Russian Economic Reform Agenda

Meeting Report, Vol. 3, No. 9, March 16, 2001

On March 16, 2001 Carnegie Endowment Senior Associate Anders Åslund hosted a lunch meeting with Sergei Vasiliev, Scholar-in-Residence and Co-Director of the Carnegie Moscow Center's Program on Post-Soviet Economies in Transition, as well as President of the Leontief Center. We provide below a summary of Vasiliev's remarks and the discussion that followed.

Introduction

Carnegie Endowment Senior Associate Anders Åslund introduced Sergei Vasiliev by emphasizing his first-hand experience in assisting economic reform in Russia throughout the last decade. After the collapse of the Soviet Union, Vasiliev, one of the original "young Russian reformers," was appointed by then Deputy Prime Minister Yegor Gaidar to head the Working Center for Economic Reform, a key advisory think-tank. Vasiliev then moved on to the post of Deputy Minister of Economy, where he was in charge of the reform agenda from 1994 to 1997. Afterwards, Vasiliev's posts included First Deputy Head of Russian Government Apparatus, Chairman of International Investment Bank, President of Leontief Center and head of PetroEnergoBank. He has also joined the Carnegie Moscow Center staff this year. After this introduction, Åslund invited Vasiliev to discuss the present state of the Russian economic reform agenda.

Narrow window of opportunity and Gref's program

Sergei Vasiliev started his presentation by reviewing Russia's "mixed track record" on economic reforms. While the initial period of 1992-1995 reforms was quite successful in introducing privatization and macroeconomic stabilization programs, Yeltsin's second term was a failure, due to the government's "inability to control public deficits and debt crises," as well as frequent changes in government composition. The elections of 1999-2000 have opened a new window of opportunity for economic reform. Now there is a new center-right majority in State Duma, as well as Minister of Economic Development and Trade Herman Gref's comprehensive program of economic reform. Finally, President Putin has publicly affirmed his commitment to further economic development. For these reasons, Vasiliev cannot fully agree with Yegor Gaidar's statement, made during his talk at Carnegie Endowment in January 2001, that Gref's program contains too many priorities. Vasiliev argues that the reforms advocated in Gref's medium-term program are in fact long overdue -- the government would "have to do everything at the same time if it wants economic progress." Besides, the favorable situation brought about by recent elections can change in a couple of years, so Gref's team has to do as much as possible in view of the ever-narrowing window of opportunity.

Vasiliev then went on to analyze three major structural reforms, contained in Gref's program. The first one was the restructuring of natural monopolies. Vasiliev stressed the importance of this reform, as at the present time inefficient and unaccountable natural monopolies "undermine the competitiveness of domestic industries, and they will undermine it even more after the inevitable real appreciation of the ruble." The first natural monopoly to undergo restructuring is United Energy Systems (UES), headed by Anatoly Chubais. First developed in 1997, the plan for UES restructuring is endangered by claims of foreign minority shareholders, who feel that restructuring would threaten their interests, and by the unstable position of Chubais, who is under constant attack by the government administration. While there has not been much progress in this matter recently, during a crucial May meeting the company will decide whether to adopt the restructuring program. Vasiliev cautioned that progress will be difficult both for political and for technical reasons. While UES restructuring is moving forward, albeit at a painfully slow pace, the powers behind two other natural monopolies, Gazprom and railroads, are "trying to restructure these companies in line with their own interests, to preserve their monopolistic positions and avoid any privatization."

Another crucial economic reform included in Gref's program is deregulation. While right after the collapse of the Soviet Union the economic environment in Russia was very liberal, since then numerous "unnecessary restrictions on business activities" have been adopted. Vasiliev maintained that the restrictions do not protect either consumers' rights or the state's interests, but serve as rent-seeking instruments and prevent both foreign and domestic investment. Gref's deregulation package of laws already passed the government, but Vasiliev predicts that it will face fierce pressure by specific interest groups in the Duma. The package consists of a new licensing law, which would reduce the number of industries where licensing is required; a new law on registration of new businesses, which would facilitate new business entry; and an emphasis on self-regulation in lieu of government regulation, introducing document certification by private firms.

Along with natural monopoly restructuring and deregulation, pension reform is a vital component of Gref's plan. Vasiliev saw major retreats on this issue from the original plan, developed in 1997, that included switching to a fully-funded private pension system based on Chilean and World Bank models. Gref's program did not advocate a private pension fund, although it did specify that citizens' shares would be individualized. However, at the present time, the proposed reform retreated further and withdrew its individualization of shares clause. In view of the Russian state's bad track record in preserving its citizens' savings, Vasiliev was pessimistic about the de-clawed pension reform.

Additional economic reforms

A true reformer at heart, Vasiliev went on to describe some economic issues, which should figure prominently on Russia's agenda but which were not sufficiently developed in Gref's program. The first one was local self-management. Not mentioned in Gref's plan and rarely present in government legislation, this issue is fundamental for Putin's "vertical of power" project. Vasiliev maintained that municipalities have been proven much more effective in fulfilling local needs than regional authorities, but the progressive legislation on their powers was never implemented, thus leaving them financially unsustainable.
Next, Vasiliev turned to privatization, criticizing Russia's Ministry of Property Affairs for "spending 90% of its time with state property" and having a very bad track record on privatization throughout the 1990s. More troubling, according to Vasiliev, is the trend towards re-nationalization of enterprises, particularly the military-industrial complex. De-privatization is made easier by three different instruments. "The notorious October 23, 2000 presidential decree allowed the creation of holding companies in the military-industrial complex, and thus made de-privatization possible." Also, re-evaluation of intellectual property, previously considered companies' private capital, helped re-nationalize Tupolev company. Finally, bankruptcy mechanisms are used to assist re-nationalization of military-industrial complex enterprises. However, the recently revealed lack of budget revenues in Year 2000 budget provided an incentive for the government to encourage privatization. Vasiliev argued that this policy reversal proves that "the unwillingness of the West to write off Soviet debts provides a stimulus for the Russian government to implement structural reforms; the government needs revenue constraints in order to pursue reforms."

The third issue that received too little attention in Gref's program is financial and banking sector reform. Vasiliev maintained that Russian banking sector is in deep crisis, and Gref's minimal measures would not be enough to correct the situation. At the present time, Russian banks are effective only as a system of payments, but they do not operate as vehicles for investment. The Central Bank cannot prevent continuous banking crises, and banks continue to be overregulated in comparison with enterprises. While "big banks avoid regulation by capturing the regulators, small banks do not have resources to bribe officials." Vasiliev shared his own agenda for banking sector reform, which would minimize both systemic and currency risks, thereby reducing instability in the financial sector. For payments banks, he suggested 100% reserve system. In order to eliminate currency risks, there are two options -- either to introduce a currency board or legalize foreign currency as legal tender. Vasiliev also advocated allowing Western fundraising institutions, such as banks, insurance companies and pension funds, operate in Russia. He also urged complete liberalization of capital flows and deregulation of financial markets, instituting self-regulation and competition of regulatory bodies.

The present and the future of Russian economic reform program

Turning to the discussion of the current status of Gref's program, Vasiliev noted that he was "quite pessimistic" about it several weeks ago. There seemed to be problems with the energy sector restructuring and no success in pushing through the licensing law, while at the same time Chairman of the Pension Fund Mikhail Zurabov was ramming through his version of pension reform. However, the atmosphere has changed with the recent adoption of the licensing law supported by Presidential Advisor Andrei Illarionov, as well as the opening of debate on pension reform. Vasiliev pointed to three factors, which would determine the success of structural reforms in Russia. The first one is oil prices and revenues. "When oil prices are high, there is a low demand for reforms; when you have a lot of money, why change anything?" The short planning horizon, frequently employed by Russian political elite should also be taken into consideration. Half-year or year targets are not enough for structural reforms, reasoned Vasiliev, but Russian politicians are not yet mature enough to work on longer-term goals. Finally, the political setting in the Russian government plays a vital role in economic reform process. According to Vasiliev, it was "a mistake to have only one big reform minister [Herman Gref]." With only one minister responsible for reforms, a bureaucratic bottleneck was created. Thus, development and implementation of economic reform programs should be the task of the whole government. While "the president should not take immediate responsibility for the reforms," he should have a "reformist, not technical Prime Minister, heavily supported by several top officials in the President's administration." Ending his remarks, Vasiliev stressed the importance of building a pro-reform coalition in the Duma, which would closely work with the government.

Discussion Period

Vasiliev's presentation catalyzed a quite energetic question-and-answer session.

· Asked to forecast Russian economic situation for the next few years, Vasiliev suggested that the economic growth would continue for a while at the rate of 4-5% GDP per year, and that much would depend on the fluctuations of oil prices. He also predicted that inflation would be higher than it is expected, somewhere around 30-35% this year, which is "bad but not too bad." If proper economic policy is implemented, we can expect growth in the manufacturing sector. However, due to inefficiency and inexperience in the financial sector, higher investment in the real sector would inevitably lead to a banking crisis in about 2003. Vasiliev sees this future crisis as a catalyst for financial sector reform.

· Discussing monetary and exchange rate policy of the Central Bank, Vasiliev explained that Russia's economy has a case of the "Dutch disease" -- while its raw materials sector can be competitive only with high ruble exchange rates, its manufacturing sector can only survive with low ruble exchange rates. Thus, the Central Bank has to "artificially keep the real exchange rate at a low level, which can be done by maintaining a high primary surplus in the federal budget, accumulating reserves, and using these reserves to pay off debt, thereby sterilizing the extra monetary supply." Another option of sterilization -- new bond issue -- is expensive, as the GKO crisis has aptly demonstrated.

· When asked for recommendations to Western creditors on Russian debt, Vasiliev maintained that he sees no reason for long-term debt restructuring or write-off. The only restructuring that could be useful would concentrate on smoothing out of the debt scheduling. Regarding debt-for-equity swaps, he was in favor of privatization of Russian assets and paying off debt through the received revenues. However, direct exchange of assets for debts was dangerous due to these swaps' lack of transparency and tendency to become corrupt.

· Tackling a comment about regulation in the financial sector as a precondition to capital accounts liberalization, Vasiliev argued that Russian financial regulatory institutions, such as the Central Bank, the Securities Exchange Commission and the General Prosecutor's office, while independent, also tend to be inefficient and corrupt. Thus, instead of relying on them, he advocated "competitive private agencies, which would monitor financial markets."

· In response to a question on land privatization, Vasiliev stressed the political and "symbolic" implications of this reform. While rural land in Russia is not going to be a significant factor of progress for some time to come due to its deep structural crisis, its privatization could serve as a signal to foreign investors about the changing financial and political climate in Russia. It would reduce the uncertainty factor in business environment, and help bring foreign investment into Russia.

Summary by Victoria Levin, Junior Fellow with the Russian and Eurasian Program