STAFFDEL BRANEGAN IN MOSCOW: INTERNATIONAL

C O N F I D E N T I A L SECTION 01 OF 03 MOSCOW 002151

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E.O. 12958: DECL: 08/21/2019
TAGS: ECON EFIN RS
SUBJECT: STAFFDEL BRANEGAN IN MOSCOW: INTERNATIONAL
FINANCIAL INSTITUTIONS IN RUSSIA -- ARE THEY EFFECTIVE?

Classified By: CDA Eric Rubin for reasons 1.4 (b) and (d)

1.(C) Summary: In an effort to assess the effectiveness of
international financial institutions (IFIs) in Russia ) an
assignment from Senator Lugar ) Staffdel Branegan held a
series of meetings on 14-15 August with representatives of
the IMF, the World Bank, the EBRD, MinFin and with outside
experts. Branegan asked the EBRD representative why a net
creditor like Russia, with huge oil exports and a reserve
fund, should receive 42% of EBRD loans, including its biggest
loan ever to the state-owned rail monopoly, Russian Railways.
In a separate meeting, a Russian oligarch who had received
many EBRD loans stressed that his personal relationship with
EBRD was very strong and that his companies found getting
EBRD loans easy. On the whole, Russian interlocutors
concluded that IFIs had made a positive impact on Russia's
economic development - through loan conditionalities, equity
participation, and lending with relatively low interest rates
and long maturities. However, we were left with the
impression that some of the EBRD's lending to oligarchs and
state corporations distorted the market to the detriment of
cash-starved smaller companies and the regions. End Summary.

2.(SBU) In connection with a request by Senator Lugar to
draft a report on the effectiveness of international
financial institutions (IFIs),Senate Foreign Relations
Committee staff member Jay Branegan visited Moscow from
August 13-15. During two days of meetings, Branegan met with
representatives of the European Bank of Reconstruction and
Development (EBRD),the International Monetary Fund (IMF),
the Ministry of Finance (MinFin),a Russian oligarch and
recipient of EBRD loans, and local organizations that had
worked with the IFIs.

EBRD's Biggest Loan Ever to State-Owned Russian Railways
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3.(C) In July the EBRD announced that it was giving its
biggest loan ever ) a half billion dollars ) to a giant
state-owned monopoly, Russian Railways. Branegan asked EBRD
Russia Business Group Director for Infrastructure and Energy
Natasha Khanjenkhova a series of hard-hitting questions,
including why EBRD was supporting state-owned companies, what
the transition impact would be, and how this was in line with
EBRD's mandate. Khanjenkova gave a comprehensive answer,
beginning with the fact that EBRD had long been involved with
the Russian railway sector, investing in nine projects
overall. She said Russian Railways had originally planned to
raise money through bonds, but the financial crisis had made
that not feasible. The company had a bridge loan about to be
due when EBRD stepped in, and Khanjenkova noted that the
length of the loan given by EBRD would be otherwise
unavailable. Now in its third stage of reform, Russian
Railways has signed many pro-reform covenants in order to get
this loan. Khanjenkova explained that this loan was in
support of transitioning a state-owned corporation to a more
commercial and market-oriented way of doing business. So for
example, it will split off a separate freight car and
passenger companies and gradually divest itself of those
shares, thus increasing competition by separating the
infrastructure (the railways) from the provision of services
(freight and passengers). She also said that Russian
Railways had agreed to work with EBRD to ensure an
independent railway regulator would be set up and that
regulation would be improved to provide equal access to the
infrastructure for private locomotive operators, which she
estimated at more than half of all locomotive operators in
Russia. Finally, she said there was an energy efficiency
component to one of the covenants.

4.(C) Besides covenants, she made the made the point that
rail is a "strategic sector" for EBRD to be in, and that
supporting infrastructure development, whether rail or EBRD's
projects in electricity and ports, indirectly supported small
and medium enterprise growth as well, since they had such a
hard time getting connected to infrastructure. Asked what
the additionality of EBRD's involvement was, Khanjenkova
stressed that EBRD was a catalyzing agent and that its
covenents gave meaningful benchmarks. She added that its
loans gave it a seat at the table with Russian Railways,
allowing EBRD to bring in best international practices and
consultants.

5.(C) In a more general discussion about EBRD's philosophy

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and track record in Russia, Branegan asked why EBRD should be
so engaged with Russia (42% of its lending) when Russia had
so much oil, a big reserve fund, and a healthier and more
developed economy than many of its neighbors. Branegan also
asked whether, given a certain amount of money to loan in
Russia, it would have more impact and be more in line with
EBRD's mandate to lend to small and regional companies and
stop lending to big state-owned companies like Russian
Railways or to rich oligarchs (see para 6). Khanjenkova said
that 42% of EBRD's lending was to Russia, and in fact a full
86% of that was to private firms. She added that a third of
their portfolio was in the banking sector, including 36
banking relationships, of which half were regional banks and
the rest had large regional networks. She noted that 27% of
the transactions were equity investments, allowing EBRD to
influence corporate governance with a seat on the Board. She
reported that loans in Russia totaled Euro 1.8 billion in
2008 and 2.5 billion in 2009.

Oligarch Explains His Taking EBRD Loans
--------------
6.(C) Ranked 77th on Forbes' 2009 list of world billionaires,
Vladimir Yevtushenkov is the owner of Sistema, a giant
holding company, and such firms as MTS (listed on the NYSE).
Branegan asked Yevtushenkov why one of his companies had
received a loan for EURO 120 million a month earlier, and why
his company had not gone to the regular banking system for
credit. Yevtushenkov put the situation in context, first
giving some background information. He stated that over the
last 10 years, his companies had taken perhaps 10 EBRD loans.
He said he personally knew all of the EBRD Chairmen during
that time, that EBRD had had a long-term and successful
relationship with him and his team, and that his company had
a good credit history with EBRD. He said his companies got
financing from many sources, including for example a recent
USD one billion loan from a Chinese bank. Branegan asked why
he would want to go through the extra bureaucracy and
requirements of getting an EBRD loan when he could just get a
loan from traditional banks. Yevtushenkov responded that
while for many companies it is complicated to get money from
EBRD, for him it is easy. More concretely, he said that EBRD
had flexible credit instruments, such as taking some equity
or options. In conclusion, Yevtushenkov said he was very
pleased with how EBRD was doing business in Russia and he did
not think that they should change their modus operandi.

Practitioners Relate Their IFI Experiences
--------------

7.(C) Director General of the Center for Fiscal Policy Galina
Kurlyandskaya had direct experience mainly with the World
Bank and she was quite positive about its track record in
Russia. She said that the WB had run a very successful
program with technical assistance loans to governments at the
sub-national level to improve their budgeting process and
intergovernmental relations. Starting in 2000, the program
engendered competition for loans among regions, and worked so
well that when the program expired, the GOR actually decided
to continue the program itself, without the WB. She noted
that in Russia the WB has a solid reputation while the IMF
does not, but she said that the WB's fee-for-service
operations were undermining competition in the consulting
sector, in part because the WB has an exemption from the
procurements law that governs other consultants. She also
noted that negotiations for WB loans sometimes dragged out so
long that the loan was no longer needed by the time agreement
was reached. Finally, she observed that the WB required
federal guarantees before giving loans to regional
governments, and, given the GOR's reluctance to make those
guarantees, hoped a way could be found to make such loans
anyway.

8.(C) In a meeting with President of the Russian Microfinance
Center Mikhail Mamuta and two of his associates, Mamuta
declared that EBRD currently was and had been the bank
providing the most small- and medium-size enterprise (SME)
related loans of any bank in Russia, for example to credit
cooperatives. He said that before the EBRD, Russian banks
had no SME lending programs. He continued that since 2001,
the World Bank has been negotiating with the Ministry of
Finance on a USD 100 million project to support SMEs,
including new legislation, policy advocacy, and lending.
Three or four years ago the Microfinance Center was involved

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in drafting the project document, but an agreement had still
not been reached. Overall, Mamuta was complimentary of
EBRD's work with SME lending, and critical of the WB's SME
project's lack of progress over eight years.

MinFin's Perspective
--------------
9.(C) Ministry of Finance Unit Head for State Debt and State
Financial Assets Ekaterina Dmitrieva and Deputy Unit Head
Pavel Chernyshev told Branegan that the World Bank had done
about 60 projects in Russia since starting operations. At
the beginning, these were focused on covering budget
deficits, but later transitioned into joint investments in
mainly the housing, utilities, and healthcare sectors, plus
some public administration reform projects. She said that
during the financial crisis, MinFin had been trying to
strengthen its work with the WB, including looking at
different mechanisms such as guarantees from an as yet
unformed multi-lateral guarantee agency. She stated that
MinFin was using advisory services from both the WB and the
EBRD, which she noted had large operations in Russia that
hopefully would not decrease. Asked what the advantage was
for a state-owned company to get a loan from the EBRD rather
than the private sector, Dmitrieva gave three reasons. First
was the cache of an EBRD loan and its guarantees of
performance. Second was the fact that the loan were
longer-term than was easily available in Russia, and finally
that EBRD gave a good (read: low) percentage rate.
International Finance Corporation (IFC) had increased its
Russian lending operations significantly over the last three
years, reaching USD 700 million in 2008 mainly in the housing
and utilities sectors.

IMF: Reputation Still Sullied Since the 1990s
--------------
10.(C) Senior Resident Represent of the IMF Odd Per Brekk,
like a few other of our interlocutors, admitted that for
Russia, the IMF is still associated with the crisis in 1998.
He reported that while the IMF generally focuses on economic
monitoring, technical assistance, and lending, in Russia it
is not lending. He confirmed that the GOR may be thinking
about a loan from the World Bank, but not from the IMF.
Besides some small technical assistance programs in, for
example, inflation targeting training and statistics, the
IMF's main value in the country was its "surveillance" )
monitoring of economic development and policies and having a
dialogue with the GOR, mainly the MinFin and the Central Bank.

Comment
--------------
11.(C) Branegan authored a 2006 SFRC report on the EBRD, and
it was EBRD's activities in Russia that were his most
important agenda item in this trip. Whereas EBRD's
Khanjenkova spoke well about how EBRD's projects had
"additionality," the fact remains that with only a finite
amount of money to loan out, the state-owned monopoly railway
received a half billion dollars for a project that could most
likely have gotten funding elsewhere. A broader impact on
the economy could have been achieved with a greater number of
smaller and regional loans to entities that are otherwise
credit-starved. And going from bad to worse, the oligarch
Yevtushenkov was amazingly frank in how much he stressed his
personal relationship with EBRD and how easy it was to get a
loan.


12. (C) The current tightness in the global capital markets
may create a real incentive for Russia to pursue reforms that
have languished for the last six years. The EBRD should be
sensitive to that, and might do well to examine whether some
of its lending is in fact creating "additionalities" or
distorting the market by falling into a "bailout" role, where
it is picking the winners and losers at the GOR's behest -
i.e., in favor of oligarchs and state corporations. End
Comment.
RUBIN