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. Last Updated: 07/27/2016

The Kremlin Gets a Pocket Bank of Its Own

A new state giant has been born that will shape the future of the economy by its ability to parcel out the country's massive energy wealth.

But insiders fear that the Development Bank is already showing signs that it will not be able to tread the fine line between serving state interests and remaining economically viable.

The Development Bank, 99 percent controlled by the government, is tasked with coordinating all state investments starting next year.

By then, its capital -- made up mostly of funds from state-owned Vneshekonombank, the development arm of the Soviet Union created in 1924 -- will reach $10 billion, and the bank should attract between $40 billion and $50 billion into the country's economy in the next two or three years, said Andrei Mazurov, the bank's head of communications.

Its entire capital base will come from the state.

"In terms of its scope, the bank's place will be unique," Mazurov said. "It will be an entirely new economic entity, without precedent in Russia, and will be guided by the priorities of the government and its long-term needs.

"The country has been waiting for this for 15 years," he added.

During this period, oil and gas exports have allowed Russia to amass nearly $420 billion in foreign currency and gold reserves and a stabilization fund worth more than $120 billion, which it has been very careful not to spend.

Meanwhile, the country's infrastructure has wasted away, surviving largely on the roads, homes and machinery inherited from the Soviet Union.

Total investment stands at around 19 percent of gross domestic product, less than half of the levels seen under communism, according to the Russian Institute for Economics, Policy and Law, a state research body. The average age of infrastructure is therefore more than 20 years, the institute said, old enough to account for at least some of the mining accidents and plane crashes that make headlines.

In the past year, the government has woken up to this reality. From the $157 billion spent in 2006, budget expenditures are set to almost double next year, reaching $275 billion and spelling a decline in the fiscal restraint the government has shown in recent years.

"But simple budget spending is never really efficient," said Anatoly Aksakov, deputy head of the State Duma's committee on financial markets and credit organizations, which co-wrote the law on the Development Bank.

"Simple bureaucrats do not have their pay depend on the efficiency of their decisions," Aksakov said. "That is why it was important to channel the spending through a bank that behaves more or less according to market principles."

On this point, Russia has taken its cues from similar institutions in Germany, China and Japan, all of which used state banks to channel their investments during their own periods of economic transition.

All of them have had to strike the balance now awaiting Russia's Development Bank, the one between serving state interests and staying economically viable. By some indications, the state is getting its new bank off on the wrong foot.

Friends in High Places

Indeed, if anything has become clear, it is that the state will not take a liberal approach. In fact, the bank's loyalty to the Kremlin is expected to be unrivaled, even in the already crowded arena of state national champions.

The bank's eight-member supervisory board, which makes all executive decisions, is handpicked by President Vladimir Putin and headed by Prime Minister Mikhail Fradkov.

Its list of board members reads like the names in the morning headlines: Deputy Prime Minster Sergei Naryshkin, Economic Development and Trade Minster German Gref, Finance Minster Alexei Kudrin, Industry and Energy Minister Viktor Khristenko, and Sergei Kiriyenko, head of the Federal Atomic Energy Agency.

Friends like this have already garnered the bank a few favors.

Under the legislation that established the bank, it is not obligated to hold a banking license, making it the only lender not subject to Central Bank regulations. It also has exclusive rights to loan out the money in the Investment Fund, which gets $2.5 billion per year from the budget.

Moreover, the bank will not have to compete with other lenders. "One of our basic principles is not to enter into competition with commercial banks," Mazurov said. "We will only take part in investment projects that cannot be financed by commercial banks."

This means that the bank will focus on loans for five years or longer and 2 billion rubles ($78 million) or more, according to the bank's statute, which was adopted Aug. 2. Such loans offer such meager returns that almost no other banks would be interested in giving them, said Yulia Tseplyayeva, economist at Merrill Lynch.

Among the bank's founders, this was the most controversial point, as it raised fears that the bank would not be able to make ends meet.

Finding Viable Projects

The debate on this issue -- fought mainly between the hawkish camp around Fradkov and the liberal one around Gref -- decided how susceptible the bank would be to competition from other banks. Earlier this year, when Fradkov was placed at the helm of the bank, the hard-liners won out, and the principle of noncompetition was written into the rules.

"The question now becomes: Can the bank choose the most efficient investment projects, or will we end up again with these loss-making ideas?" Tseplyayeva said.

Some of the signs on this score have not been very good.

Last year, when inflation reached 9.8 percent, the bank's investment of the $11 billion state pension fund was only able to get 5.67 percent in returns, shaving more than 4 percent off the value of the fund. This was caused by the state's unwillingness to invest pensions in anything much riskier than government bonds, generally the safest bet with the smallest returns.

"This is a state-run bank, so objectively speaking, the influence of the bureaucratic decisions will be a hindrance," said Aksakov, the Duma deputy. "In this sense, it will be important for the supervisory board to be influenced by market players, who can optimize the investment decisions."

The great hope for this influence will come from the so-called public-private partnerships, which will account for most of the investment projects the bank takes on.

The 10 projects that have already been chosen by Gref's ministry -- including ones to build sewage processing plants in Rostov-on-Don and toll roads in Novorossiisk -- have private partners that are leveraging state money by more than 20 times, spending $30 billion while the state spends less than $2 billion.

"PPPs may well prove to be the most effective means of allocating public money," said Roland Nash, head of research at Renaissance Capital.

If Nash's prediction pans out, the bank may well achieve its goal of renewing Russia's capital base and diversifying the economy.

But in any event, as the holder of the key to Kremlin coffers, it will be an institution Russians will hear about for years to come. Tseplyayeva even suggested that Putin, after stepping down from his post next March, would take over as the bank's chairman.

"Such a scenario would explain why the government has been in such a hurry to found the new institution, and how President Putin might retain his strong political influence after 2008," she said in a report last month.

Kremlin spokespeople declined to comment on this possibility or any other details of the bank. All of Fradkov's consultants and deputies reached for this report referred questions to the prime minister, who also declined through a spokesman to comment.