C O N F I D E N T I A L MOSCOW 000535

C O R R E C T E D COPY

SIPDIS

STATE/EEB/OMA ALEX WHITTINGTON
STATE FOR EUR/RUS
TREASURY/IMB BILL MURDEN, WILBUR MONROE, MARY BEASLY

E.O. 12958: DECL: 03/04/2119
TAGS: ECON EFIN RS
SUBJECT: INFORMATION REQUST IN ADVANCE OF G-20 MEETINGS

REF: A. A) STATE 17502

B. B) 08 MOSCOW 3376

C. C) 09 MOSCOW 101

D. D) 09 MOSCOW 160

E. E) 09 MOSCOW 334

F. F) 09 MOSCOW 346

G. G) 09 MOSCOW 364

H. H) 09 MOSCOW 365

Classified By: Econmincouns Eric T. Schultz, Reasons 1.4 (b,d)

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Economic Overview
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1. (SBU) Russia's economic downturn appears to be
accelerating. Oil and gas revenues have plummeted;
industrial production has fallen by 16 percent. Growth is
forecast at negative 2.2 percent his year but will likely be
even worse as the economy has been contracting at close to 10
percent in recent months. The government is forecasting
inflation at 14 percent inflation, meaning that Russia is in
"stagflation". The ruble has lost a third of its value since
September 2008, and unemployment, about 8 percent, is
increasing. The Finance Ministry forecasts budget revenues
will drop 40 percent or more this year, leaving the country
with a eight percent budget deficit - the first in nearly a
decade.


2. (SBU) Initially, the government's crisis response was
predicated on a return to growth and rising commodity prices
by the year's end. However, the GOR has now finally
acknowledged that the economic downturn will be long and
severe and an extended budget debate has resulted, which pits
advocates of deficit spending against proponents of fiscal
restraint. The GOR's main objective is to prevent an
increase in social tensions through spending. However, with
budget revenues sure to drop by 42 percent this year, it is
uncertain how Russia will continue to finance social
expenditures this year or next.


3. (SBU) The government currently plans to increase spending
by $14 billion this year. Much of the spending will go to
anti-crisis commitments: more funds for banking sector
capitalization, maintaining social spending (health care,
pensions), and increasing unemployment benefits. In that
regard, the government plans to finance the deficit from the

reserve fund, accumulated during previous years of high oil
prices and amounting to approximately 10 percent of GDP.
However, the government is also looking for ways to reduce
spending; for instance, it recently announced that it will no
longer provide funds to individual firms to repay their
foreign debts. The government may have to borrow externally,
likely at high interest rates.


4. (SBU) Going into the G-20, GOR officials are keenly aware
that global - particularly U.S. recovery is critical to
Russia's recovery. They are tracking the U.S. debate over
fiscal and monetary policy closely, and in many respects
their policy approaches parallel our own. At the London
Summit, the Russians will want to coordinate anti-crisis
measures closely and will be looking to cooperate on reform
of the international financial architecture. In that regard,
the GOR focus is on reform of rating agencies, the IMF, and
monitoring agencies. End Summary and introduction.


5. (U) The following responses are cued to questions in para
5, ref A.

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I. Objectives for the London Summit
--------------


6. (SBU) GOR officials have stated they want the G-20 Summit
to move beyond specifics. Beyond that, officials have not
provided details in their public statements about what they
expect from the summit. Russian proposals for the London
Summit (as shared with the government of the G-8 countries)
call for agreement on the parameters of a new global
financial architecture and a follow-up conference to decide
on the ground rules for a new global financial regulatory
framework.


7. (SBU) The GOR, which has had a difficult relationship with
the IMF, proposes revising the role of the Fund's mandate in
light of the global crisis. This would include increasing
IMF resources, developing new credit facilities to help
countries particularly hard hit by the crisis, a
redistribution of IMF quotas and, probably most importantly,
a greater voice for emerging and developing countries (with
fewer conditionalities on loans). The GOR suggests that the
IMF or an ad-hoc working group of the G-20 study the
possibility of expanding the list of currencies used as
reserves (presumably to include the ruble) and supports the
establishment of multiple, regional financial centers
(presumably to include Moscow). In addition, the GOR
proposes the establishment of a supra-national structure, not
necessarily associated with the IMF, to function as a crisis
early warning system and a global lender of last resort. The
GOR is in favor increasing resources for development
financing and the implementation of an energy-efficient
growth concept.


8. (SBU) The GOR supports in principle the Declaration of the
Washington Summit to refrain from any barriers to global
trade and the movement of capital, though in practice it has
taken a number of protectionist steps since the summit. It
also proposes that measures the G-20 countries are taking to
promote domestic demand are consistent with "long-term
macroeconomic stability" as reflected in low-inflation, a
reasonable budget deficit and public debt levels.

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II. Impact of the Global Financial Crisis
--------------

A) Support for the Banking Sector:


9. (SBU) The GOR has prioritized support for the banking
sector. The goal has been to supply an increase of long-term
and short-term credits to the banking sector. Last fall, the
GOR approved, but did not allocate all of, USD 38 billion in
subordinated loans from Central Bank reserves and the
National Welfare Fun principally for the benefit of the
country's state-owned banks. The 2009 federal budget is
expected to add another USD 13.1 billion to this amount. The
additional liquidity has not, however, found its way to the
real economy and has instead been used to shore up bank
balance sheets, including through currency speculation
(shorting the ruble). In addtion, the state Vneshekonombank
(VEB) received USD 50 billion from Central Bank reserves to
provide loans to Russian companies with foreign debts. Only
USD 11 billion were disbursed. The repayment terms were
LIBOR 100 basis points due at the end of 2009. VEB
approved financing for UC Rusal (USD 4.5 billion), Alfa Group
(USD 2 billion), Evraz (USD 1.8 billion), Mechel (USD 1.5
billion), Rosneft (USD 774 million), Russian Railways (USD
USD 270 million), and PIK Group (USD 262 million).


10. (SBU) Last fall, the GOR increased the amount of retail
deposits fully covered by Deposit Insurance Agency
guarantees. In October 2008, the 100-percent guarantee for
retail deposits increased from RUR 400,000 (USD 11,000) to
RUR 700,000 (USD 20,000). The Deposit Insurance Agency (DIA)
also received an additional capital infusion of USD 8 billion
to prevent bankruptcies. The DIA briefly took control over
VEFK Bank, Moskovskiy Capital, MZ Bank, and Bank Tarkhany.
DIA also facilitated the reorganization of Rossiyskiy
Capital, Russian Development Bank (not be confused with the
Development Bank of Russia state corporation that forms part
of VEB), Potentialbank, Gazenergobank,
Nizhegorodpromstroybank, Bashinvestbank, GB Nizhniy Novgorod,
Bank Severnaya Kazna, Elektronika Bank, and Bank24.ru.


11. (SBU) During the autumn of 2008, the Finance Ministry
increased the frequency of its short-term loans of surplus
budget funds, a program that ended as of December 31, 2008
with all loans repaid. The Central Bank (CBR) also moved to
ease the liquidity squeeze by providing larger volumes of
short-term loans and by lowering reserve requirements. Since
late January 2009, however, the CBR has raised interest rates
on its short-term loans as a means of defending the ruble
against speculative attacks.


12. (SBU) The GOR has not made a formal decision concerning
the treatment of bad assets, but is reportedly considering
options. As for regulatory changes, Prime Minister Putin has
voiced public support for a transfer of bank supervision to
an agency/body separate from the Central Bank, which
currently has responsibility for the function, and that might
incorporate elements of the Deposit Insurance Agency.

B) Foreign Exchange Reserves:

13. (SBU) Russia,s foreign exchange reserves have declined
more than USD 200 billion dollars since early August as the
result of capital flight, reflecting concerns about the
aftermath of the conflict with Georgia, falling oil prices
and uncertainty about the solvency of the country,s banking
sector. The combination of the Georgia conflict and falling
oil prices compelled the Central Bank to intervene in foreign
exchange markets to prevent a steep decline in the value of
the ruble. Mid-September reports of interbank loan defaults
by some of the country,s larger private banks sent
securities, prices sharply lower and added to the downward
pressure on the ruble. By mid-November, the Central Bank
moderated its defense of the ruble by announcing it would
allow the ruble to gradually fall against a basket composed
of 0.55 dollars and 0.45 euros in 1-percent increments. On
January 22, the Central Bank announced the end of its managed
CBR would refrain from intervening until/unless the ruble
depreciated another 10 percent, which happened within a week
of the January 22 announcement. By that time, the ruble had
lost nearly a third of its value. Since that time, the
government has used increased interest rates and informal
administrative controls to stabilize the ruble without
recourse to currency interventions. All told, Russia,s
foreign exchange reserves have declined from USD 596 billion
in August to USD 380 billion today, primarily as a result of
the ruble defense and its gradual devaluation.

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III. The Broader Economic Crisis
--------------

A) The Budget:


14. (SBU) The GOR is in the process of revising its 2009
budget, aprocess that is now two months old. In late
December, Prime Minister Putin directed the Cabinet to revise
the budget in light of new economic realities, namely a
substantially lower prices for oil, which had previously
supplied as much as 43 percent of revenues. The original
budget, approved in the fall of 2008, forecast a 3-percent of
GDP surplus based on an oil price assumption of USD 95 per
barrel. Putin said the revised budget should be based on an
assumption of USD 41 per barrel. The budget also needed to
account for the USD 70 billion 'anti-crisis' stimulus Putin
outlined in his United Party Congress address on November 20.


15. (SBU) Finance Minister Kudrin,s public statements
indicate the revised 2009 federal budget will face a deficit
of 8 percent of GDP, due to an expected drop in revenues of
at least 40 percent (compared to the original budget) and a
5.5 increase in spending (again, relative to the original
budget). Officials have offered few clues about how budget
discussions are shaping up. The budget was to have been made
public the first week of March but has been delayed again,
until late March, reportedly over disagreements over what
priorities to fund.


16. (SBU) Officials have offered few clues about the budget
discussions. Prime Minister Putin has stated that the GOR
will fund 100 percent of its social policy obligations,
namely health care, pensions, and education. First Deputy
Prime Minister Igor Shuvalov said publicly on February 4 that
spending on infrastructure projects not already underway
would be cut. Press reporting has indicated that Cabinet
ministers received instructions to cut their ministries,
budgets by 15 percent, but Finance Minister Kudrin has said
in a number of interviews that reporting on spending or the
size of the deficit should be dismissed as imprecise.


17. (SBU) Russia,s budget code does not contain provisions
for a mechanism akin to a continuing resolution. Tax revenue
continues to come into the federal treasury, and salaries
continue to be paid. However, in the absence of a budget,
ministries must request funding for their projects and
programs from the Finance Ministry and government spending
has reportedly fallen dramatically as a result.

B) Support to Domestic Industry:


18. SBU) A number of domestic industries have either received
direct financial bailouts from the GOR, or have benefited
from other stimulus measures. Three of Russia,s major
producers of cars and trucks have already received
multi-million dollar loans from the GOR to weather the
crisis, while the GOR is working on a restructuring and
financing plan for the fourth major car and truck
manufacturer. In addition, in order to stimulate domestic
demand, in February 2009, the GOR announced a $347 million
state procurement of vehicles and $55.6 million in subsidized
financing for consumers willing to buy domestically produced
'economy class' car models.


19. (SBU) The defense and aerospace industries have been
given billions of dollars to stay afloat through the crisis,
largely by means of the direct transfer of sums from the GOR
budget to the state-owned corporation Rostekhnologii, which
owns over 400 Russian companies in the defense, aerospace,
titanium and automotive sectors. Many of Russia,s
financially strapped airlines have been promised bailouts,
and several insolvent airlines are being recapitalized and
merged into a new aviation subsidiary of Rotekhnologii. All
of Russia,s airlines will benefit from subsidized GOR
financing for the purchase of jet fuel, while those still
financially able to purchase planes from abroad will receive
temporary relief from the duties charged on many types of
imported leased or purchased aircraft.


20. (SBU) GOR bailouts have also been deployed to prop up
Russia,s metals and mining companies, including a $4.5
billion GOR loan to major aluminum producer RusAl (owned by
oligarch Oleg Deripaska), and a $1 billion loan for coal and
steel producer Mechel from the state-owned GazPromBank.

C) Trade Policy:


21. (SBU) In response to the global economic crisis, the GOR
has increased duties on several categories of products,
including automobiles and trucks; harvesters; steel pipe,
tube and rebar; and dairy products. Observers view virtually
all of these duty increases as protectionist measures
intended to provide relief to vulnerable domestic industries
that are losing market share to imports and struggling to
cope with the crisis. The GOR claims that their actions are
consistent with those of other countires. For instance, they
note that the recent duty increases on dairy products such as
butter and milk were only announced after the EU recently
began offering export refunds to EU dairy producers.


22. (SBU) The GOR is also currently considering other
potential duty increases to protect domestic producers of
footwear, televisions, certain industrial equipment, and
cheese. In addition to duty increases, the GOR has in the
last three months reduced the export duties on certain
categories of metals, including copper cathode and nickel.
The reductions in export duties are meant to make domestic
producers, exports more globally competitive with the prices
charged by other producers.


23. (SBU) On February 1, the GOR also imposed a
discriminatory tax on EU, Swiss and Turkmenistani trucks that
use Russian roads. Russian officials argue that the measure
was intended to be a reciprocal charge on countries that
charge similar taxes on Russian trucks, but EU officials have
countered that similar fees charged in some EU member states
are applied equally to all truckers, both foreign and
domestic. The measure appears to put EU trucking companies
at a competitive disadvantage vis--vis other major users of
the domestic road system, including Russia, Ukrainian and
Turkish firms, and to collect a disproportionate amount of
revenue from the EU for badly needed improvements to
Russia,s transportation system
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V. Political and Foreign Policy Ramifications
-------------- -
A) Impact on leadership:

24. (C) As the economic crisis deepens, differences in policy
approaches among various elite groupings within the Kremlin
and the White House have emerged. Opposition parties within
the State Duma have also publicly begun to question the
direction of GOR crisis response policy. However, none of
these differences, and the yet-uncoordinated and relatively
small public manifestations of discontent, currently present
a challenge to the ruling party (United Russia), its leader,
Prime Minister Putin, or to President Medvedev. However, as
the government's reserves dwindle, and as commodity prices
remain low (in comparison to even 6 months ago), it is
possible resentment over government mismanagement could
translate into political and social unrest.
B) Possibility of Unrest:

25. (C) The risk of crisis-driven unrest in Russia remains
low and is likely to remain so, at least through the summer.
Public opinion surveys show an up-tick in dissatisfaction
with the country's general direction, but with no indication
that the darkening mood signals an increased tendency for
protest or other signs of active discontent. Some argue with
justification that society has yet to feel the full effect of
the economic crisis. They predict a moment of truth next
fall, when the number of unemployed (or underemployed)
Russians begin to rise amid continued deprivations and
expected cutbacks in government benefits and support. The
greater short-term risk is that of intra-elite infighting,
driven by competition over dwindling wealth and resources,
particularly if the sides try to stir up public
dissatisfaction as an instrument of leverage.

C) Criticism of U.S.:


26. (C) Russians by and large have been conditioned through
pronouncements since autumn 2008 from their senior leaders to
blame the U.S. for having started the crisis. Since the
inauguration of President Obama, Russian government criticism
of the U.S. has tapered off. Some more acerbic commentators,
including a few permitted to use state-run television as
their platform, have spouted anti-U.S. statements, aiming
them at the Bush administration, though also attacking some
economic policies initiated by President Obama. Even
pro-Western commentators have criticized the U.S. for
continuing to monopolize world capital markets, drawing
investment from China for government securities at a time
when Russia and other countries need additional capital
inflows. It is possible that, as the crisis deepens in
Russia, criticism of the U.S. might further increase.

D) Foreign Policy Implications:


27. (C) Some commentators have argued that the government
might use a foreign crisis to divert attention from economic
hardships. This might take the form of conflict with
Ukraine, or again with Georgia. Others note that to do so
would amount to economic suicide, costing the government huge
sums while potentially resulting in cut offs from foreign
credit and further flight of foreign investment from Russia.
That said, at this point, it does not seem that Russia is
interested as yet in scaling back its desire to play a more
controlling role in the affairs of its neighbors. Despite
its own economic problems, Russia has already made additional
financial commitments to Kyrgyzstan and Belarus and is
considering loans to Ukraine as means of enhancing its
influence. This is happening even Russia faces the
likelihood of renewed external borrowing in 2010, if not
before, at high interest rates.


28. (U) Embassy contact is ECON John Stepanchuk,
Stepanchukjc@state.gov.


BEYRLE