Alexei Kudrin's address:

Ladies and gentlemen,

It is a great honour for me to address this audience at a time when the Russian Union of Industrialists and Entrepreneurs is summarising last year's achievements. I am glad to greet this congress on the prime minister's behalf, and wish its participants every success.

We should work in dialogue, listen to each other, and be aware that we are working towards a common objective. Economic development depends on the business community, while the state should provide conditions in which business is able to develop the economy. It is critically important to discuss such conditions and related problems. Discussion of those issues will continue today, when the prime minister meets with the Bureau of the Board of Directors of the Union of Industrialists and Entrepreneurs. I think the issues raised at the congress will be reviewed at that meeting again.

I paid close attention to all the details of Mr Shokhin's address. I would like to remind you that when I criticised our problems rather harshly in my address in Krasnoyarsk, I illustrated my arguments with a study of the Union of Industrialists and Entrepreneurs on the business community's primary concerns. The authors of the study concluded that the state's strategy and goals, and the choice of economic model were in the foreground. This conclusion concerns the government closer than anyone else. I confirm this point.

I talked to Mr Dvorkovich at this congress about strategies offered for debates in developed countries. A strategy is adopted prior to an election that brings into office a political party whose platform reflects this strategy. Later on, a cabinet is formed to implement it. That is what makes political competition indispensable for normal strong performance of any community and economic system. We would like to see more dynamic political competition and active decision-making.

Today's government meeting will focus on the scenarios for economic development in the next three years. These scenarios depend not only on oil prices. More than that, experts do not think that the changes of these scenarios depend on oil prices at all. Really, growth rates remain the same despite the ups and downs of those prices. That's the problem. It proves an alarming fact: oil prices have outlived their potential, though they were a major incentive for development before the downturn. Likewise, the oil and gas industry is no longer a vehicle of development as it was in former years, especially in the first half of the previous decade, when our economic growth rate was 10% a year. Oil prices were a major resource that propelled the economy forward.

Even though oil revenues were stocked up in federal funds, a part of them were injected into the economy due to contracts with oil, gas and steel companies. The money mass grew by 50% a year sometimes – compared to the 8% economic growth rate. We had to pay for development with inflation and other evils. The Central Bank tried to curb inflation by strengthening the rouble, and thus undermining our industrial exports and bloating imports, which grew by several dozen percentage points in some years.

Dependence on oil has played its negative part. Trade, finance and construction developed fast while industries that could make the basis of modernisation continued to lag behind. That was how we got an economy warped by oil money. It is equally dependant on the rapidly growing social expenditures. Budget expenses have grown 300% in real terms as teachers' and doctors salaries increased by the same factor and allocations for road construction and other purposes also grew. The model resting on oil and gas revenues alone proved ineffective. Present development scenarios do not take them into consideration any longer now that they have stopped working. It is far more likely that rising oil prices will undermine the economy.

The government meeting today will focus on essential principles, and the discussion will probably need to be continued at a later time. Our calculations on some issues will last into the summer or possibly even autumn, when we are to submit the draft budget to the State Duma. Our choices concern, among others, social and other expenditures. The president determined to increase military expenditures by 1.5% of the gross domestic product next year. We will either have to add these extra expenditures to the budget deficit or increase taxes, or again, draw more on oil and gas revenues in the hope of high prices. These are our three options. There is another one: to cut all other expenditures, for instance, road construction or education.

Perhaps, many of you have an idea of what the military-industrial complex is like. You know that an ambitious contract is being distributed there. It amounts to 20 trillion roubles, a sum that exceeds the growth of medium-term defence expenditures by 200%. So the complex is being upgraded. It is to double its output in just three years, which demands investment in new facilities. The 1.5% of GDP that I mentioned includes not only the government defence contract but also military salaries, which are to increase by 150%, as announced.

Does it imply an increase of the budget deficit? Russia is different from Germany or the UK. If the financing of our federal budget deficit exceeds 2% of market revenues, private investment will inevitably suffer because the state will withdraw some funds from the market in the hope of high oil prices. This year, we will have a zero deficit if the oil price averages at $115 a barrel. Next year, it will take $122. We have made our dependence on oil prices even worse: we bring oil revenues to the market, thus strengthening the rouble and unable to curb inflation as quickly as we would like. Consequently, interest rates will go up, too. I will not now analyse the option of increasing taxes.

All these options reflect the relations between the state and our economic environment. Are we making the right choice or is it too ambitious for us? Or should we base modernisation on private investment and put off the increase of expenditures?

I would also like to tell you about the essential decision to reduce insurance premiums. It was hard to make the decision on their increase, and it took experts two years to prepare for it, and another six months of harsh government debates. What does the pension system boil down to? It is the confirmation of formative rules for future accumulations, primarily their insurance part. You all pay this tax and know that there is personified accounting for every individual who accumulates his rights. There is an accumulated part of the pension, and a personal one, connected with personal rights. There is also the joint part of the tax, which adds to all pensions. Usually it is what we call the "basic pension". This decision was hard to make, and long discussions preceded it. I favoured another option, with lower tax rates and the main burden shifted to higher earnings. I described this method in one of my articles.

It was a hard decision. We concluded that if we were defending insurance principles, we should increase the tax rate for higher incomes, starting not with 463,000 roubles [a year] but with 800,000 or 900,000. So the pension rights of those who presently earn more than 30,000-50,000 roubles a month will be greater. We passed the decision, the arrangement was in force for just one quarter and we abolished it six months later.

We are making sophisticated calculations for several decades ahead. We say now that this way of accumulating pension rights is wrong, and we should switch to another system. But we have just six weeks to make new calculations. That is a great challenge and we are looking for solutions. We also take stock of proposals from the business community. Delovaya Rossiya proposes to reduce the rate while abolishing the scale or making it very broad. But if we abolish it, the reform will not reduce taxes but only shift them to higher earnings, with the tax rate somewhere around 28.5%. If we reduce the rate, the deficit of the pension system will grow.

It is a very far-reaching decision, and it has to do with powerful principles. If we do not change liabilities and the pension age, we will ignore again major demographic problems of ageing while the economically active population is shrinking and the number of pensioners growing. However, no proposals have been made on this score.

We are facing extremely complicated decisions as modernisation begins not with increasing expenditures, taxes or the budget deficit. We can increase expenditures to an extent that will eternalise our dependence on high oil prices. Let us take an all-round view of things instead of saying torrents of words about modernisation. I am often reproached for talking too much about the budget and the balance between revenues and expenditures. I think I have clearly illustrated their interconnection. Today, we are choosing a model for the future. We must give public responses to questions, and pose the questions with the utmost honesty. You, too, should take part in discussions, in which the answers are not always evident.

This year's economic growth rate will be somewhere around 4.2%, while next year's forecast is 3.5%. It is difficult to mobilise growth drivers necessary for modernisation and a friendlier investment climate. It is very difficult to improve public administration, the fiscal climate, and the terms of foreign trade.

Present-day Russia will be doomed to stagnation and able to address only routine problems if the growth rate falls below the 3% mark. A rate of 3-4.5% means slight and unstable growth incompatible with modernisation. Industries will be unable to update their assets. Investment growth by 6-8.8% is not sufficient for the Russian economy. Modernisation demands an increase roughly by 30% of GDP with an efficient and competitive economy. What we need is factors to build up confidence in the economy sufficient for investment and expectation of profits. You know my views. Modernisation will remain wishful thinking with inflation at 7-8%. It can start when inflation gets below 3% with 5-7% loan interest rates on a 10-15 year term. The majority of industries will work effectively in such conditions.

Inflation cannot be fought by increasing expenditures and stockpiling oil and gas revenues. On the contrary, they bolster inflation and strengthen the rouble. That is why I expect animated debates at the government meeting today.

We had heated conversations yesterday with experts and at federal ministries and agencies. Tariffs were one of the subjects discussed. We want to limit the tariff increases even now but industries connected with them say that they have investment programmes, and other industries will not develop unless the infrastructure is upgraded. We will discuss all this today.

The ten points which President Dmitry Medvedev enumerated in Magnitogorsk certainly meet our expectations. These might be only the first steps that will not solve all the problems of the investment climate. More ideas may come up later. I said so to the president. State-business relations start to improve when the government chooses the pattern of public expenditures and taxation.

We discussed the president's ten points together. For instance, I proposed that the Ministry of Economic Development be granted extra rights to limit other ministries' activities when it believes that they are encroaching on business interests. In fact, I proposed an even tougher option. However, legal experts said that it was too tough, and there was the legal procedure to comply with. I would like the government to establish an agency to which one could appeal, in particular, on matters concerning ministries – an agency that would make additional expertise of such bodies as the Fire Inspection, the Federal Service for Supervision of Consumer Protection and Welfare, the Federal Service for Supervision of Environment, Technology and Nuclear Management, or customs offices.

One proposal concerned privatisation. I would like to remind you that the government proposed to privatise the stock of several leading companies last year. In this instance, the president intends to streamline the procedure. We will promote competition and reduce the role of the state. There will be no prerequisites for modernisation unless all these factors are brought together.

Thank you.