Why Putin's $88 billion raid on rainy-day fund won't cure what ails Russia

By
Courtesy of the Associated Press

(c) 2014, Bloomberg News.

MOSCOW — President Vladimir Putin's government is blowing a hole in Russia's finances by unsealing one of its rainy-day funds, all for a growth spurt that will fizzle out, according to the Finance Ministry's debt chief.

By tapping into the $88 billion stockpile to finance infrastructure, Russia is eroding the defenses that helped it weather a slump five years ago, Konstantin Vyshkovsky said. The tradeoff is that Russia will be at risk of "running on empty" after a "sharp and very brief acceleration," he said.

"The National Wellbeing Fund is now seen as an instrument of stimulating economic growth, investment," Vyshkovsky said in an interview in Moscow. "There's a prevailing attitude toward the fund that treats it as an instrument for resolving current problems related to an investment pause, slowing growth, not an instrument of stability and insurance from risks."

Faced with an economy that just skirted a recession last quarter after capital markets seized up for Russia in the wake of the Ukrainian crisis, Putin is draining what Vyshkovsky calls the country's "last reserve." In 2013, the Russian leader ordered the cabinet to invest as much as 40 percent of the fund in infrastructure. Even though no money has yet been spent, Prime Minister Dmitry Medvedev's government increased the threshold to 60 percent, with the Economy Ministry clamoring to allocate the entire 100 percent.

"The Economy Ministry's proposal to support investment at the cost of the National Wellbeing Fund compensates for the lack of reforms and a bad structure of the federal budget, which has overstated social commitments and low investment," said Alexei Kudrin, the former finance minister who oversaw the creation of a forerunner to Russia's wealth funds a decade ago.

The $2 trillion economy remains hamstrung by corruption and inefficiencies. Its public institutions rank 118th and the level of competition 135th of 148 nations in the World Economic Forum's latest Global Competitiveness Report. It has also emerged as the world's most corrupt major economy. Russia ranks alongside Pakistan and Nicaragua at 127th, out of 176 nations, by Transparency International, down from 82nd in 2000, a year after Putin came to power.

The world's largest energy exporter has amassed its reserves by beginning in 2004 to funnel windfall revenue from oil and gas sales into what was then known as the Stabilization Fund. The holdings, later split into the Reserve Fund and the National Wellbeing Fund, allowed the government five years ago to finance its first deficit since Russia's 1998 default.

"Apparently, it's become politically impossible to accumulate reserves similarly to previous years, so the notion that part of these resources should be put to work for the sake of the economy is timely," Vyshkovsky said. "Our concerns have to do not with why that's being done but with how to do it."

Vyshkovsky, 40, joined the Finance Ministry in 2005, rising through the ranks to take charge of its debt department three years later. In 2010, he presided over Russia's first Eurobond sale since the government defaulted on domestic debt in 1998.

While the Reserve Fund is used to patch up shortfalls in the budget, the National Wellbeing Fund covers long-term outlays for social spending such as supporting the pension system. The government wants the Reserve Fund, which totaled $87 billion at end-June, to swell to 7 percent of gross domestic product from about 4 percent now. Extra earnings will then be sent to the Wellbeing Fund, which hasn't been replenished since a 2009 slump.

"The fund's reallocation in favor of more risky investments such as infrastructure suggests the government sees an increase in payroll and other taxes as the main way for insuring pensions," Kudrin said by email. "That may result in a concentration of risks in the nearest future. I don't think that policy is correct."

The Reserve Fund and the Wellbeing Fund are managed by the central bank in accordance with Finance Ministry guidelines. Under current rules, money in the Wellbeing Fund can be invested in sovereign debt, deposits at state development lender Vnesheconombank, or VEB, and infrastructure projects.

The government has already approved allocating 150 billion rubles ($4.4 billion) to develop the Baikal-Amur rail line in Siberia and the Far East and the same amount for building a new ring road around Moscow. Other projects backed by the fund include an 86 billion-ruble investment in another railway in Siberia. Telecommunications provider Rostelecom and Russian Grids, the nation's largest electricity distributor, are also slated to receive billions in funding.

Last month the government allowed as much as 10 percent of the Wellbeing Fund to be invested in state nuclear agency Rosatom and the same share in projects overseen by the Kremlin- backed Russian Direct Investment Fund.

First investments from the fund may be made before the end of this year, according to Vyshkovsky.

With 23 percent of the rainy-day stockpile held on deposit at VEB, the Wellbeing Fund is left with little more than 1 trillion rubles of liquid assets even as other projects are being considered by the government, according to Vyshkovsky. The additional new investments could lay claim to more than 1 trillion rubles from the fund, he said.

Meanwhile, the cabinet has started to introduce exceptions to the rules that set out procedures for selecting projects and impose credit-rating requirements, according to Vyshkovsky.

Last December, the government used a portion of the Wellbeing Fund to buy newly issued Ukrainian Eurobonds to prop up the wobbling government of Viktor Yanukovych, who was ousted from the presidency two months later after violent protests. At the time, Ukraine was rated six levels below investment grade at B-by Standard & Poor's and Fitch Ratings.

"The National Wellbeing Fund is a very important factor for rating agencies and foreign investors," Vyshkovsky said. "For the agencies, the existence of the funds is the only thing that outweighs other minuses and risks in our economy. They balance out the scale."

bc-russia-econ-assess