The Stabilization Fund as a personal security fund for the bureaucracy

The decisions of venal Russian bureaucrats will enable Western governments to spend Russia’s money on building up their own military might. Instead of being invested abroad, the Stabilization Fund ought to be spent on the Russian Armed Forces and the defense industry.

The government still hasn’t figured out what to do with the growing Stabilization Fund. The authorities maintain that the money must not be spent, since the Stabilization Fund is a safety net for that rainy day when oil prices fall.

The history of the Stabilization Fund, which started operating on January 1, 2004, is a story of lost opportunities and lost profits. The government decided to direct part of its bonus revenues from oil exports into the Stabilization Fund – for the purpose of getting the “crazy” money out of the economy. In the government’s opinion, this money wasn’t secured by anything and only served to exacerbate inflation.

The Finance Ministry maintains that this money should only be spent on paying off foreign debts; this is still being done. So some of the money has been used to repay debts, while the rest remains a dead weight in the Federal Treasury. Not until December 2005, when Auditing Chamber Chairman Sergei Stepashin sent in a threatening letter, did President Putin instruct Prime Minister Mikhail Fradkov to think up something or other.

Then a bureaucratic war broke out in the government between Finance Minister Alexei Kudrin and Mikhail Kopeikin, deputy Cabinet chief-of-staff, who accused the Finance Ministry of allowing inflation to eat away at the Stabilization Fund by keeping the money in rubles at the Central Bank. The Cabinet staff calculated that the losses amounted to 152 billion rubles in 2004-05 and could exceed 680 billion rubles for 2004-08 if no action was taken. Kopeikin proposed investing part of the Stabilization Fund in high-yield shares in foreign corporations. After all, while the foreign government bonds that we’re preparing to buy are reliable, the yield is only 2% per annum. Russia’s inflation rate last year was 10.9%. Kudrin replied that inflation isn’t a problem, since all the money is held in the form of gold and foreign currency reserves.

In late April, after all these arguments, Fradkov finally signed a resoluton on Stabilization Fund management. By the end of June, the Finance Ministry should start using Stabilization Fund money to buy “permitted forms of foreign currency” and “bonds issued by foreign governments.” In effect, however, nothing has changed.

Kopeikin’s proposal to invest in foreign blue chips has been rejected. Not even the World Bank could help, although it stated that Russia could make over $800 billion by 2030 if it adopted the proposal. Kudrin’s stance remained unchanged: reliability takes precedence over yield. Moreover, Kudrin doesn’t listen to arguments that the biggest problem for Russian citizens isn’t monetary inflation, but rising rates for the services of monopolies.

The Finance Ministry is firmly opposed to investing Stabilization Fund money in modernizing industry and economic infrastructure, importing high-tech equipment that isn’t produced in Russia, subsidized loans for small and medium-sized business, or supporting the mortgage system and municipal housing construction. Some economists have calculated that with a sensible policy in place, such moves could pay real dividends for the state in the future. But the Finance Ministry has its own economists.

Senior Deputy Prime Minister Dmitri Medvedev, chief curator of the national projects, has already proposed including “gasification” among them. Economic Development Minister Herman Gref maintains that 120 billion rubles should be made available for state investment. As the elections approach, it’s clear that the Stabilization Fund’s reference price will be raised to cover spending on the social sector.

Lacking money for industrialization, the Bolsheviks sold off art treasures from Russian museums and bought industrial machinery. In Russia today, industrial machinery is so old that it’s barely functioning – but the government doesn’t care. State officials seem to be hoping that Stabilization Fund money will suffice to keep the situation under control in the short term. They aren’t at all concerned about what will happen later. “After me, the flood.” Thus, they’re effectively treating the Stabilization Fund as their personal security fund for the future – a shield against the consequences of their own economic policies.

This year, for the first time, the bureaucracy has decided to spend some Stabilization Fund money within Russia. At Herman Gref’s insistence, and with the promise that it would boost GDP growth by 0.5%, Russia has established an Investment Fund that contains almost 70 billion rubles. No one knows what effect this will have, but there is reason to believe that the results will be the same as ever.

Some basic economic principles are worth repeating here, with regard to Russia’s investments. Any form of investment involves two stages: first you spend money, then you get a return on your investment. When it comes to state funds, Russia’s bureaucrats excel at the first stage, but the second stage never seems to work out. Perhaps that’s because the return is supposed to go to the state, not to the bureaucrats.

Why this focus on the bureaucracy? Because although the state has declared that the Investment Fund will be spent on state-private partnership projects, it’s still the bureaucrats who will decide which companies get the money.

In March, the Economic Development Ministry started accepting applications for Investment Fund projects. These are supposed to be selected on a competitive basis, with applications closing in late May, the winners announced in June, and money distributed in September. As far as we know, however, not a single official application had been received by the start of May.

Indeed, why bother with application paperwork, when everything is decided in advance? The likely winners are already known. As early as February, some Economic Development Ministry officials were saying that the “closest focus” was on investment projects for the Lower Angara in the Krasnoyarsk territory, the Moscow-St. Petersburg high-speed highway, the Nizhnekamsk petrochemical complex (Tatarstan), and the Western high-speed project in St. Petersburg.

True, in the last few days before the deadline, the Economic Development Ministry found itself snowed under with applications. Yuri Zhdanov, head of the Federal Agency for Managing Special Economic Zones, told the media on May 18 that “we already have ten applications.” The next day, Zhdanov was corrected: “The Ministry has received over 20 applications.” The final count was 46 applications; but the top priority and “closest focus” stayed with the same projects that were favored back in February. Even if a hundred applications had come in each day, the money would still go to the “right” projects.

It’s worth noting that the Lower Angara project could easily get by with state guarantees rather than Investment Fund grants. The project’s total cost is estimated at $6 billion, and once it’s complete, the Krasnoyarsk territory’s contribution to GDP should increase by $39 billion a year. The participating companies are by no means short of money, and they’re well acquainted with the state: the largest state-owned gas and oil companies, planning to develop fields in the Lower Angara area; Russian Aluminum, planning to build a pulp and paper mill and an aluminum plant; and Russia’s electricity monopoly, planning to complete construction of the Boguchansk hydro-electric power plant. At first, the region’s state investment requirements were estimated at only $760 million; but now the Lower Angara project’s requests for state funding have risen to 34 billion rubles ($1.26 billion).

Then there’s the project for a high-speed highway between Moscow and St. Petersburg. This is not to be confused with the High-Speed Railway project that suffered a premature death, leaving only a giant hole in the ground in St. Petersburg, its total cost still unknown. This new project is all about a road, costing a mere $6 billion to build. The contribution requested from the state is substantial: over $3 billion. But independent experts say that this project could also get by without state funding, if the government passed some proper laws on private roads.

Even for projects where state involvement could take the form of guarantees and concessions, the bureaucrats are focusing on direct state funding. This is understandable enough: it offers more opportunities for kickbacks.

With bureaucrats like these, maybe Russia really doesn’t need an Investment Fund at all – or maybe it would be better to bring in some capitalists to manage it. And they’d have to be foreign capitalists, because all our business leaders are bureaucrats as well, whether in the past or in the future; the most adaptable of them manage to combine both roles in the present.

The federal government has issued a resolution on procedures for managing Stabilization Fund resources. Huge sums of money, around 2 trillion rubles, will be invested in foreign currency and the government bonds of other countries – most of which, by some strange coincidence, are NATO members. But a resolution isn’t a law, and ministers (even the best of them, like Kudrin) aren’t the president. Therefore, it’s too soon to close the discussion of how this money, which belongs to the whole country, should be used.

In a speech to war veterans shortly before Victory Day, Moscow Mayor Yuri Luzhkov spoke of the objectives that ought to be pursued with the help of the Stabilization Fund.

The growing combat capability of the Russian Armed Forces is just as much a myth as doubling GDP by 2010, making the ruble fully convertible, or oil prices staying high forever. Yes, Russia’s defense spending as a percentage of GDP is comparable to the spending of other nuclear powers – but how can our country’s territory, natural resources, and social and geopolitical specifics be compared to those of Britain or France? Observing international agreements on a non-militarist budget pays tribute to the poverty-stricken Yeltsin era, when there simply wasn’t enough money to support the Armed Forces. That’s why we had to accept those terms. Meanwhile, China still keeps its defense spending secret.

The Russian Armed Forces are in critical condition with regard to military hardware. Russia now has 58% fewer strategic bombers than it had 15 years ago. In most aviation units, no more than ten aircraft out of the regulation 36 are capable of flying. Russia will have only 10-12 nuclear-powered submarines left by 2010, compared to its former total of 47. The Pacific Fleet already doesn’t have any nuclear-powered missile-carrying submarines. Eighty percent of Russia’s ICBMs have exceeded their service lifespans, and while 150 missiles have been withdrawn from service, only seven have been purchased to replace them. Russia doesn’t have a single optical spy satellite in orbit, although there are 16 American spy satellites constantly monitoring our country.

All claims that the armaments situation has improved in recent years are nothing more than empty talk. President Putin’s address to parliament this year only mentioned two submarines under construction, the untested Bulava missile system, and a few recently-acquired Topol-M systems. Last year, the Air Defense Forces waited in vain for new S-400 missile systems; the Air Force waited in vain for Mi-28 helicopters; and the Ground Forces received only 19 tanks instead of 91. Yet the Finance Ministry and the Defense Ministry haven’t even completed payments for the minimal amount of hardware that was delivered.

When foreign governments receive money from our Stabilization Fund, they won’t just spend it on social programs or agricultural subsidies. They’ll also spend it on arms procurement, creating jobs in their defense sectors, and developing new dual-use technologies. Instead of funding rearmament for the Russian Armed Forces, the Finance Ministry proposes to reinforce the military might of the United States and its European allies in NATO.

Even though military might is coming to play an increasingly important role in the international economy, Fradkov has signed a resolution that directs almost $70 billion into supporting the domestic and foreign policies of the countries President Putin had in mind when he said: “Comrade Wolf goes ahead and eats, not listening to anyone.”

There’s another aspect to the negative economic effect of investing Stabilization Fund money abroad: when oil prices fall and Russia’s nuclear shield wears out entirely, there simply won’t be any money for rearmament. The bonds issued by Western governments have fixed terms, and withdrawing our money ahead of schedule would entail huge losses. Will national defense be left penniless again?

The Stabilization Fund offers a rare opportunity to provide full funding for arms procurement without increasing the federal budget’s military spending. Despite conversion, privatization, and bureaucratization, the products of our defense sector are still among Russia’s few internationally-competitive goods. For example, fighter jets account for two-thirds of Russia’s arms exports. It would take around $6 billion to get a Russian fifth-generation fighter into production. The export price would be at least $40 million per aircraft, and within a few years we could sell about a thousand fighters, for a total of $40 billion.

If we develop our technology properly, many countries are prepared to buy Russian-made ships and submarines until at least 2020. All over the world, there is great interest in our tanks, radar installations, and space technology. Now compare the yield from investing Stabilization Fund money in foreign government bonds – 4% per annum – with profit rates of several hundred (!) percent if Russia rearms its own Armed Forces and develops its defense industry simultaneously. Judging by the government’s latest actions, it doesn’t favor that option. It’s far easier to sit in an office, stare at a computer screen, and count virtual profits.

Directing part of Stabilization Fund money into the defense sector would enable defense enterprises in the regions to rise from their knees. This would stimulate associated sectors, and breathe life into hundreds of Russian cities where defense enterprises used to dominate the municipal economy. Revitalized defense enterprises would also start making civilian products, since many technologies used in the military are dual-use technologies.

Kudrin’s fairy tale about inflation rising if Stabilization Fund money is spent within Russia is easily refuted. Firstly, Stabilization Fund rubles are already real money, lying as a dead weight in the Finance Ministry’s accounts; so the monetary mass won’t increase. Secondly, wages and other payments to defense sector workers would come from revenue earned, not from the federal budget; so there wouldn’t be any extra burden on the budget. Thirdly, the rising costs that are constantly mentioned by ministers don’t depend on the defense sector. After all, the government itself approves annual increases in the rates charged by monopolies. So if anyone can explain how investing in the defense sector would boost inflation, let them do so.

In short, if we don’t direct part of the oil windfall into the defense sector, we’ll lose a promising source of export revenue and an opportunity for national revival. Then, in the near future, we might be left with only one way to prove our defense capability: special missiles that respond to the destruction of the central command headquarters by flying across the country and automatically raising any surviving remnants of our former nuclear might from their silos.