There was some real drama at this year’s European Bank for Reconstruction and Development annual meeting in Cyprus, largely a glorified investment roadshow for most of the countries in its patch: the board of governors “overwhelmingly” voted to reject a bid by a high-level Russian delegation to restart the development bank’s lending there.
In rival back-to-back press conferences on May 10, the EBRD president Suma Chakrabarti announced that the vote on Russia was “final”.
“The board of governors overwhelmingly agreed that the bank has complied with its own internal rules with respect to its engagement with the Russian Federation. That is a final and binding resolution,” Chakrabarti said at the press conference.
It was followed half an hour later by a press conference held by Russian Economics Minister and EBRD Governor Maxim Oreshkin, who read out a long list of complaints and claimed that without Russia the bank’s profitability would plunge.
In the first part of his speech Oreshkin quoted the bank’s own charter that states: “No member country can be suspended or otherwise restricted on any grounds or in any manner not set forth in the agreement establishing the bank.” Oreshkin went on to say that this creates a dangerous precedent where any international financial institution (IFI) could curtail member rights based on the statutory documents. “We see that the EBRD has become a tool of foreign policy and is not a development institution,” Oreshkin said.
Oreshkin’s presser ended in mild threats that Russia would not participate in the EBRD’s recapitalisation “when it inevitably becomes necessary”, and said Russia would complain to the international ratings agencies, as “the EBRD no longer deserves its ‘AAA’ rating”.
The showdown is the culmination of a fight started in 2014 when the leading members of the EU told their directors on the EBRD board that they should refuse to approve any new investment projects in Russia, after Moscow annexed the Ukrainain territory of Crimea and began supporting pro-Russian separatists in the eastern region of Donbas with arms and personnel.
The ban on new investment in Russia is not the same as sanctions – as the EBRD is an IFI it is exempt from sanctions – but it has still left the bank’s €3.77bn Russian portfolio in limbo. Existing investments can continue to be serviced but no new projects started.
Russia has already twice requested that the EBRD resume lending, but only to the board of directors that actually run the bank. This was the first time Russia had appealed to the board of governors that make up the EBRD shareholders. The Kremlin made sure its appeal was high profile by sending not only Oreshkin to head the delegation, but also the CEO of state-owned Sberbank, German Gref, who attended the meeting to sit on a panel about promoting competitiveness.
But the cards were stacked against Oreshkin from the start. The board of governors is dominated not only by the EU, but also by members from Canada, the US, Japan and China that joined last year.
Oreshkin gave a long speech to the governors, according to those in attendance, which sought to make two main points: the EBRD had broken its own rules by refusing to put up new projects to the board for approval; and that without the Russian business the bank’s profits will be badly hurt and this will undermine its financial stability.
The first point turns on a technicality and Oreshkin brought a legal opinion written by an emeritus professor from Sorbonne university that concluded the EBRD had broken its own rules. But he said the board of governors “evaded” the discussion in the meeting.
Chakrabarti reiterated that the board had studied the issue and voted that it had done no wrong. Under the EBRD’s charter all new investments must be approved by the board, which is at liberty to refuse any project.
Part of what has incensed Russia is the blanket nature of the ban, which largely affects companies in the private sector that have not been included in the international sanctions regime. In the early negotiations in 2014 the Russian side were pushing for the private sector investments at least to continue, even if those with state participation were blackballed.
More than half of the EBRD’s Russia portfolio is made up of debt, with the remainder comprising public and private equity investments. About 83% is invested in the private sector, with just 17% in state-controlled entities, few of them on the sanctions list.
“During the meeting we highlighted the way the bank broke its own rules,” related Oreshkin. “In our opinion the freeze is unfair. It is preventing lending to the whole economy and not just selected sectors as the EU and US sanctions do.”
The points on the EBRD’s financial health were far more contentious. The Russian delegation kicked off by saying: “It is not Russia that needs the EBRD, but the EBRD that needs Russia,” going on to highlight the economic recovery that has taken hold since the start of the year.
“On the bank side, the situation is different,” said Oreshkin. “When the freeze was imposed, Russia was providing half of all the bank’s revenues at that time… As the revenue flow from Russia will decline, the bank will inevitably rapidly decline in profitability.”
The EBRD denied Oreshkin's claims, which it says are inaccurate projections.
Oreshkin claimed that the bank's cost/income ratio has worsened, though it is running at a pretty healthy 42%. He continued that Russia doesn't believe the EBRD deserves its ‘AAA’ rating and would present all its evidence to the international rating agencies recommending a downgrade.
“Well, that decision is not up to Russia,” one senior EBRD staffer was heard saying on the sidelines of the press conference.
As bne IntelliNews reported at the start of this week, the EBRD is slowly winding up its Russian portfolio, as its share in the bank’s profitability falls. Russia now makes up 10% of the bank’s portfolio and will continue to lose ground as the EBRD ups investment in its other countries of operation, including Ukraine, which has become a major recipient of new EBRD money in the last two years.
However, the EBRD’s Russia portfolio remains the second largest after Turkey, even after shrinking by 30% to €5.35bn a year ago, according to data available on the lender’s website. The bank is still involved in 788 projects but the run-off in the portfolio is clearly accelerating, as assets had been worth €6.3bn in mid-2015.
Chakrabarti stressed that the EBRD is maintaining contacts with the Russian government and is continuing its work including a small and medium-sized enterprise (SME) advisory programme that has received some funding from the Russian government since the freeze on EBRD activity was imposed. At the same time the EBRD has been facilitating some Russian private sector investment in the bank’s other countries of operation in partnership with the bank.
“I for one look to continuing to engage with the Russian authorities. And as you know we have a track record of 25 years of that,” said Chakrabarti.
One of the ironies here is the EBRD itself is not comfortable with the freeze on the Russian business, although it is far too diplomatic to say so in public. Chakrabarti has made it plain that this is the decision of the governors and not the bank’s policy. In the meantime the bank continues to work diligently on maintaining its existing investments and ensuring they deliver on their mandated goal: making a transitional impact. And in private comments to bne IntelliNews, the local staff are openly angry at the decision as, irrespective of the geopolitical showdown, building a healthy Russian economy based on transparent and liberal market principles is in everyone’s interests, they argue.
Russia’s push to re-join the EBRD family is as much a question of pride as necessity and also a plank in the Kremlin’s on-going campaign to sow seeds of dissent in Europe where Russia enjoys much support, especially in the EBRD region.
The EBRD has provided much needed money and expertise to projects in Russia and has been the biggest single foreign investor for much of the last decade. And its money is needed more than ever now. Foreign direct investment (FDI) has collapsed in recent years from a peak of $74.7bn in 2008 to $4.8bn in 2015. In 2016 FDI recovered somewhat to $25bn, according to Rosstat, but the bulk of this was profits reinvested by foreign-owned businesses already operating in Russia. In this environment an extra $1bn-$2bn a year from the EBRD would be useful, but insufficient money to make a material impact on the economy.
Despite the fracas there has been no talk of Russia quitting the bank. Chakrabarti made it clear neither side was contemplating Russia’s withdrawal from the bank. Oreshkin confirmed after the presser that Russia had no intention to quit the EBRD or to stop doing business with it.
The Kremlin is now fully focused on reforming the economy, albeit in its own terms, and the EBRD would be in a better position than ever to advise and support this drive. Former Finance Minister and co-head of the presidential council Alexei Kudrin is due to present a new blueprint for reform to president Vladimir Putin in the second half of May.