HOPES WERE HIGH for the start of Vladimir Putin's second term after his re-election as Russia's president in March. He had already pushed through enough radical reform to put the Russian economy on a path to sustainable recovery, and despite hiccups no-one doubted that he was committed to the reform of the country's creaking institutions.
Then came the summer crackdown on the Yukos oil company, which has unnerved investors and caused the stock market to lose all of the gains it had made since the start of the year. Each week brings a fresh round of banner headlines detailing the last blow and counter-strike as the two sides slug it out.
But lost among the news is the fact that the Russian economy is roaring ahead: if it weren't for the Yukos affair Moscow would be boom town as investors flocked in to set up shop.
At the start of August, the economic development and trade ministry revised its year-end estimates up again and issued a slew of upbeat predictions. The government had assumed average oil prices of $26.50 a barrel when drawing up last year's budget, but with average prices of $30 over the first six months, the ministry has subsequently revised its end-of-year GDP growth figure to a tigerish 7.4%. The government now admits that even this is already starting to look conservative.
Russia's oil engine
Oil remains the engine of Russia's economy and current record high prices have pushed its share of GDP yet higher: but rising oil prices mask the booming consumer sector.
Russians' real disposable incomes are growing. Nominal monthly wages are up a full quarter in June to $240 – nearly a five-fold increase from 1998 – and even real wages were up 14.1%.
"Growth is up about 7%, wages are up about 14%, and disposable incomes are up 30%. At each stage you leverage up another notch and the result is that retail is booming," says Richard Tinker, the head of HSBC's Russia office.
With money in the pocket and a more certain future ahead, Russians have started to enjoy themselves a little. Retail trade continues to roar ahead, up a whopping 11% year on year by June.
Strong sales are feeding through to the five core sectors of the economy: industry, agriculture, construction, transport and retail trade collectively grew by 7.9% over the first five months of this year compared with the same period a year before. And meanwhile, on top of this the service sector continues to outpace industrial growth.
Despite Russia's bad press, most corporate investors seem to have shrugged off worries of renationalization and the Kremlin's selective use of the law for its own political ends: both domestic fixed investment and foreign direct investment have picked up sharply over the first half of this year.
Domestic fixed investment has been putting in double-digit growth for nearly six years and grew another 12.6% over the first half of the year. Russian exporters are awash with cash from strong international commodity prices and are ploughing the windfalls back into the economy.
Retained earnings still account for half of all invested capital and bank credits play virtually no role in investment [see Bank reform takes on new urgency, this issue], so most of Russia's investment capital falls into the "other sources" category – black money coming home where it can earn better returns than it could languishing in the vaults of an offshore haven.
As long as international commodity prices stay high, analysts are expecting Russians to maintain this high level of investment, which is also becoming an important source of growth: in Russia a one percentage point rise in fixed investment is thought to add about 0.3% to GDP growth.
Lion's share
Although oil and oil-related industries still attract the lion's share of investment, more and more is flowing into sectors such as construction and machine-building, which is now one of the fastest growing sectors of the Russian economy, up 14.9% over the first half of this year. Machine-building is growing twice as fast as aggregate industrial production.
High oil prices have also translated into a fat trade surplus. Russia is still digging oil and metal out of the ground faster than its population can spend the proceeds on imported shoes and cheese.
Exports over the first five months of this year were up by a quarter to $64.9 billion while traders imported $34.4 billion-worth of goods, up 23%, leaving the country with a healthy $30.4 billion trade surplus.
Russian exports overtook those of France and the UK in the first half of the year and should overtake Japan's in the second half. As commodity prices rise even higher, economists are expecting the gap between exports and imports to widen to $72 billion by the end of the year.
Money is pouring into the Russian central bank's coffers and hard currency reserves continue to break records nearly every week: gross international reserves passed the $80 billion mark this summer and are expected to top $100 billion by the end of the year. These are equivalent to more than nine months of imports, so Russia already has one of the highest reserve levels in the world by this measure.
The strong growth has also fed through to healthy public finances. Tax revenues came in at a robust $62.8 billion between January and July compared with expenditure of $53.1 billion, leaving a whopping surplus of 3.2% of GDP and a primary surplus (which excludes repayment of foreign debt) of 4.6%.
And the government has been spending its unexpected gains wisely, paying off international debt early so that the debt to GDP ratio is now only 26%, down from over 80% in the mid-1990s.
Prudence is a new word in the Kremlin's financial lexicon and Putin called for more of the same in a speech in July that opened the annual budget debate.
"Starting in 2006, [the budget plan] must be approved by the government of the Russian Federation so as to expand the planning horizon, improve the predictability of the budget policy and the quality of budget drafting and create incentives for optimizing budget expenditures," he told Duma deputies.