DEUTSCHE BANK CHIEF ECONOMIST ON CRISIS IN RUSSIA,

C O N F I D E N T I A L SECTION 01 OF 02 MOSCOW 003586 SIPDIS DEPT FOR EUR/RUS E.O. 12958: DECL: 12/11/2018 TAGS: ECON EINV ENRG ETRD EFIN PREL PGOV RS SUBJECT: DEUTSCHE BANK CHIEF ECONOMIST ON CRISIS IN RUSSIA, RUBLE, SCAPEGOATS Classified By: A/DCM Alice Wells for reasons 1.4 (b/d). -------------- Summary -------------- ¶1. (C) In a December 6 meeting with EEB Special Representative Frank Mermoud, Deutsche Bank's Chief Economist Yaroslav Lissovolik said that investors, foreign and Russian, were concerned about increased GOR control over the economy. He said the GOR's intervention in support of the ruble was a mistake that was bound to fail. Finally, he acknowledged that the GOR might eventually have to sacrifice a senior official to assuage public opinion and agreed that in that event the most likely candidate would be Deputy Prime Minister Shuvalov. End Summary. -------------- Investor's Fear Increased State Control -------------- ¶2. (C) Lissovolik said he had just recently returned from a trip to Western Europe to meet with interested potential investors. He said the numbers were far greater than the same trip he had taken the year before. For instance, in Stockholm he said 40 potential investors had shown up for his presentation; the year before it had been five. Lissovolik said, however, that the degree of interest was not good news since most of the attendees had expressed concern about corporate governance issues and the future of the market model in Russia. ¶3. (C) Lissovolik said he had told the investors that the role of the Russian state in the economy might increase because of the crisis. The Russian government was divided on economic issues into camps of liberals and hard-liners. The former favored an open and integrated economy, the latter wanted greater state control. Prime Minister Putin was at the nexus of this divide and was himself "half liberal and half hard-liner." Putin's background and training inclined him toward state control but he always understood that his main goal for the past few years, to catch up economically to the West, required foreign capital and a more open economy. ¶4. (C) Lissovolik said, however, that at least for the short term, Putin and the government's goal had changed. It could change again when the global recession begins to ease, which Lissovolik thought could come as early as the fourth quarter next year. But for now the goal was survival and this was playing into the hands of the hardliners. The downturn undermined Putin's main achievement as president, the restoration of stability, and an extended downturn could lead to increased social tensions. The hardliner were using this to push for greater government control over the economy. In addition, the degree of Russian dependency on foreign capital had come as a nasty shock for the regime and the hardliners were using that to argue for less international integration. ¶5. (C) Lissovolik acknowledged concern in the Russian business community that with the hardliners ascendant, the GOR was unlikely to use the downturn to enact needed reforms and position Russia for the end of the recession. Even more worrisome was the possibility that powerful elements within the government would use greater state control over the economy to further their own personal interests. The incident that was causing the most concern in this regard was the government investigation of potash miner Uralkali. The government's sudden reopening of the investigation into a mine collapse and the prospect of a massive fine that would cripple the company (reported in the NYTimes last weekend) were fueling suspicions that someone in the government planned to seize the company. -------------- Ruble Devaluation -------------- ¶6. (C) Lissovolik said that downward pressure on the ruble would continue as long as oil prices continued to fall. $40 a barrel (breached late last week) was a key barrier for the GOR. Below this, they would have to rethink their policies, especially projected revenues and planned expenditures. He said that roughly two-thirds of the $150 billion in lost reserves over the past two months had been used to support the ruble. The other third had been result of valuation MOSCOW 00003586 002 OF 002 changes (the U.S. dollar appreciating relative to the Euro, driving down the value of Russian reserves denominated in Euros ) 60 percent of the total). ¶7. (C) Lissovolik said the GOR's current policy, gradually devaluing the ruble in small increments, would not work. In his view, gradualism was a recipe for failure; it had never worked anywhere it had been tried. It would be better for the GOR to accept the inevitable and devalue the currency now, rather than waste its reserves slowing the rate of depreciation for political reasons. Lissovolik acknowledged, however, that this would be politically difficult for the government, which was genuinely concerned that a one off devaluation could cause panic, leading to a meltdown of the currency as happened in 1998. However, despite the risks, Lissovolik said a devaluation was inevitable. The Central Bank was burning through its reserves too quickly and did not have enough to sustain the current policy if the downturn persisted until the second half of 2009. -------------- Finding a Scapegoat -------------- ¶8. (C) Lissovolik agreed that if the downturn persisted well into next year it would not be enough to blame the crisis on global factors, including especially the U.S. -- a domestic scapegoat would need to be found. He discounted rumors that Putin himself might step down or that Medvedev would go; they were simply too important. He also discounted the rumors that it might be Kudrin. The Finance Minister was too central to economic decision-making and market confidence and too close to Putin. In addition, the GOR had spun the reserves as the major difference from 1998 and Kudrin was widely credited with their accumulation. In that context, it would be difficult to explain his dismissal. ¶9. (C) Lissovolik said Central Bank head Ignatiev could be a candidate, especially in the event of a decision to devalue, which Ignatiev would have to announce. A broader cabinet shuffle could also include MED Minister Nabiullina, who Lissovolik said was generally thought to have been unimpressive in the position. However, Lissovolik agreed that these individuals might prove neither well enough known nor important enough to serve as a scapegoat. In that event, it would need to be someone more senior and the only likely candidate left was Deputy Prime Minister Shuvalov. Lissovolik said the latter already appeared to be taking the lead on anti-crisis measures and might be setting himself up for the role. (N.B. Putin announced December 12 that Shuvalov would head a newly formed anti-crisis commission.) Lissovolik said given how decisions were made in the regime, Shuvalov would have to have agreed to take the fall and would be rewarded for doing so, first with a profitable position in the &private8 sector and later with a return to government in an even more important position. ¶10. (C) Lissovolik added that though he thought Kudrin was safe, his impression from talking to his sources within the GOR was that the Finance Minister's position had been weakened by the crisis. This would likely make it more difficult for him to hold the line on tax cuts. The proponents of tax cuts, especially at the Ministry of Economic Development (MED) were arguing that a VAT reduction, which they had long advocated, could stimulate the economy. Kudrin might also be unable to hold off tax cuts for the oil industry, which was getting squeezed by high taxes and falling prices. -------------- Comment -------------- ¶11. (C) One of the favorite parlor games in Moscow today is guessing which government official might take the fall for the economic crisis. The news today about Shuvalov's new responsibilities would seem to support Lissovolik's view that Shuvalov is a likely suspect. Lissovolik is also on safe ground in predicting increased state control over the economy as a result of the crisis, at least in the short-term. RUBIN