bne -

The Kremlin is calling for 5% economic growth, but the only way to achieve that is by turning on the spending spigots and reversing the Central Bank of Russia's (CBR) current tight monetary policy. The CBR has nailed its inflation-fighting colours to the mast, but with its chairman, Sergey Ignatiev, due to be replaced soon and a new financial mega-regulator in the works, the Kremlin's leverage over Russia's monetary policy and the central bank's vast cash reserves could change dramatically this year.

The CBR has covered itself in glory over the last decade. The battle-hardened central bank has fought off a number of potentially financial sector-busting crises with aplomb.

First it oversaw the recovery of the 1998 ruble crisis and managed to quickly put the banking sector back on its feet, which contributed to the 10% growth the economy posted in 2000. Then it dealt with the 2004 "mini-bank crisis" that threatened to bring the sector down, after the medium-sized Guta Bank went bust. And when Kit Finance went bust at the start of the 2008 meltdown on September 17, it found a white knight for the consumer lender by lunchtime the same day. Finally, it implanted a controlled 30% devaluation of the ruble in 2009 that economists initially lambasted, only to change their minds completely a year later when it delivered a rapid economic recovery. Although it is not generally acknowledged, Russia has boasted one of the best-run central banks in the world.

That all might change later this year. In January, the government drew up a list of potential replacements to replace Ignatiev as chairman - although it is not naming names yet. Amongst the candidates, according to press speculation, are: the CBR's public face, First Deputy Chairman Alexey Ulyukaev; liberal economist and Deputy Prime Minister Arkady Dvorkovich; former finance minister Alexei Kudrin; VTB Bank CEO Andrei Kostin; and VTB 24 CEO Mikhail Zadornov, who is a wunderkind of the retail banking world.

Ulyukayev would be bne's favourite choice, as it would mean continuity with the current policies. Kostin would be our least favourite; he grew up as an economic attaché at the Soviet UK embassy where he served with his close personal friend and Gosbank representative Viktor Gerashchenko, the previous CBR head who led the banking sector into the 1998 crisis. Kostin cut his banking teeth working for Alexander Lebedev's National Reserve Bank before running the state banking giants, first Vnesheconombank (VEB) and now VTB, but is an old school-style banker.

Big brother

The other relevant event on the horizon is the creation of the mega-regulator that will take over the supervision of both the banking sector and the development of the domestic capital markets.

The State Duma adopted in a first reading a government bill to amend the Russian Federation's budget code and to set requirements for the staff of a specialised financial organisation on January 25. The bill will see the central bank absorb the stock market regulator, the Federal Service for Financial Markets, to create a mega-regulator. Russian President Vladimir Putin personally backs the move, which could happen by the end of this year. But the danger, say critics, is that doing so could undermine the independence of the central bank in the process.

And there is also talk of setting up an open joint stock company to manage Russia's sovereign reserves that has also raised questions in some quarters. The company has the working name of the Russian Financial Agency (Rosfinagentstvo), which will be given the job of managing the state's financial reserves derived from mining and oil exports, currently held in the Reserve Fund and National Welfare Fund. The agency will also take over managing Russia's debt obligations and pension funds, which is currently the job of VEB.

Rosfinagentstvo will completely change the relationship between the state and these large piles of money - some $300bn or a bit more than half of all of Russia's hard currency reserves. VEB is not actually a bank, but functions by dint of a special decree of the president that has to be renewed each year, whereas Rosfinagentstvo will work under contract with the Ministry of Finance.

The motive driving this change is the Kremlin's growing awareness that the state's finances are in serious trouble, as the current system will not be able to cover the country's pension obligations in the future. Russia famously has a very low debt level, but Deutsche Bank argued in a report in February that if the state's promises of future payments are taken into account, then things don't look quite so rosy.

"If the implicit debt stemming from the increase in pension- and health-expenditure is taken into account (and adequately discounted), countries like China and Russia, the two countries with the lowest government debt levels, begin to compare much less favourably to countries with currently large public debt burdens but limited implicit pension and healthcare liabilities, such as India," says Markus Jaeger, an economist with Deutsche Bank.

According to the International Monetary Fund (IMF), the difference between the present value of cash inflows and the future spending increases in 2011-2050 is 100-260% of GDP for China, Russia, South Korea and Turkey, but less than 100% of GDP for India, Mexico, Indonesia, South Africa and Poland.

This massive increase in spending is the "Ghost of Christmas Future" for Russia - not necessarily its fate if the money it has now could be made to work a little harder. And that is the point of the new agency - it will have a mandate to "most actively" invest its funds. In 2008, the then-finance minister Alexei Kudrin initially floated the idea for Rosfinagentstvo. It now looks increasingly like it will become a reality. But the idea of taking funds that are under the direct control of the state and giving it to a semi-independent body scares the B'jesus out of some commentators. "Consolidating such huge state-owned reserves in the hands of a trading/commercial company should be seen as risky, given that Russian economy is inefficiently managed, bureaucratic and afflicted with pervasive corruption," wrote Ewa Fischer of the Centre of Eastern Studies (OSW), in a note on January 30. "The money earmarked for infrastructure projects may be directed to companies involved with the ruling team. This was the case in a number of projects funded from the state budget, such as the construction of facilities for the Winter Olympic Games in Sochi, and investments in Vladivostok connected with the summit of APEC countries held there in September 2012."