Pavel Bykov, Maxim Rubchenko, Marina Talskaya
The plan for rehabilitating the Russian economy is the first, very cautious step that will help mitigate the recession the national economy is plunging into.
On November 7, 2008, the Government published a plan of action to rehabilitate the financial sector and some other economic sectors. The media immediately dubbed it an "anti-crisis plan" though the document specially avoided the word "crisis". The adoption of this plan is the second stage in the efforts to improve the economy in Russia.
Note that the Government's first act of rehabilitation boiled down to a massive injection of budget funds in major national banks, primarily those under state-control. This measure resulted in an unpleasant surprise for Government officials: in October 2008, capital flight from the country reached a record high $50 billion.
Russia's Finance Minister, Alexei Kudrin, hastened to explain that "nearly half of this amount is not capital outflow from Russia but the funds reserved by Russian companies and banks for foreign debt, therefore half of the funds withdrawn from Russia in October remain in the balances of our banks and companies."
However, Russian Prime Minister Vladimir Putin said at a meeting with bankers last Monday that "the total amount of funds transferred to foreign banks is decreasing, while the banks which are state fund recipients are registering an increase in the volume of such operations."
Theoretically, capital outflow is not necessarily connected with inappropriate bank policy: it may be caused by client payment orders or their desire to temporarily place their funds in foreign currencies when the rouble is weakening or by the purchase of cheapened foreign debt by both the banks and their clients. However, the Government seems to know full well that October's capital flight cannot be explained by these justifiable reasons alone. Evidence of this is the Prime Minister's demand to use law enforcement to see that the allocated funds are spent for the intended purpose. Also, President Dmitry Medvedev made a statement on the need to keep a close watch on capital flight "in a manually-operated mode" and dismissed Sergei Osipov, state secretary of the Federal Financial Monitoring Service (Rosfinmonitoring).
Naturally, the Central Bank has not been standing idly by in the efforts to stop capital flight. On November 11, the bank expanded the technical rouble exchange rate fluctuation corridor against its dual currency basket from 30.4 to 30.7 roubles. Also, the Central Bank raised its refinancing rate (from 11% to 12%) and the rates on its operations with banks (especially, on the rouble side of foreign exchange swaps) from 9% to 12%. According to the Central Bank's press release, the goal is "to reduce capital flight from Russia and restrain inflation tendencies."
Most bankers have met the change in the rouble's weight against the foreign exchange basket with understanding: the Central Bank has to spend huge funds to restrain players against the national currency. However, it is impossible to play against the market for a long time: no amount of gold and foreign exchange reserves will be enough for this, so a certain drop in the rouble exchange rate is natural.
Meanwhile, analysts are seriously concerned over rising bank rates: the toughening of the monetary policy during conditions of a lack of liquidity is not a trivial measure. Judging by all signs, the Central Bank hopes to make rouble savings more attractive. Experience shows that a rise or drop in the Central Bank's refinancing rate is inevitably followed by a respective change in interest on deposits with the Russian major state-run savings bank Sberbank and throughout the entire banking market.
However, when Sergei Ignatyev, the Central Bank's head, began talking about the expansion of the currency corridor at a press briefing, both journalists and the public at large decided that he admitted a rouble devaluation. This resulted in a speculative demand for foreign currency: within 24 hours the dollar rose by 37 kopecks, and the euro by 24 kopecks, against the rouble.
It seems the Central Bank's top managers, who had acted faultlessly throughout the entire crisis period, have finally made a mistake. "I do not regard the rouble as being in a critical situation: the top exchange rate is within the basic trend of 29.5 roubles," Natalia Orlova, chief economist with Alfa Bank, says. "However, I see the panic provoked by the Central Bank, which can lead to a crisis. The bank's actions caused another round of capital flight, and the very next day it had to spend $7 billion in order to contain the attack on the rouble."
However, as they say, only he who does nothing does not err. In the future, the Central Bank intends to act in a planned and balanced way. Sergei Ignatyev told journalists last week that he intended to monitor the dynamics of currency deposits at government-supported banks.
The rehabilitation plan provides for a set of measures to control the targeted use of state funds. In particular, mandatory credit quotas are to be established for government-supported banks to credit "defence industry businesses, agribusiness and small and medium businesses." In addition, these banks "must, when using their funds, give priority to such economic sectors as the auto industry, farm machine production, the airline industry and housing construction." The Government's recommendations to commercial banks on changes to their internal documentation must be drafted this month [November 2008].
True, analysts are sceptical about the effectiveness of these measures. "What difference does it make if the banks, or the enterprises which receive bank loans, invest money in foreign currency?" Natalia Orlova asks. "Credit will not be resumed until the banks and companies understand what they can expect from the rouble exchange rate and the rate of inflation. This uncertainty dictates the overall unwillingness to keep roubles."
Note that since early August the rouble has dropped 18% against the dollar and further devaluation is not impossible, experts say. "The rouble rate will largely depend on oil prices," Oleg Solntsev, a leading expert at the Centre for Macroeconomic Analysis and Short-Term Forecasting, says. "If oil prices stay at $60 per barrel, the Government will, perforce, revert to the policy of weakening the rouble. This year's budget was drafted on the basis of those prices, and there was no talk of any devaluation. There is yet another hypothesis afloat: the growing current account deficit will be covered by a growing capital influx. Now it is clear that nothing of the kind will happen, hence the need to revise prospects for the national currency. If the rouble is devalued by 10% a year at a time when oil prices stay low and the capital flows are not yet reversed, the economy may recover if the current account deficit is balanced. If oil prices drop below $50 per barrel, the rouble rate may be revised by more than 10% a year. In any case, there is no talk of a large-scale devaluation as in 1998. However, fluctuations in exchange rates will be a serious test of the banks and companies' financial stability," Oleg Solntsev said in conclusion.
A compromise plan
Apart from the provisions on control over the banks' use of government funds, which appeared in the document after the recent events, Putin's Plan was compiled on the basis of proposals made by Russian businessmen during their meetings with Government officials in the last two to three months. Earlier initiatives ignored by officials before were also taken into account. Thus, last summer they promised to simplify the pledge mechanism written into the bill which provided for an out of court procedure for distraining and selling a mortgaged property. The bankers have repeatedly asked the Government to organise the refinancing of loans granted by commercial banks to small businesses through Vnesheconombank (or VEB). The VEB supervisory board is to approve the respective decision by the end of November. Cuts in tariff quotas for poultry and pork imports were also lobbied for, long before the crisis, but they were included in the anti-crisis measures (cuts in poultry import quotas by 300,000 metric tons were announced on November 8). The decision on pork must be adopted by the end of November 2008.
Putin's Plan pays much attention to customs tariff regulations. Its two provisions, on reducing the monitoring period and the period for which the customs duty on oil and petrochemical imports is established" and "on a six-month customs duty deferment granted to the [national] airlines importing foreign aircraft and components," seem to be most significant.
Regarding the procedure for establishing duties on oil and petrochemicals, what is meant is the mitigation of the effect of the so-called "Kudrin's scissors": at present, the government-established export duty is based on a two-month monitoring of world prices which, during a steep fall in oil prices, has made exports unprofitable as the oil companies spend the bulk of their profits to pay the duty. Putin's Plan provides for changing the duty rate every month starting December 2008.
The situation concerning import duties on aircraft is even more complicated. State support is a matter of life and death for the national airlines, which had already been weakened by high fuel prices when they entered the financial crisis. After the breakdown of the AirUnion alliance, the banks stopped issuing loans even to the companies which were not its members. The crisis buried their hopes to restructure their debt as bond loans. As a result, we can expect a collapse of the air transportation market as early as this winter. State support alone can help these companies to survive.
The six-month deferment of customs duty payments, as proposed by the anti-crisis plan, will allow the companies to save as much as 20% of the aircraft costs (such is the duty rate today). This is not too bad at first glance. However, actually, the annulment of the duty is not just a stimulus for development but rather an attempt to restore common sense regarding customs duties on aircraft.
Boris Rybak, director general of the Infomost consulting firm, explains that these duties, which have been applied for over 10 years now, are not connected in any way with the Russian aircraft building sector and they do not encourage the national airlines to buy Russian aircraft. During the crisis, it is unreasonable to continue to apply duties imposed on the airlines as extra taxes.
The provisions of Putin's Plan on customs tariff support for oil companies and airlines are indicative in one respect: while agreeing to support the Russian companies by customs measures, the Government categorically refuses to adjust its tax policy. In commenting on the oil producers' request to reduce mineral tax because of the crisis, Alexei Kudrin said in a recent interview that "changes can be made only from 2010, and respective proposals are being discussed now."
Regarding the airlines, Boris Rybak points out that in most countries civil aviation is exempt from the VAT, whereas the Russian companies pay both the import duty and the customs VAT. Though Putin's Plan proposed a temporary exemption from duty, the issue of an exemption from the VAT, or even a VAT reduction, has not been raised in principle.
Wholly oriented to budget purposes, the Russian tax policy of recent years is still considered "inviolable", even during the crisis when the Government has to resort to unusual measures to eliminate its direct consequences.
The Central Bank's new clients
Today, professional investors on the securities market, i.e., management and investment companies, investment banks, brokers and dealers, also suffer from a lack of liquidity. However, unlike banks, whose liquidity is supported by the Central Bank, the stock market operators do not have such a money source. For this reason, they have decided to organise such a source: for three months now the relevant agencies have been debating the possibility of the Central Bank giving access to the refinancing operations to professional investors on the securities exchange. This measure was written into the Government's anti-crisis plan and even the timeframe for implementing it was indicated - February 2009.
It is not clear, however, how this measure could be implemented: in order to obtain a Central Bank loan, the borrowing bank must be accountable to the Central Bank and comply with all banking requirements. In the absence of official criterion, experts have to engage in guesswork. "Perhaps, what is meant is refinancing connected with peak capital outflow, in particular from mutual funds. For example, in the United States such refinancing was carried out with regard to the money market funds. As for the mechanism of implementing this measure, a certain compensation fund of funds may be set up to enter the largest mutual funds of the major management companies as anchor partners," Vadim Loginov, strategic marketing director at the Alfa Capital management company, thinks.
According to Oleg Ivanov, vice president of the Russia Association of Regional Banks, this idea was promoted by the major stock market investors, who are ready to operate under the patronage of the Central Bank (instead of the Federal Financial Markets Service) in order to get access to money funds. "The question at issue is changing the law on the Central Bank by introducing a special licence of a non-lending organisation for such companies. Surely, they will not be permitted to attract deposits, but they will have to comply with the Central Bank's regulations. Now a sort of palliative status is being devised to "extinguish the fire" of the liquidity deficit in the securities market," says Oleg Ivanov recalling that such practices are common abroad. "In conditions of crisis, the major national banks - the Central Bank in Russia and the Federal Reserve System (FRS) in the United States - proved to be the only sources of liquidity. Therefore, investment banks immediately raised the concern that they need an urgent source of liquidity. The US financial institutions which survived the crisis (Goldman Sachs, J.P. Morgan and others) urgently obtained licences as commercial banks to access FRS funds. As a result, the United States actually chose the European format deciding that it did not need investment banks. So far, we have not yet formulated such principled conclusions; we are devising palliatives instead. In my opinion, the crisis has graphically shown that the present national financial system modelled after America's is absolutely unviable. Instead of doing patchwork here and there, we must ponder a system-based market architecture," Oleg Ivanov said in conclusion.
"Second window": Agency for Housing Mortgage Lending
The Agency for Housing Mortgage Lending will play a more noticeable role than before in refinancing banks. Alexander Semenyaka, the agency's director general, told journalists that the agency was planning to increase the average monthly buyout of mortgage bonds from 3 billion to 5 billion roubles. All the funds (60 billion roubles) the Government has recently contributed to the agency's capital will be used for this purpose within next year.
Apart from the traditional buyout of mortgage bonds, the agency intends to open another money source for banks (dubbed by Alexander Semenyaka as "the second window"): it is ready to issue 500 billion roubles' worth of guarantees on the banks' mortgage bonds. Obviously, the buyers will not queue for such securities, therefore the agency is pressing for these bonds to be included in the Central Bank's Lombard List so that they can be used as security in obtaining Central Bank loans. In addition, the agency intends to float its own bonds by exchanging them for the banks' mortgage assets.
Experts are cautious in assessing these initiatives. "The Agency for Housing Mortgage Lending intends to follow in the wake of the Government National Mortgage Association (GNMA) and ‘stamp' mortgage bonds with a sort of ‘quality seal'," says Pavel Pikulev of the Trust investment bank. "In real fact, the agency's message is this: you have mortgage loans; we have looked at them and found them good enough; we will publicly approve them and then you can borrow money against them (from the Central Bank or any other source). Without the buyout of mortgage bonds, the banks which have issued mortgage loans will be left without financing as before. Instead, they will receive papers issued on the agency's behalf, or the securities stamped as the agency's guarantee. Who will buy them now? There is no demand for such instruments on the market. Even if these securities are included in the Central Bank's Lombard List, it will be nothing but a measure to support the bank's liquidity. It will not help to comprehensively solve the problem of mortgage market development. It is impossible to develop a market of 10- to 13-year loans by using overnight money. Even a six-month repo transaction will hardly improve the liquidity situation."
Stock market bonds
Putin's Plan proposes several measures which should make it easier for Russian companies to access capital. It is planned, in particular, to prolong the bond circulation period to three years. The stock market bonds are more attractive because it is extremely easy to issue them: the Federal Financial Markets Service (FFMS) does not require state registration of the issue nor a report on placement results. The issues are registered directly by stock exchanges on only one condition: the issuer's shares must be included in quotation lists of a stock exchange. Theoretically, the idea is good: there is no excessive administrative red tape for reliable market-tested companies. Securities can trade next day after registration.
However, according to analysts the final say in such matters belongs to investors not issuers. Meanwhile, investors are not overenthusiastic about securities today. Ivan Manayenko, head of the debt market analysis department at the Veles Capital investment company, is convinced that "even if the bond circulation period was increased to 10 years and a telephone call was enough to have the bonds issued, this would not solve the issuers' problems."
Besides, an increase in the securities circulation period can scare off, rather than attract, investors.
"The rouble bonds were popular earlier this year because they were short-term securities. This bond was, in fact, a stock market analogue of a promissory note. Naturally, under the present conditions, long-term securities will not be in demand," Pavel Pikulev said. Reliance on a simplified procedure is not indisputable either.
According to Ivan Manayenko, "in the current environment, with a huge number of corporate bond defaults, investors will probably be more interested in papers with tougher registration rules providing control over the issuer at the issue preparation stage."
In order to set the investors at ease, the Government's anti-crisis plan proposes holding a general bondholders meeting. One can only assume what powers this meeting will have. According to Manayenko, it will make sense only if the bondholders are assigned the covenant right - the possibility to demand an earlier redemption of securities.
Nevertheless, we regard the package of proposals connected with the development of the Russian bond market as one of the most important in Putin's Plan, for what is really meant is the creation of a new system for bringing money to industry. The anti-crisis plan provides "for additional issues of shares and bonds of some strategic companies with a subsequent buyout by authorised organisations" and also for "issuing infrastructure bonds to finance infrastructure projects implemented on the principles of a public-private partnership." Respective regulatory documents are to be drafted in the first quarter of next year.
A large-scale issue of Transneft's bonds worth billions of roubles is being prepared now, which helps in understanding the essence of these proposals. It is expected that the issued bonds will be accepted as collateral by the Central Bank under a repossession transaction. Therefore the commercial banks which will buy them will be entitled to full refinancing up to the worth of these bonds. Under a similar scheme, the authorities intend to attract funds for infrastructure projects carried out on the principles of a public-private partnership (see Expert No. 27, 2008, on public-private partnership in action). Thus, Russia is creating a mechanism for market financing of long-term projects.
It is good only on paper
The question of how attractive the new bonds will be to private investors remains open. According to some sources, the plan is to introduce guarantees of profitability and the return of the funds. However, this is specifically banned by current legislation. Lawyers say that now the country's legal think tank is pondering the legal substantiation and legal framework for such guarantees. If jurists fail to find them, the possibility of pledging infrastructure bonds under a repo transaction with the Central Bank will become the only stimulus for their purchase. This is not enough during the crisis.
At present, analysts refuse to assess the effectiveness of the proposed anti-crisis measures as a whole. "Our problem is not the crash of the financial market, but the potential effect of the crisis on the troubled sectors," says Natalia Burykina, chairperson of the tax legislation subcommittee at the State Duma committee for budget and taxes. "Thus the crisis in the auto sector has led to a steep drop in the demand for steel and, consequently, for coking coal. The coal sector could be supported if it could switch over to export, but coal production is cheaper than coal transportation in Russia. The Government must provide special anti-crisis measures for the troubled sectors. It has a general anti-crisis plan, but it must also have such a plan for specific industries. We need a deeper analysis of the situation in industry, and we must take preventive measures to avoid stagnation," she said.
Oleg Ivanov is more pessimistic. "The present hasty ‘rapid-fire' law-making brings only palliatives for lawyers to haggle over for the next several years. The need to adopt nearly all financial laws proposed now by the Government was formulated back in 2004 in the Strategy for the Development of the Banking Sector, which was completely torpedoed as far as the legislation was concerned. Nearly five years of inertia have resulted in a month and a half rush job. Naturally, the quality of such documents will be far from ideal."
However, we are convinced that there cannot be any ideal anti-crisis plan. Under the current conditions, any action aimed at supporting liquidity is better than inaction as it helps to mitigate the crisis. At the same time, we can expect no miracles from any action. We are in for a hard year.
The article was compiled by Olga Zaikina and Vladislav Tyumenev.
Searching for a compromise
Andrei Kudryashev, vice president of the closed joint stock company International Law and Tax Services Association (I.LTS), one of the authors of the Russian Customs Tariff, who headed the central department for tariff and non-tariff regulation at the Federal Customs Service of Russia:
Item 39 of the plan provides for the "adjustment of import customs duties on automobiles." The current duty on car imports is high, 20%. It could be raised by several percentage points, but this will not cardinally change the situation. There is not much point in completely closing the market now, for the available operating capacities do not meet demand. Russian auto makers are not very successful, but there are several foreign investors who have launched auto assembly plants in Russia. It is quite possible that duty rates may be raised in this segment in order to support these companies and provide markets for them in the crisis conditions. This is reasonable, but we must ensure that these rates really work.
Item 44 stipulates "the expansion of the list of commodities for processing and domestic consumption, provided that the goods (electronic goods in this case) are placed under customs regulations." It seems there is a mistake in wording. The Customs Code contains the regulation on processing [goods] for domestic consumption. It is used in international practice when the tariff escalation principle is violated for one reason or another and the duty rate on finished goods is lower than on raw materials. Here is a classic example: no duty is paid on textbooks (in compliance with international conventions), while the duty rate on paper is 15%. This means that the same regulation can apply to paper which can be processed into a textbook and put on the domestic market as a finished product at the zero rate. Apart from this case, this regulation does not work because the Government must first compile a list of goods subject to this regulation in the event of economic efficiency. Since there is no such list (though the Customs Code has been in effect since 2004), it is not quite clear what should be expanded. I believe this scheme could apply to some electronic goods. For example, the rates on mobile phones and digital electronics have been lowered (in order to ‘whitewash' the market), but on some components they have been kept high (10-15%) in order to protect Russian producers. If the said regulation applies to the components on which high duty rates are imposed, Russian companies will process them into finished goods and put them on the market at lower rates. This is a proper measure but it should have been introduced before.
On the whole, we must not forget that a customs tariff is a search for compromise between the producers and consumers and, at the same time, lobbyism. There are national producers who are constantly lobbying to restrict the import of a competitor's product. This constant rivalry between national producers and importers is a normal process, though it may grow more acute during the crisis. The proposed measures are rather traditional: they will not lead to any radical change but they may distort the plan during its implementation. A customs tariff cannot be calculated mathematically in practice; it is adjusted by using the progressive approximation (or trial-and-error) method. It is most important for the decision-making body to have complete information, not for a one-time case, but in general market dynamics. This work must be conducted all the time: customs houses will regularly compile statistical data, and economic agencies responsible for the elaboration of the national customs tariff policy will make decisions within the Government's commission for protective measures in foreign trade and customs tariff regulation. Regrettably, there is not even a long-term plan for the commission's work. Besides, customs tariffs are largely dependent on economic growth; so, in order to calculate their adequate level, it must be made clear first which sectors should be given priority in state support programmes. Nothing of the kind is being done today.
Recorded by Olga Zaikina.
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These are correct measures but...
Natalia Burykina, chairperson of the tax legislation subcommittee at the State Duma's committee for budget and taxes:
Item 25 of the anti-crisis plan provides for "the transfer of some fixed assets, since January 1, 2010, into depreciation groups with a shorter useful life period in order to stimulate equipment modernisation." I think the Government intends to reorganise the depreciation groups once again to bring obsolescence closer to physical aging and thus accelerate the write-off and modernisation of machinery and equipment. Currently, equipment grows obsolete faster than it physically ages.
This is a correct measure, but I think it could be introduced in 2009, not in 2010. The budget would not incur any tangible losses, whereas during the financial crisis with its impact on calculations, many smaller companies needing loans could save some of their funds on taxes, because taxable profit and, consequently, profit tax are reduced with high amortisation expenses.
It would have been even better if this decision had been made before the crisis. However, even during the crisis the amortisation policy can be changed because we must stimulate not only mineral extraction, but other sectors as well, primarily engineering and equipment manufacture.
Item 42 of the plan provides for "expanding the practice of granting investment tax credits to defence industry enterprises." This measure is aimed, primarily, not at stimulating the defence industry but at preventing its bankruptcy. Perhaps, such loans will be issued upon recommendation of the ministries and departments concerned, in cases when, for instance, budget funds have not been transferred to some defence industry plants on time. How can they survive? What could be done for them? They can only be granted tax deferments to help them meet their wage obligations to workers. This is the task set.
(Under the Tax Code, an investment tax credit provides for changing the tax payment deadline so that the company would have an opportunity to make smaller tax payments over a certain period with the subsequent stage-by-stage repayment of the credit and the accrued interest. An investment tax credit may be used in regard to tax and regional and local tax payments.
Recorded by Olga Zaikina.
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Heading for an iceberg
According to an analysis of four years ago devoted to the Stabilisation Fund, "the Government is accumulating money which it will not be able to use during the forthcoming crisis because the injection of more money into an inefficient financial system can only increase capital flight and put additional pressure on the currency exchange rate. Regrettably, this pessimistic forecast has come true now.
The monetary policy of the past four years has been consistently pushing the Russian economy towards the crisis. In the autumn of 2004, the monetary policy was unjustifiably toughened in order to accelerate the accumulation of currency reserves (see the diagram). It shows that at that very time the coverage of the domestic money supply with currency reserves (monetary aggregate M2) began to grow fast. The second wave of toughening the monetary policy came in early 2006, when the Government laid a course for combating inflation at any costs, i.e., through greater restrictions on domestic money supply and a stronger rouble.
As a result, Russia has failed to combat inflation, while the Russian economy has been caught in a classic trap of strengthening the national currency against the background of efforts to artificially toughen the country's monetary policy. By the way, this is exactly the "treatment" prescribed by the International Monetary Fund to its "patients", which usually pushed their national economies to a crisis. The question that arises is why the Russian authorities are criticising the IMF now if they followed its worst recommendations for years of their own free will.
By August 2008, a very strange situation had evolved. The Central Bank's official exchange rate was higher than the rate at which all the roubles could be exchanged for the total foreign exchange reserves. In other words, the entire foreign exchange reserves covered, over and above, the entire rouble supply at the official exchange rate. This is the currency board in the worst and most extreme sense of the word: had these dollars and euros circulated freely in Russia, it would have had more money in August than with rouble circulation. No wonder the crisis has hit Russia so hard. Another question is why all this talk about making the rouble our reserve currency if the whole country is following the line of not recognising the rouble as an independent currency. Since the roubles in this country are 100% covered by dollars and euros, it is better to invest in them directly.
However, no matter what plans we may have, we are more concerned now about the continuation of this monetary policy which pushes this country deeper into recession. The above diagram shows that the Government's financial injections have failed to mitigate the monetary policy: the country badly needs money and loans. This means that the crisis phenomena in the [Russian] economy will continue (2009 will be difficult for the global economy, so we cannot expect any support from external markets). The worsening situation will trigger further capital flight, because we have failed to create an effective financial system in this country over the years.
It is clear that in these conditions we must continue boosting liquidity by all possible means. This will be difficult to achieve without direct agreements between all the participants in the financial market, of which there are no more than 200 in this country.