Daily analyst comments

The new concept of the stabilization fund was voiced by Russian President in the budget address (March 2007) and was nearly in line with concepts of Finance Minister Alexei Kudrin. It was said that the Stabilization Fund of the Russian Federation is to be reorganized in the Reserve Fund (in order to ensure budget spending in the event of a considerable decline in crude prices) and the Future Generations Fund. Kudrin's concept provided for establishing the Oil and Gas Fund based on the Stabilization Fund and the O&G fund is to be split into three segments: current transfer (3.7% of GDP), the reserve fund (around 10% of GDP) and the future generations fund (the savings fund). In addition, the resources of the reserve fund are to be invested in the most liquid and reliable shares. The resources of the future generations fund were intended for more aggressive investments into high yield stocks, real estate and shares of international oil majors. A few days ago, Alexei Kudrin said the Future Generations Fund will amount to Rub 771 bln ($29.95 bln) by January 1, 2008. After that, its amount will be left unchanged. By 2019, the fund could play itself out. For many years, MinFin consistently banned spending the resources of the stabilization fund inside Russia and attributed this to the threat of inflation.

Formally, the President's address had the same structure. However, considerable adjustments were made in terms of contents. Vladimir Putin confirmed the split of the oil and gas fund into three parts:

1. The reserve fund (its functions include minimization of risks of the economy in the event of a steep decline in global energy prices, maintaining macroeconomic stability and reining in inflation).

2. Transfer to the federal budget to execute large-scale social programs

3. The Future Generations Fund (the savings fund) = the National Prosperity Fund. All remaining oil and gas revenues will be transferred there. The concept of this part of the stabilization fund was clearly revised:

Alexei Kudrin's concept – the Savings Fund performs the function of saving part of oil and gas revenue for future generations and ensuring stability of the budget system in the long term.

Concept of the President's address – the financial resources of this fund should be allocated to improve life quality of people and economic development. They should work to improve well-being of both future and current generations.

Therefore, the President not only proposed the new name of the future generations fund, but also formulated its different functions. The President not only lifted the barrier to using the financial resources inside the country but also proposed precise targets to use these resources:

1. Capitalization of development institutions (Development Bank, the Investment Fund, Russian Venture Company and Nanotechnology Corporation). A total of Rub 300 bln ($11.65 bln) is to be earmarked to these organizations and allocations are to be made for futuree periods. According to the president, development institutions are to finance projects devoted to resolve the following tasks:

   • elimination of infrastructural limitations to growth;
   • improving efficiency of subsoil use;
   • upgrade and development of hi tech industrial productions.
   
   

2. Resolution of problems in the pension system. Co-financing of voluntary pension accruals by citizens and formation of pension capital of citizens. The President mentioned doubling voluntary savings of citizens: "per every Rub 1,000 the state is to add another Rub 1,000" and these savings are to be invested with required returns and reliability in order to protect them from devaluation. In the future, the resources of the National Prosperity Fund could be spent, if necessary, to cover deficit of the Pension fund. Thus, nearly 40% of the scheduled savings fund (as of the beginning of 2008, it will amount Rub 471 bln ($18.29 bln) and not Rub 771 bln ($29.95 bln)) is to be allocated to capitalization of development institutions.

In our opinion, the concept of using O&G revenues to resolve key infrastructural problems of the Russian economy and protection of pension accruals, which we defended for several years, is a breakthrough for the stabilization fund concept. It is quite logical that the concept is shifted towards priorities understandable for many people on the eve of the elections. According to Alexei Kudrin, implementation of the initiatives voiced by Vladimir Putin in his address will require nearly Rub 750 bln ($29.13 bln).

We can also point to clear social announcements in the address, such as hiking average pensions in 2007-2009 at least by 65% and Rub 250 bln ($9.71 bln) state financing for programs related to the municipal housing economy (dwelling stock repair and support to emergency fund resettlement) including use of the proceeds from Yukos liquidation auctions (around Rub 400 bln or $15.54 bln). Needless to say, the idea of doubling voluntary pension savings looks attractive. However, we believe that clear-cut guarantees of protection to pension savings from the state would also be very important for depositors.

Let's have a brief look at key priorities of the coming years state in the address. They are expected to become key priorities of budget financing with attracting private investments.

1. The utilities industry: by 2020 Russia's electricity output is to be increased by 66%. In order to achieve this target, the state and private companies will invest nearly Rub 12 tln ($466.20 bln). A nuclear power corporation is to be established and major HPPs are to be built in Siberia and the Far East and the share of the coal-fired utilities is to be increased. In our opinion, the problem of genco shortage already exists and in the future, this could seriously hinder economic growth. For this reason, to resolve it is long overdue need.

2. Establishing an efficient transportation system (development of networks of motorways, bridges, railways, air and seaways, development program for airports, sea ports, upgrade of the Volga-Don and Volga-Baltic channels). In our opinion, implementation of Russia's transit potential is at issue, since the country can serve as a "bridge" between major economic centers of Europe, South-East Asia and Central Asian countries. In addition, infrastructure development is to increase inter-regional integration and economic potential of Russian regions and flexibility of labor resources.

3. Higher volume of processing mineral resources in Russia (oil refining, associated gas utilization, woodworking, etc.). The task was voiced by the President at the meeting with spokespersons of the Russian Union of Industrialists and Entrepreneurs in February and in the budget address. In our opinion, this is nearly the only real source of diversification and improving competitive edge of the Russian economy.

4. Considerably stronger volumes of housing construction and support to restructuring the municipal housing economy and emergency fund resettlement (see above).

5. Support to the Russian science. Priorities set in this segment came as a surprise for us. The president spoke of nanotechnologies (based on nuclear and molecular construction) as a key development segment for modern industry and science, which are to serve as a basis for ensuring "improved life quality of people, national security and support robust economic growth". Therefore, Russian nanotechnology corporation is to be established (to which the state will earmark Rub 130 bln ($5.05 bln)) and overall, financing of this segment from the federal budget will amount to nearly Rub 180 bln ($6.99 bln) which according to Vladimir Putin, is comparable with the overall amount of financing of Russian science! A total of Rub 48 bln ($1.86 bln) is to be allocated to fundamental research in 2008. Thus, huge financing is at issue for some megaproject, which promises impressive but only general results in the future and it represents the "black box" for most people, except for a narrow group of experts. We do not rule out that a key segment in the science can be at issue. However, we believe that the risks are associated with a weak scope of actual information about this project coupled with such huge amounts of financing.

Thus, in our opinion, the key economic concept of the State of the Nation address is a focus on upgrading the Russian economy coupled with further support to social programs. In the event that this strategy is put into action reasonably, we view it as more efficient than piling banal unlimited savings of budget petrodollars "for a rainy day" in financial instruments of foreign states and corporations.