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TO RUEHC/SECSTATE WASHDC IMMEDIATE 6769
INFO RUEHZL/EUROPEAN POLITICAL COLLECTIVE PRIORITY
RUEHXD/MOSCOW POLITICAL COLLECTIVE PRIORITY
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RHMFISS/DEPT OF ENERGY WASHINGTON DC PRIORITY
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C O N F I D E N T I A L SECTION 01 OF 03 MOSCOW 000496 
 
SIPDIS 
 
SIPDIS 
 
DEPT FOR EUR/RUS, DEPT PASS TO FEDERAL RESERVE, NSC FOR 
WARLICK 
 
E.O. 12958: DECL: 02/21/2018 
TAGS: ECON ENIV ENRG PREL RS ETRD
SUBJECT: RUSSIA'S RESERVES: A $500 BILLION QUESTION 
 
 
Classified By: Ambassador William J. Burns for reasons 1.4 (b/d). 
 
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Summary 
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¶1. (C) Russian government policy has been to use its windfall 
from oil and gas revenues to build large reserves, rather 
than to address the country's many domestic needs.  The bulk 
of Russia's reserves, which are approaching $500 billion, are 
held in low-yield government bonds in foreign currencies. 
The GOR has publicly maintained that this policy is driven by 
concerns over inflation and corruption but government 
officials acknowledge privately that psychological factors 
also play a role: specifically the GOR sees the reserves as a 
hedge against external shocks and as evidence of Russia's 
return to great power status. 
 
¶2. (C) The GOR's current plans are to further increase the 
reserves while directing most of the increase into Sovereign 
Wealth Funds that will seek investments with a higher rate of 
return.  However, pressure is reportedly building in Russia's 
private sector to begin using the reserves to address the 
country's deteriorating infrastructure and to reinforce its 
social welfare systems.  In the near-term, the main effect of 
this policy choice will be felt in Russia and whether to draw 
down the reserves to improve infrastructure and social 
programs could prove a key issue for Medvedev early in his 
presidency.  Longer-term, Russia's growing reserves and how 
they are used could also pose questions for the global 
economy writ large.  End Summary 
 
-------------------------------- 
Russia's Current Reserves Policy 
-------------------------------- 
 
¶3. (SBU) James Fallows, a Beijing-based American journalist 
wrote an article for the January 2008 edition of the Atlantic 
magazine entitled "China's $1.4 trillion question."  In the 
article, Fallows questions why a relatively poor country like 
China would in effect loan a wealthy country like the United 
States $1.4 trillion -- the total of China's reserves, most 
of which is invested in U.S. Treasury notes.  Fallows' 
article set us thinking about Russia and its reserves -- 
Russia's "$500 billion question." 
 
¶4. (SBU) Like China, Russia has a policy of building up large 
reserves.  As of February 2008, Russia has $481 billion in 
government reserves.  In absolute terms, this is the third 
largest total after China and Japan.  And like China, though 
there are rich Russians, Russia as a whole is relatively 
speaking still a poor country, ranking around 60th in per 
capita income according to most measures. 
 
¶5. (SBU) Unlike China, Russia's economy is not driven by 
manufactured exports.  Instead, Russia's reserves have been 
largely fueled by the government's share of rising oil and 
gas revenues.  Russia is the world's largest exporter of 
hydrocarbons, and energy prices have increased by nearly 400 
percent in the last ten years.  The GOR has stockpiled much 
of this windfall in government reserves, most of which are 
held in low-yield government bonds in a mix of currencies, 
including the U.S. dollar. 
 
¶6. (SBU) The oil and gas revenue has entered the government's 
reserves either through the "Stabilization Fund," which is 
controlled by the Finance Ministry, or into the Central 
Bank's traditional reserves via the budget surplus, 4.8 
percent of GDP, in 2007.  The Central Bank's reserves are 
currently by far the larger of the two components, with more 
than $400 billion compared to the $157 billion (as of January 
30) that has accumulated in the Stabilization Fund. 
 
----------------------------- 
Why Russia Has Large Reserves 
----------------------------- 
 
¶7. (SBU) Publicly, the GOR claims that the reserves are 
intended to "sterilize " the economy from the run up in 
energy prices and thereby prevent inflation.  The argument 
advanced by Deputy Prime Minister Kudrin and others is that 
had this additional liquidity found its way into the economy, 
it would have tipped a growing economy into an overheating 
one.  The IMF Resrep in Moscow seconded this argument in a 
 
MOSCOW 00000496  002 OF 003 
 
 
meeting with us and said the sterilization policy had helped 
to reduce inflation in recent years.  (N.B. However, he also 
said the main cause of renewed Russian inflation, which 
reached 12 percent year-on-year in January, was lax monetary 
policy and that the government's efforts to control it, 
including the build up in reserves as well as price controls, 
would not be successful without monetary tightening.) 
 
¶8. (C) The second argument advanced by the GOR for its large 
reserves, again often stated by Kudrin himself, is that the 
GOR is concerned that if the windfall from oil and gas 
exports were to be spent, official corruption would consume a 
large percentage of the funds.  At a January meeting of the 
Moscow G-7 Economic Minister Counselors, several of the 
western diplomats with long experience in the country 
supported both the inflation and corruption arguments but 
still argued that in economic terms it made little sense for 
Russia to maintain large reserves, especially in such 
low-yield investments, and particularly, in light of the 
country's many needs. 
 
¶9. (C) Vadim Grishin, Kudrin's aide, acknowledged to us that 
economically speaking it made little sense for Russia to 
maintain such high reserves.  He gave inflation and 
corruption relatively short shrift as explanations, instead 
arguing that the main cause was psychological.  The 
government elite needed the security the reserves provided. 
The crash of 1998, when the country essentially went broke, 
had been a searing experience for Russia's governing elite 
and they wanted to maintain a hedge against future shocks, 
such as a drop in the price of oil and gas.  Grishin said the 
government did intend to eventually use the funds to address 
the country's deficiencies, he specifically noted the pension 
system, but that implementation of these plans was still some 
ways off. 
 
¶10. (C) Another "psychological" explanation for Russia's 
large reserves is that it buttresses the GOR's claims to have 
returned to great power status.  The German Economic Minister 
Counselor said that he saw this as a key part of the 
explanation.  Russia uses its large reserves as visible 
evidence of its economic success and to support its claims to 
more influence in international economics.  Grishin 
acknowledged that this was also part of the explanation, 
noting that "political realties" had yet to adapt to the new 
"economic realties" internationally.  For instance, he 
complained that in Tokyo earlier this month, the discussion 
on financial markets had been by the G-7 rather than the G-8. 
 Given Russia's increasing weight in international economics, 
including its large reserves, it should have a greater voice, 
including within the World Bank and the IMF. 
 
-------------------------------------- 
What will Russia do with its Reserves? 
-------------------------------------- 
 
¶11. (C) There is reportedly pressure building among some 
Russian elites for the government to begin spending the 
reserves.  Igor Yurgens, the senior Russian partner at 
Renaissance Capital, recently told us that all of the young 
entrepreneurs and economists that he knows were 
overwhelmingly supportive of investing the reserves now, in 
particular in upgrading Russia's infrastructure.  Yurgens 
noted that former Minister of Trade and Economic Development 
German Gref, who had supported the current policy while in 
government, had now publicly called for spending the 
reserves.  And Yurgens predicted that Kudrin would also 
change his point of view if and when he left government. 
 
¶12. (C) Roland Nash, one of Renaissance's senior analysts, 
said driving this view is a sense that Russia's growth will 
begin to slow if infrastructure bottlenecks are not addressed 
and if Russia's human capital is not renewed.  He told us 
that much of the wealth generated in Russia over the last ten 
years could be thought of in accounting terms as 
depreciation.  Russia has invested very little in maintaining 
the infrastructure it inherited from the Soviet Union.  Among 
the results are crumbling roads, an overstretched electrical 
grid, and deteriorating ports and airports.  According to 
Nash, the country needs to invest upwards of a trillion 
dollars in infrastructure alone and still more in its social 
welfare systems. 
 
¶13. (C) Yurgens said the GOR may also begin to face public 
 
MOSCOW 00000496  003 OF 003 
 
 
pressure to spend the reserves.  He noted that the National 
Priority Projects in health, education, agriculture, and 
housing, which have been headed by President Putin's 
designated heir, Dmitriy Medvedev, were intended in part to 
provide political cover for the government's overall economic 
policies.  However, Yurgens, who has been part of a small 
commission advising Medvedev on the projects, said that to 
date few funds have been spent and the focus has been on 
relatively small "pilot projects" that have had little effect 
on society at large.  As president, Medvedev may face 
increasing calls to make good on his past NPP promises. 
 
¶14. (C) Despite this pressure, the GOR is unlikely to begin 
spending down the reserves any time soon.  In fact, a large 
increase in the reserves is more likely to occur, as Russia 
is about to change both the way it accumulates reserves and 
how it invests them.  Russia's 2008-2010 budget calls for the 
Stabilization Fund to be divided into two parts: a Reserve 
Fund and a National Welfare Fund, both of which but 
especially the latter appear to be Sovereign Wealth Funds. 
The Reserve Fund will henceforth accumulate all oil and gas 
revenues up to 10 percent of GDP (which would have been 
roughly $125 billion or so in 2007).  All remaining revenue 
from oil and gas over and above the 10 percent figure will 
accumulate in the National Welfare Fund.  The government 
budget, though deprived of oil and gas revenue, will be kept 
in balance through transfers from the Reserve Fund as needed 
through at least 2010. 
 
¶15. (C) If the GOR sticks to its current plans and energy 
prices remain high, the two SWFs, the Reserve Fund and the 
National Welfare Fund, could double in a year, and in just a 
few years, will dwarf Russia's sizeable traditional reserves. 
 The Reserve Fund, along with the Central Bank's reserves, is 
to continue to be held in low-risk, low-yield, government 
bonds as well as bank deposits.  However, the National 
Welfare Fund is supposed to undertake riskier investments 
with potentially greater returns.  Grishin told us that for 
the time being the National Welfare Fund would also be 
invested very conservatively.  It would not yet, for 
instance, be invested in corporate bonds, let alone any 
direct investments in enterprises.  Grishin added that the 
mix of currencies in which Russia put its reserves, dollars, 
euros, and pounds sterling might be altered to include yen 
and that the weight would also likely change if the dollar 
continued to lose value. 
 
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Comment 
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¶16. Russia's $500 billion dollar question, soon to be a much 
larger question, is whether the GOR will use its reserves to 
jump start a process of renewing its physical infrastructure 
and its social welfare systems.  Medvedev may have to decide 
whether to draw down the reserves to achieve some of the 
economic modernization and social improvements he has already 
outlined in public statements.  As of now, however, the signs 
are that the GOR is not planning to do so any time soon.  The 
effects of this policy decision are likely to be felt 
initially primarily within Russia, where the decision to 
further build up the government's reserves could prove 
unpopular with many Russians, who may begin questioning the 
government's priorities.  Longer term, if Russia follows 
through on plans to invest its increasing reserves more 
aggressively, it could have consequences for the global 
economy. 
BURNS