Whither the Russian Economy?

DATE: 17:00 – 18:00, Wednesday 14 March 2018
VENUE: Committee Room 4, House of Lords, Palace of Westminster, London SW1A OPA
SPEAKER: Dr. Sergei Guriev, Chief Economist, European Bank for Reconstruction and Development
EVENT CHAIR: Chris Bryant, Chair of the All-Party Parliamentary Russia Group

I am Chris Bryant and I am Chair of the All-Party Russia Group, which the Russian ambassador thinks should be a cheerleader for the Russian state and I think of more as an all-party group on Russia than for Russia. And so we meet at a very interesting moment on two fronts, obviously because bilateral relationships between the UK and Russia are, as everybody will know, at a very complicated state following everything that has happened in Salisbury – I must say that I personally thought the Prime Minister was pitch-perfect in the Chamber today. If there is anything I would have pushed her a bit more towards doing things around unexplained wealth orders and the finances of some of the Russian oligarchs who are parts indeed of the Putin government in the UK. I am being taken on a tour of some of the riches of the Russian elite around London next week, which I am looking forward to. And for many of us, I think, this moment is not only just a tragedy obviously for Sergei Skripal and his daughter and for all his friends, it is also a tragedy really because I think Britain and Russia should be countries that should be able to establish good relations. I personally, as many others in the House of Commons, have been working hard to try to improve relations over these years. It is just difficult when people start getting murdered on your streets and when there are many other signs as well of pernicious influence in British politics and what feels like an attempt to turn that which is good about an open, democratic, liberal society in on itself in the electoral cycle. They tried that in France and I think in Germany and in the UK as well.

But, this is also an interesting moment because it is bound to be a sort of general election in Russia. I say sort of, because it does not meet most of the criteria that most people I would think would accept to be the representatives of a free and fair election. And, you know, when not anybody, you cannot just stand because you want to stand, you have to get the certain number of people to sign up and all the rest of it. Well, we all know all the political problems there are in Russia. I will not get into that in great length, but the key element in many ways that determines a nation’s strength or its weakness is its economy. I was very struck once when I went to Nizhny Novgorod, how it felt like a ‘monogorod’, it was a town that only did one thing – cars. And not particularly good cars at that. This is perhaps one of the issues that Sergei is going to talk about, but the sense to in which that Russia is a ‘monogorod’ too, that it does one economic, it has one industry, which it either does well or badly depending on how you view that, and the dangers are inherent in it. I am struck that the Russian economy, unless I am corrected, is roughly similar in size to that of Spain, maybe a little bit smaller depending on the exchange rate and yet obviously covers a much larger territory and has much bigger resources and much larger population. Anyway, Sergei is going to talk to us now. I was a bit disturbed because it says in his biography: ‘Sergei is responsible for advising the President’ and I was thinking, well, which president is that but I realise that it is the president and other senior members of the bank’s management team on economic issues, namely the European Bank for Reconstruction and Development, rather than Mr. Putin himself personally. So, he has a long track record…

I used to advise the Russian president actually.

Yes, I was…

A different president.

A different president, yes, indeed. So without further due, Sergei, over to you. Thank you very much for coming and there will be plenty of opportunity for questions later on so I hope everybody will chip in. Sergei.

Please, thank you very much for arranging this. Before talking about the economy, let me say a few things about disclaimers and caveats. So, my job is indeed to be Chief Economist of the European Bank for Reconstruction and Development, which is an international organisation of which the UK is a shareholder, an important shareholder – Russia is as well – and as such, we international diplomats always stick to rules and job descriptions to not upset our shareholders. My job is to analyse and to talk about the economy. As a Russian citizen, of course, I have my own views, but here I represent the bank and I do not want shareholders of the bank to take reputational or other losses related to me walking away from my job description. We do have people in the bank that talk about politics and other things, but that is not my job. As we discussed when we set this event, when we arranged this event, I will talk about the Russian economy. My other disclaimer is actually personal, as Chris is going to board this bus and go on tour of various big houses, he will probably see a house which is owned by Andrei Guriev, whose name is spelled exactly as mine, and whose first name is actually spelled as the name of my son, Andrei Guriev. I should just say that we are not related, we are not even namesakes – these are different names in Russian, so whenever he sees that house he should remember that it is not me, it is not my family, it is not my son.

Well, you say that…  [laughter]

Just in case, just in case. At least that person, Andrei Guriev, believes that we are not related, and he never welcomes me in that house. With that in place, let me say a few words about the recent past and the state of the Russian economy as well as short-term and long-term perspectives of the Russian economy. Basically, what I am going to talk about is pretty much a consensus, which is shared not just by economists within the EBRD but also by economists in international financial institutions, and more or less in the marketplace. There are some investment banks that are more optimistic than we are, but all international organisations, pretty much, stick to the same view. This view is as follows:

Last year, recession in Russian economy ended. This recession was driven by pretty much three factors: the lack of structural reforms, which I am going to talk about in particular; the decline in oil prices in 2014, 2015 and 2016 from which actually all markets have recovered; and also, the introduction of various measures by the West and its partners in 2014 and later on, which increased the isolation of the Russian economy, cut it off global financial markets. This recession has been weathered by Russian economy, overall. Russian GDP declined with something like three percentage points during this recession and, basically, according to the data analysis suggests that out of these three percentage points, two or two and a half are due to the oil price collapse. The remaining half or one percentage point is due to what people in the press or in the public would call sanctions, or other measures that have constrained the Russian economy’s integration to the global economy.

What happens next? Last year, there was a lot of optimism in the first half of 2017. The Russian economy had a couple of good quarters. The second half of 2017 was not great, pretty much the Russian economy did not grow. Last year was not great, and the growth of the Russian economy will still be revised as we move through the first quarter, but basically, in 2017 we will see growth of 1.7/1.8 per cent and that is exactly what we forecast in our analysis. That creates a scope for credibility of our forecast going forward, which is again between 1.5 to 2 per cent in the years to come, so Russian GDP will not collapse. It will grow but it will grow at 1.5 or 2 per cent for the foreseeable future, which means, in our case, a couple of years ahead, and in the case of IMF, it is about four years ahead. The forecast is, as some people would call it, recovery. Some people would call it stagnation. Nobody will call it fast, in convergence with the West. The global economy, as you know, is growing faster – it is 3.5 per cent. Even the European economy is growing faster, the American economy is growing much faster and the Indian and Chinese economies are growing much, much faster.

So this is where we are. When people talk about possibilities to stimulate further growth, the tools that the Russian government has are actually quite limited. Without reforms, it is going to be very hard to accelerate growth rates. Economists usually think in terms of short-term measures that allow the economy to recover from cyclical recession and to catch up with potential growth. Whenever you are in recession you stimulate with monetary fiscal policy and the economy converges to the long-term steady growth rate. This is not what the Russian economy can do. Despite the slow growth, we believe, and this is supported by [inaudiable] analysis, that the Russian economy is actually at the potential rate. Russia cannot grow faster, because labour force participation is high, unemployment is very low, and it is very hard without investment in physical capital to grow faster.

Investment is low. Just to give you some numbers, in 2012 when Mr. Putin came into the President’s Office, he signed a number of decrees – the so-called May Decrees – on May 7 2012. Among other things, he signed his decree number 596 about long-run state economic policy, and that decree actually put some numbers on paper. One of those numbers was to raise investment from 21 per cent of GDP to 27 per cent of GDP. Now, we are now at 21 per cent of GDP. In the last couple of years, we were actually below 20 per cent. This has not happened – investment has not grown. The reason for that is, of course, the lack of structural reform; poor investment climate, high corruption, denomination of the state and the lack of integration with the global economy and no access to global financial markets.

We can go one by one, but basically, many things that investors were cheering in that May 7 2012 decree number 596 about reforms, privatisation, deregulation, investment in human capital, these things have not materialised. If you have questions, I will go number by number in that decree. For example, productivity growth was supposed to be in total of 50 per cent since 2011, the real number is, like, 7 per cent. That decree also promised to create 25 million modern jobs – this is a huge number for any country, even for Russia – in Russia, the total employment is 70 million. So 25 million is pretty much a comprehensive transformation of the industry and the economy that has not happened. Many things, which have been promised, would be possible if Russia implemented those reforms, but those reforms have not been implemented. That is why we believe that the status quo is what it is and that, without those structural reforms – without opening up the economy, without making it more competitive – growth will not exceed 2 per cent per year. Now, oil prices can recover and then growth will be a bit faster. Oil prices can go down and growth will be a bit slower, but this is the range – 1.5 to 2 per cent – where Russian growth rate will stay if oil prices stay where they are.

What does that mean for the budget? Indeed, Russia is a bit like a ‘monotown’ in terms of the budget. About half of Russian budget revenues come from taxes on oil and gas and other commodities, so when oil prices are lower the Russian budget is in a difficult position. Now what has happened over the last three years? The Russian government has undertaken a major austerity exercise – lowering pensions in real terms, lowering the salaries for teachers and doctors in real terms, and so on. That, of course, resulted in lower household incomes. Unlike the great recession of 2008 and 2009, which was mostly paid by the budget with the use of the stabilisation fund of the reserve fund, this time around, the burden of the crisis was borne by the households. Household incomes today are about ten per cent lower in real terms than three years ago. So, that has happened, and somehow the spending in real terms of the federal budget and of the consolidated budget has been brought down to correspond to oil prices at 14 dollars per barrel. Today, oil prices are much higher, and, actually, it is very likely that by the end of 2018, Russia will accumulate more money in the National Welfare Fund, which is the remaining sovereign wealth fund, than it has now, simply because the budget today is based on 14 dollars per barrel and oil prices are high. So it is unlikely that Russia will face a fiscal meltdown anytime soon if oil prices are above 14 dollars per barrel, which they are predicted to be. There is no reason to expect a macroeconomic disaster in the next two-three years, for sure. So that’s where we are.

Another issue is, of course, the monetary situation. Here, the Central Bank has done a great job on monetary policy; targeting inflation, bringing inflation down and actually bringing it even lower than the target of four per cent. Now, inflation is in the range of low 2-2.5 per cent. The Central bank has moved to the regime where it acknowledges that the Russian economy depends on oil prices. It acknowledges that the rouble should track oil prices and so, unlike 2008 and 2009, the Russian Central Bank does not defend the national currency – it allows the rouble to go up and down as oil prices go up and down. That allows the Central Bank to target inflation and the Central Bank lowered inflation to levels that have never been seen in Russia since 1991. Inflation is now at an acceptable level so this is good news.

Now, there are some bad news and the Central Bank deserves some criticism for this as well, which is that the Russian banking system is not doing well. We have seen major bank failures in the last couple of years, especially last year, and the Central Bank took over major Russian banks, the largest private Russian banks. Out of top ten banks, only one is a private bank. That, of course, is something that does not make us optimistic about the quality of lending, the quality of credit, the transparency and accountability of the banking system, but so far, the Central Bank has managed to address those issues without banking money, without a [inaudible] on the banks. It has enough firepower to address those issues and it costs everybody literally trillions of roubles, but so far there is no banking panic.

The next situation is what is going to happen after, three years from now or five years from now. Should we be more optimistic in the longer run? Suppose this government, or another government, reads its own electoral programmes and economic promises and says: we have promised to deliver reforms, we have promised to fight corruption, we have promised to be a member of the global economy, so let’s overcome the isolation, let’s invest in competitiveness, invest in human capital, let’s have state-owned enterprises exit the economy and let’s privatise and de-regulate. Other reasons to be optimistic: can Russia grow faster? Can Russia catch up with the more advanced peers and neighbours? If you asked me a few years ago, I would have said something like, well, Russia has a big advantage of high human capital – it is much better educated than countries with a similar income level. If Russia manages to fight corruption, it will converge up to levels of GDP that correspond to its level of human capital. You cannot have this mismatch between quality of human capital and low income that corresponds to a much lower level of development.

By now, I am a bit more pessimistic. The convergence may actually go the other way. Recent trends are not in the direction of fighting corruption and improving human capital. Recent trends are in the direction of destroying human capital, brain drain and increasing corruption. We cannot have a long-term equilibrium for a country to be so educated and so corrupt, so convergence may happen in the direction of fighting corruption, becoming richer and better educated or go the other way, destroying human capital, brain drain and staying as a less developed, corrupt and poor country. There is a lot of uncertainty beyond the next five years and honestly, I do not really know what is going to happen. Will Russia reform before it loses its competitive advantage of being educated or not? Human capital is something which is very hard to build over time, and that means that, if you think about Russia in 2030 or Russia in 2050, you want to invest in human capital now. Unfortunately, that is something that is not happening now. If anything, Russian economic, social, and educational policy is unfortunately not going in the right direction and I could go on and on about this but let me stop here and summarise once again.

The forecast for the immediate future is 1.5 – 2 per cent per year. Recession is over. Russian macroeconomic situation is reasonably stable. Incomes are lower than they used to be and incomes are unlikely to grow fast. In the long run, we have major uncertainty. I cannot really be too optimistic in the long run, even though there are many good things to say about the Russian economy and society. And I will stop here.

Thank you very much. Very interesting. It is an interesting set of concerns to have around productivity as well, some of these issues are mirrored in the UK. Likewise, I was struck when you were talking about growth levels and you were saying 1.5 – 2 per cent, well, I think the Chancellor yesterday predicted that we will be bumping along on 1.3 per cent for the next few years. Some of that is politically related. I mean, it relates to political decisions being made and I suppose you are saying the same about Russia. Is that right?

Well, there are two things I would like to say here. One thing is indeed, there are many things preventing Russia from growing faster and I am sure you can be much more open about political barriers to growth in the United Kingdom. I am much more confident that whatever political decisions are made in this country, this country is going to remain a democratic, prosperous and peaceful country with potential for productivity growth. Yet, I would like to say that this country is much more developed and we have the law of conditional convergence which says that the poorer the country the faster the growth rate should be. So it is normal that Russia should be growing faster than the UK, and should be catching up with the UK. A growth rate of 1.5 per cent for the UK is a good growth rate. For Russia, it is stagnation. If Russia grows at 1.5 – 2 per cent the next few years, Russia will be behind China in terms of income per capita. In five to ten years, it will be behind Kazakhstan in income per capita. Today, already, Russia is a low-wage destination. In principal, when you think whether to outsource to China or Russia, the east of China is now paying higher salaries than Russia. It would be normal if Russia was growing at five or six per cent, rather than 1.5 – 2 per cent. We should not compare growth rates in rich countries and less developed countries.

Very good point. Right, well, I am opening up to questions and there was a hand over there, which was the first I saw.

How can Russia maintain its level of defence spending?

Right, so Russia has reduced spending on defence relative to what was announced just two years ago. If you look at the Russian budget, it was always promised that Russia would spend more than 3.5 per cent of GDP on defence, but eventually, by the end of the year, until a couple of years ago, effectively they spent less because Russia has very strict budget regulations. Defence is, whatever people think in this city, normally the trillions that Russia want to spend on defence should go through the budget. That means very strict rules and it means that it is very hard to spend. It turned out, before a couple of years ago, that it was very hard to spend more than four per cent.

Then, in 2015, Russia made a bold move and started to spend more than four per cent, and then, Russia discovered that it cannot maintain four or 4.3 per cent of GDP spending and actually retracted it. I think we should assume that the budget of 2.5 – 3.5 per cent is sustainable. Indeed, I have mentioned that Russia has gone through austerity. It also cut defence spending, but it mostly cut, in real terms, pensions, teachers’ salaries, and the education budget. Professors are also not doing well.

All these things, in real terms, were cut. The budget deficit today is something like 2.5 per cent of GDP, which is completely manageable. Russia still has a sovereign fund of four per cent, and, as I said, if oil prices are above 14 dollars per barrel, which is going to be the case, Russia will actually build up the sovereign fund. So spending two per cent of GDP on the deficit is going to be easy. The current budget is stable in the foreseeable future. To what extent three or four per cent is a lot of money – we are talking about 60-70 billion dollars a year depending on the oil price – is that a lot? Is that a little? Is that enough to engage in this or that military operation? It is not a question for me. I am just giving you the numbers, dollars, billions, and so on, percentage of GDP and I guess people around the room can translate into whatever political or geopolitical implications. It is not my job to comment on this.

Okay, yes, I might take three if that is okay and come back to you. It would be helpful if people said who they were.

Thank you very much. Grant, from the Institute of Statecraft. I simply do not believe the Russian government on poisoning.

You don’t believe the Russian government?

I do not believe what they are saying about the poisoning. Just quick, could you just remind us – you mentioned the percentage of the budget is derived from oil and gas – what was that percentage?

In the last decade, the average would be half of budget revenue. In the proposed budget, which is based on 40 dollars per barrel, we are talking more about – so the total budget revenue would be 16 per cent of GDP – the direct oil and gas revenues would be something like, say, seven per cent of GDP. Then, of course, you have additional taxes coming from oil and gas firms, profit taxes and so on. But we are roughly talking about half, in bad years 40 per cent.

So roughly half the budget, and, sorry, the question was how sustainable or expandable are Russia’s oil and gas reserves? Taking into account, the climatic issues, sanctions and technology.

When you say climatic issues, just to understand the question, what do you mean?

The Arctic, how difficult it is, and, of course, US shale.


Okay, and then the gentleman there.

Arthur Lawrence [inaudible], World Bank consultant. After 2012, there were actually, the reason we left [inaudible] the business climate reforms. Interesting to know if you thought any of that was effective in any way. Also you mentioned [inaudible] I was wondering if you had modelled any of these reports on scenarios and if it is actually perhaps a reform party would favour any reform scenario?

With the austerity budget over the last several years, it has been suggested that the regions have been asked to shoulder a large amount of social spending and they in turn have had to both press local businesses for more tax, but more importantly, they have been borrowing more, but there is not a high deal of visibility about how much debt they are taking on. Could you comment a bit on that and do we potentially have a regional debt crisis in the making?

Okay, so on the first question about the expansion of Russian oil, so overall, even 40 dollars per barrel is still a good price for Russian oil, in the sense that Russian oil is still producing profits in [inaudible]. But your question is in capital investment, capital expenditure terms and basically, the industry is very divided on that. But the majority of industry analysts would say that Russia can actually peak next year, exactly because it does not have access to modern technology to invest in the Arctic for example. Indeed, as you rightly said, US shale oil is a major constraint on oil prices. Oil prices are unlikely to go to 80 and 100 exactly because US shale would expand privately. That is what industry analysts would say, but, of course, industry analysts four years ago believed that 110 is a good price and three years ago believed that 30 is a good price. There is at least a logical narrative regarding US shale expanding very quickly if oil prices go beyond 80, so 80 is very unlikely to be a sustainable price. So that is where we are. The Russian government itself does not really hope for a great expansion of oil output. In three year budget, in whatever long-term planning, they do not really expect Russian oil production and Russian quotas to grow.

On the question about reforms and the business climate reforms, the one thing that was promised and more or less delivered was doing business rankings. Russian President Vladimir Putin, in January 2012, announced that we are now ranked 120 in doing business indicators and we will be top 20 in 2018. In principal, you can say that doing business report 2018 have been published, it was published in September 2017, in that report Russia is number 35, which is great progress. A lot has been done. It has not brought capital flow, for a lot of other reasons, but at least there was a consistent effort to try to move Russia forward. I personally actually take some credit for this because the president of the World Bank was asked by some shareholders to revise the methodology and he put together a team of economists from around the world, myself included, asking to revise the methodology in 2013, which gave Russia something like 20-30 positions jump in these rankings. In that sense, it is not easy to compare, but still Russia is 35 this year. It is unlikely to be top 20 next year, but at least there is a major progress.

I am happy to talk about why this progress has not actually brought foreign investments. In general, we are talking exactly about investment climate, lack of rule of law, [inaudibale] judiciary system, and lack of restrains on what they call law enforcement agencies. As Mr. Putin himself and his own bureaucrats admit, law enforcement agencies, unfortunately, are involved in expropriating businesses rather than protecting businesses. Of course, this is a major issue. If you ask me what reforms should be undertaken, I think many counter-productive measures have to be withdrawn including all kinds of anti-trade measures the Russian government itself introduced. Also, Russia would benefit if it managed to convince its trading partners to remove so-called sanctions. And, of course, the Russian economy would benefit if the Russian government started to fight corruption, reform the judiciary system, reform the so-called law enforcement agencies and so on and so forth. In that May 7 2012 decree, the government also promised to privatise everything but natural resources and defence, and it has not privatised almost anything. We see that state-owned enterprises are not efficient, they require bailouts, tax breaks, and state banks get recapitalised over and over again. With the exception of Sperbank, other state-owned companies are not paragons of efficiency and productivity.

There was another question about regions. Regions are indeed in trouble, but if you add up the whole problem of regional debt, rating agencies believe that this is still not a big deal for the federal budget. For each region, it may be a problem. For each bankrupt region, it may be a problem but on the total, rating agencies are still quite happy about the Russian macroeconomic situation. They believe the Russian government can bailout the regions and everything will be fine. If you go to a region – Nizhny Novgorod is doing kind of okay – if you go to Kirov, they will tell you that things are not great and we do not have the money. But if you ask SNP, will that break the Russian system, the backbone of the financial system and macroeconomic stability down? The answer is no.

I am Kerry McCarthy, a Labour MP; I was going to ask about the trading relationships with other countries, what their balance payments look like. Obviously, the sanctions are a big problem, but is there an aspiration to sign more trade deals? Where are the main export markets?

I am Madeleine Moon, another Labour MP. Nord Stream 2, the cancellation by the Germans, how is that impacting? Is that going to damage their capacity to earn more for their oil and gas? Are less people willing to buy from Russia, is there a greater insecurity about feeling that they are a reliable source of supply?

I wanted to ask you also on the sanctions, and the effect they have on the Russian economy and more specifically. I am a journalist and I was in Moscow last week and it generally feels like a booming metropolis, it is not like a city under sanctions where there are weary what they spend. So in what sectors do you think sanctions can be effective or should they even be effective as it leads to more isolation and more plays into Putin’s hands in a certain way too?

On trade deals, so Russia is a member of WTO and Russia is a member of the Eurasian Economic Union. We hear a lot of complaints from other members of the Eurasian Economic Union that Russia is not always sticking to the commitments and playing by the rules or that particular trade arrangement. These are all countries with operations of ours, so we care for them a lot, as well as we care for Russia. [inaudible] says we are interested in prosperous, democratic, peace for Russia, as a Russian citizen, I also am. In terms of trade deals, whenever you say trade deals you probably think about something deep and comprehensive free trade agreement, free trade areas, and all kind of stuff like that. That is not really on the table, except for Eurasian Economic Union.

As I said, in principal, there should be no borders between Russia and other members of the Eurasian Economic Union but occasionally Russia engages in trade disputes with those other members. They thought they would benefit from accessing the huge Russian market and in many examples, they do, but in some cases they do not. And so, we hear complaints from Belarus and Kazakhstan, and some other countries, that Russia does not always respect the rules that this union put together.

Do you have an example of how they do not respect the rules?

[inaudible] restrictions on importing chicken, I just do not really remember – milk from Belarus, something like that, you know. Half a year ago, this milk is great, this year it is nothing. Somehow, you have special bacteria in that.

On other trade deals, so Russia is trying to engage with Asia, is much more active. It is not really trade deal, like the [inaudible], but it is trying to sign deals for pipelines, sign deals on Chinese investment in Russia, so that has been ten assignments, I think, between President Putin and President Xi Jinping. By the terms of tangible investment it is still in single digit, so there are many letters of intent, many memoranda of understanding, but if you actually look at actual investment it is still only [inaudible]. We do not know to what extent all these deals will go ahead. For example, one of the deals was the sale of a stake in Rosneft to the Chinese state-owned oil company, which has again been delayed. Things happen, delays happen. It is not really trade; it is more like bilateral deals between state companies and state companies.

On the pipelines, Russia has enough pipeline capacity to serve European market today. The problem is that some of this pipeline capacity goes through Ukraine and Russia’s relations with Ukraine, and in particular the relations between Gazprom and Naftagaz, is not great. Naftagaz is a large client of EBRD so I cannot really talk too much about this. But basically, Nord Stream 2 would not address an issue of abiding constrain of transit capacity. There is enough transit capacity now for Russian gas going to Europe. This is an issue between Naftagaz and Gazprom, which does not allow a smooth transportation of gas through Ukraine and, again, to go into details I would have to go into details of how Naftagaz functions and to politics, which is not my job. Economically, there is no need to build additional capacity for Gazprom. There is enough pipeline capacity.

But are people still willing to buy it?

Yeah. There is a market in Europe for Russian gas and Gazprom is exporting as much as it can to Europe. Ukraine stopped buying gas from Gazprom. You can also follow the decision from the Stockholm Arbitrage Court and see that now Gazprom owes Naftagaz a couple of billions. Gazprom does not like that. I do not know what is going to happen, but people in Europe are buying Gazprom gas.

And the last question was about the impact of sanctions. The overall impact of sanctions introduced in 2014 is not huge. At most, it accounts for a one per cent of GDP fall in 2015 and 2016, so it is not huge. It is a much bigger problem for the future of Russia. If you are an investor in the Russian economy, you do not really know what is going to happen. Will we have access to Western technology? Western financial markets? What your cost of capital will be? And this is why we do not really see an inflow of foreign direct investment in Russia. That is why Russian investors are taking money out. If you are thinking about a booming economy with many investment opportunities, and, honestly, Russia has many market niches, Russia has many industries you can invest in, and yet investment is not there. The reason for that is fundamental country risk, fundamental uncertainty. Part of that uncertainty is sanctions, and that is why I am not able to chart a vision, a long-term vision for the Russian economy, and the Russian government cannot do that as well.

If you ask Russian officials for a long-term forecast of the Russian economy, they will not give you something rosy or pessimistic. They will not give you anything beyond three years from now. I think that is a problem. Investors would like to have a longer view, and that is, of course, something which is missing. But, as I said, the Russian economy is growing, and Moscow is a quintessential part of this growth. One of the things, which, of course, shows the tangible growth, is real estate prices, and real estate prices are not growing, not even in roubles. It kind of suggests that things are not going as great as they were, sometimes, before.

At least estate prices for Russians still seem to be going up. So I have got JD at the door and then the gentleman here.

Thank you, Chris. In some ways, you have already answered this question in your previous response, but is there an additional message in relation to the current budgetary environment and how British industry might wish to take note of opportunities in Russia? Is it that the regions, and some of the more prosperous regions that you referred to earlier, are the way to go? Secondly, does the customs union in Kazakhstan and Belarus play an opportunity to divert this whole sanctions really, in one form or the other?

Hugo [inaudible]]. Do you think Russia will benefit from Chinese investment in Central Asia as part of its ‘One Belt, One Road’ initiative and how will the Russian economy benefit from all, or not benefit from, economic growth in Central Asia?

I am John Wright, from the FT. You said earlier that wages had gone down by about ten per cent, have you recovered at all in the last year or few, or expect them to recover? And how far does the gap between the very rich and the average incomes, or the poor, how far is that? Has it grown larger or has it dropped?

Let’s go one by one. On opportunities for British industries, Russia is a huge economy with low wages, and even with low wages it is an economy which is bigger than Spain, which is almost the size of Italy. It is a great opportunity, sure.

Does the current relationship impact on that process?

Of course, it does.

And adversity.

Of course, it does, adversity yes.

Of course, sanctions never promote an investment climate. I just said that the Russian economy is big, but you also want to be able to import intermediate inputs, parts, be able to travel there easily, to send your managers there and back. These barriers to investment – people movement, goods movement, capital movement – these are big challenges to the investment climate. In the long-run, if there is reform, if there is a reintegration of the Russian economy with the global economy, then, of course, Russia will be a great destination for British investment.

The customs union is no longer the Customs Union, it is the Eurasian Economic Union, which not only includes Belarus and Kazakhstan, but also other countries. As I said before, in principal, Russia sometimes does not like when it gets Belarusian oysters or salmon…

Foreign investors could invest in Kazakhstan and then those goods are tariff free to Russia?

That was the plan for Kazakhstan, and right now, foreign investors are sceptical about this because occasionally Russia erects barriers on the border, even though it is not supposed to do that. In principal, that was the idea, that you would have competition in terms of the business climate between Belarus, Kazakhstan and Russia. Investors would choose the better jurisdiction and access the whole market. It is not really working like this. You do not hear about British companies being excited about entering the Belarusian market and expanding to Vladivostok. I would say that there are many good things to say about Belarus and Kazakhstan, but there are also problems with the business climate in those countries. There are still problems.

The next question was about the Belt Road initiative. Russia, of course, benefits from economic growth in Central Asia, and peace and stability in Central Asia. Russia benefits from not having fragile states at its border. Whenever we, EBRD, invest, or co-invest with the Asian Infrastructure Investment Bank, in Central Asia, we also benefit Russia. Jobs created in Central Asia create stability and security in Central Asia and therefore create prosperity in Russia as well. Now, part of the Belt Road plans are not just for Central Asia but Russia proper, so we do not really work on those projects because we do not do any new business in Russia since 2014, but there are some plans. These plans are still on paper, but given that Mr. Xi is going to stay longer than people expected just a half year ago, maybe they will go ahead. Currently, there is much more activity in Central Asia than in Russia. But of course, these countries are neighbours and benefit from each other’s prosperity and security. As a Russian citizen, I am very happy that jobs are created in Uzbekistan.

The last question was about wages, wages and inequality. So, what I just said was today, wages, in real terms – household incomes in real terms – are ten or eleven per cent lower than in 2014. That is the fact. They have not recovered in the last half a year or a year, but they will recover. As recession is over, wages overall will probably grow with two per cent. Now, the Russian government just announced that, before the election, it would be paying teachers, doctors, university professors, soldiers, more. This is not what the budget believes to be sustainable. I would expect wages and incomes growing at two per cent a year.

The issue of inequality is a very big issue. I encourage you to check a paper by Filip Novokmet, Thomas Piketty and Gabriel Zucman. Thomas Piketty you probably know, Filip Novokmet is his student and Zucman is the author from Berkeley. They look at inequality in Russia and basically, they have collected data on inequality from many countries in the world and Russia is the most unequal country in terms of wealth inequality, not income inequality but wealth inequality. One of the numbers they produce, they suggest that Russian offshore wealth – and that probably matters for this country – is something like 800 billion to one trillion US dollars, which is as much as all Russian domestic household wealth.

They argue that this offshore wealth is owned by something like top 0.00001 per cent of Russian household. We are talking about tens of thousands of people, not millions of Russians. That is the level of inequality that we are looking at. Whatever measures of inequality, in terms of wealth inequality, you look at, you end up with this situation where Russians have taken abroad a lot of wealth, and enjoy returns on this wealth, so that is the measure of inequality.Has it increased in recent years? Their argument is that every year, Russians are taking money abroad, constantly and piling up this cash outside of Russia. That is the story.

I was in a meeting the other week with Mikhail Khodorkovsky and he was saying ‘you know, I hear people, they say bad things about Russia, that the whole of the criminal justice system is corrupt, this is not true – it is only two per cent of the criminal justice system that is corrupt – it is just that that is 40,000 cases a year and they are the big cases.’ I just wondered, certainly in the UK, one of the things that has made Britain a popular place for Russians with lots of money to have their assets and to do a lot of their business is because the rule of law. It is safe and secure. I presume that the obvert of that makes it more difficult to grow an economy if you cannot be certain that by the end of the year your contract will be adhered to.

Well, it is not only money that Russians have taken out of the country find their place in the Royal Courts of Justice. Some deals, which are conducted within Russia, sometimes are based on contracts, which are enforceable in London courts. You do not have to do business outside of Russia to come to London-based judges. You can still develop the economy and import judiciary services from the UK. That is also possible, but basically, I do not know the source of the data that Mr. Khodorkovsky is using.

In general, overall, measures of rule of law and corruption place Russia in a very low place, in all international rankings. Russia is much more corrupt than countries with similar levels of development. On judges, just a walk away from Russia, I would just say that Kazakhstan is now building an international financial centre in Astana. It is physically importing UK judges, so there is actually a court based on Common Law and UK judges, retired judges, will be arbitrating the cases between Kazakh investors, or international investors investing in the Kazakh economy. There are many models, but yes, there is a respect for the UK legal system.

Anybody else? Yes.

[inaudible]. What are the effects of Russia’s current foreign policy, militarily, on its economy, and could it afford large-scale longer-term engagements?

As I said, there is a budget, which foresees a certain demand of defence spending. This budget has a budget deficit of something like 1.5 – 2 per cent, depending on how you count, the primary deficit after servicing the debt. But basically, a two per cent budget deficit is affordable, so the current level of defence spending is affordable. Can Russia double the defence spending? The answer is no that will not be affordable. Can Russia increase defence spending by ten per cent or twenty per cent? Yes it can. I will leave it to you military and geopolitical specialists to say whether it is ten per cent you are talking about or twenty per cent, or you need to double or triple the military budget for doing something that you have in mind as Russia’s foreign policy.

So economic shocks are always possible, and in economic shocks, you tend to be forced into a pretty intense reform environment. Has there been enough [inaudible] in international financial institutions in Russian academia? I am not asking you to comment on Russian ministries or the Kremlin or whatnot. Just thinking about preparing for, perhaps the not completely unlikely high shock, high-pressure reforms scenario in Russia and what one might do?

Let me rephrase this question as a general question, not a Russia question. We operate in three countries and territories and we think in those terms, indeed. We see that some countries, at some point, realise that the status quo is not sustainable and we think about this as an opening for reforms. Not all of those openings take off, so not all of those are actually being used. There are dialogues that we have in many countries in our region, where we come to the government and we say, look you want to be in the same place in five years? You want to achieve higher incomes for your voters? The current system is not going to deliver. If you have an economic shock that drives this message even closer.

In some cases, governments say ‘let’s reform the business climate, let’s reintegrate with the world economy and let’s bring in foreign investors – what can we do, what can you advise us?’ We say, look, in another country, we did this and that brought growth – in another country, we did this and that eliminated corruption, so, of course, we do that. If you are asking the question about a specific country, our baseline scenario is that there will be no reforms in the next three years and growth will be 1.5 – 2 per cent. That is our baseline scenario and this is a consensus among international institutions.

All right, go on, I thought I had exhausted the room and we got like two minutes I think.

Well, this is going to be very quick. [inaudible], a private Russian watcher. I suspect most people here are Russian watchers. I am just curious, with permission of the chair, if everyone could just, a show of hands in the room, as to who is perhaps inclined to believe Russia regarding the poisoning in Salisbury – apologies it is not an economic question.

I am abstaining – this is a question for Chris.

All right, people interested to do that? Sort of, all right, who believes Russia on poisoning of Sergei Skripal? [laughter]

Should we have a vote on who does not? As, of course, that could –

All right, who does not believe Russia on poisoning Sergei Skripal?

Maybe a few abstainers.

No, not really. I am going to ask Andrew now to maybe say a few words as well as just asking a question, but I should say, incidentally, that I have had vast quantities of horrible things said of me over my life. In particular over the last few days because of the stuff I have said about Russia, some of it prompted by the Russian ambassador himself. But one of the things I often get accused of is being tied to this ferociously right-wing organisation, the Henry Jackson Society, and can I just say that over the years, the Henry Jackson Society, in the time that I have been an MP – there may be other parts of it that I might not agree with – but on Russia I think has been absolutely spot on. It has kept more MPs informed about the real situation in Russia on a wide range of issues in Russia than any other organisation. I do not suppose any of you in the room care about this, but I am not resigning or whatever – I am not even a member – but I am proud of my relationship with the Henry Jackson Society, not embarrassed by it. Andrew –

Democracy, freedom and human rights – what is there not to like?

Well, Scoop Jackson was not perfect on everything; it has to be said, but, Andrew –

Sergei, I wonder if I could take this opportunity to say we are four days away, obviously, from Russia’s presidential election – four days will mark the four years, the fourth anniversary of the annexation of Crimea. I wonder if you could, with your economic hat on not with your political hat on, what has been the impact of, in economic terms, the annexation of Crimea? How much of a cost has it had for the Russian economy and for the Russian budget?

This is something that I mentioned I think; it created an environment where Russia became isolated from the global economy and it created an environment where investors – foreign and domestic investors – lost confidence in the Russian business climate. I think, in principal, you could have imagined that in 2013, the Russian government suddenly came back to the promises it made in 2012, started to reform, and got back on the pro-growth, pro-reform trajectory. I think that in 2013, this opportunity was pretty much publicly rejected. In a sense, that was a turning point in many ways. I will stop here.

Right, well, we might be thrown out in a moment, of the room I mean. I just want to say, Sergei, I thought that was fascinating. You are a master of being able to deliver clear facts –

Economic –

Yes, there was no politics in it at all. I did not even see your eyebrow rise, with sort of wry commentary at all. No, seriously, I thought it was fascinating and really, really useful, and good to inform us about issues other than nerve agents, so Sergei, thank you very much.


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