Military

Thank you, Mr. Chairman and members of the committee, for the opportunity to testify today on behalf of the U.S.-Russia Business Council.

The U.S.-Russia Business Council is a Washington-based nonprofit trade association formed in early 1993. The Council’s mission is to expand and enhance the U.S.-Russian commercial relationship on behalf of 260 American firms active in U.S.-Russian trade and investment. Guided by member interests, the Council promotes an economic environment in which U.S. business can succeed in a challenging Russian market. To achieve its mission, the Council conducts activities and provides services that fall into the following categories: company-specific assistance and problem-solving; Russian and U.S. government policy work; information products; Russian business relationships; and formal and informal briefing and networking opportunities.

I am pleased to be here on Capitol Hill to convey the business community perspectives on Russia’s economic transition and the commercial climate in Russia. Our message from the business community seeks to ensure balance in the discussion of Russia’s transition by conveying several positive aspects of what we see unfolding in Russia. I want to stress several important points in reference to the commercial climate.

A viable market economy has taken hold in Russia. The Russian market will continue to grow, and U.S. firms want to be well positioned vis-a-vis European competitors.

American companies have recovered from the 1998 financial crisis fallout, are meeting their corporate benchmarks and are increasingly posting profits.

Within the American business community in Russia, there is a growing sense of optimism that the Putin team’s economic policy is sound and that, in contrast to certain empty promises of the past, the Putin Administration is promoting real change when it comes to Russia’s economic transformation. The Putin team’s rhetoric is backed by a series of concrete actions on issues ranging from tax reform to corporate governance, just two of many areas where structural changes are needed to sustain economic growth. Recent developments indicate how serious the Russians are in additional areas where bold steps are required: currency controls, pension reform, land reform, money laundering, judicial reform, and many others.

The business community has initiated a healthy dialogue with the Russian government entities charged with structural transformation. This exchange on proposed legislative and administrative changes ranges from tax reform to commentary on Russia’s recently adopted e-signature law, and it includes several WTO-driven initiatives.

U.S. government support is crucial to the success of this effort, and intense and ongoing engagement with Russia should not be exclusively focused on strategic and geopolitical issues. Cooperative public-private engagement on the commercial front helps to advance an overarching U.S. interest in further integrating Russia into the global economy. I am pleased to note that our organization is helping to shape a new initiative in this regard, the Russian-American Business Dialogue, to which I will return later in my statement.

In rendering an outlook for a country such as Russia, our challenge is to weigh competing variables, collecting anecdotal and empirical evidence to try to balance the "transition fatigue" identified by some companies with the long-term commitments evidenced by most. The same is true for the juxtaposition between long-term optimism versus the short-term pressure companies feel to make their quarterly numbers and move from red to black on the P&L sheet. The business community’s positive outlook on Russia often does not correlate to mainstream media coverage of the pitfalls of Russia’s unprecedented transition, perhaps in part because companies are closer to non-headline incremental movement.

Generally speaking, the business community is the most optimistic it has been since the period prior to the August 1998 crash, with more multinational corporations operating in Russia now than prior to 1998. This optimism ranges from business development plans to profits. A survey of 100 multinationals conducted by the Economist Intelligence Unit generated some interesting data to this effect.

No company in the survey believes that political risk is increasing, with 82 percent actually seeing an improvement.

Two-thirds feel that the tax environment is getting better, with only 5 percent believing it is becoming worse.

More than 60 percent are currently operating at pre-crisis levels.

More than 80 percent reported making a profit in 2000, and more than half expected sales in 2001 to grow between 10 percent and 25 percent.

More than 70 percent hired new personnel in 2000 and planned to continue hiring in 2001.

Essentially, investors care about three things that fall into the "make or break" category for any decision matrix: political stability, the tax regime (rates, transparency/predictability and enforcement/appeals) and property rights (whether shareholder rights or intellectual property rights). Fortunately, Russia has demonstrated recent and meaningful progress in these critical areas, having tackled political consolidation in Putin’s first year in office before moving on last year to pass a reduced corporate profits tax, a Land Code, and a money-laundering law.

While pressing forward in 2001 in other areas such as pension reform and judicial reform, the Russian government also gave a boost to entrepreneurial activity by passing a new law that reduces the number of business activities requiring a license from 2,000 to just 100. The law also instituted a "one-stop shop" for the registration of new firms. As the World Bank and others have demonstrated, the rapid growth of Central European and Baltic economies in the 1990s was due in large part to small and medium-size enterprises (SMEs). Firms in those countries with 50 or less employees account for more than half of all employment, whereas in the former Soviet countries only one-fifth of workers are employed in small firms.

The business community has been quick to recognize the momentum: an analyst at Aton Capital recently noted, "In the past two years, the current administration has probably implemented more reforms than Boris Yeltsin managed in his nine years in power." That momentum is unabated in early 2002, as the State Duma’s spring session will focus on more than 500 bills, 101 of which have been labeled "priority measures." Among the priority measures are an extension of the private property provisions of the Land Code to agricultural plots, as well as further steps in the areas of tax and pension reform, the latter of which is expected to generate up to $3 billion in investment assets over the next two years.

While implementation is the key to realizing economic benefits, the good news is that the policies are sound and the leadership exudes confidence. This has spawned a new surge in investor confidence in the team led by Minister of Economic Development and Trade German Gref and the coherent economic program they have fashioned to chart Russia’s course. The business community believes the Russian government has made good use of the "breathing room" it was afforded by the twin benefits of devaluation dividends and high oil prices—that is, they are laying the groundwork for sustainable economic growth rather than cycling through tranches of IMF money.

Russia has plenty of absorption capacity when it comes to investment inflows. The FDI stock in Russia is only five percent of GDP, which is one of the lowest in the world, and much of that amount is attributable to returning flight capital. Furthermore, according to Council member Troika Dialog, foreign investment is heavily concentrated in "islands" of opportunity where local officials have made a concerted effort to assist with a daunting bureaucracy and an unstable tax system: the top 10 regions account for 83 percent of FDI.

Russia attracted $3.2 billion in FDI in 1999 and $4 billion in 2000 (including an 18 percent increase in investment in fixed assets). According to the Central Bank of Russia, foreign direct investment in the first nine months of 2001 was $2.9 billion, while preliminary data indicate that gross capital fixed investment grew by 8.7 percent in 2001 to just over 17 percent of GDP. Even with the 50 percent surge in FDI that Russia hoped for in 2001, it would still equate to one-sixth of China’s 2000 total and less than three percent of the U.S. figure for 2000. While cumulative FDI in Russia over the past decade is estimated at roughly $18 billion (compared with over $350 billion in China), with demonstrated improvements in the tax environment and other policy realms, FDI is expected to grow quickly in the next few years, perhaps doubling by 2005.

The top ratings agencies concur with the business community’s sense that Russia has become an increasingly attractive place to invest. In October 2001, Fitch raised its Russia rating from B to B+, attributing the revised rating to "exceptional macroeconomic performance and acceleration in structural reform," and suggested that its strengthened policy framework makes Russia "well placed to weather even a severe global downturn and rising risk aversion." The following month, Russia redeemed it $1 billion Eurobond, in what some analysts described as "Russia’s first-ever full non-restructured redemption." Moody’s responded by raising its Russia rating two notches to Ba3, citing the Russian government’s commitment to debt service, prudent monetary policy and structural reform. On December 19, Standard & Poor’s again upgraded Russia’s long-term sovereign credit ratings from B to B+ — just two years ago, S&P’s minimum rating was SD (Selected Default); and just last week, S&P upgraded its outlook on Russia’s sovereign debt from stable to positive.

Both in terms of publicly traded debt and the Russian stock market, Russia has to be viewed as one of the best performing emerging markets of the past year. The RTS, Russia’s main market barometer, was up 81.4 percent in 2001, including a 44.1 percent gain in the 4^th quarter alone. The market diversification away from oil and gas is also encouraging—for example, fruit juice and dairy provider Wimm Bill Dann launched an IPO earlier this month, the first such offering since two Russian telecoms (MTS and Vimpelcom) placed shares in 1999. Furthermore, with yields declining to near 10 percent, prominent Russian companies such as Sibneft, TNK, Gazprom, Severstal, MTS, and Vimpelcom have announced plans to follow the lead of Rosneft, which last fall issued the first corporate Eurobond since 1998 ($150 million). Finally, in addition to these corporate placements, the fact that the yield on Russia’s 30-year Eurobond dropped more than five points last year is another sign of investor confidence and declining risk.

The optimism and the FDI statistics are easily translated into company activity, as evidenced by a few examples of the long-term commitments American firms have made to the Russian market.

Ford Motor Company is investing $150 million to produce the Focus platform in Vsevolozhsk, in Leningrad Oblast. Ford planned to sell 4,500 cars in Russia in 2001, which is 230 percent more than in 2000. The Focus model is the company’s leading seller in Russia, and by 2005 annual sales in Russia should amount to 17,800 units.

International Paper’s Svetogorsk facility, also in Northwest Russia, is the leading supplier of copy papers in Russia. With 3,200 employees, the factory is ahead of the ramp-up schedule approved by International Paper’s Board of Directors.

In 2000, Philip Morris inaugurated its $330 million Izhora facility in Northwest Russia, the company’s largest, newly built facility in Eastern Europe. Last fall, Philip Morris announced an additional investment of $100 million to expand its production capacity. The company had expected to recover the $330 million invested in the factory by 2009, but the enterprise is operating so successfully that management now expects that initial investment to pay for itself by the second quarter of 2003.

During the trade mission to Russia led by U.S. Secretary of Commerce Don Evans last fall, Frito-Lay announced a $40 million investment to build a new plant in the Kashira region of Russia.

Boeing has invested $1.3 billion in Russia over the last decade on projects such as the International Space Station and the Sea Launch satellite-launching venture. With 350 Russian aerospace engineers at its Moscow Design Center, the company is also working with Russian design bureaus Sukhoi and Ilyushin to develop a regional aircraft.

Announced in early 2001, the $330 million GM/Avtovaz deal is a tremendous example of successful international investment in Russia. Its bearing on market psychology is evidenced by a wide range of analyst comments, who described it as: "a tremendous vote of confidence in the Russian economy, which will likely lead to other foreign investments…it will have a positive catalytic effect on foreign investors who have been sitting on the fence…a very positive sign for foreign companies to begin to look at Russia as a target for investment plans." The EBRD was so convinced of the potential that it took both a debt and an equity stake in the project, part of the bank’s optimistic outlook on Russia overall, which yielded a 50 percent increase in its funds dedicated to Russia/NIS over the next five years.

The Caspian Pipeline Consortium (CPC) is one of the latest manifestations of the optimism surrounding the investment climate. The total cost of the 1,000 mile pipeline project will be $2.6 billion, of which $2.2 billion is being invested in Russia. Almost half of the money is coming from two U.S. corporations, principally Chevron Texaco (30%) and Exxon Mobil (15%), with much of the rest from companies with substantial U.S. shareholdings (BP and Shell). The CPC opens up a new major oil export facility from the Caspian to world markets, and several companies shipping production from Kazakhstan will share in the success. The first tanker loadout from Novorossisysk in October 2001 required the approval of the CPC Quality Bank by the Russian State Customs Committee, the Central Bank, and the Ministry of Finance, among others—the Russian government delivered on its commitment.

Most recently, Exxon Mobil announced a $4.7 billion commitment to Phase-I development of the Sakhalin-I offshore project, which could total $20 billion upon completion.

The investment climate has also been the beneficiary of a vote of confidence by the U.S. Government, as the U.S. Export-Import Bank recently issued a loan guarantee of $3.2 million to MDM Bank from Commerzbank, the first such facility extended to a Russian bank since August 1998. (MDM also received a syndicated $13 million loan from Western banks in November 2001.)

Finally, another helpful barometer comes from gauging employment trends such as "relocation services" for expatriates. According to Ernst & Young, "not since 1997 have we seen such a surge in European and global clients returning to the market…Client activity is up 50 percent on the same period last year, giving further credence to the general market revival sentiment."

The business community’s optimism about the Russian market is supported by impressive trend-lines with respect to macroeconomic statistics. In fact, many of last year’s macroeconomic forecasts had to be revised upward during the year as Russia’s performance exceeded expectations. To put these accomplishments into perspective, however, we should bear in mind that Russia’s per capita GDP is one-half of Hungary’s and one-third of that found in the Czech Republic.

Russia posted growth rates of 5.4 percent in 1999 and 9 percent in 2000 (with even higher jumps in industrial productivity). In the midst of a global recession, the 2001 figure has been initially reported as 5 percent, with production in the five core sectors of the economy (agriculture, construction, industry, retail trade, and transportation) registering a 5.7 percent increase. This marks the first time that post-Soviet Russia has registered three consecutive expansions. According to Andrei Illarionov, President Putin’s economic adviser, real incomes climbed by 6 percent in 2001, capping off a three-year run that constituted the country’s strongest performance since the 1966-69 Soviet economy. Most analysts expect growth of up to 3.5 percent in 2002.

While Russia did not make its inflation target last year, (the 2001 budget projected a 12 percent annual rate), the final 2001 figure of 18.6 percent represented continued improvement over the three previous years, when it registered 20.2, 36.5 and 84.4 percent. Whereas barter represented more than half of all economic transactions in 1998, the Russian economy today is increasingly monetized, as that proportion has dropped to less than 20 percent.

Perhaps most important, Russia is running surpluses across the board. Russia enjoyed a budget surplus of more than $7 billion in 2001 (more than 6 percent of GDP), from which it devoted $5.5 billion to debt service and $1.5 billion to increase cash reserves. Thanks to improved tax collection, primary surpluses have doubled in recent years, from 8 percent in 1997 to around 16 percent in 2001. Much of this improvement is attributable to successful collection from Gazprom, UES and 18 oil companies: these firms contribute more than 40 percent of taxes to the federal budget (and Gazprom is responsible for half of that amount). Russia’s good fortune also includes a large current account surplus ($34 billion), a $50 billion trade surplus, and gold/currency reserves of $37 billion, which have tripled since early 2000.

Thus Russia finds itself in a good position to manage its foreign debt burden, roughly two-thirds of which stems from Soviet-era obligations. Last June, Prime Minister Kasyanov announced that Russia will not seek to restructure its debt service in 2002 and 2003, when the country faces $14 billion and $16 billion in debt service, respectively. Having repaid last year more than $17 billion in foreign debt— including $2.8 billion ahead of schedule—Russia has lowered its outstanding debt from more than $150 billion to $133 billion. Finally, this spring Russia plans to issue $2 billion in new bonds maturing in 2010 and 2030 to cover its $6.6 billion in holdover foreign trade debt from the Soviet era, which has climbed from a nickel to 40 cents on the dollar recently.

Most analysts agree on three key points: Russia’s 2002-03 debt load seems manageable; if needed, a several billion dollar cushion can be negotiated through an IMF loan and/or a Paris Club restructuring; and the key variable in the equation is the price of oil. Much of the forecasting is tied to oil prices hovering around $18.5 per barrel. Each dollar increment below that target costs the federal coffers roughly $700 million to $1 billion, which means a return to deficit spending at $14.5 per barrel. The assumptions are especially shaky and all bets are off if the average price falls into the "danger zone" of $10-12 per barrel. The downward pressure on oil prices may provide an added impetus to speed up the pace of reforms. One could argue that prices zooming through the 20s contributed to a false sense of economic security and, if taken to the extreme, acted as a disincentive to bolster the reform process.

I’ve devoted time to discussing the optimistic approach American companies have toward the Russian market, but I want to make clear that this optimism is grounded in a realistic assessment of the obstacles that must be surmounted if free market activity is to truly flourish. Investors have a keen appreciation for the challenges that lie ahead and are, on balance, comfortable with their own calculations of risk vs. reward. What I would like to do next is briefly survey a few of the key commercial issues and outline recent policy progress to give you a sense of some these challenges and how the Russian government is responding to them.

Having accomplished his three major priorities in 2000—federal reform, customs reform and some pieces of the new Tax Code—President Putin laid out an ambitious set of priorities for 2001, beginning with a continuation of critical tax reforms, especially the Corporate Profits Tax. He signaled another affirmation of property rights by designating the draft Land Code a top priority, and in October 2001 he signed into law a Land Code codifying the rights of sale and disposal for nonagricultural land, the collateral provisions of which will also spur the development of credit markets.

He also noted his intention to overhaul Russia’s system of currency controls to bring it in line with world practice, based on a recognition that the current regime stifles legitimate business but does not stop $20 billion in capital flight each year. Last summer, the Russian government reduced the mandatory currency conversion requirement for export proceeds from 75 to 50 percent. That step, coupled with other measures under discussion to ease restrictions on capital operations, signifies an important philosophical reorientation as to how to keep capital inside the country—by delivering on a policy agenda that improves the local investment climate.

At the same time, important new legislation sought to distinguish between capital flight and money laundering. The new law "Concerning the Counteraction of the Legitimization (Laundering) of the Proceeds of Crime" was signed by Putin on August 7, 2001. Among its features are the Article 6 controls established for transactions exceeding $20,000, including cash transactions and those involving accounts in countries with no disclosure requirements or numbered accounts.

Russia’s policy progress should be assessed in relative terms. For instance, we have seen virtually no progress on reforming and re-capitalizing Russia’s banking sector, where minimum capitalization requirements and other measures have yet to be introduced, and there is still a great reluctance to allow foreign banks to help develop this sector. A vibrant, truly flourishing market cannot exist without a functioning commercial banking system engaged in typical banking activities such as lending. By contrast, Russia has taken several steps to strengthen investor protections, and an important signal was sent in June 2001 with the leadership change at Gazprom, where the government retains 38 percent ownership. These changes, and similar efforts to improve the tax environment and tackle corruption, are profiled below.

Much work remains to be done in several areas that go to the core of investor confidence: capital dilution, transfer pricing/asset stripping, and the failure to comply with information disclosure requirements. The progress made to date and the measure of what remains to be done can be defined in terms of enforcement and amendments to existing law.

In the enforcement realm, the Putin team has strengthened the powers of the Federal Commission on the Securities Market (FCSM), though not enough in both civil and criminal terms. In 2000, the FCSM imposed fines on 1,400 companies for failure to disclose, a 10-fold increase over the previous year. This spring, Russia is expected to codify amendments to the Criminal Code related to nondisclosure, which will carry a punishment of up to three years in jail. Also on the docket is a new law on insider trading, designed to take effect in January 2003.

Of both symbolic importance and practical significance, in December 2001 the Russian government approved a draft Corporate Governance Code based on OECD guidelines, which the private sector has reviewed and commented on extensively. While compliance is voluntary, the Code raises the public pressure to incorporate suggestions that could have a far-reaching impact—for example, the guideline that independent directors represent at least 25 percent of a company’s board.

Importantly, the working groups tasked with developing the Code were not just comprised of international investors and law and accounting firms. The process also included representatives of natural monopolies such as Gazprom and UES, and major listed companies such as YUKOS and Sibneft, which along with UES and Lenenergo, have also adopted their own corporate governance codes. Russian companies are increasingly cognizant of the link between transparency and capital attraction, and this is especially the case with resource firms. For example, Norilsk Nickel consolidated its metal exporting intermediary, and Sibneft recently acquired three foreign trading companies (effectively recapturing profits left offshore).

Beyond the approval of the Corporate Governance Code, the Russian government devoted considerable effort last year to five key sets of amendments to close exploited loopholes in existing laws pertaining to Joint-Stock Companies, the Protection of Investor Rights, Affiliated Parties, Insolvency (Bankruptcy), and the framework Law on the Securities Market.

For example, in August 2001, President Putin signed the law "On Amendments and Additions to the Federal Law on Joint Stock Companies" after a two-year legislative struggle. Though several loopholes remain, the new law is a significant step forward, and it pertains to all companies (as opposed to the previous threshold of 1,000 shareholders) as of January 2002. It provides for broader shareholder rights related to new share subscriptions (including a preemptive purchase right), and the new law reduces certain ambiguities pertaining to company charter changes, making any revisions that infringe upon shareholder rights subject to approval by 75 percent of preferred shareholders.

Several private-sector initiatives are also raising the pressure to reform, with rating systems launched by Standard & Poor’s and the Institute for Corporate Law and Corporate Governance, the latter of which has seen a behavioral shift as it now fields complaints from Russian firms at the bottom of its charts. And the Investor Protection Association is working across Russia to organize small shareholders to contest board elections, successfully placing independent directors on the boards of 38 major Russian companies in 2001.

But further improvements are still needed to safeguard the rights of investors in a more uniform, predictable way, as hardly a month goes by without an American company voicing a concern in this area. The investment dispute faced by Ohio-based Sawyer Research Products is among the more publicized cases involving the collusion of local officials in seizing a plant and its inventory. It quite clearly demonstrates the link between investor rights and judicial reform and the importance of Kremlin efforts to rid the judiciary of influence and corruption. So in this as in many areas of Russian commercial policy, actions speak louder than words.

Of all the commercial policy issues brought to the fore during Russia’s decade-long market transition, one has consistently topped the list of investor concerns: the dire need for reform of Russia’s complex tax system. Russia’s tax system has been cited time and again by companies as a major obstacle to foreign investment and to business activity more generally, impeding business plans, deterring new market participants and constraining Russia’s considerable economic potential.

In addition to tax policy, companies face serious tax administration issues, many of which involve interpreting and implementing laws and regulations with consistency rather than targeting firms with solid track records of paying their levies on time. Companies highlight three primary concerns about administrative procedures: central control over inconsistent regional bodies; making VAT refunds available when due; and the need for a mechanism to resolve tax disputes (without full-blown litigation).

Russia made substantial efforts to rationalize its tax system in 2000 by adopting key components of Part II of the Tax Code, which came into force on January 1, 2001. The adoption and implementation of these chapters included what could be fairly characterized as a radical liberalization of the income tax, social funds and turnover tax regimes. To put the magnitude of these accomplishments into perspective, the four chapters covering the flat Income Tax (set at 13 percent), social taxes, excise taxes, and the Value Added Tax (VAT) represent 60 percent of the revenue side of Russia’s ledger. Revenues from these four line items increased by 60 percent for the first half of 2001 on a year-on-year basis. As far as the 13 percent flat income tax is concerned, receipts increased 54 percent in 2001 (y-o-y) despite the abolition of higher brackets.

The Putin Administration made overhauling the Profits Tax its top tax-related priority for 2001, and President Putin signed it into law in August, to take effect on January 1, 2002. In addition to business-friendly provisions pertaining to thin capitalization rules and depreciation of fixed assets, the bill has produced two major accomplishments that will have a far-reaching impact on bottom-line performance: a considerable rate reduction from 35 to 24 percent and full deductibility of legitimate business expenses.

The Russian government expects this stimulus will increase revenue by 1.75 percent of GDP, and businesses will also feel the immediate impact of this changed environment in 2002. The direct correlation to investment growth is striking—Alfa Bank analysts calculate that over half (54 percent) of capital investment in Russia is funded by company profits, while bank financing accounts for only 3 percent.

According to Aton Capital in Moscow, with an Income Tax set at 13 percent and a Profits Tax of 24 percent, suddenly Russia has one of the lowest marginal tax rates in the world. The revenue benefit from increased compliance and overall economic activity could be precisely the boon the Russian government needs to help manage some $30 billion of debt burden in 2002-03.

Though positive sentiment prevails in the marketplace, of course one should not exaggerate the cautious optimism or mask the real distortions that still exist, as not all the news from Russia is good. As former British Ambassador to Russia Andrew Wood puts it, "there is material for pessimists to work on as well…The Kremlin’s dominance of the Duma and influence on the media, along with the emasculation of the Federation Council, represent a certain hollowing out of democracy. Corruption, including by manipulation of the judicial system, remains a major problem—and not just for foreigners." Indeed, Russia ranks 79^th out of 91 countries in a "Corruption Perception Index" established by Transparency International.

However, there are many recent indications that the Putin team has taken note of the dire situation with respect to corruption, with hints that isolated cases may actually be part of a coordinated campaign. Among the more noteworthy episodes is the forced resignation of Nikolai Aksyonenko, the Railways Minister removed and criminally investigated for misappropriation of government funds. The effort underway goes beyond his removal and the subsequent criminal investigation. For instance, the Russian government has instituted new rules governing the discounts that shippers can receive from rail regulators, which are typically correlated to the bribes paid. Second, the judicial reforms enacted on December 17, 2001 attempt to reduce courtroom bribes by providing a fivefold increase in judges’ salaries, and the adopted measures also prohibit the involvement of state prosecutors in commercial disputes. Finally, the opportunities for graft will presumably dwindle as yet another new law reduces the number of business activities that require a license from 2,000 to just 100.

The Russian brokerage Troika Dialog has calculated that, together with corporate governance violations, this graft siphons off about $45 billion in book value from the Russian stock market, and PricewaterhouseCoopers estimates that a successful cleanup campaign could attract another $10 billion a year in FDI (twice the current level).

Even in the murkiest of cases, the market has a way of making the linkage obvious—since Putin dismissed Rem Vyakhirev as Gazprom CEO last May, the natural gas giant’s shares have risen 44 percent. In December 2001, new CEO Alexei Miller persuaded the Gazprom board to repurchase a 32 percent stake in its Purgaz subsidiary, which had been "sold" in 1999 to Itera, the Florida-based firm at the center of Gazprom asset-stripping controversies under Vyakhirev. Early in 2002, the Putin team has picked up where it left off last year, as a top director of Gazprom and the head of its Sibur subsidiary were recently detained by Russian prosecutors for alleged asset stripping amounting to $85 million.

In Russia, there is always a next "test case" for investors to watch. On deck is the partial privatization of Russia’s second-largest bank, Vneshtorgbank, which both the government and the Central Bank want to manage. The EBRD is said to be interested in a 20 percent stake, and with $4.5 billion in assets, a foreign bank might be a likely suitor—if permitted. The market access dimension will perhaps make this a dual litmus test just as the Working Party negotiations over Russia’s WTO accession heat up in 2002.

The business community is supportive of Russia’s aspirations because much is at stake in terms of market access and uniform acceptance of agreed rules of the game.

Russia first applied to join the GATT in 1993 and its successor, the WTO, in 1995. Although Russia’s official WTO accession process began in 1995, not much substantial progress was made during the 1990s. Since 1995, there have been 13 formal meetings of the WTO Working Party on Russia held in Geneva. Prior to the arrival of the Putin Administration, no official Working Party meetings were held between December 1998 and May 2000. Since that time, there have been four official Working Party meetings (the most recent occurring on January 23-24, 2002, with another meeting scheduled for April) and several unofficial meetings.

In addition to the increase in Working Party meetings, the U.S. business community is seeing a new momentum within the Putin Administration, which represents an internal recognition of the need for and benefits of WTO accession (as compared to external pressure from the international community). We are not only seeing WTO accession as a mandate from Putin himself and the Executive Branch, but the Duma has created an Experts Council on Foreign Trade and Investment, whose main task is to review current legislation in terms of its WTO compliance and recommend required changes. The Duma is currently considering amendments to 55 Russian laws related to WTO norms.

While the Putin Administration has designated WTO accession a priority for Russia, there are, however, only limited pockets of officials within the Russian government who are working on accession and who have an understanding of the need for and benefits of WTO membership. These include the Ministry of Economic Development & Trade (the lead agency tasked with negotiations), some Duma committees, and a loose smattering of staff in several executive branch agencies. Because a clear mechanism for incorporating input from the Russian private sector into the accession process has yet to be established, a private-sector initiative to address this need is being developed under the auspices of the Russian-American Business Dialogue.

Russia has completed the information-gathering phase of the accession process, and is now focused on legislative compliance and reform in areas such as agriculture and financial services, among others. Russia attended the WTO Ministerial in Qatar in November 2001 with observer status. Until it becomes a WTO member, Russia will not be able to participate in the new round of trade negotiations.

Russia enjoys widespread support for its accession to the WTO, most notably from the U.S. and the European Union. At the end of 2001, U.S. Trade Representative Zoellick, Russian Minister of Economic Development and Trade Gref and European Union Trade Commissioner Pascal Lamy expressed their support for preparation of a draft Working Party Report on Russia during the first quarter of 2002. (This report would spell out Russia’s rights and obligations as a WTO member.) Soon afterward, following the January 2002 Working Party Meeting on Russia, the decision was made to begin drafting the Working Party Report. While it is expected that the draft will be circulated to the membership by the end of March, no official timeframe has been estimated for the completion of this report.

Bilaterally, much progress has been made. Several bilateral meetings took place in 2001, including a meeting of the U.S.-Russia Bilateral Working Group on Intellectual Property Rights held last spring in Washington. Ambassador Zoellick and Minister Gref exchanged bilateral work plans in August 2001, which was followed by Zoellick’s trip to Moscow in late September. Minister Gref and Ambassador Zoellick also met in Paris in December 2001 to discuss WTO accession and other aspects of the bilateral economic relationship. In early 2002, following the January Working Party meeting in Geneva, the U.S. and Russia held a bilateral meeting to address agriculture, market access and non-tariff barriers. Several other bilateral meetings are expected throughout the year.

Outlined below are several priority areas that need to be addressed in order to facilitate Russia’s accession to the WTO.

Financial Services: The strengthening of Russia’s financial services sector is crucial to the country’s economic development. Some important steps include a reduction in the number of state-owned banks; increased liberalization to allow mergers and acquisitions; greater access for foreign banks; openness to international participation in the Russian insurance industry (which remains poorly developed and whose members have promoted exclusionary legislation to date); development of a legislative framework governing the leasing industry; and improvement in access to capital and credit relationships. Another important issue is Russia’s adoption of International Accounting Standards (IAS).

Intellectual Property Rights: Protection of intellectual property rights is a key factor influencing Russia’s WTO accession and its ability to attract foreign investment. IPR violations—including trademark and patent infringement, counterfeiting, copyright violations, and piracy—remain epidemic. Incomplete anti-counterfeit legislation, lack of enforcement, weak penalties, corruption, and lack of education and training of law enforcement and judicial officials in this area are key impediments to better IPR protection and enforcement in Russia. Specifically, significant shortcomings remain in the country’s trademark and patent laws, especially provisions dealing with famous trademarks and geographical indications, as well as confiscation and destruction of counterfeit goods.

The WTO Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS) covers seven types of IPR: patents, copyright, trademarks, geographical indications, industrial designs, layout-designs of integrated circuits, and undisclosed information. Each WTO member is obligated to implement the TRIPS agreement through their respective domestic legislation, to incorporate the rights and obligations of an IPR-holder and the manner in which these will be enforced.

Legislative progress is being made in Russia. The government submitted a legislative package to the State Duma in July 2001. The package includes amendments to the Law on Trademarks, Service Marks and Appellations of Origin of Goods; Patent Law; Copyright Law; and the Law on Legal Protection of Computer Programs and Databases; among others. The amendments to the Trademark Law and the Patent Law have passed the first reading in the Duma, but the amendments to the Copyright Law have not. In most respects, the proposed amendments will bring Russia’s legislation into TRIPS compliance.

Bilaterally, the U.S. government has not hesitated to criticize the Russian government on its failure to protect intellectual property rights: in May 2001, the USTR placed Russia on the Special 301 Priority Watch List. The USTR also began a review last year of Russia’s eligibility under the Generalized System of Preferences (GSP) program, based on issues raised by the U.S. copyright industry concerning Russia’s intellectual property regime. (The GSP program is currently expired; however, pending its reauthorization, the review of Russia’s GSP eligibility would continue.)

Agriculture: Russia’s domestic support for its agricultural sector is a major impediment to accession. It is important to recognize that the WTO does not prohibit domestic support (a popular misperception in Russia); rather, it limits certain types of support (for example, export subsidies). In WTO terminology, subsidies in general are identified by "boxes" that are given the colors of traffic lights: green (permitted), amber (slow down or reduce), and red (forbidden). The WTO Agriculture Agreement has no red box; therefore WTO members with trade-distorting domestic supports in the amber box must make commitments to reduce these measures.

Over the past 10 years, Russia’s subsidies have primarily been amber-box measures. The government’s main task in current WTO agricultural negotiations is to reduce these measures and focus on green-box measures. Examples of green-box measures include programs that are not directed at particular products such as environmental protection, rural infrastructure and regional development programs.

In terms of annual support levels, Russia has offered a $16 billion ceiling on its subsidies, and this issue continues to be negotiated (WTO members prefer a figure closer to $2-3 billion). Due to the sensitive role agriculture continues to play in the economy, Russian government officials consider agriculture one of the most politically sensitive issues of its accession.

Civil Aircraft: Russia maintains high tariffs on imported aircraft. The Russian government has confirmed that it will eventually become a signatory to the Agreement on Trade in Civil Aircraft, which, together with other WTO agreements, establishes the basic international rules governing trade in the aircraft sector.

In the interim, before Russia fully accepts these international trade obligations, a 1996 bilateral MOU on "Market Access for Civil Aircraft" commits Russia to take trade-liberalizing steps such as tariff reductions and tariff waivers. (The MOU has no expiration date.) These steps are designed to enable Russian airlines to import American and other non-Russian civil aircraft on a nondiscriminatory basis. Since the MOU was signed, Russian tariffs on foreign aircraft have been reduced from 50 to 25 percent.

While the MOU does not specifically provide for tariff waivers on imports of aircraft, it states that Russia will facilitate the participation of American and other non-Russian aircraft components manufacturers in Russia’s aerospace market. Although Russian aircraft makers have applied to the Russian government for tariff waivers on imports of aircraft parts, none has been granted thus far. However, in August 2001, the Russian government took market-opening steps by repealing a July 1998 resolution on "Additional Measures for State Support of Russian Civil Aviation," which had established certain conditions for obtaining tariff waivers (or tariff reductions) on the importation of aircraft, engines and flight simulators.

The WTO negotiation process can serve as a positive framework for engaging both the U.S. and Russian governments on many of the issues of great importance to the private sector. The Russian-American Business Dialogue (RABD) is playing a key role in this process. In December 2001, the RABD issued an Interim Report to U.S. Commerce Secretary Evans and Minister of Economic Development and Trade Gref, outlining six issue areas the private sector plans to address in its initial work plan.

The RABD plans to hold a series of WTO seminars addressing specific industry sectors and the potential impact WTO accession will have on each. These seminars will create a forum for discussion among Russian executive branch officials, legislative branch officials, international experts and representatives of the private sector. The initial seminar, scheduled for March 27 in Moscow, will focus on financial services, one of the most important sectors for Russia.

Finally, as part of the accession process, the U.S. and Russia will negotiate a series of bilateral agreements that will advance our commercial interests and provide important opportunities to pursue RABD goals through public-private partnerships. Similarly, the Dialogue will interface with USTR and the U.S. government’s interagency process to channel regular input from the business community on issues ranging from market access to intellectual property rights, customs, financial services, and the development of e-commerce, among others.

After its first year in office, we have been impressed by the Bush Administration’s commitment to ensuring that our economic and commercial relationship with Russia receives the attention it deserves. For example, Commerce Secretary Don Evans led a trade mission to Moscow with 14 U.S. companies last fall. Another indication that the U.S. Government is supportive of Russia’s efforts to create a more investor-friendly environment is the creation last summer of a Russian-American Business Dialogue.

The Russian-American Business Dialogue (RABD) is a private-sector effort designed to strengthen the economic and commercial relationship between the United States and Russia and complement the ongoing official engagement between the two governments. This business-to-business mechanism was announced by Presidents Bush and Putin during their July summit meeting in Genoa.

Through the RABD, the business community is playing a leadership role in setting the commercial policy agenda and formulating policy recommendations that will strengthen the trade and investment ties between the two countries. The U.S. and Russian governments have agreed to maintain regular consultations regarding the policy priorities emanating from this private-sector initiative, and the RABD held three Cabinet-level exchanges prior to the December delivery of the Dialogue’s Interim Status Report, which covered a half-dozen initial priorities:

I. Administrative Obstacles

II. Market Access

III. Investment Policies

IV. High-Tech Support

V. Growth of Small and Medium-Size Enterprises (SMEs)

VI. Judicial Reform

As Russian Prime Minister Mikhail Kasyanov noted in a speech to USRBC members last month, "The Russian-American Business Dialogue, which was launched half a year ago, is becoming one of the mainstays for the entire system of our bilateral economic cooperation."

One of the top priorities identified by the RABD—indeed one of the highlights of our "transition paper" submitted to the Bush Administration in early 2001—is the unmistakable importance the business community attaches to terminating the application of the Jackson-Vanik amendment to Russia. I recognize that this is not the committee of jurisdiction; nevertheless, perhaps the most important thing I can do today is to express our strong support for filing away this anachronism in the Cold War archives where it belongs.

The changing nature of our relationship with Russia has been startling. As this evolution unfolds, it is important that the trade and investment aspect of our relationship keep pace with the times—removing Russia from annual Jackson-Vanik consideration is an important part of this evolution. Jews in Russia today are free to emigrate, and Russia is no longer a controlled economy. Terminating the amendment’s application to Russia would help foster a sense of normal trade relations between the U.S. and Russia and demonstrate to countries that continue to restrict emigration that such a step is possible with the right reforms.

Furthermore, we believe that Jackson-Vanik and Russia’s WTO accession are two separate issues and should be treated as such. At no time since Russia applied for WTO membership has any U.S. official linked Jackson-Vanik to Russia’s WTO accession. Such an action would be perceived as moving the goalpost on WTO accession and would treat Russia differently from other countries in the accession process.

The United States has an excellent track record in setting the highest bar for new entrants to the WTO. We are confident that the USTR will continue to seek strong commitments from Russia pertaining to the adoption of WTO rules governing its trade regime, the provision of market access in goods and services, the establishment of limits on agricultural supports, and the enforcement of the rule of law in commerce. The United States has the leverage it needs to address trade concerns with Russia, as obviously Russia cannot accede to the WTO without U.S. consent. While there remains much to be done, we are confident that the U.S. government will remain engaged on Russia’s accession process and, likewise, Russia will continue to make great progress.

To conclude, I wish to emphasize the Council’s belief that our partnership on the trade and investment side has been going well, and working on WTO accession and promoting new private-sector linkages through the RABD are ways in which we will help our partnership reach its potential. And in terms of what the U.S. government can do, granting Russia market economy status in our Cold War-era trade laws is near the top of the list. The application to do so is currently under review at the U.S. Department of Commerce, and the U.S.-Russia Business Council has submitted its commentary in support of Russia’s application.

To be sure, remaining tax, corporate governance and other structural reforms lend a cautionary note to the prevailing optimism in the business community. But the recent track record may help Russia finally close the chapter on its post-crisis recovery and begin a new chapter featuring truly sustainable, diversified economic growth.

On behalf of the Council’s 260 member companies, thank you very much, Mr. Chairman, for allowing me to share the business community’s viewpoints at this important time in our relationship with Russia.