Is Russia's spectacular growth spurt already over? As 2001 drew to a close, nearly all economic indicators dipped for the first time in nearly three years and, as Ben Aris reports, the period of effortless improvement has clearly come to an end.
The economy has grown by an average of 6 percent over the past three years, but in October, growth slowed dramatically. Conventional wisdom has it that high oil prices have been driving growth for the past few years, and indeed, oil prices took a sharp dip in November as Russia went head-to-head with OPEC over production cuts to bolster prices.
However, economists say money earned from oil ceased to be the main driver of economic growth as consumer spending took over. Private consumption was up by 8.7 percent last year and investment by 11.5 percent.
"In 1999 growth was driven by exports and the high international prices as well as the beneficial effects of devaluation," said Christof R?hl, the World Bank's chief economist in Moscow. "In 2000, investment was the driver of growth. And in 2001, it had become consumption. It looks like a trickle-down effect triggered by high oil prices."
Devaluation may have slashed the value of workers' money, but following the crisis, the big difference was that devalued cash was in workers' pockets rather than overpriced rubles in managers' desks as IOUs. Since the crash, wages and pension arrears have fallen off to next to nothing. And people have been spending their cash.
Wholesale retail sales have almost doubled since 1998, while real income has recovered to pre-crisis levels and continues to grow strongly, according to the State Statistics Committee. At the same time, real wages are rising twice as fast, increasing by a quarter last year alone.
The growth seems to have peaked last summer. Between October and January, nearly all the economic indicators began to fall: Growth fell by half to 0.3 percent per month, profits dipped, margins were squeezed and most of the increase in retail sales were taken up by imports.
Falling oil prices have been a factor, but are affecting the budget more than business. The government has been running a budget surplus of more than 2.5 percent since March 2000, but in January, receipts fell below the budget's target for the first time.
Of all the results, the rise of imports is the most worrying. Demand continues to climb and doubled between 2000 and 2001, according to the World Bank, but imports are rising even more quickly.
The trade surplus fell by $10 billion from 2000 to 2001 to about $50 billion.
Part of this is due to falling oil and gas prices, which between them make up half of all Russian exports, but consumer-orientated companies are also feeling the pinch.
Textile sales continued to grow, but the domestic textiles producers saw demand stagnate in the last quarter of 2001 as foreign competitors took nearly all new spending: Average imports by value rose by about 3.4 percent per month over most of last year, but textile imports jumped a 28.8 percent in October.
Importers are largely insulated from the current global slowdown, but exporters are feeling the pinch from a combination of rising prices at home and falling prices abroad.
The steel industry in particular is suffering, and the recent trade spat with the United States over duties will only make matters worse. Likewise the conflict with OPEC over production cuts, which has recently abated, could also squeeze the oil companies.
There is much confusion over just how fast Russia will progress. The consensus is that Russia will grow about 3.5 percent in 2002, but instead of offering a prediction of where Russia will be in January 2003, international financial institutions are offering various scenarios that depend on how factors such as oil price, inflation and the ruble exchange rate combine.
According to R?hl, Russia faces three threats to continued growth. In the short term, the first is if companies' rising productivity fails to keep up with production costs, which will depend on companies' ability to attract investment and the strength of foreign competition, which in turn is related to the exchange rate.
Part of the debate over the new Central Bank chairman is what monetary policy the bank is going to follow -- in other words how fast it will allow the value of the currency to rise.
The Economist Intelligence Unit estimates the ruble appreciated by 8.6 percent in real effective terms in the course of 2001, roughly half the rate seen in 2000, although it accelerated again at the end of the year.
The second threat is costs being driven up too fast. Tariff reforms, wages and money supply-inspired inflation are the most important factors here and companies were already feeling the pinch by the end of last year.
The government has set a target inflation rate of 12 percent to 14 percent, but economists believe that inflation will end the year around 15 percent to 16 percent, which is at least better than last year's 18.6 percent. Russia got off to a bad start in January when the monthly inflation rate spiked to more than 3 percent -- its highest level in three years -- before falling back to a more reasonable 1.1 percent in March.
President Vladimir Putin's economic adviser, Andrei Illarionov, said in January that tariffs were too high and warned that planned hikes, averaging 35 percent, will act as a brake on growth.
The Economic Development and Trade Ministry is acutely aware of the dangers of high inflation. Although it is trying to bring inflation down to help small- and medium-sized businesses, or SMEs, it is equally concerned about the need to boost tariffs in order to allow the natural monopolies to raise badly needed investment capital. The government has already cut back on the natural monopolies' investment plans for this year and compromised on tariff hikes after the January numbers came out.
"There is a need to hike tariffs so that the natural monopolies can be reformed, but tariff hikes feed through into both inflation and value of the ruble," said Peter Westin, an economist with Aton. "Other countries of Eastern Europe have managed dramatic growth with high inflation, but they also had vibrant small and medium-sized enterprise sectors, which just don't exist in Russia."
Illarionov is more concerned about the health of private business and believes the interests of the natural monopolies ought to be sacrificed to support SMEs, which could be a more powerful engine for growth.
"The so-called natural monopolies are unnatural because government regulation created them," he said in January.
As Russia's natural monopolies are so inefficient, Illarionov argued, it would be better to squeeze more money out of them by boosting efficiency rather than raising tariffs. This would have the advantage of creating the needed investment capital, without punishing other businesses with the associated inflation. However, as the problems already present in the economy from labor constraints show, efficiency-driven productivity gains are extremely difficult to win and are a long-term solution.
Price, inflation and ruble exchange rates are all short term factors, but underlying the fluctuations on the international commodity markets, business is faced with a much more serious problem that indicates the economy will be unable to repeat last year's spectacular result for several years.
The third danger -- making itself felt for the first time -- is if the Kremlin fails to make its reforms work.
Economists and pundits have been surprised by the strength of Russia's growth since 1998. At the start of 1999, Russian Economic Trends took an average of 11 leading institutions' predictions for GDP growth that year, which included the International Monetary Fund, the World Bank and JP Morgan. Together, they predicted the economy would shrink by 8 percent, when it actually grew by about 5 percent -- a huge discrepancy by economic standards.
The nay-sayers pointed to the lack of a banking sector and an unreformed legislative base as the drag on growth.
The devaluation of the ruble led to the collapse of imports and created a $30 billion hole in the market that domestic producers gleefully stepped into. Ironically, industry has been able to boost production to meet this demand without either a banking system or investments. Most of the growth in recent years has come from tempting idle employees back to work by doing little more than using the mushrooming cash flow to pay their salaries on time.
"It is one of the more remarkable facets of the Dr. Seuss economy that evolved in the '90s that despite a 60 percent decrease in industrial production between 1991 and 1999, unemployment rose by less than 5 percent," said Roland Nash, head of research at Renaissance Capital. "The fact that workers received no wages and factories produced no output appeared to do little to damage the relationship between employers and employees. Workers went to work, hung out, pottered around a little and went home. Employers seemed to enjoy having them around."
After three years, it seems that companies have now taken up most labor slack and this, not oil, was causing the slow down at the end of last year.
According to the Russian Economic Barometer, a monthly business survey, the take up of labor has already risen from just over 70 percent in 1998 to just under 90 percent by the start of 2001, while machinery utilization has climbed half as quickly. On average, a third of factories' machines remain idle.
As the economy slowed in November, unemployment fell by 1 percent instead of rising as would be expected. At the same time, wage increases continue unabated.
"If all the slack in labor productivity gains has been taken up, then the window of opportunity is now closed," said the World Bank's R?hl. "Life will get more difficult if further production gains become dependent purely on the investment flows."
Clearly, there are still more gains to be won from making staff work better, rather than just harder, but study is still needed on Russia's labor productivity and it is difficult to say just how important this is; these types of productivity gains usually require extensive training and time.
It doesn't take much money to make employees work, but as companies bump up against labor capacity ceilings, it is going to get much more difficult to further increase production without buying new equipment.
Banks have contributed almost nothing to growth. Despite rising fixed investment, last year bank credits made up a pathetic 3 percent of total capital invested into industry.
Companies are already on the hunt for investment capital. Companies in the oil and gas sectors are awash with cash following three years of high international commodity prices, but many of them are planning to rationalize their financing needs by issuing Eurobonds.
In addition to the $4 billion worth of Eurobonds the state is expected to issue this year, 12 blue chip corporations are expected to issue about $3 billion worth of Eurobonds.
One tier down, big companies such as domestic health and beauty product producer Kalina and diamond monopoly Alrosa are tapping into the growing pool of rubles that banks have been depositing in correspondent accounts with the Central Bank.
More than 100 companies issued a total of $2.6 billion worth of ruble-denominated corporate bonds last year. Both numbers are expected to double this year.
And there has been a small trickle of Russian companies using their stock to raise money. Wimm-Bill-Dann's initial public offering on the New York Stock Exchange in February was one of the most recent, and this month will see Russia's first ever Initial Public Offering as RosBusinessConsulting sells its shares directly on the RTS and MICEX.
All these sources of capital are closed to the huge swathe of SMEs forced to pay for investments out of retained earnings or by finding private investors.
The lack of SMEs is a serious problem. Their number has fallen in recent years to about 800,000 or about 4 percent of gross domestic product, according to official statistics, although there is much debate over how the number should be measured. Other estimates put the number at 15 percent to 18 percent of GDP and growing.
Whatever the real number, there are clearly not enough SMEs. A few years ago, a World Bank study concluded that a vibrant SME sector was an important contributor to rapid growth.
"If a thriving segment of new, small- and medium-sized firms is already in place, it becomes easier to import the conditions leading to the restructuring of old enterprises because it is relatively easy for people to find new jobs elsewhere," the study said. "If, on the other hand, alternative employment opportunities and government support are absent, the recommendation to close down non-viable plants may appear very cynical."
There is good news on this front, too, as Putin in September urged the State Duma and the government to "pay special attention to small and medium businesses," and reiterated the importance of boosting SMEs in recent weeks.
But the fast growth of SMEs depends on successfully reforming the bureaucracy. Apart from feeling more optimistic about the future, small businesses say they see little or no change on the ground. The lack of access to capital is another problem.
Bank credit portfolios have been rising strongly over the past year, but the maturity length of loans has been dropping equally quickly, suggesting that most of the credits are going to fund working capital. More worrying, wage arrears also began to creep up in February, suggesting that even retained earnings are no longer enough to fund the pace of growth.
"Firms for the first time are running into capital constraints just as they are being hit by the combined force of ruble appreciation and rising tariffs," says Renaissance Capital's Nash. "If the new chairman of the Central Bank [Sergei Ignatyev] is unable to facilitate the redistribution of capital from that sector of the economy which generates it, to that which requires it, then Russia's brief flirtation with fast growth will soon end."
The slowdown at the end of last year marks the end of the first and successful phase of Putin's attempt to transform Russia Inc. into a profitable concern. As it is being caused as much by capacity constraints and demand as the fall of international oil prices, some economists are even talking about "Russia's first business cycle."
Business cycles are driven more by fluctuations in demand than what happens on the London metal market, and after the Christmas downturn, demand picked up again at the start of this year.
The Moscow Narodny Bank's production managers index, a survey of business activity, found that by February, confidence, output and orders had all picked up again, although problems with labor persist.
The PMI index also grew in March. Nash said: "The March Moscow Narodny Bank PMI index shows the pick-up in industrial production levels continued in March, which supports our views that manufacturing growth has recovered, and that it is likely to continue until October as it has every year since 1999. It means the lower rate of manufacturing growth this winter was nothing more than a seasonal phenomenon and is no cause for concern."
Last month, Deputy Economic Development and Trade Minister Arkady Dvorkovich said preliminary State Statistics Committee figures show the economy was up 2 percent year on year -- the lowest figure since May 1999 -- although this was being driven by large enterprises and is not sustainable in his view.
He pointed again to the need to develop the SME sector in the long term.
The lack of a banking sector is already dragging on growth. The Russian Economic Barometer survey found managers are not worried about the cost of capital and companies with investment plans are increasingly implementing them. But it did find an increasing number are worried about the rising cost of equipment. However, 90 percent of managers said their biggest problem is simply the lack of access to capital, up from two-thirds a year ago.
Russia's economy remains top-heavy with two thirds of investment going into fuel and energy and budget-funded enterprises. The only companies doing really well tend to be catering directly to consumers. Huge chunks of the economy are simply being bypassed, and investment into state-owned enterprises is wasteful.
"At the moment, the government is part of the economy in a way it should not be," Prime Minister Mikhail Kasyanov said in January. "This includes not only banking, but the economy as a whole."
The government plans to conduct a thorough, across-the-board analysis and inventory of state-controlled enterprises at all levels and intends to spin off its stakes, says Kasyanov, but this process has yet to begin.
A World Bank report in 1992 noted that the only foreign investors in Russia were those that "had" to be there; companies in the extraction industries and multinationals with famous brands.
R?hl points out that foreigners would like to invest in oil, because that's where the big money is. But as the oil companies are awash with money, there are few opportunities.
The government would like foreigners to invest into areas such as the utilities sector, but the amount of money required -- Unified Energy Systems estimates that it needs $5 billion a year for the next decade -- are so huge, no one is prepared to take the risk.
The country's natural wealth means expert-orientated industries should be attractive, but the venal state of the customs service means that few have taken the plunge (IKEA's recent pledges to make Russia a production center for furniture are a notable exception). This leaves the industries connected to the consumer, such as beer and food processing, which is exactly where foreign investment is going.
Putin has been hitting bullseyes with his reform program. All the major problems outlined in this article are being addressed. And in what is increasingly typical of Putin's pragmatic style, the problems have been addressed more or less in order of importance.
Starting with tax reform, the Kremlin quickly moved on to tackle the natural monopolies which affect both budget revenues and inflation. Of the instructional changes, customs reforms topped the list, followed by Putin's call to focus on promoting SMEs at the end of last year.
Last month, Viktor Gerashchenko resigned six months before his term as Central Bank chairman was due to expire, a sign the Kremlin is already concerned about doing something about the banking sector.
All these policy initiatives are very encouraging, but the implementation is only just beginning. Russia will continue to grow, but for the next few years it is likely to look like a U rather than a V.
"The easy stuff has been done," said United Financial Group chairman Charles Ryan. "Now the hard part starts."
The economy has grown by an average of 6 percent over the past three years, but in October, growth slowed dramatically. Conventional wisdom has it that high oil prices have been driving growth for the past few years, and indeed, oil prices took a sharp dip in November as Russia went head-to-head with OPEC over production cuts to bolster prices.
However, economists say money earned from oil ceased to be the main driver of economic growth as consumer spending took over. Private consumption was up by 8.7 percent last year and investment by 11.5 percent.
"In 1999 growth was driven by exports and the high international prices as well as the beneficial effects of devaluation," said Christof R?hl, the World Bank's chief economist in Moscow. "In 2000, investment was the driver of growth. And in 2001, it had become consumption. It looks like a trickle-down effect triggered by high oil prices."
Devaluation may have slashed the value of workers' money, but following the crisis, the big difference was that devalued cash was in workers' pockets rather than overpriced rubles in managers' desks as IOUs. Since the crash, wages and pension arrears have fallen off to next to nothing. And people have been spending their cash.
Wholesale retail sales have almost doubled since 1998, while real income has recovered to pre-crisis levels and continues to grow strongly, according to the State Statistics Committee. At the same time, real wages are rising twice as fast, increasing by a quarter last year alone.
Economy Off the Boil
The growth seems to have peaked last summer. Between October and January, nearly all the economic indicators began to fall: Growth fell by half to 0.3 percent per month, profits dipped, margins were squeezed and most of the increase in retail sales were taken up by imports.
Falling oil prices have been a factor, but are affecting the budget more than business. The government has been running a budget surplus of more than 2.5 percent since March 2000, but in January, receipts fell below the budget's target for the first time.
Of all the results, the rise of imports is the most worrying. Demand continues to climb and doubled between 2000 and 2001, according to the World Bank, but imports are rising even more quickly.
The trade surplus fell by $10 billion from 2000 to 2001 to about $50 billion.
Part of this is due to falling oil and gas prices, which between them make up half of all Russian exports, but consumer-orientated companies are also feeling the pinch.
Textile sales continued to grow, but the domestic textiles producers saw demand stagnate in the last quarter of 2001 as foreign competitors took nearly all new spending: Average imports by value rose by about 3.4 percent per month over most of last year, but textile imports jumped a 28.8 percent in October.
Importers are largely insulated from the current global slowdown, but exporters are feeling the pinch from a combination of rising prices at home and falling prices abroad.
The steel industry in particular is suffering, and the recent trade spat with the United States over duties will only make matters worse. Likewise the conflict with OPEC over production cuts, which has recently abated, could also squeeze the oil companies.
Short-Term Problems
There is much confusion over just how fast Russia will progress. The consensus is that Russia will grow about 3.5 percent in 2002, but instead of offering a prediction of where Russia will be in January 2003, international financial institutions are offering various scenarios that depend on how factors such as oil price, inflation and the ruble exchange rate combine.
According to R?hl, Russia faces three threats to continued growth. In the short term, the first is if companies' rising productivity fails to keep up with production costs, which will depend on companies' ability to attract investment and the strength of foreign competition, which in turn is related to the exchange rate.
Part of the debate over the new Central Bank chairman is what monetary policy the bank is going to follow -- in other words how fast it will allow the value of the currency to rise.
The Economist Intelligence Unit estimates the ruble appreciated by 8.6 percent in real effective terms in the course of 2001, roughly half the rate seen in 2000, although it accelerated again at the end of the year.
The second threat is costs being driven up too fast. Tariff reforms, wages and money supply-inspired inflation are the most important factors here and companies were already feeling the pinch by the end of last year.
The government has set a target inflation rate of 12 percent to 14 percent, but economists believe that inflation will end the year around 15 percent to 16 percent, which is at least better than last year's 18.6 percent. Russia got off to a bad start in January when the monthly inflation rate spiked to more than 3 percent -- its highest level in three years -- before falling back to a more reasonable 1.1 percent in March.
President Vladimir Putin's economic adviser, Andrei Illarionov, said in January that tariffs were too high and warned that planned hikes, averaging 35 percent, will act as a brake on growth.
The Economic Development and Trade Ministry is acutely aware of the dangers of high inflation. Although it is trying to bring inflation down to help small- and medium-sized businesses, or SMEs, it is equally concerned about the need to boost tariffs in order to allow the natural monopolies to raise badly needed investment capital. The government has already cut back on the natural monopolies' investment plans for this year and compromised on tariff hikes after the January numbers came out.
"There is a need to hike tariffs so that the natural monopolies can be reformed, but tariff hikes feed through into both inflation and value of the ruble," said Peter Westin, an economist with Aton. "Other countries of Eastern Europe have managed dramatic growth with high inflation, but they also had vibrant small and medium-sized enterprise sectors, which just don't exist in Russia."
Illarionov is more concerned about the health of private business and believes the interests of the natural monopolies ought to be sacrificed to support SMEs, which could be a more powerful engine for growth.
"The so-called natural monopolies are unnatural because government regulation created them," he said in January.
As Russia's natural monopolies are so inefficient, Illarionov argued, it would be better to squeeze more money out of them by boosting efficiency rather than raising tariffs. This would have the advantage of creating the needed investment capital, without punishing other businesses with the associated inflation. However, as the problems already present in the economy from labor constraints show, efficiency-driven productivity gains are extremely difficult to win and are a long-term solution.
Price, inflation and ruble exchange rates are all short term factors, but underlying the fluctuations on the international commodity markets, business is faced with a much more serious problem that indicates the economy will be unable to repeat last year's spectacular result for several years.
The third danger -- making itself felt for the first time -- is if the Kremlin fails to make its reforms work.
Capacity Utilization
Economists and pundits have been surprised by the strength of Russia's growth since 1998. At the start of 1999, Russian Economic Trends took an average of 11 leading institutions' predictions for GDP growth that year, which included the International Monetary Fund, the World Bank and JP Morgan. Together, they predicted the economy would shrink by 8 percent, when it actually grew by about 5 percent -- a huge discrepancy by economic standards.
The nay-sayers pointed to the lack of a banking sector and an unreformed legislative base as the drag on growth.
The devaluation of the ruble led to the collapse of imports and created a $30 billion hole in the market that domestic producers gleefully stepped into. Ironically, industry has been able to boost production to meet this demand without either a banking system or investments. Most of the growth in recent years has come from tempting idle employees back to work by doing little more than using the mushrooming cash flow to pay their salaries on time.
"It is one of the more remarkable facets of the Dr. Seuss economy that evolved in the '90s that despite a 60 percent decrease in industrial production between 1991 and 1999, unemployment rose by less than 5 percent," said Roland Nash, head of research at Renaissance Capital. "The fact that workers received no wages and factories produced no output appeared to do little to damage the relationship between employers and employees. Workers went to work, hung out, pottered around a little and went home. Employers seemed to enjoy having them around."
After three years, it seems that companies have now taken up most labor slack and this, not oil, was causing the slow down at the end of last year.
According to the Russian Economic Barometer, a monthly business survey, the take up of labor has already risen from just over 70 percent in 1998 to just under 90 percent by the start of 2001, while machinery utilization has climbed half as quickly. On average, a third of factories' machines remain idle.
As the economy slowed in November, unemployment fell by 1 percent instead of rising as would be expected. At the same time, wage increases continue unabated.
"If all the slack in labor productivity gains has been taken up, then the window of opportunity is now closed," said the World Bank's R?hl. "Life will get more difficult if further production gains become dependent purely on the investment flows."
Clearly, there are still more gains to be won from making staff work better, rather than just harder, but study is still needed on Russia's labor productivity and it is difficult to say just how important this is; these types of productivity gains usually require extensive training and time.
Reform and Banks
It doesn't take much money to make employees work, but as companies bump up against labor capacity ceilings, it is going to get much more difficult to further increase production without buying new equipment.
Banks have contributed almost nothing to growth. Despite rising fixed investment, last year bank credits made up a pathetic 3 percent of total capital invested into industry.
Companies are already on the hunt for investment capital. Companies in the oil and gas sectors are awash with cash following three years of high international commodity prices, but many of them are planning to rationalize their financing needs by issuing Eurobonds.
In addition to the $4 billion worth of Eurobonds the state is expected to issue this year, 12 blue chip corporations are expected to issue about $3 billion worth of Eurobonds.
One tier down, big companies such as domestic health and beauty product producer Kalina and diamond monopoly Alrosa are tapping into the growing pool of rubles that banks have been depositing in correspondent accounts with the Central Bank.
More than 100 companies issued a total of $2.6 billion worth of ruble-denominated corporate bonds last year. Both numbers are expected to double this year.
And there has been a small trickle of Russian companies using their stock to raise money. Wimm-Bill-Dann's initial public offering on the New York Stock Exchange in February was one of the most recent, and this month will see Russia's first ever Initial Public Offering as RosBusinessConsulting sells its shares directly on the RTS and MICEX.
All these sources of capital are closed to the huge swathe of SMEs forced to pay for investments out of retained earnings or by finding private investors.
The lack of SMEs is a serious problem. Their number has fallen in recent years to about 800,000 or about 4 percent of gross domestic product, according to official statistics, although there is much debate over how the number should be measured. Other estimates put the number at 15 percent to 18 percent of GDP and growing.
Whatever the real number, there are clearly not enough SMEs. A few years ago, a World Bank study concluded that a vibrant SME sector was an important contributor to rapid growth.
"If a thriving segment of new, small- and medium-sized firms is already in place, it becomes easier to import the conditions leading to the restructuring of old enterprises because it is relatively easy for people to find new jobs elsewhere," the study said. "If, on the other hand, alternative employment opportunities and government support are absent, the recommendation to close down non-viable plants may appear very cynical."
There is good news on this front, too, as Putin in September urged the State Duma and the government to "pay special attention to small and medium businesses," and reiterated the importance of boosting SMEs in recent weeks.
But the fast growth of SMEs depends on successfully reforming the bureaucracy. Apart from feeling more optimistic about the future, small businesses say they see little or no change on the ground. The lack of access to capital is another problem.
Bank credit portfolios have been rising strongly over the past year, but the maturity length of loans has been dropping equally quickly, suggesting that most of the credits are going to fund working capital. More worrying, wage arrears also began to creep up in February, suggesting that even retained earnings are no longer enough to fund the pace of growth.
"Firms for the first time are running into capital constraints just as they are being hit by the combined force of ruble appreciation and rising tariffs," says Renaissance Capital's Nash. "If the new chairman of the Central Bank [Sergei Ignatyev] is unable to facilitate the redistribution of capital from that sector of the economy which generates it, to that which requires it, then Russia's brief flirtation with fast growth will soon end."
'Now the Hard Part Starts'
The slowdown at the end of last year marks the end of the first and successful phase of Putin's attempt to transform Russia Inc. into a profitable concern. As it is being caused as much by capacity constraints and demand as the fall of international oil prices, some economists are even talking about "Russia's first business cycle."
Business cycles are driven more by fluctuations in demand than what happens on the London metal market, and after the Christmas downturn, demand picked up again at the start of this year.
The Moscow Narodny Bank's production managers index, a survey of business activity, found that by February, confidence, output and orders had all picked up again, although problems with labor persist.
The PMI index also grew in March. Nash said: "The March Moscow Narodny Bank PMI index shows the pick-up in industrial production levels continued in March, which supports our views that manufacturing growth has recovered, and that it is likely to continue until October as it has every year since 1999. It means the lower rate of manufacturing growth this winter was nothing more than a seasonal phenomenon and is no cause for concern."
Last month, Deputy Economic Development and Trade Minister Arkady Dvorkovich said preliminary State Statistics Committee figures show the economy was up 2 percent year on year -- the lowest figure since May 1999 -- although this was being driven by large enterprises and is not sustainable in his view.
He pointed again to the need to develop the SME sector in the long term.
The lack of a banking sector is already dragging on growth. The Russian Economic Barometer survey found managers are not worried about the cost of capital and companies with investment plans are increasingly implementing them. But it did find an increasing number are worried about the rising cost of equipment. However, 90 percent of managers said their biggest problem is simply the lack of access to capital, up from two-thirds a year ago.
Russia's economy remains top-heavy with two thirds of investment going into fuel and energy and budget-funded enterprises. The only companies doing really well tend to be catering directly to consumers. Huge chunks of the economy are simply being bypassed, and investment into state-owned enterprises is wasteful.
"At the moment, the government is part of the economy in a way it should not be," Prime Minister Mikhail Kasyanov said in January. "This includes not only banking, but the economy as a whole."
The government plans to conduct a thorough, across-the-board analysis and inventory of state-controlled enterprises at all levels and intends to spin off its stakes, says Kasyanov, but this process has yet to begin.
A World Bank report in 1992 noted that the only foreign investors in Russia were those that "had" to be there; companies in the extraction industries and multinationals with famous brands.
R?hl points out that foreigners would like to invest in oil, because that's where the big money is. But as the oil companies are awash with money, there are few opportunities.
The government would like foreigners to invest into areas such as the utilities sector, but the amount of money required -- Unified Energy Systems estimates that it needs $5 billion a year for the next decade -- are so huge, no one is prepared to take the risk.
The country's natural wealth means expert-orientated industries should be attractive, but the venal state of the customs service means that few have taken the plunge (IKEA's recent pledges to make Russia a production center for furniture are a notable exception). This leaves the industries connected to the consumer, such as beer and food processing, which is exactly where foreign investment is going.
Putin has been hitting bullseyes with his reform program. All the major problems outlined in this article are being addressed. And in what is increasingly typical of Putin's pragmatic style, the problems have been addressed more or less in order of importance.
Starting with tax reform, the Kremlin quickly moved on to tackle the natural monopolies which affect both budget revenues and inflation. Of the instructional changes, customs reforms topped the list, followed by Putin's call to focus on promoting SMEs at the end of last year.
Last month, Viktor Gerashchenko resigned six months before his term as Central Bank chairman was due to expire, a sign the Kremlin is already concerned about doing something about the banking sector.
All these policy initiatives are very encouraging, but the implementation is only just beginning. Russia will continue to grow, but for the next few years it is likely to look like a U rather than a V.
"The easy stuff has been done," said United Financial Group chairman Charles Ryan. "Now the hard part starts."
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