Davos jamboree brings scant cheer for Russia

Davos jamboree brings scant cheer for Russia
Outspoken: Russia's former finance minister Alexei Kudrin
By Ben Aris January 25, 2016

"Committed to building a better world." That is the motto of the World Economic Forum, which just concluded its 46th annual jamboree at the Swiss ski resort of Davos, but pointedly failed to make much progress this year, at least as far as Russia is concerned.

Just how bad things became was underscored when Central Bank of Russia (CBR) governor Elvira Nabiullina cancelled her trip to Davos at the last moment to hold an emergency bank session after the ruble took a fresh plunge, hammered by another wave of oil price falls to under $28 that threatens to destabilise Russia's already pressured banking sector.

The ruble crashed to new post-1998 lows on January 21, suffering one of its biggest intraday drops in around a year. The CBR introduced so-called "forbearance measures" at the end of 2014 – banks are allowed to use a discounted ruble-dollar exchange rate when calculating their capital adequacy – but even the unreal exchange rate looks expensive now that the ruble has tanked again.

The Kremlin quickly rallied and tried to reassure both investors and the population that the fall of the ruble was not a "collapse" and that the state has enough in reserves to weather the storm.

"I would not use the world 'collapse', the rate is changing indeed, the rate is volatile but it is a far cry from collapse," Russian President Vladimir Putin's spokesman Dmitry Peskov told reporters.

Hands off our banks

Russia's other top bankers didn't seem worried and remained at the January 20-23 event in Davos, where they were openly lobbying against having their banks included in the privatisation plan for this year.

VTB's CEO Andrei Kostin told guests at the VTB breakfast: "The crisis is when at 7 a.m. instead of a cup of coffee you need a glass of vodka. I'm still happy with my coffee in the morning, so I did not reach that stage."

More seriously, Kostin, like many other bosses of big state-owned assets is fiercely resisting Finance Minister Anton Silanov's push to sell off shares and make the government a minority shareholder in some of Russia's most famous names. That would end the cushy ride most of these bosses have had – and hopefully also impose some better management on the companies.

VTB is a case in point: under Kostin's stewardship it ran up such large losses in 2015 that the state had to commit a third of the funds earmarked for supporting the struggling banking sector in 2015 to just a VTB bailout of RUB300bn ($3.9bn).

The bank scraped into profit at the end of 2015, but only by pulling a few accounting tricks, according to bne IntelliNews sources. Put another way: the bank's finances are still far from healthy. Yet despite these issues the management has set itself firmly against giving up any control.

"I spoke to the prime minister and ministers in the government and they seem to be very much eager to continue privatisation but the timing is perhaps not the very best," Kostin said, reports CNBC.

The Russian state owns a majority 60.9% stake in the second-largest Russian banking group VTB and holds 50% of the share capital plus one voting share in Russia's largest lender Sberbank.

Sberbank CEO Herman Gref, told CNBC that it could take a year to prepare the ground for privatisation: "I think that we can speak about privatisation at the end of this year or next year, but not earlier ... Now is the right time for privatisation but we must wait for market stabilisation first," he said.

Funding fight builds

These state bosses object to selling their shares at the currently extremely low valuations, whereas the Finance Ministry is simply looking for a way to finance a gaping hole in the budget without cutting social spending. Putin has ruled that the federal budget deficit should not be more than 3% of GDP, which was possible under the original $50 oil prices assumption. But that guess has been blown out of the water in the first weeks of January, and with oil at around $30 Russia will use up all its reserve funds and still not be able to meet the 3% mark; according to some estimates the deficit could be as high as 7.5% this year.

The obvious solution would be to cut the two biggest spending items – military and social. However, Putin has also ruled these are sacrosanct. The Kremlin leader is not willing to climb down from his aggressive geo-political goals that are manifest in the Russian military operations in Syria and around Ukraine (and activily within its eastern regions, by Kyiv's and Nato's reckoning), so spending on military modernisation can't be touched.

And with parliamentary elections scheduled for September, social spending is also out of bounds. The ruling United Russia party barely cleared the 50% mark in the last elections (actually it didn't and had some 12% added to its count which lead to large street demonstrations in December 2011), so cutting social spending, most of which goes to Putin’'s core blue collar constituency, is extremely unattractive.

Of course, all of this could have been avoided if the Kremlin had made use of the torrent of oil cash in the mid-noughties to reform and diversify the economy. Davos has become one of the traditional forums of the liberalisation crowd to voice their views, and this year their calls were louder than ever.

Kudrin leads policy reform charge

Chief wolf crier and former finance minister Alexei Kudrin was on form, calling the state's policies "monstrous".

"It goes to show how inefficient the monstrous methods that are used by law enforcement against business are," he told the WEF audience.

"Given the situation, our budget needs to be regrouped significantly," Kudrin said. "We need to focus predominantly on investment areas to support businesses and the government is discussing these factors."

Russia's bean counters also need to calculate how much each ruble brings in terms of return and investments for the economy, Kudrin stressed: "If we redistribute our budget based on this analysis I hope the population will understand us and within two to three years we can build a foundation for Russia's new economy."

The ex-minister also argued that the ruble and oil price crash have been a "cold shower" for policy makers, suggesting that this time there will be a little more steel in their resolve to make some real changes. However, the remarks of VTB head Kostin and Sberbank's Gref highlight the institutional resistance to change from well placed state managers, and these people are very deeply entrenched.

The 2016 budget was a bet that oil prices would remain at about $50, but that bet has already gone bad. Kudrin said that $16 oil was possible and that with average prices of $30 the deficit would be 6% of GDP. He called on policymakers to "give up hopes of a oil price recovery" and make a new long-term strategy based on low oil prices in the next two months.

"The recent crisis shows everything may occur on the oil market. We need to understand oil prices may reach very low values, while social policy, defense potential and infrastructure should not be exposed," Kudrin said.  "The nearest two-three months for Russia is time to work out an answer to all these challenges. Russia should decide not merely for this year but on its strategy as well." Existing problems can not be resolved within a year, Kudrin added.

Russia still has some wiggle room. The population has built up a cushion thanks to a decade of 10% annual wage rises; Kudrin says Russia has two years of "social calm" in reserve which should be enough time to fundamentally retool state policy and embark on a new direction – if the state acts now.

Oil rebound hopes

In the meantime, Russia is hoping for a rebound in oil prices to ease the pressure.

The CEO of Russian oil major Lukoil, Vagit Alekperov, took part in a meeting of heads of the largest oil companies that was held on the sidelines of the forum. "We discussed the current topics, the forecast of supply and demand. And everyone tend to think that in the second half of the year we will still see an upward trend in oil prices," Alekperov said, expressing a view echoed by IMF chief Christine Lagarde, who said the Fund is watching the growth of demand for oil in recent months and predics a rise in prices in the near future.

On the third day of the event, the price of oil obligingly rose, leading to a 10% jump in the RTS index and producing some optimism among Russian participants. But with oil still bumping along at around $30 it will take more than a few dollars rally in the cost of Brent to fix Russia's current economic woes.