February: how would reforms incite economic growth

HomeNewsFebruary: how would reforms incite economic growth

World Bank names two paths to «prosperity» for Russia’s economy

There are two ways for Russia’s economy to grow: one is to increase productivity, the other is the amplification of human capital, affirms a recent World Bank report. Neither would be possible without a firm budget and an effective public administration system.

The current model of the Russian state, according to the WB, is based on a strong influence exercised by the authorities upon economic and social policies, as well as on a wide political support. However, this support might decrease in a slowing economy, as Russia risks becoming a victim of its own success due to the increased expectations on the part of the population.

Russia has a good potential for the first path pointed at by the WB — the productivity growth, although it needs to get rid of the existing restrictions ’at the level of economy as a whole, enterprise and individual.’
These restrictions appear due to depreciation of the fixed capital and ’distortion of market mechanisms and the foreign trade’: it is difficult and expensive to move goods around the country, which slows down the economy, as the WB points out. Private capital might help rectify the situation, among other forms, through the mechanism of public—private partnerships (PPP). The current efforts in this field, undertaken by the authorities, are not sufficient; there must be a better assessment of project feasibility and a subsequent follow-through to implementation, risk analysis, and an extended access to low-cost long-term loans. Today, business participation in the infrastructure projects in Russia is ’severely handicapped by the lack of competition, insufficient volume of the domestic capital market, a fragmented and overcomplicated legal system and a lack of specialists.’

Limited access to innovations at the corporate level also prevents the growth of productivity. Businesses need a capable management, impossible without additional investments. On top of this, one of the major negative factors for the development of the Russian companies, according to the report, is a deficit of qualified personnel. Even though Russians generally demonstrate a ’very high level of formal education,’ this does not translate into skills required by companies from the potential employees.

Another quoted obstacle is the decline in foreign direct investment (FDI) following the introduction of sanctions in 2014, although even prior to that, the existing foreign investments were not quite contributing to the growth of external competitiveness and a required gradual shift of focus to the more high-tech products. At the same time, today, the exports diversification can hardly be implemented through the FDI due to the hostile external environment, and the authorities will need to put much effort in order to improve the investment climate. Serious issues quoted by the Russian businesses, according to the World Bank, also include corruption, heavy taxes and the ’onerous license and operational requirements.’

Economists mention two strategic methods that might restore productivity growth. The first consists of realigning of the competition terms, promoting a ’departure of unproductive old-timers’ thus giving way to more productive companies in their place. The second method is a renewal of corporate potential, for instance in technology implementation market. On the whole, Russia needs reforms that, as the World Bank points out, would help overcome the internal and external constraints.

Human capital

The second path described by the World Bank is improving the ’human capital’. The main source of income for the country’s poorest 40% is public funding, which should rather be replaced by an employment-derived income. Additionally, the workplaces, the WB observes, have moved in a more vulnerable informal sector. According to expert estimates, shadow labour market hosts 30 million Russians, or 40.3% of the economically active population. Every year, since 2009, the number of the formal jobs cut exceeded the number of the new jobs created, while there is no any conclusive evidence that the ’white’ employment pays better than the jobs in the informal economy.

Other problems include the ageing of the economically active population exacerbated by relatively low public expenditure for the health care system. According to the WB report, Russia should make the investment in social programmes more efficient. Today, the poorest groups of population receive a negligible share of the allocated resources: a quarter of the funding is addressed to the poorest 20%. In the countries with targeted assistance, similar social groups receive over 50% of the funds. WB also draws attention to the low level of pension payments in Russia.

The economists propose to engage wider public group in the economic activity while also increasing productivity to solve these issues. More specifically, this presumes a more active involvement of female population and an increase of the employment age (meaning a push back in the retirement age).

The inevitable

The World Bank highlights the conditions inevitable for the economic recovery in Russia. First of all, it is the fiscal stability: a reduction of the budget deficit is planned by the authorities for the next three years, at its lowest in 2019 it should fall to 1.2% of the GDP.

«A significant tightening of the budget constraints, occurring in recent years, exacerbates the tough choice between supporting individual incomes and increasing investment in human and tangible capital», economists explain. In the past, the social expenditure was carried out at the expense of the investment in infrastructure and in human capital, whereas now it needs to be redirected at ’resolving the top priorities and improving the administration of the public investment.’ This process, however, should be accompanied by a comprehensive tax reform, stresses the World Bank.

In the end of 2016, President Putin announced the upcoming changes in the fiscal system which should be enforced as of 2019. As Finance Minister Anton Siluanov explained, the new rules presume an increase in luxury tax, tax on harmful products, as well as a decrease in employers’ social insurance contributions, along with a VAT growth.

The second condition set out by the WB is the management of natural resources, which still remains non-rational and inefficient, according to the WB vision. The depletion of resources and pollution of the environment directly reflect on the economy, while the climate change «increases the vulnerability of the Russian economy to the risks associated with weather conditions.»

And finally, one more premise: the efficiency of public administration. Public authorities must «be responsive to the needs of business community and citizens, as well as protect the principles of the rule of law.» At the same time, as the WB report affirms, the government has already achieved certain goals in public administration sector, although the progress is not homogeneous and Russia’s ranking in this field remains below the global average. Problems persist with the procedure of business registration, the levels of entrepreneurship, the investment and innovation, as well as with the accountability to the public.

China: no time to hold back the reforms

The global economic environment is likely to be seriously influenced by the way in which the Chinese authorities manage the country’s monetary system in 2017. Despite all the efforts by Beijing, capital keeps leaving the country: the balance of payments stood at USD 469 billion in deficit in the third quarter of 2016. Attempts to stop the capital flight will most likely bear no fruit although they might evoke new risks.

Capital flight picked up the momentum dramatically in 2012, when the Chinese authorities liberalised the transactions for acquisition of raw materials and services. Resourceful Chinese businessmen were quick to realise: while they cannot officially wire funds abroad to buy a villa (natural persons in China are not allowed to export more than USD 50.000 a year), they can nonetheless create false invoices and use them to withdraw as much cash as they might need. This resulted in a serious discrepancy between the payments registered as import settlements and the declared value of the imported goods that have passed through the customs. Statistically, last year, this hidden outflow amounted to USD 526 billion.

According to a French investment consulting firm, capital flight from China should exceed USD 900 billion in 2016, despite the new financial restrictions, including bans on the use of credit and debit cards to pay for insurance products in Hong Kong.

Recently, one more item was added to the restrictions list. The government announced that all international transactions over USD 5 million must be approved by a special public commission on foreign currency.
This new feature made the business community feel extremely concerned, as the entrepreneurs believe that the ministry would not have enough resources to handle the huge amount of transactions to be controlled. Once these restrictions are introduced, targeting the capital transactions, it is only a matter of time for their appearance in respect of the payments for goods and services. This brings up one simple question: while Beijing is heavily supporting the yuan, why is it unable to restrain the capital flight?

Although authorities claim that they fear the consequences of yuan devaluation, this is not quite the case. Once the government has dropped the value of yuan on August 11 last year, the cumulated volume of import/export operations dropped by only 8%, even following devaluation of yuan against the US dollar. Today, any reduction in the exchange rate does not ensue much difference, given the weakness of the global economy. The true reason is the government being concerned about the consequences of any further liberalisation. China’s banking system is unstable, the number of overdue loans is close to 30%. The credit institutions receive regular liquidity injections from the People’s Bank of China. Given the current capital mobility, large-scale withdrawal of funds might hit China, and thus provoke further decline in the liquidity of banks, already suffering due to growth of delayed payments.

In short, China found itself in a complex situation: while the authorities re-enforce the national currency ensuring its gradual slow decline, large capitals leave the country unhindered, threatening the whole of the banking sector.

This is an embarrassing position, but the authorities are forced to admit: the days when it could use regular trade surplus to accumulate large foreign exchange reserves, are in the past. The facts point at the long-term net capital outflow. The Chinese citizens who have acquired real estate in Vancouver, in Cyprus, or in Sydney, are not going to return their investment in the near future.

On top of this, the authorities should resolve some long-standing issues. Although for over a year now they keep speaking of borrowing more, total financing of the social sector increased by 15%, or twice the rate of the GDP growth. If the financial system was in such a bad shape, the risk of yuan falling would be much lower. However, the government does little to address the profound problems faced by banks. The longer reforms are postponed, the higher the final bill will be. Any financial crisis, any ’hard landing’ always have more than one reason, while often they are caused by a set of coincidences. Should China refuse to solve its problems today, the likelihood of this crisis will grow.

Russian billionaire Vekselberg buys major stake in the Bank of Cyprus

According to the Central Bank of Cyprus, the Russian billionaire’s, Viktor Vekselberg’s, Lamesa Holdings became one of the largest shareholders in the capital of the Bank of Cyprus (BOC) with a 9.3% stake.

This is the second time that Vekselberg, the head of Renova Group, increases his investment in this Cypriot bank, thus becoming a key shareholder. In 2015, he increased his share by purchasing a 0.7% stake from the ex-head of Norilsk Nickel and Rostourism Vladimir Strzhalkovsky, Kathimerini daily reported. Back in September 2014, the Cypriot bank revealed the share of Renova Group in its capital during an additional issue of shares, which at the time amounted to 5.4%.

Previously, a Renova representative described the investment in the Bank of Cyprus as having a good financial potential. Renova reported that Vekselberg’s new acquisition is not related to any significant debt associated with the bank. «The bank has a good standing», commented a Renova rep.

Renova came up among the bank’s shareholders after 2013 crisis, when thousands of account holders in the Bank of Cyprus, including a large number of Russians, received shares in exchange for their savings withdrawn under the bailout programme aimed to save the Cyprus financial sector. Authorities forcefully exchanged 47.5% of the deposits in excess of EUR 100.000 for the shares of the bank. As a result of this reorganisation, Russian companies that kept accounts in the Bank of Cyprus received over 30% of its shares thus becoming the bank’s largest shareholders. The BOC has also absorbed its nearest competitor, Cyprus Popular Bank, within the framework of restructuring plan for the banking sector, endorsed by the European Union and the International Monetary Fund.

The centre for protection of shareholder and investor rights in Cyprus-based banks estimated the losses of Russian depositors with the Bank of Cyprus as at least USD 4 billion. Russians often took part on the board of BOC, among them, Strzhalkovsky already mentioned above, Director General of the North Domodedovo complex Eriskhan Kurazov (reported to have represented co-owner of BIN-Bank Mikhail Shishkhanov for the purchase of the central National hotel in Moscow), a member of BIN-Bank’s Board of Directors Angelica Anshakova, and Anton Smetanin, who represented the interests of Vitaly Yusufov on the board of the Bank of Moscow.

However, the pioneer of the Cyprus market is the Russian billionaire Dmitry Rybolovlev, the former owner of Uralkali. Prior to the financial crisis of 2010 he was already one of the largest shareholders of the Bank of Cyprus (with 9,7%). On top of this, the bank used to operate a large network of branches in Russia, as well as own the Uniastrum Bank, which was later sold to the owner of the Regionalny Kredit bank.