By cutting foreign debt, the authorities are putting the breaks on economic growth. By giving state guarantees to SUAL, they are putting financial policy in action.

Yana Galukhina, Yuri Korotetsky, and Ekaterina Shokina

On July 15th, the government discussed the federal foreign debt program for 2005. The Ministry of Finance and Ministry of Economic Development and Trade, as always, did not see eye to eye. Finance Minister Alexei Kudrin demanded that the state refuse any new loans and keep foreign debt stable. “One of the most important tasks before the government is to bring the foreign debt down to the safe level of 20-25% of the GDP,” Kudrin argued at the cabinet meeting.
It should be said that by the end of 2004 Russia’s total foreign debt was 26.5% of the GDP and the total burden of both state and corporate debt was around 30% of the GDP. According to Director of the Ministry of Finance’s Department for International Financial Relations and State Financial Assets, Sergei Kolotukhin, this is “a reasonable level compared to developed nations.” However, the Russian economy, according to the Finance Ministry, is subject to greater risk than the economies of developed countries, and therefore the safe debt level should be considerably lower.
German Gref, head of the Economic Development Ministry, is more tolerant of foreign debt. He insists that the state needs at least three new loans from the World Bank: to modernize the state statistics system ($80 million), to reform finance in the regions ($100 million), and to reform housing and utilities ($300 million). Yet the Ministry of Finance won out all the same. This is becoming a regular event. A month ago it also beat out the Economic Development Ministry and insisted on a budget surplus instead of luxuries like the implementation of federal target programs or state investment projects that would increase the Russian economy’s competitiveness.
In 2005 the Russian government will take on practically no new foreign debt. According to the approved plan, only projects that have already begun with international financial organizations will continue, for a total of $952 million. The only new loan from the World Bank for approximately $200 million will go to reform housing and utilities. Statistics reform, regional finance reform, and other projects will be paid for out of the federal budget. In the case of a major crisis or natural catastrophe, the government is authorized to borrow another $2.5 billion by issuing eurobonds.

To borrow or not to borrow?

The issue of federal foreign debt has divided not only the Ministry of Finance and the Ministry of Economic Development and Trade, but also most experts.
Anton Struchenevsky, an economist at Troika Dialog Investments, is in favor of reducing state debt. “The problem is that our domestic financial sector is simply in no condition to satisfy the demand from large companies. The maximum amount one can borrow on the domestic bond market is 10 billion rubles, or $300 million. This is just a drop in the bucket for big corporations. If they need to borrow in the billions of dollars, they are forced to look abroad. As the president and the cabinet have clearly pointed to the modernization of the economy as the main goal, investment demand will obviously become a factor in economic growth. Without foreign borrowing by the private sector, growth is not likely to happen. For this reason, it seems reasonable to reduce state foreign debt in order to give private companies a chance to borrow on foreign markets and keep total debt at a safe level. Crises of payment connected to loans happen all the time. Mexico and many Asian countries are going through this. When the private sector is seeing a boom in borrowing, one has to approach public borrowing very carefully.”
Sergei Drobyshevsky, Senior Researcher at the Institute for the Economy in Transition, agrees: “It is completely possible that the aggregate foreign debt of Russia could rise to 50% of the GDP two years from now, as large natural commodities corporations enter international markets. This kind of borrowing is already growing by 30-40% a year. As these companies are also extremely dependent on external market conditions, we cannot rule out that they could possibly face problems servicing their debt.”
However, those opposed to cutting state foreign debt also have some strong arguments on their side. “To maintain high growth rates in Russia, we need to invest more money in major infrastructure projects and transportation. It is stupid to hope that private capital will get involved. These are areas for state investment. To do this, the Russian government will absolutely have to have foreign loans, as the state has already indicated that the Stabilization Fund and budget surplus will not be used for such ends,” believes Igor Nikolaev, Director of the Strategic Analysis Department at FBK. “Mr. Kudrin’s argument that loans are not being used efficiently and that they should not exceed 20% of the GDP are, to put it mildly, inadequate. Just because money is being used inefficiently does not mean that it isn’t needed.”

A revolutionary decision

Nonetheless, the Finance Ministry’s debt program did include something radically new. The state is planning to provide a guarantee of $200 million for four years for SUAL-Holding’s Komi Aluminum project. Russia’s partner in this guarantee will be the International Bank for Reconstruction and Development. Should things go wrong, the bank will be responsible for compensating investors and creditors. Only, of course, to the tune of $200 million and this is a drop in the bucket compared to the project’s total price tag ($2-2.2 billion). Yet the real issue is not the amount. This is the first time a private Russian company has gotten a state guarantee for a commercial project. Until recently, only projects with state participation were granted this kind of state support. For instance, starting in 1997, the government provided guarantees of $100 million for the international sea-based rocket launch pad, Morskoi Start. In 2005, the state will guarantee $21.9 million of a project to launch aerospace equipment at Baikonur, Nazemny Start. Expert analysis is still underway on a variety of small projects in timber and coal.

The government protects investors from itself

SUAL did not get this guarantee overnight. According to Irina Lozhkina, an analyst at Prospekt Investment Company, it has been pushing for it for at least three years. Those in the aluminum industry are not disguising their delight. SUAL is also happy with the size of the guarantee.
The guarantee means first and foremost that the state is insuring the project against its own meddling. The mere fact that the guarantee is against “non-commercial risks” indicates that bureaucrats won’t interfere with the project’s implementation. “With all the chaos and mess here in Russia, this gives Western investors a tool to get permits and approvals in a timely fashion. In other words, they now can feel confident that they won’t have to worry about any administrative problems in implementing the project,” says Maria Kalugina, Director of the Department for Guarantee Operations at the Federal Center for Project Financing, which oversees projects. Thus, this guarantee is important to SUAL both as an investor and as a party hoping to attract investment. “The risk associated with a project declines as it nears completion. The initial stage is the riskiest. This is when guarantees are an absolute necessity. Then, investment in the project will be less costly,” explains Timothy McCutcheon, Senior Analyst at Aton. “Large metal producers in Russia borrow for 3-5 years at 10% p.a. With a state guarantee, this interest rate could fall by 2-3 percentage points.” However, as the state only guarantees against non-commercial risks and everything else is the responsibility of the company, interest rates are not likely to fall to such an extent.
State guarantees have a much more significant role to play in attracting strategic investors. SUAL is currently conducting negotiations with the American company Alcoa, the world’s largest aluminum producer, to bring the company into the Komi Aluminum project in its final phase, the construction of an aluminum mill.

A modest start

The SUAL guarantee is setting a precedent in Russian state finance. In the years since the 1998 crisis, the state has been stubbornly accumulating all kinds of surpluses, funds, and reserves. And now finally it has decided to get involved in manufacturing. Support for large-scale projects in metal production, infrastructure, and transportation is just what the Russian economy needs. However, if the state really wants to encourage this kind of projects, guarantees against “non-commercial risks” are not enough.
“The state could acquire the necessary amount of resources to promote a system of state programs to widen the bottlenecks in the Russian economy with the help of capital from private investors via increased borrowing on international and domestic markets and by moving toward a policy of zero budget surplus [the 2005 budget surplus is projected at 1%--Expert],” believes Dmitri Belousov, a specialist at the Center for Macroeconomic Analysis and Short-Term Forecasting. “A system of state-private programs and projects based on equal partnership could become a means for attracting more capital to Russian business. The newly reestablished Council on Competitiveness could become the place for dialogue between the authorities and business regarding such programs.”
In conclusion, it’s interesting to note that even the US government, far from indulgent toward private companies, has accumulated more than a trillion dollars in active state guarantees to private business. This is almost 10% of the GDP or a third of the federal budget. A similar level of guarantees for the Russian economy would mean $40-50 billion. For the time being, the government has only pledged $200 million. But, as they say, not bad for a start.

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