Russian Banks: Foundation for Economic Growth

Petr Aven, President of Alfa Bank in Moscow spoke about Russia's macroeconomic situation, its banking sector, and the enduring need for reforms.

Russia, in the four years since the 1998 financial crisis, has achieved impressive economic growth, a large fiscal surplus, and clearer, more transparent "rules of the game," which allow a sustainable economic recovery. Yet foreign direct investment (FDI) in Russia remains too low. The country last year received less than one percent of world FDI. Russia has made noteworthy progress in many areas, but major reforms are still necessary to attract investors to return.

The Road Ahead

Russia must focus on three areas of reform, argued Aven.

First, greater liberalization is needed. The number of small and medium-sized enterprises (SMEs) in Russia is below one million and declining, with many buckling under the weight of burdensome regulations and investigations. SMEs employ only 15% of the labor force in Russia, as compared to 49% in the UK or 54% in the US.

Second, government spending must be cut. Currently fiscal expenditures amount to 34% of Russia's GDP, while the tax burden remains high, at 37% of GDP-a "pure deduction from economic growth." In China, by comparison, only 17 to 18% of GDP is distributed through the state budget. Since 1992, there has been little change in Russia's budget structure. For instance, six hundred thousand cultural workers receive their salaries from the state, and the share of state employees to the population has risen since the Soviet period.

Third, Russia's natural monopolies must be reformed. Some efforts have been made to change RAO UES, which controls the country's electricity supply, and Gazprom, the natural gas giant, but, Aven noted, there is no clear long-term strategy. "For sure, this will take years," he said.

These reforms will be vital, since the devalued exchange rate, high oil prices, and a weak euro-three drivers of Russia's economic growth in recent years-are now "exhausted," explained Aven. The real exchange rate will continue to appreciate as the debt burden forces the government to keep the nominal exchange rate stable, and the risk of inflation will persist. Aven expected the increase in oil production to level off in 2002. Finally, the weak euro boosted imports by 18% in 2001, but this went to consumption, not to improving Russia's production capacity.

Russia's Banks: Room for Improvement

Russian banks make insignificant loans to companies, which must finance investment from their own profits. Russia's banks contribute only about 3% of overall investment in Russia and suffer from a shortage of reliable clients. Loans are too expensive for all but the biggest enterprises, and lending represents only 40% of bank assets. Russian banks are inefficient and operating expenses are high.

Though there is much talk of capital flight out of Russia, much of that money never leaves the country, said Aven. AT least $30 billion in savings-and probably much more-is kept in US dollars "under mattresses." Money on deposit with banks represents only 7% of GDP, which is quite low compared to Germany and the Czech Republic, where the figure is closer to 50%. Sberbank, with preferential treatment from the state and thousands of branches nationwide, holds 73% of deposits. Alfa Bank comes in second, holding 2% of bank deposits.

Under current arrangements, all banks, starting in 2004, will have to use western accounting standards and capital adequacy requirements. But why not starting this year? asked Aven. The question is not whether the situation will improve, but how quickly. Without acceleration of reforms, Russia will have difficulty competing for investment with other countries.

Questions and Discussion

Aven had high hopes for Sergei Ignatiev, who recently replaced Viktor Gerashchenko as Chairman of the Russian Central Bank. Under Ignatiev, Aven wants to see strict accounting standards implemented as soon as possible, federal deposit insurance extended to all banks (currently, only Sberbank enjoys such a guarantee), consolidation of myriad small banks whose only operations are cash transactions into more sophisticated financial institutions, and the downsizing of the Central Bank bureaucracy, which employs 95,000 people.

Housing mortgages are necessary to build a middle class, but only Sberbank has the resources to provide this service. Alfa Bank has plans to open 250 retail branches over the next two years, offering a full range of services to clients, with the exception of mortgages and consumer credit.

Asked when he expected FDI to Russia to reach pre-1998 levels, Aven responded that foreign money will return eventually, as investors realize that there is no threat of another crisis. But Russia will have difficulty appearing as attractive as neighbors Ukraine and Kazakhstan, where he expects growth rates higher than Russia's over the next few years.

Alfa Group's portfolio primarily covers four economic sectors: Banking, oil, telecoms, and retail. Their investments in oil, through their ownership stake in TNK are the most extensive, tying up about $4 billion of Alfa's assets, but the most profitable, Aven said. Would they consider selling TNK? Aven did not exclude it. Banking is financially less significant, worth $300 million, but "banking is our business, the one we know best," he explained. Alfa has important stakes in telecom companies, including VimpelCom and Golden Telecom in Russia and Kiev Star in Ukraine. Aven noted that his is the only Russian conglomerate to have acquired all its holdings with cash, never through loans-for-shares schemes. He anticipated their further expansion in Russia, Ukraine, and possibly also in Belarus.

Aven hoped to see greater US-Russian private-sector collaboration, with more power and freedom for non-state actors. Earlier that morning, June 3, in Washington, Aven had signed a Memorandum of Understanding with the US Overseas Private Investment Corporation (OPIC). WTO accession is "absolutely necessary for Russia," said Aven, and he predicted that the main obstacle would be trade issues with China.

Summary by Caroline McGregor, Junior Fellow, Russian and Eurasian Program.