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. Last Updated: 07/27/2016

Illarionov Blasts Kasyanov's Debt Strategy

Prime Minister Mikhail Kasyanov's plan to increase domestic borrowing to stimulate the struggling financial sector is a mistake, President Vladimir Putin's top economic adviser said Thursday.

"The prime minister made an erroneous proposal that is not worth carrying out," Andrei Illarionov was quoted by news agencies as saying.

Kasyanov said at a meeting of top Finance Ministry officials Wednesday that the government should shift the focus of its borrowing away from Western capital markets toward the domestic market. He said increased domestic borrowing would help sterilize rubles, counteract inflationary pressure and act as an indicator of interest rates in the economy.

"This proposal was based on false assumptions, on false logic, and carrying it out would have negative consequences for the economy," Illarionov said.

The government is not yet in a position where it needs to borrow -- the Finance Ministry's reserves have reached a comfortable 81 billion rubles ($2.6 billion) and the Central Bank's reserves are $36.8 billion -- and Kasyanov said that the external debt peak in 2003 is under control. Additionally, the 2002 budget foresees a surplus, and the trade balance remains positive.

When the government borrows again -- it plans to place Eurobonds worth $1 billion to $2 billion this year -- the external markets could offer better conditions than the domestic market.

The government currently has 153 billion rubles ($5 billion) in tradable domestic debt outstanding. Its foreign commitments were between $132 billion and $134 billion at the beginning of the year.

Analysts said the downside is that to attract buyers, domestic debt instruments would have to carry a fairly high coupon rate, above inflation at the very least. But if the government sets rates too high, it could attract too much money at the expense of the real economy.

Spiraling rates on government bonds in 1997 and 1998 fueled the 1998 financial crisis.

"This is a highly debatable issue. There is the problem of crowding out -- when the government borrows at high rates, private lenders can't compete, like in 1997 and 1998. It has a very negative effect and slows economic growth," said Alexei Moiseyev, economist at Renaissance Capital. "On the other hand, the economy needs a normal yield curve in the national currency, so borrowers and lenders have an inter-rate benchmark. Also, liquid domestic government securities and an effective market would provide banks a good instrument for managing liquidity, and this could have a good effect on inflation."

"The government doesn't need the money. It would only be to attract money from under mattresses," said Vladimir Tikhomirov, economist at NIKoil. "With inflation still fairly high, there are only two possibilities. ... If the rates are lower or equal to inflation rates, it would look like a government trick and create further mistrust. Or if the rates are high, it would create a heavy burden on the budget, which is not necessary now."

The Finance Ministry is nevertheless preparing to increase its presence on the domestic market, promising reasonable rates. On Wednesday the Finance Ministry place 4.6 billion rubles of government short-term bonds, or GKOs, at a yield of 13.9 percent.

While domestic borrowing remains a thorny issue, economists agree on the need to coordinate borrowing to avoid future debt peaks. The 2003, 2005 and 2008 peaks are the result of chaotic and uncoordinated borrowing in the mid-1990s.

"At this moment domestic debt management and external debt management are separate and quite independent. This should be changed," said Oleg Vyugin, chief economist at Troika Dialog.

The Finance Ministry has embarked on a plan to change that: Its proposal to create a single agency to oversee both domestic and external debt and risk management was approved by the government Thursday, with directions to work on certain areas.

"The point of combining domestic and external debt management is to ensure that funds are borrowed where the conditions are best, which doesn't happen now. Right now the budget sets out a plan for domestic borrowing and a plan for external borrowing. The other reason is to avoid having to resolve debt peaks," Moiseyev said.