Russia’s new debt problem: not a foundation for prosperity

The national economy continues its transformation into a fiefdom of state officials. Where are state-controlled corporations getting the money to buy up more assets? From export earnings, and rising levels of borrowing at home and abroad.

The national economy continues its transformation into a fiefdom of state officials. The Rosneft oil company has acquired Yuganskneftegaz. Gazprom, in which the state recently acquired a controlling interest, has its sights set on Sibneft. Further deals of this nature may soon be announced. In part, all this is understandable: no one other than the government controls financial flows of such magnitude these days – it is simply drowning in state revenue. But state spending is restricted by the federal budget’s parameters; besides, the buyers of more and more new assets are state-controlled corporations, not the State Property Fund. So where are the astronomical sums of money coming from?

The main source is export earnings, of course – rising rapidly along with international prices for natural resources. But another no-less-substantial source is borrowing, both at home and abroad. This factor is a cause of concern, and prompts some thoughts.

Since the start of this year we have learned of a number of major deals. Rosneft borrowed $6.1 billion to buy Yuganskneftegaz. Rosneftegaz is taking out a $7.3 billion loan to pay for the 10.74% Gazprom stake which has now become state property. SberBank has issued $1 billion in Eurobonds, VneshtorgBank has issued $920 million, and GazpromBank has taken out a syndicated loan of $450 million to cover its current needs. As talk of its possible acquisition of Sibneft continues, Gazprom has been offered a $12 billion loan.

But are these sums all that large, really, compared to the gigantic budget surplus and the Central Bank’s growing currency reserves? Besides, the government paid out 561.7 billion rubles (just under $20 billion) between January and July to service foreign debt.

Statistics show that over the past 18 months, the Russian Federation’s foreign debt has dropped by 13%, from $98.2 billion to $85.3 billion. Over the same period, the debts of corporations (not including banks) have grown by 68%, from $55.1 billion to $92.6 billion. For the first time, the foreign debts of the non-financial sector now exceed state debt. What’s more, the dynamics of Russia’s international investment position show that the growth of debts is steadily outpacing the growth of Central Bank reserves and the assets of Russian companies abroad. In January 2001, this position was expressed as $51.5 billion; by January 2003 the figure was down to $31.3 billion, and by January 2005 it was $9.3 billion. To all appearances, after this year it will be a negative number.

What conclusions should we draw from this? At least two: one economic, the other political.

First: the reserves so often mentioned by state officials are actually shrinking, not growing. The Central Bank uses rubles to buy up the dollars entering Russia; foreign currency assets are held abroad, but their growth isn’t keeping pace with the rise in total foreign debts. The Russian Federation’s position as a sovereign debtor is improving, but the debt burden of Russia’s largest companies (many of them state-owned to some degree) is growing.

In part, this could a case of transferring money “from one pocket to another” – but only in part, primarily because if anything goes wrong, companies would find it much harder than the government to get their debts to foreign banks restructured. Most of them have used export contracts as collateral, so any defaults would either lead to foreign companies acquiring substantial stakes in the companies, or foreign-currency export earnings drying up – a disastrous blow to federal budget revenues. Thus, it probably wouldn’t be possible to transform these debts into “smoke,” as the GKO bonds were transformed in 1998.

So the present favorable circumstances aren’t really laying a foundation for Russia’s economic prosperity – only helping Russia make ends meet, no more than that. The situation might be different were it not for capital flight from Russia – estimated by Fitch at $25 billion in 2003, $33 billion in 2004, and $9.5 billion for the first quarter of 2005. Yet there is no reason for capital flight to stop.

The second conclusion is even more gloomy. The explosive growth in debt for Russian companies has happened since October 1, 2004, when the extent of the state’s acquisition of formerly-privatized assets became known. In effect, money streamed into companies controlled by Kremlin officials. But “construction costs in Siberia” is just as good a pretext for writing off spending as “reconstruction work in Chechnya.” And it’s much harder to verify that Rosneft and Gazprom have been spending money properly than it is to audit state spending. So it isn’t hard to imagine that money which is essentially state funding, but is given “for temporary use” to state officials who have turned into private-sector entrepreneurs and executives, might be spent on “state needs” such as acquiring or establishing media outlets, funding pro-Kremlin parties and movements, and preparing election campaigns. And Russia will pay for the boundless appetites of political consultants like it pays for everything else – with natural resources, and an ongoing lack of demand for people who don’t know much about high politics.