Demands exchange controls and state control of investment policy
This post first appeared on Russia Insider
The Russian economist Sergei Glazyev is as we have said previously, very much a man to watch.
Though he is no sense a policy-maker or close to Putin (despite his formal title of “Presidential Adviser”) his views carry wide traction within Russia’s elite and are growing in influence.
For that reason we are publishing this very lengthy piece Glazyev has written in full despite its dense language and close reasoning, which do not make it an easy read.
What Glazyev says tends after a time to happen and in setting out what is in effect an Economic Manifesto for Russia’s future this article spotlights the sort of discussions that are now taking place within Russia’s elite about the country’s future direction.
In order to read this article properly it is however essential to understand what Glazyev is doing.
The article begins with a fierce attack on the interest rate policy of the Central Bank and is scathing in its criticism of the Central Bank's handling of the rouble’s devaluation.
The fact that Glazyev barely mentions in the article the true cause of the rouble’s devaluation – the collapse in oil prices – is however a sign that this part of the article is not intended to be taken entirely seriously.
As Glazyev undoubtedly knows, in conditions of 8-10% inflation an increase in interest rates to 10.5% is not going to make a great difference to industry or have the disastrous consequences he says.
The decision to raise interest rates was made at least in part in order to ensure that interest rates remain positive (ie. higher than inflation), which is important for many reasons of which not the least is the need to ensure that it remains profitable for ordinary Russians to keep their money on deposit in roubles in the country’s banks.
What Glazyev is actually doing is making the best of what is for him turning out to be a very good crisis in order to push the terms of the economic debate further in his direction.
Glazyev’s programme is one that is intended to increase the rate of domestic investment in the manufacturing sector of Russia’s economy. In order to promote this policy he mischaracterises the policy of the Central Bank and of the Finance Ministry as one of trying to develop the Russian economy by attracting foreign (ie. Western) investment into Russia.
At a time of international tension when the West has imposed sanctions on Russia it is easy for Glazyev to represent this policy and the people who supposedly hold to it as "stupid" or “unpatriotic” or as “servants of foreign capital”.
In reality, as Glazyev undoubtedly knows, the policy of the people he is criticising is aimed at reducing Russia’s inflation rate to 4% precisely in order to increase the rate of domestic investment in the economy. In other words the objective is the same as his own even if the methods differ.
Where Glazyev differs from his opponents in the Central Bank and the government is that unlike them he wants to use the monetary resources of the Central Bank to invest directly in the economy through the banking system.
For this to happen the banking system would have to be brought under direct state control whilst credit and money flows into and out of Russia would be tightly regulated through a system of exchange controls managed in part through the tax system. Though Glazyev does not spell it out, there would also have to be some sort of national planning agency to direct investment to the right places.
This is not a call for a return to the sort of centrally planned economy Russia had during the Soviet period. The economy would remain market based with prices determined by supply and demand. Rather what Glazyev envisages is an economic system that bears a certain resemblance to that of China today and previously (in the 1950s to 1970s) to that of Japan or (going back further still) to that of Soviet Russia in the 1920s during the period of NEP.
It is very unlikely that the entire package Glazyev is proposing will ever be adopted. In particular the government has consistently ruled out the idea of imposing exchange controls, not just for ideological reasons but because it regards the whole idea as unworkable.
However other elements of Glazyev’s manifesto are already being quietly adopted. Russia is seeking to “de offshore-rise” its economy (as with the declaration of the recent amnesty on repatriated funds), is moving to set up its own domestic interbank payment system, and is also moving to replace the dollar in foreign trade transactions with key partners such as Iran, India and China with local currencies, just as Glazyev recommends.
Russia is also now committed to a policy of import substitution and of industrial investment in which the banking system will doubtless be expected to play its part.
There follows a translation of an article by Glazyev “Stupidity is Worse than Theft” which was first published by The Vineyard of the Saker.
Why did the Central Bank raise the interest rate and let the ruble flow?
Another increase in key interest rates on loans issued by the Bank of Russia, for the purpose of refinancing commercial banks, made loans completely inaccessible for the majority of enterprises of the real sector of the economy. When the average profitability of the manufacturing industry is 7.5-8%, credit issued at rates of 10% or higher cannot be used by most businesses, either for investment or for replenishing working capital. Such decisions cut off the real economy, with the exception of some sectors of the oil, gas, and chemical-metallurgical sector, from credit issued by the State.
Prior to that, the consumer lending boom drove millions of citizens into a 10-trillion ruble debt and the real economy lost the savings of the population, becoming a net debtor. Also, the Government withdrew pension savings from the economy. Sanctions imposed by NATO countries deprive the economy of the bulk of external credit. Most businesses have only their own funds to finance working capital and investments, which is clearly not enough to provide even simple reproduction, never mind an expanded one. The amount of profit of enterprises this year (taking into account the fall in the prices of export goods) will be no more than 10% of the required rate of investment of 25-30% of GDP. It’s no surprise that as a result of such decisions amidst the economic recovery in almost all countries of the world this year, Russia is experiencing an unexpected decline in investment and production.
According to the Central Bank’s report, On the key rate of the Bank of Russia, October 31, 2014, its decision to raise interest rates was made because of external circumstances: “In September-October the external environment has changed significantly: oil prices dropped significantly while there has been a tightening of sanctions imposed by individual countries to a number of large Russian companies. The ruble has been weakening in this environment, which, against the backdrop of August’s restrictions on import of certain food products, led to a further acceleration of growth of consumer prices”. To support its previous decision to raise interest rates, the Central Bank argued that “inflationary risks had increased, including rising geopolitical tensions and their possible impact on the dynamics of the course of the national currency, as well as changes in the tax and tariff policy.” In the same policy statement, the Central Bank explained its decision to raise interest rates by “a stronger than expected effect of exchange rate dynamics on consumer prices, rising inflation expectations, as well as the unfavorable trends in the market for certain goods.”
This reasoning does not stand up to criticism.
Any entrepreneur dealing with the real economy and not with the utopian models of market equilibrium will say that the increase in the interest rate leads to a rise in the cost of credit. This leads to increased costs for the borrowing enterprises and, consequently, to higher prices for their products. Increasing percentage in excess of the rate of return on assets does not make sense for financing investments, nor does excess of profitability of manufactured products make sense for working capital. It results in reduced production, which in return causes an increase in cost per unit of production and a further increase in its prices. The inability to get investment loans deprives businesses of opportunities to reduce costs by increasing scale and technological improvements of production, which shuts off the main ways of reducing prices.
All of the above have been proven many times theoretically and confirmed in practice. An increase in interest rates and accompanying contraction of the money supply led to the same consequences in all countries - the decline in investment and production on the one hand and increased costs on the other. The result was a dramatic bankruptcy of many enterprises faced with the impossibility of refinancing their production processes. Today, just as in the 1990s, this policy drives the economy into a stagflationary trap and deprives it of development opportunities.
Apparently, the heads of the Central Bank are guided by fantasies gleaned from student textbooks on macroeconomics. In some of them, to facilitate students’ understanding, market mechanisms are simplified to primitive mathematical equilibrium models, which were brought to economic science from classical mechanics almost a century ago. The economy in these mechanistic models is presented as a set of economic agents oriented towards maximizing profits, having perfect knowledge, and working in conditions of perfect competition and instant availability of any resource. According to these models, an increase in the money supply, as with any other product, leads to lower prices, which is equivalent to higher inflation. And vice versa, an increase in the price of money (interest rates) entails reducing their supply and falling inflation. On this basis, a favorite monetarists’ Fisher identity (equation) postulates a direct proportional relationship between money growth and prices. Despite the fact that it is not statistically confirmed, the advocates of this theory continue steadfastly to profess the dogma of a direct linear relationship between money supply growth and inflation, and, accordingly, the inverse relationship between inflation and the interest rate. Amateurs, in their simplicity, seem to believe it’s obvious and impose it on public opinion. It’s an equivalent of trying to cure all diseases by bloodletting, a practice of medieval doctors on trusting patients.
In reality, none of the assumptions taken as an axiom in equilibrium models is being observed. Being guided by them in economic policy is akin to building socialism guided by the Communist Manifesto of Marx and Engels, without taking into account the diversity of the people and institutions built by them, without distinction of enterprises, industries and technologies, and without mechanisms of development. Such economic “theory” degenerates into scholasticism, unsuitable for practical use. Therefore, none of the managers in developed countries uses the equilibrium theory in practice. Instead, they are guided by extracting profits in non-equilibrium situations and developing an economy by its complexity. A mechanistic picture of the equilibrium of the economy remains for amateurs; it is used to convince them of the uselessness of government intervention in the economy. This theory is being hammered with special tenacity into the public consciousness of developing countries in order to deprive them of the ability to creatively develop their institutions, which are replaced with the “free market” forces and managed by developed capitalist countries’ monopolies. Unfortunately, our monetary authorities willingly adhere to this mythology without understanding the basic meaning of how credit functions in a modern economy. This meaning should be explained.
The birth of modern capitalism is associated with the invention of public money as an unlimited source of credit through the issue of national currency by a special institution, the Central Bank. Currency issue is essentially a mechanism to advance economic growth, and its use is in both the private and public interest. In the first case, of which the US Federal Reserve is an example, the money issue is subordinate to the interests of the owners of the Central Bank, which receive huge access to market manipulation. From the experience of financial crises, these manipulations are undertaken by them to not only receive income from the emission but also to appropriate national wealth. By lowering interest rates and expanding the money supply, the Central Bank stimulates the growth of production and investment. By increasing interest rates, it provokes bankruptcy of companies that are hooked on the cheap loans needle. The assets of these companies are transferred to the banks that are close to the Central Bank, which gives them unlimited access to the created loans.
When the Central Bank is a state monopoly, as is the case in most countries, its right to issue money can be used to ensure the development and growth of the national economy by providing the necessary amount of loans. This happens in Japan, China, India, Brazil, the Eurozone, Iran, and Turkey. In other cases the right to issue money may not be used if the country is not independent and transfers control of its Central Bank to external management. This is typical of many former colonies, the elite of which have their interests closely linked to those of their colonial masters, who still control their monetary policy.
In the postwar period, many developing countries were caught in the debt trap when trying to finance their development through external loans. Under the threat of bankruptcy, they were forced to give up control over their monetary policy to creditors, whose collective interests were represented by the International Monetary Fund. These interests mainly came down to the opening of the national economies to the free flow of foreign capital; the requirements of which the monetary policy was subordinated to. The latter include free convertibility of the national currency, removing any restrictions on foreign investment and outflow of capital, and the binding of the issue of the national currency to the growth of foreign exchange reserves, which were formed in the currencies of creditor countries. Thus the economies of the debtor countries were subordinated to the interests of capital of creditor countries, an absolute leader of which was the United States, which imposed the use of the dollar as a world currency in the capitalist world.
Russia, having taken upon herself the external responsibilities of the Soviet Union, found herself in precisely such a colonial state, caught in the debt trap. Moreover, even though the Russian state has now paid off those debts the Russian Central bank still subordinates itself to the interests of International capital. As a result the fiscal authorities refuse to implement capital controls, subordinating fiscal policy and particularly the stimulation of the money supply to the growth of foreign currency reserves and handing over the grading of credit risk to the American rating agencies. These policies are justified by the expectation that this will attract inward investment and that the chief engine of economic growth is indeed such foreign investment.
Actually, the expectation of an inflow of foreign capital yielded the opposite outcome - colossal capital flight. Russia became one the main net donors to the world financial system, giving practically free credit to the USA and the other G7 economies cash reserves of almost 100 billion USD annually. As a direct result of these policies serving international capital we see the further degradation of an economy already based on low value-add extractive industries whose production is sold again on the market denominated in USD and Euros. Under such conditions foreign capital extracts, as a result of these financial policies, enormous profits which again artificially inflate the domestic financial markets.
It is straightforward to evidence that for every dollar invested in speculation on vouchers and securities issued as a result of the privatisation carried out between 1993 and 1996 international 'investors' received up to five dollars in profit. The expansion of speculation as a result of the State issued short term bonds (GKOs) between 1996 and 1998 doubled that profit. International investors then repatriated of that capital from Russia and the resultant destabilisation of the financial markets led the state to default which, in turn led to securities being devalued to a 10th of their previous value. The International investors then returned and scooped up those securities at fire-sale prices creating a new spike in the market and, yet again doubling their capital and then, predictably, withdrawing the lot just before the 2007 global financial crisis struck.
It was in precisely this way that the subordination of national fiscal policy to international capital gave the international investors a return of two hundred dollars for ever invested dollar. The vast majority of that profit was simply taken out of the country. These profits were harvested from the state and the Russian population. The share of that money which translated into direct investment in productive industry or into tangible securities was negligible.
It follows that the Russians who collaborated with these 'investors' were not left out in the cold. Many of them became genuine pioneers of the 'offshoring' of the Russian Economy constituting themselves a new caste – The Offshore Oligarchy. The temporary commission of the Russian Federation set up to investigate the reasons, circumstances and consequences of the 1998 default were given evidence of direct collusion between the representatives of international capital and an entire pantheon of the 'great and the good' of both the Central Bank and the Russian government. Some of those individuals to the present day, regardless of the recommendations of the federal council, still occupy influential posts within the state. I quote “To ensure that persons involved in the preparation and decision-making of 17 August, could no longer hold any position or in the public service or in organizations where there is state ownership”
During the 2008 financial crisis the Russian Oligarchy, having by now mastered the methods of the earlier foreign investors began to interfere with the money supply themselves. Having now paid external debts, the Russian financial authorities no longer needed to subordinate themselves to the IMF or to their masters in the United States. Under pressure from crisis-driven capital flight they started to stimulate the money supply with no further regard to pegging it to hard currency reserves. However this was not done with the aim of stabilising industry, shrunk by the crisis by around 5 to 40% but rather to enrich a group of privileged commercial banks. They directed that expanded, tax and interest-free money supply straight to the financial markets extracting 300 Billion Rubles (12 Billion USD) of profit again, with the cost being borne by the devaluation of domestic savers' holdings.
And today the majority of the cash issued by the Russian Central Bank to refinance the commercial banks has been used for pure speculation which contradicts the policy aims of the central bank itself. It is clear that by increasing the interest rate while adopting a free floating currency rate, the central bank, on one hand is blocking the inflow of credits to the industrial sector and on the other is enabling the extraction of super-profits from speculation against the Ruble. Its precisely by doing this that a speculative vortex has been created where the savings of the population are (yet again) converted into super profits in speculators' bank accounts not to mention the equities of Russian corporations which, when unable to pay the spiralling interest rates thus created are more fodder for the hard currency speculators pillaging the market from their offshore accounts.
In this way the “holy Simplicity” of the managers of the central bank, these unquestioning believers in the inconvertible truth of the mechanical representation of the world given to them by the laws of economic equilibrium, but not innocent rather subordinated to transnational capital, of which the Russian offshore forms a part. It is entirely plausible that being true believers in the Washington Consensus, they not know not what they do. However their activities are highly regarded by the academic priesthood in the American universities. In the not-to-distant future those finance ministers and central bank representatives will again be singled out for praise as “best practice” just like their predecessors in earlier years. “Best practice” in the sense that they have created the most efficient conditions for the legal enrichment of the “oligarchic international” on the backs of the wealth of our country and its citizens.
The escalating crisis that we see today in more than one way, reminds us of the situation which prevailed in 1997. Now, as then the government decided to sharply decrease export duties which removed significant resources from the budget. International capital began to move out. Now as then, instead of instituting capital controls, interest rates were raised leading to capital contraction on the financial markets. As a result, then as now, there was no incentive to provide credit to the industrial sector and the rate of investment in industry began to fall.
The main difference is that the budget is in surplus and there is no state debt (this is made up for by similar amounts of corporate debt) and decision not to maintain a stable ruble is made in the presence of large foreign exchange reserves. In summary, default does not threaten the state but the same cannot be said of corporate borrowers.
Given that there is far more stability than in 1997, the fiscal authorities are actually themselves the greatest threat provoking a collapse in business activity and destabilising the currency. However this will not avert crisis, simply prolonging it to the delight of the offshore oligarchy who can now, without risk and at their leisure plan their speculation. It is inevitable that the consequences of these policies will be a fall in the rate of industrial activity and investment, a fall in profits and a stream of bankrupt corporations and thus the subsequent and successive devaluation of the population's savings.
This fiscal policy is taking place in the background of a sustained global trend towards stagflation which manifests as a volatile ruble and high inflation on one hand coupled with a fall in the rate of investment and economic activity on the other. The trigger for this crisis was the imposition of economic sanctions. On one hand this materialised in the refusal by western creditors to renew / rollover loans made to Russian corporations and the collapse of foreign investment. On the other side we see acceleration in already unprecedented capital flight. The volume of which, in the current year, is expected to exceed 100 billion USD. Incorporated into this is tax evasion which, comprising up to one third of this amount, represents a direct loss to the state budget of up to one trillion rubles annually.
Currently more than 50% of the fiscal base created by external credit and through offshore accounts comprises between 30% and 40% of the non-state investment. The aggregate external debt of Russia stands at 650 billion USD (74% of which is denominated in Euro or Dollars), which exceeds the currency reserves standing at 420 Billion USD. The majority of this debt at over 60% is owed by state owned corporations and banks. In fact the majority of external debts are from countries residing under the jurisdiction of the NATO member states. The sanctions imposed by them lead to a capital outflow of 11000 billion rubles to the end of 2014. The intensification of sanctions could lead to the blockade of Russian capital from offshore zones, through which flow over 50 billion USD yearly in investment.
As a result of the ruble destabilisation we shall see the 'dollarization' of the population's savings which in turn will become another form of capital flight which already amounts, through this means alone 30 billion USD.
Regardless of the US imposed war on Russia, our central bank continues to treat the US Dollar as the reserve currency, referring to it as the definition of value, the means of capital accumulation and the base rate for FX trading. The central banks current politics envision the dollar being utilised as a parallel, de-facto base currency in which the foreign currency reserves, external trade debts and credits are denominated and to which the ruble is effectively a subordinate currency. These policies clearly resemble those inflicted by the 3rd Reich on the Soviet territory occupied by them during the 2nd World War.
The Central Bank does not take any measures either to stop capital outflows, or to replace ebbing external sources of loans with internal ones. Though the U.S. has waged a financial war against Russia, the Bank is still governed by the Washington consensus, which develops macroeconomic policy in favor of foreign capital. This exacerbates the impact of sanctions in manifold ways, whereas it could be neutralized by simple measures of currency control combined with amplifying internal sources of credit.
The latter is exactly what Mr Gerashchenko [ex-chairman of the Russian Central Bank] did in order to pull the country out of the 1998 crisis. Having pegged the currency position of commercial banks and refused the IMF-initiated rise in interest rate, the Bank of Russia was able to increase the money supply. Contrary to what the Central Bank’s managers thought, this did not cause a rise but in fact a swift fall in inflation accompanied by an upsurge in production and stabilization of the value of the ruble. Today the Central Bank is doing the opposite and the results are as expected: a fall in production, the ruble’s depreciation, and the growth of inflation.
Loans allocated by the Bank of Russia to the banking system offset neither capital withdrawn by western creditors nor money transferred by the Government to stabilization funds. This causes the monetary base to shrink and consequently results in credit crunch and slumps in investment and production. So far, the Government has taken money out of productive industry, having withdrawn 7 trillion rubles into reserve funds. At the same time, the Central Bank has provided 5 trillion rubles in loans to the banks, which then use these loans for monetary and financial speculation. In this way, the monetary authorities pump money from the productive industrial sector into the financial sector, reducing its supply. By the end of the next year, if the Central Bank’s policy is not changed, the external loan freeze will lead to a monetary base squeeze of 15-10 %. This in turn will cause spasmodic contraction of the money supply, investment fall-off by more than 5 %, and production decline of 3-4 %. The reduction of money supply poses the threat of a 2007-2008-like crash of the finance market. The capital outflow may provoke defaults in many lending entities, and the number of defaults might become overwhelming.
The policy of increasing the refinancing rate set by the Central Bank results in a rise in the cost of credit, and secures a tendency to shrink the money supply and worsen the deficit in addition to the aforementioned negative consequences. For all that, inflation does not decrease, due to the ongoing influence of non-monetary factors, increased losses due to the rise in the cost of credit, production decline, and ruble devaluation. Since credit is inaccessible, currency devaluation has no net positive effect on export expansion and import substitution. Due to the worsened conditions for capital growth, money continues to be exported, despite the increase in interest rates. The economy is artificially sucked into a whirlpool of dropping supply and demand, and sagging incomes and investments. Attempting to hold onto budget gains by increasing taxes exacerbates the capital outflow and decline in business activity.
Forcing the economy into this stagnation trap happens solely due to monetary and loan policy. Meanwhile there are available production capacities that are only 30-80 % employed, part-time idleness, savings exceeding investments, and an excess of raw materials. The economy, which continues to be a donor to the world financial system, uses just 2/3 of its potential capacity.
To exit this stagnation trap it is necessary to halt the “capital outflow – money supply reduction – demand drop and credit crunch – rise in costs - inflation growth - production and investment decline” spiral. To do so, simultaneous measures to stop capital outflow, to stabilize macroeconomic situation, to de-offshore the economy, and to create mechanisms to nourish economic growth from internal sources must be taken.
In order to stop capital outflow it is critical, first, to burden cross-border transactions so that their illicit gains are offset, second, to cut speculative operations meant to destabilize the currency and finance markets, and third, to close off the channels of internal flow of capital into accounts in foreign currency.
The first task can be performed by introducing a tax on capital outflow at the rate of the VAT imposed on cashless cross-border transactions in foreign currency. In the event the legality of those transactions is confirmed (delivery of imported goods, service rendition, confirmation of interest payments and cancellation of loans, dividends and other legal returns on invested capital), the VAT is refunded. In this manner, only the illegal, tax-dodging outflow of capital will be subject to taxation. Whilst the tax is being introduced, the Central Bank can call for reservation of the potential tax money for all suspicious cross-border operations for up to a year or until their legality is confirmed.
In addition, the VAT should be reimbursed to exporters only after submission of export earnings. A penalty must be imposed for overdue debit debt under importation contracts, non-reporting of export earnings and other types of capital export in its full amount. It is essential to stop including non-residents´ distressed debts owed to Russian enterprises into non-operational expenses (and thus decrease assessable income). Claims must also be filed to indemnify an entity or state for losses against managers, if such debts are reported.
To restrain illicit capital export accompanied by tax evasion, a unified information system of currency and tax control must be created, including electronic declaration of operation IDs and insertion of these IDs into databases of currency and tax monitoring institutions. Rules must be introduced to determine the responsibility of the entities´ managers in cases where there is an accumulation of overdue debit debts related to export and import operations.
To stem cash export, a rational limit must be set, which, if hit, signals capital export operations (e.g., 1 million rubles, a sum obviously greater than gastarbeiters’ combined wages, tourism expenses, and other day-to-day operations). The export of foreign cash in an amount exceeding 1 million rubles shall then be taxed (tax on capital outflow).
Transparency of cross-border transactions for tax and currency control must be achieved. Following the example of America, agreements with foreign countries must be concluded in which tax information is exchanged and foreign banks register and share information concerning all global transactions involving Russian Banks’ money. At the same time, Russian beneficiaries must be responsible for declaration and taxation of their foreign accounts, assets, and operations in conformity with Russian laws.
To separate legal and illegal export of capital, the Central Bank should require licensing of capital export operations in foreign currency. This should include in-advance notification of capital export, increased regulation of operations in foreign currency by Russian banks, and a limit on the scaling-up of the currency positions of commercial banks.
To avoid excessive losses, restrictions should be placed on the amount of foreign off-balance sheet assets and valuables, including U.S. treasury bonds and securities having large budget deficits or high national debt.
To stop internal capital outflow, opening deposit accounts in foreign currency or depositing the money into previously-opened accounts should be banned. The system of safeguarding citizens’ bank deposits should be confined to deposits in rubles. These measures are necessary because the state cannot secure preservation of valuables denominated in foreign currency while there is a financial war against Russia. At any moment, they could be devalued or frozen due to enemy activities or for other reasons beyond Russia’s influence.
Currency control should encompass not only bank operations, but all financial operations including those involving insurance, which can be used to export capital and evade taxes. It is necessary to at least stop making insurance agreements in foreign currency. In addition, the monopoly wielded by the City of London on reinsurance operations, through which much income is exported, must be abolished. Experience shows that, if a party asserts force majeure, it is idle to expect foreign companies to meet their insurance obligations. The most efficient and sustainable solution is to establish a state monopoly on reinsurance, which could be allotted, for example, to the Export Insurance Agency of Russia.
Generally, during financial war regulators must deem transactions performed in rubles more reliable than those conducted in foreign currency. At the same time transactions in the currencies of the belligerent countries (which imposed sanctions against Russia) should be considered the most risky ones. In view of this, the Central Bank should establish higher reserve requirements and standards of evaluation of risks involved in bank operations in foreign currency vs. those made in rubles.
In order to de-dollarize the economy and to insulate the currency and financial system of the country from speculative attacks, it makes sense to levy a 5% tax on the purchase of foreign currency or bonds denominated in foreign currency.
Aforementioned measures to regulate cross-border transactions should be applied exclusively to foreign-currency transactions. Up until the 2007 financial crisis, the lack of such operations did not have a great impact on macroeconomic stability due to a more robust trade-surplus growth, which was greater than a non-trade deficit. Although the Russian financial system suffered big losses, the foreign currency reserves grew and secured the strength of the ruble. But as capital is exported and corporations’ and banks’ external debt went up, the risk of destabilization of the finance and currency system appeared. This risk was manifested in a 1.5-fold reduction in the ruble’s value and a three-fold stock market crash, along with the loss of the 2007-2008 reserves worth $200-billion dollars.
In the near future, the same thing, but on a larger scale, might take place.
Unlike the export of foreign-currency assets, the export of ruble assets does not create a direct threat of macroeconomic destabilization provided the above-mentioned measures of currency control are in place. There is, of course, the risk that an avalanche of foreign-accumulated rubles could flood the internal market causing inflation and/or strengthening of the national currency beyond the equilibrium level. However, applying the above measures to discourage speculations against the ruble creates a fairly high and essentially insurmountable barrier against speculators when there are sufficient currency reserves.
At the same time, ruble export of rubles implies that the profit accruing to the currency issuer (seigniorage) remains in Russia´s financial system where it can be used to multiply investments, to boost imports of vital commodities and services and to expand reserves. Within certain bounds, building up capacities of the financial system, decreasing foreign transaction costs and increasing competitive edges are beneficial to the national economy. Making the ruble the reserve currency is indispensable to ensuring the stability of the Eurasian integration. This is why it is necessary to withdraw from imposing restraints on cross-border ruble operations, create conditions for recognition of the ruble as a reserve currency by money authorities in other countries, and stimulate the import and export paid for in rubles.
To widen the demand for rubles and thus impart more stability to the national currency and finance system, switching to mutual payments in rubles within the CIS must be encouraged and also when arranging payments with the EU – in rubles and euros, and with China – in rubles and yuans. It is appropriate to recommend business entities to settle payments for exported and imported goods and services in rubles. Herewith it is necessary to provide for allocation of tied rouble loans meant for the countries that import Russian commodities, in order to maintain the commodity circulation, and also to use the currency-linked credit swaps.
It is of the utmost importance to expand the settlement system in national currencies between establishments of the CIS states through the CIS´ Interstatebank or through Russia-controlled international financial organizations (IBEC [International Bank of Economic Cooperation], MIB [Moscow Industrial Bank], Eurasian Bank of Development [EABD] and others). It would make sense to create a payment and settlement system in the national currencies of the EurAsEC [Eurasian Economic Community] members, develop and deploy internal independent system of international payments, having included Russian banks, those of the Customs Union and CIS member states as well as those of Chinese, Iranian, Indian, Syrian, Venezuelan and other traditional partners.
These measures will create all necessary conditions protect the value of the ruble and the financial market to external threats. Therewith, the internal threats related to migration of the money supply into the currency market persist. Although this threat became apparent in the 90s, when rubles were emitted to provide agriculture and other branches of non-financial sector of economy with loans and these rubles then migrated into speculation in the currency market. It revealed itself in 2008 as well: 2-trillion rubles emitted for anti-crisis purposes went into currency market speculation and this depreciated savings once again. The monetary authorities keep disregarding this threat and do so despite the fact that, while the Central Bank amplifies the refinancing of commercial banks, capital export grows. This leads us to assume that commercial banks use most of the loans received from the Central Bank to speculate against the ruble in the global currency market.
In order to stabilize the currency and finance market, it is necessary to stop inflating the finance and currency market by emitting rubles. It does not mean that the Bank of Russia should cease refinancing commercial banks. Quite the opposite; to overcome the recession and ensure economic growth, refinancing should be stepped up. But it should be done cleverly, imposing liabilities on banks which resort to refinancing for illegitimate ends. In particular, the receipt of a loan from the Bank of Russia might only happen on the condition that commercial banks assume responsibility to properly use the credit, excluding the possibility of banks using loans for speculation. To control the fulfillment of this liability, the currency position of commercial banks could be fixed, special accounts used, the bank margin restricted, and project financing tools applied.
The Central Bank could considerably enlarge and extend refinancing operations for banks that consent to the Central Bank’s monitoring of loan use. And the Central Bank should preferably do so on security of bills receivable of end-use borrowers, which exclusively should be manufacturing enterprises, than upon sale and repurchase agreements. The manufacturing enterprises should be monitored by lending banks in order to see whether the loans are properly used, solely to replenish the current capital or investments into core assets. Considering that either company can carry out a vast range of financial operations, including the speculative ones (among them those of capital export), there are good reasons to bring the standards of maximum allowed ratio between credit and debit debt on all legal bodies and to limit financial leverage to no greater than double value the principle.
The very mechanism of refinancing commercial banks should be varied to comply with objective needs for credit. Refinancing service for loans made to manufacturing enterprises should be rendered at interest rate of less than 4%, with bank margin reduced to 1%, so that manufacturing enterprises could take out a loan at a rate that does not exceed their profitability; for other purposes, at current rate according to financial market.
The above measures are about monitoring the offer rate of the ruble and designed to limit demand for foreign currency, purely in order to pay for imported commodities and services, pay interests on external loans and recompense other legal operations. It is obvious that measures to ensure stable offering of sufficient currency are required for stable ruble value. More specifically, it makes sense to reestablish obligatory sale of currency earning by exporters.
After taking the above measures to block rampant speculation, the ruble value could be taken under control. To stop speculation in foreign exchange, it is possible to temporarily fix the exchange rate of the ruble with a value lower than the market one, then to purposefully adjust it without warning. The market insiders will therefore have to consider the balance of payment and optimization of a balance between the need for import and the need for maintaining the competitiveness of national commodity prices. International experience convincingly shows that, when stabilizing, discrete modification of the value of a national currency is better that the floating one, because it halts speculative eddies.
Applying the specified macroeconomic stabilization measures creates conditions for resolving the issue of replacement of external loan sources with internal ones without the risk of starting the inflation.
In order to prevent bankruptcy of backbone companies, it is necessary to replace external loans taken out by Russian corporations with Russian banks’ loans. For this the Central Bank must conduct well-aimed emission of credit resources and supply them to companies on the same conditions as external creditors do. Taking into account the scale of this task (credits subject to cancelation before the end of the next year are worth $180-billion), it needs to be completed only through state-controlled lending institutions. Their managers must bear personal responsibility for appropriate use of credits allocated to specified corporations so that they could meet their obligations to external creditors.
In order to prevent commercial banks’ default on external bonds, those banks should undergo stress tests, while the Central Bank, if needed, allocates stabilization loans to them on terms equal to those of external borrowings.
A special problem is presented by the need to replace the foreign loans which Russian enterprises obtained from European development institutions in order to pay for new equipment. In particular, to prevent the termination of equipment leases financed by foreign lenders, credit facilities must be issued to fund [new] development institutions that would operate in a similar way, using the funds allocated to them for that same purpose. In each case we have to consider, in parallel, whether domestic products could be substituted for foreign imports. Even if they cost more and are inferior in quality, ultimately this approach may be more advantageous, as it reduces the risks, expands the revenue base and opens the way to modernization and growth. We should also stop using state credit resources to lease foreign technology.
The de-offshorization of the economy should begin with the selection of those business activities that are most vulnerable to the corrupt practices that tend to go hand in hand with the use of offshore tax havens. For this, it makes sense to introduce a legal definition of the term “national company” – a company registered in Russia and having no affiliation with foreign entities and jurisdictions. Only such companies should be given access to mineral resources, state subsidies, and to work that is strategically important for the state.
The ultimate owners of shares in Russia’s strategic enterprises should be required to step out of the shadows off-shore and register their ownership in the Russian registers. There has been talk, for a long time now, about the need to follow the example of developed countries by concluding agreements covering the exchange of tax information with offshore tax havens and doing away with existing agreements on avoidance of double taxation, including with Cyprus and Luxembourg, which are known to be offshore transit points. We need to define a uniform list of offshore companies, including those that are part of onshore companies. Transferring assets to offshore jurisdictions that shy away from such agreements must be prohibited.
In addition, we need to require offshore companies owned by Russian residents to abide by Russian legislative provisions on furnishing information about the members of the company, as well as on the disclosure, for tax purposes in Russia, of tax information on all income received from Russian sources, under threat of establishing a 30% tax on all transactions with those who are “un-cooperative”.
Implementing the above measures will create the conditions necessary for the extension of credit without the risk of a flood of money being issued and returned to the currency and financial markets from offshore for speculative purposes. After these measures are adopted, the non-inflationary expansion of the money supply becomes possible along with the re-monetization of the economy in order to increase investment and business activity.
The current decline in production is mainly caused by a contraction in the money supply, deteriorating credit conditions, and the destabilization of the currency and financial markets which resulted in the flight of capital and a drop in investment activity. To stop the downward trend in investment activity, we have to give businesses the opportunity to increase their working capital to allow for the optimal utilization of existing production facilities.
As explained above, we need to establish channels for the unlimited refinancing of commercial banks by the Russian Central Bank, secured by manufacturing companies with the credit already granted requirements to production companies already issued credits at a rate not higher than the average profitability of the manufacturing industry, with the mandatory condition that the credit resources be provided exclusively to manufacturing enterprises, with bank margins limited to 1%. This will result in the changing the credit market from a buyer’s market, where banks enjoy the advantage of a monopoly and business-borrowers have to take loans at usurious rates, into a seller’s market, in which banks will have to compete for customers. This will give solvent manufacturers access to credit on the same terms their competitors see in the West and in the East.
Providing a way to finance working capital will put an end to declining production and will ensure growth at existing facilities. In this way the output of the manufacturing industry, construction and agriculture will be increased by 10–15% within two years.
If we take extra steps toward import substitution, the returns will be commensurate. This would require establishing a lending mechanism earmarked for projects to expand existing production facilities and to create new ones based on the existing technological base. The relevant sectors and agencies need to work actively to prepare and evaluate the proposed import substitution projects. Projects that are selected as promising should receive guarantees from the government or federal agencies in order to attract loans from development institutions and commercial banks, which would subsequently be refinanced by the Bank of Russia at a rate of 2%, while bank margins are limited to 1%.
Productivity growth and import substitution will provide economic growth in the next 3 to 4 years. Sustainable growth in the future requires long-term investment in the modernization of existing production facilities. This means creating a means for the Bank of Russia to refinance commercial banks, through loans secured by bonds and shares in strategic enterprises, at a rate no higher than the average return on shares in the manufacturing industry, while holding the commercial banks liable for the proper use of the credit received. The principles of project financing must be applied broadly.
To achieve rapid development, we need a sharp increase in R & D and investment in the development of promising new technologies, which form the material and technological basis for a long new wave of economic growth. At present, the institutions supporting innovation are patently unable to cope with the task. In order to increase investment in the creation of new industries and the development of new technologies, channels must be established for the refinancing of development banks and state-controlled commercial banks by the Bank of Russia, with the right to claim 2% of the assets generated per annum and on the condition that the credit facilities are used in accordance with the principles of project financing with a margin of no more than 1%. In order to expand the means of financing development institutions, it is desirable that the budget line for their funding be supplemented with a mechanism for refinancing by the Bank of Russia at 2% per annum for the purpose of project financing, secured by the assets thus created.
Along with creating mechanisms for greater lending and for investment in general, special lending institutions should be designed to encourage large scale expansion of those industries that show low profitability. These include strongly seasonal industries, where the turnover cycle is not less than a year (agriculture, resorts and recreational services) and industries with a long production cycle (machine building, construction) lasting more than 3 years. For companies in these sectors, there should be mechanisms for subsidizing interest rates through specialized credit institutions, some of which are already in place. These funds could come from stabilization funds accumulated by the government out of oil and gas revenues. In this case, the Reserve Fund should be converted into a development budget, whose funds should be spent to encourage investment in promising areas of economic growth by funding development institutions. To do this, the capital accumulated in the Reserve Fund should be placed in development institutions, bonds of state-owned corporations, and in infrastructure bonds.
To start on the path of accelerated development requires a multipronged expansion of financing for innovation and investment projects. But this will make sense only if responsibility for their effective implementation is radically increased. This means we should make a transition to our own domestic way of evaluating a project’s economic worth. In particular, to reduce systemic risks, we must replace foreign credit rating agencies, and auditing and consulting companies with Russian ones for every step involved in investment decision-making by public authorities and by banks that are partly state owned. In addition, to make the investments more efficient, a system needs to be created for evaluating and selecting the priority areas for scientific-technical and economic development within the framework set by the strategic planning system.
The implementation of such a comprehensive system of measures to stop capital flight and make the transition from foreign to domestic sources of credit, with the simultaneous de-offshorization of the economy, makes it possible to pursue a policy of rapid development on the basis of a multi-faceted increase in investment and innovation, in key areas of building a new technological foundation. The re-monetization of the economy by having the state boost the lending capacity of the banking system, and the return from offshore tax havens of the capital that has been taken out, will enable us in the next 2 years to see annual GDP growth of 6–8% per year, while investment increases by 15% per year, and R & D spending by 20% per year, all while keeping inflation in the single digits.
1 Report of the Interim Commission of the Federation Council to investigate the causes, circumstances and consequences of the decision of the Government of the Russian Federation and the Central Bank of the Russian Federation, dated 17 August 1998, on the restructuring of short-term obligations, the devaluation of the ruble exchange rate, and a moratorium on executing capital foreign exchange operations.
This post first appeared on Russia Insider
Anyone is free to republish, copy, and redistribute the text in this content (but not the images or videos) in any medium or format, with the right to remix, transform, and build upon it, even commercially, as long as they provide a backlink and credit to Russia Insider. It is not necessary to notify Russia Insider. Licensed Creative Commons