Sovereign Wealth Funds:

New challenges for the Caspian countries

Summary

ThisbookconsidersfinancialmanagementandtransparencyaspectsofSovereignWealthFunds(SWF).Italsodiscussestheimpactoftheglobalfinancialmeltdown(2008-2009),commoditypricefluctuationsandtheriseoftherisksintheemergingworldonSWFsfinancialperformanceandtheirinvestmentactivities.ThebookparticularlyconcentratesonCaspianBasincountries(Azerbaijan,Russia,andKazakhstan)plusNorwayasexplanatorycasestudies.

Baku–2011

KhazaruniversityAddress:11Mehsetistr.,BakuAZ1096,Azerbaijan

www.khazar.org

PublicFinanceMonitoringCenterAddress:CaspianPlaza3;44,J.Jabbarlystr.,

9thfloorBakuAZ1065,Azerbaijan

Tel/Fax:(+99412)4978967,4970467E-mail:office@pfmc.az

www.pfmc.az

Acronyms

EITI ExtractiveIndustriesTransparencyInitiative

GAPP GenerallyAcceptedPrinciplesandPractices

GDP GrossDomesticProduct

IFI InternationalFinancialInstitutions

IMF InternationalMonetaryFund

NASDAQ NationalAssociationofSecuritiesDealersAutomatedQuotations

NGOs Non-governmentalOrganizations

NGPF NorwegianGovernmentPensionFund

OECD TheOrganizationforEconomicCooperationandDevelopment

SOFAZ StateOilFundofAzerbaijanRepublic

SWF SovereignWealthFunds

USD UnitedStatesDollar

US/G7 UnitedStatesGroupSeven

3

Content

Foreword...........................................................................................................4

SovereignWealthFundsastheemergingplayersintheglobalfinancialarena:characteristics,risksandgovernance................................................................6

Governance,transparencyandaccountabilityinSovereignWealthFunds:remarksontheassessment,rankingsandbenchmarkstodate......................47

StateOilFundofAzerbaijanRepublic:Past,presentandfuture...................................................................................73

TheNationalFundoftheRepublicofKazakhstan(NFRK):Fromstress-testtoglobalfuture.....................................................................100

RussianSovereignWealthFunds.................................................................130 Aboutauthors................................................................................................159

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Russian Sovereign Wealth Funds

Sergey DrobyshevskyHeadofMacroeconomicsandFinanceDivisionoftheGaidarInstituteforEconomicPolicy

(Moscow,Russia)

Russia hasa relatively longbut rather peculiar history of sovereign fundsdevelopment.Havingstartedin2004withonefund-theStabilizationFundoftheRussianFederation-thecountryhadtwofairlylargefunds,includingtheNationalWelfareFund,in2008onthevergeofthecrisis.However,attheendofthecrisisinthemediumterm,bothfundsmayceasefunctioning,havingmetonlyapartoftheirobjectives.

Short History, Mission and Type

Creation of the firstRussian sovereign fund, theStabilizationFund of theRussianFederation,wasrelated to the ideaof institutionalizing federalbudgetsurplusgeneratedintheformofbalancesonthebudgetaccountswiththeCentralBank of Russia since 2000. Understanding the situational nature of budgetrevenuesinthebackgroundofrisingoilpricesintheworldmarket,andwishingtoavoidaproportionalgrowthofthebudgetexpenditurecommitments,theRFgovernment in 2003 proposed establishment of the Stabilization Fund, whichwouldbeformedfromtheexcessiverevenuesfromoilproductionandexports(ascomparedwiththeestimatedlong-termoilprice,cut-offpriceorbaselineprice).

FederalLaw«OnAmendmentstotheBudgetCodeoftheRussianFederationregardingtheestablishmentoftheStabilizationFundoftheRussianFederation”No.184-FZ,onthebasisofwhichtheStabilizationFundoftheRussianFederationwascreatedin2004,wasadoptedDecember23,2003.

Thepurposeof theStabilizationFundofRussiawastoensurethefederalbudget balanceduringadecrease in oil pricesbelow thebaseline.Accordingto theRFMinistryofFinance, “theFundcontributes tostabilityandeconomicdevelopment;itisoneofthemaininstrumentsofbindingtheexcessiveliquidity,which is reducing inflationary pressures and the dependence of nationaleconomy from adverse fluctuations of revenue from commodity exports.”Thus,at the initialstageofestablishment, theFund isaclassicversionof thecommodityfund,designedtosuppressfluctuationsofthemarketrevenueofthefederalgovernment.TheFundassetscouldbeusedtocoverthefederalbudgetdeficitonlyinthecaseofoilpricesdroppingbelowthebaseline.However,iftheaccumulatedamountoftheFundexceeded500billionrubles,theexcesscouldbeusedforotherpurposes.

FromJanuary1,2004 thebasepricewassetat$20perbarrel forUrals,andonJanuary1,2006,thecut-offpricewasraisedto$27.Despitecontinuedgrowthinoilprices,therewasnofurtherincreaseinthe«cut-offprice»becauseoftheriskofrisinginflationandincreasingbudgetdependenceontheexternal

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economicsituation.Since in 2005 the Fund exceeded the level of 500 billion rubles (RUR

1,387.8bln),apartoftheassetswasaddressedtootherpurposes,namelyforthepaymentofexternal debtof theRussianFederation (RUR643.1bln)andreplenishmentofthedeficitofthePensionFundoftheRussianFederation(30billionrubles,seeTable1).

Table 1. RF Stabilization Fund Assets: Dynamics in 2004-2007 (RUR bln)

Year

Proceeds Utilization

BalanceasoftheendoftheyearTo

tal

Exportduty

Royalty(oil)

Balances ofFed-

eralBudget

Externaldebt

reco

very

Development

Institutions

financing

RFPension

Funddeficit

replenishm

ent

2004 522.3 240.8 175.5 106.0 – – – 522.32005 1387.8 663.4 507.3 217.1 643.1 – 30.0 1237.02006 1708.6 991.2 646.7 47.8 604.7 – – 2346.92007 1895.9 918.9 674.7 156.7 33.7 300.0 – 3849.1Total 5514.6 2814.8 2004.1 527.6 1281.5 300.0 30.0

Source: RF Federal Treasury

In2005,attheexpenseoftheStabilizationFund,repaymentofexternaldebtofRussiawasmadeintheamountof643.1bln,including:

• 93.5 billion rubles (equivalent to USD 3.3 billion) - the debt to theInternationalMonetaryFund;

• 430.1billionrubles(equivalenttoUSD15billion)-thedebttothemembercountriesoftheParisClub;

• 123.8 billion rubles (equivalent to USD 4.3 billion) - the debt toVnesheconombankundercreditgrantedbytheMinistryofFinanceoftheRussianFederationin1998-1999fortherepaymentandservicingofexternalgovernmentdebtoftheRussianFederation.

In2006,604.7billionrublesandin2007,33.7billionrubleswerespentforexternaldebtredemption.In2005,30.0billionrubles(equivalentto1.04billionU.S.dollars)wereallocatedtocoverthedeficitoftheRFPensionFund,andin2007–300.0billion rubles to financedevelopment institutions (Rusnano - 30billionrubles,VEB-180billionrubles,InvestmentFund-90billionrubles).

BythetimetheFundsplitin2008,theassets’totalvolumewas3,851.8billionrubles(157.38billionU.S.dollars),reachingapproximately11.6%ofannualGDPofRussia(Fig. 1).

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Figure 1. The total volume of the RF Stabilization Fund

Source: RF Ministry of Finance

StartinginFebruary1,2008theStabilizationFundofRussiawasdividedintotwoparts:theReserveFund(withaninitialvolumeofRUR3069.0bln)andtheNationalWelfareFund(initiallyRUR782.8billion),hereinafterreferredtoasFNB.

TheReserveFund,liketheearlierStabilizationFund,isapartofthefederalbudget.TheFundisintendedtoassistthegovernmenttoupholdbudgetspendingcommitmentsintheeventoflowoilandgasrevenues.ThenormativevalueoftheReserveFundisestablishedatalevelequalto10%ofGDP.IncontrasttotheStabilizationFundof theRussianFederation, inaddition to federalbudgetrevenuesfromoilproductionandexport,thesourcesformingtheReserveFundalsoincludefederalbudgetrevenuesfromgasproductionandgasexport.

Figure 2. Reserve Fund Total Assets Volume

Source: RF Ministry of Finance

 

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TheNationalWelfareFundisapartofthefederalbudgetsubjecttoseparateaccounting and management to ensure co-financing of voluntary retirementsavingsof theRussiancitizens,aswellas tocover thedeficitof thePensionFundbudget.

Figure 3. National Welfare Fund Total Assets Volume

Source: RF Ministry of Finance

TheReserveFundactuallybecameafunctionalsuccessoroftheStabilizationFundasapartofthefederalbudgetwithseparateaccountingandmanagementfor thepurposeofoilandgas transfers in theeventof insufficientoilandgasrevenuesforthefinancialsupportofthistransfer.Thereservefundisfinancedbyexcessoilrevenuesofthefederalbudgetinthescopeauthorizedforthefinancialyearintheamountofoilandgastransfers,providedthattheaccumulatedamountof the Reserve Fund does not exceed its established value, as well as fromrevenuesderivedfromthemanagementoftheReserveFund.Inotherwords,itisaclassiccommodityfund.

Inturn,theFNBisclosetothesovereignfundsorfuturegenerationsfundsinnature,andisaccumulatedfromoilandgasrevenuesofthefederalbudgetexceedingtheamountofoilandgastransfersapprovedforthefinancialyear,inthecasethattheaccumulatedamountoftheReserveFundreaches(exceeds)itsestablishedvalue,aswellasrevenuesderivedfromFNBmanagement.

AsofJune1,2010theReserveFundofRussiahasbeenreducedtoRUR1,197.66billion(USD39.27billion).ThevolumeoftheNationalWelfareFundisRUR2,616.54billion(USD85.8billion).

Legal basis, accountability and reporting

Asmentionedabove,in2003theFederalLaw“OnAmendmentstotheBudgetCodeoftheRussianFederationregardingtheestablishmentoftheStabilizationFund of theRussian Federation” of 23.12.2003No. 184-FZwas adopted, onthebasisofwhichin2004theStabilizationFundoftheRussianFederationwasestablished.The lawhas introducedChapter 13.1 in theBudgetCode,which

 

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stipulatedfundamentalsoftheStabilizationFundanditsmanagementprocedure.According to the law, theStabilizationFund isapartof the federalbudget

assets,formedfromtheexcessofoilpricesoverthebaselineprice,subjecttoseparateaccounting,managementanduseinordertobalancethefederalbudgetincaseofadecreaseinoilpricesbelowthebaseline.

ThesourcesoftheinitialformationoftheStabilizationFundwere:• federalbudgetsurplusrevenues,whichareassessedasanexcessoil

pricesoverthebaselineprice;• balancesof the federalbudgetassetsat thebeginningof the relevant

fiscalyear,includingtheproceedsfromtheStabilizationFundassetsallocation.AdditionalfederalbudgetrevenuestobecreditedtotheStabilizationFundin

thecurrentmonthwereassessedasthesumof: • actual revenue to the federalbudget from theexportcustomsdutyon

crudeoilobtainedinthecurrentmonth,multipliedbytheratioofthedifferencebetweentherateofexportdutyoncrudeoileffectiveinthecurrentmonthandtheestimatedrateofthatdutywiththebaselinepriceforoiltotherateofexportcustomsdutyoncrudeoileffectiveinthecurrentmonth;

• actualrevenueofthefederalbudgetfromseverancetax(oil)obtainedinthecurrentmonthmultipliedbytheratioofthedifferencebetweentheseverancetaxrateeffectiveinthecurrentmonthforoilextractionandtheestimatedrateofthistaxwiththebaselinepriceoilextractiontaxrateeffectiveinthecurrentmonthonextractionofminerals(oil).

Onlyone targetwas foreseen in theRFBudgetCode for theStabilizationFund,namely-financingofthefederalbudgetdeficit“inthecaseofadecreaseinoilpricesbelowthebaseline,aswellasforotherpurposes,iftheaccumulatedvolumeoftheStabilizationFundexceeds500millionrubles.”

AccordingtoArt.96.4BCRF,theMinistryofFinanceofRussiawasauthorizedtomanagetheStabilizationFund,butsomerelevantfunctionscouldbeperformedbytheCentralBankoftheRussianFederation.ThelistoffunctionsperformedbytheCBRwasnotspecifiedintheBudgetCode.

AsaneffectofChapter13.1oftheRFBudgetCode,amendmentsweremademainlyinregardtothebaselineforoilprices,butnotaffectingthemanagementoftheFundortheirtargetuse.Attheexecutivelevel,themanagementprocedureof the Stabilization Fund was governed by a number of legal acts, themostimportantofwhichare:

• TheRFGovernmentRegulationsNo.508of30.09.2004andNo.229from 21.04.2006 “On the Procedure of the Stabilization Fund of the RussianFederationManagement”

• TheRFGovernmentRegulationNo.31of23.01.2004“OnApprovaloftheRulesoftransfertotheStabilizationFundoftheRussianFederationoftheadditional federal budget revenues, balances of the federal budget as of thebeginningofthefiscalyear,andrevenuesfromtheallocationoftheStabilizationFundoftheRussianFederation”

• OrderoftheRFMinistryofFinanceNo.20of28.01.2004“OnApprovalofRules of assessment and transfer to theStabilizationFund of theRussianFederation of the federal budget surplus revenues and fund balances of thefederalbudgetbythebeginningofthefiscalyear,”and

• OrderoftheRFMinistryofFinanceNo.158of22.05.2006“Onapproval

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of theminimumandmaximumtimelines for repaymentof thedebt liabilitiesofforeign countries, in which the Stabilization Fund of the Russian Federationassetscanbeinvested.”

Of particular interest are the RF Government Regulation No. 508 of30.09.2004, “On theorderof theStabilizationFundof theRussianFederationassets management,” and No. 229 from 21.04.2006 “On the order of themanagementoffundsoftheStabilizationFundoftheRussianFederation.”Oneof the key tasks in the first stagewas to set conditions for investment of theRFStabilizationFundbytheCentralBankabroadandtoprovideatleastsomesafeguards toprotect them fromclaimsof foreigncreditors.As investments inforeignfinancial instruments,federalfundslosethestatusofpublicfundsand,accordingly,anystatejurisdictionalimmunity.

The Regulation No. 508 of 30.09.2004 stipulated the following allocationof investments. The Fund assets were legally separated from the assets ofthe Central Bank1 and were legally considered “commercial” investments oftheRussianFederationasa legalentity.Thiscreatedcertain risks for foreigninvestmentsoftheStabilizationFund,sincetherewasnojurisdictionalimmunityof theRussian Federation in regard to those funds.As a result, therewas apossibilityofforeclosureontheStabilizationFundfromforeigncreditors.

The government feared the risk of foreclosure on these funds2, and theadoptionof“ontheprocedureformanagingtheStabilizationFundoftheRussianFederation”No.229from21.04.2006triedtogivethemthestatusoffundsusedfor “governmental and non-commercial” purposes3, which are protected withjurisdictionalimmunity.Tothisend,theassetsplacedabroadweretransferredtothestatusoffundsbelongingtotheCentralBankofRussia.

TheRegulationprovidedthefollowingprocedureforinvestingtheStabilizationFundassets:theypassedtotheFederalTreasury,andtheTreasurythenplacedtheminaspecialaccountwiththeRFCentralBank,notonthebasisoftheassetsmanagementcontractasitwasbefore,butonthebasisofacontractforabankaccount. Since the funds deposited in an account with the bank are formallytransferredtoitsownership,itallowedtheCentralBanktoinvestthemabroadasitsownfundsusedfor“publicnon-commercialpurposes.”Herewith,theMinistryofFinancehasretainedthekeyresponsibilityformanagementoftheinvestmentprocessforallocationoftheStabilizationFundassets4.

Inparticular,theMinistryofFinancewasauthorizedtodefine:• thestandardcurrencystructureoftheStabilizationFund,theprocedure

ofpursuingthestandardcurrencystructure;• standardsofminimumandmaximummaturityofdebtsecurities,

1Theassetsweretransferredunderthemanagementcontract,concludedbetweentheRussianFinanceMinistryandCentralBank,anddidnotlegallybecomethepropertyofRFCentralBank.

2See,forinstance,UnitedNationConferenceonTradeandDevelopment.WorldInvestmentReport:TransnationalCorporations,ExtractiveIndustriesandDevelopment.newYorkandGeneva,2007.P.XVII.;McKnightA.TheLawofInternationalFinance.OxfordUniversityPress,2008.P.368,369.

3 Immunity to this category of funds is provided under theUnitedNationsConvention “OnJurisdictionalImmunityoftheStatesandtheirProperty”from02.12.2004.

4ThisDecreestipulates“managementoftheStabilizationFundbytheMinistryofFinanceoftheRussianFederation”.

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• theprocedureforaccountingandcreditinginterestaccruedonbalancesoftheStabilizationFundaccounts,aswellasotherconditionsofthebankaccountcontract;and

• the procedure of interactionwith the FederalTreasury in carrying outtransactionswiththeaccountsoftheStabilizationFund.

Monitoring of theRussianFinanceMinistry control functions over the useoftheStabilizationFundwaslimitedtothedutiesofprovidingquarterlyannualreportstotheGovernmentofRussiaonthestatusofthefollowingindicators:

• the amount of authorized foreign currency purchased and foreigncurrencyplacedontheaccountsoftheStabilizationFund;

• estimatedinterestratesfortheallocationoftheStabilizationFundassetsintheaccounts;

• estimated income for theallocationof theStabilizationFundassets intheaccounts;

• names and basic characteristics of foreign countries’ debt liabilitiesacquiredwiththeStabilizationFundassets;

• incomederivedfromtheplacementoftheStabilizationFundassetsintobondsofforeigncountriesbytypeofdebtliabilitiesofforeigncountries;

• informationonbalancesof theaccountsof theStabilizationFund(peryear);and

• detailsofinterestpaidoverthepastyearfortheuseofStabilizationFundassetsplacedintheaccounts(peryear).

In2007,theprocedurefortheformationoffunds,accumulatingoilandgasrevenuesof the federalbudget,and theprocedure tomanage the fundswereradically amended. Relevant amendments were made with the Federal LawNo.63-FZof26.04.2007“OnAmendmentstotheBudgetCodeoftheRussianFederation in terms of regulating the budgetary process and bringing certainlegislativeactsof theRussianFederation in linewith thebudget legislationoftheRussianFederation.”UnderthisAct,theStabilizationFundwassplitintotwoparts,andthefollowingwereestablished:

1.aReserveFundinordertominimizetherisksoftheRussianeconomyinthecaseofasharpdropinenergysources’pricesintheworldmarkets(Art.96.9oftheRFBudgetCode)

2. a National Welfare Fund, in order to ensure co-financing voluntaryretirementsavingsoftheRussianFederationcitizens,aswellastoensurethebalance (cover the deficit) of the budget of thePension Fund of theRussianFederation(Art.96.10BCCode).

Inaddition,startingfrom2007,apartoftheoilandgasrevenuewasusedasapartofthefederalbudgettoimplementinparticularlarge-scalesocialprogramsandreplenishmentofthefederalbudgetdeficitthroughtheso-called“oilandgastransfers”(Article96.8oftheRFBudgetCode).

Reserve FundThe reserve fund is formed from the oil revenues of the federal budget

exceedingthelevelofoilandgastransfersauthorizedfortherelevantfinancialyear,providedthatthecumulativeReserveFunddoesnotexceeditsestablishedvalue,aswellasfromrevenuesfromthemanagementofthereservefund.

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Item 2 of art. 96.9 of the RF Budget Code established a procedure forestimationof thenormativevaluesof theReserveFund.Under this item, it isassigned an absolute amount, assessed on the basis of 10 percent of GDPplannedfortherelevantfiscalyear.

However,alargepartoftheprovisionsofArt.96.9oftheRFBudgetCodewerenot set tobeput intoeffectuntil 2013.The relevantdecisionwas takenaspartoftheanti-crisismeasuresandapprovedbytheFederalLawNo.314-FZof17.12.2009 “OnAmendments toCertainLegislativeActsof theRussianFederation”inconnectionwiththeFederalLaw“Onthefederalbudgetfor2010andtheplannedperiodof2011and2012.”

Before2013,while the revenue from theReserveFundmanagementwasallocated to financing the budget expenditures, the procedure for the fundassessment,stipulatedbyItem2ofArticle96.9,couldbeignored.Also,before2013, the RF Government could, without amending the federal law on thefederalbudget,makedecisionsontheuseof theStabilizationFundandotherbalances of the federal budget for the implementation of payments, reducingdebtliabilities,borrowing,andtobalancethefederalbudgetexecution(includingfinancial support of oil and gas transfers), including the excess of the totalfederalbudgetexpenditureswithinincreasedbudgetaryallocationsofthefederalbudgettoprovideintergovernmentaltransfersinordertobalancethebudgetsofstateextra-budgetary fundsof theRussianFederation,with thecorrespondingamendmentstothebudgetregistry5.

National Welfare FundAccordingtoArt.96.10oftheRFBudgetCode,theNationalWelfareFund

is formed fromoil revenuesof the federalbudgetexceeding theamountofoilandgastransfersapprovedforthefinancialyear,iftheaccumulatedamountoftheReserveFundreaches(exceeds)itsestablishedvalue,aswellasfromtheincomederivedfromtheNationalWelfareFundmanagement.Thelatter,aswellas income from theReserveFundmanagement from2009 through2013,areallocatedtothefinancingofthebudgetexpenditures6.

Art.96.11oftheRFBudgetCodeestablishestheprocedureformanagingtheFunds’assets,aswellassettinguprequirementsfortheassetsoftheFundsthatcanbeusedforinvestments.Theserequirementsarespecifiedindetailonthesub-lawlevel.Accordingtothisarticle,theReserveFundandNationalWelfareFundaremanagedbytheMinistryofFinanceoftheRussianFederationinthemanner established by theGovernment of theRussian Federation.Herewith,some responsibility formanaging theReserveFundcanbeperformedby theCentral Bank of theRussian Federation, and some of those in regard to theNationalWelfareFund-bytheCentralBankoftheRussianFederationandbyspecialfinancialinstitutions,inaccordancewithagreementswiththeMinistryofFinanceoftheRussianFederationinthemannerprescribedbytheGovernmentoftheRussianFederation.

5SeeFederalLaw№58-FZof09.04.2009“OnamendmentstotheBudgetCodeoftheRussianFederationandsomelegislativeactsoftheRussianFederation”

6SeeFederalLaw№58-FZof09.04.2009“OnamendmentstotheBudgetCodeoftheRussianFederationandsomelegislativeactsoftheRussianFederation”

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Currently,theprocedureforthemanagementoftheFundsisgovernedby:• TheRFGovernmentRegulationNo.892of17.12.2007“Ontheestimates

andtransferoffundsinconnectionwiththeformationandusageofoilandgasrevenuesofthefederalbudget,oilandgastransfersandtheassetsofReserveFundandNationalWealth;”

• TheRFGovernmentRegulationNo.955of29.12.2007“OntheprocedureoftheReserveFundmanagement;”

• TheRFGovernmentRegulationNo.18of19.01.2008“OntheprocedureoftheNationalWelfareFundassetsmanagement;”

• The Order of the RF Ministry of Finance No. 3 of 16.01.2008 “Onapprovalof theauthorizedshares inthetotalvolumeoffinancialassetsof theReserveFundandtheprocedureforassessmentoftheactualauthorizedshareof financial assets in the total assets of theReserveFund to bring them intoconformitywiththeestablishedrates;”

• The Order of the RF Ministry of Finance No. 26 of 24.01.2008 “Onapprovalof theauthorizedshares inthetotalvolumeoffinancialassetsof theNationalWelfareFundandtheprocedureforassessmentoftheactualauthorizedshareoffinancialassetsinthetotalvolumeoftheNationalWelfareFundtobringthemintoconformitywiththeestablishedrates;”

• TheOrderoftheMinistryofFinanceN517of21.10.2008“OnamendmentstotheOrderoftheMinistryofFinanceoftheRussianFederationN26onJanuary24,2008;”

• The Order of the RF Ministry of Finance No. 24 of 24.01.2008 “Onapproval of the established foreign currency structure of theNationalWelfareFund and the Procedure to bring the actual foreign currency structure of theNationalWelfareFundintocompliancewiththeestablishedrates;”and

• The Order of the RF Ministry of Finance No. 5 of 16.01.2008, “OnapprovalofthelistofforeigngovernmentagenciesinwhichthedebtliabilitiesoftheReserveFundcanbeallocated.”

Ingeneral,themanagementprocedureoftheFunds,establishedonthebasisoftheStabilizationFund,isgovernedbythelogiclaiddownbythegovernmentintheRegulationNo.229issuedin2006.Accordingtothe“new”OrderNo.892of 17.12.2007, the key functions associated with management decisions areperformedbytheMinistryofFinance,whiletheCentralBankcarriesouttechnicalworkrelatedtoensuringtheir implementation.RelationsamongtheMinistryofFinance,TreasuryandCentralBankarebasedonthebankaccountagreement.TheAgreement, as before, is reachedbetween theRFCentralBankand theTreasury.

• AccordingtotheMinistryofFinanceOrderNo.25Hof14.02.2008,theoilandgasrevenuesofthefederalbudget,theReserveFundandNationalWelfareFund are registered in special accounts of the federal budget opened for theFederalTreasurywith theCentralBank of theRussianFederation. For thesepurposes,inaccordancewiththeBankAccountAgreemententeredintobytheFederalTreasuryandtheCentralBankoftheRussianFederation,onthebalanceofaccountNo.40105“Thefederalbudget,”separateaccountsareopened:

• toaccountforoilandgasrevenuesofthefederalbudget;• toaccountfortheReserveFundassetsinthenationalcurrencyofthe

RussianFederationinthespecialaccountoftheReserveFund;

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• toaccountfortheNationalWelfareFundassetsintheRussiannationalcurrencyandaccountfortherecordingoftheNationalWelfareFundassets.

Transferoftheoilandgasrevenuesofthefederalbudget,theReserveFundandNationalWelfareFund in thenationalcurrencyof theRussianFederationis performed by the Federal Treasury upon instructions from the Ministry ofFinanceoftheRussianFederationtoconducttransactionsontheaccountsfortheaccountingofoilandgasrevenues,theReserveFundandNationalWelfareFund,aswellaspaymentdocuments.

All the above-mentioned laws provide for the minimum requirements inrelationtothecontrolprocessoverinvestingtheReserveFundandtheNationalWelfareFundassets.

ControlarisesfromthefactthattheFinanceMinistryprovidesquarterlyandannualreportsonthemanagementoftheFundsassetstothegovernmentoftheRussianFederation.ThereportsprovidedtotheGovernmentcomprise:

• informationonthebalancesoftheFunds;• informationonthevolumeoftheboughtandsoldassets;• informationontheestimated interest rates for theusageassetsof the

Fundallocatedtotheaccounts;• informationontheestimatedamountsofincomederivedfromtheuseof

thefundsallocatedtotheaccountsoftheFunds;• the names and basic characteristics of financial assets, in which the

Funds’assetswereplaced;• detailsofincomereceivedfromtheplacementoffunds.Inaddition,nolaterthanonthe20thofeachmonth,theMinistryofFinance

compiles and publishes in its website monthly summary reports available forpublic use. Published reports provide an overview of the total assets of theNationalWelfareFundasof thebeginningof the reportingmonth, aswell asinformationon theassetscredited to the fund, theirplacementanduse in thereportingmonth.

Theserequirementsonthecontroloverinvestmentofoilandgasrevenuesare limited.Speakingof controlling theuseof the funds,oneshouldalsopayattentiontothefactthattherepresentativebodiesofthestatepowerarevirtuallynotinvolvedinthecontrolofthefunds’investments,anddonotmakemanagementdecisionsontheseissues.

Moreover,asnotedabove,from2009to2013thedecisionsontheuseoftheReserveFundweremadebytheRFGovernmentwithnochangestothelawonthefederalbudget;thatis,thefundnotonlyinvests,butalsopartlyspendstheFundassetswithouttheapprovaloftheParliament.Therefore,themanagementoftheFundsisvirtuallybeyondtheParliament’scontrol.

OnMay6,2010theRFGovernmentRegulationNo.267of21.04.2010“OnthesuspensionoftheactsoftheRFGovernmentontheformationanduseofoil and gas revenues of the federal budget, income frommanagement of theReserve Fund andNationalWelfare Fund” came into effect, underwhich thefollowingrequirementsfortheMinistryofFinancearecancelled:

• publishing of information on the Russian Ministry of Finance websiteaboutthecollectionanduseofoilandgasrevenuesofthefederalbudget,theirenrollmentintheReserveFundandNationalWealthFund,andtheadmissionofincomefrommanagementoftheReserveFundandNationalWealthFundtothe

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Fund(beforeFebruary1,2012);• submissionofreportstotheGovernmentofRussiaontheformationof

theReserveFundandNationalWelfareFundandontherevenuefromtheuseofoilandgasrevenuesofthefederalbudget(beforeJanuary1,2013).

Inaddition,issuesoftheformationandusageoftheoilandgasrevenuefrombefore January 1, 2013 are excluded from the review for the formulation andapprovalofthefederalbudgetforthenextfiscalyearandtheplannedthree-yearterm.

Thus,thisRegulationestablishesadeparturefromtheconceptofseparationofthebudgetbyoilandgasandnon-oiland-gascomponentsandofoilandgastransfer as a source of funding the non-oil budget deficit, andmakes theRFMinistryofFinanceandtheGovernmentofRussiavirtuallyunaccountabletotheStateDumaintermsofbothFunds’assetsmanagement.

However, it should be noted that theRFMinistry of Finance continued topublishinformationonthestatusoftheFundsonitswebsiteasofJune1,2010.

Institutional base and institutional quality

CreationoftheRFStabilizationFundin2004,althoughitgoesbeyondthechronologicalframework,shouldbeconsideredinthecontextoftheoveralllogicofeconomic reformsofV.V.Putin’s first term inoffice (2000-2003),of theso-called “Gref Program”7 or “Strategy-2010.” In the framework of this program,radical tax reformwas carried out, the foundationwas laid for the new fiscalpolicy (transition to three-year budget planning), and the contours of majorinstitutionalreformswereoutlined(administrativereform,judicialreform,reformofnaturalmonopolies),although the latterones,unfortunately,have remainedlargelyunimplemented.Inaddition,whenmakingeconomicpolicydecisions,thethen-recenteventsof thecrisis thathappened inAugust1998weretaken intoaccount,leadingtothenationalcurrencydevaluation,theenlargeddebtburdenonthebudgetandthefearofuncontrolledgovernmentdeficit.Inparticular,thedynamics of oil prices in the worldmarkets, even in the short term, seemedextremelyvolatile,astherewasahighprobabilityofanewdeclinethereoftothelevelof$9-10perbarrel,aswasobservedin1998-1999.

Inthiscontext,theauthorsoftheconceptoftheStabilizationFundfacedthetaskofdevelopingareliable,sustainablemechanismfortheprotectionofexportrevenuestothebudgetfromtheirusageforthecurrentbudgetcommitmentsandemergingnewbudgetarycommitments in thecaseofashort-term increase inoilprices,aswellasminimizationofthenegativeimpactoftheinflowofexportrevenueson theeconomy ingeneral (namely, preventing theaccumulationofliquidityintheeconomy,thesituationofadeficitofinvestmentprojects,andthewillingnessofbusinessesandbankstoinvestintherealsector).

Thus,asstatedabove,ininstitutionalterms,theRFStabilizationFundwasapartofthefederalbudgetassets,subjecttoseparateaccounting,managementandutilization.Inotherwords,theFundassetswereaccountedforandplacedinaspecialaccountoftheRFMinistryofFinancewiththeRFCentralBankofRussia.Theplanned revenue to theFund for the relevant fiscal yearand the

7 NamedaftertheMinisterofEconomicDevelopmentG.O.Gref.

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amountoftheFundasoftheendofeachfinancialyearwereapprovedbytheFederalAssembly(Parliament)ofRussiabythelawonthefederalbudgetforthenextfiscalyearandtheplannedthree-yearterm.

Managementof theFundwasexecutedby theRFCentralBankunderanagreementwiththeRFMinistryofFinance.Herewith,theBankofRussia,infact,actedasthemanagementcompany,andtheRFGovernmentandtheRussianMinistryofFinancedefinedthestrategyforthemanagementoftheFundandascopeofpermissibleassets.

TheRFReserveFundofRussiaandtheNationalWelfareFundalsomakeupapartofthefederalbudgetsubjecttoseparateaccountingandmanagement.Atthesametime,theyare(atleastuntilthebeginningofMay2010)subjecttothesameinstitutionalconstraintsandconditionsastheStabilizationFundofRussia.

AssessingtheoverallqualityoftheinstitutionalenvironmentoftheRussiansovereignfunds,onecandistinguishthefollowingadvantagesanddisadvantages.

Advantages• Strong legal status of the Funds through the addition of individual

ChapterstotheBudgetCode,whichbeforethecrisiscreatedareliablesystemforprotectingtheFunds’assetsfrompoliticalandsituationaltemptationsonthepartofboththeRFGovernmentandrepresentativesofthepowerauthorities.

• FormationofthefundsinspecialaccountsoftheRFGovernmentintheBank of Russia, whichminimized the effect of additional situational revenuesfromoilexportsnotonlytothebudgetsystem,butalsoonmonetary-creditandexchangeratepolicies.

• AnadequatelinkingofthesourcesoftheFunds’formationwiththemarketrevenuesfromoilexports.Calculationsshowthatin2005-2008,whenthelevelofoilpricesintheworldmarketwasabove$35-40perbarrelversusthenationalmarket,upto95%ofthesurplusincomefromoilexportswereaddressedtotheStabilizationFundintheformofexportdutiesandmineralextractiontax.

• Splittingof theStabilizationFund into theReserveFundandNationalWelfareFundin2008.EvenduringtheworstcrisissituationinRussia,in2008-2009, and the high budget deficit in the subsequent years, the institutionalconditionsallowedtheNationalWelfareFundtobesavedasasovereignfundforfuturegenerations,usingitforfinancingthefederalbudgetdeficit.Obviously,if onlyoneof theStabilizationFundshadbeenmaintainedduring thisperiod,its fundswouldhavebeen fullyspent for thesolutionof thecurrentbudgetaryproblems.

Shortages• TheconservativemanagementschemeoftheFunds.Managementofall

Fundassetsremainsinthehandsoftheagencies,forwhichthisissueisoutsidetheir main objective (RF Central Bank and the Russian Ministry of Finance).Involvementofprivateprofessionalmanagementcompanies(Russianorforeign)inthemanagementoftheFundsremainspoliticallyunacceptable.

• The lackofa legal framework for targetedparametersof theNationalWelfareFund.DespitethefactthattheobjectiveoftheNationalWelfareFundwasdeclaredthe“co-financingofvoluntaryretirementsavingsofRussiancitizens,”

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aswellas“recoveringofthe(deficit)budgetofthePensionFund,”therequiredparameters are not in place to link to the pension fund reform. Under thesecircumstances,theNationalWelfareFundcouldexclusivelybecomeasourceoffundingforthecurrentdeficitofthePensionFund,andnotatoolforsolvinglong-termproblemsofthepensionsystemintheRussianFederation.

• The lack of institutional capacity to develop individual strategies formanagingtheassetsofthetwoexistingFunds,notonlybasedonprinciplesofriskmanagement,butalsotoensuremaximumyieldatagivenlevelofrisk.

Investment Portfolio and Asset Management

Intheperiodfrom2004to2006,thefollowingrequirementswereappliedtoassetsthatcanbeinvestedintheStabilizationFund:

a)theissuerofthedebtliabilitiesshouldhavealong-termcreditratingofnotlower thanthe level“AAA”bytheclassificationofFitchRatingsorStandard&Poor’s,ornotbelowthelevelof“AAA”undertheratingagencyMoody’sInvestorsService;

b)maturityofdebtsecurities isfixed; thetermsof issueandcirculationdonotprovidetheissuertherighttoaffecttheirearlyredemption(maturity)ortherightoftheownertosubmitthemforredemption(maturity)bytheissuerofdebtinstrumentsaheadofschedule;

c)thecurrentmaturitydateofissuedoesnotexceedoneyearfordiscountliabilitiesor10yearsforcouponbonds;

d)couponratepaidoncouponbondsisfixede)thebondvalueisdenominatedinoneoftheauthorizedforeigncurrencies

and payments toward the debt liabilities are made in the currency of itsdenomination;

f)thevolumeofthedebtliabilitiesissuedincirculationisnotlessthanUS$1billionforthedebtliabilitiesdenominatedinU.S.dollars,Euro1billionfordebtliabilitiesdenominated inEuro,orGBP1billion for thebondsdenominated inpoundssterling.

From2006to2007therequirementsunderwentminimalchangeswherebythevolumeofdebt liabilities incirculationanddenominated inpoundssterlingwasreducedfromGBP1billionto0.5billion.

Also in theResolutionNo. 229 of 21.04.2006 there appeared a clarifyingrequirementthattheissuanceofdebtliabilitiesinwhichinvestmentsaremadeshouldnotbeissuesintendedforprivate(non-public)placement.Inaddition,itwasstatedintheRegulationthatthestandardsoftheminimumandmaximumtermtomaturityofthebondissuesareestablishedbytheMinistryofFinance.

Thedistributionofsharesamongthevarioustypesofinvestmentinstrumentsused for placement of the Fund assets was established by the Order of RFMinistry of FinanceNo. 157 of 22.05.2006, providing for the following foreigncurrencystructureoftheStabilizationFund:

• U.S.Dollar-45%;• Euro-45%;• PoundSterling-10%.The limits of permissible deviations of actual monetary structure of the

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StabilizationFundfromtheestimatedforeigncurrencystructurewere: • fortheStabilizationFundinU.S.dollars-+/-5percentagepoints;• fortheStabilizationFundinEuro-+/-5percentagepoints• fortheStabilizationFundinBritishpoundssterling-+/-2percentage

points.In2007,theFinanceMinistryalsoclarifiedtherequirementsfortheminimum

andmaximummaturityofdebtbytheOrderoftheRFMinistryofFinanceNo.737of05.12.2007“OnapprovalofstandardsfortheminimumandmaximummaturitytermofbondissuesofforeigncountriesinwhichtheassetsoftheStabilizationFund of the Russian Federation may be located.” For the debt instrumentsdenominatedinU.S.dollarsandEuro,theminimumtermtomaturityhasbeensetat2months,andthemaximum-15months.FortheliabilitiesdenominatedinBritishpoundssterlingtheminimumtermtomaturitywassetat3monthsandthemaximumterm-36months.

During thefunctioningperiodof theStabilizationFundtheprocedureof itsinvestment policy had been developed only in general and was insufficientlydetailed8.TherewerenorulesgoverningtheformationoftheinvestmentpolicyoftheRussianMinistryofFinance.Inparticular,therewasnoclearregulationoftheorderofinformationinteractionbetweentheMinistryofFinanceandTreasury,althoughtheneedforsuchaprocedurewasmentionedintheregulationsoftheGovernment.

Once theStabilizationFundwassplit into theReserveFundandNationalWelfare Fund, the regulation of matters related to investment of their assetswas detailed9. In particular, the order of the RFMinistry of Finance No. 25Hfrom14.02.2008regulatedtheissuesoftheinformationexchangewiththeRFTreasury.

AccordingtoResolutionsNo.955andNo.18,theRussianMinistryofFinanceestablished:

a)astandardforeigncurrencystructureofassetsofbothfunds,theprocedureforbringingtheactualforeigncurrencystructureoftheFundsintoalignmentwiththeestablishedstandards;

b) the share of financial assets authorized for allocation in the total Fundassetswithin the prescribed requirements and procedure for estimates of theactualshareoffinancialassetsauthorizedforallocationinthetotalFundassets(bringingthemintoconformitywiththenormativeshares);

c)standardminimumandmaximummaturitytermsofdebtliabilitiesofforeigncountries,foreigngovernmentagenciesandcentralbanks,andofinternationalfinancialorganizations,includingthoseinsecurities;

d)alistofforeigngovernmentagenciesintothedebtinstrumentsofwhichtheFundassetscanbeplaced;

e)standardminimumandmaximumtermsofplacing the fundsondepositwithforeignbanksandcreditinstitutions;

f)proceduresforestimatesofcreditsandinterestearnedonfundsdepositedintheFundaccountsandotherprovisionsofthebankaccountcontracts;

8 Thesewereprovided in theRFgovernmentRegulationNo.508of30.09.2004and in theAnnextotheRFgovernmentRegulationNo.229of21.04.2006.

9Listofnormativeactsregulatingthemanagementofinvestmentfundspolicyisgivenabove.

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g) procedures of interaction with the Federal Treasury in carrying outtransactionswiththeFundaccountsinthemanagementoftheReserveFund;

h)proceduresofinteractionwithFederalTreasuryindeterminingthetermsofthecontractwithbankaccountsinthemanagementoftheFundsassets.

In addition, the twoRegulations (in the annexes) have approved detailedrequirementsforfinancialassetsinwhichtheNationalWelfareFundandReserveFundassetsmaybeplaced.

Thus, the regulation of issues related to the process of the Funds’managementhasbecomemoredetailedingeneral.However,theproceduresarestillinsufficienttoregulatehowindividualauthoritiesmanagetheFunds’assetsbymeansofspecializedfinancialinstitutions,aswellastheirinvolvementintheimplementationofthosepowers10.

There is a lack of clarity in the issues related to the implementation ofinvestmenttransactionsbytheCentralBankthatcarriesouttheactualallocationofthefunds.Currently,therearenointernalCentralBankregulationsgoverningsuchfunctionsinthisarea.

Thus, in 2004 and 2005 there were no investment transactions of theStabilization Fund assets. During the period from July 24, 2006 (the startingdateof investmentof theStabilizationFund) throughDecember15,2007, thetotal income from the investmentsamounted to174.8billion rubles. (Over theyearfromDecember15,2006toDecember15,2007therevenuereached151.9billionrubles).Therefore,thereturnsfrominvestmentsinU.S.dollarsfortheyearamountedto10.94%perannumandinrubles-about5%.Giventheannualrateofinflation(respectively11.7%and10.9%),wecanseeanegativereturnontheFund.

Table 2. Stabilization Fund Growth Rate in RUR1) and in USD2), %

01.09.2006

01.10.2006

01.11.2006

01.12.2006

01.01.2007

01.02.2007

01.03.2007

01.04.2007

01.05.2007

01.06.2007

01.07.2007

01.08.2007

01.09.2007

01.10.2007

01.11.2007

01.12.2007

01.01.2008

1 -21.6 9.4 8.2 6.8 7.2 12.8 2.3 3.8 3.9 3.6 3.8 3.9 4.5 3.2 3.7 -3.6 9.42 -21.2 9.3 8.3 8.6 7.1 11.9 3.8 4.4 5.2 2.8 4.1 4.8 4.3 6.1 4.6 -2.1 8.6

Source: RF Ministry of Finance

10TheneedforsuchregulationisexpresslyprovidedbytheResolution№18,whichobligedtheMinistryofFinancejointlywithotheragencies(MinistryofEconomicDevelopment,FederalFinancialMarketsService,theMinistryofJusticeandCentralBank)to“developandsubmittotheGovernmentoftheRussianFederationthedraftRegulationintheestablishedprocedure.”

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Requirements for placing assets of the Reserve Fund

Ingeneral,therequirementsfortheFundassetsarestipulatedinArt.69.11oftheRFBudgetCode,andalsogivenindetailatthesub-lawlevel11.TheArticlepresentsvariousrequirementsfortheinvestmentofthetwoFunds.

OptionsforallocationoftheReserveFundassetsaremuchmorelimitedthanthosefortheplacementoftheFundofNationalWelfareassets.ReserveFundassetsmaybeplacedinforeigncurrencyandinthefollowingtypesoffinancialinstrumentsdenominatedinforeigncurrency:

• debtliabilitiesofforeigncountries;• debtliabilitiesofforeigngovernmentagenciesandcentralbanks12;• debt liabilities of international financial organizations, including

securities13;• depositsandbalances inbankaccountswith foreignbanksandcredit

organizations;• deposits and account balances with the Central Bank of Russian

Federation.RFGovernmentRegulationNo. 955 of 29.12.2007 «On themanagement

procedureofadministrationoftheReserveFund»clarifiestheserequirements,settingminimumandmaximumsharesoftheallocatedassets,aswellasmoredetailedrequirementsforthem.

Thus, the share of foreign countries’ debts should be from 50 to 100%.Herewith,suchassetscanbeinvestedexclusivelyindebtinstrumentsin:Austria,Belgium, Britain, Germany, Denmark, Ireland, Spain, Canada, Luxembourg,Netherlands,USA,Finland,FranceandSweden.

TheRegulationcontainsanopenlist14ofrecommendedinternationalfinancialinstitutionswhosedebt liabilities canbeused for investment.Theyare:AsianDevelopmentBank,ADB;CouncilofEuropeDevelopmentBank,CEB;EuropeanBankforReconstructionandDevelopment,EBRD;EuropeanInvestmentBank,EIB;Inter-AmericanDevelopmentBank,IADB;InternationalFinanceCorporation,IFC; International Bank for Reconstruction and Development, IBRD; NordicInvestmentBank,NIB;andInternationalMonetaryFund,IMF.

The right to define the currency structure of both Funds, as before, wasprovidedtotheMinistryofFinance.AccordingtotheSub-ItemA,Item4oftheRegulation No. 955, «On management of the Reserve Fund, the Ministry ofFinance approves ... normative currency structure of theReserve Fund» and

11SeetheRFGovernmentDecree№955of29.12.2007“OnthemanagementprocedureoftheReserveFund”andtheRFGovernmentDecree№18of19.01.2008“OnthemanagementprocedureoftheFundofNationalWelfare”.

12 The share of foreign government agencies and central banks assets should not exceed30%.SeetheRFGovernmentDecree№955of29.12.2007“OnthemanagementprocedureoftheReserveFund”.

13 The shareof theseassets should be15%.See theRFGovernmentDecree№955 of29.12.2007“OnthemanagementprocedureoftheReserveFund”

14 The regulation uses the following wording: “the debt liabilities of international financialorganizations,inwhichtheFundsassetscanbeinvestedincludethedebtliabilities,securitiesamongthem,ofthefollowingfinancial institutions....”Thatis,otherinstrumentsbesidesthoseamongthelisted“includingthesecurities”arelikelytobeused.

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theprocedureforbringingtheactualcurrencystructureoftheReserveFundintoaccordancewiththeestablishedstandard.

Currently the currency structure of the Reserve Fund is governed by theOrderoftheRFMinistryofFinanceNo.3of16.01.2008.TheOrderestablishedthefollowingauthorizedsharesinthetotalamountoftheReserveFund:

• debtliabilitiesofforeigncountries-95%;• debtliabilitiesofforeigngovernmentagenciesandcentralbanks-0%;• debtliabilitiesofinternationalfinancialorganizations,includingsecurities

-5%;• depositsinforeignbanksandcreditinstitutions-0%.Thislimitsthepermissibledeviationsofactualsharesofthefinancialassets

inthetotalamountofallocatedfundsfromtheReserveFundfromtheestablishedsharesasfollows:

• forthedebtliabilitiesofforeigncountries-+/-5percentagepoints;• for the debt liabilities of international financial organizations, including

securities,-+/-5percentagepoints. Inaddition,theMinistryofFinancehasapprovedtheformulaforassessment

oftheactualshareoffinancialassetsoftheReserveFundanddeviationsoftheactualshareoffinancialassetsfromtheestablishedshareoffinancialassets.

TheRegulationNo.955of29.12.2007imposesthefollowingrequirementsforthedebtinstrumentsfortheinvestmentoftheReserveFund:

• theissuerofthedebtinstrumentsshouldhavealong-termcreditratingnotlowerthan«AA-accordingtotheclassificationofFitch-RatingsortheStandard&Poor'sratingagenciesornotbelowthe«GaAs»byclassificationofMoody'sInvestorsServiceratingagency.Iftheissuerofdebtliabilitiesisassigneddifferentlong-termcreditratingsbythoseagencies,thelowestassignedlong-termcreditrating is selected.Comparedwith the requirements to the selection criteria inrelationtoassetsusedtoinvesttheStabilizationFundassets,therequirementscontainedintheRFGovernmentRegulationNo.955of29.12.2007werereduced.Asmentionedabove,previousrequirementstotheassetswere«AAA»15levelor«AAA»16ratings;

• Maturitytermsofthedebtliabilitiesarefixed;theconditionsofissueandcirculationdonotprovidetheissuertherighttocarryouttheirearlyredemption(maturity)andtherightsoftheownerofthedebttosubmitthemforredemption(maturity)bytheissueraheadofschedule;

• standards of theminimumandmaximummaturity terms for the bondissues, established by theMinistry of Financeof theRussianFederation, aremandatory;

• couponyieldrateoncouponbonds,andthenominalvalueofthedebtliabilities,arefixed;

• denomination of debt is expressed in U.S. dollars, Euro and PoundsSterling, and payments under debt liabilities are made in the currency ofdenomination;

• thevolumeofdebtliabilitiesissuedincirculationisnotlessthanUS$1billionfordebtliabilitiesdenominatedinU.S.dollars,notlessthanEUR1billion

15AccordingtoclassificationsofFitch-RatingsorStandard&Poor’sratingagencies.16AccordingtoclassificationsofMoody’sInvestorsServiceratingagency.

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forthedebtliabilitiesdenominatedinEuro,andatleastBSP0.5billionfordebtliabilitiesdenominatedinpoundssterling;

• debtliabilityissuanceisnotintendedforprivate(non-public)placement;• thenominalamountofdebtliabilitiespurchasedfromoneissueshould

notexceed15percentofthenominalamountoftheissue;• the total volume of the Reserve Fund invested on deposit in foreign

banksorcreditinstitutionsshallnotexceed25percentofthetotalReserveFund.

Requirements for placing assets of the National Welfare Fund

AccordingtoArt.96.11oftheRFBudgetCode,theNationalWelfareFundmay also be allocated in all of the above instruments, except for deposits inforeignbanks.However,theFundassetsmayadditionallybeinvestedin:

• depositsandbankaccountbalanceswithbanksandcreditorganizations,aswellasintheStateCorporation«BankforDevelopmentandForeignEconomicAffairs(Vnesheconombank);»

• debtsecuritiesandstocksoflegalentities;• shares(stakes)ofinvestmentfunds.Inaddition,theNationalWelfareFundassetscanbetransferredtothetrust

managementofspecializedfinancialinstitutions.17ProvisionsoftheBudgetCodearedetailedintheRFGovernmentRegulation

No.18of19.01.2008«OntheprocedureofmanagementoftheFundofNationalWelfare.”Toalargeextent,theyrepeattherequirementsforassetsusedfortheplacementoftheReserveFund.Thus,theResolutionNo.18hasstipulated:

• asimilarlistofcountrieswhosedebtliabilities(aswellastheliabilitiesoftheiragenciesandcentralbanks)maybeusedforallocationofassets;

• asimilarlistofinternationalfinancialorganizations,• similarrequirementsforlong-termcreditratingofforeignissuersofdebt

liabilities.However, since the listofassetsused to invest theNationalWealthFund

assetsisbroader,theRFGovernmentRegulationNo.18of19.01.2008mentionsanumberofspecificrequirements.Thus:

-amongotherthings,theRegulationincludesthefollowingrequirementstothedebt liabilitiesoftheRussiancompanies.Russianissuersofdebt liabilitiesshould have a long-term credit rating not lower than the “BBB-” level by theclassificationofFitchRatingsorStandard&Poor's,ornotlowerthanthelevelof“Baa3”bytheclassificationofMoody'sInvestorsServiceratingagency.IftheRussianissuerisassigneddifferentlong-termcreditratings,thelowestassignedisselectedasthelong-termcreditrating.

Thus, the requirements for the debt liability rating of foreign issuers18 are higherthantherequirementsfortheRussianones.

17ThefounderoftheoftheNationalWelfareFundtrustmanagementistheRussianFederation.TheMinistryofFinanceoftheRussianFederationisinchargeoflegalrelationsinconnectionwiththeestablishmentoftheNationalWelfareFundtrustmanagementonbehalfoftheRussianFederation.

18 Asmentioned above, their rating has to be at least level “AA-” under the classificationofFitch-RatingsorStandard&Poor’s, or at least level “АаЗ” under the classificationofMoody’sInvestorsService.

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-inrelationtosharesandstocks(sharesofparticipation)ofinvestmentfunds,thefollowingrequirementsareestablished19:

• sharesoflegalentitiesshouldbeincludedinthequotationlistofatleastonestockexchange;

• sharesofforeignissuersshouldbeincludedinthelistsofsecuritiesusedtoestimatethestockindicesofMSCIWorldIndexandFTSEAll-WorldIndex;

• sharesofRussiancompaniesshouldbeincludedinthelistsofsecuritiesusedtoestimatethestockindicesofRTSorMICEX;

• the structure of the assets of investment funds,whose issued shares(stakes)shouldincludeonlytheauthorizedfinancialassets.

-inrelationtodepositsandaccountswiththebanksandcreditinstitutions,thefollowingrequirementsareestablished.Thebankorcreditorganizationshouldhavealong-termcreditratingnotlowerthan“AA-”accordingtotheclassificationof Fitch-Ratings or Standard & Poor's rating agencies or not below the levelof “Aa3” by the classification ofMoody's InvestorsService rating agency. If abankorcreditorganizationisassignedadifferentoflong-termratingbyofthoseagencies,thelowestratingisassignedasalong-termcreditrating;

-inrelationtodepositsoftheStateCorporation«BankforDevelopmentandForeignEconomicAffairs (Vnesheconombank), the following requirementsareestablished:

• thefundscanbeplacedondepositinRussianrubles,U.S.dollars,EuroandPoundsSterling;

• themaximumtotalamounttobeplacedondeposits inRussianrublesis655billionrubles.Atthesametime,upto175billionrublescanbeplacedondeposit,theamount,termandotheressentialprovisionsofwhicharedeterminedbytheMinistryofFinance.

WithregardtotheNationalWelfareFund,theMinistryofFinance20hasalsoestablished the authorized standard shares of the total assets of the Fund inforeigncurrencytobeinvestedinfinancialinstruments,denominatedinforeigncurrency:

• debtinstrumentsofforeigncountries-80%;• debtliabilitiesofforeigngovernmentagenciesandcentralbanks-15%;• debtliabilitiesofinternationalfinancialinstitutions,includingsecurities-

5%;• deposits and balances in the accounts with foreign banks and credit

institutions-0%;• stocksandshares(stakes)offoreignlegalentities-0%;• debtliabilitysecuritiesofforeignlegalentities-0%.• theOrderoftheRFMinistryofFinanceNo.24of24.01.2008approves

thefollowingnormativecurrencystructureoftheNationalWelfareFund:• U.S.Dollar-45%+/-5percentagepoints,• Euro-45%,+/-5percentagepoints;

19Ifacquiredsharesoflegalentitiesorstocks(sharesofparticipation)ofinvestmentfundsdonotmatchanyoftheaboverequirements,suchsharesorstocks(sharesofparticipation)ofinvestmentfundsaretobesoldwithin3monthsfromthedateofinconsistencyarising.

20SeetheOrderoftheMinistryofFinanceNo.517from21.10.2008“OnAmendingtheOrderoftheMinistryofFinanceoftheRussianFederationNo.26ofJanuary24,2008”.

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• PoundSterling-10%,+/-2percentagepoints.Thus,thecurrencystructureoftheNationalWelfareFundisnodifferentfrom

thecurrencystructureoftheStabilizationFund.DuringthefirstyearaftertheReserveFundandtheNationalWelfareFund

formation(fromFebruary1,2008toFebruary1,2009),theirmanagementhadnegativeUS$ returns,whichamounted to -2.47%.Given thosedynamics, theRussianMinistryofFinancehasproposedanewindex--theso-calledaggregateprofitability--whichdoesnottakeintoaccountthefluctuationsoftheEuro,PoundSterlingandUSdollar.Theaggregatedindexofreturninthecurrencybasketfortheyearamountedto5.41%(see Table. 3).

Table 3. Annual Revenue from the Reserve Fund and National Welfare Fund management (over the year from 02.2008 to 02.2009),%

Currency Account currency In USD In RURUSD 3.9 3.9 35.14Euro 5.94 –4.99 23.67GBP 9.58 –19.8 4.57Total 5.41 –2.47 26.92

Source: RF Ministry of Finance

WhenconvertedintoEuro,thetotalgainwouldamountto9.3%perannum,and into rubles -more than26%perannum.Themain reason for the lossoffunds indollar termswastheU.S.dollar’sstrengtheningagainst theEuroandBritishpoundsterling in2008.Settingatight limitoncurrenciespreventedthecompensationforthenegativeimpactofweakeningcurrencies,inwhich55%ofbothfundsweredenominated.

Macroeconomic and fiscal linkages; highlights of political economy

Intermsofmacroeconomiceffectsandimplicationsofthesovereignwealthfunds’formationinRussia,therearethreenoteworthyaspects:

1.Intertemporalstabilizationofthefederalbudget.2.Support to theRFCentralBank’santi-inflationarypolicyandpoliciesof

limitedRURappreciation.3.Fundingofanti-crisismeasuresin2008-2009.

Budget PolicyAs mentioned above, the main objective of the RF Stabilization Fund

establishment was institutionalized accumulation of surpluses of the federalbudget under the circumstances of the external environment due to the highoil revenues. Oil and gas revenues include proceeds from taxes on mineralextractionofhydrocarbons,exportdutiesoncrudeoil,naturalgas,andgoods

150

producedfromcrudeoil.Some oil and gas revenues are addressed toward financing current

expendituresof the federalbudget (oilandgas transfer),and thebalancecanbesaved.Toassesstheshort-termrisksintermsofstabilityofpublicfinances,thenon-oildeficitindicatorisimportant,representingthedifferencebetweenthenon-oilrevenueandthetotalbudgetexpenditures(seeTable.4).Accordingly,theamountofthefundisincreasing(see Figs. 4).

Table 4. Revenues and Expenditures of the Federal Budget in 2000-2009. (% of GDP)

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009Expenditures(1)

14.2 14.8 18.9 17.8 15.8 16.3 15.9 18.1 18.2 24.7

Revenues(2) 15.5 17.8 20.3 19.5 20.1 23.7 23.3 23.6 22.3 18.8Includingnon-oilrevenue(2.1)

11.7 13.1 15.1 14.1 13.5 13.6 12.7 14.6 11.8 11.2

Oilrevenue(2.2)

3.8 4.7 5.2 5.4 6.6 10.1 10.9 9.0 10.6 7.6

RFfederalbudgetsur-plus(3)=(2)–(1)

1.4 3 1.4 1.7 4.3 7.4 7.5 5.5 4.1 –5.9

Non-oildeficit(4)=(2.1)–(1)

2.5 1.7 3.8 3.7 2.3 2.7 3.4 3.5 6.4 13.5

Note: when assessing the non-oil deficit in 2009, income from the man-agement of the Reserve Fund and National Welfare Fund, which amounted to

respectively 0.8% of GDP, were taken into account.

Source: Federal Treasury of Russia

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Figure 4. Stabilization Fund, Reserve Fund, the National Welfare Fund in 2004-2009, % of GDP

Note: The Stabilization Fund is a hypothetical fund equal to the amount of the Reserve Fund and National Welfare Fund

Thus,duringtheperiodofafavorableexternalmarketsituation,thepresenceof theStabilizationFundwasaserious institutionalconstraint to thegrowthofbudgetaryexpenditures.Atthesametime,evensuchaconstrainthadalimitedeffect,andin2007-2008,duringinthepeakinoilprices,amarkedincreaseinthefederalbudgetexpenditureswasobservedinrealterms.

Inturn,in2009-2010,theReserveFundbecamethemainsourceoffinancingthe federalbudgetdeficit, formeddue toreductionof thebudget revenues,aswell as due to adoption of thepackageof anti-crisismeasures.However, thescopeofthebudgetdeficit intheRF(likeinmanycountriesaroundtheworld)clearlyexceedsexpectations.Forexample, if the initiallyestimatedscope theStabilizationFund,andthentheReserveFund,wasassessedbasedontheneedtofinancethedeficitof3%ofGDPforthetermnotexceedingthreeyears,whenin2009thedeficitofthefederalbudgetamountedto5.9%,in2010itisexpectedtoamountto6-7%ofGDP,whichmeansacompleteexhaustionoftheReserveFundalreadyinthecurrentyear.BecauseinthefuturethegovernmentofRussiaexpectsthefederalbudgetdeficittobesustained(withagradualdecreaseto2%ofGDPin2013withanaverageoilpriceofnotbelow70dollarsperbarrel),thereisariskofneedingtheinvolvementoftheNationalWelfareFundforthebudgetdeficitfinancingaswell.

Monetary and Exchange Rate PolicyTheavailabilityofbudgetarysovereignfunds,aswellastheirallocationinthe

internationalreservesoftheBankofRussia,hasimportantimplicationsforthe

 

0,0%

2,0%

4,0%

6,0%

8,0%

10,0%

12,0%

14,0%

16,0%

18,0%

20,0%I II III I I II III I I II III I I II III I I II III I I II III I

2004 2005 2006 2007 2008 2009

% G

DP

Stabilisationfund Reservefund

Fundofnationalwell-being Stabilisationfund'

152

monetaryandexchangeratepolicyinRussia.Thus,thetotalvolumeofmonetarysupply,withdrawnfromtheeconomyand

allocatedtotheaccountswiththeRFCentralBankasofJanuary1,2009,wasapproximately120%ofthemonetarybase(high-poweredmoney)at thattime.Savingthisvolumeofmonetarysupply in theeconomyover2004-2008wouldincrease the rate of the monetary supply growth by about 15-20 percentagepointsperyear.Theinflationaryconsequenceofthiscouldbetheincreaseoftheaverageannualinflationratefrom11.35%perannum(whichisoneofthehighestratesintheworld)to13.5-14%perannum.

Atthesametime,thetotalamountoffundsplacedintheforeigncurrencyisabout35-40%ofthetotalsurplusoftheRussianbalanceofpaymentsfrom2006through thefirst sixmonthsof2008.Accordingly,ademandwas formed fromtheRussianMinistryofFinanceforsuchinflowofthecurrencytothedomesticmarket,whichhashelpedtheBankofRussiatokeeptherublerateatalevelnohigherthan23.5-24.0rublesperdollar.Modelingasituationwherein2006-2008therewasnoneed toallocate the funds in foreigncurrencyshows that in thiscase,thenominalrubleexchangeratecouldrisetothelevelof13-15rublesperdollarbyAugust2008.Accordingly,therealeffectiverubleratebythebeginningofthecrisisinautumn2008wouldhaveamountednotto116.5%ascomparedwithJuly1998(themaximumvalueof therealexchangeratebeforethe1998crisis),butto180-200%,whichwouldmeanacompletelossofcompetitivenessofdomesticproducersandasharpslowdownineconomicgrowth,evenagainstthebackgroundofhighpricesforoilandotherRussianexportgoodsin2007.

Anti-crisis measures funding in 2008-2009Financingoflarge-scalemeasuresforthesupportofthenationaleconomy

withouttheinvolvementofexternalborrowingin2008-2009waspossiblethanksto the reservesaccumulatedduring theeconomicgrowth. In fact, oil andgasrevenuesbecamethemainsourcestosupportthebalanceofthefederalbudgetin2009. Inparticular, tofinance thebudgetaryexpenditures fromtheReserveFund,aboutRUR2.964trillionwasallocated.Thisfactallowsustoconcludethattheideaofforminganoilandgasfundwasfullyjustified,andcanberegardedasanadvantageinthenationalfiscalpolicy.

Table 5. Dynamics of Formation and Use of Oil and Gas Assets in 2009(RUR bln)

FundBalanceasoflate2008*

Revenueover2009:

Expenditureover2009:

Balanceasoflate2009*Oiland

gasrev-enue

Revenuefromassetsmanage-ment

Supportofthefederalbalancesolvency

Supportofoil

andgastransfer

ReserveFund

4027.6(9.8%of

GDP)488.5 205.0 2964.8 179.4

1830.5(4.7%ofGDP)

153

NationalWelfareFund

2584.5(6.3%of

GDP)– 92.5 – –

2769.0(7.1%ofGDP)

Total6612.1

(16.0%ofGDP)

488.5 297.5 2964.8 179.44599.5

(11.8%ofGDP)

* Balances are estimated at the exchange rates of January 1, 2009 and January 1 of 2010, accordingly.

Source: Federal Treasury

Formally,theassetsoftheNationalWelfareFundwerenotusedtofinancethe federal budget deficit and the financing of anti-crisismeasures.However,starting fromOctober 13, 2008, theRFPresidentDmitryMedvedev signed apackageof lawspreviously enactedby theStateDumaandapprovedby theFederalCouncilonthestabilizationof thefinancialsystemduringthefinancialcrisis: inparticular, legislativeamendmentsallowedplacementof theNationalWelfareFundassetswith theVnesheconombankdepositsuntilDecember31,2019,totalingnomorethan450billionrublesattherateof7%perannum.

Thus,therewasonlyachangeintheportfoliooffixedassetsfortheallocationof the NationalWelfare Fund; it was replenished with the ruble-denominateddepositsoftheRFVnesheconombank.Inthefuture,theuseofthoseresourcesfor the implementation of anti-crisis measures was already implemented bytheRFVnesheconombank. Inparticular,404billion rublesweregranted to14Russiancommercialbanksintheformofsubordinatedloansand30billionrublesweretransferredtothe“RussianDevelopmentBank”forcreditingSME.

Ingeneral,analyzingtheroleoftheReserveFundasasourceoffinancingofthefederalbudgetdeficitinRussiaover2009-2010,oneshouldtakeintoaccountthreeissuesrelatedtotheproperunderstandingofthe“reserve”natureofthesefunds:

1. On the one hand, the use of the Reserve Fund assets to cover thebudget deficit is a commonmonetary emissionof theCentralBank, since inpracticesuchanoperationmeanstheflowoffundsintheRFCentralBankfromthespecialaccountsoftheRFGovernmenttothemonetarybase(throughthecurrentaccountoftheGovernment).Thenon-emissionnatureofthisoperationcouldtakeplaceiftheBankofRussiaatthesametimewouldsellforeigncurrency(whichisformallyacounterpartoftheReserveFund),butafteradownfalltoitslowest level inJanuary2009, the international reservesof theBankofRussiahaveconsiderablygrown.Thus, intermsofmonetarypolicy, theFundisnotareserve,butisaseparatechannelforthemoneyinflowintheeconomy.

2. Ontheotherhand,thedescribedeffectofmonetaryemissionfromthebudget account is observed every timewhen the government spendsmoneyon the basis of the existingRF systemof theTreasury,which has budgetaryaccountswiththeBankofRussia,i.e.thosewithdrawnfromthemonetarysupply.

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Irregular fluctuations are observed within the year (e.g., the sharp growth ofmonetaryassetsinDecember,whenthebudgetexpensesareperformedwhenthemoneybaseisreducedeachmonthinthelastdaysofthemonth,whentaxesarepaid),butbyvirtueofthebudgetreportingterm,namelythefiscalyear,asarule,onlythefinalimpactofthebudgetexecutiononthemoneysupplyistakenintoaccount.If,however,weextendtheperiodofconsiderationfromoneto,forexample,5years,thentheuseoftheReserveFundshallceasetobeamereemission,sincethemoneyaccumulatedinitwithinsuchatermmayberegardedastemporarilywithdrawnandreturnedtotheeconomyassets.

3. Fromanotherperspective,intermsoffiscalanddebtpolicy,theReserveFundassetscertainlycanberegardedasareserveoftheRFGovernment,astheymakeitpossibletoreplenishthebudgetdeficitwithoutborrowinginthedebtmarketandavoidingtheincreaseofthegovernmentdebt.Atthesametime,astheexperienceofEUcountries,USA,Japan,UKandothersshows,thegrowthofpublicdebttofinancetheanti-crisismeasurespackagehasbecomeoneofthekeychallengesfortheeconomicpolicyatthestageofrecoveryfromthecrisis.Inthisregard,theexistenceoftheReserveFundinRussiacanberegardedasapotentialallowingthecountrytoavoidthegrowthofdebtburdenandtoshiftcurrentbudgetexpensesforthefuturegenerations.

The impact on poverty eradication, social policy and labor marketFromthepointofviewofthecurrentsocialeffectsandsupportoftheliving

standardsofthepopulationofRussia,thesovereignwealthfundsprovidelimitedand,forthemostpart, indirecteffects.It isextremelydifficulttodistinguishtheimpactofeachoftheexistingfunds.

Fromourpointofview, themost important impacton thepopulation livingstandards is the provision of an anti-inflationary effect of theRFStabilizationFund(seeabove).Weestimatethetotalincreaseinincomeinrealtermsduetolowerinflationintheperiodof2004-2008atabout20percentagepoints.

AnotherimportantconsequenceoftheReserveFund’sexistenceisfundingofthefederalbudgetdeficitin2009.Thesocialprojectsinparticular,whichallowedagrowthinrealincomesby2.3%inthesituationofaseverecrisis(declineinrealGDPin2009by7.9%),reducedthenegativeimpactoflowerdomesticdemandandensuredthegrowthofhouseholdsavings.Herewith,asnotedabove,thoseexpenditureshavebeenfinancedwithoutincreasingthenationalborrowingand,consequently,thegrowthoftheborrowingputsaburdenonthefuturegenerations.

TheroleoftheNationalWelfareFundinsolvingthesocialproblemsatthemomentisextremelysmall.Moreover,theNationalWelfareFundobviouslydoesnotplaytherole imposedon it--butnotensured in institutionaland legislativeterms-- as an instrument for the long-term solutions of thepension system inRussia.WewillconsiderthetentativeoptionsoftheNationalWelfareFundinthisareainthefinalsectionofthismemo.

Compliance with Santiago PrinciplesTable 6showsourexpertassessmentofcomplianceoftheRFReserveFund

andNationalWelfareFundwiththeGenerallyAcceptedPrinciplesandPractices(GAPP),orSantiagoPrinciples.Compliancewith theseprinciples ispresented

155

for each fund separately, although, as shown above, the legal provisions oftheiroperation,managementsystemandtherequirementtoinvestmentsofthefundsarepractically identical.Nevertheless,basedonthedifferentnatureandpurposesofeachofthefunds’formations,theextentoftheircompliancewiththeSantiagoPrinciplesvaries.

Table 6. Santiago Principles and Implementation thereof for the Rus-sian Sovereign Wealth Funds

Principles RF Reserve fund RF National Welfare FundGAPP1GAPP1.1GAPP1.2

+++

+++

GAPP2 + –GAPP3 + +/–GAPP4GAPP4.1GAPP4.2

+++

+++/–

GAPP5 +(?) +(?)GAPP6 +/– –GAPP7 +/– –GAPP8 +/– –GAPP9 – –GAPP10 +/– +/–GAPP11 + +GAPP12 – –GAPP13 – –GAPP14 – –GAPP15 + +GAPP16 +/– +/–GAPP17 + +/–GAPP18GAPP18.1GAPP18.2GAPP18.3

+/–+/–++/–

––+/–+/–

GAPP19GAPP19.1GAPP19.2

+/–++/–

–+/––

GAPP20 + +GAPP21 – –

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GAPP22GAPP22.1GAPP22.2

––+/–

––+/–

GAPP23 +/–(?) +/–(?)GAPP24 – –

Therefore, as seen from the above estimates for the RF Reserve Fund,compliancewith theSantiagoPrinciples isobserved inninepositions (andsixsub-positions),andpartialcomplianceineightpositions(foursub-positions).Insevenpositions(andonesub-position)thereisnocompliance.

FortheNationalWelfareFund,thesituationlooksevenworse:• compliance-in6positions(3sub-positions)• partialcompliance–in5positions(5sub-positions)• inconsistency–in13positions(3sub-positions).Itshouldbenotedthat forbothFundsfullcompliancebyonepositionand

partialcompliancewiththeotherpositionsareinquestionbecauseoftheabove-mentioned decision of theRFGovernment,which has refused to provide theinformationontheFunds’statusforpublicdisclosuresinceMay2010.

Perspectives and Predictability after the Global Economic CrisisAsstatedabove,thesituationwiththedynamicsofbothRussiansovereign

funds during the recent crisis is ambiguous.At the beginning of the crisis intheRussianFederation inautumn2008 (October1,2008), thevolumeof theStabilizationFundofRussiaamountedtoabout141billionUSdollars,andtheNationalWelfareFund–48.7billionUSdollars.AllassetswereplacedinhighlyreliablesecuritiesdenominatedinUSdollars,Euro,poundssterlingandJapaneseyen.Thus,fromthebeginningofthecrisisdespitethedevaluationoftheruble,aswellaslowerinterestratesintheleadingglobaleconomiesfortheruble,assetsbegantogrow.Incontrasttotheassetsofothersovereignfunds,intheRussianfundstherewerenoassetsincorporatesecurities(stocks),sothedownfallinthestockmarketdidnothaveseriousconsequencesonthem.

At the same time, the growth of the federal budget deficit and the RFGovernment'sneedforadditionalfinancialresourceshaveresultedinattractingthefundstomeetcurrentfinancialdemands.Fallingoilpricesintheworldmarketsandthereducedinflowofexportearningstothecountryledtothedisappearanceoftheincomepartofbothfunds.ByearlyJune2010,thebalanceintheReserveFundshouldnotexceed40billionUSdollars,andallthemoneyfromthefundshouldbeallocated to finance the federal budget deficit in 2010.However, inourview,theutilizationofthefundin2009-2010cannotberegardedasalossbecausetheassetswereusedfortheimplementationofthefund’smainobjective-torecoverabudgetdeficitthataroseinconsequenceofshort-termandcyclicalswingsinrevenues.Inaddition,availabilityofthissourcetofinancethebudgetdeficitallowsRussiatoavoidthetrapintowhichothereconomiesoftheworldfall,namelytherapidaccumulationofpublicdebt.TherenewalofrevenueinflowtotheReserveFundofRussiaisexpectednotearlierthanin2012-2013(inthecaseofthemoderatelyoptimisticscenario,revivingtheglobaleconomyandthe

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preservationoftheglobaloilpricesatnotlessthan70USdollarsperbarrel).NationalWelfareFundassetswerenotdirectlyusedtofinancethefederal

budget deficit, and the assets spent in the context of an anti-crisismeasurespackage for operations in the stockmarket of Russia and the support of thebankingsysteminRussiawereprovidedastheconversionoffundsfromforeigncurrency intorublesandtheirallocation inrubleassets(approximately20%oftheNationalWelfareFund).ThoseRURinvestmentsarepotentiallylost,butduetotheirlong-termnaturetheywillbereflectedinanexplicitformlater.Thus,withregardtotheeffectoftherubledevaluationandthefactthatbuyingtheRussiancompanies’shareswascarriedoutatclosetoaminimumprice,specifically intimesof crisis, theFundhasnot suffered losses in ruble terms. Losseswererecordedin2010,asthenominalexchangerate,andconsequently,rubleratingswerereduced,affectingthefundassets.Similarlosseswereobservedinthepre-crisisperiod,when the rublewasalso rapidlystrengtheningagainst themajorworldcurrencies.

However, in the absence of fiscal consolidation in 2011-2013, the RFgovernmentwillbecompelledtofinancethefederalbudgetdeficitattheexpenseoftheNationalWelfareFund,downtoitsfullexhaustion(exceptfortheamountofthelong-termruble-denominatedinvestmentsmadeintheframeworkofAnti-CrisisMeasures).Accordingly,onecanmentionthefollowingmainrecommendationstoimprovethefunctioningoftheRussiansovereignfunds:

1.Withrespecttothe Reserve Fund of Russia–thesoonestreturntotheaccumulationoftheassetsatthehighprofitabilityinthelongtermperiod.

2.WithrespecttotheNational Welfare Fund–theRFGovernmentshouldclearlydefinethestrategicobjectivesoftheFund.CurrentlytheFund,inessence,isaseparatefundoftheRFGovernment,protectedfromspendingtocoverthebudgetdeficitfinancing(sofar!),whichhasnoclearpurpose.Forthepurposesof the Fund, one can propose its transformation into a savings pension fund(for example, like theGovernmentPension Fund ofNorway), i.e., it could beaddressedtoresolvetheshortageinthepensionsystemovertheprospectofatleast15-20years.ItisthereforenecessarytoreverttotheaccumulationofassetsintheNationalWelfareFund.

CurrentvolumeoftheFund(lessthan10%ofGDP)isclearlyinsufficienttosolveanyseriousproblem.Inadditiontotheshort-termrevenuesfromexportsofrawmaterials,themostobvioussourceforthereplenishmentoftheFundmaybetheproceedsofprivatizationofthestateassetsandrealassetsownedbythestate.Asof2007(priortothecrisiseventsintheglobaleconomy),assessmentofsuchassetsandpropertyisnotlessthan57%oftheRussianGDP.InthecaseoftransferofthesefundstotheNationalWelfareFund,witharealreturnontheinvestmentsoftheFundatthelevelof4.5%peryear,theamountoftheFundbytheendof2015shouldamountto70.6%ofGDPandbytheendof2025–80.5%,whichisenoughtokeepthereplacementrateofretirementpensionat30%until2025.

3. With respect to both funds-principlesandapproachestomanagingthefunds’assetsshouldbedifferentiated. Inparticular, theNationalWelfareFundshould bemanaged essentially on different terms than theReserve Fund. Inother words, an authorized structure of assets and management mechanismshouldberevised.

158

First,theNationalWelfareFundhasalongerprospectusforinvestmentthantheReserveFund,andtheNationalWelfareFundassetscanbeinvestedinmorevolatileandprofitablefinancialinstruments.

Secondly,theNationalWelfareFundshort-termliquidityhasalowervalue,andconsequently,itispermissibletoinvestitinnon-marketableassets.

Third,internationalexperienceshowsthattoimproveefficiencyofmanagementandprofitabilityofsuchasovereignfund,itisreasonabletotransfermanagementofsuchasovereignfundtoprivateprofessionalmanagementcompanies,ratherthantotheCentralBankoraspecializedstateagency.

Therefore,achangeintheinstitutionalandlegalbasesofbothfunds’functionsisrequiredtoimprovetheircompliancewiththeSantiagoPrinciples.