Russian Economic Overview

President Putin targets a pro-business path for growth…
President Putin delivered his sixth annual address to the Federal Assembly this
week with the general undercurrent geared towards promoting Russia’s business
environment and underlining the country’s commitment its main political and
ideological goal of developing a free and democratic state. The President
envisages such activities to be pursued along the path of undertaking measures
to develop the state, strengthening the law and political system and finally,
developing the individual and civil society. In the absence of any significant policy
anchors, such as the ‘doubling of GDP’ target envisaged in the 2003 annual
address, the following political, social and economic goals were outlined:

Implementation policies that will enhance the effectiveness of the
‘bureaucratic apparatus’ and ensure that those officials strictly obey the rule
of law and provide quality public services to the population.

The pursuit of a vigorous policy that promotes the liberalisation of
private enterprise, as the President advocated the need to reduce the
statute of limitations regarding the period in which privatisation deals can be
legally revisited from the current period of 10 years to 3 years. Indeed, it was
highlighted that 10 years was too long both in terms of economic and legal
considerations.

Both tax and custom authorities need to prioritise compliance as
opposed to fulfilment of specific ‘plans’ to collect taxes and duties. At the
same time, the President underlined the importance of the tax agencies not
‘terrorising’ businesses by repeatedly investigating the same issues and that
repayment of arrears needs to be undertaken in a manner that is conducive to
the state, while not being to the detriment of the economy and business.

The creation of a rules based approach for FDI that differentiates between
strategically important sectors, including defence, mineral deposits and
infrastructure facilities, that are essentially off limits to foreign participation or
retain a limited participation component and those sectors that require
favourable conditions for the inflow of private foreign capital.

An amnesty on previously undeclared earnings by means of introducing a
simplified procedure incorporating a flat 13% income tax and that all relevant
monies are deposited with Russian bank accounts.

Public sector wages are to be increased 1.5x the rate of inflation over the
next three years in a bid to reduce the disparity between private and public
sector wages and also increase expenditure across education, health and
science.

Establish guarantees that will ensure that state media and broadcasting
are as objective as possible and that this reflect the whole political spectrum
from which forces will have an equal opportunity to express views on key
developments facing the country.
As always, the key test will be implementation of the above policies and it remains
imperative that such measures are put into force without delay. In our view the
capital amnesty offers significant upside, particularly given the success in tax
compliance stemming from the previous move to simplify the income tax code.
That is, given that net private sector outflows reached US$9.4 billion in 2004, as
reported by the CBR, against a backdrop of an estimated US$200 billion of
Russian funds held offshore, only a small fraction of repatriation flows is required
to have a significant impact on Russia’s banking system. Finally, in the absence
of any explicit reference to repayment of Russia’s outstanding external debt
obligations the overall impact on Russia’s financial markets was neutral.