8 April 2013

Sergei Storchak: Strike a balance between politics and sense

In an interview with the Rossiya 24 channel, Russian Deputy Finance Minister Sergei Storchak expounds on the problem of government borrowing in the global economy and on the solutions proposed by the G20.

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Question: Let's start with the main issue on our agenda - the public debt level discussion by the Group of Twenty. What do you think should be changed in the budget deficit and public debt management system?

Sergei Storchak: We recently held a seminar in Moscow on public debt management in the so-called non-conventional conditions in which the G20 countries have found themselves.

The conditions are described as non-conventional not simply because the accumulated public debt is too high. When I say too high, I actually mean the following. Until recently, in most developed economies, public debt was far below than 60% of GDP. Today, the G20 countries that are considered developed economies have reached a level of 90%, notwithstanding the fact that, according to the experts of the International Monetary Fund, once government borrowing crosses the 70%-80% threshold, it stops being a source of economic growth and no longer stimulates increase in job openings.

Consequently, at some point on its upward curve, public debt begins working for its own sake, like a ravenous flame, and something needs to be done about it. Actually, at this stage we have persuaded G20 to accept our belief that government borrowing issues need to be discussed professionally. This is reflected in the final declaration adopted by the G20 Finance Ministers and Central Bank Governors when they met in Moscow about a month ago.

Question: You mentioned non-conventional conditions. Some measurements have certainly changed, like the US sovereign debt exceeding 100%, while the UK has no problem refinancing its debt on the open market. Russia does not seem to have a problem either. So why is this issue so pressing in the first place?

Sergei Storchak: It is pressing because of the extremely low interest rates these countries are currently borrowing at. Experts, including Russian economists, believe that this situation - I mean the low borrowing interest - cannot last forever. One should bear in mind that low interest rates benefit sovereign states operating on the market. At the same time, they are also a headache for banks which need to make a profit to be able to pay interest on individual and corporate deposits.

No one can say how much longer customers will put up with deposit incomes at no more than 2%, and how soon they will start searching for better investment options for their temporarily available cash. This often leads to the emergence of pyramid schemes. I should say we are now past the stage where Russia was described as "a country of headlong investors." Yet, I must remind you that Cypriot banks have offered savers - including Russians - interest rates two or three times those offered in their home jurisdictions. They just showed a normal and perfectly natural desire to make more money. I would not like to guess at whether Cyprus has used some kind of Ponzi scheme or not. I think this should be an issue for their internal investigation, which is already underway, and they will certainly come to their own conclusions.

Question: Can we say that Russia, as a sovereign creditor, is not satisfied with such low interest rates?

Sergei Storchak: We certainly aren't satisfied, as a sovereign creditor and a country that would like to invest its sovereign funds. As an investor, Russia would like other sovereign states which issue bonds to pursue a clear policy that is predictable in the medium term- not just short-term. This is actually one of the new approaches used by the IMF in issuing borrowing policy recommendations to sovereign borrowers. The IMF encourages countries to compile medium-term programs which are public, well-grounded and understandable by a wide range of investors.

Question: There is one more problem which concerns both investors and borrowers - the interest rate risk. If interest rates change, as you said, the securities that we hold will fall in value. Borrowers will be hit too because it will be harder for them to refinance their debt. Do you think this would lead to any system-wide consequences?

Sergei Storchak: Yes. This will certainly lead to system-wide consequences by putting increasing pressure on the budgets of countries with large public debt. It is difficult to estimate whether their budgets will withstand this pressure. Moreover, this problem will come amid a market situation in which it is not easy to increase the tax burden on private corporations. The unemployment rate is hovering at a threatening level in many developed economies, where social tensions are likely to increase, rather than ease.

I do not think the international community should be indifferent to this, not after having gone through devastating wars and revolutions. The Group of Twenty is anything but indifferent, and I hope that we will be able to reach agreement and generate new and wiser recommendations for more reasonable and safer borrowing practices.

Question: What should the relevant international practice be like in that case, and what will Russia recommend within the G20?

Sergei Storchak: Just over ten years ago, the International Monetary Fund and the World Bank issued a so-called special manual instructing sovereign states on how to compile and implement specific borrowing plans. That document was based on the relevant experience of overcoming the debt crises amassed by emerging markets in the 1980s-1990s. It envisioned specific transparency levels for state borrowing programs, as well as a number of other criteria linked with this professional work. But we have lived through, and are living through, another situation in which previous recommendations have, to a certain extent, started contradicting new historical conditions.

For instance, there is a key recommendation that holds that the countries should strive to minimize the price of loans by sticking to a reasonable level of specific risks. This sounds a bit academic, but in reality it means that countries that are able to take out short-term loans should do so. And the current situation highlights refinancing risks. The experience of the last few years shows that the long-term debt structure, or the debt duration, to use the professional language, which is several years long (in reality, about 10-12 years), is more profitable for the debt stability of a sovereign country than the benefits of short-term borrowing. In the latter case, debt duration totals 18-24 months, or when the public-debt structure is dominated by short-term and cheap loans.

Question: Mr. Storchak, what recommendations can be issued to the G20 countries?

Sergei Storchak: First, a questionnaire will be compiled during Russia's presidency of the G20. Consequently, every sovereign state will be able to say to what extent it abides by International Monetary Fund and World Bank recommendations, and how these recommendations can be updated. I believe that this questionnaire will be rather detailed. It will be sent to public-debt managers of all the G20 countries. Quite possibly, we will even expand the number of recipients for greater representation. We will receive information for making all final decisions as to what best practices should be used in order to clarify and update these recommendations.

One specific recommendation stipulates commission for every state guarantee. The experience of developed economies shows that, first, the existence of this commission de-motivates bad faith and negligent creditors who, in reality, do not want to assess possible risks, and who want to earn quick and reliable money. Second, many commissions received by sovereign countries during the provision of state guarantees are a substantial source of national-budget revenues.

A representative of the Swedish National Debt Office recently delivered a candid talk on the provision of state guarantees in 2008, when financial markets turbulence had reached an all-time high. First, they did not use any single national state guarantee. In effect, it was not necessary to pay in line with those guarantees. And, second, I was most impressed by his statement that they had earned $1 billion through those operations.

This means that they combined the interests of borrowers and creditors, they helped them find each other, they restored trust, and they earned money. Many other sovereign guarantors or sovereign creditors could strive to accomplish this objective in the next decade.

Question: You have highlighted two very important aspects, which are usually not discussed, namely, the debt structure, including debt urgency, debt duration, average debt duration and the balance of issued sovereign debts, as well as state guarantees. But still I have not heard anything about the budget deficit. They usually say that the budget deficit must be curbed, and that public-debt levels must be limited. Are you paying less attention to these parameters because they, in fact, regulate nothing? Or are there some other reasons for this?

Sergei Storchak: Budget deficit issues are in line with a decision by Leaders that was made at the Toronto Summit. It was decided at the 2010 Toronto Summit that the Group of Twenty would go down a track highlighting a reduction in the correlation between state budget deficit and debt levels and the GDP by 2016. Although an agreement was reached, the situation proved extremely unfavorable for several states in terms of practical movement toward reducing these coefficients. The denominator in the debt-to-GDP fraction was not as impressive as had been expected. However, the numerator tends to increase because of the need to mobilize resources for stimulating this growth.

The G20 has found itself in this trap, while fulfilling its own obligations. This is a very serious problem, this is a Realpolitik issue, rather than a technical issue. I believe that Russia's mission as G20 President would be accomplished if the Group of Twenty managed to agree that specific recommendations linked with the reasonable borrowing practice should, in a certain sense, become binding for all political decision-makers.

Australia, which will assume the G20 presidency already on December 1, 2013, is also ready to work in this field. Australia also co-chairs another permanent G20 working group dealing with the international financial system. This group is responsible for the debt management and debt markets issues. As Co-Chair of this group and as future G20 President, Australia will inherit our initiative in a natural way. And this provides an even bigger hope that we will truly manage to find a reasonable balance between politics and sense in the context of organizing the sovereign borrowing process.