RD Explainer: Russia Direct explains the goals and functions of the National Welfare Fund, which is Russia’s sovereign wealth fund that will play an important role in carrying out the Kremlin’s plans to handle the economic crisis.
It remains to be seen if Russia's reserves will be enough to tackle the economic crisis. Photo: RIA Novosti
The Russian government recently announced a comprehensive set of anti-crisis measures to deal with the economic problems now affecting the country in the wake of Western sanctions. One key element in this package of anti-crisis measures is the Russian National Welfare Fund, a sovereign wealth fund that has been described by Western analysts as a “rainy day” fund for the Russian government to handle exactly these types of economic crises.
Below, we provide an introduction to the Russian National Welfare Fund via a brief series of questions and answers.
What’s the history of sovereign wealth funds?
Sovereign wealth funds (SWF) are increasingly becoming major players in international finance. First appearing after World War II, their current level of investment activity has become an important factor affecting the dynamics of global equity and foreign currency markets.
The first sovereign wealth fund, into which excess funds, in terms of public revenue receipts, were accumulated and saved for the benefit of future generations of citizens, was founded in Kuwait in 1953, even before that country gained its independence from Britain. Funds into the Kuwait Investment Authority came from oil exports, and were not invested into consumption or investments in the country, but into assets outside of the state.
The SWF rankings
The largest SWNs by assets under management in 2014. Source: Sovereign Wealth Fund Institute
What functions do sovereign wealth funds typically handle?
In terms of their activity, sovereign wealth funds have traditionally focused on two main areas. The first area is the stabilization function associated with counter-cyclical activities of governments and central banks (to help the national economy in times of crisis, and then keeping it from overheating during periods of economic boom). The second area is the savings function, aimed at the accumulation of resources for the consumption of future generations. Currently, similar funds exist in about 30 countries, and Morgan Stanley estimates the total size of their assets at $2.85 trillion.
Photo: RIA Novosti
By whom and when was the Russian National Wealth Fund formed?
The Russian National Wealth Fund (NWF) was formed on the basis of changes made by Russian lawmakers to the Budget Code of the Russian Federation, as well as via the adoption of a series of federal laws regulating its structure and activities. The Fund was launched in February 2008, as a result of reforms made to its predecessor, the Stabilization Fund of the Russian Federation.
Russia's Stabilization Fund. Source: RIA Novosti
The latter was formed in January 2004, at a time when foreign currency inflows from energy exports threatened to create conditions for the occurrence of the “Dutch Disease” in the Russian economy. This condition is traditionally expressed in the form of the appreciation of the national currency, reducing the country’s export potential and accompanied by a surge of imports that threaten the entire national economy, particularly its real sector.
In February 2008, the Stabilization Fund was split into the Reserve Fund (guaranteeing the execution of oil and gas transfers as one of the major sources of fulfilling the national budget of Russia) and the National Welfare Fund. Under current legislation, the main priority of the NWF is providing co-financing for voluntary pension savings of citizens of the Russian Federation and balancing (covering deficits) in the budget of the Pension Fund of the Russian Federation. As of December 1, 2014, according to the Ministry of Finance of the Russia, the volume of funds in the NWF is about $80 billion. Its resources are considered as being a part of Russia’s gold and foreign currency reserves.
Source: RIA Novosti
What can the NWF spend its resources on?
The Ministry of Finance of the Russian Federation carries out the management of the NWF. Separate authority to manage its resources is also delegated to the Central Bank of Russia. In addition, legislation allows for the possibility of attracting specialized financial institutions for the implementation of certain powers to manage the NWF.
The Budget Code of Russia provides the following areas for the placement of NWF resources: debt obligations of foreign countries and their central banks; deposits and bank accounts with banks and credit institutions; deposits with the Central Bank of Russia and Vnesheconombank; debt obligations of legal entities; and corporate shares and equity (stakes) of investment funds.
*This request from Russia's largest oil company has not been approved. The company sent the request in January 2015 to finance 28 critical projects. Earlier in 2014 Rosneft requested from NWF about $23 billion in summer and $36.6 billion in the fall (in current currency terms), yet afterwards reassessed its needs. ** The authorities pledged to give this sum of money. *** Expected, as indicated by the official statement. Source: Vedomosti
At the same time, Russian legislation severely limits the conditions for placement of NWF resources. In particular, these can be placed into bonds of only 13 states (the countries of Europe, the U.S. and Canada); foreign issuers must have a rating of at least “AA-” by classification of the leading rating agencies; funds can be placed in only eight international financial institutions, including in six regional development banks, as well as the International Finance Corporation and the International Bank for Reconstruction and Development (IBRD); and purchased shares must be listed on one of the world’s leading exchanges.
Preference is given for the placement of NWF resources into foreign currencies, allowing the placement of 100 percent of its funds into these foreign currencies. The share of ruble-denominated assets may not exceed 40 percent of the Fund’s resources.
Who decides on the expenditure of resource from the National Welfare Fund, and is approval of the State Duma needed?
The Russian Ministry of Finance makes decisions on the spending of NWF resources, while individual authority to manage the NWF can be carried out by the Central Bank of Russia. For these activities, the approval of the State Duma or the Federation Council is not required. This situation can be changed only in the event the Russian Federal Assembly makes amendments to the Budget Code of Russia.
Men at the entrance of the Ministry of Finance of the Russian Federation on Ilyinka Street. Photo: RIA Novosti
Given the current economic situation, how long will Russia’s resources last?
Funds accumulated in the NWF are significant, especially in terms of the size and scope of the Russian economy. In the current crisis conditions, there should be sufficient resources for quite a long period (two to three years) with careful use. However, the head of the largest Russian bank Sberbank, German Gref, announced at the Gaidar Forum in Moscow that the Fund’s resources would last only a year and a half, even with their conservative application.
The dynamics of spending of resources during the previous financial and economic crisis (the years 2008-2010) show that during two years, the total amount of funds in the Reserve Fund of Russia decreased to $142.6 billion in September 2008, and to $25.2 billion in December 2011. That is, in two years, the level of resources had decreased almost six-fold. However, soon after that, the amount in the Reserve Fund quickly recovered to a level of $90 billion, thanks to an improved macroeconomic environment in which energy prices began to rise.
The dynamics of the NWF are considerably more stable. During the current crisis in Russia’s relations with the U.S. and member states of the EU, the amount of resources at its disposal has remained stable, fluctuating at around the level of $87 billion. Only in December of 2014 did it decline to the level of $80 billion.
How is it replenished now, and how much money goes into it?
Oil and gas revenues coming into the federal budget play the greatest role in replenishing the NWF. During the current period of low oil prices, a significant amount of replenishment of the NWF from this source is extremely difficult.
The second resource of replenishment is income earned from the management of the Fund’s own resources. It is obvious that this income, due to the stringent requirements for the quality of all acquired assets by the NWF, is very small, and thus cannot play a significant role in the replenishment of available resources.
There are similar funds around the world, so what are the key differences with Russia’s?
The Russian National Welfare Fund was designed on the model that has been common around the world since the 1970s, when the flow of petrodollars forced a number of nations to make efforts to “sterilize” their national financial systems from large incoming revenues, negatively affecting their economies and finances.
Today, the largest sovereign wealth funds exist in countries that are exporters of energy and other mineral resources (United Arab Emirates, Norway, Saudi Arabia, Kuwait, Canada, Russia and Australia), as well as in countries with large trade balance surpluses, due to large volumes of exports of goods and services (China, Hong Kong, and Singapore). Assets of the largest sovereign fund on the planet, the Abu Dhabi Investment Authority, today exceed $600 billion, while the total volume of the five sovereign funds established by China is more than $1.4 trillion.
For more infromation about SWFs, read here.
All sovereign funds operate in about the same way – they try to invest their available resources into conservative assets that generate a small profit, but ensure a high degree of investment conservation. These differ from the Russian NWF, perhaps, only in the fact that, due to the significant dependence of the national economy on the oil and gas sector and its revenues, the political consequences of any wrong decisions taken by the fund in Russia are significantly higher than in other states.
As the experience of the previous crisis, which began in 2008, has shown – the Russian government will not hesitate to use the resources of the Fund. That is, it is ready at any moment to sacrifice its “savings” function and use its resources as an additional source of budget revenues during periods of economic turmoil.