Changes at Vnesheconombank, a key Russian state corporation, hint at the types of bold steps the Kremlin will have to take to survive the current economic recession.
The Statue of St. George on the Manezh Square near the Kremlin in central Moscow. Photo: RIA Novosti
Due to the current economic crisis, the Russian government is seeking to cut budget costs and optimize the public sector. That much can be deduced from personnel changes at Vnesheconombank (VEB), a Russian state corporation that has no Russian banking license and is not subject to the Law on Banks and Banking Activity and some other regulations regarding state corporations, yet plays an important role in financing Russian economic projects.
VEB presents an interesting example of the instruments the Russian government could be willing to use to cut expenses and increase spending efficiency.
Rescuing the rescuers
On Feb. 26, Vladimir Dmitriev, the chairman of the management board of Vneshekonombank, yielded his seat to Sergey Gorkov, former deputy to German Gref, the head and chairman of the executive board of the largest Russian bank, Sberbank. The new appointment was caused by the difficult situation surrounding VEB, the largest government institution for economic development.
The key problems of VEB involved the overwhelming external debt that the bank was unable to repay due to the devaluation of the ruble and unavailability of Western capital markets as part of sanctions on Russia, as well as a number of bad assets, some of them related to investments in Eastern Ukraine. According to VEB's previous head, Vladimir Dmitriev, the bank needed $21.1 billion in state funds to stay afloat.
The government used VEB to transfer money to commercial banks during the 2008 crisis and finance construction projects of the 2014 Sochi Winter Olympics. This state corporation de facto served as the government's purse. It did not so much invest as distribute money. After 2013, this operating model had an adverse effect on the bank's financial indicators. In 2014, its losses reached $3.5 million, and in the first quarter of 2015, the bank lost another $1 million.
In his latest address to the Federal Assembly, Russian President Vladimir Putin pointed out that some development institutions had turned into "a pile of bad debts." The phrase is commonly thought to be a reference to Vneshekonombank.
In December 2015, Gref said that the government should wait to provide funds to VEB. In his opinion, it was necessary to figure out the reasons behind the bank's dreadful state of affairs, devise a strategy for overcoming the crisis, and only then determine the exact amount of state support for the bank. The head of Sberbank pointed out that Vneshekonombank was not supposed to perform regular commercial transactions, but had ignored that rule.
"Vneshekonombank grew a network of subsidiaries. If we assess the structure of its bad assets, they were largely acquired in an attempt, a failed attempt, to compete against commercial banks. This strategy led to the current situation where we have to rescue a institution that was created as a rescue mechanism," Gref said.
As the new VEB head, Gorkov will face difficult negotiations with foreign agencies and banks on the fulfillment of external obligations and business process optimization within the state corporation. So far, it is unclear what solutions Gorkov will have to offer. However, some experts are now saying that VEB’s changes are symptomatic of the government's resolve to increase the efficiency of state corporations.
The changing role of state corporations in today’s Russia
Anton Siluanov, Russia's Finance Minister, addressed the inefficiency of state corporation management at the Sochi Economic Forum held in October 2015.
"We need to diversify our state corporations," he said. "In Russia, we essentially have a state-run economy. And now we are using budget funding to support the state economy, which is completely wrong."
At the same time, he stated that the revenue from monopoly sectors should be put in reserve funds to help stabilize the Russian ruble.
Oleg Vyugin, the chairman of MDM Bank’s Board of Directors, argues that the widening of the state sector due to high interest income, which started in 2003-2004, lay the foundation for the current crisis. At the same time, the decrease in government participation in the economy does not necessitate the introduction of a savings strategy. Money can also be invested into various market mechanisms.
"Not everyone agrees that interest income should be stored, like they do in Norway, never to be used. There are many different spending options. The money can be used to widen the state sector, or it can be put to work through market mechanisms, such as accumulation systems, e.g. the investment part of the retirement plan," the banker said at a conference held at National Research University Higher School of Economics in April 2015. In his opinion, even infrastructure projects can obtain funding through market mechanisms. In an interview with Russia Direct, Vyugin was skeptical about the prospects of cutting budget spending.
"So far, we have heard that defense spending will be reduced by 5 percent, and some other articles of expenditure will be cut by 10 percent. I think that it will result in an average 5 percent decrease in total budget spending," the banker stated.
He added that cost reduction was not keeping up with the decrease in budget revenue, which meant that the government would have to use reserve funds to cover the deficit.
"There are plans [to cut budget spending], but it is too early to speak of any real results," Vyugin concluded.
A number of tools could help optimize state company operations, such as privatization, sale of non-core assets, and salary cuts and downsizing. The government is actively applying the first two methods in the state sector and so far has been steering clear of the third (for obvious political reasons).
Privatization of state companies can bring in $14 billion to state coffers this year, according to Siluanov. The government plans on selling 19.5 percent of Rosneft stock, 25 percent of Bashneft and 10.9 percent of VTB. The state also intends on selling its shares in Aeroflot, Alrosa and other companies.
Due to economic sanctions, foreign capital will have no part in the privatization, so the government is counting on non-state retirement funds (NRFs) and "strategic investors" that might include the leadership of major companies.
Nikita Maslennikov, the head of the Finance and Economics Section at the Institute of Contemporary Development, believes that the second scenario is the more likely one. In his opinion, NRFs could participate in privatization, but they have "a bunch of other goals." Besides, due to the freeze of the investment part of retirement, the system is short on money.
Maslennikov thinks that, under the present circumstances, the government is looking for "strategic investors" who might be interested in state assets as a means to develop their own business. Maslennikov notes that billionaire Alisher Usmanov put in a bid for Alrosa, and Lukoil could acquire a share in Bashneft.
Konstantin Simonov, the director of the National Energy Security Fund, emphasizes that the government sees the current privatization as an actual sale of shares to private investors as opposed to "shifting assets from one pocket to another." Anyway, the government is going to keep the controlling stake in most companies.
"There will be few sales of the entire state stock in the near future, at least this year, the largest being the sale of Bashneft, where the federal authorities plan on selling the majority stock and even give up the golden share, which will also increase the influence of private companies," Simonov says.
He believes that, in spite of the recession, Russia will not see radical denationalization, "I forecast that the private sector share will keep growing, but it is premature to speak of a radical new trend and the beginning of a sell out of state assets. The course of action will be pursued very carefully."
Sale of non-core assets
The government should approve the procedure for the sale of non-core assets by July 10. Among other things, the bill will define the asset profiling procedure, describe the cost assessment procedure and the evaluation of economic practicability of asset disposals, and in some cases, regulate the procedure for selling below the net value.
In the meantime, according to Igor Artemyev, the head of the Federal Antimonopoly Service, the disposal of non-core assets has been progressing very slowly.
"We are now dealing with complicated social infrastructure cases. For example, Russian Railways (RZhD) owns several hundred hospitals that sometimes are critical to the well being of entire districts. But when it comes to restaurants, amusement facilities, and sports teams, they all need to be sold," Artemyev explains.
Let us not forget that Russian Railways' non-core assets include a popular sports team (FC Lokomotiv) and a TV channel, RZhD-TV.
According to Maslennikov, the sale of state companies' non-core assets has less to do with budget cuts and more with cost reduction under the business process optimization initiative. Nevertheless, these measures should indirectly influence the state budget, for cost reduction will mean that state corporations require less state support.
Maslennikov is moderately optimistic about the matter.
"It is hard to estimate how successful this initiative is going to be, for it just started. But since it has been supported by political decisions, I think it will work. Our authorities rarely make such announcements unless they are positive that at least 50 percent of what was promised can be actually done," he says.
The government can influence the number of state company employees through boards of directors that vote in accordance with state directives. However, experts doubt that this instrument will be widely used.
"If the state decides to reduce the number of company employees, it can very well do that, but I really do not believe it will come to that. Why were there no social protests during the recession? The answer is simple. Because in Russia, unlike other countries, the unemployment rate is controlled by the state," the expert says.
He thinks that the state will try to avoid mass layoffs in order to prevent negative social fallout. Simonov cites an example. This year, the Russian automaker, AvtoVAZ, recorded major losses, but kept its staff. Only the company director was fired.
The analyst emphasizes that the government is not likely to conduct layoffs during the State Duma election campaign.
"The private sector will be growing, but not in a revolutionary or sensational way. The government will try to avoid firing state company employees because they are voters, and clearly, if they are laid off, they will not be able to get another job during the recession," Simonov comments.
In 2014, in his address to the Federal Assembly, Putin said that state corporation costs had to decrease by 3 percent per year. In fall 2015, the government was talking about 5-10 percent cuts and specifically indicated that, due to the deteriorating economic situation, cost reduction was no longer a recommendation, but a requirement.
It appears that state companies will have to cut costs mainly by selling non-core assets, making procurement processes more transparent and implementing independent auditing procedures for investment projects.
Cutting the salaries of top government officials
In March 2015, Putin signed the decree on salary cuts for officials working in the Executive Office of the Government and the Administration of the President, Ministers, Prosecutor General, Chairman of the Investigative Committee, Federal Security Service Directors, Foreign Intelligence Service, Federal Protective Service and Federal Drug Control Service.
In 2015, state officials' pay was supposed to decrease by 10 percent. In reality, according to the Federal State Statistics Service, Russian officials saw a pay raise of 2.3 percent in 2015. The average pay was $1,562 a month. The Executive Office of the Government was paid the highest. Its employees' average income amounted to $3,256 a month. The Administration of the President came in second with an average salary of $3,045 a month. Still, compared with 2014, these government bodies lowered their salaries by 7 percent and 6.5 percent, respectively.
The Investigative Committee experienced the most significant cuts, which reached as high as 57 percent. Its average salary is now only $659 a month.
Some government bodies are actually making more these days. For example, members of the Federal Assembly are now earning 42 percent more, State Duma deputies are earning 31 percent more, and the Ministry of Foreign Affairs saw a 30 percent raise.
Valentina Matvienko, the chair of the Federaion Council, the upper chamber of the Russian Parliament, does not have a problem with high salaries for government officials.
"Low-paid officials end up being very expensive for the country. Based on global experience, we know that in order to attract qualified professionals to responsible government positions, we need to offer adequate compensation," she says.
In Matvienko's opinion, low salaries lead to high turnover rate and deprive the government of the opportunity to motivate well-trained specialists, who then opt for corporate jobs.
Apart from salary cuts, the government is reducing the number of its employees. For example, in 2015, 110,000 Ministry of Internal Affairs staff members were fired under the ministry’s reform program. The layoffs did not include local police officers working in the field, but instead targeted administrative personnel, auxiliary services and, first and foremost, private security officers.
Similar measures were also taken at the regional level. For example, the Moscow government downsized by 30 percent.
"The government is clearly striving to save budget funds by introducing salary cuts in the public sector while trying to impress voters and send a message that officials are also suffering from the recession just like regular citizens," according to Ekaterina Schulmann, a political scientist and senior lecturer at the Russian Presidential Academy of National Economy and Public Administration (RANEPA).
In her interview with Russia Direct, she stated that outsiders did not necessarily have the right perspective on the steps necessary for public sector optimization. This lack of understanding manifested itself in the response to raising the retirement age.
"For officials, the raise [of the retirement age] is a plus because they are usually afraid of losing their jobs, and if someone has to be fired, the first ones to go are typically older employees. For them, this is an opportunity to keep government jobs for a longer period of time. Nevertheless, it is made to look like they are sharing recession-related hardships with the rest of the people,” the expert explained.
Schulmann is positive that government downsizing is inevitable, but regrets that it is often done rather carelessly. First, they get rid of vacant positions. Then they lay off employees that are past the retirement age. Finally, they terminate low-paid employees. The expert thinks that this approach is seriously lacking because she sees no correlation between age and worker efficiency and believes that excess employment is characteristic mostly of higher echelons of power.
"Our government is overstaffed at the top. I mean high-ranking officials and their entourage: secretaries, aides, press relations, PR, analysts, etc. A Deputy Minister is not just one person on a high salary. It is an entire network of auxiliary staff that also makes pretty good money. If we are trying to find extra resources for our economy, that is where we need to look. Not at the bottom, but at the top," Schulmann says.