Depleting Russia’s Reserves

The Ministry of Finance posted a long explanation at the beginning of the week on the state of Russia’s two reserve funds. I was planning on breaking it down, but Vladimir Milov has done my work for me. Some key points:

In the Reserve Fund as of 1 January [2017], there were only 0.97 trillion rubles, [that is] more than a trillion rubles were spent [in December alone];

It is unclear, Milov continues, what happened to the money supposedly received from the “privatization” of Rosneft [see my previous blog post on this].

In the SWF [Sovereign Welfare Fund] remains 2.8 trillion rubles that are “liquid” (© Siluanov).

And finally, Milov writes, the budget deficit for 2017 is slated to be 2.75 trillion rubles.

If everything continues in the current trajectory, by the end of this year the two funds will be depleted.

“Anyone who tells you that this supposedly “does not matter because the government is selling the currency to the Central Bank, while maintaining the same volume of gold reserves” is dissembling or does not understand the essence of the matter, because to finance the budget deficit with the gold reserves is useless.”

And once the reserves are empty, then “the fiscal deficit can only be financed by borrowing (and in this respect, the removal of the sanctions acquires a decisive role), or the Central Bank has to loan money to the government…”

Or the third option the government could take is budget cuts.

For reference – even at today’s frozen budget expenditures:

  • real pensions declined by 3.5% for 11 months of 2016;
  • the indexation of wages in education and health care for 11 months in 2016 were 4.2% and 6%, respectively (Rosstat).

By reducing budget spending you can imagine what will happen.

Protracted Crisis

The total amount of loans to Russians, both consumer and mortgage, is 9.23 trillion rubles. The most complicated situation is in mortgages. According to the “United Credit Bureau”, the number of late payments on mortgages in the third quarter of this year increased by 3.7%. The amount of debt of Russian citizens to banks for mortgage loans amounted to 160 billion rubles.

Rosbalt spoke to the director of the Institute of Strategic Analysis, Igor Nikolaev:

How serious is the problem of defaults on loans for our economy?

“The debt is significant,” Nikolaev acknowledges, “the problem is in a frozen state, but it will not go away, it is not resolved, the situation has simply now become a bit better.”

However, he continues, “if the economic situation were to deteriorate again… then, of course, this problem will also manifest itself in a more explicit form.” He mentions another weakening of the rouble, or the rapid decline in real income as factors.

An added problem is that people have begun borrowing again, but this time in “consumer credit”.

“This is celebrated as a positive trend….” but, he says, “I think that the risks are high, because problems remain in the Russian economy.”

Rosbalt calls Nikolaev out on his claim that there has been “some improvement in the situation in the Russian economy.”

“Can you clarify in what area, because apart from the stabilization of the ruble… there is nothing, at least outwardly, that has changed in a positive way.”

Nikolaev replies:

“Well, I already mentioned the growth of consumer credit. This is noted by “Sberbank” and other credit institutions. This is information from August-September. With regard to the whole economy, it is not falling now as it fell in 2015. That is, some stabilization is observed.”

Rosbalt moves on, asking about mortgages. Many Russians, during the good years, took out mortgages in foreign denominations (particularly US dollars).

Nikolaev replies:

“There is also a frozen state, although some intensification of mortgages is taking place. But the situation with the foreign currency mortgage is not exactly resolved.”

It has gotten a bit better because the ruble has gotten slightly stronger, he notes. “But if it gives way again, the problem will arise again with the same sharpness.”

Rosbalt asks about the situation with the ruble:

“It is not clear why the ruble strengthened, given that oil remains at the same level.”

Nikolaev disagrees, saying:

“Well, the price of oil has soared. If you recall that it was $35 a barrel, and now it is more than $50 [note: Brent today is ~$49 a barrel].”

He also notes that the Russians and OPEC are playing the market with their talks of an oil production freeze.

“In addition, the role played by the action of the Central Bank to raise reserve requirements on foreign currency deposits (the so-called devaluation of bank assets). This policy, which has been carried out since the winter of 2016, is not advertised, but it has had a strong influence on the currency, playing a large role in strengthening the ruble, as it becomes less and less profitable for banks to attract foreign currency loans.”

And finally, Nikolaev says, the US Federal Reserve has not increased the refinancing rate.

Meanwhile, current proposals to fix the situation facing foreign currency borrowers are only temporary while “the crisis has taken on a protracted nature.”

Instead, Nikolaev tells Rosbalt, the burden rests with the Central Bank, “because the stability of the national currency was not provided at the time.”

So foreign currency mortgage holders could say that while they took out loans in a foreign currency, “the State did not ensure the stability of the ruble.”

Then, he says, these people could be compensated in some way “for lost revenues by State banks when translating foreign currency mortgages into rubles”.

“Naturally, it would not be a total payment, and a heavy financial burden will remain on the borrowers, but such a move would be important as a precedent. Because when the government says “it’s not my business,” I believe that this is also wrong.

Asset Stripping Fraud

The article is a translation of a blog post by former deputy chairman of Russia’s Central Bank, Sergei Aleksashenko. In the article Aleskashenko details how the Central Bank is committing asset stripping fraud of Russian banks.

“The scheme is ridiculously simple.

  • The Central Bank turns a blind eye to capital and clients’ deposits being siphoned off from a bank;
  • those same Central Bank passive onlookers then decide that the bank has to be saved (although of 30 bail-outs, not one bank has yet managed to return to full operation);
  • the same people choose which bank will save the bankrupt bank and decide how much money has to be allocated for this noble purpose;
  • then those very same people give the DIA [Deposit Insurance Agency; the equivalent of the US FDIC] a loan for 6-8 years at an interest rate of 0.5% (that’s right – half a percentage point);
  • after that the same people [from the Central Bank], or some of them, visit the DIA where, as members of the Board of Directors, they decide to issue a loan of billions of roubles (at an interest rate of 0.51%) to the banks involved in the bail-out.
  • The bank doing the rescuing then uses the funds it has received to buy a federal loan bond at the current rate of return from the Finance Ministry and receives a guaranteed income;
  • the Finance Ministry meanwhile uses funds from the federal budget for the next 6-8 years to pay the interest on the bond sold to the bail-out banks.
  • At maturity, the bond should pay off all the money received as a loan.”

This scheme, Aleksashenko writes:

“…has already cost over one and a half trillion roubles and, taking into account the interest to be paid, the federal budget is going to have to shell out considerably more than two trillion roubles.”

Now, he concedes,

“To be fair, it should be said that the banks have paid back slightly more than 20% of the one and half trillion roubles disbursed. To this end, some assets have been transferred on to the DIA balance sheet. But their real value is unknown as the DIA site carries no information about the nature of these assets, why the DIA needs them, what it has done – or intends to do – with them.”

He continues:

“There have never been, nor are there still, any clear or transparent criteria for deciding which bank should be bailed out – and which should be left to collapse – and it is only the bureaucrats who are allowed to have anything to do with analysing proposals for bail-outs…. Moreover, after some time it emerged that the rescuers were finding the allocated funds insufficient, so multiple hasty appeals for top-ups were launched at the Central Bank because “what you sent last week was gobbled up straight away” (a quote from Korney Chukovsky’s children’s story Telephone).”

Aleksashenko concludes:

“….This way the federal budget is incurring ever more debt, although we know that there is no longer any money left in it, so any extra unplanned kopecks spent throws the Finance Minister, who is also a DIA board member, into a blind spin of rage. It looks to me as though this endless stream of new decisions about money to be allocated was one of the main reasons for the recent purge of the Central Bank’s supervisory committee.

When I decided to look at the final summary of what the sacked “supervisors” had been up to, force of habit led me first to the usual place on the DIA site in the hope of downloading the usual tables, but I didn’t find any. So the bureaucrats’ cat had a very good idea of whose meat she had been eating and decided to sweep all the information about her dinner under the carpet – to avoid any uncomfortable questions for the officials.

We must disabuse the said officials: we will find the information, we shall be asking questions, and we shall name and shame those who are personally responsible.”

Diamonds & Gold

The Finance Ministry is cutting back purchases of precious metals and gems for Gokhran (Russia’s precious metals and gems repository) this year by 2.5 times, from 12 billion rubles to 5 billion rubles, “Izvestia” reported today.

At the same time, large-scale sales of gold and diamonds are planned to replenish the state treasury.

As of 1 October, the paper reports, the Ministry of Finance had only spent 19.9% (or 2.4 billion rubles) of the 12 billion rubles budgeted for purchasing precious metals and stones.

The Ministry’s press service told “Izvestia” that they only planned to spend about 7 billion rubles in total this year.

In conjunction the Finance Ministry intends to increase sales of precious metals and stones in the next three years. The Ministry plans to sell off about 4.522 billion rubles of the commodities this year, 10.411 billion next year, and another 10.5 billion in 2018-2019. These sales will be used to “provide operational funding for the federal budget deficit”, the Ministry claims.

In 2015-2016, purchases of these assets were doubled, analyst Roman Tkachuk told the paper. He stated that the Ministry is now returning to its pre-crisis patterns:

“Between 2012 and 2014 Gokhran bought mainly diamonds, but in the past few years, most of the funds have been invested in precious metals.”

“The relatively high prices prevailing in the market today will allow the Finance Ministry to profitably sell these assets,” the paper claims, “World prices for precious metals and diamonds have been fairly stable this year.”

“The Ministry’s decision will have a moderately negative impact on the diamond market, experts say.”

Gokhran purchases from state diamond company, “Alrosa” are secret, but according to Tkachuk, they range somewhere between “1 and 10 billion rubles a year” (or only 1-5% of the company’s total revenue).

“But the State Fund has traditionally bought… the most expensive stones, the export of which is prohibited abroad. So the news is marginally negative for the diamond company.”

Another analyst told “Izvestia” that the reduction of state purchases from “Alrosa” could make it easier for the company to sell its product abroad. But, he added, “the sale of state reserves will put additional pressure on world prices, which are already reduced in recent years.”

“At the same time, gold producers are not affected: on the one hand, the market is able to support the demand, on the other – procurement plans are stored in the Bank of Russia,” the paper wrote, quoting the head of the Union of Gold Producers:

“So far we have to more substantially cooperate with our other creditors in the market, especially with Russian banks, as well as more and more active fund development in the Far East and the Baikal region. And the high domestic liquidity of gold, as always, is provided to us by the Central Bank.”

Capital Outflow

The Russian Regime appears to be very concerned with the potential impact that a further weakening of the ruble would have and have been warning about it. There have been several articles (some of which I have highlighted here already) mostly pointing to the fact that Rosneft’s lack of ready cash could cause major problems for the Russian currency come December.

According to Russia’s Central Bank Russian companies have $21.6 billion in external debt due by the end of the year, and another $15.2 billion due by the end of the first quarter of 2017. This does not include banks or other financial institutions.

As for the banks, Raiffeisenbank analysts predict a further outflow of capital.

“Since the beginning of the year, foreign currency in corporate accounts decreased by $20.5 billion or 14%.”

That is, every 7th dollar has left.

“Foreign exchange reserves of the banking system, the reserves on the accounts in foreign banks – remained at its lowest level in 5 years and reached $20.4 billion, down by 20% from the beginning of the year.”

The columnist Sergei Shelin wrote earlier this week that a drop in the price of oil could hurt the ruble too. But, he says, the main thing is that people panic. There are three things that could happen with the ruble:

“A more or less marked weakening of the ruble in the coming months is quite possible, although not guaranteed.”

The rising price of oil may prevent this, however. But Shelin writes, “I do not believe this is very likely.”

Second, if the ruble is again weakened, he says, “it is unlikely to be on the same scale as two years ago or even one year ago.”

And third, Shelin does not rule out “a powerful devaluation” but for this to happen, there would have to be external shocks, “such as the collapse of the global energy market, or some major adventures on the domestic and external fronts.”

Rosneft Debt

More bad news about Rosneft.

The Central Bank’s governor, Elvira Naibullina, told reporters this week that “she saw no risk to the ruble from oil firm Rosneft possibly buying its own shares from state holding company Rosneftegaz.”

But Raiffeisenbank is saying that Rosneft’s expansion plans could cause problems for the ruble.

Rosneft could reduce the sale of foreign currency earnings on the Moscow Stock Exchange in 2017 and cause a “double blow” to the ruble.


Rosneft is the biggest single seller of dollars on the Moscow Stock Exchange. In 2015, the company sold $45.5 billion and in 2014, it sold more than $90 billion.

But due to its rapid expansion and current debt problems (which I discussed here earlier this week), Rosneft may have to cut back on that activity.

Analysts at Raiffeisenbank calculated that at the end of the first half of the year, Rosneft had about $20 billion in foreign currency on their accounts, another approximately $4 billion that the company should obtain from the sale of shares in Vankorneft and Taas-Yuryakh.

That is it should have $24 billion in readily available foreign currency.

Of that [$24 billion], $5 billion [it was actually $5.3 billion – ed.] was spent on the purchase of Bashneft (the transaction was completed on 12 October), $4.7 billion in scheduled loans are due by the end of the year. Another $11 billion will be used to buy back its own shares from the State.

That is, as mentioned above, Rosneft plans to participate in its own privatization by buying the 19.5 percent stake in itself that the State will put up for sale before the end of the year.

If it does so, Raiffeisenbank says that “…at the end of the year Rosneft will have about $5.7 billion (including rubles), which covers only half of the $11.7 billion debt that needs to be paid in 2017…”

“In the next year, Rosneft could reduce the sale of foreign currency earnings to replenish its foreign exchange assets depleted due to the repurchase of shares (in the case of “self-privatization”), at least until the resale of shares to foreign investors,” warned Raiffeisenbank analyst Denis Poryvai.

In his view, the result is a double blow for the ruble: the company will take a substantial amount of currency from accounts in Russian banks, as a result of which the market will run short of dollar liquidity, and later reduce the sale of foreign currency earnings on the stock exchange.


Lies & Statistics

Russian economist Sergei Aleksachenko writes on his blog today:

Often, when discussing statistical reports, it is necessary to say that there are lies, great lies, and statistics. Because, for example, connecting in a single line cheese production and cheese products can give the authorities the evidence of the success of [their] import substitution policies. And the fact that this very product does not contain a single drop of animal fat – this is not the statistical part!

But there are also opposite situations where policy makers act in their own interests and deliberately distort the statistical information. For example, the Bank of Russia is doing great and very high-quality work on the balance of payments, the document, which is one of the most important statistical forms for understanding what is happening in the economic relations of the country with the rest of the world, whether or not there is a threat to the stability of the national currency.

Everybody waits impatiently for the publication of this document, he writes, including the Kremlin.

He recounts how President Putin stated at the “Russia Calling” forum in Moscow this week:

“Compared to last year, net capital outflow from Russia for the first three quarters of this year fell, I beg your attention, five times, to 9.6 billion dollars. I remind [you] that in the first three quarters last year, the export of capital amounted to more than $48 billion.”

Who is forcing him to tells these lies, Aleksashenko queries. And at an event where “at least half of the participants” know he is lying, because they’ve read the Central Bank’s report.

What really happened? Between 2015 and 2016, he says, the Central Bank used a variety of different tools to distort the statistics. And more importantly, “…in 2015, the Bank of Russia gave foreign currency loans, but in 2016 they began to demand their repayment.”

To make the math come out right the so-called “experts” at the Central Bank added additional rows to their chart.

The real numbers are actually $37.7 billion capital outflow in the first three quarters of 2015, and $21.4 billion in the same period of 2015. “The difference [between the two] is not five times, but a little less than two.”

And, Aleksashenko continues, “if we compare the performance of capital outflow with the current account balance – this is the result of economic exchange (trade in good, services, wages, interest and dividends, etc.) between Russia and the rest of the world – that is, there is a difference, and this difference is a large [one].”

Traditionally it is believed that the stability of the balance of payments and, consequently, the Russian ruble is based on a stable surplus in the current account balance. This year, that figure began to decline rapidly, from $54.4 billion for the first 9 months of 2015 to $15.6 billion in the same period of 2016.

And if you compare the volume of capital outflows with the current account balance then, in the version of the Russian President, nothing serious is happening: the outflow of capital is less than the surplus of the current account balance. But in the Central Bank’s version, the weakness manifests itself immediately – the outflow of capital is 50% greater than the surplus in the current account balance. This means that the ruble is not in such a comfortable position as it may seem, looking at its dynamics in recent months.

Aleksashenko concludes:

I am far from thinking that the Russian president himself visits the Central Bank’s website and finds the necessary data. Of course, it is done by his assistants. And when they put clearly inadequate information in the text of the president’s speech, I am plagued by two questions: are they doing it deliberately…  or are they [economically] illiterate? And… is the president too illiterate?

Auctioning Assets

I have discussed the Central Bank’s asset stripping of the banks it is shutting down here before. Rossiskaya Gazeta published an interview today with the Deposit Insurance Agency’s Deputy General Director, Oleg Baranov, about the agency’s plans to hold live auctions to sell the property of bankrupt banks. The assets will be sold to repay defrauded investors, Baranov claimed.

The DIA (Russia’s equivalent to the US’ FDIC)  plans to revive live auctions, with the first one taking place before the end of the year. Ordinary citizens will be allowed to participate in the process. Baranov told RG that they hoped that the competitive atmosphere of a live auction would net them more profit from the assets. He also explained that customers would be allowed to see the items before the auction to see what they were getting.

The DIA is already selling some items online, Baranov acknowledged, furniture, phones, computers, and so on. They are hoping to start selling the same type of items in live auction. If it goes well, they will expand and start auctioning off items of greater value, at least up to half a million rubles.

The newspaper also asked Baranov about the value of the total assets of liquidated banks.

The DIA is overseeing the liquidation of 287 credit institutions, Baranov answered. “The aggregate value of their assets is about three trillion rubles. And it is constantly growing due to the ongoing withdrawal of licences.” He also told the paper that his agency is currently overseeing the elimination of 34 state pension funds.

The Russian government is also looking to recoup its losses by seizing assets of Russian bankers who have fled abroad. The British authorities are still cooperating in this retrieval process, Baranov told RG, “despite some geopolitical differences” they “acted… according to the law, and not guided by emotions.” He cited the case of Sergei Pugachev, whose assets were turned over to the DIA this year by a British court. The International Business Times reported in August that “Pugachev is accused of siphoning $700m (£531m) from his bank, Mezhprombank, including Russian government bailout funds during the financial crisis.” The agency is currently in the process of selling two of Pugachev’s UK properties.

The Deluge

Sergei Shelin writes in Rosbalt:

The new Duma, hastily convened for stamping multiple emergency laws and, in particular, the draft budget for next year, will have to first approve the final version of the 2016 budget. It was just released by the Ministry of Finance and was full of surprises.

Though federal revenue this year will be significantly lower than planned, government spending increased significantly (from 16.1 trillion to 16.4 trillion), the “open” part of government spending has been reduced by almost 0.4 trillion and the “closed” has grown about 0.7 trillion.

“Closed” consists of secret and top secret, he notes, “firstly, the military (but not only them).”

Almost everything that is connected with the immediate benefit to ordinary citizens, is to be put under the knife, in contrast to last year, they are no longer hesitant and even transfers to the Pension Fund increased by a couple hundred of billions of rubles. But the main prize is prepared for the military. More precisely, the military industrialists, as you might expect.

“In making these proposals,” he continues, “the Finance Ministry has abruptly changed course…”

“Numerous statements by Finance Minister Anton Siluanov expressed the invincible will to further reduce the budget deficit by cutting down on government spending, including the military, and to reduce inflation to the unprecedented in the post-Soviet era four percent in the next two to three years.”

The budget deficit could be as high as 3.9%, he writes. The Russian Finance Ministry has already conceded that they have exceeded their targets, and that the deficit could sit at 3.7% by the end of 2016. Shelin also acknowledges that the government is manipulating these numbers, and using the Reserve Fund to cover their losses, among other things.

The current relative stability of the Russian economy and finance (albeit without any prospects for the transition to growth), slowing the rate of decline in living standards and a fairly impressive reduction of inflation – is the fruit of the policy of containment of public expenditure, which, until recently, was held by Siliuanov’s Ministry of Finance, in alliance with Nabiullina’s Central Bank.

I do not know if this is a one-off surge in government spending, which will happen between October and December, but if something like that will continue in 2017… stability can be scrapped.

Shelin then attempts to defend Finance Minister Siluanov, and places the blame at Putin’s door:

The supervisor of Anton Siluanov is Vladimir Putin. The reason for the sudden change in the budget views of Minister can only be obtained on his [Putin’s] orders.

It is clear that first and foremost this is an additional lever for the Supreme Commander and the Minister-redistributor will be only an advisor and a responsible executor [of the President’s will].

The author thinks that there are two explanations for what is happening. One is political. The so-called “detente” with the US is not working. Syria is a problem, and the new report about the shooting down of the Malaysian flight MH17 did not help matters. Meanwhile, the Russians have halted cooperation on a 2000 agreement on disposal of weapons-grade plutonium.

So the emotional atmosphere in October can in principle be considered suitable for impulsive arms build-up, without regard for economic consequences.

But you cannot count, because financial realism sometimes (and this is not uncommon) coexists with the most acute foreign policy conspiracy theories.

Shelin also suggests that the move could be what he calls “tactical”. Essentially that the government is robbing Peter to pay Paul (to use the cliche). Which he already suggested in his reference to the Reserve Fund.

There is one other explanation that Shelin does not offer. The Reserve Fund and the National Welfare Fund fell by nearly 155 billion rubles in September. The two funds collectively have about $105 billion left in them (on paper, anyway). If the government stays on this trajectory, the funds will likely run out in the next six months. And after that, it is unclear what the government will do.

They are still offering bonds and so on, but the money they are getting from that is minimal at best. Their privatization scheme scam (which I have written about previously) is not going well. Bloomberg recently reported that the government took a loss on its sale of a stake in diamond miner, Alrosa.

I don’t anticipate that the newly re-instituted sales of stakes in Bashneft and Rosneft will go any better.

And what then?

Après nous le déluge

After us, the deluge

Where is the money?

The Rosbalt news service published an article yesterday about the Russian government’s new efforts to find more money to plug holes in the federal budget.

Officials at the Ministry of Finance have taken initiatives to find extra money. There are two options being considered: to reform the system of premiums [to increase the payroll tax] or to increase the value-added tax (VAT).

The problem with these proposals is that the government will end up driving more businesses underground. The shadow economy, which already makes up a large portion of Russia’s economy, will only grow larger. The Russian Presidential Academy of National Economy and Public Administration published a survey in July alleging Russia’s “garage economy” currently consists of about 30 million people (“40 percent of the economically active population”).

INSOR’s Nikita Maslennikov notes that companies would also be more likely to show lower wages on their books in an effort to avoid the higher tax bracket. He also thinks it is unlikely that the VAT will be raised because it would “increase the risks of failure to reach the [Central Bank’s] target of 4 percent inflation by the end of 2017. This would be a blow to the plans of the Central Bank and its apparent bid to tighten monetary policy.”

It would be better, Maslennikov continues, to “move in directions which are more neutral in terms of the tax burden and comfortable in terms of stimulating economic growth. That is the reduction of inefficient government spending and expansion of the state borrowing program by increasing the release of federal loan bonds [OFZs].”

There is also a proposal to get rid of the 13 percent flat income tax implemented early in Putin’s first term. But the authorities are hesitant to reintroduce a progressive income tax. Most likely because they worry about a backlash by their constituents. It would also likely again force more people to operate off the books.

The Rosbalt article concludes by asking who the government’s “next “cash cow”” will be.