It seemed prudent last summer that in presenting the draft 2010 budget to the State Duma the government announced that it would seek to raise as much as $17.8 billion in eurobonds this year for the first time since just before the 1998 default.
Since then, the need for budget financing appears to be even higher. A month ago, the projected 2010 deficit was raised from 6.9 percent of gross domestic product, which was projected in the summer, to 7.2 percent of GDP, or 3.1 trillion rubles (more than $100 billion). For 2009, the GDP deficit was 5.9 percent. The government contends that spending is set to increase and rising oil prices will be fully offset by ruble appreciation and lower inflation.
The authorities continue to assert that Russia will issue eurobonds this year, though the timing and volume are unclear. In early February the government announced that it had hired a consortium of banks as co-organizers of the initial installment of a planned eurobond issue.
There’s only one problem, though. Russia should not borrow in foreign markets this year. From an economic point of view, it makes no sense. Despite all of the commotion, Russia just doesn’t need the money. If Russia proceeds anyway, it could be a headache for both the budget and macroeconomic balances. The only losers from such forbearance would be some disappointed bankers and those lobbying for higher budget spending.
Let’s start with the budget assumptions. The 2010 budget is based on an average Urals price of $58 per barrel. On Monday, it was trading at $80 per barrel, and it has averaged about $75 per barrel since the beginning of the year. The budget also assumes a sharp decline in tax buoyancy (the revenue-to-GDP ratio) and only 3.2 percent real GDP growth. These assumptions are exceedingly prudent. In fact, several weeks ago Finance Minister Alexei Kudrin acknowledged that the budget deficit this year probably would not exceed 7 percent of GDP because of higher oil prices. His conservatism is welcome from a political viewpoint since it will help to avoid spending increases, but it should not serve as an excuse to borrow more than is really needed.
In fact, the 2010 budget deficit will only be at 1.2 trillion rubles ($40.3 billion) if the Urals oil price stays at $70 per barrel. So far, budget revenues have outstripped the government’s target since the start of the year. In fact, at an average price of $80 per barrel, the budget could be about in balance, assuming that spending is not raised.
The Reserve Fund, one of the two sovereign wealth funds that capture windfall oil profits, amounted to $59 billion at the end of February and should be sufficient to cover the entire deficit. If any market financing is needed, the government would be well advised to turn to domestic borrowing. There is abundant domestic liquidity, so “crowding-out” of private credit should not be an issue. In addition, one of the key lessons for Russia from the recent global financial crisis is the inadequacy of domestic capital markets. The government could play a central role in helping develop their breadth and depth through new instruments, much like the U.S. Treasury in the good old days before excessive debt became a serious concern.
Besides the fact that foreign borrowing is not needed to finance this year’s budget deficit, it would have a perverse effect on managing monetary aggregates and the ruble exchange rate. Emerging markets, including Russia, are attracting unwanted speculative capital flows. In Russia’s case, the lethargy of the Central Bank in lowering interest rates provides an even greater incentive for investors to use the ruble as a destination for their global carry trade, adding to volatility. The Central Bank is even considering raising capital reserve requirements for banks on foreign currency deposits and banks’ liabilities to nonresidents. Higher taxes on foreign borrowing by corporations and control of foreign borrowing by companies in which the state holds a stake are under consideration. In these circumstances, it would be strange in the extreme for the Finance Ministry to add to the burden by bringing in yet more foreign exchange by borrowing abroad.
Given these arguments against foreign borrowing this year, some analysts have suggested that it is a good time for the government to get back in the market with an issue that would set prices for all subsequent issues by establishing a benchmark. While there may be some validity to the point, it is hardly a priority at this time.
Russia would be venturing back onto international credit markets just as investors are retreating from developing nation assets on concerns that Greece’s budget crisis could spread to other European economies and emerging markets. The best way to demonstrate that Russia is different from Greece is done by keeping debt low in the first place and pursuing prudent macroeconomic policies. With sovereign foreign debt of less than 3 percent of GDP, Russia is almost in a category of its own. It is best to stay that way when debt will be the albatross of many countries for years to come.
In any case, foreign borrowing is not so cheap. The extra yield that investors demand to own Russian bonds rather than U.S. Treasuries widened at the end of last week to 2.19 percentage points, the highest level since Dec. 18. The yield on Russia’s existing 30-year benchmark dollar bonds maturing in 2030 rose 3 basis points to 5.446 percent, its highest level since Nov. 10, prices on Bloomberg show. And it would be ironic to pay more in the markets when Russia just announced that it has turned down low interest cost loans from the World Bank.
Sovereign borrowing, if it happens, would contribute to an escalation of ineffective expenditures and inflation in the years to come. Yevgeny Gavrilenkov, chief economist at Troika Dialog, argues that foreign borrowing would create a new higher “benchmark” for public expenditures that would only go to enrich a group of enthusiasts who are always keen to absorb trillions of rubles from the budget for their favorite projects. Just over five years ago, the budget could be in balance with oil prices at $20 per barrel. By continuously ratcheting up spending, it now takes $80 per barrel to do the same. In a world of volatile commodity prices, this is an ominous development for Russia.
Kudrin should know better. The bottom line in 2010 is that there is no need for foreign borrowing by the government.
Yes, bankers can be very convincing when tempting borrowers, whether consumers or governments. After all, it is their job to lend money and arrange deals. But borrowers should be wary. When necessary, at the right time and on appropriate terms, it may make sense for Russia to return to the international markets for the first time since 1998. But not now. Just ask the Greeks where it can lead.
Martin Gilman, former senior representative of the International Monetary Fund in Russia, is a professor at the Higher School of Economics.