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. Last Updated: 07/27/2016

Crisis Silencing Kudrin's Critics

BloombergKudrin, pictured at a meeting in Washington last month, came under fire for his stubborness on the stabilization fund, but now his stance looks prudent.
Editor's note: This is the fourth in a series of reports about the effect of the global financial crisis on Russia.

Mikhail Kopeikin, the Cabinet's deputy chief of staff, sat red-faced in the corner as Finance Minister Alexei Kudrin scolded him for suggesting that the two-year-old stabilization fund be invested in riskier, high-yield assets.

Besieged for weeks with demands to spend the money on welfare and the military, Kudrin finally lost his cool with Kopeikin on that day in March 2006. Raising his voice, Kudrin denied Kopeikin's claim that leaving the fund to accumulate gas and oil revenues untouched would mean a loss of 600 million rubles over three years because of inflation.

Kudrin shouted that Kopeikin's claim was "completely uninformed."

Kudrin later told reporters that Kopeikin had "cast a shadow over the president and the government."

Two and a half years later, Kudrin must be smiling. His financial prudence is paying off as Russia faces its biggest financial crisis since the 1998 default. The government has used billions of dollars that he stockpiled during the years of sky-high oil prices to rescue banks and other companies caught in the global turmoil.

"Kudrin has played a very lonely but admirable role," said Jonathan Schiffer, Moody's chief sovereign ratings analyst for Russia.

"For all the volatility and the depreciation of the ruble, if you didn't have that stabilization fund, that volatility would be multiplied two or three times. Kudrin has been validated," he said.

But Kudrin is facing new pressures as he plays a risky game in trying to maintain solid economic growth, including a controversial decision to dip into stabilization fund money that has been earmarked for pension reform.

The question on everybody's minds is: How long will the state's billions last?

Since his appointment as finance minister in 2000, Kudrin, along with a few fiscally liberal supporters, has managed to accumulate $600 billion of foreign exchange reserves, mostly from oil and gas revenues.

His stabilization fund was established on Jan. 1, 2004, as a reserve in the event of declining oil prices. Since peaking this summer, oil prices have fallen more than 50 percent to below $70 a barrel, and the Finance Ministry has jumped to provide more than $210 billion to Russia's financial sector — a feat that would not have been possible if Kudrin had given in to his opponents in 2006.

While Kudrin still has his critics, many of them have since shifted to his side, including Kopeikin himself, government insiders said.

Kopeikin's office refused repeated requests for comment for this article. But a source familiar with the situation said Kopeikin, along with Federation Council Speaker Sergei Mironov and State Duma Speaker Boris Gryzlov, have in recent weeks turned in favor of Kudrin and his policies.

Alexei Kondaurov, a vocal critic of Kudrin's stabilization fund policy as a Communist Duma deputy in 2006, conceded that Kudrin's current policies matched the size of the crisis.

"Refinancing loans to the West during the financial crisis will be incredibly difficult so, because of this and the slowdown of economic growth, spending money from the stabilization fund is necessary," Kondaurov said.

After accumulating $157 billion, the stabilization fund was split last January into the Reserve Fund, which serves the same purpose of the original fund, and the National Welfare Fund, which is to refinance the decaying pension system through high-yield investments.

Under the new system, surpluses of oil prices above $70 a barrel travel first to the Reserve Fund, until the fund equals 10 percent of national gross domestic product, which it accomplished in August. All additional revenue is supposed to be earmarked for the Welfare Fund, but the initial capital in the Welfare Fund is already being used for the government's crisis bailout package.

The Finance Ministry plans to invest $7.17 billion from the Welfare Fund in what it deems solvent Russian stocks. At the beginning of November, the fund held a total of $62.8 billion, while the Reserve Fund held $134.8 billion, according to the ministry.

The decision to spend from the Welfare Fund goes directly against the fund's defining principles, said Andrei Illarionov, a former Kremlin economic adviser and the first official to suggest creating the stabilization fund.

"I don't think they should take this money out at all, regardless of the speed, regardless of the size," Illarionov said. "The resources of the stabilization fund cannot be used first domestically and, second, in the investment of shares."

Some investors are privately voicing similar concerns. "I would question the decision to invest a large portion of the Welfare Fund in the equities market," said a finance markets source who asked not to be identified because he did not want to draw attention to his company during the crisis. "The fund was set up to recapitalize the pension system, which is still a big problem, and if they invest it and the stocks continue to plummet they will have just wasted all that cash."

Vidar Dalsbo, communications adviser at Norges Bank, which manages Norway's own stabilization fund, said Norway had no intention of following Russia's lead. "The only objective of the fund is to create return for future welfare, and the strategy will not change because of the financial crisis," he said.

Alexei Nikolsky / Ria-Novosti
Aven, seen with Putin at an Alfa Bank branch in Novosibirsk in October, sees the stabilization fund as a success.
In addition to concerns about dipping into a fund intended for pension refinancing, some market players are worried that the Finance Ministry might be extracting money from the national reserves at a pace that is too aggressive and too rapid. The foreign exchange reserves recorded a record post-Soviet drop in the third week of October, declining $31 billion to $484.7 billion. Reserves fell $100 million to $484.6 billion in the week to Oct. 31, the Central Bank said Thursday.

Since the start of September, the reserves have fallen at a rate of 2.2 percent a week, prompting Standard & Poor's to downgrade its outlook rating for Russia.

The Finance Ministry is standing by its policies, saying in a brief statement, "Our funds will play a great role to help the situation in the Russian economy during this crisis." The ministry refused further comment for this article.

Even some of the ministry's biggest supporters have doubts about the wisdom of its bailout measures. "How much do you put in before the stabilization fund collapses?" said Andrew Somers, head of the American Chamber of Commerce in Russia.

International ratings agencies tie Russia's sovereign rating closely to the size of its foreign exchange reserves. So far, the reserves have fallen by more than $116 billion since reaching a peak of $600 billion in August. Fitch Ratings estimates that they will lose a total of $160 billion, or a quarter of their value, by the end of 2009.

Fitch warned in a recent report that its long-standing concerns about Russia's banking sector would come to the fore during the crisis. But unlike S&P, Fitch expects to maintain its BBB+ sovereign rating of Russia. Schiffer, Moody's chief sovereign ratings analyst for Russia, said Moody's also had no plans to adjust its Russia ratings.

"It would take a really big weakening and diminution of the resources and the will to use those resources for Moody's to re-examine its position," Schiffer said. "Our ratings are all relative, and compared to everybody else Russia is much better equipped to deal with the crisis."

Economists said the government had little choice but to delve into its foreign exchange reserves to support the economy, and their only qualms lie in the use of the Welfare Fund.

Yevgeny Nadorshin, chief economist at Trust Bank, said some of the state money being funneled to commercial banks indirectly came from the Welfare Fund, but he said the use of that money would be temporary and serve as a form of high-yield investment, the stated purpose for the Welfare Fund.

With the country already using state reserves to stimulate the banking sector, he said, it seems logical to also use Welfare Fund money for a similar purpose. "If you're going to choose a risky asset, it's better to choose your own," he said.

According to rules adopted late last month, up to 40 percent of the Welfare Fund may be invested in Russian assets. This month, the Finance Ministry plans to present a new investment strategy for the fund that will likely favor high-yield investments over safer, more conservative investment choices.

Igor Tabakov / MT
Illarionov said Welfare Fund spending violated the fund's defining principles.
"The government is spending money very, very fast, and maybe too fast, but that's a government decision," said Vladimir Osakovsky, an economist at UniCredit Aton. "If we have a fire, we need to put out the fire, and on the stock markets these are really tough times."

Russian exports could drop by as much as 20 percent to 40 percent next year — a figure that could help slow GDP growth to 3 percent to 4 percent for the coming year, according to the Peterson Institute for International Economics in Washington. The IMF on Thursday cut its outlook for Russian GDP from 7 percent to 6.8 percent for 2008 and from 5.5 percent to 3.5 percent for 2009.

Last week, the Economic Development Ministry cut its projected 2008 growth by half a percentage point to 7.3 percent.

The real economy is likely to start to feel the slowdown of GDP growth within weeks, said Zhelko Bogetich, the World Bank's chief economist for Russia. "It's clearly slowing down — and slowing down very fast," Bogetich said, adding that ordinary Russians have noticed early signs of the depreciating ruble, rushing to currency exchanges to change their money into dollars.

"People remember the history of the financial crisis from 10 years ago," Bogetich said.

Despite concerns about how the Finance Ministry is spending money, the ministry has surprised critics in the past. The IMF initially advised it not to set up the stabilization fund in 2004, worrying that oil prices would slide and that fund money would be squandered on pet projects.

"The preconditions for the fund's successful operation were unlikely to fit together in the Russian context. There were too many governance and transparency issues for a fund like this to really be effective," said Martin Gilman, a former IMF representative to Russia.

"In a blunt categorization, Russia was not Norway — Russia was more like Nigeria," he said.

The difference between Russia's financial condition then and now is astounding, Alfa Bank president Pyotr Aven said at a conference last week. Attributing the stabilization fund's success to both Kudrin and former President Vladimir Putin, Aven said the fund would play an unparalleled role in Russia's ability to survive the crisis.

"It is absolutely a success," Aven said. "To save is always a success."

Previous crisis-related reports can be found at