Russia Growth Diagnostics (3): Finance

< Part 2: Introduction to Russia

I test for financial constraints in Russia in two steps. First, measuring the amount of resources potentially available to Russian companies. Second, checking whether the financial sector mediates these resources efficiently.

HRV do these test to separate two groups of symptoms: those caused by financial constraints and the symptoms of low social returns to investments. In other words, an economy may have big growth opportunities that get no funding because of some problems in the financial industry.

Savings and Capital Markets

In some narratives, banks create money out of nothing and lend them to firms. In others, the central bank purposefully keeps the rates high and, thus, deprives business of credit. Such monetary issues aside, the economy can invest only what it hasn’t consumed yet. International borrowing may smooth this choice between consumption and investment, though only temporarily. Let’s see the internal resources first.

Savings are defined as GDP minus consumption: S = Y - ( C + G ) in the GDP definition Y = C + G + I + X - M). Savings already include investments I. The remaining term in S is net export X - M. It’s basically the part of output that has not been invested or consumed, and therefore, is potentially available for business investment:


The gap between these two lines is Russia’s trade balance. It’s positive, while the average savings rate at 30% stands above the world median:


So Russia doesn’t seem constrained in domestic resources.

How about the access to international capital markets? The government has (at least, had before 2014) a very favorable macro and could borrow abroad. Large companies also had access to external credit. They even accumulated some debt. This debt isn’t entirely “external” since capital moves mostly between Russia and a few offshores, where Russian business owns proxy parent companies. When a Cyprus proxy lends to its Russian subsidiary, this can’t be called an “access to international debt markets” (until each word is taken in separate quotes).

For this and the recent sanctions, Russia has problems with reaching international capital markets. But given the trade surplus, financial resources don’t bind on average.

The Financial Sector

Maybe the resources are abundant and the financial sector mediates them poorly? Consider key players.

The Central Bank

Does the Central Bank of Russia (CBR) set rates too high? Adjusted for inflation, it does not seem so. In fact, if you take the GDP deflator, instead of the CPI, the rates turn negative. The CBR key rate (sort of a Federal Funds Rate for Russia) remained below the deflator for years.

Russian business complains about high lending rates, but reducing the key rate won’t help much under full employment. Worth recalling: the market rates depend on the key rate, macro risks, and firm-specific risks. Even taken together, they still don’t beat the deflator, meaning that the real lending rate is already low:


This plot is based on a somewhat arbitrary average market lending rate, so we’ll look at this market closer.


A monopolistic banking sector may induce credit rationing and high market rates. Is it monopolistic in Russia?

Russian financial assets are managed by commercial banks and large industrial holdings. A non-banking asset management industry (mutual funds, private equity, hedge funds) is virtually absent. Banks manage household savings and industrial groups manage their own corporate investments.

In banking, assets are concentrated in three banks, with Sberbank alone having as much assets as the other nine banks in the top ten. The government owns major stakes at these largest banks. State-owned banks are managed independently from each other, so they compete to some extend.

This structure does not generate excessive profits for banks. The net interest spread declines:


Many discussions in Russia concern long-term funding. A popular suggestion is to get the funds from people. A recent innovation is the tax-deductible retirement account (similar to the US IRA) at brokers and asset managers.

Though undoubtedly useful for citizens, such supply-side solutions do not add much to long-term investments, because matching maturities isn’t the only way to get things done. Short-term debt also can fund long-term investments. Alternatively, banks can smooth fluctuations in short-term deposits and supply long-term debt to businesses.

Why neither happens? Because long-term investments themselves must be sufficiently attractive.

Why not Finance?

Russia has freely available financial resources and a competitive financial industry. Maybe not as much and as competitive as somewhere else, but it’s not the main problem. The lending rates appears to be high to businesses because business returns nearly equal these rates. It’s expected after finding no signs of wedges in the financial industry.


Since the funds don’t bind, it’s time to find out what contains returns to investments. The factor of human capital follows.


Data sources: PWT7 and World Bank.

Notes: More on variable definitions and computations will be available in the Stata file later. For more detailed checks of the financial industry, I recommend the IMF data.

When ROI Hits the Roof


The Coalition for Evidence-Based Policy has a nice compilation of low-cost program evaluations. Example #2 tells us about a $75 million education program that improved nothing. The cost of finding this out was $50K. The simple math says that returns on money invested in evaluation reached 150,000%. It kinda outperforms S&P500.

What’s the trick? First, as mentioned before, maybe the same program completes something else. The program had aimed at improving student results and attendance, and it didn’t improve them. But the teachers got $3K more each and bought themselves useful things. Nothing wrong with that, but we need other ideas to improve education.

Second, so-called unconditional money transfers rarely motivate better performance, though it may seem counterintuitive. Not only in education. Public services just happened to be in full view of everybody. Then ROI in evaluation depends on how much the government or business puts into unchecked programs. This time it was $75 million, next time it’s $750 million. Big policies promise big returns, either due to better selection or faster rejection.

Third, such opportunities exist because big organizations evaluate execution, not impact. Execution is easier to monitor, so public corporations have to have independent auditors who ensure that employees don’t steal. In contrast, efficiency audit requires management’s genuine interest in rigorous evaluation, but there’s no incentives for that. After all, stealing is everywhere a crime, while incompetence is not (despite incompetence being more wasteful).

With that said, ROI of 150,000% is a fact. If you spend on a policy doing X and the policy does nothing to X, you can just leave $75M on the table. Without that $50K evaluation, you’d lose them.

Investing and failures in startups

The efficient market hypothesis got a bad press after 2008. Not surprisingly. It’s a half-truth. For instance, what Robert Shiller identified as genuine mispricing Robert Lucas called a minor deviation. Also, the hypothesis has many interpretations, and here’s one of them.

(data link)

On the left we have the mean of money that startups received over their lifetime. On the right is a rude measure of risk: the ratio of acquisitions to closed companies in the respective market. So, enterprise software has three successful acquisitions per one failure. I dropped “operating” startups because it’s difficult to interpret their success.

The graph is interesting because clean tech gets much funding but has one acquisition per two failures. Analytics gets small funds (not so sexiest as it was called?), but gives very stable outcomes. These two are exceptions because in general funding match the risk measure. And so in other markets: it’s enough for one product (like housing) to have abnormal pricing for the entire market to be under risk.

That is an attempt to make complex things embarrassingly simple, of course. For example, some may insist that average funding is a measure of capital intensity, not of competition among investors. Or what we should honestly calculate returns, as was done here. But it all seems to be half-truths, including this piece. We have to keep watching.