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The Russians are coming — loaded with cash

by Sergei Guriev and Aleh Tsyvinski

MOSCOW — Russia’s government is sitting on a giant pile of cash that it plans to invest in foreign assets. The glimpse of its economic muscle was revealed when the prime minister of Iceland announced that Russia may come with about $5 billion to save its troubled economy. Who could have thought that, given the chaotic Russia of the 1990s, only 10 years later it would be in the position to bail out a developed country? Even more surprising is the fact that the helping hand for Iceland comes at a time when the domestic stock market is in a free fall and trading on the Moscow stock exchange is routinely halted.

The Kremlin thinks that now is the time to buy assets cheaply, using the current financial crisis to emerge as a powerful global economic player. As Prime Minister Vladimir Putin remarked at a recent meeting with the CEO of state-owned bank VTB, “Perhaps we should buy something (abroad)? Something that is up for grabs?” According to Arkady Dvorkovich, an economic aide to President Dmitry Medvedev, the government will support — both diplomatically and financially — the expansion of Russian companies abroad.

Following the Russian-Georgian war, the West is scared that Russia’s government will use its cash not just for economic purposes, but as an aggressive foreign policy tool. Should the West really consider blocking Russian investments abroad as a way to influence Russia?

Trying to erect an Iron Curtain around Russian funds and businesses will prove counterproductive. Indeed, a large-scale “invasion” of Russian business would be a positive development, because it would foster economic interdependence. This is true even if the economic expansion is led by state-owned companies and by Russian sovereign wealth funds. By investing in American and European assets, Russia’s government and business elites are buying a stake in the global economy. This should bring better mutual understanding and a more rational and accountable foreign policy.

Paradoxically, despite recent hits to the Russian stock market, Russia remains awash with cash. Russia’s government just rolled out a $130 billion bailout plan for the country’s banking system; as a percentage of gross domestic product this would be equivalent to about $1.3 trillion in the U.S. — almost double the Paulson plan. Yet, even this package has not significantly eaten into Russia’s sovereign wealth funds and its world’s third largest currency reserves.

The government’s Reserve Fund, created to cushion the economy from a fall in oil prices, stands at $140 billion, and the National Welfare Fund, intended mainly to solve the coming pension crisis, holds another $30 billion. The NWF, though not yet officially a “sovereign wealth fund,” is already among the 10 largest such funds, rivaling the Brunei Investment Agency.

A combined Russian Sovereign Wealth Fund (excluding the half-trillion dollars in foreign-exchange reserves) would rival Singapore’s Temasek Holdings (currently sixth in the world) and lag just behind the China Investment Corporation. By design, these funds are intended to be invested outside Russia. As today’s financial crisis has made many Western assets cheap, they are now within reach of Russia’s government and leading Russian companies.

Russian private and state-owned companies have already invested abroad extensively, often buying stakes in large foreign companies. Overall, the top 25 Russian companies hold $59 billion in foreign assets and are the third largest investors in emerging economies, following Hong Kong and Brazil. Even though the financial crisis has wiped out the Russian stock market, some of the best-run companies are hit less badly than their Western counterparts and will therefore be shopping in the global market next year.

Russian corporations’ foreign investments have already generated a heated debate in both the United States and Europe — even when investment was done by a private company. The largest controversy surrounded a merger that Russian steel giant SeverStal sought with Luxembourg-based Arcelor. SeverStal was rejected in favor of Mittal Steel, with some commentators claiming that the decision was taken on political grounds. But no investment by a private Russian company has, so far, been vetoed by Western governments.

Yet hostility toward investment by Russia’s government (and government companies) has been almost universal until recently. U.S. and European policymakers do not trust that foreign governments (and their sovereign wealth funds) invest solely on business grounds.

But the financial crisis is making the West happy to find “friends with cash.” During his visit to Russia in June, U.S. Treasury Secretary Henry Paulson emphasized that the U.S. is interested in welcoming Russian investment, including investment by Russia’s sovereign wealth funds.

But Russia’s government still needs to set up a transparent and accountable structure to manage its sovereign wealth. Doing so will also help to convince other countries that the government’s agenda is economic, not political.

Russian authorities may be advancing that goal by taking initial steps toward improving corporate governance in state-owned companies. In an unprecedented move, the government replaced a large number of bureaucrats on the boards of these companies with independent directors (including a couple of foreigners). While it is unlikely that Russian sovereign wealth funds and state-owned companies will change overnight, they will certainly become more transparent and efficient in the near future.

The key benefit of Russian foreign investment is not economic, but that it helps Russia become a global citizen. Consider Russia’s elites, who buy houses in London, ski in the Alps, and educate their children in Switzerland. They have too much to lose from a worsening political climate between Russia and the West. It is time to make Russia’s big business — and its government — stakeholders in the world economy.

Sergei Guriev is rector of New Economic School in Moscow. Aleh Tsyvinski is a professor of Economics at Yale University. © 2008 Project Syndicate