“VEB Will Show a More Impressive Performance if it is not Diverted from its Core Activity”

Nationally significant, infrastructure, industrial and housing projects are funded by development institutions all over the world. Five years ago, Russia staked on such institutions establishing, in particular, a Bank for Development on the basis of Vnesheconombank of the USSR. Today, hundreds of major infrastructure, modernization or import-substituting production facilities construction projects are being implemented across the country. Most of them – with VEB’s assistance. Nevertheless, the track record of Brazil’s China’s and Germany’s development banks demonstrates that Vnesheconombank’s capabilities are not used to 100% yet for a number of reasons, Vnesheconombank VLADIMIR DMITRIEV told about this in his article specially written for the newspaper Kommersant.

Logic of Assets and Liabilities

In the past ten years development banks have been increasingly coordinating their activity with each other upgrading the paradigm of sustainable national and supranational development, project finance, corporate and social responsibility. To this end, international consortiums of development institutions are created, specifically, the International Development Finance Club, (IDFC) in the activity of which Vnesheconombank takes an active part.

Regular contacts between development banks of various countries help to thoroughly study their track record. Many of best practices used by our colleagues abroad might be effectively adopted in Russia.

Let’s look, for example, at the Brazil Development Bank – BNDES. This is the country’s leading financial institution responsible for providing long-term financing in line with the Brazilian Government’s strategic priorities. In 2010, it was ranked second among development banks of BRICS countries (after the China Development Bank). More than half of its liabilities are formed by two Brazilian state-run funds – Brazil’s Workers Support Fund (FAT) and the PIS-PASDEP FUND. These Funds are financed through tax payments from the labor remuneration fund made by employers. In their turn, the Funds deposit a significant part of accumulated financial resources in BNDES at a preferential rate that is lower than a market one. Such deposits’ maturity is 30-40 and it exceeds maturity of any market financing sources thus enabling the Bank to work the most complicated projects with long payback periods. Therefore, BNDES has no problem funding. For example, in 2010, BNDES’ capital increased by 2.5 times through using government budgetary funds. Financial resources were made available to support investment projects under the Growth Acceleration Program (PAC) and the Sustainable Investment Program (PSI).

BNDES’ example demonstrates an inexorable logic of its liabilities to assets ratio. Given that investments made by a classical development bank go by definition beyond purely market projects, it’s logical that sources of funding a development bank can’t be purely market ones.

It should be noted that at present this operating logic isn’t being followed to a full extent as Vnesheconombank has a significant portion of purely market liabilities. After the state’s contribution to the Bank’s charter capital VEB didn’t receive any budgetary or quasi-budgetary resources not directly linked to specific projects. The Central Bank’s deposits placed with the Bank are paid ones – the Bank makes interest payments on them in the amount of 13 billion rubles per year.

And VEB’s assets are largely non-market ones. These are investments in projects whose payback periods are a lot longer than average market ones but they have high social externalities. All over the world, high social externalities of infrastructure and economic projects are funded by taxpayers.

In this sense, Vnesheconombank set a precedent: it made a number of successful borrowings on domestic and foreign markets and this allows the Bank to undertake its core activities. At the same time, some alarming signals we received from the market at the end of 2011 show that for the Bank to develop continuously and fund investment projects it is extremely important to have room for maneuver. In our opinion, one of such opportunities is to expand the list of instruments for investing pension savings funds as well as financial resources of the National Wealth Fund. We discussed this issue at a collegium of the Finance Ministry in April of 2012. We believe that it makes sense to include infrastructure bonds into VEB’s investment portfolio. It’s of primary importance to use resources mobilized through issuing the said bonds in a strictly targeted way against direct guarantees of the Finance Ministry.

We need to connect the country

It’s pretty logical to use infrastructure bonds for building railways. In this sense, China and the China Development Bank are success stories. The China Development Bank (CDB) is designed to extend credits at low interest rates to fund infrastructure and basic economic sectors. China’s National Development and Reform Commission is responsible for selecting facilities for funding. One of CDB’s priorities over the last years has been to fund the construction of a high speed railways network. In terms of high-speed railways mileage (about 8 thousand km) China is ranked first in the world today. The amount of funds that CDB invested in the construction of national railways was $25.7 billion by the end of 2010. The following railway lines were built – Guangzhou – Wuhan line with a mileage of 1068 km and with an average commercial train speed of 350 km/h (maximum speed is 394 km/h), this speed is a lot higher than that of high-speed lines in Japan and France. The key funding source of these and other sectoral investments is CDB – it issued special bonds - the so called policy banks financial bonds.

We have also high-speed railways construction projects in Russia but their practical implementation is hampered by problems associated with raising funds. OJSC RZHD’s investment program deficit only for the coming years is estimated at 400 billion rubles and a scheme for closing this deficit through issuing infrastructure bonds with state guarantees hasn’t found any support so far. At present, an estimated amount of investments in the high-speed rail project-1 – a railway that would connect Moscow and Saint-Petersburg is 500-700 billion rubles. This project’s funding is not allowed for in the federal budget for 2012 and 2013. In our opinion the said deficit might be closed through issuing infrastructure bonds.

Skeptics say that if these bonds are not secured by direct and full guarantees their investment appeal will be low. But the world’s experience in funding infrastructure projects is pretty considerable. In particular, such infrastructure bonds can be secured through using tax increment financing generated as a result of implementing projects.

Financing requirements of Russian project-initiating companies are extremely high and they of course exceed Vnesheconombank’s current capabilities. And in connection with this we believe that it is of overriding importance to maximally concentrate the Bank’s resources on undertaking its core activity and reducing the amount of its non-core activities. Unfortunately, at present we often come up against important and responsible objectives that must be accomplished but they are not fully in line with the Bank’s core activities.

Frontal coverage

As opposed to Vnesheconombank, Brazil’s BNDES hasn’t factually any sectoral restrictions in terms of sectors where it can invest funds. VEB’s Memorandum on Financial Policies bars Vnesheconombank from investing credit resources in oil production but BNDES is actively lending to Brazilian oil companies, specifically, to Petrobras and mining giant Company VALE. It also funds bioethanol production projects, beef stock farming as well as power engineering and high technologies.

We can say that although sectoral restrictions in Russia are justified because the country seeks to overcome its dependence on raw materials we believe that another restriction that BNDES doesn’t have is unnecessary. Here we mean that companies that receive BNDES’ financial support can be controlled even by foreigners. The only principal requirement is that they must be registered in Brazil and have their headquarters and corporate governance bodies on the country’s territory. It is an instructive example of creating a clear incentive for refusing to register  companies operating national assets  in offshore zones.

Stages and sequence of removng industrial and scope constraints on businesses and projects supported by VEB are a matter of serious analysis and discussion. Vnesheconombank has already initiated the removal of a 25 percent limit on foreign ownership in those SMEs that receive support from Vnesheconombank Group, including through our subsidiary SME Bank. Relevant discussions with legislators are already underway.

Another aspect of our business, which requires thorough consideration, is a kind of problem faced by medium-sized enterprises. The fact is that a lower limit of loans amount granted by Vnesheconombank directly to end borrowers, is today 1 billion rubles. At the same time, an upper limit of SME loans, refinanced under the program of our subsidiary SME Bank is 150 million rubles. As a result, all mid-term loans ranging from 150 million to 1 billion rubles are regulatorily excluded from the area of our expert examination and support, although in this range of loans there is a huge loan gap that can’t be closed by commercial banks.

There may be different solutions to this regulatory conflict. They might include additional capitalization through using budgetary funds, and expanding the functions of SME Bank (Vnesheconombank has already decided to transfer 10% of its profits to SME Bank each year). However, international practice suggests that we should create a special mechanism, a special window to provide support for the fast-growing medium-sized enterprises. For example, BNDES has a program of opening automatic credit lines - BNDES Automatico. Credits are extended through authorized banks and organizations for a long period of time with a grace period. Therefore, this is another possibility, which we use in our practice, that is, a creation of specialized structures to support medium-sized enterprises. VEB is currently holding negotiations with German corporation KfW to establish a fund which would meet financing requirements of medium-sized enterprises. At the same time, we are actively cooperating with the Strategic Initiatives Agency, which supports medium-sized enterprises. At the same time, there is no doubt that this line of activity should be improved.

It would be wrong to think that development banks’ activities focus exclusively on mega projects in infrastructure and heavy industry sectors. The most important line of their activities is to provide support for housing construction and development of housing market. In this respect, business experience of the German development bank, Kreditanstalt fuer Wiederaufbau (its assets as of the end of 2010 were $591 billion, second place in the world) is extremely instructive. It is worth noting that KfW is the largest issuer of corporate bonds in Europe, with all its borrowings being covered by a sovereign guarantee.

There are currently ten programs of KfW to support and develop housing stock in Germany. Their total financing amount in 2010 reached 18 billion euros. The programs are aimed primarily at energy-efficient modernization of housing stock, and at adapting housing for the elderly, energy-efficient construction and maintenance, assisting in acquiring stakes in housing co-operatives.

It is important to note that KfW does not provide funding for all these programs directly to consumers, but through refinancing commercial banks and specialized financial institutions.

VEB’s support for the housing market today is limited to relatively small amounts of bonds that it buys out from the Housing Mortgage Lending Agency and bonds of commercial banks, secured by pools of standard mortgage loans, with the said bonds’ limited yields (weighted average coupon yield of not more than 7% per annum). The severity of the housing problem in Russia today, where 60% of its population is unable to improve their living conditions in a market or non-market way, and 15-20% of households have to live under one roof, makes it necessary for Vnesheconombank to step up its efforts in this line of activity. It seems justified to expand forms and ease terms of VEB’s refinancing commercial banks’ mortgage lending programs.

Hard-won victory

In the coming years, Russia will embark on a massive re-industrialization. In this regard, it is obvious that the Bank for Development will play a significant role in this process: we have gained extensive experience in arranging for financing large-scale and very complicated projects, we have an excellent reputation that enables us to arrange for borrowings on unique terms and we set up Vnesheconombank Group which is capable of taking various measures for diversifying the Russian economy.

At the same time, in order to achieve major and ambitious objectives we need to maximally concentrate all our resources in the most efficient way. I am sure, Vnesheconombank will be able to show more impressive results if it is not diverted from its core activity and legislative restrictions in its activity are eased and it is given a chance to use monetary resources at the state’s disposal in the most efficient way. And in this case, the last component of success will be prioritization: we need to choose several sectors in which Russia hasn’t lost its competitive edge and base new reindustrialization and modernization on them. In this respect, it makes sense to look at Brazilian company Embraer’s track record. It has been trying to become a member of the world’s elite of aircraft manufacturers since 1969. The company became successful only in the mid 1990s when it concentrated its efforts on creating small regional aircraft having frozen for the time being all other lines of development and manufacturing. Having produced its first aircraft in 1996, the company started to energetically tap the national market gradually going beyond its limits and establishing distribution centers in the U.S., Asia, Europe and even in Africa.

Embraer was among the Brazilian Bank’s top-priority projects for many years being one of the largest and credit recipients and the main beneficiary of the support program. Moreover, BNDES’ support for Emraer was not limited to money alone. Having locked horns with Canada’s Bombardier in a fight for air carriers’ orders throughout the world, BNDES managed to beat off Canadians’ claims fraught with severe sanctions within the WTO when they accused Embraer of enjoying government subsidies. Investigations and negotiations reached a deadlock when Brazilians put forward convincing arguments that Bombardier used similar but although intricately structured preferences from their government.

Today, Embraer’s planes are operating in airlines of many countries including CIS and Russia competing fiercely with Russia’s new regional SSJ-100 aircraft created with Vnesheconombank’s financial assistance.

Embraer’s success story shows that it is extremely important for development banks to conduct expert examination of projects they fund at the initial stage of their development and then support export expansion of proven industrial models and it also confirms that we should concentrate our resources on boosting competitive edge. There are a number of efficient sectors in Russia such as its defense industry, aviation industry, pharmaceutics, power engineering industry, space technologies. If we stake on them we’ll succeed.

Specifics of model or growth ceilings

A choice of operating model used by a development bank has its pluses and minuses. I have already mentioned that unlike leading national development institutions whose resources are replenished by the state on a regular basis, VEB has to replenish its resources through raising funds on the market. And the Bank does not have current accounts of corporate clients and natural persons. The Bank is not allowed to compete with commercial banks. This requirement was formulated and set forth in Vnesheconombank’s Memorandum on Financial Policies. This means that Vnesheconombank’s financial capabilities depend on the conditions of world financial markets and the Bank itself is audited by international companies and rated by international rating agencies and the cost and potential amount of borrowings depend on our balance. Despite the unfavorable market conditions in the past four years, VEB has been doing pretty well on the borrowings market. Up until now the Bank has been able to make borrowings on the most favorable terms and factually VEB managed to borrow as much capital as it needed. But it’s obvious that the Bank’s borrowing capabilities and hence its investment potential depend heavily on market conditions and any deterioration in the global economy will immediately trigger increased competition for credit resources and toughen policies of international issue centers.

We have often heard that VEB could replenish its investment purse through selling a number of its assets and above all non-core assets it received during the 2008-2009 crisis. They offer us to get rid of Globex Bank and Svyaz-Bank before the end of the current year. We are sure to withdraw from these banks capital but we’ll do it when we are able to generate proceeds for them and for problem assets bought out from their balances that are no less than the funds we spent to purchase them in order to avert negative budgetary efficiency of rehabilitation procedures. But it would be wrong to rely on these transactions as substantial sources of replenishing VEB’s resources. It would be more realistic to repay the Central Bank’s deposit. We can’t sell these banks on the sluggish market today. There are no buyers ready to pay for Svyaz-Bank and Globex as much as we would like to get. And these assets are pretty large. The banks are among the thirty largest banks in terms of assets and their total capital is 44 billion rubles.

A conservative approach to a policy of borrowings used by VEB implies that an amount of funds the Bank plans to raise on the capital market is no more than 4 rubles for one ruble of is charter capital. We’ll reach this ceiling by 2015. And this is a minimum that Vnesheconombank can reach, given its current amount of charter capital. The amount of VEB’s assets has already exceeded 2 trillion rubles. It’s quite a number but as compared with a number of colleagues, for example, with Germany’s KfW (the amount of its assets in 2010 was 442 billion euros) and BNDES (the amount of its assets in 2010 was $331 billion) and against the backdrop of Russia’s increasing demand for investments, it’s not much.

Nevertheless, development banks’ activities are associated with serious risks and in order to take them on their balances such banks should have significant capital. Therefore, our task today is to expand VEB’s funding base and this task can be fulfilled only by the economic authorities, given the Bank’s limited room for maneuver.

Perhaps, the most important lesson we should learn from analyzing foreign development banks’ track record is that their efficient activity is directly linked to identifying strategic objectives of their countries’ economic and social development. Development banks are highly instrumental in developing, examining and implementing national economic policy. And they can achieve more ambitious objectives if they adopt a more systemic and strategic approach.