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In Upbeat Mood, Putin Reviews the Economy with his Team

Meetings between Putin, Economics Minister Ulyukaev and the rest of his economics team suggest growing confidence and decisions on interest rates as inflation falls and more foreign debt is paid off

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This post first appeared on Russia Insider

Putin recently had an interesting meeting with Economics Minister Ulyukaev, in which they discussed the economy.

Since the transcript of the meeting published on the Kremlin’s website is relatively short, I attach it below in full.

The transcript of course only covers the public part of what Putin and Ulyukaev said to each other.  

It is a virtual certainty the meeting went on for much longer than the transcript shows, and that much more was said which has not been published, and that the really important part of the discussion was the part that has not been published.

There is no reason however to think the transcript does not convey the overall tone and sense of the meeting.  The figures Ulyukaev reels off are the figures previously published by Rosstat and can be independently verified. It is difficult to see what he could have said to Putin in private which differs from the situation suggested by the figures he cited, which are public. 

The tone of Ulyukaev’s comments in the private part of his conversation with Putin was no doubt more subdued and businesslike than his published comments.  However the difference is probably only one of degree.

The first thing to take away from the meeting is that the mood was upbeat.  

I have often spoken of how the recession Russia is going through is essentially an exercise in rebalancing the economy away from its historic reliance on foreign capital and imports towards a more investment-led model.  

That essentially is what Ulyukaev is saying, and he is saying moreover that the rebalancing is being carried out successfully and is about to bear fruit.

The second point to take away from the conversation is that Ulyukaev confirms the timeline of the recession given by us often here on Russia Insider.

The worst point of the recession was the second quarter of 2015.  

Output has since been generally steady.  The economy absorbed what Ulyukaev calls “the second external shock” - the second collapse of oil prices and of the rouble which began in the second half of 2015 - well.  

Whereas the first shock - the collapse of oil prices and the rouble in the second half of 2014 - caused a recession and a big inflation spike - the second shock has so far gone by with barely a blip.

I would add just two points to the things Ulyukaev told Putin.

The first I have said before.  This is that I am sure that the economy’s contraction in 2015 would have been close or even below Ulyukaev’s original 3% forecast instead of the 3.7% it turned out to be if the Central Bank had cut interest rates in the spring and summer as I think it should have done.  

Moreover certain things Ulyukaev said last June make me sure he thinks the same thing.  I would not be surprised if it is one of the things he said to Putin in the part of their conversation that has not been published.

The second is that though the dip Ulyukaev mentions which happened in November was indeed caused by the “second external shock” as Ulyukaev says, what Ulyukaev does not say is that every one of the major economies apart from Sweden also experienced a contraction in November.  

In other words Russia’s contraction that month was not unique to Russia but was part of a worldwide phenomenon.

I have no doubt that the cause was global alarm that at its meeting in December the US Federal Reserve Board was going to raise US interest rates.  

I have no doubt either that it was the Federal Reserve Board’s decision to increase interest rates in December - and even more its forward guidance that it would continue to increase interest rates throughout 2016 (with talk of four interest rate rises over the course of 2016) - which has been behind the plunges in the markets (including the oil market) that have happened this January.

With the dollar still the world’s reserve currency, in a grotesquely over-leveraged world - caused by the Federal Reserve Board’s reckless policy of money printing since the 2008 crash and its grossly lax monetary policies in the decades before the crash - any hint of a rise in US interest rates is enough to panic the markets and send them into a tailspin.

Not surprisingly there is growing anger at the Federal Reserve’s Board’s decision to raise interest rates in December, with more and more people calling it a mistake (amongst the countless  articles saying this, see examples here and here).

On the question of leverage Russia is the exception to what is otherwise across the world now the almost universal rule. 

Historically tight monetary and fiscal policies, together with a clamp-down on external borrowing after the 2008 crash - tightened even further in the summer of 2012 - mean that despite the sanctions Russia entered the global crisis period which began in mid-2014 in much better financial shape than the other so-called “emerging market economies” - and indeed some of the so-called developed economies of the West.

A good comparison is with Brazil, a country with a population roughly the same size as Russia’s, and whose economy is often compared to Russia’s.

Brazil’s state debt to GDP ratio is roughly 66% of GDP.  Russia’s is 18%.  Brazil’s budget deficit in 2015 was roughly 10% of GDP.  Russia’s was 2.6% (the figure of 3% of GDP given to Putin by Ulyukaev is wrong.  The correct figure of 2.6% of GDP was recently provided by Finance Minister Siluanov). 

Brazil’s total external debt (state and corporate) was $3.4 trillion as of 1st January 2016.  Russia’s total external debt (state and corporate) as of 1st January 2016 was $515 billion.

The result is that though the size of the contraction in Brazil and Russia in 2015 was almost the same - 3.6% and 3.7% respectively - and though reported inflation was higher in Russia than in Brazil (12.9% against 10% - though Brazil’s reported 10% figure may be too low), the mood amongst policy-makers in Russia is increasingly upbeat - as Ulyukaev’s meeting with Putin shows - whilst the mood in Brazil is one of panic and crisis, with growing fears of a coming default and a feeling that the situation is spiralling out of control.

Though Brazil’s story is well-known because the international media has - unfairly - focused on it, Brazil is actually far more typical of the so-called “emerging market economies” than Russia is.

Not only is Russia much richer than any of the other so-called “emerging market economies”, but it has scientific, technological and industrial resources none of the others can remotely match, its finances are in far better shape, and the quality of its governance is much higher.

As it happens I don’t think Russia should be called an “emerging market economy” at all - any more than China should - and I think it is positively misleading to bracket Russia with economies that are generally called that.

In private correspondence Jon Hellevig has pointed out to me that a substantial part of the roughly $500 billion Russian banks and companies still nominally owe in foreign debt is in fact not really debt at all but is rather the record of intra-company transactions Russian companies often carry out through foreign financial havens like Cyprus in order to cover their foreign currency operations and of course for tax avoidance.

The Central Bank has admitted this in the past and has confirmed that the total figure for external debt that is published (presently $515 billion) in fact exaggerates the real amount of debt that is actually owed. 

Unsurprisingly it is very difficult to put a figure on the part of the foreign debt that is actually intra-company book debt that.  However it is widely thought to be very large.  Guesses I have heard put the figure at more than half total nominal foreign debt.

The Russian Central Bank has just released figures for the level of foreign debt as of the start of 2016, and of foreign debt payments through 2016.   

They show that foreign debt has fallen to $515 billion from a peak of $733 billion in mid 2014.  This graph shows the pace of the deleveraging.  

Payments of foreign debt in 2016 at around $100 billion seem to be roughly the same as last year, though they seem to be better spaced out over the year as a whole rather being bunched up in the last quarter, as was true in 2014 and 2015.

According to the Central Bank payments in the first quarter will be $26 billion ($21 billion principal and $5 billion interest) as compared to $43 billion in the last quarter of 2015.   

Debt payments thereafter are expected to remain at roughly the same level, totalling $27 billion in the second quarter, $21 billion in the third quarter, and $24 billion in the fourth quarter, making for a total of $98 billion in debt payments over the whole year.

The heaviest month for debt payments in 2016 will apparently be March, with payments totalling $12.5 billion.  This compares with debt payments of $24 billion in December last year. 

Assuming that roughly a quarter of foreign debt payments in 2016 are interest payments, this should mean that the total amount of foreign debt by the end of 2016 should fall to around $430 billion.  Given that a substantial part of Russia’s remaining debt is intra-company book debt, this reinforces the impression that the end of the period of deleveraging of foreign debt is now in sight.

As I have discussed previously, that fact in itself will cause the rouble to strengthen regardless of what happens to oil prices. 

The reduced pressure on the rouble compared to the second half of 2014, when the pace of foreign debt payment was running at more than twice the present level, shows that this is already starting to happen.  

Though the rouble briefly touched 85 to the dollar over the last 2 weeks, it did so when oil prices had fallen to $26 a barrel for Brent crude.  This compares with the situation on 17th December 2014 when the rouble touched 80 to the dollar with a Brent crude price of $57 a barrel.  

As of the time of writing the rouble is trading at 78 to the dollar, with the Brent crude price above $30 a barrel. 

In the past I have speculated that the point when the rouble will start to decouple from oil prices will be when the total foreign debt that is actually due falls below the amount of Russia’s foreign exchange reserves held by the Central Bank (currently roughly $370 billion). 

All the evidence suggests that that point is fast approaching, and if is true that only half of the nominal amount of $515 billion of foreign debt is debt that is actually due, then that point may already have been passed - even it is not yet visible in the published figures.

Given that that is so, since it is very much in Russia’s interests to keep the rouble low in line with oil prices - to choke off imports to support to agriculture and industry and to keep the external trade balance in surplus at a time of low oil prices - I have come round to Jon Hellevig’s view that the Central Bank should cut interest rates without further delay.

Inflation is falling fast and - as Jon Hellevig says -  in Russia it is not primarily a monetary phenomenon anyway.  

Since inflation is falling fast and since there is no need to support the rouble - on the contrary an excessive rise in the rouble like the one last spring would actually do harm - there is no reason to keep interest rates high.  All the high interest rates are now doing is prolonging the recession.

Unfortunately, if recent history is a guide, the Central Bank will once again err on the side of caution, and - spooked by the recent fall in the rouble and worries about further interest rate rises in the US - will decide to keep interest rates high at its next scheduled meeting at the end of January.

The day when interest rates are cut cannot however now be far off.  Beyond a certain point not just economic logic but political pressure from business, the Duma and the government will make an interest rate cut inevitable.

At that point, with inflation falling, de-leveraging on foreign debt largely accomplished, and with the prospect of output rising as both investment and demand recover, Ulyukaev and Putin will have more good news to tell each other.

Postscript: After writing the above release of more figures from Rosstat showed that inflation has fallen to an annualised rate of just over 10% as of 25th January 2016.  Its annualised rate may fall to single figures as soon as the first week of February.  

The recent fall in the rouble may delay further falls in inflation for a few weeks, but the trend is clearly strongly down.  It is in fact striking how little effect the recent fall in the rouble has had on inflation.

Other figures just released by Rosstat also showed that in December Russian companies largely paid off the wage arrears that additionally accrued in November as a result of the contraction that happened that month.  

That reinforces the impression that - as Ulyukaev said to Putin - the November contraction was a one-off, caused by the global market panic that began in November as it became clear the Federal Reserve Board was about to raise interest rates, and that it was followed by a rebound in the economy in December.

The Kremlin meanwhile has also confirmed that a meeting took place on Wednesday between Putin and the members of the government in charge of the economy.  

Though Nabiullina, the Central Bank’s Chairman, is not technically a member of the government, she was also present.  

It is inconceivable that the issue of interest rates was not brought up at this meeting.  

Nabiullina is almost certain to have come under pressure from some of the people present to say when interest rates are going to be cut, with some almost certainly demanding a cut now.


This is a transcript of a conversation that was first published by the Russian Presidential website:

President of Russia Vladimir Putin: Mr Ulyukayev, we are summing up last year’s results. Though it may yet be early to speak of final results, the numbers at the disposal of your Ministry are very close to what we will see in the final report.

It was not an easy year; nevertheless, we have reasons to feel somewhat optimistic regarding the current and future periods. What is the reason for this optimism?

Minister of Economic Development Alexei Ulyukayev: Mr President, it is true, the year was economically unique in terms of the combination of unfavourable objective and subjective circumstances, starting with the situation on the market of raw materials. An unprecedented four-fold drop in oil prices and a similar drop in prices of non-primary goods, turbulence on the financial markets plus the geopolitical actions by our partners – all this created a very nervous atmosphere, of course.

Vladimir Putin: And a world economic slump.

Alexei Ulyukayev: Absolutely. Global demand dropped sharply, serious risk hotbeds appeared where nobody expected to see them, and I mean the former leaders – Southeast Asia.

It was against this backdrop, as you may remember, that last January, exactly a year ago we were adjusting our forecast in a rather nervous atmosphere, practically in an atmosphere of panic among certain market players and analysts. The expectations were most unfavourable, but nevertheless, I want to look at the forecasts and the reality.

It turns out that our forecast was very close to the actual situation.

We expected the price of oil to be at $50 per barrel, the actual figure was $51. We expected the consumer price index to be 12.2, it was 12.9 – a difference of less than 1 percent. We estimated the dollar exchange rate at 61.5, the annual average was 60.

Vladimir Putin: This is the annual average, for all of last year?

Alexei Ulyukayev: That’s right, for all of 2015. We expected a 3 percent GDP decline, and it ended up being a little higher, at 3.7 percent. On the other hand, the decline rate for investments in fixed capital turned out to be significantly lower – 8.4 percent instead of 13.7 percent. But this is after adjustments, because investments are always adjusted at the end of the year.

I want to particularly point out the situation with private capital and the movement of private capital. We all expected a very high outflow, around $115 billion, but in fact, we had an outflow of $57 million, just half of what we expected. Capital outflow is a business assessment of internal and external factors, an assessment of future working conditions.

Why did this happen? I think the most important factor was the high adaptability of the Russian economy. In just a few months, the market participants, companies and whole sectors were able to find their niches and adjust to the changing circumstances.

This is illustrated by two shock waves, in the second half of 2014 and the second half of 2015 – I am referring to the objective shocks in the raw materials markets. Just look, the base indicator changed in almost the same way; the oil price dropped to $45, a 60 percent decrease.

In the second case, during the second half of 2015, there was a 62 percent drop. How did Russian markets and Russian sectors respond to this? In the first case, we had the same level of currency devaluation – more than twofold, from 33 to 69 [rubles per dollar]. Consumer prices more than doubled, the rate went up from 7.8 to 16.9. The Bank of Russia’s key interest rate, more than doubled, from 7.5 to 17 percent: it was forced to respond to these circumstances. As a result, the GDP decreased by an additional 2.4 percent.

In the second half of 2015, we had the same Russian economy, the same level of shock. We had 70 percent devaluation. It was enormous, but significantly less than during the first episode. Consumer prices decelerated, rather than accelerating. We started this period at negative 15.5 percent, and ended the year at about 10 percent. Not only did the key rate not increase, but it even decreased slightly during this period, because the inflation risks had been assessed correctly.

Finally, GDP dropped slightly in November, but the overall decline was 0.4 percent, which is incommensurate with what we had before. This is very important. It means that apparently, market participants have worked properly and, perhaps, the Government even helped make the right decisions through its actions.

Vladimir Putin: Has the debt decreased?

Alexei Ulyukayev: The debt has decreased very significantly. Our sovereign debt has always been low, but the corporate foreign debt was reduced enormously. Incidentally, we had $130 billion worth of external debt repayment on our schedule last year, while the outflow of capital during the same period decreased by 57 billion. It turned out that companies know how to work in this situation. They find opportunities to refinance, and although our partners’ options became much more complicated, this was done nevertheless.

Part of the debt was internal corporate debt, which also needed to be resolved. And it is very important that the public and businesses have stopped being sensitive to currency exchange rate fluctuations. They are used to the fact that exchange rates fluctuate, so there is no need to run and exchange currency, there is no need to immediately change the structure of one’s investment portfolio. This is also very important.

Vladimir Putin: In conjunction with the budget deficit, and with a deficit that is lower than expected as well as good reserves, a low level of debt – in conjunction with what frankly turned out to be a small budget deficit, will we see favourable conditions so we can count on improving the current situation?

Alexei Ulyukayev: Absolutely. The budget takes into account a deficit of 2.6 percent GDP; last year’s budget had a deficit of more than 3 percent. The Bank of Russia reserves remain at a fairly high historical level. All this has created a situation of macroeconomic stability that market participants are responding to it correctly.

We have already talked many times about the fact that the deepest part of the recession, when the adaptation was taking place, was somewhere toward the end of the second quarter. Starting in the third quarter, we observed movement in the right direction. We saw the emergence of what may be the foundation for growth – perhaps not very significant or confident, but growth nevertheless. While we had some GDP decline in the first quarter (2.2 percent), we saw the greatest decline in the second quarter (4.6 percent), and then had 4.1 percent and 3.8 percent decreases in the third and fourth quarters, respectively. We had a cumulative decline of 3.7 percent for the year.

We are seeing similar figures in manufacturing, construction, and freight transportation, and in all of these industries, the lowest point was in the second quarter, and after that there was some stabilisation, uncertain, perhaps, but stabilisation with elements of growth. In November, we had a slight wave downward, as a response to that second shock. Since December, we are once again entering a periodwhere the situation is becoming relatively favourable.

Vladimir Putin: Has there been growth in agriculture?

Alexei Ulyukayev: We had 3 percent growth in agriculture. Particularly with cattle breeding – we had over 4 percent growth for cattle. While the grain harvest depends significantly on the weather, cattle remains much more stable. This indicator shows the results of economic activity and investments, with growth of over 4 percent.

Thus, the food industry had growth of over 3 percent. Overall, I want to say that this is very important, that it is a very good financial result for Russian companies. This happened in part because costs declined, in part because exchange rates changed, and in part because the salary policy became more adequate, there was more attention toward increasing labour productivity, in part to better control the rates of natural monopolies. All this led to the fact that last year, Russian companies’ income increased by 48 percent, or 1.5-fold. That is over eight trillion rubles in additional funds that can be invested and that can serve as a foundation for development.

In some areas, the situation is simply amazing. Incidentally, it is good that these are not extractive industries, but rather, processing industries. The processing sectors of manufacturing increased profitability nearly threefold – 2.9-fold. Chemicals held the record, with a 15-fold increase in profitability. And what is very interesting is that we saw a real increase in profitability in the science sector.

Research and development became a profitable activity, which means they are in demand. Businesses are seeking opportunities to use scientific research to reduce their spending and move forward. Profits from research and development have increased 2.1-fold. I think this is an exceedingly important element of development. In this area, we truly have a very good foundation; now we just need to be smart about using it. I think we can move into this year with measured, careful optimism.

Vladimir Putin: We have a positive trade balance. Taking into account the drop in prices for our main export goods, including raw materials, what caused this positive trade balance?

Alexei Ulyukayev: We have a positive trade balance and balance for current operations.This is what is most important. In 2015, we had a trade surplus of about 145 billion rubles. This is slightly less than we had before. First and foremost, this is due to the drop in our export prices. Physical volumes have not declined, and the fourfold oil market drop, as well as the drop in the markets for gas and ferrous and non-ferrous metals, have led to a serious decrease in the price of exported goods. But the cost of imports has also declined.

As a result of this, as a result of the import substitution policy, we have an increase in Russian retail trade: the share of Russian goods has become much higher. Thus, the trade balance has decreased slightly, but remains strongly positive, while the position of the current balance of payments has not decreased at all, and in fact has increased slightly.

Why is that? It turned out much better than our forecasts. Because our services bill has decreased significantly. In essence, our citizens no longer leave their money in Turkey, Egypt and many other countries, and have begun to spend it in Sochi, Crimea and other Russian regions for tourism and recreation.

Because of our reduced corporate debt, the sums for servicing this debt have decreased well. So our current account is in good shape, and as I already said, and our capital account outflow turned out to be much lower. The overall net position of the payment balance is positive. We have 66 for the current account, and negative 57 for the capital account, with a net result of 9. This means that we do not need to use our reserves, and we may even be able to increase them. All of this adds stability to the economy.

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