Despite the economic downturn in the early part of 1990s and the disruption caused by the financial crisis in 1998, the Russian economy recovered at a much faster pace than expected. By the turn of the century, while the world economy was sluggish, the Russian economy was expanding steadily. A surge in oil prices in recent years, though affecting the economy of oil importing countries, has in fact benefited Russia. This is because oil and energy products contribute to a substantial portion of the country's industrial output. Sustained world demand for such items has thus helped boost its exports.

In the meantime, the country's foreign sales have been stimulated by the weakness of the Russian rouble, whose value against the US dollar has depreciated substantially. In 1998, the exchange rate was 9.71 roubles per US dollar before the outbreak of the financial crisis. But it dropped to 24.6 roubles in 1999. The exchange stood at about 28.3 roubles per US dollar in 2005¹. Notably, a weaker exchange rate has in turn facilitated industrial production in the country and also enhanced the competitiveness of local products against imports in the domestic market.

Higher capacity utilisation and brightened prospects have resulted in increases in business investment, and business sentiment has become more favourable. Meanwhile, consumer spending has expanded at a steady pace, a reflection of the reduced tax burden and a stable employment situation. Although increases in price levels have eroded consumers' purchasing power, inflation actually fell from over 100% in the first half of 1999 to below 20% in the second half of 2000, thanks to a prudent monetary policy.

More importantly, the Russian economy has benefited from the return of law and order in the country. Indeed, Russia's political environment has become more stable under the current Putin presidency, marking and end to the long-standing political turmoil of the Yeltsin era in the 1990s. This has been proven to be favourable for sustained growth in爐he longer term. Putin's measures, including his efforts to improve the business environment and strengthen tax collection, while reducing personal income and corporate taxes via tax reforms, have impressed foreign investors. A stable environment, coupled with sound economic measures, has resulted in the return of foreign capital that fled the country during the 1998 financial crisis.

Against this background, Russia's GDP rebounded rapidly by 6.4% in 1999 and 10% in 2000, after a 5.3% contraction 1998. Notwithstanding the slower world economy since 2000, Russia's GDP continued to grow steadily. The good showing of the economy, coupled with the return of foreign capital, has stimulated domestic demand, which has translated into increases in consumer spending.

Of interest to Hong Kong companies, there exists a large underground economy in Russia. Since a large portion of business activities and incomes of the country's private sector are not reported, official statistics tend to understate Russia's actual economic performance. If these unreported earnings, estimated to be some 20 to 30% of the official GDP, are taken into account, the Russian economy would show a better performance.

B. Growing Purchasing Power

The good showing of the economy has facilitated employment growth. The Russian unemployment rate fell steadily from over 13% after the financial crisis in 1998 to some 8% at present, as increases in business and industrial activities stimulated demand in the labour market. Coupled with the improvement in company profitability, wages in Russia have been growing rapidly in the last few years. According to official figures, the average monthly wage reached 8,550 roubles (around US$302) in 2005, increasing by more than triple the 2,223 roubles in 2000, when the economy had recovered fully from the financial crisis.

While these figures have revealed the pace of wage increases, it should be noted that such official figures have understated actual income levels. This is because a substantial portion of business activities and incomes of the private sector are not recorded by official statistics, as there is an active underground economy in the country. (As mentioned, such unreported activities are estimated to account for some 20% to 30% of the official GDP.)

On the other hand, it should be noted that the majority of the higher income classes mainly reside in Moscow and St. Petersburg, Russia's major business centres. These two cities are the most populated in the country, with 10.4 million and 4.6 million people, respectively. While there are over 1,000 cities and towns in various districts, except for Moscow and St. Petersburg, none has a population exceeding 1.5 million. As a result, the impact of increases in income and consumer spending is more apparent in Moscow and St. Petersburg than in other cities.

Official figures showed that the average monthly wage in Moscow and St. Petersburg stood at 10,638 roubles (US$370) and 8,152 roubles (US$283), respectively, in 2004. But actual earnings, which include unregistered incomes, are much higher. Except for the low-income class which is largely composed of less educated and unskilled workers, it is estimated that actual earnings in the two cities now amount to some US$700-US$1,500 per month. This has been facilitated by the fast pace of increases in income in the last couple of years.

Russian consumers have relatively more money to spend on non-essential items. For one thing, it is estimated that less than 0.1% of the population is saddled with a mortgage. Rents for apartments and fees for water supplies, utilities, fuel, transport and education, which are subsidised by the government, are estimated to account for less than 20% of household income. Against this background, robust income growth, coupled with a desire to improve living standards, has translated into stronger consumer demand, boding well for relevant suppliers to the market.

C. Limited Production of Consumer Goods

Despite stronger consumer demand, production of consumer goods is limited in the country. Russia has established a strong manufacturing base since the Soviet era, but its output consists mainly of heavy industrial goods and resources-based products, as the country is rich in natural resources. Leading outputs of Russian industry are machine building and metalworking items, which accounted for over one-fifth of total industrial output in 2004. The second largest industrial sector is fuels, which cover oil extraction and refining, gas and coal. Other major sectors include food, non-ferrous metallurgy and ferrous metallurgy, electric power, chemicals, etc. Thanks also to the richness of mineral and other natural resources, the country has substantial production in relation to ferrous and non-ferrous metallurgies, chemicals and petrochemicals, as well as wood-related and paper products. While such production is meant for local consumption, a substantial portion of output is for overseas sales.

As for light consumer goods, production is less significant, accounting for only 1.4% of total industrial output in 2004. As a result, demand for consumer goods such as clothing, electrical appliances and other household items from the 143 million strong population has to be met by imports. Moreover, there is a lack of ancillary industries to support local production of consumer items. Most consumer goods producers therefore need to rely on imported parts and accessories to support their production. All these have created vast trading opportunities for relevant suppliers.

D. Surge in Foreign Trade

Externally, Russia's foreign trade has grown gradually and surpassed the level it was at before the financial crisis. In particular, exports have been fuelled by increases in world demand for energy products. More importantly, Russian enterprises have striven to compete in the international market. While capitalising on their long-established network with the Commonwealth Independent States (CIS), they are looking for non-CIS markets for business expansion. As a result, over 80% of Russian exports are now sold to markets outside the CIS. The major non-CIS markets include the Netherlands (absorbed 10% of Russia's total exports in 2005), Germany (8%), Italy (8%), the Chinese mainland (5%), Turkey (4%) and Switzerland (4%)².

Growing exports have resulted in increasing foreign receipts, which have enabled the country to finance its growing imports despite the substantial depreciation of the rouble during the last few years. While increases in industrial activities have spurred import demand for inputs, increases in income and foreign receipts have stimulated demand for consumer goods. The major suppliers to Russia include Germany (accounting for 14% of the total imports in 2005), Ukraine (8%), Belarus (6%), the US (5%), France (4%), Kazakhstan (3%) and Italy (3%). Although goods from the Chinese mainland also accounted for 7% of Russian imports in 2005, it should be noted that the mainland has a substantial border trade with Russia, which has not been fully recorded by official trade statistics.

Product-wise, Russia's major exports are mainly energy and resources-based items. As for imports, the largest category is machinery, equipment and transportation means, accounting for 44% of the total爄mports in 2005. But it is noteworthy that such imports have been spurred not only by the strong input demand for industrial equipment and products from foreign and local enterprises for their business needs, but also household demand for electrical appliances to improve living standards. Other major import items include foodstuffs and agricultural raw materials, accounting for 18% of Russia's total imports, followed by chemicals (17%), metals, precious stones and related items (8%). Meanwhile, consumer goods like textiles, footwear and related articles accounted for 4% of the imports.

¹ IMF
² Federal State Statistics Service of Russia