PRESIDENT'S ECONOMIC ADVISOR DISCUSSES ANTI-CRISIS

C O N F I D E N T I A L MOSCOW 003741 SIPDIS STATE FOR EUR/RUS, EEB/IFD TREASURY FOR TORGERSON DOC FOR 4231/MAC/EUR/JBROUGHER NSC FOR ELLISON E.O. 12958: DECL: 12/22/2018 TAGS: ECON EFIN EINV OREP PREL RS SUBJECT: PRESIDENT'S ECONOMIC ADVISOR DISCUSSES ANTI-CRISIS PLANS WITH SENATOR LUGAR Classified By: CDA:ERUBIN REASONS (1.4 b,d) -------------- SUMMARY -------------- ¶1. (C) In a December 19 meeting with Senator Lugar, President Medvedev's Chief Economic Advisor, Arkadiy Dvorkovich, was uncharacteristically pessimistic about Russia's growth prospects over the short and medium term and predicted a protracted global economic slow down. Dvorkovich said that depending on the global price of oil, Russia's economy could experience negative growth rates in 2009. The government would use reserves to support social programs and stimulate the economy. The GOR would continue to gradually devalue the ruble but it could not afford to support the currency indefinitely out of reserves. There were no plans to introduce currency controls. A further reduction in export taxes for oil and gas exports was likely early next year. Dvorkovich and Senator Lugar agreed on the importance of increasing bilateral trade and investment ties and on close cooperation in the context of the G-20. End Summary. -------------- Gloomy Prospects for Economic Growth -------------- ¶2. (C) In a December 19 meeting with Senator Lugar, President Medvedev's Chief Economic Advisor, Arkadiy Dvorkovich, discussed the GOR's strategies for dealing with the economic crisis and prospects for economic cooperation with the U.S. and the G-20. He noted that the global outlook for the first half of 2009 was pessimistic and that Russia's economy was linked to the global economy. ¶3. (C) Dvorkovich said the key variable for Russia's economy was the price of its commodity exports, especially oil. Under the most optimistic scenario, with oil prices at $60 to 65 dollars a barrel in 2009, Russia could maintain its pre-crisis growth rate of about 7 percent and maintain its present economic policies. This would, however, depend on recovery of the global financial system, which Dvorkovich deemed unlikely before the second quarter of 2009, and on continued strong economic growth in China, an important customer for Russian exports, which he also thought unlikely. ¶4. (C) Dvorkovich said a more realistic estimate was that China's growth would not exceed 6.5 percent next year with oil prices at $50 a barrel. In that event, the Russian economy would record a modest growth rate of two percent and the GOR would only have to slightly alter its current mix of policies. However, Dvorkovich acknowledged that if the global recession was protracted, it would lead to lower oil prices, potentially as low as $10 to $20 a barrel. In that event, economic growth in Russia would be negative and could fall as low as negative five percent. Under this scenario, the GOR would have to rethink many of its current policies. -------------- Greater Emphasis on Human Capital -------------- ¶5. (C) The only positive aspect of the crisis, in Dvorkovich's view, was that it could give impetus to more efficient management and better legislation. He stated that there were no plans to deviate from the "four I's" articulated by President Medvedev at the Krasnoyarsk Investment Forum last February: institution building; innovation support; infrastructure optimization; and investment growth. However, during the crisis period, preference would be given to developing "human capital" through greater investments in health and education. Also, more attention would be paid to cost effectiveness and efficiency in the management of public funds so as to obtain better results without increasing expenditures. The government would also continue to use reserve funds to stimulate the economy: "after all, they were set up to be used during the down times". -------------- Unbalanced Growth of the Banking Sector -------------- ¶6. (C) Senator Lugar inquired about the evolution of the market economy in Russia, particularly in the banking and financial sectors. Dvorkovich responded that Russia had made great strides over the last 15 years, but still had a long way to go. Many Russians continued to distrust market methods and private business - given a bad name by the oligarchs in the 1990s. The banking sector was bloated with over 1000 financial institutions, only a handful of which corresponded to U.S./Western standards. Regulation and transparency in transactions were moving slowly. Russian banks had played an active role in the country's pre-crisis seven percent growth rate, and banking assets had increased by 40 to 50 percent over the past three years alone. However, the high growth rates in the banking sector were a mixed blessing. There had been too much borrowing from abroad - especially of derivatives and other risky instruments. -------------- "Managed" Devaluation -------------- ¶7. (C) Dvorkovich said the government was pursuing a policy of gradual and managed devaluation: the ruble had lost 11 percent of its value vis a vis the dollar/euro basket since August. However, the government could not use reserves indefinitely to support the ruble, and a "more substantial" depreciation was in store. Dvorkovich admitted that Russians were investing heavily in dollars and euros as a safe haven during the crisis, and people in the large cities, especially, were monitoring exchange rates very closely. However, Dvorkovich said, according to recent public option polls, the ruble was still the currency of choice for 70 percent of Russians, and 80 percent of bank deposits were in rubles. ¶8. (C) Dvorkovich added that regulations allowing for ruble convertibility three years ago were also a major factor in the growth of foreign borrowing. Nevertheless, there would be no move to abolish the free flow of currency or introduce currency controls. In that regard, Senator Lugar remarked he had observed a proliferation of foreign exchange kiosks throughout Moscow, a visible sign of the GOR's commitment to continued ruble convertibility. -------------- Tax Cuts for Energy Sector -------------- ¶9. (C) When asked about fiscal policy, Dvorkovich commented that finding an efficient method for taxing oil and gas profits was a work in progress. In the 1990s, oil companies did not pay taxes because they were complicated and poorly administered. When Putin came to power in 2000, Dvorkovich said, an effort was made to streamline tax administration for the energy sector and make taxes more responsive to changes in global oil prices. Now, however, the government needed to provide more incentives for energy companies to compensate for the high costs of investment, particularly exploration offshore and in remote areas. Export duties were lowered this year and would be further reduced early next year. -------------- Closer Bilateral Economic Ties -------------- ¶10. (C) Commenting on the bilateral relationship, Dvorkovich wished the new US administration success in coping with the domestic economic situation, noting that Russia and the U.S. "were in the same boat and had a single goal - to restore confidence." Senator Lugar responded that it was important for the U.S. that Russia succeed economically, and pledged his support for helping the economic leaders of both countries to work more closely, both in the public and private sectors, and to help stimulate Russian investment in the U.S. and U.S. investment in Russia. ¶11. (C) Dvorkovich said that the G-20 summit in Washington made a positive contribution to establishing new principles for managing the global financial sector over the next few years. He was pleased with the support he had received from the State Department during the Summit as well as his meeting with former Secretary Albright in her capacity as the head of the State Department Transition team. He said the GOR was working on preparations for the London G-20 Summit next April. -------------- Comment -------------- ¶12. (C) Dvorkovich was candid and objective in his assessment of the global crisis and its impact on the Russian economy. His rather pessimistic outlook for the country's growth prospects contrasted with his usually bullish public statements, possibly reflecting a growing awareness within the GOR of the challenges ahead. End Comment. RUBIN