The Russian Federation is committed to and applying the principles of multiparty democracy, pluralism and market economics in accordance with the conditions specified in Article 1 of the Agreement Establishing the Bank; however, in the past Strategy period, application of these principles has been uneven.
Political stability and consolidation – notably through the confirmation of a reform-minded government, the creation of a strong parliamentary majority and the establishment of a common legal space across the Federation – is an important achievement which can contribute positively to the country’s continued structural reform efforts. Following a wave of terrorist attacks in the North Caucasus and in Moscow, the government has taken steps to reinforce public security and re-establish central political control over the regions. Recent political developments suggest a concentration of power in the hands of the executive and a perceptible drift from democratic practice that has raised concerns in the international community. At the same time, a robust system of checks and balances is the most effective way to guard against potential abuse of power and to encourage policy innovation. In this connection, the Bank welcomes the statement made by the President following his re-election, defining the creation of “a free society of free people” in Russia as the foundation for economic growth and political stability.
Russia’s economic performance over the past two years has been robust, with strong GDP growth and a sharp acceleration in domestic investment. Management of public finances has been sound, with the federal budget running a large overall surplus for the fifth consecutive year in 2004. Inflation has gradually declined while the exchange rate has remained firm. Foreign investment into Russia has also accelerated, including in the form of FDI inflows. However, the accumulated stock of FDI amounts to about 6.5 per cent of GDP: only a fifth of the average level of the other European transition economies. The current account has recorded large surpluses in recent years and reserves are at record highs. However, following years of substantial declines, net private capital outflows have increased significantly.
Structural and institutional reforms have remained on track over the past two years, with progress on several fronts, including tax and fiscal reforms, trade and currency liberalisation, advances in creating a new pension system, initial stage reform of the banking sector, public administration, restructuring of the power and railway sectors and in improving the regulatory framework for SMEs. Notwithstanding this positive record, the election cycle in 2003-2004 brought a deceleration in the pace of reform in important areas and reform implementation in general remains a major weakness. The investment climate has continued to improve in many respects. However, significant uncertainties and risks have emerged with regard to the protection of property rights, and there have been conflicting signals regarding the role of the state in the economy. Corruption also remains a serious problem. According to Transparency International's Corruption Perceptions Index for 2004, Russia's score of 2.8 out of 10 (where 10 is "clean") suggests that corruption is "rampant". Russia's score is better than most CIS countries, but well below that of the advanced transition economies. Finally, the volatility of the financial markets and capital flows, as well as the recent banking sector turbulence, are important reminders of how vulnerable the economy remains and of the fragility of the confidence-building process.
Although the country’s overall macroeconomic and reform performance has been positive, it is not yet based on solid fundamentals. Growth – though helped also by a fundamentally sound macroeconomic policy framework and the beneficial impact of previous reforms – has been to a large extent driven by a combination of favourable external factors, including high commodity prices, abundant global liquidity, low interest rates and strong investor interest in emerging markets. Moreover the influence of two additional ‘temporary’ factors in Russia’s macroeconomic achievements – the boost in competitiveness stemming from a sharp devaluation of the rouble in 1998 and the availability of under-utilised productive capacity – have already begun to taper off as growth drivers.
The challenge ahead is to build the foundations for consistently good long-term macroeconomic performance and steady improvements in living standards, as well as to make the economy less vulnerable to external developments.
Meeting these challenges and making growth sustainable will require advancing a series of wide-ranging structural and institutional reforms to promote:
* modernisation and restructuring of the economy;
* the diversification process;
* reform of public institutions, clarifying the role of the state and the rules of the game for private businesses
* reform of the social sector, and
* Russia’s integration into the world economy.
The Russian Government has considered these as strategic tasks since the adoption of the original long-term socio-economic and development programme for 2000-2010. Their significance is further increased as the traditional growth drivers are being exhausted and should be replaced by steady efficiency and productivity improvements. The insufficient progress in reforming the state institutions and the social sector has become a crucial bottleneck in the transition process. Clearly faster progress is needed in all these dimensions over the next few years.
Through a broad range of investment operations, its catalytic impact on other investors plus its policy dialogue, the Bank is well-placed to work together with Russia in addressing these challenges. In particular the Bank’s transactions that help to advance technological modernisation and efficiency improvements in key sectors of the economy can make a significant contribution toward the goal of strengthening the microeconomic foundations of the sustainability of growth and facilitating Russia’s integration into the world economy. The Bank can pro-actively contribute to the diversification process across sectors and regions alike, including by further supporting small business finance through the Russia Small Business Fund. By being a reliable strategic partner at a time of increased uncertainties, by taking higher risk and providing comfort to investors the Bank can substantially contribute to building and strengthening confidence among the different market participants as well as between businesses and the state.
The Bank will seek non-sovereign financing solutions including in sectors and types of transactions traditionally financed directly by the state. The Bank plans to issue Rouble Bonds and use its local currency financing instruments on a wider scale for SMEs, domestically oriented companies and municipalities alike.
The Bank will have a strong focus on private sector development including broader participation in privatisation based on the forthcoming new phase of the Russian privatisation process in 2005-2007. The Bank will also provide assistance in IPOs of Russian private and public companies and will encourage more active use of equity participation in its clients’ share capital. Improving corporate governance, given the difficult legacy in this regard and its fundamental importance in company valuation, risk management and access to investment finance, remains an overriding consideration for the Bank in the context of the Strategy as well.
The Bank has made expansion of business volume in the Russian regions a top priority in previous Strategies, and the results over the past few years have been encouraging. The Bank now has 250 projects and sub-projects in 41 Russian regions and an increasing proportion of business volume outside the large cities of Moscow and St Petersburg. Currently, 86 per cent of the Bank’s project pipeline volume and 84 per cent of the number of projects in the pipeline are being developed in regions outside Moscow and St Petersburg, suggesting that this trend of increasing business (in terms of both the volume and number of projects) in the regions will continue. To sustain and accelerate this trend, the Bank will review resource allocation to the field offices across Russia, with a view towards strengthening the regional presence during the coming Strategy period.
The Bank will ensure that all its operations in the Russian Federation remain subject to its environmental procedures, and will continue to give due consideration to the social impact of its operations.
The main sectoral priorities for the time horizon of the strategy will be:
Assisting the modernisation and restructuring process of key Russian industries and large enterprises through:
* Financing the modernisation and efficiency improvement programmes of large Russian standalone companies. Where feasible, the restructuring programme should include energy efficiency and environmental improvement ingredients. In so doing, the Bank will seek to expand its volume of greenhouse gas emission-reduction projects and assist the Russian Federation and project sponsors in utilising carbon trading mechanisms under the Kyoto Protocol. The Bank will also engage its clients to make credible commitments to improve their corporate governance standards and practices. In particular, the Bank will continue to play a pro-active role in the practical implementation of the Russian Corporate Governance Code, through the requirements placed on its corporate clients where appropriate, in the context of individual projects.
* Supporting the entrance and business expansion of reputable foreign strategic investors and facilitating their role in transferring technology and skills, enhancing competition, and in setting quality, productivity, environmental and other standards for entire industries. Attracting FDI in the non-energy/natural resource sectors will remain a major strategic orientation.
Broadening the Bank’s activities promoting private entrepreneurship including through more active use of equity instruments:
* Seeking to expand its Russia Small Business Fund programme in terms of intermediaries (supporting banks in developing small business lending operations as an integral part of their business), regional coverage and the range of investment instruments offered.
* Completing the restructuring of the existing Regional Venture Funds and supporting management groups with a good track record with follow on funds. The Bank will also work towards attracting new investment teams and equity funds into Russia.
* Pro-active efforts to participate in privatisation of state or municipal owned production and service companies, infrastructure firms and financial institutions.
* Making equity investments to provide comfort and assistance to foreign investors setting up new ventures.
* Assisting Russian companies and entrepreneurs in building and strengthening their capital base, creating real partnerships through the Bank’s investments. This will promote the entrance of more local companies in the domestic and international capital markets with debt or equity instruments.
Assistance in the consolidation and reform process of the financial sector and support to the development of the capital markets by:
* Supporting consolidation of the banking sector, promoting/participating in acquisitions and mergers of banks and assisting in the privatisation process of State (and regional government) owned banks.
* Providing a combination of loans, equity participation and policy dialogue to support the implementation of the authorities’ new banking sector strategy (to be finalised), and to help strengthen confidence in the private sector financial institutions.
* Working with “pocket” banks with credible commitment to change operations, improve transparency and governance, diversify ownership and become independent.
* Supporting existing foreign banks and non-banking financial institutions and attracting new foreign strategic investors into the financial sector.
* Promoting institution-building in and competition among pension, insurance, mortgage and leasing companies.
* Utilising the Bank’s Rouble funding programme to help the development of the capital markets.
Promote upgrading and reform of Russia’s infrastructure through:
* Continued active involvement in the restructuring of the country’s natural monopolies with special regard to the power sector and possible investment in the gas sector once the reform process takes off.
* Financing the modernisation and expansion of the pipeline infrastructure on a non-sovereign basis while conducting dialogue on tariff issues. Financing new pipeline infrastructure that enhances the integration with neighbouring countries notably under the EU/Russia Energy Dialogue.
* Promotion of institutional reform and commercialisation of key state-owned transport sector agencies through public-sector non-sovereign transactions.
* Expansion of municipal projects into more regions and broadening the focus of the portfolio from water-related and solid waste transactions to district heating, urban transport as well as housing projects. Continued focus on institution-building at both the municipal and service-provider company levels.
* Proactive efforts to initiate and participate in public private partnerships and other private sector projects.
* Special emphasis on environmental and nuclear safety projects especially under the Northern Dimension Environmental Partnership framework and the Strategic Master Plan for nuclear waste management.
* Use of sovereign support in cases where it will be required for projects of national and/or social priority, for instance where the assets are owned directly by the State, or when they are financed together with the European Investment Bank.
In implementing this Strategy, the Bank will continue to co-operate closely with other international financial institutions and donor organisations, including but not limited to the relevant agencies within the World Bank Group, the Nordic Investment Bank, the IMF, the EU and the European Investment Bank.