State officials disagree on investing the Stabilization Fund

The Finance Ministry proposes investing the money in highly reliable, low-return government bonds of developed nations. The Cabinet staff proposes investing in corporate securities, with a higher rate of return, in order to protect the Stabilization Fund from dollar and ruble inflation.

Last week’s harsh exchange of words between Mikhail Kopeikin, deputy Cabinet chief-of-staff, and Finance Minister Alexei Kudrin revealed the government’s chief intrigue of early 2006. Kopeikin said that the existing way of storing Stabilization Fund money means Russia will lose 600 million rubles over the next three years. Kudrin described Kopeikin’s calculations as ignorant, since Stabilization Fund money will never be stored in the form of ruble assets, so it’s pointless to calculate losses due to ruble inflation. On the contrary, as the Finance Ministry explains, a stronger ruble means that Stabilization Fund money, nominated in rubles, is able to buy more securities nominated in dollars.

At present, Stabilization Fund money (1.459 trillion rubles as at February 1) is nominally stored in the Finance Ministry’s ruble accounts with the Central Bank. De facto, it is secured by various instruments from the Central Bank’s gold and currency reserves. Dividends from the use of Stabilization Fund money are not counted as a separate item in the Central Bank’s revenues. According to the Central Bank’s report for 2004, the rate of return on investing Stabilization Fund money in dollar assets was 1.4%. That’s less than consumer inflation in the United States (2.7%).

The Finance Ministry’s proposed rules for managing the Stabilization Fund still haven’t been approved. The Finance Ministry proposes investing the money in highly reliable (AAA rating), and therefore low-return, government bonds of developed nations. The Cabinet staff proposes investing Stabilization Fund money in corporate securities, with a higher rate of return, in order to protect the Stabilization Fund from dollar and ruble inflation. In that case, a private financial management company should be brought in to manage the money. The Finance Ministry objects that the Stabilization Fund’s purpose is to stabilize the federal budget in the event that oil prices fall. Investing the money in shares would deprive the Stabilization Fund of “its fundamental quality – high liquidity – since it would be impossible to exchange high-risk shares for cash quickly.”

Sergei Drobyshevsky, head of monetary-credit policy research at the Transition Economy Institute, says that as a rule, stabilization funds in developed nations and regions (such as Norway or Alaska) can invest some of their money in shares, and these investments are usually managed by private companies. In developing nations, however, funds are usually invested in government bonds. Drobyshevsky says: “One reason is that investing in the sovereign bonds of other states is a far less corruption-prone option, and that’s an important consideration for developing nations where corruption is widespread.” In consequence, return on investment for the funds of developing nations was only 5-6% in 2003-04, while in developed nations it reached 10-20%.

Essentially, we’re talking about two different models. One is focused on rates of return, the other is focused on reliability. The Finance Ministry appears to be right in saying that since the Stabilization Fund’s purpose is defined by law as stabilizing the federal budget, the reliability model is preferable. At least, this is confirmed by experience in other countries.

Citing such experiences abroad, proponents of active investment for Russia’s Stabilization Fund say that its legal minimum quantity, 500 billion rubles ($17.8 billion), should be invested according to the Finance Ministry’s conservative model, while the rest of the money should be invested in higher-return instruments, like Norway’s Oil Fund. But the Finance Ministry has an objection to that as well: “At present, Norway’s Stabilization Fund amounts to $190 billion, or 70% of Norway’s GDP, and is still growing. Russia’s Stabilization Fund is substantially smaller, around $50 billion, or 7% of GDP – not to mention our foreign debt of $90 billion.”

So this historic dispute is taking place on two levels at present.

The first level concerns principles, or macroeconomics. It consists of the following question: is enough money being accumulated in the Stabilization Fund, relative to GDP and the current level of state spending? Note that federal budget spending for 2006 will be over $152 billion, while the Stabilization Fund’s reference price is set at $27 per barrel.

The second level of the dispute concerns the bureaucracy and corruption. If the model aimed at increasing rates of return is adopted, the Finance Ministry would lose control of Stabilization Fund money. Naturally, there would be a huge power-struggle over who gets to manage such substantial sums.