Russian Economic Report 14

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The World Bank in Russia: Economic Review

#14 Russian Economic Report June 2007

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Recent Economic Developments

page 2

GDP and Industrial Production, Investment, The Balance of Payments, Capital Flows, FDI, Ination and stabilization policy, Fiscal policy, Federal Budget, Income, Employment, Recent Policy Initiatives.

2

Russian Regional Growth And Agglomeration Effects

page 12

Recent trends in industrial growth: 1999-2003 and 2004-2006 contrasted, Differences in regional growth and agglomeration effects, Concluding comments.

3

Developing Targeted Social Assistance In Russia

page 20

http://www.worldbank.org.ru

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Russian Economic Report 14

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June 2007

Recent Economic Developments

Russian economic growth and investment accelerated notably in early 2007.

For the first time in years, manufacturing posted very impressive growth relative to the same period in 2006, although at least some of the factors supporting manufacturing were temporary in nature. The investment boom has continued into the second quarter of the year, and 2007 looks to be a year of relatively rapid economic growth for Russia.

Contrary to some expectations, Russia’s balance of payments has strengthened still further due to high capital inflows in the first half of the year. This has created challenges for macroeconomic policy. Money supply growth is reaching record levels, and less of the monetary expansion is being sterilized by accumulation in the Stabilization Fund than in the past. Inflation has remained under control in early 2007, but could very well become problematic in the second half of the year.

Table 1

Main Macroeconomic Indicators 2001

2002

2003

2004

2005

2006

2007-4M

GDP growth, %

5.1

4.7

7.3

7.2

6.4

6.7

n/a

Industrial production growth, y-o-y, %

4.9

3.7

7.0

8.3

4.0

3.9

7.5

Fixed capital investment growth, %, y-o-y

8.7

2.6

12.5

10.9

10.5

12.6

19.9

Federal government balance, % GDP

3.0

2.3

1.7

4.2

7.5

7.5

5.9

Inflation (CPI), % change, y-o-y

18.6

15.1

12.0

11.7

10.9

9.0

4.0

Current Account, billion $

35.1

32.8

35.9

60.1

86.6

94.5

21.8*

Reserves (including gold) billion $, end-o-p

36.6

47.8

76.9

124.5

182.2

303.7

369.1

a Fund for Future Generations, which will be invested in longer-term assets.

But questions and controversies persist over the investment strategy and potential uses for the Fund for Future Generations.

GDP and Industrial Production The Russian economy experienced accelerated growth in the first four months of 2007 in the context of strong energy prices, substantial capital inflows, a rapid expansion of domestic demand, and an unusually warm winter. Almost all sectors of the economy reported a considerable increase in their rates of growth relative to the same period in 2006. Sectors servicing the domestic market like trade (13.6 percent growth) and construction (23.7 percent) continued to boom. More surprising to many economic experts has been the strong growth in industry (7.5 percent) and, particularly, manufacturing (12.5 percent), during this period. By official estimates, the rate of aggregate output growth of the base industries and sectors (often used as a proxy for GDP growth) amounted to 8.8 percent in the first quarter of 2007, as compared to 4.2 percent for the corresponding period of 2006 (table 2).

The 12.5 percent growth in first four months of 2007 represents a sharp

Table 2 Output Growth by Sectors: 2006-2007 2006

4M-2006

4M-2007

Base industries and sectors

6.1

4.2*

8.8*

Agriculture

2.8

1.3

2.2

Extraction of mineral resources

2.3

1.9

3.7

Manufacturing

4.4

3.5

12.5

Electricity, gas, water production and distribution

4.2

5.9

-5.0

Construction

15.7

4.8

23.7

Retail trade

13.9

11.4

13.6

Transport

2.3

1.7

2.8

* Data for the first quarter; Source: Rosstat, Minfin, CBR

The Russian government has approved and submitted to the Duma its first three-year budget, which represents important progress in increasing the horizon of budgetary planning. It has also changed the rules for the management of surplus oil revenues, and will divide the Stabilization Fund into a Reserve Fund for insuring the budget against fluctuations in oil prices and

* Data for the first quarter of a year; Source: Rosstat

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Some, but not all, of the strong showing of Russian manufacturing in early 2007 can be explained by temporary factors: the very warm winter, a particularly low level of manufacturing in Q1 2006 and an unusually large increase in infrastructure orders for machine-building. Rapid growth in the food sector (12.6 percent in the first four months of 2007 relative to the same period in 2006) made an important contribution to overall growth in manufacturing.

Output in the food sector was particularly low in early 2006, however, in the context of a very cold weather and new regulations on the sale of alcoholic beverages that depressed output. Thus, one reason for exceptionally high growth in 2007 was a low base in 2006. The numbers for March and April of 2007 show somewhat more modest, although still strong, growth relative to 2006 (8.0 and 9.6 percent respectively).

Machine-building was responsible for an even stronger contribution to high manufacturing growth in early 2007.

An unprecedented increase in investment demand (see below) can be associated with a major jump in orders for machinery and equipment, electro technical and optical equipment, and transportation equipment (figure 2). The increase in orders for mechanical equipment was particularly strong: 52.5 percent in January-April 2007, which can be compared to a decline of 41 percent during the same period of 2006 (table 3). A good part of this demand might be associated with large state companies, including the electricity giant, RAO UES. The production of hydroelectric turbines, for example, increased by 2.7 times in the first four months of 2007, compared to a considerable decline reported a year ago. The same tendencies can be observed in the production of other electricity generating machines. The

Figure 1 Growth rate, %

break from the steady downward trend in manufacturing growth rates in recent years, which occurred in the context of the rapid real appreciation of the ruble, low investment rates, and high capacity utilization (Figure 1).

Quarterly growth in Russia manufacturing: (relative to the same period of the previous year)

18 16 14 12 10 8 6 4 2 0 2003-1 2003-2 2003-3 2003-4 2004-1 2004-2 2004-3 2004-4 2005-1 2005-2 2005-3 2005-4 2006-1 2006-2 2006-3 2006-4 2007-1

Net growth rate, y-o-y

Linear (Net growth rate, y-o-y)

Source: Rosstat

production of specialized machines and equipment grew by 17.9 percent during the first four months of 2007, as compared to 6.0 percent increase a year ago.

The production of specialized machines for oil-processing, ferrous and non-ferrous metallurgy expanded very quickly (table 3). The booming construction in-

Figure 2

Growth rates in machine building, %

Table 3 Production of selected machinery, growth rates to the same period of the previous year, (%) Mechanical equipment

4M-2006

4M-2007

-41.1

52.5

Gas turbines

-1.5

42.6

Hydraulic turbines

-74.2

170

General purposes machines

-10.9

8.9

Auto-cranes

4.0

30.7

Cranes

33.8

72.4

Specialized oil-processing equipment

-9.5

26.4

Production of specialized machineries

6.0

17.9

Technological equipment for nonferrous metallurgy

4.1

130

-10.2

30.4

Blast-furnace and steal production equipment Bulldozers Caterpillar tractors Transportation devices

6.1

64.2

-18.9

38.1

3.7

16.2

Trucks

21.4

25.3

Trailers for tractors

23.0

75.1

Source: Rosstat

Figure 3

Growth rates in chemicals and metallurgy, %

Source: Rosstat

Russian Economic Report 14

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Figure 4

Growth rates in food and light industry, %

June 2007

dustry can be associated with a pick up in orders for cranes, tractors and other devices. In general, much higher investment demand for machines and equip-

Table 4 Growth rates in industry, % to the same period of the previous year Jan-Apr 2006

Figure 5

Growth rates in wood and oil processing, %

Source: Rosstat

Jan-Apr 2007

April 2006

April 2007

Extraction industries

1.9

3.7

3.8

2.0

Manufacturing

3.5

12.5

5.6

7.0

Production and distribution of electricity, gas and water

5.9

7.0

3.5

-2.1

percent higher, primarily due to continued strong performance in machine building (Table 4). The factors that have restrained growth in manufacturing in recent years are still present. The real appreciation of the ruble should again be quite significant in 2007 (see below). Parts of manufacturing that service domestic demand with limited competition from imports may continue to thrive in Russia’s booming domestic market, but the key task of achieving export competitiveness outside of resources and metals will remain difficult in the current environment.

Source: Rosstat

ment has been coming primarily from natural monopolies, resource-oriented firms, metals and construction.

Is the turnaround in Russian manufacturing sustainable? The most recent data on industrial growth from April suggest that the first quarter of the year was indeed exceptional. Industrial output in April 2007 was only an estimated 4.6 percent higher than in April 2006, although manufacturing remained 7

Table 5

Investment Russian investment growth has mushroomed into a genuine boom in early 2007. While part of the estimated 19.9 percent growth in fixed capital investment in the first four months of the year could be attributed to unusually warm weather in January and February, monthly figures for March (18.5 percent) and April (19.4 percent) suggest that investment growth in 2007 could even exceed the record 17.4 percent reg-

Total Fixed Capital Investment by Sector (% of total) 2005

2006

Q12006

Q12007

Growth rates, Q12007, y-o-y

Agriculture, hunting, forestry

3.2

4.0

2.9

3.8

62.8

Extraction of mineral resources

15.2

17.3

20.5

23.1

31.3

Manufacturing

17.6

16.4

21.4

17.9

4.0

Food industry, incl beverages, tobacco production

3.1

3.0

3.5

3.3

15.6

Coke and oil products

1.8

1.7

2.1

1.7

-1.1

Machine building

0.5

0.7

1.9

0.6

-53.0

Chemical products

1.7

1.9

2.6

1.9

-6.4

Other non-metal mineral products

1.5

1.2

1.2

1.5

37.9

Metallurgy and metal products

4.7

4.3

6.2

4.5

-8.8

Electricity, gas and water production and distribution

7.8

7.8

6.1

5.7

12.1

Construction

2.9

3.3

3.4

2.6

9.7

Retail and wholesale trade, maintenance of vehicles, home appliances and etc.

2.8

2.9

2.3

2.6

2.1

Transport and communication

28.8

26.8

25.7

24.6

13.3

6.7

5.5

5.2

4.6

-5.4

Real estate operations, leasing and services provision

11.5

11.5

10.7

12.4

36.1

Health care and social services

2.3

2.5

1.8

1.6

7.2

Provision of other public utilities, social and personal services

2.3

2.5

1.7

1.9

33.3

Communication

Source: Rosstat

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istered in 2000. Both domestic and foreign investors have steadily increased their interest in investment in the Russian market, where the national currency is appreciating and profit margins are high relative to many other countries in the world.

Despite the unusual growth in manufacturing in early 2007 described above, resource sectors, metals, and the domestic market (non-tradables) remain the favorite directions for most domestic and foreign investment. Manufacturing received an estimated 17.9 percent of fixed capital investment in the first quarter of the year, almost half of which went into metals and food. Investment in manufacturing stood at only 4 percent higher in the first quarter of 2007 than in the same period of 2006. FDI inflows during the first quarter of 2007 reached an estimated record USD 9.8 billion. Most of this investment (USD 7.7 billion), was in the extraction industries (USD 7.4 bln. from the Netherlands). Manufacturing received only USD 0.7 billion in foreign direct investment (7 percent of all FDI inflows) with almost half of this total amount (USD 264 million) going to food, drinks and tobacco production.

For comparison, in Q1-2006, FDI to-

Table 6 Shares of Foreign Direct Investment

by Sector of the Economy 2006 % total

Q1-2007 % total

Agriculture, hunting, forestry

1.4

0.2

Extraction of mineral resources

33.1

78.6

Manufacturing

19.0

7

Electricity, gas and water production and distribution

0.4

0.2

Construction

2.0

0.5

Retail and wholesale trade, maintenance of vehicles, home appliances and etc.

6.1

3.1

Hotels and restaurants

0.2

taled USD 3.8 billion, with manufacturing accounting for 15 percent of the total FDI inflows (USD 577 million).

CPI and PPI 12 months inflation, %, p-o-p

The Balance of Payments, Capital Flows, and FDI Major changes in Russia’s balance of payments are altering the overall macroeconomic picture in the country, and are creating new challenges for macroeconomic policy. While rapid import growth is shrinking Russia’s current account, capital inflows have much more than compensated for this decline, thereby pushing the balance of payments surplus to further record highs and exerting new upward pressure on the ruble.

The current account has continued to weaken since the second half of 2006 due to the relative stabilization of energy prices and much more rapid import than export growth. Although a strengthening of energy prices generated a sizeable and higher-than-expected estimated current account surplus of USD 21.8 billion in the first quarter of 2007, this was smaller than the USD 30.5 billion surplus from the same period of 2006 (table 7). Import growth accelerated to over 35 percent in Q1 2007, while exports grew by only 3.7 percent during the same period. Unless oil prices increase, Russia’s current account should continue to shrink.

Source Rosstat

Figure 7

Capital investments, % to previous year

Source Rosstat * data for January – April

Figure 8

Real Effective Exchange Rate Index

Source: Staff estimates

Figure 9

Oil Prices and Trade Balance

Table 7 Balance of Payments (USD billions) 2004

2005

2006

Q12006

Q12007*

Current Account Balance

58.6

83.8

94.5

30.5

21.8

Trade Balance

85.8

118.4

139.2

36.4

27.9

Capital and Financial Account

-6.3

-13.6

11.9

-7.3

11.4

Transport and communication

2.8

0.4

Finance

11.0

5.2

-8.8

1.1

-1.8

-0.3

23.5

4.6

Errors and Omissions

-7.1

Real estate operations, leasing and services provision

61.5

107.5

21.4

32.9

0.4

0.1

Change in Reserves

45.2

Provision of other public utilities, social and personal services Source: Rosstat

Figure 6

Source: CBR *preliminary estimates

Source Rosstat

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Russian Economic Report 14

June 2007

The big story of early 2007, however, has been the pick up in capital inflows, which has much more than compensated for the weaker current account, and led to a record accumulation of foreign reserves. In the first quarter of the year, the strong capital account reflected an acceleration in foreign borrowing by corporations (USD 24 billion), much of which can be associated with financing bids for the privatization tenders of remaining Yukos assets. While the corporate sector experienced strong inflows

Table 8 Net Capital Inflows to the Private Sector (USD billion) 2006

Q42006

Q12007

41.7

14.3

13.0

Net capital inflows to the banking sector

27.5

11.8

-8.9

Net capital inflows to the non-banking sector

14.2

2.5

21.9

Total net capital inflows to the private sector

Source: CBR

in Q1 2007, the banking sector actually experienced net outflows, which followed large inflows in the second half of 2006 (table 8).

April and May brought still new record capital inflows to Russia that far exceeded expectations. Preliminary estimates place capital inflows at USD 17 billion for April alone, and the Central Bank is now projecting about USD 45 billion in inflows for the first five months of the year. US$ 8 billion alone in recent inflows came from an IPO of Vneshtorgbank. The gross reserves of the Central Bank mushroomed from USD 303.7 billon at the beginning of 2007, to USD 338.8 billion at the end of the first quarter of the year, to US 369 billion at endApril, and over USD 400 billion by the end of May. Thus, despite a weakening current account, the balance of payments continues to strengthen, and the pace of reserve accumulation in Russia has accelerated notably. This raises a number of questions for the conduct of macroeconomic policy, which are discussed below.

Inflation and stabilization policy Inflation remained largely under control in early 2007, although the government may be challenged to keep it under control until the end of the year and meet the yearly target of 8 percent.

According to preliminary data, CPI inflation for the first three months of 2007 amounted to 3.4 percent, as compared to 5.0 percent during the corresponding period of 2006 (table 9). Relatively high inflation in the early months of the year can be associated with annual increases in administratively controlled utility prices, as well as some other seasonal factors. These increases were smaller in 2007 than in 2006. However, core CPI inflation (excluding administrative and seasonal price increases) was also a percentage point lower than during the same period last year, despite the more rapid monetary expansion in late 2006 and early 2007. Money supply (M2) growth for the first four months of the year reached 11.2 percent versus 5.2 percent in the same period of 2006.

An examination of the basket of goods used to calculate the CPI reveals the source of lower inflation in early 2007 relative to 2006 (table 10). The majority of the difference in inflation (1% out of 1.6%) can be attributed to two sets of prices: those for fruits and vegetables and those for housing and utilities. The latter are regulated administratively.

Lower increases in food prices reflect more favorable weather conditions and higher food production, as discussed above. For other major items in the CPI basket, Rosstat reported either relatively modest decreases or even increases

Table 9

Monetary Indicators First Quarter

April

2006

2007

2006

2007

CPI inflation, %

5.0

3.4

0.4

0.6

Core CPI Inflation, %

2.8

1.7

0.4

0.5

M2 growth, %

2.0

4.6

3.1

6.3

Source: CBR

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(most services). Thus, lower inflation in early 2007 should not be considered a breakthrough in the reduction of core inflationary pressures. Preliminary estimates suggest that consumer prices in April 2007 grew faster than a year ago (0.6 versus 0.4 in 2006).

Table 10 Changes in prices of the main components of the CPI weight in CPI

Price change (end period) Q1-2007

Q1-2006

Meat products

10.28

0.9

0.9

Milk and milk products

2.68

1.9

3.4

Bread and bakery products

2.23

2.2

4.6

Fruit and vegetables

3.83

11.2

29.3

Alcohol

6.63

2.0

2.2

Clothing

5.27

1.5

1.9

Footwear

2.55

0.8

1.1

Construction materials

2.07

2.2

1.5

Housing utility services

8.83

12.7

15.6

Transportation services

3.26

6.7

5.8

Communication services

3.19

10.4

0.5

Education services

2.5

2.6

1.9

Source: Rosstat

Given mounting balance of payments inflows and limited monetary instruments for sterilization, keeping inflation in check promises to be a difficult task for the Russian government and Central Bank. As in previous years, the accumulation of large fiscal surpluses in the Stabilization Fund remains a primary means of sterilizing the large inflows. In the past, most these additional inflows came as a result of sharp increases in oil prices. In this case, the Stabilization Fund is an automatic stabilizer, as the majority of additional oil revenues due to higher prices accrues to the government through high marginal taxes, and is then accumulated in the Stabilization Fund. The strong growth in balance of payments inflows in 2007 was not due to higher oil prices, however, but to capital inflows, which are not sterilized through the Stabilization Fund.

Figure 10 illustrates the close relationship in recent years between growth in gross foreign reserves (driven mostly by balance of payments inflows) and the Stabilization Fund. Money supply growth in Russia follows a similar path to reserve accumulation, as forex purchases are the primary source of money emission in the economy. Until the Spring of 2006, the Stabilization Fund grew largely in parallel with foreign reserves. During this time, accumulation in the Stabilization Fund represented about half of the amount of growth in gross foreign reserves, i.e. more than half of the additional monetary expansion from the purchase of foreign reserves was effectively sterilized by the Stabilization Fund. Since this time, capital inflows, which are not absorbed into the Stabilization Fund, have become an increasingly important source of reserve accumulation (and money supply expansion). Correspondingly, the relationship between accumulation in the Stabilization Fund and reserve accumulation between April 2006 through April 2007 has become much weaker, and averaged only 33 percent. From MarchMay 2007, accumulation in the Stabilization Fund amounted to only 15.2 percent of reserve accumulation. At the

Figure 10

Source CBR

Accumulation of Foreign Reserves and the Stabilization Fund

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Russian Economic Report 14

same time, as indicated above, money supply growth has accelerated.

While the pick up in growth has so far helped to absorb additional liquidity in the Russian economy, the implications for stabilization policy in Russia of the weakening of its automatic stabilizer in the form of the Stabilization Fund are potentially serious. As the pressures are coming from the balance of payments, the most obvious policy response would be to allow a more rapid nominal appreciation of the ruble. Since the end of 2006, the ruble appreciated in nominal terms by 1.7 percent against the US dollar, although it depreciated by 0.4 percent against the Euro. If the pressures for the real appreciation of the ruble are not relieved through nominal appreciation, then significant inflation for relatively non-tradable goods and services will be exceedingly difficult to avoid.

For the Russian case, however, more rapid nominal appreciation carries important risks as well as benefits. The danger is so called “leakages” from the capital account. Expectations of rapid nominal appreciation can potentially attract even more foreign capital to Russia, which could potentially swamp the stabilizing effect of this policy measure.

Speculative capital flows in the last few years appear to be closely connected to nominal exchange rate appreciation (See RER 13). While maintaining overall stability on currency markets, various options that would allow more flexibility (nominal appreciation) are nevertheless worthy of consideration in the present situation.

The sterilization of capital inflows through other policy measures in Russia is quite difficult. The domestic bond market is still very small in relation to the size of inflows. The Central Bank has already increased reserve requirements for commercial banks from 3.5 to 4.5 percent (4 percent for ruble deposits of households) as of July 1, 2007. Further increases in reserve requirements might help absorb excess liquidity in the event that the recent pace of foreign inflows does not slow. Increasing inter-

June 2007

est rates is another potential means of tightening liquidity, but has the same risks as nominal appreciation for attracting more capital inflows.

Regardless of the specific choices made in monetary policy, the unexpectedly high balance of payments inflows should make 2007 another year of rapid real exchange rate appreciation. By the end of April, the ruble had already appreciated in real terms in by 2.3 percent, and the pace of this appreciation should increase.

Fiscal policy and the Federal Budget According to preliminary estimates for the four months of 2007, the Federal Budget generated a surplus of 5.9 percent of GDP. Nevertheless, federal budgetary revenues (21.2 percent of GDP) were considerably lower than during the same period of 2006 (24.3 percent). The difference reflects lower receipts from energy taxes in the context of lower oil prices and lower VAT revenues relative to GDP. The government is currently drafting a supplementary budget that should increase federal spending for the year by at least 0.8 percent of GDP. The additional spending will likely correspond to two special sources of finance: (a) receipts of debts for Yukos following sales of its remaining assets and (b) a one-off transfer to the budget from the Stabilization Fund.. Much of this additional spending will likely be directed at capitalizing special state development organizations, including a Development Bank, a Venture Fund, and a Housing Construction Fund. The extent of additional federal spending in 2007 is still uncertain, and Table 11 gives a very conservative estimate. The latest proposed revised federal budget also envisages a reduction in revenue collection by 2 percent of GDP (Table 11).

The federal government has been making some important progress in budgetary reform, particularly in the development of longer-term strategic budgeting. Fol-

9

lowing amendments to the Budget Code, the Russian government approved and submitted to the Duma the first three year (2008-2010) medium-term federal budget for the Russian Federation.

The preparation of this budget involved substantial work on a registry of federal expenditure liabilities and a division of functions between ministries, agencies and budget organizations. Federal targeted (investment) programs and national priority projects are incorporated completely into the budget according to functional and organizational classifications. Three year budgetary projects took into account statements of intent and performance from ministries, federal agencies, and federal services as a first step toward the development of performance-based budgeting. For future years, federal expenditures are divided into baseline priority outlays that are pre-allocated according to specific budget obligations and conditionally approved general expenditures that will be allocated only during the future process of confirming the yearly budget. General planned parameters of the 3-year budget are given in Table 11 above.

World experience with medium term budgetary planning suggests that the development of an effective such instrument in Russia will require some time and effort. Nevertheless, the process itself of preparing the 3-year budget, and of taking stock of federal expenditures, priorities, and investment programs, was most likely very valuable for increasing the effectiveness of budgeting in Russia. The budgetary process has suffered from an excessive myopic focus on the yearly budget to the detriment of a longer-term vision and the multi-year finance of priority projects.

Recent amendments to the Budget Code also have major implications for the management of surplus oil revenues (Stabilization Fund resources). Under the new amendments, the Stabilization Fund will be split into two funds in 2008: a Reserve Fund and a Fund for Future Generations. Surplus revenues from both oil and gas will accrue to

Table 11

The Federal Budget (% of GDP) Three year budget plan 2007 Budget Law (approved)

Possible 2007 Budget (with additions)

2008

2009

2010

Revenues

22.3

20.3

19.0

18.8

18.1

Expenditures

17.5

18.3

18.8

18.8

18.1

Of which: General state management w/o interest expenditure

2.1

2.1

1.9

1.8

National defense

2.6

2.7

2.7

2.7

National security, law enforcement

2.1

2.2

2.3

2.2

National economy

1.6

2.1

2.0

1.2

Education

0.9

0.9

0.8

0.8

Culture, mass media

0.2

0.2

0.2

0.2

Health and sport

0.7

0.6

0.6

0.6

Social policy

0.7

0.8

0.9

1.0

2.5

2.6

2.3

2.0

Transfers to extrabudgetary funds

Interbudgetary transfers

3.4

3.8

3.8

4.1

Total non-interest expenditure

17.0

17.8

18.2

18.2

17.5

Interest payment

0.5

0.5

0.5

0.5

0.6

4.9

6.1

5.3

4.5

Oil and Gas Transfer Sources: Minfin, EEG, World Bank staff calculation

these funds (as opposed to only oil revenues in the past). The Reserve Fund will ensure the budget against fluctuations in energy prices. It will hold surplus revenues up to 10 percent of GDP, and will be invested in safe and liquid assets such as government bonds. Additional surplus revenues will accrue to the Fund for Future Generations, which will be invested in a diversified portfolio that includes longer-term and riskier assets such as blue chip stocks.

A yearly “oil and gas transfer” to the budget from oil and gas revenues (present or past) will be used to finance the non-oil deficit of the federal budget (the deficit that would exist in the absence of oil and gas tax revenues). The draft 3-year budget plan sets the oil and gas transfer at 4.9 percent of GDP for 2007, 6.1 percent in 2008, 5.3 percent in 2009 and 4.5 percent in 2010. After this time, it should amount to 3.7 percent of GDP. The Budget Code also restricts the non-oil and gas federal budget deficit to less than 4.7 percent of GDP. By implication, deficit finance of the annual

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Russian Economic Report 14

June 2007

budget cannot amount to more than 1 percent of GDP. Much uncertainty still surrounds the Fund for Future Generations. According to best practices in other oil producing countries, this fund would be invested in longer-term foreign assets that would, over the medium term, provide the country with a major source of budgetary revenue that is independent of oil and gas. One proposal is that this fund could also be used to capitalize the Russian pension fund, which is experiencing mounting deficits that would otherwise continue to widen in the medium term.

In his recent Address to the National Assembly, the President suggested that parts of the Fund for Future Generations (aka the “National Welfare Fund”) could be used for current projects or for covering pension fund deficits. Furthermore, it has been suggested that part of the Fund for Future Generations may be invested not in foreign assets, but in domestic Russian corporate stocks. This would partially negate the Fund’s purpose as a means of sterilizing surplus energy revenues and creating a source of income for the country that is independent of oil and gas. It would also add to already substantial inflationary pressures in the country.

Income and Employment Consistent with the economic expansion, real disposable income and wages of the population exhibited even more rapid growth in January-April 2007.

Official estimates place this growth at 11.5 and 18.5 percent, respectively. Almost all sectors of the economy reported wage growth above 15 percent. Wage

Table 12

Social Indicators 2003

2004

2005

2006

4M2006

4M2007 11.5

Real disposable income growth, %

14.9

9.9

8.8

10.2

7.1

Real wage growth, %

10.9

10.6

10.0

13.4

10.4

18.5

Average monthly wage, USD

179.4

237.2

301.6

394.7

341.4

459.7

8.6

8.2

7.6

7.1

7.9

7.1

Unemployment (%, ILO definition) Source: Rosstat

growth was the highest in the public sector, trade, and construction (about 22-23 percent). Current trends in wage growth, together with the continued real appreciation of the ruble, suggest that the average monthly dollar wage in Russia for 2007 should exceed USD 500.

Despite high and increasing demand for labor in Russia and negligible growth in the working population, the rate of unemployment (ILO definition) has remained quite stable in the range of 7.2 - 7.6 percent since 2005. Most of this unemployment is likely either structural (associated with restructuring) or regionally concentrated. Indeed, unemployment is particularly concentrated in the poorer agriculturally-oriented republics of the Southern Federal Okrug. Data on registered unemployment (available by region) suggests that unemployment in Southern Russia is roughly three times as high on average as in the Central, North West, or Volga Okrugs, and about twice as high as in Siberia and the Far East.

Recent Policy Initiatives Economic policy initiatives in Russia have become particularly focused on two major speeches of President Vladimir Putin: the Budgetary Address on March 9, 2007 and the Address to the National Assembly on April 26, 2007. The budgetary address stressed the importance of maintaining restrictive fiscal policy in the presence of inflationary pressures, of developing institutions for mediumterm budgeting, and of realizing the current reforms in interbudgetary relations and local self-government that delegate more expenditure autonomy to lower levels of government. The Address to the National Assembly focused on policies to realize key development objectives in the country, including the availability of housing, infrastructure, innovation, diversification, and the pension system. On the latter subject, the President proposed not only increasing average pensions by at least 65 percent during 2007-2009, but also introducing

11

Table 13

Main projects proposed by the President Amount (bln. Rubles)

% of current GDP

Housing and municipal services

250

0.8

Capitalizing development institution (Development Bank, Investment Fund Russian Venture Company)

300

1.0

Intracity road construction

100

0.3

Capitalization Fund for Nanotechnology development

180

0.6

Proposal/Project

Source: Putin’s State of the Nation Address

a scheme to stimulate the development of a savings-based pension system in Russia: 1000 state rubles for every 1000 rubles of individual savings in a volunteer pension fund. For the realization of development objectives, the President proposed the creation of a number of state funds and development organizations. He also remarked that the new “Fund for Future Generations” would be better to name the “National Welfare Fund,” as proceeds should be spent on both current and future generations.

He indicated that support for the deficit-ridden pension system would be a proper function for the “National Welfare Fund” Table 13 lists the major important proposals for government programs in the President’s Address to the National Assembly, as well as their proposed costs.

Some of these costs have already been incorporated into the draft 3-year budget discussed above. Other costs are to be covered by receipts in 2007 from Yukos and a one-off transfer from the Stabilization Fund to the budget. The question of affordable housing received special attention: A 250 billion ruble fund for construction and renovation is to be set up in 2007. This includes 100 billion for relocating people out of dilapidated housing. The capitalization of state development institutions and road construction are to receive 300 billion and 100 billion rubles, respectively, in 2007. The Address also surprised many specialists in its proposal to devote 130 billion rubles (50 billion of which was already included in the draft Budget) for the capitalization of a Nanotechnology Support Fund. The commitment of this amount to a single branch of science is unprecedented in Russia.

Increasingly tense economic relations between Russia, the EU, and other G-8 countries have again raised some uncertainty about the date of Russia’s accession to the WTO. Russia has stated that it remains committed to completing the accession process, and the EU and US have given indications that they continue to support Russia’s membership.

12

2

Russian Economic Report 14

Russian Regional Growth and Agglomeration Effects

Many recent studies have emphasized large and growing regional disparities in Russia as an increasing development challenge for the country. The new factors driving economic growth in Russia in recent years are more unevenly distributed among regions than were the factors supporting growth in the immediate post-1998 crisis period.

Consequently, regional differentiation in growth rates has increased. Nevertheless, an examination of the data does not conďŹ rm the existence of an overall trend toward greater regional divergence. On the contrary, many poorer regions have exhibited faster growth in recent years, while a number of resource-rich regions have grown at slower rates. The most important trend appears to be a greater concentration of growth in the Center, North West, and South relative to the rest of the country. Statistical analysis supports the hypothesis that strong urban and regional agglomeration effects are contributing to growth in these areas.

The exceptionally large size and diversity of the Russian Federation poses a particular challenge for economic development. Economic transition in the 1990s brought enormous regional differentials in growth and income, which reect a highly uneven territorial distribution of economic comparative advantages and endowments, and the legacy of territorial planning that concentrated some settlements and economic activity in areas with questionable promise for achieving competitiveness on world markets.

Large gaps in regional development have persisted during the recent period of economic growth. The difference in GDP per capita in PPP terms between the ten largest and ten poorest regions in Russia stood at 4.23 times in 2004.

June 2007

Economic growth since 1999 has actually disproportionately favored many poorer regions. As highlighted in part 2 of Russian Economic Report 11 from 2005 and the World Bank poverty study1, quite a number of relatively poor regions achieved higher-than-average rates of growth and poverty reduction during the period of 1999-2003. The initial drivers of economic growth in Russia after the 1998 crisis (weak ruble, excess capacity, cheap energy) favored broad based regional growth, especially in depressed industrial regions that had experienced the largest declines in the 1990s.

These initial drivers of growth have weakened steadily, and have now virtually disappeared. The factors that have supported growth in more recent years (high resource prices, booming domestic demand, agglomerations) imply highly unequal beneďŹ ts to different Russian regions, and arguably no longer favor the same sort of broad-based regional growth. On the basis of limited available data, Russian Economic Report 11 cited a rapidly increasing variance in industrial production data as indicative of possible growing future challenges in regional disparities. Primarily on the basis of social data, Zubarevich1 and some other experts argue that a serious disparity may be widening between regions in high growth areas of European Russia or resource-rich regions and the rest of the country.

Recent work on a new World Bank Country Economic Memorandum on Russian regional development has looked into this question. Data on gross regional product are not yet available for 2005 or 2006, which prevents using this data for testing the most recent trends. But output data from industry, agriculture, trade, and construction are now available for these years. The discussion in the next section below employs data on industrial growth, which has been highly correlated with gross regional product in most Russian regions. Other output data support similar conclusions.

13

Recent trends in industrial growth: 1999-2003 and 2004-2006 contrasted A comparison of industrial growth between 1999-2003 and 2004-2006 provides further confirmation of the fact that this growth has now become much less equally distributed among regions.

(Figures 2.1 & 2.2) At the same time that median industrial growth in Russian regions declined from 7.6 to 5.8 percent, the standard deviation of the distribution increased from 3.8 to 6.1 percent.

Figure 2.1

Industrial Growth 1999-2003: Dispersion across RF Regions

The higher variance in industrial growth does indeed appear to be related to a growing contrast between regions in the Central and North West Okrugs (in proximity to Moscow and Saint Petersburg), the South and remaining geographic parts of Russia. Figures 2.3 and 2.4 show cumulative industrial growth from 1999-2003 and 2004-2006 by Federal Okrug. While the Central Federal Okrug had already distinguished itself in the 1999-2003 period with much higher average growth, growth among remaining regions was distributed more evenly, even if somewhat higher in the North West, the South and Siberia, and somewhat lower in the Volga and Far East. In 2004-2006, average industrial growth actually accelerated in Central, North West, and Southern Russia at the same time that it slowed in the country as a whole. Other territorial Okrugs in Russia achieved average industrial

growth rates less than half of those in Center, North West, and South.

The fact that the variance of industrial growth has increased across regions and Okrugs does not imply, in and of itself, a tendency toward divergence, i.e. that more unequal growth is leading to greater inequality among regions. This would be true if the faster-growing regions were indeed the richest regions.

Interestingly enough, on average, this has not been the case in either the 19992003 or 2004-2006 periods. As illustrated in the scatter diagrams in figures

Figure 2.2

Industrial Growth 2004-06: Dispersion across RF Regions

2.5 and 2.6, which graph the relationship between industrial growth and (the log of) GRP per capita in the initial year for 1999-2003 and 2004-2006, many of the highest regional growth rates are still coming from regions with relatively low GRP per capita. In fact, a removal of a handful of outliers in these figures would make the relationships downward sloping: regions with lower GRP per capita achieved higher industrial growth on average for both subperiods.

Various statistical tests for convergence, including those that correct for differences in investment rates and human capital endowments, confirm this relationship.

Why is it the case that data from the more recent period still appears favorable toward regional convergence (relatively faster growth in poor regions in the long run will lead to the convergence

14

Russian Economic Report 14

June 2007

Figure 2.3

Figure 2.4

of regional GRP per capita), despite the facts that the drivers of economic growth have shifted to factors that are distributed highly unequally among regions, and that industrial growth itself has become less evenly distributed? The answer to this question appears related to two phenomena: (a) rapid growth in a number of regions in European Russia and the South that still had relatively low GRP per capita in 2003, (b) slower growth in a number of resource rich regions with relatively high GRP per capita. The complete picture is given in the table in Annex 2.1.

physical capital investment in Moscow and Saint Petersburg increased relative to the surrounding provinces. In addition to attracting the lion’s share of investment not accruing to the resource industries, Saint Petersburg and (particularly) Moscow attracted the most qualiďŹ ed and brightest employees from neighboring regions.

Industrial Growth: 2000-2003 by Federal Okrug (Annualized, %)

Industrial Growth: 2004-2006 by Federal Okrug (Annualized, %)

Many regions in the central part of Russia began economic transition with lower-than-average output and income per capita. Most of these regions suffered strong declines in the 1990s. Furthermore, until more recent years, proximity to Moscow or Saint Petersburg was arguably as much of a disadvantage as an advantage. As growth agglomerations initially formed around these cities, the advantages of both human and

More recent trends have arguably worked in the opposite direction, however. As the Moscow and Saint Petersburg agglomerations have expanded, and the cities themselves have become more congested and expensive, the attractiveness of surrounding regions for investment and location has steadily increased. Consequently, while a number of regions in central European Russia still had lower-than-average GRP per capita in 2003, many were able to achieve relatively rapid industrial growth from 2004-2006: Kaluga, Tver, Vladimir, Voronezh, Ryazan, Bryansk, Kostroma, Tula, and Ivanovo. While the picture in the Volga part of European Russia is

Figure 2.5

Figure 2.6

Industrial Growth vs initial GRP per capita 1999-03

Industrial Growth vs initial GRP per capita 2004-06

15

much more mixed, several poorer regions in this Okrug still achieved above average industrial growth in recent years: Mari El, Chuvashia, Saratov, and Penza. In the South, Rostov and Krasnodar, with lower than average per capita GRP, have been booming. The relatively poor and largely agrarian ethnic republics of the South have followed a somewhat different path of development than the rest of the country as a whole, and have exhibited both some of the highest (albeit from a low base) and some of the lowest industrial growth rates between 2004-2006.

advantages such as climate, infrastructure, or resource endowments?

Agglomeration effects refer to advantages from the geographic proximity to markets that can take a number of specific economic forms, from direct linkages in production chains to a closer availability of diverse production inputs, to better opportunities for servicing growing demand. For the Russian case, two types of agglomeration effects deserve attention: the size and scope of cities (urban agglomeration) and spillover effects on economic growth from one region to another (spatial correlation of growth).

Resource-rich regions with higherthan-average per capita GRP that experienced relatively slow industrial growth in more recent years include Bashkortostan, Tatarstan, Tyumen, Kemerovo, Komi, Perm, Murmansk, Sakha (Yakutia), Krasnoyarsk, and Tomsk. Significantly slower growth in the extraction industries has certainly been a factor working in the direction of convergence during the 2004-2006 period. Sakhalin, by contrast, has exhibited very high growth in recent years in the context of the realization of special projects in the gas industry.

Work on the new Country Economic Memorandum for Russia is examining differentiation in regional growth on the basis of gross regional product data from 1999 through 2004. Factors such as climate, energy-intensity, human capital endowments, infrastructure, investment climate, and proximity to ports were examined, together with agglomeration effects. Results of this work will be published in the fall of 2007. Preliminary conclusions include the following:

In the direction of divergence, a number of regions in proximity to Moscow or Saint Petersburg with higher-than-average GRP per capita continued to grow quickly in 2004-2006: Leningrad oblast, Moscow, Moscow oblast, Saint Petersburg (services), Karelia, Belgorod, Orel, Novgorod, Vologda, Arkhangelsk.

A few higher GRP per capita regions in Western Siberia (Novosibirsk, Omsk) also managed to sustain relatively rapid growth.

Differences in regional growth and agglomeration effects To what degree can the increasing geographic concentration of growth be explained by so called agglomeration effects as opposed to other geographic

Investment, human capital endow-

• ments, high resource (fuel) endowments, ports, and climate (average temperature or no permafrost) all appear positively related to regional growth during the 19992004 period. Infrastructure variables such as road and rail density proved more difficult to relate to regional growth.

Urban agglomeration, measured

• as the size of the largest city in a

region, emerges as one of the most important explanatory variables for regional growth.

Spatial (spillover) agglomeration

• effects also appear quite significant.

While there appears to be little advantage of proximity to relatively rich regions, there does appear to be a strong advantage of proximity to rapidly growing regions with large economies. Estimated spillo-

16

Russian Economic Report 14

June 2007

ver effects are particularly strong in the regions surrounding Moscow and Saint Petersburg, as well as, to some degree, Rostov in the South.

The following map (Figure 2.7) shows calculated spatial agglomeration effects for Russia, which corresponds to the amount of average GRP growth in 1999-2004 in one region that can be explained by growth in other regions.

The specific statistical regression used to generate Figure 2.7 relates growth in a single region to initial GRP level, investment rates, resource (fuel abundance), urban agglomeration (size of largest city), and spatial effects (growth rates in other regions weighted by size and distance). Other specifications that vary exogenous variables yield similar estimates of significant spatial agglomeration effects. Consistent with the evidence presented in the previous section, spatial agglomeration effects are particularly strong in European Russia around Moscow and Saint Petersburg, as well as in the South.

Concluding comments The analysis summarized above offers a mixed picture for Russian regional development. On the positive side, most Russian regions continue to exhibit significant rates of growth and poverty

Figure 2.7

reduction.

Contrary to suggestions made in some studies, there does not yet appear to be an aggregate trend toward greater divergence in output levels among Russian regions. Many of the regions exhibiting higher growth rates have relatively low GRP per capita.

Nevertheless, the increasing concentration of growth in European Russia in the presence of agglomeration effects has important policy implications.

Once the vast majority rapidly growing European regions in the Central Okrug achieve GRP per capita levels above the national average, their further accelerated growth would be associated with divergence rather than convergence.

Given climatic and other geographic advantages, the current European growth agglomeration may very well spread to the Volga region in the near future.

The map in Figure 2.7 already suggests that spatial agglomeration effects are relatively significant in that Okrug, although so far weaker than in most of the rest of European Russia. Nevertheless, general problems in regional disparities will very likely become more severe over the medium and longer term in the presence of strong agglomeration effects, which suggests the importance of developing a national strategy to meet these challenges. The Russian government has indeed been giving increasing attention in recent years to the development of such a strategy.

Estimated spatial agglomeration effects in Russian regions: the amount of % average annual GRP growth (1999-2004) for a given region that can be explained by growth in other regions.

17

Footnotes: 1 Russian Federation: Reducing Poverty through Growth And Social Reform, World Bank, Feb, 2005 2 Zubarevich, Natalia V., «Регионы России: социальная проекция экономического роста» Demoscop Weekly, #273, 22 January-4 February, 2007 3 A number of studies, including Gaddy, Cifford and Hill, Fiona, The Siberian Curse:

How Communist Planners Left Russia Out in the Cold (Brookings Inst. 2003), have highlighted the relative disadvantages for a number of Russian regions in the North and East due to severe climatic conditions.

4 This work involved close cooperation with the Moscow Institute for the Economy in Transition in the context of a CIDA funded project on Russian regional development.

Russian Economic Report 14

18

June 2007

Annex 2.1: Industrial Growth in 1999-2003 and 2004-2006 by Russian region

Industrial Growth 1999-03

GRP per capita

2004-06

1998

2003

Growth above median, GRP per capita above median--2004-06 ▲ indicates indgr rose above median in 2004-06 from below median in 1999-03 Nwest

Arkhangelsk oblast

8.99

22.79

34,121

55,260

Nwest

Leningrad oblast

10.09

17.49

27,096

51,252

Fareast

Primorskii krai

0.74

15.26

28,206

34,492

Fareast

Sakhalin oblast

9.07

15.20

60,349

94,955

Growth below median, GRP per capita above median--2004-06

Central

Moscow city

14.69

15.19

105,263

155,712

▼ indicates indgr fell below median in 2004-06 from above median in 1999-03

Central

Moskow oblast

14.20

14.80

26,945

38,415

Volga

Tatarstan republic

5.20

5.79

46,661

66,445

Volga

Mordovia republic

13.90

10.13

22,999

35,693

Central

Lipetsk oblast

10.35

5.56

▼

34,673

49,241

▼

▲

▲

Nwest

Karelia republic

6.04

10.03

31,654

44,793

Central

Yaroslavl oblast

8.87

5.23

27,198

40,806

Central

Belgorod oblast

11.43

9.11

23,594

33,628

Volga

Bashkortostan republic

5.04

5.13

35,141

47,124

Siberia

Novosibirsk oblast

7.92

8.85

23,508

36,866

Siberia

Irkutsk oblast

6.46

5.07

37,451

45,501

Central

Oryol oblast

8.46

8.08

23,960

34,849

Urals

Tyumen oblast

5.86

4.83

171,087

234,989

Volga

Orenburg oblast

8.22

7.73

30,485

44,714

Siberia

Kemerovo oblast

6.38

4.59

27,135

37,896

Urals

Sverdlovsk oblast

9.74

6.75

31,534

46,058

Nwest

Komi republic

3.07

4.40

56,774

69,863

Nwest

Novgorod oblast

7.75

6.66

26,993

35,857

Volga

Nizhny Novgorod oblast

2.44

4.33

27,015

38,906

Urals

Chelyabinsk oblast

8.10

6.49

30,695

42,710

Fareast

Chukotka autonomous okrug

11.67

4.23

▼

61,546

177,478

Nwest

Vologda oblast

4.47

5.92

43,748

61,140

Nwest

St. Petersburg city

10.32

3.71

▼

36,631

59,136

Volga

Samara oblast

7.35

3.56

43,129

56,089

-0.63

2.66

47,192

48,845

2.32

36,789

50,234

▲

Growth above median, GRP per capita below median--2004-06 Nwest

Kaliningrad oblast

7.57

32.17

▲

South

Dagestan republic

1.35

18.62

▲

South

Adygeya republic

11.72

16.68

11,877

14,194

Nwest

Murmansk oblast

2.81

2.20

53,897

65,707

South

Rostov oblast

12.00

14.41

17,302

27,776

Fareast

Sakha (Yakutia) republic

3.58

1.61

72,312

91,741

Volga

Mari-El republic

5.20

13.61

16,570

18,791

Volga

Udmurtia Republic

2.35

1.55

30,310

40,116

Siberia

Omsk oblast

9.06

11.51

20,692

31,666

Siberia

Krasnoyarsk krai

4.45

1.48

63,959

85,478

South

Kabardino-Balkar republic

12.95

10.58

13,981

22,106

South

Astrakhan oblast

5.75

1.06

24,682

37,092

Central

Bryansk oblast

9.96

10.11

16,600

23,030

Siberia

Tomsk oblast

10.95

-1.79

▼

35,647

56,431

South

Krasnodar krai

8.93

9.67

22,224

31,299

Fareast

Khabarovsk krai

11.65

-2.01

▼

37,258

56,970

17,508

22,357

Fareast

Amur oblast

2.45

-2.64

25,329

35,155

12,631

17,530

Fareast

Magadan oblast

2.46

-5.48

60,034

72,098

20,910

30,772

Growth below median, GRP per capita below median--2004-06

21,773

30,249

Urals

Kurgan oblast

3.91

5.76

16,616

21,591

22,563

29,440

South

Karachaevo-Cherkess republic

12.80

5.67

11,886

16,220

22,295

31,240

16,404

26,341

▲

Volga

Chuvash republic

5.22

9.33

▲

Central

Ivanovo oblast

6.22

9.24

▲

Volga

Saratov oblast

11.33

8.97

Central

Tver oblast

4.51

7.97

Central

Tula oblast

7.72

7.97

▲

20,786

32,044

Fareast

Kamchatka oblast

7,549

12,233

Volga

Perm krai

▼

Central

Kostroma oblast

6.06

7.73

▲

20,513

26,523

Central

Kursk oblast

4.25

5.44

Central

Ryazan oblast

6.84

7.40

▲

21,346

29,468

Central

Tambov oblast

7.80

5.14

Central

Voronezh oblast

5.79

7.36

▲

18,629

25,492

Siberia

Khakasia republic

4.15

5.07

29,051

33,314

South

Stavropol krai

7.83

6.69

18,955

26,057

Volga

Ulyanovsk oblast

2.74

4.26

20,655

26,645

Volga

Penza oblast

8.96

6.26

15,204

21,398

South

Volgograd oblast

3.80

3.94

22,298

31,713

Siberia

Tuva republic

4.86

6.19

10,820

14,859

Volga

Kirov oblast

2.09

3.84

21,642

25,992

Siberia

Altai republic

12.13

6.12

16,165

24,120

Central

Smolensk oblast

8.05

3.30

▼

20,584

32,594

Central

Kaluga oblast

13.50

6.11

21,730

29,697

Nwest

Pskov oblast

8.04

3.03

▼

17,135

24,910

Central

Vladimir oblast

11.07

5.96

18,438

26,275

Siberia

Altai krai

7.94

1.52

▼

15,914

22,600

▼

Siberia

Buryat republic

11.46

5.85

▲

18,900

26,901

▼

Fareast

Evrei autonomous oblast

11.43

1.35

17,128

24,710

South

North Osetiya republic

6.45

0.05

11,602

18,076

Mean

7.22

6.58

25,646

35,967

Siberia

Chita oblast

6.64

-0.82

20,830

30,939

Median

7.65

5.85

22,999

33,314

South

Ingush republic

-2.92

-6.07

16,249

12,267

Russian Federation

6.64

5.24

36,060

51,958

South

Kalmyk republic

0.98

-6.37

16,363

20,671

While much social assistance in the country is still not targeted specifically at the poor, Russia has been developing targeted social assistance in three areas: child allowances, housing and utility allowances, and regional programs for the poor. However, success in targeting has been limited in comparison to programs in a number of other countries. A forthcoming study investigates the reasons for this, and concludes that a joint effort at the federal, regional, and local levels Russia could significantly improve the effectiveness of targeted social assistance in Russia.

Broad-based economic growth in Russia since 1999 can be associated with major success in poverty reduction. The estimated number of families living below the poverty line declined from almost 30 percent in 1999 to less than 14 percent by 2006. Nevertheless, poverty remains an important problem in Russia, and is particularly concentrated at the regional level. There are still Russian regions where the majority of the population lives below the poverty line.

As suggested in Part 2 of this Report, the contrast between rapidly developing and backward regions in Russia may very well increase over the medium and longer term. Particularly given the current emphasis in economic policy on supporting growth points, the question of effective social assistance in Russia should increase in importance over the medium term for the social welfare of much of the population.

The World Bank has been focusing its most recent poverty work in Russia on social assistance, particularly at the regional level, and on the question of how the Russian system of social assistance can be made more effective. Within the World Bank Programmatic Poverty Assessment Program, The Institute for Urban Economics (Moscow), The Independent Institute for Social Policy (Moscow), and The Urban Institute (Washington DC) conducted a recent comprehensive study: “Improving Social Assistance Programs to Combat Poverty (Forthcoming, fall 2007).” This note

3

Developing Targeted Social Assistance In Russia

summarizes a few results of this work.

In addition to making use of household survey and regional survey data, this study gathered in-depth qualitative information from five regions: Tver, Tatarstan, Tomsk, Kalmykia, and Karachaeyevo-Cherkessia. This included extensive interviews with administrations, heads of raion offices, case-workers, and other officials involved in implementing social assistance programs.

As highlighted in the World Bank Poverty Assessment of 2005 and part 3 of Russian Economic Report 9, the current social assistance system in Russia is highly regressive compared to most other middle income countries in that the actual poor receive a small share of social benefits by international standards. A primary reason for this is the fact that 90% of social assistance spending in Russia is not targeted directly at the poor, but at various groups of the population regardless of income level (pensioners, war veterans, invalids, etc.). Only 8% of this spending reaches the poorest 20% of the population . At the same time, Russia has been developing targeted (income-tested) social assistance in three areas: child allowances, housing and utility allowances, and regional programs for the poor. Aggregate spending on these targeted programs amounts to roughly 0.3% of GDP (80 bn rubles). This note limits attention to these targeted programs.

How do Russia’s targeted social programs compare with other countries in the world? Using household budget survey data from different countries, it is possible to estimate and compare the share of targeted social assistance that is actually received by the poorest quintile of the population. These estimates are presented in Figure 3.1

19

20

Russian Economic Report 14

June 2007

Figure 3.1

Share of Targeted Social Assistance Received by the True Poor in Selected Countries.

Figure 3.1 indicates that Russia’s performance in targeting the poor is comparable to that in some other CIS and Latin American countries, but lags far behind Eastern Europe, Brazil, or the United States. According to the latest available information (2005), only 40 percent of the beneficiaries of child and household allowances were indeed poor, which can be compared with 80 percent in the best cases, some of which include transition economies. One consequence of relatively poor targeting in Russia is that average benefits often become very small due to the fact that they are spread over a large number of people, many of them not poor. For example, basic child allowances range from only 70 to 105 rubles a month, which is not high enough to have a strong impact on poverty. Russia may have major room for improving social assistance through increasing the effectiveness of its programs.

Why is targeting accuracy so low in Russia? “Improving Social Assistance Programs to Combat Poverty.” identifies a number of problems related to the design of assistance programs, the measurement and verification of income, and insufficient cooperation among government bodies in sharing information.

In general, income-tested social assistance is difficult in countries with large shadow economies, and where income is hard to measure accurately. This is a primary reason why less developed countries typically have more trouble implementing means testing and targeted social assistance. Figure 2 makes use of information on the structure of household incomes from a 2003 household survey that included comprehensive sources of income (Nobus) to estimate discrepancies in recent administrative data (reported income for benefits in 2006) for a random sample of beneficiaries. Figure 2.3 suggests that income is systematically underreported, and that non-wage income, in particular, goes largely unreported.

Procedures to verify income reported by applicants through documents, crosschecks, or spot checks are infrequent or absent. Key problems in this regard include staff shortages, ambiguities in the rules, and poor information sharing among government bodies. Audits generally focus on verifying the presence of required documentation, as opposed to checking the accuracy of information reported. The Tax Service, Pension Fund, and Employment Service have valuable

21

Figure 3.2

Data on incomes: declared and implied by household budget survey

information that could be used for cross checks and verification, but typically do not share this information with officials in charge of social assistance.

The overall monitoring of social assistance, including evaluations of targeting accuracy, are minimal and infrequent in Russia. “Improving Social Assistance Programs to Combat Poverty.” represents the first attempt to do a comprehensive exercise of this type. Thus, policy makers and program managers currently possess little information for evaluating and improving targeted social assistance.

Although the current institutional conditions of Russia create some challenges for the development of more effective and better targeted social assistance, world experience suggests that Russia already has the capacity to make significant progress in this direction. Сountries like Poland, Bulgaria, Romania, and Brazil suffer from some of the same institutional problems as Russia, but have nevertheless managed to improve significantly their systems of social protection through better targeting. All of these countries have de-

signed social assistance programs under a single and consistent objective to reach poor beneficiaries, and perform regular monitoring of how well they are achieving this objective. All of these countries use means testing that go beyond an examination of income to look at assets (wealth) as well, together with cross checks for the verification of information. Other methods are commonly used to increase incentives for reporting truthful information. For example, able-bodied individuals in Albania and Romania are required to perform social work in the community as a condition for receiving benefits. This reduces the incentive for wealthier individuals to attempt fraud.

Russian regions (Subjects of the Federation) have recently received greater autonomy for managing their social assistance programs, and can potentially tap into a wealth of world experience for strengthening targeting and efficiency.

Multiple regional pilots would also allow the natural emergence of best practices for the Russian case, which could be spread to other regions. Increasing the efficiency of social assistance at the regional level can free up resources for

22

Russian Economic Report 14

other budgetary priorities.

The role of the federal government would also be critical for encouraging the adoption of such programs at the regional level, and providing an overall framework for sufďŹ cient monitoring, cooperation between government bodies (including information sharing), and

June 2007

veriďŹ cation. Such an initiative for improving social assistance is very much in line with the general goal of developing performance-based budgeting in the Russian Federation. Social assistance is an area of performance-based budgeting that can have a direct impact on poverty.

23

2001 4.7 3.7 1.1 6.8 2.6

2002

1.7 1.3 44.8 12.0 14.0 12.5 30.7 127.3 3.0 76.9

7.3 7.0 10.3 8.7 12.5

2003

11.5 13.0

86.9 54.7 58.6 183.2 96.3 9420 34.1

4.3 4.5 42.5 11.7 20.1 28.8 28.8 137.3 7.8 18.7 124.5

7.2 8.3 10.5 6.8 10.9

2004

-8.4

10.7 12.0

118.3 61.1 84.2 243.6 125.3 13072 45.2

7.5 7.7 35.6 10.9 19.2 13.4 28.3 149.3 8.7 42.9 182.2

6.4 4.0 5.7 1.3 10.5

2005

-3.4

10.1 11.5

12.2 25.9 13.7 59.6

8.7 2.0 0.7 1.7 26.9 165.1 0.5 82.1 265.7

Июль 2.9 2.5 3.1 10.7

-3.4

10.3 11.5

13.7 28.2 14.5 63.7

8.8 3.0 0.2 2.2 26.8 165.2 0.0 64.7 259.9

Авг 5.6 6.2 3.8 12.6

-1.9

10.5 11.5

11.2 65.2 23.1 25.8 14.6 10268 58.9

8.7 10.3 4.1 0.1 18.7 1.4 26.7 166.0 0.5 70.7 266.2

1.4

10.1 11.0

9.0 24.9 16.0 53.9

9.2 0.2 0.3 -2.8 26.9 166.2 0.1 76.6 272.5

2006 Сент Окт 6.5 4.1 5.4 5.1 7.5 1.7 0.6 15.0 19.1

3.6

10.6 11.0

9.2 25.5 16.3 52.0

8.7 3.1 0.6 -2.5 26.6 165.8 -0.2 83.2 289.0

Ноябрь 3.0 2.9 2.5 15.2

0.3

10.5 11.0

9.9 59.0 15.7 29.7 19.8 13678 52.4

7.4 8.5 12.2 0.8 16.1 1.0 26.3 166.2 0.2 89.1 303.7

Дек 6.7 1.9 2.7 2.6 16.5

-1.6

10.5 11.0

139.2 63.3 95.6 303.9 164.7 13678 56.2

7.4 8.5 43.6 9.0 16.1 10.4 27.1 163.5 9.5 89.1 303.7

6.7 3.9 4.4 2.3 13.5

-1.5

9.9 10.5

9.8 21.4 11.6 50.9

10.9 -3.3 1.7 1.7 26.5 168.7 1.5 99.8 303.9

Янв 8.4 17.3 4.2 23.2

1.5

9.9 10.5

9.4 23.6 14.2 49.0

8.1 2.3 1.1 0.1 26.3 169.3 0.3 103.6 314.5

Фев 8.7 14.0 4.3 19.6

10.5

9.2 62.1 21.8 26.4 17.2 9756 52.5

108.1 338.8

0.0 26.1

7.0 11.4 5.7 0.6

10.4 12.5 3.8 20.9

113.7 369.1

4.3 25.8

5.9 6.3 0.6

Апр 4.6 7.0 2.0 19.4

Main Macroeconomic Indicators

5.1 4.9 8.7 1.4 34.1 15.1 15.7 17.7 31.4 123.6 2.8 47.8 59.9 54.2 35.4 135.9 76.1 6781 23.9

-10.1

Сальдо федерального бюджета, % ВВП 1/ Сальдо консолидированного бюджета, % ВВП 1/ M2, % по сравнению с предыдущим пер Инфляция (ИПЦ), % по сравнению с предыдущим пер Дефлятор ВВП, % Индекс цен производителей промышленных товаров, % к предыд. пер. Средний номинальный валютный курс, руб за доллар США Реальный эффективный валютный курс, июль 1998 = 100 (МВФ) Реальный эффективный валютный курс, % к пред. пер Стабилизац. фонд, млрд. долл. США, конец периода Золотовалютные резервы, млрд. долл. США, конец периода Показатели платежного баланса Торговый баланс, млрд. долл. США Доля энергоресурсов в экспорте, % Сальдо счета текущих операций, млрд. долл. США Объем экспорта, млрд. долл. США Объем импорта, млрд. долл. США Объем прямых иностранных инвестиций, млн долл. США 1/ Средняя экспортная цена российской нефти, долл. США / баррель Показатели финансового рынка

479.0 4.4 359.1

41.3 14.5 20.7

897.8 6.8 567.3

171.7 237.2 8.2

35.8 15.2 25.5

1210.2 7.1 614.1

187.7 301.6 7.6

33.5 13.8 25.3

1603.6 7.4 1125.6

206.5 442.2 6.8

35.7 26.4

273.4 1551.1

211.7 405.9 6.5

34.3 26.2

233.8 1626.7

211.3 415.5 6.4

32.6 14.9 26.7

265.1 10.7 1550.0

210.0 413.0 6.7

33.1 25.0

196.7 1613.6

211.7 429.6 6.7

32.0 25.8

274.0 1766.7

309.1 541.7 6.9

29.7 14.3 25.6

362.1 11.4 1921.9

206.5 395.3 7.1

29.7 14.3 25.6

2636.8 9.8 1922

165.1 430.8 7.1

34.7 44.6

155.4 1842.9

201.2 449.4 7.3

34.7 37.4

229.9 1858.1

214.1 478.6 7.2

16.5

1935.7

222.8 487.1 7.0

-

1935.5

10.5

-

43.4 10.8 17.4

155.5 179.4 8.6

Март

3.0 44.6 18.6 16.5 8.3 29.2 120.3 20.3 36.6 46.3 52.4 29.1 107.3 61.0 4002 21.0

-2.2

13.1 16.0

135.3 138.6 8.1

2006

48.1 51.2 33.9 101.9 53.8 3980 20.9

3.9

15.8 21.0

Показатели производства

-1.1

17.9 25.0

ВВП, %, в годовом выражении 1/ Промышленное производство, % к пред. пер. Обрабатывающ. пр-ва, % к соотв. пер. пред. года Добыча полезных ископаемых, % к соотв. пер. пред. года Инвестиции в основной капитал, % к предыдущ. пер Бюджетно-финансовые показатели

Средневзвешенная ставка по кредитам для предприятий, % 4/ Ставка рефинансирования ЦБ РФ, конец периода

-

Реальная средняя ставка по рублевым кредитам, (дефлировано по ИЦП)

Чистые кредиты реальному сектору, млрд. руб.

486.0 Чистые кредиты реальному сектору, % ВВП 5.4 Индекс фондового рынка (РТС) 260.1 Финансы предприятий 38.4 Доля убыточных компаний 1/ Доля кредитов в инвестициях в основной капитал 1/ 25.6 Прибыльность (чистая прибыль / объем продаж), % /1 Доходы, бедность и рынок труда Реальные располагаемые доходы, 1999 = 100 121.7 Средняя заработная плата в долл. США 112.4 Уровень безработицы (%, по определению МОТ) 9.0 1/ Нарастающим итогом с начала года 2/ Начиная с 2006 года, с учетом внебюджетных фондов 3/ Годовое изменение рассчитывается по изменению среднегодового показателя M2 4/ По всем срокам до 1 года Источник: Госкомстат, ЦБР, EEG, МВФ, оценки ВБ

24

Russian Economic Report 14

June 2007

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Russian Economic Report #14 • June 2007