enough Enough Insufficient Balance

1996 38 54 8 30

1997 37 57 6 31

1998 39 55 6 33

1999 24 66 10 14

2000 15 68 17 -2

2001 13 71 16 -3

2002 19 68 13 6

2003 16 70 14 2

2004 15 70 15 0

Fig. 34. The Dynamics of Main Positions of Enterprises on the Labor Market

The group of companies with excessive staff but not experiencing problems with personnel while boosting their output holds the second position. They have managed to main-

201

tain "a qualitative" excess of workforce needed to secure a prompt and painless (from the staffing perspective) production expansion. Indeed, as soon as Russian industrial sector began to boost output in the wake of the default, the proportion of these enterprises started to promptly shrink from 39% (July 1998) to 10% (July 2000), while in 2004 their share accounted on average for 13%. Such an excessiveness and the enterprises policy are, anyway, worth of a positive score, for they allow to keep the most qualified personnel at enterprises, which are ready to immediately take part in the production process, once the respective demand and output grow. These staffing cohorts in a sense can be likened to the industrial sector's mobilization potential, while the sole fundamental difference between them is that the former are intended to meet effective demand, rather than military needs.

The proportion of the enterprises that lack staff, albeit personnel do not pose a problem to production expansion appears most stable. The lack of personnel due to envisaged changes in demand speaks of the absence of "competitive stock" of workforce at the enterprises, i.e. such an excess that can be used in production, once the demand for a given enterprise's output grows. But these enterprises do not believe the lack of staff is an obstacle to growth in their output. The surveys evidence that the number of such companies in Russia has always been a. 5%. Most likely, they can solve their staffing problems through the labor market. Small proportion of this particular group is explained chiefly by a unique for the country situation, in which an enterprise has managed to fully get rid of the excessive workforce, but at the same time it enjoys the possibility of prompt staff employment on the labor market.

The enterprises that as well do not possess a sufficient number of their own staff due to envisaged changes in demand, and this staff shortage constraint their output. It can be assumed that likewise the preceding group, having got rid of the excessive workforce and even after going further beyond that, this group of enterprises found itself incapable to receive the lacking workforce from the labor market, either because of the lack of the latter in their respective region, or due to the existence of structural disproportions on that. The dynamics of the sector in question appear quite logical. While prior to the default there were on average 2% of such enterprises in the national industrial sector, after the default their average share grew up to 9%. In 2004, it rose up to 13%.

In conclusion let us results of an assessment of the model that demonstrates which of the available indicators form a situation under which qualified personnel constrain production boom in the national industrial sector. We use the enterprises' responses to the question as to whether or not the lack of staff forms the factor that constrains the rise in their output as independent variable. It is the dichotomized variable ("forms" - "does not form"). The binary logistical regression enables us to assess the impact independent variables have on the probability of positive answer ("the staff shortages constrain the rise in output"). As concerns conceptual indicators, it was assessments of demand on the scale "over norm - normal - below norm" that have the strongest and steadily significant effect on citing in our surveys personnel shortages as an obstacle. Negative coefficients speak that the probability of the constraining effect on output on the part of personnel grows along with the rise of satisfaction with demand. Another assessment - based characteristics of demand: that is, the assessment of finished products in stock, - began to exert a substantial influence on the emergence of the probability of staffing deficit only in 2004. This impact was correct: the deficit of reserves and the need to boost output to meet an unforeseen rise in demand were increasing the probability. The dynamics of the demand (growth - no changes - decline) did not have a substantial effect on the probability of referring to the obstacle, yet the positive sign of the coefficient appears illogical - staff be-202

gins to hamper the rise in output against a lowering demand. But the dynamics of output compel enterprises to recall the staffing problems. The impact of this particular variable, as a rule, appears substantial and expected. The enterprises' intentions to boost their output cause the same reaction: more optimistic production plans raise the probability of staff shortages. However, yet another critical characteristics of the enterprise's production activity, the capacity loading rate, does not affect the staff shortages, perhaps, because the already loaded capacities have been already staffed. But the prospects for a guaranteed sufficiency with work (orders in months) generate the staffing problem in the national industrial sector.

3.2.4. Capacity-related constraints to rising output.

Our surveys show that since 2000 some 18-19% on average of Russian industrial companies have believed the shortages of equipment hamper the rise in their output. The only exception was 2002, when demand discontinued its growth, while output growth rates decelerated (Fig. 35). Prior to the default, 6% of enterprises on average referred to equipment shortages as an impediment to boost in output, while post-default their number grew up to 16%, with the peak value of 22% registered in October 2003.

Balance

Fig. 35. Balances of Changes in Demand and Output, and the Frequency of Reference to Equipment Shortages

In the 2nd and 3rd quarters 2004, the same number of enterprises (21%) reported equipment shortages, with the forestry complex reporting it for the second year in line. Over one-third companies of the complex lacked equipment to boost their output in order to meet the growing demand. In 2004, the value of the respective index surged up to 38% -an absolute annual maximum, with very likely prospects for its further rise in the future. The construction materials industry and machine engineering hold the second and third positions with the value of the respective indicator accounting for 19% and 18%, respectively. But these two sectors display different paths, so long as the need in equipment to boost their output is concerned. The machine-engineering industry has experienced an annually

rising need in equipment - while prior to the default 3% of its enterprises fell short of equipment, after the default their number grew up to 18%. In 2004, it further rose up to 21%, with the shortage being especially acute in power-engineering, instrument-making sub-sectors, as well as production of metal constructions and means of communication. The construction industry passed its peak shortage of equipment in 2002. At the time, 26% of enterprises reported this problem. In 2004, it hampered just 15% of plants to boost the output of construction materials.

By contrast, the least need in equipment in 2004 was noted in the light industry - only 9% of the respective companies believed they fell short of equipment to ensure their production expansion. Most likely, the reason behind this is a gradual contraction in the respective demand and output, under which even the existing capacity was idle, rather than a considerable volume of investment in the sector. In 2001, when the sector was still capitalizing on the 1998 devaluation effects and hoped for a restoration of its sales, 16% of enterprises experienced the need in equipment to boost their output.

Fig. 36. The Frequency of References to Equipment Shortage as an Obstacle to Production Growth in Some Industries

The capacities loading dynamics also evidence the need in increase of equipment procurements to boost output. This particular indicator surged from 57 in early 2003 to 67% in the 3rd quarter 2004 (Fig.37). Such a rapid and long-lasting rise in the use of capacities was earlier registered only right after the default. The loading rate grew from 42% to 56% between July 1998 - April 2000, but already in the 4th quarter 2004 the loading rate remained unchanged. This, of course, can be explained by the stagnating industrial output noted both by our surveys and the official statistics.

%

Months

70

9

65

8

60

7

55

6

50

5

45

4

40

3

35 . | . | , | . | . | .|, | . | . | , | . | . | . |, | . | . | . | . | . | . | ,| . | . | . | 2

1/93 1/94 1/95 1/96 1/97 1/98 1/99 1/00 1/01 1/02 1/03 1/04 1/05

Fig. 37. Capacity Loading Rate (as %) and Sufficiency with Orders (as Months)

However, the dynamics of another survey indicator testifies in favor of an increasing exhaustion by the national industrial sector of a "overhang" (or reserve) of excessive capacities. The enterprises' assessments of excessiveness, sufficiency and shortage of the existing production capacities due to envisaged changes in demand demonstrated a drastic fall in the proportion of enterprises with excessive capacities right in the 4th quarter 2004 (Fig.38). As a result, a. 20% of enterprises report their capacities be excessive vis-a-vis the envisaged demand - such low a proportion of enterprises with excessive capacities never noted since 1993. In the second half 2004, the capacities shortage in the industrial sector stabilized at 14%, which beat the preceding record value (13% in 2000) and just by 1 point missed the absolute record of 1993. But as the comparison between 1993 and 2004 seems incorrect, it can be argued that Russian industrial sector presently is in a record-breaking need for production capacities. But overall across the sector there have been more enterprises with excessive capacities than those falling short of them, which is why the respective balance remains positive, albeit it has sunk to its absolute minimum. The capacities overhang has still been there, which leaves some inertia to Russian industries, meaning it for some time would not be in urgent need for investment. Once the overhang fades, the future industrial growth will be limited already by a physical shortage of competitive capacities.

70 -p %

60

50 --

40 --

30

20

10 --

0

1/93 1/94 1/95 1/96 1/97 1/98 1/99 1/00 1/01 1/02 1/03 1/04 1/05

Fig. 38. The Proportion of Enterprises with Sufficient, Excessive and Insufficient Capacities

The post-default rise in the sales volume changes enterprises' view on a normal volume of demand and, accordingly, on sufficiency of their capacities to meet that. The computations of balances of assessments of capacities made for main demand assessments show that the national enterprises have already fallen short of capacities to secure normal demand volumes with their output. The average annual balance of capacities assessments in the group of enterprises with normal demand for their output for the first time became negative in 2004. Thus, the further industrial growth, in all likelihood, will result in a rise in the shortage of capacities capable to meet the demand. Let us note that breaking enterprises into groups by another two parameters (size and property form) did not result in negative balances of the capacities assessments, with considerable negative balances found only while studying into the sectoral specifics of the non-ferrous metallurgy ad forestry. As well, they have been noted recently in the ferrous metallurgy.

Balance

60

50 40 30

20 10 0 -10 -20

1/93 1/94 1/95 1/96 1/97 1/98 1/99 1/00 1/01 1/02 1/03 1/04 1/05

Fig. 39. Balances of Assessments of Capacities for Different Demand Assessments

The binary logistical regression enables us to assess which factors compel Russian industrial enterprises to consider the equipment shortage to form an impediment to production growth. As before, we are going to use enterprises' responses to the question as to whether or not the shortage of equipment forms an impediment to economic growth. It was demand assessments that had the strongest and always substantial impact on the probability of the shortage of equipment. As soon as demand volumes, according to the enterprises assessments, elevated from the "below norm" category to the "normal" one, the enterprises began to face a shortage of equipment, which became especially notable in 2001 and 2004. Thus, "normality" in the domestic industrial sector implies mobilization of all the personnel and equipment available and the possibility of their more intense introduction to production.

The second position by intensity of their effect on the probability of reference to equipment shortages is held by indicators of finished products in stock - actual and expected changes of their volumes, as well as the current assessments of those by the "above norm-normal-below norm" scale. In 2001, the actual changes in the stock of finished products had positive and significant coefficients, which meant that once the volumes lowered, the enterprises were compelled to cite a shortage of equipment as an impediment to growth in its output. That could occur in the event of an unforeseen by enterprises rise in demand, which they had to meet from their stored reserves, while the completing of the latter by means of intensification of output became problematic, because of the shortage of the equipment that could manufacture the much-needed produce. Let us note that it was in 2001 that Russian industrial sector seemed to abandon the mission of minimization of the stock of finished produce in favor of the task of maintaining them in an excessive state, which allows enterprises to meet new consumers' demand in an instant. Most likely, this particular transition compelled enterprise to cite the lack of equipment. The dynamics of the stock of finished products over the subsequent years has not any longer been affecting the probability of referring to equipment shortages as an ob-

stacle to boost of output - the lack of equipment has presently begun to be determined by assessments of finished produce in stock. Positive coefficients for this variable speak that the probability of mentioning equipment shortages as an obstacle grows, providing a given enterprise assesses its stock as insufficient. In 2004, it also was forecasts of changes in the stock of finished produce that forced enterprises to focus on equipment shortages. The projected lowering of volumes of finished produce in stock requires production expansion, but faces the problem of equipment and machinery being in short supply.

Despite the capacities loading and sufficiency with orders have a substantial and logical effect on the problem of equipment shortage, their rates appear very insignificant. The dynamics of demand, as well as the dynamics of output do not substantially affect the probability of citing the impediment in question.

The dynamics of effective demand for the national industrial enterprises' produce quite allowed the domestic industries to maintain high growth rates in 2004, at least, not worse than in the prior years. By the 4th quarter of the year the constraining effect of demand slid to minimum, while the satisfaction with its volume peaked maximum and overshot the "below norm" assessments. Thus, most Russian enterprises have adapted to market. The factors that determine the level of their market adaptation became the dynamics of demand, assessments of finished produce in stock and enterprises' financial and economic state, the dynamics of profit, and the absence of excessive capacities.

The monitoring of impediments to production growth shows highlighted the emergence of a new structure in the domestic industrial sector. With the frequencies of citing most of traditional impediments continuing their fall, some of them hit record-breaking low values. Some others, by contrast begin to affect an increasingly greater number of enterprises. The regression analysis results showed that in 2000-2004 it was only the reference to the personnel and equipment shortages that was de-facto associated with an actual production decline.

At the outset of every year Russia's industrial sector usually demonstrates good growth rates and high optimism of forecasts. The year of 2005 has formed no exception in this respect, with its start being yet even more vigorous than before. Should the industrial sector succeed in overcoming the growing staffing and equipment starvation, as well as the banking system's distrust, the economy growth forecasts could be revised in favor of their increase.

3.3. Investments in the Real Sector of the Economy

In the 2000-2004 period, growth in investment in fixed capital was higher than dynamics of the GDP and output of primary industries. Analysis of dynamics and specifics of formation of demand in investment in the post-crisis period permitted to identify (depending on the impact of factors) the following few stages:

• Mobilization of competitive reserve capacities in a situation of a radical drop in import of capital goods from the 3rd quarter 1998 to the 3rd quarter 1999;

• Growth in domestic demand in Russian investment products from the 3rd quarter 1999 to the 4th quarter 2000 caused by intense growth in domestic production, profitability and income thanks to favorable changes in prices on international markets;

• Slow-down of investment in fixed capital from the 1st quarter 2001 due to intense growth in domestic consumer demand caused by an increase in households' income

and decrease in income from exports due to a drop both in prices and demand in hydrocarbons on international markets;

• From the second half of 2001, growth in import volumes of machinery and equipment and a share of foreign capital goods in investment expenditure in a situation of slow dynamics of domestic output of engineering industry;

• Sluggish dynamics of demand in investment in 2002 due to a decrease in income from foreign economic activities, reduction of the domestic market and reduced profitability of production;

• From the beginning of 2003, resumed higher growth rates of investment in fixed capital as compared to the GDP dynamics because of growth in income from foreign economic activities and business activities at home;

• Smaller impact of growth rates of investment in fixed capital on dynamics of the domestic market in a situation of growing income from exports and reduced transformation thereof into investment resources from the 2nd quarter 2004.

Fig. 40. Rates of growth in the GDP and investment in the fixed capital in the 1998-2004 (% of the respective quarter in the previous year)

From 1999, growth in accumulation and investment was faster than dynamics of GDP. In 2004, growth in investment in fixed capital amounted to 10.9% (the GDP - 7.1%). Growth in demand in investment ensured nearly 25% of an increase in the volume of the GDP.

Intense growth in income of the economy had a significant effect on the specifics of investment activities. It was related, on one hand, to favorable changes in prices on hydrocarbon materials and metals in international markets and, on the other hand, an active policy by the Russian business which was aimed at filling in niches on the domestic market with Russian goods (Fig. 40). Growth in profitability of production and income from foreign

economic activities initiated an expansion of demand in capital goods, which was based on higher rates of output of related industries. Aimed at intensive modernization and upgrading of production, both the export sector and manufacturing industry experienced greater need in machinery and equipment.

In a situation of existing imbalances between dynamics of fixed capital and investment expenditure on the domestic capital market, dynamic growth in import machinery and equipment had a greater role to play (with seasonal factors excluded, a decrease in the share of imports in the volume of consumption of engineering industry's products began in 4th quarter 1998 and was over in the 3rd quarter 1999). A rise in demand in import machinery and equipment took place in 2000; faster growth rates of import machinery and equipment as compared to dynamics of domestic engineering industry became sustained and corresponded to dynamics of investment activities. In the 2000-2004 period, growth in output of engineering industry and building materials industry amounted to nearly 60% and 37.7%, respectively, with volumes of import machinery and equipment and means of transportation increasing by 150% (Fig. 41).

Fig. 41. Growth rates of investment in fixed capital, output and import of capital goods in the 1992-2004 period (% of the previous year figure)

Dynamics of output of capital goods by the branch of engineering industry reflected prompt response by the Russian business to changes in market situation at home. Whereas in the 1992-1997 period, motor industry was a factor, which prevented recession in engineering industry, in the 1999-2004 period it yielded that place to industrial equipment manufacturing. Branches specializing in manufacturing of equipment for oil and chemical industries and domestic market-oriented branches of engineering industry, such as railway engineering and metallurgical engineering were leaders as regards output of investment goods. Intense development of service industries gave an impetus to growth in

output of road building engineering, lifting equipment manufacturing, communication industry and instrument making industry. Higher competitive advantages of domestic engineering as compared to those of foreign analogs (as regards pricing) promoted growth in output of equipment meant for branches of the consumer's sector.

Replacement of worn equipment remained a principal line of investment in fixed capital. In 2004, about 33.3% of entities increased their production capacities with a product range still unchanged. In nearly 40-47% of entities, investment activities were determined by higher efficiency of production related to introduction of new production technologies, reduction of production costs and saving of energy resources. As a result, in 2004 a larger portion of investment in fixed capital was spent on purchase of machinery and equipment. According to the data of the statistical service, 88% of entities bought new Russian-made equipment and machinery, while 60% of entities, import equipment; on the secondary market 22% of entities bought Russian-made equipment, while 5%, import equipment. In January-September 2004, investment in purchase of import equipment amounted to 23% of the total volume of investment in machinery, equipment and means of transportation.

A shift from investment into fixed capital financed at entities' and enterprises' own account to a greater use of borrowed funds was a principally new factor behind economic growth. The above points to quality changes in mechanism of investment development aimed at ensuring greater efficiency of flows of investment resources. In 2004, the share of own funds accounted for 47.2% of the total investment in fixed capital, which corresponded to the 2000 level (the record high demand in investment during the entire period of recovery growth). There were also changes in the structure of borrowing: the share of bank loans and borrowed funds of other institutions increased, while that of budgetary financing went down by 1.9%. In the past few years, the share of federal budget funds in investment financing gradually decreased in a situation of growth in the share of budgets of constituent entities of the Russian Federation. In 2004, the share of the federal budget in the structure of budgetary funds decreased by 3.8% on the 2003 figure.

By estimation, in 2004 growth in lending to enterprises and entities amounted to nearly 31.6%. In 2004, the share of bank loans in investment rose to 7.7%, as against 5.2% in 2003 and 2.9% in 2000. With high economic growth rates in the 2003-2004 period, positive growth dynamics of direct foreign investments in Russian economy were registered. According to the results of the three-quarters of 2004, an increase in foreign investment amounted to 39.1%, while the share of foreign investment in the total volume of investments in national economy, to 5.4%. Industry was getting more and more attractive to foreign investors, followed by commerce, public catering and general commercial market services (Table 22).

De-dollarization of households' savings was a factor behind greater role of banks and other entities in advancement of loans. Drop in cash foreign currency holdings by households and conversion thereof into rubles were accompanied by growth in bank deposits. With the existing average level of profitability in the economy, low real value of credit resources contributed to growth in the number of domestic market-oriented borrower-enterprises. With a decrease in the lending rate of refinancing of the Bank of Russia from 16% in 2003 to 13% in June 2004 and an increase in the share of medium and long-term funds accumulated by the banking system, the money market became more attractive.

At the same time, in a situation of economic growth it became clear that investment management was not in line with restructuring processes taking place in Russian economy. Lack of investment financial institutions, underdevelopment of the stock market and legal irregularities made borrowing rather complicated. Also, due to a lack of mechanisms of intersectorial flow of capital, investment at the level of enterprises, branches and re-

gions was complicated. As known from experience, in making of reserve savings taking of investment decisions requires both prudence and efficient management of investment flows. Lack of long-term development strategy and business priorities was a factor behind reduced investment motivation.

Table 22

Structure of investment in fixed capital by the source of financing (%)

1998 1999 2000 2001 2002 2003 2004

Investment in fixed capital - total 100 100 100 100 100 100 100

Including by the source of financing:

Own funds 53.2 52.4 47.7 49.4 48.0 46.2 47.4

Including:

profit 13.2 15.9 23.4 24.0 20.5 17.2 17.0

Borrowed funds 46.8 47.6 52.5 50.6 52.0 53.8 52.6

Including :

Bank loans 4.8 4.2 2.9 4.4 4.8 5.2 7.7

Including loans by foreign banks 0.6 0.9 0.5 0.8 1.4

Borrowed funds of other entities 4.3 5.6 7.2 4.9 6.0 8.6 7.3

Budgetary funds: 19.1 17.0 22.0 20.4 19.6 18.8 16.9

federal budget funds 6.5 6.4 6.0 5.8 6.0 6.5 4.9

funds out of budgets of constituent enti-

ties of the Russian Federation and local 12.6 10.6 16.0 1 4.6 13.6 11.5 11.2

budgets

foreign investment in the total volume of 3.5 6.6 4.7 4.5 4.1 4.7 5.4

investment in fixed capital

According to the data of January-November 2004 .

Source: The Federal Service of State Statistics.

In 2004, dynamics of demand in investment were determined by an aggregate impact of factors behind changes in sectorial, technological and reproduction structures of national economy. Reallocation of flows of investments was accompanied by an increase in the share of the services sector. In the 1999-2004 period, the share of transport, communication and commerce accounted for 25% of the total volume of investments in fixed capital, as against 15% on average in the 1992-1996 period. Growth in investment activities in service industries and an increase in demand in such services became an indicator of the potential of economic growth, all the more so investment activities in the above sector were primarily aimed at attainment of long-term objectives.

In analyzing of investment inflow by the sector of the economy, it was important to take into account the specifics of dynamics and structure of investment in housing construction. Analysis of the structure of new commissioned housing showed that non-public investors (which accounted for nearly 80% of new commissioned housing) had a greater role to play in that sector. At the same time, in the last decade there was growth in the share of housing financing by households.

There were also changes in the sectorial structure of investment in fixed capital. The total volumes and dynamics of investment were determined to a great extent by natural monopolies' industries and branches of oil industry. With transport, communication industry and fuel industry accounting for 45% of the volume of investment in national economy it was obvious that business activities in the above industries had a significant effect on dynamics and structure of demand in investment. In the 2003-2004 period, growth rates of investment in transport development were positive, which factor permitted to overcome negative implications related to a drop in investments in 2002. In January-September 2004, the share of investment in the transport sector amounted to 20%, as against 21.6% 212

*

in 2003. In the past four years, branches of the services sector were characterized by faster growth in investment in fixed capital of communication industry and commerce. From 2001, positive investment growth rates were registered in healthcare, education, culture and science. In the 2002-2004 period, the aggregate unit weight of investment in the above sectors of the economy amounted to nearly 5.8%, which factor permitted stabilization of the rates of service rendering.

In 2004, the share of investment in fixed capital of branches of the physical production sector remained at the previous year's level and amounted to 48.5%, which situation was caused by a low-key growth in investment in industry. Also, a slow down of investment activities was registered both in the export-oriented sector and domestic market-oriented industries.

Investment industries accounted for 9.0% of the total volume of investment in industry, while branches of the consumer's sector, for 7.7%. With the existing age, technological and reproduction structure of fixed capital, low investment rates of branches of manufacturing industry were a factor behind a slow down of economic growth rates (Fig. 42).

Fig. 42. Change in the structure of investment in fixed capital by the branch of industry in the 2001-2004 period (% of the previous year figure)

Fuel industry kept dominating in the structure of investment; it accounted for over 45% of the investment in industry with over 50% of such investment made in oil industry. However, in the 2003-2004 period the oil sector of the economy was characterized by low-key investment dynamics. In January-September 2004, a share of the fuel sector in the total volume of investment in industry decreased by 2.9% as compared to the same period in 2003.

Prospects for further economic growth depend to a great extent on intensive changes in the structure of investment in favor of domestic-market oriented industries. Implementation of the above suggests coordination of decision-making in fiscal, tax, tariff, customs and monetary policies. A tax system reform and budgetary reform are to promote

diversification processes in the economy and make manufacturing branches more attractive to investors.

For the purpose of ensuring investment into the economy, financial infrastructure and the system of financial intermediation are currently reformed. In September 2004, the Russian Government approved a plan of actions for development of financial markets. The plan included amendment of the legislation on financial markets and was aimed at ensuring of a greater use of derivative financial instruments, further application of self-regulation principles and harmonization of requirements in respect of formation of own capital, placement of funds and composition and structure of assets of financial institutions.

In 2004, the President of the RF signed a number of laws concerning the stock market, including amendments to the Federal Law on Execution Proceeding aimed at protection of funds of client-participants in the securities market and the Federal Law on Joint-Stock Companies aimed at upgrading of investment activities by joint-stock companies through implementation of effective dividend policy and ensuring of financial and business transparency. Also passed were statutory acts dealing with regulation (risk reduction) of activities by professional participants in the securities market, development of new financial instruments (which would help attract foreign and domestic investors), simplification of the securities registration system and development of the system of provision of information by issuers to investors.

In July 2004, the President of RF signed a law on amendment of the Federal Law on Prevention of Legalization (Money Laundering) of Income Received from Criminal Activities and Financing of Terrorism which permitted to control activities by banks and institutional investors, as well as operations with real estate, cash funds and securities.

In August 2004, the Federal Law on Amendment of the Federal Law on Insolvency of Credit Institutions (aimed at upgrading of legal regulation in respect of bankruptcy prevention and bankruptcy proceedings of credit institutions) was passed.

In July 2004, the Government of the RF approved in principle the draft Strategy of Development of the Banking Sector in the RF.

The Federal Law on Amendment of the Federal Law on Insurance Operations in the Russian Federation (aimed at ensuring of a higher share [up to 25%] of foreign capital in the charter capital of Russian insurance companies and removal of a number of limitations imposed on insurance companies in which foreign investment accounted for 49% of the charter capital) contributed to a greater transparency of the insurance market. In addition to the above, within restructuring of the banking sector and implementation of the strategy of development of the banking sector it was planned to ensure a nondiscriminatory access for foreign capital to the Russian banking sector.

Standard&Poor's (an international rating agency) raised Russia's long-term sovereign credit rating in foreign currency from BB+ to BBB-. The last level according to the S&P methods was considered the first one in the so-called investment category. As other international rating agencies, such as Moody's and Fitch Rating raised Russia's rating to the above level, it can be stated that the three leading rating agencies included Russia into the "investment" category. However, recognizing positive changes in dynamics of economic growth, foreign economic activities and fiscal policy S&P experts pointed to existing high political risks, non-transparency of business and slow progress in institutional reforms.

With upgrading of Russia's rating to the investment level, Russia can expect better borrowing terms on international capital markets. Such a situation can permit to a certain extent relieve strain of temporary high foreign debt payments on dynamics of economic growth and adjust a mechanism of investment regulation. Concurrently, real prospects will arise for growth in capital flows in Russia by portfolio institutional investors, which are re-214

quired to invest only in instruments having an investment rating. With growth rates within a range of 7% a year, the Russian market is attractive enough to foreign investors. At the same time, with Russia assigned the investment rating new problems may arise. In a situation of a better investment climate (judging by formal factors), the Russian financial market may become dependent to a greater extent on fluctuations on international foreign exchange and securities markets.

Foreign investments in Russian economy

The economic development in the recent four (4) years is characterized by growing volumes of foreign investments into the Russian economy with regard to the GDP dynamics and the business activity indicators of domestic investors. As compared against the year of 2003, the volume of foreign investments experienced a 36.4% growth thus comprising 40.5 bln US dollars (Table 23). Positive influence on increasing the investment attractiveness degree of the Russian economy in 2004 was exerted due to raising by the respective international rating agencies of the sovereign crediting rating of Russia up to the level of investing.

Formed in 2003, the trend towards increase in the share of direct investments still remain preserved. The increment of direct foreign investments in 2004 comprised 138.9% and their respective share grew up to 23.3%. The share of other investments in the aggregate foreign investments into the Russian Federation in the year of 2004 remained at the level of 75.8% and the portfolio ones went down to 0.8%.

Table 23

Volume of foreign investments into the non financial sector of the economy of Russia by kinds*

in mln dollars in % to the preceding year

Year Total Direct Portfolio Others Total Direct Portfolio Others

2000 10 958 4 429 145 6 384 114.6 104.0 467.7 121.2

2001 14 258 3 980 451 9 827 130.1 89.9 311.0 153.9

2002 19 780 4 002 472 15 306 138.7 100.6 104.7 155.8

2003 29 699 6 781 401 22 517 150.1 169.4 85.0 147.1

2004 40 509 9 420 333 30 756 136.4 138.9 83.0 136.6

* With no account taken of the money credit regulating bodies and the commercial and saving banks,

including the rouble investments, re-counted in the US dollars. Source: The Federal Service of the state Statistics.

It is for the second year running that the volumes of the foreign investments into the Russian economy outstrip such of the business activities of Russian investors in foreign countries (Fig. 1). In 2004, the value of foreign investments in the Russian economy exceeded Russian investments into foreign countries by 6.74 bln US dollars. In 2003, the same indicator was estimated as 6.44 bln US dollars.

Fig. 43. Foreign investments in the Russian Federation and investments from the Russian Federation abroad in 2000-2004

As of the end of December, 2004, the foreign capital accumulated in the non finance sector of the Russian economy, comprised 82 bln US dollars which is 43.8% higher than the indicator as of January 1, 2004. The structure of foreign investments accumulated as of the end of December, 2004, is predominated by other investments which account for 54.0% (as of January 1, 2004, this indicator was estimated as 51.7%). A similar indicator for the direct foreign investments comprised 44.1% (January 1, 2004 - 45.8%).

According to the results of 2004, the leaders in the total volume of the accumulated foreign investments were Cyprus, Netherlands, Luxembourg, Germany and the Great Britain whose share comprised 67.9% (the year of 2003 - 57.1%) (see Table 24). The top five investing countries also account for 64.5% of direct investments (the year of 2003 -51.4%), 48.9% of portfolio investments(the year of 2003 - 73.0%) and 71.3% of other investments (the year of 2003 - 61.4%).

Table 24

Foreign investments in the economy of Russia by the main countries - investors, in mln US dollars

Accumulated by 01.01.2005_Accumulated by 01.01.2004

Total Direct Portfolio Others Total Direct Portfolio Others

USA 6624 4310 41 8 1896 5296 4297 41 958

Germany 9324 2550 8 6766 10204 2542 383 7279

France 3 874 433 0.3 3 441 4776 331 0.1 4445

Gr. Britain 8673 1602 1 42 6929 7220 2828 107 4285

Cyprus 13790 10094 585 3111 8085 5037 547 2501

Netherlands 11996 8805 43 3148 3575 2796 5 774

Luxembourg 11880 263 1 11616 3464 222 1 3241

Other states 15836 8090 396 7350 14394 8078 344.9 5971

Total 81997 36147 593 44257 57014 26131 1429 29454

Source: The Federal service of the state statistics.

In 2004, like in the preceding year, the concentration of foreign investments in the two spheres of the Russian economy, that is in industry and in the sphere of trade and public catering, remained preserved. The highest growth rates of foreign investments in 2004 at that, were observed in the sphere of finance, crediting and insurance. Distribution of foreign investments by the basic industries of the Russian economy is presented in Table 25. Definitely positive is the fact that the growth of investments in industry remained preserved in the year of 2004 as well.

Table 25

Branch structure of foreign investments in the Russian economy in 2002-2004

In mln dollars. In % to the total

2002 2003 2004 2002 2003 2004

1 2 3 4 5 6 7

Industry 7 332 12 330 20 170 37.1 41.5 49.8

Transport & communication 610 1 083 2 033 3.1 3.6 5.0

Trade & public catering e 8 800 10 516 13 037* 44.5 35.4 32.2

Commercial activities for servicing the market 1 355 3 403 2572** 6.9 11.5 6.3

Finance, credit, insurance provision of pensions 130 640 1 001*** 0.7 2.2 2.5

Other branches 1 553 1 727 1 697 7.9 5.8 4.2

* In connection with the changed procedure of providing information by the RF Rosstat (The Federal Service of the State Statistics) in 2005, the column contains data on foreign investments for organizations whose main business activities are "wholesale and retail trade, repair of the transport means, motorcycles, domestic goods and personal usage goods".

**This column contains data on foreign investments for organisations whose main business activities are "commercial operations with real estate, renting and provision of services".

*** This column contains data on foreign investments for organizations dealing with financial activities. Source: Federal Service of the State Statistics.

Other industries - 27.4

Metallurgy productio and production of metallurgy goods-25.3

Extraction of energy and fuel fossils -43.5

Chemical production 3.8

Fig. 44. Branch structure of foreign investments in industry in 2004, %

Like in the year of 2003, the structure of foreign investments into industry is characterized by a higher share of direct investments (the year of 2004 - 34.7%) as compared against the corresponding structure of the total volume of foreign investments into the Russian economy.

Significant changes in the structure of foreign investments in a number of industrial branches were observed in 2004. The specific weight of direct investments in the chemical industry in 2004 grew up to 31.1% while in 2003 it comprised but only 19.1%. A similar situation was observed in the metallurgy industry - the share of direct investments in this industry increased more than 6 times over and comprised 22.4%.

Considerable growth of investments in the fuel industry (about 65%) resulted in changes in the regional structure of foreign investments into the Russian economy. The volume of investments in Moscow, for instance, remained at the level of 2003 while such foreign investments in the Tyumen region within the period of 9 months of the year of 2004 comprised 4.7 bln US dollars which is 3.1 times more as compared against the same period of 2003. A similar indicator for the Khanty - Mansi administrative okrug (AP) is estimated to be in the amount of 3.9 bln US dollars which is 2.7 times higher than such level in 2003. On the whole, foreign investments in Saint Petersburg grew in 2004 by 41.6% as compared against such in 2003 (up to 985.1 mln US dollars) and by 44% in the Littoral Region (up to 65 mln US dollars).

The leading position in the geographic structure of foreign investments into the Russian economy belongs to Luxembourg whose share comprises 20.8% of the total volume of foreign investments in the Russian economy in the year of 2004, the second place takes the Great Britain - 17.3% of the total volume (Fig. 45).

Fig.45. Geographic structure of foreign investments in the Russian economy

in 2002-2004

In 2004, investors from Luxembourg increased their investments into Russian economy 3.8 times while investments from Netherlands during the same period grew up to 2.9 times. The most significant reduction of investments in 2004 was observed among the German investors. Relevant investments from Germany in the period under consideration

comprised 1.7 bln US dollars (4.3 bln US dollars in 2003). French investments in Russian economy also reduced down to 2.3 bln US dollars (from 3.7 bln US dollars in 2003). Differences in the dynamics of investments from various countries resulted in significant changes of the geographic structure of foreign investments in Russian economy. The specific weight of Germany, for example, went down from 14.5% in 2003 to 4.3% in 2004, such for France decreased from 12.5% down to 5.8%, Netherlands increased their share from 5.9% up to 12.6%, Luxembourg increased it from 7.5% up to 20.8%.

The year of 2004 also witnessed changes in the branch priorities of foreign investors from different countries. For instance, in the year of 2003, investors from Luxembourg usually invested in the trade public catering (60.1 of total investments from Luxembourg in the Russian Federation in 2003) and in the metallurgy industry (35.2%), but in 2004, they already gave preference to the extractive industry (45.2% of the total investments from Luxembourg into the Russian Federation in 2004), to the communication enterprises and to the sphere of trade (35.4%).

Entrepreneurs from the Great Britain considerably lowered down their investments into the general commercial activities for ensuring market functioning in the year of 2004. At that, they also increased investing into the sphere of trade (from 39.6% in 2003 up to 53.4% in 2004) and in the metallurgy industry (from 10.3% up to 19.8%). The share of the communication industry in the investments from the Great Britain accounts for 6% (any data on investments in communication in the year of 2003 are not available).

In 2003, a priority industry for the investors from France was the fuel industry into which they invested 2.7 bln US dollars or 72.5% of the total investments from France into the RF in 2003. In the year of 2004, the share of trade in the French investments into the Russian economy grew up to 55%.

3.4. Russian agrifood sector: basic trends in 2004

3.4.1. Exhaustion of growth factors and dichotomy forming in the sector

The Russian agrifood sector performance in 2004 definitely indicates that the period of recuperative growth launched by 1998 crisis is over. Both agriculture and food industry stopped growing (Fig. 1 and Fig. 2).

In recent years the basic growth factor in the sector has been the shelter of domestic market from import due to devaluated ruble. Larger exports can also be attributed to this factor (although to a lesser extent). But beginning from 2000 the deficit of agrifood trade started to build up again. Given the agrifood imports' growth rates throughout the last year, their annual value in 2004 will surpass the 1998 indicators. In this situation the government attempts to extend the factor's effect by strengthening trade protectionism. Year after year budget support to agriculture in real terms diminishes while the overall level of protection (estimated by PSE4) increases quite intensely. In other words, on the national level the government tries to prolong growth in the sector by protecting it from import. Indeed, in recent years the weighted average import duty5 on agrifood items got higher (in 2002 it amounted to 13.2%, in 2003 - to 15.3%6), meat quotas, duties on import of rice and other commodities were introduced, cases of non-tariffs barriers to import became more frequent.

4 PSE - producer support estimate is a complex indicator of state support's level. It includes both budget transfers to farm producers and price transfer - the result of measures leading to higher prices for agricultural commodities (including trade protectionism tools).

5 Ad valorem part without specific component.

6 IET estimates.

However, all these measures have failed to improve the sector's performance - the average growth rates are falling at a high pace. Production indicators in some agricultural sub-sectors deteriorate. Although the output of many farm crops in 2004 exceeds the level of extremely poor-crop 2003, it still remains quite low as compared with previous years (Fig. 3). Production of basic livestock products decreases as well, the only exception being poultry the output of which grows by 15-19% per annum for already several years.

Does this mean that opportunities opened before the Russian agrifood sector after 1998 have been fully missed? We find that it's not exactly so. The above mentioned facts reflect the situation in domestic agrifood sector at large. However, from the Soviet period it inherited quite a lot of marginal producers that long remained afloat due to soft budget constraints, lack of efficient bankruptcy mechanism, non-developed land market and other market reform failures. Actually, the sector is rapidly polarizing: on the one side, we witness the emergence of quite competitive producers that succeeded in modernizing technologies, management and production structure within the short respite after 1998; on the other side, enterprises for which the period of recuperative growth only protracted the dying agony still continue operating.

This process is most apparent in agriculture where bankruptcy of enterprises is coupled with acute social problem and poor legislative basis. One can surely assert that two segments shaped in the sector presently referred to as "agriculture": farm production proper characterized by larger output, higher productivity and modernization, and the segment of former Soviet agricultural enterprises that became marginal producers and currently survive only thanks to state support at all levels having just one goal - to provide a source of income for local population. In fact, the second segment cannot be regarded as a part of the sector, and these are its performance indicators that pull the national averages of growth and productivity down. This assertion is supported by a lot of indirect evidences that will be described below.

First of all, agricultural production is quite clearly concentrating in a limited number of producers (Table 26). For instance, the top 100 companies account for the following shares in output: grain - 4% before the crisis and over 8% after the crisis, sugar beets -less than 15% and over 20%, respectively. This concentration is even more apparent in livestock production. Before the crisis the top 50 companies produced 15% of poultry, today - over one half; the top 100 pig producers accounted for 22% of output before 1998, presently - also for over one half.

According to estimates of V. Uzun7 slightly over 40% of financially viable farm producers account for about 75% of the sector's commodity output (in 2002 42% of farms were profitable, in 2003 - 49%). The research of M.Grazhdaninova8 showed that about one half of agricultural producers is situated on the production possibility frontier while the other half is within this frontier. In other words, the output produced by one half of farm producers using available resources is much smaller than the one currently possible in Russia (i.e. the one produced using similar resources by the other half of producers).

One more interesting sign of production concentration can be detected on the regional level - it's a striking change of grain yields by weeks of harvesting. During the first weeks of harvesting average yield indicators are the highest since they reflect perform-

7 V.Uzun. Large and small business in the Russian agriculture: adjustment to market and efficiency. Moscow, 2004. Proceedings of IET conference "Social and economic transformation in the CIS countries: achievements and problems" held on September 13-15, 2004. Mimeo.

8 M.Grazhdaninova. Factors of agricultural production efficiency in the Russian transitional economy. Ph.D. dissertation paper. 2004, IET.

ance in the southern, most fertile regions. Later the average starts to encompass indicators of regions situated to the north where yields are lower, and respectively begins to slide down. In previous years the decrease was rather smooth but in 2004 the difference between southern and other regions was very impressive (Fig. 6) evidencing a qualitative leap in grain productivity. Production of milk is also gradually concentrating: in 2000 the top 10 regions accounted for 12% of its gross output, in 2004 - for already over 15%.

Investments grow both in agriculture and in food industry (Fig. 4 and 5). In case the agrifood sector really plunged into a crisis, it wouldn't attract capital. But given the above mentioned dichotomy of the sector, it becomes clear that investments are made in its efficient part.

Moreover, production of farm machinery again started growing (Table 27). Since its export is very limited, this supplement is consumed by the domestic market. Machinery is also purchased by the part of agricultural producers that are most efficient and dynamically developing.

One can draw some conclusions about these producers on the basis of foreign investments' dynamics. Fig. 5 shows that in the past two years the share of portfolio investments in agriculture noticeably grew - quite a strange phenomenon for traditional farming since shares of major producers are not quoted on the stock market. The matter is that new farm producers named agriholdings emerged in Russia. These are large corporations that among others have agricultural departments in their structure. Shares of such holdings are quite quotable on the stock markets, some of them - even on the world markets (e.g. those of Wimm-Bill-Dann company).

The second - non-efficient - part of farm producers gradually shrinks. Some of these enterprises simply get closed, others either improve efficiency or get into more efficient hands and thus also become more efficient. Before 2003 the number of agricultural enterprises grew, first of all due to the creation of parallel entities to which non-indebted assets were transferred. Loss-making farms were the primary initiators of such new farms' foundation, and accordingly the share of loss-making entities was growing (Table 28). In 2003 the number of loss-making farms reduced by 2800: on the one hand, price parity improved helping 1500 more farms to end the year with positive balance and, on the other hand, 1300 failed farms (or 4.5%) were liquidated. As a result the share of profitable farms grew.

As mentioned above, the bulk of liquidated farms are a kind of bridge enterprises intended to solve the problem of indebtedness. However, in the current situation mass bankruptcy of marginal farms will soon start leading to their liquidation. The developments in recent years show that agrarian protectionism fails to solve the problem. Thus the present-day agricultural policies should be urgently retargeted at solving problems of this part of agriculture, or, to be more exact, of the former agriculture. First of all, the problems of reemployment and social rehabilitation of people in these areas as well as of efficient use of other released factors of agricultural production should be addressed. But so far the policy is targeted at supporting loss-making farms. For instance, in 2003 subsidies to agriculture exceeded the sector's net result 1.6 fold (in 2002 the ratio was even more striking - 24 fold!). This means that the only sources of covering expenses in some farms were subsidies and credit defaults that in fact are also subsidies.

Table 26

Concentration of agricultural production

Share of the top 100 farm producers in the commodity output, %

2000-2002 1996-1998

Grain 8.3 4

Sunflower seeds 16.6 10

Sugar beets 20.7 14.8

Potatoes 35.5 16.2

Vegetables 54.9 40.4

Milk 9.8 3.9

Beef 9.2 3.5

Pork 54 22.1

Poultry meat (top 50 farms) 58.3 15.5

Eggs 60.8 54.6

Source: V.Uzun. Large and small business in the Russian agriculture: adjustment to market and efficiency. Moscow, 2004. Mimeo.

Table 27

Production of agricultural inputs (as % of the previous year)

2000 2001 2002 2003 2004 2004 as % of 1990

Tractors 137.2 78.8 63.5 87.3 107.5 4.1

Tractor ploughs 170.8 113 68.9 44.6 124.3 1.4

Tractor seeders 166.9 122 82.2 77.4 137.4 11.2

Grain harvesters 2.2 fold 174.3 83.4 80.4 145.4 12.0

Mineral fertilizers 106.2 106.9 104 103 111.5 98.1

Source: Social and economic situation in Russia (respective years).

Table 28

Financial performance of agricultural enterprises

2000 2001 2002 2003

Number of farms, thousand 28.5 29.6 29.9 28.6

Number of profitable farms, thousand 13.3 13.0 12.5* 14.0*

Number of loss-making farms, thousand 15.2 16.0 17.4* 14.6

Share of profitable farms in the total number of farms, % 47 44 42 49

Overall profitability (including subsidies and compensations), % 6.7 9.2 0.2 3.0

Net overall income of farms (including budget subsidies), million rubles 13858 23922 621 10128

Including subsidies from the budget, million rubles 8952 12051 15006 16824

Subsidies as % of net income 64.5 50.3 2416 166.1

Returns from marketing all products, billion rubles 232 299 317 362

* The original data is adjusted by 5% as it seems to contain an arithmetic error.

Source: calculated using data at http://www.mcx.ru/dep_doc.html?he_id=797&doc_id=4868

Table 29

The incidence of insured events in the sampled farms

2002 2003

Number of positive responses 23 33

as % of the total number of insured farms 79 83

Number of negative responses 14 10

including given by insured farms 6 5*

as % of the total number of insured farms 21 12*

including given by non-insured farms 8 5

as % of the total number of non-insured farms 57 83

* 4 of the insured farms did not answer this question.

Source: results of the sample survey conducted by the AFE Centre in Perm oblast in 2004, 49 agricultural enterprises.

10

5 0 -5 -10 -15 -20 -25 -30

Source: Federal Service of State Statistics.

Fig. 46. Russian agriculture: percent change of annual output in 1985-2004

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Fig. 47. Russian food industry: percent change of annual output in 1986-2004

120 100 80 60 40 -20 0

+

+

+

+

+

+

+

+

-J- 30 25 20 15 10 5 0

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

sugar beets 'sunflower seeds

grain (left axis)

Source: Federal Service of State Statistics.

Fig. 48. Gross output of basic farm crops (million tons)

agriculture industry

Source: Economic Journal of the Highest School of Economics.

Fig. 49. Investments in agrifood sector's fixed capital (constant 1995 prices)

foreign investments in Russian agriculture including direct investments

Source: Economic Journal of the Highest School of Economics.

Fig. 50. Foreign investments in Russian agriculture

36 34 32 30 28 26 4 24 22 20 18

3 2

0 3

w w -I—» w -I—» w

3 3 3 3

ro ro ra ro

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Source: WJ Review. Weekly Journal. No. 30, November 9, 2004.

Fig. 51. Average grain (except corn) yields in agricultural enterprises by weeks during harvesting, cwt/ha

zw? ZOO^

Livestock and poultry for slaughter (live weight) Milk

Source: Federal Service of State Statistics.

Fig. 52. Production of basic livestock products (as % of the previous month)

3.4.2. Basic shifts in domestic support to agriculture

Transfer of agricultural regulation authority to the regional level

In 2004 the decision was taken to transfer farm support authority to the regional level9. As a result only one tool is left for federal bodies to regulate agriculture - implementation of departmental budget programs of supporting the sector. These programs are to become the primary form of state regulation on the federal level. At the same time it's necessary to find ways for limiting those activities of regional administrations that may lead to the destruction of nation-wide market of agricultural and food products. One of such ways was proposed in the draft Federal Law "On agricultural development and agrifood policy". But in 2004 this document hasn't been adopted.

The granting to regions of exclusive powers to regulate agriculture will have the most destructive effect on the sector. First of all, regions-donors able to finance support to agriculture on their territories are primarily located in the climatic zones that are the least fit for farming. Thus the shifting of farm support's gravity center from the federal to regional level implies encouraging of non-efficient resource utilization in agricultural production. Second, for already many years regional support results in "trade wars" between regions, attempts to oust neighbors from the market by means of direct subsidies to local producers, bans on agricultural and food products' transit, etc. In other words, this decision of the RF Government brings in the domestic market all the negative effects of protectionism on the world agricultural markets that the WTO Agreement on Agriculture strives to eliminate (by the way, Russia wants to join this organization with its anti-protectionism principles).

9 In compliance with the Federal Law "On introducing amendments to the Federal Law "On general principles of organization of legislative and executive bodies of state power in constituent members of the Russian Federation"" No. 95-FZ.

One more outcome of this decision will be the broadening of state intervention in agrifood markets. In 2004 this trend could already be observed, primarily on the regional level. On the federal level beginning from 2005 the number of applied regulation programs reduced while the share of expenditures on general services is up (Table 30 and Table 31). On the contrary, on the regional level all the increase of expenditures (Fig. 10) goes to direct support implying state intervention in agricultural and food markets. The structure of agrifood sector regulation in most regions becomes more complicated, the number of programs and spheres of regulation grows. The hardening of administrative pressure on agrifood markets and the emergence of barriers to inter-regional trade will be the inevitable outcomes of funding authority's transfer to the regional level.

The government's refrain from any long-term commitments as a factor of instability in the sector

The draft Law "On agricultural development and agrifood policy" suggested the shift to medium-term budget planning as an important tool for improving the efficiency of budget expenditures on the agrifood sector. At present some stability has settled in the sector and economic entities plan their activities 3-5 years ahead, while the term of government regulations is only one year and thus they cannot be taken into account when making production decisions. The draft Law suggested the adoption of 3-year-term programs of farm support that would contain principal amounts of budget expenditures under the program, foreign trade regulation baselines for the period of its implementation, intervention prices on the grain market and other essentials needed by the economic entities. At the same time the Ministry of Agriculture would have an opportunity to revise the adopted indicators in case the market situation changes but not more than by 10-15%. Besides, the annual budget provisions would allow 10-15% deviations for meeting changes in the financial situation.

However, the draft Law provisions pertaining to medium-term planning of budget expenditures were not supported by federal bodies, and the passage of the Law was suspended. The main cause thereof was the financial authorities' refrain from any medium-term commitments undermining the sector's stability and hindering the creation of preconditions for long-term growth. Besides, when medium-term programs of farm support are not backed up by budget commitments and any concrete figures at all their efficiency cannot be estimated since it depends on the amount of funds that will be spent. This reveals a declarative nature of the administrative reform currently underway and the reform of budget financing both from the point of view of transfer to result-oriented budgeting and of medium-term planning of budget expenditures.

Reform of budget classifier and budget process in the agrifood sector

The reform of budget classifier in force from January 1, 2005 has not solved the problems engendered by the effective system of classifying budget expenditures on agriculture that has long become a hindrance to raising the efficiency of domestic state support to the sector.

The classifier determines the structure of budget expenditures largely focused on direct subsidizing of farm producers that distorts the market. At the same time there are no articles envisaging expenditures on budget services and development of institutional infrastructure; expenditures on science, education, social policy and other measures important for the sector's development but not implying direct government intervention are not transparent. Due to the classifier's non-flexibility, the budget year after year includes pro-

grams the efficiency of which is not appraised and respective expenditures are not revised remaining constant in nominal terms.

The reform of budget classifier in the process of drafting 2005 budget has actually skipped agricultural articles and failed to solve the problems that accumulated in this field. The only positive shift is that specific programs supporting crop and livestock production are no longer named in the budget - such programs as "subsidies to flex and hemp producers", "subsidies to wool producers", etc. have long been found non-efficient and got funds only due to the preservation of respective articles in the budget.

Other problems of budget classifier remain unsolved. Its reform is a compulsory condition for Russia's accession to WTO and for improving the efficiency of budget expenditures on agriculture.

Table 30

Structure of federal budget expenditures on agriculture (thousand rubles)

2000

2001

2002

2003

2004 2005

2005

2005

execution

execu- execu- execution tion tion

plan

draft

as % of 2004

structure

Agricultural production (subsidies)

Land resources State support of grain inspection institutions Investments in authorized capital of the leasing company Forming of authorized capital of Rosselkhozbank (Russian Agricultural Bank) Science

Russian Academy of Agricultural Sciences Education

Fixed capital investments (from 2002 - in agricultural production, in 2005 - non-program investments and construction) Fixed capital investments / Special federal program "Soil fertility improvement in Russia in 2002-2005" Ministry staff International activities Healthcare Social policies Financial assistance to regional and local budgets including: Special federal program "Rural social development till 2010" Other expenditures Total expenditures on agriculture

6608 12468 20281 6 699 6 959 1 347 41 57 98

22365 1401 138

870

24689

1 985 153

2 000

22602 2209 0

0

92 111 0

0

53 5 0

2 000 1 420 850 0 0 0

113 187 172 200 213 301 142 1

739 1 056 1 496 1747 1 991 2319 116 5

2 929 3 751 5 350 6461 7 817 8548 109 20

711 347 247 1 1 46 0 2435 6

1884 4

99 129 1 42 167 266 378 1 42 1

16 0 365 713 10 1 0

12 13 14 107 0

4 5 5 0 0 0

374 2 1634 67 0 0 0

2172 5

96 33 0.4 0 0 0

18 036 27 349 30 555 37 361 39 911 42 872 107 100

Source: RF Ministry of Finance.

0

Table 31

Subsidies to agriculture (million rubles)

2000 2001 2002 2003 2004 2005 2005 2005

execu- execu- execu- execu- plan draft as % of struc-

tion tion tion tion 2004 ture

Support to livestock production 603 945 1 100 1 194 1 195 745 62 3

including: 0

Pedigree stock-breeding 298 619 703 744 745 745 100 3

Subsidies to wool producers 142 256 327 350 350 0 0

Reindeer breeding 70 70 100 100 0 0

Purchase of formula feeds 162 0

Support to crop production 223 554 622 1 170 2 270 2670 118 12

including:

Elite seed growing 68 248 270 270 270 770 285 3

Subsidies to producers of flax and hemp 72 85 67 100 100 0 0

Partial compensation of

expenditures on crop in- - 222 285 800 1 900 1900 100 8

surance

Other expenditures including: Building of federal reserve 2 998 686 5 530 2 153 2 733 1754 64 8

0

of veterinary drugs

Subsidies to waste dis- 3 39 40 45 0

posal plants

Centralized delivery of

seeds to northern and 1 40 200 0

mountain regions

Subsidies to horticulture and grape growing 300 400 0

Building of pesticide reserve 300 300 0

Creation of leasing fund 2 624 5 500 2 780 0

Building of federal seed reserve 100 150 150 80 0

Fixed capital expenditures 865 864 0

Other 275 647 955 344 0

Maintenance of subordinate institutions 2 505 2 888 6 144 8 964 9 291 9531 103 42

Environment protection 59 100 0

Subsidizing of interest on credits 1 627 2 017 3 200 3 200 5370 168 24

Including: short-term credits 1 400 2 000 0 0

Long-term credits 617 1 200 0 0

out of them: credits on

construction of port eleva- 130 0 0

tors

Seasonal crediting -37 0 0

Program "Soil fertility improvement" - 4 767 4 531 4 530 1683 37 7

including: 0 0

2000 2001 2002 2003 2004 2005 2005 2005

execu- execu- execu- execu- , . .. as % of struc-

pian draft

tion tion tion tion 2004 ture

Partial compensation of 83* 237 2 100 0 0

mineral fertilizers' cost

Special federal program

"Rural social develop- 1470 1 470 1 ** 0 0

ment"

Subventions for financing

food grain purchase inter- 1152 0 250 1

ventions

State administration ex- 518

penditures

Support to individual 2 0 0

farmers

Total 6 297 12 468 20 281 22 365 24 689 22602 92 100

* in 2000 purchase of mineral fertilizers was subsidized not under the program "Soil fertility improvement". ** in 2005 this item includes only direct subsidies in the framework of this program while investment expenditures are presented in Table 33. Source: RF Ministry of Finance.

Table 32

Investments in Leasing fund from the federal budget (prior to 1997 - billion rubles, after 1998 - million rubles)

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

Plan 1000 1351 2700 2400 2000 2280 2624 3000 0 870 2000

Actual allocations 1053.6 1080.6 1928.9 736.6 1007 2241 2624 5 500 0 870 n.a.

Source: RF Ministry of Finance.

50 000

40 000 -

30 000 - ^ -----■

20 000 - - * .

^ -f- * -♦

10 000

1999 2000 2001 2002 2003 2004 2005

—♦^Federal agricultural budget — ■■ - Consolidated agricultural budget

Source: RF Ministry of Finance.

Fig.53. Consolidated and federal budget expenditures on agriculture, million rubles in constant 1999 prices (2004 - estimate)

Source: IET calculations.

Fig. 54. Producer support estimate (PSE), %

2004 (January-November) 2003 2002

2001

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% □ Federal ■ Regional ■ Local

Source: RF Ministry of Finance.

Fig. 55. Structure of consolidated budget support to agriculture

3.4.3. Basic trends in agrifood foreign trade

The persistence of negative trade balance

Russia still remains a net importer of agricultural and food products: in 2004 agrifood imports exceeded respective exports 5.4 fold10.

Average foreign trade indicators of the sector at large do not demonstrate any apparent trends towards reduction of agrifood trade's negative balance. Imports continued to steadily grow while exports were hampered by toughened export regulations and unfavourable for Russian grain exporters situation on the world market (Fig. 56). In previous years the growth of imports was partially set off by expanding export supplies. In January-

10 January-September 2004.

September 2004 agrifood exports were 11% below the corresponding 2003 indicator while imports were up 10.8%.

Trade indicators by selected commodities look more optimistic: despite smaller exports Russia continues to be a net exporter of sunflower seeds, wheat and wheat flour (Table 36). Exports of chocolate products, condensed milk and cream are growing. Active supplies of sunflower oil to foreign markets shortened the gap between its exports and imports. But from the price point of view Russia is still more competitive in exporting the raw input (sunflower seeds) than in exporting the finished product (sunflower oil). A new trend in the oilseeds market is the growing export of rapeseeds and rapeseed oil from Russia. In 2003/2004 marketing year exports of rapeseeds were up 77.8%". In recent time the world market of this crop is actively developing. Rapeseeds have become the third by their share in the world production of oilseed crops.

Meat quotas

As mentioned before, the main efforts of the government's agricultural policies are currently targeted at the protection of domestic market from agrifood import. Sugar and meat continued to be the primary objects of foreign trade regulation in 2004.

Quotas on import of meat to Russia (tariff quota on beef and pork and absolute quota on poultry meat) introduced in 2003 were maintained. Meat quotas concern a large number of operators on this market. Meat is a very heterogeneous product and many other products are produced out of it. Thus the distribution of quotas and amending of its mechanism raised a lot of debate on all levels of state governance throughout all the period of their action. Let's examine whether these quotas were efficient and have they really brought the desired result, i.e. the growth of domestic production.

As we have supposed, such a constraint fails to support domestic producers. First, the quota is not applied to meat products and, second, it's not applied to the CIS countries.

Despite the introduction of quotas the decline in livestock production hasn't been halted. Only poultry production is growing but this growth started before the enforcement of quotas and the latter hasn't led to its acceleration.

Imports of raw meat to Russia from the non-CIS countries are falling (Table 38). This trend was most obvious in the first year of meat quotas' application (2003). In 2004 imports of pork and beef to the Russian market were down slightly (by 10%) but still remained approximately the same as in the previous years when quotas were not applied.

The introduction of quotas on meat import from the non-CIS countries was accompanied by larger supplies from the CIS. But in 2004 they fell as well. The principal cause thereof is that after a heated discussion of problems entailed by escalating "grey" import of meat from the CIS (in fact originating from other countries) customs bodies stiffened control over supplies from these states. Besides, raw meat supplied by them is much more expensive than that from the non-CIS countries and thus processors' demand for it is limited (Table 39).

At the same time the decline of raw meat imports was outweighed by growing supplies of meat products, especially from the CIS countries (Table 38). So, Russia has actually introduced a regression scale of import duty. All countries strive to strengthen tariff protection as degree of processing grows while the introduction of meat quotas in Russia stimulated import of processed products and discouraged import of raw meat.

11 WJ Inter Agro.

232

The result was the increase of CIS share in meat import value from 9% in 2002 (before the introduction of quotas) to 10.5-12% in 2003-2004 (for meat products - up to 37% in the first half of 2004). Since prices for raw meat from the CIS are much higher than those paid to the non-CIS countries (Table 39), prices for meat products manufactured out of this input on the average grow.

So, meat quotas introduced by Russia in 2003 have led neither to larger domestic production nor to smaller imports. At the same time they entailed change in the structure of meat import (larger shares of finished meat products and supplies from the CIS) that was one, although not the only, factor of price growth on the domestic market.

Variable import duty on raw sugar

In December 2003 a new mechanism of sugar market regulation was introduced in Russia - the variable import tariff. It actually sets the level of raw sugar support price at 470 US dollars per ton presuming that the basis of "Caribbean Sea - Krasnodar region" deliveries is 100 dollars per ton. The world price is determined on the basis of New York Board of Trade (CSCE/NYCE) quotations. The principal formula for calculating the size of duty is as follows: the support price less delivery basis and less the average monthly price for raw sugar at the exchange. Since the first two variables are fixed, the duty is determined by the world price: the higher it is, the lower is the duty and vice versa. So, the world market fluctuations are mitigated on the domestic market ensuring certain stability for both buyers and sellers.

But in fact the calculation of import duty on raw sugar bases upon price that established at the exchange 2 months ago. This mechanism does help to level off import prices to some extent. But the effect is much smaller than it could be in case of a 1-month span (Fig. 57).

Besides, the effect of the variable duty is lessened by the actual lack of constraints on import of sugar from the CIS countries accounting for 90% of the total Russia's sugar imports. In January-October 2004 the volume of CIS supplies was almost twice above the corresponding previous year indicators. In order to settle the problem customs control over import of sugar from these countries was stiffened by means of taking samples to prove the commodity's origin. But this measure will hardly solve the problem since in case of a favourable ratio between prices for imported and for domestic sugar countries of the Commonwealth will satisfy their markets' demand by importing the product while the home-grown sugar will be exported to Russia.

In order to synchronize measures on regulating import of selected sugar-based products the term of tariff thereon (230 EUR/ton) was extended.

Similar to the end of 2003, sugar market operators till the last moment were not sure about the customs regime to be effective in the coming year, and this uncertainty produced a highly destabilizing effect on the market. The Resolution on sugar import regulation in 2005 was adopted only in the middle of December. The new regulation scheme actually copies the previous one with just one exception: the period for calculating the arithmetical mean of exchange price for raw sugar was extended from one to three months. As shown above, even a 2-month span in determining the size of variable duty diminishes its smoothening effect. In case of the 3-month price averaging this effect will be even smaller, i.e. the variable duty will ultimately loose sense and engaged market operators will insist on regaining quota auctions.

Grain market regulation

For the first time since the start of reforms, at the beginning of 2004 Russia introduced temporary export duties on rye, wheat and their mix, the declared reason being growth of domestic prices for bread. However, as shown in the next section this growth was not caused by poor grain supply on the domestic market. At the same time duties on export of grain could not seriously influence its volume since contracts had been signed earlier and traders had to supply grain to foreign markets despite worse price situation. So, the introduced duties have just deteriorated conditions for export of grain. Still, after their abolition in April export of wheat started to expand at a high rate.

Table 33

Export of basic agricultural and food products (thousand tons)*

9 months 2004

2000 2001 2002 2003 As % of 9 months 2003 Export/ import ratio

Fish, frozen 290.6 324.1 292.8 255.0 67.8 0.4

Wheat and wheat/rye mix 419.0 1635.7 10259.3 7587.9 43.6 3.1

Wheat flour 165.7 n.a. 122.8 288.6 46.2 1.2

Sunflower oil 194.8 115.3 74.2 84.1 195.3 0.8

Sunflower seeds 1114.9 n.a. 86.8 292.1 117.8 16.7

Bread, bakery products and confectionery 34.3 36.9 38.6 52.6 123.6 0.7

Milk and cream, condensed 73.7 45.6 35.0 11.3 121.4 0.8

Chocolate products 25.7 35.1 35.1 42.2 132.4 0.4

* Less trade with Byelorussia.

Source: Customs statistics of FR foreign trade.

Table 34

Import of basic agricultural and food products (thousand tons)*

10 months

2000 2001 2002 2003 2004 as% of 10 months 2003**

Beef 282.3 459.2 504.6 507.8 89.3

Pork 212.9 369.6 602.0 535.2

Poultry meat 687.2 1383.3 1375.2 1190.0 89.6

Butter 45.4 81.4 94.1 114.0 98.8

Sunflower oil 149.5 182.8 175.7 200.8 79.0

Wheat and wheat/rye mix 2631.3 916.2 264.8 640.7 2.3.fold

Raw sugar 4546.6 5410.4 4441.0 4112.0 62.2

White sugar 271.4 143.1 163.2 151.1 179.0

Citrus fruits 472.2 562.1 701.3 781.1 105.0

Coffee 20.3 21.6 25.7 32.0 90.7

Tea 158.3 154.4 165.3 168.9 99.6

* Less trade with Byelorussia. ** Including trade with Byelorussia.

Source: Customs statistics of FR foreign trade, Federal Service of State Statistics.

The import duty on rice and rice products remained in force for the second year. This measure resulted in smaller import supplies and higher import prices. In April-June 2004

the average contract price for imported rice was 30%12 above the January-March indicator and continued to grow in the second half of the year. In the past two years this is the largest increase of price within a 3-month period. Within 2 years (from December 2002 to September 2004) the retail price for polished rice grew by 128% while the aggregate retail price index for food products within the same period was below 120%. Still, the mechanism is preserved.

Table 35

Import of raw meat and meat products after the introduction

of meat quotas (%)

2003/2002 I-IX 2004/I-IX 2003

Total CIS Total CIS

Frozen beef: 106.2 119.1 93.6 69.7

Carcasses and half-carcasses 100.3 101.9 71.5 71.5

Other cuts, non-boned 25.9 100.0 17.7 1.5

Other cuts, boned 119.4 162.8 99.8 67.5

Pork: 88.8 1007.7 82.3 78.0

Carcasses and half-carcasses, fresh or chilled 138.8 - n.a. n.a.

Carcasses and half-carcasses, frozen 96.5 1140.0 64.8 30.6

Pork hams, bladebones and cuts, frozen 53.2 - n.a. n.a.

Other 88.5 500.0 95.0 405.2

Poultry meat: 87.1 145.5 83.4 15.3

Broilers, frozen 61.7 60.0 n.a. n.a.

Broiler parts and sub-products, frozen 93.0 12.9 83.4 25.7

Turkey parts and sub-products, frozen 66.3 - n.a. n.a.

Meat products: 109.5 286.7 152.5 226.0

Sausages 50.9 60.9 n.a. n.a.

Finished and canned products out of meat and sub-products 192.2 522.7 152.5 226.0

Source: calculated using data of the RF State Customs Committee.

Table 36

Average import prices for meat (dollars per ton)

1997 1998 1 999 2000 2001 2002 2003 I-IX 2004

non-CIS

Red meat 1436 1471 958 1072 925 1099 1061 1277

Poultry meat 709 691 651 535 546 589 586 595

CIS

Red meat 1134 1724 1151 1284 1687 1463 1437 1966

Poultry meat 1782 657 1243 816 1340 1108 899 658

Source: calculated using data of the RF State Customs Committee.

12 RF State Customs Committee.

Less trade with Byelorussia.

Source: Customs statistics of FR foreign trade .

Fig. 56. Foreign trade in agricultural and food products (million dollars)

100

80 -I-60 40 20 0 -20 -40 -60 J

June

n-.

July

August September October

□ average import price

□ import price in case of effective tariff (time span - 2 months) ■ import price in case of estimated tariff (time span - 1 month)

Source: Customs statistics of FR foreign trade, Federal Service of State Statistics, IET estimates.

Fig. 57. Increase of average import price for granulated sugar in 2004 (as % of the previous month)

3.4.4. Food markets

In 2004 the retail price rise was the highest for the following products: red meat (especially beef and pork) and poultry, bread, macaroni products and eggs. Price indices for most other products did not deviate much from the aggregate consumer food price index (112.3%), and for some products (sunflower oil, fruits and vegetables, granulated sugar) were even well below it.

Market of bread and bakery products

In 2004 the market of bread and bakery products was greatly influenced by government regulation triggered by accelerated growth of prices for bread and bakery products. This growth started as far back as in April 2003 when price index for these products surpassed the aggregate food price index (Fig. 58).

The growth of prices for bread served the cause for a quite noticeable government intervention in this market in 2004. It was effected in two ways:

• Government Resolution No. 749 of December 11, 2003 for the first time since the start of reform introduced temporary export duties on wheat, rye and their mix;

• From February to June 2004 trade interventions were carried out on the grain market in order to lower prices for food grain and thus to constrain growth of prices for bread. Overall, about 1.5 million tons of soft wheat No. 3 and No. 4 and rye no. A were sold - the volume almost equaling monthly consumption of food grain in the country. This means that each month the market received additionally from 20 to 25% of grain.

The period when prices for bread grew faster than prices for food products at large was rather long and lasted till June 2004. In 2003 prices for bread and bakery products were up 30%, in 2004 - 16.7%.

Despite all the efforts made the growth of prices for bread and bakery products was above the aggregate food price index both in 2003 and 2004 (Table 37). At the same time if we look at the dynamics of bread prices beginning from 1997, we'll see that these prices were the most constrained ones: during this period food prices grew 5.7 fold while prices for bread - 4.4 fold. It's quite natural that at some moment they had to "catch up" with the general price trend (Fig. 67).

The process was triggered by poor grain crop in 2002 and growth of grain prices in 2003. Besides, rising personal incomes, larger GDP and high oil prices formed positive expectations in the economy and to some extent weakened political control of federal and regional authorities over consumer prices. Bread market agents seem to have used grain market fluctuations for liquidating the accumulated arrear of bread prices from the general trend.

The most common explanation for growth of bread prices in 2003-2004 was the growth of prices for grain in poor-crop 2003. Indeed, in March-December 2003 prices for wheat No. 3 did rise 2.5 fold (Fig. 59).

Growth of grain prices continued in 2004 and by March they reached their maximum level - about 6500 rubles per ton of wheat No. 3 which is 2.6 fold above the corresponding indicator of March 2003 (Fig. 60).

Such an upsurge of grain prices could be an explanation for higher prices for bread and bakery products but following this logic the latter should be lowering in the second half of 2004 after grain prices started to fall (Fig. 60). But no such trend was observed. Growth of prices for bread in this period slowed down but hasn't become negative. This is an evidence that the mechanism of price transmission between the market of grain and the market of bread and bakery products is more intricate than a simple linear one.

Noticeable differences between grain and bread price trends are quite natural and comply both with the basic economic postulates and the world practice. Prices on the markets of raw commodities especially the ones quoted on the world commodity exchanges (such as wheat) are much more volatile than prices for perishable day-to-day goods (such as bread) and are shaped by different factors.

The possibility of direct influence of grain prices on the retail prices for bread is also very slim. According to data of the Federal Service of State Statistics the cost of raw materials does not exceed 37% of the retail bread price. In its turn, the cost of raw input (i.e. grain) accounts for only 43% of the cost of flour.

So, even presumed that flour is the only input used for producing bread (such a supposition overvalues the factor's importance), the share of grain cost in the retail price for bread is not more than 16%. This implies the minimum possibility to influence retail prices for bread through regulating grain market in order to cut down prices for grain.

In other words, the cause of higher prices for bread is not the growth of prices for grain due to its shortage. The trend is attributable to factors of other kind, i.e. the specifics of market development and its structure. This conclusion is supported by the fact that production of all other grain products except bread demonstrates quite a steady growth.

Summing up the effect of government regulation of grain market, the introduction of export duties fails to achieve its goal but notably undermines positions of Russian grain traders on the world market that strengthened markedly in 2002/2003. These traders launched large investment projects aimed at creation of export port infrastructure and got support of the government that allocated funds from the federal budget to subsidize interest on credits for construction of port grain loading facilities13.

So, export duties on grain, on the one hand, deteriorate positions of Russian exporters and, on the other hand, have minimal chances to produce an economic effect on retail prices for bread, i.e. are an economically senseless measure.

Let's examine some specifics of the market of bread influencing situation thereon. Bread is an inferior commodity characterized by negative income elasticity of demand. As incomes grow its consumption reduces in favor of meat and dairy products, vegetables and fruits.

The comparison of dynamics of bread and bakery production and production of other food products during the period from 1997 to 2003 proves the negative correlation between personal incomes and consumption of bread in the Russian Federation (Fig. 61 and Fig. 62). For instance, in 1999 bakery industry noticeably grew while meat processing declined following the sharp drop of population's real disposable incomes. In 2000 higher personal incomes entailed growth in meat production and decline in production of bread and bakery products.

Consumption of bread greatly differs by income groups. For instance, families with per member income above 7 thousand rubles are likely to eat bread once a day while families with lower incomes do it much more often (several times a day) (Fig. 63).

Smaller consumption of bread in the richest income groups goes in line with higher quality and packing requirements and readiness to pay more for the product that better conforms with their preferences. The demand for such products is largely satisfied by mini-bakeries, own bakeries of large trading networks ("Ashan", "Ramstor", etc.) and modernized bakery plants. The price for them is at least 1.5 fold, and sometimes even ten fold above the average published by the Federal Service of State Statistics.

13 Supplement No. 36 to Federal Law "On 2003 federal budget"

238

People with monthly per capita income above 7 thousand rubles tend to buy high quality and respectively more expensive bread and bakery products in supermarkets and large general stores while the poorest consumers prefer to do it at street outlets, city markets and small shops offering standard products of standard quality at an affordable price (Fig. 64).

One should note the growing share of better quality products at higher prices in the total sales of bread and bakery products. According to data of RBC (Russian Business Consulting) the share of supermarkets in the total retail trade turnover in Moscow was up from 0.2% in 1999 to 30% in 2003.

The growth of segment of superior quality products results in higher average prices. However, this process contributes to better satisfaction of solvent consumer demand and signifies a qualitative improvement and development of food market basing on advanced production technologies and innovations, up-to-date packing and product promotion.

Market of meat

The mechanism of foreign trade quotas enforced in the middle of 2003 continued to be the factor determining basic trends on the market of meat.

The principal goal of introducing restrictions on import of meat from non-CIS countries was the encouraging of its domestic production.

Given the high share of import in the national consumption, foreign trade measures targeted at the support of domestic producers should be thoroughly elaborated and balanced in order to achieve the declared goal and not to deteriorate situation on the consumer market.

The introduction of quotas was supposed to foster recovery in the livestock sector that suffered the most in the process of reforms. While the contraction of planted areas remained below 30% even in the worst 1998, the number of livestock on the average more than halved and no positive trend can be observed after 1998.

However, in case of a simple reduction of import supplies no due regard is paid to the sectoral and institutional structure of the market resulting in failure to achieve the desired goal. First of all, corporate farms accounted for only 52.3% of the domestic meat output in 2004 while the rest was dispersed by household plots and individual private farms. This production structure remained rather constant throughout recent years. The share of households' produce equals 44.8% of the total output but due to some reasons (first of all the institutional ones) is rarely used by processors. Production in household plots is mostly subsidiary and intended for satisfying family demand rather than supplying to the market, and thus this producer segment is less responsive to market signals.

Besides, livestock (and especially cattle) production is characterized by a long production cycle that is a serious limitation for rapid increase of output as it is. Given the depth of the sector's decline (actually total perishing of pedigree stock-breeding during years after the start of reforms, long period required for restoring pedigree inventories, large investments needed to increase output) the market could not quickly respond by expanding production.

The 2004 indicators show that constraints on import of red meat have not resulted in growth of domestic production. In January-November 2004 output of livestock and poultry for slaughter (live weight) increased by 2.1% but this increase was due to larger output of poultry that made up for the fall of beef and pork output.

The decline in red meat production went in line with a notable drop in both cattle and pig numbers. By December 1, 2004 inventories of cattle in all farms reduced by 6.5% as

compared with the same date in 2003 (of them cows - by 6.3%), inventories of pigs - by 11.3%. Numbers of sheep and goats grew by 3.4%.

Probably, the shown above negative dynamics reflect the general negative trend of the recent years. However, the rates of livestock inventories' decrease in 2003 and especially in 2004 have notably accelerated as compared with after-1998 averages. Such an accelerated decrease might be a producers' strategy - reduction of livestock numbers in order to maximize sales at high prices.

A natural response of the market to smaller meat supplies is the growth of prices for raw meat and finished meat products as well as the search for alternative supply channels and products-substitutes. The growth of prices for meat on the domestic market started in the middle of 2003 and continued in 2004.

It's a common knowledge that consumption of meat products is very price-elastic. Growth of prices for them negatively affects consumption. But at present this effect is constrained by the increase of disposable personal incomes and is mainly materialized in substitution of poultry meat for red meat in the daily ration. Further substitution of the kind will result in an even bigger consumption's lag behind the physiological norm - 80 kg of meat per capita a year (currently the actual consumption is about 50 kg).

Given growth of prices for raw meat and high price elasticity of demand for finished products, many processors decided to create/expand their own input basis. For instance, "Omsk bacon" produces about 2000 tons of pork monthly; "Cherkizovsky" plant announced the purchase of pig breeding farm in Vologda oblast. High prices for meat attract large businesses to the sector: "Agros" and "Agrico" are engaged in livestock production, "Rusagro" reported having created the biggest pig breeding farm in Belgorod oblast that will produce up to 60 thousand tons of pork annually.

Table 37

Price indices for selected groups of food products by the end of period (%)

2004 (as % of the previous month) December December

2004 as % of 2003 as % of

October November December December 2003 December 2002

Bread and bakery products 100.8 100.4 100.4 116.7 130.4

Cereals and beans 100.7 100.3 100.0 111.6 117.0

Pastas 100.5 100.6 100.5 1 1 4.6 1 1 4.0

Meat and poultry 102.3 101.7 102.8 119.6 108.9

Fish and sea products 101.7 101.8 102.4 111.5 109.9

Milk and milk products 102.6 103.5 102.5 112.8 113.1

Butter 101.8 102.1 101.8 106.8 111.4

Sunflower oil 100.6 101.0 100.9 102.1 107.6

Fruits and vegetables 97.3 102.2 105.4 103.3 95.8

Granulated sugar 97.9 98.0 99.2 107.5 94.4

Alcoholic beverages 100.6 100.5 100.8 108.7 109.9

Food products 101.4 101.5 101.7 112.6 110.2

Source: Federal Service of State Statistics.

Active investments in domestic livestock production give grounds to forecast an increase of meat output in the medium term. However, it should be noted that the market of meat is so attractive because of the high prices resulting from active foreign trade regulation, i.e. current prices may give a deceptive signal overestimating the market's potential. Growth of domestic meat supply coupled with abolition of import regulation may entail a notable drop of market prices that will question profitability of new large-scale investment projects in livestock production.

The observed in 2004 downward trends in livestock inventories and output of beef and pork despite the effective mechanisms of foreign trade regulation do not allow to make any optimistic forecasts about domestic production of these products in 2005. As a result, there are no grounds to expect any slowing down of price growth on this market.

Table 38

Retail price indices for selected groups of food products (as % of previous December)

2002 2003 2004 2004/1997 2004/2002

Food products 111.0 110.2 110.4 533.5 99.5

Meat and poultry 102.7 106.8 119.6 632.0 116.5

Fish products 112.1 107.1 111.5 566.9 99.5

Butter 112.0 107.4 106.8 429.9 95.4

Vegetable oil 106.5 107.6 100.9 512.4 94.7

Milk and milk products 105.9 105.7 102.5 457.1 96.8

Eggs 106.3 110.5 122.1 483.8 114.9

Granulated sugar 130.8 95.2 107.5 666.6 82.2

Bread and bakery products 104.9 125.5 116.7 418.4 111.2

Cereals and beans 126.4 117.1 111.6 554.1 88.3

Pastas 106.5 110.2 114.6 429.7 107.6

Alcoholic beverages 108.9 107.3 108.7 447.6 99.8

Source: calculated using data of Federal Service of State Statistics.

■•— 2004 - * - 2003 2002

Source: calculated using data of Federal Service of State Statistics.

Fig. 58. Ratio of monthly price indices for bread and bakery products and for food products at large

6 000 5 500 5 000 4 500 4 000 3 500 3 000 2 500 2 000 1 500 1 000

3

o

co

2

3

o

0

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o 10 o

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2

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o o o O

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Wheat No. 3 Wheat No. 4 Wheat Nb. 5

□ Feed barley Food rye

Source: Group of companies "Unidell".

Fig. 59. Russia: prices for grain in 2003 (European part), rubles per ton

Wheat No. 3 Wheat No. 4 Wheat No. 5

□ Feed barley ^^^ Food rye

Source: WJ InterAgro.

Fig. 60. Russia: prices for grain in 2004-2005 (European part), rubles per ton

Source: calculated using data of Federal Service of State Statistics.

Fig. 61. Production of selected food products, as % of the previous year

15

10

-5

-10

-15

199

2000

>01

»02

003

I Bakery industry □ Meat industry

5

0

7

8

9

Source: calculated using data of Federal Service of State Statistics.

Fig. 62. Growth rates in bakery and meat industries, %

0

u

< 1500 rubles 1500-3000 rubles 3000-5000 rubles

se 5000-7000 rubles i)

7000-9000 rubles

> 9000 rubles

0 20

Consumption of bread several times a day |—| Consumption of bread once a day h

50 _i_

100 %

150 _i_

200

40 60 80 100 120

Conformity index

Source: Comcon-2. (R-TGI) - 2004/3.

Fig. 63. Consumption of bread by consumers with different income levels

In supermarkets

In large general stores

In small shops

At wholesale markets

At street outlets

0

50

100

150

200

Income per family member ■ <1500 rubles

□ 1500-3000 rubles

□ 3000-5000 rubles

□ 5000-7000 rubles

□ 7000-9000 rubles

□ >9000 rubles

Conformity index 250

Source: Comcon-2. (R-TGI) - 2004/3.

Fig. 64. Trade outlets where consumers with different income levels purchase bread

20

15

10

2,1

livestock and poultry for slaughter cattle -7,5 Pigs poultry

-5,4

-10

5

0

Source: Federal Service of State Statistics.

Fig. 65. Growth of livestock and poultry production in 2004, %

10%

5%

0%

-5%

-10%

-15%

-20%

19^ 1293 1994 1995 1996 1997 1J9^ \ / / \2003 2004*

V -N ^ /yj

■cattle _ cows □ pigs

Source: Federal Service of State Statistics.

Fig. 66. Change in the total livestock inventories, as % of the previous year

all food products — — bread * eggs

Source: Federal Service of State Statistics.

Fig. 67. Price indices for food products, bread and bakery products and eggs

(as % of previous December)

2000 2001 2002 2003

—*— corporate farms

- household plots

1 individual private farms (left axis)

Source: http://www.mcx.ru/dep_doc.html?he_id=797&doc_id=4868

Fig. 68. Gross output produced by different types of farm producers (billion rubles, constant 2000 prices)

2003

2000

58%

38%

54%

□ corporate farms

□ household plots

4%

□ individual private farms

43%

3%

Source: http://www.mcx.ru/dep_doc.html?he_id=797&doc_id=4868

Fig. 69. Structure of gross agricultural output by types of farm producers

3.5. Research and Development Sector

2004 is expected to become a year of innovation development as based upon key strategic goals set forth by the Ministry of Industry, Science and Technologies for the same period. The goals, however, have been changed as a result of implementation of administrative reform in March and creation of a single Ministry of Education and Science: the goals have grown in number, while the priority of the decision has become less evident. Various concept and strategic documents were developed and revised (dramatically in some cases) during the year, and the process is still ongoing.

There are several most significant events of the previous year that are worth being focused on:

• reorganizing the system of public management of science and innovations;

• developing a concept of reorganization of scientific institutions;

• making changes in the system of public financing of science, including that related to transition to a new budget classification and performance-based budgeting;

• initializing public initiatives on resolution of HR-related problems;

• expanding business involvement in providing financial support for science, as well as development of private charity;

• developing innovations and focusing on private and public partnership mechanism and indirect regulation.

3.5.1. Administrative Reform in Science

The administrative reform resulted in creating a Ministry of Education and Science as a replacement for the Ministry of Education and the Research and Development Department under the Ministry of Industry, Science and Technologies. Integration of science and education can be considered an advanced step against the former administrative framework, which testifies to the fact that the federal government has been adhering to the integration trend. Creation of the new ministry has shifted priority from scientific and industrial

activity to scientific and educational one. Nevertheless, it is essential that the issues of innovation development were included into the competence of the new ministry14.

Apart from the single ministry, an advisory body - Council for Science, Technologies and Education under the RF President - emerged15. It replaced the former Council for Science and IT and took over its functions: provide the President with information on the situation in the sphere of research and education, develop proposals on topical issues of research and educational policy, perform expertise of draft federal laws and other regulations. The Council is to meet at least twice a year. Composition of the Council shows that topical research and educational issues that require a principal emphasis of the President are expected to be selected exclusively by academicians of public academies, primarily the Russian Academy of Sciences (RAS). A share of representatives from industry-based science and public research centers (PRC) in the Council is miserable: wardens account for 20% of the total membership. Such inadequate composition may have a material effect on both the selection and fulfillment of the set tasks.

By the end of 2004, a Strategy of the Russian Federation in Science and Innovation Development for the Period Ending in 2010 (hereinafter referred to as the "Strategy") emerged as developed by the Ministry of Education and Science. It provides for two of science and innovation development, namely inertial one and active one. It also sets up key goals and Strategy implementation periods. The list of tasks includes all aspects concerning science and innovations, which makes it impossible to prioritize. Listed among the key tasks are to strengthen support for fundamental research, improve research and development performance, provide integration into the global economy, and develop innovation infrastructure. At the same time, some equally ranked technical tasks are also included, namely to develop institution of intellectual property right protection and create "technological corridors". In general, the text of the Strategy is implying that political choice has already been made for the benefit of fundamental sciences. It is not, however, indicated how to assess whether a fundamental research is a world-class achievement or not. Neither is indicated how one can improve, indirectly through development of fundamental research, capitalization of performance of scientific and technological activity strictly by providing integration of science and education without having direct relationship with business sector.

The section of the Strategy that is dedicated to innovations, provides no mechanisms of interaction between civil and military sectors of science, while only civil science expenditures are considered as a source of financing innovations. In addition, the issues of interaction between innovation process participants (this is the basic weakness of the modern Russian innovation system); neither reorganization prospects in the sector of applied research nor the future development of public scientific centers is described. Finally, it is not only within the scope of the Ministry of Education and Science, which has a direct control of merely 1/4 of civil science expenditures, to provide support to the innovation sector, but also other ministries. The document provides no interaction whatsoever between them.

The Strategy is likely to be updated and become an essential guideline in the development of science and innovations for the nearest five years, provided that it is made coherent to the Strategies of other industries supporting innovations, as well as the Strategy of educational development. To date, however, the text of the Strategy suggests that the government has no clear picture of a consistent model for the scientific and innovation sector.

14 Issues on the Ministry of Education and Science of the Russian Federation . Resolution of the RF Government of April 6 , 2004 , No..158 .

15 Decree of the RF President of August 30, 2004, No.1131 "On the Council for Science, Technologies and Education under the RF President" .

An alternative Strategy-plan was somehow presented in the report on human potential development in the Russian Federation prepared as part of the United Nations Development Program (UNDP) named "Towards a Knowledge-Based Society". The report specifies that increasing budget financing of the Russian Academy of Sciences is a key mechanism in transition to an innovation-based economy, because it is the RAS that forms the basis of "innovative breakthrough". In this case, base financing of the RAS is considered as payment for its reputation rather than a state guaranteed order. In general, the budget is expected to grow at the expense of interest contributions generated from export of basic raw materials, namely: crude oil, gas, coal, ferrous and non-ferrous metals, chemical products, lumber, diamonds, etc. The report provides a clear picture of the Russian science as viewed by representatives of the Academy, since the majority of the authors are employed at academic institutions.

One of the material changes in the field of administration is also related to actual abolishment of accreditation of scientific organizations. In 2004, a draft law "On Invalidity of Provisions of RF Regulations Relating to the Issues of Public Accreditation of Scientific Organizations" was developed and approved, under which such accreditation is deemed needless. This resolution is in line with the policy aimed at eliminating needless administrative barriers and reducing the number of activities subject to licensing. At present, the draft law has been submitted to the RF State Duma for consideration.

Public accreditation of scientific organizations was introduced in 1997 primarily for the purpose of providing tax allowances and other benefits. Only accredited organizations were authorized to bid for a state guaranteed order and participate at other types of public tenders. Accreditation was granted subject to the principal criterion, 70:30 ratio, meaning that research and development should account for 70% of the core activity of a scientific organization. This regulation gradually became a barrier for the development of innovative activity. At the same time, a new Tax Code came into force, which terminated a series of former allowances and benefits previously granted to scientific organizations. These circumstances led to an actual abolishment of accreditation.

Abolishment of accreditation provides any organizations with access to budget financing. This is increasing a risk of lobbying and ineffective disbursement of budget funds, unless additional procedures are introduced due to the abolishment (which is in effect de facto) at the stage of tender for state guaranteed orders, which would allow bidders' potential and performance history to be assessed. The practice of preliminary assessment of organizations, bidders for state guaranteed orders, is applied in all developed countries by creating data bases of prospective performers of state guaranteed orders along with lists of corporations and firms which are not supposed to be admitted.

3.5.2. Attempting to Reorganize Scientific Institutions

In the period between summer and fall of 2004, the Ministry of Education and Science developed a Concept of Participation of the Russian Federation in Management of Public Organizations Operating in the Field of Science. Upon publishing, the Concept received a fairly negative review both by the scientific society and especially the Russian Academy of Sciences. A task force was set up by a request of the RAS comprising representatives of the Ministry of Education and Science, the RAS and the Council of Wardens of Russia. Eventually, the task force came up with a new version of the Concept as revised and approved by the three parties. The revised version was named the Concept of Participation of the Russian Federation in Management of Property Complexes of Public Organizations Operating in the Field of Science. It differs largely from the original version.

Originally, the Concept provided methods, most importantly the scope, of the reform of the public research and development sector. Four hundred to 700 scientific organizations are expected to remain in federal ownership by 2008, including 100 to 200 public research and development institutes and 300 to 500 organizations representing an "infra-structural component of public sector of science". This constitutes a material reduction, since there are more than 450 institutes alone that are currently operating under the Russian Academy of Sciences, let alone departmental research organizations, scientific and research institutes within the framework of institutions of higher education, and public unitary enterprises, all totaling over 2,8 thousand state-owned organizations. It is the reduction figures along with unclear criteria of selection of organizations, that received such a negative review of the Concept among common scientists and managers of scientific organizations. In addition, In addition, the Academy perceived the Concept as a new offensive against the RAS's status, since a drastic reduction of the number of subordinate academic institutions means de facto that the Presidium of the Russian Academy of Sciences will lose the power to dispose of public property.

Only one guideline left as a result of the RAS's participation in updating the Concept: the number of state-financed scientific institutions is scheduled to be cut down to 800 (by 55%) by 2006. More information emerged with regard to specific figures of financing of the federal scientific sector, which are scheduled for 2008. Minimum budget provision of a single scientist is excepted to be RUR700 to 750 thousand a year (in 2004 prices). The number of scientific personnel in state-financed organizations will be defined with consideration of mandatory compliance of this figure. This section can be considered as the only failure committed by the RAS in its struggle for retaining all its powers and privileges: given the fact that budget provision of a single scientist is currently RUR133 thousand a year (according to the estimates of the Ministry of Education and Science), then the foregoing figure of budget provision specified in the Concept would require at least doubled reduction in the number of scientific personnel in the federal sector of science, even though the scheduled gowth in budget allocations was considered (up to RUR110 billion by 2008 against RUR46,2 billion in 2004).

The Concept identifies the goals, tasks and principles of participation of the Russian Federation in management of public scientific organizations. The initial and the second options differ largely in composition of goals. For instance, the initial option contains the goals as follows:

• provide breakthrough in the top-priority guidelines of development of science, equipment and technology ;

• achieve competitiveness ;

• develop HR potential of science ;

• optimize organizational and financial expenditures of the federal government in managing scientific organizations ;

• improve budget efficiency in utilizing public property.

As is seen from the list, goals (4) and (5) are showing to a certain extent the purpose of reforming the public sector of science. All things considered, the list provides nothing new as compared to similar documents presented in the previous periods (including those adopted in 2002, Policy Principles of the Russian Federation in Development of Science and Equipment for the Period ending in 2010 and Beyond).

However, the second option moves away from the idea of reforming the public sector and is focused on the need to support science by the federal government in general and strengthen and build up scientific potential and develop fundamental science in particular. Altogether the new 5 goals look even more eclectic in this option :

• build up the role of science in resolving the national task aimed at doubling the gross domestic product ;

• improve quality of fundamental research and development ;

• retain and improve the scientific and technological potential of the country ;

• comprehensive development of the national innovative system ;

• create conditions to develop and improve competitiveness of "HR capital".

Though the new name of the Concept is focused on management of property complexes, the revised version includes no goal to improve budget efficiency in utilizing public property which was included in the initial version.

Criteria of retaining organizations within the public sector of science appeared to be specified in nothing but general terms. Most substantial failure is the fact that a series of criteria are declarative, and it is not specified who and how would apply these criteria in assessing and selecting particular organizations. It should be noted that the set of options for reforming organizations will shrink: under the new version public organizations can be reorganized only into funds or self-dependant non-profit organization as opposed to the previous idea of them being reorganized into funds, self-dependant non-profit organizations and open joint stock companies, or selling entire property complexes of organizations.

The developed Concept fails to consider two types of public organizations: self-dependant organization and public (municipal) one. At present, a package of corresponding draft laws is under consideration by the Government. These types of organizations play a fairly important role in the field of science and their introduction could substantially optimize reorganization of scientific organizations. In this case, all reorganization schemes descried in the Concept would need updating. Since the Concept is a long-term document, it should provide for introduction of new legal and organizational forms.

In general, the Concept provides a narrow view of privatization of scientific organizations, i.e. as a change in the form of ownership. At the same time, privatization may mean loss of the federal government's function in relation to organizations. Such forms of privatization have been gaining a wider use16 in the developed countries, as well as serving as the basis of various private and public partnerships, including management of scientific organizations.

The new version of the Concept is distinguished mainly by a new special section dedicated to RAS's role and place. The section is called Principles of Management of Property Complexes of the Russian Academy of Sciences and State-Owned Sectoral Academies of Sciences. It is evident from this section that the RAS is retaining all its functions and receiving new authorities. It suggests that the RAS is not only a "main center of fundamental research in the country", but also provides high quality of those trends in applied science which are falling within "the responsibility of the federal government". In addition, the RAS is becoming a coordinator of fundamental research conducted in institutions of higher education, public research centers, sectoral academies owned by the government. On the basis of a greater number of authorities (even in comparison with the RAS's Charter), the RAS itself will optimize a composition of subordinate agencies and organizations, and develop not only criteria of efficiency for such institutions but also "a plan of special actions on management of property complexes".

All things considered, the transformation of the Concept can be deemed a political victory of the RAS in its struggle to maintain a status quo. Though the initial version of the Concept could be criticized for incompleteness, it is still viable option of reforming the pub-

16 At the Threshold of Knowledge Economics (Global Practice in Research and Innovative Development) / Edit. A.A. Dynkin, A.A. Dagayev. M.: IMEMO , RAS , 2004 . C. 180-182 .

lic sector, while the updated version is evident of the fact that real reforming is delayed for an uncertain period. Firstly, the academic sector is remaining predominant, while it is a prevailing segment of the "network". Secondly, according to clarification made by the Ministry of Education and Science, none of the existing institutions will be shut down. They will be integrated with educational and industrial organizations. Such approach seems not to be promising because epidemic integration of organizations will create new problems instead of eliminating the old ones. In particular, integration will not resolve the problem of optimization of personnel of scientific organizations.

Upon adoption of the Concept, the Presidium of the RAS took first steps towards its implementation: in November 2004, a new stage of restructuring was announced. It will include qualification of all scientific personnel employed at the institutions under the RAS . The qualification is scheduled throughout the entire 2005.

3.5.3. Perspective Forms of Integration of Science and Education

One of the trends in reorganization in the field of science deserves a special attention, i.e. integration of science and education.

The need in such integration was stated as one of the national strategic tasks even before the break-up of the Soviet Union. In 2004, however, development of this trend was animated again. As like as not, the need to continue integration of science and education referred to in RF President's annual letter became one of the catalyzing factors .

The main collision in the first half of the year was represented by emergence of the two alternative and overlapping concepts - leading institutions of higher education and research universities. The administrative reform resulted in only one concept left - research institutes. A new term, "national universities" , emerged at the end of the year.

Elite universities and higher education institutions used to be distinguished in the previous years, as well as various forms of their special support. This is strongly exemplified in the Moscow State University which is financed from a special expenditure item in the federal budget for science. The Concept of a leading higher education institution was developed by the former RF Ministry of Education for the purpose of supporting elite higher education institutes. From 15 to 20 higher education institutes of federal priority were scheduled to receive a status of leading institute, and another 80 to 85 institutes were expected to be distinguished as "leading by research sector". The selected higher education institutes would receive additional budget financing. The leading institutes are supposed to conduct both research and innovative activity. Skilled scientists and professors should be employed at such higher education institutes, and qualified personnel should be trained beyond the overall average. The leading higher education institutes should have developed relationships with other domestic and foreign organizations, they should represent a center of cultural and social development on its territory. A total of over 50 formalized criteria were identified for selecting leading higher education institutes.

The status of "higher education institute" is similar to the approach that was used in creating public scientific centers early in the '90. The idea is the same: maintain the strongest organizations by granting them a special status and additional financing. The experience related to the public scientific centers shows that once such status received, organizations do their best to retain it, and new participants are unlikely to be included into the list of the selected. Such approach is justified only in crisis, when the existing structures need to be maintained and preserved.

The concept of "leading higher education institute" was finalized by the period of administrative reform, when the Ministry of Education ceased to exist. The new Ministry of Education and Science revived the concept of "research institute" which is currently con-

sidered within the framework of the general concept of integration, including the Strategy. The Concept of "research institute" suggests voluntary integration of varying "depth" as based upon interaction between universities and academic institutions, as well as public scientific centers. A total of three "depth" degrees of integration is provided for: full integration of science and education with creation of juridical person, especially a research university; partial integration (scientific and research institutes under higher education institutes, basic departments, basic laboratories); contractual integration (for instance, between legally independent scientific and research institutes and a higher education institute)17. Criteria of distinguishing higher education institutes as research universities remain unclear. The previously granted statuses are expected to be revised (university-academy-institute). From now on, a higher education institute may receive the status of university provided that it is conducting advanced research.

Since various types of integration of academic organizations and higher education institutes have long been existing and particular experience has been obtained, one can argue that cooperation is normally developing until a certain limit is reached without transition to new qualitative forms. No deep integration takes place, when, for example, organizations can integrate into horizontal or vertical associations. This is partially due to quite moderate financing of integration programs and existing legal and regulatory problems which are interfering with deep integration. Even the new budget classification still contains separate financing of science in general and scientific research conducted at higher education institutes. These expenditures are also administered by various agencies.

Creation of integration structures in the form of "research university" requires amendments to the applicable law, because the notion of "research university" is not existing in Russia from the legal point of view. A package of draft laws on integration and education has been prepared, and initial practical steps on testing a mechanism of deep integration have been taken. The RF Government is preparing a Regulation on integrating the Novosibirsk State University into the scope of the Siberian Department of the RAS18, and subordination of another university, the Moscow Physicotechnical Institute, under the scope of the RAS is under consideration. A Department on Integration of Science and Education was set up within the framework of the RAS in January 200519.

Thus, the statement that fundamental research is a RAS's prerogative right is prevailing in resolution of the integration issue as well. Indeed, the RAS would like to expand primarily such form of integration as basic departments (there are 360 departments available for the time being, of which scientific personnel of academic institutions account for nearly 8%), as well as establish an Academic Association of Universities which have a close relationship with the RAS institutes20, open its own "academic" universities and reassign some of the existing ones. Emergence of "academic" universities should promote solution of HR problems in the academic sector of science, though such approach has its obvious deficiencies. First, single-purpose training schedules are very likely to be drafted, since it is well known which institutions students are going to be employed at. Second, this a departmental approach with all the costs it implies. Third, since the Academy has no experience in managing large educational organizations, it may have an adverse effect on the quality of organization of educational process.

17 Strategy of the Russian Federation in Science and Innovation Development for the Period Ending in 2010, the RF Ministry of Education and Science. November 2004, Annex 4 "Forms of Integration of Science and Education".

18 Poisk. No. 48. November 26, 2004. P. 2 .

19 Poisk. No. 2-3. January 21, 2005 . P. 3 .

20 Speech of V. Kozlov, RAS Vice-president , at a meeting of the Council for Science, Technologies and Education under the RF President // Poisk. No. 44. October 29, 2004. P. 4.

Late in 2004, the Ministry of Education and Science announced, along with the intention to establish research universities, that "national universities" would receive a special support. The "national universities" is a sort of modified idea of granting a "leading" status to some institutions. Nearly 100 universities may become "national" ones as well as be the first to receive budget financing. Perhaps, this method is suggested to select public higher education institutions for identifying organizations which would receive state budget financing.

3.5.4. Optimizing Budget Financing of Research and Development

Reorganization of science is closely associated with the issues of optimization of budget funds utilization. Reorganization of budgetary process and development of performance-based budgetary procedures concern both science and innovations.

A new budget classification will come into force with the budget of 2005, which appears to be less transparent than the former one. The new classification allows for only indirect calculations and assessments as compared to the former special item 06, "Fundamental Research and Scientific and Technical Progress Promotion", which regardless of its well-known deficiencies, reflected clearly enough the size and the trends in financing the Russian civil science, a share of program financing, consistency with the obligations to public scientific funds, etc. now, the first section of the state budget - "General Public Issues" - includes expenditures on financing fundamental and applied research. In addition, another 9 sections of the budget contain an "Applied Research" item. Thus, the budget on science is dispersed, and the first question is how to calculate adequacy of funds' budgets with public obligations on their financing?

It is well known that the budget of the Russian Fund for Fundamental Research (RFFR) must account for 6% of civil science expenditures, the budget of the Russian Humanitarian Scientific Fund (RHSF) - 1%, the budget of the Promotion Fund for Small Enterprises in Science (the Promotion Fund) - 1.5%. The current situation is opposite to the previous periods when actual amount of financing of the funds was determined in percentage of total financing specified in 06 item : experts have defined planned volumes of civil science financing considering that the money allocated to the funds comply with the obligations approved.

Allocations for fundamental research grew up to account for 22.3%, which is beyond the average incremental growth in financing allocated for civil science, though growth in allocations for applied research can be assessed only roughly. Thus, public academies, primarily the RAS, which are expected to undergo less reorganization, received the biggest share of financing.

In general, the percentage of civil science expenditures continued to decline, while the percentage of military research and development grew up.

The biggest growth, 44.5%, is expected in regard to Federal Targeted Programs (FTP). The budget growth is basically related to the programs like "National Technological Basis" and "Federal Space Program". A series of FTP are scheduled to be terminated and, unfortunately, biomedical research, which is considered top priority worldwide, is likely to be reduced. In particular, a program on developing remedies against most dangerous pathogens was suspended.

Changes in budget classification in 2004 were accompanied by developing a performance-based method of budgeting, i.e. determining goals, tasks and measures for performance measurement of the subjects involved in budgeting. The Ministry of Education and Science, which is responsible for development of science and innovations in the

structure of federal goals, developed its own vision of goals and methods of their fulfillment. Two goals were determined for the sector of science and innovations :

• create conditions for development and efficient utilization of scientific and technological potential ; and

• create conditions for animation of innovative activity.

Such wording provides no opportunity to assess the degree of achievement of the goals set. In addition, unclear goals make it impossible to determine mechanisms of their implementation. We believe that goals should be more specific as follows:

• develop and improve performance of the research and development sector as a "knowledge generator"; and

• create innovation-sensible medium and promote innovative activity.

Such wording is correlating with the goals and tasks set forth in the Strategy and the Middle-Term Program of Social and Economic Development of the Russian Federation (2005-2008). It is obvious that all these documents should be interrelated and non-contradictory.

A composition of indicators designed to assess achievement of goals is still overloaded with resource and structural measures which could give occasion for requesting more budget funds. The indicator of internal research and development costs in percentage of GDP is the most dramatic example. It is a resource-based indicator. In addition, there is no doubt that this indicator is essential for making comparisons on international level, but it has nothing to do with the scope of the ministry, because it represents aggregate characteristics of economy's research intensity. For instance, the Ministry of Education and Science bears no responsibility for changes in financing parameters for defense research and development which represent a significant share of internal research and development costs. Including this indicator into a composition of performance-based measures of the ministry would have the effect similar to that previously occurred with the indicator of fixed share of civil science allocations from the disbursement section of the budget, which should account for at least 4%. This regulation was introduced by the Federal Law "On Science and Public Scientific and Technological Policy", but never was observed. At the same time, this was a basic claim to the Government. The regulation remained in force after changes in the budget structure, GDP volume, but the requirement for 4% allocation for science remained unchanged. The 4% regulation was withdrawn from the Law on Science pursuant to the amendments that came in force from January 1, 2005.

The second material deficiency of the proposed system of indicators is that some of them are outdated and requiring changes in calculation method, while the others are fairly generalized. Their sole advantage is associability, as they are collected by public statistics agencies on an annual basis. Indeed, it is difficult to introduce indicators which require a brand new forms and methods of calculation. However, attempts to build up a system of performance measurement on the basis of outdated and easy-to-collect indicators would be at least ineffective and normally risky for modernization.

It should be noted that all quantitative measures for the science sector are efficient only relatively, since many aspects constituting the essence of scientific work can not be formalized. This is why the foreign system of indicators designed for performance-based budgeting is accompanied by the peer-review system, i.e. expert appraisal of the initiatives originated by the ministry or agency operating in the sector of research and development.

The key issue in measuring performance in the field of science is what and how to measure. For example, what should be measured to determine the extent to which scientific and industrial centers have an effect on industrial compositeness ? Such traditional

indicators as licensing, mutual agreements, patents etc. can only be used to measure a short-term effect rather than long-term one. Long-term effects, in its turn, normally show a qualitative rather than quantitative value. Thus, there are two specific features of measuring goals and performance which can be emphasized for the sector of science. First, it is difficult to directly relate the performance of a research to the annual investments in science, because a real effect is expected to be evident in several years or even decades to come from the initial investment. Second, performance measurement in science always has a retrospective character and consequently involves skilled experts. In some countries, an alternative method was adopted to measure efficiency of investments in science: qualitative performance measurement rather than quantitative one. Besides, case-study methods are often used in addition to expert appraisal, which can determine how scientific work is promoting a socially essential performance21. Utilizing only qualitative indicators is risky in that such approach normally excludes top-priority tasks which can not be reliably measured for quality, as well as it ignores such task components which have no direct effect on values of the indicators set for assessment.

The Ministry plans to implement the task in the field of science and innovations as part of the Program on Research and Development in Top-Priority Trends of Science and Technology, which since 2005 became a single program in the field of scientific, technological and innovative work, including FTP actions, Integration of Science and Higher Education in Russia and top-priority scientific research, including the national key projects on innovative work.

Nevertheless, the federal budget can provide a significant resource to achieve the goals set. This is budget funds allocated to the public academies of sciences. Over the last few years, allocations to these academies have been accounting for 30 to 33% of the total state budget allocations for the benefit of civil science. The biggest volume of fundamental research is provided within the system of institutions subordinate to the Russian Academy of Sciences, which in fact makes the RAS responsible for achievement of a strategic goal of the country: build up potential for future development. In addition, over the last few years, the RAS has been actively participating in innovation work thus justifying its participation (statements and reports) in resolving the issues of innovation development. At present, however, this significant resource is not being in use, as the RAS and other public academies are not the subjects of budgeting due to their special legal status. Thus, a fairly large share of public funds allocated to the development of science appears to be excluded from budgeting.

3.5.5. Public Scientific Funds and Private Charity

Operating conditions gradually deteriorated for scientific funds (RF FI and RHSF) during the year. First, it was caused by the fact that the RAS strengthened its control over their activity. Their reorganization into state-financed organizations as accompanied by changes in the management in the previous year, was followed by a new step, i.e. changes in composition of their Councils. There are currently no scientists representing higher education institutions in the RF FI's Council, while a percentage of representatives of non-academic science is miserable in the RHSF's Council. Thus, the RAS has come to have a decisive effect on decision making in the funds. In addition, the funds have lost the right to self-governance pursuant to a revised version of the Law on Science effective from Janu-

21 Roessner D. Outcome measurement in the United States: State of the Art. Paper presented at the Annual Meeting of the AAAS. Boston, MA. February 17. 2002.

ary 1, 2005. This may have an adverse effect on contest-based selection of projects for grant financing.

Under the circumstances, the funds are getting rely upon partnership with ministries and further diversification of their activity. The RF FI and the Federal Agency for Industry entered into an agreement on cooperation. Under the agreement they will conduct joint contests of projects designed to continue applying research and development findings in various industries (in particular, radioelectronics, aviation and shipbuilding).

Second, it is also related to work organization at the funds. Over the last few years, Demands and role of science have gradually been changing which should be taken into account in the criteria of assessment and selection of projects. Being public agencies, the funds have to perform some of the public functions, including reformation in the field of science in Russia. It seems to be expedient to introduce such criteria of project assessment as compliance with the national top-priorities, effect of a proposed project on the development of other sciences, as well as applicability of project's findings beyond fundamental research. To date, both the assessment criteria and the classification of sciences still remain unchanged in spite of a heavy criticism.

Third, there is a problem of an ambiguous interpretation of the "grant" term by the funds, which was not resolved in 2004. Such interpretation plays a decisive role in the entire financing system at the funds. A type of obligations defined as "charity" in clause 582, section 2 of the GC RF is closest to the meaning of "grant". Grant recipients are defined as legal entities (medical, educational, scientific, social and charitable, etc.), as well as public and religious funds. This definition is imposing material limits on Russian legal entities as parties of a grant agreement by classifying them as non-profit organizations, including state-financed ones.

Fourth, there is a problem of taxation of grants. With regard to grants, it is expedient to apply the system of tax allowances which is applicable to foreign grants. Under the applicable RF Tax Law, grants are not identified as monetary funds received from Russian scientific funds, though they are exempted from profit tax22. Subventions, subsidies or transfers received by citizens and organizations of the Russian Federation from the RF FI and the RHSF and allocated for conducting scientific research, holding scientific conferences and implementing other programs realized by these funds should be defined as grants.

No progress was made in private charity in 2004 as judged by the number of new organizations implementing science promotion programs. At the same time, the non-profit organizations established in the previous years expanded their scope and the number of programs for support. This is especially true in regard to such organizations as the Domestic Science Promotion Fund and Dynasty Fund. At the same time, however, the initiatives of YUKOS, a major benefactor, were reduced (for instance, provision of financial support for regional Internet centers.

In the period ending in 2004, the RAO EES (RAO Unified Energy Systems of Russia) and the RAS entered into an agreement on establishing a New Generation Contest for young scientists and students of higher education institutions conducting research in the sector of power energy and related sciences. The RAO EES plans to establish an annual award in the amount of $100 thousand to the best scientists at the age of up to 35 ($2.000) and scholarships to the best students ($1.000 each) whose major is power energy.

Tax imposed on grants of non-profit organizations is one of the problems interfering with the development of private charity. In 2004, corresponding amendments the Tax Code

22 Pursuant to section 1, paragraph 14, clause 251 of the RF Tax Code (the Federal Law as in force since May 29, 2002, No. 57-FZ).

were under consideration, and a draft law passed fist reading. From now on, Russian benefactors may provide profit-tax-free grants, provided that such benefactors are registered in the list of such non-profit organizations. The list is subject to approval by the Government of the Russian Federation. Thus, a procedure is suggested which is similar to that applied to foreign organizations operating in Russia. There is a restricted number of well-established and well-known foreign organizations operating in Russia, while any Russian non-profit organization may establish its grant and consequently obtain tax allowance in this country. So far, there is no criteria for selecting non-profit organizations for the list of benefactors. Neither is existing any revision procedure for the list. It seems to be expedient to draft and adopt a special law on grants concerning both public and private funds with a special provision for their scope, rights, possibilities and limitations.

3.5.6. Developing a Program on Foreign Funds and International Organizations

In 2004, the United States, major sponsor, continued to reduce the number of Programs on Russian Science Promotion. In particular, financing pursuant to the US Law, Act in Support of Freedom, was cut off. This means termination of the initiatives of such organizations as AIREX, ASPRAL, the Kennan Institute, the Eurasia Fund. The US Agency for International Development also reduced its allocations for Russia. Such a situation is mostly due to gradual changes in US goals. Initially, large amounts were invested in conversion of military-oriented science into a civil one, preventing brain drain, establishing a civil society, and supporting social sciences. It is admitted for the time being that the majority of the above listed goals have been reached. The British Council has been reducing dramatically its financing the Russian sector of science and innovations, including support for Russian programs and a series of foreign organizations.

At the same time, some initiatives are likely to be enlarged in scale. Consideration is under way of expanding Russian-American initiatives relating to short-term exchange programs, and increasing the number of participants by reducing the term of their staying abroad23. Another advancing trend in cooperation is commercialization of scientific and technical performance. It is scheduled to be developed by International Scientific and Technical Center (ISTC), organization which in 2004 cancelled the 10-year operation in Russia. During its operation the ISTC provided support for 60 thousand scientists of the CIS countries by having allocated nearly $600 million. A share of annual allocations from this Center accounts for 5% of budget financing of civil science in Russia. Canada became a member of the ISTC from March 2004, which plans to provide an annual contribution of up to $18 million to the programs on financing scientists that used to be employed in the former defense sector of science. At its inception, the center provided financing for civil scientific research conducted by the former defense-sector scientists in order to keep them employed in the country. Over the last few years, the ISTC has turning into a "technological broker" by outsourcing private foreign firms for the project and developing partnership projects. At present, the ISTC is providing cooperation between Russian scientists and 229 foreign private companies. Over the last two years, the annual growth rate of private investments has been accounting for nearly 150%24. The ISTC plans to increase its investments in patenting, commercialization of scientific research findings, creating infrastructure of technologies transfer, including former restricted cities, i.e. special research and development cities. Another key aspect is placing focus on supporting special re-

23 Preparing for a New Decade of Exchange Programs Between Russia and the United States. Materials of the Symposium. M., 2004. P. 25 , 37 .

24 ISTC - 10 years (1994 - 2004). M. : ISTC, 2004 . P. 3.

search for the benefit of all the parties involved. This is primarily related to terrorism fighting, developing new sources of energy and biological research.

The InTAS, another major international organization, has been developing the similar way. It became obvious in 2004 that provision of the same kind of support to all and each of the CIS countries could not be efficient any longer. This is why the InTAS conducted appraisal of its programs which resulted in developing several scenarios.

Scenario 1 provides for continuing the cooperation programs by placing emphasis on conducting special contests (dedicated to power energy, IT and biology), practical application of the research findings, as well as programs for young scientists. European researchers have been showing less interest in the practice of supporting broad networks of scientists, which forms the basis of InTAS operation. According to assessment of the former initiatives, support for small partnership teams of representatives from 2 to 5 organizations proves more efficient than that of the networks. This (1) insures better compliance with the basics of organization of scientific process and (2), allows administrative costs to be reduced.

Under Scenario 2, the InTAS is expected to broaden its advisory functions in regard to the CIS countries. In doing so, it will rely mostly on top-priorities of the Frame Programs of the European Union.

Finally, Scenario 3 provides for converting the InTAS into nothing but a consultant, which will provide consultancy in the field of science and services for countries-recipients. In this case, Russia will be replaced as the key client with Central Asian and Transcauca-sian countries, where scientific and research forecast institutions are poorly developed and need support in establishing and developing.

Final decision on InTAS development strategy still remains to be taken, but experts tend to Scenario 1. Russia is not yet ready to become a full member of the EU projects. First, the EU frame programs are intended to strengthen the European scientific field rather than development of the CIS countries. Second, Russia is incapable to equally participate in contests with the Western European countries. Russian bidders still remain less competitive in formulating a research plan, project management structure, delegation of responsibilities between researches, indicating relationship between them and organizations-participants, as well as describing the expected findings. This is why Russia has achieved a miserable success in contests as part of the Sixth Frame Program: success coefficient averages nearly 12%.

At the background of reduction and reorganization of foreign organizations and funds, pooling of foreign and domestic monetary funds, including private ones, could be a rational decision. It is this approach that was selected by the New Eurasia Fund which began to operate late in 2004.

New Eurasia Fund was established as a partnership project including Russia, the United States and Europe. Russian Dynasty Fund and European Madariaga Fund (headed by J. Solana, Representative on Unified Foreign Policy and Security Policy of the European Union) and American Eurasia Fund are cofounders of New Eurasia Fund. The latter operated in Russia between 1993 and 2004, and its new fund became a sort of "entry strategy".

Basic goals of New Eurasia Fund are to support and strengthen civil society in Russia as well as promote country's integration into the world community of small business, including support to scientific and innovative projects. Fund's budget will total more than $10 million annually.

3.5.7. HR-Related Problems in Science

In 2004, the brain drain problem came alive again to become a topic of discussion along with measures to be taken to prevent the corresponding loses and prevent young scientists from looking for a job in other countries. The concern of the HP-related problem is somehow substantiated: little has been done to improve the situation of young scientists, young generation of scientists continues to be uncalled, some of them having to search for a job in other countries. The polls conducted in 2004 by specialists of the Science of Science Center of the Institute of History of Science and Techniques under the RAS jointly with sociologists of the Institute of Economics and Industrial Production Organization showed an increased disintegration in the scientific community. Only 5% of the scientists have a business-sector income (i.e. $500 and more)25. This group of well-paid scientists consists mostly of researches at the age of 35 to 50. Earnings of the rest of the scientists are comparably lower. Additional earnings are gained mainly though research work (grants of various funds, contracts and agreements with customers) and professorship. Nevertheless, there is a positive trend: only 8% of scientists has non-science business as a principal earner. The figure is less than that of the mid-'90 when up to 70% of researches were engaged in non-science business26.

At the same time, simultaneous work in various projects, and most often in various organizations, results in poor scientific output, because there are no adequate conditions available for serious research work. This phenomenon was reflected in statistics: over the last three years, a share of Russian authors in the global scientific literature was reduced from 3.6 down to 2.4%27. In addition, Russian scientists are poorly engaged in the global scientific community: according to the Institute of Psychology under the RAS, only 39% of Russian researches are participating in international programs and projects28. According to polls, 56% of scientists are not expecting changes in their earnings in the years coming. Such situation is not attractive whatsoever for young scientists, and nearly 1/3 of them have plans to find a new high-paying job in the nearest 3 years.

In February 2004, the Council on Science and High Technology under the RF President held a meeting dedicated to the issue of human resources for the research and technology center of the country. Implementation of a Presidential Program on Scientific Human Resource of Russia was expected to be commenced as a result of this meeting, which would have provided for a set of measures aimed at retaining human resources in the field of science, including initiatives on increasing wages and introducing a system of soft-term crediting of housing construction for young scientists29.

However, the meeting resulted only in a Decree of the RF President "On Measures of Supporting Employees Engaged in the RF Defense Industry". Pursuant to this Decree, from March 1, 2004 nearly 400 scientists, designers, technologists and other engineers employed at organizations executing state guaranteed orders and having prominent services to the cause of manufacturing armaments, military and special-purpose equipment, received monthly stipends to the amount of RUR20 thousand. Thus, resolution of the HR-related problem boiled own to the repeatedly tested measure, i.e. selective and temporal salary increments for special group of employees.

25 The sample included 786 persons from various regions of Russia. Refer to : Yurevich A. , Tsapenko I., Prikhodko A., How and How Much Do Our Scientists Earn? // Naukovedeniye. 2004. No. 1. , P. 58.

26 Yurevich A., Smart but Poor: Scientists in Modern Russia. M.: MONF, 1998., P. 104.

27 Saltykov B., "Designing the Future of Russian Fundamental Science" // www.opec.ru/point_doc.asp?tmpl=point_doc_print&d_No.=53827

28 Yurevich A., "Passive" Integration // Nezavisimaya Gazeta - Nauka, 12 January 2005, P. 12.

29 For more details on the draft program refer to: Russian Economy in 2003. Trends and Outlooks. Issue 25. M.: IET, 2004. P. 261. 260

As far as the brain drain concerns, it is not considered as totally negative by the government, since migration of Russian scientist to other countries falls within limits of common migration. Such opinion, however, is argued by many opponents who believe that losses incurred from brain drain are enormous - emigration of a single Russian specialist to other county incurs losses of $200 to 250 thousand, which is totaling $25 billion on average.

The issue of brain drain still remains accompanied by various kinds of myths. This is somehow related to the lack of reliable statistics on emigration. There are frightening data showing that 60% of the winners of international scientific Olympiads are getting employed in other countries, and Russian emigrants in the United States provide 20 to 25% of the US high-tech production.

Russia would have incurred approximately $7,5 billion losses in total over the last thirteen years of post-Soviet emigration on the assumption that the cost of a single specialist's emigration to other country was really $200 to 250 thousand (this amount is probably calculated by using the cost method proceeding from the assumption that if a young specialist stayed in Russia, his/her monthly production output during his/her career would amount to $500), and on the basis of official statistics and polls showing that the Russian community in other countries is 20 to 40 thousand persons. no doubt, this figure is far below $25 billion which is most often referred to in mass media .

Furthermore, by referring to the official statistics, we can see that scientists account for not more than 2% of the total emigrants. Thus, the threat of brain drain is fairly overstated, though emigration of single specialist may shut down a particular research as a whole. Nevertheless, such cases are very uncommon, since emigration has become younger. In addition, external factors that constrain emigration have become stronger. The United States - where the majority of scientists emigrate to - imposed heavy restrictions on obtaining entrance visas in 2004 . The number foreign scientists obtained US entrance visas reduced to 65%30 over the year.

At the same time, the Russian scientific community abroad is actively engaged in stimulating inflow of young Russian scientists. On the one hand, Russian scientists employed at foreign laboratories are trying to support their former compatriots in obtaining grants and entering into contracts on research and development. On the other hand, they monitor and select best students to offer them a job in the future. The scale of such channel has not been measured yet, but it is widely used indeed: those scientists who are currently employed abroad used to work at almost all leading Russian research institutes, and they still maintain relationship with their "parent" organizations.

More intensive is emigration of young scientists from highly potential research teams. For example, outflow of young scientists from scientific and educational centers established at Russian higher education institutes under the auspices of the Ministry of Education and the American Fund of Civil Research and Development accounted for nearly 7% over the last two years, which is notably beyond the overall average in the country. Brain drain is less evident at some very few research centers where all-inclusive conditions have been created to retain young scientists: stable financing with public and foreign sources, sustained relationship with foreign scientific centers, constantly upgraded scientific equipment, career motivation for young scientists.

In order to discourage scientists' emigration, it is essential, besides pay increase, to develop a system of additional science financing. Globally, business sector is considered the key source of financing science.

30 Business Week. October 4, 2004. P. 62.

3.5.8. Expanding Business Participation in Financing Research and Development

Last year businesses continued to pay more interest in supporting research and development. The support was mainly based on two forms of financing :

• establishing their own research and development units or institutes ;

• financing research projects implemented at public scientific organizations and higher education institutes .

Official statistics on innovations in industry (including research and development financing) typically remain very scarce. At the same time, analyses made by some large companies are testifying to the fact that business sector has become more involved in research and development financing, which, however, remains selective by industry so far. At present, annual research and development expenditures by OAO Russian Railroads, RAO Unified Energy Systems (RAO EES) and Gazprom amount to RUR15 billion31 which account for nearly 1/3 of the public allocations on civil science in 2004, while research and development expenditures by Norilsk Nikel exceed by 2.5 times those of the Moscow State University32.

Several notable initiatives on research and development financing were advanced by businesses last year :

• System Joint Stock Corporation and the related companies (RTI Systems Concern, Scientific Center Concern and Telecom System) announced about conclusion of a master agreement with the Moscow Bauman Technical University and the Institute of Radioelectronics under the RAS. Under the terms and conditions of the agreement, the companies and higher education institutions will jointly develop innovation infrastructure and implement promising research projects, including expert examination of research and technology developments with a view to utilizing them in commercially promising projects as well as obtaining patent protection on the developments in use.

• The RAS Siberian Affiliation and the Krasnoyarsk Mining and Chemical Plant entered into an agreement for a period between 2005 and 2008 at total value of RUR25 million. Six research institutes of the RAS Siberian Affiliation will participate in research and development for the benefit of the plant.

• An agreement concluded between the RAS and Norilsk Nikel was continued. A Norilsk Palladium Research Center is scheduled to be established on the basis of the United Institute for CO Catalysis under the RAS, which will implement a research program aimed at creating competitive science-intensive materials that could be used in industry. At next stage Norilsk Nikel is ready to play a role of a seed capitalist and continue to support successful projects on a long-term basis.

• A private High-tech Center was opened in Khimki city. The Center is intended to develop new medical remedies for AIDS, cancer, cardiovascular and other diseases. A share of foreign investments accounts for nearly $5 million. Research personnel of the Center is expected to reach 1500 persons at mean age of 38.

Development of research and innovation activity has become essential for industrial enterprises: according to a poll conducted by the IET33, 72% of enterprises have outdated plant and equipment, which makes their products less competitive.

More business involvement in research and development projects, establishing new research units and providing more direct orders to research organizations would play a significant role at the background of actual stagnation of the Russian Technological Devel-

31 Ideological Bargaining // Rossyiskaya Gazeta. January 23, 2004.

32 Poisk. No. 2 and 3. January 21 2005. P. 8.

33 IET's poll. No. 145. May 2004 .

opment Fund (RF TDF) which is supposed to support implementation of inter-sectoral projects on the basis of extra budgetary research and development funds.

Extra budgetary sectoral funds were built up by ministries, public agencies, concerns, corporations and associations on the basis of contributions made by enterprises as 1.5% of their products (works, services) cost. The budget of the RF TDF was based upon 25% contributions from extra budgetary funds. Soon after Chapter 25, Part 2 of the RF Tax Code entered in effect and a series of amendments were made to it, extra budgetary research and development funds began to be based on voluntary contributions of enterprises, up to 0.5% of gross profit. The changes in the procedure of contributions to extra budgetary research and development funds implied actually an almost double reduction of contributions to the RF TDF (by industries which make such contributions). As a result, in 2004 the RF TDF had enough money only to be able to comply with its obligations under previously concluded agreements rather than finance new projects.

At the same time, introduction of new criteria of classifying organizations as extra budgetary funds led to changes in composition and number of extra budgetary funds. Unlike previous years when extra budgetary funds were supposed to be established only under federal executive authorities or commercial enterprises or associations of enterprises, in 2004 extra budgetary funds had to be exclusively non-profit organizations in accordance with the new requirements. As a result, the RF TDF's operation was frozen, which may have an adverse effect on innovation activity and applied cross-disciplinary research, while having in mind that the cross-discipline principle is the key development of science.

3.5.9. Private and Public Partnerships

The issue of promoting private and public partnerships (PPP) became more relevant in 2004 than in the previous years. The term "private and public partnership" means using mechanisms to promote private business participation in innovation activity. PPP promote pooling resources, sharing profits and risks, creating a competitive environment and utilizing efficiently budget funds.

The practice of private and public partnerships in various advanced countries shows that such mechanism can be used whenever the government and businesses have complementary interests while being unable to act independently and separately. Among the PPP forms which are most commonly used in research and technology and innovation fields are cofinancing research and development projects at a pre-competitive stage (industrial enterprises are encouraged to be involved on the basis of getting entitled to utilize the findings of the research for business purposes); co financing at initial stages of commercialization (seed financing); establishing joint research centers in the fields which traditionally fall within the scope of the state (healthcare, environmental protection, national defense). Since PPP provide for a fairly complex management, it is essential to initially identify zones of responsibility of the state and the private business, as well as provide for risk-free mechanisms of their revision for each party.

Of most interest is the PPP practice established in the Southeast Asian countries, where an innovation breakthrough took place. PPP was one of the basic initial mechanisms that was used along with building a material infrastructure of innovation activity and licensing patents of foreign technologies. Implementation of two concurrent processes - mastering the methods developed in mature economies and creating conditions for creating domestic environment for innovative development and ensuring a leading role of the private sector in the national system of innovations - resulted in increased financing of the research and innovation sectors by the private business. To date, the ratio of public and

private involvement in the research and development sector is 1:1,5 (Singapore, Malaysia) to 1:3 (Korea, Taiwan)34.

Basic provisions on development of private and public partnerships in the Russian sector of research and innovations were developed last year. The ongoing mega projects, development of infrastructure of the national innovation system and regulation of rights to findings of research and technology activity received top-priority. The latter is fairly important, and a corresponding draft government regulation was developed as early as in January 2004, yet not adopted due to lack of consensus with the RF Ministry of Finance. The approved draft regulation "On the Procedure of Execution of Rights to Outcomes of Research and Technology Activity Obtained Through Federal Budget Financing" contains a provision stating that "an organization shall retain rights to findings of research and technology activity obtained through federal budget financing as subsidies and subventions for grants and financial support. Such financing shall be provided under the condition of affording a right to the Russian Federation to uncompensated non-profit utilization of such findings with a view to performing works or supplying goods for public purposes". The same government regulation provides a legal initiative for the development of Russian laws similar to the Buy-Doule laws and other laws and regulations aimed at improving the regulatory and legal framework related to protection and utilization of findings of intellectual activity obtained through federal budget financing, on the basis of securing rights to these findings for the originators with simultaneous creation of conditions of commercialization. Another federal law is also suggested for development, which would typify the American Stevenson-Widler law.

According to the American practice, the laws should be adopted at one time because of their interdependence. In the United States, both laws were intended to promote commercialization of research and development financed by the government. The Buy-Doule law is applied to the patent rights to research and development findings obtained through public financing, while the Stevenson-Widler is applied to regulate research and development ownership in the case of research jointly conducted by public research laboratories and external partners.

Any delay in adopting laws on intellectual property rights is interfering with efficient utilization of such property. According to the Federal Service for Intellectual Property, Patents and Trade Marks, a share of research and technology findings in Russian economic turnover is 0.4% against 70% at the developed countries.

One of the PPP options utilized in practice is mega projects35 or major innovative projects implemented by teams comprising scientists and industry representatives. The projects were selected primarily on the basis of joint interests of science and business, as well as high economic efficiency of a particular project as judged by representatives of the former Ministry of Industrial Science. The mega projects are based on the idea of risk sharing between the state and businesses in development of new technologies. To date, a total of 12 projects are being financed.

Experts are wary of the mega projects in terms of their implementation. First, there was lobbying in their selection. Second, one question remains to be answered: whether these projects are innovative or it is a mere financing of modernization of production? In other words, it remains to be seen whether public financing of such projects is substantiated, or they are supposed to be financed by business instead ?

34 At the Threshold of Knowledge Economics (Global Practice in Research and Innovative Development) / Edit. A. A. Dynkin, A. A. Dagayev. M.: IMEMO , RAS, 2004. P. 86 , 90, 93-94.

35 For more details on the mega projects refer to: Dezhina M. , Saltykov E. Promotion Mechanisms of Research and Development Commercialization. Scientific Works, No. 72- P. M.: IET, 2004. P. 107-108 .

Foreign experience testifies to the fact that subject matter is always considered in allocating budget funds to applied research and development as part of a PPP. Projects considered for financing must comply with national priorities or be highly potential in terms of social impact. In this case, private sector's profit from development of such projects should not be evident in the period of assessment.

Neither field of research nor its social significance are essential in the Russian version of selecting mega projects. Initial findings were expected to be assessed at the end of 2004, while total effect of the program on mega projects unless 2006. These terms, however, were extended, and the initial findings still remain to be published. Upon introduction of a new budget classification, the item of expenditures on mega projects was divided between two ministries. Now, 72% of total financing of mega projects goes through the Ministry of Education and Science, while the remainder funds - through the Ministry of Industrial Energy36. It remains to be specified how the development of the program on mega projects will be coordinated in general.

A Seed Innovation Fund or "Fund of Funds" which was established in 2000, can be considered as a form of PPP, whose funds may form the basis for establishing sectoral and regional seed funds. To date, efficiency of the Seed Innovation Fund has been poor in terms of the funds established (two funds were established in total). Not much success has been achieved in the experience of seed financing in supporting promising innovation projects through the mechanisms of seed fairs supported by the Ministry of Education and Science. As a result of 5 seed fairs, less than 1% of the participants could find investors and nearly 6% of them are conducting negotiations.

In 2004, there was a down ward trend in seed financing of high-tech on the part of Russian investors at the background of dominating foreign investments. Total volume of seed investments also declined as compared to 2003. Due to undeveloped conditions for seed financing in Russia, there is a widely applied scheme under which research and development is financed in Russia and further commercialized in other countries. Promotion of private and public partnerships is therefore becoming one of the topical measures in creating a favorable innovation environment.

3.5.10. Shaping Infrastructure of Innovation Activity

In 2004, both financial and physical infrastructures developed, which are primarily designed to support small innovation business. However, the number of small enterprises registered in industry as "science and scientific service", remained steadily negative. Small innovation firms are concentrated not only in the "science and scientific service" sector used for statistical recording, but also in other sector of economy. According the estimates of the Fund for Small Business Promotion in Science and Technology, nearly 120 thousand small enterprises are operating in the industrial sector. Supposing that at least nearly 1/4 of them were innovative ones, the assessment of total number of small innovative forms should be doubled. However, these figures are tentative. The problem of inadequacy of statistical base in the field of science is getting greater , since the lack of clear picture of an object may compromise any attempts in making a reform.

In 2004, the IET conducted a pilot survey of 25 successful small innovative enterprises. The firms included into the survey were selected among the winners of the "Russian Innovations Contest" which is regularly held since 2001 by Expert magazine under the auspices of the RF Ministry of Industry, Science and Technologies and the RF Ministry of

36 Berdashkevich A. On Organization of Financing in Science and Education in 2005 // Innovations 2004. No. 8. P. 5.

Nuclear Industry. The survey was intended to study the conditions for development of small innovative business37.

Analysis of companies' profiles showed that a small science-intensive company can grow on the basis of one of the following four basic options: where scientists and engineers quit their research institute and retain the right to their research work (1) or already patented technology (2); where former researches return to science-intensive business on the basis of initial capital they gained in other type of business (3); by creating an alliance of scientist and businessman (4).

Option 1 is most common, i.e. this is a classic situation of "technology push", when the process is started from the development rather than market demand. Option 4 is most infrequent, when businessmen who are interested in starting manufacturing science-intensive products perform the following actions: marketing research, search for developers, provide research and development and finally private production. Option 4 is opposite to option 1. In this case the demand is dictating the order of technological research works (demand pull), and this approach normally appears to be success. Thus, so far the from-research-towards-market approach remains dominating rather than visa versa. In this case, new research works may not always result in innovative advance and improved com-positeness, since they may find no demand. Even the "technology" term differs in meaning for scientists and businessmen: the former define the term as new knowledge, while the latter define it as a debugged production line.

The survey revealed that innovation infrastructure established with participation of the state for promoting small innovation businesses is inconsistent: representatives of small firms focused on the importance of the existing innovation promotion funds rather than physical infrastructure. So far, such elements of infrastructure as technological parks and innovation and technology centers (ITC) are considered by managers of small companies more as nice premises for rent rather than structures enabling to promote small enterprises renting these premises. There is a good reason for scepsis in regard to the ability of industrial infrastructure: it is well known that many technological parks and ITC were established exclusively for the purpose of receiving additional budget allocations without market evaluation of the potential of an infrastructure being created.

In 2004, an issue of creating new elements, clusters, of the innovation structure was brought up. The clusters have been gaining a wide usage worldwide as a form of network interaction due to growing interdisciplinarity and interdependence between all participants of innovative process. The clusters normally mean a network of independent enterprises, scientific organizations, universities, services for interaction of science and production, professional consultants and brokers, as well as customers united in a single production chain producing any value added38. It is agreed that the clusters can improve significantly labor productivity. At present, innovation clusters are being spontaneously developed in a limited number of regions. The clusters can be formed both by initiative of regional authorities and business. The Ministry of Industrial Science jointly with the RF TDF also launched an experiment on establishing two new industrial clusters in Saint-Petersburg and Zeleno-grad, but the initiative was suspended due to reorganization of the Ministry of Industrial Science and frozen operation of the RF TDF39.

37 Dezhina I., Saltykov B. Promotion Mechanisms of Research and Development Commercialization. Scientific Works, No. 72-P. M.: IET, 2004. P. 94-103 .

38 Boosting Innovations: The Cluster Approach. Paris: OECD, 1999 .

39 Fomichev Yu., Naumov A. Involving Intellectual Property Objects into Economic Turnover: Challenges and Solutions // Intellectual Property. Industrial Property. 2004 . No. 3. P . 9 .

An example of a cluster is found in a research-city in some cases. Yet, this form of innovation promotion is not efficient enough. Four years of implementation of a development program on the first research-city (city of Obninsk) showed that stable, grant-free and self-financed development of the city failed, no integration between the science and industrial sectors was achieved, the number of young researchers failed to grow at the background of scientific labor outflow of Obninsk. Such situation was caused by organizational and administrative failures committed in particular by the municipal executive authorities acting as the general contractor of the program, who consider the current matters of municipal economy as top-priority, not innovative development. In addition, no mechanisms of monitoring and adjustment of the program were developed40.

Due to poor efficiency of the existing infrastructure (research-cities, technological parks, incubators), the government has been seeking new and highly efficient types of innovation infrastructure. In particular, late in 2004, the issue of special economic zones (SEZ) in Russia was brought up again. A Federal Law "On Special Economic Zones in the Russian Federation" is to be submitted to the State Duma for consideration not later than on March 1. One of the two types of zones - technological and commissioning ones -should be established on the territory within not more than 2 square kilometers which a view to establishing and industrial commissioning research and technological products. The first practical step in establishing SEZ was formulated as a national task of creating several technological parks in the field of information technologies (IT). The case in point is to establish 4 technological parks till 2010 in Dubna, Chernogolovka, Saint-Petersburg and Nizhy Novgorod. Tomsk Region is being considered as a construction site of such technological park.

Construction of an IT technological park was commenced in Dubna prior to the date when it became a strategic task of innovation development. A group of companies Information Business Systems (IBS) was the originator of such technological park. Ten thousand Russian software specialists are expected to participate. Boeing Company expressed its intension to invest in development of the technological park as well as the infrastructure being under development at Saint-Petersburg .

A Nizhny Novgorod technological park will be established on the basis of the Sarov Federal Nuclear Center. AFK System will be the investor of record. The regional government has already allocated a site for the project, and AFK has purchased a controlling interest from Sarov System Technologies Transfer Center management company, as well as invested nearly $1 million in first-stage construction of the technological park. Sarov System is currently negotiating on participation of international corporations in the technological park. Intel may be one of the first ones.

It should seem that IT sector has been selected due to a short-term return. The Indian experience is also worth considering. India has achieved a share of up to 12.5% in the world export market of software products. The Russian share still accounts for 0.7%. Such selection, however, is ambiguous because IT can not be included into the list of industries in which Russia has competitive advantage. Since high qualification of Russian software specialists is universally accepted and their wages are higher than that of their Indian or Chinese counterparts, it is quite natural that Russia is occupying a sophisticated software niche in the market. However, the market share of software is objectively small, which provides no reserves for future growth. This is why IT technological parks is a continuation of offshore outsourcing as well as further development of the scheme under which the country is selling research and development rather than ready-to-use technologies.

40 According to the materials of the Committee of Social Council for Research-City Issues, city of Obninsk

Though a new law on SEZ is expected to reflect specific features of the IT industry (inclusing taxes and customs duties), elimination of administrative barriers would be one of the basic incentives for innovation development within the framework of technological parks. According to the Ministry of Economic Development and Trade, creation of a single zone infrastructure is estimated to cost $100 to 150 million. These figures seem to be overestimated as compared to the foreign practice in establishing technological parks: the average costs incurred on technological park development in the United States and Great Britain is $10 to 12 million, and nearly $100 to 200 thousand in Poland. In addition, the existing estimates on the Nizhy Novgorod technological park show that it would cost $28 to 29 million. In doing so, it is important that SEZ should comprise various types of infrastructure, including developing lines, social sector and utilities sector, road network. Efficiency of new technological parks will depend on the principles representing the mechanism of companies selection, as well as the criteria applied.

There are several amendments to the applicable law that could interfere with the development of the clusters, research-cities and other elements of the infrastructure. The Federal Law "On Amendments to Laws of the Russian Federation and Invalidity of Various Laws of the Russian Federation in Relation to Adoption of Federal Laws "On Amendments to the Federal Law "On General Principles of Organization of Public Legislative (Representative) and Executive Agencies of Constituent Entities of the Russian Federation" and "On General Principles of Organization of Local Self-Government in the Russian Federation"41 is almost excluding from the Federal Law On Science all issues related to the authorities of a constituent entity of the Russian Federation concerning general issues of science which are constitutionally delegated to joint administration of the RF and constituent entities of the RF . Science is not included in the list of issues of joint administration on which RF constituent entities may utilize their budget funds. Innovation structure is established on the basis of cofinancing by the federal and local budgets. Moreover, according to a revised version of the Law on Science, only "procurement and financial provision of scientific and technological activity of government agencies of RF constituent entities shall fall within the authorities of government bodies of RF constituent entities" (paragraph 3, clause 12)". Since no scientific organizations fall within the authorities of RF constituent entities, it means that RF constituent entities are not supposed to finance scientific and innovation activity. Some clauses of the provision were amended late in 2004, when a Federal Law "On Amendments to the Law of the Russian Federation In Relation to Accretion of Powers of Government Authorities of RF Constituent Entities On the Issues of Joint Administration of the RF and RF Constituent Entities, As Well As In Relation to Enlargement of the List of Local Issues of Municipalities "42 was adopted. Pursuant to the Law, RF constituent entities may initiate and implement regional scientific and technological programs and projects (paragraph 53, clause 11).

In 2004, the RAS conducted preliminary actions and made organizational changes for establishing its own innovation infrastructure. At present, the RAS framework includes several structures intended to provide centralized record keeping of the ongoing innovation process at institutes within the RAS, namely a Working Committee for Intellectual Property under the RAS Presidium, Steering Committee for Innovation Activity under the RAS , Innovation Agency under the RAS , ITC Association under the RAS. A Department for Intellectual Property is under development with the RAS framework. It will specialize in building up a data base of most promising and commercially potential research works,

41 Federal Law of August 22, 2004 , No. 122-FL.

42 Federal Law ot December 29, 2004, No. 199-FL.

monitoring intellectual property turnover at RAS institutes, developing major innovation projects under the supervision of the RAS, patenting-related activity. In addition, a concept creating an "innovation belt " around the RAS is under dynamic development, which would comprise technologies promotion centers (TPC), technological parks, research-and-development-based cities and other elements of infrastructure, and for commercialization of research works " under RAS copyright "43.

Technologies promotion centers were established both within the framework of the RAS and other sectors of science. To date, the majority of TPC have been operating for a period of one year or so. Most common challenges that are facing almost all TPC in the inception period are as follows. First, on the one hand, scientists are poorly prepared for commercialization of the findings of their research, quite often they have no desire to conduct this kind of work. On the other hand, some believe that they have sufficient resources to do everything autonomously, while TPC may help only through supplementary financing. Second, the majority of research and development findings are poorly designed for commercial utilization: a model is normally made rather than the end product. Third, there are problems related to legal provision, especially in regulating relationship between employees and employers on a contractual basis. As a consequence, organizations have no information on the research work performed by their employees. There is another material loophole in the law regarding regulation of rights to intellectual property. Finally, forth, there is a general lack of information on findings of research works at different organizations. Some TPC started to establish information networks due to this problem.

At present, TPC are operating at the stage of revision of research works of those institutes they were developed at, or organizations of the regions they are located in. Corporate markets survey is less intensive due to lack of qualified managers of these centers. The share of commercial services accounts for not more than 5% of total TPC works performed, yet there is no such profit item for TPC as revenues from licensing of revenues. Basic revenues sources in TPC's budgets are public budget allocations, financial support from the "parent" institute or region, and grants. Efficiency of the established TPC remains to be measured, however the Ministry of Education and Science made a decision to finance establishing of another 10 centers. General practice of supporting TPC is that the government provides them with financing for a period of 7 to 8 years, whereupon such structures should become self-financed.

Managers of such centers believe that their further development will be related with more involvement in a START program implemented by the Promotion Fund for Small Enterprises in Science. In 2004, 474 projects on small innovation enterprises were financed to a total amount of RUR375 million as part of the START program 44. There were approximately 6 bidders per grant. The program should end up as follows: establishing and developing a new small enterprise employing 5 to 20 persons by the end of the third year of operation, a volume of sales of innovation products is supposed to reach at least RUR600 thousand as per 1 employee per year. Another 400 projects within the framework of the START program are scheduled for financing in 2005.

The START program received a complex respond by scientific environment. So, managers of various RAS institutes and universities consider it as destruction of scientific organizations which top researches would resign from to get employed at small innovation business enterprises. Their opponents argue that a combination of research work or professorship at a

43 According to the materials of the Conference on Innovative Management in Global Environment, September 22, 2004 . M. : the RAS , 2004.

44 For description of the Start Program refer to : Russian Economy in 2003. Trends and Outlooks. Issue 25. M.: IET, 2004. C.269-270.

higher education institution and establishing a small business company should be permitted. Such requirements are likely to give evidence of poor viability of the institutes that can be adversely effected by resignation of several researches. According to the practice of foreign countries, implementation of similar programs always requires either a full resignation of a researcher from his/ her scientific organization or his/ her temporal employment at a small enterprise over a fixed period of time (2 to 3 years in general).

Both effectiveness and impact of the START program on development of small innovation business remains to be seen, because it takes at least one year until definite findings are revealed thus enabling success to be assessed: by this time small enterprises are expected to find an investor for further development. Only 3% of the candidates had found an investor by the time of selection of offers, while 12% had preliminary arrangements with potential investors45. In addition, only nearly 5% of the bidders had rights to objects of intellectual property. The general picture is expected to be improved in one year of the START program. The estimated success of the program seems to be reliable, nearly 10%.

Besides the START program, the Promotion Fund announced inception of a new TEMP program. The program is intended to stimulate innovations in industry and simultaneously promote development of relationships between small enterprises and large and medium-size businesses. The Fund intends to support small enterprises in irrevocable and grant financing of research and development to be conducted upon purchasing a license from scientific organizations, higher education institutions or physical entities. Thus, research and development that holder of license (basically) and licenser need to conduct for license utilization will be payable. The Fund is ready to consider proposals on participation in a program of medium-size and large enterprises provided that they organize work with participation of a small enterprise and ensure production capacity for manufacturing licensed products for the same purpose. In general there are two options to select: either a license is purchased and utilized autonomously or jointly with small and large (medium-size) enterprises. In this case, a small enterprise is acting as research and development performer, developer of technology and, maybe, series of trial products, and production supporter.

Great care should be taken when allowing large enterprises to get involved in the program, because the government in the name of the Fund is likely to start financing the costs that should be covered by the enterprise if the latter is interested in purchasing a license for real. There is a high risk of the government performing private business's functions.

Implementation of the TEMP program is expected to reorient enterprises from importing equipment towards purchasing research solutions developed by domestic scientists. The Fund expressed its interest in promoting commercialization of the rights to such intellectual property that was developed with federal budget financing. Therein lies the key problem. The period of several months since the announcement of the program showed that it was facing a big problem of unregulated rights to intellectual property. This is the main reason for having no offers for the tender as of February 1, 2005.

There is another initiative being under consideration - establishment of an Investment Seed Fund which would operate along with the existing Innovation Seed Fund. The new Fund is primarily intended to finance innovative and infrastructural projects related to industries' development strategies.

The idea of establishing a new fund was born at the Ministry of Economic Development and Trade. It represents the old idea of creating a development budget within the federal budget. The fund is expected to be based upon financing with the Stabilization Fund, its budget being at least RUR60 billion, but it would be granted the status of extra

45 Soloviova O., Shubin M. First Round Findings of the Start Program. (2003 to 2004) // Innovations 2004. No. 8. P. 21 .

270

budgetary fund. Such status is needed for borrowing private funds and receiving revenues from investments.

The current model of the new Fund is nothing but conceptual one, since neither management form nor key supervising agencies have been determined yet, nor procedures of budget funds utilization have been specified. At the same time, the idea of interconnecting infrastructural and innovative projects is considered promising. Creating a favorable innovation environment (in clusters and other similar structures) implies simultaneous formation of all types of infrastructure. For example, it is simultaneous development of transport, public utilities and innovative infrastructures that makes special economic zones successful in China .

3.5.11. Considering Mechanisms of Indirect Regulation in Science and Technology

In 2004, the Ministry of Education and Science proposed a set of measures, primarily taxation initiatives, aimed at indirect promoting research and development activity. The Strategy contains a list of corresponding initiatives, though too many of them. For example, it is suggested: to simultaneously introduce accelerated and additional depreciation; to charge research and development costs to product cost to the amount not more than 100% of research and development costs; to differentiate rates of single social tax and VAT for innovation enterprises and introduce tax allowances at the initial stage of their operation; and to simplify tax collection procedures. Tax preferences are suggested to be concentrated at technological parks, innovation and technological centers, technological clusters. In particular, the single social tax rate is scheduled to be reduced from 26 to 14% at IT technological parks as part of the Law On Special Economic Zones which is under development. Local taxes are expected to be reduced as well. This is one the conditions for SEZ formation.

The proposed measures on tax incentives are not based on careful calculations, since neither comparative nor introduction priorities were determined by type of tax initiatives. It was not specified whether the proposed tax allowances may be applicable to seed investments. In addition, it was not indicated how the proposed VAT allowances agree with the government's plans on further reduction of the VAT rate.

General legislative environment in the research and technological field has great loopholes, which is interfering with introduction of indirect regulation measures. Up to now, no decision has been made on whether a special law on innovation activity is needed (there was a prevailing opinion last year that such law is needed), and how basic definitions and terms related to innovation activity and specific forms of their financing could be legalized. Tax allowances can not be introduced for this type of activity until the "innovations" term is clearly defined by the law.

The foreign practice shows that a great care should be taken in applying indirect regulation mechanisms in research and technological field, as well as tax allowances should be introduced step by step. Tax initiatives are in common use in stable economies, since tax incentives offer a variety of advantages over direct budget financing. It keeps the public sector autonomous and ensures its economic responsibility for selection of research trends and implementation of such research. Furthermore, it requires less bureaucratic paper work at all governmental levels and is not tied to annual budgeting process involving mandatory approvals of allocations and coordination of interests of various departments. Finally, indirect regulation offers political advantages as represented by less social resistance against general tax allowances as compared to subsidies for selected companies. This is why tax allowances, which are originally introduced on a temporal basis, are maintained and extended in the majority of countries.

Over the last 20 years, a great number of macro and micro-level scientific research have been performed at various countries to study effects of introducing tax allowances in the field of research and technology. Specialists of the majority of countries where tax allowances are being in effect agree on a positive impact of such as based on the findings obtained. It has not been proved, however, that tax allowances are always an effective mechanism of borrowing private investments for research and development 46.

The recent research conducted in Great Britain shows that introduction of a new crediting system - tax credit - in the field of innovation and technologies has not proved effective yet. Therefore, it has been decided neither to expand tax allowances nor introduce new ones until the impact of the existing tax allowances is carefully analyzed47.

The issue of introduction of tax credit in the research and development field was brought up in Russia as well. The RF Ministry of Economic Development and Trade, which proposed to introduce this type of tax allowances, believes that it could be feasible for research and development despite the fact that such experience has not revealed much success in this country.

In spite of the fact that introduction of the proposed tax allowances seem to have not been substantiated, the fact the Strategy was updated with a section dedicated to indirect regulatory measures for research organizations rather than innovation enterprises is noteworthy. In addition, it should be noted that innovation activity can be promoted not only through direct financing and tax regulation. Introducing a system of standards, including environmental ones, which force the business to perform innovations, is a universally accepted mechanism.

■k -k -k

Innovation development trends are indicative of two ongoing processes: businesses have been starting to build up their own research data base and developing cooperation with research organizations, while the government has been creating an infrastructure which is not always in demand as was originally expected. Governmental influence on development of innovation activity in industry remains minimum. At the same time, development of various forms and volumes of support for science by the business sector are indicative of the fact that nonparticipation of the government has a positive impact against its attempts in regulating or even cofinancing various projects. However, new signs of interest in direct stimulation emerged in 2004 in spite of dominance of such form of support as direct government financing of selected initiatives.

The year 2004 also showed that legal regulation problems related to the research and innovation sector remained unresolved, or any corresponding decisions were delayed, or amendments to the law were found to be ill-considered and needed urgent correction. At present, there is no governmental structure which would represent interests of the research and innovation sector in general and be able to assume key coordination functions in this field.

46 At the Threshold of Knowledge Economics (Global Practice in Research and Innovative Development) / Edit. A.A. Dynkin, A.A. Dagayev. M.: IMEMO , RAS, 2004. P. 168.

47 Review of Cooperation Between Universities and Businesses in Great Britain. R. Lambert's report. London. December 2003 . P. 15.

3.6. Sube-sectors of the Socio-Cultural Sphere

3.6.1. Health Care

Main Indicators of the Health Care Institutions'Performance

The Russian population's morbidity and mortality rates tend to grow (Fig. 70). However, in 2004, it was the first time over the last five years the mortality rate per 1,000 reduced (from 16.4 in 2003 to 15.9 in 2004). Besides, infantile mortality rate decreased essentially over the last five years: from 16.9 in 1999 to 11.6 with per 1,000 births. Life expectancy indicators at birth have stabilized, albeit on an extremely low level. In 2003, this value equaled 65.5 years, for men - 59.1 years and for women - 72.5 years.

80 70 60 50 40 30 20 10 0

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

Life expectancy at birth, as years Morbidity rate per 100 individuals, as cases Mortality rate per 1,000 of the population Infantile (up to 1 year) mortality rate per 1,000 of births

Source: according to the Russian Statistics Agency data.

Fig. 70. Indicators of the State of Russia's Populations Health

So far as fundamental principles of provision of medical assistance are concerned, the Russian health care system has not much changed vis-avis the Soviet times. Nowadays it comprises a countrywide medical-preventive institutions network, a great number of hospital beds, and a great number of medical doctors. Over the last 15 years volume indicators of the hospital system were declining (Table 39). The number of beds per 10,000 of the population in 2003 accounted for 81% vis-a-vis 1990. The number of medical institutions has fallen by 21% since 1990, but the number of policlinic institutions did not change that much. By contrast, the number of medical doctors was steadily growing: in 2003 it at 7% exceeded the respective 1990 level and accounted for 48 medical doctors per 10,000

of the population. By contrast to that, the number of the nurses per 10,000 residents fell approximately by 13% during the 1999-2003.

Table 39

The Medical-Preventive Institutions Network in Russia

1990 1995 2000 2001 2002 2003

The number of policlinic institutions, as Thos. 12,8 12,1 10,7 10,6 10,3 10,1

The number of hospital beds per 10,000 resi- 137,5 126,1 115,9 115,4 113,7 111,6

dents (as of the end of the year)

The number of policlinic institutions (inde-

pendent and belonged to other institutions), 21,5 21,1 21,3 21,3 21,4 21,5

as Thos.

Capacity of medical policlinic institutions per

10,000 residents (as of the end of the year), 217,4 235,6 245,0 247,6 250,2 248,7

as visits per shift

The number of doctors per 10,000 residents 45,0 44,5 47,2 47,3 47,9 48,0

(as of the end of the year), as persons

The number of nurses per 10,000 residents 124,5 111,0 108,4 107,8 109,3 108,5

(as of the end of the year), as persons

Sources: Rossiysky Statistichesky Yezhegodnik. M.: Rosstat, 2004; WHO Regional Office for Europe health for all database.

In spite of the above-mentioned reductions, the Russian health care vis-avis European countries and even CIS countries still enjoys greater indicators of provision of the population with doctors and hospital beds. But the efficiency of the use of the available resource potential is low. A great sufficiency of beds goes in pair with a longer duration of hospitalization (Fig. 71).

120 100 80 60 40 20 0

y

1 y y —

\w V, F

Russia CIS countries Central and EU (2002)

Eastern Europe

□ hospitalization duration, as days □ medical doctors per 10,000 Dbeds per 10,000

Sources: Rossisky Statistichesky Yezhegodnik. M.: Rosstat, 2004; WHO Regional Office for Europe health for all database.

Fig. 71. Indicators of Health Care Systems, 2003

Stationary medical assistance prevails over the system of medical services in the country. Meanwhile, according to the assessments of the RF Ministry of Health Care, more than 30% of hospital patients could receive an effective medical assistance on the outpatient basis. According to insurance company "ROSNO-MS", 24% of hospital patients as a minimum had diagnoses that did not require a stationary treatment. When checking the validity of the medical bills submitted by hospitals, the insurance company exposed shortcomings of the organization of medical assistance in 10% of stationary treatment cases. The main causes underlying the inefficiency of medical services are extension of treatment term and hospitalization without sufficient medical diagnoses.

The health care system comprises a complex of fundamental economic problems that reproduced themselves over the last 10 years:

• financial insufficiency of the state guarantees of medical assistance to the population;

• unregulated replacement of the state expenses by private ones without revision of guarantees;

• incompleteness of introduction of the compulsory medical insurance system;

• considerable differentiation of the amounts of the state financing across regions;

• absence of economic mechanisms that encourage participants in the health care system to increase the effectiveness of the use of public resources.

The volume of the government financing of the health care system that had reduced by more than one-third in the 90-s began increasing since 2000, but has still failed to reach the level registered 15 years ago (Fig. 72). In addition to that, the public guarantees, as in the Soviet times, provide for medical assistance being free for the population at the public and municipal health care institutions, albeit the volume of such guarantees for single individual has not been defined as yet. The divergence between the population's expected volumes of their provision and real capabilities of the state is immanent for such guaranties. Given the reduced government financing, this divergence transforms into the gap between the declared and real economic conditions of receiving medical assistance.

120 -, 100 80 60 40 20 0

84

-1-1-1-1-1-1-1-1-1-1-1-1-1-1

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

■ Budget assignments on health care system and contributions to CMI

Source: Calculated basing on the Russia's Rosstat data

Fig. 72. The Dynamics of the Government Expenses on the Health Care System

(1991=100%)

Paid medical services Medicines

Source: Calculated basing on the Russia's Rosstat data

Fig. 73. The Population's Expenses on Health Care System, as Rb. billion in the 2000 prices

Financing of the medical assistance to a greater extent is shifted onto households and employers. The population's spending on medicines and medical services grows steadily at a high pace, which has not reduced over the last years, in spite of the growth of the government financing, but outstrip it (Fig. 72 and 73). The replacement of the government expenses by private spending is a spontaneous process. The attempts to regulate the process are undertaken on the micro, rather than macrolevel. A high real level of the population's contribution to paying for medical assistance does not go together with a revision of inadequately fulfilled guarantees.

Compulsory Medical Insurance

The existing system of compulsory medical insurance (CMI) suffers a number of serious shortcomings that need to be overcome through changing the CMI model itself.

There is no coordination between the CMI programs and the amounts of insurance premiums. This is the fundamental shortcoming. The CMI system accumulates 46% of the aggregate volume of the public health care insurance, while the value of the basic CMI program accounts for 63% of the value of the government guarantees program on free medical assistance to the population. This problem is mainly associated with the breach of obligations with regard to insurance contributions for the non-working population by RF Subjects and local authorities.

In 2004, the government proceeded with its 2003 experiment on the Pension Fund's participation in co-financing of the CMI contributions on behalf of the unemployed pensioners. The amount of resources allocated from the Pension Fund's budget for these purposes has grown from 1.5 billion rubles in 2003 up to 6 billion in 2004. It is intended to increase the amount up to 10 billion in 2005. The experiment and the process of intensifi-276

cation of governors' dependence on the federal center have recently contributed to a considerable growth of the amount of contributions for the non-working population, but that does not fundamentally change the situation in the CMI area.

The current CMI model has failed to exert an essential influence on the efficiency of the use of health care resources. The original expectations of the emergence of a competition between the insurers, which was envisaged to have a stimulating effect on their proactive stance in regard to protection of insurants' rights and optimization of placement of orders among suppliers of the medical services, have vanished. The population can hardly choose an insurer. In addition to that, insurers are not subjected to any financial risks in regard to the payment of medical assistance. So they are not interested in selecting more efficient options of organization of provision of medical assistance for insurants.

The basic rate of the social tax that is directed in part to CMI was reduced from 3.6% to 2.8% but its centralized part was simultaneously increased from 0.2% to 0.8%. The 2005 federal budget provides for subventions at the amount of 3 Rb. bln. that are envisaged to be forwarded to the CMI Federal Fund to co-finance insurance contributions on compulsory medical assistance for the non-working population (children). In fact, this forms a compensation for the revenue losses of the CMI system resulting from the reduction of the social tax rate. So, the CMI Federal Fund receives considerable resources to equalize the financial sufficiency of the territorial CMI programs.

The economic mechanisms presently existing in the health care system do not create incentives for its participants to enhance the efficiency of use of public resources. The duality of sources and methods of the public and municipal health care institutions' financing for provision of medical assistance to the population that are envisaged by the basic CMI program pose a main problem, so long as procedures of their financing are concerned. According to the CMI system' s design, such kinds of assistance should have been paid only at the expense of the CMI funds, but in practice they continue to be financed both from the CMI system and from the budget. Public and municipal medical-preventive institutions (MPI) receive approximately 50-60% of their resources in the form of the budget financing of maintenance of the institution, about 30-50% from the CMI system in the form of payment for the provided medical assistance and from 5 to 15% in the form of incomes from provision of the population with paid medical services. According to the federal recommendations, the budget and insurance resources should be employed for reimbursement of different expenditure items. In practice, however, some single expenditure items of the MPI are simultaneously covered from the two above-mentioned sources of financing. This creates the institutions' eagerness to spend more, rather than to use the resources in a more efficient manner.

Development of the Health Care Reform Guidelines

The discussion on the guidelines of the much-needed health care reform has been under way in the government since 1997. Between the 2000-2003 the Ministry for Economic Development played a leading role in designing of the respective proposals. The bill on CMI had been developed by March, 2004. It was coordinated with all the agencies con-cerned48. The consequent government reform has changed the configuration of positions. The new leadership of the RF Ministry for Health Care and Social Development began to play a principal role in the preparation of the health care reform proposals.

In 2004, the preparation of the health care reform developed into a new phase. It is worthwhile noting that in official documents the wording "health care reform" was substi-

48 For the Concept of this bill see: Rossiyskaya Ekonomika v 2003 godu. Tendentsii i perspektivy. M.: IET, 2004. P. 282-283

277

tuted by "health care modernization". In 2004, the Presidential Address highlighted some key avenues of the health care modernization:

• specification of guarantees of free medical assistance basing on development of standards of medical services, which include an array of medical-diagnostic procedures and medicines, and minimal requirements to conditions of provisions of medical assistance;

• transition from the estimate-based principle of maintenance of medical institutions to the payment for the provided volume and quality of medical assistance produced in compliance with the principles of the compulsory insurance;

• fostering incentives for voluntary insurance.

During 2004 the RF Ministry for Health Care and Social Development with the assistance of experts of the Center of Strategic Development was working on the preparation of two bills designated to form a legal base of the health care modernization:49

• "On state guaranties of medical assistance";

• "On compulsory medical insurance".

The first bill sets kinds of the guaranteed medical assistance. Their current array that should be provided at no cost remains almost invariable. In contrast to the current system of state guarantees of medical assistance, the bill provides for specification of these guarantees across volumes, conditions and procedures of provision of medical services at different stages of medical assistance.

The guaranteed volumes of medical assistance are specified on the basis of standardization of medical technologies. Clinical protocols (sectoral standards) are designed for every kind of morbidity on the federal level. They comprise lists of medical services suggested (doses and application recurrence, levels of provision of medical assistance, etc.). In the framework of the respective list and algorithms of fulfillment of the protocols are common for the whole country.

Basing on the clinical protocols the RF Subjects design clinical-economic standards (CES=s), which specify requirements of clinical protocols and comprise an assessment of the value of the pre-set "package". CES=s determine actual volumes of medical assistance across every illness with account of peculiarities of the employed medical technologies (both what to do and how to do) and prices of resources. Every RF Subject adopts and employs its own clinical-economic standards.

Clinical protocols and CES=s comprise two parts. The fixed part is formed by a set of medical services and medicines that is compulsory for all patients with a given illness. A volume of services of the fixed part is equal for all patients with the same illness. The variable part is formed by a set of medical services needed for the part of patients with a given illness, depending on peculiarities of its anamnesis. The volume of services of the variable part is computed on account of an aggregate of patients (for example, 60 ultrasonic examinations are required per 100 patients with the diagnosis "Cholecystitis").

The fixed part of services is guaranteed to every patient, while the variable one is delivered according to medical diagnoses. So far the variable part is concerned, the medical doctor takes a decision in an order that is set by a head of a given medical organization. In case of medical contra-indications to the use of services and medicines included in CES, medical assistance, which is not envisaged by the standard, is guaranteed. But this implies a higher level of decision- making - by a clinical-expert commission under the medical institution.

49 Slepnev A.A., Shevskiy V.I., Sheiman I.M., Shishkin S.V.Modernizatsiya sistemy zdravookhraneniya: poisk resheniy//Manager zdravookhraneniya. 2004. №11.

Such a structure of the standard, on the one hand, provides for a specification of the set of medical services and medicines its patients receive, while on the other, it ensures a medical doctor freedom necessary to take decision under conditions of the variety of manifestation of the same illness by different patients.

The procedures of provision for medical assistance in the framework of the public guarantees are based on the following principle: the provision of medical assistance is guaranteed, providing there exists a pre-set "route" of the patient across the levels of provision of medical assistance. A local medical doctor and a general-practice doctor play the roles of an organizer and coordinator, respectively, of provision of medical assistance on other stages. The planned particularized medical assistance on an outpatient basis and in hospital conditions is delivered according to their prescriptions. In case of the absence of the respective prescriptions, the planned medical assistance provides for a direct payment by the patient.

The procedures set a "queue" of the planned particularized medical assistance and maintenance of a list of patients. The queue is to be kept under control.

The bill envisages setting quotas on high-tech kinds of medical assistance delivered both at the federal medical institutions (for the RF Subjects) and at the RF Subjects' medical institutions of the tertiary level (for municipal institutions). The RF Subjects can introduce additional guaranties in regard to such kinds of assistance - on the basis of direct agreements with federal medical organizations at tariffs that are set for the medical assistance subject to quotas. The lists and amounts of quotas of the respective kinds of provided medical assistance and lists of medical organizations are set annually, according to the federal and territorial programs of state guaranties.

The government agencies of the RF Subjects set the guaranteed conditions of provision of medical assistance on the level not lower than the one set by the federal program of state guarantees of medical assistance. The latter sets requirements to standards of patients' length of stay and provision with food in hospitals, as well as to the marginal term of waiting for the planned medical assistance.

The state guaranties of medical assistance should be implemented through the compulsory medical insurance system. The bill "On compulsory medical insurance" envisages its modernization.

In order to increase the manageability of the CMI system and the state control over targeted and rational employment of the CMI funds, the bill establishes the principle of subordination of the municipal CMI funds to the Federal CMI Fund. The head of a territorial CMI fund is appointed by the head of the Federal CMI Fund upon consent of the supreme executive body of the RF Subject. Thus created vertical is to ensure the integrity of the system and its financial stability.

In addition to this, the proposed structural modifications ensure that the RF Subjects' administrative bodies preserve control over the functioning of municipal CMI funds. The representative body of the RF Subject approves of the municipal CMI fund's budget. The municipal CMI fund sets the standards of the per capita financing of insurers upon consent with the executive body of the RF Subject.

The bill provides for an introduction of social partnership institutions to the CMI system's administration. The RF agencies, associations of Russian trade unions and employers form the territorial CMI Fund's supervisory board. The Supervisory boards control the performance of such Funds' budgets.

The executive body of the respective RF Subject, basing on an agreement with the municipal CMI fund, as well as associations of medical organizations, professional unions

of employers and insurance medical organizations set tariffs on medical assistance of the medical institutions provide to the insurants.

The bill sets a number of requirements and mechanisms that ensure a balance between the CMI programs and financial resources. Insurance premiums of the RF Subject on CMI on behalf of the non-working population should be set at an amount not lesser than that, which provides the balance of the amount formed by all sources designated for financing the basic CMI program and its value. The procedure of calculation of the value of the basic CMI program in the RF Subjects and the methodology of calculation of amount of premiums on CMI on behalf of the non-working population are approved by the RF Government.

The CMI tariffs that are pre-set in the calculation of the price of the basic CMI program cannot be lower than the values computed according to the methodology of computation of minimal tariffs on the guaranteed medical assistance approved by the federal executive agency in compliance with the law on public guarantees of medical assistance, providing the said agency conducts legal regulation in the health care area. As a result, this should increase requirements to the resource-based provision of medical assistance and on this basis help overcome the regions' eagerness to synthetically lower the value of the CMI program and, consequently, the amount of the CMI premiums on behalf of the non-working population.

The equalization of conditions of financing of the basic CMI program in the RF Subjects is made at the expense of both Federal CMI Fund and subsidies and subventions from the federal budget. The CMI financial resources are distributed at the expense of subsidies from the Federal CMI Fund in favor of regions that are unable to collect funds sufficient for the provision of the basic value of the CMI program due to objective social and economic reasons. One calculates the amount of subsidies with a due account of levels of the RF Subjects' budget sufficiency and sets it in the structure of the RF Federal CMI Fund's budget expenditures across single regions.

The subsidies from the Federal CMI Fund are earmarked under the following conditions:

• compliance of a CMI program in a given RF Subject with the requirements to its formation;

• absence of unsettled debts of the RF Subject on insurance premiums on CMI on behalf of the non-working population.

The bill reads that it is insurance medical institutions (IMI) can serve as the CMI insurers. But at the same time the conditions of their functioning are subject to substantial modifications.

1. The bill grants insurants with the right to select an insurant company by themselves, rather than by their employer, as it de-facto happens today. This right is fixed in the current legislation on medical insurance and it is secured by the current procedures of change of the insurer, as well as by personified accounting in the compulsory medical insurance system. As a result, the intensifying competition between IMI=s should encourage them to re-galvanize their operations on protection of patients' rights and control over the quality of medical assistance.

2. The bill increases IMI's responsibility for organization of provision of medical assistance: in the event the insurant finds it impossible to receive the necessary medical assistance at a selected medical institution (in the frame of a territorial IMI program), the insurer is bound to immediately undertake steps on securing the provision of the insurant with the required medical assistance.

3. The bill sets the IMI's obligation to plan volumes of medical assistance delivered as per contract on provision of the medical assistance by CMI, to ensure the consistency of overall volumes of medical assistance to insurants with indicators of volumes stipulated in the territorial CMI program. The insurers are accountable to the territorial office with respect to fulfillment of their contract on provision of medical assistance. These requirements are aimed at an increase of efficiency of the use of CMI funds. Accordingly, the insurant's operations are evaluated on the basis of his contribution to the increase of the efficiency of the use of CMI funds.

4. The bill introduces a system of division of financial risks between the territorial IMI's fund and insurants: the latter will undertake the part of risks associated with the bias in actual spending on provision of insurants with medical assistance from the planned ones. Accordingly, while interacting with medical institutions, IMI=s will not be able to limit their respective functions with the "cashier" one. This should increase their motivation to search for a more efficient structure of provision of insurants with medical assistance.

The bill provides for a possibility of a targeted setting of additional guarantees in the CMI system. The basic CMI program can be complemented with federal and territorial programs of additional medical insurance funded at the expense of additional insurants premiums payable by the RF and/or the RF Subjects, as well as by other entities.

The framework of the effective law bears the problem of duplication of funding the compulsory and voluntary medical insurance and the departmental medical services. At many enterprises, the employers have to arrange a parallel system of medical assistance for their employees, either by using their own medical treatment basis and funding it out of the enterprise' proceeds or by applying the voluntary medical insurance (VMI), thus paying twice for the same risks.

For the purpose of liquidation of the above-mentioned duplication, the bill suggests an introduction of a mechanism of compensations for the part of insurance premium from the CMI funds payable by insurers according to medical insurance contracts.50The provision of premium is conditioned by the conformity between CMI and insurance programs to a medical insurance contract. The premium is provided at the amount of the per capita financing standard per 1 insurant in CMI system. The provision of the premium in such an amount and the simultaneous reassignment of obligations to an insurer, who has entered in a medical insurance contract on financing medical assistance in the volume as per the basic CMI program, will not result in a financial destabilization of the CMI system and will not infringe upon the rights of other insurants under the CMI system. Moreover, the availability of VMI should rise considerably thanks to compensating for a part of the insurance premium as per the medical insurance contract. This will secure additional proceeds in the health care system and foster the transition to more solidary and legal forms of the population's participation in paying for medical assistance.

The CMI requirements, particularly, an introduction of the system of personified accounting of insurants, control over the volume, quality, terms, conditions and validity of provision of medical assistance to insurants, protection of their rights, etc. apply to insurers that exercise their mission in compliance with such medical assurance contract.

According to the noted medical insurance contract, an insurant has the right to resort to the CMI system in emergency cases, which require an urgent interference, while being

50 IET introduced and developed this approach over years. (see: Shishkin S.V. Reforma finansirovaniya rossiyskogo zdravookhraneniya. M.: IET; Teis, 2000 // www.iet.ru. P. 316-318; Gudkov A.A., Popovich L.D., Shishkin S.V. Perspektivy sochet-aniya obyazatel'nogo i dobrovol'nogo meditsinskogo i sotsialnogo strakhovaniya v Rossii. Sotsial'noye obespecheniye eko-nomicheskikh reform M.: Institute for the Economy in Transition, 2002. P. 128-150.

away from their permanent residence, in the event they are in need for provision of a specialized high-tech medical assistance and impossibility to receive the much-needed medical assistance in medical institutions, with which the insurer has contractual relations as per to the respective medical insurance contract. In these cases medical services delivered in the CMI system are payable for to the given medical institution by territorial departments with the consequent reimbursement for these sums by an insurer as per the respective medical insurance contract.

The designing of the bills has been underway until the late 2004. They have not been presented to the Government for consideration. So, disagreements between the Ministry of Health Care and Social Development, the Ministry of Finance and the Ministry of Economic Development across single positions were not removed.

A New Mechanism of Provision of Medicines to "Beneficiaries'

The design of mechanisms of implementation of provisions of Federal Law No. 122 of August, 22, 2004, which envisaged the modification of social benefits delivered in kind for an array of categories of the population (war invalids and participants, veterans; members of families of the deceased war veterans, survivors of the Leningrad blockade, disabled, etc.) became a priority task of the Ministry for Health Care and Social Development (MHCSD) in late 2004. Such benefits also comprise a beneficial provision of medicines (free or with the 50% discount) and the sanatorium and rehabilitation treatment. Since 2005 the mechanism of delivery of medicines, the sanatorium and rehabilitation treatment and traveling to the treatment spots has changed for the respective categories of the population. These kinds of services account for an independent set of social services (the so-called "social package") that is equal across all the above-mentioned categories and amounts to 450 rubles per month. Expenses associated with provision of the given social package are compensated from the Federal Budget. In 2006, citizens will be able to opt for either compensation in cash, equivalent of the cost of the social package or receipt of services included therein.

The main part of the social package is the provision of medicines equivalent of 350 rubles per month. Free medicines are provided for all the respective categories of "beneficiaries" (earlier just a part of the recipients of benefits enjoyed only the 50% discount for the purchased medicines). MHCSD approved a list of medicines that can be delivered to beneficiaries. It comprises 352 international unlicensed brands, or over 2,000 commercial brands. Basing on the method of qualified selection without tender, the Federal Service for supervision in the sphere of health care and social development under the Ministry selected distributor pharmaceutical institutions that were assigned to supply medicines to distribution centers (drugstores) for the individuals entitled for benefits. The Federal Service made the ability to supply all kinds of medicines included in the list the principal selection criterion. As many as 5 distributor companies matched the given criterion. Each of them has monopolized a given federal district and regional market and become a sole supplier of medicines to the recipients of benefits there. "Proteck" supplies medicines to the Central and North-Western federal districts, "SIA - International" - to the Southern and Ural districts, "Biotech" - to Volga district, and ZAO ROSTA - to the Far-Eastern and Siberian districts. "Farmimeks" company supplies medicines to Ingushetia and Chechnya's drugstores. In late February 2005, ZAO "Apteka-Holding", the sixth distributor, was permitted to participate in supplying medicines to beneficiaries.

The network of drugstores provides medicines to the beneficiary categories of the population. The networks are selected by the RF Subjects and local agencies. Medicines

provided to beneficiary categories of the population should be paid for through the CMI system. The Federal Budget funds are forwarded to the Federal CMI Fund, which distributes them across territorial CMI funds as per their requests.

The federal agencies failed to explain to all participants the new mechanism of financing the provision of medicines to beneficiaries. It is worthwhile noting that until November 2004 MHCSD mainly focused on designing the set of medicines, negotiations with their manufacturers and selection of suppliers. The procedures of interaction between all participants in the system have been quickly worked out over the two last months of the year. Legal acts that regulate the procedures of contracts on supply of medicines to individuals entitled for benefits and conduct of the respective calculations arrived in regions only in the last decade 2004.

Originally, it was intended to include insurers who participated in the CMI system in the system of payments. The insurers were to receive resources from territorial CMI. Insurers were to sign contracts on supply of medicines to beneficiaries with the distributors and exercise control over validity of the respective prescriptions by medical institutions. The participation of insurers in provision of medicines to beneficiaries was conditioned by MHCSD. The Ministry demanded that they should obtain a special license on the provision of the respective insurance services. Using the insider information, 12 out of 348 medical insurance institutions that participated in CMI, succeeded in getting such licenses until early 2005. The list of such organizations comprises Alfastrakhovaniye-MS, Gazprommed-strakh-M, Ingosstrakh-M, Maks-M, Kapital, Meditsinskoye strakhovaniye, Krasnyy Krest, ROSNO-MS, Soglasiye-Vita, Solidarnost' dlya zhizni.

Under control on the part of the Ministry for Health Care and Social Development, insurers identified regions for their further operations and started to conclude contracts with pharmaceutical distributors. The insurers' attempts to intrude into regions where they had not ever operated caused conflicts with local governors, who desired to reassign rights of payment for medicine supplies to the regional insurance companies. The Mayor of Moscow was the strongest opponent and he objected the insurers' participation in this program. As a result, in early February 2005, it was decided to exclude insurers from participation in the payment arrangements for medicines and to use for this purpose solely the Federal and territorial CMI funds. However, 8 insurance companies opposed this ruling in their joint statement.

Distributors started supplying medicines to beneficiaries without a fore-payment, i.e. in the form of commodity credit. The procedural arrangements envisaged that the payment was to be effected upon the end of the first quarter against bills for medicines de facto supplied to beneficiaries. This particular arrangement emerged because the absence of accurate data on real volumes of needs in securing for those entitled for benefits with medicines and, consequently, the impossibility to hold tenders on their supply. Such a decision gave a rise to high risks of emergence of problems with price levels and ensuring the general match between the assortment and volumes of supplies of medicines and the respective demand for them.

The above-mentioned procedure quite naturally gives incentives to distributors to include risk premiums in the prices set by them. According to the Ministry for Health Care and Social Development, it agreed with the manufacturers of medicines on marginal levels of registered prices for medicines that are included in the list at the level lower than the producer prices sales of medicines. The amounts of price caps set by distributors producers and importers' prices were not subject to regulation. Meanwhile, January and February saw numerous cases when the amounts of the pre-set prices on the medicines for beneficiaries were higher than those for the same medicines sold on the commercial basis. In

response to that, MHCSD proposed to conclude agreements with manufacturers (importers) of medicines on additional obligations to exercise control over prices and quality of medicines. By late February 2005, 170 out of 324 manufacturers of medicines included in the list signed such agreements.

Lack of maturity of regulation of the volume of demand for the respective medicines is Achilles' heel of the new mechanism. Medical doctors independently determine the volumes of the prescribed medicines. Insurers were supposed to exercise control over the accuracy and validity in respect to prescriptions medical institutions produced for beneficiaries. But they failed to start this work. MHCSD deliberately refused to impose any restrictions on the volumes of the prescribed medicines during the first months of implementation of the new system. This can be easily explained by the fact that it was keen to exhaust the delayed demand of the individuals entitled for benefits for much-needed medicines and by means of an experiment to find a real volume of the beneficiaries' needs for their provision. According to the Ministry of Health Care and Social Development, the 50.8 Rb. bln allocated in the 2005 Federal Budget in for these purposes (which is much greater than the respective 2004 budget allocations) and honoring agreements with suppliers about the price levels for medicines for beneficiaries will allow to cope with the rise in the delayed demand for the medicines that had earlier been in short supply to the benefit recipients due to regional budgets falling short of funds to pay for them. It was suggested to work out mechanisms of adjustment of the volumes of the prescribed medicines upon the first months of the attempt to implement the new provision arrangement.

During the first two months of the year, the number of medical prescriptions for beneficiaries grew more than 2.5 times vis-a-vis the analogous period of 2004.

There immediately began to arise with benefit recipients failing to get prescribed medicines. However, that was a countrywide phenomenon. MHCSD, along with subordinated institutions, had to fine-tune the procedures of provision of medicines and to intensify administrative efforts to ensure their effectiveness. The Federal Fund formed a centralized pool of resources, which were going to be earmarked between regions in an immediate-reaction mode, once an emergency associated with payment for medicines arose. Mr. M. Zyrabov happened to move from one region to other investigating into causes of the faults with supplies of medicines. According to the Ministry's data, until mid-February beneficiaries received 6.6 mln. prescriptions. About 88% of them were fulfilled.

The new procedures of provision of medicines to beneficiaries made the federal agencies responsible for paying for all the volume of the prescribed medicines, which they do not control. The beginning of payment to suppliers for the sold medicines will form the X-hour. If the government fails to design mechanisms of adjustment of prescription and there remains the procedure of payment against the actual amount of sales of medicines, this would entail either the necessity for the Federal Budget to further raise in its expenditures on these purposes, or in a rise in social tensions fueled by the impossibility to deliver the prescribed medicines in full.

3.6.2. Education

The development of Russian educational system has recently been conditioned by changes in the demographic situation, the dynamics of demands of the labor market, processes of redistribution of powers between government levels, as well as attempts to pursue reforms in this sphere. As concerns considerable changes in this sector, one should note, first of all, the rise in the number of university and secondary polytechnic insti-

tutions students (Table 40). The higher education has actually become broadly available in this country.51

Table 40

Educational Institutions Network in Russia

No Indicators 1998 1 999 2000 2001 2002 2003

1 Quantity of pre-school institutions, as thousand 56,6 53,9 51,3 50,0 48,9 47,8

A number of children, as thousands 4379 4225 4263 4246 4267 4321

- as % of children of the respective age 53,9 54,9 56,0 57,2 58,1 57,6

2 Quantity of institutions of general education, as thousand.Including: 67,9 67,5 67,0 66,9 65,7 64,5

- in public and municipal 67,3 66,9 66,4 66,2 65,0 63,8

- in non-government 0,6 0,6 0,6 0,7 0,7 0,7

3 Quantity of students of institutions of general education, as thousand 21479 20879 20074 19429 18440 17323

- in public and municipal 21429 20826 20013 19363 18372 17254

- in non-government 50 53 61 66 68 69

4 Quantity of elementary polytechnic

institutions. Quantity of students, as 3954 3911 3893 3872 3843 3798

thousand

1676 1694 1679 1649 1651 1649

5 Quantity of secondary polytechnic institutions 2631 2649 2703 2684 2816 2809

6 Quantity of students in secondary polytechnic institutions, as thousand 2069 2175 2361 2470 2586 2613

- total quantity on public and municipal institutions, as thousand 2052 2147 2309 2410 2489 2502

- per 10.000 of the population 141 148 160 167 173 174

7 Quantity of higher educational institutions 914 939 965 1008 1039 1046

- public and municipal 580 590 607 621 655 654

- non-government 334 349 358 387 384 392

8 Quantity of students in the higher educational institutions, as thousand 3598 4073 4742 5427 5948 6456

- per 10.000 of the population 229 256 294 332 364 388

- in non-government institutions 251 345 471 630 719 860

Source: Rossiyskiy Statisticheskiy Yezhegodnik. 2004: Stat. sb. M.: Rosstat, 2004. p.227.

The analysis of financing of the system of education shows that the Federal Budget has maintained a fairly high growth rate of spending on education. Between 1999 and 2002 the spending was not lower than 43% annually in nominal terms. In 2003, growth rates reduced, with the rise in expenditures on education accounting 24.6% vis-a-vis 2002, while in 2004 - 21.5% vis-a-vis 2003 (Table 41). But the 2003-2004 budgets did not take into account the recommendation of the RF State Council to increase the amount of financing of education by not less than 25% annually. Nevertheless, the share of expenditures on education is growing in the structure of the Federal Budget as well as in Gross Domestic Product (GDP) from 0.73% in 2002 to 0.76% in 2004.

51 Dostupnost' vysshego obrazovaniya v Rossii / Otv. red. S.V. Shishkin. M.: Independent Institute for Social Policy, 2004.

285

Table 41

Expenditures on Education in the Federal Budget

1998 1999 2000 2001 2002 2003 2004

The Federal Budget, as Rb. bln. 388,9 664,7 1029,2 1325,7 1947,4 2354,9 2659,4

Expenditures on education:

- Rb. bln. 14,6 20,9 38,1 54,5 80,1 99,8 121,3

- as % to the prior year 143,1 182,2 143,0 147,0 124,6 121,5

The share of expenditures one

education in the Federal 3,7 3,1 3,7 4,11 4,11 4,24 4,56

Budget, as %

Source: Calculated basing on the Rosstat data.

According to the 2004 results, the level of the average monthly wages of employees in the sphere of education remains lower vis-avis the health care and culture spheres (4,824 and 4,747, respectively). Moreover, during the year one noted a slight decline in the level of average monthly wages in the sphere of education relative to the nation-wide average level of wages. The same tendency is typical of the health care and culture spheres (Table 42). The volume of budgetary wages arrears in the social-cultural sub-sectors plunged as much as 2.8 times by late 2004, with the greatest volume of the arrears falling on the educational sphere (Table 42).

Table 42

The Average Monthly Wages Due in the Social-Cultural Sub-Sectors (Less Social Contributions) per 1 Employee, as Rubles

January March June September December

Total 5932 6428 7003 6918 7344

Education 3832 4126 4885 4231 4614

- To the nationwide

average wages level, as % 65 64 70 61 63

Health Care 4254 4485 5259 4700 4824

- To the nationwide

average wages level, as % 72 70 75 68 66

Culture 3927 4132 4595 4265 4747

- To the nationwide

average wages level, as % 66 64 66 62 65

Source: Calculated basing on the Russsian Rosstat data.

The 2004 educational policy involved the continuation of an experimental refining of an instrument of the combined assessment of the final and enrollment examination, alias The Uniform State Examination (USE), mechanisms of funding of the higher education on the basis of State Individual Financial Obligations (SIFO). In addition to the above, the government adopts a series of strategic documents and legal statutes that substantially affect the essence and vector of the Russian educational reform efforts.

Table 43

The Outstanding Budget Wages Arrears in the Social-Cultural Sub-Sectors (Except for Small Businesses), as Rb. Mln.

01.02.04 01.04.04 01.07.04 01.10.04 01.01.05

Total 2730 2652 2924 2654 1005

Of which:

Social Sub-sectors - total Including: 1741 1601 1821 1602 618

- from the Federal Budget 10 9,5 12 10 5

- from the budgets of the

RF Subjects and local 1731 1591 1809 1592 613

budgets

Education - total Including: 308 263 384 326 94

- from the Federal Budget 7 7 9 8 4

- from the budgets of the

RF Subjects and local 301 256 375 318 90

budgets

Health Care - total Including: 174 1 77 225 249 49

- from the Federal Budget 0,3 1 0,3 0,3 0,1

- from the budgets of the

RF Subjects and local 174 1 76 224 249 49

budgets

Culture - total Including: 64 66 96 72 19

- from the Federal Budget 0,0 0,0 - - -

- from the budgets of the

RF Subjects and local 64 66 96 72 19

budgets

Source: According to the Russian Rosstat data.

Outcomes of, and Prospects for the Nationwide Transition to USE

In 2004, in compliance with government Resolution of 16 January 2004 No. 725 "On Prolongation for 2004 of the Term of Conduct of the Experiment on Introduction of the Uniform State Examination", the Russian educational system proceeded with the given experiment. Last year, the accent was put on probation of a few technologies of its conduct and enhancement of the quality of control measuring materials by expanding the participation of representatives of the polytechnic education in their design and evaluation. In addition to that, the government stressed the need for improvement of informational orientation available to those enrolling to the higher education and secondary specialized educational institutions.

As many as 65 RF Subjects voluntarily took part in the USE experiment, with some regions holding it by all 14 subjects. Notably, the number of participants in the experiment hit the record-breaking 982,000, or at 1.3 times more than in the prior year. As many as 29 federal ministries and agencies that have subordinated higher education and secondary polytechnic education institutions have expressed their consent to participate in USE. When compared with 2003, the number of universities accepting students by their USE scores more than doubled, while the number of secondary polytechnic educational institutions recognizing the USE scores accounted for 1,530 (Table 44).

Table 44

The Progress in the USE Experiment

_ 2001 2002 2003 2004

The number of the RF Subjects taking part in the USE experiment

The number of students that passed USE, as thousand

The number of USE subjects

The number of universities and their branches participating in the USE experiment

The number of secondary polytechnic educational institutions participating in the USE experiment

Source: Basing on the data of the RF Ministry for education and Science.

The rise in the number of participants in the experiment evidences that regions and universities are keen to benefit from its results. That said the progress with the experiment owes its success to order of 10 February 2004 No. 560 of the RF Ministry for education and Science on the mandatory account of the USE scores by the universities of the federal subordination (except for the Moscow Lomonosov University) located in Moscow and Moscow oblast. They were ordered to identify, as a rule, not less than 50% of the overall specialties across which the 2004 enrollment with account of the USE scores was consequently conducted.

Single regional educational agencies (the Moscow City Department of Education among them) were not in a position to ensure a full-scale conduct of the experiment. That created certain complexities with regard to securing the quality of rights of graduates from the public secondary institutions in Moscow and those of other Subjects in the course of enrollment to the Moscow-based universities. To overcome this contradiction, upon a submission by the Moscow City Department of Education, on 11 February 2004 the RF Ministry for Education and Science issued its order No. 584. The order reads that for graduates from the 11th (12th) forms of public secondary educational institutions based in the city of Moscow that their participation in the USE is voluntary, while the examination is conducted by 5 subjects.

In 2004, the Ministry of Education specified methodological documents that regulated the procedure and the content of USE, the procedure of functioning of the state examination and arbitration commissions of the RF Subjects, the procedure of enrollment to higher educational and secondary polytechnic institutions. In addition to that, the Ministry created an informational infrastructure on the basis of the federal and 63 regional information processing centers. The higher education and secondary polytechnic institutions were allowed to check evidences of the USE outcomes in the Federal Base of Evidences.

In October 2004, IV Russian Conference on the experiment outcomes and setting tasks for the 2005 experiment was held. The conference positively assessed the USE experiment.

In 2005-2006, it is intended to complete the approbation of the procedure and technology of USE in all the RF Subjects, while reserving the right for them to select patterns of participation (quantity of subjects, obligatory/voluntary participation in USE by graduates and institutions). In 2005, it is planned to introduce USE in full across 16 regions where the USE experiment lasted not less than 3 years. In 2005, as many as 78 regions expressed

5 16 47 65

30 300 752 982

8 9 12 14

16 117 464 946

- 79 928 1530

their intention to participate in the USE experiment. So, about 83% of Russian secondary school graduates are going to take USE next year.

It is planned to ensure a step-by-step transformation of USE into a sole examination instrument throughout Russia in 2006-2008. So, the deadline for the compulsory introduction of USE across the country is postponed from the originally scheduled 2006 to 2008.

Meanwhile, the RF Ministry of Education and Science's stand is that USE should not be considered the only instrument of examination for the graduates enrolling for universities. The Ministry calls for alternative forms of the entrance examinations. According to the head of the Federal Service for Supervision in the sphere of education, universities will undoubtedly maintain the right to carry out competitions, whose results allow graduates to enroll for the leading universities. The competitions presently exist in the pyramidal form: school - city - oblast - okrug - the federation. It is intended to somewhat modify this arrangement to ensure the winners of regional competitions are accepted by all Russian universities on a non-competition basis. Besides, universities will be able to hold additional examinations for graduates with USE certificates.

Approbation of New Mechanisms of University Financing

In compliance with RF government Resolution of 26 June 2004 No 313, the experiment on transition to the financing of single universities by means of state nominal financial obligations (SNFO) was prolonged through 2004. The structure of universities participating in the experiment approved by order of 30 June 2004 No. 37 of the Federal Agency for Education under the RF Ministry for Education and Science remained unchanged vis-avis 2003. It comprises 6 universities: Mari State University, Mari State Polytechnic University, Chuvash State University, Yakut State University, Mari State Teachers' Training University, Chuvash State Teachers' Training University. The overall number of students using SNFO accounts for 12,548 in 2004 of which 11,657 had a SNFO of a regular amount, while the remaining 891enjoyed an increased amount of SNFO.

Those were the students whose specialties are especially significant for social and economic development of regions, albeit not demonstrating a sufficient demand for them on the part of the population.

The methodological basis of the experiment that determines conditions and procedures of its implementation remained practically unchanged in 2004, albeit in the late 2003, according to the outcomes of the first stage of the experiment, the RF Ministry for Education prepared a number of proposals on its improvement.

In 2004, the value of the budget funds earmarked for the SNFO purposes as per order of the RF Ministry for Education of 22 July 2004 No. 26 remained unchanged vis-avis 2003. The average proportional costs across the SNFO items in universities accounted for 11,800 rubles. Such an approach against the background of the overall growth of costs for university education essentially means a reduction in the budgetary financing of the universities' current spending. The dynamics of distribution across SNFO categories in universities testifies to the growth in 2004 of the share of the 3rd and 4th SNFO categories and some drop in the share of the 1st - 2nd SNFO categories.

It is worthwhile noting that in the universities that participate in the experiment the correlation between the first-year students whose education was paid for from the federal budget and those who co-financed their education has slightly changed in favor of the former group over the past three years (Table 45).

Table 45

Distribution by SNFO Categories in the Universities Participating in the Experiment (Across All the Forms of Education), as %

2002 2003 2004

1st category 8,0 11,6 8,8

2nd category 39,0 27,5 27,4

3rd category 37,6 42,7 46,9

4th category 10,8 12,5 12,7

5th category 4.7 5,7 4,4

Source: Basing on the data of the State University - the Higher School of Economics.

Table 46

The Share of the First-Year Students in the Universities Participating in the Experiment at the Expense of the Federal Budget and Co-Funding Their Education, as %

2002 2003 2004

Across all the forms of tution:

- at the expense of the federal 58,7 59,7 61,7

budget3a

- co-funding 41,3 40,3 38,3

Regular tution:

- at the expense of the federal budgeta 58,8 58,6 60,0

- co-funding 41,2 41,4 40,0

By correspondence:

- at the expense of the federal budgeta 58,6 64,0 66,5

- co-funding 41,3 36,0 33,5

Source: Basing on the data of the State University - the Higher School of Economics.

To extend the information base of the SNFO experiment with its order of 13 August 2004 No. 51 the Federal Agency for Education bound a number of universities that were not participating in the experiment to submit data necessary for conducting model computations of the SNFO functioning. Notwithstanding the above, 2004 did not witness any real steps on the experiment modification, while all the above deficiencies of the approbated new mechanism of university funding52 essentially were still there. That concerns, primarily, an increase of the SNFO amount across all the categories, reduction in their number from 5 to 3, awarding the winners of the nationwide school competitions and participants in international school competitions with the highest SNFO category to ensure the possibility for them to enroll for the respective departments of the public universities, introducing a greater amount of SNFO for the specialties that objectively appear more costly than the others. As well, one should ensure the possibility for changing the originally granted SNFO category according to the student's performance and examination results.

Given the scope of the experiments underway, they address single avenues of the education system reform and do not form an integral complex strategy of modernization of all elements of the Russian education system. This has not allowed for a much-needed mass support of the reforms underway and making their goals clear and shared by the majority of the educational community and society on the whole.

52 Rossiyskaya Ekonomika v 2003. Tendentsii i perspektivy. M.: IET, 2004. P. 289-290.

290

Modifications in the Education Legislation

In compliance with Federal Law No. 122-FZ of summer 2004, the education legislation underwent substantial modifications. Consequently, a number of provisions of the Law "On Education" that envisaged public guarantees of priority of education, particularly, the higher education (on issues of financing the education system including the universities' social sphere, provision of tax and other benefits, etc.) was abolished.

As per the Law, the provisions that regulated the standardized financing of educational institutions were modified. The Law formulates a new content of the concepts of the federal, regional and local standards of financing educational institutions. Thus, the federal standard concerns financing institutions of the federal subordination, the regional standard - those of the regional subordination. So far the local standard is concerned, it is related to institutions of the local subordination. In addition to that, item 41 of the Law "On Education" reads that the financing of public educational institutions under the RF Subjects and municipal educational institutions is exercised basing on the federal standards and those of the RF Subjects. However, the Law does not stipulate the procedure of approving of the respective federal standards.

Meanwhile, the Law maintained the provision, which provides for the setting of standards of financial costs for small rural and considered as such by government and educational agencies institutions. These costs do not depend on the quantity of students therein.

Hence, in compliance with the Law the procedure of regulation of issues associated with organization of control and financing of the education system was fundamentally modified. This primarily concerns assignment of competence in the education sphere between levels of government and exclusion of the possibility for an additional financial support from the budgets of other levels. Division of powers between the levels of government is chiefly made basing on the principle of a strict tying to the level of financing of educational institutions. This would result in a restriction of possibilities for an additional financial support of institutions, their employees and student as well.

The Law has lifted restrictions on the paid-for enrollment of students for their training in the sphere of jurisprudence, economics, management (the share of students who paid for educational services could not earlier exceed 50% of their respective number at a given department). The abolition of this restriction, on the one hand, allows to meet the population's effective demand for educational services and solidify the financial state of universities, while, on the other, to intensify the urgency of the task of provision of a proper control over the quality of education.

The legal modifications also concerned the practice of co-founding of educational institutions. The Law "On Education" had earlier permitted the co-founding, but now such possibility is excluded, because it contradicted to the Civil Code. The system of co-founding of educational institutions was rather efficiently employed in Samara oblast in the course of organization of a two-level financing of schools, with educational expenses being covered from the regional budget, while communal expenses and those on the real estate maintenance from the municipal budget. The removal of this provision intensifies the urgency of the task of development of new integration forms of provision of educational institutions with resources.

In compliance with the new legislation, the procedure of provision of social protection to students from the budget funds is replaced by a mechanism of implementation of social support measures. It is provided that this particular mission will fall under the competence of educational institutions themselves. Given the above, the current legislation cancels the students' meals and transportation benefits, particularly, for those trained at the publicly

accredited non-government educational institutions that are deprived of the right for benefits that the RF law set for students of public and municipal educational institutions.

The Law substantially modified labor compensations to the budget employees and, particularly, those in the education sphere. The minimal amount of tariff rate (wages) of the budget employees is no longer recognized as a uniform and mandatory one nationwide. Besides, it became the differentiated (depending on the level of the budget financing and residence) instrument of regulation of labor compensations in the regions, which considerably lowered the level of employees' labor rights. Moreover, the Law abolished the government obligations on adjustment of the level of teachers' wages by means of setting labor compensation standards in the form of the labor compensations in the educational sector to those in the industrial sector ratio.

Resulting from the abolishment of RSFSR Law of 21 December 1990 No 438-1 "On Social Development of the Countryside", rural teachers have lost their right for the extra 25% wages and tariff rates vis-avis their urban colleagues. The abolishment of the given benefit substantially deteriorates their economic state of and will have an extremely negative effect on the staffing capacity of the sector. As well, this will derail the teachers' professional prestige, which presently has already sunk considerably.

It is worth noting that in the course of debates of legislative innovations associated with changes in the teachers' social status the trade unions have succeeded in keeping the provision on the pedagogical staff's right for a free housing with heating and lighting in the countryside and settlements of urban type, and for a priority provision of housing to them. But the amount, conditions and procedure of compensation for the costs associated with provision of the noted social support measures have to be set by the RF Subjects' legal statutes, which raises doubts about the actual provision of these rights.

The aforementioned amendments to the educational law have formally brought it in a due consistence with the Civil and Budget Codes of RF, Federal Law of 4 July 2003 No 95-FZ "On Introducing Amendments to the Federal Law "On General Principles of Organization of Legislative (Representative) and Executive Bodies of State Power of Subjects of the Russian Federation, Federal Law of 6 October 2003 No 131-FZ "On General Principles of Organization of Local Self-Governance in the Russian Federation". Notwithstanding this, the priority of education declared by numerous program documents has failed to find the respective legislative fundamentals in the new version of the law "On Education".

Identification of the Future Government Policy Priorities

At its meeting on December 9, 2004, the RF Government considered the present educational reform priority avenues until 2010 for the purpose of securing the country's socio-economic development on the basis of the capacity and by means of the educational sphere. As well, the Government concluded interim results of the 2001 Concept for Modernization53. It was noted that the implementation of the Concept for Modernization through 2001-2004 has allowed:

• to secure the growth of budget expenditures on educational needs;

• to intensify the work on the legislative and legal provision of development of the education system;

• to conduct a number of large-scale experiments on introduction of new mechanisms of financing, assessment of students' progress, provision of accessibility of the higher education.

53 The 2001 Concept for Modernization of Russian Education through 2010 identified enhancement of the quality, accessibility and efficiency of education as principal objectives of its development.

At the government meeting it was also noted that the Russian education system does not meet the respective requirements due to the following reasons:

• an insufficient orientation of vocational training to labor market demands;

• lack of consistency education;

• absence of due connection between education and science;

• an insufficient level of public and government control over the quality of education;

• a low level of teachers' labor compensations;

• an insufficient participation of the general public in the educational reform underway;

• a poor integration of Russian education into the international educational community.

The Government also identified priorities of the present government educational policy, which would allow to successfully find solutions to the objectives set by the Concept for Modernization of the Russian education, as follows:

• development of a modern system of the consistent vocational training;

• improvement of quality of vocational training;

• provision of accessibility of a qualitative general education;

• increasing investment attractiveness of the sphere of education.

It was also noted that one of the most promising avenues of creation of conditions of increasing of economic independence of educational institutions is to encourage the variety of their organizational and legal forms.

Transformation of financial-economic mechanisms that provide for conditions of implementation of the noted priorities, is primarily associated with the attempt to refuse the estimate-based procedure of the budget financing of educational institutions, because this procedure hamper incentives to improve the quality and efficiency of educational services. In the budget reform framework, it is proposed to finance the education system basing on the "performance-oriented management" principle. Such an approach requires from any education development program funded from the budget to comprise a strict list of performance indicators, which would allow to increase the efficiency of the budget spending.

The strategy of the government implies the development and employment of various mechanisms of financing educational institutions from the budget, particularly: 1) standardized per capita financing that allows to secure transparency of allocation of budget funds and to tie the volume of financing directly with the consumer of a given educational service; 2) universities financing on the basis of state nominal financial obligations (SNFO).

A complete transition to the standardized per capita financing is mainly impeded by the absence of the much-needed legislative basis, practical methodologies of calculation of standards across educational levels, types and kinds of educational institutions. In addition to that, some Russian regions' (Samara oblast, Chuvash Republic, Yroslavl oblast) positive experience in this sphere allows to argue about the efficiency of application of the given financing mechanism and the necessity of its further extension to other regions.

In compliance with the government recommendations that were discussed at the government meeting in December 2004, it is proposed to approve the system of differentiated standards of budget financing within the framework of application of standardized per capita budget financing: according to the USE results, international, nationwide, regional competitions; across training avenues, with account of regional specifics.

Due to its complexity and scathing criticism on the part of some rectors of leading universities, the ongoing experiment on universities financing on the SNFO basis requires further specification and suggests inclusion of a greater number of participating universities.

The fundamental institutional modifications in the area of regulation of organizational-legal and financial-economic relations in the sphere of education that were approved by the strategic government documents compel this particular sphere to focus on a

more pro-active integration in market relations. This requires a thorough monitoring of ongoing changes and evaluation of socio-economic risks associated with the planned reforms.

3.6.3. The Start of Restructuring the Budgetary Institutions Network

The task of reforming the budgetary institutions network was formulated in the RF Presidential Address to the RF Federal Assembly of RF in May 2003. It was further specified in "Principles of the Budget Sector Restructuring in the Russian Federation in 20032004 and for the period until 2006", drafted by the RF Ministry of Finance and approved by the RF Government in September 2003.

In 2004, the Government made attempts to implement this mission by starting with the federal institutions network.

Since July 2004 the RF Government has initiated an intense discussion on measures on optimization of the federal budgetary institutions network and reorganization of budget institutions. The Government worked out proposals on two new organizational-legal forms: autonomous institution and public (municipal) autonomous non-profit organization.

In July 2004, the Government Commission on administrative reform approved the procedure of organization of work on optimization of the network of federal state unitary enterprises and federal public institutions subordinated to federal executive agencies.54 The Government Commission suggested to break the noted organizations into groups and prepare, accordingly, four arrays of organizations subjected to: 1) remaining in the federal property; 2) transfer to the RF Subjects' and municipal property; 3) step-by-step privatization; 4) an additional consideration after adoption of legal acts on the procedure of privatization of federal public institutions or their transformation into other organizational-legal forms.

The Government Commission paid a special attention to public educational institutions. It also emphasized appropriateness of a transfer of educational institutions that currently remain in the federal property, as a rule, to the purview of the Federal Agency for Education. However, the RF Ministry of Health Care and Social Development and the RF Ministry of Culture have succeeded to save medical universities and universities of culture and arts from this lot.

The Government Commission suggested to include in list (3) organizations that managed real estate and other property fixed with the federal agencies, in list (4) - organizations exercised functions on the material-technical and social-household provision of civil servants' operations and institutions whose operations were funded from the budget, albeit these funds appeared extrabudgetary, as they result from contracts between such institutions and public agencies.

Overall, the government has demonstrated rather modest progress in this particular reform area. The majority of federal public institutions fell under list (1), while the main part of institutions of elementary and secondary vocational education that had earlier belonged to the federal property is currently included in list (2).

In late October 2004, the RF Government approved the list of institutions of elementary and secondary vocational education (EVE and SVE, respectively) assigned under the regions' competence. Consequently, the Government started the process of assignment of these institutions to the regional level. By 1 January 2005 as many as 2,517 institutions of elementary and 299 ones of secondary vocational education were assigned to the RF Subjects. In all likelihood, the assignment process would result in the restructuring of the

54 Minutes of the meeting of the RF Government Commission on administrative reform of 13 July 2004. No 18.

294

EVE and SVE institutions network with account of budget capacity of the RF Subject and actual needs in the respective qualified staff demonstrated by regional labor markets.

Basing on the experiences of Nizhniy Novgorod oblast, Novgorod oblast, Samara oblast and the city of St. Petersburg that had taken EVE and SVE institutions under their competence in late 90-s, the RF Ministry of Education and Science expects positive changes the given innovation should generate nationwide. The experience of Nizhniy Novgorod oblast exemplifies such a model of the EVE and SVE regional system, under which regional enterprises by themselves select the needed specialists, provide for a production base and tutors, set regional increments to their labor compensations and, consequently, have qualified workers. In addition to that, the oblast has preserved the vocational colleges network, implemented their partial optimization by means of their integration with NVE institutions and regional universities. As a result, during their training students already receive labor compensations up to 5,000 Rubles.

Design of Forms of New Public Organizations

The design of proposals on transformation of budgetary institutions into other organizational-legal forms became an independent critical avenue of the preparation for the budgetary sector reform.

In the 90-s, prior to the implementation of the new Budget Code, budget institutions de-facto had enjoyed a high degree of independence in exercising their economic operations, capital attraction and spending budgetary and extrabudgetary resources. The situation has started to change recently. With the government pursuing the policy aimed at strengthening the financial discipline in planning and spending budget funds, the implacable logic compels it to restrict the independence of public institutions. The government has consistently attempted to bring this array of rights in conformity to the model of budget organization laid down in the organizational-legal form of a given institution. The milestones of this process became: the transition to the treasury execution of operations with the budget funds of public institutions; the adoption of a new, detailed, classification of budget expenditures, in compliance with which the budget financing of institutions and approval of their expenditure estimate are executed; and, finally, the likewise transition of institutions' extrabudgetary revenue and expenditure operations to the treasury execution, which implies a strict control over every item of the institution's revenue and expenditure estimate on the part of its founder.

For the majority of budgetary institutions such the above will lead to the gap between the volume of rights they will enjoy and requirements to their efficiency caused by actual conditions of their functioning. This concerns the institutions whose revenues are formed by compensations from the budgetary and extrabudgetary sources for the services they provide. The array of such institutions comprises health care institutions that participate in the compulsory medical insurance system and receive funds from it according to the volume and quality of the medical assistance delivered; vocational education institutions and institutions of culture and arts, whose revenues to a significant extent are formed by extrabudgetary receipts, etc.

Excessive restrictions of such institutions' operations will result in a weaker motivation to adequate accounting of demands of consumers of their services and efficient utilization of their capacity. That is why there exists an actual need in the public sector having both administratively controlled budget institutions and those that enjoy the legislatively set right for independent economic operations.

The document entitled "Principles of restructuring of the RF budget sector" presents two variants of transformation of budget institutions:

1) into a specialized public or municipal non-profit organization;

2) into a public or municipal autonomous non-profit organization.

The RF Ministry of Economic Development, the State University-the Higher School of Economics, Institute for the Economy in Transition55 designed the above variants. Each of the latter grants a public organization with a broader range of powers versus public institution, while at the same time, discharge a part of obligations from the state with regard to the economic provision of its operations.

In spring 2004, on the basis of earlier drafts, the Center of Private Law designed the following bills:

• "On autonomous institutions";

• "On public (municipal) non-profit organizations";

• "On setting the procedure, conditions and criteria of reorganization of public and municipal institutions in the form of transformation";

• on amendments to the Civil and Budget Codes of RF, the Federal Law "On non-profit organizations".

Since summer the revision of these bills has been conducted under the aegis of the RF Ministry of Economic Development. These draft laws envisage a special kind of the right for operative property management, which the founder of the public (municipal) autonomous institution fixes with that. By contrast to the existing institutional form, the owner does not bear subsidiary responsibility for the autonomous institution's obligations. As concerns the autonomous institution itself, it is liable by all its obligations with the property it has under its operative control, except for real estate and particularly valuable movables. The power to identify particularly valuable movables falls under the RF Government's competence.

The autonomous institution independently controls other property (including real estate) that it purchased for revenues from its operations.

The noted revenues are subject to the institution's independent control and are used to fulfill its principal mission.

The owner of the autonomous institution has a right to assign tasks to autonomous institutions, the fulfillment of which he is bound to finance. While granting a broader independence to the autonomous institution, the state should have more transparent mechanisms of control over its operations. A form of control alternative to the administrative control over the organization on the part of a superior government agency is the establishment of the board of trustees with the autonomous institution. It should comprise individuals appointed by the founder, albeit not employed and receiving compensations for their contribution to the board's activity. The board will oversee the consistency of the organization's operations to its mission as per its Charter, particularly, review its plans and reports, approve of large deals, etc.

The form of a public (municipal) autonomous non-profit organization suggests that its property, particularly, that the founder transfer to it upon its establishment belongs to the organization in question. Should the public (municipal) autonomous non-profit organization have any revenues and spend those particularly to acquire any property, the said revenues and property become subject to its independent control.

55 Povysheniye effektivnosti bjudgetnogo finansirovaniya gosudarstvennykh uchrejdeniy i upravleniya gosudarstvennymi uni-tarnymi predpriyatiyami T. I. M.: IET, 2003. C. 151-250.

The government maintains control over operations of such an organization by means of the board of trustees, established in a manner analogous to the board of trustees of the autonomous institution. But this particular case this collective board is granted with both supervisory powers and the rights to make certain decision: approval of organization's annual financial plans and the respective reports; consideration of the organization's financial performance over shorter periods of time (half year, quarter); making decisions as to whether or not these or those kinds of its commercial operations other than the principal ones are in consistency with its statutory objectives.

It is suggested that these forms should complement, rather than replace, the current form of the institution. While some existing public budgetary organizations are going to remain in their current form, the others will be transformed into new forms. Economic conditions of various kinds of operations of social institutions, the correlation between their various revenue sources, the extent to which the institutions find themselves dependable on budget appropriations appear substantially different across the sectors of the social sphere and within single sectors.

Decision-making with respect to the appropriateness of the transformation of the institutions into new forms should be exercised with account of economic conditions of their operations (revenue and expenditure structure, presence of an actual and potential competition, etc.).

Transformation from the current form of an institution into the one of the autonomous institution poses an urgent challenge to pre-school institutions and schools in medium-size towns and big cities as well as most public vocational education organizations, and urban outpatient-policlinic and hospital institutions. As their operations combine the provision of free and paid services to consumers, or insurers pay for these services, the consumers or insurers have a right to exert economic influence on their operations.

Some public vocational education and health care organizations find themselves under an intense competition and pressure on the part of consumers. This primarily concerns economic, law, linguistic universities, computer and communication training centers, primary and secondary vocational training institutions, medical institutions of the same profile located in the same city, among others. These organizations face an urgent challenge of transformation into public autonomous non-profit organizations.

However, the coordination of the above bills with the agencies concerned has been delayed. The property regime proposed for an autonomous institution has formed the major sticking point. While the RF Ministry of Economic Development and Trade advocate the stand formulated by the Center of Private Law: that is, the property regime in question is a kind of the right for operative control, the stance of the Chief Legal Department of the presidential Administration is that the respective volume of powers falls beyond the operative control framework, which is why it may not be considered as a kind of it.

In November 2004, the debate on the bills in question gained a new hue. More specifically, the leadership of the All-Russia Theatre Union speculated that the above proposals were an attempt to impose an administrative control over Russian theatres' creative and economic operations. They undertook a number of actions highlighted by the national media. The numerous appeals to the government cited the collapse of the Russian repertoire theatre, should theatres be transformed into the aforementioned new forms and demanded to protect the national treasure. In reality, however, theatre directors propone the existing practice, which grants them with an uncontrollable right to manage the property fixed with the theatre and the respective revenues, along with a minimum economic responsibility for their independent economic performance.

3.7. Foreign Economic Activity

3.7.1. Main Trends in Russia's Foreign Trade

Growth rates of the world economy were boosted in 2004 to account for 4%, according to the World Bank. The general global economic situation was animated mainly by a substantial growth in Chinese economy (8%) as well as improved economic situation in Japan and the United States. GDP growth rates in these countries exceeded 4%. The US economic growth was caused mainly by increased investments and consumer spendings. European countries showed slower economic growth rates. Economic growth in Western Europe and Japan was caused mainly by export growth due to increased demand in developing countries.

According to the World Bank, the world trade volume increased by 10.2% in 2004 due to a rapid growth in industrial output. China accounted for over 20% of the world trade volume of goods. Considerable growth in foreign trade turnover in China was caused by a positive impact from its accession to the World Trade Organization, as well as high growth in investments and consumer demand .

Raw goods trade demonstrated the fastest growth rates due to a great demand in such goods, which served as a material incentive for expanding commercial business at a variety of developing countries. In addition, investment goods trade was growing rapidly thus promoting export expansion in Germany and Japan which are specializing in manufacturing machinery and equipment.

In 2005, production growth is expected to slow down due to a price rise of fuel and raw materials. Export volumes have been declining. According to the forecast of the World Bank , the world economic growth is estimated to drop to 3.2%, and the world trade is expected to decline to 8.5% in 2005. World trade flows will be governed by, besides prices of raw goods, the size of budget deficit in the United States affecting the USD exchange rate, as well as a likelihood of economic decline in China.

In 2003, the Russian Federation was ranked 17th in the world on export volumes with a share accounting for 1.8% in the world export. Russia may come 15th on goods export volumes according to the results achieved in 2004. Last year, the Russian Federation was ranked 23rd in import volume in the world with a share accounting for nearly 1% of the total world import. Russia is included in the list of top forty leading countries in terms of sales turnover.

Russian growth rates in foreign trade turnover is by more than 4 times ahead of its economic growth rates. In 2004, sales turnover grew by 31.1%, and GDP - by 7.1%.

At the same time, Russia is falling behind in service trade. For example, it is 29th in the world in terms of service trade with a share accounting for less than 1% of the world volume. Russia comes 22nd in the world in terms of service import, its share accounting for slightly more than 1%.

In regard to foreign trade, in 2004 the Russian Federation showed record-breaking growth ever achieved over the last 15 years in terms of monetary volumes of both export and import of goods, with export supply growing faster thus promoting together with foreign trade turnover growth a substantial growth in positive trade balance .

Favorable world market situation for Russian exporters, RUR strengthening, as well as expanding domestic consumer and investment demand had a basic positive impact on foreign trade turnover growth in the Russian Federation in 2004.

In 2004, the Russian foreign trade turnover amounted to $278,0 billion as calculated by using the method of balance of payments, which exceeds by 31.1% that of the previous

year (Fig. 71). Sales turnover with CIS countries grew faster to reach $49,99 billion, which is by 37.2% higher than that in 2003. Russian sales turnover with foreign countries other than CIS countries increased by 29.9% to amount to $228,03 billion.

300,0 -,

250,0

200,0

150,0

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

Export outside CIS ■ Export CIS HImport outside CIS □ Import CIS

Source: the RF Central Bank .

Fig. 71. Russian Foreign Trade Turnover (USD billion)

It was primarily the price factor that had an impact on import growth of Russian goods in 2004 (Table 71). According to the Bank of Russia, incremental growth of world prices of basic Russian export goods accounted for 20% on the average in 2004 as compared to 2003, while volume export index was 111.1% (correspondingly 114.6 and 110.5% in 2003).

Table 47

Average Annual Prices_

1996 1997 1998 1999 2000 2001 2002 2003 2004

Oil (Brent), USD per barrel 21.33 17.4 1 4.1 15.9 28.19 24.84 25.02 28.83 37.4

Natural gas,

USD/1 million . - 1.9642 2.5469 2.1876 4.3442 3.9764 3.3857 5.461 5.993

BTU

Gas, USD per gallon 0.71 0.615 0.511 0.529 0.887 0.7922 0.755 0.891 1.197

Copper, USD per ton 2574.9 2369.7 1775.3 1539.9 1863.9 1613.6 1592.9 1785.6 2808.2

Aluminum, USD per ton 1590.2 1554.0 1413.5 1318.0 1550.0 1444.7 1350.7 1424.7 1693.2

Nikel, USD per ton 8053.9 7312.4 5352.5 5239.5 8624.0 5966.0 6175.1 9580.8 13756.8

Source: calculated on the basis of the data of London Metal Exchange (Great Britain, London), International Oil Stock Exchange (London).

World oil prices were maintained at a record level in 2004, which was caused by slightly increased demand for oil over the last 24 year at the background of geopolitical instability in oil producing countries. For example, the average world price of Urals oil was $ 28,86 per barrel in January, $ 38,11 per barrel (growth by 32.1%) in September, and $ 42,26 per barrel in October (growth by 46.4% as compared to January and by 10.9% as compared to September 2004).

Average monthly oil price of the same oil in 2004 was $ 34,4 per barrel (growth by 25.9% as compared to 2003). In October 2004, oil prices at the New York Stock Exchange reached $55 per barrel .

The OPEC decreased substantially oil production in accordance with the decision approved at its meeting held in September: from 27,69 million barrels daily in September to 30,61 million barrels daily in October , which reduced tension in the world oil market along with oil prices. However, OPEC's oil production reached its maximum over the last 25 years. Saudi Arabia showed the highest oil production as compared to other oil producers, and it still has reserves to further increase its capacity. Other OPEC countries are very close to reach their full oil-production capacity.

Natural gas prices in Europe increased by 9.7% against the previous year, gasoline prices grew by 34.3%, diesel fuel increased by 26.6%, fuel oil by 2.8%. The average price of energy resources increased by 15% and non-energy goods by 23% in 2004.

Non-ferrous metals were in great demand in 2004. Price rise on plumb, zinc, copper, tin and aluminum was found to be substantial as compared to that in 2003. The price explosion was caused basically, besides general factors, by a growing demand for these products in rapidly developing Asian countries. In addition, metal supply to the world market was reduced due to increased metal consumption in metal producing countries. There was a marked downward trend in reserves of several groups of metals (aluminum, tin, copper, plumb) at warehouses of the leading world commodity exchanges. The majority of metals reached their price maximum in fall. Non-ferrous metals were more expensive by average of 34% in 2004 against 2003 (aluminum by 18.8%, copper by 57.3%, nickel by 43.6%), iron ore by 19%, price index of steel production increased by 54%.

Prices of aluminum remain high mainly due to growing demand for aluminum in China, as well as deficit in alumina and electric power. According to Metal Bulletin Research, deficit in aluminum in the world market was 460 to 550 thousand tons by the end of 2004 . Aluminum consumption in China increased by 16 to 17%.

In last January, price of nickel reached its maximum over the last 14 years. World nickel production volumes do not meet the demand yet, primarily in Asian countries. The world nickel supply will not be able equal the demand until 2006-2007, provided that major nickel mines are put into operation in Canada u Australia.

The world copper market situation was quite favorable for copper producers in 2004. Prices of cooper have steadily been growing over the last three years. the world market prices copper prices grew by merely 8.4% in 2002, by 38% in 2003 , and by 42.9% more in 2004 .

Copper prices were changed due to a variety of factors :

• first, deficit in copper in the world market. Though the copper supply met and even exceeded the growing demand in the market in 2002, there was a deficit of 376 thousand tons in 2003 and 701 thousand tons in 2004, which resulted in price rise ;

• second, growing copper production costs (mainly due to increasing prices of raw materials) ;

• third, transition of product markets to new price levels that was under way throughout a period between 2003 and 2004.

In 2005, the copper market situation will become more attractive than in 2004. In particular, copper production is expected to increase by 7.7% (up to 17 094 thousand tons) with simultaneous growth in demand by 4.1% (up to 17 146 thousand tons). This is expected to improve the balance of the world copper market and reduce substantially the deficit in cooper in the market.

With this situation in mind, one can forecast in 2005 a growth in prices of the metals traded at stock exchanges due to growing demand in several countries, primarily in the United States and China. There is no reason, however, for expecting growth rates similar to those of the pervious year, because the growing demand resulted in boosted production of the metals being in shortage, which provides no stability whatsoever for the world market in general.

As a result of unfavorable world market situation, unprecedented high growth rates in Russian exports was noted during 2004, its monetary volume being increased by 34.8% against 2003 to break the record over the last decade - $183.2 billion (Table 48).

Table 48

Russian Exports Movement

1996 1997 1998 1999 2000 2001 2002 2003 2004

Export, USD billion . 89.7 86.9 74.4 75.6 105.0 101.9 107.2 135.4 183.2

Including :

Foreign countries other than 7^ ^ 67.8 58.7 63.6 90.8 86.6 91.0 113.9 152.9

CIS countries . 71.1

Growth rates, % of the previous year

Volume of exports index . 100.1 101.8 99.7 109.4 110.2 104.2 115.0 109.5 111.1

Price Index . 108.6 98.1 84.2 92.1 128.2 93.8 86.0 113.4 120.5

Source: the RF Central Bank.

However, the quantitative growth had no impact whatsoever on the quality of Russian exports still facing a major problem of inefficient structure of goods. Though several mature economies (for example, Canada and Norway) have a substantial share of raw materials in their export, they also export end products, including high technology products. A share of processed goods in Russian exports is miserable. Furthermore, this share is getting smaller (according to the corresponding parameter calculated for Russia by using the World Bank's method, the share is not over 30% over the last few years). The share of Russia in the world sales volume of machinery and technological equipment accounts for 0.3%, vehicles - 0.1%, electronic goods - 0.04%.

Thus, Russian specialization in raw materials trade, which can be deemed applicable at a certain period of time and under certain conditions, is not evolving into more developed forms related to raw materials processing thus interfering with increasing Russia's share in the world market.

Russian export growth still remain based mainly on the two product groups: fuel and energy products whose export increased by 34.9% in value terms in 2004 as compared to 2003, as well as metals and metal-based products which grew to 64.8% (Fig. 72).

Machinery, equipment and vehicles; 7.2%

Other products; 1.1%

Metals and related product^' ö0/-

Food products and agricultural raw mate-rials; 1.4%

Precious stones, pre-cious metals and re-lated products; 3.8%

Mineral products; 58.8%

Textile, textile prod-ucts and footgear; 0.4%

Lumber and paper-pulp products; 4.0%

Chemical industry products, raw rubber; 6.4%

Rawhide, peltry and related products; 0.1%

Source: the RF Federal Customs Service .

Fig. 72. Russian Export Structure in 2004 (%)

In 2004, a share of fuel and energy products accounted for 58.2% of the total Russian export structure, which is slightly bigger than that in the previous year (57.8%).

Foreign exchange proceeding from exports of Russian oil amounted to $55,0 billion in 2004 and exceeded by 49.3% that in 2003. Total oil production in Russia in 2004 amounted to 459,0 million tons and exceeded by 8.9% that in the previous year. Oil sales in the domestic market increased by 2.1% up to 177,6 million tons; export supplies increased by 13.3% up to 239,6 million tons.

A share of export in total oil export volume in Russia in 2004 accounted for 32.3%, and 55.5% in export of fuel and energy products (in 2003, the figures were 29.2 and 50.5% correspondingly).

A share of supply volume in export of oil-products grew by 4.5%, from 77,4 million tons up to 80,9 million tons. Export volume in money terms increased by 35.4%, up to $19,0 billion against $14,03 billion in 2003.

2004 saw the highest growth rates in prices of metals since 1992 . This was responsible for an increase from 14 up to 16.8% in a share of the group of goods (metals and related products) which is the second one in order of importance in Russian export (mainly through export of ferrous metals to foreign countries other than CIS countries, which grew by 82.1%).

A share of exports of machinery and equipment (7.2%), chemical products (6.4%), and lumber (4%) in total export volume of products in the Russian Federation remained the same as in the previous year.

Negative effect in the Russian export movement was caused by a 16% decrease in value of food products and related raw materials which resulted mainly from reduction in export supplies of grains.

High prices in the world market fostered growth in contract prices almost of all basic range of Russian export products (Table 49).

Table 49

Average Contractual Prices of Basic Russian Export Products (supplies to foreign countries other than CIS countries, USD/ton)

1996 1997 1998 1999 2000 2001 2002 2003 2004

Crude oil 133,5 118,5 74,4 110,9 179,9 156,4 162,4 181,2 231,4

Oil products 129,9 115,7 75,7 94,5 171,9 145,2 147,9 180,2 230,3

Natural gas, thousand cubic meters 84,2 88,6 72,2 55,31 85,91 105,21 91,4 112,3 113,6

Hydrogen nitride 125,6 113,0 83,1 53,0 97,5 81,7 72,4 118,5 158,3

Nitrogen manure 128,0 90,3 58,3 36,8 57,9 61,8 60,6 76,0 103,1

Potassic menure 7,2 79,7 87,4 86,4 86,6 76,8 74,9 77,8 94,3

Lumber, cubic meters 59,4 57,5 46,9 43,5 43,4 45,6 44,8 47,8 56,2

Cellulose 407,3 373,5 342,9 274,0 352,2 293,4 300,0 321,7 371,9

Newsprint paper 473,7 383,4 394,0 349,5 386,6 421,7 332,2 338,3 387,9

Cast iron 136,8 124,2 104,3 66,8 80,7 86,2 91,1 126,8 242,7

Ferrous-based alloys 1114 819,2 740,8 548,2 625,6 601,7 625,7 634,6 1097,8

Copper 2143 2099 1655 1495 1675 1465,3 1371,4 1564,9 2587,6

Nickel 7272 6733 5140 5761 8629 5730,9 6143,9 8584,0 1266,0

Aluminum 1500 1401 1352 1157 1296 1176,3 1036,9 1050,0 1162,1

Source: Customs statistical data .

A share of export is nearly 1/3 of total sales volume of industrial products (considering transportation costs and trade markup). The share of export is exceeding substantially the average figure in a variety of industries.

Raw materials industry and primary process industries, primarily fuel industry, metallurgical industry and timber-and-paper industry, as well as in production of special types of basic chemical products and mineral fertilizers, are most oriented at and dependant on export.

A share of export in industries of high-level processing is normally smaller due to poor competitiveness of the manufactured products (Table 50).

Table 50

Export Share in Production of Essential Goods (%)

1995 1 996 1 997 1 998 1999 2000 2001 2002 2003 2004

Crude oil 41 ,5 41 ,7 41,6 45,2 44,2 44,7 45,9 50,3 53,0 53,9

Oil products 25,8 32,4 34,7 32,9 33,6 36,0 39,8 40,9 41 ,3 52,4

Natural gas 32,2 33,1 35,2 34,5 34,6 33,2 32,8 33,1 32,6 34,4

Coal 17,1 15,8 1 4,5 15,7 16,7 25,7 39,7 37,2 48,9 25,0

Mineral fertilizers 83,9 85,9 80,6 86,5 83,2 82,9 81,8 78,1 75,2

Raw wood 22,3 23,2 29,3 34,1 40,1 42,4 53,4 51,0 50,9 42,1

Wood pulp 74,8 85,7 82,8 77,6 79,1 82,4 83,7 85,1 83,3 74,9

Newsprint paper 71,1 72,2 70,1 74,6 70,6 69,0 67,4 68,6 66,6 63,9

Plywood 71,4 63,2 67,0 67,2 69,2 65,8 64,5 64,2 61,4 61,8

Flat-rolled

steel and iron 53,1 59,7 58,6 63,5 60,6 55,3 43,0 50,5 47,1 44,7

products

Cars 16,7 10,4 4,9 8,3 7,3 12,2 10,1 12,3 11,7 11,5

Trucks 25,4 17,4 10,7 9,6 8,3 7,0 12,3 20,8 19,2 21,2

Source: the RF State Statistics Committee; Customs statistical data.

Restricted access of Russian goods to foreign markets constitutes is a serious obstacle for export growth.

Russia is ranked second after China in the list of countries on which antidumping measures were imposed by the WTO countries in the first half of. As of October 1, 2004, 107 restrictions were imposed on Russian goods, including 53 antidumping duties, 10 quota restrictions, 6 price restrictions, 1 product range restriction, 3 import prohibitions, 2 additional taxes, and 1 protective duty.

According to the Central Bank of Russia, the export transitions efficiency index (ETEI) for an aggregate of goods including nearly 65% of the Russian export value, was estimated as 1,11 in January - October 2004 (in was 1,12 in January thru October 2003). The decrease in the index was mostly caused by growth in prices of goods exported in the domestic market, which ran ahead of contact prices, as well as increased duties on oil and oil products.

Import movement was characterized by growing rates. Volumes import supplies increased by 24.7%, up to $94,8 billion, which a record-breaking figure over the last decade.

Growth in import volumes were basically responsible for import growth in 2004 (Table 51), which reached 120.8% against a moderate growth in prices, 103.1%.

Table 51

Russian Import (USD billion)

1996 1997 1998 1999 2000 2001 2002 2003 2004

Total import 68.1 72.0 58.0 39.5 44.9 53.8 60.5 75.4 94.8

Including :

Foreign countries other than 47.3 53.4 43.7 29.2 31.4 40.3 48.2 60.0 75.1

CIS countries

Growth rates, % of the previous year

Import volume index 98.1 121.1 89.0 84.4 129.2 129.1 117.6 119.2 120.8

Price index 100.2 94.8 92.3 82.1 86.7 94.3 93.4 98.7 103.1

Data source: Bank of Russia.

The Russian import growth was mainly based on real RUR strengthening and good figures of economic growth which slowed down by the end of the year though. According tot the Bank of Russia, in 2004, the RUR became stronger by 15.0% against the USD (4.2% were achieved in quarter IV), by 5.6% against the EURO and by 6.1% against the currency basket. By comparison, in 2003 a real strengthening of the RUR against the USD accounted for 13.6%, while by 0.8% to the currency basket.

The ongoing economic growth and relatively low inflation fostered real monetary personal income, which increased by 9% (by 13.6% in 2003) in 2004 against 2003. This results in consumer demand by individuals and industrial enterprises.

Growth in import of goods was mainly based on increased number of machinery and equipment (by 47.8%). Their share in total import of products increased from 37% in 2003 up to 41.6% in 2004, and from 40.8 up to 45.7% in the volume of goods imported from foreign countries other than CIS countries. Increased volumes of land transportation means (their value increased by 1,9 times) was responsible for a half of the growth achieved.

Reduction in volumes of purchases of meet products and sugar and consequent decrease in monetary volumes (by 9 and 25% correspondingly) had an effect on the decrease in a share of food products and related raw materials in total volume of foreign imported goods from 21.2 to 18.5%.

A share of products of chemical industry and related industries accounted for 16.5%, which is almost equal to that in the previous year (Fig. 73). This item is ranked 3rd in the Russian import structure.

Other products 3.9%

Food products and

agricultural raw mate-rials; 18.5%

Machinery, equipment and vehicles; 41.6%

Metals and related products; 7.4%

Precious stones, pre-cious metals

and re-lated products; 0.3%

Textile, textile products and foot-gear; 3.7%

Mineral products; 4.0%

Chemical industry products, raw rubber; 16.5%

Rawhide, peltry

and related products; 0.3%

Lumber and paper-pulp products; 3.8%

Source: the RF Federal Customs Service .

Fig.73. Russian Import Structure in 2004 (%)

Growth in import supplies has most adverse affect on Russian motorcar factories. They have been suffering from the consequences of RUR strengthening and competition improvement. The demand for Russian motor vehicles has gradually been declining since the middle of 2003 against growing demand for imported motor. In 2004, import of light motor vehicles to Russia grew by 2,3 times as compared to 2003, its volume reached $5 163,5 million.

The policy aimed at protecting domestic manufacturers by way of introducing import duties on foreign motor vehicles failed to achieve the expected efficiency. Neither quality of Russian vehicles nor output volumes have been improved over a period of two years of the customs duties imposed. Consequently, the RF Government plans to rely on using imported auto parts to assemble vehicles in Russia .

The Interdepartmental Commission for Protection Measures in Foreign Trade and Tariff Policy made a decision on its meeting held on January 27, 2005 to recommend the RF Government to abolish the import duty on a part of the auto parts imported to the Russian Federation for car assembly, as well as reduce it for several types of auto parts by 3 to 5%. Auto parts imported for free trading in the secondary market would be subject to the applicable rates of duties.

Reducing import duties on auto parts has a direct relationship with integration of the Russian automobile industry into the world automobile industry. This is an objective process which will help to improve quality of motor vehicles. At the same time, domestic manufacturers will not suffer from a decrease in duties on auto parts. At present, almost all modern car assembly enterprises enter into investment agreements with the RF Govern-

ment , which specify zero rates of customs duties on all auto parts. Thus, the new decision will create equal conditions for all automobile manufacturers.

At the same time, the duties on imported foreign cars will remain high enough. Russia has achieved agreements with almost all countries with advanced automobile industries (except for Japan) on supply of motor vehicles to Russia after its accession to the WTO . The duties imposed on import of second-hand light motor vehicles, trucks, autobuses being in service more than 7 years will remain unchanged, i.e. banned in fact. Duties on new vehicles will be reduced from 25 to 15%. The decrease, however, will continue within a period of 7 years. The rates will remain the same over the first 4 years out of the 7 ones. Customs duties on import of foreign light cars being in service from 3 to 7 years from the production date will be reduced insignificantly, however, they must not exceed the duties on import of new motor vehicles by a least 5%.

Foreign trade conditions improved for the Russian Federation on the majority of product lines in 2004. Average growth in export prices exceeded the growth in import ones by 12 percentage points.

Export surplus was positive in 2004, $88,3 billion ($59,9 billion in 2003).

Geographical structure of Russian foreign trade was slightly changed in 2004 (Fig. 74). Due to the accession of 10 new countries to the European Union in May 2004, a share of this group in the gross volume of Russian foreign trade increased from 36.7% in January thru April up to 48.8% in May thru December 2004. Thus, in analyzing foreign trade transactions of Russia with the European Union, we will consider new EU countries apart from the old ones.

2003 January-April 2004 May - December 2004

□ EU QEU candidates DAPEC □ CIS □ Other countries Source: the RF Federal Customs Service .

Fig. 74. Geographical structure of Russian foreign trade

In 2004, Russian foreign trade turnover with the old EU members increased by 36.6% as compared to the previous years, including export by 40.5% and import by 28.4%. For-

eign trade turnover with the new EU countries increased by 21.7%, including export by 20.6% and import by 26.8%.

It should be noted that a share of the old EU countries in the foreign trade turnover stricture increased by 0,5 percentage points in 2004 as compared to that in 2003. At the same time, a share of this group of countries increased by 1,2 percentage points in the Russian export structure, and decreased by 1,1 percentage points in the import structure. A share of the countries newly accessed to the European Union decreased by 1 percentage point, a share in the export structure decreased by 1,2 percentage points, and by 0,3 percentage points in the import structure.

CIS countries remain second in the structure of foreign trade turnover volume and import. Other countries come second in export volumes, export to the APEC (Asian Pacific Economic Cooperation) countries and the new members of the European Union is nearly equal in volume.

Analysis of the foreign trade turnover structure revealed the following trends: a share of the old EU countries and CIS countries is increasing in the geographical structure of Russian export, while a share of the countries accessed to the European Union in May 2004 and a group of other countries is decreasing.

A share of the APEC and CIS countries increased in the geographical structure of Russian import at the background of decreasing share of the old and new members of the European Union .

Russian foreign trade represents an important factor in financial stabilization of the national economy. Revenues from foreign economic activity have a substantial impact on the revenues of the Russian budget. In 2004, the federal budget received RUR1 219,5 billion in revenues, which is by 61% more than that received in 2003 (Fig. 75). Customs payments accounted for 5.65% of GDP in 2003, and nearly 8% of GDP in 2004. The increase in federal budget revenues was caused mainly by growth in prices of energy sources as well as increased import volume.

45.00 -

40.00 --

35.00 --

30.00 --

25.00 ----

2000 -------- -

15.00--- - -

10.00 — - - - - -

5.00 — - - - - - - -

0.00

1997 1998 1999 2000 2001 2002 2003 2004

Source: the RF Federal Customs Service .

Fig. 75. Customs Revenues Inflow to the RF Budget (USD billion)

A share of revenues from export of goods increased in 2004 against the previous year. In 2003 a share of export revenues accounted for 39% against 54% in 2004 . However, though a share of import revenues (import duties, VAT , excises, customs duties) decreased, there was an upward movement in import revenues.

Basic import revenues are received from goods imported from foreign countries other than CIS countries. Transportation means come first (group 87). In 2004, import of these goods accounted for 19% of import revenues (12% in 2003), primarily motor vehicles. Other types of equipment come second (groups 84 and 85). Meat products come third (group 2) whose import volumes remain substantial in spite of the introduced quotas. Plastic materials and related products come forth (group 39). Such goods as sugar (group 17) and pharmaceutical products (group 30) are also considered as basic goods generating import revenues.

3.7.2. Establishing a Single Economic Zone for Russia, Ukraine, Byelorussia and Kazakhstan

Creating a Single Economic Zone (SEZ) for Russia , Byelorussia, Kazakhstan and Ukraine is one of the top priorities for Russia for the time being. A search for new and optimal ways of economic integration resulted in an Agreement and Concepts of Establishing a Single Economic Zone signed on September 19, 2003 in Yalta.

The Single Economic Zone means an economic zone which is integrating customs zones of the member-countries for the purpose of ensuring free movement of goods, services, cash and labor force and pursuing a single foreign trade, financial and foreign exchange policies.

In the long term, the four countries are expected to use a single currency. Most importantly, the SEZ is nothing but economic organization meeting the vital interests of all its members.

It was agreed that the SEZ would be created on a stage-by-stage basis, each stage including fulfillment of certain obligations on achievement of a particular stage of integration. A new stage can not be approved until obligations of the previous stage are fulfilled.

The primary goals are to establish a free-trade regime for imported goods of the SEZ members, create conditions for establishing a customs union and a single competitive environment, take measures on harmonization of national laws. Next step is to create a free-trade zone without exceptions and restrictions, conduct a coordinated competition policy, and establish the customs union providing a single tariff. Finally, to ensure a free movement of goods, services, cash and labor force as a result of joints efforts of all the members.

It is proposed to establish a single regulatory body which could assume some powers from the SEZ countries. Decisions of the body would be approved by a weighted voting and mandatory for all the four members. A Council of Heads of States would be a supreme body of the organization. Decisions of the Council would be taken on a consensus basis.

At present, there is a High-Level Group acting as working body of the SEZ, which is represented by Deputies Prime Minister of the member countries. Russia is represented by V.B. Khristenko, Minister of Industry and Power Industry and a special representative of the RF President on integration cooperation issues with CIS countries. The High-Level Group includes 7 task groups working in various segments:

1. Customs and tariff regulation, non-tariff regulation, customs administration ;

2. Competition policy, natural monopolies, subsidies, government purchases, privatization ;

3. Technical regulations, intellectual property ;

4. Tax, budget and monetary policy. Foreign exchange regulation and control, macroeco-nomic performances ;

5. Services ;

6. Cash flow, investments ;

7. Labor force movement.

A meeting of the heads of the SEZ countries that was held on September 15, 2004 in Astana (Kazakhstan) actually initiated a practical implementation of the provisions of the Agreement and Concepts of Establishing a Single Economic Zone. In particular, a list of 25 top-priority international regulatory documents aimed at substantial liberalization of mutual trade and creating conditions for further advance towards the customs union and a single competition environment as drafted by the High-Level Group was approved. These agreements are scheduled for signing before July 2005.

Humanitarian issues are also among the vital ones. A series of agreements were developed for the purpose of simplifying formalities in crossing state borders by citizens of the SEZ countries.

The experience gained as part of the bilateral relations established between our countries is widely used in creating the SEZ. For example, a series of bilateral agreements were signed in Astana to ensure that VAT in is collected on the "country of destination" principle without exceptions as early as January 1, 2005 in the member countries. To date, the High-Level Group has developed a draft basic set of international agreements (more than 80 ones) which represent a legal and regulatory basis of the SEZ has been drafted by .

The Agreement and Concepts of Establishing a Single Economic Zone is open for accession of other countries sharing its principles, provided that they meet the established macroeconomic and institutional criteria. It should be borne in mind, however, that it is the Single Economic Zone that should be established first, primarily its contractual and legal basis, to ensure that every SEZ membership-seeker be able to measure its compliance and capacity provided for by the aforementioned documents.

Accession to the WTO of all the four countries is evidently one of the key issues effecting the entire process of SEZ establishment. The SEZ countries have already established a mechanism of coordination in regard to their accession to the WTO.

3.7.3. Regulating Foreign Trade

In 2004, measures on improvement of tariff and non-tariff regulation in the Russian foreign trade were continued to develop.

In regard to tariff regulation in 2004, a wide range of issues was considered on adjusting export (in particular, asbestos and bleached sulfate pulp) and import (for example, various types of meet, cheese, sodium sulfite, digital audio and video equipment) customs duties.

Rats of export duties on oil and oil products were changed several times due to a price growth of energy resources. A new regulation took effect in February 2002 specifying that the rate of export duty on Russian oil must be determined on the basis of its price in the world markets. The oil export duty was revised once on a two-month basis (Table 52). The rate of duty on oil products was adopted together with the rate of duty on oil. It accounted for 90% of the export duty on oil until 1 August 2004, and 65% after 1 August.

Table 52

Rates of Export Duties on Oil and Oil Products in 2004 (USD/tons)

Oil Oil products

January 31.2 28.1

since February 1 33.9 30.5

since April 1 35.2 31.7

since June 1 41.6 37.5

since August 1 69.9 45.4

since October 1 87.9

since November 20 57.0

since December 1 101.0

Data source: regulations issued by the RF Government

Rates of export duty on oil products became differentiated from November 2004. Now they are calculated on the basis of world oil prices and will average nearly 65% of the oil export tariff. Inside the "oil products basket", however, export of fuel oil will be twice as cheap as export of refined oil products. For example, with general rate of duty on the "oil products basket" is 15% of export value, the duty on fuel oil is 10%, while that on other oil-based products is 20%.

On the basis of the foregoing, the RF Government approved on October 18 a new rate of customs duties to be imposed on oil-based products exported from the Russian Federation to countries other than the customs union's member countries. Benzol, toluene, xylol, lubrication oils, oil product residues , propane, butane and other condensed gazes are subject to the rate of duty of $57 per ton. Since November 20, the same rate was applied to export from Russia of xylols, distillates, gas oils, residues from refining of oil and oil products produced from bituminous rocks. Crude oil products and calcined oil char are exempted from export duty.

The Interdepartmental Commission for Protection Measures in Foreign Trade and Customs and Tariff Policy approved in general the new procedure of export duties on oil products at its meeting held on January 27, 2005 . Export duties on oil products will be calculated concurrently with oil duties for a period of 2 months on the basis of monitoring of oil prices in the world market. The following equation will be used : For oil products (except for fuel oil):

• 0,416 * (P is 109,5)

for fuel oil:

• 0,224 * (P is 109,5),

where P is oil price , according to the conducted monitoring; 109,5 is oil price per ton, tax exempted.

New export duties on oil products will be determined on April 1, 2005 . In 2004, measures of protection of domestic manufacturers were based on two guidelines as follows.

First guideline: improving and developing a legal and regulatory basis regulating application of protective measures in the internal market:

• a concept and terms of reference for the Federal Draft Law "On Amendments to the Customs Code the Russian Federation" was developed. The documents were submitted to federal executive agencies for coordination. The Draft Law provides for updating a procedure of declaring various names of goods contained in a single shipment as specified in Clause 128 of the RF Customs Code, as well as a procedure of paying and refunding preliminary special , antidumping and compensatory duties ;

• Regulation No. 546 "On Approval of Rules of Calculation of Specific Subsidy of Foreign Country (Union of Foreign Countries) and On Invalidity of Various Laws of the RF Government Regulating Application of Special Protection, Antidumping and Compensatory Measures in Import of Goods" was prepared and adopted by the RF Government.

Second guideline: providing protection of domestic manufacturers by applying special protection, antidumping or compensatory measures.

The following measures and duties were applied in 2004 on the basis of findings of the previous studies: special protective measures were applied against growing import to the Russian Federation of potato and corn starch, caramel, refrigerating compressors, poultry meet, as well as a compensatory duty was imposed on subsided import of reinforced concrete rounds from Ukraine.

The effect of the Agreement On Regulation of Black Pipes Supply concluded on April 10, 2001 between the Ministry of Economic Development and Trade of Russia and the Ministry of Economy of Ukraine was extended for the period of 2004 for the purpose of regulating black pipes supply from Ukraine to the Russian Federation.

As a result of negotiations, an Agreement on Regulation of Galvanized Rolled Iron Supply from Ukraine to the Russian Federation was concluded on January 23, 2004 between the Ministry of Economic Development and Trade of Russia and the Ministry of Economy of Ukraine.

Monitoring of effectiveness of special protective measures against import of potato and corn starch, caramel, refrigerating compressors, poultry meet to the Russian Federation and the compensatory duty on import of reinforced concrete rounds to the Russian Federation from Ukraine were monitored throughout 2004. Furthermore, the situation of the Russian caramel market was analyzed.

The monitoring resulted in decisions aimed at reducing the applicable duty on potato starch import and updating the rate of import customs duties on native and modified starches by introducing combined duty rates with a specific component in order to prevent understatement of the customs value.

Growth of imported dried yeasts in the Russian market as well as dumping import of channel beams to Russia from Ukraine were investigated into.

Investigations into dumping import of asynchronous motors to the Russian Federation from the Republic of Belarus and Ukraine and various types of pipes from Ukraine, flat-rolled products from the European Union, as well as increased import of white sugar and electric bulbs to the Russian market were commenced.

Negotiations on conditions of Russia's accession to the World Trade Organization (WTO) were animated in 2004.

The Task Group held its 22nd meeting on February 5, 2004 in Geneva. The meeting was dedicated to further consideration of the Final Report made by the Task Group, which represents a basic element of the final package of documents for the accession. The meeting resulted in consideration of another 10 sections of the Final Report, including collection of excises and import VAT, export duties, government purchases, regulation of trade in cases of transit, etc.

In addition, two-day bilateral negotiations were held on the subject matter of market access of goods and services. As a result, agreements on tariffs were finalized with 13 countries, however, 1 to 2 items remain to be agreed with 10 countries; agreements on services are expected to be achieved with 11-12 countries. In addition, multilateral consultations on the new RF Customs Code, agricultural issues and tariff quotas were held. The consultations covered mostly technical issues.

The Task Group held its 23rd meeting on March 29 thru April 2, 2004. Ten updated sections of the draft report were considered and coordinated during the meeting. In addition, a series of bilateral arrangements were conducted, including representatives of foreign business communities.

The Task Group held its 24th meeting on Russia's accession to the WTO on July 15 thru 16, 2004 in Geneva. Sections of the Final Report dedicated to customs clearance, foreign trade licensing and intellectual property protection in Russia were considered.

The meeting was dedicated to the issues related to customs. Most of the WTO members express their concern about the new RF Customs Code, especially in regard to shipment clearance at customs stations and customs value determination.

The Task Group held its 25th official meeting dedicated to Russia's accession to the WTO on November 18, 2004 in Geneva. The third revision of the Final Report on Russia's accession to the WTO which was substantially updated as compared to the previous one, was considered.

Customs service is one of the most delicate issues at the negotiations, especially customs value determination, law enforcement, several agricultural problems, sanitary and phytosanitary control and technical regulation in general, as well as intellectual property protection.

Furthermore, the United States and Canada continue express their high concern of the issue related to double pricing of energy sources. Russia, however, is not ready to offer substantial concessions in this field.

The progress is as follows. Russia finalized negotiations on terms and conditions of mutual access to product markets with 14 countries (in particular, major trade partners of Russia : nearly 50% of trade turnover with the European Union, 10% with China, 4% with South Korea). A total of 46 countries (in addition, over 10 countries have been negotiating on services only, other WTO members have no claims whatsoever to Russia as they have no economic relationship) expressed their desire to negotiate with Russia. It is important that all of them should agree on Russia's accession to the WOT, because decisions on accession of a new member to the WTO must be made by common consent of the existing WTO members. Russian negotiators expect to finalize negotiations with Australia in spring of 2005.

The hardest part upon achieving an agreement with the European Union and China is to do the same with the United States. Prospects of the Russian aircraft industry is the issue that still remains unresolved. Accession to the WTO has various impact on various industrial sectors . Some of them (telecommunications, banking, insurance services, etc.) has an up-to-date institutional and technological base, but anticipate a sever competition upon opening of the market, though they are competitive and even have an advantage over their competitors in the Russian market. Others, above all processing industries, recognize their poor competitiveness against importers and consequently tend to a harder protective policy. Aircraft industry is the "hardest" one: it needs huge investments, secured leasing treatment and more to make it catch up with the contemporary market of passenger air jets. This industry must continue for strategic purposes.

Copyright is the second complicated problem in the negotiations with the United States. Russia is ranked second in the world in production of illegal copies (software, video and audio products). At a press conference held recently in Moscow, the US party has demonstrated DVD movies that haven't been released in the United States yet.

Thus, the Russian Federation has reached the final stage in accession to the WTO, when most complicated issues are to be resolved. Potential obligations on all parameters of the accession (tariffs, agricultural obligations, service market access, system-based 312

issues) will be based on current and future economic situation and ensure the required protection of domestic manufacturers and adequate competitive environment.

Construction of legal and regulatory framework regulating foreign economic activity is expected to be finalized soon. A lot of work has been performed to bring the Russian customs legislation in compliance with the WTO's regulations. A total of fifteen laws and draft laws were considered in the previous year. The RF Customs Code took effect on January 1, 2004; RF Law "On Regulation in Foreign Trade" came into force on July 15, 2004. RF Antidumping Law and Law on Technical Regulation regulating a minimum set of standards and reducing the number of required licenses were adopted. A foundation of legal protection of intellectual property was laid.

The applicable legal base regulating Russian foreign trade includes the new RF Customs Code, 12 regulations and 2 instructions issued by the RF Government, more than 80 regulations of the RF Federal Customs Service issued in elaboration of the RF Customs Code.

However, the initial year of operation under the new the RF Customs Code revealed that several of the RF Customs Code need to be more clear-cut, certain and legally elaborated. The same is true with the regulations issued on the basis of the RF Customs Code and orders of the RF Government, as well as law enforcement. In addition, nearly 30% of more than 10 000 different regulations, orders and instructions issued on the basis of the RF Customs Code of 1993 are still effective. RF Law "On Customs Tariff" needs to be brought in compliance with the new RF Customs Code and the requirements of the World Trade Organization . No amendments were made to the RF Tax Code the Russian Federation in regard to value added tax refund, in particular processing products exported from the customs territory of Russia. Provisions of the RF Customs Code and the RF Tax Law remain to be correlated . Altogether this is evident of the fact that legal basis of customs regulation still remains to be finalized.

Application of simplified customs clearance mechanisms to special types of entities is one of the essential new developments of the RF Customs Code. Such mechanisms provide for faster customs clearance for the entities which respect customs regulations in good faith.

However, special simplified procedures of customs clearance came to be applied only in May 2004 pursuant to Federal Law "On Amendments to Various Regulations of the Russian Federation and Invalidity of Various Regulations of the Russian Federation Due To Application of Measures on Public Administration" of June 29, 2004 No. 58-FL. This is caused by the fact that the RF Customs Code neither specifies clear application mechanisms of such procedures nor authorizes departments to establish such procedures. So, amendments were made to the RF Customs Code authorizing the Ministry of Economic Development and Trade of the Russian Federation to establish such procedures.

There is another new and essential development provided for by the RF Customs Code - computer-based declaring of goods - that needs to be finalized too. The RF Customs Code permits provision of electronic documents. However, neither list of electronic documents which may be submitted nor their forms have been specified to date. The required software and hardware are not available yet.

Foreign trade operators are facing serious economic, legal and administrative problems caused by expanding practice of the RF Federal Customs Service aimed at restricting the number of customs clearance stations for declaring certain categories of goods.

There were 34 regulations restricting the number of customs clearance stations for declaring certain categories of goods before the new the RF Customs Code came into effect. Such measures allowed declared goods to become legal in trade and increased in

number: electronic household appliances by 1,5 to 2 times and meat by 2,5 times, with insignificant changes in export of such goods to the Russian Federation .

Article 125 of the RF Customs Code provides for submission of customs declarations to any customs clearance station. However, practical application of this Clause by agencies under the RF Federal Customs Service makes this provision ineffective in regard to numerous categories of goods by underlying a new category: "goods related to frequent violations of the RF Customs Law". Such practice is governed by Clause 2(3), Article 125 of the RF Customs Code which is uncertain and referential in essence, thus allowing the RF Federal Customs Service to restrict by internal regulations the number of customs clearance stations for declaring numerous categories of goods. Such practice of application of Article 125 of the RF Customs Code received a fairly negative response from the Task Group on Russia's accession the WTO as being considered a form of non-tariff protectionism.

At the same time, maintaining such authorities of federal government agencies complies with the international practice (standard rule 3.20 of the General Schedule attached to the Kyoto Convention 1999) and is aimed at improving control efficiency. Unlike the former regulation, the new RF Customs Code Russia provides for clear-cut criteria for restricting the number of customs clearance stations. Such measures must be justified and based on risk analysis, and abolished if they prove inefficient and have an adverse effect on operation of foreign trade participants. The number of customs clearance stations for certain categories of goods will gradually be increasing under liberalized customs regulations and due to a wide use of IT-based customs clearance and supervision procedures, as well as introduction of a system of risk assessment and management. At present, the RF Federal Customs Service has prepared proposals on reduction of restrictions imposed on the number of customs clearance stations for declaring goods imported to the customs territory in accordance with the plan coordinated with the Ministry of Economic Development and Trade Russia .

The new RF Customs Code resulted in substantial changes in composition of the so-called customs-related organizations (customs brokers, customs carriers, owners of interim storage facilities).

Establishing large amounts of security for entities which run the customs-related business, has already ousted small and medium-size companies from the market, which are unable to secure their responsibility to customs authorities. For example, 1469 organizations provided services on interim storage of goods before the RF Customs Code came into force, while 1116 companies appeared to be listed in the corresponding Register of owners of interim storage facilities at the end of 2004. The number of companies operating as owners of customs warehouses and providing storage services at these warehouse was reduced from 219 (including 4 organizations established by customs authorities), as of January 1, 2004, to 168 (including 3 warehouses established by customs authorities).

A monitoring conducted late in 2004 of the changes in the market of services provided by customs brokers (representatives) showed that such services were rendered by 278 organizations listed in the Customs Broker Register (representatives) and qualified for being included in such Register, as well as 122 organizations operating as customs brokers with licenses (prior to the end of license period) issued by customs authorities prior to January 1, 2004. Thus, total number of customs brokers was 400. Prior to the new RF Customs Code took effect, 843 customs brokerage licenses were issued, while the number of customs brokers was reduced by 2,1 in 2004.

There is a threat of monopolization of broker services by a dozen of large brokers. This may entail monopolized prices of brokerage services, encourage corruption trends in this environment, increase costs incurred by trade operators and boost up prices of imported consumer goods. The same is true with the market of customs carriers and storage services.

Thus, a series of problems were revealed during the initial year under the new RF Customs Code, which could be resolved by making amendments to the regulatory documents and, in special cases, updating corresponding provisions of the RF Customs Code .

The following problems are worth mentioning:

• to date, no amendments were made to the customs-related laws and regulations of the Russian Federation ;

• RF Law "On Customs Tariff" was neither brought in compliance with the new RF Customs Code nor the requirements of the World Trade Organization ;

• no amendments were made to the RF Tax Code in regard to VAT refund, in particular on processing products exported from the customs territory of Russia ;

• problems still can be found in incompliance of provisions of the RF Customs Code Russia with the Tax Law the Russian Federation in regard to tax base determination for assessing customs duties and taxes, as well as in incompliance of limitation periods of customs payments enforcement with integrity checks of data provided for customs clearance after products are manufactured.

Invoice processing rules established pursuant to RF Law On Taxes and Duties, make no allowance for the fact that goods may be produced prior to submission of a customs declaration, when a state customs number is not yet assigned and consequently can not be indicated in an invoice so that the goods can be sold in the domestic market.

Tax authorities may face problems after January 1, 2005 in applying the provisions of the RF Customs Code referring to the Law On Taxes and Duties, due to the amendments made by the Federal Law of July 29, 2004 to Article 13 of the RF Tax Code under which the customs duty is excluded from the list of federal taxes .

At the same time, it should be noted that some amendments to the RF Customs Code were already made. RF Law "On Amendments to the RF Customs Code" was adopted, which added a new Chapter ("Customs Duties") to the RF Customs Code. This was done for the purpose of ensuring a legal support in collecting customs duties.

Article 33.1 ("Customs Duties") provides definition of the "customs duties" term and specifies a list limiting their categories: customs duties on customs clearance, carrying and storage. The Draft Law specifies the maximum rate of customs clearance duty: RUR100 thousand. It also specifies fixed rates of customs carrying and storage of goods at interim storage facility or customs warehouses owned by customs authorities. The Draft Law specifies fixed rates of special categories of customs duties thus making it a direct-effect law.

For example, customs duty for escort of goods is RUR2000 per each vehicle and each unit of rolling stock at a carrying distance of up to 50 km and RUR3 000 for that at a distance of 51 to 100 km. However, customs duty for escort of goods at a distance more than 200 km is RUR1000 per every 100 km of the road, but not less than RUR6000. The amount of customs escort duty is RUR20 000 per every sea vessel, river craft or aircraft regardless of carrying distance.

Making amendments to the Code will help Russia to meet its commitments in the field of customs duty at the negotiations on its accession to the WTO : pursuant to Article VIII of the General Agreement on Tariffs and Trade (GATT), customs duties must be collected as compensation for customs costs rather than for fiscal purposes.

Federal Laws "On Basic Principles of Public Regulation in Foreign Trade" and "On Foreign Exchange Regulation and Control" took effect in June 2004, which play an important role in regulating foreign economic activity. These laws underwent expertise confirming their compliance with the corresponding WTO regulations .

RF Law "On Basic Principles of Public Regulation in Foreign Trade" provides updated definitions of basic terms (foreign trade, import, export, etc.) and introduces a series of new terms and definitions (transit, free trade zone, customs union). The Law contains provisions on separate public regulation of foreign trade in goods, services and intellectual property. It also includes new provisions on regulation of foreign barter trade and on pre-shipment inspection. A new procedure on counter measures is introduced.

The Law specifies basic principles of public regulation of foreign trade on the basis customs-tariff and non-tariff methods, including the following ones measures: establishing and abolishing import and export customs duties and dues; imposing and withdrawing restrictions and limitations in international trade in products, services and intellectual property; arranging and withdrawing economic and administrative measures promoting development of foreign trade; concluding international trade agreements as well as agreements on customs unions, free trade zones or regional economic integration.

The Law ensures that the Russian legislation meet the provisions of Articles I, III, V, XI, XIII, and XXIV of the GAAT of 1994 as well as the WTO Agreements on import licensing and pre-shipment inspection.

Furthermore, the Law specifies regulations on imposing restrictions and limitations provided for by Articles XX and XXI of the GAAT of 1994. Special provisions of the Law are intended to ensure transparency in accordance with Article X of the GAAT of 1994.

Developing new regulations and making amendments to the applicable ones is one of the basic tasks of the present period in implementing provisions of Federal Law "On Basic Principles of Public Regulation in Foreign Trade", in particular measures of non-tariff regulations.

FR Law "On Foreign Exchange Regulation and Control" excludes precious metals and precious stones from the list of currency valuables, which provides for liberalization in this field and makes the Russian legislation compliant with Article XX of the GAAT of 1994 in this respect.

The Law also specifies the term for abolishing the existing restrictions, as well as reduces the number of capital transactions requiring permission of the Bank of Russia, with consideration of international agreements of the Russian Federation, including Article. VIII of the Agreement with the IMF.

The list of non-commercial operations classified as current exchange transactions is largely expanded. The list is open, which provides for further liberalization of foreign exchange regulations.

In November 2002 , when a new revision of RF Law "On Foreign Exchange Regulation and Control" was prepared, RF Minister of Finance A. Kudrin pointed out that the standard of compulsory disposal by exporters of a share of foreign exchange earnings might range from 0 to 30% subject to the RF Central Bank. This standard should be reduced on a regular basis, while it also may be increased provided that Urals oil price drop to $12 USD per barrel. In last July, the RF Central Bank already used its right to change the standard by reducing it half as much, down to 25%.

At the end of November 2004, the RF Central Bank made a decision to sharply reduce the standard of compulsory disposal of a share of foreign exchange export earnings from 25 to 10%. This is a decision of major importance, because it was this standard that

the Russian Government was using for a long period a tool to influence inflation and USD/RUR exchange rate.

The standard of compulsory disposal by exporters of a share of foreign exchange earnings came into force on January 1, 1992 pursuant to a Regulation On Liberalization of Foreign Economic Activity issued by President B. Yeltsin. The mechanism worked as follows: a republican foreign exchange reserve received 40% of foreign exchange earnings at a special exchange rate, and a foreign exchange stabilization fund of the RF Central Bank was built up on the basis of 10%. The foreign exchange reserve and special exchange rate were abolished on 1 July 1992 : the entire 50% of foreign exchange earnings was supposed to be sold in the domestic foreign exchange market according to the procedure established by the RF Central Bank: 20% in the domestic foreign exchange market and 30% directly to the RF Central Bank to replenish its foreign exchange reserves. It was only a year after, on July 1, 1993, when the RF Central Bank allowed the entire 50% of earnings to be sold in the foreign exchange market. Economic situation of that time was undoubtedly complex: downward trend in RUR exchange rate, huge inflation and short supply of consumer goods.

The RF Government again brought up the issue after the post-crisis period in 1998. The State Duma approved a decision to increase the standard from 50 to 75% in December of the same year.

In 2001 the standard was reduced from 75 to 50% due to high oil prices. In 2004 the standard was reduced to 10% as result of ultra high oil prices in the world market .

Thus, in 2004, the Russian Government continued to bring the RF law in compliance with the WTO requirements, which above all meets the Russian national interests and is conditioned by intensive expansion of foreign trade relationships with other countries, Russia's integration into the world economy and consequently the need to develop an up-to-date and adequate mechanism of trade policy as based on the principles and rules of international trade.

3.8. Military Security of Russia under Present Conditions: Economic Problems

3.8.1. Military policies and military-economic activities in the Russian Federation

The bases of the RF state policies in the field of military organization for the period of up to the year of 2010 were determined by the Supreme Commander- in-Chief, the RF President, as far back as 2002 and such policies are further specified by the President in his annual addresses to the Federal Assembly. Jointly with the National Security Concept and the RF Military Doctrine, these documents define objectives and tasks of both military organization and military activities in general. Concrete programs, the Federal Target-Oriented Program (FTP) for transition to a new system of army recruitment in particular, were respectively approved by the RF Government.

Adoption of the federal budget by the early 2004 permitted timely approval of the state defense order as well.

Thus, positive solution of the RF military security tasks, it would seem, was to be supported with all the necessary resources which did not augur any faults in functioning of the respective "power bodies".

However, analysis of the Defense Ministry activities in 2004 construes an impression that its governing bodies proceeded basically from their own understanding of the objectives and tasks of the said activities as stated in the "Development the RF Armed Forces:

Topical Tasks" (the so called "White Book" of the Defense Ministry, October, 2003). This is mostly attributable to a strong wish of the Defense Ministry governing bodies to close down the question of the Russian military reform as though it has already been fully, successfully and finally completed.

Yet, even if double failure of the submarines' strategic missiles during the exemplary 2004 naval maneuvers, attended also by V.V. Putin, RF president, was indeed quite accidental but at that accidental rather demonstrative. It once again graphically showed that with their de facto results being neither compared against the respective costs nor estimated with regard to the economic expediency, the administration system of the "power bodies" is simply liable to have low efficiency. Another significant factor was lack of due civilian control.

A number of facts are leading to a conclusion that the military-political leadership of Russia began at last to understand this situation which in turn brought about the appearance of political will to overcome such. So it is not by any chance that early last year a group of top ranking Defense Ministry officials, for the fist time during many years, made a special trip to visit their colleagues in Great Britain just in order to study their practical experience in the area of defense financing. However, there was something more important here - the RF administrative reform which started in April, did not pass the "power bodies" by. So the necessity of their participation in this reform once again graphically demonstrated unlikeness of the defense ministry's thesis that the military reform had already been fully, successfully and finally completed.

Results of ensuring RF military security on the international arena in the last year do not at all seem to be unambiguous. On the whole, these may be considered as successful with regard to foreign countries. For instance, Russia was able to preserve its principle position in the Iraqi question and rejected insistent invitations to join the US military effort in this country. At the same time, however, because of its own national interests, Russia continued to support international forces in Afghanistan by providing for transit of military and other respective cargo through its territory. Stronger became its cooperation with the NATO: 34 joint actions took place during the year, including military games in the headquarters of NATO in Brussels, joint naval maneuvers in the Ionian Sea and the Northern Atlantic Ocean, the first entry of a Russian A-submarine into the French sea port of Brest and maneuvers simulating defense of nuclear objectives on the Kola Peninsula.

Steadily maintained is a sufficiently high level of Russia's military and technical cooperation with foreign countries. As officially declared, the volume of military exports for the said year exceeded 6 (six) bln US dollars. In the same period, however, claims were for the first time openly made to Russia in connection with her inability to complement all the supplied armaments with the necessary spare parts. Besides, there still remains the problem of money deductions for the intellectual property in the Indians-made Russian armaments models.

Quite positive results were also achieved in both military and military and technical cooperation with the former Soviet republics. Successful were the "Border 2004" antiterrorist maneuvers conducted in Kirghizia within the framework of the Agreement on the CIS Collective Security. At the same time, however, a number of observers openly expressed their opinion that Russian peace-keeping forces did not at all act in the best way during the aggravation stage of the July 2004 international conflict in the Southern Os-setia.

In the Russian Federation itself, in 2004, its armed forces were used in Chechnya, Ingushetia and the Northern Ossetia. The special forces and anti-mine engineering units combat operations in Chechnya are considered as sufficiently efficient. The troops own 318

losses somewhat decreased as compared with the previous years. Yet, any attempts to free the territory of this republic from the terrorist bands and catch their leaders were rather unsuccessful. And although withdrawal of the airborne units from Chechnya by the end of November basically completed the reduction process of the troops strength on its territory, almost simultaneously plans were published to form two mountaineering-rifle brigades in the Northern Caucasus. It is noteworthy that stationing one of them on the territory of the mountainous Daghestan was confronted with active protestations of the local population caused, as reported, by plans of the military to alienate certain agricultural lands.

Of particular significance is the fact that actions of all "power bodies" during the criminal sally of the terrorist fighters in Ingushetia on June 22 and the Beslan tragedy on September 1-3 were extremely unsuccessful. The latter were in both cases able to take initiative at least for a certain period of time.

Last year, the composition, organization and functions of the Defense Ministry were significantly changed - the General Staff of the RF Armed Forces lost a number of administrative functions as regards direct control of troops and was placed under the authority of the Defense Minister which, as expected, should enable him to concentrate on matters of strategic planning and perspective development of the RF Armed Forces.

Practically completed is the change-over to a unified inter-departmental supply system under which the Armed Forces Logistics Services were made responsible for supplying the troops of all the "power bodies" with the Defense Minister controlling financing of the nuclear defense system.

In July, 2004, the system of military education experienced another change of names which, on the one hand, to some extent returned it to its former state (with military academies and military schools) but, on the other, it was accompanied with the lowest graduation rate of officers from the respective military institutions for the recent years. In the course of three years alone, this graduation rate decreased from 24 thousand down to 14 thousand military servicemen. Accordingly, plans were worked out to draft 15 thousand graduates of civilian higher educational institutions to serve as officers. At that, the Defense Ministry considers the resultant full strength of officers in the RF Armed Forces to be about 88% of the "optimum". The Defense Ministry also started a three-year experiment on the competitive distribution of the respective funding between civilian educational establishments intended for training officers with humanitarian specialization. Although the main funds of the Federal Target-Oriented Program (FTP) for reforming the system of military education in 2004 were allocated to certification of the military educational institutions, their connection to Internet and renewing the stock of the respective libraries' educational materials.

One of really significant events in the area of military and technical policies and purchases of armaments was the document: "Main Development Directions of Armaments, Military and Special Machinery for the Period of up to the Year of 2020" adopted at the Defense Ministry Collegium in late March, 2004.

According to the "Red Star" newspaper, more than 300 armaments and military machinery models were added to the RF armory in the period from 2001 which somewhat contradicts frequent complaints about insufficient financing of the R&D by the state. But the situation, possibly, is rather reverse. The said R&D problems, it seems, are primarily caused by exceptional privacy of R&D, poor connection with requirements of different army branches, flourishing corruption and excessive abuses.

In the year of 2004, there still was no positive solution of the defense industry problems. To somewhat facilitate its reforming process, the list of strategic industrial enter-

prises was cut down from 3 thousand to 1059. Attempts were also continued to administratively introduce vertical structures: for example, the end of the year saw setting up of a helicopter-construction corporation headed by the "OPK Oboronprom" Open Joint Stock Society and consisting of the Mil Moscow Helicopter Plant, the Ulan-Ude and Kazan aviation plants which "Rosvertola" (with 51% federal share in the corporation) is expected to join in future. However, a number of observers have strong doubts that such measures are capable of positively solving of the so called "disproportion" problem. Besides, of major significance is becoming the quality of the armaments and military machinery produced - the number of claims for product replacement has grown 10 times on the domestic and 20 times on the foreign markets.

Not everything is going well enough with transition of the RF military organization to the new system of recruitment for the army.

The previous year of 2004 was the first to see the start of implementing the "Transition to Recruiting Contracted Servicemen for a Number of Military Units and Formations" FTP for the period from 2004 to 2007. Besides, an attempt was made to attract the CIS citizenry to contract servicing but so far with little positive results.

Fully contracted in the Defense Ministry already is the 76th Guards Airborne Division (the city of Pskov). Intensively being re-equipped are the barracks and hostels where the military units and formations are stationed which are preparing for transition to the new recruitment system for the army in 2005.

As has been officially declared, there are no more drafted RF Defense Ministry servicemen in Chechnya. Yet, there still remain in Chechnya 3.8 thousand Ministry of Internal Affairs Forces (MIAF) drafted servicemen and that contributes neither to better efficiency of the troops nor to decreasing negative attitudes of the public as concerns the draft system of recruitment for the army.

As different either from the RF Armed Forces top officials who do not intend to give up draft recruitment in full, or the MIA Internal troops which have not yet determined their position on this matter, the Frontier Troops have already firmly decided in favor of such transition to contracted service of all their servicemen by the year of 2008 and in 2004 even rejected 6 thousand of drafted servicemen.

On the whole, the situation with compulsory drafting in the Russian Federation does remain rather problematic. Abundant is corruption which fact is graphically evidenced by bringing to criminal account of a number of functionaries from the military registration and enlistment offices: all in all, 27 men were brought to criminal account during the year of 2004 alone.

No more joyful were the social results of 2004 for professional military servicemen. Not everybody was quite happy with regard to abolition of privileges. Attitudes towards the mortgage system to provide living accommodations for military servicemen remains rather suspicious since such a system does not directly concern most of those with no living accommodations. There is a lot of criticism regarding indexation of servicemen's money allowances and wages of the civilian personnel.

It is quite difficult for military servicemen to understand the Defense Ministry policy in this respect - it is neither sufficiently transparent nor any logically consistent. Which is, in particular, evident from analyzing the situation concerning practical implementation of the above said FTP. Appearing in the mass media means, Yu. N. Baluevsky, the new Head of the RF DM General Staff, frequently noted the low quality of the citizenry who agree to serve on the contract basis, explaining it by the fact that "most of our countrymen consider payment for military labor as definitely insufficient" - 6200 roubles a month (outside Chechnya) including all the due bonuses. Obviously, this is too little, particularly so if ac-320

count is taken of the fact that the average monthly wages/salaries in the country already comprise something about 7000 roubles. However, fully in accordance with Article 13, Clause 9, "On the Status of Military Servicemen"of the Federal Law, any increments to the basic money allowance are determined by none else than the "Defense Minister of the Russian Federation (Head of another federal body of executive power in which the federal law provides for military service)". As stated in the said law, "within the limits of the funds allocated" but nevertheless by these very persons. It is their direct duty to strive for allocation of such funding.

However, actions of the Defense Ministry during the last two years insistently demonstrate quite a different policy. As far back as early 2003, when the inter-departmental Working Group was set up to prepare the FTP, all members of the Group were given a document signed by the Defense Minister. This document set up the calculated level of the money allowance for the contracted servicemen - 4000 roubles a month. Any reasonable objections of some Group members that this level does not correspond to the results of the respective sociologic polls and is grossly understated were simply ignored. Moreover, while the RF Government were preparing a Resolution on the FTP (the formal approval took place on August 25) the Defense Minister signed Order No 245, dated 9.07.03, on establishing monthly extra pay "to certain categories of military servicemen for the importance degree of the tasks performed". Such "certain categories" included officers of the DM central bodies of administration and the said extra pay comprised 75% of their basic salaries.

It was only in December 2003 that the same minister, on the same grounds and fully in accordance with the approved FTP that Order No 450 was finally signed introducing extra pay "for special conditions of combat training" to contracted servicemen in military units and formations to be transferred to the new system of recruitment for the army. The Order instructs to introduce significant extra pay to those serving in the 42nd Guards Division, stationed in Chechnya, and extra pay in the amount from 2700 roubles to 3300 roubles in other military units and formations to be transferred to the new system of recruitment for the army, the guiding principle being: the higher the rank, the higher the extra pay. Yet, the respective payments started not right away but only "beginning from the day of assumption of an office but not earlier than the date when the commander of the respective military unit by his order officially declared transition of such unit to the new system of recruitment for the army". In the result, the money allowance level of contracted privates and junior rank officers in the permanent alert military units and formations turned out to be lower than the average wages/salaries in the country. Moreover, totally forgotten were contracted servicemen in other military units and formations not being transferred to the new system of recruitment for the army. Such turned out to be market motivation for joining the army on the contract basis!

A year later, when it became clear that with this level of payment RF citizenry are not very willing to become contracted servicemen on a voluntary basis and that such level indeed needs to be raised, functionaries of the Defense Ministry just repeated the approach efficiently tested in the previous year: they just prepared a new Order - No 346, dated 30.10.04, which increased the said extra payment up to 120% of the basic money allowance but... only to military servicemen in the central administration.

It is also noteworthy that the said extra payments in the military units and formations are eventually determined by the commanding officers thus opening the way for possible arbitrariness with regard to military servicemen.

3.8.2. Military expenditures of the federal budget

Since the federal budget for the year of 2004, military expenditures of the state included, was approved in due time it enabled all the executive bodies to practically immediately start its implementation. And although growth of prices on fuels and lubricants, electrical energy and housing and communal services during the year required that the corresponding expenditure articles be increased, proficit of the federal budget permitted such increases which was practically done in November 2004.

Due to changes in the law on the Federal Budget, its expenditures were increased up to 2 768.1 bln roubles (or by 4.1%) which allowed to increase military expenditures as well. Finally, the defense expenditures grew by 3.9% on the whole; at that, the military program of Minatom (Ministry of Atomic Energy) went up by 8.9% and expenditures on the military reform grew by 16.5%. Expenditures on pensions to military servicemen remained at the same level and on pensions in the law enforcement bodies even went down by 7.7%. Thus, growth of the military budget turned out to be less than such of the federal budget on the whole. No indexation of the money allowance for the military servicemen or of salaries for the civilian personnel were provided. In view of the regular indexation of salaries for the federal state employees, it was understood in the military servicemen community as intention of the state's military and political elite to solve macroeconomic stabilization problems at the expense of worsening the social status of families of military servicemen, military pensioners and civilian personnel of the "power bodies".

Absolute and relative indicators of the basic military expenses in accordance with the final version of the federal budget are represented in Tables 53 and 54.

Table 53

Direct military expenditures of the federal budget for "National defense"

2004, mln Changes in 2004 as com- Share of expenditures/its changes as compared against on m o/.

Name of the section and subsec- roub./the same in prices of pared against 2003, mln

# tions

2003 roub/ growth in Fed. Budget GNP

rates % 2004

1 National defense 427 376 382 610 27 704 7.24 15.44 0.74 2.65 -0.03

1.1 Building and maintaining of RF 403 376 25 026 14.59 2.50

Armed Forces 361 504 6.92 0.65 -0.04

1.2 Military program of Minatom 18 326 16 407 3 395 20.69 0.66 0.12 0.11 0.02

1.3 Mobilization and military training for 4 696 34 0.17 0.03

civilians 4 204 0.82 0.00 0.00

1.4 Collective security and peace keeping (preparation189 and participation) Branches for the national de- 211 189 -706 -373.43 0.01 -0.03 0.00 -0.01

1.5 343 -46 0.01 0.00

fense 307 -14.93 0.00 0.00

Table 54

Direct and indirect military expenditures for other federal budget sections

No Name of the section and subsec- 2004, mln roub/the Changes in 2004 as compared Share of expenditures/its changes as compared against on m o/.

tions same in against 2003 mln M-\J uw, /u

prices of roub in Fed. Budget GNP

2 Expenditures on military organization in "Law enforcement and state security"

2.1 Internal troops of RF MIA 23 347 20 902 1 680 8.04 0.84 0.05 0.14 0.00

2.2 State security bodies 53 571 47 960 -216 -0.45 1.94 -0.06 0.33 -0.03

2.3 Bodies of border services 31 272 27 996 1 797 6.42 1.13 0.04 0.19 0.00

3 Military and related expenditures provided for in other sections of the federal budget

3.1 Men, combat training, material and technical supply of MES forces (without fire service) 6 630 5 935 422 7.11 0.24 0.01 0.04 0.00

3.2 Maintenance of special construction 1 093 -49 0.04 0.01

bodies 979 -4.99 0.00 0.00

3.3 Mobilization preparation of economy 1 100 985 500 49.23 0.04 0.02 0.01 0.00

3.4 Civil defense 67 60 -7 -11.70 0.00 0.00 0.00 0.00

3.5 Military reform 8 438 7 554 -10 100 -133.70 0.30 -0.43 0.05 -0.08

3.6 Russian defensive sports-technical 18 -43 0.00 0.00

organization 16 -266.55 0.00 0.00

It is noteworthy that growth of military expenditures of the Russian Federation after the 1998 crisis is of a stable character. However, as shown in Table 55 and Fig. 76, in constant prices of 1999 this growth is of a fading character.

Table 55

Dynamics of expenditures on defense and security in 1999-2004

Sections of the federal budget

1999 2000 2001 2002 2003 2004

Expenditures on "National defense" in prices of the budget year ( 1999, mln roubles) Increment as compared against the previous year, % 93 702 140 852 214 688 281 970 354 907 427 376

93 702 117 181 150 598 173 504 190 987 204 816

- 25.1 28.5 15.2 10.1 7.2

Increment as compared against 1999,% - 25.1 60.7 85.2 103.8 118.6

Expenditures on "Law enforcement and state security" In prices of the budget year (1999, mln roubles 51 324 51 324 79 802 66 391 131 621 92 329 165 999 102 144 249 799 135 618 318 543 152 442

Increment as compared against the previous year, % - 29.4 39.1 10.6 32.8 12.4

Increment as compared against 1999,% - 29.4 79.9 99.0 164.2 197.0

450.0 400.0 350.0 300.0 250.0 200.0 150.0 100.0 50.0

- Expenditures on

defense (nominal)

- Expenditures on

defense (real)

-A— - Expenditures on

security (nominal)

- - -X' ' - Expenditures on

security (real)

n-1-1-1-r

1999 2000 2001 2002 2003 2004

Source: Calculations of IET

Fig. 76. Dynamics of expenditures on defense and state security,

bln roubles

As to indirect military expenditures (Table 56), noteworthy is their stabilization which is determined by completion of the main processes of transition of Russia's military organization to a new system. There also took place further decrease of the real (5%) expenditures on pensions to military servicemen which is stimulating loss of the military service prestige.

Table 56

Indirect military expenditures connected with previous military service

№

Name of the section and subsections

2004, mln roub./the same in prices of 2003

Changes in 2004 as compared against 2003 mln roub/growth rates %

Share of expenditures/its changes as compared against 2003, %

in Fed. Budget 2004

GNP

4 1 Pensions to military ser- 4.1 vicemen 66 606 -2 969 2.41 0.41

59 629 -4.98 -0.19 -0.06

Utilization and liquidation

4 2 of armaments, including 4.2 performance of interna- 10 944 -962 0.40 0.07

9 797 -9.82 -0.05 -0.01

tional agreements

4.3 Conversion of defense 4.3 industry 190 -80 0.01 0.00

170 -46.97 0.00 0.00

Table 57

Summary indicators of military and related expenditures

No Name of expenditures Expenditures (mln roubles) Share of expenditures/its changes as compared against 2003, %

In federal budget 2004 GNP

1 2 Summary direct military expenditures Summary direct and indirect military expenditures connected with the present and past military service 544 474 630 651 19.67 0.80 22.78 0.13 3.38 -0.06 3.91 -0.22

3 Total expenditures on national defense, law enforcement and national security 745 919 26.95 1.90 4.62 0.06

4 Summary direct and indirect federal expenditures connected with the present and past military and law enforcement and state security 881 768 31.85 1.20 5.47 -012

Data on performance of the military and related expenditures, based on Ministry of Finance monthly reports concerning performance of the consolidated budget, are represented in Table 58 and Fig. 77. When analyzing them, account should be taken of the fact that in 2004, the Ministry of Finance turned to quarterly allocation of expenditure quotas whereas in 2003, such quotas were determined on a monthly basis. Effect of such innovation seems to be rather doubtful because, for example, with the general excess of the planned level of expenditures on "Building and maintenance of the Armed Forces" in the amount of 3.2 bln roubles, indebtedness to the Defense Ministry's suppliers comprised in the end of the year more than 5 bln roubles. Accordingly, it seems somewhat paradoxical that significant financial effect was achieved with regard to articles "State security bodies", "Pensions to servicemen of the RF Defense Ministry" and "Military reform" where savings comprised 1.7, 1.7 and 2.2 bln roubles, respectively.

Table 58

Performance of military and related expenditures in the federal budget

by months, mln roubles

No Expenditures |8|Jüiji|l|?J°oo!3Ü

M z Q .g

_J_2_3 4 5 6 7 8 9 10 11 12 13 14 15 16

411 473

1 National defense 473 18 432 30 310 40 597 96 218 22 084 29 158 37 042 28 888 32 511 36 217 36 868 65 806 (2 586) 376

Building and ^^

1 1 maintaining of RF 403 16 467 27 670 37 610 46 581 24 457 28 727 34 479 27 424 31 026 34 795 34 984 62 801 (3 222)

Armed Forces 0°„

800

1.2 Military program of 16 826 1 842 2 346 2 539 1 092 1 122 - 2 189 1 148 1 157 1 097 1 519 2 275 Minatom 18 326

Mobilization and 4 687

1.3 military training of 4-687 119 254 397 398 330 413 356 308 317 301 298 591 614

4 696

civilians

No

Expenditures

J2 ü

Ol O

I 8

o.

p

<

■Q £

o O

£

e

o

e

Q

> Q. ra x tn o

1.5

Collective security 1 4 and peace keeping . (preparation and participation) Branches for the nationa defense

Law enforcement and

2 1 nternal troops

2.2 State security bodies

Bodies of border services

Conversion of defense Maintenance of spe-3.2 cia construction bodies

Prevention and liqui-4.1 dation of consequences of

Civil defense

2.3 3.1

4.2

5

Pensions to military servicemen Utilization and liquidation of armaments, including performance of international agreements Mobilization of economy

Military reform

215 211

343 343 310 577 318 543 21 531 23 347 49 737 53 571 29 993 31 272 190 190

1 089 1 093

15 705 15 977

SZ 67 66 606 66 606

10 365 10 944

1 100 1 100

7 246

8 458

16

24

15 17 25 18

18

36 43

68

10 25 22 16

45 341

21

11 189 22 435 26 656 27 650 20 970 27 870 25 085 22 409 27 344 25 688 28 246 49 809 3 192

720 1 397 1 868 1 927 1 725 2206 1 888 1 836 1 990 1 981 2467 3575 (233)

2 536 3 634 3 915 4 258 3 498 4 045 4 558 3 391 4 170 4 001 3 710 10 146 1 709

803 1 355 2 035 2 683 1 896 2 538 2 028 2 768 2 586 2 626 3 016 6 377 561

15 19 - 56 16 - - - - - 81 4

19

457

17

89

- 56 84 101

82

95

93

69

74

62

64

142 119

713 1 054 1 250 1 708 1 005 1 429 1 343 1 302 1 285 1 304 1 393 2 083 106

- - 13 3 8 3 5 14 - 10 2 8

5 225 5 253 5 381 8 127 2 676 5 382 5 396 5 515 5 475 5 500 5 448 5 480 1 747

844 1 453 310 1 653 79 588 1 201 528 1 075 1 106 1 632

36

124

258 257

7 37 13 45 103 252 252

328 594

067 860

713 561 379 586 546 325 743 393 364 739

17

8

2 185

2

8

2

6

As can be seen from the comparative analysis of the defense expenditures structure of a number of foreign countries (Fig. 78), a rather popular opinion about an insufficient level of the investment component in Russia's military expenditures is most likely just a habitually wrong understanding. Should the decision of the RF Security Council on the "optimum" share of expenditures on the respective development equaling 40%, be implemented, then Russia will be among the top in this indicator category leaving behind the USA, the Great Britain and Germany. Whether this is really needed and what the effect of such "optimality" will be, to a considerable extent still remains a question with no answer. Neither the criterion of optimization nor its methodology are yet known to the Russian scientific community. So far, the funding of the investment component, for instance, in the Defense Ministry are to a considerable extent formed at the expense of expenditures on the money allowances and salaries what its governing bodies are absolutely not shy to officially and regularly declare in different mass media means.

bln roub. 70 65 60 -55 50 45 -40 35 30 -25 20 15 10 -5 0

Average monthly level of expenditures by the changed variant of the budget

Average monthly level of expenditures by the initial variant of the budget

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

Source: Calculations of IET based on the RF Ministry of Finance data.

Fig. 77 Expenditures on building and maintenance of RF Armed Forces in 2004.

100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0%

34,2%

65,8%

16,6%

83,4%

46,0%

54,0%

25,6%

75,0%

□ Content □ Equipment

21,2%

78,8%

38,0%

62,0%

USA Great Britain France Germany Poland

Russia

Fig. 78 Structure of expenditures on equipment and maintenance of armed forces of a number of countries in 2004.

Sources: 1. Der Verteidigungsetat 2004. Einzelplan 14/2004 im Vergleich zum Haushalt 2003 (in der vom Parlament verabschiedeten Fassung, Stand 28.11.2003);

2. UK Defence Statistics Factsheet 2003 Edition. - London: The Stationery Office, 2003;

3. Budget of the United States Government Fiscal Year 2006;

4. Budget de la defense pour 2004. Novembre 2003;

5. Podstawowe informacje o budïecie MON na 2004 rok. - Warszawa: Ministerstrwo obrony narodowej, 2004.

3.8.3. Problems of further modernization of Russia's military organization

Within the executive power reform which started in the year of 2004, a principally new, the main and a priority element in the activities of the RF Defense Ministry and other "power bodies", as the respective state government organs, in 2005 will most likely be restructuring the budget planning activity, the routine activity itself and the respective accounting procedures. To be put to good order are to be the following activity parameters of all subjects of planning, the "power block" included:

1. Objectives and tasks of activities;

2. Obligations with regard to expenditures and formation of returns;

3. Results of activities;

4. Distribution of expenditures by objectives, tasks and programs;

5. Results of the budget expenditures.

Accordingly, these parameters determine the section names of a special document called: "Report on the Results and the Main Directions of Activities of the Budget Planning Subjects". Actually, some of the above parameters were also formulated in such documents as: "The National Security Concept" (NSC), "The Military Doctrine" (MD), "The Fundamentals of the RF State Policies in the Field of the Military Organization" (Fundamentals) and others. Distribution of expenditures by objectives, tasks and programs as well as estimating the results of the respective activities in close coordination with expenditures for the RF Defense Ministry on the whole is a principally new task. which is but only partially familiar to the RF Defense Ministry administration officers, for example, from the experience they gained when working out the State Program of Armaments" (SPA).

If we take the first group of the above parameters of activities alone, even then close coordination of strategic objectives, tactical tasks, and targeted programs, as required by the Government, will nevertheless turn out to be quite problematic. No less problematic seems to be coordination of a number of indicators in time.

The published methodological recommendations (MR) do contain an approximate list of Russia's strategic objectives to be used in working out the said Reports but it is neither exhaustively full nor sufficiently enough satisfies the requirements to formulating such objectives by the MR themselves. Besides, the corresponding objectives of the budget planning subjects, in particular such for the Defense Ministry's activities, are to be worked out for each strategic objective of the country. This approximate list does have certain notional faults as well, such as, for example, division of threats into external and internal ones although the difference between them consists only in the fact that aggression is initiated not by foreign states but by transnational centers which usually tend to operate in secret and under cover.

Noteworthy is also one more requirement with regard to the objectives and tasks which determine activities of the budget planning subjects. This is conditioned by a simple fact that one of the most important sections of the Report, namely "Distribution of expenditures by objectives, tasks and programs" (see above, p. 4, in the list of parameters and sections), must be first worked out and then practically used. However, in accordance with both the Budget Code and the Law on the Budget Classification, expenditures must be distributed according to the officially approved classification groupings of expenditures, primarily so by sections, subsections, specialized articles and expenditure types of the budget functional classification.

The structure of two expenditure sections and their subsections in the Federal Budget for the year of 2005 (FB - 2005), to such or other extent connected with ensuring the national military security, is presented in Table 59. This table also contains the ap-

proved values of respective expenditures as well as shares of expenditures by subsections in each section.

Values of future military expenditures permit to make the following conclusion: Expenditures on the "national defense" have grown in the absolute value and are expected to comprise the figure of 533.1 bln roubles or about 16% of the FB expenditures. In relation to the GNP, the level of expenditures will change rather insignificantly.

The structure of expenditures does not clearly show what part of such will be allocated to the technical equipping of the RF Armed Forces although, according to official declarations of the Defense Minister, it equals 186.9 bln roubles (35.2% of the total expenditures). The said structure includes expenditures on R&D (33.7%), on purchasing new and modernized models of MAT (60%) and on repairing MAT (6.3%). Any proof as to how optimal such expenditures distribution is, or may be, is not yet know either.

The social component of the military expenditures still continues to be criticized by both military servicemen and civilian personnel. No indexation of the basic pay is provided for in the budget, nor many people seem to be very happy about the increasing special allowances. To avoid social protests, early in 2005, the RF President instructed the RF Government to find a positive solution for these social problems of all those connected with the country's military security at the expense of the expected additional revenues.

Comparison of the budget expenditure groupings, as represented in Table 59, with the strategic aims (both shown in the said methodological recommendations and those mentioned earlier in the approved conceptual documents) inevitably leads to a conclusion that they do not correspond with each other.

Moreover, such classification structure of the military expenditures in the RF was different in the earlier years (it is changed almost every year) which will make analysis of expenditures for the period of six years, including the previous years, undoubtedly much more difficult. Suggestions contained in the said methodological recommendations, i.e. to group expenditures of the functional and economic classification by objectives and tasks, are actually rather hard to practically implement. Sufficiently accurate in this case can only be presentation of such expenditures by objectives and by the budget classification groups simultaneously.

Little doubt causes something else: if all the state spending is to be put under control then the same should be extended to the so called "non budget returns" of the RF Defense Ministry and other "power bodies" as well. These must become sufficiently obvious for the budget and be put under control.

Moreover, the problem of inconsistencies is not at all exhausted with that. For, there is a number of by-laws setting aims and objectives of the budgetary planning subjects. This primarily concerns the so called "power bodies" - subjects of the budgetary planning.

For instance, in the Regulations on the RF Defense Ministry, by the Decree of the President of the Russian Federation, dated 16.08.04, functions of this ministry are set as consisting of:

1. working out and implementing state policy in the field of defense;

2. normative and legislative regulation in the field of defense;

3. performing other functions in the same area as established by the respective RF laws, presidential Acts and the Government of the Russian Federation.

Table 59

Structure of budget expenditures connected with ensuring the national security

Share in

Name of section and subsection Amount summary

(mln roubl). expenditures %

National defense 531 139.2 100

Armed Forces of the Russian Federation 388 028.8 73.1

Mobilization and military training of civilians 1 895.4 0.4

Mobilization preparation of economy 3 500.0 0.7

Collective security and peace keeping (preparation and participation) 61.1 0.0

Nuclear and weapons complex 8 693.1 1.6

International obligations in the area of military and technical cooperation 6 231.0 1.2

Applied scientific research in the field of national defense 79 189.9 14.9

Other matters in the area of national defense 43 539.9 8.2

National security and law enforcement 398 889.5 100

Internal troops 23 893.8 6.0

Security bodies 62 315.8 15.6

Border services 31 685.0 7.9

Prevention and liquidation of consequences of emergencies and natural 22 054.7 5.5

calamities, civil defense

Applied scientific research in the field of national security and law en- 2 654.3 0.7

forcement

Other matters in the area of national security and law enforcement 19 100.1 4.8

The said Regulations contain neither directions nor formulations of the objectives to be reached which needs implementing of the said functions. So, on the face of it, there can be no contradictions with any suggestions concerning activities of the RF Defense Ministry. However, further on, the Regulations explicitly state the tasks of the Defense Ministry and if these are considered as tasks of the budgetary planning subject, then, due to the absence of respective objectives, these tasks turn out to be, figuratively speaking, pointless. Of the ten tasks, enumerated in the Regulations on the RF Defense Ministry, the first three and the tenth one apply to working out the policy and the respective normative and legislative regulation but in the most general form. Accordingly, estimating the solution of these tasks can be only strictly formal. Hence, there will be no practical possibility either to evaluate the degree of solving such tasks or to make workable conclusions as to rationality of the respective military expenditures.

Very much the same can be said about tasks of the Defense Ministry in the field of coordination. The said formulation of the tasks make it practically impossible to understand the exact purpose of such coordination or where it is actually leading to. To give an account of their performance is indeed possible but again - in a strictly formal form. Which will undoubtedly contradict the very idea of the said reforming the system of state governance.

The above analysis results of documents which do not sufficiently enough coincide with each other, permit at this stage to work out but only some proposals of conceptual nature which are connected with the reform of the state governance in the RF and relate to the sphere of activities of the RF Defense Ministry.

1. First of all, in our opinion, we must change our understanding as to the practical use of the RF Armed Forces in the present, relatively peaceful time. This relates, for example, to the intelligence and analytical activities of the Main Intelligence Department of the

General Staff and other departments of the RF Defense Ministry aimed mainly at timely revealing of military threats and ways to efficiently parry them back. Novelty of the present situation lies in the transnational nature of military threats and their merging with the terrorist separatism in the Russian Federation.

2. The objective of technically equipping the RF Armed Forces must be made and kept contentually adequate and fully in accordance with the changes in the tactical and technical parameters (TTP) of the armed struggle means and principally new features of the contemporary period in the economic development of humanity.

3. Content of the task connected with solving social problems of military servicemen, must be tied up with ensuring a high social status for all categories of such servicemen and full exclusion of the compulsory military service in regular military forces in peaceful time.

4. The most radical changes must be made in the content of the basic military tasks in peaceful time. For, the main for many combat branches now is not combat readiness for possible hypothetical military actions but combat watch, force determent of aggression and solution of other concrete military tasks aimed at preventing any aggression. Later on, these kinds of activities must become main for all kinds and branches of the Armed Forces.

Analysis of the Regulations on the RF Ministry of Internal Affairs (MIA), approved by the RF President in his Decree, dated 19.07.04, resulted in the following conclusions: the established functions of this ministry consist in working out and practically implementing the state policy as well as in the normative and legislative regulation in the sphere of internal affairs, matters of migration included.

One of the MIA tasks is that of controlling its internal troops (IT MIA) and organizing their practical functioning. But the nature of such activities is not at all specified in the said Regulations. Nor there is any confirmation of the task which was posed to the troops in the previous version of the "Fundamentals of the State Policy in the Field of Military Organization", namely "suppression, localization and neutralization of internal armed conflicts on the territory of the Russian Federation". There is only one clause of authorities determining participation of the RF MIA in "securing the wartime regime" as well as in "conducting measures of the wartime regime".

Accordingly, to plan the budget spending on the MIA internal troops as well as to estimate the efficiency of their activities on the basis of such task setting can hardly be deemed possible.

Such situation with determining the role of other troops and military formations in other bodies having them at their command, is quite similar.