Can a state asset sell-off turn around Russia’s economy? Matvey Kaploukhiy for The Banker
As Russia continues to grapple with low oil prices and Western sanctions, the government's structural reforms and privatisation plans are designed to kick-start growth and balance the budget deficit. But is the time right to sell state assets? Stefanie Linhardt investigates.
In Russia, a country so heavily reliant on revenues from oil and gas that the rouble rises and falls with the oil price, the bulk of economic performance can be linked to hydrocarbons. And with prices still down by more than half of where they traded two years ago, the government is under increasing pressure to deliver an economic strategy for growth.
While Brent Crude oil (which traded at more than $100 a barrel in August 2014) has recovered from January 2016’s lows of below $30 a barrel, it remained below $50 a barrel as of August, according to data from the Financial Times. And with some 44% of Russia's fiscal revenue being oil reliant in 2015, the country's poor economic performance has come as no surprise.
Russia’s gross domestic product (GDP) plunged by 3.75% at constant prices in 2015, according to International Monetary Fund (IMF) data, and fell by another 1% in the first five months of 2016, according to Alfa Bank research.
Estimates for 2016 differ widely, from further GDP contractions of as much as 1.8% according to the IMF, the central bank’s expectations of a 0.5% fall, and Alfa Bank research stating its 0.3% contraction forecast for 2016 could change to close to 1% if “budget policy does not change” in the second half of the year. It blames spending cuts for declines in retail sales and construction. Yet, despite the cuts, the budget deficit is expected to widen to 3% in 2016.
Restructuring the economy
In this environment, and with Western sanctions against Russia extended until at least the end of 2016, the government is seeking to push through structural reforms aimed at diversifying the country's economy.
“We do need structural reforms in order to avoid stagnating growth rates,” said former Russian finance minister Alexey Kudrin at the Saint Petersburg International Economic Forum (SPIEF).
Mr Kudrin, now deputy chairman of the Economic Council under the President of the Russian Federation, added that “unless we engage in economic reforms and structural reforms, our growth rates may drop to zero” in the medium to long term as the Russian economy, which is “based on its oil foundation”, has “outgrown it already”.
To help with diversification, the government is seeking to support small and medium-sized enterprises (SMEs) in particular. They were given a central role at this year’s SPIEF, with calls to better support SME financing and include SMEs in public procurement.
Anatoly Aksakov, chairman of the Committee on Economic Policy, Innovative Development and Entrepreneurship of Russia’s State Duma (lower house), told The Banker he believes SMEs “should play the key role in the diversification of the economy” and he called for the state to “significantly” increase SME support.
Experts agree that SMEs could influence Russia’s growth if some adjustments to tax legislation were made and if a single legislative base was created for them. Mr Aksakov also sees a need to reduce the “administrative burden on business” and “develop necessary business infrastructure” to further support economic growth.
Across large and small businesses, among the industries that have so far fared the best in the sanctions environment are agriculture and the fertiliser chemical industry, substituting products that are not being imported as long as Russia’s ban on food products from western Europe persists.
Yet Mr Aksakov hints that the development of industries to substitute imports will also need international markets to open up, so that they can evaluate whether these new businesses are competitive internationally and thus able to support the economy in the long run.
Selling national assets
Another strategy the government is pursuing to support economic growth and a balanced budget is privatisation. This includes stakes in assets such as Russia’s largest oil company, Rosneft, its peer Bashneft, shipping company Sovcomflot and VTB Group, the country’s second largest lender.
In July, the government sold a 10.9% stake in the world’s largest diamond miner, Alrosa, for Rbs52.2bn ($816m). Alrosa’s Rbs65-per-share stake sale was done via a secondary public offering, a route that is not expected for any of the other companies.
For the part-privatisation of assets such as Bashneft, the government is likely looking to bypass the equity market and seek large strategic investors instead, according to Matvey Kaploukhiy, partner corporate, mergers and acquisitions, at law firm Goltsblat BLP. He says there are several routes that state asset sales can take according to Russian privatisation law: an auction, a tender or a secondary public offering (as in the case of Alrosa).
“But sometimes the government might not want to take the risk that some unexpected participants win a tender or auction process, so there is what I call a ‘back door’ in the privatisation law that allows assets to be sold through a private transaction if the government issues a decree,” he says.
The decree route has been used several times in the past, he adds. “It is not only about who is capable but who will be allowed by the government to take part in privatisations,” he says.
Often this means that buyers come from Russia rather than from abroad – largely for political reasons – although the benefits of a foreign investor would be additional money being brought into the economy, says Mr Kaploukhiy.
States of confusion
Chinese strategic investors might be welcomed in Russia, but their bids could come with conditions. China’s state-owned oil company, China National Petroleum Corporation (CNPC), has indicated it would want at least one seat on the management board if it were to buy a stake in Rosneft. CNPC said in early August that it was interested in bidding but had not yet received any offers to participate in the 19.5% privatisation.
In Bashneft’s case, fellow state-owned Rosneft itself was keen to take over the 50% stake on offer but at the time of writing it was unclear whether Rosneft was allowed to participate in the auction process – or even if the privatisation of Bashneft would continue this year.
With both companies being state run and on the privatisation list, some participants question whether Rosneft should be allowed to acquire the stake, as this would represent a transfer of assets from one state-owned business to another. The other main contender for the Bashneft stake was privately owned peer Lukoil.
All eyes on 2017
Herbert Moos, deputy president and chairman of the VTB management board – a company that is also on the privatisation list – thinks that “apart from the important objective of reducing the government ownership in the economy, the proposed privatisation of assets including VTB and Alrosa has a clear fiscal objective”.
“Based on the successful track record of the finance ministry of executing the budget better than the forecast deficits over the past few years, I believe if oil stays at current levels [of about $50 a barrel], this year will not be an exception,” he adds, indicating that there might not be a pressing need for further privatisations in 2016.
He adds that the picture could be different next year, especially if sanctions are lifted. “If sanctions are removed, privatisations will become a much simpler exercise,” he says – a view supported by several market participants critical of the timing of privatisations.
“It is easy to sell something at a cheap price,” says Vlad Khokhlov, a board member at Promsvyazbank. “The valuations today are skewed. There is an argument to develop assets further before privatising, to return more money to the budget.”
The Russian finance ministry expects the 2016 budget deficit to reach 3% with the oil price at $40 a barrel, and targets a reduction of about one percentage point in the deficit per year thereafter, to reach a balanced budget by 2019 or 2020.
The bulk of the tightening is expected to come from controls on spending rather than higher taxes – something one-quarter of the population know too well, thanks to the government’s public sector salary freeze that started in 2014.
But a reduction in the deficit is also important in the quest to reduce inflation and attract international investment into Russia. The May reading of consumer price index inflation of 7.3% is still far off the central bank’s target of 4% by the end of 2017. Central bank governor Elvira Nabiullina said at SPIEF that a key risk to achieving the target was “sustained expectations of higher inflation”.
“No one is going to invest in roubles in the long term if they are concerned that the inflation rate is so high [that] all of their profit will be lost on the price growth,” she said, adding that for this reason reaching the 4% target was important. Lower inflation would be supportive to the economy and would bring with it cuts in Russia’s still very high key interest rate (which at the time of writing was at 10.5%), both of which would help boost investment and stronger economic growth in the medium and long term.
But Ms Nabiullina stressed there was a clear link between budget consolidation, inflation and the interest rate, saying: “We are planning to maintain higher interest rates in order to obtain the 4% inflation target by [the end of] 2017 if the strategy of budget consolidation is not shaped in such a manner that we can
mitigate monetary policy.”
Yet, according to the Ministry of Economic Development, inflation targeting will only add about 15 basis points to the targeted long-term two percentage-point growth. The ministry aims for medium-term economic growth of 1.5% to 2% and long-term growth of 4%.
With such ambitious goals – and such diverse economic forecasts – the resolve of the Russian government and its future actions are bound to capture the markets’ attention.
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