The president’s address on budget priorities contains guidelines for financial and economic policies over the next three years. Looking at it more broadly, it also provides the orientation for all activities the country’s top economic leaders will undertake. In times of crisis, the role and importance of this document is rather substantial.
 
The signals included in this address will be in the news for a long time, since the economic and political priorities of both society and the market will be formed upon them. At the same time, there are three sets of issues we must address in the near future considering the tasks set before us. These are based on both tax and customs policies, as well as everything connected with money circulation – inflation and Central Bank interest rates, regardless of what kind of credit policies other banks pursue.
 
Tax Solitaire
 
Let us begin with taxes, since they form the basis of the budget. For quite some time there was an argument over whether it was best to lower or raise the fiscal burden. Especially heated arguments concerned the issue of the unified social tax.
 
It has been decided that the unified social tax will be replaced by social payments, but the overall size of the tax burden next year will not change; it will gradually increase thereafter. Businesses have been pushing hard for its decrease. In my view, the issue here is not so simple. During a crisis, it is not certain that businesses having extra money due to a decrease in social payments will immediately put that money to good use. The business environment and the long-term crisis trends are too unclear.
 
What should be done with the money? Save it, use it to pay off debts, or put it back into the business? And if businesses are to invest it, in what sector?
 
In my opinion, the budget address took this factor into account. It also gave a clear signal that it needs to be determined whether decreasing the tax burden is possible in order to mitigate the negative effect that the increase in healthcare and pension premiums has on taxpayers. Thus, unified social tax reforms will eventually be implemented, and tax remissions will be sought in other areas. Here I should mention VAT repayments, which appears to have become a hot topic. It has been called the most susceptible to corruption. This tax should be repaid, but all sorts of crazy things happen to exporters: large groups of entrepreneurs simply cannot get any money out of the government without the use of courts and protracted proceedings. If we resolve this problem, we would make life significantly easier for businesses, giving them a chance to develop.
 
But this leads us to another, no less important, question: how should businesses develop?
 
The budget address mentioned that “tax policy should be aimed at completing two fundamental tasks: modernizing the Russian economy and maintaining the necessary level of revenue for the budget.”
 
In other words, the entire package of tax measures on the one hand regulates and encourages entrepreneurs to invest in one sector or another and certain business activities; but on the other, it fills up or, conversely, exhausts the budget. Economic development will depend on the kind of policies the government chooses. This is true not only for the next several years but for the long term as well. The most important question is this: are we going to stimulate innovative sectors, and, if so, how? Without this, we can forget about their development, as innovation is doomed if it is not stimulated – through taxes and other means. Businessmen will not invest money in it.
 
At the same time, I am reminded of the position so popular in both expert and government circles: that we need to keep a careful eye on the state of the budget and our reserves. Also, as we are on the brink of a second wave of the crisis caused by defaults on bank loans, we need to put aside more money in preparation for this too. There is an answer to this as well: “we should not adopt measures that – though resolving short-term problems in individual economic sectors – could hamper long-term goals …”. We have recently seen a popularization of the view that we have two sectors which, without doubt, need assistance to be able to drive our economy out of the crisis. These are the fuel and energy and military-industrial complexes. But this is still disputable. In my view, it is not a hard and fast fact that these are the sectors that will be the drivers of our economy. The quality and quantity of what they produce, judged by international market conditions, will undergo major changes. It is perfectly clear that the modernization and diversification of the Russian economy should follow the path of innovative technology. Thus, it is necessary to stimulate nano, bio and information technologies, that is, the areas in which we can provide benefits for the world. Our patent policies are 20 years behind. We do not have the technologies other countries have – technologies that add value to GDP much quicker than, for example, metals, oil and other raw materials.
 
Another subject of heated public debate is the unfairness of the flat-rate income tax system – where both the rich and the poor pay the same 13 percent of their personal income to the state. This flat rate is unpopular with left-wing parties, while the authorities retort that since its introduction we have increased the income tax collection rate several times over. Before, people went to great lengths to avoid it – including off-the-books cash salary payments. Economically, the tax is also not a major source of revenue for the budget.
 
But politically it remains an important issue. And it is still a matter of interest to large groups of the population. If we leave the flat rate, we would be making a choice in favor of “equality in poverty and wealth”. But perhaps it is time to have the rich pay more in proportion to their income, as is done in other countries? I do not have an answer to this question.
 
As a citizen I am more inclined to vote for the latter. But I am no judge of what the state should do. I am just raising the issue with the hope of receiving an answer.
 
Customs as a Modernization Tool
 
The second set of issues of paramount importance for both beefing up the budget and modernizing the economy relates to customs.
 
In some years customs provided up to 40 percent of all budget revenue - a huge chunk. Import and export duties and other customs duties for years were seen by the authorities as a tool of “import-export taxation”.
 
But the situation has changed.
 
The G-20, at its meetings in Washington and London, and key economic think tanks have warned: protectionism in times of crisis is the worst method to use for fighting it. Protective measures to defend national economies and particular industries hinder world trade and seriously draw out the crisis. Unrestricted trade is precisely the tool needed to stimulate global economic growth. At least that is how the theory goes. But as soon as they get home, heads of state become the target of intense lobbying by large agricultural, automotive and financial groups.
 
Some 700 protectionist measures have been introduced by countries since the London summit, experts say, and Russia is no stranger to the trend. How is our country going to reconcile policies professed by G-20 declarations with the current domestic and international conjuncture?
 
The budget address did not provide any specific clues. Still, the business community is waiting for a clear signal as to how we are going to use customs. If customs will be used as nothing but a means for propping up the budget, it will create a big problem for both importers and exporters alike. It is no secret that there were duty collection plans (and tax collection plans) that took little account of the plans of companies. It was pay up and shut up, no discussion.
 
Lately, the situation has certainly started to change somewhat. But we still need to modernize further and make the tax and customs authorities learn civilized ways of doing their jobs. This is a very important part of the general modernization of our economic system.
 
As with taxes, we will have to pass between Scylla and Charybdis with customs. The finance ministry is responsible for the budget and it is only natural for it to press the customs to collect more duties. At the same time, customs pressure on imports of new equipment and goods that Russian producers do not produce must be brought down to a minimum. Otherwise, attempts to restructure an economy burdened with industries that are years behind their foreign counterparts will get nowhere.
 
Credit Is King
 
And finally, the third set of issues – financial regulation. Both bankers and the government are still engaged in a public debate on how to regulate credit. Small, medium and large businesses are whining about how expensive it is, with banks charging up to 25 percent interest. It is unthinkable to borrow from banks on such terms and repay everything within six months or a year. This by itself may precipitate a second wave of the banking crisis. Borrowers will not be able to pay back credit. There will be defaults and bankruptcies. And the state will have to replenish somehow or other the banks’ coffers.
 
A couple of weeks ago the finance minister said that we may have to provide additional support to banks in 2009 if the share of bad loans exceeds ten percent of all loans. But assessments of the situation today is different as there is no common measurement system. The Bank of Russia estimates the share of overdue loans well below ten percent. For the finance ministry they have already reached the critical amount. But the banking community and rating agencies view the situation as much more dramatic. Just a month ago, the figure of 18-20 percent [bad loans] was seen as conservative, and 30 percent as pessimistic. With the former figure, additional recapitalization of $26 billion would be required; in the latter – $71 billion. And recently suggestions have emerged, and not unfounded ones, that under the baseline scenario the level of bad credit may hit 35-50 percent, and in the worst-case scenario it could rise up to 60 percent. Certainly there are reasons to believe that this scenario will never come about and we will manage to avoid an all-out banking crisis. But 20 percent is still the level at which the banking system will stagnate, running on negative capital and dragging out the credit crunch and, consequently, putting off broad economic recovery until the very distant future.
 
Bankers say that credit will remain expensive while the refinancing rate of the Central Bank remains high. We are to return money borrowed from the Central Bank, and the latter explains that it cannot bring the refinancing rate well below the inflation, since this would simply result in lost money. The annual inflation rate is currently ay 12-13%. This is why the 12-13% interest rate is said to be normal. Bankers add that a further reduction would not lead to increases in loans taken out.

The reason does not boil down only to the interest rate. There is also the fact that banks do not trust their borrowers, since they are unable to predict how the economy will develop. What if the entire sector a borrower operates in becomes unprofitable in the post-crisis period? The Central Bank does not exclude the possibility that banks borrowing at a low interest rate will more actively gamble on the currency exchange. This would be more effective in terms of making money. However, they could also hold the cash back until the situation becomes clear.

This dispute as to a possible reduction of the interest rate and ways to cope with this issue is also crucial. On the one hand, this measure is inflationary: you reduce the Central Bank’s interest rate, funds become more affordable, more money gets to banks, which in their turn lend more money to the real sector and to the population. Inflation is gaining momentum. However, we cannot be sure that the money will safely reach the real sector. How should we stimulate credit activities under such circumstances?

Should we appoint Central Bank commissioners at banks? And not only at those managing to secure state support. And should they have the deciding vote when it comes to crediting the real sector?

Which Methods Should Be applied? Forced or Market-Based?

Here we will have to strive for a delicate balance. If the ruble maintains stability, we will have sound reasons to ask the Central Bank for a reduction in the interest rate. From a broader point of view, it is high time to decide in favor of structural reform of the banking sector, which presupposes its consolidation, giving up all obsolete and malignant elements, and treatment of entrenched issues like bridging the gap between assets and liabilities – currently hitting nearly four trillion rubles. We are to come up with a program of financial modernization, which would unite budget planning, expenses and tax policy with restructuring of the banking sector and development of the financial market, including formation of an international financial center.

The preparations would take six months, and starting from 2010 we should proceed with the program’s implementation.  We cannot afford to linger any longer.  Otherwise we will come out of the crisis (if the global demand for energy resources enables us to do so) with a more misbalanced and weaker financial and banking system than ever. The change in the principles of banks’ funding might become an element of such a program. It is possible to make the value of money lower than the official bank rate. The only condition is that banks are to finance the modernization of plants, enterprises and companies. In reality, this pattern is a certain restart of the hands-on control approach on the basis of strategic enterprises. I also think that we might have to boost the volume of state guarantees.

There are no easy solutions to any of these issues, but society and business must know which rules of the game will be in force, since it will be a crucial point even if some believe them unfair or somewhat irrelevant. The main thing is to have such rules. The variety of opinions and confusion existing between various business echelons, entrepreneurs and the state, make our task even more complicated, especially under crisis conditions, which only aggravate the situation.

Igor Yurgens, Chairman, Institute of Contemporary Development

These comments were published in Rossiiskaya Gazeta on May 27, 2009