Over the next decade, Russia could double its public foreign debt without harming its economy, provided that there are channels for efficient use of these borrowed funds in place. At the moment, however, the private sector is using loans more productively.

Boris Kheifits*

*Doctor of Economics and Senior Researcher, Institute for International Economic and Political Studies at the Russian Academy of Sciences,

According to a recent statement made by Sergei Kolotukhin, Deputy Minister of Finance, Russia’s foreign debt as of January 1st, 2004 amounted to $119.6 billion. The Bank of Russia gives somewhat different figures. According to official Central Bank statistics, Russia’s debt amounts to $106.8 billion, including federal subjects’ liabilities and the Central Bank’s own debts. After the 1998 Crisis, the public foreign debt has decreased by nearly a third. The government plans to further reduce foreign debt to $115 billion by early 2005, and after 2008 it could shrink to $100 billion. The Bank of Russia has produced statistics on private sector debts as well. Over the last four years, private debt has increased by 2.6 times and mounted to $75.1 billion. The rapid growth of private debt has resulted in Russia’s gross debt resuming its growth in the last two years. Comparable international statistics on external debts only become available with a long delay. Therefore, it is not currently possible to establish Russia’s exact place in the rankings by debt among emerging markets. According to result from 2001, we lagged behind Brazil, China, and Mexico in terms of gross debt. Today, we perhaps yield only to Brazil. Meanwhile, relative indices of the debt burden on the Russian economy are not heavy and are consistently falling. The gross external debt-to-GDP ratio fell from 96 percent in 1999 to 42 percent in the last year, while the debt-to-export of commodities and services ratio moved from 195 percent in 1998 down to 103 percent in 2003.

At any price

However, after more detailed analysis, the general optimism regarding the considerable reduction in the public foreign debt diminishes significantly. The problem is more than such relatively small problems as prolonged restructuring of commercial debts, deals to purchase Russian debt to the Czech Republic and Slovakia that are indecently profitable for certain intermediaries, or unsettled debts with countries such as Kuwait, Oman, Greece, and Malta.
The main problem is that the price of debt reduction is too high. Over the last four years, Russia’s debt has been reduced by $39.3 billion. Here, we should take into account the debt write-off thanks to restructuring of Russian obligations to the London Club creditors in 2000 (by $10.4 billion), as well as discounts resultant from the restructuring and buy-out of debts to former socialist countries (former GDR and Yugoslavia, as well as the Czech Republic, Slovakia, Hungary, and Bulgaria) to the tune of about $7.3 billion. Thus, the reduction of the foreign debt due to regular payments to creditors amounted to $21.6 billion, whereas the very total payments turned out to be more than twice as much, namely $48.6 billion. This was caused by the high cost of these debts, which entailed massive interest payments, as well as by continued borrowing, although this was exponentially smaller in scale. The growth of the euro and other foreign currency exchange rates also affected payment. As of early 2003, they accounted for 35 percent of all Russian foreign debt.
However, these huge debt payments point to its irrational structure, both in terms of dates and cost. Its substantial part falls to debts to the official creditors of the Paris Club, whose loans come with interest rates 7-8 % p.a. In addition, Russia continues to service Eurobonds with coupons yielding 11-12.75%. The actual cost of borrowing new financial resources for a term of 15-20 years for Russia with its present half-investment-degree rating would be no more than 6-7%.
Moreover, few medium-developed countries in the world pay their debts only via direct cash payments. A variety of conversion transactions, debt buy-outs at a discount, securitization of the indebtedness etc. have become a norm for debt management. However, as a result of the considerably improved macroeconomic parameters of the Russian economy, many of these opportunities have been lost: international creditors are tough on the countries with huge foreign currency reserves and growing natural commodities exports.
Other global projects, like the debt write-offs for Russia’s expenditures on eliminating weapons of mass destruction or discounted buy-outs of the former USSR’s debt to the Paris Club, debts questionable to begin with, have not been implemented. 

Unequal exchange

New hidden challenges to Russia’s debt stability have emerged. The increase in domestic debt and corporate indebtedness are most important of them. The policy pursued to replace foreign with domestic borrowing aims to reduce the macroeconomic risks of foreign currency service and reduce the cost of public borrowing. Another argument of no less importance is the need to tie down the rapidly growing money supply caused by the influx of dollars into Russia. In 2004, domestic debt will make a dramatic leap forward. The federal government plans to issue new securities totaling 291 billion rubles that are expected to sell for 258 billion rubles. Given the requirement 118 billion rubles for bond redemption, the net attraction of funds will amount to about 141 rubles versus 9 billion rubles in 2003. In the long term, one can expect the domestic debt to increase from around 700 billion rubles in 2003 to 1.2-1.3 trillion rubles in 2006. After 2010, the foreign versus domestic debt ratio may be 1:1. Its maximum value was 7.8:1 in 2000, and its minimum value was 1.3:1 in the pre-default year of 1997.
The hazard of excessive growth in domestic borrowing, as was the case in the mid-1990s, is the fact that increased domestic debt in the context of worsening economic conditions could spur rapid inflation growth with all its ensuing negative consequences. Furthermore, investment in government securities tends to beat out capital investments in the private sector, thus depriving the real economy of considerable investment resources required for the future growth.
The rapid increase in domestic borrowing seems odd in the context of huge financial resources the state has available, such as financial reserves, the stabilization fund, gold and foreign currency reserves, and the state pension fund. The resources of these potential “safety cushions” are not being used efficiently at all.

Hungry private owners

The rapid growth of corporate debt is another potential threat to financial stability. Many experts believe that the problem of corporate indebtedness is purely the corporations’ problem and nobody else’s. However, companies and banks, in which the state owns a substantial stake, account for a considerable share in the total volume of Russian corporate debt. For example, Gazprom’s total foreign and domestic loans exceed $14 billion, putting its financial collapse on par with a crisis in public finances.
As the Asian Crisis of 1997-1998 demonstrated, huge private indebtedness can became the main reason for increasing negative processes in the economies of a number of Asian countries. It caused defaults, which led to the devaluation of national currencies, panic on financial markets, and mass bankruptcies. Foreign corporate debt leads to additional foreign currency inflow in the Russian economy, meaning they in essence exacerbate the “Dutch disease.”
Of course, we shouldn’t deprive corporations of their right to refinance their loans or raise investments where money is cheapest. At this point, one has to admit that corporate debt policy responds to ruble appreciation more flexibly than that pursued by the state.
Besides, some corporate loans are actually illegally removed capital returning from abroad, when affiliated foreign structures allocate funds to Russian subsidiaries. With the recession in the West, when investments’ yield has dropped dramatically, the Russian markets provide better investment opportunities. In this context, default seems much less of a threat.

Prospects

Given that the government wants to double Russia’s GDP, we can expect the Russian economy to move to a qualitatively new state. It is within this economy’s power to service public debt in the amount of $200-220 billion. In other words, the state is likely to raise additional $80-100 billion of borrowed resources in the long term.
Moreover, many dynamically developing countries with emerging markets are experiencing growing foreign debt along with a substantial influx of foreign investments.
The growth of the public debt enables the government to reduce the tax burden on the national economy, which creates additional prerequisites for economic growth. Developed countries use this method to overcome recession.
In contrast to 2002 and 2003, when the Russian government refused to make Eurobond issues envisaged in the budget, it has declared lately that in 2004, it will most likely issue $3 billion in bonds. This will create favorable conditions for refinancing the debt so as to reduce the cost of debt servicing. It may also help new long-term guides in the policy of public debt management develop, including with respect to domestic borrowing. 

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