Alex Nice of The Economist Intelligence Unit -
Since the EU and US imposed sanctions on Russia’s banking, defence and energy sectors in mid-2014, there has been speculation that the Russian government would use its sovereign reserves to provide cheap financing to companies effectively shut out of international credit markets. Yet despite strong lobbying from powerful state-owned companies, the government has to date been reluctant to commit assets from its National Wealth Fund (NWF, a sovereign wealth fund) to large investment projects in Russia. As disputes over future budget spending intensify, the stability of the NWF suggests that fiscal conservatives in the government can still fight their corner.
As of August 1, the NWF held the equivalent of just under $75bn (RUB4.4tn) in assets, accumulated from surplus energy revenues during Russia’s boom years. Under government rules, up to 40% of NWF assets can be invested in infrastructure projects in Russia, with a further 10% assigned respectively to both the Russian Direct Investment Fund and the nuclear holding Rosatom.
The official purpose of the NWF is to provide sustainable support to the pension system. Its assets are, therefore, intended to be placed in secure long-term investments that offer a good rate of return. Yet the government has in the recent past ignored these rules for the sake of short-term goals. Most notably, in December 2013 it loaned $3bn from the Fund to the government of former Ukrainian president Viktor Yanukovych, despite Ukraine’s low credit rating. Had Yanukovych not been overthrown in February 2014, Russia would have increased the loan to a massive $15bn.
Following the imposition of sectoral sanctions by the West, expectations were high that the Russian government would raid the NWF to bail out companies and provide short-term support to those no longer able to tap financial markets. Russia’s standoff with the West has consolidated protectionist attitudes within the leadership. From agriculture to medicine, Russian companies have leapt on the autarky bandwagon to lobby for state support and intervention for their particular sectors.
Companies quickly lined up to petition the government for support from the Fund. As early as August 2014, the massive state oil producer Rosneft floated the possibility that the NWF could buy RUB1.5tn of its bonds – coincidentally or not, almost exactly the value of its external debt stock. By October, Rosneft’s wish list had risen to RUB2.4tn, despite the fact that the company’s total investment programme for the year was just RUB730bn. Applications followed in subsequent months from private sector gas producer Novatek, Russian Railways, the so-called Independent Oil and Gas company, the power operator Rosseti, and the Gazprom subsidiary Neftekhim Salavat. The combined value of the applications exceeded the total size of the NWF. Capturing the free-for-all atmosphere, Lukoil’s vice president Leonid Fedun told reporters that, “if everyone else is going to be applying, then we will too.”
But the Russian government has proved reluctant to hand out blank cheques from the NWF to sanctioned companies. As the chart below shows, the bulk of NWF assets remain in foreign currency held on account at the central bank. As of August 1, 69% of assets were held in foreign currency, compared with 77% in January 1, 2014 (applying August 2015 exchange rates in both cases). Around $5.7bn has been invested in domestic infrastructure projects, but several of these, such as the Baikal-Amur Railway and the new Moscow Ring Road, were approved before the imposition of sectoral sanctions. Of the funds allocated since mid-2014, a large share of these (RUB280bn) has gone to recapitalise systemic banks through the acquisition of privileged shares.
Rosneft, the most prominent supplicant for NWF funding, has received short shrift. In February this year, President Vladimir Putin gave a public dressing down to Rosneft boss Igor Sechin for seeking state support for a proposed refinery in the Far East. Of 28 projects put forward by Rosneft by the end of 2014, only five were considered by the government. And in early August, Vedomosti reported that Putin had rejected all but one of these proposals, leaving only an application of RUB89bn to support the construction of a shipbuilding facility on the table.
Overall, the government has so far refused to raise the 60% cap on domestic investments for the Fund, and has broadly stuck to the principle that assets should be used to support high-value infrastructure projects, not as soft loans to cover general operations for struggling state companies.
The government’s approach to managing NWF assets has wider implications for the likely trajectory of budgetary policy over the next few years. It suggests that those in the "economic bloc" advocating fiscal prudence continue to be heeded. While economic policy has taken a dirigiste turn over the past year, the government has so far balanced the demands of industrial lobbies for short-term support against the need to maintain good macroeconomic fundamentals and maintain external buffers.
However, the struggle for state resources is only beginning to heat up. With commodity prices likely to stay low over the next few years, Russia’s elite will be riven by deep disagreements over the fiscal policy and the division of public funds. The finance ministry’s ambitious plans to reduce the deficit to under 1% of GDP by 2018 will come into conflict with spiralling defence commitments and political pressures to boost spending as the next electoral cycle approaches.
The story of the NWF is an encouraging sign of how these conflicts will be managed, but it is early days.
Alex Nice is an analyst at The Economist Intelligence Unit
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