RUSSIAN INTERNATIONAL FINANCE

1. Instructor’s comments: It is hardly analytical am may not be regarded as a ‘best’ project. Yet it is an honest and comprehensive summary of Russia’s open macroeconomic survey in his efforts to understand the overall working of Russia as his own country. ::gold::oil::gas::diamonds::minerals:: RUSSIAN INTERNATIONAL FINANCE By: For Dr. J.D. Han, Economics 3370a King’s University College 2011

2. Illustration 1 Presnensky District – Home of Moscow’s Financial District

3. Purpose Table of Contents There currently are lots of exciting new developments in the economy of Russia, which deserve a closer attention. :: Relevant Background and Statistics ::Investigation of Russian Economy’s Sources of Growth ::2008 Global Financial Crisis and its effects on Russia ::Russia and European Union ::Russia and “Near Abroad” ::Russia and Japan ::Current Developments ::Conclusion

4. Historical Background & Relevant Statistics • December 1991: USSR split into Russia and 14 other independent republics in part because USSR lost to China in the United States’ bid for a preferred business partner due to their unwillingness to adopt new technology. • Adopted a semi-authoritarian state, carefullymanaged politics, prudent management of Russia's windfall energy wealth • Largest state in the world: 17,098,242 sq km (1.8 times the size of the US) • Wide natural resource base including major deposits of oil, natural gas, coal, and many strategic minerals, timber. Even though, like in Canada, climate, terrain, and distance hinders resource exploitation, the world demand is gradually making it feasible to exploit the above resources. • Population of 139,390,205 (July 2010 est.) 9th globally (-0.465% growth rate) • GDP of $2.116 trillion USD (2009 est.) (8th in the world; 73rd in per capita) • Comparatively low investment ratio: 21.5% of GDP (2009 est.) 74th in globally • Decelerating inflation rate – 11.7% (2009 est.) from 14.1% (2008 est.) • #2 natural gas (#1 exporter) producer globally; #1 proved reserves • #6 positive current account balance globally :: Source : CIA World Factbook ::

5. Investigation of the Russian Economy’s Sources of Growth Long Term Growth is Due to Real Factors • Productivity (leads to higher profits, so that firms can invest in new technologies, create jobs, pay more in wages and dividends) Total factor productivity growth of 5.8 percent has been the driving force behind average GDP growth of 6.5 percent over 1999 – 2005 due to utilization of excess capacity, relocation of labour and capital to more productive sectors (World Bank) But: • Russian firms have exhausted the post-soviet productivity gains derived from more efferent labour and capital allocations. The capacity utilization rates rose from 42 percent in 1999 to almost 70 percent in 2005. (The World Bank) • Low Investment Rate Prevents Russian Economical Growth Russia has a wide range of natural resources, demand for which is rising, but the investment rate in only 21.5% of GDP (2009 est.) (74th Globally (CIA Factbook) Therefore To sustain growth Russia needs to increase productivity in terms of technology, foreign development and foreign know-how, as the growth from the post-socialist transition is running out. Russia needs to make foreign investment more attractive to make up for its low domestic investment. Russian government is currently taking steps to do the above. :: The Old Saint Petersburg Stock Exchange :: CIA Factbook ::

6. Russia and The Economic Crisis • Reliance on commodity exports makes Russia vulnerable to boom and bust cycles that follow the highly volatile swings in global commodity prices (CIA Factbook) • Russian government and people, awash with money, were convinced their economy was invulnerable to the world financial crisis until the 2008 crash of oil prices and world markets (The Seattle Times) • Russia made the mistake of confusing high oil prices with the genius of their economic management. -Rory MacFarquhar, Goldman Sachs in Moscow • Kremlin and Duma failed to let businesses and the economy diversify. (The Seattle Times) • Heavy focus on oil resulted in no paved roads from Moscow to Vladivostok for Russian people and businesses, 10-20% interest rates for entrepreneurs (0% is optimal, as discussed in class), and scientists leaving for better equipped laboratories and universities in Europe and America (The Seattle Times), devastating home-grown research and innovations. • Russian government acknowledged these vulnerabilities of the Russian State’s economy and currently is working with international bodies, such as EU, Japan, and ex-Soviet states to strengthen Russian economy. • The government starting in 2007 has embarked on an ambitious program to reduce this dependency and build up the country's high technology sectors. (CIA Factbook)

7. Russia and the EU Bloc • Almost half Russian imports and exports are with EU states. (Spiegel Online) EU is the biggest trading partner of Russia. Russia is EU’s third largest trading partner (Spiegel), allowing the block to press their political agenda against Russia, even though businesses, like Siemens and Volkswagen (Spiegel), that can benefit from a more free trade lobby its governments to change their position. • In Germany Putin criticized obstacles to Russian investment in Europe. According to him, Russian companies are keen to invest in European firms, but encounter resistance from the European side again and again. (Spiegel Online) Such cooperation would improve Russian productivity and access to technologies. • Governments in Berlin, Warsaw and Paris are not completely open to such cooperation. They fear domination by the Russian state’s energy giant Gazprom. (Spiegel) • EU is under Russian energy dependence. “What will you use, firewood? But you will need to go to Siberia to get the firewood, too." – V.V. Putin in Berlin Nov 2010 • This exerts economic and political pressure on the European bloc. • Russia is number 2 producer of natural gas globally. #1 is USA, but it is used there domestically. • Economically there is no choice, but to cooperate with Moscow for EU. (EUbusiness) • Therefore, the declining European bloc is forced to cooperate with Russia in order to generate profits for its enterprises, and to achieve stability in the energy sectors. Russia should (in its interests) and does apply these advantages to push Europe to put its isolationist policies against Russia aside, and to build a freer economic relationship. In Europe governments fear that the future will bring economic relations on markedly Russian, rather than European terms.

8. Russian “Near Abroad” Russian politicians refer to the ex-soviet block as the “Near Abroad” (Wikipedia) and exert political and economical pressures to control them. For example, when with Russian backing a pro-Russian government came to power in Ukraine in the early 2010, the trade turnover increased 70% in 6 months (RIA Novosti), largely due to sale of uranium reserves and aviation industry capital. Russia wants a ‘single economic space in the post-Soviet area” (RIA Novosti) and to establish Rouble as a key currency in the region. Russia, Belarus, Kyrgyzstan, Tajikistan and Kazakhstan agreed to create a single economic space by January 1, 2012 as Eurasian Economic Community. Ukraine withheld (RIA Novosti), as it is a member of WTO. (Kyiv Post) Russia is attempting to re-establish a monetary hegemony in the “near abroad,” which will give it control over the monetary systems of the region. Russian relations with a formerly socialist Poland have warmed up after a plane crash of an openly-hostile to Russia former polish president under mysterious circumstances over the Russian territory. For the first time by a Russian head of state in nine years (MSN News), Dmitri Medvedev visited Poland on December 6th 2010 and paved over historical problems with a new russophile government. He signed a series of economic agreements for bilateral investment between countries. (Voice of America)

9. Economics, Russia, Japan and the Pacific • As the world demand for raw material is growing, Russia starts developing its deposit reserves further and further into its challenging terrain. This includes the Pacific, specifically the disputed with Japan Kuril Islands. • “We are interested in people to stay here. The development is important here, we will certainly invest money here.” -Medvedev (Tatar Inform) • The islands are believed to have offshore hydrocarbon reserves (New Europe) • Critics await ASEAN 2012 conference in Vladivostok, as it is predicted that by then Japan and Russia will resolve a deal for a co-development of the region, without giving up sovereignty, which is politically unacceptable. (Vladivostok2012.com) • Japan’s Mitsui and Mitsubishi work with Russia’s Gazprom on the Sakhalin II field and Japanese companies would also like to be involved in the development of the Yamal peninsula, despite that both countries are technically still at war. (NewEurope) • High savings rate of Japan, its technological ability and know-how will prove crucial in developing the lucrative Russian mineral and petrochemical deposits. This shows how international finance can supersede political or emotional tensions. Pecuniary reasons and good economics cause foes to collaborate. • A mutual cooperation is seen with Korea, where Russian side is used as a conduit for trade with Europe, trans-Korean railway liked with the Siberian railway system forces North Korea to be more open and lays steps toward a peaceful re-unification, and reduces gas dependence from the Middle East (U.S. Army War College). KOGAS is leading the development and investment in Irkutsk, Russia (Subsea O&G Directory) and in the Kovykta field (TNK.BP). Such cooperation for Japan’s waning economy means trading its innovation driven know-how for the investment opportunities in Russia, where Korea and China are already doing business. :: Photo: CIA Factbook – Russia ::

10. Current Developments “Trade can improve productivity by providing access to new investment capital, technologies, expertise and export markets, but this has not happened in Russia.” “Russia’s integration into global production chains remains limited.” “Export diversification towards greater sophistication of products needs to be promoted.” -The World Bank 2007 • Nov 25, 2010 – Vladimir Putin proposes creation of a harmonious economic community (a free trade zone) stretching from Lisbon to Vladivostok There he reaches an agreement on the elimination of tariffs on raw materials such as wood (Spiegel Online) and railway freight (MSN News) on November 7th. • Moscow is hoping to become a member of WTO in 2011 (Spiegel Online) with US backing. • The government is now in process of easing restrictions and opening deposits of up to 250 (up from 50) tons to foreign firms. (Russia Today) Anything over the limit is a strategic resource and falls under government jurisdiction. • Max Keiser, a Russian economist states: “The UK is long gone, continental Europe is outside of Germany – doesn’t produce anything.” Markus Kerber, a professor of political science at Berlin University, says economic crisis can be used an opportunity for Russia and Germany to open a new chapter in their trade relationship. According to him “Russia is a natural ally to Germany” (Russia Today), at least economically, as its resources are needed to match German high productivity. Russia needs German technologies and investment to increase its productivity, and the government of Russia currently lobbies EU governments and businesses for a closer and less restricted economic cooperation. • September 2010 - Vladimir Putin’s Government invested 5 billion roubles into Moscow State University and allocated money for an additional 50 billion rouble investment from non-government sources. (XinHuaNet) This will boost productivity through R and D.

11. Closing – The Good Russia does not have an entrepreneurial culture. Entrepreneurship and leadership are alien concepts for an average Russian. Russia is a well-educated nation. To counter this, the new Skolkovo School of Management, scheduled to be open by 2012 has gained national attention and Putin's support. According to Ruban Vardanian, a founder of the school, "Russia's future lies in its people, not its oil and gas.“ (The Seattle Times) All things considered, it seems that Russia has learned from the 2008 economic crisis and its on its way to become a more open country with a greater diversity of international business. Its vast natural resources allow for an investment opportunity from Germany, Japan and other nations, which will bring new technological and managerial knowledge. However, Russia needs to invest more in its people and diversify its industry. Signs that the leadership is paying attention to these issues emerge. Russia now invests heavily into IT, is now a net agricultural exporter, and a the middle class in emerging. (CIA Factbook) However, a lot is yet to be done to ensure that Russia does not fall victim to the next economic downturn. Economic forces supplant the political, historical and nationalistic policies of Russia and its neighbours, as the world demand for natural resources increases.

12. Closing – The Bad and the Ugly • In Russia power and wealth is still largely concentrated in the hands of oligarchs, and 15.8% (November 2007) below poverty line (CIA Factbook). • In the past decade Russian government officials traded in their rusty Volgas for bulletproof, shiny Mercedes, and invested in an Elton John concert, while they could have brought to Moscow Harvard business professors, Cornell agricultural scientists, Microsoft's managers, developed nanotechnology or built new genetic research labs. (The Seattle Times) Now the government is trying to get on track and catch up with innovations and bids for foreign investment. • Protection of property rights is still weak and the private sector remains subject to heavy state interference (CIA Factbook), threatening foreign investment. • European Union foresees an uneven playing field while dealing with Russia, this impedes their bilateral economic cooperation. Europe is constantly trying to buffer against Russian Influence. • Low domestic investment rate due to poor entrepreneurial culture, high bank interest rates, and lack of opportunities and free market. • Long-term challenges for Russia include a shrinking workforce, a high level of corruption (which was once describes as number one industry in Russia on BBC News), and poor infrastructure in need of large capital investment (CIA Factbook)

13. Sources World Bank (2007) Russian Economic Report http://siteresources.worldbank.org/INTRUSSIANFEDERATION/Resources/Chap2.pdf Central Intelligence Agency (2010) The World Factbook – Central Asia: Russia https://www.cia.gov/library/publications/the-world-factbook/geos/rs.html RIA Novosti Russia expects CIS countries to create free trade zone by yearend http://en.rian.ru/exsoviet/20100617/159463469.html RIA Novosti (2010) Russia-Ukraine trade up 70% in 6 months – Yanukovychhttp://en.rian.ru/russia/20100828/160377834.html Spiegel Online International Putin's Free-Trade Proposal Is 'Just a Smokescreen‘ http://www.spiegel.de/international/europe/0,1518,731370,00.html MSN News EU opens WTO door to Russia in 'milestone' deal http://news.ph.msn.com/top-stories/article.aspx?cp-documentid=4507188

14. Sources Continued Vladivostok 2012 (2010) http://www.vladivostok2012.com/review/?p=6&rpp=53 KyivPost (2010) Yanukovych: Ukraine won't join Customs Union http://www.kyivpost.com/news/nation/detail/65139/ Russia Today (2010) Russian gold looks to strategic law change for growth http://rt.com/business/news/strategic-law-growth-going/ Tatar-inform (2010) Russia interested in development of Kuril Islands - Medvedev http://eng.tatar-inform.ru/news/2010/11/01/32387/ New Europe (2010) Russia, Japan near Kuril Islands endgame http://www.neurope.eu/articles/103618.php AH6HY - David Flack (2003) Japan/Russia (disputed IOTA islands) http://www.qsl.net/ah6hy/occupied.html EUbusiness (2010) EU should consult Russia on energy reforms: Putin http://www.eubusiness.com/news-eu/russia-germany.79j/

15. Sources Continued 2 Russia Today (2010) Putin talks post-crisis economy with Merkel http://rt.com/news/putin-talk-post-crisis-economy/ The Seattle Times on Russia Blog (2008) Russia's Economic Crisis Could Have Been Avoided http://www.russiablog.org/2008/12/russias_economic_crisis_could_have_been_avoided_mamchur.php XINHUANEWS (2010) Russia to invest 5 bln roubles in its top university http://news.xinhuanet.com/english2010/culture/2010-09/27/c_13532523.htm Voice of America (2010) Medvedev's Visit Signals Warming Relations with Poland http://www.voanews.com/english/news/europe/Medvedevs-Visit-Signals-Warming-Relations-with-Poland-111533384.html U.S. Army War College – John W. Bauer (2009) Unlocking Russian Interests on the Korean Peninsula http://www.carlisle.army.mil/usawc/parameters/Articles/09summer/bauer.pdf Subsea Oil and Gas Directory (2009) KOGAS Korea Gas Corporation http://www.subsea.org/company/listdetails.asp?companyid=2771 TNK*BP (2010) Kovykta Project http://www.tnk-bp.com/operations/exploration-production/projects/kovykta/

16. Appendix A – Geographic Reference United States Moscow Kuril Islands Europe Vladivostok Japan China From the U.S. Army War College. The proposed Trans Korean Pipeline and Railroad, which is envisioned to facilitate Korean unification, once completed. A parallel cooperation is envisioned over the Kuril Islands. This shows how economic forces facilitate international development, despite the political intrigue and conflicts.

17. Fin Happy Holidays