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Alexey Ulyukaev: We can either have a development budget or a degradation budget

16.10.15

Moscow hosts VTB-Capital's Russia Calling! International Economic Forum.

Ilya Kopelevich, Editor-in-Chief of Business FM, spoke with Alexey Ulyukaev, Head of the Ministry of Economic Development, attending the event.

An open discussion took place at the forum you attended with Igor Sechin, Minister of Finance and President of Rosneft. That format of discussing such challenging decisions as budget balancing under stringent restrictions did not result in a consensus with cardinal differences remaining. We are concerned that the decision made today with regard to additional withholdings from oil companies will entail a reduction of the revenue base as early as in a year. Do you think it means that a discussion is under way or we will have to be based on the situation we will face a year later?

Alexey Ulyukaev: The discussion is ongoing. I would like to emphasise that the initial message of the discussion was to increase an oil royalty and withhold another 600 billion rubles. Our arguments and the arguments of the Minister of Energy were heard by the parties during the discussion and that option was the worst for investing in oil companies and reducing production which meant a reduction of budget revenue in the future. The option we have now officially means that we will not cut an export duty rate in 2016 from 42 to 36 as expected but will close this gap and cover 12 percentage points in 2017. This question can be asked but it spread the measure in time. I can hardly imagine that we will be able to make this large step overnight. A more realistic solution is a gradual progress. So, jointly with the Minster of Energy we have proposed another compromise which involves a reduction of an export duty to 39 instead of 36 as was expected in line with the tax measure. This shortage in income of about 100 billion rubles would be compensated by increasing oil production and excises. It would bring us a comparable amount.

There is a common situation which has not been publicly discussed or noticed by the public. We witnessed the budgeting process becoming an emergency. But if you trace forecasts and opinions of our financial regulators throughout the year, you will see that the idea dominating in the first six months was the possibility of spending reserves during three years with current low oil prices and their use as a cushion in the challenging situation. Then in mid-summer, a decision was made to limit spending of reserves and stretch funds until 2018 to maintain half of the reserves. What was the basis for that decision? Does not it limit manoeuvring options required to create any investment growth reserves etc.?

Alexey Ulyukaev: I don't find it a unique decision taken in mid-year. It is actually an array of decisions pertaining to budget deficit constraint. The idea was ventured to have zero deficit in 2018 but it was later decided to set deficit at 1%. The situation has been very flexible. I generally believe that all requirements to increase the budget deficit go second after overall budget target requirements. The budget is not a goal, it is means of achieving specific goals. And a budget can be customised to meet a goal. You can either have a development budget or a degradation budget Therefore, I think it would make us good to have more flexibility in increasing the deficit. We certainly mean the amount which would not entail any macroeconomic risks and could be partially leveraged with borrowings and partially financed with reserve funds.

Here's another sore subject related to these budget solutions. The investment part of the pension was frozen once again for the third time, for the third consecutive year making up to about 340 billion rubles per year. Frozen amounts will total almost a trillion. What do you think, is it at least theoretically possible that these funds could be returned to the investment accounts or is it time to give it up altogether?

Alexey Ulyukaev: I believe it is theoretically possible. They are three years and trillion rubles. The investment system has invested about three trillion and it would be four. And that would provide a serious support to corporate deposits because current deposits of the investment pension system is a corporate long-term debt mainly for implementation of major corporate projects. Therefore, it would make a very serious contribution to secure additional opportunities for economy growth. I hope to come back to this issue next year.

Would it be possible for the budget and the Pension Fund to have trillion roubles to repay?

Alexey Ulyukaev: I understand that it looks very unlikely. But it will depend on budget implementation and the macroeconomic situation in general. I think it is too early to give up on the investment pension system.

Another point is to be made. The Accounts Chamber performed a review of a crisis management plan that stipulated spending of funds to maintain different industries and concluded that spending under the plan barely reached 28%. Do you agree with this score? And if so, what are the grounds?

Alexey Ulyukaev: I do not agree with this score because the most significant item is capitalisation of banks with federal loan bonds deposited in the Deposit Insurance Agency. Almost 625 billion rubles was added to the capitals of the first and second tier banks. This item only accounts for satisfactory completion. There are certainly items with low completion values, such as employment activities which remained unclaimed. The current unemployment rate is 5.3% which is a record low rate. Therefore, we had 52 billion rubles for active policy in the labour market and 30 billion rubles to provide special support to the unemployed. These funds are not claimed.

It is not about inadequate mechanisms. We offer different initiatives for small business such as project financing, lending, and decreased rates. Maybe these measures just do not work and money is not spent?

Alexey Ulyukaev: It is partially true because we have two items within budget guarantee system and guarantee support, which include 60 billion rubles for project financing which have been almost spent. Another item is support to backbone companies. A total of 16 million out of 200 billion rubles have been spent to date. Guarantee process is really challenging and multi-stage. That item was on the agenda of the Prime Minister's meeting yesterday. The Prime Minister instructed us to streamline communication between a company and the Minister of Finance. I hope they will work well.

Now, let me mention the most important task of the Ministry of Finance which is forecasting. The forecast for the first two quarters is almost in line with actual GDP of minus 3.4%. But a rate decline significantly increased in Q2. So what are year-end and next-year forecasts?

Alexey Ulyukaev: The aggregate decline for the three quarters is 3.8%. We believe that Q4 will be almost flat and a year-end decline will stay at 3.8-3.9%.

According to estimates, we will see the bottom in Q4 while a recovery and an onset of growth will be observed as early as in 2016. Is it still true?

Alexey Ulyukaev: Statistically (quarter over quarter), Q4 will be better than Q3. We will see some developments in Q4. Q2 2016 will be representative for year-over-year performance. We believe Q2 2016 demonstrate a positive value year-over-year.

Another fierce macroeconomics dispute is about state-backed companies. Firstly, there are staff changes which command a lot of attention. Let us start with the Russian Railways, then. Igor Sechin, Head of Rosneft, for example, claimed extensive funds from the National Welfare Fund to receive almost nothing. While the investment initiatives of the Russian Railways were mainly confirmed despite a management change. Does it mean they are better than those of Rosneft?

Alexey Ulyukaev: It means that they have been accepted. These initiatives have been approved earlier. The same is true about the Baikal/Amur or Trans-Siberian Railway and rolling stock. These initiatives have been approved, they are being implemented and financed.

Then, new management entailed more dispute and discussion as to further reforms. It is a well-known subject of locomotive privatisation. We have gradually come to understand the position of the Ministry of Economics. It is not about immediate sharing and selling, it is about separate accounting. A question then, what was the basis for the tariff? The infrastructure (rail tracks) and locomotive operation were not separated, so was is a "black box"?

Alexey Ulyukaev: It was. It was an aggregated indicator we would not understand. We did not know about that though.

Is it generally a normal practice because it is natural monopoly and tariffs must be transparent for users to know the price of every single component?

Alexey Ulyukaev: Certainly, not. Tariffs must be more transparent. This requires well-balanced separation of infrastructure and rolling stock costs. But I believe this is not enough. This means that process price audit of the investment programme, any work scope aimed to improve investment efficiency, and a price list related require revisions. We are working on that jointly with the new Russian Railways management by developing a road map to improve Russian Railways performance and expect good progress here.

Another question about state-backed companies. It is social, political, and economy-related, too. The Ministry of Finance, the financial unit, and the government strive to limit pension indexation not to align it with the actual inflation rate. On the other hand, the indexation rate of natural monopoly tariffs is much higher than pension indexation. Is it true and is it to be expected?

Alexey Ulyukaev: We are based on this assumption. We assume pension indexation of 4%. They might be indexed additionally later based on the budget fulfilment rate in the first six moth but it is still to be discussed. We have budgeted 4% as of today. Therefore, housing and utilities bills cannot exceed this value. It would be socially, politically, and economically unacceptable. Hence, by limiting housing and utilities tariff increase to 4%, we arrive at gas tariff indexation rate of 2%. As for electricity, only grid infrastructure prices are indexed. We find it possible to index grid infrastructure tariffs by 7.5% (their share of housing and utilities services is minor). Therefore, we will have more or less even indexation of repair, operation, and maintenance costs for heat and water supply grids which is critical for the housing and utilities sector with the final indexation rate of 4%.

Another essential social and economy-related issue is salary indexation. With a pension indexing rate of 4%, a total salary indexation rate in state-backed companies of 8% or 10% must raise social tension, especially since they receive financial aid from the government although limited. Is the government aware of this?

Alexey Ulyukaev: The government is aware thereof viewing this from different perspectives. For instance, one of the prerequisites of bank capital top-up with these federal bonds is no increase in corporate payroll. They promise to do so. I believe we will use this system at a broader scale.

As for an income level, I'm aware of the statistics as at mid-year and we have a significant growth of the poverty rate of 14%. Entrepreneurs and large businessmen leading companies focus on the demand. And they are deeply concerned about a reduction of actual income. Is this a focus for the government and are there any measures aimed to support the demand and are they realistic? Is it a generally central topic? We have seen this discussed during the forum. Business spoke about the demand and ministers spoke about balancing the budget and taxes.

Alexey Ulyukaev: I do not think it is a priority. We have demand encouragement tools, for instance, in the car sales sector. It is a workable solution. We will allocate about 20 billion roubles to support a demand for new cars. This enables the declining market to stop falling dramatically. Some other equipment is covered by the programme, too. Mortgage initiatives are supported. Mortgage at reduced interest rates, additional financing to banks to provide mortgage loans with a 12% interest rate supports new construction. This has made available mortgage loans of about 176 billion rubles. We expect this figure to increase by end of the year. We must generally understand that demand encouragement is in many ways import encouragement. Unfortunately, the share of imported goods in the consumer basket offered in outlets and retail chains is large. Therefore, we would like this process to be in line with import substitution trends subject to a national share increase in the consumer market.

The depreciation effect is not that strongly felt here. For example, we have localised companies here selling under international brands from Renault to Indesit and they are many. We could see that they did not succeed with the export of their goods.

Alexey Ulyukaev: The reason for export is a challenging case. It is access to markets, pre-export financing, export insurance, and many other components. We have built an export centre attempting to merge insurance and crediting systems. But there are budget restrictions here, too. I think we can rely on an effect. It is just a delayed prospective, it is not immediate.

Speaking about the effects from import substitution, what are figures there and what industries are involved?

Alexey Ulyukaev: These are also agricultural and food industries.

And lastly, this covers the most important tasks of the Ministry of Economics which are investment indicators. The figure specified by the Russian President was mentioned here during one of the sessions. It is 25% of investment in GDP which is currently 17-18%. What is the current trend in your forecast for the last quarter and the next year?

Alexey Ulyukaev: This indicator in the current situation is about 18%. The target forecast is based on a gradual increase to 22.7% by 2018.

And what are the main sources?

Alexey Ulyukaev: These are traditional sources including internal corporate financing which currently accounts for 48% of the total investment. The second source is bank loans of about 20% (we hope we can gain more) of the total investment. Auxiliary sources are the National Welfare Fund and Russian Private Equity Fund but they are just supporting sources.

Ukraine is expected to accede the EU free trade zone. This has been sort of forgotten now but is it monitored or negotiated? Or is it reasonable to believe that our trade contacts with Ukraine have been reduced to make this matter inapplicable?

Alexey Ulyukaev: It is a fact that they have substantially decreased but it is an important question and it is not about this year, it is about the long-term cooperation. We are taking joint efforts to find a solution. Last Thursday we had another expert meeting in Brussels to consider our solution and the solution proposed by our EU colleagues. We agreed that the second option was not acceptable and we would try to work out the first one. The first solution prepared by our party is a trilateral binding agreement between Ukraine, Russia, and EU pertaining to the implementation of the free trade zone agreement, transition periods for technical regulations, customs information exchange, verification of certificates of conformance, invariability of sanitary and phytosanitary control and so on. The other party proposed another option binding the Russian Federation to maintain a zero tariff policy at the Ukrainian boundary. And our colleagues did not include other obligations in their proposals. We find it unacceptable.

If there is no understanding, what actions would the Russian party take?

Alexey Ulyukaev: We expect some progress here. We will hold the next and probably the year's last bilateral meeting in the ministry in November to reflect on the year-end results. If they stick to their approach and do not accept our proposals as legally binding (with adjustments as we are open to discussion and are willing to adjust the package), we will introduce the "most favourable treatment" for trade with Ukraine and reject "preferential treatment".

And the last but not least. We are on the threshold of major events in global trade. The Trans-Pacific Partnership was set up. And most importantly, its Trans-Atlantic counterpart, including the United States and European Union, is on the agenda. The question is: is it still reasonable to keep WTO in these conditions? And what effect will it have on foreign trade?

Alexey Ulyukaev: These are regional trade unions and regional free trade zones. There is nothing new here, they have existed for ages. It is true that the Trans-Pacific Partnership advances further. It is not only cancellation of tariffs with transitions periods, it is about protection of intellectual property and ecology. The bottom line is that it is a holistic system. Just beware that when they speak about a system, they are not based on a specific document. We do not have any and no one has. They are just bits and pieces and we might be somewhat mistaken. Nevertheless, WTO has just held a meeting of TOP 20 minister of economics and commerce who primarily discussed the next WTO minister meeting scheduled for December and the minimum resolutions to be passed at the meeting. It pertains to the cancellation of excessive export subsidy and global trade transparency issues. We believe these resolutions will be adopted.

In other words, assuming there is a Trans-Atlantic free trade zone, including the United States and EU, will it be difficult to deliver our products, including commodities, to the European market, due to preferences for competing American goods?

Alexey Ulyukaev: This is a very specific question which depends on the degree of document study. If the countries remove barriers, it would mean the highest probability of A country market filled with goods from B country within the preferential zone. And third party vendors outside the zone will have fewer opportunities. But America and Europe do not really trade in commodities. But we need to see into the contents of the agreement.

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