14Section 2. Monetary and budgetary spheres
2.1. Monetary Policy
The RF Government's monetary policy drew more attention in 2004 than in the previous 3 to 4 years. This was basically caused by some developments that took place in the banking system in May and June, namely breaking the upper limit of seasonal movements in the consumer price index that was prevailing over the last few years, and breaking the upper limit of inflation set as a targeted value by the Central Bank and the RF Government.
At the same time, close association of inflation developments and monetary aggregate movements normally breaks up under moderate and low inflation rates, as was clearly demonstrated by comparing their patterns in the previous year. In this case, cost-push inflation (prices of raw materials) and structural changes in prices had more impact on the rate of price increases. Under such circumstances, however, the role the RF Central Bank came down to practically curb real growth of the RUR exchange rate (against the basket of currencies), create initial conditions for introduction of free RUR convertibility and monitor the situation in the banking sector, while the RF Government was entrusted with the task of controlling inflation .
In this context, the following issues are worth analyzing :
• movements and factors of inflation developments ;
• changes in the demand and supply in the money market ;
• movements in nominal and real RUR exchange rate ;
• banking system development.
We will consider these in details below.
2.1.1. Inflation Development
At the beginning of 2004, monthly values of the CPI were less than the corresponding figures in 2003 (Fig. 1). The results obtained in the first half of the year allowed one to rely upon the forecast of consumer price growth in 2004 (from 8 to 10%). Since July, however, incremental growth of prices began to exceed the figures of 2003. Such movement was caused by a variety of factors, among which a rapid growth of prices of food products should be emphasized as compared to the previous year. In regard to the prices of nonfood products, prices of motor gasoline grew faster than those in 2003. Finally, in regard to paid services, prices of the services rendered to the general public by the passenger transport industry and preschool institutions grew faster than those in 2003 .
Let's consider quarterly movements of the CPI.
Growth rates of consumer prices slowed down notably throughout the quarter 1 of 2004. In spite of the fact that in January prices of paid services for the general public were increasing at the rates comparable to those in January of the previous year, a more moderate movement of prices of food products caused a general decline in the CPI from 2.4% (in January 2003) to 1.8% in January 2004. The figures in February were also positive enough, especially having regard to prices of paid services for the general public whose growth rates dropped by 2.5 percentage points. Growth rates (by 1 percentage point) of prices of paid services kept declining in March 2004, which resulted in that the CPI growth rates decreased down to 0.8%. At the same time, the fact that growth rates in prices of food products and non-food products stopped to decline as was the case over the last few years, was a negative sign in March. Underlying inflation was 2.4% in the quarter 1.
Fig. 1. Producer Price Index Movement in Russian Federation in the Period Between 2003 and 2004
In the quarter 2, the fastest incremental price growth, 11% over the first half of 2004 (by 15.6% in 2003), continued in the category of paid services for the general public. In general, in the first half of the year, all groups of prices of paid services for the general public grew more moderately as compared to the previous year, except for the prices of services rendered by preschool institutions and cultural organizations. Food products came second by incremental growth rates of inflation with price movements coming up to the values of 2003 (8%) for the first time since the beginning of 2004. Total incremental growth in this group accounted for 6% (against 7.3% in the first half of 2003). Basic inflation continued to slow down in the quarter 2 of the year. It accounted for 0.5% in June against 0.6% in May and 0.8% in April. Thus, unerlying inflation accounted for 1.9% in the quarter 2. Basic inflation dropped gradually as a result of monetary pressure on prices (see below). It should be noted that inflation rates were equal to the corresponding values of 2003 only in April and June. Taking into account that the CPI grew at a slower rates during the rest of the months of the first half of the year than in the previous year, there were reasons to suggest that consumer prices would grow up within the expected limit of 10%.
However, from the beginning of July consumer prices began to grow at faster rates than in 2003. For example, in the period between July and September 2004 they increased by 1.7% (by 0.6% over the quarter 3 of 2003). The CPI in 2004 was beyond the corresponding value in 2003 in each month of the quarter. By the end of the quarter, prices of food products grew up by 7.2% since the beginning of the year (against 6.1% in 2003). In the period between July and August 2004, seasonal decline in prices of fruits and vegetables went slower as compared to the previous year. As early as in August, when growth rates in prices of food products were positive as opposed to July, price growth since the beginning of the year exceeded the values of the two last years. Prices of non-food products grew by 5.5% by the end of September (by 6.6% in 2003). Prices in all sub-groups of non-food products increased at more moderate rates in 2004 as compared to the previous years. Incremental growth of tariffs on paid services for the general public accounted for
14.3% by the end of the quarter 3 (by 19.7% over the corresponding period of 2003). In this sub-group, incremental growth of services of preschool organizations exceeded the corresponding figures of the previous year (by 6.9 percentage points). The reference index of consumer prices increased by 6.8% since the beginning of the year.
Thus, it is fair to say that according to the figures of the quarter 3, there was no traditional seasonal growth impairment of consumer prices in August thru September, let alone any decrease. In spite of a positive movements of monetary factors (incremental growth of the narrow monetary base accounted for 5.1% over 9 months in 2004 against 26.1% over 9 months in 2003) which encouraged restriction of underlying inflation , a record price rise of industrial products by industrial manufacturers as well as substantial price growth of motor gasoline and a series of vital food products imposed additional inflationary impact on the economy.
Rate of price increases stabilized at 1.1% monthly in the quarter 4 (in 2003, such inflation rate was recorded only in December , while the CPI equaled to 1% in October and November). Prices of food products grew up more rapidly (+4.7%). Prices of food products get up by 12.3% from the beginning of the year (against 10.2% in 2003). It should be noted that prices of red meat and poultry meat grew up dramatically: by 19.6% in 2004, while they didn't exceed 8.9% in 2003. Paid services for the general public came second in terms of growth rates which accounted for 3% in the quarter 4 of 2004 against 17.7% in 2004 (22.3% in 2003). Prices of passenger transportation services (+18% in 2004 against + 13.7% in 2003) and services of preschool institutions (+21.6% in 2004 against 15.1% in 2003) grew at faster rates in this group as compared to 2003. Finally, prices of non-food products grew by 1.8% in the period between October and December 2004, while in 2004 they grew up by a total of 7.4% (by 9.2% in 2003). Prices of motor gasoline dropped in December (by -1.7%). However, prices of motor gasoline grew by a total of 31.3% in 2004 (as compared to 16.8% in 2003).
Going to the analysis of factors which governed the growth in consumer prices in 2004, it should be noted that cost-push inflation became the main cause that maintained fast growth rates of the CPI, i.e. price rice of manufacturers' products, prices of final products grew at faster rates in the majority of industries in 2004 as opposed to the previous years (Fig. 2). In addition, it is seen from the Figure below that prices of products of food industry and light industry grew at extremely fast rates in 2003, which effected retail prices of the products of these industries in 2004 .
In 2004, prices of the products of fuel industry and iron and steel industry (over 60% annually) grew at fastest rates, which is mostly associated with the price rise of corresponding products in the world markets. Hence, one can say that the internal market of oil and ferrous metals in Russia has gradually been integrating into (due to transparency of such industries and a larger share of exported products) the world market, and fluctuations of world prices also have an effect on the internal market. Consequently, high rates of price growth were also recorded in industries consuming the products manufactured by fuel industry and iron and steel industry, i.e. chemical industry, petrochemical industry and machine industry.
Fig. 2. Incremental Growth of Prices of Manufacturers' Products in Various Industries
in the Period Between 2002 and 2004
Hence, according to the figures of 2004, the CPI in Russia accounted for 11.7%, which is slightly beyond the figure (12%) of the previous year. The underlying inflation was 10.5% in 2004 (11.2% in 2003). The industrial manufacturers' price index reached 28.3% (13.1% in 2003). The latter creates preconditions for further growth or retarded decline of inflation in 2005 (for details on the inflation forecast for 2005 please refer to section "Mac-roeconomic Forecast for 2005" below).
2.1.2. Money Supply in the Economy
In 2004, the gold and foreign exchange reserves of the Russian Federation were built up steadily. This was mainly caused by record-breaking prices of basic Russian export goods, primarily oil. At the same time, incremental growth of the reserves was moderate enough until September when they grew substantially as a result of the USD exchange rate fall in the global financial markets, as well as stabilized situation in the Russian capital market. By the end of the year, the gold and foreign exchange reserves reached $124.5 billion thus increasing by 61.9% (+$47,6 billion) during the year.
Such growth of the gold and foreign exchange reserves was apparently accompanied by printing of currency by the RF Central Bank in making transactions in the foreign exchange market. However, annual accumulation of the gold and foreign exchange reserves by the Bank of Russia and consequently monetary base growth was not steady (Fig.3).
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Gold and Foreign Exchange Reserves ( USD billion
Fig.3. Movements in Monetary Base and Gold and Foreign Exchange Reserves in 2004
By the end of the quarter 1 of 2004, the broad monetary base1 accounted for RUR1936,6 billion thus increasing by 1.2% since the beginning of the year. It should be noted that the broad monetary base grew at faster rates (4.2%) in the quarter 1 of 2003. At the same time, the volume of cash in hand decreased by 1.9% over the period under review in 2003 against the growth by 0.8% in 2004. Hence, for the first time over the last few years we could see increasing volume of cash in hand in composition of the monetary base in the quarter 1. Growth rates of compulsory reserves in the quarter 1 decreased slightly from 8.9% in 2003 to 7.9% in 2004. The narrow monetary base grew from 1392,1 up to RUR1458,5 billion (+4,8%) over the quarter 1. Incremental growth in the narrow monetary base over the corresponding period in 2003 accounted for 1.1% against 17.4% in the quarter 4 of 2003. Growth rates of the monetary base was caused mainly by slow-downed growth rates of the gold and foreign exchange reserves of the Bank of Russia . According to the results of the quarter, the gold and foreign exchange reserves grew from $77,8 billion up to $83,7 billion (+7.6%), which was related mainly to the Bank of Russia's transactions aimed at flattening fluctuations of the USD exchange rate in the Moscow Interbank Currency Exchange (MICEX) and external debt payments .
In the quarter 2, the broad monetary base decreased by 0.9% to account for RUR1,92 trillion as of July 1, 2004. The volume of monetary base increased by 0.3% as compared to the corresponding figure as of January 1, 2004 . It should be noted that the volume of monetary base decreased by 3.5% over the period between April and May, and grew by 2.7% only in June. It will be recalled that the monetary base increased by 19.4% in the quarter 2 of 2003. As of July 1, the volume of cash in hand accounted for RUR1.35 trillion (which exceeds by 9.5% the figures as of April 1, 2004) including cash balances of
1 The RF broad monetary base includes money on correspondent accounts of credit organizations and bank deposits with the Bank of Russia, besides the outstanding cash issued by the Bank of Russia and compulsory reserve balances in national currency of the funds borrowed by credit organizations and deposited with the Bank of Russia .
credit organizations. The volume of accounts of credit organizations with the Bank of Russia shrank by 3.9% down to RUR223,1 billion over the quarter 2. Compulsory reserves shrank by 12.7% down to RUR251,2 billion in the period between April and June. Banks' deposits with the Bank of Russia decreased down to RUR38,4 billion (-65%) over the quarter 1. As of July 1, the amount of obligations of the Bank of Russia on repurchase of securities decreased by 22.9% as compared to April 1 and accounted for RUR56 billion. Hence the structure of monetary base was effected by the crisis in the banking sector of the Russian Federation that took place in the period between May and June of 2004: sharp reduction in liquidity of the interbank credit market resulted in shrinkage of banks' deposits and accounts with the RF Central Bank, compulsory reserves were reduced as a result of depositors outflow, and the RF Central Bank's attempts to increase liquidity of the interbank credit market led to reduction of its obligations to banks on repurchase of securities.
Substantial growth in volume of cash in hand (+9.5%) in the quarter 2, including deposits outflow from the banking sector and reduction of compulsory reserves, led to increase in the narrow monetary base (cash + compulsory reserves) by 5.9%.
The broad monetary base reduced by 4.8% in the quarter 3 and accounted for RUR1,83 trillion as of October 1, 2004. The monetary base was reduced by 4.5% as compared to the corresponding figure as of January 1, 2004. It should be noted that an insignificant growth of the monetary base was recorded only in September (+0.1%), while it was shrinking in the period between July and August. It will be recalled that the monetary base was reduced by 3.2% over the quarter 3 of the previous year. As of October 1, cash in hand plus balances of credit organizations accounted for RUR1,37 trillion (which exceeds by 1.6% the corresponding figure of July 1 of the current year). In the quarter 3, the volume of credit organizations' accounts with the Bank of Russia remained practically the same and accounted for RUR223,4 billion at the end of the quarter. Compulsory reserves were sharply reduced down to RUR116,1 billion (-53.8%) in the period between July and September . At the same time, banks' deposits with the Bank of Russia increased up to RUR45,4 billion (+18.2%) over the quarter 3. As of October 1, the value of obligations of the Bank of Russia for repurchase of securities increased by 21.4% as compared to July 1 and accounted for a RUR68 billion. Hence the downward movement of the monetary base in the quarter 3 was caused mainly by the shrinkage of the compulsory reserves fund due to substantial reduction in corresponding regulations of the RF Central Bank (since July 8, 2004). At the same time, stabilization in the banking sector led to a growth of banks' deposits with the Bank of Russia and its obligations on repurchase of securities.
Changes in the narrow monetary base (cash + compulsory reserves) in the quarter 3 were also governed by a sharp reduction of the compulsory reserves fund at the background of insignificant growth in cash: as a result, this aggregation was reduced by 4.8% over the period between July and September . In spite of a substantial growth in the gold and foreign exchange reserves in the quarter 3 (+7.8%), the monetary base couldn't show growth due to large withdrawals of liquidity to the budgetary system (incremental growth of deposits of state administration agencies with the RF Central Bank exceeded RUR125 billion in the period between July and August alone).
Over the quarter 4, the broad monetary base increased by 30.6% and accounted for RUR2,39 trillion as of January 1, 2005 . The volume of monetary base increased by 24.7% as compared to the corresponding figure as of January 1, 2004 . It should be noted that the volume of monetary base increased throughout the entire quarter 4, the fastest growth was recorded in December (+14.5%). It will be recalled that over the quarter 4 of 2003, the monetary base increased by 29% with total growth accounting for 55.3% over 2003. The volume of cash in hand plus balances of credit organizations accounted for RUR1,67 tril -
lion as of January 1 (which exceed by 21.6% the corresponding figure of October 1, 2004). Volume of accounts of credit organizations with the Bank of Russia increased by 2,2 times, up to RUR486,4 billion over the quarter 4. Compulsory reserves grew by 4.8% up to RUR121,7 billion in the period between October and December . The volume of banks' deposits with the Bank of Russia grew up to RUR91,4 billion (double increase) in the quarter 4. As of January 1, the value of obligations of the Bank of Russia on repurchase of securities reduced by 96% and accounted for a RUR2,5 billion as compared to October 1. Hence, the monetary base of the Russian Federation was notably widened in the quarter 4 at the background of a substantial growth in the gold and foreign exchange reserves .
Expansive growth in both cash in hand (+21.6%) and compulsory reserves (+4.8%) in the quarter 4 led to a 20.3% increase in the narrow monetary base (Fig. 3). Such growth was caused by purchase of large volumes foreign currency by the RF Central Bank. The gold and foreign exchange reserves of the Bank of Russia grew by 31% and reached $124,5 billion in total over the period between October and December.
Hence, according to the results of 2004, the monetary base grew more moderately that in 2003. However, it grew at faster rates in the quarter 4 than in the previous year. It should be noted that the gold and foreign exchange reserves grew slower until September as compared to 2003. On the other hand, reserves of commercial banks shrank substantially after reduction of the compulsory reserve regulations in summer, but such shrinkage ceased to exist in fall. Thus, according to the results of the year, incremental growth in the narrow monetary base accounted for 24.8% (48.7% in 2003) and reserves for 24.4% (54.1% in 2003). The volume of M0 cash increased by 33.8% against 50.3% in 2003. Consequently, money supply in 2004 was not that heavy as in 2003. The federal budget, specifically the Stabilization Fund, played the key role in sterilizing money issuance of the RF Central Bank. In 2004 incremental growth of deposits of the general government with the RF Central Bank accounted for nearly RUR600 billion, more than a half of the entire issuance of the Bank of Russia was withdrawn from the economy through the budget system of the Russian Federation in 2004. Final incremental growth of reserve money (broad money) was no more than RUR476 billion.
2.1.3. Money Demand
According to the results in 2004, broad money grew at slower rates than the corresponding values in 2003. In particular, M1 grew by 30.5% over the year against 45.6% in 2003. M2 grew by 35.8% (50.5% in 2003). A relative fast growth in broad monetary aggregates was recorded only in the quarter 1 (as compared to 2003), however it slowed down in the quarter 2 and 3. Traditionally, monetary aggregates grew up at faster rates in the quarter 4. Such growth, however, was more moderate than in 2003.
Hence, according to the results of 2004, monetization of GDP increased merely from 24.3% of GDP up to 26.0%, but it still remained low. (in 2003, for example, monetization of GDP (calculated by using the IFS data base) was 47% in Bulgaria, 40% in Estonia, 48% in Hungary, 37% in Latvia, 31% in Lithuania, and 64% in Slovakia). As was noted in the previous economic review2, such situation maintains high enough growth rates of money supply, which has no adverse effects at least until monetization of GDP reaches 35 to 40%, since money supply growth will be absorbed by the economy due to growing demand for real monetary reserves (provided that currently prevailing inflationary expectations and trends in money demand remain the same).
2 Russian Economy in 2003. Trends and Outlooks. Issue 25. M.: IET, 2004.
38
At the same time, banks continued financing the real economic sector in 2004, as evidenced by the fact that money multiplier grew up to its maximum over the entire period of record (Fig. 4). In the period between August and September 2004, the multiplier even reached 2,0 (which is beyond the previous high recorded in February 1998), but it dropped then down to 1,8 due to broadening monetary base at the end of the year, while broad money aggregates are less sensitive to seasonal fluctuations in demand for liquid funds.
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Fig. 4. Money multiplier : Reserve Money Ratio) in the Period Between 1998 and 2004
More money supply from the Russian banks in 2004 was caused mainly by increased requirements to non-financing private enterprises, i.e. credits and investments in private bonds. As indicated in Fig. 5, by the end of 2004, a share of requirements to the private sector in total assets of the banking system exceeded 60%, thus growing nearly by 5 percentage points during the year. At the same time, a share of requirements to general government and foreign assets either reduced or remained the same. In total, the volume of assets of the banking system of the Russian Federation reached 39.7% of GDP and the volume of requirements to the non-financing private sector accounted for 24.55% of GDP by the end of the year, while the corresponding figures accounted for 38.57% of GDP and 21.0% of GDP at the beginning of the year.
Fig.5. Total Assets of the Banking System of the Russian Federation
2.1.4. RUR Exchange Rate Movement
The official nominal RUR exchange rate to the leading foreign currencies changed gradually enough throughout 2004 (Fig. 6). The RUR/USD exchange rate remained virtually unchanged until the end of the year (from the beginning of the second half of October), when there was an upward trend in the nominal RUR/USD exchange rate. In total, the RUR exchange rate increased from RUR29,45 to 27,75 per $1 USD, or by 5.79%.
The RUR/EURO exchange rate was less uniform. The RUR grew against the EURO during the first four months until the end of the year, when the EURO exchange rate grew up. The range of fluctuations in the RUR/EURO exchange rate was wider than that of the RUR/USD exchange rate. According to the results of 2004, the official RUR exchange rate declined by 2.68% against EURO, from RUR36,82 up to RUR37,81 per EURO.
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Fig. 7. Monthly Changes in EURO/USD Exchange Rate and EURO/RUR
Exchange Rate in 2004
As indicated in Fig. 7, the RUR/EURO exchange rate varied in the same manner as the EURO/USD exchange rate. In other words, one can argue that RF Central Bank relied, at least till October 2004, exclusively on the RUR/USD exchange rates, while the real RUR/EURO exchange rate relied on exchange rates of currencies in the world market. Un-
der such circumstances, the real RUR exchange rate could decline against the EURO in the world market, though it grew against the USD.
Close relationship between the exchange rates was broken in the final quarter, which could mean that at the background of growing RUR and EURO exchange rates against the USD the Bank of Russia refused to interfere with the growth of the real RUR/EURO exchange rate under, maybe, the circumstances of accelerated inflation.
According to the results of the year, the real RUR/USD exchange rate as calculated on the basis of nominal exchange rate and CPI rates in Russia and the United States grew by total of 15.5%, while that of RUR/EURO by 6.5% (Fig. 8). It should be noted that while the real RUR/USD exchange rate reached its maximum over the post-crisis period, the RUR is currently weaker against the EURO than, for example, in 2001. The real effective RUR exchange rate as calculated on the basis of the foreign trade pattern of the Russian Federation grew by 5.4% in the period between January and October 2004. Analysis of the real effective RUR exchange rate reveals that the current exchange rate corresponds to that in the quarter 4 of 1996, i.e. it is by nearly 10% lower than the maximum figures recorded in the middle of 1998. Hence, the pre-crisis level of real RUR exchange rate will be reached in the nearest two years provided that the RUR exchange continue to grow at the current rates and the USD exchange rate against the leading world currencies remain within a range of $1,25 to 1,35 per 1EURO and 105 to 110 yen per 1USD.
Fig.8. Real RUR Exchange Rate Movement in the Period Between 1998 and 2004
2.1.5. "Banking Crisis" in 2004
Several developments that took place in the period between May and July became most important events in the RF financial sector in 2004. For instance, in May the RF Central Bank revoked the license from and introduced a temporal management at Sodbiznes-
bank. The bank was ranked 109 by size of assets3 according to the results of the quarter 1 of 2004. Under the circumstances, other market participants discontinued their relationship with Kredittrast Bank (which was ranked 67 by size of assets as of April 1, 2004) in fear of further actions of the RF Central Bank, as it was owned by Sodbiznesbank shareholders. Its license was revoked in June 24, 2004. It is noteworthy that the majority of market participants suspected Sodbiznesbank and Kredittrast in money laundry and restricted business relations with them long before the license revocation. As a result, the actions of the Bank of Russia, though retarded, were considered by the banking community and depositors as a normal "cleaning" which could not lead to panic and banking crisis.
Late in May, however, managers of the Bank of Russia and the RF Financial Monitoring Committee alleged that they had a "black list" of banks suspected in money laundry, which were expected to suffer corresponding measures in the nearest future. In our opinion, it was the actions of the RF Central Bank and the RF Financial Monitoring Committee that caused a problem of non-confidence in the RF interbank market and led to reduction of limits determined by major Russian banks, including state-owned banks, for crediting other banks, primarily medium-size Moscow banks. Correspondingly, the major borrowers in Interbank Loans Market (for example, Guta-Bank , Paveletskiy, Dialog-optim, etc.) began to face problems in servicing their current liabilities to other bansk. Such information resulted in mass withdrawals of bank deposits by retail customers, especially from the aforementioned banks and then from those considered as non-confident (for example, those included in the list of "problem" banks published in press and Internet). Among such banks were Guta Bank, Alfa Bank, Impeksbank, Masterbank, Bin-Bank, MDM, etc. The peak of withdrawals fell into the first half of July . However, almost all banks (except for Guta Bank) managed to stay in business and maintain their positions in the private deposit market in the period between June and July 2004. A total of 9 Moscow banks lost their licenses in the period between June and September 2004 (figures in brackets refer to bank's rating in terms of size of assets as of April 1, 2004), namely Kredittrast (67), Promeksimbank (361), Commercial Savings Bank (351), Mosz-hilstroibank (1217), RIKOM (975), Dialog-optim (58), Paveletskiy (169), Meritbank (210) and Finanstorgbank (513), as well as Savings and Development Bank (663) incorporated in the Komi Republic.
Hence, we believe that the developments that took place in summer 2004 should not be considered as "banking crisis"; rather it is an indicator of local instability of the Russian system related to its structural and institutional specific features: great number of small and medium -size banks, generally passive treatment by the RF Central Bank of the banks dealing with shadow and semi-legal transactions (which is not a secret for many market participants), low capitalization of the RF banking system, discrepancy in terms of assets and liabilities at many banks, heavy reliance of small and medium-size banks on the Interbank Loans Market, etc. It could be noted on the basis of aggregated data that assets of the banking system and private deposits (both call deposits and fixed deposits) grew in general (including in real terms) in the period between May and July 2004. According to the results of the quarter 3 of 2004, only 9 out of 50 major Russian banks reported reduction in assets (it should be noted that Guta Bank demonstrated a 20% asset growth over the quarter). In addition, we believe that public support of the banking sector was insignificant: in fact, the RF Central Bank made only one move in this direction as part of its general policy: it reduced the regulation of compulsory contributions due to the Compulsory Reserve Fund from 7 to 3.5% since July 8, 2004. However, taking into account the concentra-
3 The figures herein that represent the size of assets of banks rely on the data obtained from Interfax Agency.
tion ratio of private bank deposits, one can say that most of the deposits were reopened with RF Sberbank and several major banks which could have resolved their problems in hand without such update. We also believe that the decision made by the RF State Duma on providing deposit guarantees at all commercial banks regardless of their participation in the private deposit insurance system could have adverse effects, since it encourages unnecessarily risky behavior of banks, especially those which realize that they have no chance to pass the control of the RF Central Bank to lawfully join the private deposit insurance system.
Guta Bank (ranked 17 in terms of size of assets as of July 1, 2004) was the major bank suffering losses during the "crisis". Nevertheless, it turned no bankrupt, since its acquisition by RF Vneshtorgbank was announced immediately after the bank started to face problems (it should be noted, however, that negotiations on purchasing its share by RF Vneshtorgbank or extending a major loan to Guta Bank started long before the events that look place in the period between May and June 2004). Furthermore, we believe that a stabilization loan extended by the RF Central Bank to RF Vneshtorgbank in the amount of $700 billion should not be considered a measure aimed at supporting the banking system (such loan increased substantially the total value of liabilities due by the banking sector to the monetary regulation bodies), since, firstly, the bank itself faced no problems during that period, secondly, the amount paid to purchase Guta Bank (RUR 1 billion) was far less than the value of the loan. We also believe that expenses incurred by the owners of private banks (for example, Alfa-Bank) in order to maintain stability and liquidity under a high rate of private deposit withdrawals can not be classified as expenses on "saving" the banking system, since such measures were caused by low actual capitalization of banks and mistakes in managing temporal structure of assets and liabilities.
2.1.6. The state of the balance of payments
In 2004, the stability of the RF balance of payments was maintained at the expense of record high volumes of commodity exports, primarily products of the fuel and energy complex (FEC). At the background of extremely high prices of energy resources, export of goods increased by more than one third. Accordingly, the accumulation of gold and foreign currency reserves of the RF Central Bank continued. However, in 2004 there was interrupted the trend towards a decline in the net capital outflow observed in 2000 through 2003.
According to the preliminary estimates of the RF balance of payments in 2004 published by the Bank of Russia, the surplus on current account made US $ 58.2 billion, thus increasing by 64.4 per cent in comparison with the figures registered in 2003 (see Table 1). Over the year, the active balance of trade grew by 45.7 per cent (from US $ 59.9 billion to US $ 87.2 billion), as commodity exports increased by 33.9 per cent (from US $ 135.9 billion to US $ 182 billion) and imports grew by 24.6 per cent (from US $ 76.1 billion to US $ 94.8 billion). The share of export of oil, oil products, and natural gas made about 55 per cent in the total amount of exports (as compared with 54.2 per cent observed in 2003) (see Fig. 1). Therefore, similarly to the situation observed in the preceding years, the major factor determining the amount of current account surplus was the active balance of trade, which, in turn, tremendously depended on the changes in prices of energy resources and other staple Russian exports on world markets. The data presented in Fig. 2 demonstrate that the relationship between world oil prices and Russian balance of trade, which was noticeable in 2001 through 2003, also manifested itself throughout 2004.
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Fig. 9. Dynamics of exports and the share of the Fuel and Energy Complex products in 1999 through 2003
In 2004, the deficit of the balance of services increased by US $ 14 billion in comparison with the figures registered in 2003 (+ 28.5 per cent). Export of services made US $ 20.3 billion, thus increasing by US $ 4.1 billion in comparison with the figures observed in the preceding year (+ 25 per cent). In 2004, import of services grew by 27 per cent and made US $ 34.3 billion.
In 2004, the balance of compensation of employees continued to diminish and made US $ -0.8 billion (as compared with US $ -0.1 billion registered in 2003).
In 2004, as compared with the figures observed in 2003, the deficit of the balance of investment incomes practically did not change and made US $ 13 billion. At the same time, in absolute terms the amounts of both receivable incomes and payable incomes diminished. Receivable investment incomes diminished from US $ 10.2 billion to US $ 4.5 billion, what was determined by a significant decline in the indicator pertaining to nonfinancial enterprises (from US $ 6.6 billion to US $ 0.3 billion). A similar decline in payable incomes of nonfinancial enterprises from US $ 16.8 billion to US $ 10.8 billion has determined that the total amount of payable incomes decreased from US $ 23.3 billion to US $ 17.6 billion.
As compared with the figures registered in 2003, in 2004 the balance of current transfers increased 2.9 times and made US $ -1.1 billion.
In 2004, the deficit of the capital and financial account (without changes in foreign exchange reserves) increased 6.6 times in comparison with the figures registered in 2003 (from US $ 0.8 billion to US $ 5.4 billion).
The balance of capital transfers was formed by negative figures and amounted to US $ -1.2 billion.
The increase in the foreign liabilities of the economy made US $ 27.3 billion, what was by 2.1 per cent below the value of the indicator registered in the preceding year (US $ 27.9 billion).
Table 1
Major items of the balance of payments in 2002 through 2004 (US $ billion)
Balance item
2002
2003
2004
Q 1 Q 2 Q 3 Q 4 Q 1 Q 2 Q 3 Q 4 Q 1 Q 2 Q 3 Q 44
Current account 6,4 7,7 7,2 7,8 11,4 8,1 7,3 8,6 12,6 1 3,4 14,7 1 7,4
Capital and financial account 5 -4,8 -0,5 -1,8 -4,1 -2,4 1,5 -6,7 6,7 -2,5 -8 -4,8 10
Changes in foreign exchange reserves -0,5 -6,1 -3,2 -1,6 -7,6 -8,1 2,6 -13,3 -6,8 -5 6,5 -26,9
Net errors and omissions -1,1 -1 -2,1 -2,2 -1,5 -1,6 -3,2 -1,9 -3,4 -0,4 -3,3 -0,5
Source: RF Central Bank.
25000
Ö
2 3 4 1 2 3 4 1 2 3 4 1 2 3
Ö Ö Ö Ö Ö Ö Ö Ö Ö Ö Ö Ö Ö Ö
250%
200% 150% 100% 50%
0%
ö
2001
2002
2003
2004
I iRaiance of trade —♦— Oil price index (1st quarter of 1995 = 100 %, right axis)
Fig.10. RF balance of trade and the oil price index in 2001 through 2004
Similarly to the situation observed in the preceding year, the general government was a net payer with respect to nonresident net payers. Its foreign liabilities declined by US $ 3.5 billion. As concerns the subjects of the Russian Federation, the increase in their foreign liabilities made US $ 0.1 billion. In 2004, the decrease in the liabilities of the monetary authorities made US $ 0.2 billion. A decrease in the activity of the banking sector with respect to the attraction of foreign capital resulted in the fact that the increment of liabilities of this sector (US $ + 7 billion) declined by 37.8 per cent in comparison with the value of this indicator registered in 2003. Investments of nonresidents in the real sector made US $ 24 billion (as compared with US $ 22.1 billion registered in 2003).
4 Preliminary estimates.
5 Without changes in foreign exchange reserves.
In 2004, foreign holdings of residents increased by US $ 31.5 billion (as compared with the figures registered in 2003, when the respective holdings grew by US $ 27.2 billion). Operations of the private sector accounted for almost all this increase.
Foreign assets of the general government grew by US $ 0.2 billion, while foreign assets of the banking sector increased by US $ 4 billion.
As concerns the sector of nonfinanical enterprises and households, the outflow of capital in this sector practically has not changed and made US $ 25.9 billion. At the background of an increase in the outflow of capital by items "direct and portfolio investment" (US $ 6.5 billion) and "trade credits and advances extended" (US $ 0.6 billion), the amount of cash foreign currency accumulated by this sector and the amount of indebtedness on merchandise supplies according to intergovernmental agreements have significantly decreased (by US $ 2.9 billion and US $ 1.3 billion respectively).
At the same time, in 2004 the total net outflow of capital from the nonfinancial sector made US $ 6.5 billion (in 2003, there was observed an outflow of capital amounting to US $ 1.7 billion) (see Fig. 11).
15%
10%
5%
0%
-5%
-10%
-15%
-20%
1 2 m 4 1 2 m 4 1 2 m 4 1 2 m 4
o o o o
2001
2004
J Net capital outflow (US $ billion)
-Net capital outflow / foreign trade turnover (%)
Source: RF Central Bank, IET calculations.
Fig. 11. Dynamics of net capital outflow in 2001 through 2004
It should be noted that over the first three quarters of 2004 there was observed a significant (and accelerating) outflow of capital from the RF private sector. Only in the 4th quarter there was registered an inflow of capital at the level of US 10.4 billion, which can not be explained by any fundamental changes in the investment climate in the country. Most probably, the inflow of such a large amount of capital in the country can be explained by a borrowing abroad made in order to finance the purchase of 'Yuganskneftegaz." In the case such a borrowing was not made, the total outflow of capital registered in 2004 could be even more significant.
As concerns the unofficial outflow of capital (capital flight) (see Fig. 12), in 2004 this indicator increased in real terms by 15 per cent as compared with the figures registered in the preceding year and according to the author's estimates6 made about US $ 31.8 billion.
0
0% -2% -4% -6% -8% -10% -12% -14% -16% -18%
■ ' Capital flight (US $ billion) • Capital flight / foreign trade turnover (%)
Source: RF Central Bank, IET calculations.
Fig. 12. Dynamics of capital flight in 2001 through 2004
On the whole, in 2004 there was observed an increase in the share of net capital outflow in the RF foreign trade turnover up to 2.3 per cent this (0.8 per cent in 2003). At the same time, the indicator characterizing the share of capital flight in the RF foreign trade turnover decreased from 13.1 per cent in 2003 to 11.5 per cent in 2004. It should be also noted that in contradistinction to the figures registered in 2003, last year there was observed an increase in the amounts of both net capital outflow, and capital flight.
The outflow of capital from the private sector is still at a rather high level, what may be to a significant extent explained by the situation observed in the corporate sector (the "YUKOS affair"). On the whole, at the background of rather favorable macroeconomic indicators, the worsening of the investment climate and growing risks result in an outflow of capitals from Russia.
Besides, basing on the analysis of the balance of payments, it should be noted that the revenues from the export of energy resources still make more than half of the total export revenues and the share of energy resources in the general structure of exports is growing for several years running. All these facts once again confirm the significant dependence of the Russian economy on the export of raw materials and the respective price situation. At the background of deceleration of the rates of structural reforms, it may be an
Flight of capital is calculated in accordance with the IMF methodology as a sum of items "trade credits and advances extended," "non-repatriation of exports proceeds, non-supply of goods and services against import contracts," and "net errors and omissions."
evidence of a gradual decrease in the competitiveness of the Russian economy across a number of industries and deterioration of the prospects of its further development in the case the price situation on the world market of energy resources changes.
2.1.7. Key Actions of the RF Central Bank in the Field of Monetary Policy
The fact that the Bank of Russia animated direct and reverse REPO transactions was one of the characteristic features of the RF monetary policy in 2004, since this action serves as a monetary policy tool which is commonly used in global practice, especially for sterilizing excessive money issuance and maintaining liquidity of the banking system.
The RF Central Bank reduced the refinancing rate down to14% on January 15, 2004. The last time the Bank of Russia changed the refinancing rate (from 18 to 16%) was on June 21, 2003.
In the quarter 2 of the previous year, the Bank of Russia began to apply a new benchmark that was used for determining of an exchange rates policy. The benchmark was represented by a weighted geometric average of exchange rates of basic foreign currencies to the RUR. The basic currencies were represented by the USD and the EURO. The EURO weight was set at 10 to 20% for a start. This measure, however, led to no real changes in the RUR exchange rate to these currencies, as indicated above.
In June 11 the Bank of Russia announced a reduction (from 9 to 7% since June 15) in mandatory contributions due by banks to the Compulsory Reserve Fund out of RUR funds they borrowed from legal entities and foreign currency funds they borrowed form legal entities and physical bodies. At the same time, the Bank of Russia reduced the refinancing rate from 14 to 13% per annum, as well as extended a list of securities that could be used as collateral in entering into direct REPO transactions with banks. Such measures were caused basically by low liquidity in the Russian financial market . It should be noted that changes in the refinancing rate have no such a substantial impact on the economy of the Russian Federation as it does in most of the developed countries. Nevertheless, by extending the list of securities that could be used as collateral in borrowing funds from the RF Central Bank, the Bank of Russia managed to improve liquidity management in the RF banking system. Later on, as problems raised in the banking sector, the reservation regulations were reduced once again (on July 8, 2004) to 3.5% on liabilities to residents of the Russian Federation and to 0% on liabilities to non-resident banks. However, the latest rise (up to 2%) was announced on August 1.
Since August 16, 2004 the Bank of Russia started to issue modified bank notes of 1997 (as modified in 2004) denominated in RUR10, 50, 100, 500 and 1000. The issuance was intended to increase protection of these bank notes as well as make it easy for the general public to verify their authenticity. The modified bank notes retained basic composition of the 1997 ones. The bank notes of 1997 remain as legal tender as the modified ones.
In August 2004, the Bank of Russia extended the list of securities that can be used as collateral by banks in borrowing from the Bank of Russia. The list included bonds issued by constituent entities of the Russian Federation, as well as bonds of mortgage agencies and credit organizations secured by public warranty. By extending the list, the RF Central Bank managed to improve liquidity of the RF banking system. However, the use of newly listed securities was restricted. For example, they were not supposed to be used for REPO transactions.
In November 2004, the Board of Directors of the RF Central Bank approved a document: Basic Guidelines of Unified Public Monetary Policy for 2005. Inflation forecast for 2005 remained unchanged in the document in spite of the fact the forecast for 2004 failed,
which obviously led to growth of inflationary expectations of economic agents. Hence, price advance rates are very unlikely to slow down to 6.5-8.5% in 2005 .
It is specified in the document that the real effective RUR exchange rate is the basic focus of the monetary policy. However, the calculation methodology for this indicator is quite questionable, which in practice gives no way of identifying direct relationship between the real effective RUR exchange rate and competitiveness of Russian manufacturers. In addition, inflation remains high enough in the Russian Federation, and we believe that it is the inflation that the Bank of Russia should focus on.
At the end of the year, the management of the Bank of Russia stated that the structure of gold and foreign exchange reserves could be changed. Prior to that the structure of gold and foreign exchange reserves was as follows: 70% of USD, nearly 25% of EURO and nearly 5% of other hard currencies. Perhaps, such intention of the RF Central Bank was most likely to be caused by a continuous fall of the USD exchange rate against other basic currencies.
2.2. State Budget
2.2.1. General Description of RF Budgetary System in 2004
Table 2
Execution of Revenues and Expenditures of Consolidated, Federal and Local Budgets (% of GDP)
1998 1999 2000 2001 2002* 2003 2004
Federal Budget
Tax Revenues 8.8 10.7 13.2 16.2 18.6 18.0 18.8
Including single social tax - - - - 3.1 2.7 2.6
Revenues 11.3 12.9 15.4 17.6 20.1 19.4 20.4
Expenditures 14.5 14.0 13.1 1 4.7 18.7 17.7 16.1
Deficit (-) / Surplus (+) -3.2 -1.1 2.4 2.9 1.4 1.7 4.4
Local Budgets
Tax Revenues 11.5 10.4 10.2 9.6 10.0 10.0 10.6
Revenues 14.8 13.6 14.4 1 4.3 1 4.9 1 4.5 1 4.3
Expenditures 15.2 13.6 14.0 1 4.3 15.3 1 4.9 1 4.1
Deficit (-) / Surplus (+) -0.3 0.0 0.5 0.0 -0.4 -0.4 0.2
Consolidated Budget
Tax Revenues 20.3 21.1 23.4 25.8 28.6 28.0 29.4
Revenues 24.5 25.2 28.5 29.3 32.1 31.1 32.3
Expenditures 28.1 26.3 25.6 26.4 31.1 29.7 27.8
Deficit (-) / Surplus (+) -3.6 -1.1 2.8 2.9 1.0 1.4 4.5
* Since 2002, including revenues from single social tax and consequently expenditures to finance public extra-budgetary funds.
Data source: the RF Ministry of Finance; lET's estimates.
It is noteworthy that general description of the RF budgetary system in 2004 shows much higher revenues and less expenditures as compared to 2003 (refer to Table 2). At the end of 2004, the revenues of the federal and consolidated budgets reached their maximum over the last six years. The federal budget revenues in 2004 increased by 1 percentage point of GDP, 20.4% of GDP, as compared to the previous year. In 2004, the consolidated budget revenues were nearly 1.2 percentage points of GDP thus reaching 32.3% 50
GDP. It should be noted that expenditures in 2004 continued its downward trend which started as early as 2002. Federal budget expenditures in 2004 decreased by more than 1.5 percentage points of GDP to account for 16.1%, as compared to the previous year. Local budget expenditures decreased by nearly 0.8 percentage points of GDP, while the consolidated budget accounted for 1.9 percentage points of GDP. Thus, by the end of 2004, Russia achieved the biggest budget surplus ever in the history of the post-Soviet era, namely 4.5% of GDP for the consolidated budget and 4.4% of GDP for the federal budget.
High oil prices is one of the key factors making the budgetary revenues grow, and consequently the volume of mineral tax revenues and export duties to the consolidated budget in 2004 exceeded that of the previous year by 0.5 percentage points of GDP and 1.7 percentage points of GDP correspondingly. This resulted in that on October 27, 2004, the RF State Duma approved amendments to the 2004 federal budget on increasing budgetary revenues by RUR531 billion up to RUR3273,8 billion and consequently increasing budgetary expenditures by RUR108,6 billion up to RUR2768,1 billion.
2.2.2. Analysis of Basic Tax Revenues
A series of amendments to the tax law came into force in 2004. The most essential ones are: VAT reduction from 20 to 18% with the reduced rate remaining at 10%; from January 1, 2004, increase in the basic mineral tax rate in relation to oil production from RUR340 up to RUR347 per 1 ton of raw material, as well as ad valorem tax rate on production of gas condensate from 16.5 up to 17.5%; changes in the export tax rate in relation to crude oil from the middle of 2004; abolishing sales tax on January 1, 2004.
Table 3
Basic Tax Revenues to RF Budgetary System (% of GDP)
1999 2000 2001 2002 2003 2004
Profit tax 4.6 5.4 5.7 4.2 4.0 5.2
Income tax 2.5 2.4 2.8 3.3 3.4 3.4
VAT 8.8 6.2 7.1 6.9 6.6 6.4
Excises 2.2 2.3 2.7 2.4 2.6 1.5
Mineral Tax* 1.2 1.6 1.6 2.5 2.5 3.0
Foreign trade taxes 1.8 3.1 3.6 3.0 3.4 5.1
single social tax, to the RF 3.1 2.7 2.7
consolidated budget
Data source : the RF Ministry of Finance .
* Prior to 2001, the Mineral Tax was calculated as a total amount of oil excise, mineral excises and duties and contributions to rehabilitation of mineral resources .
As is evident from Table 3, the downward trend in profit tax revenues which started in 2001, ceased to exist in 2004. At the end of 2004, the budgetary profit tax revenues accounted for nearly 5,2% of GDP thus exceeding by 1.2 percentage points of GDP that of 2003. The tax revenues growth is based mostly on the increased profit tax base. According to the Russian Statistics Agency's data, the growth in consolidated financial figures (total corporate income less losses) over the period between January thru October 2004 accounted for 50% against the same period of the preceding year , while in 2003 the growth of this parameter accounted for-12% (negative). The growth in tax revenues can be explained to some extent by termination of various profit tax allowances which entered into force prior to the tax reform in 2002.
At the end of 2004, a share of income tax revenues in GDP, as well as a share of the single social tax in GDP remained the same as compared to the previous year, 3.4 and
2.7% of GDP correspondingly. Moreover, according to the Russian Statistics' Agency, real income of the population in 2004 accounted for 7.8%, and 10.8% in real wages increase, which is exceeding the 2004 GDP growth rate by 1 percentage point and 4 percentage points correspondingly. Thus, the effective rate of single social tax in real terms appears to be lower in 2004 against 2003, while that of the income tax remained almost unchanged. The reduction of the effective rate of single social tax in 2004 can be explained by the fact that in the previous periods the Russian federal budget revenues on single social tax also included the arrears on single social tax which used to be credited to the Pension Fund.
VAT revenues to the budgetary system of the Russian Federation remain the biggest ones thus accounting for more than RUR1 trillion or 19.7% of the consolidated budget revenues and 31.2% of the federal budget revenues by the end of 2004. In spite of the decrease in the basic VAT rate from 20 to 18% from January 1, 2004, a share of VAT revenues in GDP decreased by barely 0.2 percentage points of GDP, while the forecasted decrease was expected to be by nearly 0.6 percentage points of GDP. The increase in VAT revenues was to some extent based on the decrease in VAT refund volumes. For instance, according to the Federal Tax Service, the volume of refunded VAT accounted for 1.8% of GDP over the first 8 months in 2004, while that of the similar previous period accounted for 2,3% of GDP.
In 2004, excise revenues reduced by 1.1 percentage points of GDP and accounted for nearly 1.5% of GDP as compared to the previous year. Such a substantial reduction is caused by abolition of the natural gas excise from January 1, 2004. The revenues from this excise in 2003 accounted for more than 45% of the budget aggregate revenues on excises.
The mineral tax revenues its maximum (since its initial introduction), 3% of GDP, in 2004. As noted above, the tax growth was primarily caused by high oil prices and the increase in the mineral tax base rate from RUR340 to RUR347 per 1 ton of raw materials. In addition, the growth in mineral tax revenues was encouraged by the increase in oil production in 2004 which exceeded by 8.6% that of the previous year, according to the Russian Statistics Agency's data.
The volume of the foreign trade tax revenues in 2004 was in excess of by 1.7 percentage points of GDP as compared to the previous year and accounted for 5.1% of GDP. This was mainly caused by high oil prices in 2004 and changes in export tax from the second half of 2004, both for foreign trade tax and mineral tax.
2.2.3. Budget Expenditures
No essential changes were made in the structure of the consolidated budget expenditures in 2004 (refer to Table 4) as compared to 2003. Slightly reduced were the consolidated budget expenditures on state debt service (from 1.8% of GDP in 2003 to 1.4% of GDP in 2004), expenditures on municipal housing and public utilities (from 1.9% of GDP in 2003 to 1.7% of GDP in 2004), and on "Industry, construction and power energy" item (from 2.5% of GDP in 2003 to 2.3% of GDP in 2004).
No expenditures were increased other than that on "International activity" item (by 0.1 percentage points of GDP) for the federal and consolidated budgets, and social policy item by (also by 0.1 percentage points of GDP) local budgets. Thus, the aggregate expenditures at the end of 2004 were smaller than that in the previous year for the budgets at all levels: by 1.6 percentage points of GDP for the federal budget, by 0.8 percentage points of GDP for the local budgets, and by 1.9 percentage points of GDP for the consolidated budget.
Table 4
Expenditures of Federal Budget, Local Budgets and Consolidated Budgets
in 2002 thru 2005 (% of GDP)
2002
2003
2004
Federal Budg et
Local Budg ets
Con-solidated Budg ets
Federal Budg et
Con-Local soli-Budg dated ets Budg ets
Federal Budg et
Con-Local soli-Budg dated ets Budg ets
Public administration and 0.5 0.8 1.4 0.5 0.9 1.4 0.5 0.8 1.3
local self-administration
Judicial power 0.2 0 0.2 0.2 0 0.2 0.2 0.0 0.2
International activity 0.3 0 0.3 0.2 0 0.2 0.3 0.0 0.3
National defense 2.7 - 2.7 2.7 0 2.7 2.6 0.0 2.6
Law enforcement and national security 1.7 0.5 2.2 1.9 0.4 2.3 1.9 0.4 2.3
Fundamental scientific re-
search and scientific pro- 0.3 0 0.3 0.3 0 0.3 0.3 0.0 0.3
gress promotion
Industry, power energy and construction 1 1.3 2.3 0.5 2 2.5 0.5 1.9 2.3
Agriculture and fishery 0.3 0.3 0.5 0.2 0.3 0.5 0.2 0.3 0.5
Transport, road network,
communication and infor- 0.1 0.4 0.5 0 0.3 0.3 0.0 0.2 0.3
matics *
Housing and public utilities 0 2.3 2.3 0 1.9 1.9 0.0 1.7 1.7
Education 0.7 3 3.8 0.8 2.8 3.6 0.7 2.8 3.5
Culture, arts and cinematography Mass media. 0.1 0.4 0.5 0.1 0.3 0.5 0.1 0.3 0.4
0.1 0.1 0.2 0.1 0.1 0.2 0.1 0.1 0.1
Health care and sport. 0.3 2.1 2.4 0.3 1.9 2.2 0.3 1.9 2.2
Social policy 4.4** 1.3 5.7** 1 1.4 2.4 0.9 1.5 2.4
State debt service 2 0.1 2.2 1.7 0.1 1.8 1.2 0.2 1.4
Financial aid to budgets at other levels 2.7 0 - 6.0*** 0 3.2*** 5.4 0.0 3.0
Military reform 0.1 0 0.1 0.1 0 0.1 0.0 0.0 0.0
Road network 0.4 0.4 0.7 0.3 0.5 0.8 0.3 0.2 0.5
Targeted budget funds 0.1 1.4 1.6 0.1 1.1 1.2 0.1 1.0 1.1
Total expenditures 18.7 15.3 31.1 17.7 14.9 29.7 16.1 1 4.1 27.8
In 2001, including road network expenditures. ** Including transfers to the RF Pension Fund for financing basic part of pension at the expense of a single social tax's share centralized in the federal budget.
*** Since 2003, this item reflects transfers to public extra budgetary funds.
2.2.4. Main Events in the Budget System and Changes in Tax Law
In 2004, various amendments were made as part of the tax reform to the RF tax law and budget law, in particular, single social tax (the basic rate of single social tax was reduced from 35.6 to 26% for annual wages of employees within RUR280 thousand; the single social tax rate is established at 10% for annual wages of employees ranging between RUR280 thousand and RUR600 thousand, and 2% for wages in excess of RUR600 thousand). Changes in single social tax are to become effective from 2005, which is expected to result in budget losses of nearly RUR280 billion in 2005, according to the estimates of RF Ministry of Finance.
The legislation was also amended in relation to oil export tax and mineral tax. These amendments were generally expected to result to increase load on the petroleum industry
and partially compensate the RF Pension Fund's deficit, according to the RF Government's plans. According to a new export tax schedule, a tax would be 0% if oil price was up to $15 per barrel; up to 35% of the difference between actual oil price and $15 if oil price was $15 to $20 per barrel; not more than $12,78 plus 45% of the difference between actual oil price and $20 if oil price was $20 to $25 per barrel; not more than $29,2 and 65% of the difference between actual oil price and $20 if oil price was more than $25 per barrel. At the same time, the basic mineral tax rate was increased from RUR347 to RUR400 per ton in the Mineral Tax calculation formula. The tax-free oil price threshold was also increased from $8 up to $9 . In addition, the RUR exchange rate was revised from RUR31.5 to RUR29 per $1. According to the Government's estimates, the understated RUR exchange rate in the Mineral Tax calculation formula resulted in extra amount of nearly $1 billion remained in the petroleum industry. The corresponding amendments to the Mineral Tax are to come into force since 2005.
Furthermore, for the purpose of compensating federal budget's losses incurred from the reduced single social tax rate, amendments were made to the Budget Code in relation to reallocation of 1.5% percentage points of the profit tax rate for the benefit of the federal budget. As a result, the rate at which profit income revenues are credited to the federal budget is increasing up to 6.5%. Amendments to the budget law were also related to a growth in the standards of mineral tax contributions and regular payments payable to the federal budget from 2005, transition of water tax to the federal level and consequently crediting the entire single agricultural tax to the revenues of the constituent entities of the Russian Federation.
In collecting value added tax, the RF Government plans from 2005 to shift from the "country of origin" principle to the "country of destination" on oil and gas in its relations with the CIS countries (Ukraine, Byelorussia, Kazakhstan and Moldova). As a result, the RF budget is expected to lose RUR39,9 billion. The RF Government believes that the budget losses can be compensated by increasing the mineral tax rate for production of oil and gas.
During 2004, the issues related to reforming the value added tax were under active discussion. In particular, as early as in 2004, amendments to the VAT law were adopted, including establishing a procedure of VAT collection under the "country of destination" principle" in relation to transactions with Byelorussia. In 2005, the RF Ministry of Finance plans to consider the issue of reducing the basic VAT rate from 18 to 15%-16% and simultaneous abolishing the preferential 10% rate since 2006. Other options are also under consideration, down to establishing a single rate of 13%. From 2006, transition from the cash basis to the accrual basis for VAT payment is scheduled, with some exceptions which are likely to be granted for small businesses. The RF Government also made its proposals on considering options of accelerated VAT refunding. In addition, consideration was made of an option of authorizing banks to collect data on value added tax payment. According to the official statements of representatives of the RF Ministry of Finance, in 2004, the RF Government totally refused the idea of introducing VAT accounts. As a reminder, the basic VAT rate was reduced from 20 to 18% from January 1, 2004.
In 2004, the RF Ministry of Finance commenced to consider the issue of amending the Tax Code in relation to transfer pricing. Basic amendments should be referred to specifying a list of interdependent persons and its enlarging by including companies with different structure of ownership. Also, for purpose of substantiating a transaction price, the taxpayer must provide a series of documents, as requested by tax authorities, according to a well defined list including marketing research data.
On august 22, 2004, the RF State Duma adopted a low that replaces welfare benefits with cash payments, including well-fare benefits related to healthcare, public utilities service, transport fees, etc. The majority of the welfare benefits specified in the law are to be financed with the federal budget funds with total expenditures being estimated nearly RUR171,2 billion. In this case, the constituent entities of the Russian Federation are to finance welfare benefits of the social groups as follows: retired persons with long-term service record (labor veterans), citizens who were unlawfully retaliated for alleged political disloyalty, and persons who were employed in the period between June 22, 1941 and May 9, 1945. The RF Ministry of Finance expressed its readiness to allocate RUR 5-10 billion in 2005 to assist the regions in transition under the new welfare law. Such funds will be allocated from the Reserve Fund which totals RUR30 billion.
As of January 1, 2005, the Stabilization Fund totals nearly RUR522,3 billion. According to the draft federal budget, contributions to the Stabilization Fund in 2005 are estimated to be RUR387,7 billion, with estimated utilization capacity being RUR242,6 billion, including RUR74,7 billion scheduled to cover budget deficit of the RF Pension Fund, and RUR167,9 billion to repay the Russian foreign debt.
All in all, in the nearest 2 years, the RF Ministry of Finance plans to finalize the tax reform. As a result, the main outcome could be a released tax load and simplified taxation system of the Russian Federation. For example, in 1998, the number of taxes amounted to 52, while it is expected to be reduced down to 15 by 2006. According the estimates of the RF Ministry of Finance, transfer pricing remains one of the key issues of the upcoming reform.
2.2.5. Federal Budget for the year of 2005
Tax revenues of the federal budget for 2005 have been determined in the total of RUR2 trillion 232 billion 700 million (11.93% of GDP or 10.05% of GDP without consideration of single social tax), which is less almost by 3.5 percentage points of GDP than that under the budget law for 2004. The reduction is due mostly to the changes in classification of incomes, which in 2005 enables the revenues from tax duties to be attributed to non-tax revenues which used to be reflected in the item representing foreign trade tax and foreign economic operations (Foreign economic activity revenues). In addition, from 2005, aggregate income tax revenues are to be transferred to the local budgets.
According to the tax classification of 2004, tax revenues of the federal budget in 2005 (without consideration of single social tax) should amount to nearly RUR2 trillion 834 billion, or 15.1% of GDP, which is virtually by 1.6 percentage points of GDP more than that specified in the budget law for 2004, but by 1.1 percentage points less than actual tax revenues in 2004 (nearly 16.2% of GDP). Total federal budget revenues under the 2004 law is virtually comparable with the revenues under the 2005 federal budget, 17.90 and 17.77% of GDP correspondingly. At the end of 2004, federal budget revenues appear to exceed these figures by 2.5 to 2.6 percentage points (20.6% of GDP).
The key reason for the reduction in federal budget revenues in 2005 against the actual revenues in 2004 is reduction in 2005 of the effective single social tax by nearly RUR280 billion or 1.5 percentage points of GDP, as well as reduction in the income from public and municipal property and from activity of public and municipal organizations by 0.8 percentage points of GDP.
Table 5
Revenues in Budget Laws and Execution of Federal Budget in 2003-2005 (RUR million)
2003 Executed 2004 Executed 2005 Budget Law*
Budget Law for 2003 Budget Law for 2004
Tax Revenues** 1892363,7 2029566,5 2071384,5 2712122,7 2834120,8
Profit (income) tax , capital gains tax 179550,5 537303,4 164765,6 205991,49 259003,3
Taxes on products and
services; Licensing and 1178971,2 1135752,3 1088389,6 1188151 1205557,0
incorporation duties
VAT 946218,5 882063,5 988368,2 1069691,5 1120751,3
excise 231368,3 252531,3 98516,8 117205 84805,7
Aggregate income tax *** 8478,4 10074,9 150,8 167,22 -
Single agricultural tax **** - 257,8 150,8 167,22 -
Tax on securities transaction 840,0 1663,3 824,0 121,26 -
Payments of utilization of natural resources 183129,5 249507,7 279381,1 434252,61 483035,6
Taxes on foreign trade and
foreign economic opera- 335975,5 452789,2 532538,2 859736,84 867969,0
tions
Other taxes, fees and duties 5418,6 7069,4 5335,2 23702,36 285055,9
Non-tax revenues 145721,8 176718,3 219194,4 221995,52 225420,3
Incomes from public and
municipal property and from activity of public and 83158,8 112680,8 165612,1 169394,48 73004,0
municipal organizations
Administrative fees and charges Penalties, compensation of damage 1406,5 1383,1 1381,2 2395,308 1714,0
1353,6 1975,1 1157,8 1683,37 1483,9
Incomes from foreign economic activity 55932,7 52924,3 45205,2 38470,391 51124,8
Other tax revenues 3870,0 7755,0 5827,2 10051,934 98093,6
Fund of the Ministry of
Nuclear Power Energy of the Russian Federa- 14066,3 14349,0 14061,5 14074,644 0,0
tion
Single social tax 365640,0 364593,8 438210,0 442218,25 266500,0
Total revenues 2417791,8 2586191,2 2742850,4 3426334,2 3326041,1
* In the table above, unlike the established classification of incomes specified in the draft federal budget law for 2005, the amount of tax duties (Taxes on foreign trade and foreign economic operations) is attributed to tax revenues.
** Without consideration of single social tax .
*** From 2004, for the purpose of compensation for non-receipt of revenues by the budgets of constituent entities of the Russian Federation as a result of abolished sales tax, the federal part of tax revenues under special tax treatments of small businesses, aggregate income tax, is transferred to the budgets of the constituent entities of the Russian Federation .
**** Provides for coming into force, since January 1, 2004, of a revised chapter of the Tax Code regulating a special tax treatment as a single agricultural tax .
Table 6
Revenues in Budget Laws and Execution of Federal Budget in 2003-2005
2005
Budget
2003 Exe- 2004 Exe- 2005 Law
Budget cuted for Budget cuted for Budget against
Law 2003 Law 2004 Law * 2004 Budget Law
% of GDP %
Tax Revenues** 14.2 15.3 13.5 16.2 15.1 112.0
Profit (income) tax , capital gains tax 1.4 4.0 1.1 1.2 1.4 128.6
Taxes on products and ser-
vices; Licensing and incorpora- 8.9 8.6 7.1 7.1 6.4 90.6
tion duties
VAT 7.1 6.6 6.5 6.4 6.0 92.8
excise 1.7 1.9 0.6 0.7 0.5 70.4
Aggregate income tax *** 0.1 0.1 0.0 0.0 - -
Single agricultural tax **** - 0.0 0.0 0.0 - -
Tax on securities transaction 0.0 0.0 0.0 0.0 - -
Payments of utilization of natural resources 1.4 1.9 1.8 2.6 2.6 1 41 .5
Taxes on foreign trade and foreign economic operations 2.5 3.4 3.5 5.1 4.6 133.4
Other taxes, fees and duties 0.0 0.1 0.0 0.1 1.5 -
Non-tax revenues 1.1 1.3 1.4 1.3 1.2 84.2
Incomes from public and mu-
nicipal property and from activ- 0.6 0.9 1.1 1.0 0.4 36.1
ity of public and municipal or-
ganizations
Administrative fees and charges 0.0 0.0 0.0 0.0 0.0 101.5
Penalties, compensation of damage 0.0 0.0 0.0 0.0 0.0 104.9
Incomes from foreign economic activity 0.4 0.4 0.3 0.2 0.3 92.5
Other tax revenues 0.0 0.1 0.0 0.1 0.5 -
Fund of the Ministry of Nu-
clear Power Energy of the 0.1 0.1 0.1 0.1 0.0 0.0
Russian Federation
Single social tax 2.8 2.7 2.9 2.6 1.4 49.8
Total revenues 18.2 19.5 17.9 20.4 17.8 99.2
* In the table above, unlike the established classification of incomes specified in the draft federal budget law for 2005, the amount of tax duties (Taxes on foreign trade and foreign economic operations) is attributed to tax revenues.
** Without consideration of single social tax .
*** From 2004, for the purpose of compensation for non-receipt of revenues by the budgets of constituent entities of the Russian Federation as a result of abolished sales tax, the federal part of tax revenues under special tax treatments of small businesses, aggregate income tax, is transferred to the budgets of the constituent entities of the Russian Federation .
**** Provides for coming into force, since January 1, 2004, of a revised chapter of the Tax Code regulating a special tax treatment as a single agricultural tax .
Besides the reduction of the single social tax revenues, the same is true with the value added tax revenues in 2005. In this case, the reduction is caused by introduction on January 1, 2005 of a value added tax collection procedure on the "country of destination"
basis for hydrocarbons exported to the CIS countries, as well as value added tax exemption on the goods exported to the Republic of Byelorussia.
In spite of the fact that in drafting the federal budget law for 2005, the forecasted Urals oil price is decreased down to $28 per barrel as compared to actual annual average price levels in 2004, the volume of payments for utilization of natural resources against GDP in 2005 will remain unchanged as compared to actual level of tax revenues in 2004. This is due to an increase in the tax rate on oil production.
Eventually, due to changes in the tax law, tax revenues of the federal budget were reduced by RUR251,8 billion in 2005 and by 1.35% of GDP. At the same time, changes in standards for defining taxes by budgetary level enabled the federal budget revenues to grow by RUR102,1 billion or by 0.55% of GDP.
Table 7
Expenditures in Budget Laws and Execution of Federal Budget in 1999-2004 (% of GDP)
1999 2000 2001 2002 2003 2004 2005
Bud get Law * Exe cution Bud get Law * Exe cution Bud get Law * Exe cution Bud get Law * Exe cution Bud get Law * Exe cution Bud get Law * Exe cution Draft budg et Law *
Public administra-
tion and local self- 0.34 0.31 0.48 0.34 0.53 0.46 0.52 0.52 0.51 0.50 0.50 0.48 0.48
administration
Judicial power 0.12 0.10 0.15 0.11 0.15 0.13 0.17 0.18 0.20 0.19 0.22 0.20 0.20
International activity National defense 0.91 1.22 1.05 0.15 0.29 0.33 0.43 0.31 0.38 0.24 0.29 0.32 -0.02
2.34 2.40 2.63 2.62 2.77 2.73 2.58 2.72 2.65 2.68 2.69 2.56 2.37
Law enforcement
and national secu- 1.28 1.15 1.49 1.44 1.70 1.65 1.52 1.75 1.87 1.87 2.03 1.88 1.90
rity
Fundamental sci-
entific research and scientific pro- 0.29 0.23 0.30 0.24 0.29 0.26 0.27 0.29 0.31 0.31 0.30 0.28 0.83
gress promotion
Industry, power
energy and con- 0.36 0.35 0.38 0.48 0.58 0.49 0.49 0.97 0.48 0.52 0.44 0.49 0.63
struction
Agriculture and fishery Environmental and 0.23 0.18 0.22 0.18 0.27 0.26 0.20 0.26 0.23 0.24 0.19 0.21 0.13
natural resources
protection, hydro-meteorology, 0.07 0.06 0.07 0.06 0.06 0.05 0.09 0.09 0.08 0.09 0.08 0.08 0.10
mapping and ge-
odesy
Transportation,
communication 0.02 0.02 0.03 0.03 0.39 0.41 0.05 0.07 0.04 0.05 0.04 0.04 0.22
and informatics
Market infrastructure development 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 -
Prevention and
liquidation of con-
sequences of emergency situa- 0.18 0.16 0.17 0.13 0.08 0.08 0.08 0.08 0.16 0.18 0.17 0.16 0.18
tions and natural
disasters
Education 0.52 0.43 0.60 0.52 0.63 0.60 0.71 0.75 0.75 0.75 0.77 0.72 0.81
Culture, arts and cinematography 0.08 0.06 0.09 0.07 0.08 0.07 0.09 0.09 0.11 0.11 0.11 0.10 0.14
Mass media 0.05 0.04 0.11 0.08 0.08 0.08 0.09 0.09 0.09 0.09 0.07 0.07 0.06
1999 2000 2001 2002 2003 2004 2005
Bud get Law * Exe cution Bud get Law * Exe cution Bud get Law * Exe cution Bud get Law * Exe cution Bud get Law * Exe cution Bud get Law * Exe cution Draft budg et Law *
Health care and sport Social policy 0.26 0.21 0.30 0.23 0.29 0.26 0.28 0.29 0.30 0.30 0.31 0.29 0.44
1.05 1.02 1.18 0.93 1.39 1.24 3.71 4.46 1.15 1.04 1.05 0.92 0.95
State debt service 4.17 3.38 4.11 3.53 3.09 2.56 2.65 2.11 2.13 1.66 1.88 1.22 -
Building up gov-
ernment provisions 0.00 0.00 0.00 0.00 0.01 0.00 0.00 0.01 0.16 0.16 0.13 0.12 0.00
and reserves
Financial aid to
budgets at other 1.09 1.30 1.29 1.39 2.41 2.54 2.24 2.93 5.45 5.99 5.31 5.39 5.02
levels
Disposing and
liquidation of mili-
tary weapons,
including imple- 0.04 0.07 0.04 0.05 0.08 0.07 0.09 0.10 0.08 0.08 0.07 0.07 -
mentation of inter-
national agree-
ments
Mobilizing prepa-
ration of the econ- 0.01 0.01 0.01 0.01 0.01 0.01 0.00 0.01 0.00 0.00 0.01 0.01 0.02
omy
Researches and use of space 0.07 0.07 0.06 0.06 0.06 0.08 0.09 0.09 0.06 0.07 0.08 0.07 -
Military reform 0.00 0.00 0.00 0.00 0.05 0.06 0.15 0.13 0.11 0.12 0.05 0.04 -
Other expenditures -0.24 -0.13 0.09 0.09 -0.05 0.07 -0.03 0.11 -0.05 0.74 1.00 -0.01 1.82
Road network 0.00 0.00 0.00 0.00 0.00 0.00 0.50 0.36 0.61 0.34 0.52 0.29 -
Targeted budget funds 1.10 1.17 1.13 1.34 0.18 0.16 0.13 0.14 0.11 0.11 0.09 0.08 3.57
Total expenditures 14.38 13.83 15.98 14.09 15.40 14.67 17.09 18.91 17.97 17.75 17.36 16.07 16.28
* In comparable classification of expenditures.
Expenditures of the federal budget for 2005 are planned to reach RUR3 trillion 47,9 or 16.3% of GDP with GDP forecast amounting to RUR18 720 billion. Out of this amount, RUR 341,2 billion (11.19% of total expenditures) will constitute the funds allocated to the RF Pension Fund to pay basic labor pensions, RUR254,1 billion will constitute interest costs and RUR2 trillion 793,8 billion, non-interest costs (8.33 and 91.66% correspondingly).
Interest costs the budget 2005 will be reduced by 0.5 percentage points Of GDP (virtually by 20% in comparable prices) as compared to the budget law of 2004.
Noteworthy are changes in functional classification in the draft federal budget for
2005:
• reducing the number of sections and subsections of functional classification of expenditures of the budgets of the Russian Federation ;
• reflecting expenditures on management and applied scientific research in the corresponding spheres of activity included into sections and subsections of functional classification ;
• reflecting expenditures on capital investments included into economic classification of expenditures of budgets with possibility of their distribution between all items of the functional classification ;
• strengthening the items of economic classification with their reference to a new chart of accounts .
It can be noted that under the new functional classification, in 2005 expenditures on general state issues are reduced by virtually 0.4 percentage points of GDP as compared to
the budget of 2004. In addition, expenditures on housing and public utilities, environmental protection and education will be reduced in real terms. In this case, expenditures on education will be reduced by 0.2 percentage points of GDP. In other cases, liabilities in 2005 will grow in real terms as compared to 2004. The biggest share of expenditures will be utilized for financing national defense, national security and intergovernmental transfers, correspondingly 16, 13.1 and 30.8% of the aggregate federal budget expenditures in 2005. "Applied scientific research in the field of national defense", more than RUR81 billion or 0.04% of GDP, is one of the most essential subsections of expenditures on national defense. Expenditures reflected in "National security and law enforcement" section will grow by 0.07 percentage points of GDP or by 1,17 times in comparable prices. Expenditures on "Intergovernmental transfers" will grow in real terms by 1,06 times, while they will be decreased by 0.3 percentage points of GDP.
Table 8
Comparison of Expenditures Items in the Federal Budget Law for 2004 with those of the Federal Budget Law for 2005 in comparable classification
2004 (Law) 2005 (Law) Actual
% of ex- % of ex- growt
RUR billion % GDP penditures total RUR billion % GDP pendi-tures total h rates, %
Total expenditures 2 659,4 17.36 100 3 047,9 16.28 100 106,1
General state issues 458,7 2.99 17,3 460,4 2.46 15,1 92,9
National defense 413,7 2.7 15,6 531,1 2.84 17,4 118,9
National defense
and law enforce- 316,3 2.06 11,9 398,9 2.13 13,1 116,8
ment
National economy 213,5 1.39 8 242,1 1.29 7,9 105,0
Housing and public utilities 16,6 0.11 0,6 8,6 0.05 0,3 48,2
Environmental protection 5,0 0.03 0,2 4,6 0.02 0,2 85,7
Education 156,4 1.02 5,9 155,3 0.83 5,1 92,0
Culture, cinematography, mass media 32,8 0.21 1,2 39,2 0.21 1,3 110,6
Healthcare and sport 75,5 0.49 2,8 85,7 0.46 2,8 105,1
Social policy 154,1 1.01 5,8 167,4 0.89 5,5 100,6
Intergovernmental transfers 816,7 5.33 30,7 954,5 5.10 31,3 108,2
Including to budgets at other levels 317,2 2.07 11,9 274,6 1.47 9,0 80,2
Data source: Federal Budget Law for 2005 ; lET's estimates.
2.3. Interbudgetary relations and subnational finances
In 2004, there were observed no radical changes in the system of interbugetary relations. The structure of tax revenues and tax powers of different levels of authorities remained on the whole similar to that registered in the preceding year with the exception of several insignificant changes. At the federal level, there continued to function the channels of financial support of regional budgets set up within the last few years - interbudgetary 60
transfers in the form of grants for equalization of budgetary security, subventions, and subsidies from the Compensatory Fund, interbudgetary transfers from the Fund of Regional Development, the Fund of Reform of Regional Finances, other types of interbudgetary transfers allocated on the basis of previously approved principles7. At the background of a growth in the revenues of the federal budget in real terms, the financial standing of subnational budgets (taking into account the received federal financial aid) may be characterized as rather stable.
At the same time, the expert community was focusing attention on the tax and budgetary aspects of relations among the authorities of different levels during all the period under observation. First, in 2004 there were enacted the decisions concerning the abolishment of the sales tax and redistribution of tax revenues between the federal and regional budgets for the purposes of compensation for the budgetary revenues lost because of the abolished tax; there began to function the revised tax on the property of organizations. Second, during the year there were discussed the changes in the tax and budgetary legislation, which the Parliament reviewed in the framework of the federative reform, the legal framework of which started to form yet in 20 038. Third, there was widely discussed the adoption of legislation aimed at the liquidation of unfunded mandates (so called "moneti-zation of social benefits" what was closely related to the development of interbudgetary relations. Fourth, the decision concerning the actual abolishment of the appointment of the heads of executive authorities of RF subjects by election will also have an impact on the state of interbudgetary relations and subnational finances in a medium term outlook. The law on the federal budget for year 2005 was elaborated and adopted taking into account not only the changes in the system of interbudgetary relations, but also on the basis of certain principles of the staring reform of the budgetary process.
2.3.1. Relations between budgets of different levels: basic trends of development
In order to analyze main trends observed in 2004 as concerns the relations among budgets of different levels, it would be feasible to review the structure of the consolidated budget of the Russian Federation and its dynamics over the few past years. For the data characterizing the share of tax revenues, revenues and expenditures of budgets of RF subjects in the consolidated budget of the Russian Federation see Table 9.
Table 9
The share of certain budgetary indicators in the consolidated budget of the Russian Federation in 1992 through 2004 (in %)
1992 1993 1994 1 995 1996 1997 1998 1 999 2000 2001 2002 2003 2004
Tax
reve- 44,2 53,1 53,4 47,6 49,5 53,1 56,6 49,2 43,5 37,4 35,1 39,6 36,1
nues
Revenues * 44,1 53,1 52,9 47,6 49,5 53,1 54,0 48,9 45,4 40,1 37,4 37,6 34,1
Ex-
pendi- 34,0 40,3 37,7 43,4 45,4 48,1 54,1 51,9 54,4 54,2 49,3 50,0 50,8
tures
*Without financial aid from the federal budget (with the exception of the balance of unredeemed loans from the federal budget) as well as the revenues of targeted budget funds. Source: RF Ministry of Finance, calculations of the IET.
7 See annual IET surveys for years 1999 and 2001.
8 See: Russian Economy in 2003. Trends and Outlooks. Issue 25. M.: IET, 2004.
The data presented in Table 9 demonstrate that starting since 2001 (taking into account the fact that a portion of revenues from the single social tax is due to the federal budget) the share of tax revenues of subjects of the Russian Federation in the consolidated budget of Russia fluctuated from 35 per cent to 38 per cent and was above this level in 2003. According to the results of budget administration in 2004, consolidated budgets of RF subjects received over 36 per cent of the total tax revenues of the budgetary system as compared with 39.6 per cent registered a year ago. At the same time, the share of aggregate revenues of RF subjects (without financial aid from the federal budget) in the "Revenues" item of the consolidated budget of Russia declined from 37.6 per cent in 2003 to 34.1 per cent in 2004.
It should be pointed out that over the last few years the share of revenues of regional budgets in the consolidated budget of the Russian Federation was below the value of the respective indicator characterizing tax revenues. This fact may be primarily explained by higher amounts of non-tax revenues of the federal budget and unavailability of the data characterizing such an important source of non-tax revenues of the budgets of RF subjects as interbudgetary transfers.
At the same time, the share of expenditures of RF subjects in the consolidated budget of the Russian Federation increased from 50.0 per cent to 50.8 per cent.
In this connection, it should be pointed out that by the end of 2004 there was observed an increase in the share of revenues of the consolidated budget of the Russian Federation from 31.1 per cent of GDP registered in 2003 to 32.3 per cent (by 1.2 p. p.). At the same time, the tax revenues of the consolidated budget of Russia (not taking into account extra-budgetary funds) grew more considerably - by 1.4 p. p. of GDP. It should be also noted that the federal budget accounted for a significant portion of this growth (0.8 p. p. of GDP), while the tax revenues of consolidated budgets of RF subjects increased not so significantly - up to 10.6 per cent of GDP from 10 per cent of GDP registered in 2003. Exactly this circumstance had determined the decline in the share of the tax revenues of consolidated budgets of RF subjects in the total tax revenues of the RF consolidated budget. In 2004, simultaneously with an insignificant increase in the tax revenues, there was observed a certain decline in the amount of aggregate total revenues of regional budgets -from 14.5 per cent registered in 2003 to 14.3 per cent of GDP caused by the decrease in the amount federal financial aid.
The data presented above permits to arrive to the conclusion about a certain centralization of financial resources in the federal budget to the detriment of the budgets of RF subjects: on the whole the national level of tax burden has increased, however, the federal budget accounted for the bulk of this growth. At the same time, the federal financial aid to regions calculated as the share of GDP decreased, while the share of expenditures of regional budgets in the RF consolidated budget grew. These facts indicate that the vertical imbalance of the distribution of sources of revenues and assignment of expenditure obligations across the federal and regional levels of authorities has increased. At the same time, in the course of analysis of the structure of distribution of revenues across the levels of the budgetary system in 2004 it should be taken into account that at that time the budgets of all levels received additional tax revenues resulting form the inspection of the NK YUKOS and its affiliated companies, what could distort the analyzed indicators9.
9 According to expert estimates, in 2004 the Russian budgetary system received about Rub. 140 billion as the repayment of indebtedness associated with tax payments, arrears, penalties, and fines related to the tax on profits of organizations transferred by the NK YUKOS.
In the course of analysis of the tax revenues received by consolidated regional budgets in 2004, it should be noted that similarly to the situation observed in the preceding years two taxes (the income tax on individuals and the tax on profits of organizations) accounted for more than a half of the total tax revenues (32 per cent and 37 per cent of the tax revenues of regional budgets respectively). It should be noted that in 2004 the revenues generated by these two taxes increased in terms of their shares in GDP. While the revenues generated by the income tax on individuals remained at the previous level (about 3.4 per cent of GDP), the revenues generated by the profit tax have sharply increased (from 2.7 per cent of GDP to 3.9 per cent of GDP). At the same time, the growth in excise generated revenues also grew (up to 0.8 per cent o (GDP), while the revenues associated with payments for utilization of natural resources declined (down to 0.9 per cent of GDP). The taxes on small businesses increased by 0.1 per cent of GDP after an insignificant decline registered in 2003.
In the course of analysis of the respective indicators of administration of consolidated budgets of the Russian Federation and comparison of these data with the results of execution of the federal budget, it should be stressed that starting since 2003 there has been taken the measures aimed at the increase of the rate of centralization of tax revenues in the federal budget. It should be reminded that in 2003 there were enacted such decisions as the full abolition of the tax on users of motor roads, as well as the switching to the transfer of the total amount of revenues generated by excises on tobacco products to the federal budget. In 2004, this trend became even more pronounced as there was abolished a whole range of fees the revenues from which were transferred to the budgets of RF subjects and the federal share in the revenues generated by the mineral extraction tax was raised.
However, the results of all these decisions were compensated in full by such measures in the sphere of interbudgetary redistribution of tax revenues as the transfer of the total federal share of tax revenues generated under the special taxation regimes applicable to small businesses to the budgets of RF subjects, the transfer of the federal share of excises on vodka and liquor products (the procedures governing the payment of these taxes were simultaneously reformed), and the transfer of 1 p. p. of the federal rate of the tax on the profits of organizations.
As a result, in 2004 the tax revenues of the RF subjects increased by 0.6 p. p. of GDP as compared with the figures registered in the preceding year. These developments were primarily determined by the growth in the revenues generated by the profit tax by 1.2 p. p. of GDP. The increase in the revenues generated by the profit tax was caused by both the growth in the regional share in the profits tax, and the increase in the tax base. It may be surmised that the growth of the profit tax base has been favorably affected by the reduction of the base VAT rate from 20 per cent to 18 per cent occurred in 2004. According to some hypotheses, the growth in the profit tax revenues observed in 2004 was related to the improved discipline of taxpayers caused by the active actions taken by the federal authorities with respect to the NK YUKOS.
At the same time, an analysis of the per capita indicator of the tax revenues of consolidated budgets of RF subjects demonstrates that in 2004 the interregional unevenness of this indicator increased; thus, the value of the respective Gini coefficient grew over the year and made 0.57 (as compared with 0.52 registered in 2003). A decline in the real tax revenues was observed only in four subjects of the Federation: the Republic of Adygeya, the Astrakhan oblast, the Saratov oblast, and the Republic of Altai. At the same time, in absolute terms the maximal increase in the tax revenues was registered in the city of Moscow, the Republic of Tatarstan, the Tyumen oblast, the Khanty Mansi AO, and the Republic
of Mordoviya, i.e. either in the regions characterized by high budgetary security (the first four regions), or the high shares of he profit tax in the structure of tax revenues (the Republic of Mordoviya). An analysis of changes in the per capita tax revenues demonstrates that the maximal positive increment of per capita tax revenues in real terms was observed in such regions as the Evenk AO, the Republic of Mordoviya, the Chukotka AO, the Tyumen oblast, and the Khanty Mansi AO. The success of the Tyumen oblast and the Khanty Mansi AO may be easily explained by high oil prices and the measures aimed at the exaction of additional tax payments from certain oil companies and respective growth in tax payments made by oil companies to regional budgets. At the same time, the significant growth in the per capita tax revenues in real terms in the Evenk AO, the Republic of Mordoviya, and the Chukotka AO may be explained by a high share of the profit tax in the total tax revenues of these regions. Thus, in 2004 the share of the profit tax in the total tax revenues of the Evenk AO made 95 per cent, the Chukotka AO - 85 per cent, and the Republic of Mordoviya - 78 per cent, while the average national level of this indicator was observed to make 37 per cent. As concerns the Republic of Mordoviya, there the growth in this indicator should be primarily associated with additional tax payments made by taxpayers engaged in resale of oil, who were registered in this subject of the Russian Federation, since the region granted significant tax privileges.
Therefore, the results of the analysis permit to state that tax revenues grew across all regions with the exception of four. At the same time, in 2004 the unevenness of the distribution of tax revenues only increased, what may be explained by a growing importance for their revenues of such taxes characterized by the unevenly distributed base as the profit tax. The validity of this argument is confirmed by the fact that among the regions benefiting from the redistribution of tax resources are both highly subsidized regions like the Evenk and Chukotka autonomous okrugs, and non-subsidized RF subjects, for instance, the Tyumen oblast, the Khanty Mansi AO, etc. The only specific feature common for these regions is significant payments associated with the profit tax in absolute and relative terms. Other decisions in the sphere of tax policy implemented in 2004 did not produce so significant effect across all regions. Thus, the abolishment of the sales tax, which was rather high in Moscow, did not result in a decline in the tax revenues of this region. At the same time, the changes in the scheme of distribution of excises on fuels and lubricants were not completely compensated by other redistribution measures only in the Saratov oblast.
Contrary to the situation observed in 2003 and 2002, in 2004 the aggregate surplus of consolidated budgets of RF subjects was registered at 0.2 per cent of GDP. This surplus resulted in an increase in the balance of the budget by 0.6 p. p., what made 1.2 per cent of GDP by the end of the reporting period. Among the sources of financing used by regions in 2004 there were the issue of state and municipal securities, attraction of credits on behalf of RF subjects and municipal entities, and privatization of state and municipally owned property. It should be noted that both in 2003 and 2004 at the national level there were observed negative balances of such a source of financing of the budget deficit as federal budgetary loans (i.e. in 2004, across the country RF subjects repaid their liabilities associated with these loans in amounts exceeding new respective borrowings). These developments may be seen as the turning point with respect to the negative trend observed up to 2003.
An analysis of qualitative characteristics of the financial aid to subjects of the Federation from the federal budget (see Table 10) reveals that in spite of a considerable growth in the tax revenues of the federal budget the amount federal financial resources transferred to subnational budgets on free basis increased only insignificantly in nominal terms and made about Rub. 401 billion, or 2.39 per cent of GDP (as compared with 2.85 64
per cent of GDP observed in 2003) in 2004. At the same time, in real terms the financial aid to regional budgets declined by 3 per cent in comparison with the figures registered in 2003.
In 2003, the expenditures of the federal budget associated with financial aid provided to RF subjects and municipal entities did not change as compared with the figures registered over a number of preceding years. In spite of the implementation of reforms, the specific features of this type of federal budgetary expenditures still are significant amounts of funds distributed in the course of interbudgetary regulation without any methodological, financial, and economic justification. In the total amount of transferred resources, the share of financial aid allocated on the formalized basis makes about 60 per cent. Similarly to the situation observed in the preceding years, on the formalized basis there was formed and allocated only a limited amount of financial aid (Federal Fund of Financial Support, Compensatory Fund, Fund of Co-financing of Social Expenditures, and Fund of Reform of Regional Finances). At the same time, no procedure governing the formation and allocation of even a portion of the said funds was approved in the framework of official regulatory and legal acts. The only exception was the Fund of Reform of Regional Finances, since the respective methods of formation and distribution of this fund were approved by a resolution of the RF Government, what was a condition set forth by the World Bank, which sponsored the financing of this type of financial aid. At the same time, in 2004 there became perceptible a positive trend as concerns the approval of the methodologies of formation and distribution of the funds of financial support of regions by the resolutions of the RF Government. However, the decisions with respect to formalization of financial aid to regions taken in 2004 will enter into force only in 2005.
All other types of financial support have been formed and allocated outside of any clear methodological procedures (with the exception of the grants for support of the measures aimed at the ensuring of the balanced nature of the budgets of RF subjects).
In 2004, similarly to 2003, the specific feature was the revision of the law on budget and an increase in the initially allocated amounts of financial aid to regions by Rub. 73 billion. It should be noted that over the last 4 years such changes have become rather customary, what challenges the efficiency of the reform, which had been implemented in the sphere of distribution of financial aid to regions.
The problem of annual revisions of the budget laws and increases in the initially planned amounts allocated to regional budgets is not only that the additionally allocated amounts are not subject to the formalized procedures underlying the elaboration of the law on federal budget for next financial year. The annual rises of the amounts of financial aid in comparison with the originally envisaged transfers, as well as the lack of clear and well known rules of distribution of such additional amounts result in a significant softening of budgetary constraints on subnational authorities, what is discussed in more details below. In other words, in the case the regional authorities in advance assume that in the course of allocation of additional financial aid the federal authorities will orient towards such indicators of needs as the wage and salaries arrears, the amount of creditor indebtedness in the sector of housing and public utilities, etc, and not the objective characteristics of regional tax potential and expenditure needs of regions used for the distribution of transfers from the Fund of Financial Support of Regions, it will fail to facilitate implementation of measures aimed at enhancement of efficiency of budgetary expenditures and conduct of reform of the public sector.
As examples of the existing procedures and principles of distribution of additional financial aid there may be cited the following decisions:
1) In 2004, the Compensatory Fund was increased from Rub. 49.9 billion to Rub. 56.2 billion, i.e. by 13 per cent;
2) The Fund of Co-financing of Social Expenditures was increased from Rub. 3.3 billion to Rub. 6.3 billion, i.e. by 91 per cent;
3) The grants for equalization of regional budgets were increased from Rub. 20.2 billion to Rub. 21.8 billion, i.e. by 8 per cent.
The considerations discussed above indicate that over the last years the process of the reform of interbudgetary relations started in 1997 and 1998 has been apparently slowing down, and in some cases (for instance from the viewpoint of the ratio between the federal resources distributed across regions on the basis of formalized and discretional principles) in 2002 through 2004 there was observed a certain regress. This situation may be explained by several factors.
First, at present the objective overburdening of the budget sphere with federal expenditure obligations not backed by the respective financing persists. In the situation, where the total amount of expenditure obligations exceeds the financial resources available to the authorities, the government naturally strives to have available some financial reserves, which could be immediately transferred to regions depending on the arising needs.
Second, the powers to distribute financial aid among regional budgets outside transparent procedures fixed by regulations are the most important lever of influence on the decisions and policies of subnational authorities. In the situation, where the degree of interregional unevenness of budgetary security is high (what is a specific feature of Russia), it is needed to support a rather high degree of centralization of tax revenues in the federal budget, and, respectively, a larger amount of the budgetary resources redistributed among regions. Therefore, due to the use of financial mechanisms the degree of influence on regional authorities, which to a certain degree are formally independent as concerns the decisions they take within their competence, may be rather significant. From the point of view of the authors, this situation is one of the key reasons, why the methods of distribution of the major types of financial aid used over the last years have not been fixed in the budgetary legislation as yet.
In any case, as it is demonstrated by the recent practices the reform of the principles underlying the distribution of the federal financial aid is still on the agenda, since the existing system is insufficiently transparent, what does not permit to draw any conclusions about its efficiency and provides grounds to surmise that it may be used in order to create negative incentives as concerns budgetary policies pursued by regional and local authorities. However, in 2004 there was taken a number of decisions permitting to assert that in-terbudgetary relations become more transparent and there are observed certain changes in their substantive characteristics. These changes will be discussed below.
Table 10
Financial aid provided from the federal budget to the consolidated budgets of RF subjects in 1992 through 2004 (in % of GDP)
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005* 0.00 0.02 0.09 0.06 0.09 0.13 0.10 0.06 0.15 0.54 0.28 0.29 0.27 0.24
0.11 0.12 0.11 0.11 0.09 0.08 0.11 0.06 0.06 0.05
Grants and subventions
Including:
Grants and subventions to CATEs and the town of Baikonur
Grants and subventions to CATEs
Grants to the town of Baikonur
Capital investment subventions to CATEs Resettlement subventions to CATEs
Subventions to CATEs for financing of CATE development programs Other subsidies and subventions
Grant to the town of Sochi Grants compensating losses relating to maintenance of HPU objects transferred to jurisdiction of local governments
Other grants to budgets of RF subjects (for support of the equilibrium of budgets and compensation of losses) Other subsidies and subventions to budgets of RF subjects and municipal entities Subventions Transfers from FFSR Including: Transfers
Of which: state support of seasonal deliveries to the North
Transfers at the expense of VAT
Subsidies and subventions from the Compensatory Fund
Including:
Subsides for implementation of the law on social security of disabled persons Subventions for implementation of the law on state family allowances
Subventions for compensation of privileges related to payment for HPU services in accordance with the federal legislation
Other subventions and subsidies from Compensatory Fund
Resources of the Fund of Co-Financing of Social Expenditures Resources of the Fund of Regional Development State support of road networks
Resources of the Fund of Reform of regional finances
Funds transferred as mutual payments Loans minus repayment to other levels of authorities
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005*
0.00 0.00 0.00 0.00
0.03 0.02 0.03
0.01 0.01 0.01
0.01 0.00 0.00
0.04 0.42 0.17 0.18 0.18 0.16
0.01 0.01 0.01 0.01
0.08 0.08 0.03 0.03
0.79 0.69
0.00 0.00
0.00 0.00
0.00 0.00
0.42 0.12
0.36 1.17
0.36 0.86
0.00 0.31
0.12 0.09
1.04 1.22
0.68 0.86
0.36 0.36
0.02 0.20
1.12 0.99
1.00 0.99 0.12
0.96 1.14
0.96 1.14 0.06 0.08
0.37
0.07 0.09
0.01 0.01
1.36 1.30
1.36 1.30
0.08 0.07
0.38 0.36
0.13 0.10
0.01 0.02
1.05 1.01
1.05 1.01
0.34 0.18
0.13 0.12 0.06 0.09
0.24 0.21 0.16 0.12
0.02 0.10 0.09
0.02 0.04 0.04
0.15 0.11 0.04 0.12
0.03 0.05 0.10 0.10 0.15 0.01**
0.18 0.11 0.27 0.27 0.31 0.22 0.16
0.00 0.01 0.01 0.01 0.00
0.61 1.95 2.54 0.42 0.81 0.43 0.36 0.14 0.28 0.05 0.20 0.14 0.12
0.09 0.03 0.02 0.04 0.23 0.64 -0.03 -0.10 -0.08 0.02 0.09 -0.01 -0.02
_ 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005*
Arrears of transfers from budgets of RF subjects to target budgetary funds Other types of financial aid Including:
Funds transferred to the budgets of other levels for implementation of state programs
Measures in the sphere of regional development, targeted federal and other programs
Total funds transferred to
budgets of other levels
* In accordance with federal law on the federal budget for year 2005 No. 173-FZ of December 23, 2004.
** Since 2005, only the financial resources associated with the program "Reduction of differences in the social and economic development of regions of the Russian Federation" should be included in the Fund of Regional Development
*** Including the grants to Tatarstan and Bashkortostan aimed for implementation of measures envisaged by federal targeted programs of social and economic development until year 2006.
2.3.2. The problem of soft budgetary constraints on Russian regional authorities
As it has been noted in the survey "Russian Economy in 2003. Trends and Outlooks," the amount of financial resources distributed in the form of financial among the budgets of RF subjects in the recent years has significantly exceeded the amount of financing initially envisaged by the laws on the federal budget for respective financial years and brought to the notice of regional authorities. Thus, according to the authors' point of view, in 2003 the allocation of additional financial aid to regions across different channels was carried out in line with the striving to ensure the favorable for the federal center outcomes of the Parliamentary elections held in December of 2003.
In 2004, these practices were continued. Throughout the year, there were approved legislative acts concerning the amendments to the law on the federal budget aimed at the allocation of additional revenues of the federal budget for the purposes including increases in expenditures across financial aid budget items. In the Fig. 13, there are presented the data characterizing the differences between the amounts of financial aid to regions as envisaged in the law on the federal budget approved by the Parliament and signed by the President immediately prior to the beginning of the respective financial year, and the amount of financial aid registered in the law on the federal budget as in force at the end of the respective financial year, i.e. adjusted for the amendments made to the law during the year.
As it is demonstrated by the data presented in Fig. 13, in 2003 and 2004 the increase in the amount of financial resources distributed in addition to the amount envisaged in the initial version of the law on the federal budget was significant. While the law on the federal budget for year 2002 at the end of that year envisaged the amount of resources for distribution among the budgets of RF subjects only by 4.2 per cent exceeding the targets made public prior to the beginning of the financial year, at the end of 2003 this indicator made 34.8 per cent, and at the end of 2004 - 26.7 per cent of the amount initially envisaged by the law on the federal budget.
0.00 0.00 0.00 0.02 0.05
0.00 0.13 0.18 0.23 0.19 0.30
0.00 0.11 0.00
0.18 0.23 0.13 0.30*** 1.49 2.70 3.4 1.8 2.3 2.5 1.60 1.36 1.54 2.56 3.03 2.84 2.39 2,02
Î 26,7%
a: 200 -
2002
2003
2004
■ Envisaged by the law on the federal budget approved prior to the end of financial year □ Envisaged by the law on the federal budget approved prior to the beginning of financial year
Source: The laws on the federal budget for years 2002, 2003, and 2004, different versions.
Fig. 13. The excess of financial aid envisaged by the law on the federal budget approved prior to the end of financial year over the amount of financial aid envisaged by the law on the federal budget approved prior to the beginning of financial year
There may be several factors behind this phenomenon. First, there may be responsible the financial planning of insufficient quality; for instance, in the beginning of the year such indicators as the revenues of the federal budgets and needs of regions as concerns financial resources were underestimated. Second, it is highly probable that the federal authorities deliberately kept significant amounts of financial resources for the purposes of distribution of these resources during the financial year among the regions, which due to economic and (or) political reasons are in need of additional financing. Third, such a situation might be determined by the circumstance that the planning of the revenue and expenditure indicators of the federal budget proceeded from a conservative forecast of external business situation, while favorable developments on the world markets of raw materials resulted in higher amounts of additional revenues, part of which could be distributed among the regions in the form of financial aid.
Notwithstanding the possible reasons (most probably, all three are valid to a certain degree), the present situation has a very negative impact on the incentives of regional authorities as concerns the pursuit of efficient budgetary policies. In the world literature, the situation, where the federal authorities do not adhere to the principles announced in advance and provide additional financial aid to the regions experiencing financial difficulties is defined as the situation of soft budgetary constraints10. As it is demonstrated by the international experience, soft budgetary constraints on subnational authorities result in a whole number of negative economic effects, including both the excess over the efficient
400
0
10See, for instance, Fiscal Decentralization and the Challenge of Hard Budget Constraints. Rodden, Jonathan, Gunnar Eske-land and Jennie Litvack (eds). - Cambridge: MIT Press, 2003.
level of budgetary expenditures, and effects of a more general nature (creation of barriers to the growth in private investment and increase in the number of inefficient investment projects involving higher risks).
In practice it means that in the situation, where regional authorities can justifiably expect additional financial aid as compared with the amounts made public initially, there may be observed several types of negative effects. First, regional authorities may assume higher risks both in the course of implementation of budgetary programs and as concerns borrowings. Second, the probability to receive additional financing permits regional authorities to assume additional obligations in the form of creditor indebtedness and to refrain from taking of measures aimed at the improvement of the efficiency of budgetary expenditures in the region. Third, basing on the experience of past years, regional authorities may surmise an approximate list of indicators on the basis of which the federal authorities will distribute additional financial aid among regions, regional authorities can influence the respective indicators (for instance, the level of creditor indebtedness in the region, the level of wages and salaries arrears in the public sector, the level of indebtedness of public institutions as concerns payments to public utilities, etc). As a result, the seemingly favorable for the residents of the regions receiving financial aid decision about the provision of additional financial aid may have consequences producing negative effects not only on the residents of concrete regions, but the country at large (the state of its public finances). At the same time, the probability of such negative effects increases in the cases, where additional financial aid is distributed on the regular basis.
A factor facilitating the softening of budgetary constraints on Russian regional authorities is not only the increase in the total amount of financial aid envisaged in the law on the federal budget. The amount of financial resources made public already prior to the beginning of the financial year remains rather high, however the powers concerning the decisions on the concrete methods of the distribution of these resources are vested with the Government, which takes respective decisions during the financial year. As a result, regional authorities have no information about the methods of distribution of certain financial resources, what creates incentives for origination of soft budgetary constraints, as well as for the wish of regional authorities to receive additional financial aid.
Thus, in 2004 about 25 per cent of the financial resources in the form of the grants aimed at the balancing of regional budgets were not distributed among regions on the basis of the law on the federal budget: the grants provided to the budgets of RF subjects for support of the measures aimed at the balancing of budgets of RF subjects in amount of Rub. 15 billion 194 million 335 thousand were redistributed in accordance with supplement No. 36 to the law on the federal budget, while the procedures governing the distribution and amounts of grants provided to the budgets of RF subjects with the purpose to ensure the balance of the budgets of RF subjects, which amounted to Rub. 4.965 billion, were set forth by the Government of the Russian Federation.
The creation of the reserves without having in place clear procedures of distribution in the beginning of the financial year may also have a negative impact on the fiscal behavior of regional authorities (expressed in attempts to receive yet undistributed financial reserves of the center in stead of optimization of own financial resources), and on control over the distribution and utilization of the said funds.
The same practices persist in 2005. In Fig. 14, there are presented the dynamics of grants for stabilization of regional budgets proceeding from the methodology of distribution of these funds and distribution of these funds at the Government's discretion.
16 14 12 10 8 6 4 2 0
75,4%
73,4%
24,6%
26,3% -
2004
2005
□ The procedure governing the distribution of grants is set forth in the law on budget ■ The procedure governing the distribution of grants is set forth by the RF Government
Fig. 14. The dynamics of amounts and shares of grants for stabilization of regional budgets
proceeding from the methodology of distribution of these funds and distribution of these funds at the Government's discretion (Rub. billion)
As it is demonstrated by the data presented in Fig. 14, the share and amount of grants for the support of the balances of regional budgets provided under procedures set forth by the Government were significant both in 2004, and 2005. The share of these financial resources makes about one fourth of the total amount of grants provided for the support of the balances of regional budgets.
The procedures and rules of distribution of grants provided for the support of the measures aimed at the balancing of the budgets of RF subjects in 2004 were elaborated and set forth by the governmental resolution approved in the second half of the financial year. The key feature of the said rules is that they usually base on the reporting indicators of regional budgets, although the use of such indicators was deemed inefficient yet in 1998 in the course of revision of the Methods of distribution of grants provided from FFSR11.
In accordance with the resolution of the RF Government, the right to obtain grants aimed at the balancing of budgets should have the regions, where the ratio between primary expenditures of the consolidated budget (expenditures for wages and salaries, charges on the payroll, payments associated with mandatory medical insurance as concerns non-working residents, compensation of the difference between the set level of household payments for public utilities and the economically justified tariffs, capital repairs of the housing fund, payments to the population as concerns subsidies for housing and public utilities expenditures) for the first 5 months of 2004 and the consolidated revenues for 5 months of 2004 (minus the financial reserves of the Compensatory Fund, the Federal Fund of Financial Support of RF subjects transferred in advance, and certain types of grants) made less than 60 per cent.
11 See the Concept of reform of interbudgetary relations in the Russian Federation in 1999 through 2001 approved by Resolution of the RF Government No. 862 of July 30, 1998.
The amount of the grant provided to individual regions should depend on the amount of the expenditures of the consolidated budget of this region in 2003, the ratio between its primary expenditures and revenues in the first 5 months of 2004, and the level of its budgetary security after the distribution of the FFSR financial reserves in 2004.
Grants are provided in two stages. At the first stage (in September of 2004) the regions received 30 per cent of the total amount of grants for support of the balance of regional budgets. At the second stage (in October of 2004), according to the aforementioned resolution the regions should receive 70 per cent of the amount of grants, which should be distributed among the regions on the basis of the indicators discussed above with the use of an adjustment coefficient.
This adjustment indicator of the fulfillment of measures aimed at the balancing of the budgets of RF subjects should take into account the activities of sub-federal authorities aimed at the improvement of the financial standing of regions.
The adjustment indicator was calculated on the basis of:
1) reduction of the creditor indebtedness of the regional budget as concerns wages and salaries, charges on payroll, provision of state allowances to citizens with children, and payments for public utilities;
2) attrition rate of arrears associated with the regional and local tax on profits (the share due to the consolidated budget of the RF subject);
3) attrition rate of unregulated indebtedness of the RF subject to the federal budget.
Thus, there was made an attempt to compensate negative effects of irregular provision of financial aid and to create incentives for regional authorities to use the grants for implementation of measures aimed at the rehabilitation of regional finances.
At the same time, the rationality of the existence of grants for the balancing of regional budgets proceeding from the reporting indicators and to a certain extent envisaging the targeted nature of the funds received by the region seems to be arguable.
A similar effect could have been achieved, on the one hand, by an increase in the amount of FFSR, and on the other hand, by granting various conditional subventions for rehabilitation of regional finances. Both measures could have been envisaged in the law on the budget for year 2004. All individual and extra requirements with respect to additional financing on the part of regions not related to emergency situations can be met at the expense of borrowings in the market sector. These measures could result in more reliable data used by regions in the course of elaboration of their budgets and partially mitigate the urgency of the problem of soft budgetary constraints (in the cases of active use of borrowings, the problem of soft budgetary constraints may emerge as subnational authorities are granted financial aid for the repayment of borrowings they are unable to pay at the expense of own funds).
It appears that it would be more feasible not only to distribute the total amount of planned financial aid to regions via the mechanisms set in place in advance, but also inform regional authorities about the amounts of financial aid targeted for each region even prior to the beginning of the planned period. At the same time, it is necessary either to refrain from granting financial resources in excess of the targets, or envisage the closed list of cases, where additional financial aid may be granted, and the respective procedures in the framework of the federal legislation.
Yet another "mechanism of flexibility" of the federal budget became the option permitting to redistribute grants and subventions to closed administrative and territorial entities (CATE). In accordance with the RF Government resolution No. 409 of August 12, 2004, the RF Finance Ministry was granted the right to redistribute grants from CATEs, where revenues exceeded 15 per cent, in favor of the CATEs, where the revenues were below the 72
planned level. A similar reduction should be applied to subventions for capital repairs and resettlement, as well as misused subventions.
2.3.3. Distribution of grants for equalization of budgetary security of RF subjects: new methods
In accordance with the requirements set forth by the new budgetary legislation, which has entered into force since January 1, 2005, in 2004 there was elaborated and approved by the RF Government resolution No. 670 of November 22, 2004, the new Methodology of distribution of financial resource of the Federal Fund of Financial Support of Regions (FFSR), which took into account the flaws of the preceding methodologies. For the first time since the FFSR has started to operate, the methods of distribution of grants for equalization of budgetary security of RF subjects was fixed in the form of a regulatory and legislative act (prior to 2005, the methodology existed only in the form of information materials presented by the Government in the package of documents supplemented to the draft federal law on the federal budget for the next financial year). There may be singled out the following innovations, which make the new principles of distribution of FFSR resources different from the preceding methodologies.
1. Starting from 2005, FFSR financial resources should be distributed in the form of grants only for the purposes of equalization of the rated budgetary security of RF subjects (in 2004, the grants for the equalization of rated budgetary security of regions made about 94 per cent of FFSR). The subsidies for the state support of procurement and delivery of oil, oil products, fuels, and food products to the regions of Far North and the territories granted equal status, as well as subventions for compensation of tariffs on electrical power granted to the territories of the Far East and Arkhangelsk oblast were excluded from the composition of grants for the equalization of budgetary security.
In fact, this measure completes the next stage of the reform of equalizing transfers in Russia by setting forth the non-conditional nature of distribution of all financial resources of FFSR. Yet since the switching to the unified formula of distribution of FFSR resources in 1999, certain components designated for the financing of individual types of expenditures persisted in the composition of the fund. The major factor behind the continuing existence of such components was the compromise, in the framework of which the switching to new principles of distribution of transfers provided from FFSR was accompanied by persistence of its targeted component. Gradually, this targeted component began to be singled out of the total amount of financial reserves on the basis of a unified formula and lost any connection with its declared purposes (financing of the seasonal deliveries to the North and compensation of high tariffs on electrical power). The logical completion of this stage was the abolishment of the targeted component.
2. The approved Methodology of distribution of the financial resources of the Fund of Financial Support of Regions for year 2005 reduced the level of per capita rated budgetary security setting the cap on the right of regions to receive FFSR resources. The preceding methodologies made a region eligible for financial aid provided from FFSR in the case the per capita rated budgetary security in this region decreased below the value of the respective average national level. In 2005, the border separating the regions receiving and not receiving transfers from FFSR was set somewhat below the average national level: in the case the level of rated budgetary security of a region is above 60 per cent of the average national level, the region has no right to receive grants from FFSR. This provision permits to achieve a higher degree of concentration of financial aid in recipient regions. As a result,
in 2005 the number of regions not receiving grants from FFSR increased by 2 (the Sverdlov and Arkhangelsk oblasts)12.
3. According to the new Methodology of distribution of resources of the Fund of Financial Support of Regions, the fund has ceased to single out the share of its resources previously (till 2005) aimed at the raising of the minimum budgetary security of most poor regions (subjects of the Federation with the minimal levels of per capita rated budgetary security) up to a single level (until 2005, the share of the fund allocated for these purposes made 20 per cent of its total amount). Since 2005, all financial resources of the Fund should be allocated for a prorated reduction of the gap between the per capita rated budgetary security of regions and the level of per capita budgetary security set forth as the criterion of equalization (i.e. the level of budgetary security set forth as the target of equalization).
In accordance with the new principles of distribution of FFSR financial resources, the equalization of budgetary security is carried out in two stages. At the first stage, the grants provided from FFSR are distributed among the RF subjects, where prior to the distribution of FFSR financial resources the level of rated budgetary security is at or below the criterion of equalization of budgetary security, i.e. 60 per cent of the average national per capita level of rated budgetary security.
At the same stage of equalization regions receive 85 per cent of the resources necessary to raise the level of their rated budgetary security to 60 per cent of the average national level of rated budgetary security. The gap between the actual value of the indicator and the level of 60 per cent of budgetary security is not covered in full, only up to 85 per cent. This measure is envisaged so that the regions with higher levels of budgetary security prior to the equalization could maintain their advantage after receiving grants from FFSR. The use of the 0.85 coefficient in the course of raising the actual level of rated budgetary security of regions up to 60 per cent of the average national level in fact renders the effect from such an equalization identical to the prorate equalization. According to the estimates presented by the RF Finance Ministry, this amount should be significantly below the amount of FFSR: for instance, in 2005 it should make Rub. 83.7 billion (or 44 per cent of the total amount of FFSR).
At the second stage, there is distributed the FFSR balance. The remaining funds are distributed in proportion to the divergence of the level of the rated budgetary security of the region adjusted for the amounts of transfers received at the first stage of equalization; however, the criterion of equalization (the level, towards which the amount of transfer is oriented) is the average level of budgetary security. Therefore, the balance of FFSR financial resources is distributed in proportion with the divergence of the rated per capita budgetary security of RF subjects registered after the first stage of equalization from the average national level of budgetary security.
In the framework of budget estimates for year 2005, 44 per cent of the total amount of FFSR was distributed at the first stage and 56 per cent - at the second stage of equalization.
Thus, in the period prior to 2005, the process of interbudgetary equalization was carried out as a process outlined in Fig. 15, where there are shown the level of per capita average rated budgetary security prior to the allocation of the transfer, after the first stage -proportional equalization (distribution of the first portion of FFSR equal to 80 per cent of
12 In 2004, 18 regions did not receive transfers from FFSR: the Lipetsk and Yaroslavl oblasts, the city of Moscow, the Republic of Komi, the Vologda and Leningrad oblasts, the city of St. Petersburg, the Nenets autonomous okrug, the Republic of Bashkortostan, the Republic of Tatarstan, the Udmurt Republic, the Orenburg oblast, the Perm, Samara, and Tyumen oblasts, the Khanty Mansi and Yamal Nenets autonomous okrugs, the Krasnoyarsk krai.
the amount of the Fund), and after the second stage after the raising of the level of budgetary security of the most poor regions to a common level (distribution of the second portion of FFSR equal to 20 per cent of the amount of the Fund).
3
0
01 (/>
E? ro 01 cn ■c
3
m
Average national level 3^^^^
1 2
__, .—■
Heavily subsidized regions
Subsidized regions
Non-subsidized regions
Budgetary security prior to equalization ■Budgetary security after proportional equalization ■Budgetary security after the raising up to the common level
Fig. 15. Distribution of FFSR financial resources in accordance with the methods used prior to 2005
As Fig. 15 demonstrates, certain regions being in the interval of per capita rated budgetary security between points 1 and 2 are at the equal level of budgetary security after equalization in spite of the fact that prior to equalization these levels have significantly differed. In 2004, there were 33 such regions13. Therefore, it may be surmised that in accordance with the formula of distribution of transfers used prior to 2005, there were created specific negative incentives for a rather large number of regions, since at the given low level of tax potential the amount of financial aid granted to such regions was too large. However, the methods applied since 2005 are free of this flaw.
In Fig. 16, there is schematically presented the process of equalization of the per capita budgetary security carried out in accordance with two criteria applied in the Methodology of FFSR distribution for year 2005.
13 The Bryansk, Ivanovo, Tambov, Pskov oblasts, the Republic of Adygeya, the Republic of Dagestan, the Ingush Republic, the Kabarda Balkar Republic, the Republic of Kalmykiya, the Karach Cherkessk Republic, the Republic of North Osetiya -Alaniya, the Chechen Republic, the Republic of Mari El, the Republic of Mordoviya, the Chuvash Republic, the Penza oblast, the Komi Permyak autonomous okrug, the Kurgan oblast, the Republic of Altai, the Republic of Buryatiya, the Republic of Tyva, the Altai krai, the Chita oblast, the Aginsk Buryat, Taimyr (Dolgan Nenets), Ust Orda Buryat, Evenk autonomous okrugs, the Kamchatka and Magadan oblasts, the Evreiskaya autonomous oblast, the Koryak and Chukotka autonomous okrugs.
Subsidized Non-
regions subsidized
regions
Budgetary security prior to equalization
Budgetary security after equalization in accordance with the first Budgetary security after equalization in accordance with the sec ....... First criterion of equalization - 60 %
-----Second criterion of equalization - 100 %
Fig. 16. The principle of interbudgetary equalization used in the framework of the methods of FFSR distribution for year 2005
The data presented in Fig. 16 demonstrates that according to the new methods of distribution of grants for equalization of the level of budgetary security regions retain more incentives to make fiscal efforts. This result is achieved due to the fact that subjects of the Russian Federation with higher levels of rated budgetary security observed prior to the distribution of transfers also maintain their advantages after the distribution of FFSR financial resources.
4. In the course of elaboration of the Methodology of distribution of the financial resources of the Fund of Financial Support of Regions for year 2005, there was reduced the number of industries used for the calculation of the Tax Potential Index (TPI) of regions. In particular, there were excluded such industries, the major share of taxes due to regional budgets from which is formed at the expense of indirect taxes (excises). The formula used for calculation of the tax potential index was also simplified (there were removed additional adjustment coefficients as concerns the sectoral structure of chemistry and petrochemistry, the sectoral structure of lumber, woodworking, and pulp and paper industry, the sectoral structure of light industry).
5. Alongside with the reduction of the number of parameters used in the framework of evaluation of the tax potential index, there was also reduced the number of parameters on the basis of which there is carried out the calculation of the Budgetary Expenditure Index (BEI). Thus, since 2005 the methods of evaluation of the budgetary expenditure index are based exclusively on the factors determining the amount of expenditures of subnational budgets on the whole: these factors include the level of wages and salaries in the region, the level of prices of housing and public utilities services, and the level of consumer prices in the RF subject.
It should be noted that the discussion with respect to the simplification of the Methods of distribution of FFSR financial resources as concerns the evaluation of the tax potential index and the budgetary expenditure index has been led for a rather long time - since the moment of the introduction of the new Methods of distribution of FFSR financial re-
sources. Initially, the complexity of the formula of evaluation of the budgetary expenditure index has been determined by the large amounts of unfunded mandates, which the federal legislation devolved on the regional and local budgets. As a result, the methods of calculation of BEI took into account the interregional differentiation of budgetary expenditures across each type of regional budgetary expenditures regulated by the federal legislation. After the enactment of the new Budget Code and federal law No. 122-FZ, the amount of unfunded federal mandates was significantly reduced, what permitted to substantially simplify the methods of evaluation of the budgetary expenditure index.
Somewhat different factors facilitated complication of the methods of evaluation of the tax potential index. In the course of introduction of the new Methods of distribution of FFSR financial resources the evaluation of the tax potential index has been carried out in accordance with a relatively simple method - by the way of neutralization the average national share of tax withdrawals across major sectors forming added value of the subjects of the Russian Federation. At the same time, the distortions observed in the distribution of financial aid caused by the switching to the new methodology were compensated for by the introduction of a number of limitations on the marginal size of deviations of the amounts of grants calculated in accordance with the new methods from the actual amount of grants received over the preceding year. Later, after these limitations were removed on the initiative of certain regions, the methods were extended by the way of introduction of adjustment coefficients, which took into account the specifics of the tax burden on individual industries. It should be noted that in many cases the introduction of such coefficients either had no significant impact on the amounts of financial aid distributed in accordance with the methodology, or the respective impact was limited to several regions. The cessation of the use of such coefficients permitted to simplify the methods again by returning to its original composition.
6. Starting from year 2005, it is planned to carry out the distribution of FFSR financial resources proceeding from the new census data prepared by Rosstat, this will have a significant impact on the distribution of FFSR financial resources among regions.
It should be noted that the very fact of approval of the Methods of distribution of financial resources of the Fund of Financial Support of Regions by the Resolution of the Government and the changes made in these methods in comparison with the principles applied throughout the preceding years may be evaluated in a positive way. No doubt, in the case the Russian Federation continued to maintain the system permitting to link preferences shown by regional voters and the decisions taken by the regional authorities in the tax and budgetary sphere, the respective changes would result in the creation of favorable fiscal incentives for subnational authorities. The effects of the application of the new methods in the present situation will be revealed by the results of 2005 and 2006.
2.3.4. Social policy: changes in the division of respective powers among the federal, regional, and local authorities. Monetization of social benefits
The approval of the legislation aimed at the liquidation of unfunded mandates (the so called monetization of social benefits) in 2004 was closely related to the development of interbudgetary relations and had a wide public response. Earlier, there had been made amendments to 155 laws currently in force, which contained provisions about social benefits. Besides, there was abolished law No. 41, which declared social benefits never financed in practice.
Since January 1, 2005, cash payments should have substituted the right of free use of urban and suburban transport services, free medicines, and free medical treatment at
health resorts. Initially, the RF Finance Ministry has proposed to substitute more than 10 social benefits with cash payments.
All recipients of social benefits were classified in the federal and regional groups. The category of regional recipients of social benefits was primarily composed of labor veterans, workers of the home front, and victims of political repressions. As concerns these categories of citizens, the issue of provision of social benefits and substitution thereof with cash payments should be settled at the regional level. However, the Fund of Co-financing of Social Expenditures in the framework of the federal budget for year 2005 had available significant financial resources aimed at support of regions with respect to their obligations to recipients of social benefits. Thus, it is planned to allocate Rub. 12.7 billion, or 55 per cent of the total amount of the Fund of Co-financing of Social Expenditures, for the social support of these categories of citizens. At the same time, the amount of the fund was sharply raised in comparison with the level observed in 2004 - from Rub. 6 billion to Rub. 23 billion.
In theory, subjects of the Russian Federation had enough time to evaluated the changes and determine if they maintain social benefits and in what forms.
However, in spite of the measures taking for these purposes, there may be predicted certain difficulties related to the monetization of social benefits exactly at the regional level.
First, the very fact of classification of the recipients of social benefits in the federal and regional groups contradicts the theoretical principles of efficient distribution of expenditures powers between the levels of state authorities in the sphere of social policy, since the level of social support of the population would be inevitably higher in more well to do regions, what could result in the putting in place of different barriers preventing the movement of citizens between regions. There arises a situation, where the people having equal rights and merits with respect to the Federation (for instance, workers of the home front) will most probably receive different compensations depending on their places of residence.
Second, the classification of the recipients of social benefits in the regional and federal groups diminishes the possibilities of the federal center as concerns the control over the situation at the expense of financial resources of the federal budget. Thus, the most important financial tool used for maintenance of social tranquility - indexation of pensions and social benefits - can not completely remove social tensions, since in certain regions citizens may need no such indexation, and in other regions this indexation would be insufficient to pay for abolished or underfinanced social benefits.
Third, due to the fact that there are sufficient grounds for the emergence of the problem of soft budgetary constraints discussed above (i.e. regional authorities have good reasons to believe that the federal authorities will distribute additional financial resources throughout the year), regional authorities would have incentives to understate the level of financing of the abolished social benefits in order to receive the respective resources from the federal budget.
Fourth, the process of approval of the respective legislative acts at the level of RF subjects as concerns the problems being in the jurisdiction of regions was the prerogative of the regional authorities and should not be subject to control at the federal level; therefore many regions had no time, could not, or did not want to approve respective laws by the beginning of the new financial year. Meanwhile, the population links the flaws of the new system of social protection with the legislation approved by the federal authorities.
2.3.5. Switching to the new procedures governing the election of the heads of executive authorities of RF subjects
On December 15, 2004, there were published the amendments to the federal law "On the general principles of organization of legislative (representative) and executive authorities of RF subjects." The amended law contained the decision about the actual abolishment of the electivity of the heads of executive authorities of RF subjects. According to the new scheme, the direct election of the heads of regional executive authorities is abolished and substituted by the appointment of the candidate by the legislative authorities of RF subjects. The candidate for the office of the head of the regional executive authorities should be nominated by the RF President. The new procedures governing the election of the heads of RF subjects will no doubt have an impact on the state of interbudgetary relations and subnational finances.
On the one hand, the motives of the federal authorities facilitating the transition to the new procedures envisaging the appointment of the heads of executive authorities of RF subjects are clear. Alongside with the purely political reasons, including the toughening of administrative control over the economic policies pursued by regional authorities, enhancement of controllability of the country, transfer of a number of functions performed at present by territorial agencies of the federal authorities under control of appointed officials. It may be surmised that these decisions resulted from the experiment of appointment of plenipotentiary representatives of the President in federal okrugs, although the positive results of this experiment turned out to be more modest than initially expected. The results of the activities of the Presidential representatives have demonstrated that the only important outcome of their work was the harmonization of regional legislations with the federal legislation. However, it should be noted that this result could be well achieved by the use of available institutions of federal authorities (primarily, procurators' offices). In the regions of the Northern Caucasus, the office of Presidential representative could be well justified by objective circumstances; however, first, it does not provide the grounds for the establishment of such offices for other regions (federal okrugs), and, second, as the practice revealed, the efficiency of the measures taken by the plenipotentiary representative of the President primarily depends on the personality of the official taking this post.
On the other hand, the authors believe that the negative long term consequences of these decisions are as clear as the national benefits of the abolishment of elections of governors are illusory. Thus, alongside with the purely political reasons the major factors behind the switching to the actual appointment of the heads of regional executive authorities were the creation of possibilities for optimization of the structure of regional executive authorities, liquidation of overlapping functions as concerns the territorial agencies of the federal executive authorities, the executive authorities of RF subjects, and Presidential representatives. It should be noted that the solution of all problems discussed above could be achieved by the improvement of the federal legislation as concerns the division of powers and enhancement of efficiency of the structures of federal executive authorities per se.
Besides, there may be listed the following flaws of the decision about the appointment of the heads of regional executive authorities in a long term outlook.
First, one of the main reasons of the efficiency of the federative state structure is decentralization of responsibility for the decisions taken by the authorities including the decisions in the sphere of tax and budgetary policies. A decentralized system of power implies the accountability of the elected authorities to their voters; it should be noted that the higher is the level of decentralization, the shorter is the distance dividing the authorities and the voters. In the situation of an efficient division of powers, decentralized systems re-
suit in more efficient functioning of the public sector than centralized structures14. At the same time, in the situation, where governors are appointed and legislative assemblies may be dissolved, regional authorities will reorient towards the federal authorities as concerns the decision making process, what will result in the removal of many advantages of centralized systems. It may be argued that the responsibility of regional authorities to their voters was not a determining factor in the process of decision making at the regional level; however, in this case the efforts of federal legislators and the resources of the federal authorities at large should be directed to putting in place the mechanisms aimed at the ensuring such responsibility. Thus, one of the possible mechanisms of responsibility of governors could become the procedure of recall of the top local executive officials initiated either by the federal authorities (as represented by the RF President), or the population (by referendum), or the local Legislative Assembly (vote of no confidence) on the condition that such a decision is clearly defined in the legislative terms and there is a closed list of the grounds, on which the head of a region can be dismissed from the office. For instance, the Institute of the Economy in Transition has many times proposed to introduce such an efficient mechanism of control of conscientiousness of the financial policies pursued by regional authorities as the institution of the external financial management, which has been partially stipulated in the new budgetary legislation (see below).
Second, the creation of a new system of interbudgetary relations, division of powers between the levels of state authority, approval of other decisions in the sphere of the reform of the budgetary system have been based on the prerequisite that regional authorities should be independent within the limits of their jurisdictions. Changes in the system of incentives and responsibilities of regional authorities will result not only in the fact that the tools and institutions introduced over the last few years in the practices of interbudgetary relations at a great cost may turn out partially inefficient, but to the search for new mechanisms of interbudgetary regulation based on coercion and hierarchical control. The latter can only enhance the trends towards centralization and manifestations of negative effects of the new system.
Third, centralization of responsibility may result in a slowdown of already slow pace of the reform of the economy and the budgetary sphere. It may be surmised that being limited by responsibility to the President, the appointed governors will less actively assume the risks related to the implementation of too often unpopular reforms. At the same time, the voters will believe that the President, who appointed the governor, should bear responsibility for the decisions taken at the regional level; therefore the President will also shun the active support of risky decisions taken by the appointed official. The first outcomes of the monetization of social benefits at the regional level have demonstrated that already at present voters are inclined to blame not regional, but federal authorities for the failures and negative effects of the reform.
As a result, there may be drawn the conclusion that the last political initiatives advanced by the federal center in the sphere of regional policies may have an ambiguous impact on the state of the economy and budgetary sphere at the regional and local levels of authorities in the medium and long term outlook. The new system of state authorities may prove to be less efficient than the one, which has existed over the last few years. In any case, it may be surmised that political and economic costs of improvement of this system could be significantly below the possible costs related to the functioning of the new system.
14 See, for instance, Buchanan J. M., "Federalism and Fiscal Equity" // American Economic Review. - Vol. 40 (4), September, 1950, pp. 583-599, Oates W. E., Fiscal Federalism. - New-York: Harcourt Brace Jovanovich, 1972.
2.3.6. Amendments to the budgetary and tax legislation affecting the state of interbudgetary relations
The changes occurring in the sphere of the federal legislation in 2004 and aimed at the regulation of interbudgetary relations and subnational finances turned out to be so significant that it is necessary to dwell on the analysis of these legislative acts, which have set new basic principles of interbudgetary relations in Russia for a medium term outlook.
Below, there is presented a review of federal law No. 120-FZ of August 20, 2004, "On amendments to the Budget Code of the Russian Federation as concerns the regulation of interbudgetary relations." The new version of the RF Budget Code, which implements the principles and stipulations formulated in such federal laws earlier adopted in the framework of the reform of federative relations and local government as federal law No. 95-FZ of July 4, 2003, "On amendments to the federal law "On the general principles of organization of legislative (representative) and executive authorities of RF subjects" and No. 131-FZ of October 6, 2003, "On the general principles of organization of local government in the Russian Federation" contains the detailed regulation of the financial aspect of relations among all levels of the budgetary system of the Russian Federation15. Therefore, upon the adoption of law No. 120-FZ the legislative formation of the new system of interbudgetary relations in Russia has been completed.
Law No. 120-FZ envisages that the following amendments should be made in the RF Budget Code along the following key avenues:
• more precise definition of the budgetary structure and general principles of organization of the budgetary system of the Russian Federation;
• assignment of sources of revenues to different levels of the budgetary system of the Russian Federation;
• setting up of the procedures governing the assignment of expenditure obligations to different levels of the budgetary system of the Russian Federation;
• regulation of provision of interbudgetary transfers;
• setting up of the procedures governing the exercise of fiscal powers vested with state authorities of RF subjects and local governments in the case of introduction of a provisional financial administration;
• more precise definition of procedures governing the cash servicing of the execution of the budgets within the Russian budgetary system.
Below, there is presented a detailed description of changes introduced by law No. 95-FZ of July 29, 2004, "On the amendments to Sections 1 and 2 of the Budget Code of the Russian Federation and invalidation of certain legislative acts (provisions of legislative acts) of the Russian Federation on taxes and fees." The key amendments to the RF Tax Code are directly related to the amendments made to the RF Budget Code as concerns the assignment of tax revenues to the budgets of different levels and in fact reproduce the
15 Due to the approval of law No. 95-FZ, federal law No. 184-FZ of October 6, 1999, "On the general principles of organization of legislative (representative) and executive authorities of RF subjects" was in fact presented in its new version, while federal law No. 119-FZ of June 24, 1999, "On the principles and procedures of the division of jurisdiction and powers among the authorities of the Russian Federation and the authorities of RF subjects" was abolished.
Since January 1, 2006, (i.e. from the moment of enactment of the key provisions of federal law No. 131-FZ) federal law No. 154-FZ of August 28, 1995, "On the general principles of organization of local government in the Russian Federation" and federal law No. 126-FZ of September 25, 1997, "On the financial principles of local government in the Russian Federation" become invalid. Therefore, during the transitional period from October of 2003 through January of 2006 two legislative acts will be simultaneously in force in the sphere of local government: old federal law No. 154-FZ of 1995 and new federal law No. 131-FZ. Both these laws regulate the same sphere of subjects. In spite of the fact that at present only a small part of provisions of law No. 131-FZ are in force, the public authorities of all levels will have to turn to the provisions of law No. 131-FZ in order to bring the legislation of the Russian Federation (federal and regional), as well as regulatory acts of local governments in conformity with this law.
structure of assignment of tax revenues to different budgets in the framework of tax legislation. At the same time, law No. 95-FZ introduces a number of other amendments to the RF Tax Code reviewed in detail in the respective part of this section.
Federal law No. 120-FZ "On amendments to the Budget Code of the Russian Federation as concerns the regulation of interbudgetary relations"
More precise definition of the budgetary structure and general principles of organization of the budgetary system of the Russian Federation
The new version of article 10 of the RF Budget Code defining the structure of the RF budgetary system envisages the division of local budges in the following components:
• budgets of municipal districts;
• budgets of town okrugs;
• budgets of intra-city municipal entities of the federal cities of Moscow and St. Petersburg;
• budgets of urban and rural settlements16.
At the same time, the law more precisely defines such terms as "consolidated budget," "local budget," "budget of the RF subject," and "federal budget" (articles 14 - 16 of the RF Budget Code). The preceding version of the RF Budget Code the budgets were defined as the forms of organization and expenditure of financial resources earmarked for ensuring of objectives and functions assigned to the jurisdiction of different levels of authority. However, the existing division of jurisdictions among the budgets of different levels did not permit to clearly and unambiguously determine the avenues of expenditure of budgetary funds. The new approach to the organization of the RF budgetary system unambiguously linked the definitions of budgets with the concept of expenditure obligations17. The new versions of articles 14 - 16 of the RF Budget Code define budgets as the forms of organization and expenditure of financial resources earmarked for the fulfillment of expenditure obligations of the respective budgetary level (Russian Federation, RF subjects, and municipal entities) within one financial year.
The consolidated budget of the Russian Federation comprises the federal budget and the budgets of other levels of the budgetary system of the Russian Federation without taking into account interbudgetary transfers among these budgets with the exception of budgets of the state extra-budgetary funds and territorial state extra-budgetary funds (article 16 of the RF Budget Code)18.
Among the innovations related to the definition of the concept of "budget" there should be noted the provision of article 14 of the RF Budget Code, which specifically prohibits local governments to use any forms of organization and expenditure of financial resources for the fulfillment of their expenditure obligations other than local budgets. However, the respective provisions concerning the federal budget and the budgets of RF subjects are less strict. In accordance with articles 15 and 16 of the RF Budget Code, the
16 This regulation became necessary, since law No. 131-FZ set forth the new territorial organization of local government consisting of municipal districts (town okrugs) (the "upper" level of local government) and urban and rural settlements (the "bottom" level of local government).
17 For details on the new division of expenditure powers between the levels of authorities and the term "expenditure obligation" see below.
18 Similarly, the consolidated budget of the RF subject is formed by the budget of the RF subject and the budgets of municipal entities in its composition (without taking into account the interbudgetary transfers between these budgets) (article 15 of the RF Budget Code). The consolidated budget of the municipal district is formed by the district budget and the budgets of urban and rural settlements (without taking into account the interbudgetary transfers between these budgets) (article 14 of the RF Budget Code).
state authorities of RF subjects should have the right to use other forms of organization and expenditure of their financial resources for the fulfillment of their expenditure obligations being in compliance with the RF Budget Code, while the federal authorities should have the right to use other forms of organization and expenditure of their financial resources in accordance with other federal laws. In other words, the RF Budget Code contains a direct prohibition to create any extra-budgetary funds at the local level; however, it permits the existence of other than budgets forms of expenditure of public financial resources at the level of RF subjects (somewhat limited), and at the level of the Russian Federation.
Assignment of tax revenues to different levels of the budgetary system of the Russian Federation
The following group of changes and amendments introduced to the RF Budget Code by law No. 120-FZ concerns the fixation of assignment of the sources of revenues to the different levels of the RF budgetary system (article 6 of the RF Budget Code).
The Code more precisely defines the term "own revenues of budgets," which, in accordance with the new version of article 47 of the RF Budget Code, include tax and nontax revenues, as well as the revenues obtained as free and irrevocable transfers with the exception of subventions granted from the Federal Compensatory Fund and regional compensatory funds19. Therefore, at present "own revenues of budgets" include all types of revenues with the exception of subventions transferred to the lower level budgets for the execution of "delegated" powers, i.e. the powers execution (administration) of which is devolved from the superior level of authority to the lower level together with the transfer of the respective financial resources (subventions).
Until recently (prior to the amendments made to article 6 of the RF Budget Code by law No. 120-FZ), the key concept of distribution of revenues among the levels of the Russian budgetary system was "regulatory revenues," i.e. federal and regional taxes and other payments subject to the standard rates of assignment to regional and local budgets set forth each year for not less than 3 years20. In spite of the fact that tax revenues of regional and local budgets were also financed from such sources of revenues as own taxes (regional and local), the overwhelming majority of tax revenues of the budgets of RF subjects and municipal entities were defined as regulatory revenues, i.e. the terms of assignment of such taxes and the regulation of setting of different elements of taxation were controlled by either federal authorities or authorities of RF subjects. Therefore, subnational budgets lacked significant sources of revenues formed at the expense of own taxes and non-tax payments. On the one hand, this was a very negative circumstance, since in this situation the fiscal autonomy of regional and local authorities was very limited, what had negative impact on the incentives for pursuit of efficient budgetary policies. On the other hand, this situation was determined by objective factors and it may be surmised that in that situation a significant enhancement of fiscal autonomy of regional and local authorities was impossible.
A principal innovation contained in article 6 of the RF Budget Code is the assignment of tax revenues to budgets of all levels on a long term basis and the rejection of the splitting of revenues generated by regional and local taxes among the budgets of different level via federal laws. All major taxes (VAT, income tax on individuals, profit tax on organizations, and excises) are retained as federal taxes, however, in contradistinction to the previous
19 Financial aid in the form of grants and subsidies was not included in the composition of own revenues of budgets in the previous version of item 3 of article 47 of the RF Budget Code.
20 Article 48 of the RF Budget Code, the version not amended by law No. 120-FZ.
status of regulatory tax revenues, in accordance with the new procedure the rates of assignment of such federal taxes are not subject to annual changes and are fixed directly in the RF Budget Code (see article 50, p. 2, article 56, p. 2, article 61, p. 2, article 61.1 p. 2 and article 61.2 p. 2) (see Table 11). At the same time, RF subjects received the powers concerning the setting of the rates of assignment of own (regional) taxes and other tax revenues due to regional budgets (including revenues generated by federal taxes), the budgets of municipal districts and settlements21. The only requirement set forth by the federal legislation in this case is that a law of the RF subject set uniform (for all municipal entities of the same type) rates of assignment for an indefinite period of time (the setting of these norms by laws of RF subjects for a limited period of time is prohibited by item 1 of article 58 of the RF Budget Code). Similar requirements are set with respect to the procedures governing the transfer of tax revenues of municipal districts to the budgets of settlements (article 63 of the RF Budget Code).
These requirements do not concern only the income tax on individuals, since the additional rates of assignment of this tax (in contradistinction to the minimal rates of assignment of this tax set forth by the RF Budget Code22) can be differentiated and set forth by laws of RF subjects for a limited period of time (item 2 of article 58 of the RF Budget Code). Regional authorities are also granted the right to take decisions with respect of the additional rates of assignment of the revenues generated by the income tax on individuals choosing between uniform rates (set for indefinite period of time) and additional rates (set for the respective financial year) of assignment of this tax.
In the case the RF subject takes decision to transfer tax revenues generated by this tax (the income tax on individuals) to local budgets in accordance with uniform rates, this transfer should be carried out in accordance with general rules of transfer of tax revenues due to regional budgets (i.e. on the long term basis). In the case there is taken the decision to transfer tax revenues generated by this tax to local budgets in accordance with additional rates (i.e. regulated in the course of the annual budgetary process and set forth in the course of approval of the law on the budget), the RF subject should comply with the requirement about calculation of these revenues in the framework of distribution of grants from the regional fund of financial support of settlements and respective portion of grants from the regional fund of financial support of municipal districts (town okrugs) (p. 2, article 58 of the RF Budget Code). In this case, additional rates of assignment of the income tax on individuals are defined as substitution for the grants provided from the regional fund of financial support of settlements and the regional fund of financial support of municipal districts (town okrugs) (articles 137 and 138 of the RF Budget Code). At the same time, notwithstanding the choice of the procedures governing the transfer of this type of revenues the RF subject should transfer to local budgets at least 10 per cent of the tax revenues of its consolidated budget generated by the said tax in addition to the minimal rates of assignment of the revenues from this tax (item 3, article 58 of the RF Budget Code).
The powers of state authorities of RF subjects with respect to the setting of additional rates of assignment of the income tax on individuals with the budgets of settlements may be delegated by the law of the RF subject to the representative authorities of municipal districts (p. 2, item 2 of article 58 of the RF Budget Code). In this case (if the additional rates of assignment of the income tax on individuals substitute grants provided from the regional
21 In accordance with item 1, article 58 of the RF Budget Code, the shares of federal and regional taxes and fees due to regional budgets, which should be transferred to the budgets of town okrugs, are determined as the sum of the rates set forth for settlements and municipal districts of the respective RF subject.
22 See p. 4, item 2, article 56, p. 2, item 2, article 61, p. 2, item 2, article 61.1, p. 2, item 2, article 61.2 of the RF Budget Code (version in accordance with law No. 120-FZ).
fund of financial support of settlements), according to item 6 of article 137 of the RF Budget Code the said rates should be approved by the budget of the municipal district.
As concerns the regulation of non-tax revenues, the new version of item 1 of article 51 of the RF Budget Code sets forth the extended list of non-tax revenues of the federal budget (with the exception of the revenues derived from utilization of property in state ownership, revenues from paid services provided by budgetary institutions, and a part of profits of unitary enterprises established by the Russian Federation), which includes:
• license fees for production and turnover of ethyl alcohol, alcohol and alcohol containing products at the 100 per cent rate;
• other license fees at the 100 per cent rate;
• customs duties and customs charges at the 100 per cent rate;
• fees for utilization of the forestry fund as concerns the minimal rates of payment for not felled lumber at the 100 per cent rate;
• payments for the re-registration of forest lands as non-forest lands and re-registration of forest lands as lands of other categories at the 100 per cent rate;
• payments for the use of water biological resources in accordance with intergovernmental agreements at the 100 per cent rate;
• fees for negative impact on the environment at the 20 per cent rate;
• consular fees at the 100 per cent rate;
• patent fees at the 100 per cent rate;
• payments for information about registered rights for real estate and transactions involving such real estate at the 100 per cent rate.
In accordance with the new version of article 57 of the RF Budget Code, non-tax revenues of RF subjects (with the exception of those already envisaged in articles 41-43, 46, and 57 of the RF Budget Code) should be also formed at the expense of:
• fees for negative impact on the environment at the 40 per cent rate;
• fees for utilization of the forestry fund as concerns the excess of the minimum rates of payment for not felled lumber at the 100 per cent rate23.
In accordance with the new version of article 62 of the RF Budget Code, the fees related to negative impacts on the environment are due to the budgets of municipal districts and town okrugs at the rate of 40 per cent. Until the completion of singling out of state owned lands, the revenues generated from sales and leasing of state owned land plots suitable for residential housing construction and located within the limits of settlements and town okrugs are due to the budgets of such settlements and town okrugs at the rate of 100 per cent. Until the completion of singling out of state owned lands, the revenues generated from sales and leasing of state owned land plots suitable for residential housing construction and located on inter-settlement lands are due to the budgets of municipal districts at the rate of 100 per cent.
As concerns the regulation of budgetary revenues, federal law No. 120-FZ entered into force on January 1, 2005, with the exception of certain provisions. In particular, the changes in the rates of assignment of federal tax revenues to local budgets shall come into force on January 1, 2006 (in 2005 the rates of assignment of the tax to local budgets will be set forth by the laws on budgets of RF subjects).
It appears that the new assignment of the sources of revenues to the budgets of different levels envisaged in federal laws No. 95-FZ and No. 131-FZ, which was more precisely set in Federal law No. 120-FZ, to a significantly greater degree ensures fiscal inde-
23 80 per cent of the payments for negative influence on the environment should be transferred to the budgets of federal level cities - Moscow and St. Petersburg.
pendence of subnational authorities. In contradistinction to the previously existing practices of annual fixation of the rates of assignment of the revenues from regulatory taxes assigned to regional (local) budgets, fixation of the rates of assignment on the long term basis and the cessation of the practices of setting of the rates of assignment of revenues of local budgets generated by regional taxes by federal laws permit subnational budgets to be sufficiently independent of the decisions taken by superior authorities and increase the predictability of the conditions, under which there function regional and local authorities. At the same time, these laws contain a number of flaws.
Thus, both the Budget and Tax Codes fail to settle the issue concerning self taxation of the citizens, although in accordance with law No. 131-FZ these funds are a source of revenues of local budgets (item 1, article 55).
In accordance with article 56 of law No. 131-FZ, the revenues generated by self taxation of citizens are defined as nonrecurring payments made by citizens for the settlement of concrete problems of local importance. The issues of the jurisdiction over and utilization of such payments should be settled at local referendums or meetings of citizens. The amount of payments is set in absolute terms for each resident of the municipal entity. First, this definition of self taxation permits to review it as payments of the tax nature (because of their mandatory character), and, second, the revenues generated by such payments should be of targeted nature (since these funds should be used for the settlement of local problems). However, this source of revenues of local budgets is not properly fixed both in the Tax and Budget Codes.
In accordance with the Budget Code, these funds could be defined only as free and irrevocable transfers of individuals within the composition of own revenues of local budgets; however, the Budget Code fails to regulate the necessity of targeted use of these funds. In principle, the legislation envisages such a form of matching revenues and expenditures as targeted budgetary funds. However, the new version of the RF Budget Code also fails to unambiguously stipulate if such funds can be created in the framework of regional and local budgets24.
In accordance with the new version of article 12 of the RF Tax Code, all federal, regional, and local taxes and charges are set only by the RF Tax Code (item 6). Taking into account the fact that the revenues generated by self taxation of citizens have all indications of tax payments, there arises the question about the lawfulness of introduction of such payments by decisions taken at local referendums or meetings of citizens as it is stipulated in law No. 131-FZ. At the same time, in the case the revenues generated by self taxation of citizens are of voluntary (non-mandatory) nature for all residents of the administrative territorial entity, there arises the question about the efficiency of such source of financing of expenditure obligations of subnational budgets25. Therefore, there may be drawn the following conclusion: either the procedure governing the collection of payments in the framework of self taxation of citizens should be regulated in the legislation in more detail, or this provision of law No. 131-FZ will not work.
24 Article 17 of the RF Budget Code stipulates that targeted budget funds are created in accordance with the RF legislation at the expense of targeted revenues or targeted deductions from concrete types of proceeds and other revenues and should be utilized in accordance with a separate estimate. At the same time, the RF Budget Code contains article 54, which covers revenues of the federal targeted budget funds, while there are no similar articles concerning the revenues of targeted funds of RF subjects and municipal entities.
25 The literature dedicated to the economy of public sector often addresses the well known so called "free rider problem," which prevents the financing of provision of public goods (it should be noted that it is the major function of regional and local authorities) at the expense of voluntary payments.
Table 11
Distribution of tax revenues among the levels of the RF budgetary system in accordance with law No. 120-FZ
Share (in %) due to
Tax
Federal budget
Budgets
of RF subjects
Budgets of municipal districts
Budgets of settlements
Budgets of town okrugs
I. Federal taxes and fees
Tax on profits of organizations - at the rates set for the federal budget
Tax on profits of organizations - at the rates set for the budgets of RF subjects
Tax on profits of organizations (as concerns the profits of foreign organizations not operating in the Russian Federation via their permanent representations and as concerns the profits received in the form of dividends and interest on state and municipal securities) Income tax on individuals Added value tax
Excises on ethyl alcohol produced from food raw materials
and alcohol containing products
Excises on ethyl alcohol produced from any type of raw
materials with the exception of food raw materials
Excises on alcohol products
Excises on beer
Excises on tobacco products
Excises on motor gasoline, diesel fuel, motor oils for diesel and carburetor (injector) motors Excises on cars and motorcycles
Excises on excisable goods (products) imported to the RF territory
Mineral extraction tax as concerns hydrocarbon mineral resources (flammable natural gas) Mineral extraction tax as concerns hydrocarbon mineral resources (with the exception of flammable natural gas) Mineral extraction tax (with the exception of hydrocarbon mineral resources and widespread mineral resources) Mineral extraction tax as concerns widespread mineral resources
Mineral extraction tax as concerns the extraction of mineral resources on the continental shelf of the Russian Federation, within the exclusive economic zone of the Russian Federation, outside of the territory of the Russian Federation
Water tax
Gift and inheritance tax
Fees for the use of water biological resources (excluding internal water objects)
Fees for the use of water biological resources (as concerns
internal water objects)
Fees for the use of fauna resources
Single social tax
Government duties with the exception of those due to the budgets of RF subjects and local budgets Government duties due to the budgets of RF subjects in accordance with article 56 of the RF Budget Code (version of law No. 120-FZ)
Government duties due to the budgets of municipal districts and town okrugs in accordance with articles 61.1 and 61.2 of the RF Budget Code (version of law No. 120-FZ)
II. Regional taxes* Tax on gambling Transport tax
Tax on property of organizations
100
100
100 50
100
100 40 100 100
100
95
40
100
100
70 100
100 100
100
70 50
100 100
60
20
10
30
5 60 100
100
30
100 100
100
100
100 100 100
Share (in %) due to
Tax
Federal budget
Budgets
of RF subjects
Budgets of municipal districts
Budgets Budgets of set- of town tlements okrugs
III. Local taxes
Tax on property of individuals
Tax on property of individuals collected in inter-settlement
territories
Land tax
Land tax collected in inter-settlement territories
IV. Taxes envisaged in the framework of special tax treatments
Single tax collected in relation to the application of the simplified taxation system **
Single tax on imputed income for certain types of activities *** Single agricultural tax ****
Tax on profit of organizations collected in the framework of production sharing agreements concluded prior to the enactment of federal law No. 225-FZ of December 30, 1995, "On production sharing agreements" not envisaging special rates of this tax due to the federal budget and budgets of RF subjects
Regular mineral extraction payments (royalties) collected in the framework of production sharing agreements concerning hydrocarbon raw materials (flammable natural gas) Regular mineral extraction payments (royalties) collected in the framework of production sharing agreements concerning hydrocarbon raw materials (with the exception of flammable natural gas)
Regular mineral extraction payments (royalties) as concerns the extraction of mineral resources on the continental shelf of the Russian Federation, within the exclusive economic zone of the Russian Federation, outside of the territory of the Russian_
20
100
95
100
90 30
80
100 100
90 30
100
100
100
100
0
30
90 60
* In accordance with item 4 of article 56 of the RF Budget Code (as amended by law No. 120-FZ), tax revenues generated by regional taxes set forth by the authorities of a krai (oblast), which includes an autonomous okrug are due to the budget of the krai (oblast). Tax revenues generated by regional taxes set forth by the authorities of an autonomous okrug are due to the budget of autonomous okrug. In the case there are no other arrangements set forth in an agreement between the state authorities of a krai (oblast), which includes an autonomous okrug, and the state authorities of the respective autonomous okrug, tax revenues generated by federal taxes and fees due to the budgets of RF subjects should be transferred to the budget of krai (oblast).
** In accordance with item 1.1 of article 146 of the RF Budget Code (as amended by law No. 120-FZ), the tax revenues generated by the single tax collected in relation to the application of the simplified taxation system (distributed across the levels of the RF budgetary system by the agencies of the Federal Treasury) should be transferred to the budgets of state extra-budgetary funds as follows: to the budget of the Federal Mandatory Medical Insurance Fund at the rate of 0.5 per cent; to the budgets of territorial Mandatory Medical Insurance Funds at the rate of 4.5 per cent; and the budget of the RF Social Insurance Fund at the rate of 5 per cent.
*** In accordance with article 146 of the RF Budget Code, the tax revenues generated by the single tax on imputed income for certain types of activities (distributed across the levels of the RF budgetary system by the agencies of the Federal Treasury) should be transferred to the budgets of state extra-budgetary funds as follows: to the budget of the Federal Mandatory Medical Insurance Fund at the rate of 0.5 per cent; to the budgets of territorial Mandatory Medical Insurance Funds at the rate of 4.5 per cent; and the budget of the RF Social Insurance Fund at the rate of 5 per cent.
**** In accordance with article 146 of the RF Budget Code, the tax revenues generated by the single agricultural tax (distributed across the levels of the RF budgetary system by the agencies of the Federal Treasury) should be transferred to the budgets of state extra-budgetary funds as follows: to the budget of the Federal Mandatory Medical Insurance Fund at the rate of 0.2 per cent; to the budgets of territorial Mandatory Medical Insurance Funds at the rate of 3.4 per cent; and the budget of the RF Social Insurance Fund at the rate of 6.4r cent. Source: RF Budget Code.
5
Setting of the procedures governing the assignment of expenditure obligations to the different levels of the budgetary system of the Russian Federation
The principle of independence of budgets set forth yet in the preceding version of the RF Budget Code presupposed that the authorities of RF subjects and municipal entities have the right to independently determine the substantive aspects of their expenditures. This principle has limited the possibilities of the federal authorities to directly influence the structure of expenditures of regional and municipal budgets.
At the same time, contrary to this principle there has been in force a significant number of sectoral federal laws envisaging that the expenditures incurred in the course of implementation of these legislative acts should be covered from the own funds of subnational budgets (there were introduced so called unfunded federal expenditure mandates). These laws often regulated not only the objectives and general terms of expenditures made by regions and municipal entities, but the concrete amounts of such expenditures, while envisaging no clear obligations to compensate such expenditures on the part of the Federation.
The problem of unfunded federal mandates was primarily determined by the lack of clear division of expenditure powers among the budgets of different levels. Any federal mandate is a result of such a division of powers among the authorities of different levels, which assigns legislative and executive powers concerning the same jurisdiction to the authorities of different levels. Accordingly, the problem of unfunded federal mandates could not be settled without a revision of the existing division of powers between the state authorities and local governments.
Elaboration of legislative proposals aimed at a more precise definition of the mechanism of distribution of expenditure powers among the tiers of the budgetary system of the Russian Federation and financial security of expenditure powers of budgets of different levels has been carried out since the end of 2002 and was completed by the adoption of federal laws No. 95-FZ and No. 131-FZ. Item 1 of article 26.3 of law No. 95-FZ set forth the closed list of expenditure powers vested with the state authorities of RF subjects as concerns the objects under the shared jurisdiction of the Russian Federation and RF subjects. (Annex 1). Law No. 131-FZ has set forth the exhaustive lists of issues of local importance for different types of municipal entities, including settlements (article 14), municipal districts (article 15), town okrugs (article 16). The exclusive expenditure powers of RF subjects include all powers not specifically assigned to the exclusive jurisdiction of the Russian Federation, shared jurisdiction, and issues of local importance.
At the same time, the issues of the substance of powers vested with the authorities of the Russian Federation, RF subjects, and municipal entities, as well as the issues of responsibility for financing of different obligations were addressed by another legislative act -federal law No. 122-FZ of August 22, 2004, "On amendments to legislative acts of the Russian Federation and invalidation of certain legislative acts of the Russian Federation in relation to the adoption of federal laws 'On amendments to the federal law 'On the general principles of organization of legislative (representative) and executive authorities of RF subjects' and 'On the general principles of organization of local government in the Russian Federation." Therefore, the new version of the RF Budget Code only set forth the financial mechanisms ensuring the exercise of powers by the authorities of different levels and regulated financial relations between the levels of state authorities and local governments as concerns the formation of revenue sources and the issues of financial security of financing of expenditure obligations.
In its turn, federal law No. 120-FZ introduced the new concept of "expenditure obligations" and set forth the new version of article 11 of the RF Budget Code, which addressed the assignment of expenditure obligations to the different levels of the budgetary
system. The expenditure obligations are defined as the obligations of the Russian Federation, RF subject, or municipal entity to transfer certain funds of a respective budget (state extra-budgetary fund, territorial state extra-budgetary fund) to individuals or legal entities, state authorities, local governments, foreign states, international organizations and other subjects of international law in accordance with laws, other regulatory and legal acts, treaties, or agreements (article 6 of the RF Budget Code). The major difference between the new version of article 11 of the RF Budget Code and the preceding version is the absence of the list of expenditures "co-financed" from different budgets26.
In accordance with the new assignment of expenditure powers, articles 14-16 of the RF Budget Code more precisely define the rules of reflection of expenditure obligations in budgets. In accordance with the new procedure, in each budget there should be separately earmarked the funds allocated for the expenditure obligations fulfilled at the expense of own financial resources and the expenditure obligations fulfilled at the expense of subventions from the upper budgetary level.
The general principle of the assignment of jurisdictions set forth by the aforementioned laws is that with respect to the objects under exclusive jurisdiction27 of each level of public authorities all elements of expenditure powers (i.e. the normative and legal regulation, financial security28, and execution of expenditures) are assigned to the respective level of public authorities. At the same time, it is envisaged that each level of authorities should have the right to delegate its powers concerning the execution of certain expenditures on the condition of transfer of necessary financial resources in the form of subventions. The feasibility of such a decision may be determined by higher efficiency of the subnational authorities as concerns the exercise of certain powers.
From the long list of the objects under the shared jurisdiction of the Federation and its subjects set forth by the Constitution, there were singled out the powers of RF subjects as concerns the objects under the shared jurisdiction (item 2, article 26.3 of law No. 131-FZ). All other expenditure powers related to the objects under the shared jurisdiction are deemed to be under the exclusive jurisdiction of the Russian Federation. The resulting groups of powers of the Federation and its subjects are backed by financial resources in accordance with the same procedure as the exclusive powers of the respective level of the budgetary system. In other words, the Russian Federation backs the exercise of its own powers concerning the objects under shared jurisdiction by its financial resources, while regional authorities back the exercise of their powers with respect to the objects under shared jurisdiction.
The differences between the exclusive powers of different levels of the budgetary system and powers relating to the objects under shared jurisdiction lay in the procedures of the normative and legal regulation. In accordance with the new legislation in this sphere there is no division with respect to concrete objects under shared jurisdiction: the federal authorities retain the right to adopt federal laws as concerns each object under shared jurisdiction, while regional authorities are granted the right to adopt their laws on the basis
26 The most recently adopted document was federal law No. 122-FZ of August 22, 2004, "On amendments to legislative acts of the Russian Federation and invalidation of certain legislative acts of the Russian Federation in relation to the adoption of federal laws 'On amendments to the federal law 'On the general principles of organization of legislative (representative) and executive authorities of RF subjects' and 'On the general principles of organization of local government in the Russian Federation." Beside reformulation and setting of a new division of expenditure powers between the levels of authority, this federal law is primarily aimed at the maximal reduction of non-financed expenditure mandates and harmonization of the legal acts setting forth expenditure powers of the budgets of different levels with federal laws No. 95-FZ, No. 131-FZ, and No. 120-FZ.
27 The laws do not contain the term "exclusive jurisdiction"; however, it is used in this section conventionally for greater clarity.
28 "Financial security" is understood as the allocation of own budget revenues (with the exception of the revenues received in the form of targeted transfers from the budget of other level) for financing of expenditures.
and in development of federal laws on the objects under shared jurisdiction. At the same time, the federal laws regulating the issues assigned by item 2 of article 26.3 of law No. 95-FZ to the powers of RF subjects as concerns the objects under shared jurisdiction can not set forth the amounts of expenditures of regional budgets for the exercise of these powers. Besides, the provisions of item 5, article 26.3, stipulate that until the adoption of respective federal laws RF subjects should have the right to issue their laws setting forth their powers (not envisaged by item 2 of article 26.3) as concerns the objects under shared jurisdiction on condition that such laws are in compliance with the federal laws and on condition of financial baking of such powers at the expense of own funds. In other words, until there are no respective federal laws, RF subjects should have the right to independently carry out the normative and legal regulation, provide financial baking, and execute expenditures as concerns these issues.
As concerns the objects under shared jurisdiction, the powers related to the execution of expenditures also may be delegated from one level of the budgetary system to another, and also on condition of financial baking of these powers at expense of subventions. However, there is an exception from this rule: subventions for the exercise of delegated powers may be not granted in the case the powers set forth by federal laws do not envisage the necessity to create new bodies of state authority of the RF subject, state institutions of the RF subject, and state unitary enterprises of the RF subject, as well as additional budgetary investment, payments from the budget of the RF subject to citizens and legal entities, increase in the number of state civil employees on permanent staff of the RF subject, and the number of employees of state institutions of the RF subject.
This provision retains the possibility of existence of unfunded federal mandates in the form of different standards, which do not envisage direct expenditure of funds of lower level budgets. For instance, primary and secondary educations are the object under the shared jurisdiction of the Russian Federation and its subjects. At the same time, the setting of mandatory minimal standards of secondary education (in the form of a mandatory educational program) does not meet the requirements envisaging the obligatory allocation of subventions for the exercise of the delegated powers, however, it results in the formation of expenditure obligations of regional and local budgets. This example, on the one hand, illustrates that the new legislation has not completely freed the Russian budgetary system from unfunded mandates. On the other hand, this example demonstrates that the retention of certain priorities of the national policy (for instance, as concerns the provision of secondary education of certain quality to the population) does not permit to completely reject unfunded mandates without making some amendments to the Constitution currently in force.
As concerns the issues of local importance (defined in articles 14-16 of law No. 131-FZ), the general rule remains the same: normative and legal regulation, financial baking, and execution of expenditures are vested with the local government. At the same time, in accordance with item 3 of article 18 of law No. 131-FZ federal laws and laws of RF subjects "should not contain provisions determining the amounts of expenditures of local budgets" (items 2 - 3, article 18). This provision implies that in the case the Russian Federation and its subjects have the right to carry out normative regulation of the issues of local importance, what, from the point of view of the authors, somewhat contradicts to the concept of the reform. In accordance to item 1, article 18 of law No. 131-FZ, the list of issues of local importance can not be altered in any other way as by amendments made to this law. In other words, RF subjects have no right to expand the lists of issues of local importance. Financial obligations arising in relation to the settlement of the problems of local importance are met at the expense of local budgets (with the exception of subventions granted from other levels of the budgetary system). In the cases and under the procedure set forth
by federal laws and laws of RF subjects, the said obligations may be additionally financed at the expense of financial resources of the federal budget, state extra-budgetary funds, and budgets of RF subjects.
The expenditure powers delegated to local governments are also exercised at the expense of subventions. As concerns three powers of RF subjects relating to the objects under the shared jurisdiction of the Russian Federation and its subjects (organization of educational process in general education schools, provision of targeted housing subsidies to poor citizens, and granting of allowances for public transport fares), there was introduced the regime of "mandatory delegation" of the powers of RF subjects to local governments (subparagraphs 13, 24, 25 of item 2 of article 26.3 envisage that the state authorities of RF subjects should mandatory delegate the execution of expenditures associated with the said powers to local governments and provide the respective financial resources necessary for carrying out these activities).
In order the public authorities could exercise their powers in the framework of the set assignment of expenditure powers, each level of authority is assigned property.
In accordance with article 26.11 of law No. 95-FZ, RF subjects should have the right to own the following types of properties:
• property necessary to the state authorities of RF subjects in order to exercise their powers concerning the objects under their exclusive and shared jurisdictions (i.e. powers indicated in article 26.2 and items 2, 7, and 8 of article 26.3);
• property necessary to the state authorities of RF subjects to exercise certain powers concerning the objects under the jurisdiction of the Russian Federation (i.e. powers indicated in article 26.5);
• property necessary for ensuring of activities of the state authorities of RF subjects, state civil employees of RF subjects, employees of state unitary enterprises of RF subjects and employees of state institutions of RF subjects in accordance with the laws of RF subjects.
In accordance with item 1 of article 50 of law No. 131-FZ, municipal entities may own properties designated for:
• settlement of the problems of local importance;
• exercise of certain state powers delegated to local governments in the cases determined by federal laws and laws of RF subjects;
• ensuring of activities of local governments, officials of local governments, municipal employees, employees of municipal enterprises and institutions in accordance with normative legal acts approved by representative bodies of municipal entities.
In order to implement the said provisions, the RF Government determines the procedures and terms of free transfer of property from the federal or municipal ownership to the ownership of RF subjects, as well as from ownership of RF subjects to federal or municipal ownership in accordance with the set division of powers.
Prior to January 1, 2005, laws of RF subjects should determine the lists of the types of property necessary for the exercise of the powers envisaged in articles 26.2 and 26.3 of law No. 95-FZ, as well as the property necessary to ensure the activities of the state authorities of RF subjects, state civil employees of RF subjects, employees of state unitary enterprises of RF subjects and employees of state institutions of RF subjects (as concerns RF subjects, the relations envisaged by laws No. 95-FZ and No. 120-FZ were enacted on January 1, 2005).
Accordingly, prior to January 1, 2006, the state authorities of RF subjects should set forth the lists of properties designated for the settlement of the problems of local impor-
tance, which are in ownership of RF subjects and ensure the free transfer of such properties in municipal ownership (item 1, article 85 of law No. 131-FZ).
Local governments should set forth the lists of properties, which are in municipal ownership, but are designated for the exercise of the powers of the federal authorities and the authorities of RF subjects in accordance with the set division of powers and ensure the free transfer of such properties in federal ownership and ownership of RF subjects (item 8, article 85 of law No. 131-FZ) (as concerns municipal entities, the relations envisaged by laws No. 95-FZ and No. 120-FZ will be enacted on January 1, 2006).
On the whole, as it has been mentioned above, the new assignment of expenditure powers to the budgets of different levels to a significantly greater degree ensures independence of budgets of different levels. At the same time, the adopted laws have certain flaws and in a number of cases there are observed rather substantial contradictions between these laws.
First, according to the new version of the articles of section 11 of the RF Budget Code the expenditure obligations of regional and local budgets may originate only in respective regional and local normative acts and agreements, what creates an illusion of the complete liquidation of unfunded mandates. However, it is only an illusion, since the complete liquidation of unfunded mandates is impossible in the framework of the Constitution currently in force. The process of division of expenditure powers among the levels of the budgetary system per se, which is exclusively vested with the Russian Federation, is the process of imposition of certain expenditure obligations on the subnational budgets. Besides, according to item 2 of article 26.3 of the law "On the general principles of organization of legislative (representative) and executive authorities of RF subjects" the Russian Federation has the right to regulate the procedures of execution of expenditures of regional budgets with respect to certain objects under shared jurisdiction. At the same time, item 8 of article 26.3, as it has been noted above, permits to adopt at the federal level legislative acts setting expenditure obligations of RF subjects without granting subventions from the federal budget in the case such expenditure obligations are not too "burdensome." Therefore, laws No. 95-FZ and No. 131-FZ to a certain degree permitted the setting of expenditure obligations of regional and local budgets by federal laws.
One of the most principal flaws of the preceding legislation was the substitution of division of functions for division of objects of ownership. The RF Budget Code did not assign such most important functional avenues of state expenditures as education, health care, and culture to the powers of a certain level of the budgetary system, however, it recognized the maintenance of institutions and organizations being in jurisdiction of respectively the Federation, its subjects, or municipal entities to be in exclusive powers of the budgets of each level. At the same time, the RF Budget Code failed to indicate what institutions and organizations from the viewpoint of the functions they perform should be in the jurisdiction of each level of the public authorities. Following this logic, local governments, for instance, should participate in financing of education and health care only in the cases they had the respective institutions in their jurisdiction. So in the case a higher education establishment was under jurisdiction of a local government, it should be financed from the local budget.
The new legislation also failed to completely remove this flaw. In the sense of article 26.11 of law No. 95-FZ and article 50 of law No. 131-FZ, property should be in the ownership of a level of authorities proceeding from the set assignment of expenditure powers. However, this principle is sometimes not adhered to, and this is related to the fact that the issues of local importance listed in law 131-FZ often overlap with the powers of RF subjects as set forth in law 95-FZ. For instance, in accordance with subparagraph 18 of item 1 of article 26.3 of law No. 95-FZ, "organization and support of institutions of culture and arts (with the exception of federal state cultural and art institutions, the list of which should be
93
approved by the RF Government)" should be under jurisdiction of the state authorities of RF subjects. Law No. 131-FZ envisages that town okrugs and settlements also may own property designated for provision of services provided by cultural institutions to the residents of settlements (town okrugs) (pp. 2 and 4 of article 50). Therefore, it is admissible to finance the services rendered in the sphere of culture simultaneously from regional and local budgets. Each level of authority ensures that institutions of culture in its ownership could provide their services; however, there is no legislatively determined criterion of assignment of institutions involved in the same core activities to the ownership of different levels of authorities. In this situation, the granting to regions the right to transfer property "designated for the settlement of the problems of local importance" in municipal ownership may result in vesting with municipal entities the responsibility to finance practically any institution of culture.
For the purposes of control and analysis of expenditure obligations, federal law No. 120-FZ introduced the term "registers of expenditure obligations" in the RF Budget Code. According to article 87 of the RF Budget Code, the register of expenditure obligations is defined as the list of normative and legal acts, as well as agreements and contracts (individual articles, items, subparagraphs, paragraphs of normative legal acts, contracts, and agreements) concluded by the state authorities (local governments) envisaging the generation of expenditure obligations subject to the execution at the expense of respective budgets. As it seems, the issue of accounting for expenditure obligations has not been settled yet due to the following reasons.
First, in accordance with p. p. 4 and 5 of article 87 of the RF Budget Code the registers of expenditure obligations of RF subjects and municipal entities should be maintained in accordance with the procedures set forth by the executive authority of the RF subject and local administration. Therefore, the determination of the procedure of drawing up of the list of expenditure obligations, which should be financed from regional and local budgets, is vested with the same bodies, which are responsible for formation of the respective budget. This may permit the executive state authorities of RF subjects and local administration to avoid the inclusion in the register of the obligations, the financing of which they deem undesirable.
Second, the RF Budget Code not only fails to set forth the procedures for taking into account the register of expenditure obligations in the process of formation and approval of budgets, but also does not indicate the necessity of the use of the register for these purposes. therefore, the amendments to the RF Budget Code do not prevent regions and municipal entities to ignore the existing obligations in the process of formation and approval of the budget.
Among other innovations introduced in the RF Budget Code by federal law No. 120-FZ with respect to regulation of expenditures, there should be noted the exclusion of the notion of minimal social standards. Earlier (prior to the adoption of law No. 120-FZ) the notion of "norms of financial expenditures per unit of services rendered by state institutions" was closely related to the concept of "minimal social standards." It was envisaged that minimal social standards should be enacted by a respective federal law, while the financial norms elaborated on the basis of these standards by an executive authority would be minimally acceptable for all levels of the budgetary system. However, taking into account the fact that the amendments to the RF Budget Code introduced by law No. 120-FZ removed the notion of minimal social standards from the Code, the law on state minimal social standards and article 177 of the RF Budget Code setting the norms of financial costs associ-
ated with provision of state and municipal services will never enter into force29. In this situation, federal legislators should exclude this article from the Code; however the article stipulating the norms of financial costs was preserved in its old version.
Interbudgetary transfers granted from the federal budget
According to the new version of article 16 of the RF Budget Code enunciated and introduced by law No. 120-FZ, all free transfers among the budgets and extra-budgetary funds were consolidated in the category of "interbudgetary transfers." At the same time, federal financial resources are transferred to regional and local budgets in the forms set forth by the RF Budgetary Code:
• Financial aid to the budgets of RF subjects, including the grants from the Federal Fund of Financial Support of RF Subjects and other grants and subsidies;
• Subventions to the budgets of RF subjects from the Federal Compensatory Fund and other subventions;
• Financial aid to the budgets of certain municipal entities granted in the cases and in accordance with the procedures set forth by federal laws;
• Other free and irrevocable transfers;
• Budgetary credits to the budgets of RF subjects.
Therefore, there was indicated the distinction between the financial aid, i.e. the support of relatively poor regions, and compensations for the expenditures associated with the exercise of delegated powers provided by the federal authorities, and assistance to investment in the region.
Article 130 of the RF Budget Code reflects the major conditions of granting of interbudgetary transfers. In the course of comparison of key conditions of granting of financial resources of the federal budget to RF subjects in the new and old versions of the RF Budget Code there may be singled out the following changes.
1. According to the new version of the RF Budget Code, interbudgetary transfers from the federal budget (with the exception of subventions provided from the Federal Compensatory Fund) are granted on condition the state authorities of RF subjects and local governments comply with the budget legislation of the Russian federation and the legislation of the Russian Federation on taxes and fees.
2. Budgetary credits from the federal budget are extended to the budgets of RF subjects on condition that the respective state authorities of RF subjects have no overdue indebtedness to the federal budget. The use of budgetary credits received by the budgets of RF subjects from the federal budget for granting budgetary credits to legal entities is prohibited. This innovation was intended for toughening of budgetary discipline, although the prohibition to use federal budgetary credits for extending budgetary credits to legal entities may be interpreted in two ways. In the first interpretation, regions can not use for crediting of legal entities exactly the budgetary credits extended by the federal center; however, it would be difficult to control. At the same time, the legislators could imply that the regions receiving budgetary credits are prohibited to extend credits to legal entities. In this case this provision should be clarified.
3. Grants from the Federal Fund of Financial Support of RF subjects and budgetary credits from the federal budget are provided to the budgets of RF subjects, where over two of the last three reporting years the share of such grants in the total amount of own revenues exceeded 50 per cent. The grants and credits are provided for three financial years starting form the next financial year and on condition of complying with the agreement concluded with the RF Finance Ministry with respect to the measures aimed at the en-
29 In accordance with federal law No. 159-FZ of July 9, 1999, "On the enactment of the Budget Code," article 177 of the RF Budget Code should have been enacted on the date of entering in force of the federal law on state minimal social standards.
hancement of efficiency of utilization of budget financial resources and growth of tax and non-tax revenues of the budget of the RF subject.
The preceding version of the RF Budget Code set forth quite different requirements with respect to the regions - recipients of FFSR grants. On the one hand, these requirements were much more precise: RF subjects had no right to create better conditions for state employees financed from the budget of the RF subject (wages and salaries, traveling allowances and other expenditures) in comparison with state employees of federal institutions (taking into account regional wage coefficients), extend budgetary credits to legal entities exceeding 3 per cent of the total expenditures of the budget of the RF subject, give state guarantees on behalf of the RF subject exceeding 5 per cent of the total expenditures of the budget of the RF subject. On the other hand, these requirements were set for all recipients of financial aid from FFSR (at present this condition is applicable only to heavily subsidized regions).
These developments may indicate certain shifts in the policy pursued by the federal center with respect to subsidized regions: the federal center grants to lightly subsidized regions relatively higher financial independence, while with respect to heavily subsidized regions there is carried out the transition to a very high level of control over the management of subnational finances.
4. In the case the state authorities of RF subjects and local governments infringe upon the conditions of granting of interbudgetary transfers from the federal budget set by the budgetary legislation, the RF Finance Ministry should have the right to suspend the granting of interbudgetary transfers (with the exception of subventions from the Federal Compensatory Fund) to the respective RF subjects (municipal entities). This provision in fact introduces the option of imposition of sanctions with respect to the regions failing to comply with the conditions of granting of interbudgetary transfers, what should enhance the responsibility of regional authorities as concerns their regional policies. The old version of the RF Budget Code did not envisage such tough sanctions for failures to comply with the conditions of granting of financial aid.
The new version of article 131 of the RF Budget Code sets forth the procedures governing the formation and expenditure of the financial resources of the Federal Fund of Financial Support of RF Subjects. The most important novellas of this article are the following provisions.
1. The key principles of allocation of the Fund's financial resources were fixed in the framework of the legislation, there was envisaged that the RF Government should approve the Methods of allocation of the financial resources of the Fund.
2. There was established the procedure of evaluation of the amount of the Federal Fund of Financial Support of RF Subjects, which should be approved for the next financial year. According to the new version of the RF Budget Code, this amount is evaluated by multiplying the amount of the Fund subject to approval for the current financial year by the estimated rate of inflation in the next financial year (Consumer Price Index). Earlier, the amount of FFSR was formed at 14 per cent of the expenditures of the federal budget although this rate has not been indicated in the legislation. The legislative fixation of the amount of FFSR should render financial policy pursued by the federal center more predictable for regions. At the same time, in the case the objective circumstances require significant changes in the amounts of resources provided in the form of transfers from FFSR, it will require to make amendments to the RF Budget Code.
3. There was established the procedure governing the estimation of transfers by the RF Finance Ministry. According to the requirements of the new version of the RF Budget Code, the RF Finance Ministry should forward to the executive authorities of RF subjects the initial data for the conduct of calculation with respect to the allocation of the financial resources of the Federal Fund of Financial Support of RF Subjects for the nest financial 96
year prior to August 1 of the current financial year. Prior to October 1 of the current financial year, the Ministry should carry out a comparative check of the said initial data with representatives of executive authorities of RF subjects.
The changes in the RF Budget Code noted above render the allocation of FFSR financial resources more predictable for regional authorities: the methods of allocation can be changed only by a resolution of the Government and in the framework of the legislation currently in force; the amount of FFSR is easily to estimate in advance; the terms of calculations for the further allocation of FFSR grants are clearly determined.
4. It was legislatively prohibited to use actual or prognosticated indicators of revenues and expenditures of regional budgets for the estimation of the level of budgetary security.
5. It was set forth that the level of rated budgetary security of RF subjects as adjusted for grants provided from the Federal Fund of Financial Support of RF Subjects should not exceed the level of the rated budgetary security as adjusted for grants provided from the Federal Fund of Financial Support of RF Subjects of any other RF subject, which prior to the allocation of grants from the Federal Fund of Financial Support of RF Subjects demonstrated a higher level of the rated budgetary security.
These two changes in fact have legislatively determine the key principles of the Methods of allocation of FFSR grants, which has been discussed above in the respective section of the study.
6. The new version of the RF Budget Code has regulated the issues of granting of financial aid to the autonomous okrugs being in the composition of other RF subjects. In accordance with this version of the RF Budget Code, the grants provided from FFSR to krais and oblasts, which include autonomous okrugs, should be estimated for consolidated budgets of such krais and oblasts, including the budgets of autonomous okrugs, and should be entered in the budgets of such krais and oblasts if there are no other arrangements set forth by a contract and (or) an agreement between the authorities of the krai or oblast and the authorities of the autonomous okrug.
This change in the legislation is an important step in the regional policy pursued by the federal center with the purpose of gradual elimination of such a type of region as autonomous okrugs being in the composition of other RF subjects and their integration in the respective oblasts and krais.
The new version of article 132 of the RF Budget Code envisages the objectives of creation and certain aspects of functioning of two sources of financial aid to regions: the regional development fund aimed at the granting to the budgets of RF subjects of subsidies for participation financing of investment programs, and the Fund of co-financing of social expenditures, which is formed for financing of priority socially important expenditures of consolidated budgets of RF subjects. These funds have functioning without legislative fixation even prior to the adoption of law No. 120-FZ.
The new version of article 133 of the RF Budget Code sets forth regulation of the granting of transfers from the Compensatory Fund. Since 2005, the Compensatory Fund should accumulate financial resources for financing of all explicit federal expenditure mandates existing in the legislation. The Federal Compensatory Fund is formed within the federal budget and is aimed at the granting of subventions for the execution of expenditure obligations of RF subjects and (or) municipal entities, whose financial security is ensured at the expense of subventions granted from the federal budget in accordance with the law "On the general principles of organization of legislative (representative) and executive authorities of RF subjects" and (or) "On the general principles of organization of local government in the Russian Federation."
Subventions from the Federal Compensatory Fund are distributed among the subjects of the Russian Federation in accordance with the methods approved by the RF Gov-
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ernment and in compliance with the requirements set forth by the RF Budget Code, federal laws, and normative legal acts of the RF President and the RF Government.
Subventions from the Federal Compensatory Fund are distributed among all subjects of the Russian Federation in accordance with the standard method applicable to the respective type of subventions pro rata of the size of the population (separate groups of population), consumer of respective budgetary services, eligible recipients of transfers to individuals, and other indicators taking into account objective conditions affecting the costs of provided budgetary services (amount of payments) in RF subjects.
In the course of allocation of subventions provided by the Federal Compensatory Fund, it is prohibited to use the indicators characterizing own revenues of the budgets of RF subjects (local budgets).
In accordance with the new version of the RF Budget Code, which does not envisage such type of financial aid as budgetary loans, there is set forth a stringent requirement about the repayment of budgetary credits to the budgets of RF subjects within the budget year. In the case the extended budgetary credits are not repaid in time, the balance of non-repaid credits including interests, penalties and fines is repaid at the expense of grants from the Federal Fund of Financial Support of RF subjects and at the expense of the shares in the revenues generated by federal taxes and fees, taxes set forth in the framework of special tax treatments (with the exception of local taxes) due to the budgets of RF subjects.
Interbudgetary transfers granted from the budgets of RF subjects to local budgets
According to the new version of the RF Budget Code, significant changes were made in the sphere of interbudgetary relations between regions and municipal entities. In fact, the legal norms of interbudgetary relations between the center and regions were projected to the sub-federal level. Thus, the new version of article 136 of the RF Budget Code entering into force on January 1, 2006, sets forth the key conditions of granting interbudgetary transfers from the budgets of RF subjects and practically duplicates the provisions of article 130 with respect to relations between regional and local authorities. As concerns interbudgetary relations at the sub-federal level, Article 135 of the RF Budget Code sets forth the forms of financial support mainly similar to those envisaged by article 129 of the RF Budget Code with respect to transfers provided from the federal budget:
• Financial aid to local budgets, including the grants from regional funds of financial support of settlements, grants from regional funds of financial support of municipal districts (town okrugs), other grants and subsidies;
• Subventions to local budgets from the regional compensatory funds and other subventions including those to the budgets of autonomous okrugs being in the composition of krais and oblasts; for exercise of the powers of the state authorities of RF subjects delegated on the basis of agreements concluded in compliance with the federal legislation between the state authorities of autonomous okrugs and the state authorities of respective krais or oblasts;
• The funds transferred to the federal budget in relation to the repayment and (or) servicing of the public debt of RF subjects to the federal state authorities and (or) fulfillment of other obligations of the RF subject to the federal budget;
• Other free and irrevocable transfers;
• Budgetary credits to local budgets.
In accordance with the new version of the RF Budget Code regional funds of financial support of settlements are formed within the budgets of RF subjects for the purposes of equalization proceeding from the number of residents, financial resources of local governments of settlements as concerns the exercise of their powers aimed at the settlement 98
of problems of local importance. The procedure of formation and allocation of financial resources of the fund are determined by the legislation of the respective RF subject. Besides, in the course of formation and (of) approval of the budget of the respective RF subject, grants from the regional fund of financial support of settlements due to the budget of the settlement may be in full or partially substituted by additional rates of assignment of the revenues generated by the income tax on individuals. During the financial year, it is prohibited to change the additional rates of assignment of the income tax on individuals due to the settlement, and the financial resources received by the settlement from the additional rate of assignment of the income tax on individuals in excess of the estimated amount of grants (estimated portion of the grant) from the regional fund of financial support of settlements should not be transferred to the budget of the respective RF subject and (or) be taken into account in the course of the next allocation of financial aid to local budgets. These provisions, on the one hand, permit regions to carry out financial equalization independently, and on the other hand protect municipal entities from the changes in the "rules of the game" during the financial year.
Regional funds of financial support of municipal districts (town okrugs) are formed within the budgets of RF subjects for the purposes of equalization of budgetary security of municipal districts (town okrugs). The procedure of formation and allocation of financial resources of the fund are also regulated by the respective RF subject. Grants from the regional fund of financial support of municipal districts (town okrugs) of RF subjects are provided to the municipal districts (town okrugs), where the level of rated budgetary security is at or below the level set as the criterion of equalization of the rated budgetary security of municipal districts (town okrugs).
In accordance with the provisions of the new version of the RF Budget Code, the level of rated budgetary security of municipal districts (town okrugs) is determined by the rate of the tax revenues per one resident, which could have been received by the budget of the municipal district (town okrug) proceeding from the level of development and structure of the economy and (or) the tax base (tax potential), as well as the similar indicator characterizing the average level across municipal districts and town okrugs of the respective RF subject taking into account the differences in the structure of the population, social, economic, climate, geographical, and other objective factors and conditions affecting the costs of provision of budgetary services (amount of payments) per one resident.
However, part of the grants from the regional fund of financial support of municipal districts (town okrugs) may be provided to municipal districts (town okrugs) proceeding from the number of residents of the municipal district (town okrug) and calculated per one resident and in accordance with the uniform methodology.
These provisions are rather a reference point than an action plan for the region as concerns its financial policy. The majority of mandatory stipulations concern the provision to the local governments of certain guarantees that financial policy of the region will be stable over the year. Other norms in fact grant the regional authorities the opportunity to form their own financial policy and are therefore to a significant extent of dispositive character.
According to article 139 of the RF Budget Code, within the budgets of RF subjects there may be formed funds of municipal development of RF subjects in order to provide local budgets with subsidies for participation financing of investment programs (projects) aimed at the development of public infrastructure of municipal importance, while for the purposes of provision of local budgets with subsidies for participation financing of priority socially important expenditures of local budgets there may be formed regional funds of co-financing of social expenditures.
In the cases and under procedures set forth by laws of RF subjects and other normative legal acts of the state authorities of RF subjects, local budgets may receive other
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grants and subsidies from the budgets of RF subjects at or below 10 per cent of the total amount of financial aid granted to local budgets from the budgets of RF subjects. This limitation should somewhat unify interbudgetary relations at the subnational level, since no less than 90 peer cent of financial aid to local budgets from the budget of the RF subject should be provided in the forms envisaged by the RF Budget Code. However, because of the considerable degree of freedom as concerns the formation and allocation of financial aid at the subnational level, this restriction is insignificant.
Article 140 of the RF Budget Code regulates regional compensatory funds. Regional compensatory funds are formed within the budgets of RF subjects in order to provide financial backing to local governments exercising certain state powers at the expense of:
• subventions from the Federal Compensatory Fund aimed to assist local governments to exercise certain powers vested with the federal authorities;
• own revenues and sources of financing of the budget deficits of RF subjects in the amount necessary to local governments to exercise certain powers of the state authorities of RF subjects.
As concerns the formation and allocation of the compensatory fund, the only significant restriction on regional authorities is the necessity to elaborate the uniform methods of provision of subventions to all municipal entities.
The procedure governing the granting of budgetary credits from the budgets of RF subjects to local governments is similar to the procedure under which budgetary credits are granted to the budgets of RF subjects from the federal budget as discussed above.
The new version of article 142 of the RF Budget Code envisages the following forms of interbudgetary transfers provided from local budgets:
• financial aid granted to the budgets of settlements from the budgets of municipal districts;
• subventions transferred to regional funds of financial support of settlements and regional funds of financial support of municipal districts (town okrugs);
• subventions transferred from the budgets of settlements to the budgets of municipal districts in order to settle the local problems of inter-municipal nature;
• financial resources transferred to the federal budget or budgets of RF subjects in relation to the repayment and (or) servicing of municipal debts of municipal entities to the federal state authorities or the state authorities of RF subjects, and (or) other obligations of local governments to the state authorities;
• other free and irrevocable transfers.
The procedures governing the formation and allocation of the said types of interbudg-etary transfers is rather similar to the organization of interbudgetary transfers at the regional level. No such regulation was envisaged in the preceding version of the RF Budget Code. For the first time in the Russian legislation there was envisaged the procedure of granting subventions from local budgets to the budgets of RF subjects. Laws of RF subjects may stipulate the transfers of subventions to the budgets of RF subjects from the budgets of settlements or municipal districts (town okrugs), where the estimated tax revenues of local budgets (without taking into account tax revenues associated with additional rates of assignment) exceeded the levels set forth by the laws of the respective RF subjects.
The said level should not be set below the double average level observed across settlements or municipal districts (town okrugs) of the respective RF subject calculated per one resident. Subventions from the budgets of settlements transferred to the budgets of RF subjects as stipulated by this article are due to the regional fund of financial support of settlements. In fact, this provision introduces negative interbudgetary transfers at the regional level. The RF Budget Code sets only two requirements with respect to negative interbudgetary transfers: 100
1) the amount of the said subvention for individual municipal entity in per one resident terms should not exceed 50 peer cent of the difference between the rated tax revenues of the local budget (without taking into account the revenues from additional rates of assignment) in per resident terms and the double average level of rated tax revenues in per resident terms in the last reporting year;
2) rated tax revenues of the municipal entity in per resident terms after the exclusion of the subvention due to the budget of the RF subject should not be below the rated tax revenues in per resident terms of another municipal entity, where prior to the exclusion of the said subvention had demonstrated a lower level of rated tax revenues in per resident terms.
Therefore, the adoption of law No. 120-FZ resulted in the following changes in the system of regulation of interbudgetary financial flows via the federal legislation.
1. All interbudgetary transfers at the federal, regional, and local levels were classified in three groups: financial aid, transfers from compensatory funds, and transfers from funds of regional development. There was indicated the distinction between the financial aid, i.e. the support of relatively poor regions / municipal entities, and the compensations provided by the federal / regional authorities for the expenditures associated with the exercise of delegated powers, and assistance to investment in territories. As a result, the budgetary classification differentiates between the financial resources provision of which may result in various restrictions on the part of federal / regional authorities, and other types of transfers to the budgets of lower levels, which are not related to their financial needs and are determined only by the necessity to comply with the federal / regional legislation or priorities of upper levels of authorities and various forms of joint activities.
2. The procedures governing the formation and allocation of all funds involved in distribution of interbudgetary transfers from the federal budget were fixed in the RF Budget Code.
3. The RF Budget Code was supplemented with the provisions regulating interbudgetary transfers at the regional and municipal levels. Among the specific features of these innovations there should be noted that these norms are to a significant extent of dispositive character. The majority of imperative norms in this sphere are related to the necessity of creation of equal and predictable conditions, in which municipal entities could pursue their own fiscal policies.
4. One of the most important innovations in the practice of interbudgetary relations at the regional level has become the introduction of so called negative transfers for municipal entities, i.e. the transfers from municipal budgets to the budgets of RF subjects.
Setting up the procedures governing the temporary exercise of fiscal powers vested with state authorities of RF subjects (local governments) in the case of introduction of a provisional financial administration
Until the middle of 2003, special legislative regulation of the status of insolvent regions and municipal entities has been practically nonexistent. At the same time, article 112 of the RF Budget Code envisaged the possibility to undertake certain measures with respect to regions (municipal entities) in the case they exceeded the caps on the amounts of deficit, debt, and (or) expenditures associated with the servicing of the debt, or defaulted on their debt obligations; however, in practice this article did not work. Besides, the measures stipulated by this article, which could be undertaken by the superior financial authority with respect to insolvent regions (municipal entities), like to inspect the execution of the budget or place it under the control of a superior financial authority seem to be inefficient, since insolvency practically always results from the decisions taken by the representative body and can not be overcome in the process of execution of the budget.
A qualitatively new phase of development of the legislation in this area has started with the adoption of federal laws No. 95-FZ and 131-FZ and was completed with the introduction of law No. 120-FZ, which supplemented the RF Budget Code with article 19.1. This article regulates the status and functions of provisional financial administration introduced in the case of insolvency of an RF subject or a municipal entity.
The major tenor of article 19.1 of the RF Budget Code is as follows. In the case the overdue indebtedness associated with the fulfillment of debt and (or) budgetary obligations originating through the fault of the state authorities of an RF subject (local government) exceeds 30 per cent of own revenues of the respective budget in the last reporting year, in such an RF subject (municipal entity) for up to a year there should be introduced a provisional financial administration (p. p. 1, 3, article 168.2 of the RF Budget Code). The provisional financial administration should not be introduced within one year since the date the representative body of the state authority of the RF subject (representative body of local government) was vested with power (item 5, article 168.2 of the RF Budget Code). In RF subjects, the provisional financial administration should be introduced on request of the RF Government by decision of the Supreme Arbitration Court, as concerns municipal entities, on request of the top executive or the head of the supreme executive authority of the RF subject and (or) representative body of the municipal entity, the head of the municipal entity by decision of an arbitration court of the subject of the Russian Federation (item 3, article 168.2 of the RF Budget Code).
According to article 168.3 of the RF Budget Code, the provisional financial administration introduced in the subject of the Russian Federation (municipal entity) should exercise the following powers:
• organize inspection (audit) of the budget of the RF subject (local budget) in accordance with procedures set up by the Government of the Russian Federation (the executive state authority of the RF subject);
• organize audit of the overdue indebtedness related to the debt and (or) budgetary obligations of the RF subject (municipal entity) in accordance with the procedure set forth by the federal law;
• develop a draft plan as concerns rehabilitation of solvency of the RF subject (municipal entity);
• elaborate and submit to the state authorities of the RF subject (local government) draft normative legal acts of the RF subject (local government) envisaged by the plan of rehabilitation of solvency of the RF subject (municipal entity) as approved by the Supreme Arbitration Court of the Russian Federation (arbitration court);
• in the case a draft law of the RF subject (draft decision of the representative body of municipal entity) elaborated by the provisional financial administration as concerns the amendments to the law of the RF subject (draft decision of the representative body of municipal entity) on the budget of the RF subject (local budget) for the current year, or a draft law of the RF subject (draft decision of the representative body of municipal entity) on the budget of the RF subject (local budget) for the next financial year is not adopted within one month since such draft law has been presented by the provisional financial administration to the legislative state body of the RF subject (representative body of the municipal entity), or adopted with amendments not approved by the head of the provisional financial administration, the provisional financial administration should submit to the RF Government (supreme executive body of the RF subject) the respective draft budgets for submission to the State Duma (legislative body of the RF subject) for approval of these draft budgets by a federal law (the law of the RF subject);
• in the case the draft normative legal acts of the executive authorities of the RF subject (local administration) elaborated by the provisional financial administration are not adopted within 15 days since such draft documents have been presented by the provisional financial administration, or adopted in a version not approved by the head of the provisional financial administration, the provisional financial administration should approve the aforesaid drafts;
• control the implementation of the plan of rehabilitation of solvency of the RF subject (municipal entity) approved by the Supreme Arbitration Court of the Russian Federation (arbitration court) and the respective normative legal acts;
• control execution of the budget of the RF subject (local budget).
In accordance with the temporary provisions envisaged by law No. 120-FZ, the stipulations of article 19.1 of the RF Budget Code as concerns RF subjects will enter into force since January 1, 2007, and as concerns municipal entities - since January 1, 2008.
Among the positive features of the innovations relating to the regime of provisional financial administration introduced by law No. 120-FZ, there should be noted the reflected in the law definition of the insolvency of the region (municipal entity). The merit of this definition is, first, that the provisional financial administration may be introduced not only in the case the marginal amounts of the debt or expenditures associated with the servicing of the debt are exceeded, but also in the case of the factual default on debt obligations. This option permits to refrain from taking coercive measures with respect to the region (municipal entity), which has not yet exhausted the capacity to overcome its financial crisis situation by its own efforts, for instance, via restructuring of the debt, attraction of additional borrowings for refinancing of the debt, and (or) reduction of expenditures.
The second merit of this definition is that it concerns only the indebtedness, which was originated through the fault of the region or the municipal entity. In other words, the indebtedness originated through the fault of superior authorities is excluded from the composition of the liabilities, which should be taken into account in the course of detection of the indications of insolvency. Thus, the upper levels of the budgetary system can not shuffle off the responsibility for their ill considered decisions on to the lower tiers.
Yet another merit of the definition of insolvency introduced by the law is that alongside with the indebtedness related to the obligations included in the composition of the regional (municipal) debt there should be also taken into account the indebtedness relating to the budgetary obligations. It is an important condition permitting to avoid discrimination of certain creditors of a region (municipal entity) against the others. In the case insolvency is detected proceeding only from the amount of liabilities included in the composition of the public (municipal) debt in the narrow sense of the term (i.e. liabilities resulting from credit agreements, guarantees, and bond issues) creates incentives to repay such liabilities at the expense of accumulation of creditor indebtedness relating to other types of obligations to be met at the expense of the debtor's budget. Such obligations include both the liabilities of the public law nature (i.e. those resulting form laws and other normative legal acts envisaging budgetary expenditures), and liabilities of the civil law character, which are not included in the composition of the public (municipal) debt as defined by the law. The latter include, for instance, liabilities resulting from contracts for purchase of goods, works, or services for state and municipal needs, liabilities relating to remuneration of labor of employees of budgetary organizations, etc. At the same time, in order to ensure the efficient functioning of the provision permitting to take into account the indebtedness relating to budgetary obligations in the process of taking the decision about the introduction of the provisional financial administration, it is necessary to settle the issue of what types of indebtedness and of what types of the subjects of the public sector are included in
the indebtedness of this budget. Without the regulatory settlement of this issue, there are possible abuses on the both sides.
As it appears, the major flaw of the provisional financial administration procedure envisaged in laws No. 95-FZ and 131-FZ, as well as in the respective article of the RF Budget Code, is the excessive extent of interference of superior authorities in the budgetary process of the debtor. For instance, article 19.1 of the RF Budget Code stipulates that in the case a region or a municipal entity fails to adopt the law on the budget in the version presented by the provisional financial administration, the budget law should be adopted by a federal law in the case of the RF subject, and by a law of the RF subject for a municipal entity. This stipulation appears to be rather arguable taking into account the fact that the Constitution does not envisage the option of adopting federal laws on the issues not being in the jurisdiction of the Russian Federation or in the shared jurisdiction of the Russian Federation and its subjects; or regional laws on the issues of local importance (while article 132 of the Constitution directly stipulates that approval and execution of local budgets are issues of local importance).
Besides, this provision of the law minimizes the role of the court as a moderator in the framework of insolvency proceedings concerning regions (municipal entities). In the situation, where superior authorities are vested with the right to approve the final version of the law no the debtor's budget, the importance of the plan of rehabilitation of the debtor's solvency approved by the court is leveled. It should be noted that in the case the regional budget is approved by the federal law, it is impossible to contest its contents even in the case it contradicts to the plan of rehabilitation of solvency approved by the court, since federal laws may be contested only on the grounds that they are at variance with the Constitution. Therefore, the commented provisions create risks that superior authorities may abuse the powers vested with them in the framework of insolvency proceedings.
More precise definition of procedures governing the cash servicing of the execution of the budgets of the Russian budgetary system The new version of article 215-1 of law No. 120-FZ stipulates that cash servicing of the budgets of all tiers of the budgetary system of the Russian Federation should be vested with the Federal Treasury and be implemented via accounts with the Bank of Russia. If agreed with the executive authorities of the RF subject, the powers of the Federal Treasury as concerns cash servicing of the execution of the budget of the RF subject (budgets of territorial state extra-budgetary funds of the RF subject) and budgets of municipal entities may be transferred to the executive authorities of the RF subject on condition that the said powers are financially ensured at expense of own revenues of the RF subject and that the RF subject owns (uses, manages) the property necessary for the exercise of such powers.
Therefore, it may be asserted that as a result of the changes introduced in the Code, the powers of the Federal Treasury concerning the process of execution of subnational budgets were formally broadened (earlier, the cash execution of budgets was implemented only in the RF subjects being recipients of grants for equalization of budgetary security from the federal budget). At the same time, there is observed a formal limitation of the powers vested with the Federal Treasury. While earlier item 1 of article 134 of the RF Budget Code (as not amended by law No. 120-FZ) has envisaged that the Federal Treasury directly executed the budgets of subsidized RF subjects30, the new version of the RF
30 In accordance with the previous version of item 1 of article 134 of the RF Budget Code, the financial aid allocated from the federal budget for the purposes of equalization of minimal budget security was provided to RF subjects on condition that such RF subjects should sign agreements on the execution of the respective regional budget via the Federal Treasury. There is no such provision in the new version of the RF Budget Code (see article 130 of the new version of the RF Budget Code).
Budget Code envisages only cash servicing of the execution of budgets. At the same time, article 6 of the RF Budget Code notes that cash servicing of the execution of budgets is defined as the carrying out and accounting of the operations related to cash revenues and cash expenditures of the budget. Although the Code contains the definition of cash servicing, it remains unclear what it implies.
The new version of article 227 of the RF Budget Code stipulates that cash payments of budgetary expenditures should be carried out as the debiting of funds from the single budget account in the amount of the confirmed cash liability in favor of the respective individuals and legal entities. Therefore, cash payments presupposes that a number of functions should be carried out in advance, including the function of confirmation of the cash liability, i.e. the verification that the payment documents presented by the budget recipients correspond to the approved estimates of revenues and liabilities and the limits of budget liabilities. At the same time, the law does not directly determine the agency responsible for the confirmation of cash liabilities as concerns the expenditures of regional and local budgets. In the case the confirmation of cash liabilities is transferred to the jurisdiction of the Federal Treasury, the subjects of the Russian Federation and municipal entities will lose the real control over the execution of their budgets, since exactly the Federal Treasury will decide what expenditures answer the law on the budget, budget estimates, and the limits of budgetary liabilities.
In the case it is planned that the confirmation of cash liabilities should remain with the financial agencies of RF subjects and municipal entities, the Federal Treasury will have to effect payments approved by the regional (local) financial agency. In this case, the Federal Treasury will fully duplicate the functions performed by the Bank of Russia, which does not have administrative powers with respect to budgetary funds and effecting payments exclusively on clients' instructions. In this case, the cash servicing of the execution of regional and local budgets by the Federal Treasury is reduced to execution of payment operations through two banks in stead of one.
The only effect of this measure will be the prolongation of the time of payments by minimum one working day (on the condition that the staff performs its functions with maximum efficiency, the system of flow of documents is ideal, and technical capacities are adequate), since there is introduced yet another stage of processing of payments. Longer time taken to effect payments will further negatively affect the final recipient of the payment and the payment discipline in the country. As a result, due to the additional processing of payment documents by the Federal Treasury at the end of the financial year there may be observed accumulation of large balances of budgetary funds.
Federal law No. 95-FZ "On the amendments to Sections 1 and 2 of the Budget Code of the Russian Federation and invalidation of certain legislative acts (provisions of legislative acts) of the Russian Federation on taxes and fees"
The major group of amendments introduced by federal law No. 95-FZ of July 29, 2004, "On the amendments to Sections 1 and 2 of the Budget Code of the Russian Federation and invalidation of certain legislative acts (provisions of legislative acts) of the Russian Federation on taxes and fees" concerns the new structure of assignment of own tax revenues to each level of authorities. As it has been noted above, these amendments related to the changes introduced by law No. 120-FZ to the RF Budget Code and in fact reproduce the structure of assignment of tax revenues to different budgets in the framework of tax legislation.
The new version of article 12 of the RF Tax Code stipulates that federal taxes should be defined as all taxes and fees stipulated in the RF Tax Code and mandatory payable
anywhere in the territory of the Russian Federation. Regional taxes should be defined as the taxes stipulated in the RF Tax Code and respectively by the laws of RF subjects concerning taxes and are mandatory payable in the territories of respective RF subjects. Accordingly, local taxes are defined as the taxes stipulated in the RF Tax Code and normative legal acts of representative bodies of municipal entities and mandatory payable in the territories of respective municipal entities. Special tax regimes may envisage special procedures of determination of taxation elements, as well as waivers of the obligation to pay certain taxes and fees stipulated in the RF Tax Code.
As compared with article 12 of the previous version of the RF Tax Code, the new version of the article more clearly defines the powers vested with the regional and local authorities with respect to the introduction of taxes and fees. First, the article establishes that federal, regional, and local taxes and fees should be abolished or introduced only by the RF Tax Code (items 5 and 6 of article 12). Second, regional and local authorities were deprived of the right to determine the forms of reporting with respect to regional and respectively local taxes. All elements of taxation with the exception of tax rates (within the limits set forth by the Code), the procedures and terms of payment of taxes, as well as the grounds and procedures of application of tax privileges (as concerns respectively regional and local taxes) (item 3, article 56) should be directly determined in the RF Tax Code.
The RF law No. 2118-1 of December 27, 1991, "On the principles of the tax system of the Russian Federation" was invalidated on January 1, 2005 (i.e. on the date of enactment of the bulk of amendments made to the RF Tax Code by law No. 95-FZ), while the exhaustive list of taxes was fixed in the new version of articles 12-15 of the RF Tax Code. In comparison with the list of taxes and fees stipulated by articles 19-21 of law No. 2118-1, the new version of articles 12-15 of the RF Tax Code abolished a number of taxes and fees. The Code introduced 15 taxes and fees at all three tiers of authorities. In particular, in accordance with the new version of article 13 of the RF Tax Code, the federal taxes and fees include:
• value added tax;
• excises;
• income tax on individuals;
• single social tax;
• profit tax on organizations;
• mineral extraction tax;
• gift or inheritance tax;
• water tax;
• fees for the use of fauna resources and for the use of water biological resources;
• stamp tax.
According to article 14 of the RF Tax Code, regional taxes and fees include:
• tax on property of organizations;
• tax on gambling;
• transport tax.
Local taxes (article 15 of the RF Tax Code) include:
• land tax;
• property tax on individuals.
Therefore, there were abolished two taxes - on operations with securities (a federal tax) and on advertisement (a local tax), as well as the fee for the use of terms "Russia" or "Russian Federation" and the charge for licenses permitting to produce alcohol products. At the same time, representative bodies of municipal districts or town okrugs (as well as
legislative bodies of the federal cities of Moscow and St. Petersburg) have the right to include such a type of activities as outdoor advertising in the composition of the types of activities subject to the tax on imputed income.
The new version of article 18 of the RF Tax Code introduces such special tax regimes as:
• system of taxation of agricultural producers (single agricultural tax);
• simplified taxation system;
• system of taxation in the form of the single tax on imputed income for certain types of activities;
• system of taxation applied in the course of implementation of production sharing agreements.
The following group of amendments introduced to the RF Tax Code by law No. 95-FZ is of the legal and technical nature and was made in connection to the administrative reform underway in the Russian Federation. Decree of the RF President No. 314 of March 9, 2004, transformed the RF Tax Ministry in the Federal Tax Service. The functions of the RF Tax Ministry concerning the approval of normative legal acts in the respective sphere, interpretation of the legislation of the Russian Federation on taxes and fees were transferred to the RF Finance Ministry. At the same time, the newly created within the RF Finance Ministry Federal Tax Service is the federal executive body empowered to control and supervise the sphere of taxes and fees.
The following group of amendments introduced to the RF Tax Code by law No. 95-FZ concerns a more precise definition of the procedures governing the granting of deferrals and installment plans with respect to the payment of taxes and investment tax credits. First, in accordance with the changes introduced in article 66 of the RF Tax Code, the stipulation envisaging that financial agencies of RF subjects should take decisions with respect to the extension of investment tax credits as concerns the tax on the profits (proceeds) of organizations due to the budget of the RF subject were excluded from the RF Tax Code.
According to article 63 of the RF Tax Code, there are the following agencies vested with the powers to take decisions concerning changes in the terms of payment of taxes and fees: the Federal Tax Service as concerns federal taxes and fees; territorial tax inspections acting on approval of regional (local) financial agencies - as concerns regional and local taxes and fees. At the same time, in accordance with item 6 of article 64 of the RF Tax Code (as not amended by law No. 95-FZ) "decisions concerning the granting of deferrals and installment plans with respect to the payment of taxes should be taken by an authorized agency within one month since the receipt of the application of the interested person." Thus, this stipulation did not take into account the necessity to coordinate the decision with the regional (local) financial agencies (in the case it concerns the deferrals or installment plans for taxes due to different budgets). Law 95-FZ has corrected this flaw.
It is important to note the amendment made to article 60 of the RF Tax Code. This article sets forth the obligations of banks with respect to the execution of orders for transfer of taxes and fees and decisions concerning collection of taxes and fees. In accordance with this article, banks should execute the orders given by clients of tax agents as concerns the transfer of tax payments to the respective budgets (extra-budgetary funds), as well as decisions taken by tax agencies with respect to collection of taxes at the expense of the funds of the taxpayer or the tax agent in the order of priority set forth by the civil law. Banks should execute orders for transfers of tax payments or execution of decisions about collection of taxes within one business day following the day of receipt of such order or decision if the RF Tax Code does not stipulate otherwise.
The amendment stipulates that the branches of the banks without own corresponding accounts should have additional time (5 business days) for transfer of payment documents received from citizens. The date of submission of the payment order to the bank by the taxpayer has been retained as the actual date of payment of the tax. At the same time, it should be taken into account that the taxes paid by taxpayers on the last day before the deadline will be received by the respective budget not earlier than in one week.
The last group of amendments introduced to the first section of the RF Tax Code is as follows: the term "taxes" was inserted in the articles previously referring to customs duties and payments. Therefore, it has been set forth that the customs should turn to the RF Tax Code as concerns all tax related issues.
The substantive changes in the second section of the RF Tax Code introduced by law No. 95-FZ primarily concern the tax on imputed income. There should be noted three key changes concerning this tax.
First, since January 1, 2006, the single tax on imputed income will be regulated not by regional authorities, but by the municipal level of government (also in the cities of Moscow and St. Petersburg). In accordance with item 3 of the new version of article 346.26 of the RF tax Code, the normative legal acts issued by representative bodies of municipal districts (town okrugs) and the laws adopted by the federal cities of Moscow and St. Petersburg should determine the following:
• the procedure of introduction of the single tax on imputed income in the territory of respective municipal district, town okrug, federal cities of Moscow and St. Petersburg;
• the types of entrepreneurial activities subject to the single tax as listed by the RF Tax Code;
• values of K2 coefficient (the adjustment coefficient of base profitability, which takes into account the specifics of businesses, including the assortment of goods (works, services), seasonal factor, duration of operation, amount of proceeds, specifics of the location of the business, dimensions of the information field of light and electronic displays, dimensions of the information field of printed outdoor advertisements, and other specifics).
Second, since January 1, 2005, the table of base profitability presented by article 346.29 of the RF Tax Code has been changed - practically all indicators were increased twofold.
Third, as it has been noted above, since January 1, 2005, outdoor advertising should be included in the composition of the types of activities subject to the tax on imputed income (item 2 of article 346.26 of the RF Tax Code). The respective physical indicators are set forth in article 346.29: dimensions of the information field of outdoor printed advertisements and dimensions of the information field of light and electronic outdoor displays. Both indicators are rated in square meters. The respective base profitability is set at Rub. 3000 and Rub. 4000 respectively.
The last group of amendments introduced to the second section of the RF Tax Code by law No. 95-FZ concerns the changes in the rates of the tax on the profit of organizations due to the budgets of RF subjects. In accordance with the new version of article 284 of the RF Tax Code, the amount of the tax calculated at the 6.5 per cent rate is due to the federal budget (previously the respective rate was set at 5 per cent), while the amount of the tax calculated at the 17.5 per cent rate is due to the budgets of RF subjects (previously the respective rate was set at 17 per cent). Prior to the changes introduced by law No. 95-FZ, 2 per cent of the tax on profit has been transferred to local budgets. The changes discussed
above resulted from the necessity to redistribute tax revenues among the budgets in connection to the shifts in expenditure obligations of budgets of different levels.
2.3.7. The law on the federal budget for year 2005 and interbudgetary relations
The law on the federal budget for year 2005 contains a number of innovations concerning the relations among the budgets of different levels.
First of all, it should be noted that the decisions taken in the sphere of division of powers between the tiers of state authority, as well as decisions relating to the ongoing tax reform have resulted in the necessity to redistribute tax revenues among the budgets of different levels. The most significant shift in this sphere was the next stage of redistribution of the revenues generated by the profit tax on organizations in favor of the federal budget: while in 2004 the federal budget received the revenues from the tax on the profits of enterprises and organizations calculated at the rate of 5 per cent, in 2005 the federal budget will receive the revenues from the profit tax calculated at the 6.5 per cent rate. In 2005, the revenues of regional budgets will be also affected by such decisions as the indexation of specific rates of excises, changes in the revenues generated by the tax on profits and the income tax on individuals resulting from the reduction of the effective rate of the single social tax.
As a result, the proportions of distribution of tax revenues between the federal budget and consolidated budgets of RF subjects will remain practically the same as compared with the data for years 2003 and 2004; it is planned that in 2005 the share of tax revenues of subnational budgets in the framework of the comparable budgetary classification (i.e. including in the composition of tax revenues the proceeds from external economic activities) will made about 40 per cent. However, taking into account the scale of planned transformations in different spheres; at this stage it seems problematic to arrive to conclusions abut the inter-territorial distribution of tax revenues as concerns regions.
As concerns the distribution of tax revenues among the budgets of different levels, it should be also noted that since 2005 there will be enacted the new rule of entering of revenues generated by federal taxes to the budgets of autonomous okrugs in the composition of oblasts and krais introduced by the new version of the law "On the general principles of organization of legislative (representative) and executive authorities of RF subjects" (article 26.17) and the new version of the RF Budget Code. In accordance with this rule, the revenues generated by federal taxes and fees should be due to the budget of the oblast (krai) in the case the agreement about the division of powers between the okrug and oblast (krai) does not stipulate otherwise.
However, article 27 of the law on the federal budget for year 2005 contains an exception from this rule as concerns the tax on the profits of enterprises and organizations and the mineral extraction tax as concerns hydrocarbon mineral resources (with the exception of natural gas): the respective revenues should be distributed between the budgets of Khanty Mansi and Yamal Nenets autonomous okrugs in the Tyumen oblast. The same article stipulates that these two autonomous okrugs should retain the rights to receive interbudgetary transfers similar to the rights of other RF subjects, which are not autonomous okrugs being in the composition of an oblast (krai). In other words, the draft law on the federal budget for year 2005 makes for two autonomous okrugs in the territory of the Tyumen oblast an exception from the general rule set for the RF subjects of the same status. It should be reminded that in 2004 the authorities of these okrugs agreed to transfer to the federal budget a considerable portion of additional tax revenues generated by the repayment of the tax arrears on the part of NK YUKOS; therefore, it may be surmised
that such a concession in the sphere of interbudgetary relations was made with respect to these two regions in exchange for transfer of additional revenues to the federal budget.
These practices do not seem productive, since any other forms of asymmetry and exceptions from the general arrangements set in the sphere of interbudgetary relations in a federative state undermine the efficiency of the incentives of behavior of regional authorities, soften budgetary constraints on regional and local authorities, and create incentives making the regional authorities to take decisions aimed at the satisfaction of preferences of the federal center, and not regional voters as it should be in a federative state.
In the course of an analysis of such an aspect of the law on the federal budget for year 2005 as interbudgetary relations, it is necessary to dwell on the problem of allocation of interbudgetary transfers as concerns the transfers from the federal budget to the budgets of territories. In 2005, it is planned to introduce certain changes, which seem to be radical in comparison with the trends observed in the laws on the federal budget for years 2001 through 2004.
In connection to the reform of the budgetary classification all gratis transfers between budgets and extra-budgetary funds are grouped in the section of the functional classification of budgetary expenditures "Interbudgetary transfers." At the same time, federal financial resources are transferred to regional and local budgets across several subsections: "Financial aid to budgets of other levels," "Compensatory Fund," and "Fund of Regional Development." Therefore, there was indicated the distinction between the financial aid, i.e. the support of relatively poor regions, and compensations for the expenditures associated with the exercise of delegated powers provided by the federal authorities, and assistance to investment in the region. As a result, the budgetary classification differentiates between the financial resources provision of which may result in various restrictions on the part of federal authorities (for instance, organization of the execution of regional budgets via the Federal Treasury) and other types of transfers to the budgets of lower levels, which are not related to their financial needs and are determined only by the necessity to comply with the federal legislation or priorities of upper levels of authorities and various forms of joint activities.
The total amount of financial resources planned to be transferred to the regional and local budgets in 2005 makes about Rub. 379 billion and in real terms (taking into account that the estimated growth in the consumer price index will make 8 per cent in 2005) is at about the same level as that targeted in the law on the federal budget for year 2004. However, taking into account the prognosticated growth in the gross domestic product interbudgetary transfers to territorial budgets will somewhat decline - from 2.2 per cent of GDP envisaged by the federal budget in 2004 to 1.9 per cent of GDP in 2005). As it will be demonstrated below, the structure of the planned transfers from the federal budget to regional budgets has also changed.
The major channel through which regional authorities receive financial aid is subventions for equalization of the budgetary security provided by the Fund of Financial Support of Regions; while in real terms the respective amount remained at the same level, it declined in terms of GDP: from 1.15 per cent of GDP registered in 2004 to almost 1 per cent in 2005.
In comparison with the figures registered in 2004, according to the law on the federal budget in 2005 in real terms the amounts of transfers from FFSR will decline in 33 RF subjects, increase in 36 RF subjects, and 2 regions will not receive FFSR transfers.
The regions, which are the "winners" because of the changes introduced in the Methods of distribution of FFSR financial resources include: Belgorod, Bryansk, Voronezh,
Ivanovo, Kursk, Tambov, Tula, Arkhangelsk, and Murmansk oblasts, Republic of Adygeya, Republic of Dagestan, Ingush Republic, Kabarda Balkar Republic, Karach Cherkess Republic, Stavropol krai, Volgograd and Rostov oblasts, Republic of Mari El, Chuvash Republic, Kirov, Nizhni Novgorod, and Penza oblasts, Komi Permyak autonomous okrug, Kurgan oblast, Republic of Altai, Altai krai, Irkutsk and Omsk oblasts, Taimyr (Dolgan Nenets) autonomous okrug, Republic of Sakha (Yakutiya), Primorski krai, Kamchatka and Magadan oblasts.
The regions, which are the "losers" because of the changes introduced in the Methods of distribution of FFSR financial resources include: Vladimir, Kaluga, Kostroma, Moscow, Orel, Ryazan, Smolensk, and Tver oblasts, Republic of Kareliya, Kaliningrad, Novgorod, and Pskov oblasts, Republic of Kalmykiya, Republic North Osetiya - Alaniya, Chechen Republic, Krasnodar krai, Republic of Mordoviya, Saratov, Ulyanovsk, and Chelyabinsk oblasts, Republic of Buryatiya, Republic of Tyva, Republic of Khakasiya, Kemerovo, Novosibirsk, Tomsk, and Chita oblasts, Aginsk Buryat, Ust Orda Buryat, and Evenk autonomous okrugs, Khabarovsk krai, Amur and Sakhalin oblasts, Evreiskaya autonomous oblast, Koryak and Chukotka autonomous okrugs.
The transfers of FFSR financial resources to Astrakhan and Sverdlovsk oblast were ceased.
The relationship between the changes in the amount of FFSR grants and the level of budgetary security of the region is presented in Table 12.
The data presented in Table 12 demonstrate that there is no clear relationship between the level of budgetary security and the changes observed in the amounts of grants provided by FFSR in accordance with the new methodology of distribution. This result is caused by a large number of differently directed changes in the Methods of distribution of FFSR financial resources. Thus, all 14 regions31 receiving less FFSR financial resources in real terms in 2005, in 2004 were in the group of regions receiving grants from the second part of FFSR aimed to raise the respective levels of budgetary security to the guaranteed minimum level. Due to the changes in the methodology these regions received less financial resources.
Table 12
The relationship between the changes in the amount of FFSR grants in 2005 in comparison with the data for 2004 in real terms and the level of budgetary security of the region
Level of budgetary security Number of regions receiving FFSR grants in real terms in 2005
Less than in 2004 More than in 2004
Below 50 % 14 18
50-70 % 11 9
Over 70 % 13 6
It should be noted that the law on the federal budget for year 2005 envisages a decline in the amount of the Compensatory Fund from Rub. 50 billion in 2004 to Rub. 33 billion in 2005 (from 0.33 per cent to 0.18 per cent of GDP). This development may be explained primarily by the reform of the system of social support. The transfer of powers
31 The Pskov oblast, the Republic of Kalmykiya, the Republic of North Osetiya - Alaniya, the Chechen Republic, the Republic of Mordoviya, the Republic of Buryatiya, the Republic of Tyva, the Aginsk Buryat, Ust Orda Buryat, Evenk autonomous okrugs, the Amur oblast, the Evreiskaya autonomous oblast, the Koryak and Chukotka autonomous okrugs.
concerning the introduction of the majority of social benefits (including the payment of child benefits, what represents the bulk of expenditures of the Compensatory Fund) to the regional level resulted in the following changes in the targets of subventions and subsidies provided from the Compensatory Fund in 2005:
• subventions and subsidies to certain categories eligible for federal social benefits in 2005 as concerns HPU payments (the HPU related social benefits should be abolished later), which are envisaged in federal laws on support of disabled persons, veterans, persons who participated in the liquidation of the consequences of the Chernobyl disaster, victims of other radiation accidents;
• subventions for financing of powers concerning the state registration of births, daths, and marriages;
• subventions for implementation of the stipulations of the federal legislation as concerns payments to donors of blood.
Therefore, starting since 2005, the Compensatory Fund will consolidate the financial resources for financing of all federal expenditure mandates defined as such in the legislation. It is one of the positive features of the law on the budget.
Unfortunately, the measures aimed at the reform of the system of interbudgetary transfers to regional and local authorities in 2005 practically did not concern the Fund of Regional Development (FRD). The only significant decision with respect to FRD was related to the inclusion in the composition of the Fund of transfers to RF subjects aimed at support of motor road network. From the authors' point of view, this decision can hardly be defined as justified and efficient.
The necessity of the reform of the mechanism of state support of road networks in regions and municipal entitles can not be denied. Both the methods of distribution of respective financial resources and the forms of provision thereof need to be reformed; however the inclusion of these resources in the composition of FRD does not answer the requirements of such a reform.
First, no transparent uniform methods of distribution of the funds aimed at support of the motor road network have been elaborated by 2005, and this problem has not been solved by the transfer of the respective financial resources to FRD.
Second, this transfer does not answer the objectives of the Fund set by the present concept of the further reform of interbudgetary relations - co-financing of investment projects of regional and local authorities in the sphere of social infrastructure carried out on tender basis. At present this objective can not be achieved, since FRD is a combination of federal targeted programs of regional development, where the financial resources of federal program "Equalization of differences in the social and economic development of RF subjects..." (the major source of co-financing of investment projects in the sphere of social infrastructure) makes only an insignificant part.
Third, the investment-oriented nature of the Fund of Regional Development does not correspond to the fact that financial resources for the state support of motor road networks in RF subjects are expended not only for capital construction and capital repairs of motor roads for general use, but also for maintenance and current repairs of motor roads. All these circumstances result in a significant distortion of objectives of FRD transfers and may have a significant negative impact on other components of this Fund.
Besides, it should be noted that in 2005 there will significantly decrease the expenditures (the amount of which in preceding years was rather large) associated with the federal targeted programs for development of the Republics of Tatarstan and Bashkortostan, which were adopted as a compensatory measure after the cessation of special tax and
budgetary conditions of agreements about the division of powers between these regions and the federal center. Thus, while in the preceding years the expenditures associated with these programs made more than Rub. 20 billion, in 2005 the respective financing will make about Rub. 11 billion.
The law on the federal budget for year 2005 also contains certain decisions aimed at the alteration of the procedures governing the granting of discretional (i.e. not regulated and formalized) types of interbudgetary transfers. Thus, in accordance with the new version of the RF Budget Code, which does not envisage such types of financial aid as budgetary loans, the law on the budget for year 2005 contains a tough requirement that budgetary credits to the budgets of RF subjects were extended within the budgetary year. Credits to the budgets of RF subjects from the federal budget may be provided for the purposes of liquidation of temporary cash gaps and financing of expenditures relating to the liquidation of consequences of natural calamities. At the same time, a clearly positive result of the switching to the use of budget credits is that credits from the federal budget are provided on paid basis: in 2005 the payment of the use of newly extended credits will make one fourth of the refinancing rate of the Central Bank; however, the credits extended in relation to the liquidation of consequences of natural calamities should be free.
The law on the federal budget grants the RF Finance Ministry to prolong budgetary loans extended prior to the enactment of the law, i.e. prior to October 1, 2005. However, after this date free budgetary loans should be reregistered as paid budgetary credits. The law also envisages tough measures in the cases of non-repayment of the funds of the federal budget like write-downs from accounts, withholding of revenues generated by federal taxes, recovery of transfers.
On the face of it, the provisions of the law on the federal budget for year 2005 facilitate an enhancement of efficiency of interbudgetary relations and regional finances. No doubt that the introduction of payment for the use of the financial resources of the federal budget will facilitate a gradual cessation of the use of budgetary loans as an additional type of financial aid provided on approval of the RF Finance Ministry in the case of financial difficulties.
However, the consequences of the decision to cease the use of budgetary loans will to a great extent depend on the practices of granting of budgetary credits in 2005. Taking into account the low interest rates of the credits, it may be surmised that in the case these credits are granted at a significant scale, are frequently restructured, and may be legislatively prolonged, while no measures are taken to exact overdue indebtedness, this measure may result in a further softening of budgetary constraints on regional authorities and gradual waning of positive effects expected from the introduction of these stipulations of the law on the budget.
2.4. Russian Financial markets
2.4.1. The Market for Public Debt
Since 2001 the government has demonstrated different trends in its policy on the market for external and domestic debt. More specifically, despite the existence of a stable surplus of the federal budget, the volume of the domestic debts has been growing over last 2-3 years, while the volume of borrowings overseas was declining gradually (Table 13).
Table 13
The Dynamics of Russia's External and Domestic Debt in 1993-2004
(as of End of the Year)
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
Domestic debt (as Rb.bln.) 0.22 10.62 76.76 248.98 450.97 493.74 529.83 531.81 511.06 654.7 663.67 756.82
Foreign debt (as USD bln.) 112.7 119.9 120.4 125 130.8 150 157.5 143.4 130.1 123.5 119.7 112.932
Against the background of an extremely favorable state of affairs on mineral markets in 2004, the government raised the issue of the possibility of an early debt repayment to the Paris Club. Should the parties concerned arrive to an agreement on the issue, the volume of Russia's foreign debt may decrease substantially. The state of affairs in the area of the nation's domestic and external debt in 2004 found itself under the impact of various factors that will be addressed below.
Domestic Debt
By 2004 results, the volume of Russia's public domestic debts in T-bills grew roughly by 14.0% from Rb. 663.7 to 756.8 bln. (while it fell in shares of GDP equivalent from 5.0 to 4.5% of GDP). The federal bonds account for 99.99% of the public debt (Table 14).
Table 14
The Structure of Russia's Public Domestic Debt (as Rb. Bln.)
Types of securities As of 1 January 2004 As of 1 January 2005
GKO 2.72 0.02
OFZ-PK 24.1 0.001
OFZ -PD 50.48 43.31
OFZ -FK 199.31 171.22
OFZ -AD 375.42 542.24
OGNZ 11.5 0
1992 ORVVZ. 0.04 0.03
OGSZ 0.1 0.0002
Total 663.67 756.82
In 2004, the dynamics of quotations of the Rb—denominated T-bills was not gradual . By the 2004 results the average weighted yields of the traded issues fell by just 0.43%-from 7.1 down to 7.08% annualized (Fig. 17). However the market has been quite volatile through the year, with the average weighted yields fluctuating between 4 to 9% annualized, while investors' activity grew notably vs. the respective 2003 indicators. Thus the ag-
32 As of October 1,2004.
114
gregate turnover if trades in the market for GKO-OFZ in 2004 roughly accounted for Rb. 350.8 bln. vs. 243.8 bln. in 2003 (44%). The peak weekly volume of trades in 2004 was a. Rb. 35.87 bln. (20.43 bln. in 2003), while the minimum volume was Rb. 350 mln. (in 2003750 mln.).
Fig. 17. The Dynamics of the GKO-OFZ Market in 2004
The dynamics of the market for Rb.-denominated government bonds have undergone a series of changes over 2004. Thus, between January through February the yelds tended to decline, with the market being affected by two main factors: that is, an excessive liquidity in the banking sector and a notable appreciation of Rb. against USD. The market was also affected by the RF Minfin's declaration regarding the 2004 domestic borrowing program that provided for a more than 5-fold rise in the offer of the papers vs. the 2003 indicators. In February, the market for public debt demonstrated the rise in the primary offer with a premium vs. the secondary one. That contributed to a successful completion of the actions, notwithstanding a moderate demand. Given a favorable situation with liquidity, the demand at the auctions was at an acceptable level, which, however, has led to some fall in investors' activity on the secondary market and contributed to just a moderate price rise of Rb-denominated bonds. Notably, it was February 2004 when the average weighted yields of GKO-OFZ sank to the 2004 minimum value of 3.85 % annualized.
The average weighted yields rate grew by early March, while the markets absorbed up to a half of the volume of papers offered by the MinFin. The price rise resumed after V. Putin's re-election, with non-residents apt to buy Rb.-denominated assets, which increased limits on Rb.-denominated instruments. The average weighted yields slid by mid-April to the level of 5.9% annualized, followed by the start of adjustment in the market that was in place until late May. The change of the trend was triggered by a drastic deterioration of the situation with liquidity in the banking sector, coupled with Rb. appreciating against USD.
Between June through July the quotations of T-bills were experiencing sporadic fluctuations, with no clear trend in place. The situation was affected by the commotion around sodbisnessbank and Kredittrust; plus, the market proved to be sensitive to a certain negative impact of the takeover of Guta-bank by Vshehtorgbank. And if it was not enough, YUKOS' darkening prospects generated investors' flow from the corporate securities market to the one for T-bills, which can potentially be viewed as a factor that supported the latter.
August 2004 saw a relatively stable market, whereat, on the one hand, an insignificant change in quotations could be explained by seasonality, while on the other hand, their low volatility could evidence a great stability of already emerged price levels. In September, the yields rates of the trade bonds were lowering against an extremely high level of liquidity in the banking system (with the respective indicators being the highest ones over the past half year). October-November 2004 saw the investors' overflow from the secondary to primary market, and the demand was chiefly steered by a favorable situation with the banking liquidity and the USD depreciation. Given this particular background, the November volume of trades on the secondary market sank to the 2004 minimum level, while that on the primary market proved to be record - breaking. The demand for placed papers to a significant extent was inspired by Fitch, which had increased Russia's credit rating from "BB+" up to the investment level "BBB-", with the forecasted stability of the rating.
In December, the rise in quotations of T-bills was fueled mostly by the improving situation in terms of the banking liquidity and the ongoing depreciation of USD against Rb. The leap of yields at the very end of the year could be explained by growing inflationary expectations, which could not yet been compensated by a Rb. appreciation.
In 2004, the MinFin successfully held 27 auctions on placement of GKO-OFZ. The volume of face-value offer accounted for some Rb. 172.3 bln., while the actual volume of place papers made up roughly as much as 87.9 bln. As of December 31, 2004, the volume of the GKO-OFZ market was Rb. 557.56 bln. at face-value and 544.82 bln. - in market prices. The duration of the GKO-OFZ market portfolio made up 1756.63 days.
Given the dynamics of the 2004 market for Rb.-denominated bonds, it can be assumed that in 2005 the quotations will find themselves affected by two main factors: that is, the USD/Rb. exchange rate and a high liquidity in the banking sector. Plus, as on January 31, 2005, S&P's increased Russia's rating up to the investment level may also support a favorable state of affairs on the market for Rb.-denominated T-bills. However, given the remaining trends to growth in the volume of borrowings on the domestic market, a considerable downfall in yields rates is unlikely. Yet another factor that can constrain the rise in quotations is inflation. As it has become clear in late 2004 that by results of the year the price rise rates would overshoot the 2004 original budget indicators, while the price rise over the first two months 2005 accounted for slightly under the half of the 2005inflation targets, the emergence of inflationary expectations can also exert a negative influence on prices of Rb.-denominated bonds in 2005.
External Debt
As of October 1, 2004, the volume of Russia's external debt shrank from USD 105.7 bln. to 99.8 bln. (according to CBR), which means a 5.58% reduction in the absolute amount of foreign debt accumulated by the RF Government. In 2004 Russia paid on a sole Eurobond issuance, which took place in March. By contrast, over the period in question the private sector (banks and companies) boosted their debt to non-residents from USD
80.0 bln. up to 92.3 bln. (+15.4%). So, by results of the first 9 months 2004 Russia's aggregate foreign debt grew from USD 185.7 bln. up to 192.1 bln.
As concerns the market of forex-denominated bonds, quotations of a number of trade papers were surging over the period in question, while some other were declining. More specifically, in late December 2004 the yields rates of the papers of the 5th OVVZ tranche accounted for 4.99% annualized (5.66% as of the beginning of the year), while those of the 6th OVVZ tranche - 4.2% annualized (4.34%). By contrast, the yields rates of RUS-30 dropped from 7.35% to 6.64%, while yields to maturity of RUS-07 was a. 6.35% annualized (4.42 as of early 2004), and RUS-18 were traded at prices equivalent to 7.02% annualized (6.59% as of early 2004).
The dynamics of the 2004 Eurobond market found themselves under such critical positive factors as an extremely favorable price situation in the world markets for oil and metals and a fairly stable macroeconomic situation in the country. The noted increase of Russia's investment rating by Fitch has also formed a positive factor, so long as the price dynamics for Eurobonds are concerned. Speaking of critical negative factors, one should primarily note the unfolding conflict between the authorities and YUKOS. In addition, the increase of interest rates in the US (in response to the peril of a rise of inflationary processes in the US economy) has fueled the rise in the yields rates of the US T-bills, which was also mirrored by the dynamics of the Russian segment of the world market for Eurobonds.
9.0%
8.0%
7.0%
6.0%
5.0%
4.0%
3.0%
Source: Investment Agency "Finmarket"
Fig. 18. Yields to Maturity of OVVZ in 2004
The dynamics of quotations of Eurobonds allows to single out several periods (Fig. 19). In the 1st quarter 2004, the quotations of the whole range of Eurobonds in circulation was rising gradually, which can be explained by a series of factors, such as the dynamics of the basic assets (the US T-bills). The latter was determined by statements of the FRS' representatives. They argued that it was not the time yet to raise interest rates in the economy
and the interest rate should remain unchanged, at least, within the next months. The noted increase of Russia's credit rating in forex equivalent by S&P's from "BB" up to BB+" can also be regarded as a positive factor, but it failed to secure a long-lasting effect on quotations. Rather, it it caused just a short-term price rise. A favorable macroeconomic situation in the country and the rise in world prices for oil encouraged foreign investors in the market for the Russian Eurobonds. Finally, the political environment also influenced the markets: for instance, while Mr. Putin's re-election for the second term had lowered uncertainty about the RF Government's course for the next 4 years, the Cabinet reshuffle caused just a transient and reserved reaction of the markets.
9.5%
8.5% -
7.5% -
6.5%
5.5%
4.5% I
3.5% -
2.5%
-USD-2030
-USD-2007
USD-2018
Source: Investment Agency "Finmarket"
Fig. 19. The 2004 Yields to Maturity of the Russian Eurobonds with the Maturity Dates in 2030, 2018, and 2007
April 2004 saw the change of the upward dynamics of the quotations and the start of a downfall in quotations which lasted through late May. A substantial deterioration of the situation on the market for Eurobonds was fueled by the negative dynamics of the basic assets. In addition, April saw a greater capital outflow from Russia, which could be the foreign investors' reaction to the deterioration of the investment climate in the country against the background of the YUKOS case. The situation with liquidity was also deteriorating-sometimes to the extent there were no transactions on some kinds of bonds. The vectors of prices of the Russian Eurobonds were being opposite until August: while the state of affairs on the markets for minerals had a favorable impact both on the dynamics of the quotations and Russia's budget, there were several factors that were exercising at once a negative pressure on the prices. The prices primarily reacted to a greater volatility of basic assets. Thus, over a single month the yields rates of the US government bonds would reach a two-year peak and consequently fell nonetheless. The prices of the Russian forex-denominated bonds were also affected by the issuance by Germany of credit notes tied to
Russia's debt repayment to Germany. While the notes formally are the German government papers, Investors viewed that as an increase of the offer of Russian papers. Finally, the court marshals' decision to sell the core YUKOS's oil-producing asset, Yuganskneftegas, obviously did not contribute to a rise in the quotations.
However, the trend to a rise in quotations of the Russian Eurobonds was prevailing over the next three months. More specifically, in August, the rise in quotations was triggered by the information of Russia's intention to start consultations with the Paris Club on a repayment or exchange of its USD 4.7 bln.-worth debt to the club, and investors appreciated Russia's eagerness to reduce the volume of its foreign debt. The price rise for basic assets also contributed to the one for Russia's forex-denominated bonds. In September, the quotations of the latter somewhat grew against a fall in the yields rates of the US bonds. Once the information appeared that the Moody's investors Service had decided to revise Russia;s sovereign rating up to "positive" due to the improvement of the macroeco-nomic situation in the country, it also generated the consequent price rise in October.
However, the price rise on the market for the Russian Eurobonds discontinued in November. That in part can be explained by soaring yields rates of the US bonds due to A. Greenspan's statement of a possibility for foreign investors to loose their interest in the US papers. It was only thanks to Fitch's raising of Russia's sovereign rating up to the investment level in mid-November that Russia's Eurobonds ceased to fall In December, they bounced back and forth, because of a simultaneous influence of opposite factors. On the one hand, the dynamics of prices of the US T-bills were favorable for the price rise for Russian bonds. Another favorable news became Moody's raising Gasprom's rating up the investment level. On the other hand, back- tax claimes to Megaphon and Vympelkom triggered a downfall in prices, while the results of the auction on Yugansknetegas did not appear particularly encouraging either.
Overall, the 2004 dynamics of the market for the Russian Eurobonds were fairly moderate and mirrored the presence of political risks investors might face in the country. However, against the background of the raising of the US basic interest rate the yields rates of the basic assets, the US bonds, remained practically unchanged, which also affected the dynamics of the Russian segment of the respective market. Given the current general economic trends in the US economy, one can expect a further increase of the rates. This should undoubtedly have an effect on the yields rates of the US T-bills and, accordingly, other segments of the world market for Eurobonds, including Russia's. The factor capable of neutralization of this particular effect could be just a lowering of political risks in Russia, as well as S&P's raising its credit rating up to the investment level. Furthermore, the RF Government's eagerness to ensure an early debt repayment to the Paris Club and the IMF should help the Russian Eurobonds in 2004, providing the negotiations are a success.
2.4.2. The market for subfederal and municipal debt
Dynamics of market development
Following the results of 2004, the regional consolidated budget was executed with surplus amounted to Rb 31.9 bn, i.e. 1,1% of its expenditure side or 0,19% of GDP. The budgets of the Federation's subjects were executed with a surplus of almost Rb 28.7 bn (1,6% of the expenditure side), the budgets of the municipal formations - with surplus Rb 2.2 bn (0,2% of the expenditure side).
In the preceding two years the regional consolidated budget was executed with deficit. In such a way, in 2003, deficit of the Federation's subjects' budget amounted 2,3% of its expenditure side (3,0% in 2002). Earlier, the municipalities' budgets were also executed with deficit 3,2% - in 2003, and 2,8% - in 2002 (Table 15).
Table 15
The territorial budgets' surplus (deficit) to budget expenditures (%) ratio
Regional consolidated budget Regional budgets Municipal budgets
2004 1.1 1.6 0.2
2003 -2.6 -2.3 -3.2
2002 -2.7 -3.0 -2.8
Source: IET calculations based on the data of the Ministry of Finance of the RF.
As of January 1, 2005, the consolidated budget in 43 Russian federation's subjects was executed with surplus. An aggregate volume of the budget surplus reached in those regions Rb 82.7 bn or 6,08% of the value of revenue side of their budgets. The median value of the budget surplus made 1,79% of the expenditure side of the budget.
The highest surplus to consolidated budget revenues level ratio had been achieved in the Evenk Autonomous District (AD) - 47,7%, Tyumen Region - 27,6%, Nenets AD -17,4%, Lipetsk Region- 13,8%, Khanty-Mansijsk AD - 13,6%, Chukotka AD - 12,8%, and in Vologda Region- 12,2%. Almost half - 48,8% - of aggregate surplus of the regional budget was provided by the two Federation's subjects: Khanty-Mansijsk AD - 29,5% or Rb 24.4 bn, and Tyumen Region - 18,8% or Rb 15.6 bn. According to estimates, the major cause of such considerable surplus of the Federation's subjects, following the results of 2004, became Yukos' unplanned tax revenues, paid by the company in accordance with the legal actions won by the government on the revealed tax arrears of the previous years.
In 2004, in 46 subjects of the RF the consolidated budget, an aggregate volume of which totaled Rb 50.8 bn or 3,45% of the revenue side of their budgets, had been executed with deficit.
The median level of the budget deficit made 2,3% of the relevant budget revenues. The highest deficit to budget revenues ratio observed in Khabarovsk Territory (12,6%) and Novosibirsk Region (10,1%).
About 68% of the aggregate deficit fell on 6 Federation's subjects - Moscow (27,2% or Rb 13.76 bn), the Moscow Region (10,7% or Rb 5.42 bn), Khabarovsk Territory (8,5% or Rb 4.28 bn), the Republic of Tatarstan (7,6% or Rb 3.85 bn), Republic of Sakha (Yakutia) (7,2% or Rb 3.65 bn), Novosibirsk Region (6,9% or Rb 3.5 bn) (Table 16).
Table16
Execution of consolidated budgets of the Russian Federation's subjects in 2004 (%)
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Belgorod Region 20 295.38 1 541.28 7.59 2.38 -1.41 0.76 8.93 -18.59
Bryansk Region 14 236.23 -468.09 -3.29 8.71 3.65 0.69 1.07 -110.94
Vladimir Region 18 234.29 51.07 0.28 0.78 0.02 0.06 4.22 6.56
Voronezh Region 23 850.79 -155.72 -0.65 14.49 0.95 1.33 1.74 -146.08
Ivanovo Region 14 473.23 33.76 0.23 2.56 0.59 0.18 2.79 253.49
Kaluga Region 14 905.97 -510.24 -3.42 4.08 3.20 0.08 2.88 -93.47
Kostroma Region 9 613.40 -369.48 -3.84 13.12 3.14 1.23 1.67 -81.82
Kursk Region 14 068.87 88.51 0.63 3.74 -0.96 0.40 0.61 -153.14
Lipetsk Region 24 908.78 3 438.32 13.80 0.02 -0.02 0.00 20.04 -0.11
Moscow Region 115 863.94 -5 417.58 -4.68 28.59 8.00 2.67 7.49 -171.10
Oryol Region 9 980.82 -28.75 -0.29 0.80 -0.27 0.00 3.28 95.13
Ryazan Region 13 994.32 -107.56 -0.77 2.29 -0.07 0.28 3.09 9.25
Smolensk Region 12 421.39 8 460.00 0.07 3.55 -0.10 0.38 1.29 -148.17
Tambov Region 13 853.19 -276.95 -2.00 2.31 1.54 0.04 0.65 -76.87
Tver Region 18 431.36 78.46 0.43 3.08 0.53 1.28 3.20 125,08
Tula Region 21 482.54 -177.33 -0.83 14.15 0.47 1.31 1.16 -56.94
Yaroslav Region 21 675.18 -1 958.65 -9.04 24.34 6.95 1.71 1.25 -76.92
Moscow 394 450.57 -13 760.93 -3.49 12.38 5.06 1.89 11.15 -145.16
Total 776 740.23 -17 991.41 -2.32 12.89 4.16 1.59 8.24 -179.54
North-Western federal district
Republic of Karelia 13 843.52 -593.54 -4.29 12.48 1.34 1.05 0.98 -31.34
Komi Republic 30 071.04 -23.42 -0.08 4.77 0.00 1.08 3.80 6.38
Arkhangelsk Region 24 659.77 120.02 0.49 5.13 0.74 0.44 2.38 152.77
Vologda Region 29 515.33 3 604.28 12.21 1.63 -0.52 0.27 15.47 -4.25
Kaliningrad Region 13 957.72 -268.10 -1.93 7.22 1.89 0.34 2.43 -97.95
Leningrad Region 27 310.98 -1 020.72 -3.74 9.94 3.44 0.87 4.99 -92.08
Murmansk Region 20 012.30 447.62 2.24 5.70 -1.05 0.55 3.64 -46.88
Novgorod Region 8 796.88 11.23 0.13 3.47 0.12 0.14 1.95 95,19
Pskov Region 9 463.55 -288.42 -3.05 8.51 3.91 0.46 2.37 -128.31
St. Petersburg 95 778.28 1 251.06 1.31 14.31 -1.88 1.83 4.30 -143.58
Nenets AD 5 319.72 927.63 17.44 1.69 0.56 0.39 20.21 3.23
Total 278 729.0 4 166.76 1.49 8.85 -0.06 1.03 5.18 -4.25
South federal district
Republic of Adygeya 5 074.44 -110.92 -2.19 4.67 2.10 0.02 1.97 -96.25
Republic of Dagestan 27 289.71 -453.06 -1.66 0.18 -0.09 0.00 0.89 5.56
Republic of Ingooshetia 5 271.25 162.13 3.08 0.28 -0.99 0.00 3.67 -32.07
Kabardino-Balkarian Republic 8 120.07 -48.57 -0.60 21.70 0.08 1.13 0.44 -14.01
Republic of Kalmykia 6 450.29 461.89 7.16 0.47 -2.10 0.19 6.21 -29.29
Karachai-Circassian Republic 6 033.28 -234.66 -3.89 29.60 4.11 0.50 1.20 -105.69
Republic of North Ossetia -Alania 10 566.15 192.31 1.82 0.65 -0.99 0.18 3.64 -54.67
Chechen Republic 25 038.03 428.50 1.71 0.00 -0.26 0.00 2.39 -15.08
Krasnodar Territory 65 149.14 -767.01 -1.18 2.67 0.52 0.19 3.62 -44.38
Stavropol Territory 24 979.69 -120.94 -0.48 2.01 0.82 0.02 4.72 -169.67
Astrakhan Region Volgograd Region Rostov Region Total
Privolzhsky federal district
Republic of Bashkortostan Republic of Marij El Republic of Mordovia Republic of Tatarstan Udmurtian Republic Chuvashi Republic Kirov Region Nizhni Novgorod Region Orenburg Region Penza Region Perm Region Samara Region Saratov Region Ulyanovsk Region Komi-Permyak AD Total
Ural federal district
Kurgan Region Sverdlovsk Region Tyumen Region Chelyabinsk Region Khanty-Mansijsk AD Yamalo- Nenets AD Total
Siberian federal district
Republic of Altai Republic of Buryatia Republic of Tuva Republic of Khakassia Altai Territory Krasnoyarsk Territory Irkutsk Region Kemerovo Region Novosibirsk Region Omsk Region Tomsk Region Chita Region Aginsk Buryat AD Taimyr (Dolgano-Nenetsk) AD
Ust-Ordynski Buryat AD
Evenk AD
Total
Far East federal district
Republic of Sakha (Yakutia) Primorie Territory Khabarovsk Territory
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10 872.39 -431.60 -3.97 9.37 2.56 0.36 1.65 -64.56
25 750.46 -1 285.50 -4.99 10.48 3.20 1.20 1.13 -64.03
49 521.88 709.63 1.43 0.39 -0.51 0.14 4.91 -35.32
270 116.7 -1 497.78 -0.55 3.74 0.51 0.26 3.13 -91.87
58 915.10 369.10 0.63 3.83 1.65 0.35 14.95 263.94
9 335.29 -241.20 -2.58 5.08 1.74 0.40 0.79 -67.26
23 269.49 1 387.29 5.96 0.71 -3.56 1.04 4.14 -59.72
95 824.50 -3 845.82 -4.01 5.03 1.91 0.21 1.07 -47.62
21 920.93 -537.89 -2.45 5.96 1.95 0.22 5.87 -79.51
16 680.15 -529.79 -3.18 5.29 2.63 0.61 2.60 -82.70
19 721.37 -861.96 -4.37 2.57 -1.85 0.16 1.82 42.31
40 511.90 122.32 0.30 19.29 -0.35 1.80 2.61 -117.15
26 785.52 546.25 2.04 1.02 -0.72 0.15 2.86 -35.47
15 902.18 41.15 0.26 3.86 0.28 0.24 2.60 106.59
48 278.43 3 193.72 6.62 1.85 -0.22 0.09 11.01 -3.35
47 110.39 827.07 1.76 7.55 -1.80 0.87 6.86 -102.80
27 822.35 -591.48 -2.13 7.33 1.80 0.83 0.70 -84.68
13 325.82 195.87 1.47 3.12 -1.06 0.38 3.29 -71.79
3 557 151.00 38 125.00 1.07 0.97 -0.29 0.14 2.21 -27.32
468 961.4 112.75 0.02 5.56 0.37 0.52 5.21 1 542.95
13 767.14 -49.93 -0.36 1.66 -0.42 0.32 1.12 115.44
60 207.10 912.66 1.52 1.38 -0.72 0.07 2.33 -47.81
56 332.16 15 569.77 27.64 0.20 -1.49 0.27 31.09 -5.39
55 751.02 5 469.07 9.81 0.04 -0.23 0.01 18.80 -2.31
179 227.73 24 407.37 13.62 1.20 0.27 0.29 16.67 1.96
67 774.40 2 410.28 3.56 2.25 -0.55 0.77 7.46 -15.44
433 060.4 48 719.22 11.25 1.13 -0.31 0.30 14.89 -2.78
7 042.15 -22.13 -0.31 4.67 1.09 0.28 5.66 -348.00
21 367.03 93.27 0.44 14.47 0.57 1.34 1.44 131.33
8 224.78 -26.30 -0.32 1.64 0.38 0.00 0.29 -117.88
7 694.83 209.87 2.73 1.26 -1.01 0.11 2.90 -37.01
34 786.68 -513.30 -1.48 5.61 2.06 0.08 1.36 -139.94
74 452.82 1 064.64 1.43 11.69 1.58 1.10 6.09 110.23
39 130.90 -847.02 -2.16 9.02 1.96 0.51 2.67 -90.73
61 923.98 3 072.48 4.96 0.98 -0.19 0.25 7.66 -3.90
34 626.65 -3 502.94 -10.12 126.71 15.16 5.38 1.09 -149.87
35 531.54 2 951.65 8.31 18.90 -0.96 1.09 8.77 -11.53
20 980.18 -643.07 -3.07 22.14 2.69 1.56 1.45 -87.71
20 246.43 -290.43 -1.43 1.86 1.21 0.08 1.43 -84.55
4 122.93 471.81 11.44 0.53 0.21 0.00 16.44 1.87
5 380.82 0.48 0.01 0.00 -0.28 0.00 5.47 -3 099.17
3 004.32 -38.65 -1.29 0.03 0.03 0.00 2.29 -2.36
6 630.60 3 164.13 47.72 3.17 -49.54 3.24 1.47 -103.82
385 146.6 5 144.50 1.34 19.29 1.33 1.12 4.41 99.57
59 660.85 -3 646.72
36 529.10 95.69
33 908.86 -4 284.14
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1.05 1.50 -52.14 0.25 1.06 -253.59 1.42 0.84 -56.79
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Amur Region 20 756.26 -226.64 -1.09 6.59 1.79 0.50 1.61 -163.65
Kamchatka Region 12 852.93 -501.69 -3.90 9.35 1.79 0.60 0.91 -45.73
Magadan Region 10 180.05 -176.81 -1.74 3.25 1.60 0.05 2.30 -92.08
Sakhalin Region 18 374.88 -405.66 -2.21 7.43 2.07 0.55 1.72 -93.70
Jewish Autonomous Region 4 382.00 70.63 1.61 2.23 0.28 0.08 5.29 17.34
Koryak AD 2 991.12 -144.45 -4.83 11.58 5.16 0.51 1.63 -106.85
Chukotka AD 19 257.91 2 470.97 12.83 0.00 -3.17 0.38 12.34 -24.68
Total 218 894.8 -6 748.83 -3.08 8.64 2.19 0.72 2.39 -71.00
Total federal districts 2 831 649.46 31 905.21 1.13 9.15 1.55 0.90 6.99 137.29
Source: lET's calculations based on the data of the Ministry of Finance of the RF.
Changing the structure of accumulated debt
In 2004, the volume of accumulated debt of the regional consolidated budget increased by Rb 43 684.6 million or by 0,26% GDP. Increase of the debt was due to growth of the domestic debt (i.e. the debt denominated in rubles). The foreign debt of the regional consolidated budgets decreased by Rb 3421.1 million, domestic debt - increased by Rb 47 105.6 million (Table 17).
Table 17
Net borrowings of regional and local budgets (% to GDP)
Jan.- Jan.-
1995 1996 1997 Aug. Dec. 1999 2000 2001 2002 2003 2004 1998 1998
Borrowings of sub-federal and local government including: Repayable loans
from the budgets 0.07 0.23 0.66 0.05 -0.09 -0.11 -0.03 0.04 0.12 -0.1 -0.02
0.38 0.87 1.43 0.71 0.33 0.15 -0.29 -0.04 0.47 0.37 0.26
of other level Subfederal (municipal) bonds
n.d. 0.16 0.22 0.08 -0.01 -0.05 -0.27 -0.07 0.16 0.31 0.29 other borrowings 0.31 0.48 0.55 0.58 0.43 0.31 0.01 -0.02 0.19 0.6
0.03 -0.18 0.09 0.02 -0.19 -0.30 -0.05 -0.04 -0.18 -0.62
Lessening of budgetary accounts' balances Financing deficit using borrowings and cutting the balances of budgetary accounts
0.38 0.9 1.25 0.8 0.35 -0.04 -0.59 -0.09 0.38 0.19 -0.36
Source: lET's calculations based on the data of the Ministry of Finance of the RF.
The structure of borrowings
The total volume of borrowings of the regional consolidated budget of 2004 amounted to Rb 259 019.9 million, of them the external borrowings - Rb 14 699.0 million. The external loans' recipients were: Moscow - Rb 13 434.0 million, Bashkortostan - Rb 1 262.5 million, and St. Petersburg - Rb 2.5 million.
The total volume of domestic borrowings of the regions and municipalities made up Rb 244 320.9 million. The following borrowers became the largest on the domestic market: Moscow - Rb 35.4 bn, Moscow Region - Rb 33.1 bn, Novosibirsk Region - Rb 18.0 bn, St. Petersburg - Rb 13.7 bn. As compared to 2003, an increase of borrowings in nominal terms reached Rb 26.8 bn or 11,2%, which practically is in accord with the level of inflation.
The regions with clearly defined budget deficit demonstrated the most net borrowings to budget revenues ratio: Novosibirsk Region - 15,2%, Moscow Region - 8,0, Khabarovsk Territory - 7,2, Yaroslavl Region - 7,0, Koryak AD - 5,2, Moscow - 5,1%.
The largest net borrowers became: Moscow - Rb 20.0 bn, Moscow Region - Rb 9.3 bn, Novosibirsk Region - 5.2 bn, Khabarovsk Territory - Rb 2.4 bn, Republic of Sakha (Yakutia) - Rb 1.9 bn, Republic of Tatarstan - Rb 1.8 bn, Yaroslavl Region - Rb 1.5 bn, Krasnoyarsk Territory - Rb 1.2 bn.
To the highest degree the accumulated debt was cut by: Evenk AD - Rb 3.3 bn, St. Petersburg - Rb 1.8 bn, Samara Region - Rb 850 million, Tyumen Region - Rb 839 million, Republic of Mordovia - Rb 829 million.
In the total volume of domestic borrowings of the regional consolidated budget securities issuing accounted for 32,5%, loans from the federal budget - 3,0%, other borrowings (primarily for banking credits) - 64,5%. Special attention deserves continuation of active securitization of the subfederal debt. As compared to previous year, the share of borrowings in regions' securities increased, in 2004, by 7,2 points -from 33,8 to 41,0%, and in borrowings of the municipal administrations - 1,6 times (from 2,5 to 4%). Therefore, for the last 2 years, the level of securitization of the market of domestic municipal borrowings increased 4 times, while the market of regional borrowings - more than 2 times (Table 18).
Table 18
The structure of domestic borrowings of the subnational budgets in 2004 (%)
2004 2003 2002
Regional consolidated budget Regional budget Municipal budgets Regional consolidated budget Regional budgets Municipal budgets Regional consolidated budget Regional budgets Municipal budgets
Total, million rubles 244 320 927.0 183 003.8 110 466.4 229 789.0 174 852.6 108 436.3 211 135.2 154 077.4 101 206.3
Securities issuance 32.5 41.0 4.0 26.9 33.8 2.5 1 3.8 18.3 1.0
Budgetary loans 3.0 4.0 46.4 7.9 10.6 48.9 11.9 16.7 43.1
Other borrowings 64.5 55.1 49.6 65.3 55.6 48.6 74.2 65.0 56.0
Source: lET's calculations based on the data of the Ministry of Finance of the RF.
During 2004, the aggregate surplus balances on the accounts of regional and local budgets increased by Rb 103.6 bn - to Rb 198.1 bn, i.e. an increase in real terms was 87,7%. In conditions of continuing economic growth, largely explained, as before, by the external business environment, a wish to increase the budgetary reserves of the territorial government agencies appears to be justified. 124
Domestic bonded loans In 2004 the bonded loans had been registered of 24 federation's subjects and 10 municipal formations (as compared to 23 regional and 7 municipal loans in 2003). The total volume of placed bonds made up in 2004 Rb 79,4 bln., in comparison with Rb 67.1 bln in 2003, i.e. increased for a year from 0,46 go 0,47% GDP (Table 19).
The low level of interest rates on the market of government papers contributed to placement of bonds: the spread to OFZ bonds of Moscow and St. Petersburg was 0,51,5%, other issuers, for example Murmansk and Irkutsk regions, Republic of Karelia, Komi Republic, Chuvash Republic, Republic of Bashkortostan - 2-4% of OFZ level. For a year, the spread of subfederal papers to OFZ decreased 1,5-2 times. Yield to maturity on most of the subfederal papers did not exceed the level of inflation. For the first 10 months of 2004 the volume of the market of subfederal papers had grown even 1,5 times, having increased up to Rb 121.4 bln. The volume of monthly exchange turnover of the subfederal and municipal bonds increased almost 2 times - from Rb 29.7 bln in October 2003 to Rb 59.2 bln in October 2004.
Table 19
Volume of issuance of subfederal and municipal papers (% to GDP)
1996 1997 1998 1999 2000 2001 2002 2003 2004
Issuance 0.63 0.77 0.47 0.31 0.19 0.17 0.27 0.46 0.47
Repayment 0.47 0.56 0.48 0.36 0.46 0.23 0.10 0.15 0.19
Net financing 0.16 0.22 -0.01 -0.05 -0.27 -0.07 0.16 0.31 0.29
Source: IET' calculations based on the data of the Ministry of Finance of the RF.
In 2004, issue prospectuses had been registered in the Ministry of Finance of the RF by: Moscow, St. Petersburg, Chuvash Republic, Volgograd and Tomsk regions, Komi Republic, Leningrad, Irkutsk and Moscow regions, Khabarovsk Territory, Republic of Sakha (Yakutia), the Republic of Marij El, Novosibirsk Region, Yamalo-Nenetsk AD, Yaroslavl Region, Krasnoyarsk Territory, Republic of Bashkortostan, Republic of Karelia, Krasnodar Territory, Lipetsk, Nizhni Novgorod, Voronezh, Kaluga and Bryansk regions, Ekaterinburg, Ufa, Yuzhno-Sakhalinsk, Krasnoyarsk, Novosibirsk, Tomsk, Novocheboksarsk, Barnaul, Perm, Noginsk District of Moscow Region.
The largest issuers of debt securities became: Moscow, which accounted for Rb 32.4 bln. or 40,7% of the volume of total issuance of territories, St. Petersburg - Rb 13.7 bln. or 17,2% of the total issuance, Moscow Region - Rb 9.9 bn or 12,4%, Novosibirsk region -Rb 3.8 bln. or 4,7%. Therefore, the four largest issuers accounted for 75,2% of the total volume of issuance of placed regional and municipal bonds .
Also, large volumes of issuance had been placed by: Krasnoyarsk Territory -Rb 2.2 bln., Republic of Sakha (Yakutia) - Rb 2.2 bn, Yaroslavl region - Rb 2.0 bln., Irkutsk Region- Rb 1.8 bln., Tomsk region - Rb 1.5 bln., Nizhni Novgorod Region- Rb 1.0 bln., Leningrad Region - Rb 1.0 bln., Krasnodar Territory - Rb 1.0 bln., Komi Republic - Rb 0.9 bln., Republic of Bashkortostan - Rb 0.9 bln. (Table 20).
Table 20
Placement of subfederal papers in 2004
Volume of issu- Issuer's share in Volume of issuance to domestic borrowings ra-tio,%
Federation's subject ance, million rubles. the total volume of issuance,%
Central federal district
Bryansk Region 200.0 0,25 16,13
Voronezh Region 600.09 0,76 17,37
Kaluga Region 300.0 0,38 49,27
Kostroma Region 150.0 0,19 11,89
Moscow Region 9 884.59 12,44 29,84
Yaroslav Region 1 999.12 2,52 37,89
Moscow 32 365,1 40,74 66,25
North-Western federal district
Republic of Karelia 449. 28 0,57 26,00
Komi Republic 937. 5 1,18 65,33
Leningrad Region 1 000.0 1,26 36,82
St. Petersburg 13 702.75 17,25 99,98
South federal district
Krasnodar Territory 1 000.0 1,26 57,53
Volgograd Region 769.05 0,97 28,51
Privolzhsky federal district
Republic of Bashkortostan 927.14 1,17 41,12
Republic of Marij El 200.0 0,25 42,20
Chuvashi Republic 514.82 0,65 58,33
Nizhni Novgorod Region 1 000.0 1,26 12,80
Perm Region 200.0 0,25 22,42
Komi-Permyak autonomous district 0.68 0,00 1,96
Ural federal district
Sverdlovsk Region 105.0 0,13 12,64
Khanty-Mansijsk autonomous district 539.1 0,68 24,98
Yamalo- Nenets autonomous district 0.78 0,00 0,05
Siberian federal district
Altai Territory 197.96 0,25 10,14
Krasnoyarsk Territory 2 230.0 2,81 25,61
Irkutsk Region 1 830.54 2,30 51,86
Novosibirsk Region 3 773. 0 4,75 8,60
Tomsk Region 1 464.42 1,84 31,52
Far East federal district
Republic of Sakha (Yakutia) 2 195.76 2,76 32,15
Khabarovsk Territory 700.0 0,88 11,86
Sakhalin Region 200.0 0,25 14,65
Total 79 436.7 100,00 30,67
Source: IET' calculations based on the data of the Ministry of Finance of the RF.
By now, the high level of securitization had been demonstrated by the largest issuers -these are Moscow (66%), St. Petersburg (100%), Komi Republic (65%), Chuvash Republic (58%), Krasnodar Territory (57%), Irkutsk Region (52%). At the same time, because of considerable transaction costs, concerned with organization of bonds' issuing, issuance of small loans proved to be too cost based, and the municipalities continued to borrow
from commercial banks. Still, for the largest cities, issuance of papers became more and more attractive, which led, in 2004, to increasing the volume of placed municipal bonds more than 1,5 times in real terms (Table 21).
Table 21
Volumes of net borrowings on the market of domestic subfederal and municipal papers (million rubles)
Regional consolidated budget Regional budgets Municipal budgets
2004
Net borrowings 47 880.30 44 470. 13 3 410. 17
Attraction of funds 79 436.71 74 995. 96 4 440. 74
Repayment of the principle debt body 31 556. 41 30 525. 84 1 030. 57
2003
Net borrowings 41 908. 20 40 043. 51 1 864. 69
Attraction of funds 61 712. 63 59 012. 90 2 699. 73
Repayment of the principle debt body 19 804. 44 18 969. 39 835. 05
2002
Net borrowings 17 696. 53 17 153. 76 542. 77
Funds' attraction 29 141.78 28 169. 16 972. 62
Repayment of the principle debt body 11 445. 25 11 015. 40 429. 85
2001
Net borrowings 6601.45 6 667. 59 -66. 15
Funds' attraction 15 123. 78 14 226. 93 896. 85
Repayment of the principle debt body 8 522. 34 7 559. 34 962. 99
2000
Net borrowings - 1 877. 33 -2 286. 17 408. 85
Funds' attraction 13 042. 22 10 090. 21 2 952. 01
Repayment of the principle debt body 14 919. 55 12 376. 38 2 543. 16
Source: the Ministry of Finance of the RF.
Stabilization of the financial market caused an increase in number of regions and cities, that entered the capital market on a regular basis. Since 1999, annual bond issuance had been made by Moscow, St. Petersburg, Chuvash Republic, Volgograd Region; since 2000, - Tomsk Region and Komi Republic, Ekaterinburg; since 2001, - by Leningrad and Irkutsk regions (Table 22).
Table 22
Issuance of subfederal and municipal papers in 1999-2004
Issuer Issuer Issuer Issuer Issuer Issuer Issuer Federation's Subjects_1999 2000 2001_2002 2003 2004
Moscow St. Petersburg Chuvash Republic Volgograd Region Tomsk Region Komi Republic Leningrad Region Irkutsk Region Moscow Region Khabarovsk Territory Republic of Sakha (Yakutia) Republic of Marij El Novosibirsk Region Yamalo- Nenets AD Yaroslav Region Krasnoyarsk Territory
*
*
Issuer Issuer Issuer Issuer Issuer Issuer Issuer
Federation's Subjects 1999 2000 2001 2002 2003 2004
Republic of Bashkortostan * * *
Republic of Karelia *
Krasnodar Territory *
Lipetsk Region *
Nizhni Novgorod Region *
Voronezh Region *
Kaluga Region *
Bryansk Region *
Belgorod Region * *
Tver Region * *
Khanty-Mansijsk AD * *
Murmansk Region * *
Kostroma Region * *
Samara Region *
Tambov Region *
Republic of Mordovia *
Sakhalin Region *
Kursk Region *
Stavropol Territory *
Primorie Territory *
Kabardino-Balkarian Republic *
Municipalities
Ekaterinburg * * * * *
Ufa * * *
Yuzhno-Sakhalinsk * *
Krasnoyarsk * *
Novosibirsk * *
Tomsk * *
Novocheboksarsk * * *
Barnaul *
Perm *
Noginsk District of Moscow Region *
Volgograd * * * * *
Nizhni Novgorod *
Kostroma * *
Cheboksary *
Arkhangelsk *
Dzerzhinsky *
Source: the Ministry of Finance of the RF.
Creditability of territorial governments
Credit rating
In recent years the high economic growth rates in Russia led to raising of the sovereign credit rating and rating of territorial government agencies.
In so doing, the process of raising the credit rating of the territorial governments to the investment level observed. In November 2004, the first of the Russian regions - the city of Moscow - was awarded by the credit rating agency Fitch a credit rating of the investment level "BBB-" on borrowings in foreign currency. Then, the agency Moody's granted a credit rating of the investment level "Baa3" to Moscow and St. Petersburg. At the beginning of February 2005, the agency Standard&Poor's also raised the credit rating of Moscow to the investment level "BBB-" (Table 23).
International credt rating of Standard&Poor's Table 23
Issuer name The rating award date In foreign cur-(latest update) rency/Forecast In national currency/Forecast
Sovereign credit ratings
Russian Federation 31.01.2005 "BBB-"/Stable "BBB"/Stable
Ratings of local and regional administrations
Balashikha district 10.12.2004 "B-"/Stable -/-
Bashkortostan 12.03.2004 "BB-"/Stable -/-
Vologda Region 16.02.2004 "B"/Stable -/-
Kaluga Region 16.02.2004 "B+"/Stable -/-
Krasnodar Territory 14.09.2004 "B+"/Stable "B+"/Stable
Irkutsk Region 22.11.2004 "B"/Stable -/-
Klin district 28.09.2004 "B-"/Stable -/-
Leningrad Region 25.10.2004 "B+"/Stable -/-
Moscow 01.02.2005 "BBB-"Stable -/-
Moscow Region 29.09.2004 "BB-"/Stable -/-
Samara Region 12.03.2004 "BB-"/Stable -/-
St. Petersburg 01.10.2004 "BB+"/Stable "BB+"/Stable
Sverdlovsk Region 29.12.2004 "B+"/Stable "B+"/Stable
Stavropol Territory 23.06.2004 "B"/Stable "B"/Stable
Surgut 09.12.2004 "B"/Positive "B"/Positive
Khanty-Mansijsk autonomous district 13.08.2004 "BB-"/Stable -/-
Tatarstan 08.09.2004 "B-"/Stable -/-
Ufa 14.04.2004 "B"/Stable -/-
Yamalo- Nenets autonomous district 21.10.2004 "B+"/Stable -/-
Source: Standard&Poor's.
Problems of outstanding debt restructuring
Despite raising the credit ratings of a number of the Federation's subjects, up until now the issues of outstanding debt restructuring have not been solved. According to the data of the Ministry of Finance of Russia, the volume of outstanding debt increased since November 2003 to October 2004 by more than Rb 8.7 bln., in nominal terms - from Rb 20.3 to Rb 29.0 bln., which constituted 1,02% of the revenue side of regional consolidated budget or 0,17% of GDP.
The outstanding bonded debt is most considerable in the following regions: Chu-kotka AD - Rb 6.1 bn or 31,9% of the revenue side of the budget, Oryol Region - Rb 2.8 bln. or 28,1% of the revenue side of the budget, Orenburg Region - Rb 2.5 bln. or 9,3% of the revenue side of the budget, in Republic of Tuva - Rb 0.7 bln. or 8,1% of the revenue side of the budget (Table 24).
Table 24
Non-restructured outstanding bonded debt of the Federation's subjects
The volume of outstanding debt (thousand rubles)*
Outstanding debt to
budget revenues ratio,
%**
Central Federal district
Belgorod Region Vladimir Region Kostroma Region Kursk Region Moscow Moscow Region Oryol Region Ryazan Region Smolensk Region Tver Region Yaroslav Region
North-Western federal district
Republic of Karelia Arkhangelsk Region Kaliningrad Region Leningrad Region Novgorod Region Pskov Region South federal district
Volgograd Region Kabardino-Balkarian Republic Krasnodar Territory Republic of Adygeya Republic of Kalmykia Republic of North Ossetia-Alania Stavropol Territory Privolzhsky federal district Kirov Region Nizhni Novgorod Region Orenburg Region Penza Region Perm Region
Republic of Bashkortostan Republic of Mordovia Republic of Tatarstan Samara Region Udmurtian Republic Ulyanovsk Region Ural federal district Kurgan Region Sverdlovsk Region Tyumen Region Chelyabinsk Region Siberian federal district
106 063.5 58 711.8 326 928.0 109 830.0 500 000.0 113 693.6 2 805 785.6
1 233.1 209 370.3 412 252.2 643 068.3
12 680.0 62 776.0 13 027.2
709.0 23 821.5 389 164.7
33 736.7 160 250.0 455 898.2 43 244.0 48 920.0 599 750.2 984 105.7
80 293.0 617 203.3 2502 191.3 509 120.7
659.6 106 791.5 468 091.0 194 525.0 285 576.8 539 529.6 118 727.9
103 343.0
1 855.5 816 354.0 23 902.7
0,5 0,3
3.4 0,8 0,1 0,1 28,1 0,0 1,7 2,2
3.0
0,1 0,3 0,1 0,0 0,3
4.1
0,1 2,0 0,7 0,9 0,8 5,7 3,9
0,4
1.5
9.3
3.2 0,0 0,2 2,0 0,2 0,6 2,5 0,9
0,8 0,0
1.4 0,0
The volume of outstanding debt (thousand rubles)* Outstanding debt to budget revenues ratio, %**
Altai Territory 249 415.7 0,7
Irkutsk Region 20 137.0 0,1
Krasnoyarsk Territory 935 563.4 1,3
Novosibirsk Region 325 298.9 0,9
Omsk Region 941 195.1 2,6
Republic of Tuva 662 284.3 8,1
Republic of Khakassia 2 444.7 0,0
Taimyr (Dolgano-Nenetsk) autonomous district 26 229.0 0,5
Tomsk Region 500 414.0 2,4
Ust-Ordyn Buryat Autonomous District 65 702.0 2,2
Far East federal district
Kamchatka Region 937 795.9 7,3
Magadan Region 20 450.0 0,2
Primorie Territory 424 594.0 1,2
Republic of Sakha (Yakutia) 2 121 595.9 3,6
Khabarovsk Territory 6 250.5 0,0
Chukotka Autonomous District 6 147 020.7 31,9
Total 28 964 081.8 1,02
*According to the data of October 1, 2004.
**The outstanding debt, as of October 1, 2004, to the 2004
regional (non-consolidated) budget revenues ratio.
Source: IET' calculations based on the data of the Ministry of Finance of the RF. 2.4.3. Stock Market
In 2004, Russian stock market demonstrated more moderate growth rates than in the prior years (Fig. 20), with stock indices sometimes falling down quite drastically. The reason for such downfalls were growing political risks associated with the attack against YUKOS. Backtax claims for 2001-2003, arrests of the company's bank accounts and assets, accusation and detainment of a number of its senior managers and ultimately the sale of its main oil-producing assets, Yuganskneftegas, - all that triggered sales along the whole range of Russian blue chips and resulted in the fall of the stock indices. The "crisis of confidence" burst out in the banking sector in June through July 2004 also battered the dynamics of the national financial markets and particularly the stock market.
Given the above, however, a favorable macroeconomic situation against the background of extremely high world prices for oil and oil products saved the stock market from a drastic fall and sometimes contributed to a notable rise in quotations. In addition, the dynamics of the market were encouraged by the September 2004 auction on the sale of a part of the government stake in LUKOIL, as well as the granting to Russia of investment rating by Fitch.
90
80
70
60
w 50 ra
40
E 30
20
10
1 1 Volume of trading (USD)
I \ — RTS index
V /V\
frr 1 lirt » . V " \.
1 1 V V
In 1 il Li.l r . ■ 1 j. w *
1 111» in r| |J v 1 lirriniMH i1 ■ ■ r *ir i' IHlin mm • r Vf
800.0
750.0
700.0
650.0
600.0
550.0
500.0
450.0
400.0
350.0
Source: the RTS Exchange
Fig. 20. The Dynamics of the RTS Stock Index and Volume of Trading in 2004
In 2004, the Russian RTS stock index grew by 46.7 points, from 567.4 up to 614.11 points, or by 8.23%. These results appears fairly moderate vs. those of 2003, when the RTS index grew by 206.46 points (+57.22%) in absolute terms. As to investors' activity, it proved to be lower in 2004 vs. 2003. More specifically, the 2004 turnover on the classical stock market in RTS roughly accounted for USD 5.7 bln., which is a. 7% down vs. 2003 (6.1 bln.). Plus, 2004 saw 48.84 Thos. deals stricken vis-avis 56.269 Thos. reported in 2003, which also evidences a lower activity than in 2003. The average daily turnover of trading sessions on the stock included in the computation of the RTS index in the trading system in 2004 made up USD 21.15 mln., thus a. 11.9% down vs. 2003 (USD 24.0 mln.).
The dynamics of the market were different over the year. Between January through April the market was dominated by the upward trend and the RTS index climbed up by 195.47 points - from 586.08 up to 781.55 (+33.35%). Hence, the new historic maximum registered on April 12, 2004. The rise in the RTS index was accompanied by a notable growth in the volume of trades. Given that between January to February the monthly volume of trades with the stock used to compute the RTS index roughly accounted for USD 430 mln., in March and April it grew up to USD 617 and 830 mln., respectively. At this juncture it should be noted that it was in April 2004 when the record-breaking volume of daily trades was registered: namely, on 22 April, the respective amount was USD 71.67 mln. The main reason for the positive dynamics of the stock market was an extremely high level of liquidity in the banking sector, which was growing steadily over the 1st quarter. That helped investors accumulate free capital and, at least, in part fueled their demand for stock. The market was further encouraged by presidential elections outcome, when having perceived Mr. Putin's victory as an evidence of a future political and economic stability, nonresidents began to show a greater interest in the national stock market.
The fanfares subsided in mid-April, however. The fall in the market started after the arrest of YUKOS' assets and the consequent S&P's decision to decrease the company's rating. The information that the government was considering the possibility of acquisition of the generating companies' stock not only in exchange for RAO UES Russia's stock, but also for cashcontributed to the sharp turn of the upward trend as well. As a result, by 28 July the RTS index slid to its 2004 minimum value (518.15 points), minus 33.7% (263.4 points) vs. its peak value of 12 April. Between May through July the trading volume was declining affected by the "summer idleness' actor: given that between May to June the volume of trades on the stock used to compute the RTS index remained roughly at the 2004 average level (USD 419 and 482 mln., respectively), in July it slid to some 368 mln.
Notably, the volatility of the stock market was growing between May through July. While in May it was explained by the deterioration of the cash liquidity in the banking sector that had been supporting the marlet over the first four months of the year. June was full of news associated with YUKOS, and any input often resulted in considerable fluctuations of quotations of both YUKOS's and even the most liquid papers. For instance, in June, Mr. Putin made a statement that the government was not keen to see such a company as YUKOS go bankrupt. The statement triggered a avalanche-like rise in demand for all blue chips and caused a local upward adjustment of the market as a whole. However, the nervousness present in the banking sector in July prevented the positive dynamics and shortly afterwards caused the restoration of the overall negative trend on the market. In July, the domestic market displayed an extremely negative reaction to the statement issued by representatives of the RF Ministry of Justice on a possibility to sell Yuganskneftegas to cover the company's tax arrears.
The next stage of the dynamics of the 2004 national stock market was formed by the rise in quotations between early August through mid-October, with the RTS index growing by 172.37 points, or at 33,27% vs. its value of 28 July. The growth was taking place under rather a low investor activity. More specifically, in August and September the volume of trades on the papers that are included in the listing to compute the RTS index accounted for USD 277 and 262, respectively, which is roughly 1.6-1.7 times down vis-a-vis the 2004 average monthly value (some USD 442 mln.). However, in October, after the holiday season was over, the investor activity was back to the normal level and the trading volume in RTS on the stock used for computation of its index accounted for USD 470 mln.
In that period, the stock prices found themselves under the impact of a whole range of favorable and unfavorable factors. While a substantial price rise for oil was notably backing up the quotations of the national oil companies' stock in August and the subsequent months, September in turn proved to be full of favorable corporate news: the process of making key decisions in the electricity reform area was re-galvanized, which generated a notable price rise of the energy companies' papers, primarily those of RAO UES Russia and OAO Moseenergo; the auction on the sale of a government package in LUKOIL became a success, with victorious ConocoPhilips announcing its readiness to increase its share in the company up to 20%. Against such a background, the YUKOS case began to exert a far lesser influence on the market- not because investors grew "immune" to negative news, but the company's stock lost a great deal of weight in the stock market index to stir it up. The only short-term negative effect on the stock market is September was caused by the information of some MP=s' appeal to the General Attorney's office about the necessity to investigate into "gray" schemes non-residents use to purchase the company's papers.
The announcement issued by the RF Ministry of Justice on a USD 10.4 bln.-worth appraisal of Yuganskneftegas, which proved to fall far below the market expectations,
formed a signal to the break of the upward trend and the start of the stage of consolidation. The market dynamics were moderate until mid-November, while the RTS index was fluctuating between 640 to 670 points and investors' activity was at a level slightly below the average one. Thus, the monthly volume of trades on the stock that form the listing to compute the RTS index amounted roughly to USD 350 mln.
During the last one and a half months of 2004 the stock market saw a downfall in prices for traded papers, followed by a slight adjustment. More specifically, between 18 November through 10 December 2004, the RTS index fell by 136.35 points - from 681.87 down to 545.52 points, or roughly by 20%. After some restoration of earlier lost positions, the pretext for a regular fall was formed by the statement of the RF Ministry of Justice on setting 19 December as the date of the auction on the sale of Yuganskneftegas. Plus, the tax authorities produced new claims to the company worth USD 9 bln. in backtaxes. Since that moment YUKOS' aggregate tax debts made up USD 14 bln. Furthermore, the fall of the market accelerated following the government's decision to postpone the date of the discussion of the electricity reform and take the issue of privatization of generating companies away from the agenda, which de-facto evidenced the government was not ready to sell generating capacities. Interestingly, the fall was taking place against a sufficient investor activity: the volume of trades over the period in question (18 November- 10 December 2004) accounted for some USD 406 mln., which was slightly lower than the average monthly index.
During the last three weeks in December (11-31 December) the RTS index grew by 68.59 points - up to 614.11 points. Some fall of the index was noted immediately in the wake of the auction on Yuganskneftegas formally won by the obscure Baikalfinansgroup. The uncertainty vanished by the end of that week, nonetheless, when it became known that Rosneft in turn had taken over the dark horse. In the aftermath of the scheme the investor activity fell notably, and the 2004 trading sessions finished against the background of a slight adjustment which enabled the RTS index to end the year in a positive area.
100% 75% 50% 25% 0% -25% -50% -75% -100% -J
HI
co
LU D
o <
a:
D
lo <
o
© CL
m
CO
co O
D
] Price change (%)
Source: the RTS Exchange
Fig.21. The Dynamics of Quotations of Blue Chips by Results of 2004
By contrast to 2003, when all the blue chips enjoyed a notable rise in quotations, overall 2004 became a year of a relatively stable quotations (Fig. 21). It was investment in OAO Mosenergo stock that proved to be most profitable in 2004, with the rate of return of 117.52 (114.79 in 2003), followed by OAO Sberbank of Russia - 83.46% (37.43%), while the stock of OAO Tatneft, OAO LUKOIL and OAO Surgutnetegas lagging far behind them -32.31% (44.2), 24.39% (49.07%) and 21.95% (81.4%), respectively. At the bottom of the positive area was OAO Sibneft whose stock quotations grew by meager 4.11% (vs. 28.33 in 2003). RAO UES Russia demonstrated the least rate of fall in quotations in 2004 - 1.72% (+112.36% in 20030, followed by OAO Rostelecom and OAO Norilsk Nickel -13.27% (+66.67%) and -18.67% (+ 220.38%). As far as the downfall in stock quotations is concerned, the unquestionable leader became the disgraced YUKOS whose stock lost 93.82% (+14.89% in 2003), which turned once the most attractive Russian blue chip into a clear looser.
As concerns companies of the "second echelon", the maximum increment in their 2004 stock quotations was demonstrated by OAO Verkhnesaldinsly Mettalurgicheskoye Obyedineniye (336.99%), Zhiguly Power Plant (250.0%) and Zeyskaya Power Plant (225.93%), while the market was treating these papers with caution anyway. There were less than 50 transactions involving energy companies (except for the leader), while 580 deals were stricken with the OAO Verkhnesaldinsly Mettalurgicheskoye Obyedineniye papers. It should be noted, however, out of the top 10 companies by rise in stock quotations 5 ones represent the electricity sector.
RAO UES Russia' stock once again kept their leading position in terms of the volume of turnover at RTS. By the 2004 results, their share accounted roughly for 25.86% vs. 30.23% in 2003. LUKOIL's share grew from 17.87% in 2003 up to 21.2% in 2004, followed by Norilsk Nickel (10.55% vs. 4.74% in 2003) and Surgutneftegas (6.14% vs. 10.23% in 2003). So, the overall proportion of transactions at RTS involving the noted five issuers' stock accounted for 72.44% vs. 77.35% in 2003.
As of December 31, 2004, the top five companies by the volume of capitalization comprised: Surgutnetegas worth USD 26.65 bln. (vs. 20.76 bln. in 2003), LUKOIL -26.01 bln. (19.77 bln.), Sibneft- 14.22 bln. (13.5 bln.), Norilsk Nickel -11.87 bln. (13.94 bln.), RAO UES Russia - 11.7 bln. (11.45 bln.). So, the 2004 list of leading companies somewhat changed vs. 2003. Thus, Surgutneftegas held the 2nd position in the 2003 list after YUKOS. It important to note that three out of five leaders in terms of capitalization represent the oil and gas sec-tor33, while in 2003 there were four of them. Such a stable position of mineral companies by capitalization was determined by a favorable situation on mineral markets in 2004. Plus, after holding the 6th position in 2003, RAO UES Russia entered the noted top five list, which can be explained by a successful promotion of the electricity sector reform, which encouraged investor demand for the company's stock. As concerns companies of the non-mineral sector, it is Sberbank of Russia that likewise in 2003 once again had the greatest capitalization in 2004: as of end of the year it reached USD 9.33 bln. (vs. 4.99 bln. in 2003).
The Market for Forward Contracts
The market for forward contracts, alias FORTS aged 3.5 years in December 2004. The turnover on the market has been growing substantially from year to year and 2004 did not make an exception. According to the annual results, in 2004 the aggregate turnover of trading with futures and options accounted for a. Rb. 336.37 bln. vs. 214 bln. reported in 2003. In other words over 2004 alone FORTS grew practically 1.5 times. The participants in
33 The capitalization of RAO Gasporm is not considered in the present review, as there are no official data on the company.
135
the market concluded a. 1.5 mln. deals, which made up a. 41.5 mln. contracts (vs. 901,000 deals and 34 mln. contracts in 2003). Thus, the above figures evidence a notable rise in investor activity in this particular sector of the stock market. The aggregate volume of open positions by standard contracts as of the end of the period in question (31 December) reached Rb. 8 bln., 992,000 contracts (2.335 bln. 339,000 contracts) and grew 3.5 times in Rb.- and 2.9 times in contract equivalent.
As in 2003, futures in 2004 likewise predominated over the segment of forward contracts. Their proportion in the overall volume of trades accounted for 91.95% (94.4% in 2003), or Rb. 309.3 bln. (201.9 bln. in 2003), while the share of options made up just Rb. 27.06 bln. (12.1 bln. In 2003), which evidences some rise in the latter share, albeit an insignificant one. In 2004, it still was the forward contracts on quotations of RAO UES Russia stock that formed the most attractive instrument to investors. Despite that, their proportion in the overall volume of trades fell from 66% in 2003 to 54% in 2004 and made up Rb. 182 bln. The forward contracts on Gasporm stock rose from the 3rd line in 2003 to the 2nd one in 2004, with their respective share accounting for 19.64% (Rb. 66 bln.) vs. 7% in 2003. The share of transactions with LUKOIL futures in 2004 made up 12.8% (Rb. 43 bln.) vs. 12.9% in 2003. The year 2004 saw two new contracts on the market: namely, an option for a forward contract on the RAO Rostelecom stock quotations and a forward contract on OAO Norilsk Nickel stock quotations. Hence, at present participants in FORTS enjoy the possibility to conduct operations by 8 forward and 4 option contracts.
The Market for Corporate Bonds
The dynamics of the market for corporate bonds in general followed the situation in the stock market, except for by contrast to the latter, its state of affairs had somewhat deteriorated by the end of the year. This is evidenced, in particular, by the dynamics of corporate bonds indices that Bank Zenit computes basing on market quotations of bonds traded at MICEX34. Thus, by the 2004 results, ZETBI-Corp slid by 0.42 points (-0.38%) from 111.11 down to 110.69 points, while ZETBI-Corp10 computed on the basis of quotations of the most liquid corporate bonds fell by 0.31 p. (-027.%- from 115.8 to 115.49 p.
As noted above, the market for corporate bonds passed through several periods of up- and downward trends alternating with each other, which, however, in general coincide with the respective periods noted on the stock market. However, the volatility of the market for corporate bonds was notably smaller than that of the stock market (Fig. 22).
In the 1st quarter 2004, the market for corporate bonds saw a notable rise in quotations against the background of the growing investor activity. The volume of trade with corporate bonds at MICEX in January, February and March was Rb. 39.7 bln., 55.32 bln. and 60.5 bln., respectively. Such a favorable situation was determined primarily by an excessive liquidity in the national banking sector and some appreciation of Rb. against USD. The dynamics of yields rates of the US T-bills also contributed to the price rise of corporate bonds. Interestingly, while in January and March the respective demand was concentrated mostly on the secondary market which had a direct effect on quotations, in February prices of bonds were rising against the background formed by a considerable primary offer. Additional growth factors in March became an extremely favorable state of affairs on mineral markets and Mr. Putin's re-election.
34 Bank Zenit has computed its ZETBI-Corp and ZETBI-Corp 10 indices since January 3, 2002.
136
105.0%
102.5%
100.0%
97.5%
95.0%
Source: Bank Zenit
Fig. 22. The Dynamics of Price Indices of Corporate Bonds in 2004 (January 5, 2004 = 100%)
The 2nd quarter became the period of the turn of the upward trend on the market in question. Quotations were falling at a rather high pace, while the periods of a positive adjustment were short and investor activity fluctuated considerably. Given that in April the turnover of the trades of the MICEX section of corporate bonds made up a. Rb. 68.8 bln., in May and June it was 35.5 bln. and 48.8 bln., respectively. The price downfall was determined in part by deterioration of the external environment, particularly, the rise in the US T-bills. There also were some domestic causes, such as some depreciation of Rb. and a number of fairly large placements conducted in April and May. But it was an extremely unfavorable situation with liquidity in the banking sector that had a critical effect on the dynamics of quotations. On the one hand, the tide of crisis manifestations on the interbank credit market compelled numerous banks of the 2nd-3rd echelon to sell bonds to complete their liquidity, which put a pressure on prices. On the other hand, having an excessive liquidity due to the reduction in limits on the interbank credit market, large banks were buying the first-echelon banks' bonds, thus supporting prices. Notwithstanding this, by late June-early July the sellers had intensified their pressure on the market for corporate bonds across yet a greater assortment of issues. That was fueled by rumors of Guta-Bank's problems and the private clients' raid on Alfa-Bank. Consequently, in mid-summer the bonds quotations demonstrated repetitious ups and downs against the background of a downward trend. The unfavorable situation on the market restricted possibilities for issuers to borrow capital under acceptable terms, which is why many of them decided to postpone placements of their bonds.
July saw a record-breaking downturn in quotations. Thus, the corporate bonds index Zenit computes basing on the MICEX quotations made up 107.9 p. on 8 July, while the in-
dex of the 10 most liquid bonds sank to 112.08 p. Thus, given a general improvement of the situation in the banking system, the market basically stabilized in early July, with the turnover of trades on corporate bonds accounting for Rb. 49.12 bln. The situation on the world market also remained stable, with the yields rates of the US T-bills somewhat lowering. However, in Russia, the quotations found themselves under a relatively greater impact on the part of domestic factors. More specifically, because of the private depositors' agitation, the banks had to maintain a sufficient volume of liquidity, which compelled them to sell assets and particularly the Russian corporations' bonds. More fuel to the fire was added by S&P's statement regarding vague prospects for raising Russia's credit rating because of political risks associated with the YUKOS case, problems in the banking sphere and deceleration of the electricity sector reform. The key event of the month became the information of a possible sale of Yuganskneftegas. That generated vigorous sales in all the segments of the Russian financial market, including the one for corporate bonds, which resulted in a notable downfall in quotations.
Between August through October the market for corporate bonds was undergoing the stage of a gradual restoration of quotations. In August, the activity on the market was low, due to the holiday season. External factors were remaining favorable to the bonds market, including Russia's, while a stable situation with the banking liquidity against the summer lull helped quotations stabilized at earlier attained levels. However, in the second half of the month, the market reacted to the statement of the government of the city of Moscow on its willingness to place two new issues by sales of these papers. That could be determined by the investors' eagerness to create a favorable environment prior to the trades. But, as the placements outcome had failed expectations of most investors, that resulted in fixing profits on the market. In early September, the market was still after the 'Moscow" auctions, but in mid-September investors were keen to buy the first-echelon papers. That was steered by the data on inflation that evidenced that CBR would have to cope with the "Mission Impossible" of simultaneously holding inflation within 10% and have Rb. appreciate by not more than 7%. Some investors might sense a slight rise in the USD/Rb. exchange rate as a signal that the Bank of Russia had made its choice in favor of inflation and decided not to appreciate USD. That is why stags began to close their positions on the forex market and switch to long papers. But the Central Bank kept on maintaining the USD exchange rate at the level of 29 Rb., which chilled investors' optimism and resulted in a price adjustment in the market. October 2004 saw the investor activity on the market for corporate and regional bonds being on a record-breaking level, which helped the quotations of the most liquid issues to finish the month in the positive area. The turnover of the market for corporate bonds made up a. Rb. 72 bln. The positive dynamics of the market were also inspired by Moody's decision to raise Vneshtorgbank's and Sber-bank's ratings at 1 point above the country's.
Rather a long of growth was followed by the adjustment phase in November. Given no clarity in regard to the CBR's policy priorities on the forex market, the inflation and exchange rate factors exerted far weaker inlfuence on the dynamics of quotations, thus being replaced by the external state of affairs and particularly the negative dynamics of the basic assets. After the November drop, in December investors were trying to restore their activity, albeit quotations were falling across the most liquid issues. Once a substantial volume of primary offer had attracted a considerable part of liquidity, that helped bears operating on the secondary market. Then the information on backtax claims to Vympelkom triggered the avalanche of sales, especially in the telecom sector. Notwithstanding that, the situation on the primary market was a bit better, which was evidenced by a successful
placement of the Russian Railroads' bonds against the background of a high level of liquidity in the banking sector.
The issuers' activity on the primary market differed substantially from month to month. Thus, the peak volume of placements of corporate and regional bonds on the primary market was registered in April and accounted for a. Rb. 27.93 bln., while the minimum volume was noted in May and it accounted for Rb. 4.81 bln. The aggregate volume of primary placements of corporate bonds over the whole 2004 roughly made up Rb. 194.87 bln. vs. 84 bln. reported in 2003.
The Factors of the Dynamics of the Russian Stock Market
The 2004 dynamics of the national stock market were determined a whole range of factors that can be conditionally classified into the following groups:
• Domestic political situation;
• Relations with international financial organizations;
• Situation on the international financial markets;
• World prices for minerals (oil, particularly).
Each group was exercising an ambiguous influence on the dynamics of different segments of the domestic financial market. That is why we are going to analyze their influence individually and in a greater detail, while the last group will be considered below, in the respective section of the present review.
Domestic political situation. The year 2004 has become the period of the growing pressure on the national business community, which logically was accompanied with growing political risks in the domestic financial market. While investors viewed Mr. Putin's re-election as a warrant of the continuation of the political course, it became clear that the government was keen to increase its intervention in the private sector.
The most obvious evidence became the systematic attack on YUKOS. Thus, in April 2004, the court of law ruled to arrest the company's assets. In the aftermath of that S7P's decreased the company's long-term rating. In May, the Moscow City Arbitration Court ruled to exact from YUKOS over Rb. 99 bln. in backtaxes, penalties and fines for 2000. in July, the Ministry of Taxes and Levies produced new backtax claims for 2001. Plus, at the end of that month the market received information of a possible sale of YUKOS's pearl, Yuganskneftegas, to repay the company's tax debts. In September, the RF Ministry of Justice informed of a USD 10.4 bln.-worth appraisal of Yuganskneftegas, which proved to fall far below the market expectations and the appraisal by Drezdner Kleinwort. Furthermore, there shortly appeared information of a probability of a sale of a 77% stake of Yuganskneftegas with a 60% discount. The pressure on the company intensified by the end of the year - in November, USD 9 bln. - worth backtax claims were produced which increased the aggregate amount of backtax claims up to USD 14 bln., i.e greater than the company's overall capitalization as of the date. In December, the investors' attention focused on results of the auction on Yuganskneftegas. As noted above, the formal buyer of the company became previously unknown Baikalfinansgroup, and the uncertainly around the auction vanished after it became known that the winner in turn had been acquired by Rosneft.An additional rise in political risks was caused by information of backtax claims to Vympelcom in December. By contrast with YUKOS, Vympelcom was established after the period of the "dubious" privatization deals and has been one of the most transparent companies in the country.
Overall, 2004 saw the rise in political risks and the authorities' pressure on the private sector. Despite an extremely favorable state of affairs on the world mineral markets, it is
because of the political risks that the Russian stock market ultimately demonstrated practically zero dynamics.
Relations with International Financial Organizations. Russia's relations with international financial organizations were quite successful over the year in question. Russia was fulfilling its debt obligations in full and according to the earlier set schedule. In addition, in September 2004, there appeared information of Russia's intention to start consultations with the Paris Club on an early repayment or exchange of its USD 4.7 bln.-worth debt.
In late January, S&P raised Russia's credit rating by its obligations denominated in foreign exchange from "BB" up to "BB+" and those in Rb. equivalent from 'BB+" up to "BBB-". In October, because of the improvement of the macroeconomic situation in the country, Moody's decided to change its forecast of Russia's credit rating for 'positive" But the major event of 2004 in this respect became the increase of Russia's long-term credit rating in forex and Rb. equivalent by Fitch from 'BB+' up to the investment level "BBB-"; plus, the country's short-term rating was raised, too. The agency representatives stated that it became possible due to the country's considerable progress on the macroeconomic front against high oil prices and a sound tax policy. They believed those factors considered to help the country lower the volume of its public and external debt, as well as substantially complete its foreign reserves and stabilization fund. All that, argued Fitch experts, substantially increased the RF Government's capability to service its debts even in the event of a serious crisis.
Situation on the International Financial Markets. Last year saw the state of affairs on the world stock markets improve insignificantly. For instance, by results of 2004, Dow Jones and NASDAQ Composite grew by 373.16 and 168.76 p., or by 3.58 and 8.41%, respectively vs. the beginning of the year (Fig.23). The fact that the volatility of the US stock market was considerably lower than that of the Russian stock market is worth a special attention. The main factors affecting the dynamics of the 2004 market were high oil prices that constrained economic growth in the US and encouraged inflation processes. The danger of the latter compelled the federal administration to revise their policy priorities in the monetary and credit area, which resulted in the repeated raising of the basic interest rate. But that fact did not seriously batter the US stock market, for the rate was raised gradually and market expectations, as a rule, coincided with the Federal Reserve's decisions. So, the effect from raising the rate found itself already mirrored, at least, in part, in prices prior to the respective announcement. The situation in the Middle East and particularly terrorist attacks in Iraq were the investors' headache in 2004. Finally, the US 2004 presidential race outcome gave investors clear evidence that the new Administration would pursue the same political course.
In January, extremely favorable corporate news became yeast for the dynamics of the US stock market - most corporations' performance information overran analysts' expectations, while macroeconomic statistics was basically positive. Since February, however, the quotations began their gradual slide, particularly under effect of the macroeco-nomic statistics, including unfavorable data on the state of the US labor market. But as most corporate reports proved to be better than expected, there was no drastic fall in quotations.
OCMOCMT-COT-OT-OCMOCMT-CMT-COT-OT-OCM
Fig. 23. Dynamics of Dow Jones and NASDAQ in 2004 (December 31, 2003=100%)
The market downturn further intensified in March, because of the deceleration of the US economy, unfavorable data on the labor market, world price rise for oil, and drop in Mr. Bush's popularity. Even the decision made by the omnipotent FRS Committee for Open Markets to keep the basic interest rate unchanged failed to dump the fall on the stock market that was further driven by the terrorist act in Madrid, as investors viewed that as an intensification of the terrorist threat. In April and May the stock market found itself under the impact of opposite factors. While on the one hand, positive macroeconomic statistics tat proved an acceleration of the US economic growth and positive corporate news were driving stock indices upwards, high oil prices and the deterioration of the situation in Iraq formed the negative mood, on the other. At this juncture, there was another negative factor associated with the US economy: that is, a possible increase of basic interest rates that would contribute to a revision of then existing stock market price levels towards their decline.
The US stock indices somewhat grew in June. In early June, the market was to a greater extent under the effect of the negative factor associated with the envisaged increase of interest rates, for A. Greenspan unequivocally let everybody know that FRS was ready to raise interest rates due to inflation rates. In late June, however, he somewhat revise his stance, for he argued that inflation did not pose a serious problem in the short run. Plus, the stock market sensed a notable support from some decline in oil prices earlier that month, the publication of a favorable macroeconomic statistics and some decline in yields rates of T-bills.
Despite that, the situation darkened in July and August. In July, the US basic interest rate was raised by 0.25% - up to 1.25%, while negative macroeconomic and corporate news dominated over the market. More specifically, employment indicators fell lower than expected, while oil prices resumed their rise. The US huge trade deficit did not add opti-
mism either, and all the above was driving the US stock indices down. However, a positive adjustment had been noted on the market by late August. Its causes were technical factors coupled with a notable decline in world oil prices.
In September-October the dynamics of the US stock indices on the whole were opposite, while the volatility of quotations was high. While the prices enjoyed a positive support from a relatively low yields rate of T-bills and solidification of the incumbent President's position in the presidential race underway, the discontinuation of the oil price adjustment and the subsequent price rise for oil, negative corporate financial projections, a high probability of the further increase of the interest rate and low activity on trading spots formed the group of negative factors that were driving the markets downhill. Mr. A. Greenspan's testimony to the US Congress Budget Committee proved the general opinion of the deceleration of the US economic growth and the existence of critical problems (a huge budget deficit and employment challenges).
During last two months of 2004 the US stock indices were growing notably, which can be explained by a series of positive factors. Those were, in particular: Mr. Bush's victory and some decrease in the world oil prices, as well as a number of positive macroeconomic and corporate news. The FRS once again raised the basic interest rate by another 0.25% basic points, i.e. up to 2% annualized. That, nonetheless, had a short-term negative impact on the market. In December, the stock market was growing against a substantial downfall in oil prices, while investors found themselves under the negative effect from the rising interest rates that reached 2.25% later that month. The market had been re-galvanized by late December by the news of rather high growth rates of the US economy and relatively low yields rates of T-bills.
Corporate News
A notable progress of some Russian corporations was awarded by granting them with long-term credit ratings or revising already existing ones. To exemplify the above, in late January S&P's ranted OAO Rostelecom with a 6.4 corporate governance rating score out of possible 10. According to the agency, the decision was made with account of Ros-telecom's progress in the information disclosure policy area and a pro-active approach to investors. The agency believes that so far as the above standards are concerned, Rostelecom is ahead of analogous Russian companies and in this regard is a match for numerous telecom companies overseas.
In early August, Moody's and S&P's announced they had granted Norilsk Nickel with a credit rating. While Moody's decided on "Bal" grade in forex equivalent, with the forecast of the change for "stable", S&P's went as far as "BB", with the same forecast. The company's credit rating by the national scale became "ruAA".
In October, Moody's changed its forecast of Sberbank's long-term forex-denominated rating "Ba1" from stable to "positive", while the rating of the company's bonds was raised up to "Baa2", i.e. higher than Russia's. The agency representatives argued that those decisions were associated with the Bank's significant role in the national economy and banking system, particularly in the area of private deposits.
In early November, S&P's confirmed the long-term credit rating of RAO UES Russia from "B" to "B+" and its "RuA+" rating by the national scale with the forecast "stable". The agency believes such an increase mirrors the improvement of the company's financial indicators, a gradual progress in characteristics of the markets for electricity and heating against the background of the country's ongoing economic progress.
On November 19, 2004, Fitch raised Sberbank's rating up to the investment one. The decision followed the analogous increase in Russia's sovereign rating. Sberbank's long-term rating was raised from "BB+" up to "BBB-" with the forecast "stable", while the rating of the bank's bonds was likewise raised to the same level. So, all the Bank's ratings presently are on the investment level.
Numerous Russian companies published their 2004 financial reports, of which some deserve a special attention.
On November 19, RAO Gasprom released its non-audited consolidated abridged statement over the first half 2004 drafted in compliance with IFS standards. According to the report, the company's sale proceeds over the first 6 months of 2004 grew by 12% vs. the respective period of 2003 and made up Rb. 474 mln., while net profit over the period in question dropped by 13,797 mln., or 13% vs. its respective period of 1993 and accounted for Rb. 89, 964 mln.
The same day, OAO Norilsk Nickel also produced its interim consolidated financial statement over the first half 2004. According to the report, in the period in question the total production costs of metals sold in USD equivalent grew by 12% vs. the 1st half 2003, while the declared profit over the period in question amounted to USD 889 mln., or practically tripled vs. the respective 2003 indicator.
In November, RAO UES Russia published financial results of its performance drafted according to the Russian and international accounting standards. The latter document was published on 1 November. The group's gains from the profile operations over the period in question frew by Rb. 41.9 bln - up to Rb. 342.7 bln., while expenditures grew by 36.9 bln. and accounted for 342.7 bln. The company's net profit over the first half 2004 was over Rb. 15.4 bln., or at 1.5 bln. down vis-avis the 1st half 2003. The drop in net profit can be explained by the rise in profits that fall on minority stockholders. On 15 November, the company published its accounting report for the nine months of 2004. Its gains reached Rb. 24.77 bln., or down from the respective index of the prior year, while net profit stood at the level of Rb. 17.1 bln. (2.31 bln. down vs. the same period of the prior year).
The same month OAO Rostelecom published results of its performance in the first 9 months of 2004. The document was drafted according to the Russian accounting standards. Thus, the company's gains over the period in question made up Rb. 27.64 bln., or up by 33.2% vs. the respective period of 2003. The company's net profit reached rb. 6.59 bln., or at 37.8% more than in the first 9 months of 2003.
In the very early 2005, OAO LUKOIL published results of its financial performance over the first 9 months of 2004. The company's net profit made up USD 3,095 mln., or at 1,292 mln. more than over the first 9 months of the prior year (without regard to the accumulated effect from changes in its accounting policy and less the sale of the USD 1, 262 bln.-worth share in Azei-Chirag-Guneshli project). The company reported USD 2.46 bln. in federal taxes (less the corporate profit tax), or at over 40% more than in the respective period of 2003. The rise in the company's net profit became possible thanks to a favorable state of affairs in the world mineral markets and improvement of control over its expenses. However, the rise in profits was constrained by the growing tax burden, Rb. appreciation and a continuous rise in transportation costs.
In 2004, Russian companies continued to acquire new, particularly overseas, assets and establish long-term ties that would enable them to expand their business and enhance its efficiency.
In late January 2004 LUKOIL won a tender on exploration and development of gas and condensate deposits in "Block A" in Saudi Arabia. Experts believe it is the most promising deposit in the area. To implement the project, the company is going to found a
ising deposit in the area. To implement the project, the company is going to found a joint venture with Saudi Aramco, in which LUKOIL is going to have the 80% stake.
In March, OAO Norilsk Nickel announced the purchase for cash via its London-based 100% daughter company Norimet of a. 98.5 mln. ordinary stock of the gold mining company Gold Fields Ltd. The purchase worth a total, in USD equivalent, of USD 1.16 bln., or USD 11.79 per 1 ordinary stock.
One of the critical events of 2004 became the establishment of a large-scale strategic alliance between LUKOIL and ConocoPhilips. It is envisaged that the US giant will become a strategic investor in LUKOIL's capital. The announcement was made after a ConocoPhilips' affiliated structure won in an auction on the purchase of a 7.59% the Russian oil company's declared and issued ordinary stock that had earlier belonged to the federal government. The price of the deal amounted to USD 1.988 bln. (USD 30.76 per 1 share).
By late 2004 the group of companies Slavneft had completed a deal on the purchase of a package of ordinary and preference stock of OAO Slavneft-Megionneftegaz (MNG) from minority stockholders whose interest was represented by Vostok-Nafta. The purchased stake accounts for 6.4% of the OAO Slavneft-Megionneftegaz's authorized capital. As a result of the transaction, the Slavneft's share in the MNG's authorized capital grew up to 56.4%. Slavneft owns 69.12% of the total number of ordinary and 18.11% of the total number of preference stock of OAO Slavneft-Megionneftegaz. Consolidation of the equity capital of Slavneft's dauhter companies should help the group improve its corporate structure.
In 2004, Russian companies have been fairly pro-active in attracting an additional volume of investment, particularly from overseas financial markets, and solidified their positions on the global capital markets.
In March, the LUKOIL Board ruled to issue documentary interest non-convertible payable to bearer bonds with the term of maturity of 5 years. The issue included 6 mln. bonds with the face-value of Rb. 1,000 each. Their coupon period is 6 months, and the interest rate by all the coupons is equal and should be set by results of a tender on the date of the start of the placement. The three-year offer is envisaged on the issue. The same month Slavneft repaid in full its Rb. 2.-bln- worth bonded debt, as per the terms of its issuance. At the same time, the company paid out revenues on the 4th coupon on the second-series bonds at the rate of 8.89% annualized, or Rb. 44.33 per each bond with the face-value of Rb. 1,000. The overall bonded debt repayment amounted to Rb. 88.66 mln.
Liquidity of Russian companies on the Western exchanges is worth a separate comment. In particular, in June, there appeared information that the volume of trading with the OAO LUKOIL securities at London Stock Exchange hit the record-breaking USD 2.41 bln. The dynamics of trades evidenced a constantly growing interest in the company's papers. Thus, while in 2003 the average monthly volume of trades was USD 801 mln., it reached 1.52 bln. over the first four months 2004.
In September, OAO Norilsk Nickel appointed Citigroup and Morgan Stanley co-lead-managers of the planned debut issuance of its Eurobonds denominated in USD. The USD 500 mln.- worth issue was placed on September 17, with the yields rate 7.125% and the maturity date September 30, 2009 r. The demand for the issue was more than 4 times greater than the offer. The company will irrevocably and unconditionally guarantee its Eurobonds.
In October, OAO gasporm placed its Rb.-denominated bonds of A5 series with the face-value of Rb. 1,000. The issue was worth a total of Rb. 5 bln. with the maturity term of 3 years. According to results of a tender held at MICEX, the coupon rate payable each 182 days was set at the level of 7.58% annualized. Investors submitted 120 bids worth a total of 144
Rb. 9 bln., of which 73 bids were accepted. It is intended to spend the attracted capital on funding investment necessary to maintain the existing production capacities, implementation of new promising projects and refinancing the company's short-term debts and optimizing its debt portfolio structure
In mid-October, OAO Norilsk Nickel placed a bond issue worth a total of USD 500 mln. with the yields rate under placement of 7.125% annualized with the maturity date on September 30, 2009. Again, the demand for the issue was over 4-fold greater than the offer.
On November 11, OAO LUKOIL's Board set the repayment price of the documentary interest non-convertible bonds payable to bearer, which the company planned to place until the end of the year. The repayment price was set at the level of 100% of the nominal value. The intended volume of output is - Rb. 6 bln., while the maturity term 5 years. The placement took place on Ovember 23, 2004, at MICEX. the coupon rate payable each 182 days was set at the level of 7.25% annualized 7,25%, which equals the efficient yields to maturity rate of 7.38% annualized. Investors submitted 123 bids worth a total Rb. 11.3 bln.
In early November, OAO Sibneft announced an attraction of a USD 160 mln. -worth sindicated loan with +1.4% LIBOR interest rate. This particular loan thus became the cheapest in the company's history. The 25-month loan was extended against export oil supplies. The loan sindication was arranged by ABN AMRO Bank. The company plans to spend the credit to refinance its debts and liquid capital.
On December 3, 2004 OAO Norilsk Nickel announced its intention to purchase up 12, 500. 000 of its stock (5.8% of its authorized capital, with the face- value of Rb.1 per 1 share) at a price of Rb. 1,680 руб. per 1 share. The company planned to spend up to Rb.21 bln. on the deal. ZAO "Natsionalnaya Registratsionnaya Kompania" received 372 duly arranged applications from the company's stockholders on the sale of their stock, of which stockholders -legal entities submitted 207, while private individuals - 165 applications. The total number of stock stipulated in the applications accounted for 59, 761. 360, of which 57, 965. 450 shares were offered by legal entities, while the remaining 1, 795. 910 -by private individuals. As the number of the stock offered for sale proved to be substantially greater than what the company actually was going to buy, the final number of stock it would buy from a shareholder would be computed on the proportional basis.
In December, there appeared information on the market that EBRD was going to disburse a Euro 80 mln. credit to RAO UES Russia's daughter - OAO "Systemny operator CDD-UES". The respective loan agreement was signed in London. As per the agreement, the loan should be disbursed in two tranches: while EBRD would extend the first one, worth Euro 60 mln. and for the 10-year period, to Systemny operator, the other tranche amounted to Euro 20 mln. would be extended, for the period of 7 years, by a cindicate of two banks: namely Raiffeisen Zentralbank Osterreich AG and Bayerische Landesbank.
It is envisaged that Systemny operator would spend the attracted funds to design and introduce a new automated SCADA/EMS (Supervisory Control and Data Acquisition/ Energy Management System).
It is the common knowledge that a sound dividend policy is a perfect vehicle of increasing attractiveness of stock. In 2004, some companies declared their eagerness to spend a prt of their profit on payment of dividends. In particular, at their early meeting on December 15, 2004, OAO Slavneft's stockholders ruled to distribute intermediate dividends over the 9 months of 2004, with the payment totaled a. Rb. 14.5 bln., or Rb. 3.06 per 1 ordinary share with the face-value of 0.1 kop. The dividends will be paid until December 31, 004. The list of shareholders to take part in the meeting was made according to the register data as of November 9, 2004.
At its October meeting, the Board of OAO Norilsk Nickel decided to recommend to the early shareholder meeting to distribute intermediate dividends for the 9 months of 2004 at an amount of Rb. 41.4 per 1 share. The early shareholder meeting convened on 23 November consequently approved of the Board's decision. By the 2004 results, the total volume of dividends, including intermediate ones, matches the company's dividend policy (20-25% of net profit computed according to ISA).
In early December, RAO UES Russia announced that the company had completed distribution of its 2003 dividends as scheduled- by December 1, 2004. According to the company's information, the total volume of dividend payments was Rb. 2.39 bln., of which a. 1.9 bln. was paid on ordinary shares (Rb. 0.0469 per 1 share), while Rb. 473 mln. was paid on preference stock (Rb. 0.2283 per 1 share).
2.5. Scenario- Based Macroeconomic Forecast for 2005
This section describes a scenario-based forecast of macroeconomic parameters (GDP, CPI, export, import, USD/RUR exchange rate, gold and foreign exchange reserves, real effective RUR exchange rate, retail turnover, unemployment rate, real incomes of physical bodies) for 2005 performed on the basis of the structural econometric equations. Apart from this, changes in tax revenues to consolidated and federal budgets were assessed under the examined scenarios in relation to the scheduled changes in the tax law since 2005 . In addition, we have calculated alternative assessments of basic parameters of the federal budget for 2005 under the same scenario which was used for defining parameters of the same budget.
The equations were assessed on the basis of the quarterly data for the period commencing in the 1st quarter of 1996 thru the 4th quarter of 2004 inclusively. In various cases, the model was assessed only within the interval from the 1st quarter 2000. The data source was represented by the official information obtained from the Federal Service for State Statistics of the Russian Federation, the Bank of Russia, the RF Ministry of Finance and the International Monetary Fund.
The equations describing the middle-term movement of macroeconomic parameters, include variables and their lags having a material and corresponding economically logical effect on the explained variable. The equations were also added with dummy variables allowing quarterly seasonality and structural changes to be taken into account. The members of moving average were used to eliminate autocorrelation of the reminders .
The macroeconomic parameters were calculated on the basis of pre-selected scenarios of exogenous variables movement - Urals oil price, capital investments, M2 and USD/EURO exchange rate.
Table 25
Scenario of exogenous variables in 2005
Scenario 1 Scenario 2 Scenario 3
USD/EURO exchange rate 1.21 1.22 1.15
Urals oil price (USD per barrel) 28 36 25
M2 incremental growth rate, % 28 35 20
Capital investment incremental growth, % 9.8 12.0 8.5
The macroeconomic forecast for 2005 in Table 25 was calculated for three scenarios of USD/EURO exchange rate, oil prices, growth in M2 and capital investments. Scenario 1 was drafted in accordance with the initial conditions and the forecasted figures for 2005
obtained by the RF Ministry of Economic Development (MED) (Forecast of socioeconomic development of the Russian Federation till 2007): annual average USD/EURO exchange rate is expected to be 1,21, Urals oil price is expected to be $28 per barrel, M2 incremental growth rate is expected to account for 28%, and capital investment incremental growth at the end of the year is expected to account for 9.8%. Scenario 2 is optimistic and forecasting that oil price would be equal to that of 2004 ($36 per barrel). According to Scenario 2, capital investment growth is expected to account for 12%, average annual USD/EURO exchange rate is expected to be 1,22, M2 incremental growth rate is expected to account for 35%. Scenario 3 is pessimistic and expecting Urals oil price to gradually decline down to $22 barrel by the end of 2005, which would cause the average annual Urals oil price to be $25 per barrel. In addition, according to Scenario 3, USD is expected to strengthen against EURO as compared to the previous year (average annual exchange rate would be USD1,15: EURO1 in 2005 against 1,22 in 2004), capital investments are expected to drop down to 8.5% per year, and M2 incremental growth rate is expected to account for 20% at the end of 2005.
Table 26
Forecast for 2005
2005
Scenario 1 Scenario 2 Scenario 3 MED's forecast
Real GDP incremental growth, % 5.2 6.0 3.8 6.3
GDP, RUR trillion 18.93 19.12 18.70 18.72
CPI incremental growth, % 9,0 9,3 9,0 8,5
Gold and foreign exchange reserves, USD billion 139 154 127
Strengthening rates of real effective RUR exchange rate, % 3.3 6.4 2.9 4.4
Strengthening rates of real RUR/USD, % . 4,8 8,2 2,8 4,3
Nominal USD/RUR exchange rate 28,6 27,7 29,2 30,4
Export, USD billion 161 175 155 163,2
Import, USD billion 104 108 102 104,7
Incremental growth in retail turnover, % 9,0 9,1 8,6 8,5
EPE incremental growth, % of the previous quarter 4,7 5,7 3,3 5,5
Share of unemployed persons in total gain- 7,7 7,6 7,8 8,5
fully occupied population, %
Growth in real cash income of physical entities, % 7,6 8,1 6,7 9
The macroeconomic forecast shows (refer to Table 26) that according to the optimistic scenario (Scenario 2), GDP growth rate is expected to decrease down to 6.0% in 2005 as compared to 3.8% in Scenario 3. In 2005, GDP volume in nominal terms is expected to reach: RUR18,93 trillion according to Scenario 1; RUR19,12 trillion According to Scenario 2; and RUR18,7 trillion according to Scenario 3.
In 2005, the rate of inflation is expected to decrease down to 9-9,3% depending on the forecasted changes in money quantity.
Under the lowest oil prices in 2005 (Scenario 3), gold and foreign exchange reserves are expected to grow by $6 billion, while if the oil price in 2005 would remain equal to that in 2004 (Scenario 2), incremental growth of gold and foreign exchange reserves is expected to reach $33 billion at the end of 2005.
In 2005, the rate of strengthening of the effective RUR exchange rate is expected to vary from 2.9 to 6.4%, depending on a scenario, with the fastest rate in Scenario 2. In 2005, the rate of strengthening of RUR against USD is expected to be faster under Scenario 1 and 2, i.e. if the USD/EURO exchange rate would remain equal to that in 2004. Under Scenario 3, i.e. in the case of gradual strengthening of USD against EURO during 2005, RUR is expected to strengthen against USD by nearly 2.8% at the end of 2005.
According to the data of the Bank of Russia, export volumes at the end of 2004 amount to USD183 billion. In 2005, export volumes are expected to be below the foregoing figure under each of the Scenarios. In case that oil price in 2005 would be equal to that in 2004 (Scenario 2), export volumes are expected to be nearly USD175 billion, while it would amount to nearly USD155 billion, if oil price goes down to $22 per barrel by the end of 2005. The forecasted import volumes in 2005 are expected to exceed that in 2004 under each of the Scenarios, correspondingly by USD9 billion under Scenario 1, by USD13 billion under Scenario 2 and by USD7 billion under Scenario 3. Import volumes in 2004 are nearly USD95 billion, according the data of the Bank of Russia. Thus, on the basis of the forecasts obtained, export surplus in 2005 is expected to be below that of the previous year by more than USD20 billion Under each of the Scenarios. Under the pessimistic scenario, export surplus in 2005 is expected to decline by nearly USD35 billion.
The forecasted growth rates of retail turnover, industrial production index and real cash incomes correspond in general to the estimates of GDP growth rates. In the middle-term period, the real growth rates of retail turnover appear to be comparable by volume with the growth rates in available real incomes and are below the GDP growth rates by more than 3 percentage points on the average. The growth rates of industrial production index appear to be slower than the GDP growth rates by 0.4 percentage points on the average.
In 2005, a share of the unemployed in the total number of gainfully occupied population is expected to be reduced down to 7.7% under Scenario 1, 7.6% under the conditions of the most optimistic Scenario, and 7.8% under the pessimistic Scenario, as compared to the previous year.
It should be noted that the obtained forecasts of basic macroeconomic parameters for 2005 (Scenario 1) are generally in line with the similar forecasts obtained by the RF Ministry of Economic Development under the similar initial conditions. The two forecasts disagree mostly in the figures reflecting economic activity. According to the forecast made by the RF Ministry of Economic Development, the GDP growth rate in 2005 appears to be beyond our figures by 1 percentage point. Such disagreement is typical of growth rates in cash incomes of physical entities and industrial output.
We assessed the forecasted changes in tax revenues to the RF federal budget and the RF consolidated budget in relation to the changes in tax law and budget law scheduled by RF Government in 2005 as compared to the previous years. In particular, according to the proposed scenarios of oil prices, we took into account the effects of a heavier tax load imposed on the petroleum industry from 2005: changes in export tax on oil and mineral tax rates. Tax revenues for 2005 were calculated considering the introduction of the "country of destination" principle on the value added tax imposed on hydrocarbons and other products exported to the Republic of Byelorussia. We took into account a decline in export duties by an average of 32 % for all groups in 2005, except for the fuel and energy group, which is also in line with the Ministry of Finance's forecasts conserving reduction in tax revenues . Finally, we calculated changes in revenues from single social tax due to reduction by up to 26% in the basic rate of this tax. With regard to the federal budget, we also took into account the changes in the budget law represented by adding 1.5 percentage
points of profit tax rate to the federal budget, as well as the changes in the standard of payments on mineral tax and regular payments.
The corresponding quantitative changes in the amount of tax revenues (refer to Table 27) were calculated on the basis of tax revenues received over the previous year with consideration of the taxation base growth, presented oil price scenarios, obtained forecasts of USD/RUR exchange rate, and growth rates of incomes of physical entities. The assessment of changes in single social tax revenues was based on the data on distribution of number of employees by calculated payroll obtained by the Russian Statistics Agency on the basis of a sample survey for April 2004. This allowed the aggregate effect of changes in the single social tax schedule on such tax revenues to be calculated more correctly.
Table 27
Forecast of Changes in Tax Revenues of the RF Consolidated and Federal Budgets in Relation to Changes in Tax Law and Budget Law since 2005 (RUR billion)
Scenario 1 Scenario 2 Scenario 3 Forecast of Changes in Tax Revenues of the RF Consolidated Budget in Relation to Changes in the RF Tax Law
Profit tax 40.6 0.9 55.9
Mineral Tax 20.8 36.0 15.0
single social tax -282.4 -283.2 -281.5
VAT -8.5 -8.6 -8.4
Customs duties 86.3 237.0 27.6 Forecast of Changes in Tax Revenues of the RF Federal Budget in Relation to Changes in the RF Budget Law
Profit tax 57.4 46.6 61.5
Mineral Tax 63.3 77.0 58.1
single social tax -282.4 -283.2 -281.5
VAT -8.5 -8.6 -8.4
Customs duties 86.3 237.0 27.6
It should be emphasized that the presented changes in profit tax revenues are caused primarily by corresponding changes in the tax basis due to growth in mineral tax payments and the reduction of the single social tax rate. Changes in the tax duty are caused by introduction of a new oil export tax schedule and reduction in the rate of import duties imposed on other goods.
Table 28
Forecasted Parameters, Federal Budget for 2005
Scenario 1 Scenario 2 Scenario 3
Federal budget incomes, RUR billion . 3279 3467 3179
Federal budget incomes, % of GDP 17.3 18.1 17.0
Federal budget surplus, RUR billion 231 41 9 131
Federal budget surplus, % of GDP 1.2 2.2 0.7
Thus, by adjusting the forecasted figures of the federal budget revenues in 2005 by the value of discretional changes, the profit side of the federal budget in 2005 looks as follows:
• nearly RUR3279 billion, under the condition of the same scenario which the draft federal budget for 2005 is based on (Scenario 1);
• nearly RUR3467 billion, provided that oil price in 2005 is equal to that in 2004 (Scenario 2);
• nearly RUR3179 billion, provided that oil price decline down to $22 per barrel by the end of 2005 (Scenario 3).
The forecasted surplus of the federal budget in 2005 under the conditions of the same scenario (Scenario 1) would be RUR47 billion less than that in the draft federal budget (correspondingly RUR231 billion against RUR278 billion). The federal budget surplus may reach 2.2% of GDP, provided than the basic trends of 2004 remain the same.
