SERGEY DROBYSHEVSKY: WE HAD TO IMPLEMENT PAINFUL MEASURES
Sergey Drobyshevsky, Scientific Director of the Gaidar Institute, told the“Expert”magazine how budget rule should be improved, what is the reason of paralysis in financing of national projects and why targeting inflation policy should not be corrected.
— Sergey Mikhaijlovich, there is a feeling of acute inadequacy of budget policy. We face chronic underfunding of public healthcare and education, this year real budget expenditures in the sectors of human capital are just returning to the level of 2012. All these activities take place against a tri - trillion surplus of the federal budget. A very significant lag in the unbundling of costs aimed at national projects. What is happening with our budget? Does fiscal consolidation policy continue? Does it make at least any sense?
— Let us start with definitions. Budget consolidation is one of the categories of tough budget policy. Fiscal policy in Europe after crisis of 2008-2009 started to use this term when it became clear that budgets of certain countries, especially the EU periphery, did not meet strict Maastricht criteria: budget deficit significantly exceeded 3% of the GDP, public debt and the cost of its servicing increased uncontrollably. The task was set to straighten budget balance and do it fr om both sides simultaneously. Costs were reduced in areas where they were deemed excessive, in particular, agricultural subsidies and subventions to new EU members. At the same time, tax burden increased, sometimes resulted fr om tax maneuver - an increase in VAT and a reduction in income tax.
Situation in Russia is slightly different. Budget consolidation started in 2016 was caused by necessity to adapt federal budget towards new, lower oil price. An acute budget crisis would be inevitable without such an adjustment while reserves accumulated in oil and gas funds could only delay it for a year or two. Nevertheless, presence of a certain safety cushion in a form of the Reserve Fund allowed us to carry out budget consolidation rather gently, cut costs by 1.5 percentage points of the GDP annually. In European countries, intensity of curtailment of spending ranged fr om 0.5–1 percentage points of the GDP per year to 11 percentage points of the GDP in Greece.
— That is, yes, knackery, but there were worse places, isn’t it?
- Our consolidation was, so to speak, socially oriented. It is true that construction of new schools and hospitals stopped. However, unlike European countries, pensions and social benefits did not decrease in absolute terms.
- Many hospitals and rural-medical posts deep in the countryside have closed. Doctors and nurses were forced to sweat away to feed their families as a result of a health care reform. Do you call it a socially oriented policy?
We were not in a position to choose between good and bad policy. We were compelled to take painful measures in the public sector due to the dramatically changed macroeconomic situation. By 2018, goals of fiscal consolidation were achieved in Russia. Now we have a much more stable budget pattern: budget is balancing at an oil price of $ 40-45 per barrel rather than $ 110 per barrel as in 2012.
Further, government faced a dilemma when they considered the budget for 2019-2021. It was necessary to continue tight budgetary policy or revise it given the mitigation of risks.
We all know the decision taken, but alternative existed. It was clearly formulated in the documents of the Center for Strategic Research headed by Alexey Kudrin, current Head of the Accounts Chamber. Our institute also participated in this work. It was about the fact that transition to a new growth model and a new quality of human capital does not require reduction, rather an increase in budget expenditures in a number of areas, primarily expenditures on education and healthcare. We believed that 34–35% of the GDP of expanded government budget was the lim it that Russia could afford without losing macroeconomic stability.
— And now, in fact, how much?
- The figure of the absolute size of the GDP is strongly “floating” but it is somewhere around 32–32.5%.
- That is, we can safely spend 1.5-2 points of the GDP more than at present. At the same time, total reduction of costs taking place in the course of budget consolidation is estimated at 3.3 percentage points of the GDP. As a result, it turns out that about half of the reduction can be "returned" back to economy, isn’t that right?
- Yes, something like that. With one significant clarification.
This is not pure arithmetic return. There was reduction of a number of non-productive expenditures and their return is wrong. Money should be added to other areas demanding attention, rather than return it.
—Budget policy was strongly countercyclical during 2009–2010 crisis and transparently pro-cyclical under crisis of 2014–2015. Why?
— I do not agree with this statement. It is true that in 2009–2010 budget policy was countercyclical with mode of the crisis, V-shaped, contributing. If oil prices did not return to $ 100–120 per barrel in 2009-2010 but remained at the level of early 2009: $ 60–70 per barrel, then already in 2010–2011 Russia would have forced to abandon further use of the funds of the Reserve Fund and proceed to budget consolidation.
In 2014–2015, policy was also partly countercyclical: at the initial stage, budget consolidation was mitigated by spending funds of the Reserve Fund (almost until its depletion in 2016) while completion of budget consolidation was driven by steady decrease in oil prices and adaptation of federal budget expenditures to this decrease.
Generally speaking, I think that it is incorrect to talk about a countercyclical or pro-cyclical budget policy if fluctuations in budget revenues were caused by external price fluctuations in world markets rather than movement of internal business cycle: unlike business cycle, their return to trajectory before recession cannot be guaranteed. Therefore, budgetary reserves can only smoothen transition fr om one price level to another but do not prevent economic recession caused by price fluctuations.
— Kudrin first publicly proposed to mitigate budget rule by raising the base oil price from $ 40 to $ 45 per barrel in an article in a September 2017 issue of “Voprosy ekonomiki” journal. This year, a high-profile discussion began around the issue on how to properly spend the “surplus” of the National Wealth Fund that exceeds the inviolable minimum 7% of the GDP set forth in the Budget Code. What is your opinion on the format appropriate for changing budget policy?
— I believe that the stage of macroeconomic stabilization of economy amid falling oil prices and a new geopolitical reality has ended: Russia avoided a deep acute crisis. Now we face a new task, that is, transition to growth, and this requires a change of priorities in budget policy, switch from budget consolidation to ensuring quantity and quality of budget services required for current level of the country development. No doubt, budget balance should remain under control taking into account possible fluctuations in oil prices and budget revenues. An increase of the cut-off price by $ 5, in my opinion, meets this requirement.
However, NWF should not be involved. There is still a risk of a new collapse of oil prices. That’s exactly what our previous experience tells us that no safety cushion will save. It will only help to survive for a year or two or three. I wish we could holdover a while longer. As practice of accumulating sovereign funds by different countries shows, the ceiling of the funds’ volume has not been established. Therefore, while oil prices are higher than the price, balancing budget (cut-off price), part of oil and gas revenues should reach the fund. Increasing the cut-off price allows us to reduce intensity of resources accumulation in the fund. In addition, I consider the principle of single targeted expenditures from NWF to be fundamentally wrong. Today, once we spent NWF money, say, on an export loan, we delivered, and tomorrow money ran out, so what? This is not a systemic solution.
— A large single investment of NWF within the country, say in the construction project of HSL, is able to launch multiplicative chains in economy and this process may not require constant injections.
- I will tell you more: such projects should not pay off, at least in the narrowly commercial sense of the word. It is very strange for me to hear talks that means of NWF must be invested in those projects that are repayable and pay off. I say, gentlemen, business will be happy to invest in such projects, and the state should invest in projects with high public externalities and a long or indefinite payback period.
Paralysis of public administration
— Let us now turn to recent polemic of Alexey Kudrin, Minister of Finance Anton Siluyanov and Head of the Ministry of Economic Development Maxim Oreshkin at the Forum “Russia Calling!” Kudrin complained that this year the government is underfunding their own budget allocations for Rb trillion. Oreshkin said that there is no need to frighten anyone quoting this trillion, that, allegedly, this is a common practice and money not spent today, will be spent next year. So do you have to frighten anyone using this trillion? Does this issue concern accounting or substance?
— Uneven spending of budget funds during the year is not a new problem for us. It is during years of consolidation that certain shifts were outlined in this area. Since all expenses, which by their nature may be uneven, represent investment expenses, expenditures related to public procurements and so on were squeezed, their share in the budget decreased, which meant that formally budget was executed more evenly. However, the issue remained.
Now the issue of uneven spending has been intensified by underfunding of national projects, which seriously limitated their ability to become a driver of economic growth. Allocation of finances for national projects is associated with coordination of all by-laws and various documents with their preparation being late. From fiscal policy point of view, the “delayed start" of national projects was only an additional factor that prolonged fiscal consolidation.
— According to what you say, Kudrin’s verdict is correct: this is really about the poor quality of public administration. However, what is still the reason for losing the momentum? Is the task too challenging or is it the reluctance of bureaucracy to take responsibility for decisions related to spending of budget funds?
- In many ways, this is really a new task for officials, requiring, from the bureaucrats’ point of view, rather serious preparation and study.
— Wh ere exactly the novelty is? Is it “repackaged” government programs and that’s all?
- I may not agree. At least, some changes to the projects to be financed are expected under framework of national projects. In addition, it is often suggested to involve private sector for co-financing. It significantly complicates the task. Solution requires time.
- How much additional time will be required for a full-fledged launch of national projects?
- It is hard to say. Over-cautiousness of bureaucrats that you mentioned also takes place in the context of tightening control over spending of budget funds and strengthening fight against corruption.
In fact, we witness how system of public administration is losing momentum. It has to be overcome by more rigorous procedures including possible digitalization tools. Probably, somewhere, this is possible only by replacing some people with others who are less afraid of taking responsibility. Both German Gref and Alexey Kudrin were not afraid to take responsibility when they joined the government in the early 2000s and carried out reforms during the first term of Putin’s presidency, often acting simply “manually”, sometimes bypassing all procedures, negotiating directly with the President, getting approval of the Prime Minister. Apparently, now the government needs to work in this mode again.
— If this is so, then an administrative failure can result in high-level personal decisions or a change of the entire government.
- No doubt, such a risk exists. Although this is already beyond the scope of economic analysis.
Acceleration: reserves and tools
- I would like to know your assessment of the growth rate of this year coming to a close and your forecast for next year.
- As far as this year is concerned, I agree with the latest assessment of the Prime Minister, i.e. 1.3-1.4% of the GDP growth. In 2020, it will be 1.5–2% in the best- case scenario.
- Do you expect a slight acceleration? Is this the effect of the low base of 2019 or will it happen due to substantial reasons?
— I should like to rely on a start of national projects, those, first of all, that are associated with investment expenditures, for example, “Affordable Housing” and Strategic plan of development of trunk infrastructure” up to 2024, in particular. Moreover, direct effects of launching national projects in terms of impact on growth are not so high. According to estimates of our Institute and the Institute of Economic Forecasting of the Russian Academy of Sciences, additive impact of national projects will provide less than one percentage point of additional GDP growth. The signal effect of national projects is much more important. The state should send business circles a clear, distinct signal that they believe in their own plans and capable of implementing them.
From the point of view of external economic conditions, the situation is not favorable: international economy does not make it possible to count on any significant expansion of exports.
— The discussion point of macroeconomists is whether there is a gap of the GDP in Russia now, in simple words, does the actual GDP deviate from the potential one, is there, in principle, an acceleration reserve.
There is a point of view that significant revival of economy will not happen: unemployment is close to historical minimum, GDP is close to potential one. Any stimulus will only accelerate inflation.
What do you think about this?
- You described in your question the situation of 2013-2014. There was no any gap at that time. According to our estimates, economy approached the crisis of 2014-2015 rather in an overheated state.
Now we argue that Russian economy is in a situation facing negative gap, that is, economy is significantly behind the potential level. We estimate the gap at a rate of about two percentage points of the GDP.
- If we start from current actual rate, 1.3–1.4%, plus 2%, then, according to your calculations, it turns out that potential growth rate is approaching 3.5%. Is it true?
— Well, no one has said yet that we should overcome the gap in one year. However, the fact that it exists and it is significant is a reality. We have a serious underutilization of capacities caused by a shortage of demand. There is a potential for their loading as well as increasing the aggregate factor productivity, that is, simplified, labor productivity. From the labor market point of view, the situation is more complicated. We face structural imbalance. On one hand, we face an extreme shortage of highly qualified specialists, including working professions. On the other hand, there is a huge mass of people who are formally employed, used by enterprises just in order to replace qualified personnel in quantity rather than quality.
Thus, we have reserves for economic stimulus by means of the expansion of demand. Further, the discussion should be staged about the tools aimed at demand stimulus that can be used for achieving higher or lesser success.
—Which tools are you talking about?
- We have already discussed the activation of budget policy and the preferred format for its activation. The second tool means growth of households’ purchasing power. From my point of view, fears of the Ministry of Economic Development regarding the degree of households’ debt are somehow exaggerated; we maintain a reserve for increasing retail lending. Next year, we believe consumer lending will grow by 10-12%. However, this growth will not lead to an increase in the risk of a consumer credit market crisis.
— In other words, we are not on the verge of disaster, are we?
- No, we are not on the verge. There was a moment in 2017 and 2018 when we were on a bad trajectory of rapidly building up unsecured consumer loans, but Central Bank timely tightened screws. No additional tightening is required in this segment.
As for monetary policy, monetary stimulation should be approached very carefully because there is still a risk that we get exclusively price incentives instead of real ones. You do not have to go far searching negative examples. This is Argentina. This is Turkey.
The Central Bank should be extremely careful in their policy of further monetary mitigation. Despite inflation falling below target, inflation expectations are not yet anchored.
- As for monetary stimulus, everything is fine with us: its capacity is technically limited. Interest-bearing impact channel has been deformed. 40% of the total loan banking portfolio is subjected to direct macro-prudential effects of the Central Bank, that is, it is managed in a non-price manner.
In fact, final rates respond to changes in the key rate of the Central Bank only at the mortgage market. Russia has trivially narrow financial market for quantitative mitigation: stock assets are simply too small for their potential purchase by the Central Bank to be noticeable in the macroeconomic sense.
—It goes without saying that mitigation of monetary policy contributes to growth of the money supply and expansion of lending, but this is just one important (even not necessarily required), however, not a sufficient condition for credit expansion. The expansion of monetary aggregates and growth in the volume of issued loans also strongly depend on the behavior of other economic agents: whether they demonstrate a demand for dropped in prices credit resources and liquidity, is there is a real need for lending, do banks experience lack of liquidity or whether monetary authorities expand their operations in the open market. I think that reduction of key rate by Central Bank of Russia will have a limited impact on the expansion of money supply and lending.
Rate of exchange is an optimum stabilizer
— I, personally, have one main complaint against the Central Bank. This is a switch to an orthodox inflation targeting policy in the fall of 2014. Refusal of any support for the Ruble exchange rate amid the shock of oil sharply dropped in prices and Western sanctions unfamiliar at that time, was absolutely ill- timed. This was done in a completely Bolshevik way, ignoring the circumstances. As planned in 2008, we switched over, in a single day, without any reservation.
— I cannot agree with you. Under external shock, free exchange rate is the optimum stabilizer of economy allowing it to quickly adapt to new external conditions through devaluation. Attempts to keep a lid on the exchange rate with the help of interventions did not lead to anything during the previous crisis episode at the intersection of 2008 and 2009, devaluation took place anyway but before that, we had spent about $ 200 billion of foreign exchange reserves.
— Debatable. Let us recall who exactly stopped the currency panic in December 2014. This was not at all the Central Bank, which for the first time in its history lifted the key rate at night to 17% per annum, but President Putin, who lucidly talked individually with the largest exporters and urged them, so to speak, to adjust their behavior in the foreign exchange market.
- There were no alternatives to hold the rate of exchange at least somehow stable in 2014. It would have definitely fallen to the same values. Maybe even to higher ones, just not in November-December but in January-February. In fact, exchange rate was exactly this one.
— I strongly doubt that free rate of exchange is generally appropriate for our local economy, wh ere more than 30% of final consumption represent either imports or domestic goods and services with their prices following prices of imported analogues. In a country wh ere foreign currency is still predominant, inflation targeting can not be effective. The experience of a number of countries experimenting with hybrid versions of targeting policies including elements of exchange rate controls, such as Poland, Czech Republic and Israel, shows rather good results. Why Russia should not try to switch to a hybrid inflation targeting regime?
— I believe that in the current situation there is no need to change anything in the targeting policy. The fact is that the population and economic players still demonstrate a fundamental lack of trust in the state. The most obvious evidence is the enormous gap between actual and targeted inflation, on the one hand, and inflation expectations, on the other. Actual inflation dropped to 3.5% per annum in November, inflation expectations of the population also decline according to a Central Bank survey but still make up 8.3% (see Chart 3 - “Expert”).
There is no such a gap observed anywhere in the world. Therefore, any ups and downs or even just an adjustment of monetary policy principles of the Bank of Russia are not acceptable. It may not even be optimal from the point of view of any abstract theoretical optimization model but risks of loss of confidence are higher.
Ruble is slightly underestimated
- I will not say that you have convinced me, but in any case, this is an argument for reflection. I have a technical question: since early 2018 approximately, the tie between the movement of oil prices and Ruble exchange rate has sharply weakened. Sometimes they move simply in antiphase. What happened?
— The first factor, at least in scale, is the budget rule. From February 2017, with a short break at the end of 2018 - beginning of 2019, the Ministry of Finance purchased currency in the market, replenishing the NWF. In less than two years, interventions exceeded Rb 6.2 trillion or more than $ 100 billion at the exchange rate valid in respective months. This is a rather serious autonomous factor in demand for currency contributing to Ruble devaluation. The opposite factor in the line of efforts is the investment of non-residents in the FLB market. They reduce the effect of the Ruble devaluation resulted from operations of the Ministry of Finance.
The third factor is sanctions. Information on new rounds of geopolitical tension, especially on targeted sanctions against Russian individuals and companies directly and strongly affects local foreign exchange market and exchange rate behavior.
- With regard to fundamental proportions, is Ruble undervalued or overvalued currently, in your opinion?
—- According to our estimates, the equilibrium rate today corresponds to Rb 59-60 per dollar. That is, the current rate is underestimated by 6-8%. This is not a lot. However, from the point of view of import demand, especially import of equipment and materials, an understated rate is a depressing factor for our industry.
- What is your forecast for oil prices?
— Taking into account a period of one or two years, we have a consensus with the forecast of the Ministry of Economic Development, i.e. $ 55-60 per barrel. Further, the forecast of the Ministry of Economic Development actually converges to the indexed cut-off price of the budget rule. However, we believe that oil prices in nominal terms on the horizon of at least five to seven years are likely to be higher than the budget project suggests. That is, there will be no $ 50 per barrel; rather, it is a range around $ 60–70 taking into account certain dollar inflation. This is the value that we have to start with making a forecast for the next five years.
— That is why, you also consider it safe and possible to slightly increase the cut-off price in the budget rule to $ 45 per barrel, do you?
- Yes. It is up to 45 so far and in a couple of years, maybe up to 50.
— Let us start with definitions. Budget consolidation is one of the categories of tough budget policy. Fiscal policy in Europe after crisis of 2008-2009 started to use this term when it became clear that budgets of certain countries, especially the EU periphery, did not meet strict Maastricht criteria: budget deficit significantly exceeded 3% of the GDP, public debt and the cost of its servicing increased uncontrollably. The task was set to straighten budget balance and do it fr om both sides simultaneously. Costs were reduced in areas where they were deemed excessive, in particular, agricultural subsidies and subventions to new EU members. At the same time, tax burden increased, sometimes resulted fr om tax maneuver - an increase in VAT and a reduction in income tax.
Situation in Russia is slightly different. Budget consolidation started in 2016 was caused by necessity to adapt federal budget towards new, lower oil price. An acute budget crisis would be inevitable without such an adjustment while reserves accumulated in oil and gas funds could only delay it for a year or two. Nevertheless, presence of a certain safety cushion in a form of the Reserve Fund allowed us to carry out budget consolidation rather gently, cut costs by 1.5 percentage points of the GDP annually. In European countries, intensity of curtailment of spending ranged fr om 0.5–1 percentage points of the GDP per year to 11 percentage points of the GDP in Greece.
— That is, yes, knackery, but there were worse places, isn’t it?
- Our consolidation was, so to speak, socially oriented. It is true that construction of new schools and hospitals stopped. However, unlike European countries, pensions and social benefits did not decrease in absolute terms.
- Many hospitals and rural-medical posts deep in the countryside have closed. Doctors and nurses were forced to sweat away to feed their families as a result of a health care reform. Do you call it a socially oriented policy?
We were not in a position to choose between good and bad policy. We were compelled to take painful measures in the public sector due to the dramatically changed macroeconomic situation. By 2018, goals of fiscal consolidation were achieved in Russia. Now we have a much more stable budget pattern: budget is balancing at an oil price of $ 40-45 per barrel rather than $ 110 per barrel as in 2012.
Further, government faced a dilemma when they considered the budget for 2019-2021. It was necessary to continue tight budgetary policy or revise it given the mitigation of risks.
We all know the decision taken, but alternative existed. It was clearly formulated in the documents of the Center for Strategic Research headed by Alexey Kudrin, current Head of the Accounts Chamber. Our institute also participated in this work. It was about the fact that transition to a new growth model and a new quality of human capital does not require reduction, rather an increase in budget expenditures in a number of areas, primarily expenditures on education and healthcare. We believed that 34–35% of the GDP of expanded government budget was the lim it that Russia could afford without losing macroeconomic stability.
— And now, in fact, how much?
- The figure of the absolute size of the GDP is strongly “floating” but it is somewhere around 32–32.5%.
- That is, we can safely spend 1.5-2 points of the GDP more than at present. At the same time, total reduction of costs taking place in the course of budget consolidation is estimated at 3.3 percentage points of the GDP. As a result, it turns out that about half of the reduction can be "returned" back to economy, isn’t that right?
- Yes, something like that. With one significant clarification.
This is not pure arithmetic return. There was reduction of a number of non-productive expenditures and their return is wrong. Money should be added to other areas demanding attention, rather than return it.
—Budget policy was strongly countercyclical during 2009–2010 crisis and transparently pro-cyclical under crisis of 2014–2015. Why?
— I do not agree with this statement. It is true that in 2009–2010 budget policy was countercyclical with mode of the crisis, V-shaped, contributing. If oil prices did not return to $ 100–120 per barrel in 2009-2010 but remained at the level of early 2009: $ 60–70 per barrel, then already in 2010–2011 Russia would have forced to abandon further use of the funds of the Reserve Fund and proceed to budget consolidation.
In 2014–2015, policy was also partly countercyclical: at the initial stage, budget consolidation was mitigated by spending funds of the Reserve Fund (almost until its depletion in 2016) while completion of budget consolidation was driven by steady decrease in oil prices and adaptation of federal budget expenditures to this decrease.
Generally speaking, I think that it is incorrect to talk about a countercyclical or pro-cyclical budget policy if fluctuations in budget revenues were caused by external price fluctuations in world markets rather than movement of internal business cycle: unlike business cycle, their return to trajectory before recession cannot be guaranteed. Therefore, budgetary reserves can only smoothen transition fr om one price level to another but do not prevent economic recession caused by price fluctuations.
— Kudrin first publicly proposed to mitigate budget rule by raising the base oil price from $ 40 to $ 45 per barrel in an article in a September 2017 issue of “Voprosy ekonomiki” journal. This year, a high-profile discussion began around the issue on how to properly spend the “surplus” of the National Wealth Fund that exceeds the inviolable minimum 7% of the GDP set forth in the Budget Code. What is your opinion on the format appropriate for changing budget policy?
— I believe that the stage of macroeconomic stabilization of economy amid falling oil prices and a new geopolitical reality has ended: Russia avoided a deep acute crisis. Now we face a new task, that is, transition to growth, and this requires a change of priorities in budget policy, switch from budget consolidation to ensuring quantity and quality of budget services required for current level of the country development. No doubt, budget balance should remain under control taking into account possible fluctuations in oil prices and budget revenues. An increase of the cut-off price by $ 5, in my opinion, meets this requirement.
However, NWF should not be involved. There is still a risk of a new collapse of oil prices. That’s exactly what our previous experience tells us that no safety cushion will save. It will only help to survive for a year or two or three. I wish we could holdover a while longer. As practice of accumulating sovereign funds by different countries shows, the ceiling of the funds’ volume has not been established. Therefore, while oil prices are higher than the price, balancing budget (cut-off price), part of oil and gas revenues should reach the fund. Increasing the cut-off price allows us to reduce intensity of resources accumulation in the fund. In addition, I consider the principle of single targeted expenditures from NWF to be fundamentally wrong. Today, once we spent NWF money, say, on an export loan, we delivered, and tomorrow money ran out, so what? This is not a systemic solution.
— A large single investment of NWF within the country, say in the construction project of HSL, is able to launch multiplicative chains in economy and this process may not require constant injections.
- I will tell you more: such projects should not pay off, at least in the narrowly commercial sense of the word. It is very strange for me to hear talks that means of NWF must be invested in those projects that are repayable and pay off. I say, gentlemen, business will be happy to invest in such projects, and the state should invest in projects with high public externalities and a long or indefinite payback period.
Paralysis of public administration
— Let us now turn to recent polemic of Alexey Kudrin, Minister of Finance Anton Siluyanov and Head of the Ministry of Economic Development Maxim Oreshkin at the Forum “Russia Calling!” Kudrin complained that this year the government is underfunding their own budget allocations for Rb trillion. Oreshkin said that there is no need to frighten anyone quoting this trillion, that, allegedly, this is a common practice and money not spent today, will be spent next year. So do you have to frighten anyone using this trillion? Does this issue concern accounting or substance?
— Uneven spending of budget funds during the year is not a new problem for us. It is during years of consolidation that certain shifts were outlined in this area. Since all expenses, which by their nature may be uneven, represent investment expenses, expenditures related to public procurements and so on were squeezed, their share in the budget decreased, which meant that formally budget was executed more evenly. However, the issue remained.
Now the issue of uneven spending has been intensified by underfunding of national projects, which seriously limitated their ability to become a driver of economic growth. Allocation of finances for national projects is associated with coordination of all by-laws and various documents with their preparation being late. From fiscal policy point of view, the “delayed start" of national projects was only an additional factor that prolonged fiscal consolidation.
— According to what you say, Kudrin’s verdict is correct: this is really about the poor quality of public administration. However, what is still the reason for losing the momentum? Is the task too challenging or is it the reluctance of bureaucracy to take responsibility for decisions related to spending of budget funds?
- In many ways, this is really a new task for officials, requiring, from the bureaucrats’ point of view, rather serious preparation and study.
— Wh ere exactly the novelty is? Is it “repackaged” government programs and that’s all?
- I may not agree. At least, some changes to the projects to be financed are expected under framework of national projects. In addition, it is often suggested to involve private sector for co-financing. It significantly complicates the task. Solution requires time.
- How much additional time will be required for a full-fledged launch of national projects?
- It is hard to say. Over-cautiousness of bureaucrats that you mentioned also takes place in the context of tightening control over spending of budget funds and strengthening fight against corruption.
In fact, we witness how system of public administration is losing momentum. It has to be overcome by more rigorous procedures including possible digitalization tools. Probably, somewhere, this is possible only by replacing some people with others who are less afraid of taking responsibility. Both German Gref and Alexey Kudrin were not afraid to take responsibility when they joined the government in the early 2000s and carried out reforms during the first term of Putin’s presidency, often acting simply “manually”, sometimes bypassing all procedures, negotiating directly with the President, getting approval of the Prime Minister. Apparently, now the government needs to work in this mode again.
— If this is so, then an administrative failure can result in high-level personal decisions or a change of the entire government.
- No doubt, such a risk exists. Although this is already beyond the scope of economic analysis.
Acceleration: reserves and tools
- I would like to know your assessment of the growth rate of this year coming to a close and your forecast for next year.
- As far as this year is concerned, I agree with the latest assessment of the Prime Minister, i.e. 1.3-1.4% of the GDP growth. In 2020, it will be 1.5–2% in the best- case scenario.
- Do you expect a slight acceleration? Is this the effect of the low base of 2019 or will it happen due to substantial reasons?
— I should like to rely on a start of national projects, those, first of all, that are associated with investment expenditures, for example, “Affordable Housing” and Strategic plan of development of trunk infrastructure” up to 2024, in particular. Moreover, direct effects of launching national projects in terms of impact on growth are not so high. According to estimates of our Institute and the Institute of Economic Forecasting of the Russian Academy of Sciences, additive impact of national projects will provide less than one percentage point of additional GDP growth. The signal effect of national projects is much more important. The state should send business circles a clear, distinct signal that they believe in their own plans and capable of implementing them.
From the point of view of external economic conditions, the situation is not favorable: international economy does not make it possible to count on any significant expansion of exports.
— The discussion point of macroeconomists is whether there is a gap of the GDP in Russia now, in simple words, does the actual GDP deviate from the potential one, is there, in principle, an acceleration reserve.
There is a point of view that significant revival of economy will not happen: unemployment is close to historical minimum, GDP is close to potential one. Any stimulus will only accelerate inflation.
What do you think about this?
- You described in your question the situation of 2013-2014. There was no any gap at that time. According to our estimates, economy approached the crisis of 2014-2015 rather in an overheated state.
Now we argue that Russian economy is in a situation facing negative gap, that is, economy is significantly behind the potential level. We estimate the gap at a rate of about two percentage points of the GDP.
- If we start from current actual rate, 1.3–1.4%, plus 2%, then, according to your calculations, it turns out that potential growth rate is approaching 3.5%. Is it true?
— Well, no one has said yet that we should overcome the gap in one year. However, the fact that it exists and it is significant is a reality. We have a serious underutilization of capacities caused by a shortage of demand. There is a potential for their loading as well as increasing the aggregate factor productivity, that is, simplified, labor productivity. From the labor market point of view, the situation is more complicated. We face structural imbalance. On one hand, we face an extreme shortage of highly qualified specialists, including working professions. On the other hand, there is a huge mass of people who are formally employed, used by enterprises just in order to replace qualified personnel in quantity rather than quality.
Thus, we have reserves for economic stimulus by means of the expansion of demand. Further, the discussion should be staged about the tools aimed at demand stimulus that can be used for achieving higher or lesser success.
—Which tools are you talking about?
- We have already discussed the activation of budget policy and the preferred format for its activation. The second tool means growth of households’ purchasing power. From my point of view, fears of the Ministry of Economic Development regarding the degree of households’ debt are somehow exaggerated; we maintain a reserve for increasing retail lending. Next year, we believe consumer lending will grow by 10-12%. However, this growth will not lead to an increase in the risk of a consumer credit market crisis.
— In other words, we are not on the verge of disaster, are we?
- No, we are not on the verge. There was a moment in 2017 and 2018 when we were on a bad trajectory of rapidly building up unsecured consumer loans, but Central Bank timely tightened screws. No additional tightening is required in this segment.
As for monetary policy, monetary stimulation should be approached very carefully because there is still a risk that we get exclusively price incentives instead of real ones. You do not have to go far searching negative examples. This is Argentina. This is Turkey.
The Central Bank should be extremely careful in their policy of further monetary mitigation. Despite inflation falling below target, inflation expectations are not yet anchored.
- As for monetary stimulus, everything is fine with us: its capacity is technically limited. Interest-bearing impact channel has been deformed. 40% of the total loan banking portfolio is subjected to direct macro-prudential effects of the Central Bank, that is, it is managed in a non-price manner.
In fact, final rates respond to changes in the key rate of the Central Bank only at the mortgage market. Russia has trivially narrow financial market for quantitative mitigation: stock assets are simply too small for their potential purchase by the Central Bank to be noticeable in the macroeconomic sense.
—It goes without saying that mitigation of monetary policy contributes to growth of the money supply and expansion of lending, but this is just one important (even not necessarily required), however, not a sufficient condition for credit expansion. The expansion of monetary aggregates and growth in the volume of issued loans also strongly depend on the behavior of other economic agents: whether they demonstrate a demand for dropped in prices credit resources and liquidity, is there is a real need for lending, do banks experience lack of liquidity or whether monetary authorities expand their operations in the open market. I think that reduction of key rate by Central Bank of Russia will have a limited impact on the expansion of money supply and lending.
Rate of exchange is an optimum stabilizer
— I, personally, have one main complaint against the Central Bank. This is a switch to an orthodox inflation targeting policy in the fall of 2014. Refusal of any support for the Ruble exchange rate amid the shock of oil sharply dropped in prices and Western sanctions unfamiliar at that time, was absolutely ill- timed. This was done in a completely Bolshevik way, ignoring the circumstances. As planned in 2008, we switched over, in a single day, without any reservation.
— I cannot agree with you. Under external shock, free exchange rate is the optimum stabilizer of economy allowing it to quickly adapt to new external conditions through devaluation. Attempts to keep a lid on the exchange rate with the help of interventions did not lead to anything during the previous crisis episode at the intersection of 2008 and 2009, devaluation took place anyway but before that, we had spent about $ 200 billion of foreign exchange reserves.
— Debatable. Let us recall who exactly stopped the currency panic in December 2014. This was not at all the Central Bank, which for the first time in its history lifted the key rate at night to 17% per annum, but President Putin, who lucidly talked individually with the largest exporters and urged them, so to speak, to adjust their behavior in the foreign exchange market.
- There were no alternatives to hold the rate of exchange at least somehow stable in 2014. It would have definitely fallen to the same values. Maybe even to higher ones, just not in November-December but in January-February. In fact, exchange rate was exactly this one.
— I strongly doubt that free rate of exchange is generally appropriate for our local economy, wh ere more than 30% of final consumption represent either imports or domestic goods and services with their prices following prices of imported analogues. In a country wh ere foreign currency is still predominant, inflation targeting can not be effective. The experience of a number of countries experimenting with hybrid versions of targeting policies including elements of exchange rate controls, such as Poland, Czech Republic and Israel, shows rather good results. Why Russia should not try to switch to a hybrid inflation targeting regime?
— I believe that in the current situation there is no need to change anything in the targeting policy. The fact is that the population and economic players still demonstrate a fundamental lack of trust in the state. The most obvious evidence is the enormous gap between actual and targeted inflation, on the one hand, and inflation expectations, on the other. Actual inflation dropped to 3.5% per annum in November, inflation expectations of the population also decline according to a Central Bank survey but still make up 8.3% (see Chart 3 - “Expert”).
There is no such a gap observed anywhere in the world. Therefore, any ups and downs or even just an adjustment of monetary policy principles of the Bank of Russia are not acceptable. It may not even be optimal from the point of view of any abstract theoretical optimization model but risks of loss of confidence are higher.
Ruble is slightly underestimated
- I will not say that you have convinced me, but in any case, this is an argument for reflection. I have a technical question: since early 2018 approximately, the tie between the movement of oil prices and Ruble exchange rate has sharply weakened. Sometimes they move simply in antiphase. What happened?
— The first factor, at least in scale, is the budget rule. From February 2017, with a short break at the end of 2018 - beginning of 2019, the Ministry of Finance purchased currency in the market, replenishing the NWF. In less than two years, interventions exceeded Rb 6.2 trillion or more than $ 100 billion at the exchange rate valid in respective months. This is a rather serious autonomous factor in demand for currency contributing to Ruble devaluation. The opposite factor in the line of efforts is the investment of non-residents in the FLB market. They reduce the effect of the Ruble devaluation resulted from operations of the Ministry of Finance.
The third factor is sanctions. Information on new rounds of geopolitical tension, especially on targeted sanctions against Russian individuals and companies directly and strongly affects local foreign exchange market and exchange rate behavior.
- With regard to fundamental proportions, is Ruble undervalued or overvalued currently, in your opinion?
—- According to our estimates, the equilibrium rate today corresponds to Rb 59-60 per dollar. That is, the current rate is underestimated by 6-8%. This is not a lot. However, from the point of view of import demand, especially import of equipment and materials, an understated rate is a depressing factor for our industry.
- What is your forecast for oil prices?
— Taking into account a period of one or two years, we have a consensus with the forecast of the Ministry of Economic Development, i.e. $ 55-60 per barrel. Further, the forecast of the Ministry of Economic Development actually converges to the indexed cut-off price of the budget rule. However, we believe that oil prices in nominal terms on the horizon of at least five to seven years are likely to be higher than the budget project suggests. That is, there will be no $ 50 per barrel; rather, it is a range around $ 60–70 taking into account certain dollar inflation. This is the value that we have to start with making a forecast for the next five years.
— That is why, you also consider it safe and possible to slightly increase the cut-off price in the budget rule to $ 45 per barrel, do you?
- Yes. It is up to 45 so far and in a couple of years, maybe up to 50.