Transcript of the speech:

Friends and colleagues,

Speaking about the modernisation of the Russian economy, it is perhaps necessary to speak in broader terms – about the modernisation of society. Since only effective public institutions can ensure stability and the conditions necessary for doing the job. Only they can generate the confidence and investment in the economy that is needed. Investments follow trust, and they will help modernise the Russian economy.

I will try to speak using the relevant talking points. I will try to relate the lessons of the crisis to what we need to do. This crisis was special, this was global economic crisis. For the first time, we are going through a crisis in which the situation in different countries is so deeply interconnected because of many factors. We have become linked more than ever to the same markets, with mutual flows of capital and mutual connections in general commerce. The countries most sensitive to drops in exports, for example, are countries such as Germany and Japan. Russia is among these countries, too. A very serious consequence of the crisis is capital flight, and Russia is one of the countries that bore the brunt of it. Before the crisis, we had $80 billion in capital inflow for one year. During the crisis in 2008, we had an outflow of $130 billion. An outflow of $10 billion upset our entire financial system in 1998, and in 2008 we were able to "digest" the outflow of $130 billion and resist shocks.

What is the situation today? We have global imbalances, and we need to mitigate them, and try to prevent and be ready for them. These imbalances are manifested in various forms. In order to avoid prolonged shocks from attempts to remedy them, it is necessary to coordinate the efforts of many countries to prevent potential new crises. If every country defends itself individually in the form of restrictions on capital flows, there will be reduced investment in the global economy and a slowdown of the overall global growth. If we begin to defend ourselves through import duties during a commodity markets crisis, as was the case recently, both developed and developing countries, both the U.S. and Russia tried to assist their industrial sectors and attempted to channel the demand over to their own goods, we will intensify the crisis for other countries that rely on our markets. Therefore, in times of crisis, one of the most serious threats is the introduction of major protectionist measures. All countries urged each other not to introduce them. Simply because this gradually creates new crisis situations. I am mentioning these examples to show that we need to create global regulatory institutions.

What are the problems, in my opinion, that will have a maximum impact on the world economy in the coming years? China. How much will its quasi-market economy be able to maintain its growth with stimulation of demand due to the advantages of quasi-government investments and quasi-government resources, and not create bubbles that are already being created, and not to create hundreds of billions of dollars of inefficient investment that has already happened? Will China become a new source of risk for the global economy? As I see it, the Chinese government realises this and has taken steps in trying to reduce the risk of bubbles in their markets, reduce the amount of inefficient investment, and slow economic growth. In the coming years, there is a goal of reducing the growth rate to 8% and down to 6% at the end of this decade, while greatly increasing the efficiency of investment.

Second, I would like to touch upon the situation in the United States in terms of the national debt, which does not match the US administration’s debt reduction plan. What should be done about the policy of a quantitative expansion of assets supporting the US economy but also creating excessive liquidity on global markets and facilitating the influx of speculative assets into emerging markets? Russia is currently witnessing the outflow of capital and may only receive additional speculative capital already this year. Such short-term capital is linked with high oil prices and a stronger rouble. We can therefore speak of an influx whose quality does not meet our desired parameters and does not point to an improved national investment climate, which the president clearly mentioned recently in a speech.

Returning to key issues, I would also like to mention the risks being generated by a number of nations on the European debt market. The risks posed by state securities still present a certain threat. It is hardly surprising that the European Union has decided to expand its stabilisation fund. Speaking in a global context, it is now obvious that the efforts of the International Monetary Fund as an organisation called on to help states during such balance of payments crises, as well as during external shocks or debt shocks, are no longer sufficient. They are not enough, even considering G20 efforts to raise a special fund, the so-called “new borrowing agreement”, to $600 billion. Russia has contributed at least $15 billion to the fund. Even this is not enough today. The European Union has set up its own stabilisation fund with IMF involvement. But this, too, may prove insufficient today.

High oil prices may hinder global economic growth. And other elements of the crisis are still evident. We should realise that the world is still working through the imbalances, most of which have not been eliminated. We can see this take on various forms in different nations. Consequently, we need to establish international regulators. G20 finance ministers met in early February and agreed to expand the list of national economic indicators. In the past, the United States had deemed it unacceptable for an international institution to assess its performance, to provide an objective picture of its economic situation and to issue recommendations. We have agreed on this today. And China is now prepared to have organisations established on an inter-governmental basis assess its economy and imbalances and issue recommendations. This is a major step forwards. We have agreed on transparency and the specific recommendations that will be issued. We have been pressing for this for a long time.

Speaking of economic indicators, the most difficult thing was to obtain consent that in case of an external surplus exceeding 4% of the GDP a nation should make its currency stronger, and that it could weaken it in case of a negative balance of payments. Reaching a consensus on this was the most difficult task. Analysts say a substantial external surplus without a flexible currency policy would create artificial advantages through currency rates. China had the most difficult time agreeing to such measures, but China has now agreed to this indicator and is ready to work along these lines. Other indicators, including the trade balance, the budget balance, national debt and the private-sector debt, were included during the February discussion. These indicators are crucial for assessing each other’s economies. We have agreed on the relevant mechanism for cross-examination, to which Russia will also be subject.

Last week, I visited Nanjing, China, where the French president opened a high-level seminar to discuss issues surrounding the new global financial system. On the whole, the concerned parties still disagree. Should we confine ourselves to the achievements of the past two years, namely, transparency and recommendations, to which everyone now agrees? Or are we ready to move further than that? We should introduce elements of sanctions for failure to honour such obligations. This system does not yet function reliably enough even under the Maastricht Treaty. The Europeans have decided to toughen control and to introduce new restrictions and sanctions in order to prevent the development of situations similar to those in Greece or Ireland. Will a new Maastricht Treaty be established on a global scale? Not all nations are ready to cede part of their sovereignty, to yield and to assume financial and economic responsibility for following these indicators. Will we expand the IMF’s powers, provide it with the required mandate and supplement the IMF with other international organisations for fulfilling this role? And what kind of sanctions will be stipulated? We have not agreed on this yet. Leading nations, primarily the United States, are not yet ready to submit to such regulation by international supranational organisations. The so-called “world government” is still a long way off. But we are moving step by step in this direction.

In Nanjing we also discussed whether the international monetary system would become a multicurrency system. Will we have many reserve currencies or will we need to concentrate on a few? No decision has been made so far. The French, presiding in the G20, proposed to extend the influence of the Special Drawing Rights (SDR). But I don’t think the SDRs can be an international currency, since they are conventional units created by the International Monetary Fund.  

A country with a convertible currency should buy out these special rights for some time, and thus provide a currency in circulation and used in trade to be used by other states. But these are drawing rights, and I doubt that this unit, which is not backed by an economy’s assets and which is not listed on free markets, can grow into some other currency. I do not see any reasons so far that would allow this to happen. We can consider the SDRs an additional reserve mechanism amid the economic downturn. The SDRs are a sort of insurance in their own right, which must be balanced; and the countries must be able to buy them to provide real money to the economy when it is necessary. I think we will live in the world of dollars, euros and yen.

Now China is considering faster transition of its currency to convertible currency. This means that, apart from removing restrictions to currency operations, China will have to ensure the free movement of capital. And it is not fully ready for this yet. The further liberalisation of the Chinese economy, the expansion of market institutions and the free movement of capital will make yuan convertible. But this will require much more time than one or two years. Earlier I said approximately ten years. But if this is done consistently, five to seven years will be enough.

The French suggested including yuan in the SDR currency basket in Nanjing. This, of course, does not change the role of yuan in the world economy; the currency included in the SDR basket must be convertible, but the yuan is not. Nicolas Sarkozy suggested that China make its currency convertible in two or three years. This is a very good sign, which shows that China is ready to move in this direction. During my speech at the seminar in Nanjing I proposed defining a transition period for this movement, but it should be clear and transparent. It can’t be an advance without clear obligations. But since the Chinese economy is large and everybody wants to promote its further development, make it more flexible, then China may make up the SDR basket, as an exception, for that transition period.  But I want to reiterate that the issue has not been resolved yet.

We have also discussed the role of the rouble in the basket, the possibility of its entry into the basket. Almost the same procedure applies to the rouble, which must be convertible, too.  And the rouble became convertible on July 1, 2006. But we have other disadvantages. There is a fundamental factor that distinguishes our economy and the quality of our economy from many other economies, and this is high inflation. It is lower even in many developing countries. The economic policies of many developed states allow for inflation targeting. And we haven’t targeted our economy on low inflation.

I would like to emphasise once again that low inflation is a fair distribution of powers and a reward for it, rather than fair pricing. Inflation absorbs all of this, it absorbs the cost of assets, the value of wages. It is sort of a quasi-tax, an unjust redistribution of the GDP between the sectors. Inflation hinders a just distribution of the GDP, it changes incentives, and it changes our approach. We are far from being among the leaders with this kind of inflation. We have plenty of other problems to solve. One of the reasons for inflation is our dependence on oil, our inability to cope with the pressure from petrodollars. The amount of money in circulation does not grow due to the economy’s needs, it happens because more petrodollars come in, and they do not depend on us. Our task is to manage these resources, create institutions that would limit them and make the market predictable for all investors.  

The Stabilisation Fund and the Reserve Fund were such institutions, created in accordance with the rules. There were strict rules as to the amount of taxes that would be reserved and the amount that would go into spending. This rule did not entirely work, but it created a clear target for the upcoming years for all investors working on our markets. Now, during the downturn we do not abide by this rule. The next thing I will say is banal. We can overcome our dependence on oil by, first and foremost, applying the rule for using oil and gas resources through partially saving them. And the corresponding rule should be introduced as a law. There are examples of several successful countries, which adopted this rule and experienced rapid growth. For instance, Norway does not use a single petrodollar within the country. Norway, an oil-producing country, does not use revenues from oil in its budget spending; it does not use a single petrodollar. It is accumulating a fund, which has exceeded 100% of the GDP. Norway has placed it on different world markets and accrues interest from this position. The constitution of Chile, the most successful Latin American country, dictates how to use revenues from the mining of copper. We need to create a legislative mechanism to regulate the use of oil revenues. This is necessary for us. If we manage to restore this rule, at least in a modified form, we will create a basis for reducing our dependence further. 

I would like to cite several factors that to my mind will help us create favourable conditions for private investment and significantly increase private investment by developing market institutions. The top-priority economic policy issue is Russia’s inflation rate, which sets this country apart from all countries that have successfully pursued modernisation. The second issue is establishing rules for the use of oil and gas revenues. Another issue is the long-term sustainability of markets and the budget system. When we come to consider whether we are using the available resources properly we will need to proceed to the next element, budget spending efficiency. We have adopted a programme to boost the efficiency of budget spending, but I must confess that it is difficult to implement.

Budget efficiency is not only about identifying how much the construction of a one-kilometre road should cost. To begin with, budget efficiency requires setting the right priorities and strategic planning. This is about what goals we set ourselves and how we distribute resources to achieve them. The necessary expert evaluations come next, including public ones, which will identify specific goals and the means for achieving them.

We often make decisions swiftly, almost on the spot. We tend to believe that we will set aside the money and the goal will be attained. I believe that we have not completed the mechanism for identifying budget policy goals and the appropriate ways of achieving them. We will have to decide in which spheres the government should and should not participate, what competing industries the government should fund or subsidise and where it should provide services in the form of building the roads and the infrastructure that businesses need. The line between the two is not clearly drawn yet. We are a country where the government provides vast subsidies for a number of sectors. If we get down to this task we will understand what budget structure we need, that is how we should distribute the invariably limited resources between different goals.

We will need to identify the structure and goals of our pension system and carry out a pension reform. Some might say that we just carried out this reform. Pensions were increased and the pension base and insurance components and retirement pensions underwent upgrades. Some modernisation did take place and relevant tax rates were increased. To be more exact, the tax was transformed into insurance charges and the pension fund was made responsible for collecting these charges instead of the tax service. Even within the government, the Ministry of Finance handed the responsibility for insurance charges over to the Ministry of Healthcare and Social Development. It seems that much has been done. But the most important thing was not done. We did not ensure the fiscal balance of the pension system that could guarantee that pensions would remain at a decent level and even grow.

Decisions were being made responsibly, and different duties were raised as were insurance charges. After a while, pension duties remained unchanged. According to the laws in effect, these charges have to be adjusted ahead of the inflation rate. Meanwhile, a proposal has been made to bring insurance charges down, upgrading the rate and the regressive scale according to which the charges are collected. In general, I support this decision.

The Russian president suggested decreasing the rate while raising the scale. But how high should the scale be raised? If we increase it to 1 million – and an increase to less than 1 million does not seem reasonable to me – then it will help compensate at least for most of the falling revenues. But this will simply ease the tax burden on some companies, shifting it on to enterprises with larger payrolls. And this is fair. I’m referring to the oil and natural gas and financial sectors, to about 20% of companies in transport, 20% of processing industry companies and approximately 20% of trade enterprises that are eligible for the 463,000 rouble limit. This seems reasonable to me, but this is not easing the tax burden on the economy. We need to realise that this will lighten the burden for some companies while putting additional strain on others. When we carry this out I don’t think we will stop at 1 million. The limit can be increased to 1.5 million roubles or even higher to include most of companies.

By the way, Business Russia has proposed decreasing this limit in its letters to the government, which will virtually abolish the regressive scale, that is, introducing a fixed scale for all companies. I know that some members of Business Russia disagreed with it. But not all companies fall within this limit, so some companies will have to bear a heavier tax burden. Even these measures will not compensate for all the falling revenues if we bring this limit down to where it previously stood. This will only result in a greater deficit in the pension system.

A proposal has been made to compensate for the pension system imbalance by cutting down on other expenditures. In this case, the imbalance will be remedied at the expense of other budget obligations. The Russian president has also proposed improving the efficiency of budget spending, cutting down costs by 15% while preserving the same quantity and quality. Currently the main tool that makes this possible is federal law No. 94.

But until we finalise and introduce this law, government officials will not be able to increase the efficiency of state tenders, bringing down costs. Until these practices are in place, we will not have the necessary administrative leverage, lowering prices for the same amount of work. Officials currently do not have such a legal mechanism, which makes this very difficult to implement.

This task requires fundamental research, and the improvement of cost efficiency cannot be considered a reserve to compensate for a decrease in insurance rates in the near future. This system will not be able to start working properly until next year. However, we need to work on it.

I have covered the pension issues. The next matter is the tax system, and I will be brief about this.  I support a neutral tax system, which means avoiding tax incentives as well as high tax rates. I support equal opportunities for all tax payers and equal rates even for different sectors. There may be some exemptions, but they must be limited. The effectiveness of applying such exemptions should be clearly proven. Many exemptions are either ineffective today, or they create imbalances.

I have always believed VAT is a stable tax. Now some countries are raising it. In the UK the VAT rate rose from 17.5% to 20% beginning on January 1, 2011. The 2% reduction in the profits tax of April 1 of this year will be followed by a 3% cut in 2015 while the VAT rate will grow. The profits tax is less stable in terms of profits centres, which allow an escape through offshore entities.

Competition encourages modernisation. The state’s role in capital and market regulation must be reduced, which will take a lot of work. The budget should help create a business infrastructure instead of subsidising the business itself.

Among the key issues is the reform of public administration. The inefficiency of public administration has often caused problems. Before Margaret Thatcher carried out a serious administrative reform, state officials were the most despised people in the UK. The modernisation reform took over ten years and failed to cover about 20% of the ministries. It is an immense and serious process. Thatcher eventually established a new effective system, which revived Great Britain’s economy and renewed people’s respect for the government.

Another significant factor in modernisation is trust in the government and its policies. People will not trust a government that repeals its decision on taxes within a year, or makes amendments to a decree on insurance charges soon after it was adopted. An entrepreneur must understand the goals set by the government and be sure that the government will provide the conditions promised and will not stray from the principles it has declared.

Finally, I would like to say that period before an election is always hard. People always inquire about this. While setting new political goals, including those concerning financial commitments, it is easy to break obligations restricted by a strict balance of the budget, strict rules about oil and gas revenues. Thus, the achievement of some fundamental goals prevents the fulfilment of equally important ones. If we fail to reduce inflation we will lose people’s trust for many years. Banks and investors will be incorporating the risks and reducing the insurance risk rate for many years. A temporary retreat may break the public’s trust for many years.

Thank you.