Russia’s debt default is history

With the softly spoken diffidence of an academic, Alexei Kudrin seems an unlikely fiscal hard man. Yet as petro­dollars have flooded into state coffers in recent years, he has robustly fended off demands to pour the money into inflationary social spending or tax cuts and insisted on hoarding it for Russia’s future.

Few finance ministers can have witnessed such a transformation of their country’s coffers. When Mr Kudrin took the job in May 2000, Russia’s devastating 1998 debt default and the rouble devaluation that wiped out Russians’ savings were a recent memory.

Today Russia has $356bn in gold and foreign exchange reserves (the world’s third biggest) plus $108bn in a stabilisation fund, based on the Norwegian model, that has received every dollar of oil revenue above a certain price since 2004. That is even after paying off debts including Russia’s remaining $22bn to Paris Club creditor nations last year.

High oil and gas prices have underpinned the turnround. But economists say Mr Kudrin’s strict fiscal management deserves praise nevertheless.

“It’s an extremely difficult job to pursue a conservative fiscal policy when your revenues are increasing at such speed,” says Yegor Gaidar, former prime minister and architect of Russia’s 1990s economic reforms.

Now Russia is entering a new stage. Parliament last week backed budgetary reforms championed by Mr Kudrin that will split the stabilisation fund. A reserve fund will be kept at 10 per cent of gross domestic product, which topped $1,000bn last year. That will be enough to maintain projected budget spending for three years even if oil prices halve to $30 a barrel.

A “future generations” fund, the ultimate rainy-day piggy-bank, will absorb anything left over after topping up the reserve fund to the required level out of a pre­determined transfer from oil and (for the first time) natural gas tax revenues. The transfer is set at 4.9 per cent of GDP this year and 6.1 per cent in 2008, but will fall to 3.7 per cent annually from 2011, seen as sustainable even if oil prices halve.

The new funds will be created next February 1; the reserve fund is projected to receive $142bn and the fut­ure generations fund $24bn.

“We’re developing a system of security in the reserve fund and stricter use of oil and gas revenues for spending,” Mr Kudrin told the FT. “And that will contribute to reducing inflation and stabilising the exchange rate.”

Inflation finally fell to single figures last year, 9 per cent, for the first time since the Soviet collapse, and could undershoot this year’s 8 per cent target.

Oil and gas revenues’ share of the federal budget will fall by 3 percentage points to 5.3 per cent in 2010, reducing budgetary dependence on energy just as the government is trying to wean the broader economy off reliance on oil and gas.

Meanwhile, Russia has adopted a three-year budget framework that will largely bind whoever succeeds President Vladimir Putin, after he stands down next year, to the same fiscally prudent approach.

While the budget surplus is set to shrink from last year’s 7.4 per cent to 0.1 per cent by 2010, average real spending growth should fall from 18 per cent in the past three years to 5.6 per cent in the next three.

An important shift, say economists, is under way. After living hand to mouth for so long, Russia can plan for the future. And it is finally shifting from hoarding to spending, meaning ordinary Russians will gradually start to see more of the country’s energy wealth.

Mr Kudrin says fixed capital investment is forecast to more than double from last year to $357bn by 2010.

Some see dangers ahead. Hans-Joerg Rudloff, Barclays Capital chairman, told a conference this week Russia's financial boom could end painfully as it reached cap­ac­ity limits in an expansion fuelled largely by foreign credit.

Mr Gaidar sees “no significant financial risks for Russia under any realistic scenario” in the next three years. But he warns of huge long-term challenges including raising meagre state pensions and funding promised payments to mothers of three or more children in a programme announced last year to tackle Russia’s precipitous population decline.

Yaroslav Lissovolik, an economist at Deutsche Bank, says Mr Kudrin’s reforms should at least steer Russia through coming elections without a pre-electoral spend­ing splurge, or allowing candidates to make unsustainable promises.“It’s a significant straitjacket in case the next administration wants to pursue a [spending] policy way ahead of what is budgeted for,” he says.

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