Alexey Vedev, Head of Financial Studies Department of the Gaidar Institute, spoke in an interview to “Infrastructure Economic Center” Consulting Agency about advantages of “hybrid” targeting against pure inflation targeting, anti-crisis government measures and medium-term prospects of Russian economy.
– The most debated question until recently is probably the following: are measures of the government support sufficient? Someone thinks that they are insufficient. Someone says that the NWF funds should be reserved for another "rainy day". How effective and sufficient do you find the three aid packages and the economic recovery plan? Is it possible to take some other measures to support households and business without destroying macroeconomic stability?
– The support package developed by the government and submitted to the President for consideration is estimated at RUB 5 trillion. If we talk about sufficiency, then the question splits into 2 parts. The first is economic recovery after the pandemic. The second is to enter the path of sustainable growth. However, at this point, there are many urgent questions to the economic policy.  For example, what measures will be postponed for the medium term (tax holidays or reduction of tax burden, lowering interest rates)? Which measures are considered as solely anti-crisis and will then be eliminated with the weakening of the pandemic? I believe that from this point of view, the crisis, no doubt, needs to be eliminated. The pandemic crisis is a public issue for individuals and for legal entities. It has to be eliminated at the maximum expense of public funds. We do not know yet how long it will last and whether RUB 5 trillion will be sufficient. I assume that this amount will be increased. Essentially, this is a large progress compared to expenditures incurred in April and May.
The problem will ultimately be resolved. The way I figure it, this will be a pure L-shaped crisis. That is, this year, especially in QII, we will plummet. However, further, there will be a recovery growth, rather small and quite long. According to my estimates, we will reach the level of 2019 year somewhere, probably in the middle of the 2023. It does not concern only the amount of financial assistance but also the continuity of all processes. This is also a cautious model of behavior in terms of tourism, visiting public eating places; it is also a saving model of behavior in terms of costs; Well, much, much more. Therefore, I think that these funds are not sufficient and they will be increased, however, it is unlikely that only money can expedite the economic recovery.
– If not only money, then, what else?
– It might be recalled that at the end of 2019, a rather sharp discussion arose between the economic blocks of the government. In particular, the Ministry of Economic Development then stated that we were not growing because we had a strict monetary policy and an extremely tight budget policy. The Ministry of Finance objected that we supported macroeconomic stability and a surplus budget and low debt, while this is generally one of the characteristics of macroeconomic stability. The Central Bank announced that quantitative easing and stimulating policies could not solve the problem, that all problems were structural.
After the crisis began, all positions changed dramatically. The Ministry of Finance is now considering the possibility of a deficit budget as a normal status. As for the deficit budget, I should like to emphasize once again, it means that the Ministry of Finance gives more money than it takes from the economy. Although the three-year budget plan was quite the opposite six months ago. Moreover, the Ministry of Finance allows for an increase in public debt up to 22-25 percent of GDP (basically, it also means a change of position) and also allows for the loss of taxes, in particular, reduction of labor taxes and social payments. 
Furthermore, if half a year ago, the Central Bank insisted that the real interest rate at 2-3 percent was neutral, now, I think that behind the scenes we are already talking about a zero neutral real rate.
Of course, the key question is the following: are these measures intended to mitigate both fiscal and monetary policies considered as anti-crisis measures or they signify new parameters of financial policy in the medium term to support the economic growth? This is a key question.
In essence, what will help? The stimulating economic policy will help both in the field of investments and support of small and medium-sized businesses, as well as the stimulating budget and monetary policy.
– You have tackled the state debt. To what degree we can safely rack up the state debt?
– There are numerous studies on this subject and there is no general consensus. I assume that we can increase it. However, I would set priorities related to funding sources of anti-crisis measures as follows: the first is the National Welfare Fund; the second is money emission; the third is an increase in external debt, and I would put internal borrowing in the fourth place. They are objectively quite expensive and, of course, the load on their maintenance in the next years will significantly affect the structure of budget expenditures.  Nevertheless, if it’s between the excessive macroeconomic stability and economic growth, I would definitely choose the economic growth and promote the increase of the state debt.
– Regarding the National Welfare Fund: do you think that it could be spent more effectively amid this crisis?
– Indeed. I believe that it would be possible to spend more because all the same, these reserves can be replaced by external and internal borrowings. This money can be attracted. Yes, I believe that the rainy day has come. There may be a question about the size of the spending of the National Welfare Fund. Let me remind you that, again, in the second half of 2019 there was a rather intense discussion about spending the NWF funds on investment projects. This was when “black swans” had not yet arrived. Well, if they arrived, then even more so they can be used for various anti-crisis events.
 – Alexey Leonidovich, in connection with what you said, the following question arises regarding the deal to transfer shares of Sberbank from the Bank of Russia to the government and the National Welfare Fund. What is the meaning of this transaction?
- I see it as it was written about. This is an apparent conflict of interests when the regulator owns 51% of the shares of a regulated bank. It is rather strange and senseless. Evidently, I doubt that the conflict of interests somehow influenced the activities of Sberbank and will cease to influence at this time. State-owned banks still occupy a market position close to monopoly. This is rather dangerous in terms of the quality of banking products and banking competition.
However, anyway, practically all money returned to budget. Otherwise, these are different pockets of the same coat. For this reason, I would put money emission on the second place after NWF, which plugs the hole in the banking capital, let me say so.
– A question regarding the plan to recover economy. Those trillion spending suggested for infrastructure projects have already been present in the national projects, specifically, in the complex development plan of trunk infrastructure. What is new in the new plan?
– I completely agree with you. Moreover, these 5 trillion considered as direct calculation, represent not only expenses, but also falling budget revenues. For some reason, they are also considered as costs, and this is a rather controversial issue.
The principal novation is that infrastructure projects have emerged and national projects slightly pulled back. Although, in fact, this is just the same.
I presume that essentially this is not bad, even the confirmation itself that we will follow up. However, the danger is that if state-owned companies are involved in these infrastructure projects, then traditionally this will lead to a rather high prime cost of these projects and to a low multiplier effect for the economy. Therefore, I think that if state-owned corporations divide infrastructure projects with each other, then, money will remain in the system and not used for economic growth.
–- The next question is at the junction of budget policy and the currency exchange rate. There is a perception that at present we face budget deficit. In order to balance it, it is required to devalue the Ruble. Various estimates range between 84-87- ... What is your view, can we continue for some time under budget deficit without resorting to devaluation? Are budget deficit and devaluation issues have anything in common?
– Yes, indeed, there is such a feeling. I am adamantly opposed to the position that a weak Ruble is favorable for the Russian economy. In my opinion, it is good only for the Ministry of Finance and for raw materials industries. However, for example, absolutely every manufacturing industry fails during devaluation. We must remember that we have an industrial assembly and 40% of imports are components while 30% of Russian imports are imports of investment equipment. Therefore, implementing devaluation, apparently, we kill both the manufacturing industry and the modernization of the economy, which, by all means, is largely based on the imports of machinery and equipment.
At the same time, the position of the Ministry of Finance insisting on a surplus budget always seemed rather strange. I think that there may be 1-2 countries out of 200 with the same thinking. I can not think of another country that has a surplus budget. I fail to understand the meaning for stagnated economy to save more than spend.
That is why, I believe that budget can be deficit enough. If it reaches 3% of GDP, I believe that this is absolutely normal. It is possible to use different sources to bridge deficit. Moreover, it is not necessary to strive to balance it now, especially if we still want to have some kind of stimulating effect on the economy.
My exchange rate forecast is as follows: I assume that if we are in the corridor of USD 37-40 per Urals brand barrel, then the rate of about RUB 69-71 per US Dollar is a kind of a consensus equilibrium rate. I think that by the end of the year we will reach the level of RUB 70 per US Dollar. The corridor of USD 37-38 per barrel is somehow a basic forecast for the end of this year.
- In one of your articles, you argued that pure inflation targeting loses to hybrid targeting. Is it even possible to talk about a floating exchange rate in the context of a budget rule?
 Is it possible to say that there was simply a change of terms, i.e. the Central Bank purchases/sales currency by order of the Ministry of Finance instead of Central Bank interventions?
- Of course, I mentioned that there is a substitution of concepts and that Russian Ruble has never been freely floating in the modern history.
Moreover, my statement was misinterpreted at the Gaidar Forum this year. When I spoke about the forecast of RUB 200 per US Dollar, I only meant that from the point of view of Ruble devaluation, allegedly there was a kind of free floating and Ruble tended to certain temporary equilibrium. Whereas the Minister of Finance is always openly in favor of preventing the Ruble strengthening.
Last but not the least, it is true that purchase of currency by the Central Bank (by the Ministry of Finance through the Central Bank) exceeds actually almost ten times the capital outflow causing the Ruble devaluation. That is, the budget rule provided anyhow for the weak Ruble in 2017-2019.
At present, the situation is reverse and, notably, an urgent question arose as to whether remove the budget rule. I should like to remind you that this is the fifth budget rule since 2004. Experience shows that the budget rule always works well in a stable situation and fails completely amid crisis.
Nevertheless, I believe that pure inflation targeting provides a rather low result for our economy, especially for stagnation, because the exchange rate is still a rather powerful macroeconomic tool. And certainly, I have always advocated hybrid targeting, that is, targeting both the Ruble and the inflation.
Besides, I can refer to the magazine “Money and Credit” issued by the Central Bank. If my memory serves me right, a review article was published in 2018 on 80 countries of the world being a proof that hybrid targeting provides a greater and better macroeconomic effect rather than pure inflation targeting. Therefore, I fail to understand in particular, why the Central Bank insists on pure inflation targeting.
- One more question about monetary policy. In your opinion, how applicable are for us the instruments of a “non-standard” monetary policy: quantitative easing, purchase of the state debt by the Central Bank, etc.?
– They are applicable. We suggested it already in 2015 when I worked with the Ministry of Economic Development. We proposed not to cut expenses in nominal terms but instead to reach the level of a 3% budget deficit and finance it through the purchase of the FLB by the Central bank, as you may imagine how sensitive the economy is to the reduction of budget spending. I am still convinced that this is a rather low inflationary effect.
First- of- all, this is a matter of scale. While we say “bad or good”, “0 or 1” within the framework of Boolean algebra, this is an incomprehensible debate. However, the truth is somewhere in the interval between zero and one, and the question is as follows: a) volumes and b) risks. What risks do we want to transfer to the Central Bank? Well, probably, the purchase of junk bonds by the FRS and the Bank of Japan are probably quite courageous decisions (although, I think that these are certainly cheap amounts). Here, I support the relief of such operations from taboo. Of course, they must be carried out, however, it needs to be done carefully. This is indeed imperative, however, without huge volumes.
I believe that this is more correct and pragmatic rather than to emit an internal debt, very expensive according to modern standards, numbering the share of non-residents at 33%
– Is it true that the Central Bank encourages commercial banks to purchase high-yield FLBs in order to maintain their (banks') profitability amid falling key rates and economic crisis?
At this point, I would firstly recall the dualism of the banking system. On the one hand, the banking sector establishes the GDP. On the other hand, the profit of the banking sector signifies losses for the rest. Therefore, when the banking system has shown record profits for the last two- three years, I do not know whether to be happy or upset. This is the first point.
Secondly. Taking into consideration that nine of the ten largest banks are state-owned, I think that the Central Bank does not really have to worry about the profitability of the banking system. On the contrary, I assume that a drop in profits would be a good anti-crisis measure at this time. Finally, thirdly, regarding the annual REPO, which is not in demand now. I believe that the liquidity surplus will soon exhaust itself and this will be a completely standard tool to regulate liquidity.
– The last question concerns the forecast of the Ministry of economic development published just last week. How balanced is it in your opinion? How adequate are forecasts of growth rates above 3%?
– Firstly, as far as I know, this forecast was sent back for refinement for the third time. At this point, we talk about two things. Firstly: there is a file of "initial conditions" which seems to me extremely strange, simply virtually impossible. The initial conditions include oil prices, oil production, etc. In other words, these are exogenous variables for the forecast used by the Ministry of economic development for the estimates and at the same time agreed with other institutions. Thus, for instance, the average price of Urals is USD 33 per barrel for this year in a base case and USD 31.5 in the conservative one. That is, the oil prices should be in around USD 20 for at least 4 months. And so on ... That means that it is really odd. The first comment is that external conditions must be replaced.
Secondly is that reduction by 5% in 2020 seems to me quite optimistic. Based on a 12% fall in April, I think that they should fall this year around 7%. Accordingly, I predict growth for 2021-2022, but growth weaker than falling. I mean, it will be some kind of purely technical, arithmetic growth, which is obviously inevitable after such a strong fall.
However, in order to estimate the rates in 2023 above 3%, it is important to understand at what expense will this be achieved. It is not yet visible. So far, anyway, we all agree on a certain inertial scenario, i.e. stagnation within the potential GDP. The potential GDP growth rate in this country is still 1.5-1.7%.
- That is, if we get back to one of the first questions, will the Economic Recovery Plan allow us to reach growth rates higher than these 1.5-1.7%?
  – I would repeat myself that there are 2 issues: the first one is the economic recovery and the second one is the potential growth. I should like to remand once again about the 2019 discussion stating that we do not enter the path of potential growth. Again, I can recall that one of the goals for change of the government in January prior to crisis was exactly the revival of the economy.
Consequently, the government works now as an anti-crisis body. For the time being, I estimate recovery with the letter L, i.e. a sharp drop and then a smooth growth in 2021-22.
Entirely different task is the maximum stimulation of economic growth. It should be formulated how financial and economic policies allow us to generally increase investment activity and growth.