Kremlin Economist Unfolds Russia's Roadmap

What happens when a global financial crunch forces a country to spend foreign reserves to pay bills, or when flames of a petroleum- and minerals-based economy start to flicker? Russia knows: Its government spent reserves to survive the financial crisis, and today it's busy preparing for the latter scenario by seeking alternatives to natural resource exports.

At the center of looming challenges, economic options and policy hurdles is the Russian government's leading economist, Deputy Premier Igor Shuvalov. He's deeply involved in the government's far-reaching "modernization" project, which embraces all sorts of programs from industrial upgrades to improving education. He's also busy bettering the nation's business climate and attracting foreign investment.

At the top of the agenda, Shuvalov said in an interview with Caixin in Moscow, is an effort to improve Russia's fiscal policies. One goal, he said, calls for reducing the percentage of government revenues generated by the energy sector to no more than 10 percent of expenditures, down from the current 40 percent. Another target is to promote Moscow as a global financial hub.

Reflecting a pragmatic defense of his resource-rich country, Shuvalov called for a "wise trade" approach to dealings with China. He said he wants two-way business relations rather than a draining of Russia's minerals and energy in exchange for foreign cash. Yet he spoke well of relations between Beijing and Moscow, calling the current tone "truly friendly."

The interview follows:

On Modernization

Caixin: President Dmitry Medvedev discussed at great length "Russia's modernization cause" in September 2009. How do you define Russia's ongoing modernization strategy?

Igor Shuvalov: When he became president, President Medvedev immediately announced a new development agenda for Russia. He realized the country's whole life should change, including its political life, social life, economy, and so on. He published an article called Go Russia because, you know, we had a very difficult period for 15 years after the Soviet Union collapsed. There were times when we had to survive, and there were times when we built something new, but it was a period when Russia was appreciating its old, global place in the world.

Many assets created during the Soviet era had become pretty old. Old industries became non-competitive. Science and education had to be changed and modernized. The fiscal system and economy needed new approaches for governance, and a new climate for business development needed to be introduced. So all these spheres surrounding us had to be changed.

Now, everybody talks about modernization. People think sometimes the government should have a precise agenda. Maybe you heard about a commission and five directions outlined by President Medvedev. These five directions are closely related to the modernization of Russia, including pharmaceutical, nuclear industries, etc. But in reality, modernization means everything – people's behavior, education, science. It involves everything in life.

For example, a lot of Russian scientists were able to create new technologies, but they were not able to make any business sense out of it. In Israel or the United States, Russian researchers are very popular, and quite a number of them therefore became rich. However in Russia, there's no such infrastructure. Another example is when people drive their own cars in Russia, they do not fasten their seatbelts because it was not the Soviet behavior to wear seatbelts.

When we talk about modernization, it just means we need to make changes.

Caixin: One of the biggest challenges now faced by the Russian economy is that it should rely more on sectors other than energy and resources. How do you plan to encourage people to become more innovative? Do you have a roadmap for how to diversify Russia's economy?

Shuvalov: Yes. When we talk about extensive innovation in the energy sector, it doesn't necessarily relate to energy. Approximately 40 percent of Russian revenues come out of the energy and raw materials sectors. When we talk about new economy, it means that we will depend less on the energy sector. But when we talk about innovation, it means innovation for energy may be the first priority because Russia may be last on the list in terms of energy efficiency. We need to apply new technologies to produce better, cheaper and safer energy with fewer carbon dioxide emissions. We need to consume less energy per unit of production.

Energy comes with innovation. But if you talk about a roadmap or about what to do in order to develop other sectors, my answer is to improve our fiscal policies. We are now reducing our social tax on non-energy sectors. For energy-consuming sectors, taxation is as high as 34 percent, but for other innovative sectors it would be just 14 percent. Meanwhile, we have realized we have certain bureaucratic obstacles and a lot of corruption when new businesses are established.

The answer to your question is, yes. We have a detailed roadmap to attract businesses from Russia and overseas as well to come over to make investments in all industries, not just the energy sector.

Caixin: Can you give me a description of economic development in the post-Soviet era? Can you comment on past and present situations?

Shuvalov: I think it was a period when we were shifting from the Soviet economy into something which we call the Russian economy today.

We have managed to survive with all the difficulties inherited from the Soviet era for the past 15 years. The Soviet Union ceased to exist in 1991, but we start to calculate everything from 1993 when then-President (Boris) Yeltsin and parliament clashed. In December that year, a new Russian constitution was adopted by a referendum the people brought through. It is from that date we started thinking about establishing a new Russia.

In 1996, President Yeltsin was re-elected. In fact, he did not have enough votes in the first round to become president and eventually won the election in the second round. It was a period when our political system was shifting from the Soviet pattern to a new mechanism. We were trying to build democratic principles for life, and trying to impose a real system with division of powers, that is courts, parliament and executive power. Then the real suffering disappeared.

Before 1991, the Soviet people received subsidies from the government. However, all of a sudden, everything disappeared overnight. Most common people suffered and pensioners didn't get paid. Along with new developments and creation of something in building, ordinary people suffered. I remember even in 1996 that many workers were not paid, and their indebted factories were trying to give the workers just simple food to feed their families. Suffering as a definition disappeared in 2000 and we started thinking about the future.

Before (Prime Minister Vladimir) Putin left the Kremlin in 2008, he addressed the nation, proclaiming his ambitious plan for Russia through 2020. He claimed that we cannot achieve less than we had achieved during the previous 15 years and make our country comparable with the best and the most comfortable countries in the world in terms of comforts and safety.

Caixin: What is the major task of Russia's economic reform for the near future?

Shuvalov: We need to be more flexible and adapt to change more quickly. We all remember the old Soviet times when life scarcely changed. The major task of changing as soon as possible does not only apply to the economy, but it should be the No. 1 priority for the economy. We need to learn how to be very flexible and become better at seeking innovation.

Crisis and Opportunity

Caixin: The global financial crisis had a direct impact on Russia's economy. What's your comment on this impact?

Shuvalov: I think the financial crisis helped us. On one hand, of course, it put us in a very difficult position because we started spending all our reserves to make it through the year. But on the other hand, it helped us because everybody started really thinking about the issue of efficiency.

The government and business circle are thinking together about what we can do with people who are not needed in the real sector, to find a real compromise. The government will provide certain conditions for people with real capabilities to create small and mid-sized enterprises, and gradually entrepreneurs can lay off these people from factories.

Background:

In response to the financial crisis, the Russian government implemented an Anti-Crisis Plan in 2009 that included putting aside US$ 3 billion to provide compensation, occupational training and retraining for the unemployed. At the same time, the Russian government provided subsidies to the real economy through a US$ 20 billion program.

Of all its policies, a capital injection by the government into large enterprises was among the most heavily criticized, since these enterprises are inefficient and lack profit potential. Subsidies lowered unemployment risk temporarily, but the limited amount of capital was not rationally allocated. From a long-term perspective, it is not conducive for these Russian enterprises to increase their capabilities so as to realize the overall recovery of the economy.

According to Shuvalov, once Russia gets through the crisis, a more flexible labor market will be introduced that lets enterprises lay off redundant employees. Russia plans to restart the privatization process of large enterprises and relax regulations for small and mid-sized enterprises to give enterprises more autonomy.

In the opinion of Professor Sam Park of the Center for Emerging Market Strategy at the China Europe International Business School, Russia has a long way to go before its institutions are well-established, since it now at an initial stage. Park, an expert on the economies of China, India and Russia, said that in Russia today “even if 70 to 80 percent of the top 200 enterprises were privately owned, the government can interfere with the management of the enterprises at any time.” Thus, it seems Russia faces a twisted, arduous process as it seeks to synchronize pushing forward the privatization process and reforming the government’s role.

Caixin: Do you have concerns about a double-dip recession for the world economy? 

Shuvalov: We follow such risk very closely. However, even if it happens unfortunately, it won't mean trauma for Russia because we have enough foreign reserves to see it through. But I hope, altogether, we would be able to avoid a double-dip recession.

Background:

As a country with the third largest volume of foreign reserve following China and Japan, Russia now holds foreign reserves of US$ 456 billion, down from a peak of US$ 600 billion . Some US$ 200 billion in reserves were consumed during the financial crisis.

Caixin: During the financial crisis, Russia was the first country to call for a more important role of SDR of IMF. What's your comment on SDR's role and the IMF?

Shuvalov: We agreed with the present way in which SDR works independently from IMF's currently accepted share. We spend a lot of the time discussing our common position with the governments of China, India and Brazil. The four countries all are very enthusiastic about the special approaches for spending this money.

Caixin: Russia's economic confidence lies in its advantageous holdings of huge amounts of energy and natural resources, But the volatility of commodities can influence Russia's economy as well. How can Russia avoid a negative impact?

Shuvalov: At present, we cannot avoid such an impact. It's a task that requires a period of five, 10, or even 15 years. It's impossible for some measures to be effective immediately. We have enough foreign reserves. Now, we are looking more closely at China and other Asian economies because you consume more and more energy and purchase more and more Russian products and your economies can maintain growth. Of course, at the same time, we are dependent on the European and other markets as well. If they don't grow, it means prices will go down.

In the case of volatilities you mentioned, if prices go down again, it will hurt our economy, and we have to neutralize this damage with our foreign reserves. But for the longer term, our budgetary policies cannot be dependent at that scale on the energy sector. All experts say that approximately 40 percent of budgetary revenues come from energy sector. The ideal picture would be that the revenues generated by the energy sector would not exceed 10 percent of budgetary expenditures, and the rest of the income from the energy sector would go to reserves. Reserves can never be spent on current needs.

To be less dependent on energy prices, we need to let other businesses start in Russia. Russia can now provide better opportunities for other businesses. China, India, Brazil and Russia are members of the BRIC format. Renaissance Capital, one of Russia's investment banks, has hosted a conference here in Moscow. They say that very soon developing markets will be providing their ideas about how to modernize the world. I think ideas for a new economy will come from our countries.

Russia is rich, with abundant resources, vast territory, well-educated people, strong support from our neighbors, and strategic partners in Asia. We can develop a new strategy of economic development. The most important signal is that we cannot afford to freely spend capital generated by oil and gas exports. If we are saving instead of spending, sooner or later, Russia will find new ways to develop.

Background:

Since the financial crisis, Russia has called at many international events for the U.S. dollar to play a less important role as the international reserve currency. It also advocates adding other currencies to a reserves currency basket, such as the SDR. This is, on one hand, a kind of reaction to a series of stimulus and quantitative easing measures adopted by the U.S. Federal Reserve. On the other hand, it is based on Russia’s geographic discretion. It is easy to reach consensus on issues such as diversifying international reserve currencies, having more representation in emerging markets and developing economies in the international financial institutions, and entitling these entities with more say in the decision-making process.

Russia's stance can also be used to explain why it is so enthusiastic about the mechanism of BRIC, members of which are all major emerging markets. It is hard for Russia to act alone to promote the structuring of a new international financial, economic, or even political order. But with China, India and Brazil on board, the situation might change.

Caixin: Do you have a timetable for Russia's accession to the World Trade Organization?

Shuvalov: It's now completely political because all the major questions have been resolved. For those issues that cannot be resolved at my level, they were resolved when President Medvedev met with President (Barack) Obama, and they talked about the issue seriously. According to a report from the Russian delegation after returning to Russia, I understand that just one, last question is still pending. However, even if we had resolved all the issues by September 30, it doesn't mean we would join WTO automatically.

Everybody is now watching the U.S. position. When the U.S. has better relations with us, they want to help us; when it's getting worse, they refuse us. We've gotten used to it.

What and How?

Caixin: Russian leaders are trying to make Moscow a global financial center. What measures are you going to adopt to make it more business friendly, and what lessons have you learned from the financial crisis in western countries?

Shuvalov: First of all, we don't criticize bankers the same way they did in the West. I think the reason for the crisis lies not only within the banking sector. Many difficulties just happened at once. I believe that we cannot develop without the financial sector, including banking and credit industries, which is like blood for the body that we cannot survive without. Russian banking legislation is very civilized now. All measures which are discussed in the Basel Agreement have been adopted. It's now completely transparent.

Despite all the difficulties, I would insist that Russia's banking system is still very strong. Many people criticize us, saying that we have too many banks and we need to reduce the number. But that number doesn't matter. In seeing it through the difficulties or crisis, we were able to keep the major banks on the way. Not a single major bank went bankrupt.

On these terms, we think that Moscow is a natural place for a financial center to be born. Those visiting Moscow will realize that Moscow is a quickly changing town, and it's changing every day. We have an ambition to develop Moscow into a financial center. Some East European and CIS countries are interested as well. They are seeking a friendly and familiar place where they can work for their businesses and attract capital.

Caixin: What about regulation? What kind of regulation framework do you plan to adopt in the context of America's reforming of its financial supervision and regulations?

Shuvalov: Our regulations are very close to European ways of supervision. Since we are building a common economic market with the European Union, the major economic laws are the same. As in the banking sector, I would say that they are equal with those in the European Union. What our central bank is doing is within the Basel Agreement.

Caixin: We noted inefficiency at the (Moscow) airport and customs office when we traveled to Russia. Do you plan improvements?

Shuvalov: We are ready to sell Sheremetyevo Airport because we cannot manage it very well. Two investment banks are now working for the government on this project. There are a few investors who want to buy it. At the same time, the consulting agencies suggest we should put all three, major airports in Moscow – Sheremetyevo, Domodedovo and Vnukovo – in one package. Major stock in a new company on the basis of a merger of the three airports will be sold to strategic managers. It's beneficial for us to encourage investors to buy all three airports instead of only one because these airports shouldn't compete with each other. They should compete against European freight hubs such as Frankfurt, for instance.

Caixin: The European Union has been a benchmark for Russia for years. Did Russia feel the impact of the sovereign debt crisis, and what do you think was the reason?  

Shuvalov: Yes. We are very happy that the EU was very united, and that they announced a big amount of money for creating a similar mechanism like the IMF but moving within Europe. Russia's major foreign reserve is in euros and U.S. dollars, so of course the crisis would have significant impact on Russia.

At the same time, we are working with Kazakhstan and Belarus to create a customs union and then a single market. Maybe in five years, a new currency will be introduced, and it could be a completely new currency. It could be a Russian ruble as well. Some time ago, President Nursultan Nazarbayev of Kazakhstan proposed creating a completely new currency for all three countries.

To create a single market and currency union, we should be stricter with our fiscal policies to avoid the same situations as in Greece, Portugal and Spain. The reason they got deeply caught by crisis is that they didn't entirely fulfill the necessary criteria; their budget deficits remained too high, and people were working too few hours. For us, these are very good lessons.

Caixin: You mentioned the currency union of the three countries. What about Ukraine?

Shuvalov: We started that project for four countries – Ukraine, Belarus, Kazakhstan and Russia. After President (Viktor) Yushchenko was elected, they stopped the integration process and decided to quit. All major and principal treaties had been signed by Ukraine, but when we ratified them Ukraine pulled back. That's why we are at the current stage where Russia, Belarus and Kazakhstan are living within a tariff union.

If Ukraine wants to join the union, the door is always open. It is Ukraine's call. But at the same time, Ukraine is a member of the WTO, while the three other countries are not. Now, we are able to have any form of cooperation with Ukraine, but I don't think Ukraine can become a member of the tariff union.

Background:

Reaching an agreement to create a tariff union was a significant strategic step for Russia's effort to retake its position as a regional, but not global, power. Whether the ruble or a new currency will be used, in the end the economic integration of these three former Soviet republics marked the beginning of Russia's journey back in time to its prime.

After the Orange Revolution, though, Ukraine dropped out of the integration process. And some turbulence was seen during the final stage of the tariff's union establishment by Russia, Belarus and Kazakhstan: Belarus insisted on tariff-free conditions by Russia for its oil and natural gas exports. Russia rejected that request, claiming that under the agreement a commodities tariff could be exempt only after a single market for goods, labor and investment is established in 2010. As a result, only Russia and Kazakhstan signed the agreement, which was supposed to take effect July 1. Belarus eventually signed into the union July 6, while Russia threatened several measures including the cutting of natural gas supplies to Belarus.

Neighborly China

Caixin: Could the yuan be used as the settlement currency for trade between Russia and China?

Shuvalov: We have such a plan. There's a treaty written in 1992 which provides that we need to use hard currencies when trading with each other. Later, it was changed at border regions where we can trade using the ruble and yuan. I think that we are very close to the goal that we can trade using the ruble and yuan altogether. I am aware that Chinese banks now in Russia can provide yuan to Russian companies trading with China, and it's a very positive signal because the yuan sooner or later will become an international reserve currency. It is very healthy for the global economy. I think that the ruble will become a regional reserve currency as well, and it will help both countries a lot.

Caixin: Is it possible for Chinese enterprises to make yuan investments in Russia?

Shuvalov: I think it's possible but we need to agree on what conditions should be equal, and we need to understand what kinds of game rules work for both parties equally. I think it's great if Russians and Chinese can easily invest in each other's countries using the ruble and yuan.

Caixin: We have seen increasing trade volume between Russia and China, but I don't think this number meets some high expectations for warm ties between our two countries. What do you think the two countries plan for expanding bilateral cooperation?

Shuvalov: We would like to think about "wise trade" between our two countries. We are looking forward to cooperation with China, but we don't want to just sell Russian metals and forest resources. We would like to see your investors here in Russia, and we hope that China also welcomes Russian investors coming to China. There should be cross-owned assets and cross-owned industries. It is very important to understand that what we need is to help each other, not to distrust each other.

Our two presidents now meet more often than before to talk about business, and the people exchange has expanded as well. Twenty or 30 years ago, I wouldn't say we were the closest friends. But if you look at the current relationship between Russia and China, I think it is really and truly friendly and strategic.

Background:

With Russia's rise since the turn of the century, and as the international pivot point shifts east, Russia is reviving a "double-headed eagle" strategy. Emerging markets are not only exporting natural resources, but also capital and knowledge and technologies. The listing of Rusal in Hong Kong in January was regarded as a move by Russian resource-oriented enterprises to take advantage of the Asia-Pacific capital market.

Due to the global financial crisis, bilateral trade volume between China and Russia fell from US$ 56.8 billion in 2008 to around US$ 4 billion in 2009. However, Sino-Russian trade volume was valued at US$ 16.2 billion in the first quarter of this year, a 57 percent increase from the corresponding period 2009, which means it is making its way back to pre-crisis levels. After years of ups and downs, new opportunities have emerged for energy cooperation – an essential part of bilateral economic and trade ties. Under a “loans for oil” agreement signed by the two countries in February 2009, China will provide a total US$ 25 billion in long-term loans to Russia. In return, Russia will supply via pipeline 300 million tons of oil to China, on an annual basis of 15 million tons, from 2011 to 2030.
 
The two countries are also paying close attention to trade settlement issues, especially trade settlement in border regions. The ruble and yuan together account for only 1 percent of overall trade payments, and both China and Russia are expecting that to grow. On April 27, Bank of China announced that it had started a ruble cash business against the yuan in China under the direct exchange rate account. The bank'­­­­­­­s move was seen as a realization of bilateral currency trade settlement between China and Russia in real terms.

Intern reporters Shan Zhou and Yang Yuanxiao also contributed to this article.