Maxim Oreshkin: Russia Does Not Fear Oil Prices Even Below $40
Russian Economic Development Minister, Mr. Maxim Oreshkin, speaking in the margins of the Russia Calls! Forum has told Business FM Editor-in-Chief, Mr. Ilya Kopelevich, about fundamental economic growth, project-financing factories, and plans to improve labor performance in Russia and block chain prospects.
Surprising as it may be, you say in public that this year must see the growth of 2%. It is your forecast but it is perceived as a surprise. What is the key reason of the surprise?
Maxim Oreshkin: people make their assessments of the future always looking into the past. The story is simple here. We have seen two very problematic years: 2015 with the GDP decreasing by 2.8% and 2016 with GDP decrease continuing actually. The crisis has hit the population income very hard and the expectations have been based on the negative performance or negative trends and very few people have believed that the economy will start recovering. Actually, it is recovering not very fast now and the income has to go a long way to recovery. However, the trend is positive and it will continue as both the Government and the CBR do everything to retain this positive trend.
Nevertheless, these 2% are the main thing. Although it is not a huge success, it is still better than what seemed to us a year ago. Could it be a temporary phenomenon? How much the current growth relies on growing investments, especially private ones and not public ones such as the Kerch Bridge?
Maxim Oreshkin: If my memory serves, private investments account for the bulk or circa 80% of the investment structure. Therefore, any growth of investment activity we see or circa 4% increase YTD YoY comes from private investments primarily. The task is to do everything to make investment activity grow and here I would emphasize two key priorities. The first priority is creating comprehensible and predictable conditions for the business to make these investments happen. All the structural reforms of macroeconomic policy that both the Government and the CBR has implemented for the last two to three tears aim precisely at creating the predictable macroeconomic structure to minimize the risks of abrupt changes to the situation. It is the first part.
The second part is supporting investment lending and new project financing in the new lending cycle of the Russian economy. All programs we have started this year such as SME financing for investment purposes under the Six And A Half program or the programs that will start really soon such as the project financing factory (in the first quarter we expect executing the first syndicated project financing loans) or the infrastructural mortgage being infrastructure financing (this program is expected to start in the second quarter of the next year). All the projects aim at supporting investment lending and investment activity.
Anyway, does the two-percent growth indicate low recovery growth basis? Are there any fundamentals that would ensure even such growth in the future?
Maxim Oreshkin: The cyclical decline of this economy has been very small. If we look at unemployment performance, is has seen virtually no growth during the crisis. Among other things, it results from the decision taken in relation to macroeconomic policy to avoid increasing unemployment. It is very important. It has been for the first time. Virtually all the crises in the USSR in the late 1980s and in the early 1990s and in the modern Russia have always seen increasing unemployment. It is for the first time that we have been able to contain the process meaning that the economy has seen no cyclical decline and the recovery is fundamental.
Now, let us move to a broader picture being the Russian performance within the global framework. The International Monetary Fund has published its global survey not long ago providing statistics only. For the last eight years, the Russian GDP growth has been 4.3% while the global one has been 30%. Not to be afraid we must say that in Japan it has been slightly over 4.4%, 11.5% in Belarus and even 12.7% in the US. We still rank 160th. During the first decade of the century until 2008, we have seen quite different growth rates. To return to the global track, in your opinion, do we need any fundamental changes to the economic policy, governance and approach, or have we already started developing normally and all further economic policies must limit themselves with microeconomic governance only?
Maxim Oreshkin: this negative statistic data results from the data and performance of the last three years. One must understand that for the last three years Russian economy dependent on oil prices over USD 100 per barrel has adapted itself to low oil prices. Now, the budget and payment balance will be fine even though oil prices decrease to USD 40 per barrel. This basis underlies our entire macroeconomic policy. Therefore, benchmarking the Russian economy against it is not quite fair, as we have been undergoing this structural change. Currently, we have achieved stable growth at low oil prices. The USSR could not handle it when oil prices fell in 1985 to 1986. It resulted into the major crisis in 1997 to 1998 when oil prices were declining as well. Now, it is a fundamentally different response to very heavy external shocks and this benchmarking is not quite right. Still, one must look forward and not backward: 2% growth this year with the target scenario of achieving 3% in 2020.
Changing the policy radically is certainly not required. We must do the fine-tuning of what we are doing now to improve the business climate further. Now, we are going to submit our new control and supervision bill to the State Duma to change control and supervision conditions for all Russian businesses and to improve quality of interactions with the controlling bodies. Fine-tuning all these elements, improving investment climate quality, supporting investment lending, developing digital economy services and many other priorities are numerous things one can talk about for a long time.
Therefore, is consistency the first and the most important element of this Government's approach?
Maxim Oreshkin: Consistency, comprehensibility and transparency of the policy are very important and must be relied on to ensure high economic growth rates. Economic growth likes stable conditions, smooth and gradual improvement thereof without any sudden swings. Such sudden swings cannot ensure economic growth.
As far as predictability is concerned, Vedomosti has published the Finance Ministry's letter consisting of two parts. The first parts suggest further liberalizing the currency framework, not requiring exporters to return their foreign exchange revenues under normal conditions other than certain crises and, vice versa, granting the Government and the CBR emergency powers to require that exporters return and sell their foreign exchange revenues immediately and on a mandatory basis in emergency. I would like to ask about the very possibility of such emergency. Where can it result from? Can it result from, for example, implementation of the US sanction law in the Russian foreign exchange market?
Maxim Oreshkin: First, I would like to comment on the letter of the Finance Ministry. I also believe that foreign exchange controls mentioned in the first part and retained by it are rudimental. They must be disposed of as they prevent development of foreign commerce, export and global value chains in the Russian Federation. Therefore, going forward is required here. Some colleagues may say that there are FATF requirements and financial security matters. Still, one must look at other countries. They also comply with FATF requirement and ensure their financial security but the frameworks there are simpler, less costly and less burdening for the business. Therefore, we must be not worse but better than other countries; we must not only comply with FATF requirements and ensure our financial stability but also maximize the business comfort.
So, do you believe that the first part with the liberalization idea is more important?
Maxim Oreshkin: Certainly.
Let us move on to the emergency mentioned in the second part of the letter. Does it really threaten us?
Maxim Oreshkin: I believe that the second part has appeared quite accidentally. For quite a long time already, we have had no limits on equity transactions. We have survived two major crises in 2008 to 2009 and 2014 to 2015. Both crises have seen highly volatile financial markets and highly volatile economy but still, neither the Government nor the CBR have suggested adopting any kind of equity limit. Now and for the last three years, we have structurally reformed our macroeconomic policy to establish strong domestic economy safeguards against external fluctuations. Inflation targeting, budget rules and foreign exchange purchases by the Finance Ministry jointly form a very good safety buffer from the standpoint of external environment fluctuations. Therefore and given the new existing mechanisms, talking about any equity limits is simply incorrect. I believe that this part has found its way in the Finance Ministry's letter due to red tape and due to technical reasons.
The second part is still about a certain emergency or threat to the foreign exchange market where, vice versa, the CBR is granted emergency powers to manage foreign exchange revenues rapidly. I would like to ask about the very possibility of such emergency. Can implementation of the US sanction law result into such emergency in theory?
Maxim Oreshkin: The primary and best way to protect the economy against possible adverse external events including sanction laws is the correct macroeconomic policy, the rules and performance of the inflation targeting and other tools we have developed. It is impossible to protect the economy with limitations. Only correctly developed institutes of macroeconomic policy can do it.
My next question is about the USD exchange rate. The only forecast of the ministry you chair that still cannot be fulfilled is the RUB to USD exchange rate. Early this year and even in spring, you have forecasted that it would be RUB 68 year-end. Currently, it has not reached even RUB 58.
Maxim Oreshkin: We have issued our forecast in April talking about excessive strengthening of the Russian Ruble. My primary idea is that the Russian Ruble has deviated from its fundamentals. If one looks at the effective Ruble exchange rate performance since April, the decrease is circa 10%. Thus, the Russian Ruble has weakened but has not weakened against the US Dollar, which is really the case. The forecast of 68 Rubles has been formulated at USD 40 per barrel, while we have been forecasting slightly below RUB 60 per USD at USD 55 per barrel. Why has not it weakened? The US Dollar has weakened materially against all foreign currencies including the Euro, the Chinese Yuan and other developing currencies. The Russian Ruble has not been an exception to this rule and has strengthened against the US Dollar.
For euro, your forecast has been over RUB 72.
Maxim Oreshkin: It has really been a mistake about the USD to EUR exchange rate. In April, our forecast has been at 1.06 to 1.08, but now, as you know, it is 1.17. Our Euro forecast of RUB 62 to 64 has been lower than the exchange rate of 67 to 68, if I am not mistaken, that we are now seeing in the market. We have been inaccurate about the EUR to USD exchange rate.
Now, let us move on to the project-financing factory. The name is not quite clear to everyone now. It will be formed on the VEB basis. We are very proud of our growth in numerous ratings of the Global Economic Forum, Doing Business and global competitiveness level. Still, the rating includes the business financing availability section, and here we have gone down to the 112th rank. Why does it happen?
Maxim Oreshkin: First, there has been a period of growing interest rates against the background of crisis phenomena. Gradually, we are leaving it behind us with the rates decreasing further. Still, I see the problem here with underdevelopment of certain investment financing tools, and that is why we have suggested implementing some projects now. What tools are these? SME investment lending comes first here. Therefore, the Six and a Half program has been implemented providing the rate of circa 10% to the final borrower. This program has been going on for three months since July. SMEs have been granted RUB 18 bn of loans and the amount would reach RUB 50 bn year-end. The trends exists, and the program is already operational.
The other story has been more complex and has taken us a bit more time to prepare it. It is financing of greenfield projects or the so-called project financing. The Russian banking system simply has no historically significant experience of such lending and CBR governance has been incorrect. Therefore, we have focused on the entire chain and have attempted to take some accurate decisions without excessive costs for the government for the purposes of debottlenecking here.
What will the internal workings of the project financing factory look like? Primarily, projects would be financed on arm's length conditions by private banks. It would ensure that only efficient project receive money especially given the banking system cleaning underway currently. The second aspect is changes to the CBR governance. For the first time and in the trial mode for now within the framework of the program, provisioning and equity requirements have been decreased for project financing. In the future, we would consider applying these approaches further. It is a great step forward and I must than the CBR here for its support of the initiative.
The next matter is the leverage of private financial resources entering the projects. Within the syndicated lending framework used to finance such project, the senior tranches would be the least risky. They would be taken on by the VEB's subsidiary with its government guarantees and therefore profitability for other investors in the project would be increasing. In this connection, the private investor would not only bear the project risks but also would receive more income.
Who would ensure such increased profitability, the borrower?
Maxim Oreshkin: Undoubtedly, the borrower. Still, given that the portion of the loan would be financed at the rates approximating federal bond rates, the remainder of the loan would ensure greater profitability. If the lending margin were 3 to 4% for the borrower, it would convert to 7% for private financing, as the least risky portion of the loan would be financed without any margin. This arrangement would allow the gears to rotate faster.
It has so many components. Is it operational?
Maxim Oreshkin: It is due to this very reason that implementation of this project has taken half a year of detailed negotiations with banks, retirement funds and other investors, and the Finance Ministry. We have developed the arrangement that we believe would work. There is the third important element. Within the framework of these operations, the government is ready to guarantee that the inflation does not exceed 4% long-term.
It must guarantee to lenders that the rate is not high. How would the government guarantee it?
Maxim Oreshkin: With its balance.
That is, with budget guarantees.
Maxim Oreshkin: In this case, these are subsidies the Government is ready to grant where inflation exceeds the CBR target values. The Government assumes the risk when issues its floating coupon bonds. Actually, the government is including the same interest risk into its balance sheet. Therefore and only in this case, such mechanism may be implemented as well.
I have seen the ongoing dispute about the size of such government guarantees.
Maxim Oreshkin: No, there is no dispute here. In the budget, it is circa RUB 300 bn. It is the starting amount to be used gradually and as it is drawn, we will consider increasing it.
Therefore, the lending volume based on this amount...
Maxim Oreshkin: would exceed half a trillion Rubles.
Would it change the situation materially on the overall economy scale?
Maxim Oreshkin: Our investments stand at RUB — 20 trillion per annum. If we conclude deals for RUB 400 to 500 bn, it would 2% of additional investment growth or a quite large contribution. This small business-lending program influences the population income growth and employment more than it influences the investment activity itself. The third major element is the so-called infrastructural mortgage that would also allow increasing investments into the infrastructure. All these three elements set forth in our forecast for the next three years would increase investments by circa 5%. It is a very conservative forecast for all these programs. If they were implemented in full, the investment growth would be more.
Which industries must the mechanism influence primarily?
Maxim Oreshkin: At the first stage, these are the industries set forth as priority ones in the Vnesheconombank strategy. Primarily, these are sectors of economy associated not with raw materials but with exports and new technologies.
What businesses may participate in it?
Maxim Oreshkin: The loan deal must be worth at least RUB 3 bn. That is, these are moderate and major projects.
Let us move on to another topic. Even from my personal acquaintances, I know that the Economic Development Ministry is now actively recruiting, hiring and inviting employees from Moscow offices of such companies as McKinsey and other international advisory and auditor companies. What do you need such specialists for? It is not so easy to engage them to public service. How are they incentivized?
Maxim Oreshkin: It is hard. Some people go to our Ministry with their salaries decreasing three- and four-fold. We are working for the idea, primarily.
What are they needed for? They are advisors; they are used to analyzing certain businesses and doing specific private project. What exactly do you need such people for?
Maxim Oreshkin: Now, they are working on projects for improving this country's competitive edge and creating new development mechanisms for this country. The primary objective is gathering the most talented people into the most talented team in the country to promote such changes that make common people's lives easier.
What projects are you tasking them with? Improving performance of the automotive sector? Developing some labor performance improvement plans? Are such project macroeconomic or specifically local ones?
Maxim Oreshkin: Let me give you a simple example. Ms. Yulia Urozhaeva has come to us from McKinsey and currently is employed as the aide actively governing the labor performance improvement project we have just started launching. This year, we are working with six pilot regions and Rosatom that assist us and have made a huge progress, and the Industry Ministry is participating in the project. It is a specific project that, in our opinion, would contribute to economic activity and its quality in this country.
Therefore, your offer or your plan to increase labor performance in this country relies on the government giving private businesses money for 15 years for private businesses to hire internationally recognized consulting companies to develop plans for them...
Maxim Oreshkin: You have got me wrong here, I am afraid. The primary objective of the project in connecting with labor performance is promoting and disseminating the most efficient managerial practices among Russian companies. Starting with processing industries we are going to cover the entire economy including the service sectors, the construction where labor performance is very low, the public sector where using advanced managerial practices is critical as well. The primary goal of the project is supporting and distributing the most advanced cutting-edge managerial practices among Russian companies for them to use them and improve their performance frequently without any material investments.
Which accounts will be provided further?
Maxim Oreshkin: Budget expenses for this priority project, primarily, stand in connection with employing and training people dismissed by such businesses. Another mechanism engaged as well is the Industry Development Fund loans. These loans are repayable monies the companies would be using to finance development of their performance improvement programs. On the one hand, the company must develop the project and we would support it with our knowledge and loans, and then, which is the most important, we must not forget about specific people employed by the business, provide them with assistance and re-training services, assist them in finding new jobs with salaries greater than their current ones (preferably). It is the second part requiring the bulk of budget funds.
Let us talk about the currently trending topic of block chain and crypto currencies. Generally, everyone has already understood that these are two different things. Your latest words on this topic have been quite admonishing and you are not the only one here. Recently, a wolf of Wall Street has called ICOs possibly the largest fraud in history. Still, our financial authorities have started considering creation of crypto Ruble. Let us leave criticism of bitcoin aside for now. Is crypto Ruble necessary? What individual economically useful function would it perform?
Maxim Oreshkin: Let me answer a bit different question. What do we need? We need investments into new technologies and understanding of their operating principles. Russian must be the leader in knowledge of new technologies and implementation thereof. When working with the block chain technology being the distributed registry technology, we at the Ministry, for example, have identified a number of priorities where we are implementing them. Our agency, the Rosreestr, is a good example here. Currently, we are planning to launch our trial project in Moscow to operate in parallel with the existing system. If it is successful, we shall move further. The first stage is simple accounting, while the second stage is implementation of smart contracts. Such smart contracts for real estate deals would decrease government costs materially and, most importantly, the costs of those who transact in the real estate market both from the standpoint of monetary costs and from the standpoint of the time such transactions take. It would make redundant the bulk of intermediaries to such transactions. For example, the role of real estate agents would decline abruptly as the information on the object would be public and authentic simplifying conclusion of the deal.
Are we going to be one of the ten countries to switch the real estate registry to the block chain technology?
Maxim Oreshkin: We are going to try to lead the process.
A trustworthy IT specialist I know has told me that the block chain technology suits maintenance of real estate registers and numerous commerce and logistic processes with many participants.
Maxim Oreshkin: Therefore, we are currently testing the block chain internal procurement and internal document approval systems of the ministry.
Still, he has told me that the block chain technology is not suitable for finance itself as it is impossible to correct the error in the system, which finance requires. Would you agree?
Maxim Oreshkin: I would also say that the cost of one crypto currency transaction is so high that its make large-scale use of the technology pointless.
I would like to return to the matter you have been painstakingly avoiding, the implementation of the US sanction law. Let us still forecast the foreign exchange market situation subject to specific scenarios.
Maxim Oreshkin: I must say again that our primary objective is to stand ready for any adverse external scenarios. Here, the Government is working proactively to prepare to any external shocks. These may include not only sanctions but also falling oil prices. For example, during the latest crisis, the falling oil prices have accounted for two thirds of the negative while the sanction matters account for only one third of it. Oil market risks and Chinese economy risks may materialize, and the masterful economic policy is knowing what to do and in which case.