It is barely two years since the Sochi Olympics, but Russia is already at work preparing for a new mega sporting event – the 2018 Fifa World Cup. Yet even as the country looks forward to hosting some of the world’s biggest football stars, it is struggling to digest the financial costs of its last great sporting event. With Russia now being forced to bail out Vneshekonombank (VEB), a troubled state-owned lender, the bill for the Sochi Olympics is finally coming due and provides a cautionary tale about the risks hidden inside Russia’s state-owned banks.
Many Russians might prefer not to compare the Sochi Olympics with the football World Cup. The winter olympics in February 2014 was accompanied by a political storm that the government would rather not repeat. The games were intended to showcase international friendship and cooperation, but the run-up to the opening ceremony was marked by bickering between Russia and the West over gay rights and the deteriorating situation in Ukraine, and many Western leaders responded to Russian legislation on ‘gay propaganda’ by boycotting the Olympics entirely.
The 2018 World Cup is no less in the political spotlight. For one thing, many Russians believe the corruption scandal at the football world governing body of Fifa – whose president, Sepp Blatter, was ousted earlier this year – was actually a Western plot to spoil Russia’s plans to host the upcoming tournament. Recent revelations of widespread doping in Russian sports are interpreted in a similar light.
Yet it is not only in politics that the Sochi legacy remains with Russia. It is present in financial terms, too. The government funded the Sochi games in a manner that was neither transparent nor efficient. The Olympics were marred by cost overruns from the beginning, in large part because construction contracts were distributed not on the basis of competence but on political connections. When mismanagement led to construction delays, other state-owned firms were sent in to sort out the mess. On top of that, few projects were designed with profitability in mind, and now – only several years after the Sochi games – it is already clear that many Olympics-related construction projects will never make money.
This was made possible by hiding the costs of the Sochi games within Russia’s opaque banking system, above all via VEB, a state-owned “development bank”, which is now in the midst of a controversial bailout.
There are several reasons why VEB needs a bailout now. For one thing, the bank was heavily involved in Ukraine, with $8bn invested in metals and mining in the country’s eastern region, according to its former CEO. These investments were justified only partially on business terms, and partially in accordance with the Kremlin’s foreign policy aims.
A second reason for VEB’s trouble is Western sanctions. The bank had come to rely on relatively inexpensive foreign financing to roll over its debts, accumulating $20bn in foreign currency debt. But under US and EU sanctions since 2014, however, VEB has struggled, and failed, to find a new source of funds in the private sector.
Finally – and perhaps most importantly, though credible data is hard to come by – losses from the bank’s loans for Sochi construction projects have driven it deep into loss. Indeed, describing VEB’s involvement in Sochi as ‘lending’ misses the point. In all likelihood, the bank’s managers realized that their loans to oligarch-linked business groups who were managing Sochi construction projects were not likely to be repaid. But they had little political choice: VEB was in essence helping to fund the Sochi games. By describing its payments as “loans”, the bank was able to defer recognising the true cost, a move which had short-term political and financial benefits.
Now, though, the downsides of such an approach are becoming clear. VEB is undercapitalized, and with assets of over $50bn it is widely seen as too big to fail. Yet this is the worst possible time for the government to be saddled with an additional financial burden, given that it is already struggling to hit its 3% of GDP budget deficit target in 2016. Yet despite the cost, the government is likely to agree soon on a bailout plan for VEB.
What lessons does the saga hold for Russian banking and public finance? One conclusion is that the government should be transparent about costs. Hiding public spending in bank balance sheets may be politically popular, but no matter how it is disguised, the bill will eventually come due.
Second, the story of VEB raises questions about why the institution exists in the first place. In theory, it is a development bank that is intended to boost and to diversify Russia’s long-term economic growth. In reality, it has proven to be a costly albatross, a tool by which powerful groups can dump debts onto a balance sheet that the government is ultimately liable for supporting.
As Russia looks forward to the 2018 World Cup, it should learn the lessons from the Sochi Olympics, and from all of VEB’s many other failings. So long as institutions like VEB exist – complete with their lack of clear purpose but with resources to spare – politicians will find ways to abuse them.
Chris Miller is Associate Director of the Program in Grand Strategy at Yale University. Follow him on twitter @crmiller1