It's little wonder the Moscow stock market is hitting record highs again. Oil prices have surged and Russia is, after all, the largest non-OPEC producer. At the same time, President Vladimir Putin has begun to show at least a willingness to draw a line under the Yukos affair and move on.
But the broader economic and political picture is much cloudier. Although the economic reformers are fighting their corner against the siloviki (men of force) in the Kremlin power game, government indecision and lack of investor confidence has told on growth. Corruption is rampant. The prospects for improvement between now and the 2008 presidential election seem limited.
Stock markets care more about prices today than politics tomorrow, and the Russian Trading System (RTS), Moscow's main index, hit an all-time record 815 points in mid-August – a recovery of all the losses that resulted from last year's government assault on, and break-up of, Russia's most successful oil company, Yukos. Similar confidence was displayed at the initial public offering (IPO) on the London market of Novatek, Russia's only substantial non-state gas producer, in late July: it was 13 times oversubscribed.
Pace of growth
But Russia's economic growth is disappointingly slow, given the fabulous riches generated by the oil boom, and President Putin's target of doubling GDP in ten years looks ever more unrealistic.
"Although President Putin realizes that reforms are a key, the lack of strategic decision-making is translating into slow growth and higher inflation," says Michael Marresse, head of CEEMEA economic research and sovereign strategy at JP Morgan Chase.
"For example, investment in the energy sector has been stagnant, due to confusion over who will control oil and gas assets, painfully slow decisions on new oil and gas pipelines, and extremely high marginal tax rates that provide little incentive to oil producers to boost output," he adds.
Nevertheless, the economic reformers in government are holding their own, Marresse notes. The recent decision to keep VAT at 18% for 2006-08, opposed by the siloviki who wanted a populist cut in the rate, was indicative, he says. Two other proposals in the pipeline – to restrain tax auditors' power and to introduce legislation that would end examinations of the 1990s privatizations – point in the same direction.
New standards
Oleg Vyugin, head of Russia's stock exchange regulator and a leading economic reformer, tells Emerging Markets that more progress in establishing the rule of law in business is a key to further reform. "New ethical standards must be implemented in courts' practices and in judges' behaviour," he says.
In terms of market regulation, Vyugin says that property rights protection will be improved by the establishment of a central depository system: "This will give more comfortable access to the stock market for companies planning IPOs." Other legislation is planned to target the use of insider information, and to establish a framework for derivatives trading, which the Russian market lacks.
Vyugin says that improving the investment climate is vital in order to make good use of the oil bonanza. "Russia has an extremely high trade surplus this year: it will amount to up to $120 billion or 20% of GDP. To use this more effectively, the government must make the investment environment more attractive and increase the domestic savings ratio."
Russia's problem is that Putin is surrounded on the one hand by reformers such as economic development minister German Gref (see interview this page) and Vyugin, and on the other by the siloviki, whose priority is to increase the state's role in strategic economic sectors. Their most prominent representatives are said to be Igor Sechin, deputy head of the presidential administration and chairman of the state oil company Rosneft, and telecommunications minister Leonid Reiman. And the president does not want to take sides.
Some observers are concerned that these relationships may paralyze government. Ian Bremmer, chairman of the Eurasia Group, a political risk consultancy, told Emerging Markets: "The concentration of power at the Kremlin has increased dramatically, with the switch to the direct appointment of governors, and the greater influence of the presidential administration over the judiciary, parliament and the media. But within the Kremlin, Putin himself has become withdrawn and indecisive.
"Putin is making himself into a lame duck president. Whether the conflicts between the groups of people around him are being fought for policy reasons or for personal gain, they are not to the benefit of the state or the economy."
Bribes market
The assertion of state power against business in the Yukos affair has exacerbated another problem: corruption. A recent survey by the respected Moscow research institute Indem showed that the total volume of the "bribes market" this year stands at $319 billion, 11 times more than when a previous survey was undertaken in 2001 and more than twice the federal government's budget.
More than 99% of the bribes are paid by businesses, and the recipients are mainly in the executive branch of the state, i.e. tax and other inspectors, police officers and other authorities.
Christopher Granville, chief strategist at the United Financial Group in Moscow, notes that the survey suggests "officials have learned to exploit their comparative advantage in the corruption market, i.e. where their 'services' cannot be avoided, to extort more from both citizens and businesses" – but said that signs found by Indem that people were ready to resist corruption where there was a choice "highlights the potential of deregulation, better regulation and liberalization in squeezing out corruption".