MOSCOW’S MIDAS PROBLEM: WHAT TO DO WITH ALL ITS PETRO-DOLLARS?

It looks like the Kremlin will manage to ride out the wave of social protests surrounding the monetization of social benefits without having to sacrifice Prime Minister Mikhail Fradkov. Meanwhile, the government is squabbling over what to do with the Stabilization Fund — the excess revenue flowing into federal coffers as a result of the boom in world oil prices.

Since January 1, 2004, excess taxes from oil exports when the price exceeds $20 a barrel have been paid into the Stabilization Fund. By January 31, 2005, the fund had reached 740 billion rubles ($27 billion) — double the projections of a year ago. The purpose of the fund is to even out the cyclical rise and fall in world oil prices and to prevent excess receipts from entering the domestic economy and triggering inflation. Nearly all oil-exporting countries have such a fund.

If the oil price stays above $40 (currently it is $47), by the end of this year the fund will exceed one trillion rubles. The federal budget as a whole finished 2004 with a surplus of 687 billion rubles, or 4.1% of GDP. Any remaining balances in the federal budget at the end of the year also go into the Stabilization Fund (Kommersant, February 10).

Russian law stipulates that funds in excess of 500 billion rubles may be spent. The question is what to do with the excess cash, currently some 200 billion rubles ($7 billion). The most financially conservative course would be to continue stashing it away in foreign securities or use it to pay down the national debt, which was $115 billion on January 1. But government ministers are lobbying hard for their own spending projects. Embattled Health and Social Development Minister Mikhail Zurabov has secured 74 billion rubles to cover the deficit in the Pension Fund. Another 200 billion rubles will be released to help the regions cover the costs of monetizing social benefits. The transport and energy ministers have proposed spending it on infrastructure investments. Even liberal Minister of Economic Development and Trade German Gref has joined the queue: rather than see the money wasted, he has reportedly suggested that it be used to underwrite a cut in VAT from 18% to 13% by the end of next year (Kompaniya, February 7).

The Finance Ministry favors using the money to pay down foreign debts. President Vladimir Putin concurs, telling a press conference, “The economic advantages of getting rid of the debt as soon as possible are obvious” (Prime Tass, February 11). On January 31 Russia repaid its remaining $3.3 billion debt to the International Monetary Fund ahead of schedule. But at the G7 meeting in London on February 5-6, the “Paris Club” of 19 government lenders, which holds $44 billion of Russian debt (mostly from the Soviet era) refused to give Moscow a substantial discount in return for early repayment. They prefer to continue receiving the high interest charges. Finance Minister Alexei Kudrin argued, “The cost of servicing our debt is four times as high as servicing the debt in the U.S.,” reflecting the high risks associated with holding Russian debt in the past. Russia is spending $7 billion each year on interest payments, and could save $1.3 billion for each $10 million of debt repaid (Vremya novosti, February 14).

An influx of dollars from Russia would drive up the euro, causing more financial problems for the stagnant European economy. On the other hand, such a cash injection would help Germany bring down its budget deficit. Such considerations illustrate the extent of global economic integration: Russia’s problems are also Europe’s problems, and vice versa. Still, Russia is now in good overall financial standing. Two weeks ago Standard & Poors upped its rating to investment grade, and its ratio of foreign debt to GDP is just 26%, very low by international standards.

While the Russian government faces a mountain of cash, Russian businesses are scaling down their investment plans. The business community is still reeling from the impact of the Yukos affair. In the wake of the Yukos crackdown the authorities launched what one anonymous businessman called “a taxation reign of terror.” In the first three quarters of 2004, the Federal Tax Service collected 470 billion rubles in back taxes: five times more than in 2003. During the same period the profits of Russian companies rose by 60% while their capital investment rose by only 17% (in nominal terms). Perhaps more corrosive than the machinations of the tax auditors is the perception among the business community that the government cannot be trusted to follow through on its word — for example, the repeated assurances by leading officials that Yukos would not be bankrupted, and that Rosneft would not take over Yuganskneftegaz (Profil, February 7; Kommersant, February 10).

Meanwhile Menatep, the off-shore holding company that owns Yukos, ramped up the pressure on Friday, February 11, with another filing in a Houston court seeking $20 billion in damages from companies involved in December’s auction of Yuganskneftegaz, the leading Yukos subsidiary.

Back in Moscow, Gazprom is arguing that Rosneft’s plan to borrow $5.5 billion to cover its acquisition of Yuganskneftegaz will derail its plan to merge with the natural gas monopolist. This dispute is being waged in the innermost circles of the Kremlin, since Presidential Chief of Staff Dmitry Medvedev chairs the Gazprom board, while his deputy, Igor Sechin, is board chairman at Rosneft (Moscow Times, February 15).

At first glance it seems that President Putin’s economic policies are succeeding, with oil revenues at record highs, and the Kremlin’s business rivals on the run. But the social and institutional basis for sustained, long-term economic growth is still uncertain.