STAFFDEL BRANEGAN IN MOSCOW: INTERNATIONAL

C O N F I D E N T I A L SECTION 01 OF 03 MOSCOW 002151 SIPDIS STATE FOR EUR/RUS, EEB/IFD TREASURY FOR TORGERSON, WRIGHT DOC FOR 4231/MAC/EUR/JBROUGHER NSC FOR MCFAUL 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 -------------- -------------- 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 MOSCOW 00002151 002 OF 003 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 MOSCOW 00002151 003 OF 003 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