Russia is growing below potential, but the new national projects are designed to change that. The programme is off to a slow start, but that is because the rules on how to invest money have been changed and that caused delays, Andrey Klepach, chief economist of Vnesheconombank (VEB) tells bne IntelliNews in an exclusive interview. The headline RUB27 trillion ($423bn) earmarked for the projects is only the tip of the iceberg, says Klepach, as a lot more will have to be spent to transform the country.
With the budget running a 2% surplus and expected to be in profit for several years, there is plenty of money. If more is needed then the $40 per barrel threshold above which any excess oil revenues are siphoned off into the National Welfare Fund (NWF) can simply be raised, says Klepach.
Money is not the problem. What needs to happen is an improvement in the quality and supervision of the management of all these investment projects as the ultimate goal is not just accelerated growth but a transformation in the quality of life.
bne IntelliNews editor-in-chief Ben Aris sat down with Klepach on the sidelines of the annual Rhodes Forum organised by Dialogue of Civilizations Institution to talk over these issues. The following is extracts from a podcast.
bne IntelliNews: The previous boom in the noughties was driven by the demand side – consumption. This time the state is planning to push growth from the supply side – investment into things like infrastructure. However, it is going very slowly. Growth in the first quarter was only 0.5% and in the second it was 0.9%. Why is the economy growing so slowly? What is wrong?
Andrey Klepach: We see more modest growth than last year's 2.3%. This year it will only be 1%. But we have potential for the acceleration of growth next year to say 1.7%. The main question is not the precise figure. Russia is not in a trap.
[The constraint is] a very high monetary policy rate and tight budget spending restrictions. We have a very high real interest rate of more than 3%, but at the same time we have a profitable budget, but only limited spending, despite the national projects.
There is potential for acceleration. If you look at Russian businesses they are profitable, but we are also seeing the export of capital. This year around $40bn will leave the country. It means that 2% of GDP is leaving the country each year. If the conditions are improved then this money will stay in the country.
bne: Capital flight has been a key problem, but this is not just oligarchs stashing their cash abroad, as much of it is deleveraging by banks and companies. So is it really a problem?
AK: You are right and companies want to deleverage, but there is also very modest investment. There is uncertainty. Companies don't understand the rules of the game. So there is potential for much more intensive investment than we have actually seen.
bne: Isn’t this uncertainty really the key constraint on growth? The lack of confidence which is manifest in Russia’s extremely high dividend payments. Without the investment Russian growth will be constrained. Isn’t investment missing on the private side and without this investment Russia's growth will be low?
AK: There is no substitution of private investment by government, as government investment in real terms has actually decreased over the last six years. Only next year we may see an increase in the government spending share (because of the national projects) but we have not seen increases until now.
There is a strong investment activity [by the government] in the oil and gas sector. But it will fall after this year or next as many of the mega-projects in the sector are near to completion, like [gas pipeline projects being built by state-owned Gazprom] Power of Siberia, Turk Stream and so on.
The main problem is we have very weak investment in the manufacturing and tool-making industries, agriculture and trade. Also in housing and construction activities. Many companies prefer to pay dividends and not to invest.
I think the reason is the uncertainty. We need more stable rules that can’t be changed by the government. Maybe one instrument is a new law on investment, which the government promised to give to the Duma by the end of this year that contains terms to protect investors.
bne: There was an investment law proposed by Deputy Prime Minister Dmitry Kozak that was pretty radical. So the government is talking about the right things?
AK: It is more than just talk. There are two proposals and I’m not sure which one will be adopted, but by end of this year there will be a unique position agreed. Amongst the proposals is to keep taxation stable, and not just tax but also tariffs, which may be a more crucial point for many investment projects. It is not a golden key, but it will support more investment.
bne: A separate issue is the Central Bank of Russia (CBR) has kept interest rates high because the governor Elvira Nabiullina is worried about more sanctions. It's a war mentality. The emphasis is on protection not growth, although that is fading a bit now a fiscal fortress has been built.
AK: I am not worried about a new massive wave of sanctions. Yes it is a threat, but we have been living with sanctions for the last five years – not just restrictions on borrowing, but on the sensitive topic of access to technology. Many projects were blocked as a result. But sanctions are now a condition of life.
High interest rates are not the best protection against sanctions. It is restriction of growth. We need an easing of interest rates and a loser spending policy.
bne: The reserves in the National Welfare Fund (NWF) are about to exceed 7% of GDP and there is a big debate on how to spend this extra money, made available by the fund's rules. Nabiullina has argued to go slow, as she is worried about the inflationary impact of dropping a big amount of cash on the economy. How much difference will it make to spend this money?
AK: If you look at all the money, not only in the Welfare Fund, but all the accumulation of assets in the budget from oil revenues then the fund is not 7%, but already over 9% as this cash has not been transferred to the Welfare Fund yet. By the end of this year, or the start of next year this transfer will occur.
We will have about 1% of GDP for additional spending, but it won’t have a significant inflationary effect. The Ministry of Economy is lobbying for the money to be invested abroad where it will have no impact on inflation. But if it is spent inside on things like infrastructure then it will have only a minimal inflationary effect.
It is not spending on wages. It’s spending on highways and housing. At the same time the CBR is increasing the prudential constraints on consumer lending to prevent a bubble there.
Maybe there is a bigger fear that the money will be used inefficiently. But it is better to start projects and make sure the management is qualified rather than to invest abroad.
bne: The spending will be huge, but the concern is over the quality of investment. With big state-led investment into big infrastructure projects, how can the government ensure the quality of investment?
AK: We exaggerate the problem of the quality of investment. Big infrastructure projects are a big problem not only in Russia. China has new cities with no inhabitants, but at the same time in the last few years they have created a network of high speed trains, which has really changed the mode of life and the internal vision of China.
We need similar investment projects in Russia – maybe not quite so big – but the biggest problem is the network of highways in the local regions.
We have a plan to modernise transport infrastructure in villages in Russia with population of 200 and more. Not just highways, but to modernise the entire transport system. It is an issue of the quality of life for the citizens. More than half of the buses in Russia are over 30 years old and everything needs updating and digitising.
This project needs money. We are in talks with the government as more than RUB300bn is needed for this project that will be invested through VEB. We should guarantee the quality of management of this investment.
bne: Of the RUB27 trillion I read that only 60% is funded. Is it clear where all this money going to come from?
AK: At the federal level there will be RUB17 trillion-18 trillion of spending [with rest coming from regional budgets and private investment] but it is a minimum level.
For the modernisation of things like communal transport we need much more money. As for the highways and so on we need additional RUB2 trillion. We have this money as we have a high level of reserve funds and profitable budgets for the next three years. It is not a question of money. It is a problem of making the political decision and also a problem of rules. Additional spending means we need to change our budget rule – the $40 [budget rule cap where all additional revenues are siphoned off into the welfare funds].
We slightly modified these rules last year because we borrowed to fund these projects despite the budget surplus.
bne: This has been another debate. Former finance minister and Audit Chamber head Alexei Kudrin was suggesting changing the budget rule cap to $45.
AK: Yes, I think we need to increase this level from $40 to $45-47 but it depends on the calculation on the exchange rate.
bne: Potentially it's a sliding scale as if money is tight then you can just increase the cap to $45 and that will free up a lot of extra money.
AK: Well $5 per barrel more actually means a little less than RUB1 trillion of extra revenues. The problem is not one of extra spending, but the management of it. For this year the level of spending is 10-15% less over three quarters than in the last 19 years, despite the launch of national projects, because we have transformed our system of rules on how to spend money and some of this spending was delayed.
The money will start to work only at the beginning of next year. A lot of money should be returned to the federal government and local authorities by then.
bne: Assuming all this happens, what is Russia’s potential growth rate?
AK: There is a lot of discussion. The CBR thinks it is 1.5%. From my point of view it is really a potential growth for Russia of 3-4%. In the long-term it is closer to 3%.
Potential growth can be increased if you increase investment. If investment is declining or stagnating then the growth stagnates too. It is what we see in Europe, but if you invest in physical or human capital it will increase your potential growth rate.
I am optimistic, as we are now working a little below our potential capacity. We don't need to increase the money spent but to accelerate the actualisation of these projects, then it is not the amount that is spent, but a new structure of the economy, a new face of the economy that will make a difference. The digitalisation of the education, health care system and so on. But at the same time it creates a new quality of life – not only in Moscow. In the last year we saw how the quality of Moscow life has improved, also thanks to the football championship. But we really need to improve the quality of life for the whole country. One of the main tasks for VEB and the [new chairman of VEB, Igor] Shuvalov's team is the development of the cities. I hope we can play an important role.
This article is an edited version of a bne podcast “Russia’s multi-billion dollar spending programme”
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