VZCZCXYZ0034
RR RUEHWEB

DE RUEHMO #0052/01 0101424
ZNR UUUUU ZZH
R 101424Z JAN 07
FM AMEMBASSY MOSCOW
TO RUEHC/SECSTATE WASHDC 6273
INFO RUCPDOC/DEPT OF COMMERCE WASHDC
RUEATRS/DEPT OF TREASURY WASHDC
RHEHNSC/NSC WASHDC

UNCLAS MOSCOW 000052 
 
SIPDIS 
 
SENSITIVE 
SIPDIS 
 
STATE FOR EUR/RUS 
USDOC FOR 4231/IEP/EUR/JBROUGHER 
TREASURY FOR JEFF BAKER AND MATT GAERTNER 
NSC FOR TOM GRAHAM AND TRACY MCKIBBEN 
 
E.O. 12958: N/A 
TAGS: ECON EFIN EINV RS
SUBJECT: RUSSIA'S ECONOMY: OIL STILL RULES, BUT CONSUMER 
BOOM SPURS DIVERSIFICATION 
 
Sensitive But Unclassified -- Not for Internet Distribution. 
 
Summary 
------- 
 
¶1. (SBU)  Oil has dominated the Russian economic landscape 
since before the 1998 crisis.  Its revenues have put the 
government's budget in positive territory since 2002; it has 
strengthened the ruble, and kick-started a wage increase that 
is sustaining a spending boom.  Yet, oil's prominence in 
Russian growth patterns is slipping while consumer trends 
remain strong, as shown by employment, investment and revenue 
trends.  Russia will unlikely ever escape its oil dependency, 
but there are signs of growing diversification as well as a 
nascent independence from oil industry performance, which 
suggests the economy is increasingly protected from even a 
major oil price downswing.  End Summary. 
 
The Russian Economy: One-Trick Pony? 
------------------------------------ 
 
¶2. (SBU)  It would be difficult to overstate the importance 
of oil's contribution to the Russian economy since 2000. 
Non-oil fiscal balances have been negative since 2002.  Oil 
extraction and export taxes, at almost USD 40 billion in 
2005, accounted for 32 percent of government revenues, 
producing budget surpluses in the 6 to 7 percent of GDP range 
in recent years.  And this is not due to just higher prices 
-- production has risen sharply, with Urals crude oil output 
up 50 percent since 1999.  Crude and refined oil products 
constituted 54 percent of total exports in 2000 and 65 
percent in 2005. 
 
¶3. (SBU)  Oil was the rising tide that lifted all boats from 
1999 to 2001.  Large-scale capital investments in the 
petroleum industry during the period (USD 997 million in 
1999; USD 6.3 billion in 2000; and USD 4.5 billion in 2001 
according to official statistics) primarily aimed at 
enhancing efficiency, spurred corresponding increases among 
sectors involved in bringing the product to market.  The main 
beneficiaries pulled along by these gains were 
transportation, engineering services, machine building and 
construction.  In that period, a strong correlation emerged 
between the price of oil and wages throughout the economy. 
 
Other Sectors Breaking Out 
-------------------------- 
 
¶4. (SBU)  But the story does not end there.  Ever higher 
crude oil exports have driven current account surpluses for 7 
straight years (12.6 percent of GDP in 1999; 10.9 percent in 
2005).  These, in turn, have boosted real ruble appreciation. 
 Historically, oil profits were invested abroad, but Andrey 
Klepach, Director of Macroeconomic Forecasting at the 
Ministry of Economic Development and Trade (MEDT) notes that 
the combination of a strengthening ruble and rising consumer 
demand has led to a reversal in the investment destination of 
petrodollars.  United Financial Group Chief Economist 
Yaroslav Lissovolik adds that the beneficiaries of foreign 
direct investment (FDI) are also shifting: the energy sector 
claimed 46 percent of FDI in 2004 but only 33 percent in 
¶2005.  Official statistics also show that nominal FDI into 
non-energy sectors increased 70 percent between 2004 and 
¶2005.  Lissovolik sees "behind-the-scenes diversification" in 
booming service sector growth. 
 
¶5. (SBU)  Investment, in turn, is spurring higher rates of 
return outside the energy sector.  Consumer goods, both 
wholesale and retail, have outperformed the oil sector since 
2003, with real growth rates of 13.2 percent in 2003, 11.2 
percent in 2004, and 12.3 percent in 2005.  The annual flow 
of foreign investment into the retail sector has tripled in 
the last three years, rising from USD 109 million in 2003 to 
USD 319 million through August 2006, according to official 
statistics.  Retail employment is also trending up: growing 
5.7 percent in 2004 and 7.4 percent in 2005 (despite an 
overall contraction in the labor force of more than one 
percent in both years).  Employment in the hotel and catering 
business is picking up steam, growing 15.6 percent in 2005, 
with similar rates expected for 2006; and the same trend is 
evident in retail sector employment.  Foreign investment 
flows into the hotel industry have grown from USD 8 million 
in 2003 to USD 20 million in 2005, and will be significantly 
higher in 2006, if the construction we have witnessed around 
 
the country is any proof.  The financial services sector has 
also been steadily advancing, growing by 9.6 percent in 2003, 
4.5 percent in 2004, and 6.4 percent in 2005, with foreign 
investment flows into the sector jumping from USD 112 million 
in 2003 to USD 526 million in 2005.  This is also one of the 
sectors which would experience a significant boom under a WTO 
accession scenario. 
 
Oil is Key to Growth 
 . . . But Just For Now 
----------------------- 
 
¶6. (SBU)  Finance Minister Aleksey Kudrin believes Russia is 
less and less vulnerable to swings in the world price for 
oil.  He says that in 2000, a one-dollar change in the 
per-barrel price of oil caused a 0.2 percent change in GDP 
growth; by 2005, the coefficient fell to 0.06 percent, and by 
2006, to 0.04 percent.  Using the latter coefficient, a USD 
40 drop in the per-barrel price of oil this coming year would 
knock Russia down to 5.5 percent growth rates -- hardly a 
catastrophe.  MEDT's Klepach estimates that energy is 
responsible for only one-third of today's GDP growth, and he 
claims his calculations account for the impact of 
energy-sourced liquidity that has financed other sectors.  He 
anticipates energy will soon fuel only one-quarter of total 
GDP growth, giving way to advances in the high-tech, 
automotive, and retail sectors.  A non-energy GDP, by that 
measure, could still reach 4-4.5 percent in 2007. 
 
¶7. (SBU) MEDT's Andrey Klepach also believes that wage growth 
(a key component in the current consumer drive) has been 
independent of the oil extraction industry's performance 
since 2002.  He notes that while oil industry growth rates 
have declined (10.3 percent in 2003; 7.2 percent in 2004; 1.7 
percent in 2005, and an estimated 2 percent in 2006), wages 
have experienced double-digit growth over the same period. 
Wage levels, he notes, are now closely tied to productivity 
in a growing number of consumer sectors, from retail and 
telecommunications to tourism and automotive. 
 
Comment 
------- 
 
¶8. (SBU)  Oil remains the prime driver of the Russian economy 
and Russia a key contributor to world oil output: the 
country's annual increases have accounted for 47 percent of 
the worldwide increase in annual oil production since 1999. 
More than one-third of the Russian stock market's total 
capitalization is currently concentrated in 4 oil companies, 
LUKOil, Rosneft, Tatneft and GazpromNeft, and oil exports 
have helped keep current account balances positive.  All this 
is abundantly true.  But, absent a new infusion of capital, 
hydrocarbons look likely to decline as a source of new growth 
and vitality for the country.  And there is also mounting 
evidence that the non-oil, and non-gas, sectors are emerging 
as engines of growth, with the consumer and financial sectors 
poised to push forward, especially as the spending and 
investment boom continues its spread across the regions. 
RUSSELL