Slush or Stability Fund

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In an effort to ensure smooth debt payments in the future and enforce budget discipline, the Russian government established a stabilization fund, or financial reserve, last year to hold excess budget revenues from high world oil prices.

This type of fiscal instrument has been used by other natural resource-dependent countries as a means of cushioning the economy from dramatic fluctuations in global commodity prices. Alas, few have been successful; the majority have fallen victim to the temptation of spending while the money is available. And the way the Russian government is going at the moment, it is headed for the same sorry fate.

The 2002 budget envisaged a federal surplus of 1.6 percent of GDP, or $5.7 billion. Of that, $2.2 billion was allocated to foreign debt payments, and the remaining $3.5 billion was to be channeled into the financial reserve. As a result, the government expected the financial reserve to hold $6.1 billion by the end of this year. This was based on the assumption in the 2002 budget that the average price for Russian crude would be $23.50 per barrel.

In a report published earlier this year, we estimated that an oil price of $19 per barrel is critical to ensure some build-up of the financial reserve this year. Anything less than that would result in no reserve accumulation, as the budget surplus would only cover the $2.2 billion designated for debt. In other words, the ability to accumulate reserves would hinge on the world market price for oil.

As of the end of November, the oil price this year has averaged $23.44 per barrel, almost exactly in line with the $23.50 per barrel target in the 2002 budget. But in a year when oil prices should have seen the stabilization fund steadily growing, reserves have actually run down, falling to $2.7 billion on Oct. 1, according to Finance Ministry officials (although up from the low of $1.6 billion in mid-2002). Furthermore, in August the government reduced its budget surplus forecast for 2002 from 1.6 percent of GDP to 0.7 percent of GDP, citing increased spending and lower tax collection.

Nevertheless, the government remains adamant that it will meet, or come close to meeting, its year-end financial reserve target. This would require the accumulation of an additional $3.7 billion in the last quarter, which, judging from the performance thus far, is well-nigh impossible.

It is possible, however, if we accept that there is no longer any relationship between world oil prices and the size of the stabilization fund.

Instead, it seems, the government's ability to meet the year-end target hinges on privatization revenues and possibly domestic borrowing. The price tag of the government's 75 percent stake in Slavneft slated for auction on Dec. 18 has been set at $1.7 billion, although market expectations are closer to $2.2 billion to $2.4 billion, which should help top up the fund.

The point, however, is that the original purpose of the reserve -- ensuring fiscal discipline during periods of high oil prices -- has been cast aside.

Interestingly, while the stabilization fund is reported to have fallen in the first nine months of this year, the federal government's accounts with the Central Bank have continued to grow. These accounts contain funds disbursed to ministries from the budget that remain unspent but should also contain the financial reserve's funds. As of Oct. 1, according to Central Bank figures, these accounts contained almost $10 billion. In other words, the government has a significant amount of unspent cash at its disposal. Last week, Prime Minister Mikhail Kasyanov suggested that those budget funds unspent at the end of the year would be confiscated and transferred to the financial reserve.

Apart from the stabilization fund's decoupling from oil prices, the other problem with the reserve is its lack of transparency and unclear legal status. There are no regular statements on the size of the fund or regarding what money removed from the reserve is being spent on -- its balance is only revealed through occasional public comments by Finance Ministry officials. As a result, there are no checks on management of the financial reserve.

International experience with similar stabilization funds shows a high failure rate. A study by the IMF indicates that natural resource-dependent countries that have stabilization funds nonetheless tend to increase spending when international commodity prices are high -- exactly what a stabilization fund is designed to prevent. The two exceptions are Norway and, to date, Kazakhstan. The supervision of Kazakhstan's fund remains at arm's length from the government, coming under the aegis of the National Bank of Kazakhstan, which is mandated to use it solely for debt payments.

The lack of transparency of Russia's stabilization fund is particularly worrying in light of forthcoming State Duma elections in 2003 and the presidential election in 2004. In order to dispel concerns that the financial reserve will serve as little more than a slush fund for the elections, the government should take immediate steps to clarify its role, increase transparency and ensure independent oversight.

Peter Westin is senior economist at Aton Capital. He contributed this comment to The Moscow Times.