Alexey Kudrin: Spending the Stabilization Fund Would Ruin the Economy
// Opinion and Commentary
A roundtable meeting organized by the School and Kommersant Publishing House entitled “When to Spend the Stabilization Fund and What On” was held at the Higher School of Economics. Russian economists, members of the Duma, representatives of business associations and economic officials discussed the management and possible uses of the stabilization fund and the risks associated with it, particularly inflation. The main speaker was Minister of Finance Alexey Kudrin, who discussed the need for a sliding principle for calculating inflation (in this case, its average annual rate of 12.7 percent) and of the non-oil portion of the federal budget. He gave Kommersant a copy of the text of his report.
Can Inflation Be Beaten?
The discussion in the media bout the stabilization fund and inflation demonstrates that not everything that would seem to be obvious is understood by the majority of readers or even experts in major media outlets.
The stabilization fund is for Russia first of all a “safety cushion” for those years when the price of oil may be very low. In addition, the stabilization fund is protection for our market from additional inflation and additional strengthening of the national currency. Building up this safety cushion is an important task, but today there is one that is even more important – holding down inflation. The government should ensure a low rate of inflation because, otherwise, there cannot be long-term money in the economy and the economy cannot provide a low interest rate for enterprise. On the whole, it can be said that there cannot be an innovative economy, if inflation is at 10-11 percent. High inflation creates limitations for our investment climate. Therefore, by making our goal a diversified investment climate, we should be able to lower inflation by 3-4 percent. From the point of view of macroeconomic parameters, that is a necessary condition.
Is it hard to fight inflation? Why haven't we done it yet? The government sets task but, of the various measures and decisions that are actually undertaking, lowering inflation is not high on the list. Other tasks are given priority, including spending on social needs and defense. As a result, we overlook inflation. Would it be hard to reach an inflation rate of 3-4 percent in 2009 or 4-5 percent in 2008? It's absolutely realistic. Twenty-one countries in the world have made announcements of targeted inflation and all of those countries reached their declared goals in a reasonable time – between two and five years. Does the administration have mechanisms to reach that goal? Yes. But to do so, political will is necessary. Today, the task of achieving low inflation has been made a political goal and advanced to first place. Now it will be harder for the administration to avoid it or change its goals. It can be expected that the administration will mobilize and consolidate to reach its goal. The efforts of the Ministry of Finance alone are not enough here.
The Nature of Inflation
Today it is necessary to return to a discussion of the nature of inflation. That will allow us to lower it. Recently, it has often been heard that missing declared goals on inflation is related to non-monetary factors. That is not so. Inflation has a purely monetary character. Economists know very well that the level of prices is related to the volume of the money mass and the rate of its circulation.
They say that that formula is outdated, that it doesn't work in Russia as stated because the economy is on a different level in Russia, that we have to think about investment, there is not enough money in the economy. But inflation has a monetary character and that holds true for all countries. That is why all countries have such institutions as central banks, independent of the administration, that are responsible for the money mass and for inflation. In countries such as Russia, where a positive balance of payments depends on the influx of petrodollars, the administration is responsible for that as well. In such countries (Norway and Kazakhstan are also examples), the administrations take on some of the monetary functions and ensure the protection of the economy by regulating the volume of the money mass in the economy along with the central bank.
In the “The Main Directions of the Unified State Monetary and Credit Policy,” there is a program for the Central Bank to ensure the necessary volume of money in the economy. That document has been approved by the administration, taken into consideration by the State Duma and is one of the main documents of the country's economic policy. And there it is indicated that, to reach the inflation goal with oil at a price of $40 per barrel, we will have to remove an excess money mass of 975 billion rubles from the economy, and if the price is $60 per barrel, we will have to use the stabilization fund to remove 2.145 trillion rubles. The Central Bank will have to use its instruments to sterilize 82 billion rubles if the price is $40 per barrel. If the price is $60 per barrel, the Central Bank will have to sterilize 226 billion rubles. And if the price of oil reached $80 or $100 per barrel, the Central Bank will have to sterilize more than 500 billion rubles.
Unexpected Expenses
It has to be noted that the administration and Central Bank violated their own target indicators for the growth of the money mass. In 2005, it was planned for 20-25 percent, but real growth of the money mass was 38 percent.
In addition, it is necessary to keep in mind that we have additional expenses from the export of oil that bypass the stabilization fund and fall to the budget. When the price of oil is $40 per barrel, those expenses are 225 billion rubles. The administration now in essence spends those funds (that's how it was in 2005) and by doing so violates several parameters of credit and monetary policy. If we spend the addition income that comes from an oil price of $51 per barrel, the real price cutoff is in fact $33.60 per barrel.
In recent years, the administration has very seriously increased expenses, sometimes in the course of the year, while not meeting it target indicators for the growth of the money mass and inflation. In 2005, those additional outlays were made using taxes and the additional income connected with high oil and gas prices. On the whole, the administration spent about 500 billion rubles unplanned and a large part of those funds entered the economy in December. This year, the administration decided to spend additional income by plan, changing the cutoff price form $20 to $27. Five hundred billion rubles is a large sum, but now all additional income is being considered in the planning of the main target indicators for growth of the money mass. We still have a chance to remain within the planned parameters. A large part of the responsibility, a large part of the instruments in this situation are in the hands of the Central Bank. The administration determined the expenses and changed the cutoff price, and the parameters are set.
The Oil Budget
Among the measures that will help us evaluate the situation and deal with inflation adequately are the following. First, we have to convert to a different inflation index. We measure inflation from December to December, and that indicator was 10.9 percent in 2005. But, looking at inflation month by month in 2005, it reached 13.7 percent in April and May. Thus, in reality, the Ministry of Defense and agricultural producers bought goods at prices that exceeded last year's prices by an average of 13.7 percent. But when we calculate inflation at the end of the year, our annual inflation is 10.9 percent. A fuller indicator, which should be taken advantage of, is the average monthly value of annual inflation for the year. For last year, that was 12.7 percent. That more fully reflects the situation and presents a more complex task for the administration to reach a level of inflation that is acceptable for the economy.
Second, we consider it expedient to calculate the oil balance of the budget. So far, we only calculate it, although Norway and, beginning this year, Kazakhstan, already live within the limits of that budget. In that connection, one periodical publication has already written that Kudrin wants to reduce budget expenditures by 30 percent. That is not so. Calculating the oil balance in the budget means that all income from oil goes into a separate account and transfers from it are permitted against the deficit in the country's non-oil budget. The deficit is our non-oil budget in 2004, by preliminary calculations, was 2.8 percent, and in the first half of 2005, it was 4.7 percent of the GDP. It is clear from those figures that we are increasing the expenditure of oil money. Norway and Kazakhstan have developed legislation to limit the deficit in the non-oil budget. We are not at all suggesting limiting expenditures. Rather we are suggesting only defining that deficit, recording it and not increasing it in the future. They often say today that Kazakhstan has set up an innovation fund and a fund for technology by allotting oil money for them. But strict limits were set on the deficit in the non-oil budget at the same time.
Dependability or Profitability?
The right way to manage the stabilization fund is now being discussed. There is no big question here, since the proposals made by the Finance Ministry with the Federal Service for Financial Markets, the Central Bank and the Ministry of Economic Development and Trade will most likely be approved in their entirety. The discussion is of the sum that is in the fund today that will be placed in foreign assets. We hold that a significant part of the stabilization fund, while it is still growing, should be invested in dependable high-liquidity foreign state securities. Until the fund reaches a certain size, there is no need to develop a system for investment in corporate securities. That is the next stage. We can begin developing it, but there is one limitation. That is a number of suits against the administration of Russia. Until those cases are settled, we have to act very cautiously.
It is often mentioned that the income from stabilization fund investments in 2004 was 8.94 percent. But inflation in those countries in whose assets funds were invested has to be considered and the operational expenses to set up and manage the portfolio. As a result, net income last year was 6.24 percent. From 1997 to 2004, the average income was 6.5 percent.
Seven Errors
There are several major errors in discussions of the stabilization fund. The first is that the stabilization fund can be spent. If those funds exceed our target indicators for the growth of the money mass, then that is an absolutely emissions activity that the administration has taken on that will begin to increase the quantity of money in circulation – practically printing new money. And raising the economy or social sphere by printing money is impossible.
Russia is far from being in the first place for sterilizing the money mass. In China, sterilization reaches 10 percent of the GDP. Nor do we set any records for budget surplus. In Norway in 2005, that reached 15.6 percent, and no one was upset by it, since it was in keeping with the goals of the economic policy – to protect the economy from inflation and additional strengthening of the national currency.
The second error is that economic growth will speed up if we spend the stabilization fund within the country. If we had spent the entire increase in the stabilization fund in 2005, the growth of the monetary mass would have been 70.5 percent instead of 38.6 percent. Inflation would have reached 18-20 percent and the real strengthening of the ruble would have been 16-18 percent. It would simply be the ruin of the economy, and those who say that spending the stabilization fund means supporting the economy are wrong.
The third mistake: investing the stabilization fund would not cause inflation. It doesn't matter what budget outlays went to, whether for investment or the payment of salaries. Maybe the multiplier is just a little different at the beginning, but it is all the same money on the whole. To structure budget outlays depending on how they may influence inflation is a distortion of budget policy.
The nest error is that inflation devalues the stabilization fund. Here we had authors who counted the number of billions of rubles the fund would loose by 2008. They came up with a figure of 600 billion rubles. But the funds accumulated in the stabilization fund are essentially different. That is not the emission of money. Hat is why they are accumulated in a separate fund and placed only in foreign assets. As a result, those rubles are practically annulled and cease to exist in the economy.
The fifth error is that oversterilization will lead to a banking crisis. The volume of the money mass in the economy should be determined by its consumption and not by how much liquidity the banks need. Of course, it would be more correct to do it so to gain on the refinancing rate. For that, the administration would have to spend less, so that demand exceeded supply and the refinancing rate earns money when money enters the economy at that rate. Of course, it would be even more correct for the Central Bank supported banks and private business through the refinance rate. Banks are investment institutions that choose and implement investment activities better than the administration.
Error No. 6 is that taxes can be lowered at the expense of the stabilization fund. That means that shortfalls in income should be covered using stabilization fund money, raising the cutoff price, increasing the money mass in circulation, which will essentially be excessive. I want to call attention to the experience of Norway once again. In 2005, Norway raised the VAT from 24 percent to 25 percent. The reduced VAT rate was raised as well. At the same time, the Norwegian stabilization fund increased by $57 billion in 2005. In Norway, they say that, if the state wants to spend more money, it should get it from the economy and not from additional oil income.
The seventh and final error is the stabilization fund can be spent on new technology, innovation programs and equipment that will be imported into Russia. But if the administration uses cheap money to buy, for example, a factory from a large international automaker, all private projects in that sector will die. They will be destroyed. The same if we buy equipment. We would destroy demand for the good of Russian producers in that field for years to come. And if we've had a problem with import supplier discrimination, that means that we will discredit the Russian producer in favor of the import supplier. That is unacceptable from the point of view of Russian legislation, the interests of the consumer and the development of market institutions.
We have overlooked inflation. It was more important to raise expenditures on social needs and defense. But, if there is the political will, inflation can be lower to 3-4 percent in 2009
The administration should ensure a low inflation rate because there will be no long-term money in the economy otherwise.
Alexey Kudrin, Minister of Finance of the Russian Federation
All the Article in Russian as of Mar. 30, 2006
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