- The Washington Times - Wednesday, July 12, 2006

MOSCOW — Russia has come a long way since it defaulted on $40 billion of sovereign debt in 1998, burying its image of a handout-hungry giant and positioning itself as an energy superpower within the Group of Eight nations.

But with oil revenues gushing in and its state-controlled oil and gas groups ascending, the Kremlin’s oft-stated goal of diversifying the economy away from its reliance on natural resources and turning Russia into a high-tech hub seems far in the future.

That’s hardly surprising — the oil sector’s results are spectacular enough to distract almost anyone.

With prices riding high, Russia rakes in about $550 million in oil and gas revenues per day — $380,000 every minute. The state gets 65 percent of that. Oil and gas exports account for about 60 percent of federal budget revenues and 60 percent of its exports.

The oil windfall has meant that, since the August 1998 financial collapse, Russia’s hard-currency reserves have soared from a feeble $12.5 billion to $247.1 billion — and have given its economy a stronger claim to belonging in the elite group of nations whose leaders will meet in St. Petersburg this week.

Meanwhile, the government is busy funneling oil companies’ profits above $27 per barrel into an inflation-fighting stabilization fund, which stood at $76 billion at the end of last month. This year, Russia will use $22 billion of that to pay off its remaining debts to the Paris Club of creditor nations. That’s a far cry from the years when it scarcely could make the interest payments on its foreign borrowings.

But analysts are concerned that the state’s oil revenues aren’t spread through the broader economy by incentives and tax breaks aimed at spurring revival in Russia’s rust-belt industries and its smaller businesses.

Russia’s gross domestic product is forecast at about $886 billion this year, ranking it 11th worldwide and putting it higher than India, Mexico, Turkey and Belgium. But the specifics highlight the need for the economy to diversify: Russia’s per-capita GDP comes in 59th at $6,330, far behind European lightweight Portugal’s $17,200 per capita GDP and $36,900 for Britain, according to International Monetary Fund data.

For Russia’s long-term health, the economy must be freed from the vagaries of international commodities markets, economists say.

“It’s almost the worst of both possible worlds. The profits have been taken out of the oil and gas industry, so the companies are low on cash to grow their businesses, but at the same time no diversification structure has been put in place. They are not providing the planned growth incentives for industry,” said Chris Weafer, chief strategist for Moscow’s Alfa-Bank.

Administrative reforms aimed at culling Russia’s bloated bureaucracy are stalled, allowing red tape and endemic corruption to throttle small- and medium-sized enterprises. Peter Westin, chief economist with the MDM investment bank in Moscow, said such enterprises account for just 13 percent of Russia’s overall GDP, compared with 30 percent to 50 percent in more-developed countries.

Meanwhile, graft and opaque regulations hold back foreign investment — as well as what Mr. Westin calls the crucial “spillover” of technologies and know-how that come with it. Russia’s total net foreign direct investment at the end of 2004 came to $89 per capita, compared with $5,000 for the Czech Republic and $4,000 for Hungary, Mr. Westin said.

“That’s the primary inhibitor for even more investment and the growth of small- and medium-sized business — the administrative burden and the corruption that goes with it,” said Andrew Somers, president of the American Chamber of Commerce in Russia.

Nowhere is the know-how that foreign investment can bring needed more urgently than in the oil and gas sector. With global energy consumption set to soar, all eyes are on Russia to push on with developing new and promising fields that are locked in its more hostile territories.

Changes to the tax laws that would make such investments viable are still in the works, as are long-awaited regulations that would clarify the limits on investments in certain sites in the energy sector.

Andrei Illarionov, who resigned as President Vladimir Putin’s economic adviser last year to protest what he called the government’s backtracking on freedoms, describes government talk of modernizing Russia’s economy as only public relations.

“There are no serious steps in this regard: no privatizations, no liberalization, impediments to business are not being removed — none of this is being done,” he said.

Mr. Illarionov said the Kremlin’s efforts are going into expanding the state’s monopolistic hold on strategic industries, starting with oil and gas, and ultimately are focused on forging “champion companies” — such as gas giant OAO Gazprom or oil group OAO Rosneft — that will serve as powerful geopolitical levers.

“Where you have state companies, security ends and danger arises,” Mr. Illarionov said. “The model of a state monopoly is an energy hazard to the world. It presents the world with the threat that energy supplies can be broken off at any moment for political, not economic reasons.”

Meanwhile, calls to overhaul Russia’s economy are fading, said Yevgeny Gavrilenkov, chief economist at the Troika Dialog.

“Five, six, eight years ago there was talk of diversification,” he said. “In recent years, I hear them talk about this less and less, but more about an energy superpower.”

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