Speech by Alexei Kudrin:
Good afternoon. It is a great honour for me to speak at this conference today, particularly as it is devoted to the memory of Yegor Gaidar. He made an invaluable contribution to the development of Russia, Russian democracy and science. I recently mentioned that when I was a post-graduate student at the Academy of Sciences' Institute of Economics, I used to read his articles in the Kommunist magazine. One of them was entitled "Site Preparation", if anyone here remembers. At that time, the magazine was giving criticism of the Soviet economic model. That had a great impact on the minds of many people. Perhaps we also began to look at many things with different eyes. I think it was the time when we crossed a threshold in our search for new ideas with regard to the development of the Russian economy. But even later, when Gaidar worked in the government and after that, at one of the leading research institutes in the country, the Institute of the Economy in Transit, his talent left its mark and it is a great pity that he is no longer with us.
The theme of our panel today is a budget of the new decade. This is a very responsible mission, but also an unusual one. Let us bear in mind that unlike our previous discussions, we are speaking at an unusual time, the period of a crisis that has clearly demarcated two decades. One was the decade from 2000 to 2009, and it was a successful period, when we had a budget surplus. It was a development decade. It was the time when Russia showed very high rates of economic growth approaching the trend of doubling GDP. We nearly succeeded in doubling it.
Maybe we could have doubled GDP in 11, rather than 10 years, given the average rates witnessed in the 2000s. It would have been a great deal, but as it emerged this proved a different kind of doubling, which is now very difficult to maintain. We see too many challenges and risks facing us.
Today it is very important to assess those lessons and draw new conclusions. The world crisis is continuing; it is not over yet, and it will spring some new surprises. I am not trying to frighten anyone. We see sporadically erupting local crises, be it in Dubai, Greece or in individual large banks. Last night, Moscow time, we heard the news that President Obama announced fresh initiatives dictated by the need to decide the future of major banks. It emerged at the time of the crisis that the banks were so big that they should not have been allowed to go bankrupt. Just the first case, with Lehman Brothers, triggered the entire crisis, and the US administration made great efforts to prevent a repetition of similar cases.
I must say that our government, too, tried to keep the major banks afloat. We also supported medium-sized banks to reduce the jitters that hit the markets. May I remind you that in October and November, 2008 individuals were withdrawing 300 billion to 400 billion roubles every month. That was an acid test for us and it was only thanks to the efforts of the Central Bank and the government that we managed to keep the situation in hand. We understood that the lessons from the past, whether the lessons learned during the Great Depression - if one can compare these two crises - or during Russia's 1998 crisis showed that the maintenance of a banking system was the key to further development and a more rapid recovery from the crisis.
A whole range of factors played a role in the recovery following the 1998 crisis, and we will find this process more difficult this time. It is a positive factor that we have managed to hold the entire financial system in check. But we should not forget that all the problems facing the financial sector have not been solved. We realise that banks have substantial problem assets on their balance. It appears that they have not yet been manifested in full volume. This will depend on whether the real sector of the economy, which had, as a rule, borrowed loans in the service sector, manages to rise to its feet in the next 12 to 24 months and start repaying its loans. That is why at present we still don't know how successful the development trend will be. Our fairly conservative main forecast stipulates that, if the oil price is $65 per barrel, we will post a 3% growth. This is confirmed by some analysts, including major Western and international financial institutions. However, we still face numerous challenges and a very high degree of uncertainty. We must therefore understand that the world and Russia will probably face a slow and painful recovery from the crisis.
We estimate that pre-crisis GDP levels will be attained in 2012 under a moderately optimistic forecast. I would like to mention some results of the past decade and will subsequently turn to proposals for the upcoming decade.
Our failure to diversify the economy is probably the main conclusion which is being mentioned by everyone. Why didn't this happen? To be frank, all our programmes called for economic diversification, including the first programme drafted in 2000, when a new government, a powerful team, including an economic team, had taken over. Numerous measures, including production deregulation, enhanced competitiveness and reduced customs barriers, aimed to accomplish this objective. The entire range of measures was extremely well thought-out.
I remember when I was appointed Minister of Finance in May 2000 and started planning my first budget of the early 2000s. At that time, oil prices were forecasted according to the average prices of the previous decade, which was $18.5 per barrel in this case. We believed that prices would remain at that level, that $20-23 per barrel would be quite a lot, that such revenues would make us happy and would lead to real prosperity for the country.
At that time, we stipulated rather modest expenses. Nevertheless, there were great ambitions with regard to projected spending. The government and the parliament had never reached such consolidation levels before. Four key parliamentary parties, which had the majority of seats, were still unable to reach agreement on all issues at that time. I remember the first budget of 2001 was passed in the first reading with an edge of just 2 or 3 votes. Fifty percent of the Yabloko party, headed by Grigory Yavlinsky, supported the budget, and that decided the outcome of the vote. For the first time in their history, the Communists did not vote for the budget in a body. the budget. That was the first crucial vote of the new decade.
Then oil prices surged, reaching $95 in 2008 and about $70 in 2007. The prices were very high. Oil prices in excess of $70 were last registered in 1983, that is, 26 years earlier. Nevertheless, we lived in such a successful environment that federal budget spending soared 2.3-fold in real terms from 2000 until 2010. Spending volumes more than doubled. This affected purchases, services and salaries, both real and average.
That was a decade of very successful development. Why didn't we diversify the economy? I often hear criticism for using these resources unwisely, for failing to channel them into the right industries and to create economic sectors that would expand the structure of production. The assumption is that it would have been wise to channel our resources there. But we chose the policy of saving our resources. In 2003, we established the intra-budgetary Reserve Fund. In 2004, we established the Stabilisation Fund. Starting with 2008, the Reserve Fund and the National Prosperity Fund were established. We created a new budgetary model which did not hinge on the oil and gas balance.
What was our goal when we made that decision? We needed to accumulate funds, because the main challenge of diversification - if we decided to spend the funds - would have been a quick and steep strengthening of the rouble. Had we done that, US dollar would have cost 20 roubles and possibly even less by the middle of 2008.
In other words, we would have strengthened the rouble excessively. In fact, we allowed it to strengthen too much, breaking a record for the G20 countries for the strengthening of the national currency. You know how such strengthening affects the industries, and you know all there is to know about the Dutch Disease.
That is why we made the decision to accumulate funds, and debates in the government focused on ways to contain certain expenditures, to prevent pro-cyclical expenditures of the budget at the time when prices are high, when money supply grew at up to 50% a year and loan increment was 30%-40%. At the same time, the average money supply in the EU countries was growing only 10%-14% a year, and the figure for China was 19%-20% in the period of the highest growth rate.
The average loan increment in the EU was 10%. It was 14% in France but plunged to 9% when the crisis began in 2007. Loan increment in China was around 20%, not more than 15%-20%, but the figure for Russia was as high as 50%.
But where did these loans go, why haven't they been used to promote the basic economic sectors? The funds were invested in the sectors where recoupment was assured at the annual interest rate of that period, 15% for three-year loans. The sectors that could take out the loans did so. I am referring to construction, trade, and some industrial sectors that worked predominantly with the people.
In 2007, the biggest loan increment was registered in real estate - 80% of developers bought land and property believing that the demand would sustain for a long time, and so they bought more and more. That is why the funds were distributed in this way. Because as the rouble strengthened we failed to contain the runaway inflation, which was also a reason for the big money supply and high budget expenditures. So, no matter where we invested these funds, the result was still a stronger rouble and continued inflation, which prevented a normal development of the basic sectors from the viewpoint of macroeconomic conditions.
Unfortunately, despite our resource wealth, we failed to maintain stable macroeconomic parameters necessary for the development of the basic economic sectors and the promotion of innovations. Unless we create these conditions in the next few years, namely keep the loan interest low and stable and issue long-term loans, we are going to have problems.
The budgets for 2010, 2011 and 2012 are based on an oil price forecast of $65-$70 per barrel stipulate a budget deficit of 6.8% in 2010, 4% in 2011 and 3% in 2012.
With an oil price of $70 per barrel in 2012, we will have a 3% budget deficit. Is this a big or a small deficit? Mind you, oil cost $70 in the best years, and the average price of Urals crude for the past decade, from 2000 to the end of 2009, was $48.8 per barrel. It was the new top oil price in a decade when we had most favourable internal and external conditions for development.
I would like to repeat here my analysis of the situation that has frightened many. What I said was we saw the development of three unique factors in Russia over the past decade.
First, oil prices were growing for eight years running, for the first time in the history of its monitoring. We have never had this before.
Second, oil prices reached a record-high ceiling, which has not been registered in any previous monitoring period, $95 per barrel in real prices.
And third, Russia increased oil production by up to 10% in some years in 2000-2004, after a dramatic decline in the 1990s. I don't think we will see such growth in oil production in the near future. It was a unique period when we scored incredible successes due to certain factors.
That is why I said that we will not see these three factors simultaneously in the next ten years, and possibly not even in 20 or 50 years.
After I said that, economic publications wrote that Kudrin had predicted that the external economic conditions would not be the same for the next 50 years. Non-economic newspapers wrote that Kudrin said the previous economic conditions would not be repeated. And left-wing papers wrote that Kudrin predicted a 50-year-long crisis.
We have had a unique period, and it is unlikely that the average oil price will be $70 per barrel in the next ten years. Of course, it depends on a number of other circumstances, but I think that we are going to experience more economic shocks, although the monetary authorities, including the US Federal Reserve System and the European Central Bank are working hard to prevent them. A market bubble, including bubbles in the commodities and financial instruments markets, will not be allowed to grow to the same size again. I hope that the coordinated actions taken by the governments will prevent bubbles and irresponsible moves in the global markets, including the commodities market.
An oil price of $70 per barrel, which we forecast for 2012, is relatively high compared to the one that could happen to be average for the forthcoming ten years. A 3% budget deficit is still too big even at the maximally high oil price we can hope to see. I believe that immediately after 2012 we should work to reduce the budget deficit to 1% at an oil price of $60 per barrel. A 1% budget deficit with an oil price of $60 per barrel is an optimistic scenario.
The new decade will also see one more crucial factor, which I have mentioned more than once before. Given the fact that our oil production will grow insignificantly in the next few years, by 1% or 2% at the most, GDP will grow fast, and could reach 3% and even 5%. In this case, the share of the oil and gas sector in the country's GDP will shrink from the current 25% to some 14% of even less in the next decade.
In other words, the oil and gas sector will diminish as a share of GDP, which will inevitably lead to diversification. And oil and gas revenues in the budget will also contract with regard to GDP. We will annually lose about 2.5% of GDP revenue by the end of the decade due to the shrinking export duty on oil priced at $60 per barrel.
We will also lose approximately 2.5% of GDP because of the mineral extraction tax (MET) and some 1%-1.2% because of the export duty.
Taken together, the federal budget revenue will fall by 3.5%-4% annually; the budget revenue will be smaller than we had in the past decade, when it grew 130% in real terms over the period.
At the same time, given the current price and macroeconomic forecasts, we will cut expenditures in real terms by 20% or even more in 2010, 2011 and 2012. We will reduce expenditures in real terms already within the next three years. The key budget parameters in nominal terms will decrease within the next three years.
We will increase the budget deficit in 2010, keeping it at 6.8% because we will raise pensions. Next year we will introduce payment for deductions to the Pension Fund, the Mandatory Medical Insurance Fund and the Social Insurance Fund, which will cut the use of the Pension Fund's money for covering the deficit by 1.5%-2%.
In this way, we will reduce the budget deficit to 4%, and we will have no possibility to increase expenditures. Moreover, we will have to cut them because the deficit will still be large.
In the next ten years, we will most likely maintain expenditures at the current level in real terms. It means that budget expenditures will not grow, and may even decrease in real terms. Therefore, we will have a fundamentally different situation with regard to expanding our financing programmes. In this case our priority will be to raise the effectiveness of the available funds.
But we have a big problem with reducing the current spending appetites. When oil prices grew from $40 in early 2009 to $80 at the end of the year, the belief that the next decade will be as favourable as the past one, and that we will be able to plan our expenditures without thinking of effectiveness has resurfaced overnight.
I would like to say that these sentiments recurred not only among some government members, above all those who lobby certain programmes, which does not correspond to realities.
This is why we have advanced the idea of a programme of enhancing effectiveness in all spheres, including in the sphere of structural reforms. We have no time to think. In spring we will need to draft a budget for the next three-year period, from 2011 until 2013, which should include elements stipulating an increase in the effectiveness of expenditures, in return from each invested rouble.
We will make public these measures within two weeks. We will hold a meeting of the working group on the effectiveness of state expenditures chaired by two deputy prime ministers, Sergei Sobyanin and myself. After that we will try to finalise the programme, which should be implemented in 1.5-2 years and is aimed at streamlining our spending appetites. We must do this by all means.
It will be an uphill road; it will not be easy for anyone, especially not the Ministry of Finance. In other words, it will be one of the most important developments in the near future. Consequently, it should show if we can ensure economic stability. The government's interaction with the Central Bank and the answer to the question of who invests more in the economy, the Central Bank or the government through its cyclical spending, or whether the government will opt for a moderate policy, will determine the effect on the macroeconomics.
I believe that we will see a situation in which the government will be unable to increase budget expenditures, like it increased them in nominal terms by 30% in 2009 and 25% in 2008 in nominal terms. It was an unprecedented increase. In this connection, the situation is likely to be more favourable in terms of the macroeconomics, the real economy, and interest rates in the market.
I am repeating this now, although I have presented the country's budget every year. But it was always the result of a compromise between the government and parliament and the majority party on the most crucial issues. We used to think the situation was better, but the crisis has shown that the conclusions we had made and the warnings we had issued, turned out to be correct.
When we set up the Stabilization Fund, and then the Reserve Fund, the National Wealth Fund, even though I said that the Stabilization Fund must last us three years if prices tumble, I never imagined the threat was so real. Our estimates at the time couldn't have been tested in a better way than they were tested by the crisis. But here we are, with the Stabilization Fund that can last us three years. We have three years still to keep our social obligations, salaries and pensions at the level we need. We can still carry out many of our programmes, albeit in an amended form. Thus we can still maintain the standard of living in the country and build anti-crisis instruments, while at the same time changing gears to prepare for a new decade - a decade of new opportunities.
So what is the best way to implement the diversification and modernisation policies which are widely discussed now? How can we ensure that all the good ideas voiced at our meetings, today and yesterday, would not remain on paper, as was the case with the calls for diversification in previous government programmes? This would require structural measures, primarily to support economic modernisation and innovation.
Modernisation in a broader sense - that is institutional and economic modernisation - is extremely important and will certainly be conducted. However, if we want to make our products more competitive, we need to restructure the economy, which lays too much emphasis on industry and agriculture, by expansion of services, modern engineering technologies, logistics and so forth. These sectors must be restructured, which will be an important factor of the overall modernisation.
We must build a system based on innovation in all spheres, from industry to services. Innovation should be encouraged economically, not imposed administratively: That way it will contribute to competitiveness.
Competition should be encouraged as well as equal market conditions. We need to create a stimulating environment for that, which is not yet in place. We need a plan of building an innovation-based economy, technological charts, new venture funds, establishment of additional institutions, and improvement of the existing ones. We have already established quite a few institutions to encourage innovations. There are 110 technology parks in Russia, as well as over 100 transfer centres, 50 state research centres, and over 120 business incubators. There is the Russian Venture Fund and regional venture funds, as well as the Russian Technologies State Corporation, whose primary aim is to promote new technologies.
Russian Technologies has substantial assets in the defence industry. There are design bureaus with a good record of achievements, especially in weapons manufacturing.
There is also RusNano, the Russian Nanotechnology Corporation, and the Bank for Development. The Housing and Utilities Reform Fund also must become a centre of demand for innovation, because new technologies are required in housing construction.
All of the institutions I mentioned could generate demand for construction and modernisation. What I mean is that we have enough institutions, but they are not effective enough. Russia is one of the world's top ten countries in terms of government financing allocated for R&D projects; however, private financing of such projects in Russia lags far behind other countries. We have failed to create stimuli for private investors to finance R&D, or to establish public-private partnerships in this sphere.
I am probably talking about things that you know already, but I would like to draw your attention to the effectiveness and efficiency of these institutions, which are already established and partly incorporated.
I could give you an example - Ivan Bortnik's Fund [for SME development in R&D sphere], which is considered one of the leading institutions of its kind. It offers three-year programmes. It the first stage, it selects around 1,700 proposals. During the second year, they are developed into joint R&D ventures with a share of private capital. Not all of them survive until the third year of the programme, but around 30-40 small innovation businesses are established. That is not bad.
The Russian Venture Fund has established several projects over the past three years, but the bulk of the money was not even used, because the quality of these projects was too low. Therefore, the money has been placed with bank deposits, not because the Fund wanted to make a profit this way, but because the proposed projects did not fulfil its requirements. But let me repeat, many of these institutions' operation can and must be improved. And the government must be the largest customer for innovations. Therefore, our immediate goal is to expand the share of innovation-based products purchased by the state.
The development institutions must certainly be involved in this. Suppose the Bank for Development focuses on innovation projects and provides support for innovation programmes. The Housing and Utilities Support Fund, I repeat, can also join in. RusNano Fund is already doing this. Russian Technologies, I hope, will change its approach soon.
All state institutions must become involved in this programme, which should eventually result in a situation where companies producing innovations would have priority for getting the state order. I have recently read a study which said that shortly before the global downturn, competition pressure on companies lessened as state financing and demand became less focused on innovation products. Indeed, if there is a high demand for regular products, there are no stimuli to develop innovations.
Over 50% of companies reduced their innovation-related work in 2009, while only 10% increased such activities. These are sad statistics. Only by encouraging new approaches to increasing labour productivity can we support cost cutting, increase competitiveness and design new products. Next, the private sector should become more involved. This is essentially the answer to the question where to get the money for modernisation, which is obviously a cost-intensive project. Where do we get enough resources?
The high oil prices and the inflow of short-term capital - the two major pre-crisis factors of capital inflow - are no longer there. Therefore, we need to concentrate now on the domestic financial market development, on creating a favourable environment for savings - primarily for individuals.
These savings could form the required passive base for our financial institutions, ensure banks' stability and confidence in the government as guarantor of stability. In this situation they would feel safe to issue loans for three to five years, maybe seven with time. Efforts will have to be made to support this market every year. We will need to see that interest rates go down and loan amounts go up.
Before the crisis, loans issued for more than three years were slowly growing in Russia; they surged during the crisis, but for a different reason, of course. Around 1.5 trillion worth of short-term loans were restructured as long-term ones, because the borrowers were unable to repay them.
But we should keep an eye on real factors which would benefit our financial institutions, so that the internal financial market would begin offering better conditions for crediting the national economy than the international loan market. The Russian government is facing this extremely challenging institutional, macroeconomic and monetary task.
Therefore, let me return to the role of oil in Russia's economy. It did a disservice to the country in the period before the crisis, and the government failed to check itself before spending the oil money. It should not have been spent; not in this amount anyway. In the next decade, we should try not to spend more than $60 per barrel. This is a ceiling we can afford. Budget deficit should not be running higher than 1%. If the government starts making proposals in conflict with this policy, it will mean we are failing in our tasks.
To conclude my presentation today, I would like to say that I have recently spoken here at the Academy of the Economy, in front of students. I asked them to suggest the right way to develop our economic policy or to tell me how they would like to live. One of them said - we want to live like in Norway. Indeed, Norway has extremely high living standards. It is an oil economy. It is one of the global leaders in terms of living standards and per capital GDP.
But Norway does not spend a single dollar earned from oil sales. 100% oil production taxes are accumulated in the country's oil fund. Norway only spends the interest earned from investing this money in the global economy.
Russia cannot afford to copy this model entirely. But we could learn a lesson from a small country which realises that it is producing too much oil for such a small economy. If it starts spending everything it earns from oil production, it will risk getting the Dutch Disease and becoming inefficient.
To avoid this, Norway is very determined not to spend a single oil dollar earned by the state. This model is not entirely acceptable for Russia, but I repeat, we could take a leaf out of their book and start spending less.
So, these are the major challenges the Russian economy will have to face in the next decade.
Thank you.