RUSSIA FORUM 2009 UNCOVERS POLICY DEBATE ON

C O N F I D E N T I A L MOSCOW 000330 SIPDIS STATE FOR EUR/RUS, EEB/IFD TREASURY FOR TORGERSON AND WRIGHT DOC FOR 4231/MAC/EUR/JBROUGHER NSC FOR ELLISON E.O. 12958: DECL: 02/11/2019 TAGS: EFIN ECON RS SUBJECT: RUSSIA FORUM 2009 UNCOVERS POLICY DEBATE ON ECONOMY'S WAY FORWARD REF: MOSCOW 203 Classified By: ECON MC Eric T. Schultz, Reasons 1.4 (b/d). ¶1. (C) Summary. This year's Russia Forum, hosted by Troika Dialog, highlighted fundamental disagreements in the Russian government on the best policy mix to manage the economic crisis. First Deputy Prime Minister Igor Shuvalov, voicing a "conservative" approach, declared the GOR would reduce budget expenditures for the year to minimize the expected deficit. However, Presidential Aide Arkadiy Dvorkovich, supporting a "progressive" direction, maintained that overall spending would not decrease. Bearish conference participants, including Sberbank President German Gref and New York University's "Dr. Doom" Nouriel Roubini, predicted Russia faced a prolonged recession. More bullish participants, such as Magnit supermarket chain General Director Sergei Galitskiy and Economic Policy Director at the Higher School of Economics Martin Gilman, predicted Russia would emerge from the downturn faster than expected. End Summary. -------------- Russia Forum 2009: Divided on Russia -------------- ¶2. (C) From February 4-6, leading Russian investment bank Troika Dialog hosted the 2009 "Russia Forum," an annual "Davos" in Moscow, which featured panel discussions on topics ranging from assessing the financial crisis, to prospects for Russia's banking sector, and retail chains, to next year's prospects for the ruble. Last year's Forum focused on optimal ways to transform Russia's fiscal and financial wealth into greater prosperity. This year, by contrast, the participants spent most of their time disagreeing with each other on the Russian economy's prospects in the light of the global downturn. -------------- Shuvalov vs. Dvorkovich -------------- ¶3. (C) In the Forum's opening session, First Deputy Prime Minister Igor Shuvalov declared a central component of the GOR's response to the lingering financial crisis would be a reduction in federal spending. The GOR had accepted the reality that oil prices were likely to stay below the original 2009 budget's forecast of USD 95 per barrel. Consequently, the cabinet was working to revise the budget based on USD 41 per barrel. Anti-crisis spending, namely in support of the banking sector, would rise as the GOR moved away from targeting support to individual firms. However, infrastructure spending, namely for planned projects that had not yet begun, would be cut. ¶4. (C) Shuvalov said the objective was to reduce overall expenditures, otherwise the budget deficit would reach 10 percent of GDP. Covering such a deficit with the Reserve Fund in 2009 would leave virtually no resources to cover a projected 2010 deficit of 3-5 percent of GDP. Besides depleting the Reserve Fund, Shuvalov said, a large budget deficit in 2009 threatened too much uncertainty for the Russian economy. Cutting expenditures was, therefore, the responsible course of action. He acknowledged, however, that reaching agreement within the GOR on which reductions to implement was proving difficult. ¶5. (C) In contradiction to Shuvalov, Presidential Aide Arkadiy Dvorkovich said the GOR would not cut expenditures. During the second day of the Forum, in a panel discussion on Russia's access to capital markets, he dismissed Russian Railways Senior Vice President Fyodor Andreyev's reference to Shuvalov's statements of the previous day on reducing 2009 federal budget expenditures. Dvorkovich acknowledged the crisis had prompted the need for certain changes in the "structure" of the federal budget's expenditures. Nevertheless, he maintained that the revised 2009 budget would maintain the general spending level of the budget President Medvedev had signed into law last fall. -------------- --- Observers: Gloom and Doom vs. Die-Hard Optimists -------------- --- ¶6. (C) The overall atmosphere of the Forum was grim, particularly compared to last year's event. Sberbank President German Gref predicted Russia's recession would last three years. He said 2009 would be the worst year of the slowdown but that GDP growth in 2010 and 2011 would be near zero. New York University Economics Professor Nouriel Roubini (aka "Dr. Doom") agreed with Gref and said the worst was still ahead for Russia. He predicted the recession in the U.S. could last two years as officials, regulators, and banks took on the difficult task of restoring confidence in the financial system. Consequently, a prolonged period of tight global credit would probably extend Russia's 2009 recession into at least 2010. According to Roubini, the best case scenario for Russia was a trend of muted economic growth--perhaps 3 to 4 percent--that would start in late 2010. ¶7. (C) Ecole des Hautes Etudes en Sciences Sociales (EHESS) Economics Professor Jacques Sapir told the Forum that a number of structural weaknesses threatened to make the crisis more severe and more protracted in Russia than in other emerging markets. Sapir argued that corruption and the banking sector's poor financial intermediation made Russia an unattractive place to start a business, especially for Russians. The perceived need for connections at multiple levels of government and in multiple banks had given Russia a bad reputation as a place to invest and do business. According to surveys conducted by Sapir and his institute at EHESS, Russia's would-be business owners understood that they had "one shot" to line up a successful business plan with needed government permits and start-up capital, otherwise their businesses were doomed to fail because of official corruption and excessive state control of the economy. Sapir observed that the difficulty of this task had essentially stifled entrepreneurship in Russia. ¶8. (C) Mixed in with the general gloom were, however, a few voices of optimism. European Bank for Reconstruction and Development (EBRD) First Vice President Varel Freeman said Russia was well positioned to withstand the crisis. He said Russia's overall stability had been overshadowed by the recent news of ratings downgrades, first by Standard and Poor then by Fitch. Freeman argued the downgrades were based in part on the "faulty" assumption that the GOR stood ready to use international reserves to pay off corporate foreign debts. (Note: In fact, many of the debts belong to state-owned corporations and probably are implicitly guaranteed by the GOR. End Note.) Freeman said he was confident that Russia had the fiscal and commercial resources to fund its obligations and sustain economic activity which would mitigate the recession. ¶9. (C) Sergei Galitskiy, General Director of the Magnit chain of retail supermarkets, conceded the Russian economy faced a difficult year but said that the consumer boom retained much of its economic potential. Galitskiy contended that the steady depreciation of the ruble had prompted Magnit and Russian stores to begin purchasing fewer goods from foreign suppliers in favor of domestically produced items, including food, clothing and electronics. Galitskiy's forecast was that this purchasing shift would produce a stabilizing effect for Russian industry that would multiply gains from the relatively inexpensive ruble. ¶10. (C) Straddling the divide, New York University Polytechnic Institute Professor and author of "The Black Swan," Nassim Taleb, urged bearish panelists and the audience to avoid putting too much credence in any set of negative predictions. He said excessive reliance on accepted models of forecasting had led to the current crisis situation. The world was in flux and financial professionals and government officials alike needed to question their assumptions. Taleb predicted that Russia's familiarity with extreme events--from market crashes, to rapid government changes, to banking crises--had prepared the populace and the government to survive a severe recession, regardless of how long it might last. -------------- Division Over the Ruble -------------- ¶11. (C) One of the more lively debates at the Forum centered on the near-term future of the ruble. Economic Policy Center Director at the Higher School of Economics Martin Gilman asserted that the value of the ruble was stable at RUR 41 to the dollar-euro basket. Moreover, he said the Central Bank's (CBR) gradual devaluation had allowed a soft landing to this near-equilibrium value of the ruble in a difficult oil-price environment. ¶12. (C) However, co-founder of The Quantum Fund Jim Rogers disagreed with Gilman, arguing that the CBR's pledge to support the ruble against the basket was a dangerous line in the sand. "The market has more money than any central bank," Rogers warned, noting that he had not made any ruble investments. Rogers also posited that the lingering economic slowdown might lead to social unrest, which would further undermine the ruble and the CBR's position. ¶13. (C) Eclectica Asset Management Chief Investment Officer Hugh Hendry echoed Rogers' sentiments. Hendry expected oil prices to remain subdued in the low- to mid-USD 40 range and that Russia would not be able to increase domestic production rapidly enough to bridge the gap left by declining imports. In light of the factors affecting the Russian economy that were beyond the GOR's control, Hendry said he had made a sizable bet that the ruble would continue to decline. -------------- Comment -------------- ¶14. The Forum brought further into the open the internal GOR policy debates which are delaying release of the revised 2009 federal budget. The "conservatives," represented by Shuvalov and Kudrin (reftel),favor greater fiscal balance (i.e., a smaller budget deficit) during what promises to be an uncertain year. The "progressives," represented by Dvorkovich and Economic Development Minister Nabiullina, favor greater budget outlays and a larger deficit to stimulate the Russian economy. This debate mirrors, in some respects, the debate in the U.S. between deficit hawks and advocates of a large stimulus package. However, it is occurring here against a very different background: double-digit inflation. This complicates GOR policy-making especially during a recession. Russia is caught in stagflation and getting out, absent an increase in commodity prices, will test the GOR's economic acumen. End Comment. BEYRLE