State firms to fight capital controls in Russia

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Russia will find it hard to follow Brazil in slapping curbs on "hot money" inflows because powerful state-controlled firms need access to cheap Western loans to service huge debts.

After Brazil imposed a tax on capital inflows a month ago, Russia is now the BRIC country most exposed to foreign capital, and officials have said they are considering "soft" measures to stem inflows.

Russia's central bank directly controls only one third of capital inflows through reserve requirements and has proposed to cut the amount in interest that can be claimed tax-free on foreign loans. Some big firms and banks are already crying foul.

"The international market is very important for us. Long-term resources are concentrated there. On the whole I am against such a measure," Andrei Kostin, CEO of state-controlled VTB bank, told Reuters.

Under the proposal, companies like Rosneft, which in 2008 had on average paid 4.6 percent interest on its $24 billion debt, the bulk of it foreign, will have to pay a 20 percent profit tax on any interest exceeding three percent.

The measure would have knocked only around $80 million off state-controlled Rosneft's $11 billion profit in 2008. In the likely case that interest rates for emerging borrowers rise and profits sink the impact would be more significant.

"Any increases in related costs of raising capital on foreign markets would not be welcome," Peter O'Brien, Rosneft's vice-president for finance and investments, told Reuters.

Tax can differ

Russia lifted restrictions on capital flows in 2006, opening the floodgates to "hot money" that inflated corporate debt to USD 450 billion in 2008, leading to a sharp appreciation of the rouble and high inflation rates.

Finance Minister Alexei Kudrin tried to limit state companies' huge foreign borrowings without success.

The economic crisis that hit oil-dependent Russia much harder than any other emerging economy led to capital flight totalling USD 130 billion in 2008, a 30% devaluation of the rouble and prompted talk of re-introducing capital controls.

With oil above USD 75 per barrel, international capital markets are opening up again for Russian borrowers, and the most ardent corporate advocates of capital controls such as the boss of Russian Railways Vladimir Yakunin, have changed their minds.

"We have a relationship with international lenders that allows us to borrow at rates and for a period which would not have been possible here in Russia," Yakunin, a close ally of Prime Minister Vladimir Putin, told Reuters.

Yevgeny Nadorshin, an adviser at the economy ministry, says companies cannot be thrilled about capital control proposals after splashing loans on ambitious acquisitions during the boom years instead of investing in production or organic growth.

"The equity they acquired has lost value while the debt burden has remained," he says adding that it might be better to differentiate taxation of loans taken for acquisitions and organic growth.

Putin, Russia's ultimate decision maker, has said he was initially against lifting capital controls but later backed the idea because it was the first step towards an inflation targeting regime and currency free float.

Sources close to the government have said Putin was lured by the idea of the free-floating rouble eventually becoming the global reserve currency, increasing Russia's influence in international economic affairs and adding to its nuclear and energy status.

In September, Putin was still defending the control-free regime, saying it gave Russia advantages over China, which uses stringent capital controls, but in his latest speech on the state of the economy on November 21 Putin did not mention the issue.