Communication from the Commission to the Council and to the European Parliament on relations with Russia
Date: 2004-02-10
Institutions: European Commission
Subjects: EU relations, Russia, cooperation policy, demographic analysis, economic situation, political situation, social situation

COMMISSION OF THE EUROPEAN COMMUNITIES 

Brussels, 10.2.2004 
COM(2004) 106 final 

COMMUNICATION FROM THE COMMISSION 
TO THE COUNCIL AND TO THE EUROPEAN PARLIAMENT 

On relations with Russia 

EN 

   EN 

 
 
 
  
1. 

Introduction 

The European Council in December 2003 requested the Council and the Commission to draw 
up  an  assessment  report  and  propose  measures  aimed  at  strengthening  the  strategic 
partnership  between  the  EU  and  Russia  and  the  respect  for  the  values  on  which  it  is  based. 
This  Communication  responds  to  the  request  of  the  European  Council.  Its  aim  is  to  steer  a 
review of the EU’s Russia policy at the February GAERC and to support the establishment of 
a more coherent and effective approach to relations with Russia,  reflecting the views of the 
EU-25,  in  the  first  instance  with  a  view  to  a  successful  Summit  in  May  and  to  the  further 
development of EU/Russia cooperation. This Communication also argues for a review of EU 
policy towards the southern Caucasus and the western NIS.  

The  EU’s  principal  objectives  in  its  relations  with  Russia  were  defined  following  extensive 
discussions amongst the Member States in preparation of the St. Petersburg Summit in May 
2003. In that context, the Member States agreed with Russia to work towards the creation of 
four common spaces1. It was agreed to take forward this work, notably in the framework of 
the  PCA.  It  is  the  priority  of  the  EU  at  this  stage  to  determine  the  most  effective  means  to 
work towards the agreed objective of creating the common spaces. This work should draw on 
any  elements  of  the  EU’s  neighbourhood  policy,  such  as  the  envisaged  new  neighbourhood 
instrument, that are of common interest to the EU and Russia.  

Russia is an important partner, with which there is considerable interest to engage and build a 
genuine  strategic  partnership  on  the  basis  of  positive  interdependence.  Russia  is  our  largest 
neighbour, brought even closer to the EU by enlargement. Russia is not only a key actor at 
global level and in the UN Security Council but also has significant influence in the NIS. It is 
a  major  supplier  of  energy  products  to  the  EU  and  will  in  future  become  an  even  more 
predominant source of such products. Despite its relatively small economy, Russia is a large 
market for EU goods and services, with considerable potential for growth. It is in the interest 
of the EU for Russia to take forward its reforms and to modernise its economy. In this respect, 
the Commission welcomes Russia’s recent economic growth. 

The EU and Russia have every reason to cooperate on environmental issues, migration, public 
health,  crime,  research  and  other  fields  affecting  the  security,  stability  and  well-being  of 
Europe  as  a  whole.  Russia,  for  its  part,  has  considerable  desiderata  in  its  relations  with  the 
EU,  with  significant  and  growing  economic  interdependence  and  the  development  of  EU 
foreign and security policy.  

EU  and  Russian  positions  converge  on  many  issues,  including  support  for  effective 
multilateralism  under  the  UN,  the  Middle  East  peace  process  and  combating  international 
terrorism  and  the  proliferation  of  weapons  of  mass  destruction.  There  has  also  been  fruitful 
cooperation  in  the  context  of  the  Northern  Dimension  and  the  EU  welcomes  continuing 
Russian support on ITER. The promising experience of the energy dialogue launched at the 
EU-Russia summit in 2000 has delivered tangible and welcome results in an area of strategic 
importance to the EU and to Russia, which is currently the most significant single source of 
EU hydrocarbon imports. 

1 

A  common  economic  space,  a  common  space  of  freedom,  security  and  justice,  a  common  space  of 
cooperation  in  the  field  of  external  security  as  well  as  a  common  space  of  research  and  education, 
including culture. 

2 

 
 
  
 
                                                 
Relations  have,  however,  come  under  increasing  strain,  with  divergence  between  EU  and 
Russian positions on a number of issues, including ratification of the Kyoto Protocol, Siberian 
overflight  rights,  PCA  extension  and  veterinary  agreement  negotiations  and  export 
certification. This has been coupled with a more assertive Russian stance towards a number of 
acceding  countries  and  the  NIS.  This  may  have  implications  for  Russia’s  relations  with  the 
enlarged  EU,  for  efforts  to  resolve  frozen  conflicts  and  for  EU  cooperation  with  the  NIS  in 
particular  in  the  context  of  the  European  Neighbourhood  Policy.  The  EU  acknowledges  the 
value  of  regional  economic  integration  initiatives  among  parties  who  have  decided  to  work 
together  and  which  are  compatible  with  their  international  obligations  and  aspirations. 
However, the implications of the signature in September 2003 of the Single Economic Space 
agreement by Russia, Ukraine, Kazakhstan and Belarus will need to be examined carefully in 
terms of their possible impact on work on the Common European Economic Space and on a 
possible future FTA.  

Against  this  background,  it  is  particularly  important  that  the  Commission  and  the  Member 
States  closely  concert  their  positions  and  speak  with  one  voice,  with  a  view  to  making 
progress towards our agreed objectives. 

2. 

Russia – recent developments 

President  Putin’s  four  years  in  charge  have  seen  a  drive  to  consolidate  federal  control  and 
strengthen  the  state  apparatus.  This  has  produced  more  stability,  in  itself  welcome  after  the 
uncertainty of the Yeltsin era. This period has, however, also witnessed a weakening of the 
values  to  which  the  EU  and  Russia  (as  a  member  of  the  Council  of  Europe  and  OSCE)  are 
committed. Indeed, reports by international organisations, including the OSCE and Council of 
Europe,  the  conduct  of  Duma  elections  in  December  2003,  events  in  Chechnya  and 
indications of the selective application of the law raise questions about Russia’s commitment 
and ability to uphold core universal and European values and pursue democratic reforms.  

President  Putin  has  overseen  a  relatively  strong  economic  recovery  (from  a  low  base)  with, 
overall,  positive  economic  fundamentals  now  in  place.  GDP  growth  averaged  6.5%  p.a. 
between  1999  and  2003  and  inflation  has  fallen  to  12%.  Better  tax  collection  and  spending 
discipline  contributed  to  a  federal  budget  surplus  of  1.5%  of  GDP  in  2003,  while  Russia's 
trade surplus has allowed it to maintain a strong current account position despite substantial 
foreign  debt  payments  and  capital  exports.  Partly  as  a  result,  President  Putin  enjoys  public 
approval ratings of more than 70% and is in a very strong position ahead of the Presidential 
elections  in  March  2004.  This  should  be  seen  against  the  backdrop  of  increasing  inequality 
within  Russia  (according  to  the  latest  estimates  31  million  Russian  citizens  now  live  below 
the official poverty line) and a declining and ageing population, which has not been offset by 
the immigration of ethnic Russians from other NIS. The potential significant decrease of the 
Russian  population  over  the  coming  decades  could  be  a  source  of  long-term  instability.  All 
this  has  implications  for  sustainable  development  and  economic  growth.  Annexes  on  the 
Russian economy and on demography are attached. 

While the adoption of economic reforms since mid-2000 has been impressive, implementation 
and  enforcement  of  legislation  remain  the  key  issues,  while  corruption  is  still  a  significant 
barrier.  Reform  momentum  has  been  lost  in  recent  months.  Some  reforms  have  been 
weakened or reversed as political energies have been redirected towards elections and more 
entrenched interests have been encountered. Much remains to be done to reform the natural 
monopolies (railways, energy – in particular the gas sector), the bureaucracy and the financial 
sector as well as the housing, communal services, healthcare and education sectors. Reforms 

3 

 
 
  
 
and  economic  recovery  have  not  been  accompanied  by  sufficient  diversification  of  the 
Russian economy, which remains based on traditional rents (energy, basic manufactures). The 
large  share  of  energy  in  Russian  exports  leaves  the  economy  open  to  external  shock. 
Meanwhile,  Russia  compares  unfavourably  with  other  emerging  economies  in  terms  of  its 
ability to attract FDI, the result of which is ageing capital stock and decaying infrastructure. 

3. 

The current relationship  

The  EU  and  Russia  have  agreed  ambitious  political  declarations  (e.g.  on  the  ‘common 
spaces’,  the  Energy  Dialogue,  environmental  cooperation2  and  political  and  security 
cooperation) and developed strategies for their relations, including the ‘Common Strategy of 
the EU on Russia’ and Russia’s ‘medium term strategy for relations with the EU’. But, despite 
common  interests,  growing  economic  interdependence  and  certain  steps  forward,  there  has 
been insufficient overall progress on substance. 

There is a need for increased EU coordination and coherence across all areas of EU activity - 
sending clear, unambiguous messages to Russia. It is only via engagement, making full use of 
our  combined  negotiating  strength,  that  the  EU  can  promote  a  fully  functioning  rules-based 
system in Russia, to the benefit of both.  

This  is  relevant  not  only  for  upholding  democracy  and  the  core  European  values  to  which 
Russia  is  committed  as  a  member  of  the  OSCE  and  the  Council  of  Europe  but  also  for  the 
transparent  and  non-
development  of  our  economic  and  overall  relationship.  The 
discriminatory implementation of rules is crucial for the Russian economy for example in the 
context of WTO accession. Russian convergence with universal and European values will to a 
large extent determine the nature and quality of our partnership.  

The EU is seeking to strengthen its relations with the western NIS and the southern Caucasus. 
In  this  context,  it  should  work  with  Russia  whenever  possible  to  resolve  frozen  conflicts, 
tackle political instability and promote economic growth.  

4. 

The way forward 

It is in the EU’s interest to seek an open, stable and democratic Russia, acting as a strategic 
partner which can  uphold  European  values, continue reforms, implement commitments and, 
in cooperation with the EU, play a constructive role in the NIS.  

Several factors need to be borne in mind, in particular the EU’s need: 

– 

– 

– 

– 

2 

to establish an effective, realistic, balanced and consistent approach; 

to engage with Russia; 

to maintain policy coherence and 

to improve the functioning of existing structures of cooperation.  

Both  Summits  in  2001  reaffirmed  the  strong  common  interest  in  deepening  co-operation  on  the 
environment 

4 

 
 
  
 
                                                 
The need for an effective, realistic, balanced and consistent approach 

The EU should make full use of its influence with Russia to promote and defend EU interests 
and to ensure a balanced relationship. 

This means bringing together issues in which Russia is anxious to see progress with our own 
goals. The EU needs to define realistic common positions, which can be used to present a firm 
EU line to Russian interlocutors. Care should be taken to avoid the politicisation of economic 
and technical issues, by ensuring that proposed links concern related issues. 

Such  an  approach  will  enhance  the  EU’s  credibility  and  contribute  to  a  more  substantive, 
forward-looking  partnership  with  Russia.  This  approach  has  proved  to  be  effective  in  the 
negotiations on the transit of Russian citizens to Kaliningrad and has led to a certain degree of 
progress  over  Russia’s  application  for  WTO  accession.  It  could  also  bring  benefits  in  areas 
such as: 

– 

– 

– 

– 

The application of PCA provisions to the acceding Member States from 1 May 2004 
and the application of certain trade preferences to Russia.  

Conclusion  of  an  EU/Russia  readmission  agreement  as  well  as  the  question  of  the 
facilitation of visa issuance (using existing flexibilities under Schengen).  

Active Russian cooperation with the EU to resolve frozen conflicts in our common 
neighbourhood  and  EU  readiness  to  step  up  cooperation  on  crisis  management  and 
civil protection. 

Russian  ratification  of  the  Kyoto  Protocol  as  well  as  increased  cooperation  on 
energy, including progress in negotiations on trade in nuclear materials. 

Engagement 

The  EU  can  influence  developments  in  Russia  if  it  is  ready  to  take  up  difficult  issues  with 
Russia  in  a  clear  and  forthright  manner.  The  EU  as  a  whole  should  confirm  that  shared 
European values remain the basis for deepening relations. Thus, for example, concerns over 
recent political developments, which demonstrate discriminatory application of the law, or the 
non-respect  of  human  rights,  should  be  raised  vigorously  and  coherently  by  the  EU  and  its 
Member States. The EU should also continue to take forward people to people ‘grass roots’ 
contacts, including partnerships in education, which promote European values. 

The  EU  should  demonstrate  its  readiness  to  engage  with  the  NIS  on  the  basis  of  its  own 
strategic objectives, cooperating with Russia whenever possible. 

Experience has shown that when difficult matters arise, Russia often seeks to treat questions 
by  setting  up  new  negotiating  mechanisms.  The  EU  should  make  clear  its  willingness  to 
engage with Russia on all complex issues of mutual interest but continue to give priority to 
substance over form, with a view to obtaining concrete results.  

Policy coherence 

Cooperation  should  reflect  the  mutual  interest  of  the  EU  and  Russia  and  be  balanced.  For 
example, in the field of JHA, the facilitation of visa issuance procedures is a top priority for 
Russia but the EU also has an interest in facilitating certain procedures on the Russian side. 

5 

 
 
  
 
One example of progress in this field is that the Commission will soon come forward with a 
proposal to facilitate visa issuance for third country researchers. Progress on visa facilitation 
should enable the EU to obtain progress on readmission, which is of great significance to the 
EU,  but  which  is  ultimately  also  in  Russia's  interest,  as  progress  in  this  respect  would 
contribute  to  building  the  necessary  confidence  to  deal  effectively  together  with  illegal 
migration.  The  EU  should  continue  to  pursue  broader  JHA  issues,  such  as  cooperation  on 
border  management,  the  fight  against  organised  crime,  corruption  and  illegal  migration. 
Progress achieved in the energy dialogue, too, is welcome. In order to ensure that the EU can 
speak  with  one  voice,  it  is  important  that  parallel  initiatives  are  closely  coordinated  and 
support overall EU policy vis-à-vis Russia.  

The EU needs to agree key objectives and clear positions3. This means, inter alia, drawing up 
an objectives paper for Summits, which should clearly draw ‘red lines’ for the EU, positions, 
beyond which the EU will not go. Agreed EU objectives and positions should guide all EU 
actors, in Moscow as well as in Brussels.  

Structure of cooperation 

The  current  structure  of  cooperation  and  in  particular  the  PCA  is  neither  outdated  nor 
exhausted.  The  PCA  does  not  limit  the  scope  for  EU/Russia  cooperation.  Rather,  the 
Commission should pursue increased Russian engagement in particular at working level.  

The EU should aim to reach an overall agreement with Russia on structures without delay. It 
is  in  our  interest  to  bring  discussions  on  procedures  to  an  end  quickly  in  order  to  begin  to 
make  progress  on  our  common  agenda.  The  EU  should  base  cooperation  on  the  framework 
that is already in place. 

The  PCA  institutions  need  to  become  more  operational  and  flexible.  The  Permanent 
Partnership Council (PPC) should be set up in troika format.  The  PPC can then give  a new 
impetus to EU/Russia relations, intensifying EU cooperation with ‘line’ Ministries, engaging 
the  Presidential  Administration  and  preventing  initiatives,  which  are  in  the  interests  of  both 
sides, from becoming bogged down. Indeed, the PPC offers all the flexibility and engagement 
Russia seeks, while maintaining EU coherence and transparency.  

The  EU  should  be  ready  to  schedule  PPCs  in  areas  such  as  JHA,  environment,  energy, 
transport.  In  the  field  of  JHA,  Ministerial  troikas  have  taken  place  since  April  2001. 
Ministerial meetings in the new PPC format could bring together the Commission, Presidency 
and the Russian Presidential Administration (which can coordinate all Russian Ministries with 
an  interest  in  establishing  direct  JHA  contacts).  The  need  for  additional  structures  is  not 
evident,  but  informal  high-level  meetings  may  be  held  when  they  appear  useful.  In  this 
respect,  the  idea  recently  brought  forward  by  Russia  to  discuss  at  high-level  specific  JHA 
matters should be given particular consideration. 

The  Commission  should  revitalise  the  sub-committees.  If  the  Commission  is  able  to  offer 
more substantive discussions in these fora, the Russian side will have a greater incentive to 
respond. For example, a sub-committee dedicated to JHA could be set up. The EU also needs 

3 

Community positions for issues, where progress is currently blocked by Russia but which are priorities 
for  the  EU,  are  included  in  Annex:  Kyoto  ratification,  maritime  and  nuclear  safety,  readmission 
negotiations,  the  facilitation  of  humanitarian  aid  delivery,  the  ratification  of  border  agreements  with 
Latvia and Estonia, PCA extension, Siberian overflight payments, cooperation on Galileo, energy sector 
reform and Russian safeguard measures.  

6 

 
 
  
 
                                                 
to reconsider the scale of its assistance to Russia, bearing in mind that it has produced at best 
mixed  results  and  that  satisfactory  operating  conditions  (notably  exemption  from  VAT  and 
other local charges, appropriate operating and security conditions for humanitarian aid) have 
not been established. 

5. 

Conclusion 

The  strategic  objective  of  EU/Russia  relations  agreed  at  the  St.  Petersburg  Summit  in  May 
2003 remains valid. The goal is to establish the common spaces (a common economic space, a 
common space of freedom, security and justice, a common space of cooperation in the field of 
external security as well as a common space of research and education, including culture) in 
the framework of the PCA. To reach this objective, the EU needs to improve the manner in 
which it works with Russia.  

There  is  a  need  for  strengthened  coordination  of  policy  towards  Russia.  The  Commission 
therefore recommends to the Council that the EU: 

– 

– 

– 

– 

– 

engage with Russia to build a genuine strategic partnership, moving away from grand 
political declarations and establishing an issues-based strategy and agenda. The EU 
should be ready to discuss all matters with Russia and should not hesitate to defend 
EU interests vigorously; 

underline  that  such  a  partnership  must  be  founded  on  shared  values  and  common 
interests.  This  implies  discussing  frankly  Russian  practices  that  run  counter  to 
universal  and  European  values,  such  as  democracy,  human  rights  in  Chechnya, 
media freedom and some environmental issues; 

pursue  a  more  balanced  cooperation  agenda  with  Russia  and  promote  policy 
coherence.  The  EU  should  establish  a  list  of  key  issues  of  EU  interest  at  the 
beginning of each Presidency, with clear objectives and common positions; 

bring together related issues, where relevant, to promote the EU interest; 

launch  the  Permanent  Partnership  Council  forthwith  and  examine  ways  to  improve 
the efficiency of other PCA institutions. 

A clear understanding of EU interests, objectives and priorities, as well as a more coordinated 
EU policy towards Russia, will allow us to move ahead on the creation of the four common 
spaces. 

The EU should therefore make concrete proposals to Russia on the development and content 
of the common spaces. It should present a draft joint Action Plan to Russia covering all four 
spaces, including and with specific reference to energy matters. This should be consistent with 
the  EU’s  neighbourhood  policy  and  incorporate  relevant  elements  of  this  policy  that  are  of 
common  interest  to  the  EU  and  Russia  as  well  as  draw  on  ongoing  positive  cooperation  in 
specific fields. A pro-active approach, in which the EU defines precise, realistic objectives on 
the basis of reciprocity, will send a strong signal of EU engagement to Russia. Progress with 
Russia towards agreement on the main lines of an Action Plan could be sought by the Summit 
in May, with a view to an agreement on a joint Action Plan by the Summit in the autumn. An 
agreed action plan could then replace the unilateral EU common strategy on Russia. However, 
the EU should not engage in substantive discussions with Russia on the Action Plan before 
agreement is reached on PCA extension. 

7 

 
 
  
 
The  Commission  also  recommends  that  the  EU  pursue  a  more  coherent  policy  towards  the 
southern Caucasus, including through the good offices of the EU Special Representative, and 
western NIS, wherever possible, in co-operation with Russia. The aim should be to promote 
the EU’s relations with these countries and further their economic development and political 
stabilisation, including the resolution of frozen conflicts. 

8 

 
 
  
 
ANNEXES 

9 

 
 
  
 
THE RUSSIAN ECONOMY: RECENT DEVELOPMENTS AND PROSPECTS  
FROM AN EU PERSPECTIVE 

Important progress has been achieved since 1998 

Since the 1998 financial crisis that marked the end of the first period of Russia’s bumpy post-
Soviet transition, Russia has come a long way on the road of growth and economic stability. 
Indeed,  in  sharp  contrast  to  the  previous  decade  of  economic  and  social  dislocation,  in  the 
years  1999-2003  Russia  not  only  progressively  established  a  more  stable  and  predictable 
political  environment  but  also  built  up  a  fairly  respectable  record  of  economic  growth, 
macroeconomic stabilisation and policy reforms.  

In these five years, thanks to 1) high prices for Russia’s main exports (primarily oil and gas), 
2) the devaluation of the rouble and 3) prudent macroeconomic policies, real GDP has grown 
by nearly 40%, or by  an  annual average rate of 6.5% (see table). The country has achieved 
macroeconomic  stability:  inflation  has  been  cut  drastically,  public  expenditure  has  been 
brought under control; following lessons learnt from the 1998 crisis, higher oil revenues have 
not  been  spent  but  translated  into  four  years  of  budget  surplus;  the  exchange  rate  of  the 
rouble, after losing in 1998-9 half of its value (in real terms), has been steadily appreciating – 
in real and, lately, even nominal terms. Growth and financial stabilisation have led to a large 
and  continuing  increase  of  disposable  income  (in  the  first  10  months  of  2003  alone,  real 
personal  cash  incomes  rose  by  16%)  and  to  a  reduction  in  poverty  levels  (which  decreased 
from  a  peak  of  about  40%  of  the  population  in  1999  to  about  25%  in  2003).  The  external 
balance also improved dramatically: the current account registered surpluses of up to 15% of 
GDP; capital outflows decreased and were even reversed at some point in 2003; international 
reserves  were  multiplied  by  six  since  the  end  of  1999.  Russia  took  advantage  of  this 
favourable  environment  to  normalize  its  relations  with  foreign  creditors  and  reduce 
dramatically external debt, which, at a mere 28% of GDP, is no longer a matter of concern.  

Russia : Key macroeconomic indicators, 1998 - 2003 

1998 

1999 

2000 

2001 

2002 

GDP, real % growth 

-5.3 

6.4 

10.0 

5.0 

Industrial production, real % growth 

-5.2 

11.0 

11.9 

4.9 

Fixed investments, real % growth 

-12.0 

5.3 

17.4 

8.7 

Unemployment, %, end of period 

11.8 

11.7 

10.2 

9.0 

4.7 

3.7 

2.6 

7.1 

2003 
latest 

6.7 

6.8 

As of : 

1-9/03 

1-11/03 

12.2 

1-11/03 

8.6 

11/03 

Exports, $ billion 

Imports, $ billion 

74.4 

75.6 

105.0 

101.9 

107.2 

134.4 

1-11/03 

58.0 

39.5 

44.9 

53.8 

61.0 

74.8 

1-11/03 

Current account, $ billion 

0.2 

24.6 

46.8 

35.0 

32.8 

39.1 

1-11/03 

Inflation (CPI), 12-month % change 

84.4 

36.5 

20.2 

18.6 

15.1 

12.0 

12/2003 

Federal government balance, % of GDP 

-5.9 

-1.4 

1.2 

2.9 

1.4 

2.6 

1-10/200 

Foreign currency debt, % of GDP 

50.1 

87.7 

55.3 

44.4 

36.2 

28.3 

9/2003 

Foreign currency and gold reserves, US$ bn 

12.2 

12.5 

27.9 

36.6 

47.8 

76.9 

12/03 

RUB/US$ (end of period) 

20.65 

27.00 

28.16 

30.14 

31.78 

29.45 

12/2003 

10 

 
 
  
 
 
 
On  the  structural  side,  too,  progress  was  achieved;  particularly  since  2000,  the  government 
pushed  forward  a  more  coherent  reform  strategy.  Important  reforms  encompassing  wide 
segments  of  the  economy  (such  as  business  deregulation,  taxation,  pensions  and  land 
ownership) have been—or are being—implemented since then. In the area of social policy, a 
major  overhaul  of  the  pension  system  aimed  at  putting  pensions  on  a  sound  financial  basis 
was  launched.  Yet,  in  other  important  areas,  such  as  the  energy  and  financial  sectors  and 
housing, key measures still remain to be taken. Also, much remains to be done in the area of 
state reforms (covering the public administration, the civil service, and the judiciary).  

Altogether, with a GDP of close to US$ 450 billion, per capita income of around US$ 3000, a 
score of close to 3 out of 5 on the EBRD’s transition indicator and a ranking of 63 out of 175 
countries in the UNDP development index, Russia has an economy equivalent in size to that 
of  the  Netherlands  or  one  third  of  China’s,  a  level  of  prosperity  some  20%  higher  than 
Romania’s4, a transition status close to that of Romania and a development status similar to 
that of Brazil.  

The  above  developments  in  terms  of  macro-economic  indicators  and  economic  reforms, 
impressive  as  they  are,  should  not  lead  to  an  overestimation  of  the  strength  of  the  Russian 
economy or to an underestimation of the challenges it faces. A number of other factors must 
be taken into account, when defining a meaningful strategy for the medium and long term. 

Long-term prospects are uncertain 

Building  on  the  achievements  of  the  last  years,  the  Russian  political  leadership  has  set  an 
ambitious  long-term  target  of  raising  dramatically  the  living  standards  and  transforming  the 
Russian economy into a modern, diversified and competitive economy fully integrated in the 
global economic system. In this context, the growth of the last years is viewed merely as the 
beginning  of  a  long  process  of  even  stronger  sustained  growth.  The  main  element  in  this 
strategy is the objective, set by President Putin in early 2003, to double the size of real GDP 
in ten years’ time, requiring an acceleration of growth to 8% per year.  

In order to assess how realistic these objectives are and the conditions for their achievement, 
it  is  necessary  to  review  the  main  constraints  and  challenges  to  Russia’s  economic 
development. In spite of the progress made, the economy’s performance over the last decade 
is  less  impressive  than  that  of  comparable  transition  economies.  Furthermore,  a  deeper 
analysis reveals that it remains constrained by substantial structural and social imbalances.  

•  Russia’s  economy  is  not  sufficiently  diversified.  Reliance  on  natural  resources,  in 
particular  oil  and  gas,  has  not  been  reduced  but,  on  the  contrary,  has  grown.  More  than 
80% of all exports are natural resource-based, of which nearly 60% are oil and gas. This 
makes the economy vulnerable to any sudden collapse of oil prices.5 

•  There  has  been  only  limited  restructuring  of  many  traditional  large  industrial  enterprises 
and  the  growth  of  new  firms,  particularly  SMEs,  is  slow,  owing  to  weak  enforcement  of 
competition rules and considerable bureaucratic obstacles. Hence, the weight of SMEs in 

4 

5 

In purchasing power parity terms, Russia’s GDP per head was US$8490 in 2002, compared to US$6976 
for Romania. 
According to the IMF, a decline of US$1 in oil prices leads to a 0.5 percentage-point decline in GDP 
growth, a US$1 billion (0.3% of GDP) drop in federal budget revenues and a US$2 billion reduction in 
export revenues.  

11 

 
 
  
 
                                                 
GDP, generally estimated at just 20%, is only about half of that of the advanced transition 
economies. 

•  The  result  of  the  over-reliance  on  natural  resources  and  insufficient  competition  is  the 
concentration of market power and wealth in a small number of large financial-industrial 
groups  with  linkages  to  political  power.  The  core  of  their  activities  is  mainly  export-
oriented  production  related  to  natural  resources,  reflecting  the  above-mentioned  lack  of 
diversification. The recent spectacular moves against the leaders of some of these groups 
are  very  popular  with  domestic  public  opinion,  but  do  not  necessarily  mean  that  the 
Kremlin is committed to moving away from the current model of “oligarchic” capitalism; 
they may simply be aimed at keeping the Russian big business away from active politics.  

•  Chronic  underinvestment  is  a  major  problem.  Despite  the  recent  growth  in  investment 
(over  9%  per  year  on  average  since  1999),  capital  spending  as  a  share  of  GDP  remains 
low; furthermore, most investment has been concentrated in the oil and gas sector and in 
construction,  leaving  out  the  infrastructure  and  the  manufacturing  sector.  Hence,  the 
infrastructure remains in an advanced state of decay, while much of industry has not been 
restructured, nor has  adopted  state-of-the-art technology from  abroad. The  inflow  of FDI 
remains low, as investors continue to view Russia as a risky market6.  

•  Despite the amelioration since 1999, social indicators remain weak. In particular, income 
inequality  in  Russia  is  among  the  highest  compared  to  other  transition  economies  and 
seems  to  have  increased  further  in  recent  years,  despite  a  sizeable  pickup  in  real  wages. 
Income  inequalities  across  the  county’s  regions  are  even  more  striking:  differences  in 
income and economic performance are huge and have worsened over the last decade. 

•  Russia’s  demographic  situation  has  deteriorated  over  the  past  ten  years,  when  the 
population decreased by some 3 million, despite net immigration. This was the combined 
result of lower fertility and a sharp increase in adult mortality, in particular among the male 
population (life expectancy of Russian men is 58.4 years). Both developments are largely 
due  to  precarious  social  conditions  and  the  dislocation  brought  about  by  the  transition 
years.  

•  Russia’s  geography,  consisting  of  long  distances,  harsh  climate  in  large  parts  of  the 
country  and  sparse  population,  translates  into  high  transport  costs  and  represents  a 
structural constraint to growth and to the reduction of regional imbalances (transportation 
costs  in  Russia  are  about  three  times  above  international  standards  when  measured  by 
cif/fob margins).  

As regards long-term growth prospects, it is very difficult to offer a reliable estimate. Apart 
from the government’s target rate of close to 8% per year on average for the next ten years, 
some current estimates project annual average growth at about 5% per annum in the coming 
decade. Other, less optimistic estimates, project annual real growth at 2½-3% on average as a 
baseline scenario. These lower rates would still allow a gradual reduction in  poverty  levels, 
but  would  not  be  sufficient  to  generate  broad-based,  sustainable  development  beyond  the 
current natural resource-based structure. In this scenario, there is also a clear risk that, if the 
two  key  factors  behind  Russia’s  growth  (improved  competitiveness  resulting  from  the 

6 

Over the 1992-2002 period, Russia received only US$ 23 billion in FDI, one twentieth of the amount 
received  by  China,  while  at  the  same  time  US$  245  billion  in  capital  is  estimated  to  have  flown  the 
country. 

12 

 
 
  
 
                                                 
exchange rate depreciation and high oil prices) gradually wane, the current growth pace slows 
down further and Russia enters a stagnation phase.  

Policy choices will determine whether the economy will stagnate or catch up 

In  order  to  achieve  permanently  higher  growth  rates,  a  more  diversified  economy,  higher 
employment and greater poverty reduction, structural, social and institutional reforms should 
be accelerated and aimed at markedly improving the investment climate and generating higher 
productivity, notably in the struggling manufacturing sector. If instead complacency—bred by 
today’s high oil prices—conservatism and protectionism prevail, Russia is bound to remain a 
petro-economy, dominated economically, and probably politically, by a few large oligopolies, 
and incapable of generating the Schumpeterian processes vital to reinvigorating its industry. 
Russia would not necessarily face a crisis such as in 1998, but be subject to a long period of 
modest growth, possibly lapsing into stagnation in times of low oil and gas prices, combined 
with a gradual depletion of natural resources. 

In  addition  to  maintaining  a  sound  macroeconomic  framework,  the  main  policy  priorities 
facing  Russia  are  to  (i)  improve  the  investment  climate,  (ii)  further  integrate  into  the  world 
economy,  (iii)  reform  the  State  administration  and  the  civil  service,  (iv)  enhance  human 
capital and (v) protect the vulnerable.  

Improving the investment climate 

Improving  the  investment  and  the  business  environment  requires  a  number  of  measures  in 
several  related  areas.  Among  the  most  important  issues  that  need  to  be  tackled  are  the 
following:  

•  Progress  in  the  reform  of  utilities  -power,  gas,  railways  and  oil  transportation.  These 
sectors are still dominated by monopolies benefiting from uneconomic pricing systems and 
large  subsidies  (annual  gas  and  electricity  subsidies  could  be  as  high  as  30%  of  GDP). 
These  subsidies  keep  inefficient  enterprises  alive,  are  often  provided  on  a  discriminatory 
basis, lock up scarce human, financial  and physical resources in low productivity sectors 
and  harm  the  environment  by  encouraging  waste  of  natural  resources.  Although  the 
government recognises that a phasing out of energy cross-subsidies and hence an increase 
in  prices  is  necessary,  reforms  in  this  politically  sensitive  area  have  yet  to  gather 
momentum  (except  perhaps  in  the  electricity  sector),  especially  because  many  Russian 
cities  are  almost  totally  dependent  on  a  single  large  industrial  company,  which  might  be 
bankrupted  by  a  cut  in  subsidies.  The  reluctance  to  tackle  the  low  energy  efficiency  of 
Russian manufacturing is also apparent in Russia’s growing reluctance to ratify the Kyoto 
treaty rebus sic stantibus. 

•  Despite  recent  progress  in  deregulation,  a  pervasive  system  of  government  licensing, 
inspections  and  authorization  requirements  allows  considerable  scope  for  government 
interference  in  economic  activity  and  for  corruption,  particularly  at  the  local  level, 
representing a serious obstacle to productive investment and the development of a vibrant 
private sector. More generally, the practical implementation of law is often highly uneven 
if not arbitrary. 

•  The reform of the banking and financial sector is proceeding slowly, depriving the country 
of much-needed financial intermediation. After the collapse of some of the largest private 
banks  in  1998,  the  sector  is  dominated  by  the  State  savings  bank,  which  attracts  almost 

13 

 
 
  
 
70%  of  deposits.  Given  institutional  problems,  significant  private  competitors  have  little 
real chance of emerging. 

•  Despite  undeniable  progress,  the  tax  system  should  be  simplified  further  and  made  more 

coherent. 

•  Stricter enforcement of corporate governance rules and the reform of the judiciary, with a 
view  in  particular  to  increasing  its  independence  from  the  executive,  is  crucial  to  the 
effective rule of the law.  

Internationalisation of Russia’s Economy 

Greater  integration  in  the  global  economy  by  improving  market  access  for  Russian  goods, 
could lead to a dramatic improvement in economic performance, but only if greater openness 
is accompanied by structural and institutional reforms that support the adjustment process. On 
that condition, Russia’s accession to the WTO can be a powerful stimulant for growth.  

Government Reform 

Reform of the public administration and  civil  service, both at federal and regional levels, is 
key  for  the  successful  implementation  of  structural  and  institutional  reforms  in  other  areas. 
While  relatively  large  layoffs,  abolition  of  overlapping  government  functions  and  a 
revamping of intra-governmental fiscal relations should be offset by a significant increase in 
salaries, most of these reforms are politically difficult.  

Enhancing Human Capital  

One of the main tasks facing Russia is to reverse the erosion of human capital and to address 
such issues as the growing brain drain, the deterioration  of  the education and health system 
and inequality of access to public services. 

Protecting the Vulnerable 

The  country’s  social  safety  net  is  largely  insufficient,  as  the  limited  resources  available  are 
spread over a large number of recipients. Social security should be targeted toward the most 
vulnerable,  such  as  those  most  affected  by  increases  in  utility  prices  and  by  industrial 
restructuring.  This  requires  phasing  out  untargeted  benefits  and  privileges,  redirecting 
expenditure toward health and education, and developing a modern family and child welfare 
system. 

The EU can influence important aspects of the reform process, but needs to prioritise 

The above analysis has clear implications for our relations with Russia. EU policy should be 
geared towards stabilising Russia both in economic and political terms and towards creating 
the conditions for sound economic growth and the integration of Russia into the European and 
World  economy.  Russia’s  economic  self-sufficiency  and  geopolitical  history  imply  that  the 
EU’s  leverage  should  not  be  overestimated;  nevertheless,  the  EU’s  position  can  have  a 
significant  direct  impact  on  some  of  Russia’s  strategic  interests  and  indirectly  influence 
others. 

After  EU  enlargement,  Russia  will  become  an  even  closer  neighbour,  geographically  and 
economically.  The  EU  is  by  far  Russia’s  most  important  trading  partner,  accounting  for 
around 37% of its overall trade, a figure that will rise to over 50% after EU enlargement. For 

14 

 
 
  
 
the  EU  too  Russia  is  significant:  exports  to  Russia  have  grown  at  double  digit  rates  since 
1999,  despite  low  world  economic  growth,  so  that  the  country  was  the  EU’s  fifth  largest 
trading partner in 2002 and the second trading partner of the ten acceding countries. In 2002, 
two-way  trade  in  services  (with  EU-15)  amounted  to  €9.4  billion;  two-way  trade  in  goods 
amounted  to  €78.1  billion,  of  which  €5.8  billion  was  in  agricultural  goods.  In  this  latter 
regard, the EU is concerned to conclude negotiations on certification issues in the context of a 
veterinary  agreement,  to  avoid  the  risk  that  additional  Russian  certification  requirements 
effectively  halt  EU  exports.  Under  these  circumstances,  the  EU  has  a  clear  interest  in 
supporting Russia to become a stable partner, with a dynamic, open and diversified economy. 
There  is  close  complementarity  between  the  EU  and  Russian  economies,  hence  significant 
advantages from deeper economic integration will accrue to both sides. The interdependence 
in the energy field further reinforces this assessment. 

In  this  context,  the  EU’s  main  priorities  should  be  to  continue  to  provide  active  support  to 
Russia  in  its  WTO  membership  bid  and  to  actively  engage  in  the  creation  of  a  Common 
European Economic Space (CEES). The EU has until now been a key partner for Russia in 
the WTO accession process. By joining the WTO, Russia will gain in terms of: 1. increased 
predictability,  stability  and  transparency  of  its  investment  climate  in  Russia;  2.  tariff 
reductions (that will increase the efficiency of resource allocation in the Russian economy and 
the  competitiveness  of  Russian  industry  but  without  exposing  the  Russian  economy  to  an 
unsustainable effort of adaptation; 3. increased global integration, with consequent increases 
in  FDI  inflows  bringing  technology  and  know-how  to  the  manufacturing  and  services 
industry;  and  4.  access  to  third  country  markets  and  the  protection  of  WTO  rules  and 
principles in those markets.  

The EU wants Russia to accede to the WTO on economically sustainable terms, i.e. allowing 
Russia to maintain a sufficient degree of protection for the Russian agricultural, industrial and 
services  sectors,  which  will  not  jeopardize  its  medium-term  and  long-term  development, 
while  at  the  same  time  enhancing  competition  and  technology  transfer  through  the  gradual 
liberalisation  of  the  Russian economy.  The  CEES  should  be  our  priority  following  Russia’s 
accession to the WTO. It will contribute to the economic integration of the Russian economy 
with  that  of  the  enlarged  EU.  It  should,  in  Russia’s  own  interest  aim  at  the  gradual 
harmonisation of parts of Russia’s economic legislation with the rules applicable in the EU, at 
trade  facilitation  notably  by  way  of  procedural  improvements  and  at  the  same  time  create 
trade preferential relations between the two economies beyond the WTO accession terms. It 
will also take into consideration the different degree of development and the particularities of 
the EU and Russian economies and societies.  

Investment  is  a  key  factor  in  sustaining  economic  growth  and  enabling  Russia  to  “turn  the 
corner”  in  terms  of  diversifying  its  economy,  modernising  its  industrial  base  and  benefiting 
from technology transfer. However, expanding investment flows from the EU is also key to 
the development of the Common European Economic Space. Through regulatory convergence 
with  EU  internal  market  standards  and  legislation,  Russia  will  become  more  attractive  to 
foreign  and  domestic  investment  which  may  enable  it  to  reverse  capital  flight.  In  addition, 
further  elements  of  importance  to  promoting  investment  are  enhanced  provisions  on 
investment-related issues, including the provision for national treatment in a number of listed 
sectors;  an  effective  competition  policy;  the  development  of  bilateral  agreements  on 
protection and promotion of investments (where appropriate); the development of information 
investment  opportunities;  and  uniform  and  simplified 
mechanisms  about  mutual 
administrative procedures. 

15 

 
 
  
 
DEMOGRAPHIC TRENDS IN RUSSIA 

State of Play 

Russia’s population is steadily decreasing, as the last census of October 2002 and later data 
issued  in  2003  confirmed.  From  the  previous,  1989  census  (under  the  USSR),  Russia’s 
population  fell  from  147.5  million  to  144.4  million,  or  1.7%,  as  of  September  2003  (latest 
update of the 2002 census). Some experts have questioned that the census failed to interview 
7% of the population; data giving Chechnya’s population at 1.1 million have been particularly 
surprising.  As  deteriorating  living  and  health  conditions  prompt  emigration,  and  as 
immigration only partly compensates (4.5%) for the rapid population fall, experts argue that 
the latter should be encouraged.  

Women/men, mortality/birth rates, life expectancy 

There are fewer than 1.2 births per 100 women of childbearing age, while a birth rate of 2.2 is 
necessary to avoid a population decrease (official data showed a slight increase in birth rate in 
2003).  Together  with  migration  toward  non-NIS  countries,  these  are  the  main  causes  of 
population decrease. 77.7 million of the total population are women and 67.8 million are men. 
The  10-million  gap,  the  largest  in  the  world,  has  not  changed  since  WWII  and  is  typical  of 
countries at war. The general death rate is 16.2 per 1,000 persons and is steadily rising. Many 
children  die  before  reaching  1  year.  Men’s  average  life  expectancy  is  58.4  years,  i.e.  at  an 
economically  active  age;  women’s  is  71.9;  making  64.8  years  the  general  average  life 
expectancy.  Heart  disease,  general  poor  health,  accidents  at  work,  suicide,  alcoholism,  and 
generally deteriorating living conditions are the main causes of death.  

Distribution of population 

The  Central  Federal  District  has  the  highest  concentration  (26.2%)  of  the  country’s 
population. The Volga Federal District - 21.5%; the Southern District - 15.8%; the Siberian - 
13.8%; the North-West – 9.6% and the Ural District – 8.5%. The Far East District, with 4.6%, 
has  suffered  most  from  depopulation.  Since  1989  the  population  has  increased  mostl  in  the 
Southern  (Rostov)  and  Central  (Moscow)  Federal  Districts.  Russia’s  Northern  and  Far  East 
regions have suffered the largest losses. Since 1989, the North-West Federal District has lost 
an  average  of  10%  of  its  population,  while  Dagestan  is  the  republic  with  the  highest 
population  growth  –  43%.  Chechnya  follows  with  23%.  73%  of  the  population  live  in 
cities/towns,  27%  in  the  countryside,  a  stable  trend  since  1972.  12  cities  have  a  population 
exceeding 1 million. Over 13,000 villages have become uninhabited; 35,000 villages have no 
more than 10 inhabitants. 

Migration trends and mobility; ethnic composition 

Almost 11 million migrants have come to Russia since 1989, while over 5 million have left 
the country, thus causing a net inflow of 5.5 million migrants mainly from the NIS and Baltic 
countries. This has compensated for only 4.5% of the population loss. Despite many obstacles 
to  mobility,  internal  migration  is  rising.  The  trend  is  mostly  from  East  to  West  Russia  and 
from North to South and primarily involves young people with higher education. Apart from 
ethnic Russians (who make up around 120 million of the total population), there are numerous 
minorities.  The  three  largest  groups  are  the  Tatars  (5  million),  Ukrainians  (4  million)  and 
Chechens (1.1 million). 

16 

 
 
  
 
 
Projections 

Some estimates suggest that a continuing decline will cut the population by 30% (to around 
101 million), and, under a worst-case scenario, by up to 47% (to some 76 million) by 2050. 
The trend is towards a steadily ageing population. Some forecasts warn that pensioners will 
represent  35.2%  of  citizens  in  50  years'  time,  compared  with  20.6%  today.  This  would 
confirm Russia’s need for increasing immigration. 

17