8Section 5. Institutional Problems
5.1. Property Policy in the Financial Crisis
5.1.1. The overall process of property redistribution
Even the roughest assessments make it evident, that the financial crisis, started in 2008, leads to a noticeable intensification of several inter-related property processes. First of all, the general property redistribution process in the scope of the Russian economy gets new incentives, just like after the crisis of 1997-1998.
General assessments of the market of mergers and acquisitions in 2008 are very similar with a noted downgrading as compared with 2007, whereas the first ones took place after a long period of steady growth within 2002-2007. Absolute assessments of the reducing market capacity are differed, depending on the methods used: by 36 per cent, from USD 120-122 bln to USD 77.5 bln (with regard to transactions from USD 5 mln, as per M & A Intelligence), or by 9 per cent to USD 120 bln, nearly USD 100 bln of which were addressed to the Russian assets purchase (with regard to all transactions, as per Ernst & Young estimates)1.
The assessments of the prospects for this market in 2009 are much more controversial. In general, it is expected a further reduction in the market capacity (up to 60 per cent as compared with the level of 2008), but the forecasts on the qualitative trends are rather different (depending on the further market restraints due to the problems with working capital and external funding access, up to the market reviving from mid-2009 at the expense of the purchase of problem assets and companies). In fact, it is clear that, with an overall downgrading in the market of mergers and acquisitions in the situation of the financial crisis, this channel remains «working» particularly for those businesses, which have kept liquidity and were able to take this advantage to purchase the depreciating assets (from May 2008 to February 2009 the capitalization of the Russian stock market has fallen down 4-fold, from USD 1.5 trillion to USD 370 bln).
At the same time, the activity of the insiders is growing (primarily major shareholders and Managers, which is often identical in the Russian model). According to the available information on the dynamics in the 500 largest public companies transactions, in the second half of 2008 the number of transactions on the sale of the shares by the management of the companies has significantly reduced. On the contrary, there is noted an increase in the number of transactions, in which the insiders were acting as the buyers of shares of their company, even in cases, when in earlier periods they had acted as sellers . With some reservations, the same policy, as demonstrated below, was typical in crisis situation and for the state as well.
Although the statistics is not available (primarily due to the restricted access to such information), a significant channel for the assets redistribution (including foreign assets) in 2008 could become the forced sales of bank margin securities (margin calls) of the Russian
1 Hereinafter the in the analysis of various processes in the corporate sector and measures of public anti-crisis support ther used the information and materials, allocated on the official websites of the leading news agencies and periodicals (of publishing houses) for 2008-2009. (in particular, www.vedomosti.ru,www.kommersant.ru, www.ma-journal.ru etc.).
2 However, it is not surprising in the face of crisis, especially for problem companies, when capitalization, for example, of «RBC Information Systems» for the year has fallen down 21 times in the RTS. Ref: Forced Acquisitions. - Dengy, № 3, 26 Jan, 2009.
companies. The problem assets in autumn 2008 there were found shares of Magna (Canada) and Hochtief (Germany), pledged on «Bazela» loan (disposed by creditors), as well as the share of O. Deripaska in Strabag, the company of X5 Retail Group, VimpelCom (Depository Receipts have been pledged under the Alfa-Bank loans), Rosneft, Norilsk Nickel (25per cent pledged under «Rusal» loans), «LUKOIL», Sviazinvest, STS Media (shares were pledged under Alfa Bank loans), AFK «System» (in the mortgage securities of «Sistema-Hals» Company and Bashkiria oil assets were pledged), Wimm-Bill-Dann, Seventh Continent, Novatek and others . There are also many credit agreements, secured by the minority packages of the largest Russian companies with the state participation, but (due to the state-owned control stake), the transfer of ownership is quite possible (for example, the transfer of ADR and «Gasprom» shares in the amount of 0.77per cent of Vostok Gas share to Deutsche Bank).
The majority of companies managed, however, to retain their assets. One of the peculiarities of the Russian credit market is the predominance of the Russian banks in the corporate credit portfolio (92.7 per cent in September 2008, while the total credit portfolio of the Russian banks in the non-financial sector was RUR 11.8 trillion), but the practice of margin calls is not typical to them. Sberbank of Russia, being the largest creditor of the non-financial sector (over 1/3 of the total loan portfolio), according to the available data, is not utilizing this opportunity yet. VTB has become one of the few major Russian creditors (about 10 per cent of credit portfolio), which has used this mechanism in practice4. Some companies purchased their shares at the open market as early as in summer (for instance, «Norilsk Nickel», MTS), although with the continued decline in the market, this measure could not work to full extent5.
According to estimates of Fitch Ratings agency, in the 4-th quarter of 2008 the corporate sector has repaid of USD 36 bln, under external debt, while 55 per cent of external credits has been carried over, including margin calls, burdened with debts. In 2009, about USD 140 bln need to be accumulated for the corporate debts payment.
The transition of assets can be also caused by the started in 2008 defaults in corporate debt obligations. By early November 2008, the aggregate amount of emissions under default has amounted to about RUR 30 bln.
By early 2009, there emerged a practice of debt liabilities settlement through the transfer of assets to the creditor banks (primarily in construction, retail trade, retail mobile communication services, foodstaffs production, etc.). In January 2009, there was also the case of transfer of oil and gas fields as for the debt settlement (Urals Energy to cover the to Sberbank). Among the recipients of assets we can also mention the VTB, Alfa-Bank, Yunikreditbank, Trust Bank and others. A subsequent exposure of the assets on sale is most likely (due to the inconsistency of the acquisitions to the basic banking activities, the lack of relevant experts, etc.), what urges intensification of the corporate control in the market.
3 Ref.: Corporate secret, № 46, November 24, 2008.
4 Ref: Merges and acquisitions, 2008, № 12, pp.10-16.
5 Undoubted interest was attracted autumn of 2008 by the receipt by «Don-construction», specializing in «elite real estate», credit lines in VTB in the amount of USD 0.5 billion. Herewith, the government support (at the federal and Moscow levels) was expressly promised only to the economy class developers.
5.1.2. External corporate debt and a new phase of state expansion
A specific feature of the present crisis (as opposed to the crisis of 1997-1998) is the active participation of public and state-controlled businesses in the process of property redistribution. Moreover, the current situation becomes in fact a mirror reflection of the well-remembered shares-for-loans auctions (arranged in November-December 1995), when the government, receiving the funds from private companies to supplement the budget, has placed in pledge shares of 12 major (strategic) Russian enterprises to fulfill public liabilities. Among them, in particular, there were packages of shares of «YUKOS», «LUKOIL», «Surgut-neftegas», «Sibneft», «Norilsk Nickel», «Novolipetsk Metallurgical Works» and others, but there were no cases, when such quasi-credit was repaid, which according to the vast majority of evaluations, actually meant privatization of those blocks of shares by manifold reduced prices.
In autumn 2008, the roles have been drastically changed: on the publicly declared announced grounds of «economic security», the Government expressed willingness to refinance those external credits of public and private companies, incompliance of which could result in the loss of national control over the Strategic Asset (by the state or by national capital). This means, in particular, that the objects of actual nationalization can be not only the shares of the public sector in the direct meaning of the word (those, where participation of the state capital exceeds 50 per cent), but also strategic businesses (though the definition of that term in the Russian legal framework is rather vague) of the private sector.
Back in 2006, it was noted in the IET works6, that further development of the companies with the state participation, which have become the «core targets» of the state expansion, will be defined, among other things, by their ability to redeem credits in view of global prices for energy sources. The most pessimistic estimates were based on the expressed downfall in prices for energy sources, greatly affecting the largest state-owned companies-borrowers business. It was noted that along with the downfall in oil prices, an access to financial resources in the external markets for the debts refinancing will be decreased, whereas the price for credit services will be increased. In this situation, short-term outflow of foreign capital, downfall of the stock market and severe problems in the banking system, based on reduced liquidity were expected.
In 2000-2005 external debt of the Russian state-owned companies has increased many times: USD 570 mln in 2000, USD 12 bln in 2002, USD 28 bln in 2005, that is, according to the estimates, it amounts from 30 to 40 per cent of the total external corporate debt of Russia. Thus, in 2005, the external loans of Sberbank, Vneshtorgbank, Vnesheconombank and Rosselkhozbank amounted to nearly USD 6.45 bln (about 36 per cent of the funds raised by Russian banking sector). «Gazprom», «Rosneft», «Sovkomflot», OJSC «Russian Railways», «Transneft» and «Alrosa» total external debt reached USD 28.2 bln. The tear of 2006 has been characterized by a new wave of the debt growth: the external debt of non-financial companies and commercial banks amounted to USD 135.4 bln and USD 78.5 bln accordingly (whereas the share of public companies is estimated at over 50 per cent of the total external corporate debt of Russia).
6 Ref.: Russian economy in 2005 . Trends and prospects. M., IET, 2006 and: Interview with E.Gaydar // Expert. 2006. N3. P. 6.
By July 1, 2008, according to the Bank of Russia, the total external debt of Russian companies, banks and government administration authorities reached USD 527.1 bln (an increase only within the second quarter of 2008 totaled nearly to USD 50 bln). Herewith, the share of external debt of financial institutions amounted to USD 191.3 bln (the debt growth has exceeded USD 21 bln per quarter). The dept of non-financial companies, regardless debt liabilities to the direct investors, amounted to USD 263 bln (nearly USD 25 bln growth per quarter).
As of July 1, 2008, external public debt of Russia amounted to approximately USD 41 bln. It is estimated, that the debts of state-owned companies and banks currently make around 50-60 per cent of external corporate debt of Russia (for example, «Gazprom» - around USD 60 bln, «Rosneft» - about USD 26 bln, VTB - USD 11.4 bln, subject to redemption before the end of 2009)7.
According to common formal indicators (the ratio of the company debt against operating income), the largest Russian borrowers have not reached the critical «threshold». Nevertheless, various control measures (restrictions) of public companies external debt have been extensively discussed since 2005. From the standpoint of the Ministry of Finance, the State should take some responsibility for the activities of such companies through the development of common approaches t external and domestic debts of the state-owned companies. External debts should not be banned, but they should be limited in scope and, where possible, be replaced by credits in the domestic financial market . There were some expectations from the state representatives in the Boards of Directors. Since the borrowing issue is closely related to the companies' net profit allocation (dividends to shareholders, including the State), documents were being developed for establishment of a unified system of borrowing and dividend policy. Overall, by mid-2008, no regulations or standards of these processes have been implemented. Moreover, the administrative restriction of state companies' access to external financing sources can be hardly regarded as an effective inflation curbing mechanism. The issue of external borrowing for the state holdings should be resolved from a different point, namely
7 Investment company ATON estimates: as of Oct. 5, 2007, Russian external debt grows due to state-owned companies www.svobodanews.ru. Nevertheless, it should be noted, there are difficulties in assessing the debt of the state-owned companies: first, because of the lack of consolidated corporate registers (at least disclosed ones). Secondly, there are methodological inconsistencies. Relevant statistics of the Central Bank on external debt (detailed analytical report for 2008, ref.: www.cbr.ru/statistics) takes account of external debt for public and private sectors separately, and in the public sector includes only those banks and non-financial companies «in which the government or monetary and credit authorities direct or indirect participation makes 50 or more percent in the form of shares ownership or in any other way of control over the capital». All other public companies (combined patterns of ownership), apparently, belong to the private sector. Assuming that all the major «debtors» with the state participation over 50 % are related in the Central Bank records to the public sector, the total amount of the external corporate and bank debt is notably less than the general expert estimates (USD 141.9 billion, or 34, 7 % of the total external debt of banks and public and private companies as of April 1, 2008).It should be noted, that even the debts of «Gazprom» and «Rosneft», the companies, that can be undoubtedly related to «non-financial companies» as per the definition of the Central Bank (whose debt amounts to about USD 86 billion) has already exceeded the total amount of debt of non-financial companies of «public sector» (USD 74.5 billion). And thirdly, there is in fact «double counting», because according to the estimates, some assets, recorded by the Central Bank as external debt, are in fact, the domestic credits, provided within the groups of companies (holdings), which have no relation to external debt in economic terms.
8 RIA "Novosty". December 8. 394
by definition of their priority in government issues, ensuring the transparency of financial flows and effective management of targeted assets.
It is known, that a substantial share of the leading state companies' debt has been associated with operations in the market of corporate control in 2005-2007. In other words, a large share of borrowed funds was addressed not to the existing business development, but to the process of the new property redistribution, i.e., the purchase of assets, changes in the equity capital, etc. Unlike the forceful redistribution of preceding years (for example, «YUKOS case»), the new phase, when the leaders are the state companies and number of companies, enjoying political support from the government, is the market-power by nature. Assets are sold not entirely voluntarily, but at a close to the market price (it is enough to mention the history of 50 per cent share acquisition in the project «Sakhalin-2»). As a result, the transition to the state-capitalist economic model contributes to the market growth and investments attraction. In conditions of high liquidity and favorable macroeconomic situation the state companies actively attract credit resources for the purchase of new assets, which leads to their market capitalization growth9.
Although the State is not responsible for the debts of the mixed-type companies, in fact, their debts are estimated as sovereign ones. Moreover, for investors, investing in such businesses becomes a source of virtually guaranteed profit, as the government demonstrates willingness to support those companies in both, political and state regulation terms (the program for gas prices upgrading for domestic consumers). This predetermines the extreme popularity of Russian shares in the offshore hedge funds, for which the deterioration of the institutional environment (especially «double standard» policy) in Russia is favorable in terms of profits. At the same time, foreign banks are willingly provide credits under low interest for the purchase of new assets by the state companies (note the expressed marked increase in the debt of non-state borrowers in the second quarter of 2008, i.e., during the global financial crisis).
It is obvious, that this model of market growth is largely speculative one, as there is no significant capital investment in production10 and the model is applicable only in the background capital inflow to emerging markets, as well as companies' revenues growth due to increasing prices for their products and the redistribution of assets in their favor. Furthermore, such a speculative market growth conceals the real economic problems and distortions, provoked by deterioration of the institutional environment (while the state participation in the economic sphere is being expanded). It should be reminded, that in mid-2008, ten most capitalized companies provided 66 per cent of the total market capitalization, while 50 per cent of capitalization was derived from oil and gas extraction and refining11. The huge inflow of funds is ensured by the small number of the leading companies, that are getting political sup-
9 Ref: A. Abramov, Radygin, Rogov Model Development: The Trap of the State Capitalism / / Vedomosty. 2007. April 9, P. A 4.
10 According to A.E. Abramov estimates (based on stock exchanges and Russian Statistical Service), only within the period from 2005 to the first half of 2008, the share of investment from the corporate bonds issues, invested in the fixed assets, ranged from 0.4 to 2,2 %. Only slightly better was the use of funds by companies and banks involved in the IPO. In 2007, the most successful year in terms of IPO only 3.6 billion dollars, or 10.9per cent, were implemented for the growth of real capital, out of 33 billion dollars, derived from primary and secondary placements of shares.
11 The Russian stock market. The first half of 2008. NAUFOR, SKOLKOVO Moscow Management School, 2008.
port, while in general, the allocation of investments in the economy is restrained by institutional environment failures.
This model is clearly projected on the situation and the financial crisis of 2008-2009, when emergency measures of the Russian companies and banks support are being discussed.
5.1.3. Anti-Crisis measures in the context of increasing public sector
There are several trends, that should be highlighted in the package of anti-crisis measures, taken by the Russian government authorities in September-October 2008, in respect to the problems of expanding of the public sector.
1. Public credits for foreign loans service of the Russian companies and banks (initially - USD 50 bln in 2008).
12
According to available data , in the IV quarter of 2008, the amount of payments of Russian companies on external debts was estimated at USD 47.5 bln, and at USD 115.7 bln in 2009 with regard to extensions of redemption share USD 115.7 bln. Deposits (in the amount of USD 50 bln), allocated by Central Bank in «Vnesheconombank Bank Development», were enough finance companies for payments in 2008.
Herewith, it is justified, that credit terms are estimated as extremely tough (including such terms as «temporary nationalization»): securities pledge, a pledge of export earnings, un-disputable and acceptance-free write-off of funds from any account of the borrower to recover credit, the inclusion the representatives of the Bank in the administration of the borrowing company, agreement with the bank to attract other loans and transactions on sale of more than 10 per cent of the company value, credit securities similar to foreign credits, etc. However, the VTB retains an unprecedented right for decision-making with regard to any increase in the pledge, as well as the opportunity to choose between debt redemption or the «set off» by the pledge.
By mid-October, 2008, applications were submitted for refinancing of «Rosneft», VTB, «Gaspromneft», TNK-BP, «Lukoil», UC Rusal, the AFC «System», Severstal, Michel and other companies. The minimum standard amount of the refinancing at the level of USD 100 mln (according to the Memorandum of the Bank financial policy), relates only to the largest companies and banks. OAO «Gazprom», having initially declared that there was no problem with payments, apparently can turn into an applicant for public funds, though, due to the exclusive status in view the Russian authorities, the refinancing terms and schedule can be different from common ones.
2. Direct («anti-crisis») public intervention in the stock market (RUR 175 bln in 2008 and 2009.)
In mid-October 2008, it was also decided to allocate assets from the National Welfare Fund for the purchase of the Russian companies shares (for RUR 350 bln in 2008-2009). Currently there is no official information on the interventions, the exact amount of investments and purchased shares, as well as the beneficiaries thereof. It would be at least reasonable to ask a question about the expediency of the monopolization of virtually all transactions in «Vnesheconombank-Bank of Development», on the procedures for the selection of Comptrol-
12 For more information, including detailed diagrams and charts of government anti-crisis «injections», it is enough to refer to the official web sites of the major news agencies and periodicals for October 2008 (in particular, www.vedomosti.ru,www.kommersant.ru , www.expert.ru, etc.). 396
lers (professional agents) for the transactions, which have been executed or will be executed in future, including the commission terms.
One of the very reasonable questions, that arise in relation to this kind of VEB activity, is on the source of the funds, allocated for the intervention. As you know, one of the key optimal objectives of the National Welfare Fund establishment was pension reform financing. It would be quite reasonable in the crisis situation to place the blocks of shares, acquired by the Fund in the open market, namely in the Pension Fund (or its equivalent) to ensure pension payments in future (at the stage of market capitalization growth). It is still unknown, where and to whom, in the existing nontransparent situation, the blocks of shares, purchased by VEB in 2008 and possibly in 2009-2010 will be transferred.
The issue of transparency criteria for the expediency of these transactions and their public control is no less important. According to the Decree of the RF Government dated of October 15, 2008, the Ministry of Finance has the right to invest in stocks and bonds up to 80
13
per cent of the National Welfare Fund assets, including up to 50 per cent in the securities, listed in MICEX and RTS, or included in the MSCI World Index and FTSE All-World Index, and in the funds, that carry out relevant investments.
Judging only by indirect information, such injections began only from Oct.17, 2008 in the shares of «Gazprom», «Rosneft» and Sberbank, and, according to the available data, in the shares of «Lukoil». Leaving aside general theoretical considerations of the near-to-zero efficiency of budgetary funds investments in stabilization of the stock market during the crisis14, according to the available expert estimates, no overall strategy of intervention, no proved anticrisis measures with regard to divergent market trends are implemented even in relation to the narrow range of the leading companies-emitters.
Apparently, there were three possible trends: random counteraction against margin calls, acquisition of certain problematic assets and the attempts to market adjustments in favor of individual emitters, selected by the government. The problem of insider trading and, in the broad sense, a general policy against any kind of financial abuses (theft of funds) becomes particularly acute in this context.
According to the VEB, by the end of November, 2008 the Treasury of the Bank has received RUR 115 bln (from the National Welfare Fund). RUR 85 bln was spent to the «support the financial market». The funds were addressed to «the acquisition of shares and corporate bonds of the top Russian emitters», and the actions under those operations «were approved by the Ministry of Finance»15. Although there is no more recent data on this type of interventions, in February 2009, the issue of VTB participation in this scheme, was also under consideration.
3. In October 2008, as one of the extreme measures of support, an option was considered of the acquisition of preferred shares and convertible bonds (new emissions) of the emitters, supported by the government. This tool is common and has been used in a number of countries (UK, Switzerland) to support the problematic banking groups. Moreover, its appli-
13 In the scope of USD 45-50 bln at the Fund amount as of October 2008.
14 It is estimated that during the week of October 17-24, 2008 there was spent at least USD 1 billion, but the downfall in securities equities of the supported issuers, was continued (from 15 to 33 %). This means at least direct government funds losses, although in the short-term prospect the rates downgrading would be more significant in the absence of government interventions.
15 Commersant, December 12, 2008.
cation does not make it necessary for the country to interfere in the operational management or directly participation in the stock equity.
By the end of February 2009 no information was available on the allocated for that purpose financial resources and the target of their allocation. Nevertheless, such proposals were submitted, for example, in late January, 2009 in regard to OC «Rusal» (conversion in preferred shares of the company debt to public banks in the amount of USD 6 bln. The pledge included 25 per cent of GMK «Norilsk nickel» shares, owned by «RUSAL»).
Apparently, in early 2009, the policy of support has undergone significant changes at the background of an overall shift of accent from the statements, made in autumn 2008, that «there is enough money for everybody» to the more sober strategy of reserves preservation till 2010-2011, selective support of the largest banks, rather than the global support to the companies.
First, through the above-mentioned program of foreign loans refinancing in the corporate sector, about 100 applications were submitted to VEB, totaling to USD 75 bln. However, the program was closed, when its expenditures reached USD 11 bln. Among the recipients were: Rosneft (USD 800 mln), UC Rusal (USD 4,5 bln), VimpelCom, Euras and some others. On the one hand, the program has been recognized inexpedient, as the majority of the participants have accumulated sufficient foreign currency reserves and were able to solve their problems with creditors independently (about USD 85 bln by February, 2009, which is, according to Government estimates, enough to settle credit payments in 2009)16.0n the other hand, the terms of such credits, apparently, seamed too strict to the applicants (which is however, points to the undisclosed internal resources of companies to solve their financial problems without tighter government control).
Nevertheless, it should be noted, that even on the allocated credits, transparent public information on the selection criteria of the participants of the public support program is virtually not available. It is also not clear, how VEB intends to dispose the blocks of shares, obtained as a pledge, after the established one-year term (maximum credit maturity).
Secondly, in October 2008 it was envisaged to allocate RUR 450 bln from the National Welfare Fund for allocation with the «Vnesheconombank Bank Development», followed by RUR 225 bln. Allocation in the banking system for co-financing of the capital increase (by February 2009, private banks have selected RUR 17 bln.). Nevertheless, the policy of extensive infusions of funds into the banking system (by mid-February, 2009 it amounted to nearly RUR 3.4 trillion, including RUR 1.9 trillion of the dept of the banks to the Bank of Russia
17
under unsecured credits ) did not result in the renewal of the mass bank investments in industrial sector. On the contrary, it is estimated, that the total credit, requested by the Russian enterprises from the government, was about RUR 3.5 trillion, while in December 2008, the relevant estimates of the Russian budget for 2009 imposed only RUR 325 bln for the crisis measures, and RUR 300 bln (including RUR 100 bln for defense enterprises) for the government guarantees18.
This has served, in particular, as a motivation to search for the new ways to support enterprises of the real sector by the government.
16 Money, № 6, February 16, 2009.
17 Power, № 6, February16, 2009 .
18 Merges and Acquisitions, 2009. № 1-2, P. 4. 398
The program for recapitalization of the banking system for lending to the enterprises of the real sector (in fact, that means the increase the state participation in capital), claimed in 2009, could cost about USD 40 bln (that is, actually equivalent to the «balance» of the suspended 2008 program of credit refinancing). The number of banks, which can participate in this program, is not defined yet, but there notably different official estimates, depending on the scope and models of public support and on participation (according to Vladimir Putin there should be 81 banks, according to I.Shuvalov - up to 50 in the case of subordinated credit co-financing, from 4 to a maximum of 30 banks in the case of additional emissions redemption)^ early February, 2009 the model of support, when a direct state participation in the capital is foreseen only in 3 banks (VTB, VEB, Gasprombank) looked mostly realistic. Herewith, Sberbank, VEB, VTB and Gasprombank are instructed to extend credit portfolios by at least 2 per cent per month19. It is envisaged to provide subordinated credits to private banks in the (total) amount of RUR 100 bln. In particular, that means the government unwillingness to take the risks of operational management as a shareholder.
Back in 2008, a discussion has started of alternative (financial) approaches to the support of the Russian enterprises, operating in «important sectors of economy». By the end of December 2008 the absulute number of potential recipients of the state assistance within a short term has decreased 5-fold (1500 on the initiative of Vladimir Putin, 500 - proposed by I. Shuvalov, 295 - by E. Nabiullina). Among the formal requirements for companies' enrollment in the anti-crisis program are such terms as: at least 5000 employees, RUR 15 bln of revenues, or the company is the principal local employer and mainstay. VEB should become the government agent in this trend of the state support. Companies will be able to invest up to 50 per cent of the government guarantees (enterprises of military-industrial complex - up to 70 per cent) as credit security. Herewith, the maximum amount of public guarantee to each applicant is limited to RUR 10 bln.
For 293 enterprises from 25 industries, which eventually have been included in the list of the RF Ministry of Economic Development and Trade, the credit support instruments are provided, but the range of possible solutions is much wider: the government guarantees (which are widely used as an anti-crisis measures in developed countries in the amount of nearly USD 10 trillion and require only a conditional reservation of funds), interest rates support funding, restructuring of the tax arrears, public contracts, customs and tariff policy. Some
measures on mitigation the "negative social and economic impact of the businesses closure"
20
are foreseen, apparently, in the event of bankruptcy .
By mid-February 2009, the information was disclosed on the applications of the largest Russian manufacturers for government guarantees under credits (from AvtoVAZ, GAZ, Kamaz and Sollers, totaling to RUR 29.5 bln). Among other methods of public support to the Russian automobile industry, the redemption of bonds up to RUR 60 bln and public procurement contracts for the amount of RUR 12.5 bln are envisaged. In the militry-industrial complex there were taken decisions on state guarantees provision to 3 enterprises, on subsidies for 19 enterprises, balance of capitalization of RSK «MiG», amounting to RUR 15 bln. The state corporation «Rostehnologies» (which has received 20 of the local economic mainstays and
19 Vedomosty. February 3, 2009 .
20 Ref.: Public feeder for three hundred hamsters.- www.gazeta.ru, 26.12.2008.
278 of strategic enterprises) has requested the state guarantees in the amount of RUR 110.8
21
bln (in addition to RUR 151.32 bln of material contribution) .
Though from a technical point of view, the range of anti-crisis measures of support is doubtless, there are at least two issues in terms of quality. First, the privileged list puts at an obvious risk the basis of the market (microeconomic) incentives to overcome crisis challenges on their own, namely in «the major» industries. Though the list is declared as an open one, an open tender procedure for applications for some kind of support (in case of anti-crisis programs availability) from any Russian enterprise would be more fair (if the traditional corruption component is ignored). Second, one can easily assume, that many of the problems of the enterprises are associated not only with the crisis as such, but with the management quality and credit policy, carried out in 2005-2007. It would be reasonable, if one of mandatory requirements to provide any kind of public support was the replacement of the existing operational management, perhaps, similar to the anti-crisis management (if the threat of corporate raiding and team replacement for the operation of remaining benefices are neglected).
Bankruptcy can also be regarded as a way of anti-crisis public interference. Herewith, the issue is not in the company liquidation or disintegration, rather than in the owner replacement or in the introduction of supervision by the authorized government body.
In any case, it is too early to give any more detailed assessments to the current developments, at least due to the lack of a critical mass of actually performed transactions, as well as insufficient open information, at least in regard to the scope and criteria for the State interventions. There are grounds for the most pessimistic estimates at least in regard to the basis of the overall assessment of the institutional environment, which problems, in our view, have
become one of the typical «Russian» indicators of the current financial crisis in the Russian
22
economy .
Nevertheless, the conclusion s to the beginning of a new phase in the state property expansion (even with regard to the objectively needed anti-crisis component) is indisputable. If capitalization of the Russian market would be sustained at the level of mid-October 2008, then, according to a simple calculation, one could predict the increase of the public share in the corporate sector within 2009-2010, or from 3-4 per cent (lower threshold) up to 9-10 per cent only due to the funds, allocated for intervention in the stock market. The scope of further expansion of the state sector is impressive, though there is no certainty about the Government plans yet:
- retention of public property the blocks of shares, pledged in VEB in the framework of the refinancing program in 2008 (USD 11 bln), performance term is late 2009;
- retention of public property the shares, acquired in the open stock market (USD 350 bln at the 2009-2010), decision-making deadline is in 2013-2014;
- further expansion of the state companies in the strict sense (despite partial withdrawal of the allocated financial resources);
21 It is remarkable, that it is planned to address RUR 34 billion to finance the purchase of shares in OAO «VSMPO-Avisma» by public corporation. Ref: Vedomosti, February 9-10, 2009, Kommersant, February 6, 2009.
22 Ref: A.D. Radygin. Stability or stagnation? Long-term institutional issues of development of the Russian Economy / / Economic policy. 2007. N 1 (5). P. 23-47.
- acquisition by public banks assets of commercial companies, provided under the security
23
of issued credits and through the direct acquisitions, formation of new state holdings ;
- the increase of the state share in the bank capital in the framework of recapitalization program in the banking system (USD 40 bln). According to the Bank of Russia, the aggregate capital of Russian banks in early 2009 made RUR 2.5 trillion. With the level of the recapitalization scope, declared for 2009, it means that the state can claim for 32 per cent more of bank capital at the background of the overall growth of the state share up to 75-80 per cent24.
At the same time, (other things being equal, including political and rent-corruption issues), a qualitative threshold of such expansion is obvious: the larger the public sector, the more limited are the opportunities for effective management and control. This is confirmed, in particular, by the experience of the introduction (the attempts of introduction) of any new instruments of management and control over the unitary enterprises and joint-stock companies with the state share at the late 1990-2000-ies. By analogy, with the evolution of Russian pri-
25
vate business groups in the second half of the 1990's - early 2000-ies , in the medium term, one should expect some reorganization procedures, aimed at optimization of the structure of the acquired assets and organizational and management aspects of the public companies (groups) restructuring. In view of the financial crisis of 2008-2009, this process can be accelerated due to the need of companies (both, public and private ones) to attract financial resources through the disposal of a number of assets, not directly connected with their basic activity.
Moreover, the quantitative growth of direct government participation in the economy or a large permanent share of the latter are not extraordinary in the current global situation, especially during the crisis. According to the available estimates, by the end of 2008, in the framework of anti-crisis support, various countries have spent about USD 1.4 trillion for the companies' capitalization and about USD 880 bln for the new assets acquisition. Nevertheless, among the leading global countries, taking anti-crisis actions, large direct purchases of private assets in 2008 were performed only by the USA (USD 663 bln) and Norway (USD 51 bln), while the Great Britain, France, Italy, Germany, Netherlands and Japan carried out capitalization without the direct purchase of assets26.
In fact, the financial crisis of 2008-2009 has resulted in the contradiction, or at least in the ambivalent situation.
On the one hand, the crisis events have urged a sound understanding of public sector scope expansion. The issues of the extended public sector management (in all its aspects, such as operational management, management expediency, ethical risks, «principal - agent» relations, corruption, rent, etc.) seem to be understood by the government. This is, apparently, confirmed by the gradual withdrawal of the government (during the crisis) from the direct
23 In mid-February 2009, for example, the scheme of the key communications companies consolidation was discussed through the VEB, which has already received 90 % of shares «Svyaz-Bank» in autumn 2008 (purchase of 40 % of «Rostelecom» shares from «CIT Finance», 90 % of which belong to OAO «RZD» and ALROSA since autumn of 2008, as well as 25 % +1 share purchase in «Svyazinvest» holding from AFC «System»).
24 Commersant, February 4, 2009; Money, N 5, February 9, 2009 .
25 See, for example, A.Radygin. The evolution of integration and management models: the major Russian companies and groups experience//Russian Journal of Management. 2004. V.2. N 4. October-December. P. 35-58
26 State Capitalism (Special issue). - SmartMoney, N 143, February, 16, 2009.
methods of support by direct public participation in the capital of problematic private companies and banks. Moreover, the ability of launching a new «program of global privatization», rather than the investment economic growth is becoming one of the options, discussed once again in the crisis. On the other hand, there is no reason to speak about withdrawal from the direct control principles, since the suspension of direct «anti-crisis» expansion, which is currently replaced by the stronger indirect control through a small number of banks, supported by the government, the formation of preference lists of «significant» enterprises, and through the continued activity of state corporations and state holdings (the few market subjects, having an opportunity for the new merges), the inevitable (though not as extensive as expected) and the nationalization of problem assets in its «hard» or «soft» options.
In view of the above, the most acute issues in the scope of the qualitative assessments, primarily the precise strategy, the objectives (incentives) and long-term results (costs) of the process are the most acute ones.
5.1.4. Privatization
By the end of 2008, if was evident, that privatization process was expressly slowed down, if not completely terminated. Large-scale transactions in this area were rare within the preceding years (although the reasons were different), but poor financial standing of potential buyers, as well as the reasonable reluctance of the government to dispose any assets for a trifling sum, in the face of crisis urged the slowdown in privatization of medium and small objects as well. In autumn 2008, in particular, such methods of privatization, that could beat down the price of the objects enjoying minimum demand, were suspended. Apparently, a similar situation takes place in regard to the renewable revenues from public property (the suspension of dividend payments by companies with a state share of capital, land repurchase, etc.).
According to the official data of the Russian Property Agency, in mid-January of 2009, there were 1293788 objects of movable and real property in the Register of Federal Property (including more than 1.1 million of registration objects, owned the holders of relevant legal property right, and about 107,000 of the state treasury objects). The Register comprises also 3600 blocks of shares and nearly 67000 land areas, owned by Russian Federation. About 5700 Public Unitary Enterprises still remain in the property of the Russian Federation as well.
The plan for 2008 envisages the sale of share packages or public shares in 404 joint-stock companies and privatization (incorporation) of 440 Public Unitary Enterprises. The plan for 2009 (as of September, 2008) envisages the sale of securitirs or public shares in 291 joint-stock companies and the incorporation of 235 Public Unitary Enterprises. Herewith, the annual federal budget revenues from privatization of federal property in 2008 - 2010 were estimated at RUR 12 bln.
Initially, there were no large objects in 2008-2009 privatization plans, but this is based not only on the «suspension» of public sector in the background of state capitalism policy, routine conflict of interests and resistance of official authorities. Among other reasonable grounds, the rejection to use privatization techniques to replenish the budget and some technical problems should be mentioned. First of all, there is a one-year deficit (versus the official plan of privatization) in regard to such transactions even for a number of small and medium-sized enterprises. However, in accordance with the effective legislation, the transactions,
failed to be executed before December 31 of the planned year, will be automatically shifted to the plan of the next year or dismissed from the scope of privatization process.
By some estimates, a number of innovations in the sphere of state management, that have been discussed or have already started to be implemented in 2008, could have serve as a prelude to a new phase of «global privatization». First of all, this is an appointment of independent Directors to the large joint companies, starting from summer of 2008 (i.e., the image incentive to improve the quality of corporate management preceding public offerings), an opportunity for the privatization plan extension from 1 to 3 years (what allows to take time before passing through the entire cycle of preparations for the sale of a block of shares), tentative incorporation (in the true sense of the word), of the state corporations, established in 20072008.
Even at the level of official comments, plans for the new large sales are cautiously related to the year of 2010. Rather reasonable estimates of the crisis duration in the Russian economy for at least 2009-2010 leave the issue unresolved for a longer period (even only with regard to economic factors, i.e., beyond the policy of state expansion). Nevertheless, two extreme scenarios are already quite evident.
The first scenario is clearly based on the forced return to the privatization instruments implementation for the growing budget deficit financing (as in the 90-s.), despite the low cost of the disposed assets. In the macroeconomic context, this scenario has enough chances to be realized at the peak of the crisis, when oil prices are low, financial (gold) reserves are being exhausted and the budget deficit is growing. In fact, we are speaking about the sale of a part of public assets at dumping prices, though the internal motivation might be different - from the short-term (due to non-restorable source) assurance of the previous social commitments, up to the «non-transparent» allocation of assets, privatized for trifling sums among a narrow range of subjects. The combination of these two options is quite realistic, though in the first case one can speak about a wrong economic policy, and in the second case - about future suspension of «privatization of profits, nationalization of losses» model.
The second option, much more optimistic one, is based on the «soft» exit out of the crisis after 2010, gradual restoration of the stock market capitalization (assets value) regain and the beginning of single sales at the new wave of economic recovery. Thereby, the «large-scale privatization» should not be targeted at fiscal problems, but rather, like in 2000-2007, it should solve the problem of quantitative optimization of public sector and the government rejection of inappropriate functions of business entities management.
An alternative option of those two scenarios still remains in force, i.e., further quantitative expansion of public sector (direct and indirect) in the framework of anti-crisis measures of direct control, followed-up unlimited term of state ownership of the obtained objects. With regard to the anti-crisis measures of early 2009, mentioned above, it is nevertheless possible to imply, that the indirect measures are predominant, what implies both scenarios of privatization.
5.2. The State of Property Relations, the Role of the Public Sector, and Privatization
5.2.1. The Magnitude of the Public Sector, Its Elements and Main Characteristics
Like in 2003-2006, in the second half 2008, the Russian government discussed approval of the next privatization program.
But like the previous analogous document approved in spring 2007, the 2009 Prognostic Plan (program) of privatization and main guidelines of privatization of the federal property for 2010 and 2011 contained data on the number of unitary enterprises in federal property (FUEs) and joint-stock companies with the RF's participation in their capital only as of the beginning
27
of the calendar year . That is why there are no sufficient data to objectively judge dynamics of these particular components of the public sector.
Let us consider in a greater detail the changes that took place within main categories of economic agents that fall under the federal property.
Federal Public Unitary Enterprises
Table 1 below displays dynamics and the sectoral structure of FPUEs between 2004 and 2007. In 2007, their overall number tumbled at 12.6%, down to slightly over 5,700 units.
Table 1
Dynamics and Sectoral Structure of the Federal Public Unitary Enterprises between 2004 and 2008
Sector As of June 1, 2004 As of June 1, 2005 As of June 1, 2006 As of June 1, 2007 As of June 1, 2004
units % units % units % units % units %
Non-production sphere 4,069 44.1 3,617 43.6 1,817 25.3 1,670 25.55 1,151 20.2
Industry and construction 3,012 33.0 2,773 33.45 2,376 33.1 2,207 33.8 1,744 30.5
Agriculture 1237 13.4 1111 13.4 913 12.7 826 12.65 618 10.8
Transport & communication 809 8.8 725 8.75 612 8.55 536 8.2 409 7.2
Forestry 65 0.7 67 0.8 53 0.75 49 0.75 37 0.65
Other sectors - - - - 1407 19.6 1245 19.05 1750 30.65
Total 9,222 100.0 8,293 100.0 7,178 100.0 6,533 100.0 5,709 100.0
Source: the 2004 Federal Property Privatization Program (Prognostic plan (program) of privatization of federal property for 2004 and main guidelines of privatization of the federal property through 2006); the 2005 Prognostic plan (program) of privatization of federal property; the 2006 Prognostic plan (program) of privatization of federal property and main guidelines of privatization of the federal property between 2006 and 2008; the 2007 Prognostic plan (program) of privatization of federal property and main guidelines of privatization of the federal property between 2007 and 2009; the 2008 Prognostic plan (program) of privatization of federal property and main guidelines of privatization of the federal property between 2008 and 2010; the 2009 Prognostic plan (program) of privatization of federal property and main guidelines of privatization of the federal property between 2010 and 2011; the authors' calculations.
The main trend exhibited by changes in the sectoral structure of FPUEs in 2007 was a drastic rise in an absolute number of enterprises that fall under the group of "other sectors" not included in the basic classification. As of early-2008, they formed the biggest group vis-à-vis
27 The 2003-06 prognostic plans (programs) of privatization approved in the end of the summer contained data on
the number of FPUEs and JSCs with federal blocks in them as of June 1 of each year.
other sectors (some 30.7% of the overall number of FPUEs). A somewhat smaller number of enterprises were those from the industrial sector and construction industry (30.5%). The representation of the block of sectors of the non-industrial sphere and agriculture was fairly substantial (20.2% and 10.8%, respectively), while 7.2% of FPUEs were those of the transport and communication sectors and less than 1% of FPUEs represented forestry.
With the rise in the proportion of enterprises that fall under the "other sectors" group up to 30.7% as of early-2008 vs. slightly over 19% in the prior year, the proportional weight of all other sectors decreased. The most drastic fall was noted across sectors of the non-production sphere - their proportion in the aggregate structure of FPUEs tumbled at nearly 5.5p.p., while at 3.3.p.p. plunged the proportion of industrial and construction enterprises.
Joint-stock companies whose stock are owned by the federal government
Let us consider in a greater detail the recent sectoral dynamic of the number of joint-stock companies whose stock is owned by the federal government:
Table 2
Dynamic and Sectoral Structure of Joint-Stock Companies Whose Stock Is Owned by the Federal Government or to Which the Special Right of "Golden Share" is Used in 2004-2008
Sector As of June 1, 2004 As of June 1, 2005 As of June 1, 2006 As of Jan. 1, 2007 As of Jan. 1, 2007
units % units % units % units % units %
Non-production sphere 1,781 45,6 685 18,1 356 9,6 405 10,1 638 17,4
Industry and construction 1,710 43,8 2365 62,5 2,152 57,8 2,201 55,05 1,878* 51,1
Agriculture 356 9,1 459 12,1 396 10,6 353 8,9 397 10,8
Transport & communication 43 1,1 229 6,1 363 9,7 534 13,35 761 20,7
Forestry 15 0,4 45 1,2 99 2,7 88 2,2 - -
Other sectors - - - - 358 9,6 416 10,4 - -
Total 3905 100,0 3783 100,0 3724 100,0 3997 100,0 3674 100,0
*- including the industrial sector and construction per se (695 units, or 18.9%), the fuel and energy complex (597 units and 16.25%) and the military-industrial complex (586 units, or 15.95%)
Source: the 2004 Federal Property Privatization Program (Prognostic plan (program) of privatization of federal property for 2004 and main guidelines of privatization of the federal property through 2006); the 2005 Prognostic plan (program) of privatization of federal property; the 2006 Prognostic plan (program) of privatization of federal property and main guidelines of privatization of the federal property between 2006 and 2008; the 2007 Prognostic plan (program) of privatization of federal property and main guidelines of privatization of the federal property between 2007 and 2009; the 2008 Prognostic plan (program) of privatization of federal property and main guidelines of privatization of the federal property between 2008 and 2010; the 2009 Prognostic plan (program) of privatization of federal property and main guidelines of privatization of the federal property between 2010 and 2011; the authors' calculations.
As of early-2008, the sectoral structure of JSCs whose stock is in federal property was dominated by industrial and constriction enterprises accounting for over 51% of the totality of such JSCs. But it should be noted that this aggregate figure comprises, in addition to industrial and construction enterprises per se, the JSCs that fall under the fuel and energy complex (FEC) and military-industrial complex (MIC) as well. Their consolidation in the same group with industrial and construction companies is necessitated by the need to ensure comparability with the data of the previous period when in the structure of the JSC with the federal stakes the TEC and MIC ones were separated from the group. By contrast, in early-2008, the data on the construction sector was combined with those on the industrial sector.
With that in mind, as of early-2008, the sectoral structure of JSCs whose stock is in the federal property displayed the most extensive representation of the agrarian sector (20.
followed by the industrial sector and construction (18.9%) and the block of non-production sectors (17.4%). As for TEC and MIC, which are represented by roughly the same number of enterprises (some 16% each), they appear slightly inferior to the non-production sphere, but well outpacing the transport and communication sector (10.8%).
Speaking of the 2007 shifts in the sectoral structure of JSCs whose stock is in the federal property, it is with a great deal of confidence that one can maintain it saw a notable rise of the specific weight of agriculture - at nearly 7.5 p.p. (from less than 13.4% as of early-2007 up to 20.7% as of early 2008). The proportion of transport and communication JSC posted a slight rise (at 2.p.p. - up to 10.8%). It is the specific weight of the bloc of sectors of the non-production sphere that posted the greatest growth rate (at 7.3 p.p. -up to 17.4%). But that said, as of early-2008, the sectoral structure of JSCs whose stock is in the federal property displays the absence of the group of "other sectors" that were not included in the basic classification, which allows assumption that they are attributed to sectors of the non-production sphere and, perhaps, FEC, and MIC. This complicates the task of a correct comparing of proportions of the non-production sphere, the industrial and construction sectors as of early 2007 with those of the respective period of 2008.
Equally important characteristic of JSCs with the government participation in the capital is their distribution depending on the size of the share the government owns in them (Table 3).
Table 3
Dynamics and Structure of Joint-Stock Companies in with Governmental Participation in the Capital in 1999-2008 (Including the Use of the Special Right "Golden Share") Proceeding from the Size of the Governmental Stake
Total
Up to 25%
between 25 and 50%
between 50 and 100 %
100 %
Date
"Golden share", units
units % units % units % units % units % Total, units out stock, units
1999. 3,316/3, 100 863 26.0 1601 48.3 470 14.2 382 11.5 580b
896"
January 1, 2001 3,524c 100 1746 49.55 1211 34.4 506 14.35 61 1.7
August, 2001 3,949d 100 1 843 46.7 1393 35.3 625 15.8 88 2.2 542 b
January 1, 2002 4,407 100 2270 51.5 1401 31.8 646 14.65 90 2.05 750 b
January 1, 2003 4,222d 100 2152 51.0 1382 32.7 589 13.95 99 2.35 1076 118
June 1, 2003 4,205 100 2148 51.1 1339 31.8 600 1 4. 3 118 2.8
October 1, 2003 4,035 100 2051 50.8 1308 32.4 552 13.7 124 3.1 640 148
January 1, 2004 3,704 100 1769 47.75 1235 33.35 540 14.6 160 4.3 591 251
June 1, 2004 3,905 100 1950 49.9 1183 30.3 499 12.8 273 7.0
March 1 2005 4,075/ 100 1697 44.8 1154 30.4 487 12.85 453 11.95 284
3,791#
June 1, 2005 3,783/ 100 1544 43.8 1093 31.0 474 13.5 413 11.7 259
3,524##
June 1, 2006 3,724/ 100 1063 30.5 885 25.4 397 11.4 1136 32.6 243
3,481##
January 1, 2007 3,997/ 100 932 24.4 814 21.3 368 9.6 1702 44.6 181
3,816##
January 1, 2008 3,674 100 771 21.0 645 17.6 269 7.3 1989 54.1
a - The 1999 Concept for state property management and privatization cites 3,896 economic companies (including 3,611 JSCs, 251 closed-end JSCs and 34 LLCs wit the RF's participation in them . The figure of 3,316 units is a computed value resulting from summing up the number of stock (share) packages of different size cited in the Concept.
With-
b - the total number of JSCs with the use of the special right of "golden share", without singling out of JSCs in which the government has no stock packages;
c - joint-stock companies, less 48 shares and stock packages in overseas companies; there also are data evidencing that Russia owns 119 shares and stock packages in overseas companies with a book value of USD 1.4bn; d - data of a 2002 draft privatization program the RF Ministry of Federal Property submitted to the government. At the time, according to data of the Ministry's register, as of September 1, 2001, the federal government owned 4,308 stock packages in JSCs;
e - only open-end JSCs, without regard to 118 open-end JSCs in which the government exercised the special right of "golden share" (with no stock in presence); stakes in 102 JSCs reassigned under FPUE Rosspirtprom's operative management, 75 closed-end joint-stock companies and shares in the authorized capital of LLCs transferred on the basis of Order by the RF Government of April 2, 2002, № 454-p «On termination of the government participation in authorized capital of credit institutions" or received in the order of succession, gift, or under other grounds;
# 3,791 units - the design number of JSCs whose stock is owned by RF, without regard to 284 JSCs in which the government exercised the special right of "golden share" (with no stock in presence). To ensure comparability with data on the preceding dates, the proportional weight of JSCs with this or that share in the capital was computed proceeding from this figure . For reference: as of January 1, 2005, the federal government owned stake in 3,767 JSCs, less the aforementioned ones in which the government exercised the special right of "golden share" (with no stock in presence) and shares in authorized capital of 24 LLCs reassigned to the Treasury on the basis of of Order by the RF Government of April 2, 2002, № 454-p «On termination of the government participation in authorized capital of credit institutions";
## - the design number of JSCs whose stock is owned by RF, without regard to the JSCs in which the government exercised the special right of "golden share" (with no stock in presence). To ensure comparability with data on the preceding dates, the proportional weight of JSCs with this or that share in the capital was computed proceeding form this figure
Sources: www.mgi.ru; Rossiyskaya ekonomika v 2001 godu. Teendetsii i perspektivy (Issue 23). Vol. 2. M.: IEPP, March 2002. p. 62; Braverman A.A. O merakh po povysheniyu effektivnosti upravleniya gosudarstvennoy sobstvennostyu i kriteriyakh ee otsenki. // Vestnik Minimuschetstva Rossii. 2003. № 1. pp. 13-14; Predpriyatiya s gosudarstvennym uchastiyem. Institutsionalno-pravovye aspekty i ekonomicheskaya effektivnost. Series "Nauchnye doklady: nezavisimy ekonomichesky analiz" Enterprises with state participation. Institutional and legal aspects and economic efficiency № 155. M.: Moskovsky obschetsvenny naucnyi fond; Assotsiatsiya issle-dovateley ekonomiki obschetsvennogo sektora, 2004. p. 47; the 2004 Federal Property Privatization Program (Prognostic plan (program) of privatization of federal property for 2004 and main guidelines of privatization of the federal property through 2006)// Vestnik Minimuschetstva Rossii. 2003. № 3. pp. 4-5. Klyuchevye problemy povysheniya effektivnosti upravleniya federalnoy sobstvennostyu i osnovnye napravleniya dividendnoy politiki Rossiyskoy Federatsii // Vestnik Minimuschetstva Rossii. 2003. № 4. p. 8; Andrianov V. Rossiya v globalnoy ekonomike // Obschestvo i ekonomika. 2003. № 11. p. 84; the 2005 Prognostic plan (program) of privatization of federal property; Materials for the meeting of the RF Government of March 17, 2005 "O merakh povysheniya effektivnosti upravleniya federalnoy sobstvennostyu"; the 2006 Prognostic plan (program) of privatization of federal property and main guidelines of privatization of the federal property between 2006 and 2008; the 2007 Prognostic plan (program) of privatization of federal property and main guidelines of privatization of the federal property between 2007 and 2009; the 2008 Prognostic plan (program) of privatization of federal property and main guidelines of privatization of the federal property between 2008 and 2010; the 2009 Prognostic plan (program) of privatization of federal property and main guidelines of privatization of the federal property between 2010 and 2011; the authors' calculations.
Forestalling this analysis, it should be noted that by early-2008, the total number of these JSCs had accounted for 3,674 units, which is not just less than the analogous figure of 1999, but it forms the minimum one over the whole period of 1997-2007, except for 2001,
when the respective data, perhaps, were not complete. If compared with early-2007, the num-
28
ber of JSCs whose stock is in the federal property fell by over 8% (or at 323 units) .
28 Regretfully, there are no data available on the number of JSCs where by early 2008 the government used its special right for participation in management - the golden share.
In 2007, there intensified a tendency that had been gaining momentum since mid-2005, namely, the growth in the proportion of packages that enabled the government, thanks to their size, to exercise a full-rate corporate control thanks to a drastic growth in the proportion of full packages (100% of all shares), which resulted from a real increase in the number of incorporated FPUEs.
While as of early 2007, the government could exercise a majority control or the full control in more than 54% of all the companies, while the share of those with the 100% state-owned capital was under 45%, as of January 1, 2008, all the mass of the companies with federal stakes was at 54% represented by JSCs with the 100% of state-owned block, while the aggregate specific weight of JSCs in which the government owned 50%-plus of capital exceeded 61%. Thus, for the first time since the late-1990s the state has become not just a majority, but the sole shareholder in more than a half of all the economic companies with its participation. Meanwhile, the absolute quantity and shares of minority (up to 25% of capital), blocking (between 25 and 50% of capital) and majority (over 50%, but under 100% of capital) stakes in the overall structure of the federally-owned stock packages plummeted in 2007, with minority and blocking packages being the first to suffer at most because of this development.
Another source of data on the quantitative composition of the public sector is the
29
Rosstat's monitoring . Its data suggests the following quantitative dynamic of economic agents noted between 2007 and the first half 2008 (Table 4).
Table 4
The Number of Organizations of the Public Sector of the Economy Accounted by Territorial Bodies of the State Property Agency and Bodies Controlling the Public Property of the Subjects of RF in 2007-2008
Date Total3 FPUEs, including treasury enterprises Public institutions Economic companies in whose capital 50%-plus of stock (shares) are owned by Economic companies that fall under the Ihe government public sector of the economy
As of January 1, 2007 82,410 12,735 64,295 3,920 1,439
As of July 1, 2007 81,076 11,351 64,159 4,111 1,440
As of January 1, 2008 80,570 10,598 64,440 4,111 1,410
As of July 1, 2008 77,461b 9,864 62,571 3,930 1,089
aincluding organizations whose founding documents that have passed the state registration fail to stipulate concrete kinds of operations, as a result of which the total number of organizations is in excess of that of PUEs, institutions and economic companies, but without regard to joint-stock companies whose 50%-plus stock (shares) is/are jointly owned by the government and a foreign proprietor.
bRecord of the federal property is exercised in compliance with Resolution by the RF Government of July 16, 2007, № 447 "On improving the record of the federal property".
Source: O razvitii gosudarstvennogo sektora ekonomiki Rossiyskoy Federatsii v 2006 godu. M. Rosstat, 2007, p. 120; O razvitii gosudarstvennogo sektora ekonomiki Rossiyskoy Federatsii v I gjlygodii 2007 goda. M. Rosstat, 2007, p.111; O razvitii gosudarstvennogo sektora ekonomiki Rossiyskoy Federatsii v 2007 godu. M. Rosstat, 2008, p.123; O razvitii gosudarstvennogo sektora ekonomiki Rossiyskoy Federatsii v I gjlygodii 2008 goda. M. Rosstat, 2007, p.87
29 On the basis of Resolution by the RF Government of January 4, 1999, № 1, its composition comprises the following economic agents of the federal and regional levels: (1) public unitary enterprises with the right for economic conduct and operative management (treasury); (2) public enterprises; (3) economic companies in the authorized capital of which over 50% of stock (shares) is in the state property; (4) economic companies in whose authorized capital over 50% of stock (shares) is owned by economic companies that fall under the public sector 408
Overall, in 2007, the number of organizations of the public sector of the economy plunged by 2.2%, to be followed by another 3.9% drop in the first half 2008.
The number of public unitary enterprises was shrinking at an advancing pace: by 16.8% in 2007, by 6.9% - over the period between January and June 2008 (overall, at 22.5% over a year and a half). Considering the dynamics over the said period, the number of economic companies in whose authorized capital over 50% of stock (shares) is/are owned by the economic companies that fall under the public sector of the economy experienced a drop greater than PUEs' (at 24.3%); however, by contrast with the first group, this contraction was noted chiefly during over the first half of 2008 (at nearly 23%).
The other subsectors of the public sector displayed ambiguous dynamics. Thus, the number of public institutions posted some growth in 2007 (at 0.2%), but dropped in the first half 2008 at 2.9%. A similar pattern was characteristic of the dynamic of the number of economic companies whose 50%-plus stock (shares) is/are owned by the state - it grew by some 5% in 2007 and fell between January and June 2008by roughly the same rate, thus bouncing back to the early-2007 level.
The structure and composition of the federal assets cannot be reduced to FPUEs and federal stock packages, of course.
According to Rosimuschestvo, as of mid-January 2009, the register of the federal property comprised 1,239.788 immovable and movable property objects (including over 1,100.000 objects owned by possessors of rights by the respective special property and some 107,000 treasury objects). The register also comprises over 3,500 stock packages belonging to the RF, and nearly 67,000 federally-owned land lots.
Rosimuschestvo has practically completed the inventory of assets that form the RF's state treasury. The agency continued to work with possessors of rights (FPUEs, federal public institutions, other entities) for the purpose of a complete and timely submission for filing a respective record in the register of the federal property fixed with them under respective special property terms. At this point, it should also be noted that Rosimuschestvo conducts the work on compiling the register and organizing the procedure of record maintenance of the federal property on the basis of Resolution by the RF Government of July 16, 2007, № 447 "On improving the record of the federal property". The document specifies the sequence of the record-keeping procedure. From the moment of its enactment (September 6, 2007), practically all the legal and other acts pertaining to matters of keeping record on, and conducting
30
the register of the federal property, as per the said Resolution , have been passed.
5.2.2. Medium-Term Privatization Plans
Back to the approved by Resolution by the RF Government of September 1, 2009, №1272-p Prognostic plan (program) of privatization of the federal property for 2009 and main guidelines of privatization of the federal property for 2010 and 2011, it should be noted that the document follows the pattern of analogous documents developed over recent years. It once again proposes to privatize and sell in 2009-2011 all the federal public unitary enterprises that fail to exercise the state functions of the Russian Federation, as well as to do so with stock packages of the joint-stock companies created in the course of incorporation of FPUEs, except
30 www.rosim.ru; 27.01.2009.
for JSCs included in the list of strategic joint-stock companies or those contributing to formation of integrated structures.
In 2009, it is envisaged to privatize and offer for sale the following FPUEs of the agro-industrial complex, road complex, geology and communication:
- stock packages whose size does not exceed 50% of the authorized capital of respective joint-stock companies, except for JSCs included in the list of strategic joint-stock companies or participating in formation of integrated structures, as well as stakes the sale of which will be carried out proceeding from needs in formation of the revenue part of the 2009 federal budget and for the period through 2011, as per the perspective financial plan;
- stakes in JSCs of the fuel and energy complex, construction complex, agro-industrial complex, chemical, petrochemical and polygraphic industry, geology, water transport, and joint-stock companies in the machine-engineering sector ( except for strategic joint-stock companies);
- assets of the RF treasury, that do not provide for public functions.
In all, approved by the RF Government, the 2009 Prognostic privatization plan comprises 235 FPUEs and stakes in 291 JSCs, as well as 3 shares in LLCs and 18 objects of other kinds of property. Sales of these assets should secure Rb. 12bn in revenues to the federal budget.
Notably, by contrast to analogous documents of the two past years, the current privatization program lacks any reference to the largest federal property objects due to be privatized -the priority is to continue between 2009-2011 works on shaping integrated structures in strategic sectors on the basis of joint-stock companies whose stock is owned by the federal government.
In conjunction with this, the Federal State Property Management Agency was assigned with yet more ambitious tasks to exercise managerial functions within the limits of their powers with regard to such integrated structures as public corporations Rostekhnologii, Roasatom, JSCs "United aircraft-building corporation", "United ship-building corporation", etc. (21 structure in total).
The Government considered the RF Ministry for Economic Development and Trade's plans to extend the life-span of privatization plans from 1 to 3 years. Such a modification synchronizes it with a new time horizon of budgetary planning and may serve as an additional catalyst of the privatization process.
As shown by the recent years' practices, upon promulgation of the 2001 Act on privatization, the current procedures allow one to privatize during a year not more than 1/3 of initially included in the list objects, while privatization of the remaining part of objects required repetition of the procedures the next year. Such a situation enabled management of the privatized assets (primarily unitary enterprises) to indirectly influence the progress with their privatization by delaying conciliatory procedures, etc. Besides, even if the management had no such intents towards large objects, completion of privatization procedures could take a longer time, due to a greater degree of requirements to the pre-privatization preparation (picking a favorable moment from the perspective of the situation on the stock market, the need in creation of consortiums of investment banks, accumulation of sizeable amounts of funds to take
31
part in privatization) .
31 Netreba P., Butrin D. Privatizatsii nakidyvayut srok. In: Commersant, №145/P (3962) of 18.08.2008. 410
At this point, as a reminder, from the perspective of formal declarations, since 2003 the Russian privatization has got a three-year time horizon. The respective document (the 2004 Prognostic plan (program) of privatization and main guidelines for privatization of the federal property through 2006) was approved by Resolution of the RF Government of August 15, 2003, № 1165-p. The document was accompanied with declarations of the privatization program's three-year time horizon (2004-2006), with the ultimate objective being completion of privatization of the assets that are not pertaining to execution of the government function by 2006 and completion of the privatization process as a whole by 2008.
The government thenceforth every year approved ample prognostic plans (programs) of
32
privatization of federal assets for the next year with main guidelines for the next two years . These plans and guidelines comprised hundreds of FPUEs and stock packages (shares) in economic companies of different sectoral attribution; in reality, however, the documents contained a list of privatized assets only for a year ahead.
So far the effective Act on privatization has borne a provision that implies an annual approval of the prognostic plan (program) of privatization of federal assets, which is why transition to the three-year planning will require introduction of modifications into the Act, while a practical transition to the three-year privatization plan is hardly achievable earlier than in 2010.
Perhaps by that time there have taken shape certain prerequisites for introducing into the privatization process (not excluding a public placement of new stock of an additional issuance) of large objects, which by their importance are comparable with those privatized prior to 2005. It is absolutely evident that as of today, this is constrained by the world financial crisis and a clear solidification of the institution of public corporations, to which assets, many of which are potential objects for privatization, are assigned as a property contribution.
As concerns the 2008 privatization, there have been no notable developments, as it concerned objects of no particular interest to the state.
To judge as to what extent assets formed specific objects of privatization deals, one needs to study into a scarce information about outcomes of such deals published by Rosimuschestvo. Thus, the 100% stake in JSC "Samara Hyppodrom"was sold for Rb. 370,318.000, while the 100% of stock in "Kuzbassgrazhdanproekt"- for Rb. 113,364.000. Against this background the sale of a 25.12% stock in JSC "Rosterminalugol (Leningrad oblast) for Rb. 573m in November 2008 seems a more impressive outcome. Interestingly, in
33
all these deals, the excess of the selling price over the initial one was not more than 2% .
A few amendments were introduced in the privatization law last year. There were not fundamental, though, and of all the amendments worth noting is the one to Art. 3. This particular amendment identifies the sphere of effect of the Act with the provision that particularities of small- and medium-sized businesses participation in privatization of leased public or municipal immovable property can be set by the federal law. If promoted, the provision may have certain significance for stimulation of small-and medium-sized businesses' development beyond the framework of the privatization law.
In conclusion, it is worth mentioning that the spring of 2008 saw the end of a long-lasting heated conflict between two federal agencies involved in regulation of property rela-
32 The sole exception was the 2005 Prognostic plan (program) of privatization, whose title (but not the content) lacked a reference to the next years.
33 www.rosim.ru
tions. In compliance with presidential Decree of May 12, 2008, №724, the Federal Agency for Federal Property Management (FAFPM) was transformed into the Federal Public Property Management Agency. It was delegated the mandate of the specialized public institution under the RF Government "The Russian Federal Property Fund" (RFPF) on organization of sales of privatized public assets, sales of assets arrested as per rulings by the court of law or acts of bodies that were granted the powers to make decisions regarding full recourse as well as the functions on sales of confiscated, movable ownerless, withdrawn, and other assets taken to the state in compliance with the RF law. The liquidation in late-June 2008 of RFPF, whose main function since the moment of its creation in 1991 had been conduct of privatization, seems a fairly symbolical move, as long as evolution of property relations in the country is con-
cerned.34
5.2.3. The Impact of the Dominial Presence of the State on the Structural Policy in Individual Sectors and Problems of Solidification of Its Position in the Economy
The most notable developments in this area were the ultimate formation of a new structure of the electricity sector and a continuous influence exerted by public corporations founded in 2007.
The new structure of the electricity sector has resulted from numerous decisions taken in 2004-2007 with respect to the sector restructuring on the basis of reforming RAO UES Russia. At the time, the holding's regional electricity companies were undergoing a vigorous reorganization through separation or encapsulation, with establishment of new legal entities with different profiles, primarily wholesale generating companies (aka OGKs) and territorial ones (TGKs), and their servicing and other structures.
As a reminder, the first stage of the reorganization, in the frame of which JSC OGK-5 and JSC TGK-5 were separated from RAO, was completed on September 3, 2007. Resulting from the first reorganization, in addition to their stakes in JSC RAO UES Russia, the shareholders in RAO UES were given stock in JSC OGK-5 and JSC TGK-5 in proportion to their share in the energy holding's authorized capital. Meanwhile, the number of their respective stock in RAO UES Russia remained unchanged. Upon completion of the first stage of the reorganization the government's share in the authorized capital of JSC OGK-5 made up 26.43% and that in the authorized capital of JSC TGK-5 - 25.09%.
At their meeting on October 26, 2007, the RAO UES Russia's shareholders supported the company's final reorganization. Between December 2007 and January 2008 the formation of a target structure of all thermal OGKs and TGKs, the first stage of consolidation of JSC GydroOGK, and the process of selection of network companies were completed. As many as
35
56 main network companies were established on the basis of the reorganized energo-JSCs .
In the course of the second stage that ended on July 1, 2008, the structural transformation of the energy holding's assets was over and all the companies of the sector's target structure (FSKs, OGKs, TGKs, etc.) separated from RAO UES Russia and the head company JSC RAO UES Russia discontinued their operations.
34 It does not necessarily mean a full stagnation of the privatization process, though. A serious conflict between the RFPF and FAFPM that was at pains to limit the Fund's independence was one of the reasons behind the slowdown of privatization post-2004.
35 www.rao-ees.ru 412
All the shareholders were given stock of the following 23 electricity and energy companies:
- JSC Gosudarstvenny holding and JSC Minoritarny holding FSK UES with a simultaneous joinder to JSC FSK UES;
- JSC Gosudarstvenny holding JSC Gosudarstvenny holding GydroOGK and Minoritarny holding GydroOGK with a simultaneous joinder to JSC Rusgydro;
- JSC OGK-1 Holding with a simultaneous joinder to JSC OGK-1;
- JSC OGK-2 Holding with a simultaneous joinder to JSC OGK-2;
- JSC OGK-3 Holding with a simultaneous joinder to JSC OGK-3;
- JSC OGK-4 Holding with a simultaneous joinder to JSC OGK-4;
- JSC OGK-6 Holding with a simultaneous joinder to JSC OGK-6;
- JSC TGK-1 Holding with a simultaneous joinder to JSC TGK-1;
- JSC TGK-2 Holding with a simultaneous joinder to JSC TGK-2;
- JSC Mosenergo Holding with a simultaneous joinder to JSC Mosenergo;
- JSC TGK-4 Holding with a simultaneous joinder to JSC TGK-4;
- JSC TGK-2 Holding with a simultaneous joinder to JSC TGK-2;
- JSC TGK-6 Holding with a simultaneous joinder to JSC TGK-6;
- JSC Volzhskaya TGK Holding with a simultaneous joinder to JSC Volzhskaya TGK;
- JSC YYUGK TGK-8 with a simultaneous joinder to JSC JSC YYUGK TGK-8;
- JSC TGK-9 Holding with a simultaneous joinder to JSC TGK-9;
- JSC TGK-10 Holding with a simultaneous joinder to JSC TGK-10;
- JSC TGK-11 Holding with a simultaneous joinder to JSC TGK-11;
- JSC Kuzbassenergo Holding with a simultaneous joinder to JSC Kuzbassenergo;
- JSC Eniseyskaya TGK Holding with a simultaneous joinder to JSC Eniseyskaya TGK (TGK-13);
- JSC TGK-14 Holding with a simultaneous joinder to JSC TGK-14;
- JSC INTER RAO UES Holding with a simultaneous joinder to JSC INTER RAO UES.
The public holdings (JSC Gosudarstvenny holding36 and JSC Gosudarstvenny holding
37
GydroOGK were intermediate companies. Their separation was carried out along with a simultaneous joinder to JSC FSK UES and JSC GydroOGK, respectively. That secured the government's direct participation in the companies' capital. Because of the transfer of the government share in OGKs and TGKs onto the balance sheet of JSC FSK UES and JSC Gy-droOGK the government increased its share in the Federal Network Company to a level not less than 75%+ 1 share and that in JSC GydroOGK - to a level of not less than 50%+ 1 share.
36 The following stock was to be transferred to the balance sheet of the JSC Gosudarstvenny holding: from the "governmental" stake in JSC FSK UES (at the amount proportional to the share of participation by RF in the RAO UES Russia's authorized capital as of the moment of making the decision on its reorganization), main network companies, heating generating companies (OGK and TGK ) or assets acquired resulting from sales of these or those "state-owned" stock packages in OGK/TGK (a fraction of stock packages of companies that fall at the share of the RF's participation in the RAO UES Russia's authorized capital
37 The following stock was transferred to the balance sheet of JSC Gosudarstvenny holding GydroOGK: stock of JSCs GydroOGK (in a volume of the proportion of the RF's participation RF in the RAO UES Russia's authorized capital as of the moment of making the decision on its reorganization) and stock from the "state-owned"s stock packages in heating OGK and TGK or assets acquired from sales of the shares in these OGK/TGK ( a fraction from the 52% of stock owned by JSC RAO UES Russia).
All the other holdings (except for JSC Minority holding FSK UES38 , JSC Minority holding GydroOGK39 and JSC IINTER RAO UES Holding40), i.e 5 minority OGK holdings and 13 minority TGK holdings, owned "minority" stakes in just a sole company (all the heating OGK, except for the separated in the course of the first stage OGK-5 and all the TGKs, except for the separated in the course of the first stage TGK-5).
All the stock in "Minority holding FSK", "Minority holding GydroOGK" and minority holdings TGK/OGK were distributed exclusively in favor of the JSC RAO UES Russia's minority stakeholders, except for the special shareholders (JSC CTsentrenergoholding, JSC Sibir Energoholding and JSC Intergeneratsia41). The separation of the above minority holdings was also carried out with their simultaneous joinder to a respective target company. Such a division of assets enabled one to fix shares of the RAO UES Russia's assets due to be distributed in favor of the state and minority shareholders of the former energy monopolist, and to make individual decisions regarding managing the "governmental" and "minority" shares of the JSC RAO UES Russia's assets.
In addition, as ruled by an early general shareholder meeting of October 26, 2007, the two newly created companies of the target structure of the energy sector, JSC "Holding MRSK42" and JSC "RAO Energeticheskiye systemy Vostoka43", as well as holding companies - special shareholders that are fully owned by JSC RAO UES Russia's concrete minority shareholders (JSC Tsentrenergoholding, JSC Sibenergoholding and JSC Intergeneratsia) were separated.
JSC CO UES (the System Operator) was not separated in the course of the reorganization, and 100% of its stock were be assigned to the state. The System Operator will redeem and paid for a RAO UES Russia's stock package in this company, hence, the government will consequently become a sole proprietor of JSC COUES. Upon completion of separation of all the newly created companies, JSC RAO UES Russia, on whose balance sheet, in accordance to the company's separation balance sheet there remained a fraction of assets that did not attribute to the target companies' technological operations, was to join JSC FSK UES. Thus, the RAO UES Russia's shareholders received a share of participation in JSC FSK UES not only as shareholders of the separated JSC Gosudarstvenny holding or JSC Minority Holding FSK UES, but in their capacity of a shareholder of JSC RAO UES Russia.
So, the structural transformation has resulted in the government being an owner of: - a 75%-plus stake in the Federal Network Company (with account of contribution with the federal budget funds and a part of the "public" portion of stake in OGK/TGK);
38 JSC Minority Holding FSK UES owned a "minority" fraction of stock of FSKs (48% of stock owned by JSC RAO UES Russia.
39 JSC Minority Holding GydroOGK owned a "minority" fraction of stock of GydroOGKs.
40 Inter RAO UES Holding was an aonwer of a stake in JSC Inter RAO UES and assets subjected to transfer to pay for the JSC Inter RAO UES's authorized capital.
41 Three special holdings separated in the course of the reorganization according to the additions to the scheme of reorganization approved by the Board of Directors of JSC RAO UES Russia on April 27, 2007. Shares of each of them were distributed only to a concrete shareholder of RAO UES Russia, while on their balance sheets they received shares in heating generation companies, JSC FSK UES, JSC GydroOGK, and other assets that had fallen under the given shareholder's stock in the JSC RAO UES Russia's authorized capital.
42 JSC Holding MSRK is an owner of stakes in MSRK and a number of distributive network companies.
43 Holding JSC RAO Energeticheskiye Systemy Vostoka is an owner of stakes in JSC Dalnevostochnaya ener-geticheskaya kompaniya and in isolated electricity systems.
- a 75%-plus stake in the System Operator (with account of contribution with the federal budget funds);
- a 50%-plus stake in JSC GydroOGK (with account of contribution with the federal budget funds and a part of the "public" portion of stake in OGK/TGK);
- a 50%-plus stake in JSC Inter RAO UES;
- a 52%-plus stake in JSC Holding MSRK and JSC RAO Energeticheskye Systemy Vostoka.
With account of a possible sale of the government stock packages in heat OGKs and TGKs, the government may fully abandon its participation in the heat generating companies. The minority shareholders in turn have become owners of:
- up to 100% of heating generating companies;
- under 25% of stock of JSC FSK UES;
- under 50% of stock of JSC GydroOGK and JSC Inter RAO UES;
- some 48% of stock of JSC Holding MSRK and JSC RAO Energeticheskye Systemy Vostoka.
The distribution of shares of the companies separated in the course of reorganization of JSC RAO UES Russia between its shareholders had been completed by July 23, 2008. The securities were placed by registrars on the day of the state registration of the separated companies, i.e on July 1, 2008, while nominal holders of different levels placed the securities between July 1 and 14, 2008. All stock was inducted to the shareholders' individual accounts.
The liquidation of the electricity monopolist was preceded by its redemption by January 9, 2008, of the stock rendered by the RA UES Russia's shareholders that enjoyed the right to take part in the early meeting on matters of the final reorganization of the company on October 26, 2007 and voted against that decision or failed to take part in the voting44.
So, the electricity sector saw the completion of a colossal structural transformation. It has resulted in decentralization of the sector with activation of the market competition mechanism and launch of the mechanism of attraction of private investments. But it should be noted that companies with a government's share in their capital (such as Gasprom and Rosneft) have become large shareholders of many OGKs and TGKs. By the 2007 results, the aggregate proportion of electricity generating companies owned by JSC Gasprom and JSC SUEK, with which Gasprom was going to merge its generating assets, accounted for some 20%.
In 2007, the transition to a sweeping creation of public corporations (PC) has become one of directions of the government's new policy in the property area.
From the formal perspective, it did not continued in 2008 - there was no passage of special federal acts on establishment of new economic agents of this organizational and legal form45, albeit a detailed discussion was initiated on variants of creation of PCs in the road maintenance and grain procurement sectors.
Meanwhile, some PCs founded in 2007 have succeeded in expending notably in their sphere of interests. This particularly concerns PC Rostekhnologii which has formed a nucleus of an emerging holding of the clearly conglomeration type.
44
www.rao-ees.ru
45 Created on the basis of Federal Act of July 24, 2008, №161-FZ, the Federal Fund for Assistance to Development of House Building formally has the organizational and legal form of foundation, while de-facto appears fairly close to already emerged public corporations. They all are non-for-the-profit organizations.
As a reminder, in compliance with presidential Decree of November 26, 2007, №1577, the corporation was given the 100% stake of the transformed into JSC Rosoboronexport (ROE), whose structure enveloped a great number of companies from various industries (a helicopter-building holding; AvtoVAZ, VSMPO-Avisma, Motovilikhinskiye zavody, Russpetsstal, to name a few). In addition to ROE, since early-2008, PC Rostekhnologii has begaun vigorously lobbying a reassigning to it by the government of numerous assets in other sectors as a property contribution. The move was often countered by the federal and regional authorities and other influential companies46.
According to the final variant stipulated in presidential Decree of July 10, 2008, №1052, Rostekhnologii should be assigned 183 FPUEs. These structures should be subject to incorporation with the subsequent transfer to the newly created JSC of all their equity, as well as 246 shares in various economic companies (overall, it was initially planned to assign to the company over 480 enterprises), including the state-owned share in Obyedinennaya Promyshlen-naya Korporatsia after an increase of its authorized capital with the payment by the state for additionally placed equity with stock packages in 12 companies and Nauchno-porizvodstvenny predpriyatiye "Motor" (Ufa), which is to be transformed from FPUE into JSC. Meanwhile, it is provided for a founding by Oboronprom of the daughter JSC Upravly-auyshaya kompaniya "Obyedinennaya dvigatelestroitelnayay korporatsia" with its authorized capital to be paid with state-owned stock packages with the prospect for an increase of the share in these companies up to the size of a controlling stake.
Despite the defense enterprises assets assigned to the public corporation Rostekhnologii clearly dominated over other assets, it should be noted that a part of the latter falls under civil sectors, including several air companies (Rossiya, Kavminvodyavia, Orneburgskiye avialinii, Saratovskiye avialinii), foreing trade companies, and the RF's shares located overseas (in Russian-Mongloian LLCs Erdenet and Mongolrostsvetmet (49% in each) and in the Russian-Vietnamese corporation Visorustekhs - 32%).
Shortly before that the federal stakes in air companies Domodeovskiye avialinii, Kras-noyarskiiye avialinii, and Samara were assigned to Rostechnologii. A year before that, they were picked for contributing with them to the authorized capital of a new holding, Air Union. The intended for 2007 consolidation of public and private assets of 5 air companies of the al-
47
liance should have resulted in the rise of the third biggest air carrier in the country, Airunion . Interestingly, by contrast to most recently created holdings, one admitted a possibility for the government to own in the newly created structure a stake less than the controlling one (45%). Such a structure of the company's capital has borne a greater risk of conflicts between the state and other shareholders, which manifested themselves yet in early-2008 - in the failure to convene the founding meeting caused by shareholders' different appraisals of the assets they were going to contribute with to the new company.
46 Such a situation was noted, for example, in conjunction with the PC Rostekhnologii's claims for inclusion in its structure of Nauchno-proizvodstvennaya korporatsia Uralvagonzavod ( the former FPUE Proizvodstvennoye obyedineniye Uralvagonzavodnamed after F.E. Dzerzhinsky) located in the town of Nizhny Tagil, Scredlovsk oblast. In autumn 2007, the company was transformed into JSC, with its 100% stake fixed in the federal property. The company was regarded as a head one for the formation of a panzer holding.
47 It was supposed that the new company will inherit in the Russian spelling the name of the alliance (Air Union), in which several independent air carriers had earlier participated.
An intermediate final became a sudden deep crisis that battered the air companies of the alliance between late-August and early-September 2008. It took the form of a sudden rise of huge debts to their counterparts, lawsuits and the danger of bankruptcy, delays with, and cancellation of flights, suspension of tickets sales, etc. At that juncture, it was announced that PC
48
Rostekhnologii, together with the Moscow city government and that of Krasnoyarsk krai, were to found a new air carrier, the structure of which had not been set as of that moment. Meanwhile, already in early-2009 the presidential Decree confirmed assigning to Rostekhnologii the federal stakes in Domodeovskiye avialinii (50.04%), Krasnoyarskoiye avi-alinii (51%), and Samara (46.5%), complemented by those in Vladivostok Avia (52.17%), Dalavia and Sakhalinskiye aviatrassy (100% in each).
Yet another government's contribution in the form of assets to Rostekhnologii should become all the equity of JSC Transportno-vystavochny kompleks "Rossiya" established on the basis of assets of 2 FPUEs in the town of Zhukovsky (Moscow oblast). Upon the exercise of measures of state support for the sake of preclusion from their bankruptcy, these FPUEs were subject to their transformation into a JSC with the subsequent introduction of 100% of their equity into the authorized capital of Obyedinennaya aviastroitelnaya korporatsia in an order of payment for additional equity it was to place due to an increase of its authorized capital.
The other public corporation keen to grow into a huge structure to manage public assets across the sector has become Rosatom. In 2008, the corporation's structure has become visible. The government's equity contribution to Rosatom is formed by the 100% package in JSC Atomny energopromyshlenny complex (AEP), stock packages in yet another 2 JSC (research institutions) (50% minus 1 share in each). In addition, the government should contribute with all the equity of JSC Inter RAO UES due to be assigned to the government as a result of the reorganization of RAO UES Russia. The Inter RAO UES's authorized capital should increase thanks to introducing in it all the federally-owned stakes in the two power plants - Kaliningrad TETS-2 and Sangtudinsky GES-1 in Tajikistan (which is built with Russia's participation, with funds allocated out of the federal budget).
In addition, PC Rosatom's mandate includes the power to exercise on the government's behalf the powers of a proprietor of assets of 100 FPUEs and 9 federal public institutions (FPIs), as well as the powers of a shareholder of JSCs founded by means of transformation of 55 FPUEs, to the extent of contributing with all the federally-owned equity of these JSCs in the JSC AEP's authorized capital in an order of payment for additional equity it was to place due to an increase of its authorized capital.
With account of the transfer of the 100% of AEP's equity to Rosatom, the said enterprises will find themselves under its control. In all likelihood, this prospect is real for federal enterprises and institutions with respect to which this PC is given the right to exercise the proprietor's powers, as Federal Act of December 1, 2007, № "On public corporation on nuclear energy "Rosatom" contains a provision that reads that the delegation to the PC the respective mandate with regard to FPUEs and FPIs will retain its effect during a transitional period, until their assets are assigned to the Corporation as a property contribution.
Besides the liquidation of RAO UES Russia and expansion of a number of public corporations' domains, the following developments are worth a certain attention, too.
48 The city owns control blocks of Atlant-Soyuz air carrier that has assumed the Air Union's operations and those of Vnukovo airport wherein it is based.
Notwithstanding numerous speculations in 2006-2007 that JSC Rosneftegas, which was founded in late-2004 to complete a deal on boosting the federal stake in Gasprom up to a control figure, might be liquidated or reorganized after the deal was over in the summer of 2005, the company not just lingered as an independent legal entity, but has begun to extend its structure in the course of additional stock issuances. Its authorized capital, in an order of payment for the government's share, absorbed a 90.6% stake in Kamchatgasprom and stakes of different value in 78 JSCs of the gas sector (including a 74.55% stake in JSC Rosgazifikatsia, the owner of a 0.87% package of Gasprom's equity).
In the summer 2008, the government increased the federal stake in JSC ALROSA, the national diamond monopoly, up to the control figure (from 37% to 51%). That became possible by contributing to its authorized capital with assets of the production and research institution Yakutalmaz. The agreement on the assignment of the latter to the federal property was reached in 2006, after long-lasting discussions with the local authorities of the Republic of Sakha (Yakutia) and the Rosimuschestvo's filing a lawsuit to the Supreme Arbitration Court
of RF49.
In December 2007, the RF government decided to withdraw from the FPUE Rosspirt-prom's operative management a great fraction of assets (immovable property of its 18 affiliated structures, the exclusive rights for results of intellectual activity (28 patents and 82 trade marks) stakes and shares in 58 economic companies) and to contribute with them to the authorized capital of a company with the same name, the 100% stake in which will belong in the federal property. The control stakes in 11 JSCs are to be reassigned for repayment of the company's obligations before the Bank VTB by credit agreements made in 2006, but it is the newly created JSC Rospirtprom that should exercise their trust management. A great number of objects of the social, cultural, and communal and utilities spheres fixed with Rosspirtprom are subject to reassignment to the municipal property.
As concerns developments in the defense sector in 2008, it is worth noting the introduction, as the federal contribution, of the federally owned stakes (100% minus 1 share) of 1 JSC in the authorized capital of JSC Contsern "Morskoye Podvodnoye Oruzhiye - Gydropribor", and those of 2 JSCs - in the authorized capital of JSC Contsern "Granit-Elektron" in an order of payment for additional stock placed by the companies; as well, there took place a reorganization of 2 FPUEs of the space sector by adding to each of them a unitary enterprise.
A logical effect from the increased activity of companies with the government share in their capital should have become a notable expansion of the public sector to be mirrored by various final indicators of economic activity. But the Rosstat's monitoring of the indicators in question has only partially proved this assumption (Table 5).
49 In this case the Republic of Yakutia was to loose its power to collect rental payments from JSC ALROSA. These fees constituted a considerable fraction of its budget revenues, which was compensated by the right for collecting in a full volume of the tax on extraction of diamonds (before that, as much as 40% of the respective revenues were to be assigned to the federal budget) and prospects for greater revenues generated by corporate profit tax, tax on corporate property, and dividends on the stake owned by the Republic of Yakutia's government. 418
Table 5
Proportion of the Public Sector Across Some Indicators in 2005-2008, as %
Indicator 2005 2006 2007 Ist half 2008
Volume of shipped output, works completed and services by producers
- extraction of minerals 5,5 6,0 12,8 13,7
- production of fuel and energy fossil minerals 2,9 3,9 11,8 13,6
- processing production 8,9 8,2 8,4 8,6
- electricity, natural gas and water production and distribution 13,7 10,7 11,4 12,8
Volume of construction works completed by companies 5,5 4,4 4,0 3,0
Passenger traffic by transportation organizations a 68,7 68,5 65,9 64,5
Volume of commercial shipments of cargo completed by transportation 44,9 67,2 72,9 73,3
organizations (less the pipeline transport)
Commercial cargo turnover completed by transport organizations (less the 41,8 93,9 94,6 94,2
pipeline transport)
Communication services b 9,3 9,8 9,8 9,8
Domestic costs of R&D 69,3 70,4 72,4 71,3
Volume of paid services delivered to the population 18,5 17,2 16,4 16,2
Investments in fixed assets out of all the sources of financing c 19,1/14,9 18,1/14,4 19,5/15,0 17,9/12,5
Net earnings from sales of goods, products, works, services (less VAT, 11,2 10,2 10,2 9,6
excise taxes and other analogous compulsory payments)
Staff on the payroll 25,6 26,0 24,9 24,1
a - less organizations of the urban electric passenger transport;
b - Net earnings from sales of goods, products, works, services (less VAT, excise taxes and other analogous compulsory payments);
c - in numerator- without regard to small-sized businesses
Source: O razvitii gosudarsvennogo sektora ekonomiki v 2005 godu. M., Rosstat, 2006, pp. 8, 85, 92-93, 94, 103, 137, 139, 146-147, 167; O razvitii gosudarsvennogo sektora ekonomiki v 2006 godu. M., Rosstat, 2007, pp. 8, 82, 89-90, 91, 100, 134,136, 143-144, 164; O razvitii gosudarsvennogo sektora ekonomiki v 2007 godu. M., Rosstat, 2008, pp. 9, 42, 90-91, 92, 103, 134, 136, 143-144, 164; O razvitii gosudarsvennogo sektora ekonomiki v I polugodii 2008 goda. M.,Rosstat, 2008, pp. 8, 50, 58-59, 60, 71, 93, 95, 102-103, 124.
As highlighted by Table 5, the period between 2007 and the 1st half 2008 saw the same picture as all the 2000s did - namely, by most indicators the proportion of the public sector remained insignificant and did not exceeded 10-15%. It was a bit greater by investments (1520%, without regard to small-sized businesses) and employment (24-25%), but it was only transport shipments and domestic R&D costs that stood aside as genuinely significant exceptions (70-90% and over 70%, accordingly).
Meanwhile, the official statistics noted a substantial rise in the public sector's specific weight between 2007 and 2008 vs. 2005, as far as mineral output (primarily extraction of fuel and energy minerals) and cargo shipment are concerned. Some growth was also noted across the communication services sector, domestic R&D costs and investments50.
As a result, in 2005-2006, the proportion of the public sector in mineral output was lower than the value of the indicator in the manufacturing sector, while exceeded that in terms of production and distribution of electricity, natural gas and water, in the period between 2007 and the 1st half 2008 it proved to be in excess of the noted figures. It should be particularly noted that the proportion of the public sector in production of fuel and energy minerals, which earlier had been notably inferior to the respective indicator of the public sector's contribution to mineral extraction on the whole, has practically caught up with that.
A more detailed evaluation allows one to note that by results of the period between 2007 and the 1st half 2008 it is just a few sectors by which the public sector's positions were monopolistic. Those were electricity generation at nuclear power plants, reforestation, cargo
50 However, results of the 1st half 2008 fell short of proving the said trend with respect to the last two indicators.
419
shipment and passenger railroad transportation. In some cases, the public sector held a dominant position on the market, as exemplified by production of caustic ash. In most other cases, its share was below 20%, except for production of cooking salt, ethyl hydroxide from food raw materials, cross-ties of a wide gage, some machine-engineering products (wagons, tractor seeding machines), and all kinds of paid services in which its share did not exceed 50%, anyway.
That said, one should bear in mind that the Rosstat data are based upon the definition of the public sector given in Resolution of the RF Government of January 4, 1999, №1 "On forecast of development of the public sector of the economy of the Russian Federation"(in the effective version of the document adopted by Resolution of the RF Government of December 30, 2002, №939), which fairly incompletely mirrors a real specific weight of the public sector in the economy51.
For example, according to the Rosstat's monitoring, the proportion the public sector holds in production of natural gas, electricity at the heating and hydro power plants, cargo shipment accomplished by the major pipeline transport organizations between 2007 and the 1st half 2008 did not exceed 1%, which clearly conflicts with well known facts of the domination of the largest corporations with government participation (Gasprom, RAO UES Russia, Transneft with its newly absorbed asset - Transnefteproduct) over the respective sectors. The assessment of the public sector's contribution in oil output (including gas condensate) between January and June 2008 seems somewhat more realistic (16.8%). Meanwhile, by the
2007 results the proportion of public companies - if we include in their list Rosneft (including Yuganskneftegas) and Gasprom (including Gaspromneft that consolidated all the gas giant's
52
oil assets) in oil output accounted for 31.9% , and it could hardly tumble substantially in the 1st half 2008.
The current conditions of an evident absence of transparency of property rights for a particular enterprise and the presence of a multi-stage corporate control system at public companies (by analogy with the private ones) necessitates the urgency of holding a special applied research to calculate the government's specific weight in the economy.
5.2.4. Budgetary Effect of the State Property Policy in 2000-2008
An increasingly evident effect of the world financial crisis on Russia since the autumn
2008 quite logically leads one to have a detailed examination of particular aspects of Russia's economy over recent years of a vigorous advancement. One of such aspects worth a particular attention is effects the governmental property policy has on the budgetary system.
The post-1999 shift of the emphasis of the policy from privatization onto the public property management suggests a more detailed study into financial aspects of the process and its interrelation with the budgetary system's functioning. First and foremost one discusses a considerable absolute increase in the number of sources that help complete the revenue part of the budget and their substantial diversification.
51 See in a gretare detail: Rossuyskaya ekonomika v 2007 godu. Tendentsii i peespektivy (issue 29). M., IEPP, March 2008, pp. 485-490. A new additional factor that diminishes the accuracy of the data fixed by the official statistical reporting is the rise of several public corporations in 2007-08 and assignment to them certain assets.
52 See: Rossiyskata ekonomika v 2007 g. Tendentsii i perspektivy (Issue 29). M., IEPP, March 2008, pp. 253-254. 420
The leading role in organization of the work on mobilization of respective revenues to
53
the federal budget has been assigned to the Agency on management of the federal property , which regularly, shortly after the calendar year is over, publishes preliminary data on revenues to the federal budget raised through the state property management and privatization. Meanwhile, the final figures (with account of various adjustments and specifications) published in the budgetary statistics differ from the noted data by a whole range of positions.
All the revenues the federal budget collects from the state-owned property can be split into two parts, depending on their nature and sources. One group is formed by revenues from the use of the said property (renewable sources). The other group embraces occasional revenues, which may not be renewed due to the transfer of ownership from the state to other legal entities and private individuals after its sale, particularly in the frame of privatization process (non-renewable sources).
By means of classification of renewable sources of revenues from the use of the federal property, one can break them down into domestic (located within Russia) and overseas (beyond the country's borders). In the latter case, it is possible to discuss just the earnings of the Russian participant in the Vietsovpetro joint venture. The domestic sources can also be split into two groups: (1) revenues from economic operations and (2) revenues from rent (leasing) operations. The qualitative distinction between them lies in the specificity of the government's role: in the first case, it mobilizes revenues from independent economic agents that operate mostly in the competitive environment on certain markets for goods and services, and such operations are subject to the governmental direct (in the case of unitary enterprises) or indirect (economic companies) control. By contrast, in the latter case, the government appears just a passive recipient of rental fees (for the use of real estate and land lots), without being involved in organization of the tenant companies' business processes. The array of the domestic renewable sources has extended since 2001, thanks to a part of earnings raised by FPUEs and rent payments for land lots to the federal budget.
Tables 6 and 7 below present the data contained (with minor exceptions) in the 20002007 federal budget acts in the part of the use of the public property and its sales only in the form of material objects54.
53 Presently - the Federal Agency for the Public (until May 2008 - Federal) Property Management, aka Rosimuschestvo; prior to 2004 - the RF Ministry of Property Relations.
54 The present evaluation deliberately ignores revenues to the federal budget received as payments for natural resources (including water biological ones, revenues from the use of the forest fund and subsoil reserves), compensations for losses caused to agriculture in conjunction with withdrawal of agricultural land, resulting from financial operations (revenues from placement of budget funds (revenues by the federal budget's balances and from their placement, since 2006 -also revenues from placement of funds of the Stabilization Fund of RF, revenues from placement of sums accumulated in the course of auctions on sales of stock under the ownership of RF), interest earned by extending budgetary loans within the country at the expense of the federal budget funds, interest on intergovernmental loans (receipts from governments of foreign states and their legal entities as interest payments on loans extended by RF, receipts from corporations and organizations as interest and guarantee payments on loans RF received from governments of foreign states and international financial organizations)), from provision of paid services or compensation for the government's costs, transfers of the CBR's profit, some payments made by public and municipal corporations and organizations (patent fees, registration fees for the official registration of PC software, databases and topologies of integral microchips, and other revenues which prior to 2004 were a component of payments from public organizations (apart from earnings from operations by Vi-etsovpetro joint venture since 2001 and transfers of a part of FPUEs's earnings since 2002), revenues from production sharing agreements, revenues from management and sales of confiscated and other property appropriated
Table 6
The Federal Budget Revenues from the Use of the Public Assets (Renewable Sources) in 2000-2008 rr., as Rb.m
year total Dividends on stock (2000-2008) and revenues from other forms of participation in capital (2005-2008) Leasing payments for the public land Rental payments for public assets Revenues from transferring a part of FPUEs' post-tax profit Revenues from the joint venture Vietsovpetro's operations
2000 23244,5 5676,5 - 5880,7 - 11687,3a
2001 29241,9 6478,0 3916,7b 5015,7c 209,6d 13621,9
2002 36362,4 10402,3 3588,1 8073,2 910,0 13388,8
2003 41261,1 12395,8 10276,8d 2387,6 16200,9
2004 50249,9 17228,2 908,1e 12374,5f 2539,6 17199,5
2005 56103,2 19291,9 1769,2g 14521,2h 2445,9 18075,0
2006 69173,4 25181,8 3508,0g 16809,9h 2556,0 21117,7
2007 80331,85 43542,7 4841,4g 18195,2h 3231,7 10520,85
2008 76266,7 53155,9 6042,8 114587,7h 2480,3 -
a - by the data of the RF Minimushestvo P®, not stipulated as a separate line in the 2000 Federal Budget Act, the sum of payments from public companies was set (Rb. 9887.1m) (without concrete elements); b - the amount of rent payments for (i) the farming land (ii) for urban and settlements' land; c - the sum of revenues form leasing the assets fixed with (i) research organizations, (ii) educational institutions, (iii) healthcare institutions, (iiii) public museums, public institutions of culture and fine arts, (iiiii) archive institutions, (iiiiii) the RF Ministry of Defense, (iiiiiii) organizations under the RF Ministry of Transportation, (iiiiiiii) organizations of the research services of the academies of sciences that have the public status, and (iiiiiiiii) other revenues from the lease of property owned by the state;
d - basing on the data of the RF Minimuschestvo, were not singled out as a separate item in the 2001 Act on execution of the federal budget, the amount coincided with the amount of other revenues in payments from public and municipal organizations;
e - the total value of revenues from leased the state-owned property (without singling out of rental payments for land) ;
f - the amount of rental payments for (i) urban and settlements' land (ii) land lots in the federal property after the division of the public land ownership;
h - the amount of revenues for the leased property fixed with (i) research organizations, (ii) educational institutions, (iii) healthcare institutions, (iiii) public institutions of culture and fine arts, (iiiii) public archive institutions, (iiiiii) postal institutions of the Federal Postal Service of the RF Ministry for Communication and Informatization, (iiiiiii) organizations of the research services of the academies of sciences that have the public status, and (iiiiiiii) other revenues from the lease of property owned by the state;
1 - rental payments after the division of the public property for land and funds generated by sales of the right to conclude rental contracts on land owned by the federal government (for 2008 r. - except for the federal autonomous institutions' land lots);
g -revenues from leasing the property under operating management by federal government bodies and created by them institutions, and under the FPUEs' economic management: the property assigned under operating management to having the public status: (i) research institutions, (ii) organizations of the research services of the Russian Academy of Sciences and sectoral academies of science, (iii) educational institutions, (iiii) healthcare institutions, (iiiii) institutions of the Federal Postal Service of the RF, (iiiiii) public institutions of culture and fine arts, (iiiiiii) public archive institutions, and (iiiiiiii) other revenues from the leasing of assets under operating management by the federal bodies of executive power and founded by them institutions, and under the FPUEs' economic man-
by the state (including appropriated property in the form of gift, or succession, or treasure-trove, revenues from conduct of lotteries, other revenues form the use of property and rights owned by the federal government (revenues from management of rights for results of intellectual activities (R&D and technological works) of the military, special and dual use, revenues from operations and use of property of highways and other revenues from the use of property owned by RF), as well as from permitted kinds of organizations' operations subject to credited to the federal budget, and revenues from sales of the government inventory of precious metals and precious stones. 422
agement55 (for 2006-2008- less revenues from permitted kinds of activities and use of the federal assets located beyond the RF Territory, which were collected overseas and were not singled out at all over the previous
years56).
Source: the 2000-2007 Acts on execution of the federal budget; the report on execution of the federal budget as of January 1, 2009; the authors' calculations.
The structure of revenues raised from renewable sources saw the proportion of domestic sources rise. This can be explained by the government's direct involvement in economic operations. More specifically, in 2004-06, after a non-stop growth in the specific weight of dividends in the aggregate volume of such sources was over 1/3 vs. H reported in 2000-2001 and reached 54.2% in 2007. The maximum value of the contribution of the FPUEs' earnings transferred to the budget was noted in 2003 (5.8%). The indicator has been on decline since then -6% in 2007, nonetheless, still being in excess of the 2001-02 figures.
After experiencing certain fluctuations, the proportion of revenues from leased federal assets in 2005 accounted for 25.9%, thus being just slightly in excess of its 2000 figure (25.3%); over the other years of the period in question it found itself within the range between 22 and 25% (except for 2001, when it plunged to 17.2%). Revenues of the rented land were significant only in 2001-02 (10%-plus), while after that they have never exceeded 5-6% of all the revenues from the renewable sources (2005-2007), which is apparently associated with the process of division of the government land ownership and the start of its actual assignment to the lower level of the public power.
At the same time, one cannot help but pay attention to a significant role played by revenues out of external renewable sources. In 2000, the RF's revenues from operations of the Russian-Vietnamese joint venture Vietsovpetro accounted for more than a half of all the revenues out of renewable sources. This share has declined since then. But despite of its fall (to 30% in 2006) by its absolute value this revenue item of the federal budget only once, in 200506, became the second major source after dividends on owned by the federal government shares and revenues from other forms of participation in capital within the country, respectively (in 2004, these revenues appeared comparable), thus outpacing the aggregate volume of revenues form leased federal assets and land lots. In 2007, the absolute value of revenues from Vietsovpetro experienced a sharp (more than twice) fall (below the 2000 level) and, consequently, this item found itself outpaced by dividends and revenues from leased federal assets in the list of the renewed sources.
As concerns other kinds of renewable sources, the absolute values of revenues by them have been soaring over the whole period of 2000-2007, except for some fall in aggregate revenues from leased federal assets and land lots in 2003, when the land rent fees were not singled out as a separate item, while a part of the FPUEs' earning stagnated in 2005-2006.
In 2008, the major shift in the structure of revenues to the federal budget from renewable sources became the growing role of dividends (up to 70%) and a full absence of revenues
55 In 2008, FPUEs as a source of revenues from leasing the assets under their economic management were not mentioned, while leasing of assets under operating management by the federal bodies of state power and institutions founded by them exclude the federal autonomous institutions' assets.
56 According to the RF Minimuschestvo, revenues from the use of the federal assets located overseas (apart from the revenues on the share of the Russian participant in joint venture Vietsovpetro) accounted for Rb. 315m in 1999 and 440m in 2000. Then a major role in the organization of the commercial use of the federal overseas assets was assigned to FPUE "Predpriyatiye po upravleniyu sobstvennostyu za rubezhom".
57
from Vietsovpetro . The 2008 absolute value of dividends soared at Rb. 9.7bn vs. 2007. But if compared with the aggregate amount of dividends and earnings raised through Vi-etsovpetro's operations, one has to admit its downfall. The volumes of the downfall proved to be insignificant (less than 2%), as dividends were paid by results of economic operations in 2007, when the economy did not practically sense signs of the forthcoming crisis as yet. As concerns a fraction of FPUEs' earnings due to be transferred to the budget and revenues generated from leasing public assets, the situation is far worse - these figures tumbled at 20-25%. Accordingly, also plummeted their proportion in the overall structure of renewed revenues - it has made up some 3% and 19%, respectively. The only source which in 2008 has demonstrated an unequivocal growth was land rent payments - the respective revenues to the federal budget grew by nearly H, while their specific weight - up to 8%.
Proceeding to the analysis of the federal budget revenues from privatization and sales of
public assets (Table 7), it should be noted that since 1999 revenues from sales of the bulk of
58
such assets (stock and - since 2003- land lots ) have begun to being attributed to sources of financing of the federal budget deficit.
Table 7
Revenues to the Federal Budget from Privatization and Sales of Assets (Non-Renewable Sources) in 2000-2008, as Rb.m
Year Total Sales of assets owned by the federal government (2000-2008 ) and other forms of participation in capital (2005-2008)# Sales of land lots Sales of different assets
2000 27,167.8 26,983.5 - 184.3a
2001 10,307.9 9,583.9 119.6b 217.5+ 386.5+0.4 (NTA)c
2002 10,448.9 8,255.9d 1,967.0e 226.0f
2003 94,077.6 8,9758.6 3,992.3h 316.2+10.5g
2004 70,548.1 6,5726.9 3,259.3i 197.3+1,364.6+0.04 (NTA)K
2005 41,254.2 3,4987.6 5,285.7l 980.9M
2006 24,726.4 17,567.9 5,874.2l 1284.3n
2007 25,429.4 19,274.3 959.6o 5,195.5q
2008 18914.1/12375.9r 6665.2+29.6 1,202.0p 11,017.3+0.025 (NTA) / 4,479.1c
#Refer to the sources of domestic financing of the federal budget deficit; in 2009 29.6 mln. rub. were attributed to the federal budget revenues. a - attributed to sources of domestic financing of the federal budget deficit revenues from privatization of organizations owned by the state;
b - attributed to the federal budget revenues receipts from sales of land lots and rights for rent of land lots owned by the state (with the separation of those on which privatized enterprises are located);
c - the amount of receipts from (1) sales of assets in the federal property, which are attributed to sources of domestic financing of the federal budget deficit, (2) receipts from (i) apartment sales, (ii) sales of public production and non-production assets, means of transportation, other equipment and inventories, as well as (3) revenues from sales of non-tangible assets (NTA) attributed to the federal budget revenues; d - including Rb. 6m from raised through sales of stock controlled by the RF Subjects;
e - attributed to the federal budget revenues gains from sales of land and NTA the amount of receipts by which was not single out in an individual order;
f - attributed to sources of domestic financing of the federal budget deficit revenues from sales of public assets (including Rb. 1.5m from sales of assets belonging to the RF Subjects;
57 In 2007, measures on developing JSC Zarubezhneft were completed. To the company's authorized capital were assigned stakes in 2 JSCs - research institutions and the 50% share of the Russian participant in the Vietsop-vpetro joint venture.
58 In 2003-04, with account of sales of the rental right. 424
h - including collected to the federal budget receipts from: (1) sales of land lots whereupon immovable property objects are located, which prior to their alienation had constituted federal assets, (2) sales of other land lots and sales of the right for conclusion of contracts on their rent, (3) - collected to the federal budget and attributed to sources of domestic financing of the federal budget deficit receipts from sales of land lots upon the division of land ownership, as well as from sales of the right to conclude contracts on their rent;
1 - the sum of (1) attributed to sources of domestic financing of the federal budget deficit receipts from sales of assets owned by the federal government and (2) attributed to the federal budget revenues receipts from sales of non-tangible assets ;
g - comprises revenues: (1) collected to the federal budget from sales of land lots prior to the division of ownership for land whereupon immovable property objects that prior to their alienation fell under the federal property, (2) from sales of other land lots and sales of the right for conclusion of contracts on their rent, (3) collected to the federal budget and attributed to sources of domestic financing of the federal budget deficit receipts from sales of land lots upon the division of land ownership, as well as from sales of the right to conclude contracts on their rent;
к - the sum of (1) attributed to sources of domestic financing of the federal budget deficit revenues from sales of assets owned by the federal government, collected to the federal budget receipts from (i) apartment sales, (ii) sales of public production and non-production assets, means of transportation, other equipment and inventories, as well as well as (iii) from sales of vessel utilization products, (iiii) from sales of assets of FPUEs, institutions and military inventories, (iiiii) from sales of products of utilization of armaments, military equipment and ammunition, (3) attributed to the federal budget revenues receipts from sales of non-tangible assets (NTA), relevant to the budget revenues;
' - comprises receipts from: (1) sales of land lots prior to the division of ownership for land whereupon immovable property objects that prior to their alienation fell under the federal property, (2) collected to the federal budget receipts from sales of land lots upon the division of land ownership, (3) attributed to sources of domestic financing of the federal budget deficit revenues from sales of other land lots that had been the government property prior to the division of land ownership and which are not designated for house building (the latter specification concerns solely the year of 2006);
m - revenues from sales of tangible and non-tangible assets (exclusive of the federal budget funds raised through management and sales of confiscated and other appropriated by the state assets include receipts from (i) apartments sales, (ii) sales of FPUEs' assets, (iii) sales of assets under the federal institutions' operative management, (iiii) sales of military assets, (iiiii) sales of products of utilization of armaments, military equipment and ammunition, (iiiiii) sales of other assets under the federal ownership, (iiiiiii) attributed to the federal budget revenues receipts from sales of non-tangible assets;
n - revenues from sales of tangible and non-tangible assets (exclusive of revenues in the form of a share of the government's profit production in the course of execution of production sharing agreements and the federal budget funds raised by managing and selling appropriated by the state escheat and other assets), comprise revenues from включают доходы (i) apartments sales, (ii) sales of FPUEs' assets, (iii) sales of assets under the federal institutions' operative management, (iiii) sales of military assets, (iiiii) sales of products of utilization of armaments, military equipment and ammunition, (iiiiii) attributed to the federal budget revenues receipts from sales of other assets owned by the federal government;
о - attributed to sources of financing of the federal budget deficit revenues from sales, upon the division of land ownership, of the previously owned by the federal government land lots;
p - revenues from sales of tangible and non-tangible assets (less revenues in the form of the government's profit products under execution of production sharing agreements and the federal budget funds from management and sales of escheat and other assets taken by the state, and sales of sales of sequestrated timber) include receipts from (i) apartments sales, (ii) sales of FPUEs' assets, (iii) sales of assets under the federal institutions' operative management, (iiii) sales of released movable and immovable military, and other property of federal agencies of executive power, which provide for the military and equaled to it service, (iiiii) sales of military goods the federal gencies of executive power have in the frame of military and technical cooperation, (iiiiii) attributed to the federal budget revenues receipts from sales of other assets owned by the federal government; q - attributed to the federal budget revenues receipts from sales of land lots owned by the federal government (except for land lost of federal autonomous institutions);
r - receipts from sales of government assets (less revenues in the form of the government's profit products under execution of production sharing agreements and the federal budget funds from management and sales of escheat and other assets taken by the state, and sales of sales of sequestrated timber), include those raised by (i) apart-
ments sales, (ii) sales of FPUEs' assets, (iii) sales of assets under the federal institutions' operative management (except autonomous ones)59, (iii) sales of released movable and immovable military, and other property of federal agencies of executive power, which provide for the military and equaled to it service, (iiii) from sales of products of utilization of armaments, military equipment and ammunition, (iiiii) sales of military goods the federal gencies of executive power have in the frame of military and technical cooperation, (iiiiii) sales of products of utilization of arms and military equipment in the frame of the Federal Target Program "Industrial utilization of arms and military equipment (2005-2010), (iiiiiii) sales of special raw and fissionable materials, (iiiiiiii) attributed to the federal budget revenues receipts from sales of other owned by the federal government assets, as well as receipts from sales of non-tangible assets (NTA); in the common denominator - without regard of receipts from sales of special raw and fissionable materials, which is necessary for a correct comparison with the prior years.
Source: the 2000-2007 Acts on execution of the federal budget; the report on execution of the federal budget as of January 1, 2009; the authors' calculations.
It was sales of the federal stakes that held a pivotal place in the structure of the asset-related federal budget revenues from non-renewable sources. But the specific weight of this particular source has been gradually declining from 85% in 2005 to 71% in 2006 and 76% in 2007 vs. 90%-plus in the preceding years, except for 2002 (79%).
Meanwhile, the proportion of budget gains from sales of land lots was on the rise, accounting for 12.8% in 2005 and 23.8% in 2006 vs. less than 5% reported in the prior years, except for 2002, when it made up 18.8%. The proportion of receipts from sales of other kinds of assets, including sales of the FPUEs and other institutions' assets and military property, has been fairly modest since 2004, except for 2001 and 2006 when it stood at 5-6%. In 2007, these sources of budget revenues traded places with each other: the specific weight of assets sales posted a sharp growth up to 20.4%, while that of sales of land lots plummeted to below 4%.
Having reached its maximum value in 2003 (some Rb. 89.8bn), the absolute amount of revenues from equity sales has been on decline over the next years. The fall was particularly notable in 2005-06, when the revenues plunged nearly twice. Nonetheless, even after such a drastic fall the 2006-07 the revenue volumes were practically twice as high compared to those back in 2001-2002. Characterizing the 2007 outcomes, Rosimuschestvo emphasized that despite there were no sales of large and the largest joint-stock companies' equity (worth in total of Rb. 3bn-plus), the respective receipts accounted for some Rb. 193.3bn, or 10% more than in the prior year. The agency also noted that without regard to receipts from such sales, during the last 4 years the collected to the federal budget annual amount of receipts from privatization grew nearly 2.5 times vs. the sum of Rb 7.8bn reported in 2004 (Rb. 11.8 bn. in 2003, some 12.95bn in 2005 and 12.1bn. in 2006)60.
Revenues raised through sales of land lots demonstrated a clear trend to growth (with the year of 2004 being a minor exception). But they failed to compensate for the fall in revenues (which accounted for some Rb. 5.9bn in 2006) from equity sales. The next year they shrank drastically - under Rb. 1bn. Receipts from sales of various kinds of assets have been fluctuating within an ample range - they exceeded Rb. 1 bn only in 2004 and 2006, and 2007, when they accounted for Rb. 5.2bn.
59 Less receipts from sales of the FPUEs' assets as well .
60 Otchet o privatizatsii federalnogo imuschestva v 2007 g. M., FAUFI, 2008. 426
The year of 2008 saw the absolute value of the federal budget revenues from privatization and sales of assets fall more than twice61.
Receipts from equity sales shrank nearly 3-fold, while those from sales of various assets plunged at 14%. At the same time, receipts from sales of land lots posted a nearly H growth -the specific weight of land lots in the overall structure of non-renewable sources has clearly been on the rise. But this particular source still was the least significant one vis-à-vis receipts from equity sales (54.1%) and those from sales of various assets (36.2%).
The budgetary statistics show that constancy has not been a salience of the aggregate volume of revenues from privatization and use of the government property (Table 8). This proportion became the most weighty one in 2003-2004 (Rb. 135.3bn and 120.8bn, respectively). In the next 2 years, it plunged to less than Rb. 100bn, albeit still being practically twice as high vs. the annual indicators of 2000-2002. In 2007, the amount of the federal budget revenues from privatization (sales) and use of the public property once again exceeded Rb. 100bn, albeit being inferior to the 2003-2004 indicators.
Table 8
Structure of the Federal Budget Revenues of Property Nature out of Various
Sources in 2000-2008
Year
Aggregate revenues from privatization (sales) and use of the public
assets
Receipts from privatization (nonrenewable sources)
Receipts from the use of the public property(renewable sources )
Rbm. As % to result Rbm. As % to result Rbm. As % to result
2000 50,412.3 100.0 27,167.8 53.9 23,244.5 46.1
2001 39,549.8 100.0 10,307.9 26.1 29,241.9 73.9
2002 46,811.3 100.0 10,448.9 22.3 36,362.4 77.7
2003 1,35338.7 100.0 94,077.6 69.5 41,261.1 30.5
2004 1,20798.0 100.0 70,548.1 58.4 50,249.9 41.6
2005 97,357.4 100.0 41,254.2 42.4 56,103.2 57.6
2006 93,899.8 100.0 24,726.4 26.3 69,173.4 73.7
2007 10,5761.25 100.0 25,429.4 24.0 80,331.85 76.0
2008 88,642.6 100.0 12,375.9 14.0 76,266.7 86.0
Source: the 2000-2007 Acts on execution of the federal budget; the report on execution of the federal budget as of January 1, 2009; www.roskazna.ru; the authors' calculations.
There occurred a cardinal shift in the structure of aggregate revenues from privatization (sales) and use of federal assets in favor of the renewable sources. While in 2000 the proportion of revenues from privatization and sales of assets accounted for some 54% of the aggregate revenues, the next year it shrank more than twice, while in 2002 one had noted its minimal value over the whole 7-year period (22.3%). The situation reversed drastically in favor of the privatization and assets sales revenues in 2003 - at the time, they secured nearly 70% of the volume of the aggregate revenues.
The period between 2004 and 2006 saw a steady rise in the proportion of revenues from use of public assets against a constant fall in the specific weight of revenues from privatization and sales, which in 2007 accounted just for 24%, which is comparable with the 20012002 figures. As a result, in 2005-2007, like in 2001-2002, revenues from use of public assets
61 In 2008, in receipts from sales of assets there appeared a new revenue item - receipts from sales of special and fissionable materials, which was non-existent over the prior years. That is why a correct comparison requires not to take into account this kind of receipts while evaluating the receipts raised through both sales of various assets and aggregate receipts from non-renewable sources on the whole.
secured over a half of all the aggregate revenues. Of particular notice is the fact that in 200102 and 2006-07 they secured over 70% of the aggregate budget revenues.
The 2008 financial results in the part of the structure of the asset-related federal budget revenues out of different sources have increasingly solidified this trend. The proportion of revenues form use of the public assets accounted for 86% - the maximum value ever reported over the 2000s. Accordingly, the proportion of revenues generated by privatization was the minimum one - 14%.
One should help but notice a more than a 16% fall of the indicator of the aggregate revenues vis-à-vis 2007. Its absolute value (Rb. 88.6bn) proved to be the minimum one over the period since 2003. Having managed not sink below their 2006 level, the revenues from use of public assets became a kind of buffer, while those from privatization and sales of various kinds of assets were just slightly over their respective indices of 2001-2002, but proved to be lower than both the results of all the subsequent years and figures reported in 2000.
In the conditions of the unfolding crisis, however, one cannot count on a stable influx into the budget of revenues from renewable sources, primarily because of the aggravating financial and economic state of corporations with the government participation and an overall contraction of business activity.
In this sense, the situation with dividends is quite illustrative. Rosimuschestvo proposed the RF Ministry for Economic Development and Trade to differentiate the dividend policy by breaking down all the corporations of this kind into three groups:
- the companies with publicly traded stock (for example, Gasprom, VTB, Rosneft, Aeroflot) whose approaches to the dividend policy should remain unchanged;
- the companies bound to pay dividends only on preferred stock (Transneft);
- the companies unsusceptible to the financial crisis, which must pay dividends, unless they can produce grounded plans and budgets to prove their need in funding for the ongoing operations and investment ones.
The agency believes that paying dividends by other companies is inappropriate. This primarily concerns dividends of the public companies that have failed to join in the Top-20 ones and which in 2008, by results of 2007, secured Rb. 1.9bn in dividends payable to the federal government.
Meantime, according to Rosimuschestvo, the Top-20 group of the largest public companies secured 96.4% of all the dividend payments to the budget. Of this group the following companies have their shares publicly traded: Gasprom, VTB, Sovkomflot, Aeroflot, Novorossiysk maritime commercial harbor, Irkutskenergo, FSK UES. Transneft has only its preferred shares publicly traded, while Svyazinvest - only its daughter companies' stock. As for companies with non-traded stock, the group comprises ALROSA, Zarubezhneft, Concern PVO "Almaz-Antey", JSC RZHD, International Airport Sheremetyevo, SG-trans, Tuapse maritime commercial harbor, Rosagrolizing, Sevzapelectrosetstroy, Rosgazifikatsia, Rosneftegas62.
By the 2007 results, Gasprom paid 17.5% of its profit to the shareholders (the government's share accounted for some Rb. 31.5bn), Rosneft approved dividends at an amount of 10.5% of its net profit by Russian Accounting Standards (the government's share is Rb. 12.75bn), VTB- 50% (Rb.6.7bn), Transneft - 18% (Rb. 750m), Aeroflot- 25% (some Rb.
62 While not exercising economic operations, Rosneftegas is an owner of the government stakes in Gasporm and
Rosneft, and as such, it pays dividends.
760m63), Sheremetyevo - 10% (Rb. 104m). JSC RZHD blew with just 0.6% of its profit and paid to the government Rb. 512.2m, but the railway monopolist has had a special situation, with its profit being a paper-and-pencil one as a result of the asset revaluation.
Not daring challenge minority shareholders of the public companies, Rosimuschestvo proposes to indirectly alleviate their situation, too, - the agency claims it will not insist on sizeable payments. It believes that the government should hear boards of directors' recommendations, rather than forward directives on a minimum level of payments out of the net profit. Until now Rosimuschestvo has recommended the public corporations to pay not less than 25% of their profit in dividends.
In the crisis conditions, the refusal to pay dividends can be regarded as a way to somewhat shake off the financial load - a measure to complement the tax policy ones and target aid granted by the state. This measure can give a much-needed upper hand to relatively small, nonpublic corporations.
In all, the agency hopes that in 2009 it would ultimately cash in just Rb. 30.7bn., instead of Rb. 50.7bn-worth, in dividends. This inevitably requires adjustments to budget orders64, albeit it cannot be excluded that the cold truth of the crisis would compel the government to dump the idea of collecting dividends at all.
5.2.5. A Possible Effect of the Financial Crisis on the State of Property Relations
The gradual intensification of negative developments in Russia's economy was noted through the whole year of 2008. It has affected primarily the national financial markets (including the stock market) and the investment process, and raised the question of the beginning of a new stage of Russia's as a whole.
While speaking of the country's macroeconomics and financial system, one with a greater or lesser degree of certainty can reference to possible trends of future changes, their determination by a known set of parameters (world prices for energy sources, export and import volumes, exchange rate, etc.), but the sphere of property relations exhibits a far greater level of variability, which is associated with both the impact of the global financial crisis and the start of a new business and political cycle in the country.
The crux inevitably lies in the problem of the nature of mergers and acquisitions - the usual companions to economic crises in a market economy. An evident deceleration of the privatization process post-2004, particularly on the federal level wherein the state was an owner of the most weighty and attractive assets, has chronologically coincided with the start of the today's stage of mergers and acquisitions in the economy, when corporations with governmental participation have notably expanded across a number of sectors as buyers of assets.
Investors have begun to regard the presence of a government-owned package in a company's capital as an extra factor of its reliability and sustainability, as reflected by international rating agencies' assessments. The dark side of the trend to the public companies' greater activity on the market for corporate control has become a sharp rise of their accounts payable. That highlighted the problem of alternative choices with respect to financial invest-
63 The only large corporation that was following the recommendation to forward not less than % of its net profit on payment of dividends.
64 Rebrov D., Kiseleva E., Shapovalov A. Bezdokhodnoye proizvodstvo//Kommersant, №226/P (4043) of 11.12.2008.
ments and investments in fixed assets, sources of their financing and the regulatory role the government plays as a key stakeholder in tackling this problems.
The quantitative assessments available over the period between 2003 and 2007, along with new avenues of the government's property activity over the last two years, so far have not given grounds to assume that the state has slowed down with its expansion in the sphere of property, though 2008 highlighted respective signs of that.
As the RF President declared in his Address to the Federal Assembly of November 5, 2008, the crisis would not engender a nationalization of the industrial sector and finance. Addressing the economic agenda, since the early-2009 the top political leadership put forward a comparatively new thesis of urgency of the task of acquiring of assets located overseas. The players on the M&A market (which in the pre-crisis 5-year period were mostly public companies) may interpret it as a signal to focus their efforts on what lies beyond the country's borders.
The completion of a deal between Gasprom and the Siberian Coal Energy Company (SUEK) scheduled for the end of the summer of 2008 faced the Federal Anti-Monopoly Service's opposition65.
SUEK was going to hold an additional stock issuance, to be paid for with Gasprom's electricity assets (from its share in RAO UES Russia after the reorganization of the electricity monopolist), as well as the already received by the latter shares in new companies that had emerged in the course of the process (a 15.61% stake in JSC OGK-2, a 17.13% stake in JSC OGK-6, a 5.27% stake in OGK-5, and a 5% stake in TGK-5. If completed (and with account of the summer 2007 swap of RAO UES Russia's equity between Gasprom and other minority shareholders of the electricity monopolist) , the deal would have resulted in SUEK getting control blocks in JSCs OGK-2 and OGK-6, while the natural gas monopolist should have acquire a 50%+1 share in one of the biggest national energy corporations.
Such a format of interaction between Gasprom and SUEK might imply establishment of an indirect control by the state over a considerable fraction of generating capacities in the national electricity sector, as Gasprom's control over own energy assets and SUEK's ones would complement the already existing to that day full ("Rosenergoatom" concern, which was due to be included in the structure of "Atomny energopormyshlenny kompleks" (AEP) holding, which in turn was to be assigned as a property contribution to PC "Rosatom") or partial presence of the state in assets of individual segments of this sector.
As concerns signs of a slowdown in the government's property expansion, one of them became drastic cuts in the list of the strategic enterprises and joint-stock companies. As many as 176 unitary enterprises and 195 JSCs were crossed out, to be replaced by just 1 FPUE and 2 JSCs. But the exclusion of the overwhelming majority of the assets was associated with their assigning to PC Rostekhnologii.
The formal nature of representation of the state on boards of numerous companies wherein the government has a share in the capital vis-à-vis the role played by the top executive management has made the practice of attraction of independent directors thereinto a hot issue. Of the largest corporations with a government share, it was RAO UES Russia (until its liquidation), Rosneft, Sberbank,VTB aand RZHD that attracted independent directors. By contrast, they are absent in boards of Gasprom, Svyazinvest (though there are independent di-
65 www.opec.ru, 09.06.2008. 430
rectors on all its daughter companies' boards), Transneft, Rosneftegas, Sovkommflot, and Aeroflot66.
At this juncture, given what the government representatives (I. Shuvalov, the First Vice-Premier of the RF Government, at the XII St. Petersburg International Economic Forum and A. Dvorkovich, the presidential aide, in June 2008) have ascertained, there will be steps made to limit the bureaucrats' sitting on the public corporations' boards by means of rotation of their composition, along with a gradual increase in the number of independent directors, primarily in the JSCs in which the government holds the 100% stake67. But so far there is no clarity with respect to proportions of such a replacement and the array of companies where bureaucrats will keep on representing the state interests. In practice, the novelty has already been tested at 11 public companies with the 100% government-owned stake. According to Mr. I. Shuvalov, in June 2008, independent directors were co-opted to their boards to improve corporate governance, albeit a fairly widespread opinion is that the move constitutes a first step in preparations for a possible sale of the federal stock packages in such companies68.
In this respect it should also be noted that amendments introduced by Resolution of the RF Government of July 28, 2008 № 572 to the approved in December 2004 Statute on management of owned by the federal government equity of open-end joint-stock companies and use of the special right of the Russian Federation for managing open-end joint-stock companies ("the golden share") have excluded individuals, whose candidacies the Russian Federation had proposed for electing in boards of directors as independent directors, from the group of state representatives that exercise their duties on the basis of the Statute.
Furthermore, along with representatives of the RF's interests, independent directors have now been given the right to initiate at Rosimuschestvo and other government agencies, with invitation of other governmental representatives, discussions on matters put on the agenda of a JSC's board of directors and to receive necessary information, except for the one the company is bound to provide them with.
At the same time, the circle of matters, by which Rosimuschestvo is bound to issue directives in writing to government representatives, has been slightly narrowed; plus, directives on other matters that fall under the board of director's competence, may be used, only sobeit the chairman of the board puts a respective proposal.
Let us note that against such a background, other novelties in the federal property management area appear fairly questionable. This concerns the possibility for trust FPUEs and public JSCs at the stage of their incorporation to sectoral ministries. A suggested pilot project involves road-building organizations with the prospect for creation on their basis of a huge public company or a new public corporation69.
The concept of competition between ministries and federal agencies, that currently administer unitary enterprises, explicitly conflicts the approaches declared by the 2004 administrative reform. Besides, it additionally complicates the already sophisticated pattern of interaction between different government agencies in the course of implementation of managerial procedures with regard to the economic agents under the federal ownership which lacks an undivided authority. As well, this move compels one to question the mere possibility for min-
66 Malkova I., Surzhenko V. Nezavisimye pomogut//Vedomosti, 14.09. 2007, №173 (1947), B 01.
67 Den nezavisomogo direktora. 9.06.2008. Interfax.ru
68 Netreba P., Butrin D. Privatizatsii nakidyvayut srok. In: Commersant, №145/P (3962) of 18.08.2008.
69 Netreba P. Pravitelstvo vzyalos za dorozhny vopros// Commersant, №145/P (3962) of 18.08.2008.
istries to be capable of an efficient administering of the respective sector (their mandate) on the whole, and the possibility for agencies of being capable of dealing with implementation of their respective mandates that proceed from the law (primarily, the Act on unitary enterprises). Furthermore, the effective trust mechanism emerged in the 1990s implies attraction to managing government stock packages (but not FPUEs) of legal entities (but not government agencies) on the competitive basis and with a potential orientation to getting efficient managers from the private sector involved in the process.
Yet more dubious appears a delegation to the RF Ministry of Defense of powers to exercise, on behalf of the government, the stockholder's rights (remarkably, independently by a number of issues) with respect to JSCs founded resulting from privatization of subordinated to the Ministry FPUEs, whose stock is owned by the federal government, as well as, upon the government's decision, with respect to other joint-stock companies with the federal stakes in them. This novelty was introduced in the aforementioned Statute on management of owned by the federal government equity of open-end joint-stock companies and use of the special right of the Russian Federation for managing open-end joint-stock companies ("the golden share") by Resolution of the RF Government of December 29, 2008, №1053 'On some measures on managing the federal property"70.
The absence of announced plans on a further comprehensive expansion of the sphere of the governmental entrepreneurship across whole sectors of the economy, as it had been already done in the air transportation and nuclear sectors, and the ship-building industry, does not mean an automatic contraction of the size of the public sector itself due to advancement of privatization, as inclusion in a respective program of sizeable assets that by their significance appear comparable with those privatized prior to 2004 (for instance, the government stake in the telecom giant Svyazinvest, whose sales were repeatedly postponed in the past) is questionable. In conjunction with this, it should be remembered that the previous financial crisis, which had battered the economy in 1997-98, reduced the privatization procedures to minimum, because of a multiple price downfall for assets, abandonment of the national market by numerous potential investors, and the political uncertainty, albeit at the time, it was only some emerging markets (the south-east Asian and Latin American ones), rather than G-7 countries, as today, that fell prey to the crisis.
The impact of the financial crisis of the autumn of 2008 on the Russian market for corporate control has still been not quite clear. On the one hand, having gone down in value, the assets constitute a natural object for potential mergers and acquisitions, particularly in the eyes of both public and private companies. On the other hand, the accumulated debt load and the loss of the ease of access to loans should objectively help one sell a part of the assets, or, at least, they should arrest new purchases.
Much will depend on magnitude and format of the government support to be granted to the Russian banks, their priorities of crediting the real sector, and the degree to which the state would be keen to participate on the stock market.
The major channels of extension of financial support out of budgetary funds and through CBR's loans have undoubtedly become the economic structures with the governmental par-
70 This document also introduced amendments to Resolutions by the RF Government of June 6, 2003, №333 and of December 3, 2004, №738, which defined the mechanism of realization by government bodies of powers of proprietor of FPUEs' assets in the part that concerns legal powers exercised by the RF Ministry of Defense. 432
ticipation - PC Vneshekonombank (VEB), Sberbank, and the Agency for Mortgage Loans (AIZHK).
At the same time, public companies have not dominated over the group of recipients of the funds in question - quite the opposite, it was well known private corporations, such as RUSAL, Alfa-Group, JSC Mechel that were among the first to receive cheap credits from the VEB. This contradicts to the recently established opinion of the public companies' privileged position, thanks to their interaction with authorities.
As well, one should not help noting that the comeback to the practice of extending soft loans has heralded a certain revision of principles of financial responsibility, impermissibility of soft budget constraints with respect to economic agents' operations, consistency in application of insolvency (bankruptcy) procedures, whose introduction into the national economy back in the 1990s was painful and costly. Furthermore, at the time, it was the agrarian sector, coal-mining and defense industries that were main candidates for such a support. Those were the sectors, which, due to their specificity, constituted, as proved by international experience, certain deviations from typical models of organization and conduct of business. Nowadays, the group of pretenders for the support comprises corporations from the sectors that owed their recent successful advancement to market forces (the mineral sector, metallurgy, construction and trade). It should be noted, though, that the credits to refinance the loans taken overseas were extended against their equity. Should the borrower fail to repay the loan, the VEB would be in a position to exercise the ownership right. For instance, RUSAL received Rb. 121bn on security of the blocking package in Nornickel, while Alfa-Group received a collateral loan against its stakes in X5 retailer and Vympelkom.
As well, some banks have received 10-year loans from the VEB: specifically, Vneshtorgbank received Rb. 200bn, Rosselkhozbank - Rb. 25bn, some regional banks -
71
225bn, and Sberbank - 500bn. (a 10-year loan from CBR) . It is critical what will be their actual credit policy priorities.
As concerns the VEB, in addition to resources to ensure direct credits for the real sector (Rb. 1.3trln to refinance corporations' overseas borrowings) and for the banking sector (Rb. 450bn), it received Rb. 175bn to buy stock and bonds on the exchange market, another 75bn to guarantee completion of transactions at exchanges, and 30bn to credit small- and medium-sized businesses.
Meanwhile, some business groups have failed to get access to the government support. For them the crisis, which has already drastically constrained a possibility for attraction of borrowed capital, should become a catalyst of their restructuring with a prospect of a possible change of their owners. Time will show how deep and sweeping such a restructuring will be, as far as public companies are concerned. As the recent experience (albeit in the conditions of economic growth and a positive dynamic of the financial markets) already showed, the restructuring may well comprise a sale of a fraction of the accumulated assets. That should engender a change of the role the companies with a government share in their capital would play
72
on the M&A market and lead to their transformation from major buyers into sellers . It can-
71 In addition, the RF Ministry of Finance has placed Rb. 1.5trln on deposits with commercial banks.
72 In this respect, one can reference to the practice of reforming natural monopolists, primarily, the electricity sector. Also, similar processes may be envisaged in the railroad transportation sector.
not be excluded, of course, that these companies may try new mergers and acquisitions themselves, with new corporations in various sectors being their targets.
That said, there arises an inevitable question of the role played by the state. It will be compelled to act indirectly, via its representatives in managing bodies of such companies, granting a permit to execute such deals or blocking them, rather than directly, as it was noted under standard privatization procedures. At this point, contiguous problems are the dividend policy (in the light of collection extra revenues complementing proceeds from current operations) and identification of prospects for the government with respect to retaining its participation in the corporate capital.
It is in the medium term that it shall become clear whether a reorganization of the managerial and organizational aspects of individual companies' functioning means optimization of the public sector as a whole.
Reflecting on efficiency, the government's presence in the economy in terms of property relations has to be brought in line with its real managerial capability, which is fairly modest. Hence, the government should center its efforts on optimization of the existing assets, enhancement of efficiency in managing the already existing public companies by identifying their place in the system of the state priorities, securing transparency of financial flows, and disseminating the best practices and standards of corporate governance.
As concerns the problem of the public companies' participation in mergers and acquisitions, the focal point should become restricting acquisitions of non-core assets and a more thorough selection of decisions that require consent of the government both as an owner and the market regulatory authority. Because of the financial crisis, it is fairly possible that in the nearest future the privatization process in the country will decelerate. Hence, a very possible scenario under which the government would for long remain an owner of a huge volume of assets, including those not directly associated with its public functions. That is why one can presently assert that as far as the sphere of public property management is concerned, the priority mission for several years to come will remain an ultimate implementation of the set of measures on improvement of management of public assets as outlined in the "Concept for
73
management of public property and privatization in the Russian Federation" .
5.3. Public Corporations: main development directions and trends in 2007-2008
An important element of government policy in 2007 was the establishment of large public corporations. The government has established six of the them: Bank for Development and Foreign Economic Affairs (Vnesheconombank), Russian Corporation of Nanotechnologies («Rosnanotech» or «ROSNANO»), Housing and Utility Reform Foundation, Public Corporation for the construction of Olympic facilities and the development of Sochi as a mountain
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resort («Olympstroy»), «Rostehnologies» and «Rosatom» .
Those public corporations have obtained a wide range of functions and significant scope of national property (federal budget funds, various industrial and financial assets) to secure their activities over a long term. Herewith, these public corporations are rather different in
73 Resolution by the RF Government of September 9, 1999, №1024.
74 In this section, we do not consider the activities of the public corporation «Deposit Insurance Agency», established in 2003.
75
terms of objectives, functions and basic principles of operation . In 2007-2008 the dynamic development of the government-established corporations took place along with the expansion of their scope and sometimes trends of their activities as well. In this section, we will primarily focus on the analysis of major trends of the public corporations development.
5.3.1. Specifics of public corporations development in 2007-2008
Development of the established public corporations' activities
State corporations, established in 2007 can be roughly split into three main groups:
1) Vneshekonobank and «ROSNANO» basic objectives are filling in the «gaps» in both, the market, and public administration system, as well as establishment of financial institutions for development in the form of public corporations;
2) Housing and Utility Reform Foundation, «Olympstroy» objectives are enhancement of efficiency and flexibility of the administrative system, «outsourcing» of some functions of government bodies at the level of public corporations;
3) «Rosatom», «Rostehnologies» objectives are competitive upgrading of certain strategic sectors (industries), national security support, restructuring and consolidation of the relevant national assets.
Public corporations development is rather diversified, and in some cases looks ambiguous. Let as consider some important events in each of public corporations development.
Vnesheconombank
Reviewing the public corporation as a new institution of development, the Vneshe-conombank Memorandum on financial policy, defining main trends, indicators and restrictions in it's investment and financial activities76, adopted 2 months after the official establishment of the corporation should be regarded as the starting point. The first solutions on the approval and support of the investment projects, that meet the Memorandum requirements, were adopted in March 2008, i.e., 10 months after the public corporation official registration. By October 2008, the Supervisory Board of Vnesheconombank has approved the public corporation participation in more than 20 large projects with the funding of nearly RUR 200 bln. From the point of its incorporation, the public corporation has signed a number of agreements on cooperation and collaboration with federal authorities, regional administrations, the largest public companies, such as OAO «Russian Railways», OAO «United Aircraft Corporation», GK «Rostehnologies», OAO «Rosneft», OAO «United Shipbuilding Corporation ».
Currently Vneshekonombank is an important instrument, ensuring financial stability of domestic banks and of real sector companies. In accordance with the federal law «On addi-
77
tional measures for the support to the financial system of the Russian Federation» , this public corporation has the right to:
75 For the details on the establishment of public corporations in 2007, the basic assumptions and characteristics of the process, the key characteristics of structures, see, for example: Yu. Simachev, M. Kuzyk. The creation of public corporations as an important instrument of institutional policy in 2007 / The Russian Economy in 2007. Trends and Prospects. (Issue 29) - Moscow: IET, 2008, pp.505-534.
76 Memorandum on financial policy of «the Development Bank and foreign trade activities (Vnesheconombank)» public corporation is approved by the Order № 1007-p of the RF Government on July 27, 2007.
77 Federal Law №173-FZ, dated of October 13, 2008 «On supplementary measures for the support of the Russian federation financial system».
provide credits to organizations for repayment or service of foreign debt, as well as acquire the right of claim to the foreign creditors;
provide long-term subordinated loans without security;
provide subordinated loans to OAO «Bank VTB», amounting up to RUR 200 bln and to OAO «Rosselhozbank», amounting up to RUR 25 bln.
Also Vnesheconombank was authorized to act as the RF Government Agent in 2009 on provision and execution of national guarantees under credits, attracted by the strategic enterprises of military-industrial complex, as well as by other companies, selected in accordance with the procedure, established by the Government, for implementation of the basic business activities and capital investments78.
Vnesheconombank has implemented a number of measures of both, targeted and regular support, such as:
acquisition of 98 % shares in OAO AKB «Svyaz-Bank» and 99 % shares in ZAO «Globex»;
provision of subordinated credits to a number of Russian banks (besides «VTB Bank» and «Rosselkhozbank», mentioned in the Law): «Alfa-Bank», «NOMOS-BANK», «the Khanty-Mansiysky Bank», «Gazprombank» for the total amount, exceeding RUR 30 bln;
participation in refinancing of fuel and energy sector, mining, metallurgy industry, microelectronics companies and OAO «Bank VTB» transactions for the amount of nearly USD 14 bln79.
To ensure the implementation of anti-crisis measures, additional resources were provided to the public corporation. Thus, in accordance with federal law «On additional measures to support the financial system of the Russian Federation», the Bank of Russia has placed in Vnesheconombank deposits totaling up to USD 50 bln for one year, and it is also foreseen to place the "National Welfare Fund's assets amounting to RUR 450 bln, in Vnesheconombank till the end of 2019. Herewith, there was taken the decision on contribution into the charter capital of Vnesheconombank in the amount of RUR 75 bln to implement measures to support financial market80.
In the future, the use of Vnesheconombank as a priority instrument to ensure sustain-ability of the Russian financial system and of the real sector, without doubt, will continue and, most likely, will be extended. Herewith, we believe, it would be rather difficult to ensure a reasonable combination of measures to overcome the financial crisis and the opportunity of long-term support for innovation and investment projects within one public corporation (there is a risk, that efforts will be concentrated in the first direction at the expense of t second one).
"ROSNANO" Public Corporation
Practical activity of the public corporations to support the development projects in nanotechnology started, in fact, 10 months after the date of its formal establishment. However, before that point, the public corporation has was carried out significant preparatory work: a large amount of documents was obtained, a number of departments were established, the
78 Resolutions of the RF Government N 103, 104 dated of February 14, 2009.
79 It should be noted, that in early February 2009 Vnesheconombank has suspended the applications for the companies' debt refinancing . Ref.:http://www.veb.ru/ru/about/press/news/index.php?id32=5036
80 RF Government resolution N1665-p, dated November 19, 2008. 436
scope of activities has been investigated, etc. In May 2009, the strategy of the corporation until 2020 was approved81.
During the first year of the public corporation operation, about 650 applications from more than 350 organizations for the amount exceeding RUR 400 bln were received, but only one of them was approved, at the end of May, 2008 the Supervisory Board has approved the first investment project for production of aspheric optical elements. However, afterwards, the process was accelerated and by early 2009, the corporation management took the decisions on seven projects refinancing in amount of about RUR 6 bln.
An important area in the public corporation activity is its participation in the infrastructure projects and programs. The public corporation is working to deploy, support and coordinate both, new and existing elements of nanotechnological infrastructure: it participated in co-financing of the development of material-technical base of the centers of collective usage, scientific and promotional centers, including engineering centers, as well as non-profit development institutions, such as technology parks, technology transfer centers, special economic zones and business incubators. Ten infrastructure projects have been submitted to the state coproration.
Currently, the corporation is developing the concept of infrastructure scientific and tehnological nano-centers development network for the support of business processes in different sectors of nanotechnological industry. Herewith, in late 2008, the «ROSNANO» management and the Moscow State University have agreed to establish a Center for Nanotechnol-ogy, on the basis of which research and experimental work will be carried out, as well as pilot production.
In December 2008, the «ROSNANO» Supervisory Board has approved a project in establishment the first private equity fund of venture investments. As a result of a tender among the Russian business schools, «SKOLKOVO», Moscow School of Management was selected as the «ROSNANO» corporate partner, which is going to attract to the mutual fund RUR 1 bln from co-investors. The total amount of the fund accounts to RUR 2 bln. «Troyka Dialog» will become the management company of the Fund.
The public corporation plans to launch several educational projects, aimed primarily at
training and retraining the specialists needed to implement investment projects in the field of
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nanotechnology, which «ROSNANO» finances or is planning to finance . There already have been received applications from several leading national universities for implementation of pilot projects, one of which was approved by the Supervisory Board at the end of September 2008. The project will be implemented jointly with the Moscow Institute of Steel and Alloys and with the Moscow Physical-Technical Institute. The project budget amounts to RUR 13.1 mln, whereas the share of «ROSNANO» makes RUR 11,2 mln.
The public corporation is making significant efforts to the development of communication system and to promotion of its activities, including the international level. In the preceding period, cooperation agreements are concluded with a number of federal authorities, regional administrations, Russian authorities(including the GC «Rosatom») and foreign companies, research centers (RRC «Kurchatov Institute»), Universities (Moscow State University), as well as the Russian Academy of Sciences. An important milestone in the activities of the corporation was the organization and carrying out a representative international forum
81 The document was approved by the «ROSNANO» Supervisory Board on May 29, 2008.
82 http ://www. rosnano. ru/Publication. aspx?PublicationId=860
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on nanotechnologies in December 2008, which was attended by more than 7 thousand people.
In general, over the preceding period, the public corporation activity was basically associated with the preparation for the immediate implementation of functions to support the development of nanoindustry - the study and analysis of the situation in the markets, the development of strategy of its activities, selection of principles and procedures for projects support, partnerships formation, promotion of its activity, whereas the actual implementation of projects has been started nearly a year after the corporation establishment. In the future, with regard to the distinct provisions on the public corporation activity, procedures for pilot projects selection, one can be expect intensification and expansion of the corporation activity in the
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search and selection of the innovation projects in nanotechnologies .
Housing and Utility Reform Foundation
This public corporation started its practical activities on the resources provision about six months after its formal establishment. Nevertheless, in late 2007 - early 2008 a number of documents on practical activity of public corporation and its interaction with the regions was adopted.
The first application for financial support has been approved by the public corporation management in February 2008. However, by the end of July, the number of approved applications has reached 60. Simultaneously, efforts were taken for the development of regional authorities awareness on the procedures of interaction with the fund, its assets investment, etc. In addition, the public corporation started to carry out audits of the allocated funds utilization. Currently, such audits are performed regularly.
85
According the law on public corporation provisions and amendments85, adopted in December 2008, until the end of 2009 the Fund was granted the right to provide financial support to the subjects of the Russian Federation from its assets of RUR 50 bln for resettlement of citizens from the shabby housing fund. Only 10 days later, the fund management has approved the first applications for the financial support from the the corporation funds for the resettlement of citizens from the shabby housing fund.
Currently, applications of approximately 80 subjects of the Russian Federation have been approved and financial support is provided. Moreover, to a number of regions several applications have been approved. In 2008, according to the Fund records, the corporation has transferred RUR 45.7 bln to the regional and municipal budgets in the framework of regional programs financing of apartment houses restructuring and resettlement of citizens from the worn-out housing fund. RUR 37,5 bln of this amount was addressed at capital renovation co-financing and nearly RUR 10 bln for co-financing of citizens resettlement from the worn-out housing facilities. The volume of regional co-financing of the relevant programs amounted to approximately RUR 27.5 bln86.
83 The high level of the event was confirmed by the fact that it was approved by the Order of the RF Government N 1169-p of August 12, 2008.
84 It should be noted, that according to the public corporation management estimates, it will start to work «at full scope» in the middle of 2009, when there will be considered five-six projects per month with funding of about RUR 1 billion. http://www.rusnano.com/Rubric.aspx?RubricId=494.
85 Federal Law N 225-FZ of December 1, 2008 «On Amendments to the Federal Law «On Housing and Utility Reform Foundation» and separate legislative acts of the Russian Federation».
86 http://www.fondgkh.ru/news/27931.html 438
It should be also noted, that the public corporation has entered into agreements on cooperation with a number of federal authorities, which should support its activities.
In late 2008, the Housing and Utility Reform Foundation was to a certain extent involved in the implementation of anti-crisis measures: it has allocated on the deposits of 11 banks an amount of RUR 35 bln for six months under special condition to the banks to provide loans in the amount of at least 50 % of the deposits to the Russian companies, operating in the areas of housing construction, military industrial complex, agriculture, automobile production, agricultural production, aviation, electronics industry or metallurgy.
In our view, the procedures for the operation of the public corporation are effective enough, the foundation operates in the «regular» mode, participates in the anti-crisis measures, despite the considerable volume of funds, addressed for this purpose (about 7% of the capital, allocated by the government) can hardly significantly affect the fund performance of its core functions. Therefore, the risks, associated with further development of the corporation seem to be relatively low.
Public Corporation «Olympstroy»
Practical operation of this public corporation, in fact, has been started after the RF Government has approved the Program of construction of the Olympic objects and development of Sochi city as a mountain resort at the end of December 2007, when the amount of contribution
87
from the Russian Federation budget to the public corporation was determined87.
Currently the «Olympstroy» is actively implementing the construction program: plans the land allocation, transfers tenders, carries out procedures, related to the repurchase and acquisition of real estate and land areas, enters into contracts for construction objects, organizes public events, including public hearings.
Perhaps, the most notable events in the activities of the public corporation are still the
88
replacement of its president88 (urged, according to some experts, by the backlog in the construction of Olympic facilities schedule89), expansion of the Supervisory Board90 of the corporation91, as well as an increased property contribution from the Russian Federation in the corporation to finance the program of the construction of Olympic facilities and development of Sochi city as a mountain resort. It is remarkable, that such increase occurred twice with the intervals of less than two months: in early November 2008, by RUR 25.2 bln (or approximately by 16 %)92 and in late December of the same year by at RUR 61.2 bln (34%)93. The latter case is interesting not only due to significant volume of additional resources, in both, absolute and relative terms, but also because of the diverse amendments, made to the financial plan: if in the period from 2008 to 2010 an extended financing is foreseen, in 2011 its decline
87 Resolution of the RF Government N 991 of December 29, 2007 (as amended by the RF Government Resolution N 443 from June 11, 2008) «On the Program of construction of Olympic objects and development of Sochi city as a mountain resort».
88 Decree of the RF Government N 509-p of April 17, 2008, V.V. Kolodyazhniy has been appointed the President o the public corporation.
89 For example: D. Butrin, D. Rebrov, A. Sborov. «Olympstroy» lived to restructuring. - «Commersant» N66, April 18, 2008.
90 RF Government Resolution N 1091-p, dated of July 30, 2008.
91 RF Government Regulation N 807, dated of November 6, 2008.
92 RF Government regulation N 807 of November 2008.
93 RF Government regulation N 1086 of December 31,2008.
is planned. Herewith, according to the representatives of the Russian Government and of the corporation information, the extended financing of the Russian Federation to «Olympstroy» was planned, based on the transition from the stage of projects expert assessment to the construction process.
Public Corporation «Rostehnologies»
Development of the public corporation activities was largely based on the expansion and diversification of its property by various kinds of industrial assets:
• almost simultaneously with the creation of the public corporation, it was decided to transfer to it 100 % of shares of the OAO, created on the basis of FSUE «Rosoboronexport»94;
• at the end of May 2008 it was also decided to transfer large packages in the shares of three public aircompanies for the OAO «Air union» establishment together with a group of out-
95
side investors ;
• in early January 2009, the RF President has cancelled the earlier decision on the allocation of the transfered shares of air companies to the GC «Rostehnologies» in the charter capital of OAO «Air union», and also decided to transfer large blocks of shares of three more car-
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riers ;
• in July, 2008, a decision was taken to transfer to the corporation blocks of shares from 183 joint stock companies, established through FSUEs conversion, from 243 existing joint-
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stock companies, as well as 2 joint ventures with the RF share in the capital97 (the majority of those enterprises and the societies represent the various sectors of defense industry. In addition, a number of organizations belong to the sphere of foreign economic activity, sci-
98
ence, engineering, metallurgy, aviation, and non-productive sector as well)98;
• in the middle January it was decided to transfer to GC "Rostecknologies" 18,83% of shares from OAO "AvtoVaz", which were in economic management of «Rosoboronexport» company99 (the latter, however, continues to operate as FSUE, despite the decision on corporization, taken more than a year ago).
In February 2009, the transfer of industrial assets was continued already at the regional level; in accordance with cooperation agreement between the GC «Rostehnologies» and the Government of Tatarstan, the blocks of shares of 5 companies of the radio-electronic sector, owned by Tatarstan Republic, will be invested into the corporation100.
94 RF President's Decree N1577 of November 26, 2007.
95 RF President's Decree N853 of May 26, 2008. It should be noted, that the decision on OAO «AirUnion» incorporation was taken in the first part of 2007 by the RF President's Decree N570of April 28 2007.
96 RF President's Decree N28 of January 2009.
97 RF President's Decree N1052 of July 2008.
98 It is remarkable, that the original list of companies, subject to be included in the corporation, contained about 250 names, then their number has been extended to about five hundred, but at the stage of interdepartmental coordination, a number of companies was excluded from the list, in particular, «Uralvagonzavod», the largest manufacturer of civil and military equipment. See, for example: E. Kiseleva, A. Gritskova. «Rostehnologies» get on the track. - «Kommersant» N 11, dated January 28, 2008; E. Kiseleva, R. Yanbayeva, A. Gritskova. Wagons are detached form «Rostehnologies» detach. - «Kommersant» N55, dated April 3, 2008; E. Kiseleva, A. Gritskova, K. Lantratov. Trillionth Technology - «Kommersant» N 70, dated of April 24, 2008.
99 RF President Decree N53, dated of January 13, 2009. It is worth noting, that the document also provides for the exclusion of companies from the list of FSUEs, transferred into joint stock companies, 100% of the shares are subsequently to be transferred to the GC «Rostehnologies».
100 http://www.rostechnologii.ru/upload/984/RT+tatarsnan%2010%2002%202009%201.pdf 440
It should be noted, that in addition to obtaining the granted industrial assets, the corporation also carried out purchase thereof: at the end of 2008, GC «Rostehnologies» has purchased
25,1 % of the WiMax Holding Ltd shares, the sole owner of WiMax-operator «Skartel»101.
102
The deal was estimated at not less than USD 75 mln .
Along with the vast-scale growth in productive assets, this public corporation also had additional functions in regard to its subsidiaries, by, including the works in the framework of the government military program, the national defense order and mobilization plan, federal target programs and military-technical cooperation, as well as the restructuring of subsidiaries, establishment of integrated structures on their basis. Furthermore, additional powers have been provided to the supervisory board, among them:
approval of work programs and public corporation restructuring;
upon agreement with the RF Government, approval on the alienation of shares, owned by the public corporations and holding companies;
approval of effectivness indices of the public corporations management103.
• In spring 2008, the «Rostehnologies» management has taken the initiative to provide to the public corporation an authority of the Administrator and the Recipient of budgetary funds, as well as of the State Contractor in respect of the national defense order and six Federal Targeted Programs; a draft project was submitted to the RF Government by the corpora-tion104. However, this act was not adopted, primarily due to objections of the Federal An-timonopoly Service, as in this case the corporation would act as both, the business owner and the buyer of products at the state budget funds;
• At the end of October 2008, a group of the State Duma Deputies has introduced a bill, thay provides, in particular, «Rostehnologies» with the authority of the Administrator and the Recipient of budgetary funds (as well as the rights of ownership for FSUEs property to be included in the corporation ownership, until corporatization thereof)105, which however, has not been approved even the first reading;
• In December 2008, the property complex SC «Rostehnologies» has been replenished with a significant amount of monetary assets in accordance with the introduced a month earlier amendments to the Budget Law, made by the RF Government, the decision made to extend the corporation fund by RUR 1,5 bln106 as a financial contribution from the Russian Federation;
• In January 2009, the corporation has appealed to the Ministry of Economic Development of Russia for considerble volumes of financial support: RUR 262 bln, out of which RUR
101 http://www.rostechnologii.ru/upload/7427Yota_RT.pdf
102 See, for example: A. Malakhov. «Rostechnologies» have grown up. - «Kommersant» N204, dated of November 11, 2008.
103 RF President Decree N1052, dated of July 10, 2008.
104 Ref., for instance: E. Kiseleva, A. Gritskova, K. Lantratov. Trillionth technology. - «Kommersant» N70, dated of April 24, 2008.
105 Draft Federal Law N118175-5 «On specifics of the transfer of property contribution from the Russian Federation Public Corporation «Rostehnologies» and on amendments to some legislative acts of the Russian Federation in view of the adoption of the Federal Law «On «Rostehnologies» Public corporation».
106 RF Government Order N 1847-p, dated of December 8, 2008.
151 bln - in the form of monetary assets, RUR 111 bln - in the form of the national garan-ties107.
The third key focus of the SC «Rostehnologies» activity in the preceding period (in addition to the accumulation of production and financial assets) has become the promotion of the included (or just going to be included) enterprises into the corporation, by attracting investors, entering into strategic partnerships, implementation of anti-crisis measures, and, in some cases, the formation of new businesses:
• At the end of 2007, the corporation has signed a Memorandum of Understanding with the
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companies Troika Capital Partners and Renault and in February 2008 it has entered into agreements, in which in addition to the above-mentioned companies, the partners were FSUE «Rosoboronexport», OAO «AvtoVAZ» and «Troika Dialog» Group of companies. Those documents were focused on the strategic partnership between Renault and AvtoVAZ, which assumed the acquisition by the Renault group of 25% in the «AvtoVAZ» shares from «Troyka Dialog». In October 2008, SC «Rostehnologies», «Troyka Dia-log»Group of companies, Renault and OAO «AvtoVAZ» companies have signed a shareholders' agreement, aimed at harmonizing the actions of the parties in decision-making
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process ;
• At the end of June 2008, the public corporation has informed on intention to create a holding to produce automotive parts together with «AvtoVAZ» and «Troyka Dialog»110;
• In August 2008, Pirelli Group and the SC «Rostehnologies», with the support of the Government of Samara Region have signed an agreement, under which there will be established a joint venture to produce automobile tires111. The total investment in the project should reach EURO 300 mln112;
• In December 2008, German automobile concern Daimler AG, OAO «KAMAZ», SC «Rostehnologies» and «Three Dialogue» group of companies have signed an agreement, defining the terms of an exclusive strategic partnership and principals of cooperation, under which Daimler AG acquires from «Troyka Dialog» Group of Companies 10% of «KAMAZ» shares in the amount of USD 250 mln113;
• in July 2008, SC «Rostehnologies» and «Metalloinvest» holding have signed an agreement to establish a joint venture for the development of the world's largest deposits of copper in Udokansk114. The share of public corporation in the enterprise should make at least 25 %. Currently, the SC «Rostehnologies» and «Metalloinvest» holding consider an opportunity of incorporation their metallurgy assets115;
107 E. Kiseleva. «Rostechnologies» have rejected the national budget assets. - «Kommersant» N25, dated of February 12, 2009.
108 http://www.gzt.ru/auto/2007/12/08/205926.html
109 http://www.lada-auto.ru/cgi-bin/pr.pl?id=0&id_article=40267&prev=1
110 http://www.rostechnologii.ru/upload/57/pr_015.pdf
111 http://www.rosbalt.ru/2008/08/05/510397.html
112 http://www.interfax.ru/business/news.asp?id=44017
113 Herewith, in case of positive results of financial and economic performance of OAO «KAMAZ» in 2012, Daimler AG will have to pay another USD 50 million http://www.rosbalt.ru/2008/12/12/602667.html
114 http://www.rosbalt.ru/2008/07/18/505433.html According to the Agreement terms, the joint venture will be established in case SC Mikhailovsk (Metalloinvest member company) winns the tender for the development of Udokansk deposit. In September 2008 the enterprise was declared the winner of the tender.
115 http://www.mc.ru/page.asp/news/nw/news_id/2145 442
• in September 2008, in response to the crisis, in which has got OAO «AirUnion» hap-penned to be, the SC «Rostehnologies» has provided the to the avia alliance the financial guarantee, amounting to USD 100 mln116. Around that time, the public corporation in cooperation with the authorities of Moscow and Krasnoyarsk Region, in agreement with the RF Government, made the decision to create a new consolidated aircompany «Airlines of Russia» on the basis of OAO «AirUnion», as well as a number of "Rostechnologies". Herewith, the control stock of the «Russian Airlines» shares will belong to «Rostehnologies»117;
• In November 2008, SC «Rostehnologies» and Italian group Finmeccanica have signed an
agreement on common activities on establishment of a number of enterprises in the pro-
118
duction of components out of composite materials (carbon fiber) ;
• In December 2008, the public corporation has started to establish a holding company in the optical industry, OAO «NPC «Optical Systems and Technologies», which will consolidate 20 companies119;
Therefore, up to the current date, there are two interrelated trends in the public corporation activities: the expansion of assets, extension of their functions, powers and implementation of measures on formation of production holdings, strategic alliances and creation of new businesses. There is a high degree of uncertainty in the scope and trends of further expansion of this public corporation.
Public corporation «Rosatom»
The public corporation was designed to replace the state authority, the Federal Agency for Atomic Energy, that is why the starting point for its activity as an independent entity should be considered the abolishing of the agency and transfer its functions to the public corporation. The decision was taken on March 2008, nearly 4 months after the formal establishment of the corporation120.
An important objective of its activity, along with the implementation of the state authority functions, is the management of state property. The decision to transfer to the corporation
121
the first «tranche» of the national assets was made in early February 2008 , even before the relevant federal agency liquidation. Then, simultaneously with the agency liquidation, it was decided to transfer to the public corporation the shares of 5 joint stock companies, as well as the right to perform powers of ownership for a hundred of of FSUEs on behalf of the Russian Federation.
116 http://www.rian.ru/economy/20080905/150997652.html
117 Herewith, it is planned that in the long run, the GC «Rostehnologies» will retain only the blocking minority, and the remaining shares will be sold at the market. http://www.ma-journal.ru/news/57297/
118 http://www.akm.ru/rus/news/2008/november/06/ns_2520270.htm
119 http://www.mashportal. ru/company_news-13826.aspx
120 RF President's Decree N 369, dated of March 20, 2008 «On measures on creation of the Public Corporation in Atomic Energy «Rosatom».
121 In accordance with the law «On the Public Corporation on Atomic Energy «Rosatom», the Order of the RF Government N 116, dated February 5, 2008, has stipulated 100 % transfer of OAO «Atomic power industry complex» to the Public Corporation.
An important step in the development of the public corporation was the adoption of its
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long-term (2009-2015) program of activities in September 2008. The significance of this program is based on the fact that, along with the overall objectives, the public corporation defines also a precise list of measures to be implemented and the scope of budget financing of each of them.
In fact, the corporation is not so much an economic entity, as a government authority. As the scope of the corporate profile, its long-term objectives and targets seem clear, in our assessment, there are good prospects for its development.
Plans to create new public corporations The intensity of different corporations formation in 2007 has assured various power au-
123
thorities, that this trend of national policy could be significantly expanded . Due to such understanding, plentity of proposals for the creation of new corporations have been developed, which provoked strengthening of relevant lobbying. Thus, at the end of 2007, the Ministry of Transport has presented an initiative on the establishment an «Autodor» public corporation to carry out the functions of the global federal road network operator ( repair and maintenance of roads of federal importance, as well as investors' attraction to build new commercial high-
124
ways) . Around the same time, "Rosrybolovstvo" management has informed on the plans to
125
establish «Rosrybflot» public corporation and transfer 27 fishing vessels in its ownership . In 2008, an idea was considered on the possibility of establishing a public corporation for the transfer of unused government land for housing construction126. The mass media has also reported on proposals to form public corporations for medicines procurement, export of grain, insurance services rendering, etc.
By mid-2008, the flow of initiatives to establish new public corporations was virtually exhausted. Most of the previously proposed projects and initiatives have been rejected and it was decided to establish some of the structures in a different organizational and legal form («Rosrybflot» and «Rosavtodor» in the form of open joint stock company, the Federal Fund for Housing Development in the form of the Foundation 45).
Nevertheless, in September 2008, the RF Ministry of Finance has proposed to establish
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a public corporation «the Russian Financial Agency» for the Fund of National Welfare management. It was expected, that the Ministry would submit the relevant bill to the RF Government in October 2008. According to the proposed document, a share of the Fund will be
managed by special companies, selected by public corporation, while the balance of funds will
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be invested in government securities under the supervision of the RF Central Bank . However, till the end of 2008, the draft law has not been submitted to the Russian government.
For the purpose of the allocated funds management, in the early years of its activities, the corporation should attract professional managers, both, domestic and possibly foreign
122 RF Government Regulation N 705, dated September 20, 2008 «On the long-term program of Public Corporation on Atomic Energy "Rosatom" (2009-2015)»
123 http://www.newsru.com/finance/26sep2007/fisch.html
124 http://www.newsru.com/finance/26sep2007/fisch.html
125 E. Kiseleva, A. Ekimovskiy. Mintrans is on the big rode. - «Kommersant» №176, September 27, 2007.
126 E. Kiseleva, A. Ekimovskiy. Mintrans is on the big rode. - «Kommersant» №176, September 27, 2007.
127 It is worth noting, that earlier that Ministry restrained form the initiatives on the public corporations establishment.
128 http://www.minfin.ru/ru/official/index.php?id4=6545 444
ones. Later, it is expected, that the corporation will be able to invest the assets independently in accordance with the approved national investment policy.
According to the representative of Russian Ministry of Finance, establishlent of public corporation is the best way to invest funds in the effective management, while maintaining public control over the investments. At the same time, the experts' assesments of that initiative are ambiguous. Some of them believe, that the formation of a new financial corporation will allow to delegate to it excessive functions of the Central Bank and Vneshekonombank,
129
while other experts consider this as a premature measure, at least during the crisis .
As a result of the above analysis of major trends and characteristics in the formation and development of public corporations, one can note the following:
1. In the majority of cases, the practical operation of public corporations on the specific objectives, set forth for them, was started with a backlog (from a few months to a year), as before that, the process of development and coordination of various documets, regulating their activities and other necessary arrangements had to be made. However, to date, one can say, that all of the corporations have passed through the initiate stage and proceeded directly to their key activities.
2. The desire to expand assets (financial or industrial) and additional powers is evident in the actions of some corporations, that could result in negative consequences, such as the state intervention in the economy, deterioration of business environment, especially in the situation of insufficiently clear regulation of corporations, their objectives and functions.
3. As the financial crisis is aggravating, some of the public corporations get more actively involved in implementing of various kinds of anti-crisis measures, for example, for Vnesheconombank this trend actually has become a priority. Herewith, the extensive involvement of public corporations as anti-crisis instruments can not fail to provide an adverse affect on the efficient implementation of their major functions.
4. In late 2007 - early 2008 among some executive and the legislative authorities there was certain «euphoria» in regard to public corporations and their potential capacity to resolve serious problems of socio-economic development, which urged a large number of proposals to create such structures. By mid-2008, the threat of continuing extensive establishment of public corporations and expansion of the process to the regional level got restrained. However, the financial crisis has re-awakened the interest of the power authorities to this instrument of government policy.
5.3.2. The development of corporate management in the established public corporations
With regard to the status of public corporations, it is very important to estimate the quality of corporate management. In this regard, we will try to assess the major developments in the formation of corporate management in public corporations and the level of progress in various trends.
129 Ref: N. Ivanitsky, E. Pismennaya, D. Zhelobanov. Chief Manager of trillions. - «Vedomosti» N 3, dated January 13, 2009; T. Afanasieva. Powers of the Ministry of Finance and Central Bank will be reduced. - «Rossiyskaya Gazeta» N 4826, dated January 14, 2009.
Strategy
The availability of targeted strategies and publicity thereof seem to be a necessary foundation for building an efficient system of corporate management in public corporations, objective assessment of their performance, management motivation system development and restriction of conceals lobbying of various authorities and political elites. Herewith, the progress in this trend seems inadequate.
The laws on the public corporations establishment (except for «Rosatom» and
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«Olympstroy» ) do not define the need to develop and adopt any strategies (long-term programmes) for their activities and moreover, there are no legal regulations, defining the requirements to such strategies, their development and discussion, as well as the updating thereof.
Currently the strategies are defined for two public corporations, Vnesheconombank and
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«ROSNANO» . Moreover, long-term programs of activities are developed for «Olympstroy» and «Rosatom» public corporations. Herewiith, it is worth noting, that with the exception of «Olympstroy», those documents were accepted with a significant (nearly a year) delay from the point of corporations establishment.
Therefore, up to now, there are no strategies for Housing and Utility Reform Foundation and «Rostehnologies» public corporations. Tere is no problem in regard to the Foundation, as its activities are operational and are regulated in detail by the law. As to «Rostehnologies» public corporation, in view of the large-scale and diversified activities, its active participation in the restructuring of various sectors of the economy, including the civil ones, the lack of the activities strategy decreases the predictability in a number of the economy sectors and consequently, increases the risks to the investors.
In regard to Vnesheconombank and «ROSNANO» strategies, it should be noted, that there are no «milestones» set up to them for the short and medium-term, and the current policy effect is estimated in the long run. This is significantly limiting the to possibility to assess the results of the ongoing activities of the corporations and management quality in terms of incentives and effectiveness.
Stakeholders participation in the Supervisory Boards
The advanced system of stakeholders and their subgroups participation in the Supervisory Boards is an essential provision to ensure an unbiased assessment of their performance, balanced representation of public interests in the public corporations activities, reduce the risks of subjectivism, prevent from lobbying the interests of certain groups and voluntarism in the decisions. Relatively broad representation of various stakeholder groups interests is ensured in such public corporations as the Housing and Utility Reform Foundation, «ROS-
130 There is no provision on strategy development in the Federal law «On the Public Corporation on Atomic Energy «Rosatom», but there is Chapter 4 «The long-term program of the corporation activities and its financial support». There is also no direct provision for strategy development in the Federal Law «On the Public Corporation for the construction of Olympic facilities and Sochi city development as a mountain resort», but herewith, it is defined that the activities of the corporation shall be performed in accordance with the Construction Program, approved by the RF Government (Article 3).
131 Vnesheconombank development strategy for 2008-2012 is approved by the Corporation Supervisory Board on April 3, 2008. «ROSNANO» strategy to 2020 was approved by the corporation Supervisory Board on May 29, 2008.
NANO», «Olympstroy»: their Supervisory Boards structure is more extended as compared
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with other public corporations , whereas the participation of various power branches to be
133
included in their Supervisory Boards is well defined . As a result, about one-third of the members of the Supervisory Boards of the above mentioned public corporations are not the representatives of federal authorities, which make for the broader representation of stakeholders' interests.
The distribution of authorityies and responsibilities between management and supervisory boards
The principal problem is the following : in the laws on public corporations establishe-ment, there are provisions for their management authority, but neither the spheres, nor the forms of the responsibility of various structural management members for the decisions and performance results are stipulated neither in regard to the state, no to the corporations.
It is foreseen in the laws on corporations, who can take the decision on early termination of the powers of the Supervisory Board members Chairman and their executive bodies, but there is no definition, even in the most general terms, of the «motivation» for making such decisions, requirements to appointments, early termination of powers. This provokes uncertainty in the allocation of responsibility for poor performance of corporations, as well as external motivation for public corporations management134. In this regard, we would like to note, that by October 2008, there were top management replacements in two public corpora-
135
tions, «Olympstroy» and «ROSNANO» . Herewith, in none of those cases, such decisions were not officially and publicly reasoned and were not aligned with any purpose (such as, for example, conflict of interests, the completion of start-up phase in the corporation, ineffective management, etc.) The laws on public corporations envisage «traditional» distribution of powers between management and supervisory boards: the Supervisory Board sets the priorities, principles, activities of corporations, approves major transactions, hears the Corporate Leader reports on performance, while the executive authority ensures practical implementation of the activities of the corporation actions in the framework of the preset rules, goals and objectives. At the same time, in the majority of public corporations (except for the Housing and Utility Reform Foundation and GC «Olympstroy») the positions of the leaders, appointed by the President of the Russian Federation have gained «stronger» positions. In general, that factor could be regarded as a tool for higher personal responsibility for the results of the cor-
132 The greatest number of the Supervisory Board members, who are not the staff members in the public corporation, is found in the Housing Reform Foundation, «Olympstroy» and «ROSNANO», namely, 16, 15 and 14, respectively, whereas the supervisory boards of other public corporations are far les extensive: there are only eight members in the supervisory boards of «Rostehnologeis» , «Rosatom», «Vnesheconombank».
133 Thus, the Supervisory Board of the GC «ROSNANO» is formed on the basis of «quota» allocated by the President, Federal Assembly, or Government. Similar principle is applied in regard to the Supervisory Board of the Housing Reform Foundation, which is formed under the applications of the President, Federal Assembly, the Government, the Public Chamber.
134 By the Decree of the RF Government № 509-p, dated of April 17, 2008, V.V. Kolodyazhniy has been appointed the «Olympstroy» President. By the RF President N 1401, dated of September 22, 2008, A.B. Chubays has been appointed the "ROSNANO" Corporation General Director.
135 By the Decree of the RF Government N509-p, dated of April 17, 2008, V.V. Kolodyazhniy was appointed the President of «Olimpstroy» public corporation, by the President's Decree N 1401, dated September 22, 2008, A.B. Chubays was appointed the General Director of «Rosnano» public corporation.
porations' performance, but in the absence of legible system the corporation's management assessment, that is a problem, rather than an advantage. In such public corporations as Vne-sheconombank and «ROSNANO», the Supervisory Board should approve of projects, which are supported by these public corporations (although such approval is not foreseen by the laws on their establishment). As a result, the Supervisory Boards take the responsibility not only for the regulations development and monitoring, but for management decisions in the framework of these rules as well.
For the consistent implementation of the strategic lines of the public corporations development and strengthening of the Supervisory Board members accountability for the company performance, it is important to appoint the members of the Supervisory Board for a sufficiently long term (herewith, of course, the terms for the early termination of their powers should be explicit) and to decrease the dependence of the Supervisory Board structure on the political environment and changes in the federal government. This approach is particularly important in regard to the public corporations, implementing large projects within the preset deadlines (Housing and Utility Reform Foundation - in 2012, «Olympstroy» - in 2014).
Actually, there are some relevant provisions in the laws on the establishment of public corporations: it is specified, that the members of «ROSNANO» Supervisory Board should be appointed by the RF Government for the term not exceeding 4 years, those of «Rostehnolo-gies» are appointed by the RF President for the term not exceeding 5 years, of Vnesheconom-bank - by the RF Government for the term of 5 years, of the Housing and Utility Reform Foundation - they are appointed by the RF Government for the term of the Fund activities (i.e., before January 1, 2012)136. Furthermore, in accordance with the Law on the Bank for Development, the Vnesheconombank Supervisory Board member retirement from the civil service does not provide grounds for termination of his membership in the supervisory
137
board . In our view, this approach is positive, since it strengthens the value of personal characteristics for the appointment to the Supervisory Board as compared with the official position. This approach extension to all public institutions of development could contribute to the «evolution» of independent Directors.
Regulation of public corporations activities
The major barrier in the full-scale implementation of public corporations capacity is the incomplete definition of their activity principles and decision-making procedures. It should be noted, that only the law on «Rosatom» public corporation establishment there are provisions
138
on the mandatory regulation of its activity .
One of the potential benefits of all public corporations is a significantly greater flexibility in funds management and a wider range in budget spending as compared with other instruments of public policy. However, to reduce the risk of abuse and (or) the risk of irrational use of resources, these additional capacity should be «balanced» by transparent and suffi-
136 Herewith, it seems rather strange that, in respect to the Supervisory Board of the GC «Olympstroy» there is this kind of requirement in rehard to the Olympics schedule
137 Part 6, Art. Of the federal law (On the Bank for Development"
138 Article 33 «Regulations of the Corporation» of the federal law on «Rosatom» nuclear power public corporation provides a list of the mandatory sections of the regulations(there is in particular, a section on the interaction of the corporation with the government authorities) and the requirement for the approval of the of the corporation regulations by the RF Government.
ciently detailed regulations, procedures for decision-making and performance assessment. This is particularly relevant in view of the facts that, on the one hand, there are internal functional inconsistencies in some corporations (for instance, between the non-profit nature of the corporation and commercial activities of the joint stock companies, managed by the corporation). On the other hand, in view of the extensive resources with their uncertain position in the implementation of public policy, relations with public authorities, the ambiguity of development strategies, many corporations are affected by some interested parties.
A major focus of regulatory activity in public corporations is a clear definition of principles and procedures for their interaction with the government authorities. This is particularly important in regard to financial institutions of development, which should for the successful operation have a certain level of «autonomy» from the Government in making immediate decisions in conformity with the long-term priorities of their activities. There is an expressed prohibition to the public authorities in the laws on public corporations establishment(except for Housing and Utility Reform Foundation) to interfere in the activities of public corporations (except for the cases, stipulated in federal laws). At the same time, provisons on the relations between public authorities and corporations, are rather general and are usually limited to the definition of the powers of the President and the Government in the appointment of the corporations' management, members of the supervisory board. Only in some cases, such authority is related to the definition of strategic objectives, principles and programs of their ac-
139
tivities . The need of regulation the interrelations with public authorities is mentioned only in the law on «Rosatom»140 establishment.
Transparency of the results and principles of activities
Transparency of both, the corporations performance, and the basic principles, procedure (criteria), decision-making process (especially for public corporations, acting as financial institutions for development) are the most important task of corporate management improvement. A notable progress is observed in improving the transparency of the public corporations: their official web-sites provide sufficiently detailed information on their objectives and trends, management bodies, their powers and structure, major developments in the public corporations and the most important decisions, in many cases - informative reports on their performance results (Vnesheconombank looks better than others in this respect).
Considering the legislative requirements to the activities of public corporations, it can be noted, that the requirements to the performance transparency are defined far better than those to the transparency principles and regulations of operation thereof.
All the laws on the public corporations establishment stipulate the standards for the disclosure of their reporting, fixed assets structure, included in the annual report, their performance results to be presented in their official web-sites. At the same time, if there are legal provisions for the annual report disclosure for such public corporations as Vnesheconombank, the Housing and Utility Reform Foundation, «Olympstroy», «Rostehnologies»141 , in the case of «ROSNANO» corporation only aggregate data of annual report is presented, whereas the pro-
139 Vnesheconombank - the government approves the Memorandum on financial policy, Rosatom - the government approves the long-term program for the corporation development.
140 As one of the mandatory sections of the corporation regulations, the procedure of its interaction with public authorities is outlined.
141 For GC "Rostechnologies", the requirements to national security information.
cedure of the annual report of «Rosatom» disclosure, including the information scope to be disclosed, should be established by the Supervisory Board.
For individual public corporations (Housing and Utility Reform Foundation, «Olympstroy», «ROSNANO») there are legislatively defined responsibilities for the regular monitoring of supported projects (programs) in the relevant reports. This is particularly important to assess the efficiency of those public corporations, which implement large complex long-term projects or act as financial institutions for development. In this context, there is a significant gap, i.e., the absence of legislative requirements for monitoring of projects with regard to Vnesheconombank. It should also be noted, that if the annual reports of the Housing and Utility Reform Foundation and «Olympstroy» public corporations have to be monitored (and hence, those results are subject to mandatory publication), there are still no requirements to the report on the projects monitoring in respect to «ROSNANO» public corporation. More-
142
over, the report of the monitoring results is presented to the RF President . As to the transparency of principles of the public corporations' activities and the decision-making process, one can note, that despite the very limited legal requirements to the disclosure of the decision-making procedure, the corporation themselves are quite active in this regard. To a certain extent, the leader here is «ROSNANO», which has placed on its site practically all basic documents, regulating the activities of the corporation and the decision-making process143. The principles of decision-making in the «Olympstroy» (with an overall high level of internal regulation of the corporation)144 and «Rostehnologies» remain still non-transparent.
According to the results of the analysis, the development of corporate management in public corporations, one can note the following:
1. A notable progress is observed in the development of public corporations corporate management, especially in terms of transparency of their activities, but in general, the system of corporate management became not only the major barrier is their capacity implementation and the decisions on the long-term objectives, but also a source of additional risks and problems.
2. Problems of corporate management in public corporations are largely dependant on the overall disadvantages in the representation of public interests, and in many ways are similar to corporate management problems in large shareholding companies, 100% shares of which are state-owned.
3. There is a significant potential for improvement corporate management in public corporations as through the extension ( «transfer») of certain provisions of the laws of their estab-
142 Part.5, Art. 7 of the federal law «On the Russian Nanotechnologies Public Corporation».
143 It should be noted that as of March 1, 2008, many of the regulatory documents of the GC «Rosnano» were not available for public access, whereas as on October 1, 2008 the situation has improved: the following documents heave been presented at the company web-site: business strategy, the concept of corporate involvement in the improvement of legislation; provisions on the Supervisory Board; on the Science and Technology Council, on the Management Board, on the Audit Committee, the requirements to the structure and content of projects in the field of nanotechnology, the procedure and conditions for R & D projects financingthe field of nanotechnology, the concept of the projects' expertise; qualification requirements to the experts, consolidated data of annual report.
144 The «Olympstroy» Supervisory Board has approved by a wide range of regulatory documents on the corporation activity : Regulations on the Supervisory Board activity, Management Policy, Checkup Committee, Audit, the selection of appraisers procedure, investors, works and services contractors, decision-making on entering into transactions of acquisition (disposition) of property, etc., but these documents are not displayed on the official website of the corporation.
lishment, as by filling in the «regulatory gaps» by means of additional documents, developed at the level of public corporations, governing their current activity and development (strategy, selection of projects/contractors, etc.), ensuring transparency of such documents. These initiatives can not be standard, but have to be tailored to the individual public corporation.
5.3.3. Major trends in the changing of roles and positions of public corporations
The existing public corporations significantly differ in their purpose and objectives, the structure property, invested by the Russian Federation, their administrative status and interaction with public authorities, specifics of corporate management, the level of legislative regulation of their activities (see Table 9).
Table 9
Individual Parameters of Public Corporations,, Established in 2007
Filling in the "gaps" investments and innovations investments Upgrading of public functions performance
Restructuring of national production facilities, integration structures establishment
Significant productive assets in the RF property contribution Delegation of authorities and right from public management authorities Corporations financing in the framework of a targeted long-term program Wide stakeholders' representation in Supervisory Board High administration level of the Corporation Head Transparency of performance and decision-making process Ability to apply earlier experience (skills) Clear and accurate portioning of the Corporation
Detailed presentation of objectives and purpose of activities in terms of law Validity term definition
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As a basis for the public corporations classification, we will define, if there are or there are no signs of: (1) the rights and functions of government management, (2) significant production assets. In this case, the following major categories (models) of public corporations145 (See Fig. 1):
1. Financial Institutions of Development (Vnesheconombank, «ROSNANO»);
145 For more details about the proposed classification of public corporations, see: Yu Simachev, M. Kuzyk - decree. cit., and Yu Simachev, M. Kuzyk. The establishment and development of public corporations: Institutional challenges and new opportunities. Articles collection «Public sector reformation: Issues of the Iincreased Efficiency» / Ed. T.M. Sklyar and I.N. Baranova. S. - Petersburg State University PH., 2009.
2. Government agents, the operators, implementing certain functions of public authorities (the Foundation for the reform of housing and communal services, the «Olympstroy»);
3. Quasi-holdings («Rostehnologies»);
4. Quasi-ministries («Rosatom»).
Functions and Authorities of Public Institutions
no yes
u Institutes for Development Government Agencies
A A » > B> (^RosnantT) ( Fund tor support of housing \_cromplex development^--'
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u s ■3 "Ouasi-Holdines" "Ouasi-M inistries"
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Fig. 1. Typology of public corporations, established in 2007
Let us consider the fundamental trends of the created corporations "drift" and the role thereof the likely trends of their transformation within the proposed classification, changes in their position and role.
For the Institutions_for development, a substantial likelihood of drift from the long-term strategy to the execution of current orders is observed. Herewith, in while the instrument of development is tarheted at the support of major projects, the risk of political lobbying in the choice of such projects is increasing. Public authorities are increasingly regarding the Institute of Development as a source of additional resources for the implementation of anti-crisis measures, financing the ongoing projects and programs, funded from the federal budget. On its own part, the Institute for Development, in an effort to reduce political risks and to relocate responsibility, can increasingly focus on the support to the projects of large companies with the state involvement and pay less attention to the search for the projects of private business and the support projects for small and medium businesses. In this context, multiplication of project risks and replacement of the real public-private partnership by consolidation at the project level of the institutes for developmenet and budgetary resources consolidation is expectable.
In our view, there are expressed indicators of such a drift of Vnesheconombank, which is now increasingly used as an instrument of «rapid reaction» for solving the current problems 452
of national policy issues. The likelihood of such developments in relation to the «ROS-NANO» seems reduced due to the focus of its activities on the development of the new sectors of the economy (as a consequence of the lack of large «players»), is focused on the small and medium-scale projects, related to the venture and direct investments.
For the Government agents, which are tightly tied to a particular period, can seek a chance to «unify» their activities, to find new challenges in order to justify the indefinite the term (or extend a specified term) of their activities. It is more likely n regard to «Olympstroy» and to a lesser extent - to the Housing and Utility Reform Foundation, for which the law has established the validity term of activities. In addition, in the case of «Olympstroy», because of the need to meet the deadlines for completion of the construction of Olympic facilities, as well as due to approximate estimates of necessary resources, it is likely to strengthen further attempts to obtain additional public monetary resources146.
For the «quasi-holdings», the main trend in terms of their assets, rights and powers, i.e., the strengthening of their positions as the subjects their establishment and public policy implementation. In case of insufficiency (abcense) the initial investments, public corporations of the given group can seek for strengthening their role in the budgetary resources, for example, within the Federal Program or the Federal Defense Order Fund. In the absence of a clear sectoral (framework) boundaries, they are likely to focus on obtaining additional assets from the state.
The signs of such changes are clearly tracked in the «Rostehnologies» activity. The public corporation is largely focused on expanding its production and financial assets extension (usually at the expense of the state). In addition, the corporation is increasingly positioned as a kind of «anty-crisis center» on solving the problems of development of individual sub-sectors (automotive, air transportation, etc.), based on the use of direct and indirect rights on the companies management, while increasing «conglomeration» of its structure.
Finally, for the quasi-ministries, due to the specifics of this group, is straight focused on the implementation of clearly outlined public functions, the possibility of the drift seems limited, and the chances thereof are rather low.
* * *
Reviewing the overall development of the established public corporations, trends in changing of their roles and positions, problems and prospects for improving corporate management, one can summarise, that ther is the opening opportunities/threats, related to the public corporations development.
As «opening opportunities», we have identified:
(1) formation of new agents in the development and implementation of economic policy, particularly in relation to the development of new sectors of the economy; creation of the «sites» for consolidation of the new power elites, interested in diversification and innovation; personification of responsibility;
146 It is worth reminding, that in 2008 the growth of the Russian Federation investment in the corporation was doubled.
(2) implementation of activities, focused on the long-term prospective due to autonomy, independence from political trends, available «stock» of funds; implementation of targeted approach with flexibility of resource utilization;
(3) development of the new instruments to urge economic development, public-private partnerships formation (not only in projects implementation, but also in priorities), restructuring of the public sector; improvement of selected areas of administrative system.
In our view, the most significant threats (in terms of sustainable long-term economic development) are:
(1) decline in performance (in terms of the long-term prospective) and effectiveness of public corporations due to poor representation of the interests of «stakeholders», risks of the «shadow» lobbying of the interests of different parties, enhancing situational decision-making, «blurred» responsibilities between the government and public corporations management and supervisory bodies thereof, the lack of motivation among representatives of government authorities in principle improvement of public corporations management;
(2) irrational expansion of financial and property obligations of the State to ensure the activities of public corporations due to ambiguity of the public corporations strategic position;
(3) overall enhancement of consolidation of resources to support the development of the largest businesses (primarily public sector), extension of counteraction between public corporations;
(4) strengthening of direct government involvement in the economy and rationality reduction as a result of the expansion of the existing public corporations beyond the «market gaps» and due to the potential creation of the new public corporations;
(5) deterioration in the business environment due to the lack of predictability of public corporations performance, risks of fair competition violation, abuses in rights and powers;
(6) «slowdown» in the development of the institutional environment, lack of (reduced) activity of public authorities in improvement the indirect instruments of stimulation socioeconomic development.
In that period before the financial crisis public corporations, in general, significantly improved the quality of corporate management, strategic planning, enhanced transparency in principles and results of performance, the development of practical work in accordance with the preset tasks, although there were some signs of a «drift» to the execution of the agents' functions of the institutions for development and «kvazi-holdings». Within this period, the probability of creating new public corporations has significantly decreased.
In the face of the aggravating economic crisis, the demand of the state for public corporations' agency functions in implementation of anti-crisis measures has essentially increased, while their functions as institutions of development has retreated to the second place. Extension of the agency functions of public corporations, combined with a reduction of system functioning and transparency of their activities, has reduced the scope of the «stakeholders», who actually have an impact on the decision-making processes. During this period, the sources for the creation of new public corporations within the models of «agents of the Government», and possibly, «kvaziholdings» have significantly increased.
5.4. Corporate Conflicts
The problem of corporate conflicts in Russia has presently persisted as a pressing one. By mid-2007, there were 107 public corporate conflicts unfolding in the country, with the to-
147 148
tal value of disputed assets accounting for some USD 7bn. Some experts1"0 believe that the list of leading sectors in this regard comprises the food-processing industry, agriculture, machine engineering and the fuel and energy complex (which holds a leading place by volume of disputed assets worth over USD 2bn), while other analysts refer to the fuel and energy complex, the wood-working industry, telecom and machine-engineering sector149. Region-wise, by the number of corporate conflicts the garland, as before, should be given to the Central Federal Okrug, followed by Volga and Ural ones150. As evidenced by the period between 1994 and 2005, the most disruptive conflicts in Russian joint-stock companies arise between large shareholders striving to change the structure of corporate control therein151. The year of 2008 saw corporate conflicts occur in such huge corporations as OSAO Ingosstrakh, Norilsk Nickel
152
mining company, TNK-BP, Vympelcom .
Typical reasons behind conflicts of interests between different groups of stockholders are153:
- rush to a high current rate of return on stock and their liquidity, and a short-term rise in the company's value;
- focus on the interest in a long-term surge of value of the stock, spending resources on the company's development to the detriment of current benefits;
- trend to boosting up revenues of one or a few companies in a group (holding) at the expense of redistribution of current costs and the tax burden between affiliated companies (which may result in an underdeclaration of earnings, rise of artificial losses, etc. in other companies of the group (holding));
- rush to a greater profitability of the group of companies, which determines reallocation of resources between companies, changes in their market shares, which results in an overde-claration of some companies' earnings and market value at the expense of the other ones (at this point, one may resort to transfer pricing, decrease of the tax base, etc.);
- interest in an artificial scaling back on a company's level of output, earnings and production capital to suppress competition on the market, maximizing the affiliated companies' market value and niche on the market;
- interest in an artificial decrease of a company's market value (for the sake of stakebuilding, loosening the tax burden pertaining to a shareholder or their group, resisting attempts to take over the company, etc.);
147 The data of "Sliyania i pogloschenia" journal. Taken into account were only the public conflicts under which the value of the respective enterprises was in excess of USD 5m and the disputed matter was the right for the operative control over a company/property complex.
148 See in a greater detail: "Reydery menyaut orientatsiyu"///www.ma-journal.ru
149 "Expert", №15, 16.04.2007
150 "Reydery menyaut orientatsiyu"///www.ma-journal.ru
151 P. 2.1.2.2. "Metodiki otsenki uscherba, nanesennogo protivopravnymi deystviyami na finansovyk i fondovykh rynkakh" ("Methodologiy of appraisal of damage caused by illegal actions on financial and stock markets"), approved by Executive Order of the Moscow city government of 08.09.06 №1766-RP "O systematizatsii mer po presecheniyu protivopranykh deystviy na finansovykh i fondovykh rynkakh".
152 "Antireydersky paket zakonoproektov".- "Kommersant", 01.12.08
153 See: P. 2.1.2.2. "Metodiki otsenki uscherba, nanesennogo protivopravnymi deystviyami na finansovyk i fon-dovykh rynkakh" ("Methodologiy of appraisal of damage caused by illegal actions on financial and stock markets"), approved by Executive Order of the Moscow city government of 08.09.06 №1766-RP "O systematizatsii mer po presecheniyu protivopranykh deystviy na finansovykh i fondovykh rynkakh".
- shareholders-managers and employees' urge to ensure greater awards to the detriment of a cost-saving policy, a current dividend and market return on equity;
- rush by stakeholders that form a minority group to grasp control from those forming a majority group (on the open market, by redeeming the company by its employees or managers, on the basis of M&A deals, etc.).
It is the obtaining of control over corporate assets that often forms the cause for the most serious and long-lasting corporate conflicts that frequently take the form of a criminal seizure of corporate assets. Nowadays, the level of the danger of loosing control over a company is estimated as being a fairly high one, which determines the "classified" nature of all the information concerning a significant number of entrepreneurs' business practices. According to the Accounting Chamber of RF154, the country has annually seen some 70,000 corporate seizures, while according to the data155 presented by A. Volkov, Chairman of the Commission on the Legal Provision for Countering Corruption, "every year, there occur over 60,000 raider156 attacks in Russia. Their greatest number is noted in Moscow, and some 90% of Moscow-based enterprises have found themselves in the focus of raiders' interests". That said, the phenomenon of corporate raid, aka reyderstvo, in Russia "exhibits its mass and terrifying nature: as a result of property redistribution, raiders break and destroy key strategic enterprises, drive a
157
profit-making and efficient production out of business" . As far as corporate conflicts in Russia are concerned, this problem appears to be among the most critical ones.
Generally speaking, aggressive actions on the corporate control market are typical of the emerging M&A markets, of which Russia's constitutes, perhaps, the most dynamic one. Back in 2003, PriceWaterhouse Coopers asserted that Russia was "a major driving force of the
158
M&A market in the central and eastern Europe" . Along with the absence of traditions of the corporate control market, the widespread of offenses against corporate assets appears determined primarily by corruption, particularly within law enforcement agencies, judicial system, government executive agencies, and by lacunas and imperfection of the corporate law, including a series of unregulated legal matters pertaining to conduct of securities registers, to name a few.
Criminal seizures of corporate assets, which some experts in corporate law unreasonably attribute to hostile takeovers159, became widespread in the early-2000s, when the initial process of stakebuilding and consolidation of stakes in the largest Russian enterprises had come to an end, while the bankruptcy procedures which had been vigorously used in the 1990s for the sake of assets stripping) had undergone modification (in 2002). To acquire a
154 "V Gosdume pogovorili o probleme reyderstva i reshili, chto antireyderskiye zakony budut prinyaty v kontse 2008 g", 14.11. 2008, - www.notheft.ru
155 "Reyderam gotovyat ugolovny sostav prestupleniya. Gosduma obeschaet prinyat "antireudersky" paket k rontsu 2008 g.", http://www.cig-bc.ru
156 The widespread in Russia term "raider" means an entity that carries out a seizure of corporate property on behalf of a customer or his own. The seizure involves the use of criminal methods, among others. As such this term should not be confused with the definition used in the West wherein it defines a company striving to take over another one by means of acquisition of control blocs. Such companies' actions are not criminal.
157 "V Gosdume pogovorili o probleme reyderstva i reshili, chto antireyderskiye zakony budut prinyaty v kontse 2008 g", 14.11. 2008, - www.notheft.ru
158 For greater details, see: "Sovet direktorov v systeme korporativnogo upravleniya kompanii", ed. By Belikov I.V., M., 2005, p. 390.
159 In the western corporate practice, the "hostile takeover" means acquisition of a company's control blocs without its shareholders' consent. This, too, does not imply an action subject to criminal punishment.
456
control bloc, in addition to a legal stakebuilding, one began to employ versatile methods of stock stealage - scheming with shareholder registers, falsifying instruments of share transfer, as well as using rulings by a court of law located in a remote region, blocking a principal shareholder's access to the stock, convening repeated general shareholder meetings, among others160.
Once the control block has been acquired, one sought to complete the takeover of the company and assets stripping through the chain of nominally existing companies to reach a bona fide purchaser. To ensure the takeover, one often resorted to forced seizures of objects using armed staff of private security firms or police spetznaz. Such seizures allowed one to exercise the physical control, that is, to ensure access to the company's corporate seal, accounts, commodity and cash flows, and to launch a dialogue with owners of the remaining stock package from the posture of strength.
At the time, there occurred: seizure of the Kachkanar mining plant (2000) and a new property redistribution in the ferrous and non-ferrous metallurgy; "vegetable-oil" wars between Rusagro Holding and Razgulyay Group for Anninsky oil-extracting factory (2001) and between GK Sigma and TPK Russkaya Bakaleya for Kropotkinsky oil-extracting plant's assets; redistribution of the "wood" market - the war between Bazovy Element Holding with Ilim Pulp company that owns the biggest assets in the sector (Kotlassky, Bratsk and Ust-Ilim paper and pulp plants (2001). In the course of the "wood" war, the parties attempted to initiate reprivatization processes, to arrange official inquiries from MPs and innumerous inspections by fiscal structures, as well as lawsuits and PR campaigns.
Experts name the year of 2002 the Rubicon in the history of corporate seizures in Russia, as the corporate owners sharply scaled back on the number of aggressive actions for the sake of acquisition of assets. The reason behind such a drastic behavioral change was their aspiration to build a reputation that would enable them to attract credit resources, new investors and partners to boost up their companies' advancement. Such a twist in the corporate policy has resulted in emergence of a huge number of individuals with an impressive record of a direct participation in corporate conflicts. They began offering their services on the market -created their own companies, whose profile became stockbuilding and acquisition of corporate assets by illicit ways and means, in particular. One of such means applied in 2003 became stealage of shares in limited liability companies (OOOs) to acquire control over commercial real estate (stores, etc.). That was made with the use of a fake contract on cession of the share which was registered with the tax agency. The real estate object then was resold several times.
Post-2004, there began the use of the "sponsored" criminal cases as a means to exercise pressure on owners of a business for the sake of taking over corporate assets. Typically, such cases were based on genuine or forge facts of violations of the tax, customs, environmental, etc. law. It is no accident that the beginning of this period coincided in time with the YUKOS case. The "technology" is also vigorously used today. Underpinning it are criminalization of law enforcement agencies, an inefficient functioning (dependence on the governmental executive agencies) of, and corruption in the judicial system.
An analysis of the publicly available information about criminal seizures of corporate assets between 2007 and 2008 exposes the fact that in the course of their preparation the organizers keenly employed representatives of government agencies, including police, tax au-
160 See here and below: Nobatova M. "Evolyutsia korporativnogo reyderstva v Rossii: ot skupki aktsiy v podvo-rotne do zakaznykh ugolovnykh del".- "Sliyaniya i pogloscheniya", 2007, №11, p.66
thorities, local government agencies or bankruptcy commissioners. The above authorities/individuals are supposed to falsify documents, exercise coattail, ensure adoption of apriori illegal rulings or execution of apriori illicit actions, and illegally supply relevant information. In short, their mission is to secure access to a company's assets and to give the criminals' deeds the semblance of legitimacy. Most often criminal seizures are made in the form of imposition committed by an organized group and with the use of fake documents that certify the right for share ownership.
Sometimes, co-owners of a business are keen to pile up their stake in the company at the expense of their partner's (or partners). Most often, it is stockholders (participants in a company) who own a minor share in its authorized capital and have no actual possibility either to influence corporate governance, or share its earnings that feel like doing this.
Yet another method to ensure the criminal seizure is to spread false information about a company's financial standing. This particularly concerns banking structures. Even if the seizure attempt fails, the damage caused by mass withdrawal of deposits from a bank may be a significant one, while the criminal punishment for spreading defamatory information in practice does not end up with incarceration. As concerns the most recent novelties pertaining to criminal seizures of corporate assets, experts reference to recognition of a corporate asset to be material evidence under a filed criminal case and its further safekeeping by one of participants in the conflict, followed by its ultimate alienation161.
It is medium- and small-sized companies that most often fall prey to corporate raiders' attacks. Notably, the raiders may become interested even in a most insignificant asset, while the company's poor performance does not repel them - the aggressor claims that it is a consequence of a poor management or embezzlement which will be terminated after the change of the owner.
The period between 2006 and 2008 saw the growing efficiency of law enforcement agencies' performance in this direction. Meanwhile, there emerged economic grounds for changing the situation in certain regions (for example, in the city of Moscow, the number of potential objects for raiders' assaults has declined). According to the Investigative Committee under the RF Ministry of Interior, the number of criminal charges filed in conjunction with facts of illicit seizures of property complexes has been on the rise. More specifically, in 2007 the preliminary investigation agencies considered 512 criminal cases on crimes of this category, and 130 cases were submitted to the court of law. Some experts162 believe that the revi-talization of the law enforcement agencies' activity has resulted in a decline of the number of criminal seizures of enterprises in the country, despite an overall rise of offenses against corporate assets.
Participants in the M&A market believe that the recently noted distinction between criminal raisers and those who illegally acquire corporate equity will be widening further on, with criminal seizures mostly drifting from the central part of the country to its remote regions. According to preliminary forecasts, the situation should be stabilizing, but a certain level of criminal seizures - of some 500 objects a year - will still be occurring in Russia nonetheless.
161 See here and below: Nobatova M. "Evolyutsia korporativnogo reyderstva v Rossii: ot skupki aktsiy v podvo-rotne do zakaznykh ugolovnykh del".- "Sliyaniya i pogloscheniya", 2007, №11, p.69.
162 See in a greater detail: "Reydery menyaut orientatsiyu"///www.ma-journal.ru 458
In addition to the above, experts163 lately have noted positive trends associated with:
- decline in the number of discreditable practices with stockholder registers determined by a growing efficiency of a registrar's operations on the securities market;
- decline in the intensity of cases of stealage of assets by means of the court of law's verdicts;
- emergence of facts of bringing judges to justice for issuing "apriori untrue verdicts"164;
- decline in the number of big corporations that render services in the area of criminal acquisition of assets.
Hostile corporate takeovers have remained widespread in Russia. They often are accompanied by failures to pay an adequate compensation to shareholders. The volume of hostile takeovers on the M&A market may account for 30-40% of the overall number of public deals165. The most frequently employed methods in this respect are abuse of law, breaching unregulated by the law standards of corporate ethics and decent behavior.
It was the biggest financial-industrial groups and integrated structures that until recently have been major initiators of redistribution of corporate property in Russia166. The rise of the business empires was often associated with acquisition of control over assets concerned by developing and implementing of both friendly deals and corporate seizures. In early-2000s, when most vertically-integrated group had already taken shape, while political risks had grown, the large capital considerably fell back with its activity on the M&A market. It was replaced by medium-sized integrated structures represented by corporations of the second and third echelons as most active players on the market. By some estimates, it is spouses seeking divorce and the partition of property that have increasingly often become initiators of conflicts associated with redistribution of corporate assets.
The main methods employed in the process of hostile takeovers have remained unchanged over the past decade. In a nutshell, they can be reduced to the following group:
1) buying stock packages on the secondary market;
2) lobbying privatization (trust) deals involving state-owned equity;
3) administrative leading into holdings or other groups;
4) buying up debts and transforming them into participation in property and stock;
5) seizure of control through bankruptcy procedures;
6) initiating judicial verdicts; the use of an issuer's mistakes in the course of registration of a securities issuance is particularly widespread.
163 Nobatova M. "Evolyutsia korporativnogo reyderstva v Rossii: ot skupki aktsiy v podvorotne do zakaznykh ugolovnykh del".- "Sliyaniya i pogloscheniya", 2007, №11, p.70
164 In April 2006, the Supreme Court gave a severe opinion of a judge of the Arbitration Court of the Republic of Ingoushetia, whose verdict was used by Sigma Group to seize Kropotkinsky Ooil-extracting plant. In May 2006, the Supreme Court satisfied the Prosecutor General's citation on bringing to justice a judge of the Leninsk-Kuznetsky city court (Kemerovo oblast) for rendering an "apriori untrue verdict", etc. -For details, see: Nobatova M. "Evolyutsia korporativnogo reyderstva v Rossii: ot skupki aktsiy v podvorotne do zakaznykh ugolovnykh del".- "Sliyaniya i pogloscheniya", 2007, №11, p.70
165 Gvardin S.V., Chekun I.N. Finansirovaniye sliyaniy & pogloscheniy v Rossii.-M.BINOM. Laboratoriya znaniy, 2006, p.11. By some data, the city of Moscow every day sees at least one attempt of the so-called "hostile takeover" of an enterprise with the budget of up to USD 1m
166 See here and below: Molotnikov A. Sliyaniya i pogloscheniya. Rossiysky opyt. - M., SPb "Vreshina", 2007,
pp. 25-32
It is fairly rare noted a case that assets belonging to large financial-industrial groups and integrated structures become objects of a hostile takeover - in most cases a corporation is sold by astipulation. Exceptions are the cases of an active participation of government agencies in acquisition of control over a company, as exemplified by the YUKOS case. It should be noted that public companies have never been objects of corporate seizures.
In 2006-07, the government undertook a number of steps to preclude from, and counter criminal seizures of corporate assets. Such measures include regulation of the corporate takeover (i.e. acquisition by an entity or a group of mutually related entities of a control stock package or a large one) procedures. The mechanism of such regulation pursues the goal of securing a balance of interests between the purchaser of the stock, "ertswhile" shareholders, and the company's management. If efficient, the regulation makes a mala fide takeover becomes a more costly and risky, and, consequently, less lucrative than a legitimate takeover, exercise. The Federal Act167 promulgated in January 2006 provides the following mechanisms in this respect:
a) non-mandatory offer - the option for purchase of a stake of an open-end corporation by entities that intend to acquire over 30% of the total number of common shares and preferred shares of an open-end company that give them voting authority168 , by submitting to the open-end company a public offer addressed to its shareholders169, and the method of its implementation (Art. 84.1 of Federal Act "On joint-stock companies"). Meanwhile, prior to submission of the non-mandatory offer to the open-end company, it should be submitted, together with copies of all the documents provided to the shareholders, to the federal agency of executive power overseeing the securities market (the Federal Service for Financial Markets) (p.1. Art. 84.9). The agency has the right to demand to have the offer be brought in consistency with the stipulated in the law requirements (p.4. Art. 84.9).
b) mandatory bid - the obligation of the entity that has acquired over 30% of the total amount of the open-end company's stock to put forward a bid to its shareholders that own the remaining stock and owners of the convertible into shares securities regarding purchasing from them the said securities. This obligation should also be fulfilled by submitting a public offer. The timeline for fulfillment of the obligation is 35 days from the moment of introducing the respective record to the personal account (the custody account) or from the moment the entity has become (or should have become) aware that he independently or together with affiliated entities owned the said amount of equity in question (p.1. Art. 84.2). The FSSM's powers in this case are the same as above.
In the practice of arbitration courts there appeared the first disputes associated with challenging the FSSM's rulings on bringing non-mandatory and mandatory bids on acquisition of securities in consistency with the legal requirements. These disputes are initiated both by the companies that have submitted their bids/offers and those ones that have failed to sell their papers due to the agency's rulings. The list of reasons behind the FSSM' belief a given offer on the purchase of securities is illegal comprises: - provisions violating the timelines for acceptance of such bids;
167 №7-FZ of 05.01.2006 «On introducing amendments to Federal Act "On joint-stock companies".
168 While identifying the 30%, one considers the stock owned by this entity and its affiliated entities.
169 The public offer can also contain an offer to purchase from owners of convertible into shares equity securities these papers.
- failure to meet the timelines within which securities should be accrued to the personal account (custody account) of the entity that submitted the non-mandatory offer, as well as the timelines for payment for the papers;
- failure to meet the timelines for, and the sum of the banking guarantee that should provide for the guarantor's obligation to pay the erstwhile owners of the securities the price of the papers sold in the event of the failure by the entity that has submitted the non-mandatory/ mandatory bid to honor its obligations;
- failure to honor the obligation to pay for the acquired securities in time.
In some cases, the FSSM's regulations were recognized as partially illegal. For example, some FSSM's requirements were recognized null and void due to their inconsistency with the law with regard to a compulsory bid on the purchase of securities of "Samarsky Podshipnik-ovy zavod" JSC170.
The provision concerning the price offered for purchased securities and procedures of its defining raises numerous questions. The price for papers purchased on the basis of a mandatory bid "may not be lower than their average weighted price defined by results of trading by the organizer of trading on the market for securities over the six month antecedent to the date of submission of a mandatory bid to the federal agency of executive power in charge of the securities market". As to the papers that are not publicly traded or which have been in circulation for less than six months, their price "may not be below their market value as set by an independent appraiser" (p. 4 Art. 84.2.). While the legislators' concept is crystal- clear, the practical side of implementation of the provision pertinent to the exercise of an independent equity appraisal will not allow this provision to make equity redemption a legal and justified deal. The state of the institution of appraisal - its legal regulation, the effective regulations of the market for appraisal services, the factual absence of the practice of bringing one to justice for violating requirements to appraisal operations - makes it incapable to secure the respective compliance and protection of interests of shareholders of the companies whose stock do not circulate at exchanges. FSSM will not be able to oversee appraisers' operations at such a volume, and in this sense the aforementioned novelty cannot form an efficient instrument of solving M&A-related matters, as long as the sphere of asset valuation fails to become civilized.
The legislature's requirements regarding the size of the price of the purchased equity or ways of its identification under a non-mandatory offer were stipulated in the law in July
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2007 . The act reads that in the event procedures of identification of the price of purchased securities are found in the non-mandatory offer, "there should be secured a uniform purchase price of securities of the same kind, category (type) for all their owners". At this point, there is no reference to the need to redemption at a market price. That is why under such a legal regulation of the redemption problem, the owners of small packages may find themselves in a situation when they will have to choose between being happy with a lower price for their stakes and an absolute absence of the possibility to exert influence on the company's operations, as its controlling owner has changed. With such procedures the government has on hand
170 For details, see: Resolution of the Federal Anitrust Service of Moscow okrug of 03.10.2007, 10.10. 2007 №KG_A40/9123-07 by case A40-77840/06-17-491.
171 Federal Act of 24.07.2007№220-FZ «On introducing amendments to Federal Act "On joint-stock companies" and individual legal acts of RF".
no efficient and civilized instrument of the M&A market, thus having replaced the concept of countering criminal actions on the market for corporate control with yet another profanation.
c) The right for every entity to submit, upon receipt by the open-end company of the non-mandatory or mandatory bid, a competitive bid on purchase of equity (Art 84.5.). It should be sent to the open-end company not later than within 25 days prior to expiration of the term of receipt of the last bid of the ones the open-end company received earlier.
d) The obligation to redeem shares by the entity, that has become the owner of more than 95% of the total amount of equity, on their owners' request (Art. 84.7).
e) The right for the entity that that has become the owner of more than 95% of the total amount of equity (with account of the stock owned by the entity and his affiliated entities) to redeem the remaining stock (Art. 84.8)
The arbitration court has already seen the first examples of application of the mandatory stock redemption. Thus, Alu Process Holding Limited, which as of July 1, 2006 was the owner of 96.31% of common registered stock in SUAL company redeemed a 3.69% stake in JSC SUAL at Rb. 29.93 per share. Meanwhile, JSC Kognito Investment, a minority stakeholder, demanded to recognize the transaction invalid, being a fraudulent action, and to compel the defendant to return 873,036 shares in the company. The plaintiff, however, failed in
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the court . Former stockholders filed a lawsuit on recovery of losses against JSC Rusal No-vokuznetsky Aluminum Plant, as they believed the stock was redeemed at a knock-down price. The plaintiffs insisted it should be Rb. 412.29 apiece, rather than Rb.50 as set by the appraiser and paid for by the majority shareholder. The lawsuit was declined on the grounds
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the procedures of conduct of the appraisal were in full conformity to law .
The question as to whether Art. 84.8 of the Federal Act "On joint-stock company" is in conformity with the RF Constitution was considered by the Constitutional Court of RF. According to its verdict of July 3, 2007 №714-O-P, the said legal provision conforms to the Constitution. The Court also noted that "a mandatory alienation of assets upon condition of a preliminary and equivalent compensation is possible not only for public needs, but in the cases it is exercised in pursuance of the "overall benefit for the joint-stock company" as well. The verdict also ascertains that the Constitutional court "thus has extended boundaries for application of guarantees of the right for private property stipulated in Art. 35 (part 3) of the Consti-
174
tution of the Russian Federation" . The question as to how the court of law can find that the
172 For details, see: Citation by SC of RF of 17.03.08 №3398/08 by case №A60-5846/2007-C2.
173 For details, see: Resolution of the Federal Anitrust Service of Moscow okrug of 21.01.08 №KG-A40/13933-07 by case №A40-23574/07-48-185.
174 According to the Constitutional Court's conclusions, "An efficient guarantee of maintenance of the balance of interests between participants in the respective legal relationship in the procedure of mandatory equity redemption and, consequently, protection of minority shareholders' rights is the exercise of a comprehensive judicial control over the said procedure, which implies both "the evaluation of accuracy of price-setting for the redeemed equity and the presence of losses the plaintiff has incurred due to an unduly identification of the price" and studying into factual circumstances pertaining to the mandatory redemption or the rise of the right for such a redemption, which may evidence an essential violation of legal requirements or abuse of powers and which can impact setting a fair price for the redeemed equity". Only if the court of law stands by these requirements, may the provided for by the law procedures of cassation with regard to legitimateness of rulings on mandatory redemption and filing a lawsuit on recovery of losses caused in conjunction with an unduly identification of the price for the redeemed equity be recognized as an effective means of the judicial protection of rights of the owners of the redeemed equity".
stock redemption pursues the goal of the "overall benefit for the joint-stock company" remains unanswered.
Practical conclusion from the above is that while considering disputes pertaining to the mandatory equity redemption, the court of law is bound to study into all findings that may testify to an essential violation of requirements of the law or abuse of powers and thus affect a fair pricing for the redeemed equity. Meanwhile, the minority shareholders' rights are secured by observance with a duly judicial procedure, compliance to requirements of law at each of its necessary stages, reasonable timelines under the securing of an efficient judicial control. That said, the court of law does not have to "check an economic appropriateness of decisions made by boards of directors and a general shareholder meeting, which exercise independence and an ample discretion in the sphere of business".
The concept of compulsory equity redemption is not a new one - this mechanism is practiced in France, Germany, and some other countries. But Russia has different institutional conditions, which do not allow an efficient implementation of the compulsory equity redemption procedure, including, as stated above, a nascent appraisal market, numerous abuses in the area of financial reporting and conduct of shareholder registers, a lax administrative control over transactions with securities of joint-stock companies whose shares are not traded publicly, use of insider information, to name a few. In the circumstances, mandatory equity redemption may grow into a method of stripping minority shareholders off their shares without paying an adequate compensation.
In addition, factors that condition understating the stock appraisal are the legislature's failure to fix a moment as of which the market value should be set, the possibility for the professional players on the market to "form" a pricey with account of insider information, an understated value of companies, particularly due to the employment of transfer pricing.
Regulation of the mechanism of exercise of the administrative control over completion of transactions on mandatory redemption of stock not included in exchanges' listing appears to be a failure, as the redemption bid sent out to shareholders may be submitted simultaneously with forwarding the notification of the upcoming deal to the FSSM bodies (Art.84.9). So, in the event of abuse of the shareholders' rights, the FSSM bodies' actions would not be preventive ones, but centered on minimization of effects from illicit actions. It should be noted that the rights of the minority shareholders who own stock listed at exchanges will be protected far better, as having notified a FSSM body, the majority shareholder is bound to wait for 15 days, and only if there is no order from the authorities to remedy an abuse, should he forward an offer to shareholders.
The selected method of legal regulation was predetermined by significance for the government of a way in which the largest Russian corporations' assets are redistributed, as well as by the presence therein of a considerable number of foreign corporate minorities.
Recapping on mandatory equity redemption, it should be noted that in the current conditions the recent novelties are incapable of growing into an efficient mechanism of regulation of relations between the controlling stockholder and minority ones, due to the aforementioned legal deficiencies of the respective provisions and the absence of conditions of their efficient implementation.
In addition, in spring 2007, the State Duma considered in the first reading the governmental (designed by the RF Ministry of Economic Development and Trade) package of amendments aimed on improving the corporate law. The novelties therein center on counter-
ing criminal seizures of corporate assets. The bill is aimed at improving the effective arbitration law in the part of resolution of, and preclusion from corporate disputes, and legal regulation of joint-stock companies, partnerships and cooperatives' operations.
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The most important novelties in the law are:
- introduction of the concept of "corporate dispute" and singling out corporate disputes as a separate category of cases;
- limitations on introduction of the possibility for interim measures by corporate disputes only by the arbitration court by the legal entity's location;
- a mandatory integration into the same judicial proceedings of closely interwoven claims proceeding from the same corporate dispute. In addition, informers and plaintiffs are under a duty to notify of the associated with the corporate dispute future on ongoing trial;
- reduction in the limitation of actions under challenging corporate executive bodies' rulings;
- a preliminary judicial control over conduct of an early shareholder meeting which provides for the prerogative of the court of law to convene the general meeting in the event a board of directors' has unjustifiably refusal to do this.
In the autumn of 2007, while preparing the bill for the second reading, the RF Ministry of Economic Development and Trade, together with the Supreme Arbitration Court and the State Duma Committee for Property, had designed new amendments to the document. The amendments concern primarily the adjective section of the Administrative-Processual Code and the shareholder register. It is planned to specify in a greater detail what the register and the contract on its conduct are. In addition, the administrative and law enforcement agencies' rights for issuing the register or an extract from it will be defined more clearly. Also, the bill now provides for a greater responsibility of the register holder. The document also specifies legal regulation of procedures of appeal decisions made by an organization's managerial bod-ies,a s well as large-scale deals and interest-party transactions. Finally, amendments concern the definition of the concept of 'corporate dispute", exclusion of an "arbitrary" locus standi, both territory- and subordination-wise ones, elimination of controversies in judicial verdicts.
The package of legislature aimed at countering criminal seizures of corporate assets provides for introducing criminal sanctions for fraudulence "against the legal entity associated with acquisition/establishment of control over it and its assets", with a maximum penalty (Art. 159 of the Criminal Code of RF) in the form of incarceration for up to 8 years. In addition, it is proposed to introduce criminal sanctions for forgery for the sake of seizure of an enterprise with a maximum penalty in the form of incarceration for up to 10 years.
The State Duma was initially going to consider the legislative package in 2008; however, as of February 2009, it has not been passed as yet. The novelties were supposed in many ways help eradicate favorable conditions of corporate wars with the use of the "administrative resource" and enable one to drive the corporate law, as a integral system of relations, onto a different level. While evaluating the novelties, it is worthwhile noting that if thoroughly elaborated and prepared, they would have helped create a simpler and more transparent system of legal provisions regulating procedures of consideration of corporate disputes and conduct of shareholder registers. They would complicate seizing corporate assets, yet they would
175 Rossiyskaya gazeta, 23.01.2007. 464
fall short of preventing them, due to the specificity of the institutional environment as a whole.
As concerns the corporate conflicts that do not pursue the goal of seizing control over a company, at this point, it is possible to single out typical of Russia conflicts between majority and minority shareholders determined by the absence of the board of director's independence of a large shareholder, deeply rooted traditions of conducting business, and efficient legal mechanisms that fix accommodation of interests of various groups of parties concerned. The other significant group of corporate conflicts comprises those between managers and shareholders. Underpinning these conflicts is the shareholders' aspiration to maximize the value of the stock and/or collect sizeable dividends, while managers (individuals that participate in a company's governing bodies) strive to increase expenses on payment of remunerations and their possibilities to influence the business176. In their capacity, managers are in possession of confidential information and appear far better than shareholders au fait with the state of affairs within the company, particularly with respect to earnings. The latter can have an account of the managers' performance only at the annual general meeting. In such a situation, managers remain beyond the shareholders' real control, which often allows them to fairly successfully pursue their interests. The board of directors, whose mission is to secure control over the executive bodies' actions, most often appears dependent on the controlling owner and sticks to a policy aimed at pursuance of the latter's interests in the first place.
In conclusion, as a positive trend should be noted - the legislature's attention to the problem of criminal seizures of corporate assets and attempts to improve a series of legal mechanisms which can alleviate the intensity of corporate conflicts and ensure the law enforcement agencies' more pro-active stance in this area. The passage of these measures is clearly a delayed reaction, nonetheless, they are capable of correcting the situation to some extent. But in addition to corporate wars unleashed by private individuals, there has recently been a rise in the number of offences against businesses and their assets by the state, public corporations and commercial structures affiliated with high offices. The outcome in this field is practically predetermined, while the most often employed instruments include selectivity in committing for trial for failures to pay taxes, illegal entrepreneurship and fraudulence, putting an owner and/or company's executives on the "wanted" list or their incarceration and the bankruptcy intimidation display. The employment of the civil service for the sake of redistributing assets or addressing other political and economic tasks constitutes one of the most pivotal causes behind assets stripping, a very low level of investments in capital assets and the general aptness to "closeness" of business.
5.5. Stock Market in the Crisis Conditions: Accumulation of Institutional and Structural Imbalances
5.5.1. On the Stock Markets' Capacity and Risks
Stock market can be viewed as a mechanism that allows attraction of investments, pillars economic growth and increases the citizenry's welfare. Once its competitiveness is on the
176 See: Kirilin A.V. Sovet direcktorov i ispolnitelny organ aktsionernogo obschetsva: kompetentsia iotvetstven-nost///www.businessmix.ru
rise, a national stock market exhibits a better capability to fulfill the said fundamental economic and social mission.
Regretfully, a spontaneous advancement of stock markets often drives them aside from performing the above mission, fuelling a rapid growth of short-term speculations and inflation of financial assets. In this case financial markets grow disruptive - they disorganize pricing for assets, block an influx of investments into an economy and exert a destructive influence on the nation's welfare and human psyche. The markets' cataclysmic forces reach their climax in periods of financial crises, like those ones occurred in Russia in 1997-98 and 2008-09. Meanwhile serious financial crises do not result from an accidental conjunction. Rather, they mirror irrationalities and imbalances accumulated in an economy and the financial sphere. It is the standpoint from which one can view the 2008-09 Russian financial crisis.
In the long run, financial markets grow following the dynamic of the fundamental indicators, such as corporate net earnings and GDP. As a proof to this ascertainment Fig.2 presents calculations by R. Schiller of the Yale University (USA). The historical time series of data on the S&P 500's stock capitalization and their issuers' earnings evidence that the most serious crises in the US history, particularly the Great Depression of 1929-1933, the collapse of the Internet companies bubble in 2000-02 and the current crisis fell on the periods when stock quotations sharply outpaced the growth in earnings.
Source : www.econ.yale.edu/~shiller/data.htm
Fig. 2. Growth in Stock Prices and Earnings by the US Corporations (in Real Terms, with Account of Inflation)
The author of this section has completed computations of the correlation between the dynamic of growth of stock markets and the leading economic indicators across 12 developed capital markets over the past 50 years. They evidence that the average pace of growth of stock
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indices, as a rule, corresponds to the average pace of growth of GDP in nominal terms . Fig. 3 provides data on the correlation between the pace of growth of the RTS Index, GDP and Russian corporations' earnings. The data evidence that the periods of the stock markets' crisis collapses in 1997-98 and 2008 fall on the moments in time on the eve of which growth
178
rates of financial indices were far ahead of those of GDP and corporate earnings .
Рост фондового рынка в сравнении с ростом фундаментальных показателей
3000 2500 2000 g 1500 S 1000 500
0
-500
Source: basing on the data of RTS and Rosstat
Fig. 3. Growth in Stock Market Vs. growth in the Fundamental Indicators
So, an irrational behavior by the securities market, particularly a far greater growth rates in securities' quotations vis-à-vis the fundamental economic indicators often herald dramatic financial crises. In this sense the latter can be regarded as forces that return stock markets to their original fundamental values.
5.5.2. Main Parameters of the 2008-09 Crisis on the Financial Market
The year of 2008 has become the year of one of the most intense financial crises in Russia. The rise of the stock market, that started in the late-1990s and continued up to May 2008, was replaced by its collapse since the second half of the year. At the initial phase of the crisis, between June 2008 and February 2009, it was the stock market that suffered at most, as seen on Fig. 4.
177 Section 1.3. of the presentation to NAUFOR. Rossiysky fondovyi rynok i sozdaniye mezhdunarodnogo fi-nansovogo tsentra. Idealnaya model finansovogo rynka na dolgosrochnyu perspektivu (do 2020 goda). Moskva, 2008. Posted at: www.naufor.ru
178 In this case capitalization of the RTS Index, GDP and earnings is quoted in nominal terms, without adjusting all the indicators in question to the inflation rate.
Source: basing on the data of JSC RTS
Fig. 4. Dynamic of the RTS Index, October 1995 - February 2009
Since June 2008 and over the next 8 months the RTS Index has plummeted from 2,460 to 535 points, or at 78.3%. Ten years ago, from the August '97 pick value it had been falling over the next 14 months from 506 to 44 points, i.e. at 91.3%. In the times of the Great Depression in the US, the DJIA since September 1929 and over the next 34 months had been plunging at 88.7%. So, while in terms of the depth and length of its 2008 fall the RTS Index has fallen short of breaking the "record values" of the Great Depression and the Russian crisis of 1997-98, the ongoing crisis, by its intensity and length, appears comparable to the most dramatic turmoil in the national and world financial systems over the past centennium.
The Russian market is notorious for its greater volatility against other national ones -over recent years it has been among leading or outsider major capital markets worldwide. In 2008, by the depth of its fall it has outrun practically all the emerging and developed financial markets (see Fig. 5).
Source: by the data of RBK and the World Federation of Exchanges
Fig. 5. Stock Indices by Results of 2008
By the 2008 results, the RTS Index plummeted by 67.2%, and that of MICEX - by 72.4%. By contrast, indices of other emerging markets also battered by the crisis experienced a less dramatic decline: China (Shanghai Exchange) sank at 65.4%, India - 52.5%, Turkey -51.6%, Argentina - 49.8%, Hong Kong- 48.3%, Brazil - 41.2%.
The downfall in the value of Russian companies' stock and stock indices has resulted in a drastic contraction in the volume of trading and liquidity on the futures and options market at RTS, which had been on the rise since 2005, as shown on Fig. 6.
Since August 2008 the monthly volumes of trading on the futures and options market have plummeted manifold. Meanwhile, it should be noted that the RTS's market for derivatives remained intact and the number of contracts therein even continued to rise. In contrast to the crisis of the forex terminal at MICEX in 1998, at the RTS exchange the shock on the market for basic assets has not resulted in a systemic crisis on the market for derivatives.
3 500000 3 000000
iTi
-3 •S
2 500000 C.
o
fe
2 000000 I 500000 1 000000 500 000
&&&&&& $ & * # <Ji ^ * £ > ^ ji # * #
Volume of trades with futures The number of deals with futures
I Volume of trades with options "The number of trades with options
Source: basing on the data of JSC "RTS"
Fig. 6. Volume of Trading and the Number of Deals on the Futures and Options Market JSC RTS between 1.09.2001 and 31.01.2009
5.5.3. Common and Distinguishing Features of the 1997-98 and 2008-09 Crises
While the 1997-98 and 2008-09 crises exhibit numerous differences between them, the latter should not be overestimated.
The Russian crisis of the late-1990s is usually associated with the events unfolding postAugust 1998, i.e. with the default on the market for the Russian government short-term obligations (aka GKO), an uncontrolled depreciation of the Rb., and the banking crisis. The crisis did not constitute a global one, nor it suggested there were contagion effects caused by the world economy or overseas markets. In such interpretation, the 1998 crisis resulted from the then existing authorities' inefficient financial policy, which manifested itself, among other things, in their inability to maintain the level of public expenditures in balance with the budget revenues.
By contrast, it was the stock market which received the most severe blow from the ongoing financial crisis. The unfolding of the crisis in the banking system and on the market for bonds was arrested by the government and the financial authorities' vehement use of foreign reserves the nation had accumulated by the initial phase of the crisis.
Meanwhile, these two crises that occurred in Russia over the past decade have much in common. Most importantly, they were engendered by the cyclic nature of the national economy, which has appeared strongly dependent on the world mineral prices. This can be found in a separate consideration of scenarios of each of them on Fig. 7 and 8.
Fig. 7. The 1997-98 Crisis on the Stock Market and Its Factors
The 1997-98 crisis was unfolding by the following scenario. After hitting its peak value in July 1998, the stock market nose-dived in August. The fall had been lasting for 14 months -through December 1998. The start of the collapse of stock was associated with the investors' anticipation of a drastic mounting of Russia's country and macroeconomic risks, which were attributed to the price downfall for mineral exports. As numerous researchers rightly pointed out, current quotations of the Russian blue chips are very sensitive to changes in future prices
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for oil and gas with some 9-month lag . Plus, a sharp decline of the stock market in 1997-98 was fueled by anticipation of a considerable depreciation of the Ruble. The collapse of the Asian stock markets that year also had a strong impact on the 1997 Russian stock market crisis, which fueled the foreign investors' negative sentiments towards emerging stock markets, including Russia.
The downfall of the stock quotations in 1997 became a detonator for the subsequent credit and banking crises. The falling stock prices intensified risks persisting on the national market due to capital flight, the deficit of balance of payments and anticipation of the Ruble's depreciation. Concomitant with the growing budget deficit and accumulation of imbalances in the baking system, particularly those between the banks' forex-denominated assets and liabilities, that resulted in the crisis situation in August 1998. At the time, the Ruble was depreciated nearly three-fold, the government defaulted on its domestic debt, while inspired by the state, Russian banks refused to pay off their debts to foreign creditors and the population.
179 Mirkin Y.M. Rynok tsennykh bumag Rossii: vozdeystviye fundamentalnykh faktorov, prognoz i politika raz-vitiya.-M.: Alpina Pablisher, 2002.- p. 146.
The unfolding of the 2008-09 crisis is shown on Fig. 8. Factors fueling the fall of the Russian stock market this time proved to be the same as those back in 1997. These are the price downfall for metals since May 2007 and oil since August 2008, the foreign capital outflow, and growing risks against the backdrop of anticipation of depreciation of the national currency. As a result, the stock market collapsed since June 2008. By contrast to the situation noted 10 years ago, the said factors affected the economy to a different degree. In 1997-98, the mineral prices were declining at a slower pace, while the Rb. depreciation was rapid and uncontrolled. Under the current circumstances a moderate controlled depreciation of the Ruble was coupled with a more acute and sudden downfall of oil prices by 3.5 times over several months.
R.TS Index; May'08; 100%
-O-RTS Index (left axis Y) -—Oil, Brent — Rxchange rate Rb/USD -Nickel
Source: basing on the data of JSC RTS and the International Monetary Fund
Fig. 8. the 2008-09 Crisis of Stock Market and Its Factors
The impact on the stock market by movement of the private capital, whose in- or outflow the Bank of Russia computes as difference between the growth of the Russian banks and non-financial companies' assets and liabilities is shown on Fig. 9. During the 1997-98 crisis, as much as some USD 20-25bn was annually exported out of the country. The amount was greater than the government foreign reserves at the time and that mostly was the residents' capital flight driven by uncertainty about stability of the domestic economic and political situation. The capital flight decelerated in the 2000s; more than that, in 2006 and 2007, the government boasted a net capital inflow accounting for USD 42bn and 83bn, respectively. But the precipitation of the oil prices in the second half of 2008 paired with the unfolding global financial crisis has changed the situation dramatically. According to the Bank of Russia, the 2008 capital outflow from the country accounted for USD 130bn., thus being in excess of the amount of its inflow over the two prior years combined. This evidences both the cyclic nature of the capital in- and outflow in/out of Russia determined by the state of affairs on the world
mineral markets and the respective prices, and the fact that the structure of the attracted foreign capital has been dominated by short-term investments and borrowed resources.
Source: basing on the Bank of Russia's data
Fig. 9. The Capital Inflow by the CBR's Data
The 1998 and 2008 situations on the market for the Russian issuers' stock appear similar from the perspective of the stock market's capitalization and volatility. (see Fig. 10.). A fall of the stock market is accompanied by a growing volatility measured with the use of the standard quadratic deviation of the daily return of the RTS Index. In the period of the last crisis, it accounted for 0.048; over the period the market was being on the rise it plunged to 0.013 in 2005 and 0.014 in 2007. But in 2008 it soared up to 0.042, thus hitting the 1998 level. The value of the Russian stock market's capitalization plummeted from USD 1,306bn in 2007 to USD 370bn in 2008. The distinctive feature of the 2008 crisis became the fact that the fall in the value of the financial assets had practically no effect on volumes of stock trading at Russian exchanges. The explanation of this phenomenon lies in the fact that in 2008 the growth of the stock market was secured chiefly by the REPO deals, with which public banks have been extending short-term loans to non-banking brokers and dealers.
In contrast to the 1997-98 crisis, the ongoing one so far has not encompassed the banking system and the market for debt instruments. That became possible thanks to the government's extension of an unprecedented financial support to banks and non-banking backbone companies. The magnitude of the government support is evidenced by the data on the dynamic of decline of the volume of foreign reserves in Russia between August 2008 and January 2009 given in Fig.11.
Source: basing on the data of JSC RTS and the International Monetary Fund
Fig. 10. Capitalization, Liquidity and Volatility Rates of the Russian Stock Market
Source: basing on the data of the Bank of Russia and the RF Ministry of Finance
Fig.11. Foreign Reserves and Their Elements, as USDbn.
The nation's foreign reserves comprise two parts, that is, the Stabilization Fund, which in early-2008 was transformed into the Reserve Fund, and the National Welfare Fund, and a part of the reserve governed by the Bank of Russia. The first two funds constitute target funds designated for financing a federal budget deficit (the Reserve Fund) and the pensions delivery (the National Welfare Fund). As seen on Fig.11, between the beginning of the 2008 crisis (when the stabilization funds combined accounted for USD 163bn) through January 2009 they have not shrunk but posted a robust growth, up to USD 242bn.
By contrast, the part of foreign reserves controlled by the CBR has dried out from USD 434bn in August 2008 to 162bn as of early-February 2009, or at 62.7%. This means that over the five crisis months the Bank of Russia spent as much as USD 271bn to maintain the Rb. exchange rate and to extend financial support to banks and corporations. Our computations show that some USD 90bn. (Rb. 3.1. trln.) was included in the banks' balance sheets in the form of a contribution to their capital and as borrowed resources. In 2009, the RF Ministry of
Finance is going to extend another USD 27bn (Rb. 950bn) to banks for the sake of recapitali-
180
zation and in the form of subordinated loans . At the time of the 1997-98 crisis, the government had no such funds at hand. As of the start of the crisis, in July 1997, its foreign reserves accounted for USD 24bn. which plunged to 12bn by August 1998.
At present it is hard to judge to what degree the steps undertaken to date would allow stabilization of the situation with banks and on the debt market. So far, as shown on Fig. 12, the latter has displayed a notable deceleration of growth of placement of corporate and government obligations in 2007 and contraction of their volumes in 2008. Since the second half of 2008 there emerged a growing wave of defaults in the form of refusals to honor obligations on redemption of bonds, coupon payments and redemption of tenders. The defaults in question have already totaled some Rb. 60bn. By our estimates, in 2009, the volume of redemption of corporate and regional bonds should make up some USD 20bn. Given the absence of a possibility to refinance this debt, this may accelerate the default tsunami on the market for Rb.-denominated bonds.
800 700 600 500
A400
g 300 200 100
1993 1994 1995 1996 1997 199B 1999 2000 2M1 2002 2003 2004 2005 2006 2007 2MB
E (iK.O-( >!■'/-( ¡SO O Regional bonds □ Corporate bonds
Source: basing on the data of JSC RTS and the International Monetary Fund
Fig.12. The Volume of Bonds Placement
180 Long-term loans without the right for an early withdrawal extended, as a rule, under a moderate and fixed interest rate.
So, with all the peculiarities of the 1997-98 and 2008-09 crises, underlying them were in large measure similar economic phenomena. The Russian stock market has appeared considerably dependent on the cyclic nature of the world pricing for oil, natural gas and metals, which, according to the data of the nation's balance of payments, secure 80% of its export gains. Drastic price downfalls for these minerals inevitably entail crises on the domestic stock market and in the financial system. The foreign reserves accumulated over the 2000s form a critical mechanism that allows cushioning of a financial crisis's effect on the domestic market, but this is not enough. Stability of the national financial market strongly depends on effectiveness of the government economic policy measures focused on lowering the economy's dependence on the world prices for mineral exports. In the 2000s, there has been no visible progress in this direction. Furthermore, by our estimates, the degree of dependence of the nation's forex revenues and those to the federal budget from export sales of mineral resources has grown notably over the period in question. Back in 2000, export of oil, petroleum derivatives,
natural gas and metals secured 71.6% of Russia's forex-denominated gains, while in 2008 the
181
respective proportion surged to 79.9% .
The other direction of lowering the domestic financial market's dependence on the world price situation for minerals might lie with boosting its attractiveness in the eyes of foreign institutional investors who focus on long-term and conservative investment portfolio management strategies.
5.5.4. Problems with Attracting Foreign Institutional Investors to the Russian Market
Whilst between 2000 and 2007 the Russian stock market offered lucrative returns, the country has failed to attract the most capitalized conservative investors, primarily western pension funds' resources. To understand why, one should evaluate practices of the California Employees' Retirement System (CalPERs) the largest US pension fund whose reserves account for some USD 170bn.
Until 2007 the CalPERs has been long applying a methodology of building an emerging markets rating from the perspective of investment opportunities. The methodology was public, and it was based on credible research into emerging markets, including the Freedom House's ratings of civil freedoms and freedom of press, the World Economic Forum's global competitiveness rating, the Oxford Analytica's rating of protection of stockholders and creditors' rights, the Heritage Foundation and the Wall Street Journal's assessments of economic freedom indices, Wilshire Compass and stock exchanges' analytic data, and other sources of information.
The CalPERs methodology suggested evaluation of investment opportunities in the emerging markets proceeding from two groups of factors, that is, country risks and risks inherent in a specific financial market.
CalPERs assessed country risks using the following criteria: • Political stability: the state of civil freedoms, the degree of the judicial system's independence, and political risks;
181 Calculated by the data of the Russian Federation's balance of payments published by the Bank of Russia and
Rosstat
• Informational openness, including assessment of the freedom of press, the level of information disclosure with respect to the nation's monetary policy and budget, the quality of listing at stock exchanges, efficiency of application of international accounting standards (IAS);
• The labor law's meeting requirement of international standards of regulation of labor relations, including ratification of the ILO Convention, the labor law's meeting the ILO standards, and efficiency of law enforcement.
In other words, the country risks suggest assessment of investment climate and institutions as fundamentals of financial markets.
The other group of risks suggests evaluation of quantitative and qualitative parameters of the emerging capital markets, including the following indicators:
• The stock market's liquidity and volatility, including assessment of the market capitalization and pace of its growth, the coefficient that characterize the exchanges' monthly trading turnover to market capitalization ratio, the growth in the number of companies included in the listing, volatility of the stock market and risk/return coefficients;
• Evaluation of efficiency of the banking supervision and law enforcement on the stock market, level of protection of creditors and shareholders' rights;
• Evaluation of the degree of an economy's openness to foreign investments, liberality of the regime of regulation of banks and financial institutions, restrictions on security purchases;
• Evaluation of effecieincy of settlement mechanisms in the stock market and the level of transaction costs, particularly tax ones under settlement of transactions on the securities market and income payments to their owners.
The maximum score a market could get is 3. If a country scored over 2.0, it was to be included in the list of markets available for investing CalPERs's investment assets therein. If a market failed to score the above points, it would fall under the category of markets prohibited for investing.
In 2007, inspired by R. Reed, its new Investment Director who had worked in the company for a year by then, CalPERs modified the investment decision-making methodology applied to emerging markets. Portfolio managers thenceforth were granted the right to independently pick companies from the emerging markets to invest, with a due account of risks inherent in different countries and stock markets. But even with account of the recent policy modifications of 2007-08, CalPERs has not started investing in the Russian issuers' papers. This means that the Fund's approaches to evaluation of the Russian stock market de-facto remained unchanged, and they are still relevant for understanding of the market's deficiencies as seen by conservative foreign investors.
In 2007, by the CalPERs's methodology the Russian stock market scored just 1.91 points, less than 2.0, which made it impossible for the Fund to invest in the country. Fig. 13 highlights on main factors that did not allow the Russian market to get the maximum 3.0 points by the CalPERs's scale.
Political stability 31%
Settlement practices/transactions costs 8%
Informational openness 15%_
Market regulation/legal system/ protection of investors7 rights 11%
Meeting standards of labor relations regulations 20% Openness of the capital market 15%
Source: www.CalPERs.ca.gov
Fig.13. Factors Precluding Russia from Scoring the Maximum Investment points by CalPERs's Methodology in 2007
The country risks, including political stability, informational openness and compliance of the national labor law with the international standards and requirements cost Russia 66% of the score.
Political stability in the country got 1 point out of the possible 3. The main reasons behind such a miserable score are a low assessment of civil rights, independence of the judicial system and reliability of protection of property rights, and the stability of Russia's political system.
The nation's level of informational openness performed better and earned 2.0 points - a pass to the club of permitted for investing markets. With relatively high points granted for measures on disclosure of information of the monetary policy and the budgetary system, and the exchange listing, the main challenges in this particular area were the state of freedom of press and efficiency of application of IAS (US GAAP).
The degree to which Russia's labor law meets the International Labor Organization's standards was awarded with 1.7 points out of 3.
By contrast to the conservative assessment of efficiency of the institutional factors, the quantitative and qualitative parameters of the Russian stock market have appeared quite respectable. But in this area Russia, too, has an underrun of the much-needed 34% to hit the necessary 2 points. This can be explained by existence of the following problems.
The quality of market regulation in the banking sphere and stock markets scored the average 2 points. Getting a higher score was blocked by an insufficient level of efficiency of the banking supervision and law enforcement on the stock market, as well as deficiencies in protection of creditors' rights. As concerns the criterion of openness of the capital market, the country scored a low 1.7 points, due to the existing restrictions for banks and insurance companies' entering the market.
As concerns efficiency of settlements and transactions costs, the Russian market was awarded with a high 2.3 score for their efficiency, with efficiency of settlements on the securities market earning 3.0 points, even in the absence of a central depository and a system of the guaranteed settlements without a preliminary depositing of assets. By contrast, transaction costs, that mirror the level of taxation of incomes and transactions involving securities, proved to be unsatisfactory and scored a meager 1.5 point out of 3. The main claim to taxation is the existence of the 24% corporate tax rate on sales of papers (today, this particularly strongly affects non-residents who buy Russian corporate papers and compels them to invest in Russia solely via off-shore zones), and the rate of taxation of dividends, which is greater than in other emerging economies.
Events occurred between 2008 and early-2009 have unlikely succeeded in dissipating the foreign conservative investors' prejudices with regard to high political risks of investing in Russia and feebleness of institutional factors that affect investors' risks on the stock market.
In June 2008, according to the MasterCard's Worldwide Centers of Commerce Index, Moscow held the 51st place out of 75 largest commercial hubs worldwide, or sank 1 line below its 2007 position. That Moscow's rating was lowered the research team explained by deteriorating legal and political living conditions, a lower economic stability, business climate and infrastructure of business centers. That month, according to the Freedom House, a US NGO, Russia was recognized as a non-free country, while a year before that it enjoyed the status of a partially free nation.
In July 2008, in its research into the state of corruption in 180 countries worldwide
rd
Transparency International gave Russia the 143 position and emphasized the aggravation of the situation with corruption over recent years. The World Economic Forum raised Russia's position in its Global Competitiveness Rating from 58th position in 2007 to 51st in 2008, nonetheless, citing corruption as a major challenge facing competitiveness of its economy.
In 2008, foreign investors received numerous negative signals regarding the country risks and the Russian economy's institutional weakness. The process of Russia's accession to WTO has practically stalled. The recently promulgated law on foreign investment substantially constrained opportunities for attraction of foreign investments into the country under market terms. Public companies were granted exclusive rights to develop the most promising oil and gas fields without any tender or auction procedures. The law enforcement practices exemplified by the TNK-BP, Arbat Prestizh, Russneft and Sakhalin-2 cases, to name a few, gave rise to concerns about protection of property rights in the country. Because of the PM's reckless comments on the government's claims to the metallurgic giant Mechel's tariff policy in July 2008, the corporation lost one-third of its capitalization, or a total of USD 5bn, at the NYCEX. The events around the North Ossetia and Abkhazia have not lowered political risks in the eyes of foreign investors, either. Between September and October the negative factors that increased investment risks in Russia were complemented by the trend to downfall in oil prices.
All these cases demonstrated that the fact of a selective law enforcement in the corporate conflict around YUKOS was not a sole event. Rather, it constituted the reality of the authorities' current economic policy. Here is how the head of BP Group T. Hayward commented on the outcome of the notorious conflict between the British and Russian shareholders in TNK-BP in October 2008. Answering the question as to what degree the Russian side's requirements were satisfied in an amicable agreement, he was quoted by a Russian newspaper,
as saying, "You are not aware of what their actual claims were, are you? You know just what
182
they have said in public.. .I am afraid you will never know it" . Regardless of what requirements the CEO of BP referred to, his words show how opaque for shareholders and the public at large the biggest Russian corporations' operations had become by late-2008. This evidences a serious crisis in the corporate governance practices.
As concerns the "YUKOS case", events of January 2009 showed that despite the liquidation of the oil giant back in 2007, it still persists as a serious factor of country risk for Russia. On January 29, 2007, the European Court on Human Rights in Strasburg ruled that the YUKOS's application with respect to the Russian government's actions was grounded. This gives a possibility for its ad rem consideration.
Since the second half of 2008, to the then existing investment risk assessments of Russia added serious macroeconomic risks steered by fears of an envisaged fall in Russia's 2009 GDP, decrease in export revenues from energy sources and minerals, depreciation of the Ruble, fall in foreign reserves, and the budget deficit. According to the RF Ministry of Economic Development and Trade, in 2009 Russia will see its GDP sink at 2.2% - far greater a pace than in all the developed economies and the other BRIC nations.
Recapping on the analysis of various factors influencing an assessment of the investment attractiveness of the Russian stock market as exemplified by the CalPERs's one, it should be noted that main claims concerned institutional factors and investment climate in the composition of country risks, the level of development of the capital market in the part of taxation of investors' earnings, efficiency of the banking supervision, and law enforcement practices. Potential of a further improvement of Russia's rating at the expense of the quantitative characteristics of the stock market and improvement of the infrastructure is close to zero, as the country was has won maximal scores in these areas. So, it is the very directions by which Russia has fallen behind its competitors that the nation must focus its efforts on, so that the future growth of the national stock market could be fueled not only by an inflow of speculative short-term capital, but contributions by the largest overseas portfolio investors as well.
5.5.5. Impact of the Stock Marker on the Economy
Last year, the national exchange stock market has managed to retain its competitive positions by volume of trading despite falling stock quotations and corporations' capitalization, decisions to suspend trading at the Russian exchanges reported time and again between September and November 2008, temporary bans on marginal deals and short sales for brokers. The proof of this is the data on correlation between trading volumes with Russian stock and depository receipts for Russian corporations' stock at the domestic exchanges and overseas given on Fig. 14.
182 Vmeshatelstvo rossiyskogo pravitelstva ne bylo pryamym, tolko kosvennym. Kommersant, 6 October 2008, p.20 480
l
HNYCEXand NASDAQ (CTCM)
■ German exchanges
□ London Stock Fixchange
□ The federal exchange ■'Saint Petersburg''
55 RTS- exchange market
H RTS- classical marksät
0 I _ □ The federal exchange MICEX
UW 1*99 »00 2001 2002 2003 2004 2005 2006 2007 2008
Source: the author's calculations basing on the exchanges' data
Fig. 14. The Proportional Weight of Exchanges in Trading Volumes with Stock
of Russian JSCs
In 2004, the domestic exchanges' proportion in the stock turnover plunged to 23%, and there arose a real risk of the center of pricing for, and liquidity of the domestic corporations' stock migrating overseas, to the LSE. But the perilous trend was overcome over the next years. The national exchanges and MYCEX in particular regained their positions as centers of pricing for, and liquidity of the Russian issuers. In 2008, the MICEX's proportion in the turnover of the Russian corporations' shares accounted for 73%. More than that, the spot market for stock in Russia de-facto was centralized at MICEX, while the share of RTS on this segment of the market has practically reduced to zero. Meanwhile, RTS has grown as a principal trading floor for the rising financial terminal, which after collapsing at MICEX in August 1998 was being practically non-existent over a few years. That the Russian exchanges have consolidated their positions on the market for the Russian issuers' shares became possible mostly thanks to an advanced growth in the absolute volume of stock trading at MICEX between 2005 and 2008.
Meanwhile, in addition to the problem of the stock market's liquidity, the increasingly pressing is becoming the question as to how this particular segment of the stock market affects solution of fundamental problems facing the economy. The stock market and the economy are interlaced. On the one hand, as shown above, the stock market is strongly dependent upon ongoing processes in the national economy, while on the other, it has a reciprocal impact on the economy and attraction of investments and economic growth in particular. But stock quotations and capitalizations on the rise, IPOs on track per se do not mean the stock market has positive effects on investments and economic growth rates. To make it play a constructive role in the process, one needs to build a number of prerequisites.
The stock market should contribute to growth in real investments in capital assets and production inventory. Emphasizing the links between investments and economic growth, the Nobel Prize winner in economics Neokeynesian P. Samuelson noted that "investments . are
183
made only when a tangible capital is created" . In other words tangible capital constitutes a generator of economic growth.
Investments in creation of new production capacities should be economically more lucrative than exchange purchases of stock, including those under M&A transactions, sales of stock packages to strategic or market investors, etc. The clue to the problem at the individual company level in part lies in the method of evaluation of efficiency of investment decisions on the basis of the so-called Q coefficient suggested by the Nobel Prize winner in economics J. Tobin, Professor of Yale University. The coefficient shows correlation between a company's market capitalization and its present value, i.e. the costs of capital assets analogous of those in operation. Under a low value of the coefficient, for instance, below 1, a company's shares are undervalued, and in this case it would be more profitable to invest in buying its shares. Should the company's Q value is greater than those of competitors', its stock is overvalued, thus making it profitable to invest in tangible assets. Unfortunately, data on the present value of most of Russian corporations are unavailable. Hence, to evaluate efficiency of investments in purchases of stock or in creation of new assets, one can try a different approach, that is, comparing returns rate on investment in a corporation's stock with its rate of return on assets. Should the former substantially exceed the latter, transactions on the secondary stock market become more economically attractive than investing in production capacities and material inventories.
Fig. 15 provides data on ROI in stock in the form of an RTS Index portfolio and return on assets, which can be employed as a criterion for making an investment decision with regard to efficacy of investments in boosting production capacities.
Between 1996 and 2008 it was only the two crisis year (1998 and 2008) out of all the 13 years when the rate of return on corporations' assets was greater than that of return on stock. In the conditions of an advanced price rise for shares, other conditions being equal, business will be keen to invest greater resources in stock purchases at the secondary market and in the IPO process than in creation of new production capacities and material inventories. In these cases corporations often resort to credit leverage, i.e. purchases of stock packages at the expense of collateral loans. It multi-fold boosts attractiveness of such investment strategies in the period of a rapid price rise. The stock market discontinues exerting an effective impact on attraction of real investments in corporations and economic growth. The influx of funds into the secondary stock market contributes to growth in its liquidity, price hikes for stock and, ultimately, emergence of a bubble at the stock market. In the conditions of euphoria steered by a long-lasting rise in stock quotations, as it was noted in Russia in the 2000s, businesses find it hard to catch a moment, when, according to the Tobin's Q criterion, shares have become overvalued, to drastically modify their investment strategies in favor of investing in creation of new production capacities.
183 Samuelson P.E; Nordhaus William D. Economics: transl. from Engl.: the 16th ed.: "Williams" Publishers,
2005.- p. 389.
Fig.15. Returns on Stock and Returns on Assets in the Economy
Because of this and due to a drastic downfall in stock quotations, by late-2008 numerous representatives of the national financial-industrial oligarchy had found themselves balancing on the verge of the financial abyss. The market value of their financial assets plunged below costs of their obligations before creditors. Perhaps, a certain role in the situation played the fact that, by contrast to other developed economies, in Russia, it was owners of large businesses personally coined M&A deals, rather than professional direct investment fund managers. The corporate owners have found it very challenging a mission to combine the task of developing production capacities and the production process on the whole with the investment business in the M&A area.
That in the 2000s business employed the Russian stock market as a mechanism for sales and purchases of financial assets and short-term speculations can be proved by data of the OPI statistics. In the 2000s, Russian corporations regularly held placements of corporate bonds and IPOs on the domestic market. For instance, in 2007 alone, corporations and banks placed Rb-denominated bonds worth a total of USD 18bn and attracted another as much as USD 33bn through primary and secondary stock placements. In 2007, Russia became one of the leaders on the global capital markets in terms of IPO volumes, mostly thanks to IPOs its public companies were holding at the time.
The bulk of attracted on the stock market resources was spent on redemption of businesses from their former owners, debts refinancing, and servicing M&A deals, including acquisitions of huge stakes. It was just a tiny fraction of the attracted on the stock market resources that was to form real investments (in new production capacities and material inventories), thus helping maintain economic growth. This is evidenced by Tables 10 and 11.
Table 10
Parameters of the Market for Russian Corporations' Stock (as USDbn)
2005 2006 2007 2008
Capitalization 549 1 057 1 407 370
Secondary market, including REPO 374 882 1 230 1 348
IPO 5 17 33 7*
To equity 0.3 2.5 3.6 1.9
The same as % to capitalization 0.1 0.2 0.3 1.8
The same as % of the volume of IPO 5.8 14.7 10.9 27.0
The volume of M&A deals 32 40 122 78
* with account of private placements of some companies' stock to strategic investors.
Source: calculations made basing on the data of exchanges and Rosstat. Volumes of M&A deals are given by the data of the M&A-Intelligence analytic group published in Expert, №6, 16-22 February 2009 , p. 46-48.
In the most favorable from the perspective of IPO volumes year of 1997, out of USD 33bn cashed in from primary and secondary stock placements, only USD 3.6bn., or some 10.9%, was spent to increase the tangible capital. In 2008, under a clear fall in the IPO volumes due to the financial crisis, there occurred some improvement in employment of the IPO-generated funds, with 27.0% of cash attracted through stock placement, or USD 1.9bn, being spent on shopping for capital assets. The volumes of cash collected over the 2000s through IPOs for the sake of increasing production capacities appear meager when compared with the volumes of M&A deals. For example, as noted above, in the pre-crisis 2007, the IPOs generated USD 3.6bn subsequently spent on purchases of capital assets, while the M&A market boasted a whopping USD 122bn volume.
At this point, yet more illustrative are the data on use, for the sake of real investments, of funds attracted by means of corporate bonds issuance, as given in Table 11.
Table 11
Parameters of the Market for Ruble-Denominated Bonds (as USDbn)
2005 2006 2007 2008
Capitalization 17.0 32.8 48.2 66.5
Secondary market, including REPO 44.2 134.9 371.4 454.0
IPO 9.2 16.0 17.9 15.9
To equity 0.2 0.06 0.4 0.2
The same as % to capitalization 0.2 0.06 0.4 0.3
The same as % of the volume of IPO 2.2 0.4 2.2 1.3
Source: calculated basing on the data of exchanges, Cbonds.ru and Rosstat.
Despite a dashing rise in volumes of placements of corporate bonds from USD 9.2bn in 2005 up to 17.9bn in 2007 and 15.9bn in 2008, the volume of capital spent on creation of new capital assets was extremely low. For example, with a total volume of bonds placements in 2008 worth USD 15.9bn, just as much as USD 170m was spent on buying capital assets. Overall, between 2005 and 2008 the proportion of investments in the total volume of issuances of corporate bonds channeled to the fixed capital has been fluctuating between 0.4% and 2.2%.
As shown on Fig. 16, the main sources of financing of capital assets of the real sector companies remained their own savings, the government's aid, extrabudgetary funds and banking loans. In 2008, their proportion in the total volume of investment sources in capital assets stood at nearly 70%. Over the 2000s, despite an impetuous surge of the stock market up to 2008, the proportion of funds attracted by means of bonds and stock issuances in the sources of financing of corporations' capital assets has remained practically invisible. While in 1999 it accounted for 0.7% of the volume of sources of capital assets financing, in 2008 it grew just to 1.6%.
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1998 1999 2000 2001 2902 2003 2004 2005 2006 2007 08
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□ Budget resources
and extrabudgetary funds
H Funds borrowed from other organizations
□ Bunking loans
□ Depreciation
and other own capital
□ Post-lax earnings
Source: calculated by the data of Rosstat.
Fig. 16. Structure of Sources of Investment in Capital Assets
Thus, the analysis of the role the Russian stock market played in the capital assets financing sources shows that in the 2000s the stock market had a fairly loose effect on growth in tangible capital and, accordingly, on economic growth on the whole. The stock market retained its virtual nature, mostly helping corporate owners vigorously play on the market for mergers and acquisitions, efficiently quit their former business by selling it to outside investors, refinance debts, secure cash for participants in corporate M&A transactions. During the period in question, the rate of return on such deals, that did not lead to creation of new production capacities and just indirectly affected economic growth, was substantially greater than that on investment in new capacities and material inventories. Like the market for junk bonds and IPO in the developed economies, securities placements on the Russian stock market helped one to employ borrowed and other resources to secure concentration of property in the hands of individual groups. Along with the administrative resource and selective law enforcement practices, the use of the financial leverage constituted one of the factors of a dashing advancement of the market for mergers and acquisitions, redistribution of property and
increase in the government's role of an owner of assets. An inevitable consequence of these processes became increasing credit risks on the market for bonds and an unfavorable for in-
184
vestors dynamic of the post-IPO capitalization of corporations . In parallel with that, foreign investors conceived of Russia's country risks as growing ones, due to accompanying the M&A process mass violations of property rights, raiders' activity, corruption and the increasing government's intervention in the largest companies' structure of property.
As in the early-2000s, the government's economic policy currently does not answer to the question as to at the expense of which mechanism it is supposed to complete the structural rebuilding of the economy in order to lower its dependence on oil, gas and metal exports. The stock market does not cope with this task, as with its use corporations attract less than 2% of investment sources to their capital assets. Banking credits play somewhat a role greater- the proportion of banking loans in sources of financing of capital assets accounts for 11.0%; however, they appear insufficient to ensure a radical redistribution of resources. The current model of the financial system suggests concentration of financial surpluses at the level of the governmental sovereign welfare funds, large companies that export minerals, and a number of public corporations (the Fund for Assistance to the Housing and Utilities Reform, Rostehnologii, Rosnanotech, Olympstroy, the Development Bank, among others). These mechanisms are unlikely to efficiently cope with the task of the economy restructuring. The sovereign funds center mostly on portfolio investments in overseas markets; the exporters appear are keen to invest chiefly in their own development; the public corporations focus just on individual sectors of the economy and so far have failed to demonstrate a notable performance in implementing huge investment projects.
To ensure progress in renewing the Russian economy, the government should more vigorously engage the banking system and the domestic stock market's capacity.
5.5.6. Fundamental Challenges of the Domestic Market for Bonds
A curious phenomenon of the 2000s became the unfolding of the market for Rb-denominated bonds (see Fig.17). Its capitalization sky-rocketed from Rb. 46bn in 2000 to 1,633bn in 2008, with the annual increment rates averaged 55%. The total value of regional bonds surged over the period in question from Rb. 23bn to 303bn, with the annual growth rate of 36.5%.
Because of the 1998 crisis, the government short-term bonds (GKO), with the use of which a classical financial pyramid had been built, have left the scene. In the process of novation, the government made a compulsory change of the discounted GKO for the federal bonds (OFZ). Post-crisis, the volume of the federal and savings bonds (OFZ and GSO) soared from Rb. 522bn in 2000 up to Rb. 1,421bn in 2008, with the average growth rate of 13.0%, which was clearly inferior to rates noted across the other segments of the market for Rb.-denominated bonds. This is natural, as in the conditions of a huge surplus of the federal budget, there was no economic sense in issuing government bonds, except for the need to replenish the Pension Fund's portfolio.
Regretfully, the years after the crisis of the late-1990s saw no resurrection of a liquid secondary market for federal bonds. It was the Pension Fund of RF and public banks that remained major players on this particular market. As a result, the market for government securi-
184 By our calculations, return rates of 75%-80% of Russian corporations that have held IPO on the regular basis
proved to be lower than those of RTS and MICEX Indices.
486
ties practically discontinued playing a significant role as an instrument of refinancing the banking system - these functions were reassigned, in the relationship between the Bank of Russia and commercial banks, to the CBR's bonds, while on the market for interbank loans -to more risky corporate and regional bonds.
Because of a low level of development of the market for government papers, despite a rise in absolute indicators of bonds placements, the relative indices of advancement of the bonds market in the 2000s have remained modest. In Russia, the 2008 total volume of corporate bonds to GDP accounted just for 3.8%. By its indicator of a relative level of development of the market for national bonds Russia has notably fallen behind most developed stock markets and large emerging ones.
_1998 1999 2000 2001 2002 2003 2004 MPS 1006 2007 2008
Source: basing on the data of the RF Ministry of Finance and Cbonds.ru
An important achievement of the nowadays market for Rb.- denominated bonds vis-à-vis the situation prior to the 1998 crisis became emergence of a positive correlation between the market for bonds and the real economy's needs. Prior to 1998, high costs of attraction of resources onto the GKO market would kill the mere possibility for issuing bonds for the sake of financing corporate investment projects.
At the same time, one should not overestimate the intensity of the process of transformation of the domestic market for bonds towards its re-orientation to the real economy's needs. The existing debt market appears in part a virtual one, granting greater opportunities to enjoy handsome earnings to short-term speculators, rather than the much-needed real investment- to business or chances for citizens to build long-term individual savings plans. The problem is not just the already discussed fact that funds raised thanks to corporate bonds issuances practically fail to get into the economy in the form of real investments - yet more alarming is the fact that the national market for bonds has appeared practically unprotected from carry trading, while the government's pursuance of a soft financial policy resulted in mainte-
Fig. 17. Volumes of Rb-denominated bonds in circulation
nance and even acceleration of inflation rates; the government practically encouraged a vigorous application of this strategy by Russian banks and overseas hedge funds.
In a nutshell, the carry trading strategy is simple - to raise funds by means of their borrowing in the national currency of the country wherein interest rates are low (the funding currency) for the sake of their subsequent investing in financial instruments of the country with relatively high interest rates denominated in the national currency (the investing currency). According to the Bank of International Settlements, the list of the most popular currencies comprised the JPY, Swiss franc and the USD, while that of investing currencies included the
185
Australian, New Zealand and the emerging markets' currencies . To implement the carry trading strategy one needs three prerequisites: depreciation of the currency in which the loan is arranged; low interest rates in the country where the loan is arranged; and existence of a liquid and relatively stable forex market and financial assets denominated in the national currency. It was the very prerequisites that had emerged in Russia by late-2003 (see Fig. 18). At the time, the period of a moderate price rise for oil and gas was over - they began rising by the exponential trend. The oil Dollars and natural gas Euros pouring in Russia's economy gave rise to an accelerated increase of its foreign reserves and money supply. The Ruble took the path of a long-term appreciation.
Vi;n". aggregate M2 ♦ Currency reserves À Price rise for oil -Pri™ _|:'v iurnaLurai
Source: calculated by the IMF financial statistics database.
Fig. 18. Price Rise for Energy Sources and Growth in the Cash Surplus in Russia
(the 1st Quarter 1996=100%)
185 Galati G., Heath A., McGuire P. Evidence of carry trade activity. BIS Quarterly Review, September 2007,
pp.28-29.
As evidenced by Fig. 19, since late-2003 the Rb. has been appreciating against the JPY and USD. If one takes the rate of the former currency in Rb. equivalent as of the end of the 4th quarter 1999 as equaling 100%, by the end of the 4th quarter 2003 the JPY appreciated against the Rb. at 8.9%, and after that up to the 2nd quarter 2008 it has depreciated in total of 20 p.p., down to 89.9%. Since 2004 the USD rate in Rb. equivalent has displayed a greater uncertainty in its behavior, but, anyway, it dropped at 12.5 p.p. At the same time, as evidenced by Fig. 19, through all the period in question costs of credit resources in Rb. equivalent have been substantially greater compared with those of borrowing on the US and Japan's markets.
Hence, by late-2003 in Russia there formed exceptionally favorable prerequisites for pursuing the carry trading strategy. It should also be noted that at the time the international rating agencies awarded Russia with investment ratings, which solidified the foreign investors' confidence.
Source: calculated by the IMF financial statistics database.
Fig. 19. Interest Rates and Dynamics of Exchange Rates of the US, Japanese
and Russian Currencies
All that contributed to the growing popularity of the carry trading strategy on the Russian stock market, which, in our view, fueled a dashing rise in the Russian stock market's li-
rd
quidity between the end-2003 and roughly through the 3 quarter of 2007. Since the second half 2007 this strategy has begun to exhaust itself, with the aggravation of the crisis of confidence on the world financial market, which had started with unsecured mortgage loans. The problems have sparked the crisis of confidence, and cheap funds have become increasingly hard to attract. Since the second half 2008 it became impossible to attract any funds.
The main terminals in pursuing the carry trading strategy on the Russian financial market became commercial banks and overseas hedge funds. It is fairly complex a task to assess in quantitative terms the proportion of sources of financing attracted with the use of this strategy in the overall value of the Rb.-denominated stock and bonds. For example, according to the Greenwich Associates, in 2006 as much as 45% of volumes of trading with bonds offered by issuers from the emerging countries fell on hedge funds186.
The impact the carry trading exerted on different segments of Russia's financial market can be assessed by means of analysis of the changes that were taking place in the market liquidity area since 2004, when the strategy was first tried in Russia, and since August 2007, when Russian corporations and banks began to face serious difficulties with attraction of borrowed resources.
Source: by the data of the CBR and MICEX
Fig. 20. Operations with Corporate Bonds and Banking Liquidity between 2001 and January 2009
Fig. 20 provides data on the state of the banking liquidity (the banks' balances on the corresponding accounts and deposits with the Bank of Russia), and volumes of placement of, and the secondary exchange market for Rb.-denominated corporate bonds. In 2001-2003 the market for corporate bonds and the volume of banking liquidity have been rising fairly moderately by the linear trend. Between 2004 and July 2007 the banks' balances with the CBR began to grow at a faster pace, and their amounts were growing substantially. The process was followed by a dashing rise of the market for Rb.-denominated bonds. Meanwhile, the secondary exchange market for bonds posted a rate of growth outpacing that of volumes of bonds placements. This can be explained by the fact that fueled by REPO transactions (which form
186 Major findings were published in the Wall Street Journal on August 30, a 2007. See also OECD. Financial
Markets Trends, Volume 2007/1, №92, p.42.
an a analogue to collateral loans against securities), the market for corporate bonds has increasingly emerged as one of main mechanisms of interbank crediting. A sharp fall of banking liquidity started in August 2007. By late-2008 the inflow of cheap resources from overseas had dried out, which resulted in a dramatic fall in the trading volumes and primary placements of corporate bonds.
All the three stages in the dynamic of indicators of the corporate bonds market and banking liquidity coincide with the development stages of the carry trading strategy. The advanced growth in liquidity and in the bonds market between 2004 and July 2007 coincides with a vigorous implementation of the carry trading strategy by the Russian banks and foreign hedge funds.
Fig. 21 presents an analysis of the correlation between banking liquidity and interest rates on the interbank credit market. Indicators are interest rates on interbank loans for the term between 2 and 7, and 8 and 30 days published by the Bank of Russia. In the period of a moderate liquidity of 2001-2003, the rates on the interbank credit market were high and very volatile. They would reach 15-20% annualized and fluctuate within the range between 3 and 25%. The inflow of liquidity in the period between 2004 and the first half 2007 made them and the level of their volatility tumble to some 4-5%. The only banking liquidity crisis occurred at the time (between May and June 2004) was more of a crisis of confidence - it was provoked by the CBR representatives' reckless statements concerning certain claims to a number of commercial banks. Since the second half 2007, with the global financial crisis unfolding and cheap resources on overseas financial markets growing hard to get, the interbank credit market interest rates began to soar and so did their volatility.
Between late-2008 and early-2009 the IBC rates practically hit the level of the early 2000s. Thus, the size of, and volatility on the IBC market and the banking liquidity were changing fairly synchronously with the intensity of the use of the carry trading strategy.
Fig. 21 The Average Monthly Indicators of Banking Liquidity and Interest rates on the Interbank Credit Market between 2001 and January 2009
Fig. 22 exhibits the correlation between interest rates on the IBC market and the direct REPO mechanisms employed by the CBR. In the time of growing liquidity, the Bank of Russia appeared quite efficient in affecting an excessive surge of interest rates on the IBC market by extending short-term loans to banks in the form of the direct REPO transactions involving public, corporate and regional bonds. Since the second half 2007 the CBR has continued to vigorously employ this mechanism; however, it demanded from the Bank of Russia far greater amounts of credit injections to tame an excessive growth of the IBC rates. Since September 2008 volumes of such credits have posted a substantial growth, and by today they have practically caught up with the bank's cash balances on corresponding accounts with the CBR.
35
30
-a 25
1 20 С
s
* 15 10 5
Development of the financial crisis
Period of growing liquidity
I
P
.....«.л...I .1 iJ_jJ l. 1 i 1 idiid I ÜJ-J 1 Li.i I . l AtUI I li. :
12D0
й
& ^ ^ ^ J1 & ^ ^ ^ ^ J? JP > A J- J- J* 4 >
-V _br .4- Л Л" .V b- .V A" Jar .4- A > -fa- ¿3" Л _V > Лг Л" Д -V Abr Л Л- Д
-С -fr Л" ЧУ iv<& <0' *>■ ^ vSw & ^ ^ N ^ ^ s" -fr ^ V
The period of growing liquidity -----IIU rates I'M" the term nf 1.. .7 days
Direct REPO О Interest rates hy direct RF.P credits
Source: by the CBR data.
Fig. 22. Use of the Direct REPO Mechanism for Regulation of Banking Liquidity in 2003-2008
So, as exemplified by the market for corporate bonds, banking liquidity, and interest rates on the IBC market (Fig. 20-22), it is clear that the start of banks and hedge funds' employing the carry trading strategy coincided in time with a rapid growth of banks' cash balances, volumes of placement and turnover on the secondary market for Rb.-denominated bonds, decline in the level and volatility of rates on the IBC market. And vice versa, the growing complications in employment of carry trading noted from the second half 2007 were accompanied by a tumbling banking liquidity, decline on the market for bonds, growth in the level and volatility of the IBC rates. Referencing again to Fig. 10, one can note that a dashing surge of the stock market also fell on the period between 2004 and the first half 2007, i.e. the period of a vigorous application of the carry trading strategy. All this allows one to assume that the carry trading strategy was playing a critical role in an accelerated growth of the Russian stock market in the 2000s, while the subsequent collapse of the stock market, deceleration of the growth and the rising risk of defaults on the market for corporate and regional
bonds appear determined by difficulties that arose in conjunction with the employment of this strategy since the second half 2007.
What threats does the carry trading strategy bear and what are its effects? Let us note three aspects - growing liquidity risks in the banking sector; the threat of a rapid shrinkage of the government's foreign reserves; and suppression of the population's incentives to long-term savings with the use of Rb-denominated bonds.
In the banking system, it leads to accumulation of the imbalance between the banks' forex-denominated assets and liabilities in the form of a substantial excess of the value of forex-denominated obligations vis-à-vis that of forex-denominated assets. This poses a major risk factor that has steered the liquidity crisis in the banking system. According to the IMF experts, participation of banks from the emerging economies in carry trading for the sake of funding growth in crediting the population constitutes one of the major risks these nations' financial markets may face187.
As shown on Fig. 23, in 1997, on the eve of the August crisis, the rate of the excess of the banks' forex-denominated obligations vis-à-vis their forex-denominated assets was 5% of the value of the latter. Ignorant of risks of loosing liquidity and careless of currency risks, large banks kept on attracting huge loans from foreign creditors in the form of futures. After the Rb. depreciated in August 2008, the majority of such banks could not pay off their obligations before their foreign creditors and, following that, before Russian deponents. The decision the national monetary authorities made back in August 1998, according to which banks were temporarily banned to repay their foreign debts, still appears fairly disputable. The decision did not impact the advancement of the crisis, but resulted in an inefficient use of a part of the funds allocated to keep the banking system buoyant and became an indirect bonus for the collective irresponsibility of the bankers who had partially fathered the banking crisis.
The story with carry trading per se appears a replica of the 1998 banking crisis. Since 2003 the banks saw a dashing rise of the imbalance between their obligations denominated in foreign exchange and the size of their forex-denominated assets. Banks were vehemently borrowing resources denominated in foreign exchange and invested them in Rb-denominated assets, primarily in the form of consumer and mortgage loans, bonds and loans extended to public companies. By results of the first seven months of 2008, the amount of the excess of obligations denominated in foreign exchange over forex-denominated assets accounted for 9.4% of the banks' balance-sheet totals (the respective index in 2007 was 9.5%). That was nearly twice as high as on the eve of the 1998 crisis, with a number of big banks reporting the respective figures to be far greater than the above ones. That made the threat of a serious crisis of the banking system terrifyingly real.
The aforementioned imbalance testifies to grave problems in the sphere of supervision and regulation of banking operations. Hence, the question as to how, in the conditions of various standards that regulated the financial sustainability, accumulation of such an imbalance in the national banking sphere, which at any moment can trigger a systemic financial crisis became possible.
187 IMF. Global Financial Stability Report. Financial market Turbulence: Causes, Consequences, and Policies. September 2007, pp. 22-25.
o
-3 -6 -9 -12
4,7
2,7
30,7
Excess (+); dcflcit (-) of the proportion of foreign assets over liabilities —O—Change in the tioininai exchange rate of USD in lib. equivalent
Source: calculated by the CBR's data
Fig. 23. Excess (+) and Deficit (-) of the Banks Foreign Assets over Liabilities (the Proportion of the Banks' Value of Assets (Liabilities), as %)
Between late-2008 and early-2009, the government took unprecedented steps to heal the situation. By our estimates, as noted above, the banking sector received some Rb. 3.1trln in loans, which allowed a partial solution of the imbalance problem. As of December 1, 2008, the rate of the imbalance sank to 3.6% of the banks' balance-sheet totals. That has so far alleviated the intensity of the risk of a systemic crisis in the banking sector. By our estimates, only this step alone cost the Bank of Russia USD 50bn spent out of its foreign reserves.
The carry trading strategy, that has resulted in the accumulation of a huge foreign debt by the Russian banks and companies, has engendered the threat of a fast "eating away" of the nation's foreign reserves and a wave of defaults, primarily by the non-banking businesses that do not enjoy such a generous governmental support at the expense of the country's foreign reserves as bankers do. Fig. 24 presents the correlation between the government's foreign reserves and the volume of the private sector's external debt. The key link of the economic policy in the 2000s has been withdrawing a surplus of cash savings resulting from a favorable state of affairs on international markets and channeling it into the sovereign funds (the Stabilization Fund and the CBR's foreign reserves). To bridge the resulting cash gap, corporations and banks had to borrow overseas. As a result, the amount of the foreign reserves appears comparable to the size of the aggregate corporate external debt.
~0~The private sector's external debt (the 2008 data as of 01.10. 08)
B foreign reserves, inchiding the Stabilization hnnd Source: basing on the data of the balance of payments over a number of years.
Fig. 24. The Surge in Debts by the Private Sector and in the Government's
Financial Surpluses
According to the First Deputy Prime Minister I. Shuvalov, as of the moment of preparation of this paper, the government had already earmarked as much as USD 85bn in long-term credits to businesses to cover their foreign debts. By our estimates, the majority of big Russian banks and non-banking companies presently have at hand some USD 130bn to finance their foreign debts repayment in 2009.
But the mission of foreign reserves is far more ample than a mere financing of corporate foreign debt. As highlighted in comments to Fig. 11, as of January 2009, the government had an instantly available USD 145bn to support the Rb. exchange rate, boost capitalization of the banking system and refinance the external debt. The businesses' external indebtedness at that time, with account of a partial repayment of their debt obligations in the late-2008, should account for some USD 450bn. Thus, the private companies' cumulative external debt already appears three-fold in excess of the government reserves on hand.
The other negative consequence the carry trading bears for the national market is maintenance of a rate of borrowing resources on the domestic market at the level below the inflation one. This weakens competitiveness of the domestic institutional investors (investment and pension funds, and insurance companies) whose funding is effected in Rubles and who therefore have no possibility to capitalize on the advantages borne by carry trading.
Implementation of long-term strategies of individual savings plans and building the domestic institutional investors' differentiated portfolios, necessitates these portfolios comprising, in a sufficient volume, instruments with fixed yields, primarily bonds. In compliance with the Russian law, such categories of institutional investors as non-public pension funds and
insurance companies should have Rb- denominated bonds as a prevailing part of their portfolios. But mostly because of the carry trading strategy, the real rates of return on these instruments have been steadily negative.
There are many ways for the government to combat the influx of cheap and short-term resources in the economy. But the most efficient measures are the ones aimed at a radical decrease of inflation rates. The higher the domestic inflation rate is, the greater the spread between the domestic Rb-denominated borrowing rates and the costs of attraction of resources from overseas are, and the more efficient the carry trading strategy for speculators is.
Fig. 25 provides data on the level of inflation in Russia vis-à-vis the largest developed and emerging markets. It is evident that in Russia it notably greater than elsewhere. This serves as a partial explanation to a greater volatility of the national stock market and its greater dependence on speculative capital. At the same time, the level of the Russian households' private savings is lower than in the noted countries. So, the struggle for domestic savings should start with combating inflation.
-O— Russia
50
40
30
20
10
0
Source: basing on the IMF and national statistical data.
Fig. 25. Inflation in Russia Compared with Other Countries, as % Annualized
The urgency of anti-inflationary measures as a means of pillaring the domestic savings system is yet much more important in light of the government's efforts to create a Moscow-based international financial center. The problem is that under a high inflation in Ruble equivalent, creating a center that should secure for large foreign investors, including foreign sovereign welfare funds, an easy access to the domestic market multiplies risks associated with carry trading. Such risks may result in the rates of Rb-denominated instruments falling to a minimal level and, in the event of a high inflation, securing a negative rate of return for the domestic investors whose sources of financing are funded in Rubles.
5.5.7. The Interconnection between the Stock Market and Residents' Savings
According to Rosstat, there are some 6m households with the annual income starting from USD 30,000 in Russia. This gives some idea of a total number of households with investment potential. But only a tiny fraction of this population buys securities such as stock, bonds, shares in mutual funds. Fig. 25 highlights on available data on the number of individual accounts with brokerages and in the records of owners of shares in mutual funds.
Source: basing on the CBR and Rosstat data.
Fig. 26. The Number of the Management Companies and Brokerages' Market Retail Clientele
In 2007, by our estimates, the total number of private individuals investing in securities either directly, or via mutual funds accounted for 845,000. The 2008 data on the number of market shareholders in mutual funds have not been published as yet. The number of residents taking part in the exchange trading grew from 417,000 in 2007 up to 560,000 in 2008, including the number of those who strike at least one deal a month - from 74,000 up to 83,000.
That less than 100,000 individuals out of 6m households with a real investment potential regularly buy stock on the market evidences that the stock market, in the population's eyes, so far has not become a mechanism of realization of a long-term savings strategy. The majority of residents view investments in mutual funds and corporate papers as a way of short-term investing, that is, they are speculators, rather than investors.
This is also proved by the Rosstat data on the population's aptness to savings in various kinds of financial assets, as shown by Fig. 27.
The 2008 crisis has drastically broken the residents' private savings system. Citizens have abandoned more organized forms, such as Rb-denominated bank deposits, in favor of cash in Rubles and bank deposits in hard currency. By some preliminary estimates, in 2008, the population scaled back on their savings on the Rb-denominated bank deposits. While in 2007 residents placed as much as 6.3% of their income on such deposits, in 2008 this figure tumbled drastically and currently stands at 0.6% of households' incomes.
Source: basing on the CBR and Rosstat data.
Fig. 27. Disposition of the population to saving in 1997-2008
In 2007 only 0.2% of residents' incomes was spent on raising their savings in hard currency equivalent put in banks. In 2008, the figure was 3.6%. Plus, savings in the form of hard currency cash posted a sharp growth - up to 4.6% of the households' incomes.
The level of the population's debts by consumer credits remains high - in 2008, the increment in the sums of these credits accounted for 4.1% of the households' incomes.
The 2008 proportion of the population's incomes invested in papers made up 0.5%, or thrice down vis-à-vis the 1998 crisis. It also appeared inferior to the 2006 level of savings in papers, which accounted for 0.6% of the population's incomes.
Transformation of the residents' savings into a genuine catalyst of growth of the domestic market necessitates not only millions of individuals' coming to the market, but the overwhelming majority of them sharing confidence in the potential offered by long-term (for 10,20, 30-year and longer) savings plans. So far only a very few believe in these strategies. A substantial obstacle to implementation of long-term investment strategies is the absence of Rb-denominated instruments with the fixed yields above the inflation level. A compulsory condition of implementation of a long-term investment strategy is the presence of bonds in an investor's portfolio. The older the investor is, the greater the proportion of bonds in his portfolio should be. But because under a high level of inflation in Rb. equivalent the domestic market for bonds is dominated by carry trading strategies, bonds, with their negative real rates of return, have grown practically unavailable to the domestic investors.
The above allows one to conclude that while several hundred thousand individual investors came to the domestic stock market over the favorable 2000s, it has failed to mobilize their capacity, nor it succeeded in becoming a means of implementation of their long-term invest-
ment strategies. This forms one of the most critical flaws of the Russian stock market. Yet worse, over the period in question, the government has failed to offer the national middle class an adequate pension system - launched back in 2002, the pension reform has practically become a failure.
Conclusions and Recommendations
Hence, unfolding on the Russian stock market since 2008, the serious crisis can be only partially conceived of as an unheralded one and triggered by the global financial crisis. The domestic factors of the national economy and advancement of the stock market in the 2000s have made a substantial contribution to its depth and intensity. In the period of a dashing growth in the market's capitalization and liquidity, which in many ways were fueled by the inflow of foreign speculative capital and the carry trading strategy, the financial regulators did not pay a sufficient degree of attention to risks growing in the banking system in the form of the imbalance between the banks' forex-denominated liabilities and assets. Today, the imbalance constitutes the main reason for the liquidity crisis in the banking sector. Plus, there have been other speculative strategies of funding financial intermediaries, particularly attraction of funds with the use of REPO transactions at the exchanges.
A serious deficiency of the Russian stock market that causes conservative foreign investors' distrust in it is the continuous weakness of institutional factors and high country risks. A sustained development of the domestic stock market and a successful implementation of the declared by the government project of creation of an international stock center in Russia are impossible without addressing such challenges as guarantees of protection of property rights, the judicial system's independence, progress in the area of civil rights and freedoms, openness of the financial system and the economy to foreign investments, creation of a law enforcement system on the financial markets whose efficiency should be recognized worldwide. The current crisis has demonstrated that putting stakes on public corporations as a major redistribution and crisis management mechanism on the financial market does not allow preventing financial crises, nor it ensures an efficient use of resources. One of the most efficient instruments of preclusion from financial crises lies in a greater role played by the civil society which normally exercises an independent control over processes in the economy and in the financial sphere.
The virtual nature of the Russian stock market, that is, its loose ties with economic growth and real investments, as well as its image in the population's eyes as a place for speculative, rather than savings-oriented investment strategies poses a critical challenge. A future competitiveness of the domestic stock market can be ensured only if it rests upon the domestic investors' potential. To this effect, building a domestic investment base should form a priority avenue of the national stock market's development strategy.
The growing dependence of Russia's economy on mineral exports compels one to more vigorously seek ways to boost efficiency of the financial system's impact on economic growth and the economy modernization. Clearly, the stake on an efficient redistribution of resources in favor of manufacturing industries and the new economy with the help of public corporations and sovereign welfare funds has appeared unworkable in Russia. While public corporations provide too scarce information of their performance, the sovereign funds appear to a greater degree focused on portfolio investments overseas. In Russia, there are no success stories of using sovereign funds for investing in the domestic economy, like public investment corporations in Singapore and China have done.
Meanwhile, as exposed by the 2008-09events, in the conditions of the Russian financial market's great dependence on the state of affairs in the world economy, the sticking to the Keynesian model of stimulation of the domestic demand by encouraging the population's consumption, consumer and mortgage crediting poses increased risks. With the first signs of crisis there starts a dashing growth in unpaid credits and social conflicts fueled by execution of recoveries by private debts before banks. An excessive stimulation of the population's consumer behavior entails the absence of long-term savings, which leads to reproduction of an inefficient and dangerous for the government distributive pension system.
Plus, as far as the developed economies are concerned, it is most likely that problems of the Keynesian consumption stimulation policy should be revisited. More specifically, new in-depth research should focus on the fact that a pro-Keynesian economic policy results in constraints to an investment inflow into the most capital-intensive sectors, thus giving rise to im-
188
balances in development of different industries and production spheres . As shown in the section on the impact a securities market has on an economy, the problem appears a fairly urgent one as far as the Russian economy concerns.
All this testifies that the government should center on the financial institutions reform, for the latter forms a main direction of the government's efforts to boost up efficiency of the financial system's impact on economic growth and rearmament of the Russian economy. The reform objective should become creation of a large and competitive intermediary community, which should be able to solve problems of accumulation and retention of the population's savings, businesses and governmental oil and other revenues for the sake of their efficient introduction in the crediting and financing of investment projects.
Given magnitude of the problem of the population's switching to long-term savings on the stock market, the government should design a sound reform policy for the domestic stock market, which should comprise the following steps:
- bringing inflation rates down to 4-5% annualized over next 2-3 years; adoption of restricting measures with respect to the carry trading strategy;
- adopting measures on a drastic increase of the banking and non-banking financial intermediaries' reliability and efficiency, and the transparency level of their operations; developing infrastructure, lifting obstacles to introduction of new kinds of financial products and services (for instance, investment consultancies and clubs);
- adopting measures on tax stimulation of long-term savings;
- introducing a uniform organizational structure and fundamentals of management of resources of the savings pension system and those of government sovereign funds; introducing the system of citizens' individual savings plans with the right to transfer these funds to specialized broker accounts and trust accounts;
- introducing a system of a moral and material encouragement of professional literature which explains benefits from the long-term investing
The above measures do not form a closed list, of course; however, they show that Russian residents are unlikely to switch to long-term strategies by themselves - these steps require decisive actions from the government.
188 Jesús Huerta de Soto. Dengi, bankovsky kredit i ekonomicheskiye tsykly.M: "Sotsium" Publishers, 2008, p.
259-262.
5.6. Practices of Regulation of Monopolistic High Prices in Russia in 2008
Restrictive business practices that constitute a possibility for producers to exert influence on market agents' economic conditions with respect to collecting extra earnings inhibit advancement of respective industries. The setting and maintaining of monopolistic high prices by individual producers of merchandize and services poses a profound challenge to Russia's economy.
While exposing tendencies that characterize peculiarities of the Russian practice of regulation of monopolistic high prices, one needs to examine correlation between the following factors:
• Abuse of the antimonopoly law in the part of setting a monopolistic high price;
• The sectoral specificity of a given market;
• The size of the market;
• Initiative of an investigation;
• Signs of a monopolistic high price
Table 12 systematizes cases of setting and maintaining monopolistic high prices in 2008.
Table 12
Abuses of Part 1 p. 1 Art. 10 of the Federal Act "On protection of competition" (setting a monopolistic high price) exposed by the Federal
189
Antimonopoly Service in 2008
№ Company Commodity/ Initiator of the Size of the Signs of abuse of the
Service investigation market antimonopoly law
1 Gaspromdobycha Orenburg Block granulated sulfur Consumers National Unjustified price rise
LLC (the Gasprom group)
JSC MMK, JSK Oskolsky Metal products used to FAS Individual produc- No price decrease under
2 electrometallurgical plant manufacture bearing parts tion the changed market situation
3 JSC Metallorukav, Trading Metal bonding braid for Consumer Individual produc- Unjustified price rise
House Metallorukav LLC airspace engines tion
4 JSC SUEK, JSC "Holding Thermal coal Consumer Several regional Unjustified price rise
Copmany "Yakutugol"
Holding Sibuglemet LLC, Concentrate of baking A number of con- National Unjustified price rise
JSC Subuglemet, JSC coal of crozzling marks sumers, FAS
5 Mezhdurechye, JSC "OF
Mezhdurechenskaya", JSC "OFAntonovskaya) (Holding "Sibuglemet" Group
6 JSC KD Avia Rent of office space in Consumer Local Unjustified price rise
the air terminal facility
7 JSC Vnukovo Invest Parking lot by the air Consumer Local Unjustified price rise
terminal
8 Alcoa RUS LLC, JSC Samar- Individual kinds of Consumer Individual produc- Unjustified price rise
sky metallurgical plant aluminum profiles tion
9 JSC Yuzhkuzbassugol Coke-coal FAS National Unjustified price rise
10 JSC "Ruspoliment" Circular billets from Consumer Individual produc- Unjustified price rise
nickel alloy tion
Rosneft oil company» Gasoline, diesel fuel, FAS National No price decrease under
11 aviation kerosene, fuel oil the changed market situation
JSC LUKOIL Gasoline, diesel fuel, FAS National No price decrease under
12 aviation kerosene, fuel oil the changed market situation
13 JSC Domodedovo Aerootel Parking lot by the air Consumer Local A relatively high pricing
189 The data was systematized on the basis of press releases posted on the FAS's official Homepage in the Internet www.fas.gov.ru in 2008
№
Company
Commodity/ Service
Initiator of the investigation
Size of the market
Signs of abuse of the antimonopoly law
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
TH Mechel, JSC MC "Yuz-
hny Kuzbass", JSC "Holding
Copmany "Yakutugol", JSC
Raspadsky ugol
JSC Gasprom, TNK-BP
Holding
Zhanr LLC
JSC "OC Lukoil", LUKOIL-Ukhtaneftepererabotka LLC, LUKOIL-AERO LLC (the LUKOIL Group) Toplivno-
obespechivayuschaya kom-paniya
JSC Avialinii Dagestana JSC LUKOIL-Nizhegorodneftesintez, LU-KOIL-AERO LLC JSC BRK Invest Limited, JSC Domodedovo Aerootel JSC Silvinit
Bryansky dairy plant JSC Uralsvyazinform
Electrolsatl metallurgic plant
Magadan center for standarti-zation, metrology and certification
Pervy khlebokombinat JSC Uralkaliy
terminal
Concentrate of baking coal of crozzling marks
Oil products
Access to cable TV Aviation kerosene
Aviation kerosene
Air tickets Jet fUel
Parking lot by the air
terminal
Potash chloride
Dairy products Leasing of cable in the telephone conduit channels
Circular billets
Equipment testing services
Bread
Potash chloride
FAS
FAS
Consumer FAS
FAS
FAS FAS
Consumers
Consumer
FAS
Consumers
Consumer Consumer
FAS
Consumers
National
National
Local Regional
Regional
Regional Regional
Local
National
Regional Regional
Individual production
Regional
Local National
Unjustified price rise
Unjustified price rise
Unjustified price rise Unjustified price rise
A relatively high pricing
A relatively high pricing Unjustified price rise
A relatively high pricing
Unjustified price rise
Unjustified price rise Unjustified price rise
Unjustified price rise A relatively high pricing
Unjustified price rise Unjustified price rise
According to the FAS, in 2008, the Agency investigated 28 cases in conjunction with setting and maintaining monopolistic high prices (Part 1 p. 1 Art. 10 of the Federal Act "On protection of competition").
According to the Agency's data, a minimal threshold of the exposed monopolistic high price is 35%. In 64% of cases the Agency exposed a sole producer's high price, while in 36% cases the law was abused by a group of companies. The sectoral structure of monopoly abuse is given in Fig. 28.
The bulk of cases of the setting of a monopolist high price for services (parking lot charges by airways terminals of the Moscow hub) falls on consumers. Meanwhile, the proportion of the services sector in the overall number of exposed cases of monopoly abuse is a minimal one.
The sectoral structure of abuses generally correlates with the structure of the Russian export - the maximum proportion falls on the fuel and energy sector's output, and that of the chemicals sector, while the industrial production and the food-processing sector hold a lesser proportion.
The markets wherein the aforementioned cases of monopoly abuse were exposed can be broken down size-wise into the national, regional, local ones, and the market for individual production. The latter category matters for a market that functions in the conditions of a lim-
ited number of producers and buyers (for instance, the market for metal bonding braid for airspace engines).
Fig. 28. The Sectoral Structure of Cases of Setting and Maintaining the Monopolistic High
Price
21%
18% --
/ \ 32%
©
□ National [3 Regional
□ Local
□ Individual production
29%
Fig. 29. Specific Weight of Cases of Setting a Monopolistic High Price Depending
on the Market Size
A considerable proportion of monopoly abuse cases (Fig. 29) falls on exposures of a monopolistic high pricing on the national and regional markets.
A significant for the analysis sign of the monopoly abuse is the initiator of the investigation. According to the data in question, that can be a consumer (consumers) or the FAS (the federal agency itself or its regional divisions). In total, the consumers' share accounts for 57% of the exposed cases, while that of the FAS, accordingly, stands for 43% (Fig. 30)
\ 43%
\ □ Cons
57% \ \
Fig. 30. The Structure of Cases of Setting a Monopolistic High Price Depending
on the Initiator of the Investigation
Let us consider monopoly abuses depending on exposed signs of monopolistic high prices in 2008.
In compliance with Art. 6 of Federal Act № 135 "On protection of competition", monopolistic high price for the merchandise is the one set by an economic agent that holds a dominating position, if:
1. the price is greater than the one, which in the conditions of competition on the merchandize market comparable by quantities of goods sold over a certain period of time, composition of consumers or sellers of the product and conditions of access, is set by economic agents not affiliated with buyers or sellers within the same group and not holding a dominating position on the comparable merchandise market;
2. the price is in excess of the sum of costs and proceeds necessary for production and sales of this product.
Plus, in compliance with Part 1, p.1. Art. 10 of the Act "On protection of competition", the economic agent that holds a dominating position is prohibited to exercise action or inaction, the result of which becomes or may become nonadmission, restriction, elimination of competition and/or infringement of other entities' interests, including the following actions (inaction): an overt setting, maintaining a monopolistic high price for a product.
According to the law, the abuse can take the form of the setting and maintaining of a monopolistic high price.
The practice of regulation of monopolistic high prices includes exposure of:
- signs of a maintenance of relatively high price levels;
- signs of a setting of unjustifiably high prices.
The economic situation in 2008 highlights the rise of such a sign of monopoly abuse as maintenance of price levels at the time the changed market situation dictates their decrease. Hence, a failure to decrease prices is equivalent to the setting of a monopolist high price.
Fig. 31. The Specific Weight of Cases of Setting a Monopolist High Price Depending on Signs of Abuse
Whilst considering cases of setting a monopolist high price in relation to signs of abuse, it can be argued that their considerable proportion (79% in total) is associated with the setting of a monopolist high price; accordingly, only 21% is associated with the maintenance of a monopolistic high price.
The contingency tables presented in the chart form (see Fig. 32-35) have allowed one to expose the following correlations between indicators therein:
- initiator of investigation - signs of abuse;
- signs of abuse - sector;
- size of the market - signs of abuse;
- initiator of investigation - size of the market
Fig. 32 Initiators of Investigation Depending on Signs of Abuse
The above data allows the following conclusions:
First, consumers to a greater degree are apt to being initiators of exposing monopolistic high prices in the event of their unjustified rise and a relatively high price level;
Second, it was only the FAS that exposed abuses in the form of the absence of a price decrease under the changed market situation.
Third, the data of contingency between the indicator of the sign of monopolistic high prices and sectors wherein the abuse has been exposed allows one to ascertain that an unjustified price rise appears to a greater extent inherent in the material production, while an unjustifiably high price level is more typical of the services sectors.
Fig. 33. Signs of Unjustified Price Hikes across Sectors
Fourth, there exists correlation between unjustified price rise and the size of the market. Fifth, an unjustified price rise (maintenance of a high price) is typical of regional and local markets, while the distinctive feature of the national market is abuses with signs basing on price-setting.
Fig. 34. Signs of Unjustified Price Hikes Depending on the Size of the Market
While considering the correlation between the size of the market (Fig. 8) and the initiator of the investigation, it can be argued that the FAS more often exposes signs of abuses at the national and regional markets, while consumers do so on the local markets and those associated with servicing an individual production.
Fig. 35. Initiators of Exposures of Signs of Abuses Depending on the Size of the Market
On the basis of the examination of 28 cases of the proved abuses of the antimonopoly law in the area of setting a monopolistic high price one can also draw the following statistically grounded conclusions.
According to the 2008 data, the proportion of the services market exhibits a minimum number of cases of exposure of monopolistic high prices, and their considerable fraction was exposed with the use of consumers' claims.
The FAS appears to be more efficient in exposing abuses in the event of:
- the absence of a price decrease under the changed market situation and an unjustified price rise, i.e. in the case of setting a monopolist high price;
- exposing an abuse on the national or regional markets.
By contrast, consumers are more efficient in exposing signs of abuses associated with the maintenance of a monopolistic high price on local markets and on those related to the servicing of an individual production.
5.7. Russian Market for Housing and Mortgage
5.7.1. The Russian Housing Market in 2008: from a Eight-Year Growth to the Crisis
In the previous eight years the overall growth of the national economy has been accompanied by a steady price rise for residential property, which has grown into one of the most attractive direction of investment. By contrast, in 2008, the housing market has found itself heavily battered by the crisis developments that had manifested themselves yet in 2007.
But, with all the negative impact the world crisis has had on Russia's economy, it is worth noting that the peculiarity of the housing market manifested itself in the next phase of
stabilization of prices on the market coinciding in time with a drastic intensification of the impact of the crisis on the national economy
Price situation: the main results of the year190
Forestalling an in-dept analysis of the price dynamics on the national market for residential property in 2008, it should be remembered that in the fall of 2007 there started a new round of price rise on this particular segment of the real estate market. Underpinning that were envisaged changes of the nation's political leadership, which has prevented a possible capital flight and encouraged the population to resume the deferred demand fueled by a substantial rise in real incomes and savings, and a drastic price rise for oil - suffice it to note that in the autumn of 2007 oil prices hit the level of some USD 100/barrel. Against that background there emerged new challenges to the financial stability in the form of an inflation hike on the consumer market in the autumn of 2007, the continuous fall of both the USD and stock indices, and some deterioration of situation with mortgage credits as a reaction to the crisis in the US. At the same time, as the crisis on the US mortgage market had a clearly limited effect on the situation with residential property in Russia, the prevailing view in the country was that the echo of the noted developments would not last for more than 6-9 months191.
The projections of price dynamics in the city of Moscow and some other Russian cit-
192
ies at that time allowed the assertion that a nationwide price rise would continue further on. At the time, they were expected to rise over the next three years (2007-2009) as follows: in Moscow oblast, Izhevsk, the city of Moscow, Yaroslavl - 1.7-1.9 times, in Ekaterinburg, Rostov-on-Don, St. Petersburg - 25.-2.8 times, in Perm, Novosibirsk - 3.4-3.5 times, and in Ulyanovsk - 3.7 times. At the same time, a longer-range forecast (for the next10-15 years) suggested a steady price rise (in the nominal USD equivalent) at an accelerated pace at 2530% annually, with the monthly growth rates being within the range between 0% and 8-12%.
190 The authors conducted all the calculations basing on the monthly data on the average specific offer price for housing in Russian cities supplied by the certified by the Russian Realtor Guild (RRG) analysts of the real estate market V. Lutskov, L. Kazimir (AKTS, Miel Holding), S. Sternik (Sternik's Consulting LLC), independent analysts A. Beketov, A. Sapozhnikov (all - the city of Moscow and Moscow oblast), S. Bobashev (Bullyuten ned-vizhimosti, St. Petersburg), V. Kaminsky (TITAN, Tver), V. Khorkov, A. Antasyuk, G. Tukhashvili (all RITS UPN, Ekaterinburg), P. Smelov, T. Vysotskaya (Sibakademstroynedvizhimost, Novossibirsk), E. Ermolayeva (RID Analytics, Novosibirsk, Kemerovo, Barnaul, Krasnoyarsk), R. davletshina (Prespektiva Konsalting), E. Epishina (Kamskaya dolina, all-Perm), A. Evstafyev (Villan LLC, Krasnodar), A. Chumakov (Titul), E. Prosku-rin (YUGRO, all- Rostov-on-Don), M. Reshetnikov (Agentstvo maksimum, Tomsk), N. Afanasyeva (Adalin-Ekspertiza sobstvennosti, Yaroslavl), V. Troshina (Informatsionno-analitichesky tsentr Brok, Tyumen), A. Ste-panova (SAN EXPERT, Ufa), A. Cheremnykh (UK ASSA-Story, Izhevsk), S. Blinkova (IKPKG Zhilye), E. Kalinina (Megapolis-nedvizhimost, all- Penza), N. Yarsina (Tsentr nedvizhimosti), M. Isayeva, I. Suponey (Zolotoy klyuch, all-Ulyanovsk), A. Trushnikov (B.I.N. Expert, Sterlitamak), and a group of analysts that are currently undergoing the certification procedure: G. Zyryanova (KuzbassInvestStroy, Kemerovo), A. Derbusaliyev (ISK Volga-grupp, Samara), S. Taruta "Nedvizhimost" journal, Omsk), M. savina (Agentstvo pechati i informatsii, Ryazan). The data was supplied in the currency in which the housing was quoted on the local market.
In addition, the authors employed the official data on the average monthly rates of the USD exchange rate, inflation and other macroeconomic indicators published by the CBR and Rosstat.
191 S. Domnin. Ne tak strashen chert....In: Kvartirny ryad, 20-26 December 2007, №51 (674), p.1.
192 Sternik G.M., Pechenkina A.V. Chto proiskhodit na rynke zhilya Moskvy. Makroekonomichesky podkhod (a presentation at the analytical conference of the Moscow Realtor Association "Rynok nedvizhimosti: situatsiya, tendetntsii, prognoz" of August 30, 2007) - www.realtymarket.ru, August 2007
The dynamic of the first half of 2008 was proving a high probability of that scenario.
Between December 2007 and September 2008 the housing prices in the USD equivalent were on the rise in most cities presented in Table 13. Quite surprisingly, it was Tver that topped the list of leading cities in terms of the dynamic of prices for residential property -over the 9 months in question they posted a nearly 47% growth there. The traditionally attractive for investing capital cities (Moscow and St. Petersburg) and Moscow oblast posted an impressive (at more than 1/3) price rise. Also notable in this respect was a positive price dynamic in Rostov-on-Don (up at nearly 20%), Tomsk (over 17%), Penza and Yaroslavl (nearly 13%), and Kemerovo (11%). Meanwhile, there were emerging increasingly explicit signs of price stabilization - in a big group of cities, the price rise failed to exceed 7-8%, while in Tyumen, Ekaterinburg, Izhevsk and Omsk there was noted a slight downfall in housing prices.
Table 13
The Dynamic of the Average Specific Offer Price for Housing in 2006-2008
USD/sq.m._Index
City (region) Dec. 2006. Dec. 2007 Sep. 2008 Dec. 2008 Dec. 2007/Dec. 2006 Sep. 2008 /Dec. 2007 Dec. 2008/Sep 2008 Dec. 2008./Dec. 2007
Moscow 4828 5429 7437 6641 1,124 1,370 0,893 1,223
St. Petersburg 2593 3165 4252 3601 1,221 1,343 0,847 1,138
Moscow oblast 2522 2529 3362 3235 1,003 1,329 0,962 1,279
Samara 2437 2634 2289 1,081 0,869 0,939
Tver 1370 1828 2682 2222 1,334 1,467 0,828 1,216
Ekaterinburg 2416 2607 2516 2211 1,079 0,965 0,879 0,848
Novosibirsk 1658 2401 2476 2112 1,448 1,031 0,853 0,880
Perm 1431 2271 2429 2069 1,587 1,070 0,852 0,911
Krasnodar 1370 2164 2338 2026 1,580 1,080 0,867 0,936
Rostov-on-Don 1563 2115 2536 2005 1,353 1,199 0,791 0,948
Krasnoyarsk 1115 2210 2393 1888 1,982 1,083 0,789 0,854
Tomsk 1892 2215 1881 1,171 0,849 0,994
Yaroslavl 1758 1913 2157 1866 1,088 1,128 0,865 0,975
Tyumen 1598 2186 2124 1849 1,368 0,972 0,871 0,846
Kemerovo 1369 1862 2066 1813 1,360 1,110 0,878 0,974
Ufa 1744 1994 2168 1799 1,143 1,087 0,830 0,902
Izhevsk 1843 1846 1737 1497 1,002 0,941 0,862 0,811
Omsk 1058 1798 1730 1493 1,699 0,962 0,863 0,830
Penza 1065 1517 1721 1493 1,424 1,134 0,868 0,984
Barnaul 1677 1415 0,844
Ryazan 990 1498 1523 1330 1,513 1,017 0,873 0,888
Ulyanovsk 859 1243 1329 1198 1,447 1,069 0,901 0,964
Sterlitamak (Bash- 840 1070 1143 1000 1,274 1,068 0,875 0,935
kortostan)
The wave of the world financial crisis that battered Russia between August and September 2008 and the dramatic changes in the macroeconomic parameters (primarily, the start of the depreciation of the Rb against the USD) seriously affected the price trend on the Russian housing market.
In the span of three months (between September and December) the prices in USD equivalent plunged notably. In most cities presented in Table 13 (including Moscow) they dwindled at 10-15%. A greater downfall was noted in Ufa and Tver (17%), while Rostov-on-Don and Krasnoyarsk saw their record downfall of more than 20%. The opposite pole was formed by Moscow oblast where the price downfall was minimum and accounted for less than 4%. The price pullback happened nearly everywhere and resulted in a price level lower (albeit in some locations and not for long) than that of December 2007, except for the two capitals
and Moscow oblast and Tver. Interestingly, the December 2008 price level in Ekaterinburg and Izhevsk proved to be even lower than that of December 2006.
Overall, by results of 2008 the prices in USD equivalent soared in Moscow oblast (at nearly 28%), Moscow and Tver (21-22%), as well as St. Petersburg (under 14%). The prices slid at more than 10% in Ryazan, Novosibirsk, Krasnoyarsk, Ekaterinburg, Tyumen, Omsk, Izhevsk. In the other cities of the sample presented in Table 13 the downfall accounted for less than 10%, while in Tomsk, Penza, Yaroslavl and Kemerovo it made up not more than 3%.
It should be noted, however, that despite the downfall of housing prices, in 2008 they were over USD 6,000/sq.m. in the city of Moscow, 3,000 - in Moscow oblast, 2,000 - in Tver, while in the early autumn 2008 in the city of Moscow they would hit even a higher level (some USD 7,500/sq.m.). In St. Petersburg, the ultimate 2008 price level accounted for under USD 4,000. In a whole array of cities (Tomsk, Yaroslavl, Kemerovo, Ufa), the housing prices had overshot USD 2,000/sq.m. by the early autumn, but consequently slid under this mark by the end of the year. The same is true for Tyumen and Krasnoyarsk, though in late-2007 the local prices there had been above USD 2,000/sq.m. By the late-2008 Ekaterinburg had left the trio of leading cities in terms of the price level for residential property and found itself falling behind not only Moscow oblast, but Samara and Tver as well.
As by the autumn of 2008, when the crisis developments were sensed pretty clearly, most local housing markets had already undergone dedollarization (a partial one was noted only in Moscow and Moscow oblast), the price dynamic in Rb. equivalent is worth examining, as a rise in the USD exchange rate meant an inevitable loss of a fraction of a housing price in hard currency equivalent.
In the city of Moscow and Moscow oblast, the Rb-denominated prices have been growing almost through the end of the year, and their first drop was noted only in December 2008. St. Petersburg, Ekaterinburg and Tyumen underwent the same development after a short (2-3-month) stabilization occurred between September and November. In most of the other cities (Novosibirsk, Rostov-on-Don, Perm, Krasnoyarsk, Tomsk, Izhevsk, Kemerovo, Omsk, Tver, Ufa, Penza) a gradual fall in the Rb-denominated prices for residential property was noted for the whole 4th quarter. Meanwhile, Ryazan's price dynamic was somewhat different and basically followed Moscow, Moscow oblast and Sterlitamak's - through the 2nd half of the year the local prices have been fluctuating within the range of Rb. 28-29,000/sq.m.
Taking on an analysis of real (less the inflationary) housing prices, one should reference to the dynamics of the main macroeconomic indicators. In 2008, consumer prices rose at 13.3%. For the first time since 2002 the nominal exchange rate of the national currency not just failed to appreciate, but depreciated substantially, albeit at a relatively gradual pace. Accordingly, the 2008 USD inflation rate in Russia was 0.989. So, for the first time over the decade (since the 1998 crisis) the USD discontinued to depreciate, while its purchasing power has grown, albeit at a meager 1%.
The index of real (adjusted for inflation of both the Rb. and the USD) housing prices (the IGS index193) by results of 2007, 2008, 2007-2008 vis-à-vis December 2006 in the cities of the sample is given in Table 13.
193 The IGS index is computed by the following formula: IGS=Ipr/Icpi=Ipd/Idi, где Ipr - the housing price index in Rb. equivalent рублях, Icpi - Consumer Price Index, Ipr - the housing price index in USD equivalent, Idi = Iri/Idrd - the USD inflation rate in Russia (vs. the consumer prices dynamic), Idrd - the USD-to-Rb depreciation index 510
Table 14
Nominal and Real Housing Price Indices in 2006-2008
Nominal price index IGS
City (region) Dec. 2007/Dec. Dec. 2008 /Dec. Dec. 2008/Dec. Dec. 2007/Dec. Dec. 2008 /Dec. Dec. 2008/Dec.
2006 2007 2006 2006 2007 2006
Moscow 1,124 1,223 1,375 0,939 1,236 1,160
St. Petersburg 1,221 1,138 1,389 1,020 1,150 1,172
Moscow oblast 1,003 1,279 1,283 0,838 1,293 1,083
Samara 0,939 0,949
Tver 1,334 1,216 1,622 1,114 1,229 1,369
Ekaterinburg 1,079 0,848 0,915 0,901 0,857 0,772
Novosibirsk 1,448 0,880 1,274 1,210 0,889 1,075
Perm 1,587 0,911 1,446 1,326 0,921 1,220
Krasnodar 1,580 0,936 1,479 1,320 0,946 1,248
Rostov-on-Don 1,353 0,948 1,283 1,130 0,958 1,083
Krasnoyarsk 1,982 0,854 1,693 1,656 0,863 1,429
Tomsk 0,994 1,005
Yaroslavl 1,088 0,975 1,061 0,909 0,985 0,895
Tyumen 1,368 0,846 1,157 1,143 0,855 0,976
Kemerovo 1,360 0,974 1,324 1,136 0,984 1,117
Ufa 1,143 0,902 1,031 0,955 0,912 0,870
Izhevsk 1,002 0,811 0,812 0,837 0,820 0,685
Omsk 1,699 0,830 1,411 1,419 0,839 1,191
Penza 1,424 0,984 1,401 1,190 0,994 1,182
Ryazan 1,513 0,888 1,343 1,264 0,897 1,133
Ulyanovsk 1,447 0,964 1,395 1,209 0,974 1,177
Sterlitamak (Bash- 1,274 0,935 1,191 1,064 0,945 1,005
kortostan)
As demonstrated by Table 14, the rise in real housing prices in 2008 was noted only in Moscow oblast (at more than 29%), the city of Moscow and Tver (at 22-23%), and St. Petersburg (at 15%). In Tomsk, the prices remained unchanged. As for the other cities, the real (adjusted for inflation) housing prices declined, with the drop being the most substantial one (at 14-18%) in Krasnoyarsk, Ekaterinburg, Tyumen, Omsk and Izhevsk. It is worth noting that in the city of Moscow and Moscow oblast, St. Petersburg and Tver the IGS growth rate overrun that of the prior year, with the capital regions experiencing some decline in the real housing prices in 2007. Apart from the above group, it was only Yaroslavl where the 2008 IGS index proved to be greater than in 2007, albeit it continued highlighting on some decrease in the real prices for residential property.
But an analysis of the two-year period of 2007-08 draws up a somewhat different picture. In the period in question, the Rb-to-USD depreciation index accounted for 1.07, while the USD depreciation index made up 1.185, with its purchasing power dwindling at more than 15.5%.
Unlike the year of 2008, the real housing prices grew over the two- year period in most cities, except for Tyumen, Ufa, Ekaterinburg, Izhevsk and Sterlitamak. The leading cities in terms of the IGS growth rates in 2007-2008 became Krasnoyarsk (+nearly 43%) and Tver (+nearly 37%), followed by Krasnodar and Perm (+ 22-25%). As concerns the capital cities, by results of the two-year period both Moscow and St. Petersburg found themselves in a fairly big group of cities wherein the rise in the real housing prices made up between 11 and 19%, while in Moscow oblast, together with Rostov-on-Don and Novosibirsk, it was 7-8%.
The most recent stage of the price rise for residential property in Russian cities proved to be substantially shorter than the prior two ones (the "oil-fueled" price rise of 2002-2004 and the "mortgage- and- oil-fueled" one of 2005-2006). Yet a more critical peculiarity of the
last stage of price rise for residential property was that it ended up with a crisis, rather than stabilization.
In light of this it is quite natural a step to attempt to compare the 2008 situation on the housing market with developments of the 1998 crisis. The comparative price dynamics are given in Table 15.
Table 15
Nominal and Real Housing Price Indices in 1997-1998 and 2007-2008
Nominal price index_IGS
City (region) Dec. 1998/Dec. 1997 Dec. 2008 /Dec. 2007 Dec. 1998/Dec. 1997 Dec. 2008 /Dec. 2007
Moscow 0,939 1,223 1,713 1,236
St. Petersburg 1,036 1,138 1,891 1,150
Moscow oblast 0,893 1,279 1,630 1,293
Tver 0,744 1,216 1,358 1,229
Ekaterinburg 0,624 0,848 1,139 0,857
Novosibirsk 0,479 0,880 0,875 0,889
Perm 0,356 0,911 0,650 0,921
Rostov-on-Don 0,929 0,948 1,695 0,958
Krasnoyarsk 0,431 0,854 0,786 0,863
Tomsk 0,368 0,994 0,671 1,005
Tyumen 0,383 0,846 0,699 0,855
Kemerovo 0,411 0,974 0,750 0,984
Omsk 0,453 0,830 0,827 0,839
Ryazan 0,763 0,888 1,392 0,897
Ulyanovsk 0,397 0,964 0,724 0,974
The above data show that the impact of the current crisis on the housing market so far has been far lighter than the previous one's.
First, 10 years ago, the price downfall occurred practically everywhere. By contrast, in 2008 (by results of the year), the capital cities, which undoubtedly are a nucleus of the whole Russian market, evidenced a price rise for residential property. It was also noted in Moscow oblast and Tver - the locations bordering on, accordingly, Moscow and St. Petersburg.
Secondly, the maximum intensity of the fall so far has been far less - given that in 1998, the lowest points were within the range between 35-40% of the December 1997 level, in 2008 the fall did not exceed 17%.
Third, the 2008 price downfall across all the cities by which a comparison can be drawn was less drastic than that of 1998, with its respective rate across many of them accounting for 2-3-fold. It was Ekaterinburg, Rostov-on-Don and Ryazan that proved to be dangerously close to following the 1998 pattern.
But considering the real (adjusted for inflation of both the Rb. and the USD) housing prices (IGS), the picture appears less unequivocal. Despite the 2008 price rise for residential property in Moscow, St. Petersburg, Moscow oblast and Tver, its rates proved to be less than 10 years ago. In Ekaterinburg, Rostov-on-Don and Ryazan the 2008 IGS plummeted, while in 1998 it had surged. One cannot help but note that in all these cities the prices at the time had been quoted in USD.
Meanwhile, the other half of the sample presented in Table 3 demonstrated a rise in the housing prices vs. their 1998 level. In the 1990s, in this group of cities (Novosibirsk, Perm, Krasnoyarsk, Tomsk, Tyumen, Kemerovo, Omsk) the housing prices were quoted in Rb. Also, interestingly, these cities (except for Perm) all represented Siberia.
While the 2008 developments so far have appeared more merciful than those of 1998, it is worth noting drastic differences between them. Despite some similarity (for instance, the price downfall for energy sources on the world market), the nature and magnitude of crisis phenomena are different.
The current crisis to a certain extent battered all the leading economies worldwide, while back in 1998 it had spread over a relatively narrow circle of nations, including Russia, the south-east Asian economies, and, partly, Latin American countries. When compared with 1998, Russia's economy (including the housing market and the construction sector, as well as the volume of borrowing from overseas) is far bigger than 10 years ago194.
Yet another distinction lies in the level of the country's institutional development. Ten years ago, the crisis coincided in time with a period of completion of a long-lasting transformational slump of the 1990s and the rise of basic market institutions. The depreciation of the Rb. became a powerful catalyst of a nearly immediate renewal of growth fueled by certain spare resources on hand (idle production capacities, staff, etc.) These factors of growth had exhausted by now. The length and intensity of today's crisis developments in Russian economy are hard to estimate so far.
Forestalling formulation of possible scenarios in the development sector with account to the world financial crisis, it is appropriate to examine in a greater detail the situation in the house-building sector in 2008.
Deceleration of construction volumes and placement of new hosing in operation
Like in the prior 7 years, in 2008 Russia boasted a growth in the volume of placement of new housing in operation. But its annual growth rate (4.6%) proved to be less than in 2007 (20.6%) and the least one over the period of the 2000s, equaling just to the 2001 indicators (Table 16). In all, by the preliminary data, in 2008, as many as 765.6m flats of total area of 63.8m sq.m. were put in operation, while the target had been 66.0m sq.m. (plus 10%).
Table 16
Placement of Housing in Operation in Russia in 1999-2008
year
Total area, as sq.m. million
Growth rates, as %
To the prior year
To 2000
1999 32,0 104,2 105,6
2000 30,3 94,7 100,0
2001 31,7 104,6 104,6
2002 33,8 106,6 111,5
2003 36,4 107,7 120,1
2004 41,0 112,6 135,3
2005 43,6 106,3 143,9
2006 50,6 116,0 165,7
2007 61,0 120,6 201,3
2008 63,8 104,6 210,6
Source: Rossiysky statistichesky ezhegodnik. 2007: Stat. sb./ Rosstat, M., 2007, p. 507; Sotsialno-ekonomicheskoye poliozheniye Rossii, 2007 god, M., Rosstat, pp. 87-88, the authors' calculations.
The slowdown of the rate of putting new residential property in operation started yet in the last quarter of 2007, when the growth rates was no longer accounted for double digits. The tendency continued through the first quarter 2008. By results of the first half of 2008, the vol-
194 In terms of the banking system and the real sector. A positive phenomenon, a considerable shrinkage of the public debt in the 2000s has fallen short of forming an inhibitor to the nation's growing overall external debt.
ume of placement of new housing in operation grew just by 3.3% compared with the respective period of the prior year; the respective figures of the second quarter of 2008 proved to be even lower than in the second quarter 2007.
All that became a consequence of the gradually rising complexities and constraints the developers had begun to experience since the mid-2000s, even despite adoption of the priority national project "Affordable and comfortable housing - to Russian citizens" (hereinafter referred to as "The Housing"). The situation in the construction sector began exacerbating, following the looming world financial crisis. In the 3rd and 4th quarters of 2008, volumes of placement of new residential property in operation rose at slightly over 5%, or nearly twice as lower vs. their respective values of the 4th quarter 2007 and 1st quarter 2008.
By contrast with 2007, the individual house construction has no longer played the role of catalyst of the construction process as a whole. The volumes of placement in operation of residential property built at the expense of funds (one's own and the borrowed ones) have grown roughly pro rata equal to those demonstrated by the indicator of the volume of placement in operation of all new housing. As a result, the proportion of the residential property put in operation at the expense of the population's funds remained at its 2007 level (42.6%), which, nonetheless, still is a peak value ever reported over the whole period of the 2000s.
Notwithstanding an evident deceleration of growth rates in house building across most Russian regions, the 2008 volumes of placement of new residential property in operation have grown nevertheless. Of a particular notice is the fact that they grew at more than 25% in nine Subjects of RF, including Bashkortostan and N. Novgorod oblast, i.e. in the regions whose capital cities are home to 1m-plus residents (Table 17). It is also worth noting in this respect that St. Petersburg and Chelyabinsk oblast posted a 20%-plus growth in the volume of residential property put in operation.
Table 17
Placement of Housing in Operation in Russian Regions in 2008 r.
(Ranked by Growth Rates)
Regions with a positive rate Placement(as sq.m. Thos.) Increment to the same period of the prior year Regions with a negative rate Placement(as sq.m. Thos.) Increment to the same period of the prior year
Kamchatka 63,4 в 3 раза Yamal-Nenetsky autono- 225,2 -11,2
mous okrug
Ingoushetia 59,2 +80,7 Sakha (Yakutia) 280,2 -12,5
Sakhalin oblast 146,2 +38,4 Irkutsk oblast 476,2 -17,2
Kaluga oblast 628,6 +37,2 Tver oblast 343,8 -17,9
Tyva 44,7 +34,9 Kalmykia 59,1 -23,9
Tula oblast 417,2 +29,5 The city of Moscow 3279,9 -32,0
Nenetsky autonomous 46,5 +26,9 Murmansk oblast 7,5 -40,9
okrug
Bashkortostan 2351,3 +26,6 Astrakhan oblast 382,5 -47,3
Novgorod oblast 259,0 +26,6 Chukotka autonomous 1,1 -82,9
Нижегородская 1353,3 +26,2 okrug
область^ Novgorod oblast
Source: O zhilischnom stroitelstve v 2008 godu, www.gks.ru.
Meanwhile, as many as 18 regions saw their volume of housing construction fall vis-à-vis 2007 (in 2006-2007, there were just 5-6 such regions). The data is poorly informative, though, as in the 2000s, up to the moment of a rapid promotion of "The Housing", every year there were at least 20 regions whose volumes of placement of new residential property in op-
eration proved to be lower than respective indices of the prior year. In this sense, a specific aerial of the spread of the slump in the house-building sector appears far more important.
Table 5 present regions wherein the 2008 level of placement of new residential property in operation accounted for more than 10%. Clearly, most of them are relatively densely populated territories with no largest cities therein, and the absolute value of volumes of house building is insignificant there. The city of Moscow, with a nearly 1/3 drop in the respective index, clearly stands apart against this background. Interestingly, in Moscow oblast, the respective index has remained unchanged since 2007. It is also worth noting the fall in the volumes of house building in Perm and Krasnoyarsk krais, Omsk and Irkutsk oblasts, with that in Irkutsk oblast accounting for 17%-plus. The consequence of the above became a notable deconcentration of house building in the capital region. The aggregate proportion held by the city of Moscow (5.1%) and Moscow oblast (12.2%) in the nationwide house-building volumes accounted for 17.3%, thus being lower than in 1999 (18%). However, between 1999 and 2003 volumes of placement of new residential property in operation in Moscow oblast were lower than in Russia's capital. For reference: in 2007, the share of the capital region in the overall countrywide volume of placement of new housing in operation was over 1/5, including a 12.8% share of Moscow oblast and a 7.9% one - of the city of Moscow.
With construction volumes in the city falling behind the 2008 guides, the Moscow city government confirmed their commitment to fulfill a program on construction of the so-called "social housing". At an auction held in the fall of 2008 the Mayor's office bought 378,000 sq.m. of residential property, of which 90,000 sq.m. are located in the city of Moscow (it had been planned to procure 80,000 sq.m.) and 288,000 sq.m. - in Moscow oblast (against the planned 420,000 sq,m.). The starting price for sq.m. of residential property in the capital was Rb. 65,000 and in Moscow oblast - 54,000195. The missing for completion of the 2008 plan 120,000 sq. m. are to be procured in 2009, together with another 380,000 sq.m. needed for completion of the 2009 social programs.
Challenges and risks engendered by the financial crisis. Assessment of prospects
for their overcoming and main scenarios of developments on the housing market
So, in late-2008, when the Russian market found itself half-way to the next stage of price stabilization envisaged in 2009, the national economy began to increasingly clearly sense the impact of crisis developments in the world economy (including the second wave of the mortgage crisis in the US, when the growth in the proportion of overdue loans was coupled with the downfall in housing prices), which battered financial markets, particularly after September 2008.
The crisis threatened to dry out liquidity in the banking sector, constrain the population and developers' access to banking lending, and have the population's real incomes fall due to inflation. The population began to realize additional risks of investing in newly built residential property, as such construction projects were at peril of suspension, and the demand for residential property plunged drastically. Spooked by the financial crisis, liquidity losses, prospects of devaluation of collaterals and possible bad mortgage loans, banks in turn began to reduce volumes of mortgage lending. The factor of their loosing capitalization exerted an equal impact, as at a certain level the value of a bank's own assets automatically bans credit-
195 Simonov V.V kontekste nyneshnikh problem. In: Kvartirny ryad, 5-11 February 2009, №4 (731), p.6.
ing. As early as in September 2008, daughter companies of large western banks and corporations registered in Russia got signals of the need for an urgent discontinuation of financing housing projects.
As a result, numerous construction corporations were cut off of the much-needed liquid capital and construction rates slowed down, with no new projects in sight.
Already in the first half 2008, the foreign capital inflow in Russia began drying out vs. the respective period of the prior year. While the inflow was still there in July and August, because of the mounting problems on the financial and stock markets, as well as the military action in the Southern Ossetia and Abkhazia, there began a mass capital (mostly portfolio investments) outflow, which intensified dramatically in the 4th quarter. Consequently, by the final results of 2008 the net capital outflow accounted for some USD 130bn - a peak value over the whole period starting from the mid-1990s.
The uncertainty and unpredictability of external operational conditions on local housing markets in Russian cities predetermined the need in employment of a scenario-based forecasting method for the sake of identification of a few variants of the dynamic of the external conditions. Under each variant it is possible to quite accurately calculate the market's behavioral pattern, while average weighted parameters of the most probable variant are computed on the basis of estimates of probability of each scenario.
All the diversity of possible options of the external conditions and developments on the real estate market can be reduced to four scenarios. Their original premises may become two most recent in the short history of the Russian housing market scenarios of transition to stabilization that date back to 2007 and 2004. The key question is whether the situation develops basically in line with such patterns, or it takes a genuinely original form.
Scenario №1 - the conservative one: a "soft" transition to stabilization, like it was noted in late-2006.
The local housing markets in Moscow, St. Petersburg, and a number of other cities saw the start of a natural decline in demand and sales volumes that by December 2006 had resulted in the price stabilization. Prices in St. Petersburg remained practically stalled through autumn 2007, while in Moscow they even slid at 3-5%, albeit for a short while, and it was only in October that year that they bounced back to the December 2006level. But the decline in sales volumes did not seriously affect the construction companies' ROI rates, nor it hit rates of construction of new housing.
This scenario had been fairly realistic through the spring of 2008, while the model forecast of changes in pricing was confirmed by actual data through September 2008.
Scenario №2 - a moderately pessimistic one: a "hard" transition to stabilization by analogy with the year of 2004.
At the time, after a rapid rise in 2003, a subsequent natural decline on the housing market was intensified by macroeconomic factors that took the form of a drastic rise in capital outflow as a consequence of an increasingly mounting conflict between the government and business. That triggered a 40-50% decline in sales of newly built residential property and financial difficulties for developers coupled with the liquidity crisis in the banking system (aggravated by the oversight authorities' elephantine moves), which mutually complemented and intensified each other. The housing prices in the capital cities discontinued their rise in the summer of 2004 and remained stable for a year in Moscow and year and a half in St. Petersburg, with a short period of decline in the spring of 2005. Other effects included frozen con-
struction sites, a number of construction corporations going bankrupt, protest actions by the deceived private investors, etc.
The first signs events could take such a course had manifested themselves by the summer of 2008. After three years of a steady growth in the volume of placement of new residential property in operation practically across all the regions, in the first half of the year the increment of this indicator vs. its prior year's value accounted for slightly over 3%, with the leading regions in terms of real estate prices (the city of Moscow, Moscow oblast and St. Petersburg) becoming the most problematic ones.
Since the early autumn of 2008 it seemed that the developments followed this particular scenario - in the 3rd quarter, there capital flight, banks faced liquidity shortages, a number of construction projects were brought to a halt, some developers went bankrupt, M&A processes intensified, objects and other assets were being redistributed, and new deceived private investors in residential property appeared, etc.
It was companies that banked on fast returns on their own minor investments through selling shares to private investors, i.e. by circumventing Federal Act of December 30, 2004, № 214-FZ "On participation in shared construction of blocks of apartments and other real estate objects and on introducing amendments to some legislative acts of the Russian Federation", which still is a fairly widespread practice, that were the first to face financial challenges. Chances for making such projects a success lie in a drastic growth in effective demand, which today seems highly unlikely.
Meanwhile, according to the analytical center "Inidikatory rynka nedvizhimosti IRN.RU", in 2007, there were just 9.2% of objects in Moscow built in compliance with provisions of the aforementioned Act; in Moscow oblast, the compliance rate was between 11% and 15%, while in the number of regions this figure was far greater. Notwithstanding these provisions, many corporations, including the largest, oldest and most credible ones, attempt to bypass the law, while the contract on shared participation in construction has formed nearly a sole guarantee that a given construction project will be completed. Companies that chiefly operate in compliance with the law overcome organizational complexities of the initial stage of construction by getting funds to finance their pojects from affiliated banks (including such options as acquisition by the bank of a stake in the developing company or a share in the project), which allows some hope for alleviation of risks associated with the declining market demand.
The companies that sought financial support from the domestic non-profile banks currently are at a greater risk of going bankrupt, as such banks have recently seriously tightened their lending conditions or stopped crediting developers at all. But there was some hope that the governmental measures of financial support of the banking sector and the stock market undertaken in the fall of 2008, would preclude the process from unfolding.
It was the companies that have recently completed large-scale borrowing on external markets by means of issuance of promissory notes, bonds and holding IPO that currently face the gravest financial challenges. Developers contributed to some degree to a sharp increase of the domestic corporate sector's indebtedness. The world financial crisis, increase in interest rates limited their possibilities for further borrowing overseas and complicated refinancing of such loans, which eventually undermined their financial health.
Under such scenario, one might have envisaged the offer housing prices to dwindle already since the late-2008, to further decline at 5-10% over the next half-year and to return to
the path of growth afterwards. Turning this scenario into reality in 2009 necessitates a high efficiency of the financial authorities' moves and market players' operations back-upped by the nationwide consensus between elites, mass media and the population.
Scenario №3 - the crisis one: despite the authorities' attempts, the financial crisis in the country mutates into the economic one.
Because of a contraction in orders and staff lay-offs, first in the financial sector, trade and construction, followed by many subsectors of the industrial sector, the population's solvency declines and, accordingly, the demand for residential property falls. There starts a sweeping M&A process in the construction sector. Should this scenario become a reality, the housing prices should fall at 40-50% over the year and their rise would start beyond 2010.
Scenario №4 - the catastrophic one: despite the measures undertaken by the US and European authorities and supported by other countries (including Russia), the world financial system that currently rests on the USD, would completely collapse, while establishment of a new one would take much time and colossal efforts.
The nations would take on the barter exchange coupled with a limited use of regional currencies. Because of distortion of their structures of import, the US, European, Russian and other countries' economies (including the real estate market) would follow the financial sector into an abyss, and their restoration (with an optimistic estimate of containment of armed conflicts) would take years, if not decades.
With account of the real developments in the autumn of 2008, the greatest chances to be realized had scenario №2 (75%), while realization of the other three ones looked highly unlikely (scenario №1- 0%, scenario №2- 20%, scenario №4- 5%).
These assessments allowed identification of the average weighted parameters of the price dynamic on the housing market that formed scenario №5 as the most likely one.
With account of the recent measures on support of the financial system and the construction sector (loans for banks, public procurements of residential property to fulfill social programs, increase in the financing of social benefits granted to certain categories of the population), the probability of a crisis in the development sector was estimated as a low one, assuming that it was going to be the crisis of individual (both small-sized and large) companies, rather than a systemic one. According to calculations made on the basis of some assessments, the price downfall should last roughly for a year and make up 20% on average relative to September 2008 (i.e. prices should be down to the December 2007 level).
Growth rates of placement of residential property in operation would fall with a prospect of contraction of their absolute value in 2008-2009. The fall in demand due to deterioration of the mortgage lending conditions would fuel modifications in the structure of house building (particularly in conjunction with the rising proportion of the budgetary financing in regions) , that is, relinquishing the upscale, so-called "business-class", housing in favor of the "economy-class" one, with its smaller-size apartments and lower prices.
Meanwhile, the liquidity crisis in the banking system and a possible redistribution of the market (bankruptcies, mergers and acquisitions among the developing and construction companies, the rise of new players) would reduce offer and modify its structure in favor of a high-quality housing, as all the levels of government may be keen to sell a notably greater share of the economy-class housing off the market, in the frame of government programs of support of construction companies.
In the current conditions, an appropriate move for the government is to support the market by boosting the population's effective demand, rather than to help individual developers. Should the effective demand be restored by 2010 against a shrunken volume of construction and offer of residential property, the market may enter a new cycle of renewal and housing prices rising up to a level that would secure a reasonable for developers ROI rate.
Given the analysis of the situation as of the start of the crisis, the average profitability rate of the construction business should drop for a year and a half, with no prospect for it to bounce upwards to the recent sky-high levels. So, large players that will have survived on the market by then, will be coerced to dump their former aggressive strategies and exercise more caution in weighing up business strategies.
Changes in the situation in the late-2008 and adjustment of the forecast
The change in the state of affairs in the economy, adoption of additional regulatory measures in the financial sphere on the federal and local levels, changes in the corporate and banking sectors' behavior demanded for a revision of estimates of probability of each of the above scenarios with a further adjustment of parameters of the fifth scenario as the most probable one.
More specifically, despite the deepening of the world financial crisis, such facts and developments as the appreciating USD and the November 2008 G-20 summit outcomes evidenced that the USD-based world financial system would not collapse any time soon. The new US Administration and its new ideas afforded certain grounds to assume that having survived through the period of recession, in 2-3 year time the US economy and its currency would step out of the crisis stronger than before. The possibility for a radical transformation of the financial system as a factor of the world economic crisis is still there, nonetheless. That is why the probability rate of scenario 4 remains unchanged.
Meanwhile, hopes for a better domestic macroeconomic situation, efficient government measures securing development of the situation according to scenario №2 have not come true as yet, with the course of events more and more heading for scenario №3.
First, the downfall in prices for oil as a major source of export revenues. In all likelihood the price downfall would last longer than a year, so the prices will remain low beyond 2009. Because of that, the RF Government was compelled to modify main parameters of the three-year federal budget for 2009-2011.
The correlation between the oil prices and the state of the housing market and price growth rates in Moscow and other Russian cities was researched into in the 2000s196. More specifically, studies into the correlation between the oil price dynamics and housing prices in the city of Moscow in 2002-2003 showed that the rise in oil prices at USD 5/barrel fueled a 1.2% monthly growth in housing prices on average. The further research in this direction proved the fact that the level of international oil prices was a core factor that affected housing prices nationwide, thus enabling one to single out in the development of the Russian housing market in the 2000s the stages of the "oil-fueled" growth (2002-2003) and the "mortgage-and-oil-fueled" one (2005-2006)197.
196 Sternik G.M. Statisticheskaya svyaz mesyachnykh tempov rosta na zhilye v Moskve i tsen na neft.-www.realtymarket.org, February 12, 2003.
197 See: Rossiyskaya ekonomika v 2002 godu. Tendentsii i perspektivy (Vypusk 24). M., February 2003, pp. 472473. Rossiyskaya ekonomika v 2003 godu. Tendentsii i perspektivy (Vypusk 25). M., February 2004, p. 386.
Second, a serious appreciation of the USD and EURO against the Rb. has emerged as a reality of the fall of 2008. The widening of the currency band was followed by a gradual depreciation of the Rb., which continued through the first two months of 2009.
In the conditions of a ubiquitous dedollarization of the real estate market, with the USD exchange rate rising from Rb. 25 in September 2008 up to Rb. 35 in February 2009 , it means an automatic 30% decrease of the USD equivalent of housing prices relative to those denominated in Rb.
198
The studies of the 1998-1999 crisis situation revealed that the bicurrency nature of the domestic housing market led to fundamentally different ways the housing prices behaved in the conditions of a sharp depreciation of the Rb. and a high inflation.
In the city of Moscow and other cities with prices quoted in USD (Russia-1), supply prices remained practically unchanged through the late-1998, while falling behind the rising prices in Rb. equivalent, buyers had walked out of the market by October that year, and transactions stalled. They came back to life only in 2-3 months, in the aftermath of the drop of the USD-denominated prices, which had been lasting for some two years.
In cities where the housing prices were denominated in Rb. (Russia-2, as well as the primary market in the city of Moscow) they continued to grow for 2 years, but their USD equivalent had fallen already by September 1998. Crushed by the downfall in the USD-denominated prices, the sellers had left the market yet in October, and all the deals were suspended. Meanwhile, the USD price equivalent had been just slightly decreasing over the two years.
Depending on possible inflation rates and depreciation of the Rb. against the USD, various combinations of developments can occur - either the sellers leaving the market, or an additional number of buyers doing the same. It is not quite clear whether the current dedollariza-tion of most markets (in the city of Moscow and Moscow oblast - the partial one) is going to be there for long.
Third, the recent capital flight, which became catastrophic over the last three months of 2008, has constrained the CBR's capability to counter the depreciation of the national currency. The Bank of Russia ended up with a notably shrunken volume of the nation's foreign reserves. But if the CBR had abandon that policy, the reserves would have exhausted in a relatively short time.
Having cut the volume of its interventions in the forex market between the autumn of 2008 and the winter of 2009, the CBR saved roughly as much as 2/3 of the reserves. But the question as to for how long they will last under the current price level for oil and the domestic economic situation remains unanswered.
The next negative development that added to the mounting pressure on the Rb. became the banks. Indeed, after non-residents fled the market in September 2008, the domestic banks stepped in, with their pockets full of the government financial aid, as major players in the capital-flight game.
Naive were hopes that the authorities would exercise an efficient control over a target use of the government aid. By the results of the year the capital flight became gargantuan and
Rossiyskaya ekonomika v 2007godu. Tendentsii i perspektivy (Vypusk 29). M., March 2008, pp. 551-553; also Sternik G.M. Prognoz razvitiya rynka zhilya Moskvy do 2005 goda.- Otchet AEKSIP, April 2003, www.realtymarket.org
198 Sternik G.M. Tri Rossii - tri rynka nedvizhimosti.- www.realtymarket.org. November 20, 1998. 520
totaled USD 130bn. On its way to the real sector the financial aid fell short of passing through certain "clots".
It is banks that dominate in the group of recipients of the governmental aid. More specifically, the public corporation Vneshekonombank (VEB) granted Rb. 200 bn. in a 10-year loan to Vneshtorgbank, Rb. 25bn - to Rosselkhozbank, Rb. 225bn- to regional banks, and Rb. 500 bn - to Sberbank199. It is not clear as yet how high the banks are going to place the construction industry and the real sector as a whole on the scale of their lending priorities.
The above should result in a fall of investments in capital assets in the real sector, including the house-building industry. The situation is further aggravated by the fact that, unlike a number of other industry branches, the house-building sector cannot boast large and connected with the government public corporations that form the group of main pretenders for the governmental aid. Furthermore, in the conditions in which the RF Subjects cannot any longer extend credits out of their budgets or play the role of a fidepromissor, the housing market saw no notable institutional novelties.
The only exception became the passage of Federal Act of July 24, 2008, №161-FZ "On assistance to promotion of house building". The Act suggests creation of a special federal fund for assistance to house building and sets termination of the organizations' right for the permanent use of land lots owned by the federal government without their consent and regardless of provisions of the Land Code of RF, should the powers on control and development of these lots for the sake of promotion of house construction are assigned to regional governments or the land lots themselves are assigned to the Fund to form its assets.
According to Mr. A. Braverman, the Fund's head, his structure might contribute to support of the construction sector (referring to projects that were halted due to the financial crisis) by stimulating the final demand with a subsequent sale of the residential property in question or its reassignment to municipalities200. There have been no updates on the Fund's operations so far, while the supreme political leadership already this year expressed an explicit displeasure with the tempo of works on procurement of the residential property sold to government agencies in the frame of the governmental support of construction companies.
From perspective of implementation, it is the capability of the public corporation "The Fund for assistance to the housing and utilities reforming" (FAHUR) created yet in 2007. The recently amended federal act allows a FAHUR-sponsored relocation of citizens from wrecking housing into newly constructed economy-class residential property, sobeit the construction of such housing is completed strictly within 6 months upon conclusion of a respective public contract. The Fund currently manages Rb. 50bn which is supposed to be spent on completion of construction of residential property in the regions, and a fraction of these funds is supposed to solve the above problem. According to the Association of Builders of Russia, presently construction of some % of all the housing projects in progress in the country is sponsored by private investors. Their community accounts for nearly 2m201 . That is why bringing construction projects to stall may spark a new wave of protests by deceived private investors who have invested their savings at the outset of a construction project. Some regional developers have already had their clientele face the dilemma: either they pay money in full, or the project will
199 Along with that, the RF Ministry of Finance has placed Rb. 1.5trln on deposits with commercial banks
200 A. Braverman, cit. by: Pora razmorazhivat. In: Kvartirny ryad, 22-28 January 2009, №2 (729), p.2
201 Cit. by: Kvartirny ryad, 5-11 February 2009, №4 (731), p.11
be brought to halt. Other corporations try to pacify their patrons by offering them a compensation for a failure to meet a project timelines.
At this juncture a certain role for future developments on the housing market and formation of a subsequent demand for mortgage credits may be played by a mortgage credits restructuring program the Agency for Mortgage Credits (AMC) adopted in the early-2009. But the program concerns a very narrow array of individuals - namely, those who have already
bought residential property, which naturally crosses it out from the list of measures on shaping
202
the future demand for housing . Like many other banks and companies, the Agency is to receive Rb. 60bn. in government aid to redeem the housing regional banks are holding as collateral by mortgage credits. Plus, the CBR proposed to establish on the basis of the AMC and Sberbank a special public agency on redemption of the mortgaged housing, that is, to enable insolvent borrowers to continue reside in such apartments and pay a rental fee at a level lower
203
than the market one .
In all, the governmental measures aimed at preservation of social programs chiefly concern only the groups of the population (pensioners, budgetary employees, the military, etc.) who have not entered the housing market earlier and were, as a rule, recipients of the social housing from the state. Meanwhile, retention or drop in incomes of the major group of buyers of housing formed by the private sector employees (not all of them, of course) depends on their corporations' financial state, as a part of them can face bankruptcy. Additional measures to lower the tax pressure on individuals (the tax rebate in the case of purchase of a housing has been doubled) and business (the corporate profit tax is now down at 4%) can alleviate, but not preclude the economy from sweeping head cutting and private individuals' incomes from falling.
Overall, as ascertained by E. Nabiullina, the RF Minister for Economic Development, the global financial crisis has exposed the exhaustion of the Russian economy's growth pattern which had rested upon high oil prices and the influx of cheap foreign credits to banks and corporations.
The developments in the period between December 2008 and the early-2009 (the continuous depreciation of the Rb., a further downfall in oil prices, a colossal capital outflow by the 2008 results, a miserable state of the stock market, problems with delivery of the government financial aid to the real sector, a 6% fall in the volume of industrial output in the 4th quarter 2008 and at another 16% in January 2009, the rising unemployment) allow one to discuss tangibility of a more pessimistic course of events compared to the forecast made in the autumn of 2008.
The above, with account of the real dynamic of the economic situation in the country in the 4th quarter 2008 and its impact on the market for residential property, compels one to appreciate appropriateness of adjustment of assessment of probability of scenarios №2 from 75% to 0% and №3 - from 20% to 95%, respectively.
The weighing gives the most probable scenario - №5, which de-facto contains all the prerequisites of scenarios №3 and №5 and includes the 2009 projections of the price for barrel of oil at the level of 40-45 USD, the USD/Rb exchange rate of 1:35, and a 13-14% inflation rate (Fig. 36).
202 www.ahml.ru
203 Cit. by: Gavrish A. Povorot syuzheta. In: Kvartirny ryad, 5-11 February 2009, №4(731), p.16 522
Under such scenario, at the lowest point (by late-2009) the housing prices in USD equivalent in the city of Moscow may fall at 40-45% vs. the September 2008 ones, while over the year - at 30-35%.
The Rb.-denominated housing prices should fall in 2009, too, but the level of their drop substantially depends on inflation. Should it be tamed within the range of 13-14% as per the government's forecast, the housing prices would slide at no more than 10-15%. But if the inflation rate surges up to 20-40%, the Rb-denominated housing prices can experience a trend setback and begin to surge, while the 2009 USD- denominated housing prices would plunge by 20-25%.
In contrast to the 1998 crisis, whose price trend took the U-form, under the current circumstances the market should begin to reinstate itself in 2011-2012, and the process should not be as fast as it was envisaged by the initial forecast (the L- shape of the trend) made in the autumn of 2008.
Q I I Ii I I I I 0 I 0 I I I I I I I i
SSSgsgSSS3SSg2S23S2
Fig. 36. The Scenario-Based Forecast of the Dynamic of Housing Prices
in the City of Moscow
This forecast is close to the one designed by the Sberbank's Center of Macroeconomic Research (CMR) (the estimates are given below).
In the event of a "soft" development of the situation, in 2009, the housing prices in Moscow would plunge at 20% in Rb. equivalent and at some 30% in USD equivalent. But with account of the fall in the 4th quarter 2008, when residential property began to loose its value, the ultimate downfall should account for 20-30% in Rb. equivalent and up to 46% in forex equivalent. In the event the situation develops following the worst possible scenario, as of the
rd
end of 2009 vis-à-vis the 3 quarter of 2008 the prices for residential property in the capital city would plummet roughly at 40% in Rb. equivalent and at 60% in USD equivalent, while the drop on the secondary market would account for 25% in Rb. equivalent and 50% in USD equivalent. Both scenarios imply a price downfall on the primary market being far more dramatic than that on the secondary market.
Nationwide, according to the CMR's forecast, the overall price downfall on the primary and secondary real estate markets would be less drastic when compared with that in the city of
Moscow. Under scenario №1, at the end of 2008 the price downfall (in nominal Rb-denominated prices) on the primary and secondary markets should have accounted for some 2.5% and in 2009 - between 5% and 5.3%. The aggregate price drop in USD equivalent should have been 25%. Under scenario №2, the aggregate downfall in prices between the late-2008 and the late-2009 should account on average for some 10-12% in Rb. equivalent and 4042% in USD equivalent. The less drastic fall in prices in the regions is explained primarily by their less significant rise in the period of growth, which is attributed to a looser impact the capital inflow had on the regional housing markets.
Main conclusions
In 2008, the national economy and the housing market, too, found themselves under pressure of the world financial and economic crisis, which has derailed the regular phase of its growth at the moment it started to come to an end.
The year of 2008 split into two time periods that display quite opposite trends. While until the end of the summer the price rise for residential property was noted across most of Russia's cities, since the autumn and especially in the 4th quarter of the year the prices were dwindling notably, which has led to their overall decline by results of the year. But the price fall was not ubiquitous, as there was a whole array of cities wherein the level of both nominal prices and real (with account of adjustment for inflation) prices posted growth vis-à-vis the late-2007. The composition of the group of such cities (Moscow, Moscow oblast, St. Petersburg and Tver) allows one to assume the impact of the "capital-city factor", that is, a particularly significant role the capital cities play in the national economy. The price downfall was particularly dramatic in the Ural and Siberian cities. The main factors behind the price downfall were the capital outflow, credit squeeze, a drastic deceleration of growth in the population's incomes, and rising wage arrears.
It can also be argued that the current crisis has so far battered the housing market more languidly than the 1998 one. More specifically, in 2008, the housing construction saw a drastic fall in the rate of placement of new volumes of residential property in operation, rather than their absolute contraction, albeit in the city of Moscow the respective volumes dwindled at 1/3 by results of the year.
Meanwhile, the overall situation in the economy leaves little chances for a soft overcoming of the crisis on the housing market. The regulatory measures by the government have left the housing market and the construction sector practically untouched. The mortgage lending mechanism found itself naturally squeezed, due to challenges facing the whole Russian financial system, with mechanisms supposed to substitute for it failing to emerge. In such conditions attainment of the target guides provided for by the national project on housing appears doubtful. Meanwhile, the effective term of the organizational and financial mechanism of its implementation and that of the federal target program "Housing" will expire in 2010. The current forecasts, however, suggest at best restoration of the housing market by that time. Accordingly, a new program should take into account the realities of the today's crisis and proceed from possible scenarios of the post-crisis renewal.
5.7.2. The Mortgage Market
The primary mortgage market
The volume of mortgage credits disbursed over the first three quarters of 2008 accounted for Rb. 537,463m. The volume of indebtedness over the period in question was Rb. 974,956m. The volume of mortgage crediting over the period grew 1.48 times vs. its respective period of 2007. At the same time, as of October 1, 2008, the volume of indebtedness by mortgage credits was twice as high vs. the respective figure as of October 1, 2007. The volume of mortgage debts as of January 1, 2008, accounted for 1.85% of GDP, while as of October 1, 2008 - 2.35% of the 2008 GDP. Accordingly, the indebtedness by all credits extended for the sake of house purchases was 2.30% of GDP, as of January 1, 2008, and 2.77% of the
rd
2008 GDP, as of the end of the 3 quarter 2008. The volume of mortgage credits disbursed in 2007 equaled 1.69% of GDP, while that over the 3 quarters of 2008 - 1.79% of the 2008 GDP.
Source: the CBR data.
Fig. 37. The Volume of Disbursed Mortgage Credits and Housing Purchase Credits
rd
As shown by Fig. 37, the 3 quarter of 2008 saw growth in disbursement of housing purchase credits to private individuals practically discontinued, while growth in extension of
,nd
quar-
mortgage loans was still there, albeit demonstrating a dynamic lower than that in the 2n ter.
Having reached its peak figure of 587 units, as of January 1, 2007, the growth in the number of credit institutions that disbursed mortgage credits stalled. As of April 1, 2008, it slid to 552 units, to bounce back to 586 units, as of October 1, 2008. According to printed
media and expert opinions, in the 4th quarter of 2008, the creditors not just reduced volumes of disbursement of mortgage credits, but many of them simply stopped granting them.
The growth in the proportion of indebtedness under mortgage credits in the overall volume of consumer credits was being on the rise. Over the 3 quarters 2008 the proportion of indebtedness under mortgage credits accounted for 24.31% of the volume of credits extended to private individuals, while in 2007 the respective figure was 18.23%.
16 14 12 10 8 6 4 2 0
2005 2005 2006 2006 2006 2006 2007 2007 2007 2007 2008 2008 2008 4%. 1*0 Z^Q 3">q 4%. l^Q 2ndQ 3% 4%. l^Q 2ndQ S^Q
—♦— The average weighted ¡merest rate on the Rb--denominated credits, as % —■— The average weighted interest rate on credits denominated in foreign currency, as % Source: basing on the CBR data.
Fig. 38. The Average Weighted Interest Rates
According to the CBR, in the first half 2008 the interest rates by Rb.- and forex-denominated mortgage credits in Russia (Fig. 38) still tended to decrease, and it was only in the 3rd quarter of the year that they began to rise. Between the 1st quarter and the 3rd quarter, the interest rates by Rb.-denominated credits soared at 0.3 p.p. - from 12.4% up to 12.7%. Meanwhile, the interest rate on forex-denominated credits surged at 0.1 p.p. - from 10.8% in the 2nd quarter to 10.9% in the 3rd quarter of the year.
The behavioral peculiarities of mortgage interest rates in the 4th quarter 2008 are highlighted by the average weighted offer rates on mortgage loans (Fig. 39) calculated on the basis of loan programs run by 25 banks (calculations and monitoring by Creditmart). In the 4th quarter, the fixed Rb.- denominated rate was over 18%, while the floating one - over 28%. As of end-December, the average weighted offer rates on mortgage credits calculated by the 25 banks' programs (calculations and monitoring by Creditmart) were:
- Fixed, in Rb. - 18.15%;
- Fixed, in USD -14.13%;
- Floating, in Rb. - 28.50%;
- Floating, in USD -10.39%.
-Fixed, in Rb. -Floating, in Rb.
Fixed, in USD -Floating, in USD.
Source: Creditmart company
Fig. 39. The Average Weighted Offer Rates by Mortgage Credits
Region-wise, the average weighted mortgage rates display a substantial dispersion. As of October 1, 2008, the average weighted Rb.-denominated mortgage rate in Khanty-Mansy autonomous okrug was 11.8%, in Volgograd oblast - 13.0%, and in Chechen Republic-13.3%. The mortgage rate as of the same date in Nenetsky autonomous okrug was 6.5%, while in Kurgan oblast - 12.3%.
The average weighted mortgage terms has tended to grow steadily. According to the
rd
CBR, in the 3 quarter 2008 they reached 213.9 months for Rb. -denominated credits and 206.9 months for forex-denominated credits.
The first half-year of 2008 saw persistence of the trend to growth in the proportion of indebtedness under Rb.-denominated mortgage credits in the aggregate volume of Rb.- and forex-denominated credits. More specifically, the share of loan debts rose from 78.7% as of early-2007 up to 86.7% as of July 1, 2008 with a subsequent 0.7% drop as of October 1, 2008. But due to the depreciation of the Rb. concomitant with a respective rise in forex-denominated risks, the proportion of forex-denominated credits was down in the 4th quarter 2008. More specifically, as evidenced by "Kommersant" on December 25, 2008, Sberbank announced a moratorium on disbursement of forex-denominated credits to private individuals for an unspecified term, while Rosbank canceled its program of issuance of mortgage credits in foreign currency.
The list of leading banks by volume of loans disbursed in the first half 2008 is topped by Sberbank (Rb. 157bn and 167,000 credits), followed by VTB Group (51bn and 19,500 credits), Uralsib (14bn and 8, 600 credits), DeltaCredit, etc. The leading credit organizations continued concentrating mortgage portfolios - while in 2007 the top ten credit organizations held
54% of the national mortgage market, their market share in the first half 2008 was already 83%. As of beginning of the 4th quarter 2008, volumes of the Russian banks' mortgage portfolios were as follows (see Table 18):
Table 18
Volumes of the Russian Banks' Mortgage Portfolios
Sberbank Rb.243bn
VTB24 n/a
URALSIB Rb. 46.4bn
KIT-Finance IB Rb. 42.4bn
Absolute Bank Rb. 34.775bn
Raiffaisenbank Rb. 28.6bn
Bank of Moscow Rb. 21.7bn
Rosbank Rb. 16.323bn
RIB Rb. 11.3bn
Gasprombank Rb. 5.6bn (as of August 7, 2008)
Promsvyazbank Rb. 2.151bn
Source: RealEstate.ru.
It is now common knowledge that it was subprime borrowers' failure to repay their debts that triggered the mortgage crisis in the US. In Russia, the proportion of outstanding debts by all credits to private individuals was being on the rise in 2008 and reached 3.7% by the end of the year (Table 19).
Table 19
The Dynamic of the Rise in Indebtedness across of Kinds of Credits in Russia
Credits to private individuals, as Rb. bn
Overdue indebtedness, as Rb. bn Overdue indebtedness, as %_
Source: The CBR data
According to the CBR data, the overdue debts under Rb. 339,185v- worth mortgage loans granted in the 1st half 2008 totaled Rb. 2,519m, or a.31% of the overall volume of indebtedness. The volume of indebtedness under mortgage credits over the three quarters of 2008 accounted for Rb. 974.5bn, of which the overdue debts made up Rb. 4.95bn, or 0.51%. These figures testify to a high quality of mortgage loans disbursed at the time; however, with the crisis gaining momentum, this quality may be not enough.
Table 20
The Sum of Balances of Debt under Overdue Credits to the Sum of Balances of Debt by All Credits Ratio in the Agency for Mortgage Credits's Portfolio Ratio
01.01.07 01.01.08 01.07.08 01.09.08 01.10.08 01.11.08 01.12.08 01.01.09
1877 2963,6 3580,7 3880 4007,5 4072,8 4043,9 4005,8
50,3 96,4 119,1 123,3 131,2 133,7 143,3 148,3
2,68 3,25 3,33 3,18 3,27 3,28 3,54 3,70
Date 1.06.08 1.07.08 1.08.08 1.09.08 1.10.08 1.11.08 1.12.08 1.01.09
Ratio, as % 5.18 5.53 5.59 5.64 6.03 6.50 7.51 7.95
rd
By results of the 3 quarter 2008 the averaged nationwide proportion of delinquent loans on the Agency's balance- sheet accounted for 6.03%. By results of the 4th quarter of the year it surged up to 7.95%.
In a number of regions it has run record high: as of October 1, the proportion of defaulted loans in Stavropol krai was 25.9%, Kostroma oblast - 24.2%, Republic of Mary-El-26.8%, and in the Republic of Altay - 23.4%. The proportion of credits with the length of default over 180 days rose at 1.4 p.p. and accounted for 4.8%. In the 4th quarter 2008, the biggest proportions of overdue debts were noted in Saratov oblast and Kostroma oblast (31.8% and 27.7%, respectively).
The other refinancing institutions also face the problem of rising proportion of overdue credits. But so far the failures to repay credits can be attributed to borrowers breaking the financial discipline, rather than to defaults, as there has been no respective rise in foreclosures.
To lower credit risks in the crisis conditions, many banks have tightened their requirements to borrowers, particularly by raising the threshold value of the first installment under credit, cutting volumes of disbursed credits or suspending crediting. Pre-crisis, the market even saw credit offers with a 5% first installment or no installment at all. Since October 2008 the banks began approving mortgage loans against the 30% first installment.
Since that time, the state-owned banks have drastically cut mortgage lending volumes. Specifically, effective as of October 4, VTB24 (as a reminder, No. 2 in terms of volume of mortgage lending) announced a moratorium on acceptance of applications on purchase of housing whose construction was in progress and applications on improvement of housing conditions. As well, the bank cut its credit programs at 13% down to Rb. 7.7 bn. Sberbank also reiterated that it is the quality of a credit portfolio, rather than the volume of disbursement, that forms a priority.
Having raised its interest rates on Rb.- and USD-denominated credits, Alfa-bank ruled to cut limits on its "automobile" and housing credits five-fold vs. the 2008 figures, down to USD 150m by each segment. The Moscow Mortgage Agency (aka MIA) also increased its rates and suspended a lending program with floating interest rates.
But since December 2008 some banks have begun decreasing their mortgage lending rates. For example, Alfa-bank and DeltaCredit cut them by 2 p.p. on average. The banks refer to an easier access to financing both on the domestic and international markets.
Refinancing, the secondary market
JSC "The Agency for Mortgage Credits" has become the first public refinancing institution. As many as 145 organizations in 75 Russian regions extend mortgage credits using the AMC Standards. As of January 1, 2009, the Agency refinanced 135,857 mortgage credits worth a total of Rb. 105,294bn.
The AMC attracts financial resources to the market for mortgage credits by issuing two kinds of bonds. These are mortgage bonds secured by discharged mortgages and corporate bonds under the governmental guarantees. The Agency placed 11 series of corporate bonds. The first one has been already repaid. As well, the Agency completed issuance of 2 series of mortgage bonds worth a total of Rb. 3.3 bn and 10.7bn, respectively. In compliance with the 2008 Federal Budget Act, the government granted the Agency guarantees under its corporate bonds worth a total of Rb. 28bn (4 series have been registered to date) and may provide additional guarantees worth a total of Rb. 36bn. in 2009.
Table 21
Volumes of Mortgage Retirements by Leading (According to the Rusipoteka's Rating) Refinancing Organizations on the Secondary Market for Mortgage Lending (as Rb.m.)
Company 2001 2002 2003 2004 2005 2006 2007 3 months 2008 6 months 2008 9 months 2008 12 months 2008
AMC 7 36 678 3 952 7 829 27 053 39 298 4 764 12 995 20 248 26 427
GPB-Ipoteka - - - - 4 071 13 203 13 930 3 281 5 716 7 763 n/a
ATTA-
Ipoteka - - - - 778 6 643 3 781 - - - n/a
KIT Finance - - - - - 3 241 6 740 n/a 10 10 n/a
VTB - - - - - - 11 675 5 518 10 853 14 548 n/a
Russky
Ipotechny - - - - - - 1 658 H/g 1 872 2 545 n/a
bank
Source: Rusipoteka.
As of November 6, 2008, the Federal Service for Financial Markets has registered issuances of nonconvertible housing bonds with the AMC mortgage hedging worth a total of Rb. 11, 33 bn.
The Agency is going to complement a direct retirement of mortgage from the banks operating according to its Standards with retirement of mortgage bonds issued by any other banks. In addition, the Agency is going to issue to banks warrantees that will guarantee the quality of the Agency's mortgage bonds and inclusion of such papers in the Bank of Russia's Lombard List. The Agency is going to spend over Rb. 600 bn. on support of the mortgage lending system. The government has recently ruled to increase the Agency's authorized capital by Rb. 60bn. With these resources at hand, the AMC is going to issue yet another pool of warrantees to primary creditors worth a total of Rb. 500bn.
Getting the banks' existing mortgage bond portfolios into turnover in many instances is challenged by their failure to meet the legislative restriction which demands that residential mortgage-backed securities may be issued only under a cost recovery involving mortgage bonds the credit under which does not exceed 70% of the value of the collateral. The banks earlier would circumvent the restriction by means of external securitization and attraction of capital from overseas sources.
Also possible is an arrangement under which the AMC and the bank enter into a swap deal, i.e. the Agency swaps its corporate or mortgage bonds for the bank's mortgage credits portfolio. The bank can also use that as collateral against REPO funds it receives from the CBR.
In addition, the government ruled to earmark from the budget an additional Rb. 200bn to the AMC to support the population and banks that deal with mortgage lending. In the crisis conditions, the borrowers who no longer can honor their obligations under a mortgage credit are going to have a grace period, thanks to the Agency restructuring their mortgage credit.
In addition to cooperation with the AMC, Sberbank is going to grant borrowers, who have lost their incomes due to job cuts or have their incomes plunge drastically, a grace period and installment plans by credits not pertaining to mortgage.
In late-November 2008, Sberbank disbursed Rb. 5bn in a loan to the AMC under guarantees of receiving Rb. 60bn the government had earmarked to boost the Agency's capital. 530
Between 24 and 28 November, the Agency refinanced as many as 1,247.000 mortgage bonds, or at 23% more than during the whole month of October. While the October volume of refinancing made up slightly over Rb. 1bn, the last 4 days of November saw the redemption of mortgage bonds worth a total of Rb.1.3bn-plus. As of early-December 2008, direct purchases of mortgage bonds from banks accounted for 80% of the Agency's ongoing operations. Initially, the Agency carried out refinancing operations via its regional mortgage operators, as the market was nascent and banks had no experience of working with the AMC. The regional operators were primary creditors themselves; in parallel with that, they were buying mortgage bonds from banks. Now that the banks have accumulated credit portfolios sufficient to carry out the direct refinancing operations, they have found it more profitable to work directly with the Agency, as this enables them to expedite the refinancing of the disbursed credits, thus boosting up their own liquidity.
The AMC considers a possibility for a deferral for 1 or 2 years of the discount under redemption of mortgage bonds from banks. In September 2008, the Agency introduced a discount or even a premium, depending on rates of redeemed mortgage credits. The discount rate varies from 2 to 6% depending on the quality and the rate of return on the credit. Because of the introduction of the discount, the Agency's regional partners may loose some Rb. 300bn.
Legislation and legislative acts
In compliance with the recent amendments passed by the State Duma, the size of the tax rebate pertaining to the purchase of residential property was retroactively doubled and currently accounts for up to Rb. 2m, effective as of January 1, 2008.
The government plans to procure from the market over 40,000 standard apartments and is going to allocate Rb. 83bn to this effect.
On December 19, 2008, the State Duma passed in three readings at once the Act on the possibility to use the maternity capital to repay mortgage credits. The Act has become effective as of the early-2009.
On November 19, 2008, the Duma passed in the second reading amendments to the Act "On mortgage (mortgage of real estate)" and some other legislative acts of RF that specify procedures of transferring rights on mortgagers. The amendments are to improve procedures of a transfer of huge "pools" of mortgagers. The document proposes to establish an institution which would run depository records of rights for mortgagers, which suggests that transactions that involve mortgagers are to become fixed in respective records, particularly using special technical means, by the depository institution. The establishment of such an institution should bring mortgager turnover costs down.
The CBR is going to moderate for 1 year its provisioning rates across all types of credits for banks, thus substantially extending the timeline for a coercive increase of the provisioning rate. Now the loan servicing will be recognized as a "good" one in the event the repayment delay for private individuals does not exceed 60 days and that for legal entities - 30 days. The "moderate" credit is the one the delay with repayment of which for private individuals does not exceed 90 days and that for legal entities - 60 days. Finally, the "bad" credit is the one the delay with repayment of which for private individuals does not exceed 120 days and that for legal entities - 90 days. From now on the fact of the loan restructuring per se will not affect its quality, as well as disbursement of a new credit to repay the previous ones will not have an adverse effect on the quality of the portfolio.
5.8. The Military Economy and a New Stage of the Russian Military Reform
The 2008 military and economic processes in RF have found themselves affected by changes in the nation's military and political leadership - the new Supreme Commander-inChief, new faces on key positions in the Ministry of Defense and the General Staff of the Armed Forces of the Russian Federation. A new stage of the military reform that started in 2007 was pursued more vehemently, which can partly be attributed to the events in the Southern Ossetia and Abkhazia. The military conflict between Russia and Georgia showed that the Russian armed forces had not been quite ready even for such a "five-day" war. Hence not only the intensification of the military reform, but its revision in many aspects.
Russia's military economy has also begun being affected by the global financial crisis.
5.8.1. Doctrinal Documents and their Impact on the Military Economy
The traditional fundamental documents of a long-term effect - namely, the 2000 Concept for National Security and the equally outdated Military Doctrine of RF mostly have fallen short of matching the changed environment. Their revision was clearly procrastinated. All experts sensed that; however, different generals have different vision of prospects for reforming the Russian army.
Delays with designing the military-strategic conceptual documents can be partly explained by the fact that it had been envisaged to develop in 2008 a uniform long-term government strategy and strategies proceeding from that (subordinated conceptual documents) by individual aspects of the government policy. Table 22 presents an attempt to regulate individual provisions stipulated in the conceptual documents, starting with an analysis of the Con-cept-2020 as a backbone one204.
A new military doctrine should appear, of course, upon approval of the National Security Strategy; however, one should start with revising the mission of the nation's Military Establishment and its components, such as the Ministry of Defense and the legislative concept of "defense" in particular.
The fact is that back in 1996, the Act "On defense" failed to include a reference to the population as a principal object of defense exercised by the Armed Forces of RF. As a reminder, the concept of "defense" was revised after a series of exceptional events, including the use of the armed forces in the territory of RF to solve political and domestic problems in Moscow in October 1993 and, later - starting from December 1994 - in Chechnya. The exceptional use of the armed forces originally designated for protecting the nation from an armed aggression from outside was explained by a special appropriateness. But was the exalting of this peculiarity to the rank of a permanently effective law, thus conflicting with the RF Constitution and a more general Act "On security" a legitimate move? The current Act "On defense" has been de-facto reduced to the military security of the state only, which has affected the
205
whole complex of works on modernization of the army205. An assessment of the Russian armed forces' performance, its equipment, orientation of the combat service and operational training in the peacetime depends on the formulation of the mission, objectives and tasks of the armed forces' activities.
204 The Concept for the long-term development of RF for the period through 2020.
205 Tsymbal V.I. Osobennosti modernizatsii voennoy organizatsii Rossii, obuslovlennye voennoy refor-moy//Vooruzheniye. Politka. Konversiya. 2005.№4, pp. 30-35.
Table 22
Outputs of the Analysis of Conceptual Documents
№
Conceptual documents and their _major provisions_
Comments
The Concept for the long-term development of RF for the period through 2020.
The section of target guidelines references to the importance of ensuring the society and citizens' security, which "should create conditions for releasing the population's innova-tional potential and a dynamic development of business". As a separate issue the Concept enunciates the need for attaining a high level of fighting efficiency of the Armed Forces of RF, which should match " the level of the advanced in military terms nations", particularly on the basis of the economic and social development of the nation's military organization.
Notably, there are no purely military challenges in the list of concrete ones, proceeding from which the military build-up should be planned. This means that the traditional approach to the planning that suggests orientation to an envisaged type of a war or even a probable enemy is unqualified.
Strategy of the national security of RF - through 2020
Strategy of building-up and development of the Armed Forces of RF-through 2020
Strategy of the social development of the Armed Forces of RF- through 2020206.
Has not been complete in 2008. Judging updates on the content of the draft, it should specify objectives and indicators that characterize all challenges and aspects in the security area, starting from the economic one and including military security indicators, among others.
Approved in early 2008 as a classified document.
Approved by the decision of the Collegium of the Ministry of Defense of 28.03.2008. In compliance with Order №241 of 28.04.2008 by the RF Minister of Defense, a Commission on the strategy implementation was established.
5 Main guidelines of activities of the RF Government - through 2012
The document contains a sub-section entitled "Ensuring the citizenry's private safety". It characterizes avenues of the Interior Ministry and the RF Ministry of Civil Defence and Emergency Response's (aka EMERCOM) operations, and a section entitled "Provision of the national security" which characterizes activities by the Ministry of Interior, FSA and other law enforcement agencies with respect to various aspects of the national security, including "security in the economic sphere.
Regretfully, even this particular document carries controversial provisions. For example, it declares promotion of "attractiveness of the military and law enforcement activities on the labor market", but, at the same time, cites such allegedly "stimulating" bonuses to the contract soldiers' monetary allowance that fail to bring it closer to the average salaries and wages nationwide. The document also lacks any reference to the priority of boosting up the dual-use knowledge, technologies and innovations._
2
3
4
As a reminder, from the perspective of the effective national law on defense, the "first Chechen campaign" resulted in the RF Ministry of Defense's success in accomplishing its mission, which is "securing the country's territorial integrity". Meanwhile, the fact that the then accomplished mission led to battle deaths of the Russian troops and- to a far greater extent - casualties among ordinary citizenry, as well as colossal damages to the population was interpreted only as costs inevitable under pursuance of the mission. That is why the Russian army used the warfare designed to counter an external aggressor, and there was no stress was laid upon using special, nonlethal, or precision weapons. Nowadays, an evaluation of arms programs and reports on their implementation suggests that no special attention has been paid to these means. With the effective formulation of the concept of defense, even the mission of the aerospace defense also appears a secondary one. In this context, declarations of the need for reinforcing protection from airstrikes of military, industrial and governmental objects,
207
rather than the population, do not look accidental207.
206 Strategiya sotsialnogo razvitiya Vooruzhennykh Sil Rossiyskoy Federatsii na period do 2020 goda//Krasnaya zvezda. 2008. 18.04 (№67).
207 Gavrilov Yu. V koltse zenitok//Rossiyskaya gazeta. 2008. April 30 (№94)
The focus on a genuinely voluntary manning of the regular components and increase of the status and legal protection of the army men, and provision of the safety of the military service in the peacetime have fallen short of being on a duly level.
The above rationales for amending the Act "On defense" have been in part already pub-
208
lished , but they had been prepared prior to the August 2008 events, which proved the actualite of our proposals.
5.8.2. The August 2008 Events and Their Effects on the Military Reform
In many countries worldwide, analysts have studied with gusto the August 2008 military actions, which were carried out in all the spheres, including the informational one. As for experts in the military economics area, it is not less important a task for them to analyze the military-economic aspects of the said events, either. First, the war once again has proved in-formativity of a series of military-economic indices serving as indicators of an aggressor's military preparations. The rise in the level of military expenditures (in absolute terms and as a share in GDP), participation in combat missions outside a country coupled with an intense rotation of the combat staff - these and other indicators signaled of a high probability of Georgia's invasion of the former soviet autonomous establishments' territory.
While motivations behind Georgia's military preparations and actions are of a sheer political nature and as such they transcend the framework of a military-economic analysis, we are keen to examine conclusions that lie within the noted framework.
First and foremost, the conflict has proved correctness of the course towards professional training of troops and their equipment with precision warfare pursued by most contemporary states.
There also arise several conclusions related to the warfare means the sides applied.
It appears extremely inhuman that the aggressor used jet-propelled volley-fire systems of the Russian and foreign origin, heavy ordnance and panzer forces, as well as aerial bombs. But, regretfully, to force the aggressor to peace, the Russian side likewise deployed mostly the same warfare. The Russian forces' dominance was obvious; however, the comprehensive support still raises questions. The Georgian troops were equipped with GRS receiver-indicators, combat identification systems, and far more sophisticated communication means, while the Russians used primitive ones.
The warfare, too, exposed numerous problems, and not only from the perspective of their reliability. To ensure its retaliatory strike, Russia should have used precision antimateriel weapons to cover the enemy's AA systems and core ground military objects (targets). Russia supplies such warfare to other countries - suffice it to remember it has helped India to launch their production and supplies to the national armed forces. But the Russian army had had no such weaponry on hand by the start of the August conflict.
Hence, once again there arose problems associated with development of Russia's military-industrial complex, which is fenced off the public control and fair competition. It appears disconnected from new domestic production which could contribute with its potential and ideas to the military R&D sphere.
208 Tsymbal V. neobkhodimost sovershenstvovaniya kontseptsiy i systemy upravleniya voennoy bezopasnostyu
Rossii//Economico-politicheskaya situatsiya v Rossii. 2008. May. pp. 65-70.
5.8.3. Changes in the Military Manpower Policy, the System of Manning and Social and Economic Provision of the Military
The previous federal target program (FTP) of the army's transition to the voluntary contract-based principle of manning failed in late-2007. The promised "final fulfillment" of the FTP by early-2008 failed, too. Furthermore, the analysis of the events of August 2008 in Southern Ossetia suggests that, having spent some Rb. 100bn on the FTP, we have failed to achieve its major objective, that is, the manning of the units of constant combat readiness (CCRU) with contract soldiers, even in the North Caucasus - contrary to the earlier heard from high offices assurances that conscript personnel would not take part in combat, in reality, just days after joining in the army and absolutely untrained, they did commit together with the contract soldiers.
While evaluating the newly adopted 2008 FTP, one would like to know if it takes into account of the mistakes of the previous stage, as far as the reform of the manning system is concerned. Let us compare these two programs.
1. The title. The previous program was entitled "Transition to the manning with the military doing their service under contract of a number of units and formations for 20042007". The title of the new program is far more prolix and bombastic -"Improvement of the system of staffing positions of sergeants and privates with the military transferred to the military service under contract and implementation of the manning of positions of sergeants (sergeant majors) of the Armed Forces of RF, other service arms, military formations and agencies, as well as seamen of the shipboard personnel of the RF Navy with the military doing their service under contract (2009-2015)".
2. Justification for the need for improvement of the manning system in the approved by V. Putin Concept of the FTP209 contained a fairly accurate ascertainment that, "if maintained, the system of the mixed manning shall inevitably result in: decrease in the number of the military doing their service under contract; a further decrease of attractiveness of the military service in the Armed Forces of the Russian Federation; loss of specialists capable of securing a qualitative maintenance of the military hardware and accomplishing assigned tasks; an inefficient work on training the junior command personnel".
However, the recently adopted FTP has set such parameters that would preserve the mixed manning system of the regular forces, at least, through 2016. The above fragment has been crossed out of the finally adopted FTP, which is most likely to testify to the presence in the echelons of power of a mighty "lobbying" on behalf of corruptionists.
3. Discrepancies in formulation of objectives. The previous FTP stipulated as objectives both "ensuring transition to manning with the military doing their military service under contract of military positions due to be substituted by privates and sergeants in formations and military units of constant combat readiness of the Armed Forces of RF, military units of the border-security forces and the Interior Ministry troops transferred to the new way of manning" and "improvement of combat readiness of the noted formations and military units". The new FTP contains no reference to combat readiness - the objective now is "manning by 2016 by contract of positions of sergeants (sergeant majors) of the Armed Forces of the Russian Federation, other service arms, military formations and agencies, as well as seamen of the shipboard personnel of the RF Navy".
209 Resolution by the RF Government of 15.07.2008, №1016-r.
4. Chronology. The new FTP was formally approved in the aftermath of the military clash in the Southern Ossetia and Abkhazia. However, an in-depth analysis reveals that it has failed to take it into consideration. It was later that the Russian leadership realized that the Russian Armed Forces' combat efficiency is very low. The RF President demanded to transfer "all the military units" "to the constant combat readiness" category. But no one has made any reference to the FTP, while it is evident that its objective is against the dictates of the time and situation.
5. Main tasks of the new FTP and direction of the planned measures: 1) improvement of conditions of housing for contract troops of rank and file, including those transferred to contracts under the already completed FTP of 2004-2007, and 2) ensuring attractiveness of the contract enlisted service and creation of conditions for the manning. Once it comes to the stimulation by means of monetary allowance, the FTP appears very laconic - for the seamen of the shipboard personnel of the RF Navy the "stimulating allowance" was kept at the present, long depreciated level - Rb. 3,300 a month, while that for sergeants and sergeant majors it is even lower and accounts for 100% of the rates of pay according to the military position, which currently are Rb. 2,304 and 2,496 a month.
There is no reference to the task of increasing the combat efficiency, which corresponds to the general "logic" of the FTP, as an army manned by even very well trained sergeants and untrained privates (who would form the bulk of it) cannot boast a high level of combat efficiency.
6. The planned expenditures on implementation of the new FTP made up a total of Rb. 243,437.64bn in the prices of the current years. The Program reads that the sum in full shall be spent on capital construction.
7. The comparison of socio-economic efficacy of these programs raises numerous questions. The previous FTP envisaged the following outputs: 1) lowering the public dissatisfaction with the then existing system of manning the Armed Forces, other service arms, military formations and agencies with conscripts and deploying those for military service in flash points; 2) establishing prerequisites for reducing the length of the military conscription to one year since 2008. But even after that FTP was complete, conscripts are still deployed to "flash points" and take part in military action, with consequent war and nonwar casualties.
The new FTP contains expressed in trait words hard-to-check intentions: 1) increase of the prestige of the military service and promotion of the Armed Forces of RF, other service arms, military formations and agencies' positive image; 2) improvement of the moral and psychological climate by promoting the junior commanders' status and credibility. Meanwhile, the FTP has failed to provide for assessment criteria of fulfillment of these objectives. For example, what about a twist of the moral and psychological climate in a situation when a sergeant who is a secondary school graduate with the inadequate monetary allowance is in charge of a university graduate? To make things even worse, let us assume the latter is a young father "distracted" for a year of military service from the average salary (which in RF is twice as high vs. the sergeant's monetary allowance), while his wife is entitled to a monthly compensation of Rb.6,000. What will the relationship between these two military be like? And how will they get along in their joint service?
8. The organizational and managerial aspect raises a certain concern, too. Judging the wording of the newly adopted FTP, it has left the systemic defects of the previous one fully untouched (let us note the deficiencies in question had underpinned its failure in 2007). The
extra-departmental control is missing, and so is the public one. For example, the appropriations under the auspices of the previous FTP, particularly those on capital construction, have been already spent, but contract troops still have nowhere to live, and the situation needs to be remedied in the frame of the new FTP. At the new stage, there are no guarantees of an efficient control over the budgetary spending, unless the public control is in place.
The above evaluation suggests the following conclusions:
1. The newly adopted FTP will ultimately fail to ensure progress in the system of manning. The Program centers on tackling a much-needed objective of fixing the life of contract troops and their families, albeit it essentially is a sub-mission. It is only in this sense it can be of a certain avail, and it should have been entitled in this manner. If, however, an FTP is supposed to deal solely with capital construction, while it is tagged as "improvement of the manning system", the title becomes a smokescreen, behind which there is some generals' unwillingness to abandon drawbacks of the current system of manning and the present nature of the military service, as someone benefits from them.
2. The new FTP has to be urgently revised, along with a mandatory attraction of independent experts and representatives of public organizations. Paradoxically, in this situation, public organizations should enter into alliance with V. Putin and D. Medvedev and make them aware of the situation with the new FTP. This would enable the Russian leadership to ensure an efficient and swift resolution of the problem of manning the army. As a reminder, it was V. Putin who approved the concept that contained an absolutely accurate assessment of the need for transferring the armed forces of RF on the contractual basis; likewise, it was D. Medvedev who demanded to ensure the permanent combat readiness of all combat military formations. But this is impossible to do without a forced transition to the voluntary, contract-based method of manning coupled with the securing of a great attractiveness of the military service.
The above IET's assessments and recommendations were published in analytical materials, submitted to the Ombudsman of RF and made available to the general public. It is hard to measure efficiency of such steps, but in conclusion it is worth noting that in early-January
2009, an excerpt of a decree on the size of the national armed forces was published. Shortly
210
thereon the society was informed of some new four-year FTP, which should allegedly result in "as many as 85,000 junior commander positions becoming professional by 2013". The number of professional sergeants should grow up to 250,000. Their training would take three years, and this mission will be assigned to a number of institutions of the higher military education and the former schools for warrant officers. There have been many repetitious statements like this, but the FTP has remained unchanged.
5.8.4. Modification of the Military-Technical Policy and Plans of Equipage of the Armed Forces of RF
Between June and September 2008 the RF government proved the constancy and continuity of the national military-technical policy on the whole as well as means of ensuring these policy characteristics.
At the government meeting of June 30, 2008, on discussion of the 2009-2011 draft federal budget, the Chairman of the RF Government V. Putin announced that the proportion of
210 Gavrilov Yu. Million shtykov k 2016 godu//Rossiyskaya gazeta. 2009. January 14 (№2).
expenditures on development of the Armed Forces of RF in the overall budgetary expendi-
211
tures would start growing since 2009 to ultimately reach 70% by 2015, i.e. confirmed the course the Security Council of RF had embarked upon during his term in office. But the current Russian leadership's military-technical policy objective should become securing the necessary level of the country's defense capacity, rather than pumping money into the military-
212
industrial complex. Unfortunately, even Russian economists do not always understand this .
The PM is undoubtedly well aware of the national military-technical policy bottlenecks. In three weeks prior to the noted statement Mr. Putin participated in a meeting on problems of planning the state defense order in the 2009-11 draft federal budget. He put the following tasks before participants in the meeting: transition to commercial supplies of new military hardware, concentration of resources on completion of promising projects, sobeit one fixes the
213
situation with project completion timelines and with prices . Prime-minister emphasized
214
both the danger of inflation and his hopes for Rosoboronpostavka's pro-active stance with respect to stabilization of prices for military merchandise.
In this context it is interesting to examine an interview given by Mr. S. Ivanov, the Chairman of the Military-Industrial Commission and Deputy Chairman of the RF Govern-
215
ment, and in this capacity a key player of the Russian military-technical policy .
But after the August 2008 events, it became clear that the arms program was bad and in need of a drastic modification.
Mr. S. Ivanov identified the following challenges facing implementation of the militarytechnical policy: anarchy in pricing, a customers' poor justification for technical specifications, and breaking the compulsory 2-month deadline for placing the defense order (by late-April 2008, the contracts that had been concluded to date were worth a total of 65% of the respective volume of budgetary appropriations). Plus, Mr. Ivanov noted that the number of corporations that refused to take part in tenders on placement of the state defense order was on the rise. Echoing the PM's words, Mr. Ivanov believes that the main cause behind such a situation is the manufacturers' overpricing, despite Resolution of the government №549 of August 2007 "On approving Procedures of development and implementation of the state arms programs".
The negative tendency to an increasing inefficiency of the budgetary spending on defense is unlikely to be reversed by a mere boosting up of the volume and proportion of expenditures on development against the background of the Soviet legacy - namely, inefficient institutions of the arms program and the state defense order. The Chairman of the Military-Industrial Commission can lament infinitively about unscrupulous producers' pricing, but until, for instance, Resolution #549 remains unpublished in open media, it will be up to the contract parties' freedom of will, rather than his to set rules of the game (and, accordingly, prices for military merchandize) on the domestic market.
As quoted on http://www.government.ru/content/rfgovernment/rfgovernmentchairman/chronicle/ ar-chive/2008/06/30/1884577.htm. In the accompanying video, V.Putin references to 50%.
212 For example the PM spoke to defense expenditures, which is very correct, as today they are spent, mostly guzzled away. But defense expenditures should be allocated for development. This suggests utterly different methods and approaches in this sphere, which is very subtle and delicate". Quoted by: Gontmakher E. Zatyazhka inlflyat-siye//Rossiyskaya gazeta. 2008. July 7 (№143p)
213 Text of the speech see at: http://www.government.ru/content/rfgovernment/rfgovernmentchairman/ chronicle/archive/2008/06/10/7048457.htm.
214 The Federal Agency on Supplies of Arms, Military, Special Hardware and Material Inventories.
215 Zakaz na oboronu//Rossiyskaya gazeta. 2008. July 9 (№146) 538
Without making urgent political decisions aimed at reducing substantially the proportion of the classified budgetary expenditures, excluding them from the sections of the budget that have nothing to do with defense and security, declassifying legal documents, including those pertinent to the state arms program, and making them available to the general public, as well as information by all the contracts concluded both within the frame of the state defense order and beyond it, Russia's Military Establishment should remain poorly equipped even in 2020.
5.8.5. Peculiarities of the Military-Budgetary Policy and the Problem of Openness
The time gap between approval by the second and the third presidents of RF of the ini-tial216 and the last (fifth)217 drafts of the 2008 federal budget is about 15 months. In the interim, appropriations by Section 02 "The national defense" rose from Rb. 958,346m up to
1,031.558m, with the overall rise in the federal budget spending accounting for 6.87%. The
218
2008 increment by this particular section in real terms , accounts for some 3.5% compared with the respective figures of 2007. Meanwhile, the proportion of these expenditures in GDP dwindled by 0.05%- down to 2.48%. Hence, no substantial changes in the planned volumes of financing.
Unfortunately, the form of presentation of the federal budget itself has changed fairly substantially - to the extent when the officially published texts of the respective federal acts have made it impossible to try even simplest assessments of volumes of similar to the above appropriations across sections and subsections of the expenditure classification.
The fact is that in the immediate aftermath of the introduction of regular amendments to
219
the Budgetary Code that took effect since January 2008 the annexes to the federal budget lacked tables displaying allocation of the federal budget expenditures across sections and subsections of the functional classification of expenditures. More than this, the mere concept of the functional classification became missing, too. Because of this innovation by the RF Ministry of Finance, the act on the federal budget now gives no possibility to know a full volume of budgetary appropriations not only on defense and security, but amazingly, on all other state
functions. That is why the below analysis employs both the federal budget acts and the Federal
220
Treasury's data on execution of the consolidated budget of RF .
Thus, despite an insignificant rise in the level of secrecy of the 2008 federal budget expenditures (Table 23), the transparency rate of the budget as a document plunged to a decade-low level. So it appears absolutely logical that the 2008 budget carries Rb. 15,200m in classified appropriations within the subsection "The social provision of the population", thus leaving just a sole open section of the document, that is, "Protection of environment", free from the secrecy fever.
216 On 2008 Federal Budget and on the planned period of 2009-2010: Federal law № 198-FZ, adopted by the Duma on July 6, 2007.
217 On introducing changes in the Federal law "On 2008 Federal budget and on the planned period of 20092010": Federal law № 193-FZ, adopted by the Duma on October 23, 2008.
218 By using GDP deflator index.
219 On introducing changes in the Budget Code of the Russian Federation in the way of regulating the budgetary process and bringing in line with the budgetary legislation of the Russian Federation of separate legal acts of the Russian Federation: Federal law № 63-FZ, adopted by the Duma on April 13, 2007.
220 Report as of January 1, 2009. See: http://www.roskazna.ru/store/reports_file404.xls.
Table 23
The Proportion of Classified Appropriations in the 2003-2008 Federal
Budget expenditures, as %
Code and name of the section (subsection) that contains classified appropriations 2003 2004 2005 2006 2007 2008
The federal budget expenditures on the whole 9.73 9.83 11.33 11.80 10.33 11.92
0100 General state issues n/ap 221 n/ap 3.67 6.28 5.52 8.66
0108 International relations and international cooperation 31.88 18.04 - 0.01 < 0.01 3.66
0110 State material reserve 97.73 93.33 82.86 89.23 92.18 90.17
0111 Fundamental research - - 2.13 1.22 1.12 0.97
0115 Other general issues n/ap n/ap 0.05 0.72 0.28 4.42
0200 NATIONAL DEFENSE 37.22 38.40 42.06 42.77 45.33 46.14
0201 Armed Forces of the Russian Federation 35.39 36.11 33.07 35.59 37.11 39.04
0204 Mobilization preparation of the economy 100.0 100.0 100.0 100.0 100.0 100.0
0205 Preparation of, and contribution to provision of collective security and 100.0 100.0 100.0
peacekeeping operations
0206 Nuclear and arms complex 100.0 100.0 100.0 100.0 100.0 100.0
0207 Implementation of international obligations in the sphere of military 100.0 41.05 45.22 46.90 50.65 100.0
and technical cooperation
0208 Applied research in the national defense area n/ap n/ap 98.37 93.94 93.69 93.20
0209 Other issues in the national defense area n/ap n/ap 2.49 8.79 24.38 29.21
0300 NATIONAL SECURITY AND LAW ENFORCEMENT ACTIVITIES 23.33 20.79 28.52 31.64 31.07 31.84
0302 The RF Ministry of Interior's bodies 3.40 3.01 4.76 6.31 5.16 4.97
0303 The RF Ministry of Interior's military forces 13.21 11.10 11.76 10.31 9.80 10.25
0306 Security bodies 100.00 98.91 97.80 95.49 97.31 99.05
0307 Border-guard forces 19.73 22.88 100.00 98.97 97.62 100.00
0309 Protection of the population from emergency situations of natural and 43.69 41.74 59.02 62.39 50.65 51.39
technogenic nature, civil defense
0312 Applied research in the area of national security and law enforcement activity n/ap n/ap 73.95 66.41 64.43 75.49
0314 Other issues in the area of national security and law enforcement activity n/ap n/ap 8.26 50.71 39.95 56.32
0400 NATIONAL ECONOMY n/ap n/ap 0.05 0.02 0.44 0.64
0411 Applied research in the national economy area n/ap n/ap - - 5.23 5.84
0412 Other issues in the national economy area n/ap n/ap 0.12 0.06 < 0.01 0.31
0500 HOUSING AND UTILITIES n/ap n/ap - 3.42 0.85 6.96
0501 The housing sector n/ap n/ap - 4.22 5.69 15.97
0700 EDUCATION - - 2.76 2.69 2.39 2.55
0701 Preschool education - - 2.03 2.17 2.44 2.48
0702 General education - - 1.51 1.91 2.14 2.00
0704 Secondary vocational training - - 1.06 1.03 1.02 0.86
0705 Professional training and retraining - - 16.85 15.78 17.22 1.80
0706 The higher professional and postgraduate education - - 3.15 2.93 2.53 3.08
0709 Other issues in the area of education - - 0.30 0.33 0.28 0.29
0800 CULTURE. CINEMATOGRAPHY AND MASS MEDIA - - 0.17 0.17 0.21 0.17
0801 Culture - - 0.14 0.10 0.16 0.10
0804 Periodical printed media and publishing - - 13.46 7.45 2.57 2.62
0806 Other issues in the area of culture, cinematography and mass media - - 0.02 0.15 - -
0900 HEALTH CARE, PHYSICAL CULTURE AND SPORTS - - 4.30 3.99 2.57 4.14
0901 Stationary medical aid - - 5.61 4.66 2.94 3.24
0902 Outpatient medical aid n/ap n/ap n/ap n/ap n/ap 13.94
0905 Sanatorium and rehabilitation aid n/ap n/ap n/ap n/ap n/ap 14.07
0907 sanatorium-epidemological welfare n/ap n/ap n/ap n/ap n/ap 2.09
0908 Physical culture and sports - - 0.28 0.26 0.24 0.42
0910 Other issues in the area of health care, physical culture and sports - - - - - 1.74
1000 SOCIAL POLICY - - - - - 0.01
1003 Social provision of the population - - - - - 0.02
1100 INTERBUDGETARY TRANSFERS - - - - 0.16 -
1101 Financial aid to budgets of other levels - - - - 0.50 -
Source: The IET computations basing on the 2003-2008 federal budget data (the data on 2003-2007 were adjusted to the respective sections and subsections of the budget classification that became effective as of January 2008). The 2008 data are based on the data of Federal Act № 193-FZ of November 8, 2008 and the report on
221 Non-applicable due to the change in the structure of the budget classification.
540
execution of the consolidated budget of RF as of January 1, 2009, by the Federal Treasury.
While the dynamic of the proportions of classified appropriations proves the preservation of the long-lasting protecting tendencies, it would be fair to mark some positive developments.
Thus, the draftsmen of the federal budget have finally appreciated an obvious fact that appropriations by Section 0205 "Preparation of, and contribution to provision of collective security and peacekeeping operations" may not be classified ones per se. In addition, the proportion of classified appropriations in Subsection 0705 "Professional training and retraining" of Section 07 "Education" tumbled from 17.2% in 2007 to 1.8% in 2008.
The core tendency has remained in force, nonetheless. For example, all the newly introduced in 2008 subsections of Section 09 proved to be classified ones, while the top secret one - Subsection 0905 "Sanatorium and rehabilitation aid", which accounts for 14.1%, apparently forms a key element of the national defense and security system. Similarly, expenditures on the physical culture and sports in Subsection 0908 proved to be twice as secret vs. 2007. But it is appropriations by Subsection 0501 "The Housing and utilities" that with a rise at over 10 p.p. topped the list of expenditures with the greatest increment in the secret proportion of appropriations. The reason behind that is unknown, of course.
Absolute and relative values of main components of direct military appropriations in the federal budget and their change vs. 2007 according to the final version of the 2008 federal budget are given in Table 24 (the recalculation to the 2007 prices was made using the first assessment by Rosstat of the 2008 deflator index of GDP222).
Table 24
Direct Military Appropriations out of the Federal Budget by Section 02 "The National Defense"
Names of sections and subsections 2008, as Rb.m / in the 2007 price equivalent Change in 2008 vs. 2007, as Rb.m/increment, as % Proportion of appropriations, as %/ change vs. 2007, as p.p. In the 2008 federal T „„„ , , , In GDP budget
1 2 3 4 5
NATIONAL DEFENSE 1 031 558 29 212 14.69 2.48
868 315 3.48 1.84 -0. 05
Armed Forces of RF 748 934 24 253 10.67 1.80
630 416 4.00 1.38 -0.03
Mobilization and paramilitary training 5 045 90 0.07 0.01
4 246 2.16 0.01 -
Mobilization preparation of the econ- 3 500 -1 789 0.05 0.01
omy 2 946 -37.79 -0.02 -
Preparation of, and contribution to pro- 559 354 0.01 <0.01
vision of collective security and peace- 471 302.43 0.01
keeping operations
Nuclear and arms complex 17 084 2 282 0.24 0.04
14 380 18.86 0.06 -
Implementation of international obliga- 3 911 -3 372 0 06 0 01
tions in the sphere of military and tech- 3 292 -50.60 -0.05 -0.01
nical cooperation
Applied research in the area of national 133 343 -10 518 1.90 0.32
security and law enforcement activity 112 241 -8.57 0.02 -0.05
Other issues in the national defense area 119 182 17 914 1.70 0.29
100 322 21.74 0.44 0.04
Source: the IET calculations.
222 O proizvodstve i ispolzovanii valovogo vnutrennego produkta (VVP) za 2008 gjd. M.: Rosstata, February 3, 2009. See: http://www.gks.ru/bgd/free/B04_03/IssWWW.exe/Stg/d02/13vvp30.htm
The introduced by the Budget Code since 2008 Subsection 0202 "Modernization of the Armed Forces of the Russian Federation and Military Formations" appeared missing in the open part of the federal budget. Considering the match between the amount of appropriations
223
across its subsections with that by Section 02 as a whole , it was omitted in the classified annexes, too.
Military appropriations out of the other sections of Russia's federal budget are given in Table 25.
Table 25
Direct and Indirect Military Appropriations by The Other Sections
of the Federal Budget
2008, as Change in 2008 vs. Proportion of appropriations, as %/ change
Name of the subsection or the na- Rb.m / in the 2007, as vs. 2007, as p.p.
ture of appropriations 2007 price Rb.m/increment, as In the 2008 federal In GDP
equivalent % budget In GDP
In Section 03 "National security and law enforcement activities"
The RF Ministry of Interior's armed 54 951 -139 0.78 0.13
forces 46 255 -0.30 0.07 -0.01
Security bodies 146 363 7 246 2.08 0.35
122 201 6.25 0.31 -
Border-guard bodies 68 444 686 0.97 0.16
57 613 1.20 0.10 -0.01
EMERCOM armed forces and civil 36 781 5 311 0.52 0.09
defense 30 960 20.71 0.13 0.01
In Section 04 "The national economy"
Presidential program "CW destruc- 2 604 -725 0.04 0.01
tion" 2 192 -24.86 -0.01 -
Subsidies to transportation organiza-
tions that procure automotive equip- 94 - <0.01 <0.01
ment for completing the road trans- 79 - - -
port vehicles for motorcades
Subsidies on the functioning of the 23 - <0.01 <0.01
Russia-NATO coordination center 20 - - -
Construction of special and military 6 279 -5 125 0.09 0.02
objects 5 285 -49.23 -0.07 -0.02
FTP "Industrial utilization of arms 89 -17 <0.01 <0.01
and military hardware (2005-2010) 75 -18.19 - -
Classified expenditures 5 408 1 364 0.08 0.01
4 552 42.81 0.03 -
Section 05 "Housing and utilities"
Presidential program "CW destruc- 1 792 -1 652 0.03 0.00
tion" 1 509 -52.26 -0.02 -0.01
Provision of the military with housing 33 808 14 335 0.49 0.09
perks and permanent housing 29 787 92.77 0.25 0.04
Classified expenditures 8 611 4 737 0.12 0.02
7 248 188.62 0.08 0.01
In Section 07 "Education"
The RF Ministry of Defense's expen- 35 091 1 568 0.50 0.08
ditures 29 538 5.60 0.07 -
Classified expenditures 8 623 397 0.12 0.02
7 258 5.78 0.02 -
In Section 08 "Culture, cinematography, mass media"
The RF Ministry of Defense's expen- 2 714 -144 0.04 0.01
ditures 2 285 -5.93 - -
Classified expenditures 159 -14 <0.01 <0.01
134 -9.68 - -
223 See the Federal Treasury data on execution of the consolidated budget 542
Name of the subsection or the nature of appropriations
2008, as Rb.m / in the 2007 price equivalent
Change in 2008 vs. 2007, as
Rb.m/increment, as
%
Proportion of appropriations, as %/ change _vs. 2007, as p.p._
In the 2008 federal budget
In Section 09 "Health care, physical culture and sports"
In GDP
The RF Ministry of Defense's expenditures
Classified expenditures
Pension provision of the RF Ministry of Defense
Pension provision of the FSA
Procurement of housing for the retired and dismissed military Additional monthly material allowances to disabled due to military trauma
Provision of refurbishment of individual housing belonging to family members of the military that have lost a family provider Compensations to families of the died military Subsidies and compensations to the military, individuals equaled to them and to the dismissed from the military Classified expenditures
Subsidies to the closed administrative-territorial entities Support of measures on provision of balanced budgets of administrative-territorial entities Development and support of the social and engineering infrastructure of administrative-territorial entities Implementation of the primary military records in the territories wherein are no military comissariats Lump-sum benefit to the pregnant wife of the conscript and the monthly benefit for the child of the conscript Relocation of residents out of administrative-territorial entities Material provision of specialists of the nuclear arms complex of RF Presidential Decree of August 1, 2005,№887 "On measures on improvement of the situation of the disabled due to a military trauma"
25 186 -233 0.36 0.06
21 200 -1.09 0.03 -
9 414 812 0.13 0.02
7 924 11.41 0.03 -
In Section 10 "Social policy"
96 048 -49 118 1.37 0.23
80 849 -37.79 -0.62 -0.16
15 634 -495 0.22 0.04
13 160 -3.62 0.01 -
12 057 -19 232 0.17 0.03
10 149 -65.46 -0.28 -0.06
305 -386 <0.01 <0.01
257 -60.01 -0.01 -
290 49 <0.01 <0.01
244 25.25 - -
1 453 125 0.02 <0.01
1 223 11.37 - -
8 088 -1 200 0.12 0.02
6 808 -14.98 -0.01 -
15 - 0.00 0.00
13 - - -
In Section 11 "Interbudgetary transfers"
9 778 -908 0.14 0.02
8 230 -9.93 - -
1 134 -105 0.02 <0.01
955 -9.93 - -
5 816 -575 0.08 0.01
4 896 -10.51 - -
1 625 178 0.02 <0.01
1 368 15.00 - -
1 090 - 0.02 <0.01
918 - 0.02 -
1 234 -115 0.02 <0.01
1 039 -9.93 - -
2 255 53 0.03 0.01
1 898 2.89 - -
670 - 0.01 <0.01
564 - 0.01 -
Source: the IET calculations.
When compared with 2007, appropriations to the RF Ministry of Defense on housing construction under Section 02 "The national defense" rose at 35% in real terms; in addition, appropriations to the military under Section 05 "Housing and utilities" were increased at 93%. But, at the same time, the budgetary spending on the housing certificates shrank at 65% and that on the mortgage system for the military dropped by 61%. Notably, the volume of the latter was cut from Rb. 8,270bn in the initial draft of the 2008 federal budget to 4,063bn in the final one.
In 2008, the military's pay was raised twice at 9%, while appropriations on the RF Ministry of Defense's military personnel rose at 19% in real terms. But the objective President Putin had set back in 2005 - to increase the military's incomes 1.5 times in real terms by late-2008 - was not attained. With the account of the CPI (113.3% in 2008) the military's incomes grew just by 25% over the past three years.
It was planned to allocate Rb. 28,554bn (+39%) on combat training, with the lion's share of the sum (26,961bn), as usual, falling on fuel and lubricants. By the RF Minister of Defense's decision of December 2007 other components of the combat training expenditures were quadrupled- from Rb. 244m up to 1,055 bn. But the picture changes, should one consider the fact that right before that the Head financial-economic division of the Ministry had ac-
224
complished a reverse move of cutting these very expenditures 4-fold .
Appropriations on the material and technical supplies accounted for Rb. 113,214bn, thus being at 1% down vs. 2007. It is already clear that despite the draftsmen of the three-year federal budget were confident that this would be an amount sufficient to ensure an annual procurement of not less than 3.2m. t. of fuel and lubricants, the respective 2008 procurements by the RF Ministry of Defense did not exceed 2.8m.t., while the respective appropriations made up Rb. 57,204bn (a 52% nominal growth). At this juncture the growth in the average flying time of the Russian Airforce pilots from 42 up to 55 hours over the year, as asserted by the
225
head of the Head Division of combat training and troop service of the RF Airforce , cannot be attributed just to the price downfall for oil products by the end of the year.
Whilst the RF Ministry of Defense declared 2008 the year of the Food Service, appropriations on the food supplies (Rb. 24,404 bn.) proved to be at 12% down in real terms vs. 2007. The Russian authorities displayed a similar attitude to the material support, where the respective cuts in real terms accounted at 23% - that is to say, they still are at pains to adhere to a negative rate of material supplies of 60-70%.
The 2008 appropriations on the pension provision of the RF Ministry of defense slid at 3-7% in real terms vis-à-vis 2007226 (depending on the deflation method - using either CPI, or the deflator index of GDP). This can also be regarded as an effect from the reduction in the number of military pensioners under the auspices of the Ministry - the most recent statistical data available date back to January 1, 2006.
Direct military appropriations (Table 26) in the 2008 federal budget computed in accordance with the UN military expenditures standard accounted for 3.6% of GDP, while with ac-
227
count of appropriations associated with the earlier military activities (military pensions , CW destruction, etc.) they amounted to 3.9% of GDP.
224 Raschepkin K. Teper nastupaem po vsem napravleniyam.. .//Krasnaya zvezda. 2008. February 5 (№18).
225 Krasnaya zvezda. 2008. 11 February (№23).
226 Without regard to the amount earmarked to the RF Ministry of Finance in 2007 to pay off the accumulated between 1995-1998 debt to the military pensioners.
227 Until 1998 the Ministry of Defense's pension expenditures had been included in the composition of the Section 'The national defense".
Table 26
Aggregate Indicators of the Military Appropriations and Other Associated with Them Appropriations from the Federal Budget
Name Amount, Proportion of appropriations, 2007, as p.p. as %/ change vs.
as Rb.m. In the 2008 federal In GDP
budget
Overall direct military appropriations 1 494 049 21,28 3,07 3,60 0,01
Aggregate direct and indirect military appropriations pertaining to the current and former military activities 1 636 584 23,31 2,16 3,94 -0,23
Aggregate appropriations by sections "The national defense" and "national security and law enforcement activities" 1 860 980 26,50 3,32 4,48 -0,09
Source: The IET calculations.
The execution of the 2008 federal budget in the part of military expenditures has basically remained unchanged vis-à-vis 2007. More specifically, the Federal Treasury reports show a Rb. 5,034bn.-worth excess of the limit of expenditure by the aggregate budget financing targets of the federal budget over the respective appropriations already from March. The said excess hit its peak in November 2008 (Rb. 18,406bn.) and fell by the end of the year to 12,643bn.
228
While the RF Ministry of Finance publishes the budget financing targets , their data does not allow identification of sources of growth in the military expenditure. These are most likely the remnants of the 2007 federal budget appropriations on the Federal Treasury's accounts (over Rb. 7bn by Section "The national defense") and additional revenues the RF Ministry of Defense has cashed in from sales of real estate, arms utilization and CW destruction.
The data on the monthly execution of the 2008 federal budget military expenditures and other pertaining to them expenditures are given in Table 27 and Fig. 40-42. The trend to shifting the spending to the last month of the year has become increasingly obvious in 2008, particularly because of the RF Ministry of Finance's auctions on placement of free federal budget funds. The negative effect such a manner of financing has on the combat efficiency, the military's everyday life and operations, and the whole military economy is evident.
228 See, for example: http://www1.minfin.ru/ru/budget/federal_budget/budj_rosp/
Table 27
The Monthly Execution of the Military and Other Pertaining Expenditures of the 2008 Federal Budget, as Rb.bn.
Наименование расходов As provided for by the 200FB229 The 2008 FB, modified230 January February March April May June July August September October November December Saved (overspent)
NATIONAL DEFENSE 958,3 1 031,6 22,5 71,6 77,1 97,4 71,5 72,1 80,5 60,7 60,7 82,2 78,6 261,2 (9,3)
The Armed Forces of RF 701,8 748,9 20,0 61,7 57,5 75,5 51,7 60,5 59,8 50,5 51,9 62,5 55,0 166,9 (22,7)
Mobilization and paramilitary 5,2 5,0 0,0 0,6 0,2 0,2 0,2 1,3 0,2 0,1 0,2 0,2 0,3 1,0 0,5
training
Mobilization preparation of 3,5 3,5 0,0 0,5 0,7 1,0 1,3 0,1 0,2 0,1 0,1 0,2 0,1 0,3 (1,2)
the economy
Preparation of, and contribu- 0,1 0,6 - - - 0,0 0,0 0,0 0,0 0,0 0,0 0,0 0,1 0,2 0,2
tion to provision of collective
security and peacekeeping
operations
Nuclear and arms complex 17,1 17,1 0,8 - 8,9 1,6 - - 2,3 0,1 - 0,2 1,6 2,4 -
Implementation of interna- 3,1 3,9 0,8 0,1 - - - 0,6 0,1 0,1 0,1 - 0,6 0,6 1,2
tional obligations in the sphere
of military and technical co-
operation
Applied research in the area 127,8 133,3 0,6 8,2 7,2 14,2 6,9 6,2 9,2 3,9 4,4 4,9 5,7 50,6 3,7
of national defense
Other issues in the national 99,7 119,2 0,2 0,6 2,6 4,9 11,3 3,4 8,7 5,9 4,1 14,2 15,2 39,2 9,1
defense area
NATIONAL SECURITY 772,2 829,4 27,9 53,8 62,1 66,9 61,6 68,8 66,0 60,3 65,9 71,1 75,9 137,0 (6,1)
AND LAW ENFORCE-
MENT OPERATIONS
The RF Ministry of Interior's 51,6 55,0 1,3 2,5 3,8 4,0 4,4 4,8 4,5 4,1 4,7 4,4 5,1 10,4 0,2
armed forces
Security bodies 137,4 146,4 5,1 9,4 11,0 11,2 10,4 11,9 12,3 10,3 10,2 12,8 13,3 26,2 (1,3)
Border-guard bodies 65,1 68,4 1,7 4,2 4,2 4,8 4,9 5,1 5,7 5,0 4,6 6,3 5,0 11,9 3,5
Protection of the population 45,0 47,8 1,6 2,2 5,2 5,0 3,3 3,1 3,5 3,1 3,6 3,8 3,9 10,2 (2,1)
from emergency situations of
natural and technogenic na-
ture, civil defense
Applied research in the area 6,7 6,7 0,2 0,4 0,4 0,5 0,4 0,5 0,6 0,4 0,5 0,6 0,6 1,6 (0,2)
of national security and law
enforcement activity
Other issues in the area of 4,8 5,9 0,2 0,2 0,2 0,8 0,4 0,3 0,3 0,2 0,3 0,2 1,1 0,5 1,0
national security and law
enforcement activity
Source: the IET calculations basing on the Federal Treasury data.
229 On the federal budget for 2008 and the planned period of 2009 and 2010: Federal Act № 198-FZ: passed by the State Duma on July 6, 2007.
230 On introducing amendments to the Federal Act «On the federal budget for 2008 and the planned period of 2009 and 2010 Federal Act № 193-FZ: passed by the State Duma on October 23, 2008.
25%
20%
15%
10%
5%
0%
1
2006
2007
2008
JJJ
1
I I I
I
^ ^ ^ ^ v
Source: the IET calculations basing on the Federal Treasury data.
Fig. 40. Execution of the Federal Budget Expenditures by Subsection 0201 «The Armed Forces of the Russian Federation»in 2006-2008
Source: the IET calculations basing on the Federal Treasury data.
Fig. 41. Execution of the Federal Budget Expenditures by Subsection 0207 "Applied Research
in the Area of National Defense" in 2006-2008
Source: the IET calculations basing on the Federal Treasury data.
Fig. 42. Execution of the Federal Budget Expenditures by Subsection 0208 "Other Issues in the Area of National Defense" in 2006-2008
Evaluation of the Federal Treasury's reports on execution of the consolidated budget of RF showed that the earlier nearly non-existent and, consequently, not taken into consideration, military expenditures of governments of Subjects of RF have grown into fairly comparable with the central government's ones, as far as a number of subsections of the Classification are concerned. Since 2005 they also have appeared in the Section "The national defense" (see Table 28), albeit not in excess of 0.3% of the federal government's aggregate military expenditures.
Table 28
Military Expenditure of Consolidated Budgets of the Subjects of RF
in 2003-2008 , as Rb.m.*
Name of the subsection of the Classification of _expenditures_
The Armed Forces of the Russian Federation
Modernization of the Armed Forces of the Russian Federation and military formations Mobilization and paramilitary training
Mobilization preparation of the economy** Other issues in the area of national defense The RF Ministry of Interior's armed forces Security bodies Border-guard bodies
Protection of the population from emergency situations of natural and technogenic nature, civil defense
2003 2004 2005 2006 2007 2008
- - - 35 03
- - - 0,1 0,3 0,3
- - - - - 1£
- - - - - 0,5
13,1 - 65,6 899,3 1 351,9 1 797,9
13,2 - 65,6 808,6 1 245,6 1 702,2
449,7 532,4 485,4 708,3 861,2 1 137,2
405,6 500,6 468,6 692,8 840,9 1 063,9
- - 109,6 32,8 55 07
- - 97,5 32,1 5,7 0,5
14,6 12,4 9,9 35 M 03
12,7 12,2 9,9 1,4 1,0 0,3
37 67 03 16,5 01 00
2,1 6,5 0,3 16,5 0,1 0,0
- - 0,1 - - -
6 511,0 7 968,2 11 184,6 15 636,4 19 118,4 23 895,8
6 244,1 7 281,3 10 958,9 14 367,0 18 292,6 21 456,7
*Numerator - allocated, common denominator - actual earmarking.
** Until 2995 this Subsection was not included in the Section "The national defense"
Source: the Federal Treasury
Presented in Table 29 results of a 10-year (1998-2008) statistical monitoring of Russia's military expenditures (to avoid double count) do not include the data of Table 28, as there is no clarity as yet with respect to sources of financing the RF Subjects' military expenditures (in relation to the proportion of transfers out of the federal budget) provided therein. In addition, while evaluating the dynamic of Russia's aggregate military expenditure over the period in question, it should be taken into account that initially underlying the system of their calculation was an approach that rested on a formal connection between the Military Establishment's spending and military missions and operational objectives. Hence, it is not always possible to draw a direct comparison of such statistics with the NATO members' military expenditures, as since 2004 most of them have attributed to military agencies only those ones which, with their training and arms, are capable of a direct participation in a combat action and, accordingly, do not attribute expenditures on security agencies analogous to Russia's FSA to the military ones.
Table 29
Main Indicators of Military Expenditures of the Russian Federation in 1999-2008
Execution of the FB expenditures by the Section "The national defense" under the current budget classifica-
tiona
Appropriations from FB by the Section "The national defense" under the current budget classification
placed into other section of the budget classificationb
in the comparable budget classification
Military expenditures, the UN datac Overall direct military expenditures'1 Aggregate direct and indirect military expenditures pertinent to the current and past military activitiese
Execution of the FB expenditures by the Section "The national defense" under the crrent budget classification Appropriations from FB by the Section "The national defense" under the current budget classification
placed into other section of the budget classification
in the comparable budget classification
Military expenditures, the UN data Overall direct military expenditures Aggregate direct and indirect military expenditures pertinent to the current and past military activities
Execution of the FB expenditures by the Section "The national defense" under the crrent budget classification Appropriations from FB by the Section "The national defense" under the crrent budget classification
placed into other section of the budget classification
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
1. In nominal terms (in current prices) as Rb. bn.
115,6 191,7 247,7 295,4 355,7 430,0 581,1 681,8 831,9 1 040,8
93,7 209,4 214,7 284,2 354,9 427,4 578,4 686,1 839,1 1 031,6
- - - - - - 44,3 77,7 91,3 121,0
93,7 209,4 214,7 284,2 354,9 427,4 622,6 763,9 930,4 1 152,5
- 202,6 294,4 325,9 447,0 499,0 665,0 822,1 850,2 -
128,9 270,4 283,4 357,7 464,2 552,7 770,3 1 003,9 1 214,4 1 494,0
144,0 304,6 329,6 460,1 602,3 638,8 855,1 1 090,4 1 375,6 1 636,6
2. In real terms (in the 2008 prices)e, as Rb. bn
1 012,2 1 093,0 1 050,6 987,3 997,4 1 007,3 1 093,5 1 032,1 1 039,9 1 040,8
820,5 1 194,0 910,6 949,8 995,2 1 001,2 1 088,2 1 038,7 1 048,9 1 031,6
- - - - - - 83,3 117,7 114,1 121,0
820,5 1 194,0 910,6 949,8 995,2 1 001,2 1 171,5 1 156,3 1 163,0 1 152,5
- 1 155,2 1 248,8 1 089,4 1 253,4 1 168,9 1 251,2 1 244,4 1 062,8 -
128,7 1 1541,7 1 202,1 1 195,4 1 301,7 1 294,6 1 449,4 1 519,7 1 518,0 1 494,0
261,0 1 736,7 1 397,9 1 538,0 1 688,8 1 496,5 1 609,0 1 650,6 1 719,4 1 636,6
3. In real terms (in the 1999 prices (as Rb. Bn.)
115,6 124,8 120,0 112,8 113,9 115,0 124,9 117,9 118,8 118,9
93,7 136,4 104,0 108,5 113,7 114,3 124,3 118,6 119,8 117,8
- - - - - - 9,5 13,4 13,0 13,8
1999
2000 2001 2002 2003 2004 2005 2006 2007 2008
136,4 104,0 108,5 113,7 114,3 133,8 132,1 132,8 131,6
131,9 142,6 124,4 143,1 133,5 142,9 142,1 121,4 -
176,1 137,3 136,5 148,7 147,9 165,5 173,6 173,4 171,0
198,3 159,6 175,6 192,9 170,9 183,8 188,5 196,4 187,2
: military burden of the economy, as % of GDP
2,62 2,77 2,73 2,69 2,52 2,69 2,53 2,51 2,51
2,87 2,40 2,62 2,68 2,51 2,67 2,55 2,53 2, 48
- - - - - 0,20 0,29 0,28 0,29
2,87 2,40 2,62 2,68 2,51 2,88 2,84 2,81 2,77
2,77 3,29 3,01 3,38 2,93 3,07 3,06 2,57 -
3,70 3,17 3,30 3,51 3,24 3,56 3,73 3,67 3,60
4,17 3,69 4,25 4,55 3,75 3,95 4,05 4,15 3,94
hasing power parity (in current prices), as USD bn..
26,8 30,2 31,9 34,2 36,2 45,6 48,2 54,2 62,8
29,3 26,2 30,7 34,1 35,9 45,4 48,5 54,6 62,3
- - - - - 3,5 5,5 5,9 7,3
29,3 26,2 30,7 34,1 35,9 48,9 54,0 60,6 69,6
28,3 35,9 35,2 42,9 42,0 52,2 58,1 55,4 -
37,8 34,6 38,6 44,6 46,5 60,5 71,0 79,1 90,2
42,6 40,2 49,6 57,9 53,7 67,1 77,1 89,6 98,8
For reference
137,6 116,5 115,5 114,0 120,1 119,2 115,8 113,5 118,8
153,6 134,4 126,9 119,2 119,7 124,5 124,3 121,1 125,0
7,15 8,19 9,27 10,41 11,89 12,74 14,14 15,36 16,57
in the comparable budget classification
Military expenditures, the UN data Overall direct military expenditures Aggregate direct and indirect military expenditures pertinent to the current and past military activities
Execution of the FB expenditures by the Section "The national defense" under the cuurrent budget classification
Appropriations from FB by the Section "The national defense" under the current budget classification
placed into other section of the budget classification
in the comparable budget classification
Military expenditures, the UN data Overall direct military expenditures Aggregate direct and indirect military expenditures pertinent to the current and past military activities
Execution of the FB expenditures by the Section "The national defense" under the current budget classification
Appropriations from FB by the Section "The national defense" under the current budget classification
placed into other section of the budget classification
in the comparable budget classification
Military expenditures, the UN data Overall direct military expenditures Aggregate direct and indirect military expenditures pertinent to the current and past military activities
GDP deflator, as % to the prior year Expenditure deflator on final consumption by public administrationf, as % to the prior year The purchasing power parityh, Rb./USD.
93,7
128,9 144,0 4. T
2,40 1,94
1,94
2,67 2,99 >. By pu
21,9 17,7
17,7
24,4 27,2
172,5 138,5
5,29
a For 2008 - preliminary data of the Federal Treasury on execution of the federal and consolidated budgets b Expenditures of the RF Ministry of Defense and classified expenditures by sections 04-09 and 11 of the 20052008 federal budgets.
c The 1999 data was not submitted by the RF government to the UN, the 2008 ones shall be submitted in 2009; they include.expenditures on supplies of the RF Minister of Interior's armed forces , the border- guard forces, and the civil defense in particilar.
d Inclusive of supplies of the RF Minister of Interior's armed forces , the border- guard forces, the civil defense forces, and other elements of the Military Establishment.
e Plus pensions to the military. Deflated with the use of the expenditure deflator on final consumption by public administration
g For 2008- the IET estimates.
h For 2006-2008 - the linear trend of values of the previous years (the IET estimates).
Sources: The 1999-2008 federal budget acts and acts on execution of the 1999-2007 federal budgets.; Natsional-nye scheta Rossii v 1997-2007 godakh: Sta.sb./Rosstat. M., 2005-2008; Obyektivnaya informatsiya po voennym voporsam, vklyuchaya transparentnost voyennykh raskhodov. Doklady Generalnogo Sekretarya OON 2001-2008 gg.; Rosstat; The Federal Treasury.
5.8.6. Development of Russia's Military Establishment: Trends and Outlooks
Because of a number of factors, of which the most critical one became military action in the Southern Ossetia and Abkhazia in August 2008, the government has taken on the implementation of the design of the long-needed military reform. But what raises concern is not a reactionaries' counterstand or the removal of the Federation Council from the decisionmaking process. Rather, it is the absence of support to the reformers' efforts on the part of the bulk of the military and the society, as the reform blueprint was coined privately, the decisions were made without discussion and justification. That is why its mistakes become visible only at the stage of the reform implementation - hence the déjà-vu effect of the situation around the notorious "monetization of benefits".
The equally pernicious factor of a possible failure of the reform may become corruption, which, as a nationwide challenge, is not foreign to the Military Establishment. The situation aggravated in 2008, which can be partly explained by the forthcoming mass dismissal of officers and warrant officers from the so-called plum jobs.
The time calls for legislative action. The priority should become a proposal to amend the wording of Art. 34 "On military conscription and military service" to eliminate the possibility to compel conscripts to sign a contract after the half year of service. The military in the barrack, beyond the normal framework of civil rights - such a situation is pregnant with a great number of offences. The respective proposals on amending the law were drafted in cooperation with Russian human rights organizations and submitted to the Ombudsman of RF to promote them through official channels.
The year of 2009 should become the first one of implementation of the new FTP on improvement of the system of manning of the national Military Establishment. But, as the analysis of the Program showed, it was approved in such a form that not just exacerbates its drawbacks, but ultimately blocks the intention to transfer all the regular troops to the category of military units of permanent combat alert. In a hope for a sound reaction of the veteran officers who will be in charge of such troops, one can pray of a prompt adjustment of the FTP, as it appears beneficial just for criminal structures that capitalize on defects of the manning system and the citizenry's fear of the military service.
Otherwise the country would face a social outbreak as soon as in 2009 or any time soon. The desperate contract soldiers and conscripts, including those who will be under pressure to sign military contracts will be joined by dismissed officers. Yet more negative may become sentiments of the officers who will be retained in the army, albeit being deprived of the currently declared attractive conditions of service, including a high pay and guaranteed housing. The authorities proposed, with no public discussion whatsoever, a procedure of "picking" a corps d'elite among the officer corpse to be awarded with a stunningly lavish compensation. This move seems very dubious and may result in a growing frustration and cachexy of the officer corpse. Considering the President and PM's statements, the nation's leadership cares more of developing the warfare, rather than the cadres problem. While the need in new arms is
no doubt matters, without solving the problem as to in whose hands they will go, their manufacturing and supplies to the army may not ensure a desired enhancement of the combat efficiency.
Hence, other earlier discussed proposals remain in force. These are:
1. The society must be aware of the assessment of outputs of the recently completed FTP, as well as parameters of the new one. The latter program concerns not only the Military Establishment and the government, as the problem of the manning of the Military Establishment affects interests of the overwhelming majority of the RF citizenry and impacts all the sectors of the economy. There is the need in promulgation of legislation that would unambiguously read that conscription is effective only in the peacetime, solely for the sake of obtaining a military specialty which shall be needed for a further career in the standing army or for completing the reserve force.
2. Let us note that the government implements proposals we put forward in the last year's analysis of the military economy - namely, it increases allowances to officers of the standing army and cuts their number - chiefly in the formations that do not fall under the permanent alert category. But while raising their pay, one should do the same, as far as sergeants and even privates (seamen) are concerned, otherwise the Military Establishment would not advance on the labor market, nor contract soldiers would qualify for the military service. The hope that the current economic crisis would increase the number of the unemployed and help cut the average salaries and wages nationwide, which in turn would ensure a great influx of young and healthy individuals into the army, seems very shaky. Should there be any progress in this regard, its effect will be a temporary one.
3. As the military action in the Northern Ossetia and Abkhazia has exposed numerous drawbacks in equipage of our armed forces and triggered a consequent adjustment of the State Arms Program and the State Defense Order, an urgent problem became an extradepart-mental control over this sphere of the military economy.
4. As far as budgetary problems are concerned, the year of 2008 saw no progress in this respect. Rather, the negative tendencies intensified in this particular sphere.
It is important to bring the budget classification of RF in line with the mission, goals and objectives of the national Military Establishment; equally critical appears the need in building a clear inter-relation between indicators that characterize these activities and funds spent on their exercise.
In 2008, the secrecy around the military expenditure did not dilute, but intensified. This means that the propensity for corruption in the national budgetary system will continue exerting its negative influence both on the military economy and the national economy as a whole.
5. The world financial and economic crisis, too, has contributed to the overall aggravation of the situation. It is still an unanswered question as to whether its impact on Russia's military economy may be positive and result in a greater financial discipline, a genuine optimization of management, halting of corruption and thievery, growth in the military's welfare, and, ultimately, solidification of the country's defense capacity. It may well happen that things will turn to the worse and engender a sequestration of the budget, back-out with regard to all the promises given to the military, and a lower combat efficiency. Under such circumstances the public control over the Military Establishment and the military economy forms an efficient means of getting out of the crisis with minimum sacrifices of the country's defense capacity.
