Will Russia relinquish control to fill the hole?

Neil Shering of Capital Economics talks to Tomas Hirst about how Russia will tackle its budget deficit.

Q. The financial crisis took a particularly severe toll on the Russian economy, swinging the federal budget sharply from years of surplus into deficit territory. What is the scale of country’s budget deficit?

A. Last year the deficit was 5.9% of GDP. This was down from a surplus of 4.8% in 2008 and a surplus of over 5% in 2007.

In terms of where the country is heading this year, it will depend heavily on your view of oil prices. You would need to get oil back to between $90 to $100 a barrel to balance the budget but our view is that it will fall far short of this.

Projections from the Russian Finance Ministry suggest a deficit of 5% this year falling to 3.6% in 2011.

Q. The Russian government has proposed a sale of state-owned assets to raise capital to plug the deficit. Is the asset sale going to be sufficient to accomplish this goal?

A. This depends on who you talk to in Russia. Assuming they raise the $29 billion (£18 billion) figure suggested by press outlets, it would only account for 2% of this year’s budget deficit.

Since the sales are supposed to be carried out over the next three years they will fall short of fully addressing the problem. It will simply not be enough.

Q. Some commentators have argued that the sale of state-owned assets might lead to the government stepping away from direct influence in the economy and allow for broader economic reforms. How plausible are these arguments?

A. It is an important first step but it is still too early to say whether it ­represents a broader shift towards greater liberalisation in Russia.

The government is split between the Economy Ministry and the Finance Ministry. Officials in the Economy Ministry are pushing for the scale of asset sales to be limited with the government retaining at least a 75% stake in the companies while [Alexei] Kudrin [Russia’s minister of finance] is proposing the Kremlin keep 51%.

At the moment the tone coming from the country suggests the government is leaning towards a more gradualist approach. Kudrin, however, is still pushing for a larger scale and it’s not quite clear yet who will win. (article continues below)

Q. What are the key stumbling blocks that might limit the size of the programme or threaten it altogether?

A. The big problem with all of this is that there are too many vested interests in keeping the status quo. There is a deep-seated rigidity in the politics around these institutions, particularly with the so-called “strategic industries” in the natural resources area.

Even if the Finance Ministry wins the debate, the government will still hold a controlling stake in these businesses. Given that 51% is the same stake the Kremlin holds in Gazprom, the evidence suggests it will not affect the way in which they act towards them.

It would take large-scale political and business culture reform for this enterprise to directly lead to a longer-term structural shift. There is little sign that this is what is happening.

Q. Given the size of the hole in Russia’s federal budget, is it surprising that the plans have caused such a debate within Kremlin ranks?

A. I think it’s more that the political incentive of retaining controlling stakes in what the government sees as strategic assets is outweighing the financial demands posed by the deficit.

They are keen to avoid being seen to make the same mistakes of the mid-1990s where state assets were sold off to powerful oligarchs and eventually had to be wrested back from them.

Of course, many of the comparisons being made between what happened under Yeltsin and the current situation are misguided. Russian financial markets have matured over the past decade and the government has been careful to build up foreign currency reserves to protect the country against external shocks.

What we are seeing now is not a fire sale of assets but an attempt to plug a temporary hole in government finances without dipping back into the reserve pool.

Q. Rosneft, Russia’s state-owned oil producer and one of the companies linked with the asset sale, appeared to link the move with a review of Russia’s windfall tax on oil profits, which mean the government takes 90% of profits above $25 a barrel. Is this an area that is likely to be looked at?

A. The government is really caught between a rock and a hard place on this issue. They have tried to insulate the economy from oil price volatility and came to the conclusion that the best way of doing this was by introducing a windfall tax. This means that they can build up counter-cyclical reserves when the oil price is high and use them to soften the blow when prices fall.

Removing this buffer could cause significant concerns for an economy that is heavily reliant on commodities.

That said if the oil price started to trend higher over the medium to long term there might be a case to review the level at which the windfall tax kicks in for producers.

Q. Might the government use this opportunity to raise money in international markets to help get stalled infrastructure projects moving after state funding was cut in the last budget?

A. If they’re raising capital to plug the deficit then it would be counterproductive to raise government spending on infrastructure. I think we are unlikely to see any moves in that direction until the budget deficit is brought down.

Q. Could the sale be a positive move for investors aiming to increase their exposure to higher-quality businesses in Russia?

A. So far, companies in which the government holds a majority stake have not really paid out to investors. With the government appearing set to keep their majority stakes it looks as if they might not present great opportunities for foreign investors.