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Analysis & Opinion
16.12.08 Bypassing The Banks
By Sergei Balashov

A new round of spending offered by the government focuses on the non-financial sector, since the banks failed to provide enough cash for the declining industries. However, this bailout is more directed at alleviating fear among investors and deterring possible social unrest than at actually improving the economy.

After making massive financial injections into the banking system and bolstering the ruble, the Russian government decided to turn to the economic fundamentals by working out a de-facto bailout plan for the non-financial sector. Last week, Prime Minister Vladimir Putin set up a task force comprising members of all the key ministries and large state-owned banks, including VTB, Gazprombank and Sberbank. This task force will be granted wide authority to dole out anti-crisis support to the enterprises involved in the non-financial sector, primarily to the so-called “strategic and city-forming” industries, which have been hit the hardest by the crisis. Overall, the companies selected to receive aid will comprise about 85 percent of the country’s GDP.

Putin lamented that the actual money either takes time to reach the industries or fails to do so at all, and that’s why it was important to directly support the companies rather than doing it through handing out cash to the banking system. Banks don’t trust the production and manufacturing sector enough to lend them the money they need.
The federal anti-crisis team and its regional peers are supposed to fix this problem. “If the companies receive the funding directly, this will speed up the process, and they’ll be able to use it much faster,” said the Vice President of the “OPORA RUSSIA” union of small and medium businesses Vladislav Korochkin.

Preliminary guidelines have been issued to help the committee pick the lucky ones who will receive the subsidies. The would-be recipients must have a turnover of at least 15-16 billion rubles, and a minimum of 4,000 employees. About 300 companies are expected to make the federal list, while the regional task forces, which, just like the top level, will include local authorities and banks, will add another 1,200.

Finance Minister Alexei Kudrin said that as much as $1.2 billion would be put aside to prop up the non-financial sector. When asked about the obvious parallel with the bailouts in the United States, Kudrin said that Russia would actually “go much further.”

The intricate bailout scheme offered by the government differs from that devised for the American automakers. In Russia, the support will take the form of long-term loans, interest rate subsidies, equity swaps and government contracts to ensure that the recipients do not become dependant on constant financial injections. These would dry out the reserves pretty quickly, and do little to help the producers preserve the existing production capacities and serve the market once the demand bounces back.

The economic crisis has caused production to fall, and tracking it back makes sense from some perspective. The Chief Economist at the Uralsib financial corporation Vladimir Tikhomirov however, disagrees, arguing that negative expectations could even make the industries run below the decreased demand, once the dust settles on the financial shortage. “The expectations could easily grow worse than the actual situation, and there could be a shortage if nothing is done,” said Tikhomirov.

According to Rosstat, production declined by 10.8 percent in November and posted a 8.7 percent decline year on year. December’s forecast is even worse, with an expected decline of some 19 percent.

The targeted industries will most likely include export-oriented fields such as metallurgy and oil and gas, among others. Vedomosti reported that agriculture is likely to get about ten to 15 percent of the anti-crisis pie, while aircraft manufacturer MIG has already received about $55 million worth of investment.

The so-called city forming companies will get the bulk of the aid, for a reason extending beyond pure economics. Many Russian cities are based on a single industrial entity that provides most of the employment. Even if they manage to stay afloat by opting for layoffs, the state could run into serious trouble. “This would cause major social unrest, which could quickly become a political matter,” said Tikhomirov.

The Magnitogorsk Iron and Steel Works could serve as the poster company in this case. Responding to considerable cuts in demand, it decreased production by 42 percent in November and opted for massive layoffs, spurring social protests. The protesters were supported by workers’ unions and the communists, who also participated. This effectively means that the money will also help deter possible social and political threats. “If we go by what the government says, then yes, it is more socially oriented,” said Korochkin. “It would make as much sense to bolster the demand by involving people in various off work activities and pay them for it so they’d have the money to buy from the local manufacturers,” he added.

At the same time, the troubled Russian small businesses were singled out, largely due to the structure of the economy. Virtually unchanged since the Soviet times, the bigger entities are still running the show, with small enterprises acting as subcontractors. By doing what it does, the state hopes that the money will eventually trickle down to the other sectors as well. “The policy is aimed at the large and medium sized corporations, and not at small businesses,” said Tikhomirov.

The support offered to the non-financial sector could help the government fight a possible recession. Last week, the Deputy Finance Minister Andrei Klepach argued that recession had already arrived, thereby attracting attention away from the world financial crisis and to the domestic production decline. If recession is properly defined as an annual decline in production posted in at least two quarters in a row, Russia will hardly suffer any harm from one. Production and manufacturing here takes a bigger share of the GDP than in the United States, standing at 26-28 percent against about 12. Still, the services, which account for the bulk of the GDP, are barely showing signs of a slowdown. But the very mention of a recession could cause more harm than the actual production falls and financial shortages. “This policy is also about fighting fear--it creates a situation where we get cash outflow. If banks see that the economy is still running and getting funded, they’ll have more faith,” said Tikhomirov.
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