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COMMERCIAL BACKGROUND In order to estimate the impact of tariffs and duties on the ICT sector, an in depth evaluation of the current commercial trends in the sector will be given to illustrate the estimated commercial impact if no action is taken and tariffs are not reduced. First, a factual overview of the ICT sector as related to domestic development and trade forecasts is provided. Current Trends in the Russian ICT Sector Commercial statistics of the Russian ICT sector illustrate an increasingly dynamic market. It is a growing alternative to the U.S.,particularly in view of downturns in the US domestic economy and the global economy. While still relatively small-- accounting for about $3 billion-- the Russian ICT sector grew by 18 percent in 2001 and was expected to reach $3.9 billion in 2002[i]. Driven by growth in the hardware segment, and to a certain extent by ICT services, the market is projected to grow by 20 percent in 2003[ii]. High-tech (Science Intensive) Products We have not properly used the rich scientific and technological potential of Russia. There are only a few worthy long-term projects to use it. In this connection, the government must decide on the form of state support to new technologies, find appropriate approaches toward our resources, the modern geography of markets and types of economic ties." President Putin, 18 April 2002
Russia’s long-term economic
growth will be based upon its competitiveness.
Currently, the products of the RF that are While the world market of high-technology products is valued at $2.5-3 trillion[iii], Russia is only present in this market in sectors related to nuclear technologies, military technology, and production of missile engines, commercial space-crafts, innovations in telecommunications, navigation infrastructure and similar high-priced technologies suitable only for state, quasi-government, and multinational corporate purchasers. In the last a few years, Russian high-tech exports amounted to about $3 billion every year, which is only 0.3 percent of the world’s total high-tech trade[iv]. While high-tech exports are comparatively low, Russian potential in such exports is high. Russia is able to compete in about 10-15 different sectors of science-intensive export production, including services, in such science intensive sectors as: optic-electronics, telecommunication equipment, new technological materials, nuclear technologies, and software development. Only integration, accompanied by a recovery of science-intensive and high technology sector production, and consolidation of domestic developers, innovators, and producers will be effective for Russia. A growing gap of Russia’s export of finished products, especially science-intensive products, is leading to significant losses for the domestic economy. Plans include work initiatives toward realization of government policy to support exports, focused on the increase of exports of high-tech products. Hardware[v] The most significant trends of the computer hardware market in 2000-2001 were a strong growth in laptop and server sales, due to a sizable increase of government purchases as well as domestic sales. Imports of personal computers in 2001 accounted for 15 percent of Russia's PC market, while the majority of domestic demand was fulfilled by low cost products assembled by Russian manufacturers from foreign components. PC assembly accounts for 76 percent of hardware revenues, while peripherals, networking and larger system hardware are dominated by imports. The total number of computers in Russia exceeded 11 million in 2001, translating into a penetration rate of 7.5 percent. While this was a reasonable increase over the 6.4 percent rate of 2000, there is still significant potential for growth.Total annual turnover of the Russian system integration market in 2001 was estimated in the $170 - 220 million range, and is projected to grow to $230-270 million in 2002. This market sector is maturing and new entrants will likely face serious competition from manufacturing and vendors already established in the Russian market companies. Locally assembled PCs dominate the Russian market, and 30 local computer companies are estimated to control 45% of the market. According to the market research firm IDC, the fastest growing local PC producers last year were Formoza, Aquarius, and R-Style. Among foreign producers, IBM, Compaq and Hewlett Packard (HP) enjoyed the largest growth. Aquarius boosted its turnover last year by 80% to $80.57 million. Another assembler, Excimer-DM reported 46% annual growth and plans to assemble 120,000 computers in 2002, which may account for 5-6 percent of the market. Demand in the Russian PC market is extremely price sensitive. Lower cost local producers, which had benefited from the 1998 devaluation of the Russian ruble, compete successfully against imports in the low end of the market, and have forced importers to lower their prices. Consequently, imports have risen only slightly in value because of the drop in PC prices. The need for cost savings has motivated some foreign equipment manufacturers to set up assembly operations in Russia, and thus be able to compete with local suppliers. In 2001, Hewlett Packard agreed with Russian PC makerAquarius to use two production facilities of the latter for the local assembly of HP computers. This deal should help HP to access one of the most prospective sectors – government procurement. Russian legislation prevents federal agencies from purchasing imported computers when there is an analogous Russian alternative. Competition among importers for less price sensitive corporate sales has also intensified as evidenced by an increase in the number of tenders. Software Russia's rapidly expanding software market in 2001 was estimated at $600-800 million, and growing at an annual rateof 25 percent. The best sales prospects are in Enterprise Resource Planning (ERP) products, which currently account for 30 percent of the software sector. The true demand for software is difficult to determine, due to a high level of pirated software, which some industry sources estimate as high as 90 percent. In 2001 the market for outsourcing software services was estimated at $120-150 million with the growth rate of 20 percent. Government and the software industry are cooperating to position Russia as a global leader in 'offshore' software development, with an estimated growth rate of 50 percent over the coming few years. Some Russian industry experts estimate that the eventual market for software developed in Russia could grow as high as $20 billion to $60 billion per year, and both government and industry are keen to develop the potential of this sector. ICT AttractivenessRussia's potentially extensive ICT market is an attraction to major players in the ICT field[vi], led by a number of major American and European companies that are already present in the market. While, Russian consumers, due to relatively low purchasing power, are extremely price-sensitive and generally prefer a low-cost computer to a globally recognized brand name, the Russian market remains one of the promising emerging markets for foreign businesses. Should Russia's economic performance continue its upward trend, consequently leading to an increase of consumer purchasing power, demand for imported computers will increase even more significantly. Consequently, there is growing demand for imported equipment in the less price-sensitive corporate sector. In addition, there has been a significant increase in government procurement of state-funded PCs for delivery to educational institutions under various federal and regional programs. A continuing growth in the number and purchasing power of small and medium-sized private enterprises is driving demand for legally imported operating systems, software application packages and enterprise management software. Best immediate sales prospects also include peripherals, networking equipment, and Internet technology.
Source: Brunswick UBS Warburg (forecast) The long-term prospects of growth, more critical to the development of the sustainable ICT sector, are in the following areas:
Following, is a brief background on these areas. Human Resources Potentia lOne of the many reasons for optimism regarding Russia’s growth in the ICT sector is the exceptional technical ability of its workforce. Russia has consistently produced some of the most competitive specialists in the world, and its importance as a center for offshore programming is growing by the year.
Russia is also one of the world’s leading centers for anti-virus technology. Even non-technical workers tend to exhibit openness to new technology, and a willingness to learn new ICT application and production processes, which provides a differential advantage of Russians to most emerging markets.
The downside has been a decreasing brain drain in recent years, as qualified specialists have departed in great numbers for more lucrative opportunities overseas.
Demand for High-Performance Equipment As the Russian economy gains strength, an increasing number of large, well-financed and well-managed firms are seeking sophisticated computer systems. The trend for servers leans toward high performance equipment. Demand for Internet access, combined with the need to share resources, network office sites and implement cross-industry applications solutions, have generated a notable demand for computer systems and servers. IBM and Sun Microsystems sold a number of high performance servers to Russian companies, with Sun shipping $7 million worth through Verysell, a well-known Russian distributor[vii]. At the same time, Russia is continuously exporting products, which involve high-tech software applications. In these cases, government approval is always needed and export controls apply. While high-technology products will be viewed more strictly in export approach, there is great potential for export growth. This prospect should not be overlooked, and possible tariff barriers to high-technology trade should be further examined. Internet-Related As reported on 28 September 2001 by the U.S. Commercial Service in Russia,“[A]ll internet-related activities, including Internet access services, backbone revenues, hosting, and applications generated $460 million” in 2001, growing faster by 60 percent than the rest of the Russian economy. The industry segment is expected to grow at an annual rate of 15-20 percent in 2001-2003. However, the computer penetration rate in Russia remains low and Internet infrastructure is still limited. Several infrastructure development projects are on the way, and currently American companies, with CISCO and Lucent Technologies taking the lead, supply the ICT equipment for these projects. The number of regular Internet users in Russia was estimated at 6.2 million[viii] at the end of 2001, an Internet penetration rate of just 4.3 percent, although Russia's well-educated population represents an enormous market for Internet hardware and services. In 2001, there were about 5 million PCs connected to the Web, a number projected to grow to 7 million by the end of 2003.By 2002 the number of Internet-compatible PCs owned by Russian firms and households was estimated to reach 8.4 million to 8.9 million[ix], according to Russian experts. However, these figures are relative.Figure 2: Internet Connectivity Estimates
Source: Ministry of Communications and Informatization In
the past three years, the number of Russian web servers has been growing
exponentially from 10 in 1995, to over 24,000 in February 1999[x].
Russian experts expect that the number of Internet Users will
continue to grow steadily despite economic conditions, and could explode
to 10 percent of the population if the economy recovers. Companies in
different spheres of business activity are starting to utilize Internet
services including advertising and marketing, electronic commerce,
information services, financial services, and interactive and multimedia
resources. The Russian market for Internet-related services reached $160 million in 1998, according to the Russian Internet Technologies Center. Of this amount, approximately $150 million was paid for Internet access through different providers. With currently over six million Internet users, the Russian market for Internet access provision is expected to enjoy strong growth in the coming decade.ICT Infrastructure Related However, along with positive trends in Internet connectivity, a problem with infrastructure and its expansion still remains. Setting a dial-up connection, and then keeping it, is a source of continual frustration for Russians.
Even though most Russian Internet users connect via high-speed modems, connection lines use outdated copper-cable telephone networks, which are very fragile and disconnect often while a user is on the Internet. These copper-cable networks quickly become overburdened, limiting the number of people online at any one time, and page download times are often in the minutes, rather than seconds. The only compensation for users is that local telephone calls are free throughout Russia, although internet service providers counterbalance that by charging higher-than-average subscription fees. TABLE 3.
Source: World Development Indicators Database, July 2000 Russia’s underdeveloped telecommunications infrastructure presents a formidable barrier to the development of the ICT sector. There were an estimated 36.9 million lines in service by end of 2005, according to the Russian Ministry of Communications, which comes out to only about 25.3 lines per 100 inhabitants. Even when working, these connections can rarely support speeds of more than 14.4 bps. Despite the existing hurdles, telecommunications service is improving. Online charges are falling - the average of $10 per month in 1998 was half that of the year before. Demand for connections has risen sharply despite the post-communist slump in production and income. A possible solution that some bring to the table is a satellite coverage of the Russian territory and a “wireless” infrastructure development. While this may be a partial solution, to cover vast territories of Russia, a significant amount of physical connectivity infrastructure is definitely needed. While this development and expansion of infrastructure may be considered as a burden, there will be a consequential and significant potential for sales, and the long-term value of sustainable development of the ICT sector. Russian Telecommunications Infrastructure in the Rural Sector[xi]Russia – a country of vast expanses…
Following the previous trend of thought about developing an infrastructure for extensive coverage, it must be recognized that Russia, a country of great distances, covering 11 time zones, has vastly uneven telecommunications coverage. Some 40,000 of Russia’s 150,000 villages and settlements have no telephone access, and not to mention an Internet connection. As a result of the low investment appeal of rural telecommunications projects, the number of local switches remains where it was ten years ago, averaging 10 lines per 100 people. Unlike the significant development in urban telecommunications networks in the 1990s, the telecommunications infrastructure in rural areas seems to be at a standstill.
Due to the vastness of its territory, Russia can best be considered a collection of regional markets rather than as one homogeneous market. The Russian Ministry of Communications and Informatization and ICT and Ministry of Agriculture have united efforts to improve the telecommunications infrastructure in rural telecom. Tariff reductions and therefore trade liberalization of the ICT sector, are expected to contribute to rural infrastructure development. While infrastructure, urban and rural is of great concern, another area of great focus is Russia’s intellectual scientific potential and its utilization. Packaged Software Sales and Outsourcing The previously mentioned packaged software market in Russia is considered to be a niche in Russia’s ICT market. The packaged software market experienced a major boost during 2001, rising by 18-20 %to $350 million[xii]. Growing demand has been reported for basic operating systems, integrated ERP (Enterprise Resource Planning) and application tools for database development and management. There are some positive examples of integration of Russian and Western software. Russian diamond monopoly Alrosa contracted Moscow-based systems integrator IT Co. to automate 5,400 work places based on IBM's Lotus Notes/Domino software platform and the Russian BOSS Referent workflow and document management system. The market for Computer Aided Design (CAD) software is very promising in Russia. Industry estimates[xiii] of the Russian market for heavy-duty CAD systems range from $12 million to $15 million. According to Interfax news agency, PLM Solutions, a division of EDS that provides product lifecycle management software, has signed a contract to deliver a CAD solution to Russian military aircraft maker OKB Sukhoi. PLM Solutions signed a contract to deliver Unigraphics CAD software to the Komsomolsk-na-Amure Aviation Production Association. The two Russian aircraft makers already have more than 150 Unigraphics workstations. The IT Security software market nearly doubled in 2001 reaching $40 million[xiv]. Internet security has become tremendously important worldwide and Russia has shown competitive growth in the sector. Industry experts believe the information security industry is very flexible and ready to respond to any demand increases. Furthermore, software outsourcing represents a fast-growing sector, in which Russia has a significant cost advantage. Russia has many highly qualified software engineers and researchers with experience in developing complex projects. The industry is relatively small by world standards, but is well positioned for future growth. Established in 2001, the National Association of Software Developers may also serve as a catalyst in promoting the image of Russia as a center of outsource software development. The Russian government is very supportive of the sector, as it is a way to encourage Russia's software talent to remain at home. Formation of the ICT Industry Association in 2001 is perceived as an important step in the industry's development. Around 34 companies, both Russian and the local divisions of foreign firms, have become founding members. The goals of association are to represent the interests of the Russian ICT industry domestically and internationally, to foster conditions for future growth of the ICT market, and to protect corporate interests of IT companies. The association member list includes IBM, Intel, Hewlett-Packard, Microsoft, and the Russian firms IBS, and Marvel.Overview Russia has several areas to cover in its ICT sector development and a positive trend is that Russia is very receptive to imported products. Companies such as Microsoft, IBM, Hewlett Packard, Sun Microsystems, Novell, and Oracle are present in the Russian market. This is a positive trend, establishing a good supply source for development of the Russian infrastructure, both urban and rural. The U.S., EC and Japan are considered leading suppliers of ICT networking hardware to Russia, at the same time they are major recipients of high-tech software application solutions, systems software and hardware support software. This provides a good forecast for current and future utilization of the Russian scientific and engineering labor force and development of sustainable domestic ICT industry.
ECONOMIC BACKGROUND Economic overview is critical when forecasting tariff reduction. Certain trends that may affect the ICT sector development and trade will be reviewed in order to provide validity to current and future forecasts. This section compares the Russian ICT sector economic indicators, to global economic indicators. In January 2002, the RF managed to overcome major negative economic tendencies that were created in 2001. TABLE 4. RF: Overall Socio-Economic Performance (% of previous year)
* Forecast of the Ministry of Economic Development and Trade of RF ** January-June 2002. Overall, 2002 was characterized as a successful year for the Russian economy. The basic indicators marked significant economic growth. Especially notable were gross domestic product (GDP) growth, industrial production, fixed capital investments, indicators of foreign trade activity and the real disposable money income of the population. The rate of inflation decreased, primarily under influence of constrained budget and monetary policy of the Russian government and the Bank of Russia. Financial stability was preserved, bolstered by improvements in the collection of taxes, the steady profitability of the federal budget, and restricted pricing and credit policy of the government and the Bank of Russia. Foreign debt was serviced according to the accepted schedule and without new borrowings. The currency exchange market remained steady and predictable. Normalization
of the structure of payments and an increase of the share of money
resources in the accounts of the industrial enterprises improved. Employment The total employed population in Russia increased from 63.5 million in January 2001 to 64.5 million by the beginning of 2002.The number of unemployed [calculated according to the methodology of the International Labor Organization (ILO)] was reduced from 10.5 percent of the economically active population at the beginning of 2001 to 8.7 percent by the end of the year. The share of the officially registered unemployed in the economically active population increased from 1.4 percent in the beginning of 2001 to 1.6 percent by the end of the year. GDP vs. ICT Trade GDP grew by 4 percent in 2002 with industry, agriculture and construction as the main contributors. The volume of industrial production grew by 4.4 percent.[xv]. Industrial production is an important stimulus to trade. This will be an important factor in evaluating the need to increase domestic production of the ICT in Russia.Moreover, Russia’s important economic indicator is a correlation between real gross domestic product change and trade growth change. The relationship between these two indicators is forecasted to be interdependent, meaning that if the GDP diminishes, the growth rate is likely to decline. This is the case in 2001 as estimated by the OECD, with regards to the global economy. An important factor behind the sharper-than-expected slowdown in world economic growth is the steep fall in the expenditures on information technology products. ICT sector, which plays a key role in the outstanding economic growth in many regions during the second half of the 1990’s, is now undergoing severe contraction pressures[xvi]. On the contrary, ICT spending in Russia has been on the rise continuously through 2001, 2002, and 2003 and its percentage growth is much higher than worldwide.
Figure 3. Source: Ernst and Young Worldwide sales of personal computers in the second quarter of 2001 were below their level in the corresponding period in 2000, and are expected to remain low. In 2001, the value of global shipments of semi-conductors was down by 30% compared with its level a year earlier[xvii]. The RF’s strong 20% import expansion, lead the transition economies to show the best trade performance in 2001. It can be estimated, with reference to the GDP vs. trade growth, and the global estimate of the affect of the ICT trade, that ICT trade has contributed to Russia’s import expansion.
Russia’s R&D, and her scientific and technological potential has proven exemplary when developing aeronautics, space application, nuclear technologies, and a variety of military technologies and their applications. The graph below demonstrates Russia’s standing in scientific and research staff, when compared with other technologically industrialized nations:
Ironically, Russia’s transition to a free-market economy has been marked by a decrease in federal spending on R&D as compared to spending by the Soviet Union. In addition, the direction for application of science and technology in Russia today, as it is passing through a stage of global economic integration, has changed. It is not based on building its strength by increasing its military and defense capability, but instead on building an economically strong and viable society, based not on proliferation of nuclear weapons, but on proliferation of communication and information exchange, and scientific and technological know-how. Russia has an already developed base for ICT sector growth, and is now looking for ways to expand it. One of the specifics of the ICT sector growth is potential of its national information technology sources. In 2001 Russia ranked third in the world in numbers of super-computers, bypassing the European Union and China, which only a year before topped Russia. This surge was based on the initiative of the computer center in the Russian Academy of Sciences (RAN)[xix]. Super-computer
usage includes R&D of petroleum and gas deposits, calculations for
development of aviation and space systems, applications in the R&D of
nuclear technology for peaceful use, and in the energy and automotive
sectors. The Ministry of
Science and Education, together with the RAN, has been developing further
applicationsof the super-computer for applications in telecommunications.
This program for super-computer development is scheduled to
continue through 2003, and is only one example of R&D projects taking
place in Russian ICT development, and is aimed to assist Russia’s global
economic integration. However, a further boost is needed Foreign Direct InvestmentAlong
with tariff reduction, legal basis for foreign direct investment are
important to draw investment into Russia.
President Putin has made considerable strides toward globalizing
the Russian economy. Although
he is committed to securing Russia’s WTO membership, it is not certain
how he will foster full-scale foreign investment.
While the domestic legislation for FDI is in place, as will be
illustrated further in the legal analysis section, the implementation of
investors’ protection is still questionable and leaves room for
improvement. While it is
possible that the impact of FDI in Russia could include very high returns
and become a catalyst and generator of change and development[xx]. Russian R&D, identified as a point of attraction for many foreign investors, requires an increase inflow of FDI, and ICT related projects provide a safe and sure base for such investment. [ii] Ernst and Young, www.ey.com [iii] “Socio-Economic Development Prognosis For The RF For 2003 and Certain Constant Trends Through 2005”, Ministry of Economic Development and Trade of the RF. [iv] IBID. [v] Data in the section provided by www.stat-usa.gov [vi]
D. Evans, U.S. Secretary of Commerce, Second US-Russia ICT Round
Table, [viii] Ministry of Communications and Informatization. [ix] IBID. [xi]
Inna Nazarova, US Commercial
Service- Moscow, Russia, [xii] Ernst and Young, www.ey.com [xiv] IBID. [xv] IBID. [xvi] OECD 2001 Report, Real GDP and Trade Growth of OECD Countries, www.oecd.org [xvii] Semi-conductor Industry Association, Press Release, 2 August 2001 [xviii] Telecommunications Industry Association, http://www.tiaonline.org/ [xx] “Russia – Why It Can’t Catch Up?”, Economist Intelligence Unit, Press Release, 25 July 2002. [xxi] “Bridging the Innovation Gap in Russia”, the Helsinki Seminar March 2001, OECD publication.
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