Emulating the Future
“We want to be an efficient natural resource country like Canada and Australia.” That was how a top executive in a state-owned enterprise (SOE) once put it when describing the strategy the Russian government wished to pursue.
In fact, this is an admirable target. And it fits well with the advice of former World Bank chief economist Justin Yifu Lin who, in The Quest for Prosperity, argued that developing countries should aim to emulate countries a stage or two ahead of them.
Indeed, Russia is roughly 45 to 50 years behind Australia and Canada. The Penn World Tables show that in 2010 Russia’s per-capita GDP was $15,068 – against $15,429 in Canada in 1965 and $15,512 in Australia in 1965. Over the subsequent 12 to 15 years, the latter two countries lifted their per-capita figure by about 50%, to around $21,500.
But while Australia and Canada may look like good role models for Russia, there is something that makes me doubtful their model will apply. The primary reason for that is Russia’s new approach to privatisation.
Last year we heard that banks and infrastructure companies would be privatised, while significant stakes in natural resource companies would be sold by 2016. Investors were told that Russia intended to renew the privatisation drive that President Putin alluded to in early 2008, and that corporate governance would eventually improve as a result.
Today we read that banks will remain state owned, and natural resource companies will not be sold before 2016. Particularly in oil and gas, the Russian state will remain dominant for years to come. Yet there is not one Canadian or Australian SOE in the 2011 Forbes Global 2000 list of the top public companies, and neither country has had the state dominant in banking and natural resources since the late 1970s, when privatisation started. This makes it hard for me to believe that Russia can emulate their success.
In the meantime the role of the state is far higher in some oil-producing countries. The same Forbes list shows that Russia’s level of state ownership is similar to that of Norway and Saudi Arabia. However, their pattern is hard to emulate as well, as Russia is energy poor compared to these countries in terms of per-capita production.
Deposits instead of state regulation
And what about China, which is arguably the most successful economy with a high level of SOEs? Some are misled into thinking that China (and perhaps Russia) represents an authoritarian state capitalist model that can be copied to produce sustainable strong growth. I do not believe that China’s economic success is built on the entrepreneurial brilliance of its SOE management. Rather, in my view, China’s success is due primarily to a massive pool of captive savings. Chinese deposits in the banking system are worth approximately 177% of GDP, while loans were 134% of GDP in 2012. The 43% of GDP excess (equivalent to $3.5 trillion) keeps interest rates extremely low most of the time, providing cheap funding for long-term investment. This model – also seen in Japan, Germany, Switzerland and the Czech Republic – has given companies the funds they need to invest.
Russia’s savings pool is far lower, at 46% of GDP, not quite matching loans of 53% of GDP. Indeed, Russian capital often leaves the country, maintaining high interest rates within Russia but benefiting London property prices, Chelsea football club and (until recently) Cypriot banks. The shortfall of 7% of GDP, equivalent to $142 billion, means Russian corporates and banks borrow from abroad. It also means domestic interest rates are far higher than in China.
Can Russia do anything to boost savings? The most obvious stance would be to compel Russians to contribute to private pensions. From Australia and Canada to Norway, South Africa and Chile, pension funds have bought government bonds (driving down domestic borrowing costs) or equities (providing cheap equity financing). While China does not have pension savings, it does not need them when domestic bank deposits are in such a high surplus. Russia’s problem is that it has neither and, unlike other commodity producers such as Kazakhstan or Nigeria, it is not making progress on addressing the issue.
The good news is that the government is considering pension policy changes. The bad news is that they are aimed only at preventing the state system from going bankrupt in 2030. Thus, in fact, this will just help reduce the strain on the federal budget, which at present has to bail out the pay-as-you-go system as inflows are not matching outflows.
The Ministry of Finance is hoping to boost domestic savings via tax incentives and a tax amnesty. It sees the Cyprus debacle as providing an opportunity to tempt Russian capital home. The problem I see here is that in Russia, where the income tax is as low as just 13%, it is hard to incentivise people to save more by creating ‘tax-free’ products. This problem could be helped if income tax rates were raised to 20% or more, but we have heard nothing to suggest this is likely.
Walking the way of Greece
So, here we have a country with a low savings rate that is committed to maintaining a relatively high share of state ownership over the economy, where the political leadership (as everywhere) wants to maintain power. The solution, at least for a decade or more – as seen in so many countries of the European periphery – is to increase debt levels. Governments may choose to spend more money themselves, or they can encourage more private-sector borrowing. In Russia’s case, it looks like both options will be taken.
During the boom, Russia pursued a policy of budget austerity, building up both fiscal and foreign exchange reserves, with then-Minister of Finance Alexei Kudrin arguing against ministers who wanted to spend money on infrastructure.
The tack has now changed. President Putin recently announced 450 billion rubles ($14 billion) of new infrastructural spending, taken from the 86-billion-dollar National Welfare Fund, saying that eventually half the fund may be spent on infrastructure. He tasked the government with finding the right projects, but prioritised a high-speed rail link from Kazan to Moscow, a quadrupling of capacity on the Trans-Siberian railway, and ring-road work around Moscow.
If the authorities got really ambitious, then an extra $1 trillion of debt by 2018 might only cause the debt ratio to rise to 36% of GDP, assuming the other IMF forecasts are right. With an extra trillion worth of spending over the next five years, a president fighting re-election might be able to point to new railways, airports and roads, nationwide broadband, modern electricity grids, more green power and better ports
I am afraid this is just the beginning of a new course. First, the government will run down its savings, and then it will be tempted to increase its debt stock. If a political leader wants his party to do well in 2016, and is considering re-election in 2018, it would be wise to maximise support by spending more in 2015 and 2017 respectively. We saw this pattern in the run-up to the last parliamentary and presidential elections in 2011 and 2012. It meant a considerable spending increase on pensions and public-sector wages. Unless Russia booms again, this can only be repeated by either taxing people far more (not great for re-election), or borrowing more.
The International Monetary Fund (IMF) expects Russia’s public debt stock to rise from 11% of GDP in 2012 to 13% of GDP in 2018, which, based on its GDP and ruble/dollar forecasts, means the stock of debt rising from $220 billion to $416 billion.
If the authorities got really ambitious, then an extra $1 trillion of debt by 2018 might only cause the debt ratio to rise to 36% of GDP, assuming the other IMF forecasts are right. With an extra trillion worth of spending over the next five years, a president fighting re-election might be able to point to new railways, airports and roads, nationwide broadband, modern electricity grids, more green power and better ports. He might argue the investment would accelerate potential growth. Yet the debt ratio would still be half (or less) that of Brazil, India, the eurozone, the U.S. or the U.K.
I am not advocating or promoting this course of action. As Kudrin has made clear many times, Russia is reliant on international oil and gas prices which, when they plunge, can quickly turn a benign-looking low debt-to-GDP ratio into something much more worrying. A $1.1 trillion stock of public debt would be worth 72% of GDP if nominal GDP fell by half due to a China crash or a eurozone implosion. The budget deficit would widen dramatically, and refinancing concerns would rise.
The main constraint on the scenario of much higher government spending is Putin’s evident reluctance to rely on foreign financing. Unless domestic savings explode upwards, higher public debt would require Russia to borrow from abroad and, in a nightmare scenario, perhaps require IMF support. So we are inclined to assume a modest rise in public sector debt and a larger rise in private sector debt instead.
Half a trillion here (on private sector debt) and half a trillion or a trillion there (in public sector debt), and pretty soon you are talking ‘real money.’ The debt per person would have risen by $7,100, a chunk of which would have disappeared into imported cars, white goods and Kenyan roses for wives and girlfriends. GDP itself would not benefit greatly, but voters would feel more content (or at least more content than they would be without these material gains).
While encouraging a debt boom to remain in power looks like the easiest option, it is obviously not the shortest way to the goals Russia declares it is pursuing. There is an alternative for the government though, which is to step up with real reforms – and happily there are signs that the authorities have not given up on pushing for them. This implies there is a chance that Russia can one day emerge as a new Canada or Australia, rather than a new Greece.
Charles Robertson is Global Chief Economist
at Renaissance Capital.