Finance minister of the year 2010: Kudrin’s cautious approach pays off for Russia
Russia’s finance minister, Alexei Kudrin, steered the country through the global financial crisis. The country emerged not just intact, but enhanced in the eyes of global investors. Now Kudrin faces perhaps his biggest battle of all – keeping a firm hold on spending as an election approaches. By Miriam Elder in Moscow.
Kudrin honoured by Euromoney at IMF/World Bank meetings in Washington
Sunday, October 10, 2010
FOR MANY YEARS, Alexei Kudrin was known as a survivor. As the oil price climbed to dizzying heights, bringing up with it the Russian economy, the soft-spoken finance minister battled endless attempts to reach into the country’s suddenly deep pockets and spend as if there were no tomorrow.
Today, looking back on a financial crisis that ravaged – but far from destroyed – the Russian economy, the view is very different. Kudrin is being hailed as a fiscal manager of the highest order. Not just in the west, where his championing of the free market and fiscal prudence long made him a darling of foreign investors, but also inside Russia, a country that has not taken kindly to reformers in the past.
"Kudrin was proved completely right," says Roland Nash, managing director of Renaissance Capital. "He said we need to save the oil price windfall. No one really believed him and there were huge amounts of pressure from all sides to go out and spend, and he managed to say no."
Instead, Kudrin created a stabilization fund designed to prepare for rainy days. Today, its reserve fund stands at Rb1.23 trillion ($39.5 billion) and its National Welfare Fund at Rb2.67 trillion.
"If Russia had gone into the crisis without its stabilization fund and massive reserves, it would have been 1998 all over again, only worse," says Alexander Kliment, an analyst at political risk consultancy Eurasia Group. "It would have been a catastrophe."
Instead, Russia entered the crisis with nearly $600 billion in foreign reserves, allowing it to manage a 30% decline in the rouble. The stabilization fund enabled Russia to pay off its foreign debt early and later acted as a multibillion dollar cushion that helped Russia weather the financial crisis.
"A statue should be erected to the guy in Moscow," Nash says. That’s a glowing view that’s long been held by westerners investing in Russia. Since making his way into the halls of power in the late 1990s, Kudrin has been one of the few voices championing an open investment policy and diminished government involvement.
Born in Soviet Latvia, Kudrin, who turns 50 this year, began building his career in St Petersburg, taking a PhD in economics from Leningrad State University, the alma mater of both prime minister Vladimir Putin and his protégé, president Dmitry Medvedev.
He began serving in the city government’s economic departments as the Soviet Union began to crumble, just as Putin was called upon to head its foreign investment committee. Yet it was Kudrin who was called to the Kremlin first – serving as deputy head of the presidential administration in August 1996 before being appointed deputy finance minister months later. He has held the title of finance minister since May 2000, making him the longest-serving finance minister in the G8. Since September 2007, he has held the post of deputy prime minister as well.
It hasn’t always been smooth sailing. Kudrin’s bespectacled visage and reserved demeanour belie a toughness needed to battle a powerful Kremlin contingent bent on scuppering liberal reform and ensuring that state rent-seeking remains high.
In November 2007, Kudrin’s deputy, Sergei Storchak, was arrested on charges of fraud and embezzlement – a move seen as a direct attack on the finance minister. Storchak was released one year later, the charges dropped without explanation, as the financial crisis began to unfold and Kudrin’s star started to rise once again.
"Before elections, there is always a desire to show that the government is doing a lot. It’s hard to hold back"
Yet Kudrin’s political fate is far from sealed. Election season, in so far as it can be called that, has begun in Russia. Parliamentary elections are set for late 2011 and a presidential vote is due to be held in March 2012. Kudrin himself acknowledges that the worst might lie ahead, as the ruling United Russia party, headed by Putin, seeks to spend its way to electoral popularity.
So far, he seems on track, winning basic cabinet approval for the 2011-13 budget, a conservative plan that envisages a relatively small rise in spending as Russia seeks to close its first budget deficit in a decade. Yet several rounds of parliamentary approval – and time for political meddling – lie ahead.
Praised also for his commitment to tax and budget reform, to Russia’s desire to join the World Trade Organization and to the continuing privatization of the country’s state-owned heavyweights, it’s his cautious approach and restrained spending that wins the most plaudits. For some, that’s a worry.
"In the end, not spending money is not going to be enough. Russia actually does need a big public-sector spending spree," notes Nash of RenCap. "It takes one man to say don’t spend but it takes a whole bureaucracy to spend it effectively."
That remains one of the biggest challenges for Russia, a country riddled with corruption and red tape, clannish infighting in the halls of power and inefficiencies on the factory floors. If there’s one man who’s proven he’s got the political staying power, intellect and technical ability to see Russia through that enormous task, it’s Kudrin.
Our main weakness is linked to our dependence on oil, and our main strength is also linked to it. The high oil prices of previous years allowed us to collect substantial revenues and thanks to them we were able to cut government debt to 8% of GDP and amass reserves of 10% of GDP. So we arrived at the crisis with this double cushion. That’s why today problems of high debt aren’t spreading and we still can, for some time, support a deficit. What’s more, this allowed us to carry out large-scale anti-crisis measures, to give a big fiscal stimulus. During the crisis, spending increased by 28% of the budget. That’s a very big rise, never mind that our income fell that year by 20%. The most significant part of that stimulus was secured thanks to the reserves gathered from oil.
When it comes to weaknesses, we realize that the economy isn’t highly diversified, and it’s moving only weakly in the direction of innovation and technology, because a large part of the economy’s resources are from oil, and they seem very accessible and cheap. Such a situation does nothing to stimulate the search for new serious fundamental breakthroughs – that’s also a weakness.
It’s a long-term serious turnaround of the Russian economy. It’s not just a temporary measure. It’s not just that we want these plans. The share of the oil and gas sector will decrease, from 10.5% in 2008 to 4.7% in 2020. That means that it’s happening even if we don’t want it. Oil and gas production will grow slowly, by around 1% to 2%, while the growth of the economy as a whole will be 4% to 6% over the next 10 years. Objectively, the energy sector will shrink, and our dependence on it will lessen. The growth of our economy will be spurred by other sectors. This is the objective, and it’s hard to change. That’s why it’s important for us that this [diversification] happens. We have to help other sectors become as competitive as they can, and find their niche in global markets.
The government has chosen such sectors as aviation, shipbuilding, information technology, nuclear technology, nanotechnology, pharmaceuticals, cosmonautics and energy efficiency, including new alternative energy. It’s happening through federal priority programmes, where the government devotes resources to help develop the science behind these sectors and create projects through private-public partnerships, the creation of venture funds, subsidizing credit, and building infrastructure for industrial zones and technoparks. Sometimes we have a foundation in these sectors and now need to strengthen and modernize it, for example in aviation.
Russia has always had high inflation. During the past 20 years the lowest we ever had was 9%, in 2007. High inflation makes resources expensive for domestic use. The interest rate is always higher than 10%. This, of course, complicates modernization. That’s why, until the crisis struck, many companies raised funds outside Russia. There was a very big flow of investment through credit, and the corporate sector had relatively high debt. In all, the total size of debt inside Russia, from both the government and the private sector, did not exceed 35%. This was reasonable and totally safe – the crisis showed that. Our companies were able to pay off debt, and the government helped a bit.
But when it’s more profitable for a company to raise funding abroad rather than domestically, this presents an obstacle to the quick development of small and medium-sized businesses. Not every company has access to cheap resources abroad. So [to achieve] the gradual decrease of inflation means that our budget politics, the politics of government structures, must work to decrease excesses – to lower the cost of resources on the domestic market and the excesses of companies. This is very important. If we again start spending more of our oil money, inflation will again become high. This is a very high-risk situation.
The second risk is that when the oil price rises, our national currency, as a rule, strengthens. This volatility linked to the oil price also prevents businesses from realizing export efficiency.
Many risks exist. There are risks because we are in a pre-election period. There are a large number of policy proposals, such as social service support or infrastructure development. Before elections, there is always a desire to show that the government is doing a lot. It’s hard to hold back. There is such a risk, but, so far, the first decision we took on the three-year budget in July shows that we can keep ourselves within rational parameters. Maybe I would have liked it [the budget] to be a bit stricter, but I think we adopted respectable parameters. The budget deficit for next year will be 3.6%, in 2012 it will be 3.1% and in 2013 it will be 2.9%. So we are carrying out the task suggested by the G20, to cut the deficit by half from the crisis year, when we had a budget deficit of 5.9%.
On the one hand, Russia is the world’s sixth-largest economy. This means it’s a strong market, one of the biggest in the G8. And this makes it an attractive market in which to find customers. In all, over the past 10 years, we have been able to improve the economic environment, adopt many new laws, and make the budget system and the tax system more transparent. The tax system, I think, is absolutely modern enough and the tax burden is not excessive. We have a lower tax burden than central Europe or the US, but higher than in some countries that are competing for global markets.
On the other hand, we have badly developed institutions and corporate governance, including government administration and regulation. We have corruption. So of course we lag behind other countries in these indicators.
We know the world ratings – we’re 25th in the world in terms of the quality of our macroeconomic politics, but are ranked 100th or worse in terms of the quality of government institutions. But if you take all these rankings together, we’re in the top 10.
Even when [there were problems with] our investment climate, whatever problems we may have had, business kept working and capital kept coming in. There’s a market here all the same, and many are counting on the prospect that the Bric countries, Russia included, are going to develop faster than the rest of the world. This also underscores the fact that there’s a future for business here, income will grow faster here. So business, measuring risk and gain, chooses Russia.
It’s very important for us to create quality financial markets to carry out modernization. That’s why we have set the goal of creating an international financial centre. We want to create more pleasant conditions for work in the Russian financial markets, so that they can become the strongest in the region, including in the CIS and our neighbours in the Far East. We want to create a legal regulatory environment that is in line with international law and understanding. We want to invite in specialists, and this means we’re ready to attract the banks and institutions themselves. So the residence regime will be liberalized as far as possible for financial markets specialists – perhaps there will be a special visa regime, and there will be no quotas on labour.
Many banks have already come here and have a good market share – retail banks, investment banks. There are no limits.
Yes, this is normal. I think business should choose where it is most profitable to get funds. I’d limit only the listing of government companies. The government, including state companies, should stimulate its domestic financial markets. In all, we of course would like more companies to list here, but we approach it absolutely normally when they list on other platforms.
So far there have been few such cases, Rusal is just the first. Everyone chooses the platform that is most profitable. I think Russia must work with both eastern and western platforms, because we have a big country, and want to invite investment from all regions.
The Russian banking system is completely sure of itself, and the crisis showed this. The main banks were able to cope with their problems – with the help of the government, of course. Mainly, we advanced them subsidized credit. By the way, not a huge number of banks took it – around 20 got subsidized credit and 124 got liquidity from the central bank.
"If we again start spending more of our oil money, inflation will again become high. This is a very high risk"
We have about 1,000 banks but the main banks that were on those lists are the most important basis of the Russian banking system. They coped with the crisis. They got the sort of support that their colleagues in other countries got. We didn’t have a single bankruptcy of an important bank. I think that indicates that the banking system feels confident. But of course we also need to strengthen oversight – and it will be strengthened, including in terms of international banking practice.
I don’t think a champion is absolutely necessary. However for historical reasons Sberbank is a champion in Russia and it’s the strongest bank in the CIS and eastern Europe. This is linked with the fact that we haven’t got a very stable market in terms of savings: we have inflation, the situation with our currency and instability in the markets. So people are careful about where they put their money. Since they know Sberbank is a state bank and has government support, they readily go to it.
I don’t think it would be correct to quickly decentralize banking. Sberbank’s market share is gradually decreasing. Today it’s about 50% but it will gradually decrease, through the strengthening of the whole banking system. VTB is three times smaller than Sberbank, but we will gradually but rather quickly privatize it.
I am proud of tax reform, which started in 2000 when I became finance minister. From 2000, we cut our tax burden by nearly 1% of GDP a year for about five years. Today we can say we had the fastest liberal reform. If we take an oil price of, say, $20, then the tax burden stands at 29% of GDP. With a price higher than $20, it’s at around 37%. That was the case until the crisis. Today, it stands at around 34%.
The second positive decision was, of course, the creation of the stabilization fund, and the reserve fund and the national welfare fund. These funds saved the country from Dutch disease. We took examples from many countries, including Norway – I went there to learn the details.
Other decisions I’m proud of include the budget system – the standards of budget accountability. We made this process more transparent. Also, the decision we took in 2006 to liberalize the movement of capital.
The most difficult decision was the creation of a new system of taxes for the oil sector, which started in 2001. Oil companies were very bad at paying their taxes. In 2001, we started taking decisions on a new system, where taxes go up automatically with the world oil price, and they started to pay according to that system.
This was very difficult. They are the most influential companies, linked to oligarchs. I had to hold one-on-one negotiations with the most powerful oligarchs and their financial directors. At that time, the Duma wasn’t as consolidated as it is today. In 2001, there were four parties in the Duma and we had to get them together and agree. There was no United Russia then!
As for difficult decisions that lie ahead, I think that not all the changes necessary have been made to the pension system.
When we were discussing production in eastern Siberia two years ago, we started from the assumption that conditions there would be very difficult – there was no infrastructure, there were no pipelines, no roads – and that production there would be very expensive. So we decided we would give the producers big financial concessions, a policy that was applied last year. When production began, it became clear that growth would be rapid – last year, 6 million tonnes were produced, this year there will be 12 million tonnes and next year close to 30 million.
Secondly, the quality of the fields and accessibility, especially the transport system, appeared better than expected. It’s not right to give financial concessions when conditions turn out better than expected. So we reassessed the entire economics of it, and came to this conclusion. I was able to win a victory over many, including Mr Sechin [Igor Sechin, deputy prime minister and a close adviser to prime minister Vladimir Putin, who oversees the oil and gas industry] and the energy ministry, and convince them that there were entirely reasonable conditions for production and that financial concessions weren’t needed for the long term.
I think it wasn’t right to spend so much before the crisis. The growth of the money supply in the economy remained very high, some years as high as 50%. This is too much – in other countries it’s 14% to 16%, in China it’s 20%. Fifty percent means we overheated, there was a bubble.
By the way, prime minister Putin mentioned this a few days ago in his interview with Kommersant [Putin’s interview with Russia’s leading daily newspaper was published on August 30] He said we have spent too much money and we should have spent less, so as not to create a bubble.
During the crisis it was hard because we had to take lots of decisions very quickly, and think up new systems. The Duma supported us really well; it took decisions very quickly. But I think now, after the crisis, it will be more difficult. We’ve become used to big spending, with the fiscal stimuli during the crisis. Now we have to cut spending and raise taxes, and these are the two most politically unpopular things to do. I’ve already experienced more of a workload than during the crisis. Back then it was physically hard, we had to sit for long hours and gather documents during the year of the crisis. Now, it might be very difficult politically and I’ll become unpopular again.
Our general position in the government is that when we join the WTO all tariffs will be brought in line with all the clauses of the WTO. At first, we agreed that we’d do this even before we joined the WTO, so as not to change much later. But when our accession dragged out – our agreement with the EU was signed in 2004 and that with the US in 2006 – we realized we hadn’t been accepted but were still fulfilling all the demands. The government decided that we follow WTO rules until we join. The second we join, all tariffs will be brought in line with the WTO standards. We hope that all talks will be wrapped up this year.
"Putin personally takes all key decisions, in line with his understanding of economics. Some decisions are taken that I don’t agree with"
Of course it’s important, but I’d like to note that the most important factor in the formation of the economic policy of our country is Putin. He personally takes all key decisions, in line with his understanding of economics. It’s a big thing that I am near him and suggest decisions, but he takes the decisions. Some decisions are taken that I don’t agree with.
I would say there are those who are for more government regulation and those who are for less government regulation and less government involvement. I wouldn’t say the difference is over oil resources. Neither wants a huge dependence on oil resources, so I’d rephrase the question. Both want to diversify and see oil have less of a share in the economy but have a different understanding of how to achieve that. In this way, I think we have influence on the government, government corporations, government companies. Today maybe we’ll be able to move the situation forward a bit with the privatization of big shares in government companies. But I wouldn’t say right now that one side [has more influence]. Putin’s talent is that he balances these groups. I wouldn’t say there’s any superiority right now.
He plays an important role. All important decisions are taken with his participation. In terms of taxes, the deficit, big government programmes – every decision is taken together with the president and the prime minister.
They say we still lack transparency, in the political system as in the economic sphere. Politically and economically we need more competition. Public oversight – for government decisions, for certain deals on the market, pressure on business – needs to play a bigger role.
When I was a university student, my main ambition was to write some sort of a scientific study in economics. I stopped thinking about that when I started holding high positions. Now, as we have gone through such a difficult crisis and lots of economic models and regulations are being rethought, I again want to return to research and put together my own observations. I have little time for that but it attracts me.
I have agreed to become a dean at St Petersburg State University. I’ll remain in my post, but I’ll also become dean for a new faculty of arts and humanities founded at the university with Bard College in New York. Science and education attract me.