FIRST DEPUTY PM SHUVALOV ON G-20 SUMMIT, CRISIS

C O N F I D E N T I A L MOSCOW 003222

SIPDIS

STATE FOR EUR/RUS, EEB/IFA, EEB/OMA
TREASURY FOR IMB (MURDEN, MONROE, CARNES)
NSC FOR PRICE AND ELLISON
STATE PLS PASS TO USTR (ROHDE, KLEIN, HAFNER)

E.O. 12958: DECL: 11/03/2018
TAGS: ECON EFIN RS
SUBJECT: FIRST DEPUTY PM SHUVALOV ON G-20 SUMMIT, CRISIS
RESPONSE MEASURES, AND WTO

Classified By: Ambassador John Beyrle for reasons 1.4 (b,d)

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Summary
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1. (C) In an October 30 meeting with the Ambassador, First
Deputy Prime Minister Shuvalov outlined Russia's general
positions on the G-20 Summit: coordination of currency
policy; opposition in principle to protectionism; and
improving the quality of existing government regulatory
mechanisms without expanding the role of the state in the
economy. Shuvalov warned against what he viewed as
tendencies in global crisis response, particularly in the
U.S., to over-regulate the economy. The Central bank would
support the current ruble exchange rate as long as possible
and resist devaluation. Falling oil and gas revenues and the
possibility of a budget deficit were causing concern, but
Shuvalov insisted the government was prepared to "burn
through its reserves" to support the corporate and banking
sectors during the crisis. On WTO, Shuvalov asked for U.S.
intervention to resolve bilateral issues with Georgia and
Ukraine. The Ambassador reiterated U.S. support for Russia's
WTO accession, but emphasized that the Russian government
must adhere to its commitments and rein in protectionist
elements. End Summary.

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Proposals for the G-20 Summit
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2. (C) In a candid, hour-long exchange with the Ambassador,
Deputy Prime Minister Igor Shuvalov (PM Putin's second in
command) outlined Russia's goals for the upcoming G-20 Summit
in Washington. Although he made clear President Medvedev's
chief economic aide, Arkadiy Dvorkovich, would be drafting
the specific proposals, Shuvalov was willing to discuss their
general content (suggesting that Putin's input would be
considerable).


3. (C) First of all, Shuvalov said, there had to be a general
understanding that all G-20 countries would coordinate their
actions, and that no steps taken by one member would be to
the detriment of another. For example, Russian efforts to
support the ruble must not have a negative impact on the
dollar. Reform of international financial institutions must
be coordinated with the goal of stimulating world economic
growth. The Russians were particularly uneasy about the
projected economic slowdown in the Euro zone (much more
vulnerable to global crisis than the U.S., in Shuvalov's
view),but took some comfort in that the fact that European
economies proved able to absorb the impact of escalating oil
and gas prices over the past decade. As for Russia, Shuvalov
said the worst of the crisis had passed "like a bad fever"
and that the economy would be on the road to recovery by the
middle of next year. However, he cautioned, Russia's
recovery depended on growth rates globally.


4. (C) In principle, the Russians opposed protectionism and
barriers to free global trade. However, short-term trade
distorting measures should be permitted on a case-by-case
basis to help certain vulnerable sectors and industries deal
with the effects of the crisis. At the same time, concerns
from some quarters of the G-20 (i.e., Washington) that Russia
was lapsing into protectionism or "closing its markets" were
unfounded.


5. (C) The Russian government viewed excessive government
intervention in the economy as a danger to growth and
development. The G-20 should therefore focus on improving
the quality of existing government regulatory mechanisms and
avoid tendencies to expand the role of government "management
and regulation" of national economies. Shuvalov expressed
concern that even in the U.S., where liberal market
mechanisms were firmly rooted, emergency measures atypical of
a market economy were being implemented: "we get worried
when we see the U.S.doing this." He stated that the emphasis
in Russia would be on preserving private enterprise, and
dismissed media speculation that government intervention
could lead to a broad redistribution of property or the
imposition of state management on the companies it bailed
out.

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Domestic Corporate and Financial Bailout
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6. (C) Shuvalov described the government's latest actions to
address the financial crisis. Russia was using $50 billion
of its reserves to help major corporations (the "locomotives"
of the Russian economy) redeem their foreign debt. The first
beneficiary was Oleg Deripaska's "Rusal", which had secured a
$4.5 billion loan (to purchase Norilsk Nickel). The Central
Bank transferred the cash to the state-owned Vneshekonombank
(the Development Bank),which, in turn, imposed strict
conditionalities: Rusal must pay back the loan by 2010 or
transfer its shares to the state. (Shuvalov said Deripaska
initially resisted that conditionality.) Similarly, all
companies that were converting their foreign debt to domestic
debt would be obliged to pay back the state on terms often
more stringent than they would receive from Western financial
institutions. The government would take preferred stock from
recipient companies as collateral. If the value of the
preferred shares fell, the government would act as any other
private lender and exercise margin calls. However, Shuvalov
emphasized, refinancing for the companies was an option, not
an obligation.


7. (C) Refinancing of the banking sector was taking place
through auctions of repo loans and "lombard" loans
(collateralized loans). Interbank lending rates were as high
as 16 percent; but were relatively low in real terms given
the present rate of inflation (14 percent). The biggest
problem in the banking sector was lack of trust. There was
widespread concern that small and medium sized banks would
fold, leading people to withdraw their savings from the
smaller private banks, often converting them into dollars.
Shuvalov blamed the media for exaggerating the extent of the
crisis in Russia and causing a capital flight from private
and state banks. In reality, he said, the Deposit Insurance
Agency (ISV) guaranteed deposits of up to 700,000 rubles
(approx 28,000 USD). Furthermore, the largest state savings
bank (Sberbank) had been accumulating dollars for months in
anticipation of the increased demand: "Gref is flying them
in by the planeload," Shuvalov joked, to ensure ATMs are well
stocked. Nevertheless, he acknowledged, many small and
medium sized banks would eventually fold, beginning within
the next several weeks. Consolidation of the banking sector
was to be expected; the optimal number of banks was about
450, or about half the current size.

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Supporting the Ruble
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8. (C) Shuvalov said the Central Bank would support the
current exchange rate of the ruble "as long as possible".
The government would continue to counter rumors of
denomination or devaluation. The Central Bank had spent
billions of dollars weekly to defend the ruble. In order to
deter speculation against the ruble, the Central Bank
introduced daily limits on currency swap operations. The
Central Bank would stop refinancing facilities to those banks
that merely continue switching to dollars. It would monitor
recipient banks and make decisions on granting them
collateral-free loans based on proof they would release those
funds into the Russian economy rather than keeping them in
foreign exchange.

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Burning Up the Reserves
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9. (C) Meanwhile, as oil and gas prices continued to fall,
the government was concerned about the budget surplus turning
into a deficit. Although reserves had fallen below $500
billion, they were sufficient to guarantee macroeconomic
stability: i.e., cover the costs of supporting the ruble and
refinancing banks and corporations. Other investments (e.g.,
infrastructure, public-private partnerships) might have to be
postponed. Shuvalov stated that the government was prepared
to "burn the reserves" to get out of the present crisis.
After all, the reserves were meant for a "rainy day" and that
day has come, he declared. He recalled his internal
arguments against those who wanted to tap the reserves for
budget needs like road repair or pension support. Now they
would see that that the purpose of the reserves was to jump
start the ailing banking and corporate sectors.



10. (C) The "bright side" of the crisis, Shuvalov mused, was
that Russians were now beginning to understand the real value
of money. When oil and gas revenues were at their peak,
windfall profits bred inflation and corruption. The ruble
was overvalued by as much as 60 percent. Now, people would
begin to heed Finance Minister's Kudrin's warnings about
fiscal profligacy and accumulation of large debts. Perhaps,
the crisis would be an opportunity for the government to push
for some of the reforms President Medvedev announced at
Krasnoyarsk in February - or even enact energy conservation
measures.

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WTO Accession
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11. (C) The Ambassador emphasized that the U.S. supported
Russia's WTO accession and that, contrary to allegations of
some Russian officials (including Shuvalov),Washington was
not urging U.S. companies to stop doing business in Russia.
A new U.S. administration would review the WTO issue in terms
of what Russia had done so far to meet its commitments.
Moves by the Veterinary Service and Agricultural Ministry to
walk away from side letters and commitments to the U.S. were
unhelpful. The Russian government had to rein in the
Veterinary Service and other protectionist elements if it was
serious about U.S. support. Shuvalov asked that the U.S.
intervene with Ukraine and Georgia to help resolve
outstanding bilateral WTO issues with Russia. He commented
that U.S. allies (Australia, Canada) followed the U.S. lead
in WTO and apparently added new conditions on Russia for
"political reasons" following the Georgia conflict. The
Ambassador pushed back, stressing that the WTO was
consensus-based body focused on trade not politics.

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Comment
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12. (C) Shuvalov was candid and forthcoming about Russia's
reserve problems and the pressures on the ruble exchange
rate. He also echoed recent statements by Prime Minster
Putin to the effect that Russia was not turning to
protectionism or seeking to restore the primacy of the state
sector. The position Shuvalov outlined for the G-20 summit
was basically consistent with the principles of global free
trade and reform rather than replacement of the existing
international financial system. On the domestic front,
Shuvlaov expressed a degree of confidence (lacking over the
previous weeks) that the worst of the crisis had passed. This
may have had something to do with the moderate recovery in
Russian and global markets over the past week. End Comment.





BEYRLE