JP Morgan joins Goldman Sachs in teaching Russia how to be a fair lady

Today’s edition of business daily reports that investment bank JP Morgan is about to take on the role of adviser to the Russian Ministry of Finance on how to improve the country’s credit rating. Russia’s current credit ratings are Baa1 according to Moody’s, and BBB according to Fitch and S&P. The Ministry’s financial management program forecasts that the ratings will increase to A3 and A, respectively, by 2016. JP Morgan will adapt the Ministry’s documents to suit the rating agencies’ requirements, clarify any contentious points, and maintain regular contact with the agencies. The details of the deal have not been made public and seem to be vague at this point, as this is the first contract of the kind for the Russian Ministry of Finance. Sources from the Ministry claim that JP Morgan will not receive any compensation for its consulting services, as “many banks help the Ministry of Finance on a voluntary basis in order to increase their reputation”. One might argue that the benefit for the banks is obvious – the ability to present the macroeconomic situation in the country to their clients in detail, as well as to gain access to other inside information presents an undeniable advantage.

At the same time, investment bank Goldman Sachs is already working on enhancing Russia’s investment image. However, Goldman Sachs is not doing it on a pro bono basis – it will collect USD 500,000 for the work that includes responsibilities that could lead to a more tangible immediate outcome: organizing meetings and establishing contacts with the investors.

The Ministry of Finance is in contact with the rating agencies only once a year or so, when it decides to float debt on the international markets. JP Morgan will maintain such contacts on a regular basis, which could result in higher credit ratings, as was the case with some other countries that made a similar move. A higher credit rating would be quite helpful to Russia at a time when a shadow of recession looms over its economy. Some experts estimate that the cost of borrowing might drop by between 0.25 and 0.5 percent. Last year, Russia floated 5-year Eurobonds at a rate of 3.3 percent, 10-year Eurobonds at 4.6 percent, and 30-year Eurobonds at 5.8 percent. An enhanced country rating would benefit major Russian companies as well, enabling them to borrow internationally at lower rates and, in some cases, increase their own credit ratings.

Some analysts believe that Russia’s country rating should be higher, as its central budget is balanced and the level of external debt is quite low – approximately 10 percent of the GDP. With a budget deficit of 0.8 percent in 2012 and international reserves of USD 512.4 billion, Russia has a lower rating than some of its peers with a significantly worse macroeconomic situation. However, the rating agencies have already taken the stability of Russia’s central budget into consideration and are more concerned about the structure of the economy. In its report, S&P wrote that oil and gas related revenues account for approximately half of the Government’s revenues, exposing the central budget to risks that outweigh the low level of debt. In order to reconsider Russia’s rating, Fitch requires the level of budget deficit excluding oil and gas revenues to drop from the current 10.6 percent of GDP to 4.7 percent of GDP. However, non-oil and gas deficit is expected to drop to 8.5 percent of the GDP only in 2015.

Credit ratings are not all that matters to investors. For example, Brazil has a similar rating to that of Russia, but its borrowing rate is 0.25 percent lower. An explanation can be found in Fitch’s report, where it is stated that Russia looks unfavorable compared to other countries with a similar rating in terms of the quality and efficiency of the government, the implementation of the rule of law, and corruption. Even the Vice-President of the Government Igor Shuvalov recently concluded that there are currently no grounds for the reassessment of the country’s rating. No investment bank can help the Government implement the kind of reforms that are required in order to enhance the country’s rating and image. A Government official stated that while Goldman Sachs’ weekly reports on investors’ reactions to developments in Russia did not induce the Government to reconsider any of its decisions, they did make the absurdity of the decisions more obvious.

Prime Minister Medvedev: absence of significant developments in the economy irritates everyone

Russian daily reported on Prime Minister Medvedev’s press conference in Sochi, where he talked about the Government’s results after a year in office. While certain macroeconomic indicators might be interpreted as a sign of stability – the budget deficit close to zero, low level of Government debt, low unemployment, – the state of the Russian economy is “lukewarm”, as Medvedev put it: there’s nothing good or bad going on.

Dmitry Medvedev considers the economic slowdown to be the main challenge not only to the Government, but to the society as a whole. He stated that while the central government revenues and the salaries in the country are increasing, there are no substantial developments in the economy, which irritates everyone. Medvedev had his honest moments in the past and was up to that standard when he stated that the positive macroeconomic trends in the previous year were not so much a result of the Government’s work, but a consequence of the recent positive economic cycle.  

On the other hand, the Government seems to have done quite a lot in the previous year: it implemented 111 presidential orders (out of 152 to be effected by the end of 2013), issued 3,906 of its own decrees, forwarded 269 bills to the Parliament (of which 113 passed the vote and are already signed by the President) and came up with a plan of activities until 2018, as well as the projection of long-term social and economic development by 2030.

Medvedev continued to quote positive developments, stating that approximately 400 large production facilities in Russia were modernized during the last year, with aggregate investments amounting to 500 billion rubles (USD 15.92 billion). Stimulus measures for the oil and gas sector should bring 45 trillion rubles (USD 1.43 trillion) in additional revenues by 2030. One of the major concerns for the Government, the situation in the mortgage market, still shows no signs of significant improvement: last year, the Russian banks approved 691,000 housing loans with a total value of one trillion rubles (USD 31.84 billion) and an average interest rate of 12.8 percent. In accordance with the presidential decree, the Government should strive to raise the volume of housing loans to 815,000 in 2018 and lower the interest rate to 2.2 percent above the Central Bank’s discount rate (currently at 8.25 percent).

Medvedev commented on the privatization revenues that the Government generated during the last year, saying that they were lower than expected, but are no longer seen as something “exotic”. The Government collected 217 billion rubles (USD 6.91 billion) from privatization in the last year and plans to generate 427 billion rubles (USD 13.59 billion) for the whole 2013. However, the Ministry of Finance expects that the privatization revenues will not exceed 60 billion rubles (USD 1.91 billion) in this year.

The struggle between the two opposite approaches to managing the central government budget continues as well. The President of the Russian Federation Vladimir Putin tasked the Government with taking all the necessary steps to speed up the annual GDP growth to 5-6 percent, but the Ministry of Finance expects that the Russian GDP will grow by less than half of that figure, approximately 2.4 percent. Such a discrepancy practically demands of the Government to boost investments from the central budget, which is the position shared by the Ministry of Economy. However, the Ministry of Finance is against financing large unprofitable projects in times of economic uncertainty. The decision on which approach to take is currently with the President, who promised to „put an end to this discussion“. The pension reform is another point of disagreement between the Government and the President.  At the beginning of May, President Putin complained that the Government still hasn’t come up with a transparent formula regarding individual capitalized savings. However, during his recent “direct line” with the public, Putin stated that regardless of his discontent with some of the Government’s decisions, it should be allowed more time to demonstrate its capacity.

Other interesting achievements of his Government that Medvedev mentioned were the construction of 70 new hospitals and clinics across the country, the reduction of waiting lists for nursery schools by 20 percent and the reduction of the number of convicts in Russian prisons from 818,000 in 2010 to 695,594 in April this year.  

The matter of trust in Russia

Russian business daily published findings from the „Eurobarometer in Russia“ report prepared by The Russian Presidential Academy of National Economy and Public Administration (, as well as the World Values Survey association ( study on the level of interpersonal trust in Russia. According to the reports, this indicator is on average 1.5-2 times lower than in Western Europe and the United States. 

The level of general interpersonal trust seems to be the lowest in Russian cities with a population exceeding 1 million. For instance, less than 1 percent of the surveyed in Moscow believe that people in general can be trusted – the lowest percentage in all of Russia. Three quarters of the surveyed across the country feel distrust and wariness towards strangers. In some relatively isolated communities, such as industrial small towns formed during the Soviet era, the level of distrust towards unfamiliar persons reaches a full 100 percent. 

However, the situation is quite different when it comes to interpersonal relationships with familiar people – family and friends. With the level of institutional confidence being notoriously low, Russians rely on their private social circles more than anything else. For instance, 44 percent of the surveyed stated that they would prefer borrowing money from family or friends in case of need rather than from the bank (16 percent stated the opposite). An average Russian citizen is able to raise 75,000 rubles (USD 2,390) from relatives and friends within three days. The percentage of those preferring to borrow from family and friends roughly corresponds to the percentage of those willing to lend money to a fellow in need: 42 percent of the surveyed stated that they regularly lend money to their friends and/or cousins, and they feel confident that they’ll get their money back. 

According to the studies, Russians tend to have a wide network of acquaintances, contacting with as many as 25-30 people on a regular basis. The most sociable 25 percent of the population regularly interact with between 40-60 people. Only 15 percent of the unfortunate ones maintain regular relationships with less than 10 people and are forced to rely on government institutions to a larger extent. It seems that necessity is the primary motivator behind the reliance on government institutions – individuals with a wider social circle tend to trust the institutions less than the less sociable ones. The studies conclude that the level of abstract trust (towards institutions and strangers) in Russia is very low, forcing the people to rely on family and friends both in their private and business relationships.

Small business in Russia – who is to blame and what is to be done

Russian weekly magazine „Russian Reporter“ published an interview with the Head of the Supervisory Board for the Russian entrepreneurs’ association „Russian Foundation“ ( Sergei Borisov, who contrasted the Russian Government’s imprudent measures with its desire to put Russia among the top 20 countries for doing business. The debate regarding the Government’s attitude towards small and medium business in Russia was spurred by the recent increase of mandatory social contributions that put as many as an estimated 300,000 small companies and entrepreneurs out of business since the beginning of 2013. 

Sergei Borisov is against the tax system that in effect filters out smaller businesses and individual entrepreneurs unable to pay the minimum social contributions prescribed by law. While there are forces within the Russian Government that are prepared to fight for every tax ruble – for instance, the Ministry of Labor recently requested to make social contribution tax evasion a felony – Sergei Borisov would like to relieve businesses with a monthly turnover of less than 100,000 rubles from paying any social contributions during their first year. The Russian Tax Administration claimed that 65 percent of the companies that closed their business after the increase of the mandatory social contributions weren’t operational anyway, but Borisov finds the figure arbitrary and believes that the President should punish the responsible officials who acted with gross negligence and ruined many businesses across the country. Borisov claims that there were instances when individual entrepreneurs were forced to pay contributions even though they were on maternity leave or serving in the army. As a result, after the Government increased the minimum social contributions for small businesses, approximately 100,000 new individuals applied for welfare benefits. Borisov wonders where does the Government intend to find the money to patch this new hole and warns that Russia might be approaching another recession soon. 

While the Russian Government seems to look down on entrepreneurs who are unable to meet the minimum social contribution payments, existence of micro-businesses is essential to many small, remote settlements. Borisov stated that the Russian Government provides approximately EUR 575 million for the support of small businesses annually, while France, with a population of less than half of Russia’s, allocates EUR 30 billion for the same purpose. The Government should also introduce minimum outsourcing requirements for companies participating in Government tenders, requiring them to place 20 percent of the estimated order value with small businesses. Instead, the Government seems to be much more concerned with big businesses, which is not surprising given its dependency on oil revenues and ostensible desire for modernization and innovation, which can only come from big companies with sufficient R&D budgets. Borisov argues that such attitude affects both the business and the political climate in Russia negatively. Government’s negligent approach towards the small business has already angered many entrepreneurs. However, Borisov argues against small business going into politics, as it would make itself too vulnerable in the environment with inadequate law enforcement and judicial capacities. In his own words, “I wouldn’t recommend anyone getting into that fight”. Borisov also hopes that the new Head of the Russian Central Bank will reconsider its strict monetary policy to make loans more accessible to the small businesses. He believes that the prosperity of Russian entrepreneurs is essential for changing the mentality of the population for the better.

Borisov’s interview is accompanied with statistics sourced from the “Russian Foundation” polls, showing a somewhat brighter picture compared to the previously quoted Global Entrepreneurship Monitor Report for 2012 (see previous blog post). According to the polls, 13 percent of the surveyed stated that they plan to open their own business. This figure is the highest in Ulyanovsk (21 percent), and the lowest in Volgograd (a mere 1 percent). 1.8 million small and medium sized businesses in Russia employ 11.48 million people, and 3.8 million individual entrepreneurs add 5.3 million jobs to the figure. The share of small businesses in the country’s GDP is estimated at between 20-25 percent.