11Section 2. Monetary and budgetary spheres
2.1. Monetary Policy
The major development in the RF's monetary sphere that occurred in the year 2005 was rapid growth of prices during the first half-year. In the second half-year, inflation was slowing down and, as seen by the results of January through December, became lower than in the same period of the year 2004.
2.1.1. The Money Market
In 2005, a considerable growth of the RF's gold and foreign currency reserves was observed (Fig. 1). The record prices of the major Russian export commodities, and primarily of oil prices, served as the main growth factor. A reduction in the reserves' volume (by monthly results) was seen only in July and was caused by the early repayment of the external government debt to the Paris Club in the amount of more than 15 billion USD. By the year's end, the volume of gold and foreign currency reserves reached an absolute record high of 182.24 15 billion USD.
S Ö
o
•Narrow monetary base (billion roubles) 1
Gold and foreign currency reserves ($ billion)
Source: RF Central Bank.
Fig. 1. Changes in Monetary Base and Gold and Foreign Currency Reserves
of RF in Years 2004-2005
However, in order to maintain a stable exchange rate of the national currency, the Bank of Russia was compelled to buy the foreign currency flowing into the country, thereby increasing money supply. So, let us take a closer look at the money supply dynamics.
During Q I 05, the monetary base (in a broad sense1) decreased by 130.2 billion roubles, to 2.26 trillion roubles ( 5.5 %). The broad monetary base volume as of 1 January 2005 was 2.39 trillion roubles. In the same period of the year it increased by 1.2 %. The cash-in-circulation volume, including the cash balances of credit institutions, as of 1 April, was 1.58 trillion roubles (- 5.4% as compared to 1 January), the correspondent accounts of credit institutions with the Bank of Russia - 326.9 billion roubles (- 33 %), mandatory reserves - 133,4 billion roubles (+ 9.6 %), banks' deposits with the Bank of Russia - 149.8 billion roubles (+ 63.9 %), the value of the Bank of Russia's bonds held by credit institutions - 60.6 billion roubles (growth by 5.2 times), the RF Central Bank's liabilities against securities buyback - 2.1 billion roubles (- 16 %), while the reserves on operations in foreign currencies deposited with the Bank of Russia - 4.2 billion roubles (- 10.6 %). The fall, in last year's first quarter, of the cash-in-circulation volume (- 5.4 %), with a simultaneous increase in mandatory reserves (+ 9.6 %), resulted in a reduction of the narrow monetary base (cash + mandatory reserves)2 by 0.4 % (Fig. 1). At the same time, the gold and foreign currency reserves of the RF CB also grew in January through March (by 11.6 %) and amounted, as of 1 April, to 137.4 billlion USD. At the same time, liquidity sterilization was occurring in the Stabilization Fund, whose volume as of 1 April amounted to 768.5 billion roubles (growth by 246.2 billion roubles in the first quarter).
In Q II 05 the monetary base (in a broad sense) decreased by 52.7 billion roubles to 2,31 trillion roubles (by 2.3 %). The volume of the broad monetary base as of 1 April 2005 was 2.26 trillion roubles. In the same period of the previous year, it decreased by 0.9%. The cash-in-circulation volume, including the cash balances of credit institutions, as of 1 July amounted 1.76 trillion roubles (growth by 11.2% against the amount as of 1 April), the correspondent accounts of credit institutions with the Bank of Russia - 282.7 billion roubles (- 13.5 %), mandatory reserves - 137.2 billion roubles (+ 2.8 %), banks' deposits with the Bank of Russia - 34.4 billion roubles (-77 %), the value of the Bank of Russia's bonds held by credit institutions - 93.2 billion roubles (+ 53.8 %), the RF Central Bank's liabilities against securities buyback - 0 roubles (- 2.1 billion roubles against the amount as of 1 April of the same year), while the reserves on operations in foreign currencies deposited with the Bank of Russia - 5.7 billion roubles (+ 35.7 %). The growth, in the second quarter of last year, of the cash-in-circulation volume (+ 11.2 %), with a simultaneous increase in mandatory reserves (+ 2.8 %), resulted in broadening of the narrow monetary base (cash + mandatory reserves) by 10.2 % (Fig. 1). At the same time, the gold and foreign currency reserves of the RF CB grew in April through June (+ 10.3 %) amounted, as of 1 July, to 151.6 billion USD.
In Q III 05 the monetary base (in a broad sense) grew by 236.2 billion roubles to 2.55 trillion roubles (+ 10.2 %). The volume of the broad monetary base as of 1 July 2005 amounted to 2.31 trillion roubles. In the same period of the previous year it decreased by 4.8 %. The cash-in-circulation volume, including the cash balances of credit institutions, as of 1 October became 1.86 trillion roubles (+ 5.7 % against the amount as of 1 July), the correspondent accounts of credit institutions with the Bank of Russia - 380.4 billion roubles (+ 34.6 %), mandatory reserves - 150 billion roubles (+ 9.3 %), banks' deposits with the Bank of Russia - 64.4 billion roubles (+ 87.2 %), the value of the Bank of Russia's
1 The RF's monetary base in a broad sense, in addition to the cash-in-circulation issued by the Bank of Russia, and the residuals on the accounts of mandatory reserves of the funds in the national currency attracted by credit institutions and deposited with the Bank of Russia, includes the funds in corresponding accounts with credit institutions and bank deposits placed with the Bank of Russia.
2 It should be remembered that the monetary base in a narrow sense is fully controlled by the RF Central Bank, which cannot be said in respect to the monetary base in a broad sense.
bonds held by credit institutions - 87 billion roubles (- 6.7 %), the RF Central Bank's liabilities against securities buyback - 0 roubles (no change), while the reserves on operations in foreign currencies deposited with the Bank of Russia - 7.4 billion roubles (+ 29.8 %). The growth, in the third quarter of last year, of the cash-in-circulation volume (+ 5.7 %), with a simultaneous increase in mandatory reserves (+ 9.3 %), resulted in broadening of the narrow monetary base (cash + mandatory reserves) by 6% (Fig. 2). At the same time, the gold and foreign currency reserves of the RF CB grew in July through September (+ 5.3 %), having amounted, as of 1 October, to 159.6 billion USD. At the same time, liquidity sterilization took place in the Stabilization Fund, whose volume as of 1 October amounted to 960.7 billion roubles (+ 342.8 billion roubles in Q III ).
And finally, in Q IV 05 the monetary base (in a broad sense) grew by 375.2 billion roubles to 2.91 trillion roubles (+ 14.8 %), its volume, as of 1 October 2005, amounting to 2.54 trillion roubles. The cash-in-circulation volume, including the cash balances of credit institutions, as of 1 January 2006 amounted to 2,2 trillion roubles (+ 18.3 % against the amount, as of 1 October), the correspondent accounts of credit institutions with the Bank of Russia - to 508.6 billion roubles (+35,8%), mandatory reserves - to 161.4 billion roubles (+ 7.6 %), banks' deposits with the Bank of Russia - to 7.2 billion roubles (88.8 %), the value of the Bank of Russia's bonds held by credit institutions - to 32.8 billion roubles (62.3 %), the RF Central Bank's liabilities against securities buyback - 0 roubles (no changes, as compared to the amount as of 1 October of the same year), while the reserves on operations in foreign currencies deposited with the Bank of Russia - to 8.8 billion roubles (+ 18.9 %).
The growth, in Q IV 05, of the cash-in-circulation volume (+ 18.3 %), with a simultaneous increase in mandatory reserves (+ 7.6 %), resulted in broadening of the narrow monetary base (cash + mandatory reserves) by 9,6% (Fig. 1). At the same time, the gold and foreign currency reserves of the RF CB also grew in Q IV 05, by 14.2 %, having amounted, as of 1 January 2006, to 182.2 billion USD. A substantial part of the liquidity inflow into the country was accumulated in the RF Stabilization Fund, whose volume, as of 1 January 2006, amounted to 1.237 trillion roubles (+ 510.5 billion roubles as compared to 1 October 2005).
Thus, the results of the year 2005 demonstrated a less impressive growth in money supply than that observed in the year 2004. At the same time, during last year the revenues in foreign currencies were being actively sterilized in the Stabilization Fund, the volume of which, as seen by the results of the period of January through December, exceeded 1.23 trillion roubles. In order to assess the successfulness of the efforts of the monetary and financial authorities in terms of money supply sterilization, below we analyze its excess value.
For this purpose, we assess the demand for money equation of the type
M
-— = a0 + alYt + a2Apt + a3t + et, where Mt - money supply M2, GDPt - nominal GDP
GDPt
value, Yt - GDP volume (in the 1995 prices), Apt - consumer price index, t - time. The assessment was based on the quarterly data of the years 1999-2005. The resulting residual values can be interpreted as excess of money supply. Fig. 2 shows the curves of actual money supply and estimated demand for money.
Source: RF Central Bank; the authors' calculations.
Fig. 2. Dynamics of Demand for Money and Money Supply (Money Aggregate M2) in Q I 99 - III Q 05
It can be noticed that throughout almost the whole of the year 2004, money supply was higher than demand for money. In all probability, this was one of the major factors responsible for the high inflation rate observed in the first half-year of 2005.
Source: RF Central Bank; the authors' calculations.
Fig. 3. Money Multiplier in RF in 1993-2005
It should also be noted that, despite the increased money supply, the money multiplier in the RF remains at a low level (Fig. 3). Thus, this index in Bulgaria (calculated by the IFS data base) in G II 05 amounted to 3.15, in Estonia - to 3.83, in Hungary - to 5.07, in Latvia - to 2.96, in Lithuania - to 3.24, and in Slovakia - to 5.87. Against this background, the index value of 2.8, achieved by late 2005, appears very insignificant, reflecting the underdeveloped status of this country's banking sphere.
Thus, on the basis of the above analysis of the situation on the RF money market, it becomes possible to conclude that the high inflation rate seen in early 2005 was an objective phenomenon; one of its causative factors was the excess of money supply over the demand for money in 2004. Now we are going to discuss the inflation processes in more detail and make an attempt at determining also the non-monetary factors that were responsible for the development of these processes in the RF.
2.1.2. Inflation Processes
Early 2005 saw dramatic acceleration in the rate of inflation, as compared to the year 2004 (Fig. 4). As a result, already by the results of the first half-year, it became clear that the government's 2005 target plan for keeping the annual inflation rate at the level of 8.5% was going to fail, because in the period of January through June CPI growth, as compared to December 2004, amounted to 7.8 %. It should be noted that in the spring of 2005 the target value was increased to 10 %. However, this target was also doomed to fail: according to the results of the year 2005, the inflation rate in the RF was as high as 10.9 %. So, we are going to take a closer look at the way the inflation rate was behaving throughout the year.
3,0% 2,5% 2,0% 1,5% 1,0% 0,5% 0,0% -0,5% -1,0%
- -•- 2003 —•-2004 —*— 2005
Source: Rosstat.
Fig. 4. Dynamics of CPI in RF in 2003-2005
The value of the consumer price index in the first quarter of last year amounted to 5.3 % (against 3.5 % in Q I 04 r. (Fig. 5)). In the group of food commodities the prices grew by 4.9 % (against 3.8% in January - March 2004). As seen by the results of the first quarter,
the highest growth rate was demonstrated by fruits and vegetables (+ 24 %), meat and poultry (+ 6.9 %), and fish and seafoods (+ 6.3 %). A downward trend was demonstrated by the prices of granulated sugar (- 0.8 %), grouts and legumes (- 1.2 %). Thus, judging by the results of the first three months of 2005, the prices of food commodities grew largely because of the increased, almost by one-quarter, prices of fruits and vegetables (against + 10.1% in January - March 2004). As before, CPI growth was mainly being contributed to by the growing prices of commercial services provided to the population - by 12.6 % (against 6.4 % in Q I 04). At the same time, every month during the first quarter was continual decline in the growth rate of the prices of commercial services. While in January 2005 the highest upsurge was demonstrated by the prices of housing and utilities services (+ 19.4 %), in February their growth rate went down to + 4%, and in March - to + 1.9 %. Nevertheless, in the first three months of the year 2005 it were the prices of housing and utilities services that demonstrated the most noticeable growth (+ 26.5 % against 13.1 % in the previous year), as well as the prices of pre-school education services (+ 16.7 % against + 8.4 % in the same period of the year 2004). As for non-food commodities, in the first quarter their prices went up, on the average, by 1.1 % (in Q I 04 their growth amounted to + 1.4 %). A continuing downward trend in the prices of motor petrol should also be noted (-1.6 %). At the same time, motor petrol became cheaper only in January - February, while in March its prices went up by 0.3 %. The increase of the base consumer price index3 in Q I 05 amounted to 2.4 % (against 2.4 % in the same period of the year 2004). Thus, the main reason of the inflation surge in early 2005 was the dramatic growth in the tariffs on commercial public services. Simultaneously, in January through March the prices of fruits and vegetables were also demonstrating a rather substantial growth rate.
By the results of the first half-year of 2005, the value of the consumer price index amounted to 8 % (against 6.1 % in the first half-year of 2004. (Fig. 4)). In the group of food commodities the prices grew by 8.6 % (against 6% in January through June 2004). In this connection, the greatest contribution to the growth of prices in this group of commodities was made by fruits and vegetables, their prices having increased by almost 1.5 times. The prices of commercial services were also contributing to the overall CPI growth by increasing by 15.4 % (against 11 % in the first half-year in 2004). In May - June the growth rate of their prices became stabilized at the monthly level of 0.8-0.9 %. In the first six months of 2005 the highest growth rate, as in the first quarter, was demonstrated by the prices of housing and utilities services (29.1 %, against 18.6 % in 2004), as well as by the prices of pre-school education services (21.9 %, against 12.5 % in the same period of the year 2004). As for non-food commodities, in the first half-year they became more expensive, on the average, by 2.4 % (against 3.4 % in the first half-year of 2004). The increase of the base consumer price index in the first half-year of 2005 amounted to 4.4 % (against 4.3 % in the same period of the year 2004). Thus, the main cause of the impressive inflation rate in the first half-year of last year became the dramatic growth, early in the year, of the tariffs levied on commercial services to the population, as well as the growing prices of fruits and vegetables.
The value of the consumer price index in the first 9 months of the year 2005 amounted to 8.6% (against 8% b January - September 2004 r. (Fig. 1)). Thus, in the second half-year the growth rate became slower, as compared to that in the year 2004. In the group of food commodities the prices grew by 7.1 % (against 7.2 % in January through
3 The base consumer price index reflects the inflation level on the consumer market less the seasonal factor (prices of vegetable and fruit products) and the administrative factor (tariffs on regulated services, etc.); it is calculated by the RF Statistics Service (Rosstat).
September 2004). As seen by the results of the period of January though September, the growth of food prices was mainly contributed to by the increasing prices of meat, poultry and fish. CPI growth, as before, was to a considerable degree driven by the prices of commercial services provided to the population, which increased by 18.5 % (against 14.3 % in January - September 2004). In the first 9 months of the year 2005, the highest growth rate was displayed by the housing and utilities services (31.2 % against 21.8 % in 2004), as well as by the prices of pre-school education services (27 % against 19.7 % in the same period of the year 2004). As for non-food commodities, in the first 9 months of the year their prices went up on the average by 4.5 % (against 5.5 % in the first 9 months of the year 2004). In the period of January though September, the growth rate of the prices of motor petrol was the highest (15.1 %). It is noteworthy that September, when the prices of motor petrol went up by as much as 7.9%, was the month that accounted for more than a half of its total price growth. Besides, in January though September, the prices of construction materials also demonstrated a substantial increase (+ 7.5 %, against + 6.6 % in the same period of the year 2004). The increase of the base consumer price index since the beginning of the year 2005 amounted to 6.3 % (against 6,8 %in the same period of the year 2004). Thus, the main causes of the marked inflation rate, as shown by the results of the first 9 months of the year 2005, were the growing prices of the housing and utilities services and motor petrol.
And finally, CPI as demonstrated by the year's results amounted to 10.9 %. The rate of inflation in the year 2005 was found to be lower than that in 2004, although still much higher than the initial value forecasted by the government. In the group of food commodities, prices grew by 9.6 % (against 12.3 % in 2004). Judging by the results of the period of January through December, the growing prices of food commodities were mainly the result of the increased prices of meat and poultry, fruits and vegetables, fish and seafood, milk and dairies, as well as butter. The greatest contribution to the overall annual CPI growth was made by the prices of commercial services provided to the population, which went up by 21 % (against 17.7 % in 2004). During the 12 months of 2005, the highest growth rate was displayed by the prices of housing and utilities services (32.7 % against 23.5 % in the previous year), as well as by the prices of pre-school education services (32.1 % against 21.6 % in the same period of the year 2004). As for non-food commodities, the 12 months of the year their prices went up on the average by 6.4 % (against 7.4 % in the 12 months of 2004). In January through December the prices of motor petrol displayed the highest growth rate (+ 15.8 %). The increase of the base consumer price index since the beginning of the year 2005 amounted to 8.3 % (against 10.5 % in the same period of 2004). Thus, the main causes of the dramatic inflation rate, as seen by the results of the year 2005, were the growing prices of commercial services provided to the population and of motor petrol.
Now let us turn to the factors that have been producing the greatest impact on the inflation rate in recent years. Since 1999, the Russian economy was characterized by a stable downward trend in the annual values of the consumer price index. It resulted from the moderately rigid monetary policy pursued after the 1998 financial crisis, as well as the sustained surplus of the federal budget. However, from the year 2003 onward, the decline in the inflation rate has been seen no more, and annual CPI growth became stabilized at the level of approx. 12 %.
In order to analyze the existing obstacles to decreasing the rate of consumer price growth, we are going to investigate the main inflation components observed during that period. In Fig. 5, the changes in the values of the three main CPI components are shown: the growth rates of the prices of foodstuffs, the prices of non-food commodities, and the 38
prices of commercial services provided to the population in the years 2003-2005. It can be noticed that throughout that period, the prices of commercial services provided to the population were going up much more rapidly than those of all the other commodities within the consumer's basket. From early 2003 through December 2005, consumer prices increased, on the average, by 38.7 %, while the prices of commercial services provided to the population - by 74.2 %, or almost twofold.
-CPI — — - Foodstuffs----Non-food commodities
Commercial services provided to population
Source: Rosstat; the authors' calculations.
Fig. 5. Growth Rate of Consumer Prices in Years 2002-2005 (01.01.2003 = 100)
As seen from the date in Table 1, one of the most important components of inflation in 2003-2005 was the rise in the tariffs levied on the housing and utilities services, which between January 2003 and December 2005 more than doubled. Next, in terms of their contribution to the overall inflation rate, there were the increasing prices of the basic passenger transport services (by 55.4 %). The prices of meat and poultry were also rapidly going up (by 55.5%), as well as those of bread and other bakery products (by 56.7 %).
An analysis of the dynamics of the prices and tariffs on the services and goods produced by natural monopolies (electric power, gas, cargo shipment) in 2002-2005 has demonstrated that, during the period under consideration, the highest growth rates were displayed by the gas tariffs and the prices of cargo shipment. The electric power tariffs, by their growth rates, were only slightly ahead of the CPI growth rate.
Thus, the main non-monetary factors that influence the inflation rate are, as before, the rapid rise in the prices of commercial services provided to the population and motor petrol. In such a situation, an efficient anti-inflation measure could be the imposition of restrictions on the growth of tariffs on the services provided by natural monopolies, as well as the creation of a domestic exchange for oil and oil products.
Table 1
Main Growth Factors of Consumer Prices in 2003-2005 (Growth Coefficient), as %
2003 2004 2005 January 2003 -December 2005
CPI 12.0 11.7 10.9 38.7
Foodstuffs 10.2 12.3 9.6 35.6
Bread & bakery products 30.4 16.7 3.0 56.7
Grouts and legumes 17.0 11.6 0.2 30.8
Pasta products 14.0 1 4.6 1.9 33.1
Milk & dairies 13.1 12.8 10.5 41.0
Meat & poultry 8.9 19.6 18.6 54.5
Fish & seafood 9.9 11.5 12.7 38.1
Non-food commodities 9.2 7.4 6.4 24.8
Motor petrol 16.8 31.3 15.8 77.6
Commercial services to population 22.3 17.7 21.0 74.2
Housing & utilities services 28.7 23.5 32.7 110.9
Passenger transport services 13.7 18.0 15.8 55.4
Services of cultural organizations 21.8 19.9 17.7 71.9
Pre-school education services 1 5. 1 21.6 32.1 84.9
Source: Rosstat; the lET's calculations.
It should also be noted that the failure to achieve the target inflation value set for the year 2005 (8-10 %) will, in all probability, result in growing inflation expectations. Coupled with the slowdown in GDP growth in real terms, this may result in a rather serious fall in the growth rate of the demand for money in the year 2006. Therefore, while the current level of money supply growth is maintained, further inflation growth may occur. It should be borne in mind that in 2006 the government is planning to bring down the inflation rate to 8 %, which may well prove impossible in view of the aforesaid circumstances.
By way of rounding up, we are going to compare the rates of consumer price growth in the RF and other CIS countries (Table 2). It can be observed that the majority of countries within the CIS have been far more successful than Russia in their efforts to cope with inflation.
Table 2
Indices of Consumer Price Growth in CIS in 2000 2005, as %
2000 2001 2002 2003 2004 20054
Azerbaijan 2 2 3 2 7 5.1
Armenia 1 3 1 5 7 -2.6
Belarus 169 61 43 28 18 6.2
Georgia 4 5 6 5 6 4.4
Kazakhstan 13 8 6 6 7 6.9
Kyrgyzstan 19 7 2 3 4 4.6
Moldova 31 10 5 12 12 8.7
Russia 20 19 15 12 12 10.9
Tajikistan 24 37 10 17 7 5.9
Urraine 28 12 1 5 9 9.4
Source: CIS Interstate Statistical Committee.
Consequently, one cannot say that the rapid consumer price growth in the RF is the legacy of the inflation that was characteristic of the 1990s. Obviously, it represents a rather
4 With regard to all these countries, except the RF, the data are presented for January-February 2005, and with regard to the RF - for the year 2005 as a whole.
serious problem, the causes of which may be both the growing money supply resulting from the necessity to maintain a stable rouble's exchange rate, the high degree of monopolization on the markets, the rapidly growing prices of commercial services provided to the population, and other potential factors that have not yet been clarified.
As for forecasting the rate of consumer price growth in 2006, it should be noted that in a situation of international oil prices staying at a high level, thus generating an inflow of foreign currency into this country, it would be practically impossible to try to bring down the high inflation rate (see the section "Long-term problems of monetary policy"). According to our estimations, if the average annual price of Brent crude stays at the level of $ 40-50 per 1 barrel, the growth rate of money supply will be around 25-30 % per annum, which means that the annual inflation rate can be expected at the level of 9.5-10.5 %.
2.1.3. State of Balance of Payments
Russia's steady balanceof-payments situation in 2005 as in years before was due largely to record volumes and prices on Russia's main exports, first and foremost its energy sector. With soaring world oil prices, value of Russia's exports swell by a third. Russia's official gold and foreign currency reserves rose accordingly. 2005 was also remarkable in that for the first time in Russia's modern history more capital came into the country than left it.
According to Central Bank's initial estimates on the balance-of-payments for 2005, current account surplus stood at $86.6 bn, a 47.8% growth on the year before (please see Table 1). Trading surplus in particular rose by 40.1% (from $85.8 bullion in 2004 to $120.2% bn in 2005), with growth in exports at 33.9% (from $183.2 bn in 2004 to $245.3 bn in 2005) though imports also grew by 28.4% (from $97.4 bn in 2004 to $125.1 bn in 2005). Products from the oil and gas segment of the economy took up more than two thirds (61%) of total exports, an increase from its 57% share in 2004 (see Figure 1). Just as in the years before, status of Russia's current account depends largely on its trade component, which in its turn is mostly determined by changes on prices for Russia's main exports. A quick look at Figure 2 demonstrates that the correlation between the country's trade account and the world's energy prices observed in 2004 continued in 2005 as well.
Deficit in services account as compared with 2004 rose by 9% to $14.6 bn. In 2005 Russia exported services worth of $24.3 bn, $4 bn than a year before which constituted a 19.7% increase. At the same time, value of services imported also grew by 15.4% on the year before and stood at $38.9 bn for 2005.
Labor costs in 2005 continued to decline and were -$1.6 bn. In 2004 that figure was -$.6 bn.
Russia's investment income component in the balance of payments in 2005 as compared to its 2004 levels rose by 32% to $16.5 bn. Investment income receipts rose from $9.2 bn to $16.5 bn, with most of that growth stemming from banks (from $.9 bn on 2004 to $1.7 bn by 2005) and non-financial enterprises (from $5.1 bn in 2004 to $9 bn in 2005). Similarly rising figures for investment income payments at the non-financial sector (from $15 bn in 2004 to $25.1 bn in 2005) have contributed to larger overall income payments (from $21.7 bn in 2004 to 32.7 bn in 2005).
Unilateral current transfers in 2005 changed insignificantly, and for 2005 the figure was estimated at $1 bn.
300
250 --
200 --
G
Q 150 +
in £
100 --
50
1999
2000
2001
2002
2003
2004
] Exports
Share of oil, oil products and gas in exports
70
60
50
-- 40
30
20
10
2005
Fig. 6. Share of Energy Sector in Exports
Table 3
Components
Current Account Transactions Capital Account Trans-actions6 Gold and Foreign Currency Reserves Net Errors & Omissions
Major Components of the Russia's Balance of Payments for 2003-2005 (in $bn)
2003
2004
2005
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q45
11.4 8.1 7.3 8.6 12.5 13.4 14.9 17.8 21.4 21.5 20 23.7
-2.4 1.5 -6.7 6.7 -3 -7.9 -8.1 12.8 -3.9 -0.5 -10.7 0.7
-7.6 -8.1 2.6 -13.3 -6.8 -5 6.5 -26.9 -14.4 -18 -8.1 -21
-1.5 -1.6 -3.2 -1.9 -2.8 -0.4 -0.3 -3.6 -3.1 -3 -1.2 -3.4
Source: Bank of Russia.
0
0
5 Estimates.
6 Minus changes in gold and foreign currency reserves.
Source: Bank of Russia, IFS, Authors' Own Calculations.
Fig. 7. Russian Balance of Trade and Index of World Oil Prices for 2001-2004
Russia's capital account deficit (excluding foreign reserves changes) in 2005 rose 2.3 times (from $6.3 bn to $14.4 bn) on the year before.
Capital transfers in the amount of $12.2 bn resulting from writing off Soviet era debts to a number of countries such as Iraq and Syria were largely responsible for this growing deficit. Encouragingly when such official capital transfers are excluded from the analysis, the picture is a lot more positive and it becomes clear that capital no longer flees Russia like it used to. In 12 months of 2005 capital account deficit shrank from $4.6 bn to $2.1 bn.
Growth of Russia's liabilities to foreigners in 2005 stood at $58.7 bn, down from 34.1 bn in 2004, i.e. a 72.1% reduction.
Though in 2005 Russian government external liabilities declined by $21.3bn, just as the year before it was still a net borrower to non-residents. The reduction on external liabilities resulted mainly from early repayments of Russia's sovereign debt to IMF and the Paris Club in the amount of over $18 bn. Russia's regional governments were able to reduce their external obligations in the amount of $.1 bn. Russian banks on the other hand engaged in attracting more foreign capital, hence raising their external obligations to the tune of $18 million, a 2.5 times increase on 2004. Non-residents investments in the real sector were $29.1 bn in 2004 and rose to $59.1 bn by 2005.
Russian residents' holdings of foreign assets also increased in 2005 by $60.8 bn (up from $38.7 bn in 2004). Lion share of the increase occurred in the private sector.
Foreign assets held by Russia's federal government declined by $10.7 bn. Though foreign assets held by the regulators of the country's monetary base increased by $ 5.5 bn. For country's private banks the increase was $12.7 bn.
Assets taken out of country in 2005 by non-financial sector and households were estimated at $53.3 bn, a 58.6% increase on the year before. The decline in the amount of cash held in foreign currencies ($1.9 bn) is particularly sizable when taken against significant increases in the direct and portfolio investments ($18.2 bn) as well as in trade credits
and advances. Value of export earnings not received timely, imported goods paid for under import contracts but not delivered and asset transfers on non-existing contracts virtually has not changed from 2004 and was estimated at $25.8 bn by the end of 2005.
As mentioned earlier, for the first time in Russia's modern history in 2005 the country saw a net inflow of capital at $400 million. An impressive turn-around, if compared to just a year ago when the situation was reverse and the deficit stood at 8.1 bn (see Fig. 3).
Source: Bank of Russia, IET.
Fig. 8. Net Capital Flows Dynamics for 2001-2005
It has to be noted that on quarterly basis capital flows varied significantly. In the 2nd and 4th quarters, there was a net outflow of capital from the non-financial sector in the amount of $4.2 and $3.2 bn respectively. 1st quarter saw a small inflow of capital at $.5 bn. It was the 3rd quarter with its massive $7.2 bn of net capital inflow that determined the outcome for the year as a whole. These capital inflows resulted mainly from Russian firms' and banks' active pursuit of financing from abroad as well as foreigners' enthusiasm for lending money to Russian firms in the face of the country's sounder macroeconomic fundamentals.
Unfortunately though, non-official outflows, "capital flight" (see Fig. 4) continued to grow in 2005 and in absolute terms according to these authors' calculations7 were $45 bn, a $6.4 bn increase over 2004.
7 Here we used the IMF's capital flight formula which is a sum of all "trade credits and advances", "export earnings not received timely, value of imported goods paid for under import contracts but not delivered" and "net errors and omissions".
Source: Bank of Russia, IET.
Fig. 9. Capital Flight Dynamics for 2001-2005
Moreover capital flight remained on the increase in the country's external trade turnover and from 12% in 2004 rose to 12.3% in 2005.
Taken against these data that show the capital still leaving the country on a large scale, the capital flow situation is not so unequivocally positive. Overall, one can conclude that in the face of favorable macroeconomic setting there is a net inflow of capital into the country, but the persistent nature of risks associated with the country feeds the continuing capital flight.
An important observation that has to be noted from this analysis of the country's 2005 balance of payments is that energy exports have contributed over a half of total trade earnings and that share is growing. This certainly demonstrates the economy's dependence on this one sector. Luckily for Russia, any downward revisions to the world oil prices in the near future are unlikely. With growth in export earnings ahead of imports, the balance of payments situation is expected to remain stable. Granted that net capital inflows grow and capital flight moderates, stability in the balance of payments could be sustained not only due to current account surpluses but also through capital transactions and growing gold and foreign currency reserves.
2.1.4. Basic Measures to be Implemented by CBR in the Sphere of Monetary Policy
The Bank of Russia, from 15 March 2005, established the following structure of the bi-currency basket for purposes of implementing the exchange-rate policy: the euro - 20 % and the USD - 80 %; from 16 May, the euro's share was increased to 30 %, from 1 August to 35 %, and from 2 December to 40%. It should be remembered that from 1 February the Bank of Russia has begun to apply, as an operational target for its exchangerate, the value of a foreign-currency basket where the euro's share is 10 %, while that of
the USD is 90 %. The changed structure of the basket is aimed at decreasing the rouble's exchange rate's volatility in respect to the currencies of Russia's major partners in trade.
In March 2005, representatives of the RF Bank declared that, while preserving the same cutoff price level as before, for purposes of creating a stabilization fund, the operations of money supply sterilization will be dominating over refinancing operations. However, if the cutoff price is increased, the Central Bank would be able to make a more extensive use of the existing possibilities of refinancing the banks.
From 1 June 2005, the changes to the Provisions of the Bank of Russia "On the mandatory reserves of credit institutions" came into force, which envisaged that credit institutions were to assume, toward their responsibilities relating to the equalization of the mandatory reserves against the residuals listed not only on the correspondent account of the head office of a credit institution, but also those on the correspondent subaccounts of its subsidiaries opened at the Bank of Russia. This measure is in a certain sense equivalent to the lowering of the requirements to mandatory reserves, which may result in growth of the money multiplier and money supply level in the national economy.
In May, representatives of the Central Bank announces that it was probable for the Bank of Russia to begin the refinancing of banks against the pledge of non-standard assets, which might be represented by the obligations of issuers without appropriate credit rating or market quotations. This measure is quite compatible with the Bank's latest measures designed to make easier the refinancing of commercial banks. The obligations of the Agency for Mortgage Loans against Housing and the Moscow Mortgage Agency have already been placed on the mortgage list. However, bankers felt that these measures alone were not sufficient. It is planned that the financing against the mortgage of non-standard assets will be regulated by separate guidelines. If the Bank's plans come true, this measure can be estimated as positive, because an easier procedure for refinancing will be a safeguard against crises similar to that which happened in the summer of 2004.
In May, the RF president signed the Law on the Central Bank, thereby establishing the special procedure for the issuing of short-term bonds of the Bank of Russia. Previously, the Government had made is mandatory for the Bank to register the prospectus for a loan emission with the Federal Securities Market Commission and the RF Ministry of Justice. However, under the new Law the issuing of bonds by the Bank of Russia will be effectuated without State registration of an issue, without an issue's prospectus, and without State registration of the report on the results of a bond issue. Besides, the decision concerning an issue of bonds will be made by the Board of Directors of the Bank of Russia. As of now, the yields to maturity of the Central Bank's bonds is much lower that the average market yield value. These securities will be of interest only for those banks that conduct repo operations with the Central Bank, because such securities can be accepted as a pledge. Generally speaking, this instrument can be regarded as one of those to be applied for money supply sterilization.
In 2005, the Board of Directors of the Bank of Russia decided to issue into circulation the 1997 five-thousand-rouble note of the Bank of Russia. According to the Bank's representatives, the issuing into circulation of the five-thousand-rouble note has been necessitated by the needs of the cash turnover and the growing average wage level in this country. It is planned to issue into circulation the five-thousand-rouble note in 2006.
On 16 November, the Bank of Russia submitted to the State Duma a new version of The Main Directions of Monetary Policy in the Year 2006. It should be reminded that in mid-October last year the State Duma's Committee on Budget and Taxes had already considered the draft of The Main Directions of the State's Unified Monetary Policy in the Year 2006. However, according to the Committee's members, the experience of imple-46
menting the monetary policy has shown that there exist marked discrepancies between the inflation rate's forecasted and actual indices, largely due to the underestimation of the future price of one barrel of oil. In this connection, the newly developed draft document of The Main Directions now incorporates a version of calculations based on the forecasted price of "URALS" amounting to $ 60 per barrel.
In late 2005, the information was released that from the year 2006 the published information concerning the gold and foreign currency reserves of the RF is to be based on estimations of gold at the quotations established by the Bank of Russia. Previously, for these purposes an arbitrary price had been applied, equal to 300 USD per 1 troy ounce. According to the Bank's representatives, this change in the procedure of statistical recording has been associated with the need to make the information being published compatible with a current market situation. It should be remembered that throughout the year 2005 the price of gold was higher than 400 USD per 1 troy ounce.
2.1.5. Long-Term Problems of Monetary and Exchange-Rate Policies
Russia's monetary and exchange-rate policies after the 1998 crisis have given rise to many discussions. We believe that throughout the post-crisis years these policies were sufficiently well-balanced and created the necessary conditions for economic growth in this country. Nevertheless, the currently rather high inflation rate, which is contributing to the continual and sufficiently rapid strengthening of the rouble, as well as resulting in the understanding of the high dependence of the situations in the monetary sphere and on the foreign-currency market on the state of foreign markets, require that the issues of long-term financial policy be discussed further.
Fig. 1 demonstrates the joint dynamics of the consumer price index and the rouble's real effective exchange rate. As is seen from the chart, since the year 2003 the rate of the strengthening of the rouble's real exchange rate has been accelerating. During the same period, the growth rate of CPI became stabilized at the level of 11-12% per annum.
22% 20% 18% 16% 14% 12% 10% 8% 6% 4% 2% 0%
-CPI -"—Real elTeclive exchange rale
\ \
\ N.
\ \
\ \
\ -—
2000 2001 2002 2003 2004 2005
Source: Rosstat, Bank of Russia.
Fig. 10. Annual Growth Rates of the Consumer Price Index and the Rouble's Real Effective Exchange Rate (2005 - Data on First 10 Months)
If one compares the situation when for several years the international markets have been demonstrating high oil prices and high prices of the other energy carriers with a similar situation in respect to low oil prices, it will be noted that one of the main distinctive features characterizing the external conditions for implementing the monetary and exchangerate policies will be characterized by differences in the balances of payments and the equilibrium values of the real exchange rate (that is, equilibrium from the point of view of an equilibrium balance of payments).
During the transition into a period of high international oil prices, a high positive balance of payments, coupled with capital inflow, result in an overall positive current balance and a high equilibrium value of the real exchange rate, thus generating a trend toward the rouble's real exchange rate being strengthened due either to growing domestic prices, or to a strengthening nominal exchange rate.
And vice versa - during the transition toward low international oil prices the current balance of payments becomes negative because of a negative balance of trade and capital outflow, and the equilibrium value of the real exchange rate decreases, thus resulting in a weakening real exchange rate of the rouble.
When analyzing these situations, it should be noted that, despite the seemingly symmetrical situations occurring when oil prices go down and when they go up, if one considers the costs of inflation and the fluctuations of the exchange rate being borne by the population and by the real sector, the monetary and exchange-rate policies must be fundamentally different.
Given specific preconditions, it can be demonstrated that the rational policy in this sphere for Russia in a situation when the prices of energy carriers on the world market are high will be that of maintaining a moderate rate (or suppressing the rate) of the growth of the rouble's real exchange rate in face of a sufficiently low inflation rate. This policy will be in fact reduced to a one-sided targeting of the inflation rate, that is, to the setting of an upper margin (preferably, to be further decreased every year) for the annual rate of price growth. The behavior of the RF Central Bank (RF CB) on the currency market is determined by the existing opportunities for sterilizing the issue of money arising from the need to maintain the rouble's nominal exchange rate at a certain level necessary for ensuring the desired growth rate of the rouble's real exchange rate in a situation of a continuing actual inflation.
When the prices of energy carriers go down, the rational policy appears to be that of a gradual but relatively rapid decline in the rouble's real exchange rate to the level that can ensure the equilibrium of the current account.
Certainly, highly important in both cases is the state of the balance of capital transactions, which, in the case of Russia, is heavily dependent on the situation in the sphere of foreign trade.
Now let us discuss separately the situations characterized by low and high prices of energy carriers.
When the foreign economic situation is favorable. This case corresponds to the situation currently existing in Russia, when the rouble is displaying a tendency of strengthening toward a level that can ensure an equilibrium balance of payments, while the RF Central Bank is opposing this process by its interventions on the currency market, and, as a result, is increasing both foreign currency reserves and money supply. In absence of any efficient mechanisms for sterilizing the CB's interventions, the resulting inflation represents an obstacle to providing an adequate solution to the problem of slowing down the strengthening of the rouble's real exchange rate's strengthening. The current account equilibrium could have been achieved through strengthening the rouble's nominal ex-48
change rate, if the CB had not been making its interventions, or had been making them in smaller volumes than are necessary for maintaining a stable nominal exchange rate. In such a case, resulting from inflation, the real strengthening of the rouble would have been achieved at a lower level than the actual current values of the real exchange rate, because it would have been influenced by the changes in the rouble's nominal exchange rate and would have corresponded to lower degree of monetization of the positive balance of foreign trade.
However, we believe that, irrespective of the actual results of such a policy, from the point of view of the rouble's real exchange rate being suppressed, such an approach could have had negative consequences because of the rouble's nominal exchange rate's strong response to external shocks. The application of the rouble's nominal exchange rate as an instrument for ensuring the national economy's adjustment to new economic conditions has been made difficult by its excessively sensitive response to any external changes (the flyover effect), as well as by the possibility of speculation attacks on the roubles by the participants of the currency market. As a result, with a floating exchange rate, the changing foreign trade conditions may result in instant dramatic changes in relative prices and the competitive capacities of domestic enterprises, these changes being greater than necessary for establishing an equilibrium. And if the RF Central Bank suppresses the changes in the rouble's nominal exchange rate through currency interventions, the movement of the rouble's real exchange rate towards an equilibrium can be made slow and gradual.
In this connection, we depart from the assumption that the keeping, at present, of the rouble's real exchange rate at a lower level than would be necessary for an equilibrium balance of trade is contributive to stable economic growth. At an equilibrium exchange rate of the national currency, a substantial number of production entities may presently lose their competitive capacity. As a result, the national economy's specialization will be increasingly focused on the extraction and primary procession of raw materials, which can hardly be considered a reasonable strategy under conditions of a highly changeable situation on the international raw-materials markets and their limited economic reserves. Besides, the rouble's lowered real exchange rate is quite compatible with the existing ratios of labor productivity in the RF and developed economies.
Thus, in view of the necessity to maintain the rouble's real exchange rate at a relatively low level of acceleration in a situation of a positive balance of foreign trade, the policy being currently pursued by the RF CB and the RF Ministry of Finance would appear, on the whole, to be quite reasonable. However, in the last two years, as the prices of energy carriers have been extremely high, the financial authorities have been suffering from the lack of adequate financial instruments for sterilizing the excessive money supply resulting from the RF CB's currency interventions. As a consequence, the inflation rate, that in recent years has never been below 11.5 %-12 %, is contributing to the rouble's accelerated strengthening.
In actual practice, sterilization is achieved by means of applying two instruments: budget surplus (in the form of money accumulation on the accounts of state administrative bodies, and the creation of the Stabilization Fund) and the accumulation of commercial banks' excessive reserves on the accounts with the RF CB 8. These instruments need to be further developed. Thus, it is necessary to consider the possibility of creating, either within the Stabilization Fund's framework, or outside of it (but based on the same principles), a
8 The calculations performed by the IET have pointed to the fact that when the amounts of money placed on the accounts of state administrative bodies and the excessive reserves of commercial banks are being changed, there occurs a coordination between the accumulation of reserves and the increased residuals on the accounts of state administrative bodies and commercial banks. Also, as far as the current interventions are concerned, two-thirds of their total volume is sterilized.
Fund on whose accounts the formation of funded pensions for Russian citizens will be ensured in a situation of a highly favorable foreign trade situation. The process of accumulation, by banks, of excessive reserves, which at present involves mainly those banks that are controlled by the State (The RF Sberbank, the RF Bank for Foreign Trade), is, most probably, being favored by the monetary authorities. At the same time, there exists the probability that the interest rates established for commercial banks' deposits with the RF CB may be increased.
The increasing of the norms for mandatory reserves formation (MRF) in the nearest future, obviously, cannot be regarded as an instrument for suppressing the growth of money supply. This can be explained by the considerable differentiation, in their financial status, between various Russian banks, in a situation when the market for interbank credits, as well as the mechanisms for the refinancing of commercial banks by the RF Central Bank, are underdeveloped. Under such conditions, the toughening of MRF norms may increase the risks of liquidity crises. So, before it can become possible to apply MRF norms as an instrument for managing money aggregates, measures will have to be taken that will be aimed at developing the mechanisms of granting loans to the banks which are in need of liquid funds.
An important instrument for sterilizing currency interventions may become bonds issued by the Bank of Russia. The efficiency of such bonds when applied as a sterilization instrument may be limited due to the practical difficulties associated with the need to prevent non-residents from investing in them, which may, in its turn, result in an increased inflow of foreign currency into the country, to be reflected in the status of the capital transactions account of the balance of payments. And if the investments by residents are allowed (through appropriate banks), the effect resulting from the transactions of sale, by the Bank of Russia, of these bonds, expressed in decreasing money supply, will depend on the intensity of the additional capital inflow, which will increase the requirements for the RF CB's currency interventions and, consequently, the need for sterilization.
The measures designed to limit the flow of foreign capital into the bonds issued by the Bank of Russia can be, e. g., as follows:
- sufficiently strict control over the attraction of foreign credits by banks desiring to purchase the bonds of the Bank of Russia;
- a ban on the attraction of foreign credits by banks where the State's share is more than 50%;
- the imposition of limits on the share of foreign liabilities for commercial banks;
- the introduction of requirements for reserves on short-term foreign investments flowing into this country, etc.
As an instrument designed to reduce the necessity for sterilizing the RF CB's operations on the currency market, we can point to the abolition of the requirement for mandatory repatriation of proceeds denominated in foreign currencies. There is no doubt that the introduction of such a measure can be possible only on condition of creating an efficient system of tax control over the operations of Russian companies being handled through their foreign accounts.
When implementing a monetary policy, it is necessary to take into account the fact that sterilized interventions, while not influencing directly the monetary base and inflation rate, still entail certain consequences that must not be overlooked.
Within the impact produced on the exchange rate, the monetary policy and the real sector by the sales of foreign currencies carried out by the RF Central Bank on the currency market, two components can be distinguished.
Firstly, the sale of foreign currencies on the market in the event of demand being higher than supply results in a given foreign currency's exchange rate declining or failing to rise within a short-term interval. If the RF CB's goal is to prevent the strengthening of the rouble's nominal exchange rate, the intervention's results would be, on the one hand, signals being sent to the market participants as to the character of a current monetary policy. On the other hand, the dynamics of the exchange rate in this case will not be dependent on the actions of the market participants or the values of the fundamental variables characterizing the long-term and short-term equilibrium on the currency market and the other markets; instead, it will be fully determined by the actions of the RF Central Bank. This effect has no influence on the long-term equilibrium - regular purchases of foreign currency in a situation of excessive supply during a long period results in the accumulation of reserves and gradual strengthening of the rouble's real exchange rate, depending on the existing potential for intervention starilazation.
Secondly, interventions, including the sterilized ones, may influence the exchange rate, the financial and the real sectors through the changes in the long-term equilibrium in the national economy. Such interventions may occur both as a result of asset redistribution between economic agents (changes in the volumes of foreign currencies, the monetary base or securities in the agents' portfolios), and also resulting from shifts in the monetary and exchange-rate policies or from signals that such shifts are actually taking place, the information concerning them becoming open when interventions are carried out. Accordingly, in the existing literature on this subject9, two channels for the influence of interventions on the equilibrium in the national economy are distinguished: the portfolio channel and the information (or signalling) channel.
It should be noted that the main influence of a non-sterilized intervention, in addition to a short-term impact on the exchange rate, is expressed in the changes in money supply, which in itself will result in a changing equilibrium in the national economy. If an intervention is sterilized, and the monetary base is not increased, the impact of interventions on the equilibrium is not obvious and requires an additional theoretic and empirical analysis.
The portfolio channel (portfolio balance) for the impact of sterilized interventions. The impact of interventions on the equilibrium in the national economy through the portfolio channel may be briefly described as follows. When foreign currency is purchased by the RF Central Bank, and the intervention is sterilized through a sale of securities on the domestic financial markets, there occurs a redistribution of domestic and foreign assets between the portfolios of economic agents. In the event of incomplete replaceability of domestic and foreign assets, the changes in their ratios in a portfolio, as a result of a sterilized intervention, will produce a shift in the equilibrium on the financial markets. This, in its turn, may cause changes in interest rates and, as a consequence, changes in the exchange rate.
The informational channel (or signalling channel) for the impact of interventions. The hypothesis as to the RF CB's interventions influencing the equilibrium in the national economy also through the signalling channel states that the interventions of the RF Central Bank on the currency market may give one a notion of the future monetary and exchangerate policies. The character of the interventions' impact through this channel depends on the degree of openness of the interventions and their informational content. The idea of the impact of interventions occurring through the signalling channel implied that the RF Central Bank can influence the exchange rate through providing the market with a new important and reliable information concerning the intended exchange-rate and monetary
9 For an overview, see, e. g., (Sarno, Taylor, 2001).
policies of the state authorities. Strictly speaking, the interventions may indeed influence the exchange rate, because economic agents change their expectations in respect to the future exchange rate by responding to the interventional activities of the RF CB.
When the foreign economic situation is unfavorable. We believe that in a deteriorating situation in the sphere of foreign trade, the responses of the financial authorities must be asymmetrical in respect to the policy that is pursues when the situation is, on the contrary, improving. When the trade conditions are improving, it is not feasible to apply the nominal exchange rate for achieving an equilibrium of the trade balance, firstly, because it is not desirable to maintain an artificially lowered real exchange rate of the rouble, and secondly, because of the excessively powerful responses of the nominal exchange rate to external shocks.
When the trade conditions for Russia are becoming worse, a dramatic fall in the nominal exchange rate does have some positive aspects from the point of view of economics, which primarily are reflected in the increased competitive capacity of domestic production resulting from the rouble's lowered exchange rate. However, the depreciation of the national currency can also have its negative consequences, in terms of accelerated inflation resulting from increasing prices of foreign commodities; lowering well-being of the population, whose savings are denominated in the national currency; the emergence of negative expectations on the part of both domestic and foreign investors, which may provoke further growth in the demand for foreign currencies, the dollarization of the national economy and capital outflow from this country. Besides, it should be taken into consideration that dramatic depreciation may prove impossible because it is fraught with high risks for the careers of the top government officials responsible for the implementation of such measures.
Given all the aforesaid considerations, it can be concluded that, in a worsening situation in the sphere of foreign trade, the rational policy (with some political restrictions) would be that aimed at lowering the rouble's nominal exchange rate, possible with a "flyover", thereby creating reserves for its later growth in course of the next cycle of price growth. The political implementability of such a scenario may be ensured by complying with the principles of gradual and predictable depreciation rate (possibly, with the announcement of a new prospective exchange rate value) with the help of currency interventions supportive to the rouble's exchange rate, to be carried out by the RF Central Bank with gradually shortening time intervals.
2.2 State Budget
2.2.1. General Structure of the Budget of the Russian Federation for 2005
A general analysis of the 2005 Russian State Budget will immediately point out one observation - extremely high revenues with somewhat lower level of expenditures as a percentage of GDP as compared with the year before (please see Table 1). Both the Russian federal and the consolidated budgets have continued to grow throughout 2005 and not only outperformed corresponding figures from 2004 but also reached record levels for the past 8 years. According to the actual budget figures for 2005, state revenue stood at 23.7% of GDP, 3.3 percentage points higher than the corresponding figure for 2004. Revenues for the consolidated budget were 35.1% of GDP in 2005, a 2.8 percentage points increase on 2004. State expenditures in 2005 on the other hand have not undergone any significant increases and from 16.1% of the GDP in 2004 moved up only to 16.2
in 2005. Expenditures for the consolidated budget have actually gone down from 27.8% of the GDP in 2004 to 27.4% in 2005.
Revenues in the budgets of Russia's local governments have in general been somewhat lower than in 2004. In 2005 consolidated revenues of local governments stood at 13.8% of GDP, down from 14.3% in 2004. Expenditure lines in the local government budgets as a share of GDP however have declined even further by a .5 percentage point on the year before (from 14.1 % of GDP in 2004 to 13.6% in 2005). The combination of increasing state budget revenues and a steady level of expenditures has generated surpluses of a size unprecedented in the budget history of the post Soviet Russia. Surplus in the consolidated budget was a whopping 7.7% of GDP with an equally impressive 7.4% of the GDP for the federal budget. Though a recent makeover of the tax code has made it somewhat difficult to track changes and make direct comparisons with the past when it comes to the tax base of budget revenue, a higher volume of tax-based proceeds into the consolidated budget of the Russian Federation in 2005 suggests that tax revenue in 2005 as a percentage of GDP has increased from previous years. Please see a more detailed structure of tax-based revenues below.
Table 4
Actual Revenues and Expenditures for the Consolidated, Federal and Subnational
Budgets (as a percentage of GDP)
1998 1 999 2000 2001 2002 2003 2004 2005
Federal Budget
Tax-based Revenue: 8.8 10.7 13.2 16.2 18.6 18.0 18.8
Unified Social Tax - - - - 3.1 2.7 2.6 1.23
Revenue 11.3 12.9 15.4 17.6 20.1 19.4 20.4 23.7
Expenditures 14.5 1 4.0 13.1 14.7 18.7 17.7 16.1 16.2
Deficit (-) /Surplus (+) -3.2 -1.1 2.4 2.9 1.4 1.7 4.4 7.4
Territorial Budgets
Tax-based revenue 11.5 10.4 10.2 9.6 10.0 10.0 10.6
Revenue 14.8 13.6 14.4 14.3 14.9 1 4.5 1 4.3 13.8
Expenditures 1 5. 2 13.6 1 4.0 14.3 15.3 1 4.9 1 4.1 13.6
Deficit (-) /Surplus (+) -0.3 0.0 0.5 0.0 -0.4 -0.4 0.2 0.3
Consolidated Budget
Tax-based Revenue 20.3 21.1 23.4 25.8 28.6 28.0 29.4
Revenue 24.5 25.2 28.5 29.3 32.1 31.1 32.3 35.1
Expenditures 28.1 26.3 25.6 26.4 31.1 29.7 27.8 27.4
Deficit (-) /Surplus (+) -3.6 -1.1 2.8 2.9 1.0 1.4 4.5 7.7
Source: Ministry of Finance, Russian Federation; Calculations: IET.
Higher prices for oil and other major export items (mostly natural resources) were certainly the main reason for an increase in the budget revenues in 2005. Since the actual revenues have exceeded forecasted figures, the Law on Federal Budget of the Russian Federation had to be edited in July and November of 2005. According to these changes, state budget revenues were reported to be 4979.76 billion Rubles (up from 3326.04 billion Rubles forecasted in the first draft of the Law), while the expenditures had to be revised upward from 3047.93 billion Rubles to 3539.45 billion Rubles).
2.2.2. Analysis of Tax Proceeds to the State Budget of the Russian Federation
Pursuant to the Order No. 114 issued by the Ministry of Finance on October 14, 2004 "On Guidelines for Application of Definitions in the Budget of the Russian Federation", all categories of revenues and expenditures were redefined for all types of state budgets. These changes make it somewhat difficult to compare the 2005 budget with budgets from previous years on certain categories of revenues of expenditures.
One such change for instance that came into effect on January 1, 2005 increased the Natural Resource Extraction Tax (NRET) from R347 per ton of oil to R419 per ton of oil. Other changes in the Tax Code also increased the non-taxable price of oil from $8 a barrel to $9 a barrel. In addition, the ruble/dollar exchange rate used in calculation of the NRET was revised from 31.5 Rubles to 29 Rubles for $1, reflecting a ruble's appreciation against the dollar. Thus the current formula for determining the NRET is as follows:
NRET = ÎnreT X
P x ER
IP - P)
Where:
tNRET is the NRET current rate at 419 Rubles per ton of oil; P - is the current price of oil on world markets; P* - is the non-taxable price of oil;
ERoff - is the official dollar exchange rate (currently 29 rubles for 1US dollar).
Table 5
Main Types of Tax Proceeds to the Budget of the Russian Federation
(as a percentage of GDP)
1999 2000 2001 2002 2003 2004 2005
Profits Tax 4.6 5.4 5.7 4.2 4.0 5.2 6.2
Income Tax 2.5 2.4 2.8 3.3 3.4 3.4 3.3
VAT 8.8 6.2 7.1 6.9 6.6 6.4 6.8
Excise Taxes 2.2 2.3 2.7 2.4 2.6 1.5 1.2
NRET* 1.2 1.6 1.6 2.5 2.5 3.0 4.2
External Trade Tax 1.8 3.1 3.6 3.0 3.4 5.1 7.5
Unified Social Tax 3.1 2.7 2.7 1.2
Source: Ministry of Finance, Russian Federation.
*Until 2001, the NRET was a sum of oil excise tax, natural resource use tax and contributions towards mineral base recovery (MBR).
Table 2 demonstrates that in 2005 changes in proceeds over 2004 from different types of taxes were not uniform. Profits tax collected from enterprises as a share of GDP for instance has grown significantly by a whole percentage point to 6.2%, thus continuing a 3-year trend of growth of tax revenue in that sector. Growth in income tax revenue was partly due to a growth of the tax base. In other words, according to the Russian State Statistical Agency, bottom lines in Russian businesses' balance sheets (summed revenues minus losses) have grown in the period from January to November of 2005 by 35.2% as compared with a similar period in 2004. The infamous 'Yukos Affair" has also played its role in deterring other companies from using existing loopholes in the tax code to minimize their payments of tax dues.
Individual income tax proceeds in 2005 were somewhat lower than in 2004 and stood at 3.3% of GDP, down from 3.4% of GDP in 2004. Proceeds from UST on the other hand have been more pronounced from 2.7% of GDP in 2004 down to 1.2% of GDP). Curiously though, according to the Statistical Agency official data, in 2005 real individual income grew by 8.8%, with the real wages and salaries alone rising by 9.7%, both ahead of the overall GDP growth by 2.2% and 3.3% respectively. This data suggests that in real terms individual income tax rates and the unified tax rates were lower in 2005 than in 2004, with a decrease in the unified tax rate particularly notable.
Proceeds from the value added tax remain the largest contributor to the budget of the Russian Federation. In 2004, VAT proceeds to the federal budget constituted 6.4% of the GDP. In 2005 that share grew to R1.48 trillion, or 6.8% of the GDP even though rebates on VAT have also grown to 2.1% of the GDP in 2005 from 1.9% of GDP a year earlier. Excise tax proceeds in 2005 brought in an amount worth of 1.2% of the GDP to the federal budget, .3 percentage points less than a corresponding figure for 2004.
Predictably, budget revenues from natural resource extraction taxes demonstrated considerable growth in 2005. Thus in 2005 this tax generated R908 billion to the consolidated budget of the Russian Federation, an amount worth of 4.2% of GDP, up from 3% of the GDP in 2004. An auspicious environment for energy, minerals and other major Russian exports, as well as certain changes to the tax code, like the already mentioned changes in the formula for NRET, were certainly the causes for an increase in proceeds from the natural resource extraction tax.
Taxes levied on external trade activities in 2005 have also brought in higher revenue and constituted 7.5% of the GDP, a considerable increase over the 2004 level of 5.1% of the GDP. High oil prices again are responsible for the increase in revenues from this tax.
Graph 1 depicts the changes in tax revenues on different types of taxes in real terms in the period from 1999 to 200510. As can be easily deduced from the graph, most of the growth in revenue in real terms was generated from 5 categories of taxes: external trade tax, VAT, profits tax, NRET and to a lesser degree the income tax. On the other hand proceeds from the excise tax and the federal unified social security tax have decreased in real terms in 2005. In general, changes in revenue in real terms collected from different types of taxes correspond to the changes in their nominal share in the GDP.
0 A chained consumer price index with 1999 as a base level was used as a deflator in these calculations.
Source: Ministry of Finance, Russian Federation.
Fig. 11. Changes in Major Tax Proceeds in Real Terms in 1999-2005 (mln rubles)
In conclusion of this chapter it is necessary to review the changes in the amount of taxes owed, penalties and other sanctions imposed by the budget authorities of the Russian Federation.
Table 6
Back Taxes, Tax Penalties and Sanctions in the Budget System of the Russian Federation 2002-2005 (as a percentage of GDP)
2002 2003 2004 2005
TOTAL 4.82 3.93 5.24 3.48
Including:
In the Federal Budget 4.12 3.30 4.70 3.03
Including:
Profits Tax 0.81 0.54 1.36 0.84
VAT 2.23 1.84 2.45 1.44
Payments for Usage of Natural Resources 0.19 0.16 0.33 0.25
Including:
NRET 0.01 0.02 0.17 0.14
Other Federal Taxes and Fees 0.89 0.76 0.55 0.50
Back payments on Regional Taxes and
Fees 0.42 0.35 0.30 0.25
Back Payments on Local Taxes and Fees 0.28 0.25 0.21 0.16
Source: Federal Tax Service, Reporting Form 4-NM.
Graph 3 demonstrates that in 2005 there was a significant reduction in volume of back taxes, tax penalties and sanctions. From 5.24% of the GDP in 2004 the figure went down to 3.48% of the GDP in 2005. Taxes owed to the federal budget have also decreased from 4.7% of the GDP in 2004 to 3.03% of the GDP by 2005. Most of the reduction resulted from the decrease in the taxes owed on the profits tax (from 1.36% of the GDP in 2004
down to .84% of the GDP for 2005) and on VAT (from 2.45% of the GDP in 2004 down to 1.44% of the GDP for 2005). Taxes owed on other types of duties have not undergone any significant reductions. In general however when compared with 4 previous years 2005 was notable for its lowest level of taxes owed to the budget, something that could have stemmed from a better collection efforts on part of tax authorities or higher discipline on part of taxpayers.
2.2.3. State Budget Expenditures
Reforms and changes that were introduced to the budget definitions in January of 2005 make line-by-line comparisons with previous years impossible. Therefore in this paper data up to 2004 shall be depicted separately and then analyzed with the actual budget realization in 2005. Please see Table 7 for the key characteristics of the expenditures part of the Russian State budgets of all levels in the period from 2002 to 2004.
Table 7
Expenditures in the Federal, Territorial and Consolidated Budgets in 2002-2004 (as a percentage of GDP)
2002
2003
2004
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8
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1 2 3 4 5 6 7 8 9 10
Federal and Local Affairs 0.5 0.8 1.4 0.5 0.9 1.4 0.5 0.8 1.3
Judicial Branch 0.2 0 0.2 0.2 0 0.2 0.2 0.0 0.2
International Affairs 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
Internal Security
and Law Enforce- 1.7 0.5 2.2 1.9 0.4 2.3 1.9 0.4 2.3
ment
Research and Development 0.3 0 0.3 0.3 0 0.3 0.3 0.0 0.3
Manufacturing,
Energy and Con- 1 1.3 2.3 0.5 2 2.5 0.5 1.9 2.3
struction Sectors
Agrarian Sector and Fisheries 0.3 0.3 0.5 0.2 0.3 0.5 0.2 0.3 0.5
Transportation,
Roads, IT and 0.1 0.4 0.5 0 0.3 0.3 0.0 0.2 0.3
Communications
Housing and 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
Art, Cinema and Cultural Affairs 0.1 0.4 0.5 0.1 0.3 0.5 0.1 0.3 0.4
1 23456789 10
Mass Media 0.1 0.1 0.2 0.1 0.1 0.2 0.1 0.1 0.1
Healthcare 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
Sovereign Debt Service 2 0.1 2.2 1.7 0.1 1.8 1.2 0.2 1.4
Financial Assis-
tance to Lower 2.7 0 - 6.0* 0 3.2* 5.4 0.0 3.0
Level Budgets
Military Reform 0.1 0 0.1 0.1 0 0.1 0.0 0.0 0.0
Roads 0.4 0.4 0.7 0.3 0.5 0.8 0.3 0.2 0.5
Earmarked 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 1 4.9 29.7 16.1 14.1 27.8
Source: Ministry of Finance, Russian Federation.
* Including PF transfers for financing base level pensions from the centralized federal ESN proceeds. "Starting in 2003, this article of spending also includes transfers to state non-budget foundations.
Table 8
Expenditures of the Federal, Consolidated and Territorial Budgets in 2005 (as a percentage of GDP)
Federal Budget Territorial Budgets Consolidated Budgets
State Affairs 3.5 2.3 1.2
Including state and municipal debt servicing 1.1 1.0 0.1
National Defense 2.7 2.7 0.0
Law Enforcement and Internal Security 2.7 2.1 0.6
National Economy 3.5 1.2 2.4
Housing and Utilities 2.2 0.03 2.2
Environment 0.1 0.02 0.1
Education 3.7 0.8 2.9
Art, Cinema, Cultural Affairs and Mass Media 0.7 0.2 0.5
Healthcare and Athletics 2.6 0.4 2.1
Social Policy 2.4 0.8 1.6
Interbudgetary Transfers 3.5 5.8 0.1
Total Expenditures 27.4 16.2 13.6
Source: Ministry of Finance, Russian Federation.
For a description of major budget expenditures for Russia's federal, consolidated and territorial budgets in 2005 in accordance with changes introduced in January 2005, please consult Table 8.
When comparing data from 2004 and 2005 it becomes evident that share of expenditures in the consolidated budget of the Russian Federation, as a percentage of GDP was somewhat lower for 2005 than in 2004. Thus in 2005 the figure constituted 27.4% of the GDP down from 27.8% of the GDP in 2004. Expenditures in the Russia's federal and terri-58
torial budgets in 2005 were 16.2% and 13.6% of the GDP respectively versus 16.1% and 14.1% of the GDP in 2004. In other words, in 2005, a modest growth of expenditures in the federal and consolidated budgets over the previous year has coincided with a decrease in expenditures in the territorial budgets.
An analysis of the major expenditures of the consolidated budget in 2005 will demonstrate that a lion share of the resources has gone into 4 categories of spending: Education (3.7% of the GDP), Interbudgetary Transfers, State Matters11 and National Economy12 (3.5% of the GDP each). Spending on national defense, security and internal law enforcement constituted 2.7% of the GDP, on healthcare 2.6% of the GDP, social policy took up 2.4% of the GDP and housing 2.2 % of the GDP.
In spite of the aforementioned changes to the budget classification that came into effect for the 2004 and 2005 budgets, some lines of the consolidated budget of the Russian Federation can still be directly compared with budgets from previous years. Budget spending on housing and utilities is one such instance. In 2005 that figures stood at 1.31% of the GDP against 1.66% of the GDP in 2004. Spending on education13 in 2005 remained on the same level at 3.16% of the GDP. Expenditures on healthcare and "athletic promotion and awareness" programs have increased from 1.8% of the GDP in 2004 to 2.2% of the GDP for 2005. Direct comparisons on other categories of spending are not feasible due to the aforementioned changes in budget classifications.
2.2.4. 2006 Federal Budget
In august of 2005, the Russian cabinet presented a draft Law on Federal Budget of the Russian Federation. A final version of the Law was passed in November of 2005. Further in the text we supply a commentary on certain aspects of the revenue, expenditures as well as sources for financing the budget deficit.
Please see Table 9 for a description of revenues to the federal budget in 2005 and
2006.
A look at the table demonstrates that forecasted revenues for 2006 federal budget in absolute terms were much higher than figures that had been forecasted for 2005. However 2006 forecasts were still lower than actual revenues collected in 2005. Even revised 2005 forecasts of R4,979,765.5 million do not alter the picture of growth of revenue in absolute terms. In relative (to GDP) terms however, 2006 revenue forecasts at 20.7% of the GDP were 3 percentage points lower than actual revenues collected in 2005, though still above the initially forecasted number for that year. A drop in revenue in 2006 over the previous year has been spawned by a change in certain macroeconomic environment (1.84% of the GDP), tax reform (0.35% of the GDP) as well as other factors (1.17% of the GDP).
Among changes in the macroeconomic environment it is necessary to point out a 2006 forecast for a falling price of Urals crude. This change accounted for 1.83% reduction in the forecasted budget revenue. On the other hand upward changes in amounts of extraction and export of natural gas, taxable profits, excise tax base, dollar depreciation as well as some changes in imports composition have all increased the forecasted 2006 budget revenue by 0.36%.
11 This budget article includes spending on the following subcategories: «head of state post-related expenditures», «expenses pertaining to work of highest state officials», «legislative expenditures, judicial branch expenses, «state and municipal debt servicing», etc.
12 This budget article covers spending on the following subcategories: «General Economy », «Fuel and Energy», «Transportation», «Communications and IT», «Forestry», «Water Resources», «Agrarian Sector and Fisheries», «Applied Economic Research » etc.
13 Includes spending on primary, secondary, higher and tertiary education as well as professional training and re-training expenses.
Table 9
Major Revenues to the Federal Budget of the Russian Federation in 2005 and 2006
2005 (official forecasts)
2005 n (actual)
2006 г. (official forecasts)
Mln Rubles % of GDP Mln Rubles % of GDP Mln Rubles % of GDP
Total Revenue 3 326 041.114 17.8 5 125 092.0 23.7 5 046 137.5 20.7
Including: Tax-based revenue15 3 151 745.6 16.8 4 801 229.5 22.2 4 830 748.5 19.8
Including Profits tax 259 003.3 1.38 337 591.8 1.74 344 838.1 1.41
VAT 1 120 751.3 5.99 1 472 210.2 6.80 1 634 342.6 6.70
Excise Taxes 84 805.7 0.45 107 192.1 0.49 110 186.5 0.45
Custom Duties 867 969.0 4.64 1 622 844.9 7.49 1 607 843.3 6.59
NRET 464 934.1 2.48 854 522.3 3.94 731 570.3 3.00
UNIFIED SOCIAL
TAX to the Federal 266 500.0 1.42 267 513.2 1.23 302 090.2 1.24
Budget Non-tax Revenue 174 295.5 1.0 323 862.5 1.5 215 389.0 0.9
Source: Ministry of Finance, Russian Federation.
Reforms of the tax system that have lead to a decrease in budget revenues have mainly to do with a change in the calculation of VAT for capital investments as well as an accelerated depreciation rate of 10% for capital assets. Some loss of revenue should be offset by other changes in the tax system, such as a termination f a zero tax rate for import services provided by the Russian rail freight forwarding companies, excise tax indexation as well as an increase in the tax rate for extraction of natural gas under the NRET.
Finally, a decrease in the forecasted revenue for 2006 budget over the previous year, had been a result of a considerable tax contribution made by Yukos in the first half of 2005. When 2005 and 2006 budget forecasts are brought under leveled conditions, according to the draft version of the budget, 2006 revenues should have risen in nominal terms by R318.5 billion, though relative to GDP 2006 revenues would be lower than 2005 figures by 1.81%.
To ease the process of comparison this paper used a different classification of tax and non-tax budget revenues from those employed in previous IET works. As demonstrated in Table 6, 2006 tax revenues to the federal budget in absolute terms were above forecasts made in the 2005 Law on Budget as well as actual figures for that year. As to the non-tax sources of revenue 2006 figures though still above 2005 forecast but below actual revenues collected in that year. Also, 2006 tax revenues though above corresponding values for 2005 turned out to be lower than forecasts made at the end of that year. 2006 nontax revenue in the meantime turned out to be lower than figures both forecasted and actually collected in 2005.
Table 9 also provides data on other types of taxes, which bring significant contributions to the overall budget revenue. In 2005 revenue from these taxes was higher than forecasts both for 2005 and 2006. Figures forecasted in the budget law for 2006 are also higher than corresponding figures in the 2005 budget law, with the exception of UST,
14 In accordance with changes made to the Law on Federal Budget of the Russian Federation for 2005, federal budget revenues were raised to R4,979,756.5 mln, or 23.7% of the GDP.
15 For the purposes of this research, the term "tax-based revenue" includes the following: "profits and income tax", "social security taxes", "domestic goods and services consumption taxes", "taxes on goods imported to the Russian Federation", "taxes on usage of natural resources", "state duties" and taxes on external economic activities". All other revenue articles are grouped in the "non-tax based revenue" category.
whose share of the GDP for 2006 was forecasted to be at 1.24%, down from a 2005 level of 1.42% of the GDP. In 2006 some decrease in revenue is expected from lower NRET and customs proceeds as a result of falling prices for Russian crude.
Table 10
Major Expenditures in the Federal Budget of the Russian Federation
in 2005 and 2006
2005 (official fore- 2005 r. (actual 2006 r. (official _casts)_figures)_forecasts)
Mln. Ru- % of Mln. Ru- % of Mln. Ru- % of
bles GDP bles GDP bles GDP
Total Expenditures 3 047 929.316 16.3 3 512 182.9 16.2 4 270 114.7 17.5
including:
Interest expenditures 244 150.4 1.3 208 367.1 0.9 198 482.2 0.8
Non-Interest Expenditures in-
cluding expenditures finances 2 803 778.9 15.0 3 303 815.8 15.7 4 071 632.5 16.7
by UNIFIED SOCIAL TAX_
Source: Ministry of Finance, Russian Federation.
From Table 10, which compares data on budgetary expenditures in 2005 and 2006, it is clear that in 2006 federal government spending is expected to considerably exceed 2005 levels both in absolute and relative to GDP terms. In forecasts for 2005, for instance, government spending was expected to reach 16.3% of the GDP. In reality 2005 spending turned out a little shy of that forecasts and amounted to 16.2% of the GDP. For 2006 on the other hand, government spending is forecasted to reach a 17.5% of the GDP. The increase is expected to result from a rise in non-interest spending (up to 16.7% from 15% forecasted and 15.7%actually spent in 2005). Interest expenditures in 2006 on the other hand are expected to decrease down to 0.8% from 1.3% forecasted and 0.9% actually spent in 2005.
Table 11 compares different types of government spending in 2005 and 2006 accounting for various changes introduced in that year.
Table 11
Federal Budget Expenditures in 2005 and 2006
2005 (official forecasts) 2005 (actual) 2006 (official forecasts)
Mln. Rubles % of GDP Mln. Rubles % of GDP Mln. Rubles % of GDP
1 2 3 4 5 6 7
State Affairs 491 327.72 2.62 499 291.7 2.30 638 885.61 2.62
Including State and Municipal Debt Servicing 244 150.36 1.30 208 367.1 0.96 198 482.24 0.81
National Defense 549 680.46 2.94 581 131.9 2.68 666 026.63 2.73
Law Enforcement and National Security 442 552.33 2.36 450 096.5 2.08 541 634.56 2.22
National Economy 253 507.21 1.35 248 472.5 1.15 339 333.97 1.39
Housing and Utilities 10 098.48 0.05 6 905.5 0.03 38 883.16 0.16
Environment 4 782.34 0.03 4 746.6 0.02 6 334.26 0.03
Education 162 947.72 0.87 162 0808.1 0.75 201 588.66 0.83
Arts, Cinema and Mass Media 46 149.09 0.25 47 448.8 0.22 51 248.09 0.21
16 In accordance with changes made to the Law on Federal Budget of the Russian Federation for 2005, federal expenditures were raised to R3,539,450.6 mln, or 16.8% of the GDP.
1 2 3 4 5 6 7
Healthcare and Athletics 87 876.45 0.47 88 166.3 0.41 149 098.67 0.61
Social Policy 177 476.02 0.95 178 254.1 0.82 205 253.27 0.84
Interbudgetary Transfers 1 169 871.24 6.25 1 245 589.2 5.75 1 431 827.82 5.87
Total Expenditures 3 396 268.74 18.14 3 512 182.98 16.21 4 270 114.72 17.51
In general, federal budget expenditures between 2005 (both forecasted and actual) and 2006 has changed little in relation to GDP for some categories of spending. Categories spending on which has changed significantly are as follows: "federal and municipal debt service" (down from 1.3% forecasted and 0.96% actually spent in 2005 to 0.81% of the GDP for 2006), "housing" (up from 0.05% forecasted and 0.03% actually spent in 2005 to 0.16% of the GDP for 2006), "inter-budget transfers" (down from 6.25% in 2005 to 5.87% of the GDP for 2006). Among categories that continue to command highest share of government spending one has to note the following: "general state matters", national defense, national economy and inter-budget transfers. The sum of spending on these categories amounted to 14.83% of the GDP in 2006 as compared to 15.52% forecasted and 13.96% actually spent in 2005.
Table 12
Federal Budget Surplus in 2006
2005 (official fore- 2005 r. (actual) 2006 r. (official
casts) forecasts)
Mln Ru- % of Mln Rubles % of Mln Ru- % of
bles GDP GDP bles GDP
Deficit (-)/Surplus
(+) of the Federal 278 111.8 1.5 1 612 909.8 7.44 776 022.78 3.18
Budget
Source: Ministry of Finance, Russian Federation.
A sizeable increase of budget revenues coupled with an insignificant increase in spending resulted in higher forecasts for 2006 federal budget surplus (please see Table 12). While in 2005 the budget forecasts called for a surplus of 1.5% of the GDP, in 2006 that figure rose to 3.18% of the GDP. It is interesting to note that actual budget surplus in 2005 at 7.44% of the GDP shot well above the forecasts all due to extremely high prices for crude and other major Russian exports that stayed high throughout the year.
Government debt obligations in 2006 are expected to be financed from the following sources: domestic sale of government bonds, resources from the Federal Stabilization Fund as well as funds raised through sale of government properties.
Thus issuance of government bonds on the internal market is expected to raise R238.2 billion, with only R68.4 billion worth of government bonds being repaid which leaves the net government bond issuance for 2006 at R169.8 billion. Since 2006 budget does not call for any significant reductions in the amount of government debt, re-financing will be the method for debt servicing. In addition, planned sale of government assets and land in 2006 are expected to attract R31 billion and R8 billion accordingly.
Among external sources of financing for 2006 budget there are no non-targeted loans from other sovereign states or international monetary organizations. Bundled loans on the other hand are expected to bring in $1.1 billion in 2006. Most of the currently active projects lead by international lending organizations are expected to expire within the 20062008 period thus following the Russian government's policy at ending the practice of attracting new bundled IMF loans.
The 2006 Law on Budget also calls for repaying $8.5 billion worth of sovereign external debt. In addition, in 2006 the government also plans to repay $2.8 billion of its foreign currency nominated debt. $710 million will be repaid on Russia's debt to the IBRD, while $51.8 million will be paid back to the EBRD.
The Budget Law for 2006 was devised on the basis of economic growth forecasts made by the Ministry of Economic Development and Trade of the Russian Federation. These forecasts called for two possible scenarios of Russia's economic development in 2006. Thus according to the first scenario, general inertia, falling competitiveness of Russia's economy and lack of any noteworthy positive developments in the investment climate -all put a hold on realization of any new government programs, strategies, etc. A major element in such scenario is a sharp deterioration in demand for Russian Urals crude with its price dropping down to $28 a barrel and remaining at that level for some time. In that case, revenue from crude exports was to fall by 22% even with its volume growing by 9% and crude extraction by 5.3%. Also according to this scenario, GDP growth slows down from 5.9% in 2005 down to 4-4.6%, which lifts the GDP from its base of 2004 by 20% during the 2005-2008 period.
The second scenario is based on more optimistic premises of deepening institutional reform, solid growth in key economic industries set against favorable world markets environment for Russia's major exports. It was this scenario on the basis of which the calculations for the 2006 budget and the forecasts down to 2008 were made. According to this model, a decrease in the price for the Urals crude was to be more gradual from $48 a barrel in 2005 to $40 in 2006 and further down to $35-36 a barrel in later years. In addition according to this scenario domestically instituted reforms in the tax code encouraging business expansion as well as an increase in the investment-geared government spending, including a creation of an investment fund were to spur economic growth further. In this model, the Russian GDP was to continue expanding at 5.9-6% in 2005-2008 and growing by 25.8% by the end of that period.
In an effort to provide an independent evaluation of forecasts laid as the basis of budget calculations, the IET staff has designed its own scenarios of possible economic development of the Russian economy. These scenarios were based on structural econometric models of the Russian economy. The following were used as exogenous factors for building the model: price for Brent crude, index of capital investments, changes in the real income per capita as well as changes in the M2 monetary base.
Three different scenarios of possible economic development were designed on the basis of this model. Under one such scenario dubbed as "inert ional" the price of Brent crude in 2006 is to decrease gradually to $40 a barrel thus making for a year-round average price of $43 a barrel for Brent and $40 a barrel for Urals. This particular is scenario, in other words, replicates the second model designed by the Ministry of Economic Development and Trade and was used as the basis for the 2006 budget forecasts.
Another scenario developed by the IET staff and dubbed as "likely" is based on the commonly shared expectations that crude oil prices will stay at or above $55 a barrel throughout 2006.
A third "negative" scenario presumes that oil prices plummet to an annual average of $30 for a barrel of Brent and $28 for a barrel of Urals while the dollar strengthens sharply against other leading currencies. This set of events is very similar to a first model developed by the Russian Ministry of Economic Development and Trade.
Table 13 presents expected budget revenue and expenditures corresponding to each of these three possible scenarios of economic development.
Table 13
Major Budget Characteristics as Forecasted by the IET Models of Possible
Economic Development for 2006
Budget Characteristic 2006 (official forecasts) 2006 (inertia) 2006 (likely) 2006 (negative)
Budget revenues (as % of GDP) 20.7 20.3 28.2 17.7
Budget revenues (Rb.bn) 5046 5026 7080 4350
Budget expenditures (as % of GDP) 17.5 17.3 17.0 17.4
Budget expenditures (Rb.bn) 4270 4270 4270 4270
Surplus (as % of GDP) 3.2 3.0 11.2 0.3
Source: Ministry of Finance, Russian Federation. Calculations IET.
According to the table calculations, revenues expected under the "inertia" model align very closely to Ministry figures used for determining the 2006 budget law, as both the IET and the official calculations were based on very similar premises.
Other two scenarios developed by the IET produced revenue calculations very different from those used in the budget. For instance under the "negative" scenario, federal budget revenue may decrease to 17.7% of the GDP, while in the official forecasts that figure stands at 20.7% of the GDP. Federal budget expenditures in the meantime are forecasted at more or less the same level of 17.4% of the GDP in the IET model and 17.5% under the official forecasts. A combination of sharply decreasing revenue and constant expenditures would diminish the budget surplus to an almost negligible 0.3% of the GDP as opposed to a sizable 3.2% of the GDP expected in the 2006 budget law. In other words the "negative" scenario would not have a truly ruinous effect on the Russian economy but could seriously undermine its stability.
Calculations under the "likely" model on the other hand produced results under which the budget revenue at 28.2% of the GDP was significantly higher than officially anticipated figure of 20.7% of the GDP while budgetary spending of 17% of the GDP was somewhat lower than the official version of 17.5%. In the case of expanding revenue and slowing expenditures, budget surplus understandably skyrockets to a record 11.2% of the GDP.
* * *
The following are conclusions that were made in the course of this survey of revenues and expenditures in the federal budget of the Russian Federation for 2006.
First of all, an anticipated increase in the absolute value of revenue collected may not automatically translate into higher revenue in relation to the GDP as compared with previous years. A forecasted decrease in the price of Urals crude, as was cited earlier, would be the major reason behind falling revenue. However, given the current conditions in the markets for crude oil, it appears safe to assume that actual 2006 revenue will exceed its budget projections.
Secondly, budget expenditures in 2006 are expected to rise both in absolute and relative to the GDP terms. With some minor changes in expenditures on debt servicing, in-terbudgetary transfers and housing, overall government spending on various programs has remained virtually unchanged. Given the government's priority at taming the inflation, a policy of steady spending in the face of growing revenue is, in our opinion, a justifiable course of action.
Thirdly, a more rapid rate of growth in revenue over spending has produced a significant increase in the budget surplus. This allows the government to continue its policy of increasing domestic debt while reducing its external obligations.
Interestingly the IET calculations in all three of our models though not identical but still are analogous to the figures used in the budget. Revenue and expenditure results arrived at in the "negative" and "inertia" scenarios in particular, are quite similar to the official numbers. Considerably higher revenues in the face of lower spending and a resulting record budget surplus obtained in the "likely" scenario- were certainly influenced mostly by expectations of steadily high oil prices and demonstrate the Russia's economy extreme dependence on its oil and gas sector.
Finally, on the basis of data presented in this paper, the 2006 budget of the Russian Federation can be characterized as fairly conservative, as there are no significant adjustments have been introduced to the structure of the budget since the budget of the previous year.
2.3. Interbudgetary Relations and Subnational Finance
The current system of interbudgetary relations underwent no radical changes in 2005. The structure of tax revenues and tax powers assigned to different tiers of power basically remained unchanged vs. the prior year, except for some minor modifications. The federal level retained already familiar from the previous years channels of financial support of regional budgets - that is, interbudgetary transfers in the form of subsidies to ensure equalization of budget sufficiency, subventions and subsidies from the Fund of Compensations, interbudgetary transfers from the Fund for Regional Development, Fund for Reforming Regional Finance and other kinds of interbudgetary transfers distributed on the basis of earlier approved principles17. Given the growing revenues to the federal budget in real terms, the financial state of subnational budgets, with account of the federal financial assistance can be characterized as a stable one.
However, the sum of decisions made and/or put into effect in 2005 allows conclusion that Russia has seen a gradual emergence and maturity of the national model of corporate federalism. Its distinctive feature is a considerable degree of centralization of a number of critical powers and financial resources in the hands of the federal center. The federal government enjoys broad powers, introduces universal law on all critical matters an secures the uniformity of the tax system throughout the federation. The Federal Republic of Germany perfectly exemplifies such a system. However, under the German democracy subnational authorities enjoy the possibility for exerting a substantial influence on the shaping of the federal center's policy through the party system and the Bundesrat. By contrast, the Russian way of centralization of powers and financial resources in the hands of the federal center is complemented by the administrative and political control over subnational authorities.
The year of 2005 saw the completion of building the system - the law on the actual cancellation of governor elections came into effect and a number of them were elected-appointed according to the new procedure; the federal center unilaterally made a number of decisions on the "monetization" of benefits, the administrative reform and holding the national projects, while subnational authorities were given the role of "marshals" of individual measures that the federal center planned, funded and controlled.
17 See: issues of "Russian Economy: Trends and Outlooks" No. 21-26. M., IET.
Because of the domination of the federal center, the Russian model of interbudget-ary relations is growing increasingly unitary, which can partly be attributed to the nascent party system, which in the noted Germany incorporates subnational interests into a single national policy. By contrast, in the Russian system the federal center is responsible for the economic and political development strategy, while subnational authorities chiefly exercise organizational and executive powers. As concerns the municipal level of power which the federal center believes should reflect local interests and help foster democracy bottom-up, its has been so far in the nascent state.
The above proves that the process of reforming the interbudgetary relations launched in 1997-98 has clearly slowed down over recent years. However, in contrast to other areas of the economy, this particular sphere still sees reform efforts aimed at a more efficient and transparent system of financial relations between different tiers of power. Mores specifically, in 2005 the government tried to abandon "unfounded federal mandates"; amendments to the Budget and Tax Codes were enacted18 ; the Concept for and methodology of reforming the interbudgetary relations in the Russian Federation and Subjects of the Russian Federation for 2006 and medium-term perspective. The progress in the interbudgetary relations area, however, is somewhat derailed by the Russian model of federalism.
In any case, as evidenced by the recent practice, the reform of principles of distribution of the federal financial assistance has remain on the agenda, as the current system appears insufficiently transparent, which does not allow assessment of its efficiency and provides grounds to suggest the possibility for creation with its help negative incentives for budgetary policies pursuded by regional and local authorities.
2.3.1. Main Trends of Development of Relations between Budgets of Different Levels
Evaluation of main trends of 2005 in the area of relations between budgets of different tires suggests consideration of the structure of revenues and expenditures of the consolidated budget of the Russian Federation and its dynamics over recent years. Table 14 represents data that characterize the proportion of tax revenues, as well as revenues and expenditures of budgets of Subjects of the Federation in the latter's consolidated budget.
Table 14
The Proportion of Some Indexes of Budgets of the Subjects of the Federation in the Consolidated Budget of the Russian Federation in 1992-2004 (as %)
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
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 30.9
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 33.8
Expendi- 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 49.5
tures
*Less financial aid from the federal budget (except for the balance of outstanding loans from the federal budget) and revenues to the targeted budget funds.
Source: the RF Ministry of Finance, authors' calculations.
The data in Table 14 evidence that starting from 1999 there has been a trend to centralization of revenues in the federal budget. During the period in question, the proportion of tax revenues to budgets of Subjects of the Federation in Russia's consolidated budget
18 See: Rossiyskaya Ekonomika. Tendentsii i Prespektivy. Vypusk 26. M.: IEPP, 2005. 66
slid from 56.6% in 1998 to 30.9% in 2005, while the proportion of all budget revenues of the Subjects in Russia's consolidated budget plunged from 54% to 33.8%, accordingly. It should be noted that 2005 saw a drastic fall in the share of the Subjects' tax revenues in the nation's consolidated budget - by 5.2 percent points vs. 2004. The causes for such a fall were:
1) centralization of taxes in the federal budget, and
2) a greater pace of growth of taxes and payments due primarily to the federal budget.
Fig. 12 presents the contribution different factors have made to the fall in the proportion of the Subjects' budget tax revenues in Russia's consolidated budget in 2005 vs. 2004.
18%
3%
■ Centralization of 1.5 % of corporate profit tax in the federal budget
B Centralization of 9.4% of mineral tax in the part of oil and gas
condensate □ Centralization of water tax
H Greater growth pace of tax revenues to the federal budget vs. that of tax revenues to consolidated budgets of the RF Subjects
Source: the RF Ministry of Finance, authors' calculations.
Fig. 12. Contribution of Various Factors to Decline in Proportion of Tax Revenues of Budgets of the RF Subjects in Russia's 2005 Consolidated Budget vs. t
he 2004 Consolidated Budget
The decline in the proportion of tax revenues to budgets of the RF Subjects in Russia's consolidated budget was fueled to significant extent by a greater growth rate of tax revenues to the federal budget compared with the rise in tax revenues of consolidated budgets of Subjects of the Federation. Thus, given that in 2005 all the revenues to consolidated budget of RF showed a 50% rise in nominal terms vs. 2004, the growth rate of customs duties accounted for 90% and that of mineral tax - 78%, respectively.
The centralization of taxes in the federal budget also contributed to the decline in the proportion of the RF Subjects' revenues in the nation's consolidated budget - in 2005, 1.5% of the corporate profit tax and 9.4% of the mineral tax in the part of oil and gas condensate, and water tax were centralized into the federal budget. From the perspective of subnational finance, the most significant effect was secured by the centralization of the mineral tax, which, however, did not embrace all regions, but those wherein oil and gas condensate are produced. In 2005, there were 39 such regions in Russia, while roughly as much as 95% of losses of the regional budgets resulting from the centralization of the mineral tax fell on 14 regions whose budgetary sufficiency level was greater than the average
nation one19. Thus, it can be concluded that the centralization of 9.4% of the mineral tax in the part of oil and gas condensate ensured a considerable equalization effect. By contrast, the centralization of two other taxes - that is, 1.5% of corporate profit tax and water tax concerned all the RF Subjects, albeit the respective equalization effect proved to be less significant. The regions not entitled to subsidies from the Federal Fund for Support of Regions suffered losses whose aggregate share accounted for some 40% of losses from the centralization of the water tax and some 70% of losses from the centralization of 1.5% of the corporate profit tax. Both measures, nonetheless, have had a certain equalization effect on the RF Subjects' budgetary sufficiency level. However, given a great dispersion of tax sources in the territory of Russian Federation, it can be suggested that in the current conditions centralization of practically each and every tax and levy will result in equalization of the level of the RF Subjects' budgetary sufficiency. With fixing tax sources with levels of the budgetary system, the degree of evenness of distribution of a given tax base should not form a sole criterion, for keeping subnational authorities keen to boost regions' tax capacity appears an equally important challenge. In conjunction with this, we believe there is no explicit need in centralization of the corporate profit tax and water tax.
In parallel with the above processes, the proportion of the RF Subjects' expenditures in the consolidated budget of the Russian Federation fell from 50.8% to 49.5%. Such a decline is most likely to be attributed to the following reasons: the federal budget expenditures were growing at a pace greater than that of the RF Subjects, while the decline in expenditures of the subnational budgets was driven by the lowering of the single social tax rate. Interestingly, by the end of 2005 revenues to the RF consolidated budget grew from 32.2% of GDP in 2004 to 35.1% (at 2.8 p.p.), while the growth in revenues to the federal budget accounted for 3.3 p.p. of GDP. The RF Subjects' revenues fell to 13.8% of GDP from 14.3% of GDP reported in 2004. To a significant extent (at some 0.26% of GDP) the decline was caused by the centralization of the mineral tax. It was the factor that generated decline in the proportion of tax revenues to consolidated budgets of the RF Subjects in tax revenues of Russia's consolidated budget. In parallel with the decline in tax revenues in 2005, there occurred, as noted above, the decline in the aggregate final revenues to regional budgets from 13.8% of GDP from 14.3% in 2004, which was caused by the contraction in interbudgetary transfers to regional budgets at 0.15% of GDP.
The above data allow conclusion on a considerable centralization of financial resources in the federal budget vis-avis the RF Subjects' budgets. While tax revenues grew on the whole, the growth turned to be favorable mostly to the federal budget. By the same token, the federal financial assistance to regions computed in the share of GDP equivalent shrank under an insignificant decline in the share of regional budget expenditures in the consolidated budget of RF. All this testifies to a greater vertical imbalance in distribution of revenue sources and fixing expenditure obligations between the federal and regional levels of power.
Whilst considering the state of tax revenues to the consolidated regional budgets in 2005, one should note that like before, more than a half of tax revenues are secured by revenues from the two taxes - that is, personal income tax (34% of tax revenues to regional budgets) and corporate profit tax (46%). More than this, the proportion of revenues from these taxes in tax revenues to regional budgets in 2005 displayed a drastic rise vs. 2004 (from 69% to 80%), thanks chiefly to the growth in corporate profit tax. Interestingly,
19 Orenburg, Tomsk, Samara, Astrakhan, Sverdlovsk, Perm, Tyumen oblasts, Khanty-Mansy, Yamalo-Nenetsky autonomous okrugs, Republic of Tatarstan, Republic of Bashkortostan, Republic of Komi, Nenetsky autonomous okrug, and Krasnoyar-sky krai. 68
in 2005 revenues form personal income tax in the share of GDP equivalent slightly lowered (a. 3.3% of GDP), while those from corporate income tax grew drastically (from 3.9% of GDP to 4.4% of GDP). Revenues from excise taxes dropped insignificantly (down to 0.7% of GDP), while those from payments for the use of natural resources fell considerably (to 0.26% of GDP vs. 0.9% of GDP in 2004), and taxes on small business grew from 0.3% of GDP up to 0.33% of GDP.
The above phenomena continues the process of centralization of tax revenues in the federal budget launched back in 2003. As a reminder, the year of 2003 saw coming into effect such decisions as a complete abolition of the road users tax and transition to a complete collection of revenues from tobacco excise taxes into the federal budget. The tendency intensified in 2004, with the abolition of the sales tax and a whole range of levies revenues from which had been subject to collection to the RF Subjects' budgets, and the growth in the federal proportion of the mineral tax. In 2005, the government continued to centralize the mineral (oil and gas condensate) tax (9.4 p.p.), as well as the water tax and 1.5 p.p. of the corporate profit tax.
While in 2004 the tax centralization moves were fully compensated for by such measures in the area of interbudgetary redistribution of tax revenues as a full reassignment of the federal part of tax revenues under special regimes of taxation of small businesses to the RF Subjects' budgets, of the federal proportion of liqueur excises along with a simultaneous reforming of procedures of their payments, and of 1 p.p. of the federal rate of the corporate profit tax, in 2005, as shown above, the centralization measures failed to be compensated either by an equal reassignment to regions of other taxes and levies, or an increase of financial assistance from the federal budget.
As a result, the RF Subjects' tax revenues dropped by 0.3 p.p. of GDP vs. the prior year. That occurred primarily thanks to the centralization of 9.4% of the mineral tax in the part of oil and gas condensate (0.26% of GDP) and lowering the personal income tax (0.16% of GDP). A considerable rise in revenues to the regions' consolidated budgets in 2005 was noted only with regard to the corporate income tax (by 0.46 p.p. of GDP), as well as property taxes (0.29 p.p. of GDP). The rise in revenues from the corporate income tax was fueled exclusively by the growing tax base, regardless of the declining regional share of the corporate income tax. It can be suggested that the expansion of the tax base of the corporate income tax has been under positive influence of the decrease of the basic VAT rate from 20% to 18% in 2004. According to some hypotheses, the growth in revenues from the corporate income tax since 2004 can be attributed to the taxpayers' greater discipline, which was caused by the federal authorities' steps against YUKOS. Given such a rapid growth of the tax base and taxpayers' discipline, it can be suggested that despite the mobility and a considerably uneven dispersion of corporate profit tax across the RF territory, its role in budgets of the RF Subjects will be growing.
Meanwhile, the analysis of the indicator of tax revenues per capita to the RF Subjects' consolidated budget shows that the inter-regional diversity of it decreased in 2005 -thus, the value of the respective Gini coefficient accounted for 0.51 vs. 0.57 reported in 2004. The decrease of the interregional unevenness of tax revenues per capita to the RF Subjects' consolidated budgets took place chiefly due to centralization of unevenly distributed taxes - that is, the mineral and corporate profit taxes, - as well as because of the growth in the proportion of relatively evenly distributed between regions property taxes in the RF Subjects' consolidated budgets (from 6.1% in 2004 to 8.5% in 2005).
In 2005, of all the RF Subjects 1420 reported fall in their revenues in real terms, while in 2004 only four Subjects had found themselves in such a situation, which partly proves the above thesis of the centralization of a number of taxes in the federal budget in 2005 falling short of being compensated for with decentralization of other taxes and levies or an equal increase of the financial assistance from the federal center. The maximum fall in absolute terms was registered in Khanty-Mnasy AO, Chechen Republic, Republic of Mordovia, Chukotka AO, and Evenk AO. The drop in revenues in Khanty-Mansy AO is explained by the fact that the region suffered the greatest losses from the centralization of the mineral tax in the part of oil and gas condensate. In Chechen Republic, the federal center cut its financial assistance and centralized the mineral tax which resulted in a similar situation, however, yet another factor was that the proportion of corporate profit tax revenues from which in the total volume of revenues to budgets of other regions demonstrated the most rapid growth in 2005 accounted for the meager 1.8% in the Republic's budget. The fall in revenues to the Republic of Mordovia's budget can be attributed to the fact that the peak of the additional collection of tax payments from the taxpayers - oil traders and brokers registered in this particular Subject of the Federation, which used to grant considerable tax benefits, fell on 2004. The peak was passed in 2005, and the proportion of corporate profit tax in tax revenues to the regional budget slid from 78% in 2004 to 61%, while the Republic's consolidated budget revenues plunged by 16%. Similarly, revenues to the budget of Chukotka AO sunk - the proportion of corporate profit tax in the regional budget revenues fell from 57% in 2004 to 42% in 2005. As concerns Taymyrsky and Evenk autonomous okrugs, the fall in their respective revenues can be attributed to modified tax powers under which proceeds from their corporate tax revenues have begun to be collected to the budget of Krasnoyarsk krai.
In parallel with that, a maximum increment in tax revenues in absolute terms was noted in the city of Moscow, Tyumen oblast, Moscow oblast, St. Petersburg and in Samara oblast, i.e. in the regions with a high budgetary sufficiency (the city of Moscow, Tyumen oblast, St. Petersburg and Samara oblast) and those where the proportion of the corporate profit tax in the structure of tax revenues is high (the city of Moscow, Tyumen and Samara oblasts).
The analysis of the dynamics of tax revenues per capita evidences that the maximum positive increment in tax revenues per capita in real terms was registered in such regions as Tyumen oblast, Novgorod oblast, Koryaksky AO, Stavropol krai and Novosibvirsk oblast. The success of Tyumen oblast is easily explained by high oil prices, as well as a considerable proportion of the corporate profit tax in the revenue structure of the blast's consolidated budget (63%). In contrast, a considerable rise in the average per capita revenues in real terms in Novgorod, oblast, Stavropol krai, Novosivbirsk oblast and Koryaksky AO cannot be explained by the above phenomena. The budgetary sufficiency level in these particular regions is below the average nationwide level, while the share of the co-porate profit tax in their consolidated budgets fluctuates between 3% in Koryaksky AO to 23% in Novgorod oblast, i.e., again, below the average level. The rise in revenues in the least budgetary sufficient of the noted regions (Koryaksky AO and Stavropol krai) can be attributed primarily to a greater volume of financial assistance out of the federal budget, while a similar phenomenon in Novgorod and Novosibirsk oblasts was fueled by an accelerated rise in revenues to their consolidate budgets from personal incom tax, corporate
20 Bryansk oblast, Republic of Kalmykia, Karachayevo-Cherkesskaya Republic, Chechen Republic, Republic of Mordovia, Komi-Permyatsky AO, Khanty-Mansy AO, Republic of Buryatia, Aginsky Buryatsky AO, Taymyrsky (Dolgano-Nenetsky AO), Ust-Ordynsky Buryatsky AO, Evenk AO, Jewish AO, Chukotka AO.
profit tax, taxes on small businesses, and property taxes. In both oblasts it was corporate profit tax that displayed the greatest growth rate - its growth in real terms vs. its respective index of 2004 accounted for 85% in Novgorod and 35% in Novosibirsk oblasts.
Thus, the above provides grounds to reckon that all the regions experienced a growth in revenues, except for the aforementioned 14 ones. Given a drastic growth of the federal budget revenues, this proves the existence of a certain centralization of tax revenues, as well as a growing vertical imbalance of the budgetary system. Meanwhile, the un-evenness of distribution of tax revenues in 2005 has declined for the first time over recent years, which can be explained by the assignment to the federal budget of taxes with unevenly distributed base. Despite the re-assignment of 1.5% of corporate profit tax to the federal budget, the role this particular tax plays in the subnational finance grew in 2005, which can be proved by the fact that the coefficient of the correlation between the dynamics of revenues to consolidated budgets of the RF Subjects and the ones of payments on corporate profit tax made up 75% in 2005.
The year 2005 became the second straight year of an aggregate surplus of the RF Subjects' consolidated budgets, with the respective index accounting for 0.26% of GDP, which is at 0.06% of GDP more than in 2004. The surplus resulted in a 0.48 p.p. of GDP growth in balances of budget funds as of the end of the reported period.
The group of sources of financing the regions resort to in 2005 comprises issuing state and municipal securities, attracting credits on behalf of the RF Subjects and municipal entities, and privatization of the government and municipal property. Notably enough, like in the period of 2003-05, the country as a whole displayed a negative balance of such a source of financing of budgetary deficit as federal budgetary loans and budgetary credits (since 2005 - budgetary credits only), i.e. between 2003 and 2005 across the country as a whole the Subjects of the Federation repaid loans and credits at a volume greater than that of newly received loans and credits. This can be conceived as a radical change of the negative trend in existence prior to 20 0321.
The analysis of quantitative characteristics of the financial assistance to the RF Subjects' budgets from the federal budget (see Table 2) shows that, despite a considerable increase of tax revenues to the federal budget, the volume of federal financial resources transferred for free to the subnational budgets demonstrated a insignificant growth in nominal terms. In 2005, it roughly accounted for Rb. 487 bn., or 2.25% of GDP (vs. 2.39% of GDP in 2004). However, in real terms the financial assistance to regional budgets displayed a 9.5% growth vs. 2004, while revenues to the federal budget over the period in question grew by 35%.
In 2005, the federal budget expenditures on financial assistance to the RF Subjects and municipal entities underwent certain modifications vis-à-vis a number of prior years. Thus, the tendency to lowering the financing from FFFSR was in place, with the respective support declining from 1.14% of GDP in 2001 to 0.88% of GDP in 2005. Given that the methodology of formation of the Fund is one of the most transparent ones this tendency cannot be viewed as a positive one. The volumes of financing from the Fund for Financing Social Expenditures displayed a drastic rise - from 0.04% of GDP in 2004 to 0.12% of GDP in 2005. The main cause for such a rise became the monetization of benefits (with subsi-
21 In 2005, new amendments to the Budget Code of RF came into effect. In compliance with the new version of the Code, which does not provide for such a kind of financial assistance as budgetary loans, there has been set a strict requirement to the RB Subjects' budgets to return budgetary credits within a given budgetary year. The failure to do so entails repayment of the remaining part of the credit, including interest, penalties and fines by means of subsidies from the Federal Fund for Support of Subjects of the Russian Federation, as well as deductions from the federal taxes and levies, the taxes provided for by special tax regimes (except for local taxes) due for collection to the budget of the RF Subject.
dies on a partial compensation for expenditures on measures of social support of veterans and laborers of the Home Front during the Great Patriotic War accounting for a considerable part of the Fund's expenditures). Likewise, subsidies on provision of measures on maintenance of balanced regional budgets grew considerably - from 0.11% of GDP up to 0.24% of GDP. This particular kind of financial assistance has become in 2005 a principal instrument the federal center used to smooth down negative shocks that regional budgets faced at the time, as well as to equalize the vertical imbalance of the budgetary system. The vigorous use of this particular mechanism of financing aggravated the problem of soft budget constraints in 2005. The funding from the Federal Fund for Development of Regions shrank considerably, as since 2005 the Fund has begun to comprise only funds of the "Reduction of differences in socio-economic development of regions of the Russian Federation" program. As concerns positive outcomes of the 2005 development of inter-budgetary relations, suffice it to note a considerable reduction in mutual settlements, which had been among the most non-transparent instruments of interbudgetary relations. Their volume plunged from 0.12% of GDP in 2004 to 0.01% of GDP in 2005.
In 2004-05 the government attempted to enhance the transparency of interbudgetary relations. Thus, in 2005, for the first time ever, resources of the FFFSR and the Fund for Compensations were allocated according to a methodology approved by the governmental Resolution. Likewise formalized became the procedures of formation and use of the Fund for Co-Financing of Social Expenditures, Fund for Reforming Regional Finance, and a part of subsidies on supporting measures on ensuring balanced budgets of the RF Subjects. Despite the accomplished reforms, particular characteristics of this kind of federal budgetary expenditures still are considerable amounts of funds distributed following the interbudgetary regulation procedures, but without any methodological and financial and economic justification. The proportion if financial assistance allocated on a formalized basis in the overall volume of transferred resources has been under 60%. Even given that, as far as the noted funds are concerned, it was only three Funds with respect to which procedures of formation and distribution were approved - namely: FFFSR, the Fund for Compensations and the Fund for Reforming Regional Finance.
Characteristic feature of the period of 2003-05 has become revision of the budget law and an increase of the originally pre-set amounts of financial assistance to regions at Rb. 67 bn. over the period in question. It should be noted that such modifications have lately become fairly routine, which questions the efficiency of the accomplished reform of allocation of financial assistance to regions.
To exemplify the existing procedures and principles of allocation of the additional financial assistance, suffice it to refer to the following decisions:
1) During 2005 the Fund for Compensations was increased from Rb. 33.4 bn. up to 35/8 bn., or at 7%;
2) The Fund for Co-Financing of Social Expenditures - from Rb. 23 bn. to 25.3 bn., or at 10%;
3) Subsidies to balance regional budgets were increased from Rb. 19.5 bn. to 52 bn., or at 167%.
Table 15
Financial Assistance from the Federal Budget to Consolidated Budgets of the RF Subjects between 1992 and 2006 (as % of GDP)
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006*
1. Financial assistance to budgets of other levels 2.3 2.5 1.6 1.18 1.43 1.79 2.2 1 .94 1.70 1.65 1.52
1.1. Federal targeted pro-
grams, as well as subsidies
to the RF Subjects on sup-
port of agriculture, water-economic measures, sup- 0.05 0.15
port of small businesses,
and children's health and
rehabilitation
1.2.Fund for Co-
Financing of Social 0.15 0.11 0.04 0.12 0.11
Expenditures
1.3. Fund for Financial
Support of Regions, 1.04 1.22 1.12 0.99 0.96 1.14 1.36 1.30 1.05 0.88 0.94
including:
Subsidies on equalization of budgetary sufficiency 0.68 0.86 1.00 0.99 0.96 1.14 1.36 1.30 1.05 0.88 0.94
State support of the "Northern Supply" 0.06 0.08 0.08 0.07 - - -
Transfers at the expense of VAT 0.36 0.36 0.12 - - - - - - - -
1.4. Subsidies and
subventions 0.09 0.13 0.10 0.06 0.15 0.54 0.28 0.29 0.27 0.36 0.21
including:
Subsidies and subven-
tions to closed territorialadministrative entities 0.11 0.12 0.11 0.11 0.09 0.07 0.07
and the town of Baykonur
Subsidies to budgets to
support measures on 0.11 0.24 0.10
securing their balancing
1.5.Resources of the
Fund for Reforming Re- 0.00 0.01 0.01 0.01 0.00 0.01
gional Finance
1.6 Other free and ir-
revocable transfers (sub- 0.01 0.01 0.01 0.01 0.08
sidies and subventions)
1.7. Fund for Financing of Development of Regions 0.03 0.05 0.10 0.10 0.15 0.01** 0.01
1.8.Funds allocated by mutual settlements 0.81 0.43 0.36 0.14 0.28 0.05 0.20 0.14 0.12 0.01
1.9.Loans and budget
credits less repayment due to other levels of 0.23 0.64 -0.03 -0.10 -0.08 0.02 0.09 -0.01 -0.02 -0.03
government
2. Fund for Compensations 0.37 0.38 0.36 0.34 0.17 0.3
3. Other interbudgetary
transfers 0.18 0.11 0.4 0.45 0.54 0.35 0.33 0.34
of which:
-state support of the road sector 0.18 0.11 0.27 0.27 0.31 0.22 0.13 0.15
All the funds disbursed
to other levels of gov- 2.3 2.5 1.60 1.36 1.54 2.56 3.03 2.84 2.39 2.25 2.17
ernment
* In compliance with the 2006 budget law.
** Since 2005 the Fund for Regional development comprises only resources of the program "Reducing disparity in socioeconomic development between regions of Russian Federation". *** Since 2005 r. - only budgetary credits.
2.3.2. The Problem of Soft Budget Constraints for Regional Governments
The two previous annual reviews on the Russian economy and its trends and outlooks emphasized that the volume of financial resources allocated in the form of financial assistance to budgets of the RF Subjects recently was considerably in excess of the volume of financing that was initially provided for by the law on the federal budget of the respective year and of which regional authorities were duly notified. Thus, we believe that in 2003 the allocation of an additional financial assistance to regions through various channels was made in conjunction with the eagerness to secure favorable for the federal center outcomes of the parliamentary elections of December 2003.
This practice continued in 2005. Numerous statutes on amending the law on the federal budget22 were passed during the year. They implied distribution of additional federal budget revenues, particularly for the sake of boosting expenditures on various financial assistance issues.
Fig. 2 presents the data that characterize the difference between the volume of financial assistance to the regions, as originally set in the law on the federal budget passed by the Parliament and signed by the President right prior to the start of the financial year, and the volume of financial assistance, as fixed by the law on the federal budget effective as of end-financial year, i.e. with account of amendments introduced in the law during the year.
500 450 400 350 -f 300 250 200 150 100 50 0
2002
2003
2004
2005
□ Provided for by the federal budget law passed prior to the start of the financial year ■ Provided by the federal budget law passed prior to the end of the financial year
Source: Various drafts of the federal budget law on 2002, 2003, 2004, 2005.
Fig. 13. Excess of the Amount of Financial Assistance to Regions as per the Federal Budget Law Passed Prior to the End of the Financial Year over the Amount of Financial Assistance as per the Federal Budget Law Passed prior to the Start of the Financial Year
22 See the federal statute "On introducing amendments to the federal law "On the 2005 federal budget" passed by the State Duma on June 17, 2005; federal statute on introducing amendments to the federal law "On the 2006 federal budget" No. 141 FZ of November 4, 2005.
The data in the Figure above demonstrate that the volume of financial resources assigned as additional ones to the volume stipulated in an original draft of the budget law grew dramatically in 2003-05. While the 2002 federal budget law enacted in end-2002 provide for just a 4.2% rise of funds to be distributed between the RF Subjects' budgets vis-à-vis the original intent at the start of the year, in 2003 the respective index ultimately made up 34.8%, in 2004 - 26.7%, and in 2005 - 17.7%.
Underlying such increases may be several causes, of which some appear characteristic of the whole period of 2003-05, while the others are episodic.
The universal causes for the emergence of soft budget constraints lie with the following peculiarities of Russia's economic and political situation:
1 ) an insufficient quality of financial planning - at the beginning of the year policy makers fail to accurately assess both the federal budget revenue indicators and the regions' need in financial resources;
2) because of the "corporate spirit" of the Russian federalism, the federal center bears a considerable drag of political responsibility for some regions' socio-economic state. That is why the federal authorities would deliberately leave at their disposal a considerable volume of financial resources, for the sake of their distribution over a given financial year between the regions, which, due to economic and/or political reasons, are in need for additional funding;
3) the planning of revenue and expenditure indices of the federal budget was made proceeding from a conservative forecast of the situation in the foreign trade area, while a favorable situation in the world market for minerals would entail a great inflow of additional revenues, which would partly be assigned between regions in the form of financial assistance.
In addition to the above causes, there exist a number of episodic factors that determined a considerable excess of the actually allocated volume of financial assistance in late 2004over the planned one. To evaluate the reasons, one needs to identify main sources of the excess of the actual volume of interbudgetary transfers over the planned one. In 2005, the noted excess accounted for Rb. 66.9 bn. Fig. 14 presents the contribution of various kinds of financial assistance to the excess of the volume of interbudgetary transfers to regions as of end-2005 over the respective index as of the beginning of the year.
3%
4%
5%
49%
1%
□ Federal Fund for Co-Financing of Social Expenditures
■ Subsidies for supporting measures on provision of balanced budgets of the RF Subjects
□ Subsidies to closed administrative-territorial entities
EH Subsidies for compensation for losses from maintenance of the housing and communal objects and those of socio-cultural sphere delegated under the mandate of the municipal self-governance bodies 0 Fund for Compensations
S Subsidies to Tatarstan 0 Other interbudgetary transfers
Source: federal statute No. 173-FZ of December 23, 2004 "On the 2005 federal budget" and federal statute No. 141-FZ of November 4, 2005 "On introducing amendments to the federal statute 'On the 2005 federal budget'".
Fig. 14. Contribution of various Kinds of Financial Support to the Excess of the Volume of Interbudgetary Transfers to Regions as of End-2005 over the Respective Index
of the Beginning of 2005
The data presented by Fig. 14 evidences that:
- nearly half of the unplanned in the beginning of the year financial assistance falls on subsidies on support of measures on securing the balancing of the RF Subjects' budgets;
- 19% falls on subsidies to the RF Subjects on compensating for losses from maintenance of housing and communal objects and objects of the socio-cultural sphere delegated under mandate of local self-governance bodies;
- 5% - on the Fund for Compensations (additional funding was assigned to regions to exercise the federal pwers with respect to the state registration of acts of civil status);
- 3% - on the Fund for Co-Financing of Social Expenditures (the excess of the actual volume of funding over those planned at the beginning of the year occurred due to an inaccurate assessment of the volume of subsidies to residents on housing payments).
In 2005 over 80% of unplanned in the beginning of the year interbudgetary transfers was assigned using above financial mechanisms.
The main causes for the rise of additional interbudgetary transfers in 2005 became:
1) liquidation of unfounded federal mandates (aka "monetization of benefits"), the part of the burden on which was paid upon regional budgets. As the process of preparation of the reform at the federal level was not synchronized with the local budgeting processes, there arose the need in increasing the subnational governments' expenditures. Most regions found themselves unprepared for such an increase, which resulted in the social tension, which the federal center was compelled to mitigate by means of boosting interbudgetary transfers. That formed the cause for a dramatic rise of subsidies on supporting measures on securing the balancing of the RF Subjects' budgets.
2) Lack of harmonization between the administrative reform and the budgeting resulted in the situation in which, following the division of property into the federal, regional and municipal ones, a number of the housing and communal, and socio-cultural objects were re-assigned to regional and local self-governance authorities without any financial provision. As the law has failed to strictly stipulate the property assignment procedures, in practice regions and municipalities often refuse to accept thus assigned property. This results in certain social problems, as the property comprises colleges, schools, kindergartens, departmental housing facilities, etc. To eliminate social tension, the federal center has had to transfer to regions earlier unplanned subsidies on compensation for losses from maintenance of housing and communal objects and objects of the socio-cultural sphere delegated under mandate of local self-governance bodies.
3) Plainly political reasons: thus an increase of the volume of the subsidy on implementation of measures under the federal targeted program entitled "Socio-economic development of the Republic of Tatarstan until 2006" was likely to be attributed to the celebration of the thousandth anniversary of the city of Kazan and a special status of the region in question.
Regardless of reasons, the current situation exerts the most adverse influence on incentives for regional authorities to pursue an efficient budgetary policy. The situation in which the federal authorities do not abide by already declared principles in the course of allocation of financial resources and grant financially challenged regions with an extra help, or, as in the case of Tatarstan, they practice unequal approaches to different regions is known in the literature as soft budget constraints. As evidenced by international experiences, soft budget constraints for subnational authorities generate a whole series of adverse economic effects, such as an excess of an efficient level of budgetary expenditures, as well as more general effects (the rise of obstacles to growth in private investment and a growing number of inefficient investment projects that bear greater risks).
In reality this means that in the situation in which regional authorities have all the grounds to expect financial assistance in addition to its originally announced volume there may arise several sorts of adverse effects. First, the regional authorities now can assume greater risks while implementing both budget programs and borrowing programs. Second, the probability of receipt of an extra funding enables them to assume additional obligations in the form of accounts payable and not to attempt to increase efficiency of budgetary expenditures in the region. Third, given their past experiences and being aware of a tentative list of indicators basing on which the federal government will distribute an additional financial assistance between regions, the regional authorities can influence values of the respective indicators (for instance, levels of accounts payable in their region, wage arrears in the public sector, the budgetary institutions' debt on communal payments, etc.). As a result, the seemingly favorable for the local population decision on allocation of an extra financial assistance can generate negative effects both for the population in a given region and the country as a whole (so far as the state of its public finance is concerned). The
probability of the rise of such effects is growing if the receipt of an additional financial assistance occurs periodically.
The factor that fosters the emergence and presence of the Russian subnational authorities' soft budget constraints is increase in the aggregate volume of financial assistance, as per the federal budget law. However, there exists yet another factor - that is, the continuously great volume of financial resources announced yet on the eve of the start of the new financial year. However, the decision-making powers with regard to a specific methodology of their distribution are delegated to the federal government that rules the respective decisions during the financial year. The regional authorities consequently have no information of how these or those funds will be distributed, which creates incentives for the rise of soft budget constraints, as well as encourages regional authorities to seek additional financial assistance.
Thus, in 2005, the federal budget law failed to distribute between regions over 26% of resources to be spent on subsidies on getting regional budgets balanced - the Rb. 38.417 bn.-worth subsidies allocated to the RF Subjects' budgets for the sake of getting them balanced were distributed according to Annex 16 to the federal budget law. Plus, procedures of allocation and amounts of subsidies designated for the same purpose and totaled Rb. 13.639 bn. were to be identified by the RF government.
Creation of reserves along with the failure to strictly set procedures of their utilization at the start of the financial year can also affect the regional authorities' fiscal behavior (in the form of an attempt to receive from the federal center yet unallocated financial resources, instead of seeking optimization of their own financial resources), as well as the control over distribution and consumption of the resources in question.
The practice has survived through 2005. As evidence by the data of Fig. 15, the proportion and volume of subsidies on getting regional budgets balanced have been considerable between 2004 and 2006. The proportion of the funds roughly accounts for j of the overall volume of the respective subsidies. The situation has been particularly bad in 2005, with 72%, rather than the usual 24-26%, of subsidies being allocated de-facto at the discretion of the government. Basing on the earlier designed methodology, at the beginning of the year the budget law read that just as much as Rb. 14.5 bn., or 28% of the total volume of subsidies on stabilization of regional budgets as per the federal budget law as of end-2005 was to be distributed between regions. This means that the government planned and actually implemented the rest of the volume of financing through the end of 2005. Plus, given that in 2004 the volume of subsidies on support of measures on stabilization of the RF Subjects' budgets had remained unchanged during the year, in 2005 the government made decisions that boosted the volume of financing considerably.
en
50
40 --
d 30 m
20 10 0
74%
- -75% -
74%
80%
24%
20%
2004
early 2005
end 2005
2006
□ procedures of distribution of subsidies as per the budget law ■ procedures of distribution of subsidies as per the RF Government decisions
Fig. 15. The Dynamics of the Volume of and proportion of Subsidies on Stabilization of Regional Budgets Allocated Proceeding from the Methodology of Distribution of the Given Funds and at the Discretion of the Government (as Rb. Bn.)
Subsidies to Budgets of Subjects of the Russian Federation on Supporting Measures on Provision of Stabilization of Budgets of Subjects of the Russian Federation
Whereas subsidies to budgets of subjects of the Russian Federation on supporting measures on provision of stabilization of budgets of Subjects of the Russian Federation have become in 2005 a critical mechanism that secured "flexibility" of the federal budget in the part of interbudgetary transfers, it is appropriate to provide a detailed depiction of the effect the instrument of financial assistance to regions has on the subnational authorities' fiscal behavior.
The methodology of distribution of subsidies to budgets of the RF Subjects on supporting measures on provision of stabilization of budgets of the RF Subjects was approved by the government Resolution of November 4, 2004. According to the methodology, the said subsidies are assigned in three stages.
At the first stage, the subsidies are assigned for the sake of a partial compensation for the decrease in the volume of resources of the Federal Fund for Financial Support of Subjects of the Russian Federation according to the following formula:
S1 i = SI,, * Di / D rt, where
S1i is the amount of the subsidy to a given Subject of the Federation assigned at the first stage;
S1f - the amount of subsidies assigned to all the Subjects of the Federation assigned at the first stage (the amount of the subsidies to be assigned at the first stage accounted for 20% of the initially planned volume of subsidies allocated according to the said methodology, or Rb. 2 bn.23);
23 As a reminder, a part of subsidies to Subjects of RF on supporting measures on securing stabilization of their budgets is allocated following the government decision, rather than an earlier approved methodology.
Di - difference between the volume of funds assigned to the Subject of RF out of the Federal Fund for Financial Support of Subjects of the Russian Federation, as per the federal statute "On the 2004 Federal Budget" and the volume of funds provided for the Subject of RF from the Federal Fund for Financial Support of Subjects of the Russian Federation for 2005 (only positive values are accounted for computation);
D rf-the difference between the volume of funds assigned to all the Subjects of the Federation from the Federal Fund for Financial Support of Subjects of the Russian Federation, as per the federal statute "On the 2004 Federal Budget" and the volume of funds provided for the Subject of RF from the Federal Fund for Financial Support of Subjects of the Russian Federation for 2005 (only positive values are accounted for computation).
Meanwhile, the right for the subsidy assigned at the first stage is granted only to the Subjects of the Federation that succeed to match two conditions:
1) the share of the fall in the volume of subsidies out of FFFSR for a given region in the revenues of the consolidated budget of the RF Subject24 has been over 3% over eight months of 2004;
2) the share of subsidies from FFFSR in the revenues of the consolidated budget of the RF Subject exceeded 10% over eight months of 2004.
While 14 regions25 have succeeded to match the first criterion, of which only Astrakhan and Tomsk oblast failed to meet the other one and, accordingly, they failed to receive subsidies at the first stage.
I Budgetary sufficiency in 2005 □ The ratio between the volume of per capita subsidy on stabilization of budgets of Subjects of RF and the average level in the regions that receive this kind of financial assistance, with account of the index of budgetary expenditures
Fig. 16. Correlation between Subsidies on Stabilization of Budgets of Subjects of RF Allocated on the First Stage from Budgetary Sufficiency of Subjects of RF
Thus, the subsidies on stabilization of regional budgets assigned at the first stage partially duplicate those from FFFSR. However, by contrast with the latter, their earmarking is based upon an actual data on consolidated budgets of the RF Subjects, which discourages regional authorities to employ their own fiscal efforts to get budgets balanced. The
Without regard to resources of the Fund for Compensations, subventions on implementation of development programs for cities as R&D centers, subventions to the city of Moscow on exercising federal powers, disposal of nuclear wastes, and forward transfers.
25 Kaluga, Smolensk, Tomsk, Astrakhan, Chita and Sakhalin oblasts, Republics of Kalmykia, North Ossetia-Alania and Bury-atia, Khabarovsk krai, Aginsky Buryatsky, Koryaksky and Chukotka autonomous okrugs, and Jewish autonomous oblast.
hypothesis of the duplication by the noted subsidies of those assigned from FFFSR can be proved by the following considerations:
The two regions (Astrakhan and Tomsk oblasts) which failed to receive the stabilization subsidies despite a "considerable (in the frame of the methodology) fall in subsidies out pf FFFSR, had enjoyed a high level of budgetary sufficiency (123% and 89%, respectively, with the 2006 projected value of the indicator of Tomsk oblast accounting for 107%). The other regions had a low level of budgetary sufficiency - 58% on average. There is a certain correlation between the size of stabilization subsidies and budgetary sufficiency highlighted by Fig. 16.
The data of Fig. 5 evidences that there exists a certain negative correlation between the size of the per capita subsidy on stabilization of the RF Subjects' budgets assigned at the first stage and with account of the index of budgetary expenditures and the region's budgetary sufficiency. Our computations show that the correlation coefficient between these two indices accounts for -40.2%. It could be greater, if in the course of allocation of subsidies one employed a computation tax capacity of a region, rather than actual data on its revenues. The correlation coefficient in that case would make up - 90.1%. Hence, subsidies on stabilization of regional budgets allocated at the first stage appear to be a mere duplication of those from FFFSR, thus creating negative fiscal incentives for regional authorities.
At the second stage, Rb. 3-bn. - worth subsidy is distributed for the sake of a partial compensation for revenues and increasing expenditures of the RF Subjects' budgets due to a partial centralization of the tax on minerals in the form of oil and gas condensate, centralization of water tax and 1.5 points of the corporate profit tax rate in the federal budget and according to the following formula:
S2i = S2rf * (O1,+O2,+O3, - H )/ (01rf+02rf+ 03rf - Hrf), where
S2i - the size of the subsidy to i-Subject of the Federation allocated at the second stage;
S2f - the size of the subsidy to all Subjects of the Federation allocated at the second stage;
O1, -the size of centralization of 9.4% of the tax on minerals in the form of oil and gas condensate for i-Subject of the Federation;
O2; - the size of centralization of the water tax for i-Subject of the Federation;
O3- the size of centralization of 1.5% p. of corporate profit tax in the federal budget for i-Subject of the Federation;
H— the size of savings on expenditures due to the lowering of the uniform social tax for for i-Subject of the Federation;
01rf02rt, 03f - the aggregate size of centralization of the tax on minerals in the form of oil and gas condensate, centralization of water tax and centralization of 1.5 points of the corporate profit tax rate in the federal budget across all the Subjects of the Federation;
Hf - the aggregate size of the economy on expenditures due to the lowering of the uniform social tax for for i-Subject of the Federation.
The right for the subsidy distributed at the second stage is granted only to those Subjects of the Federation for which the level of the computation budgetary sufficiency after distribution of FFFSR appeared under 110% for 2005.
For 44 Subjects, the amount of saving on expenditures due to the lowering of the uniform social tax exceeded losses from the centralization of the noted taxes, therefore at the second stage these regions failed to receive subsidies on stabilization of their budgets. Of the remaining 45 regions for which a negative budgetary effect from the centralization of the taxes exceeded the amount of saving form the lowering of the UST rate, 14 Subjects did not receive subsidies on stabilization of their budgets, because the level of their budgetary sufficiency had become over 100%26. So, at the second stage the noted subsidies were allocated to 31 regions, with the aggregate amount of negative changes in the budget stabilization across these regions amount to over Rb. 11.7 bn. So, thanks to the subsidies, at the second stage it became possible to remedy only 25.6% of the imbalance of regional budgets caused by modifications in the tax law.
Given that, the question arises as to what effect the federal center was going to ensure by allocating this very volume of funds according to the noted formula. Clearly, it did not set a task of compensating for 100% of all the withdrawn revenues, otherwise it would have appropriated a far greater volume of funds, without linking them to a degree of budgetary sufficiency. If the federal center was after equalization of the budgetary sufficiency of the RF Subjects, it is unclear what was the reason for allocating the subsidies to regions whose budgetary sufficiency was above the average nationwide level27. Those highly sufficient regions received 33% of the budget stabilization subsidies allocated at the second stage.
To prove the hypothesis that the subsidies on stabilization of regional budgets allocated at the second stage were bearing no equalization effect, Fig. 6 highlights on the correlation of the subsidies on stabilization of budgets of the RF Subjects allocated at the second stage and the RF Subjects' budgetary sufficiency.
The data presented on Fig. 17 show that there is no significant negative correlation between the amount of the per capita subsidy on balancing the RF Subjects' budgets with account of the budgetary expenditures index and the region's budgetary sufficiency. Our computations show that the coefficient of the correlation between these two indices accounts for -17.2%.
At the third stage, the Rb. 5-bln. - worth subsidy is assigned for the sake of a partial compensation for the re-assignment of main powers with regard to the preschool education, general education, primary and secondary vocational training. The assignment follows the formula:
S3i = S3f * Hi / Hrf,
where
S3h- the size of the subsidy to the subject of RF assigned at the second stage;
S3f - the size of the subsidies to all the RF Subjects assigned at the third stage;
Hi - the amount of the increase in expenditures of budgets of all the RF Subjects, due to the re-assignment of main mandates on provision of the preschool education, general education, primary and secondary vocational training.
26 Lipetsk oblast, city of Moscow, Republic of Komi, Vologda oblast, Murmansk oblast, St. Petersburg. Nenetsky autonomous okrug, Republic of Tatarstan, perm oblast, Samara oblast, Tyumen oblast, Khanty-Mansy autonomous okrug, Yamalo-nenetsky autonomous okrug, Krasnoyarsk krai.
27 Yaroslavl oblast, Leningrad oblast, Republic of Bashkortostan, Udmurt Republic, Orenburg oblast, Sverdlovsk oblast in 2005 received no subsidies on stabilization of the level of their budget sufficiency out of FFFSR, but they received subsidies on stabilization of budgets of RF Subjects.
4500% 4000% 3500% 3000% 2500% 2000% 1500% 1000% 500% 0%
■ The ratio of the volume of per capita subsidy on balancing the RF Subjects' budgets to the average level in the regions that receive this particular kind of financial assistance, with account of the budgetary expenditures index
ll
JJ □. j Ja Jaan Jno. Jan. Jo-a Jn- Ja JaaD 0 □ □ 0 0 0 D D 0 ,11
§§§§11 Ills
2 -s I S
tfniMfiiî IJJlf^
S O o O
S < < <
"5 = g Î
^ £ z &
© §
1 *
Budgetary sufficiency in 2005
Fig. 17. Correlation between Subsidies on Balancing of Budgets of the RF Subjects Assigned at the Second Stage and the Budgetary Sufficiency of the RF Subjects
Meanwhile, only the Subjects of the Russian Federation for which the level of computation budgetary sufficiency after the distribution of FFFSR for 2005 was under 110% became eligible for the subsidy.
The distinctive feature of all the three stages of allocation of subsidies on getting the RF Subjects' budgets balanced became an attempt to combine compensational and equalizing features of interbudgetary transfers. Setting a few objectives for a form of inter-budgetary support can result in the situation in which none of them would be efficiently achieved, as it happens now. As a result, a full compensation for the decrease of revenues and increase in expenditures of regional budgets has become unavailable, on the one hand, while negative fiscal incentive for regional authorities have arisen, on the other hand, as the methodology is chiefly based on reporting, rather than computation, indicators.
The shortage of compensational mechanisms laid into the methodology of distribution of subsidies to budgets of the RF Subjects on supporting measures on securing stabilization of their budgets essentially has necessitated a wide-scale revision of the total volume of subsidies on getting the RF Subjects' budgets balanced in favor of their increase.
Table 16 presents the data on the degree of compensation for unbalanced budgets of the RF Subjects by means of subsidies on supporting measures on securing stabilization of the RF Subjects' budgets.
Table 16
Compensation for Imbalance of Budgets of Subjects of RF by means of Allocation of Subsidies on Supporting the Measures on Provision of the Balancing of Budgets of Subjects of the Russian Federation
Subsidies, as provided for by the Factors that generate imbalances Changes Meth°dol°gy at the start
of budgets of the RF Subjects in in the balances of the year
2005, as per the Methodology (as Rb. bn.) Rb. bn. As % of the change in the balance
1. Declines in the volumes of funds of
the Federal Fund for Financial Support 5.53 2.0 37.7%
of Subjects of Russian Federation
2. Decline in revenues and increase in
expenditures of budgets of the RF
Subjects due to a partial centralization
of the tax on minerals in the part of oil
and gas condensate, centralization of 11.72 3.0 25.6%
the water tax and centralization of the
1.5 p. of the corporate profit tax rate in
the federal budget
3. Re-assignment to the RF Subjects
of main powers with regard to provi-
sion of the preschool and general edu- 21.33 5.0 23.4%
cation, and primary and secondary
vocational training
Total 38.58 10 25.9%
Source: the RF Ministry of Finance.
As noted above, subsidies to budgets to the RF Subjects on supporting measures on provision of their stabilization have formed a major source of soft budget constraints in 2005. Instead of originally set for 2005 by the Methodology of distribution of subsidies to budgets of the RF Subjects for the noted purpose amount of Rb. 10 bn. or 19 bn. as per the 2005 budget law, the government ultimately disbursed over Rb. 52 bn. for the said purpose.
By the degree of the destructiveness of their impact on the subnational authorities' fiscal behavior these subsidies can be conditionally broken into four groups. There are two factors underlying such a breakdown - that is, when the decision on allocation of the subsidy was made (in the beginning of the financial year, or already in the course of execution of the budget) and on which grounds the funds were allocated (whether it was done on the basis of the government decision, or proceeding from the earlier approved methodology) (Table 17).
The data of the Table above show that the subsidies in question allocated in 2005 can be divided into four categories:
1) Category A1. This category is mostly formed by subsidies allocated according to the Methodology. Their negative impact on the subnational authorities' fiscal behavior was noted above;
2) Category A2. In addition to the negative effects inherent in the subsidies of category A1, this particular kind of financial assistance fuels the subnational authorities' desire
to solve all the problems they face at the expense of the federal budget funds, rather than by their own fiscal efforts, as the volume of the subsidies is not pre-set;
3) Category B1. Given the absence of clearly articulated procedures of their distribution, this kind of subsidies, on the one hands, encourages the RfFSubjects to receive these financial resources, while, on the other hand, the federal government now has a possibility to re-assign the funds over the financial year at their discretion, which can also imply negative effects, such as political bargaining, lobbying regional and private interests, among others;
4) Category B2 appears the most "noxious", as far as the impact on the subfederal authorities' fiscal behavior is concerned. In this particular case the volume of the subsidies and procedures of their allocation are not known beforehand and form a subject of political bargaining.
Table 17
Classification of Subsidies on Supporting Measures on Provision of Balanced Budgets of the RF Subjects allocated to the RF Subjects in 2005
The procedures of distribu- The procedures of distribution of subsidies is stipu- tion of subsidies are regulated in the 2005 budget (A) lated by the government (B)
As provided by the federal Rb. 14.5 bn. Rb. 5.0 bn.
budget law passed prior to the
beginning of the 2005 financial
year(1)
Additional subsidies, as per Rb 23.9 bn. Rb 8.6 bn.
the budget law passed prior to
the end-2005 (2)
At the end of the day, the amount of Rb. 38.4 bn. in subsidies on supporting measures on getting the 2005 RF Subjects' balanced was earmarked by late 200528. Almost all the RF Subjects have received this kind of financial assistance, except for seven regions with a high degree of budgetary sufficiency - Lipetsk, Samara and Tyumen oblasts, the city of St. Petersburg, Nenetsky, Khanty-Mansy and yamalo-Nenetsky autonomous okrugs. However, we failed to identify any significant correlation between the level of budgetary sufficiency and the volume of the subsidies and the extent to which the RF Subjects' budgets were balanced. Thus, 13 regions whose budgetary sufficiency was greater than the average nationwide level received the subsidies - suffice it to refer to the city of Moscow: with its level of budgetary sufficiency being 2.2 times greater than the average nationwide one, it received Rb. 115 mn. in subsidies.
However, should one broke down the regions into three groups by the degree of their budgetary sufficiency, as follows:
1) the budgetary sufficiency is greater than the average nationwide one (the regions receive no subsidies from FFFSR);
2) the budgetary sufficiency accounts for 60-100% (the regions receive the FFFSR subsidies only on the second stage of equalization);
3) the budgetary sufficiency under 60% (the regions receive the FFFSR subsidies both n the first and second stages of equalization);
28 See Annex 16 to the Federal Law "In the 2005 federal budget" (the version of Federal Law "On introducing amendments to the federal law 'On the 2005 federal budget' No. 141-FZ of November 4, 2005.
4) one can note a certain correlation between the level of budgetary sufficiency and the amount of the subsidies in question (see Table 18).
Table 18
The Grouping of Regions That Receive Subsidies on Supporting Measures on Provision of Balanced Budgets of the RF Subjects, due to the Budgetary Sufficiency Level
Budgetary sufficiency level
Number of regions that receive the subsidies in question
The share of the subsidies in question
earmarked to the given group of the RF Subjects in the total volume of subsidies on getting the RF Subjects' budgets balanced
The average per capita subsidy on getting the RF Subjects' budgets balanced (as Rb.)
Over 100% 60-100% Under 60%
13 25 43
25.3% 29.7% 45.0%
271.5 235.3 402.8
The data of Table 18 make it evident that the average per capita subsidy in regions with a low degree of budgetary sufficiency appears 1.5-1.7 times greater than the respective index of all other regions of RF. A relatively high level of the subsidies that falls on highly sufficient regions is most likely to be caused by merely political reasons. Thus, the allocation of nearly 6% of the subsidies in question to Krasnoyarsk krai apparently was caused by the federal center's desire to promote its consolidation with Taymyr and Evenk autonomous okrugs. Should political component be excluded from the procedures of allocation of the subsidies in question, ther would occur a considerable redistribution of the respective funds in favor of regions with a low degree of budgetary sufficiency. Hence, the question arises, as to whether the subsidies are needed. It is a very urgent problem for the today's interbudgetary relations system, for, on the one hand, this kind of financial assistance bears a number of features that discourage the regional and federal authorities' fiscal behavior, while it is growing increasingly significant in the structure of interbudgetary transfers, on the other hand. The latter can be proved both by a drastic rise in the volume of the subsidies over 2005 and by the fact that the role played by this particular kind of financial assistance to the regions in the Concept for and methodology of formation of in-terbudgetary relations in Russian Federation and its Subject for 2006 and the medium term becomes increasingly significant.
According to the Concept, the year 2006 should see the implementation of Federal Law of October 6, 2003 No. 131-FZ "On general fundamentals of organization of local self-governance in Russian Federation", which will require from the RF Subjects to assign additional funds to ensure the nterbudgetary equalization between municipal entities and from the latter- to exercise the powers they are supposed to be granted, as per the Law. Because of that, the volume of subsidies on supporting measures on getting the RF Subjects' budgets balanced should grow 2.8 times29 vs. 2005 and reach Rb. 55319.7 mn. The allocation of the funds will be carried out with account of implementation of Federal Law of October 6, 2003, No. 131-FZ "n general fundamentals of organization of local self-governance
29 Meaning the volume of subsidies on getting the RF Subjects' budgets balanced, as per the federal law on federal budget enacted in early 2005 - Rb. 19.5 bn.
in Russian Federation" and modifications of the tax law, which should result in reduction of the tax bases of the RF Subjects' budgets.
Though the local self-governance reform was extended (put off) until 2009 and the volume of the subsidies in question in 2006 should account for some Rb. 25 bn., while the Concept was revised, there arises a serious danger that the federal center would be keen to "put out" all consequent drastic hikes of the vertical budget imbalances by means of such an inefficient financial instrument as the noted subsidies.
2.3.3. Methodology of Allocation of Subsidies from the Federal Fund for Co-Financing of Social Expenditures between Subjects of the Russian Federation for 2006
On August 9, 2005, the Task Force for improvement of interbudgetary relations in Russian Federation adjudicated a methodology of distribution of subsidies from the Federal Fund for Co-Financing of Social Expenditures between the RF Subjects in 2006.
According to the methodology, in 2006 the RF Subjects are going to receive subsidies from the Fund to support measures of social support to be provided to four categories of citizens:
1) rehabilitated individuals and those recognized as victims of the political repressions;
2) laborers of the Home Front;
3) veterans of labor;
4) citizens that have children.
The subsidies to the RF Subjects with regard to the two first categories of citizens rests upon two indicators - the number of citizens falling under the respective category and residing in the territory of a given Subject of RF, and the size of the cash allowance set by the federal center per one recipient (Rb. 227.9 a month for victims of the political repressions and 206.7 a month- for laborers of the Home Front).
As concerns the other two categories, the amount of subsidies is to be computed according to a more sophisticated formula, with account of the differentiation of the price scale and the level of budgetary sufficiency of the region (on which the level of co-financing depends).
To compute subsidies to veterans of labor, the methodology implies the budgetary expenditures index from the formula of subsidy allocation from FFFSR, while as far as citizens with children are concerned - the average weighted (by the number of residents in the respective cities and rayons ) rayon coefficient to wages and salaries, which is set by the federal acts in the cities (rayons) of the Subject of RF.
Given the above, the level of the co-financing of expenditures from the federal budget with respect to the both categories of citizens is found according to the formula:
a) if BS, < 1: L = 1 - BS, x (0,6 / BSmm ),
where L - level of the co-financing from the federal budget;
BS; - level of the computation budgetary sufficiency of the subject of RF after distribution of subsidies from the Federal Fund for Co-Financing of Social Expenditures of the Russian Federation;
BSmin - minimal level of budgetary sufficiency of the subject of RF after distribution of subsidies from the Federal Fund for Co-Financing of Social Expenditures of the Russian Federation;
b) if 1< BS, < 1,2: L = 0,1 / BSi ,
c) if BS, > 1,2: L = 0,05 / bS,
Like in the case of the subsidies on stabilization of regional finance, it is evident that the government is keen to simultaneously ensure both the stabilization (compensational) and equalization effects by means of a sole instrument. However, the above formula does not quite allow for equalization of the level of the regions' socio-economic development.
Fig. 18 presents a correlation between budgetary sufficiency and the level of co-financing of social expenditures in 2006, given that the minimum level of budgetary sufficiency accounted for 64%.
Fig. 18. Correlation between the Level of Co-Financing of Social Expenditures in 2006 and the Level of Budgetary Sufficiency
As evidenced by the data in Fig. 18, under the level of budgetary sufficiency being between 64 and 100% the values of the level of co-financing of social expenditures diminishes due to the level of budgetary sufficiency. However, the formula of computation of the level of co-financing of social expenditures exposes two considerable distortions under the transition from one schedule of budgetary sufficiency to the other:
1) The region with the budgetary sufficiency level of 99% is granted with a 7.2% level of co-financing of its social expenditures, while the region with the 100% budgetary sufficiency level somehow enjoys a 10% level of co-financing of social expenditures;
2) The regions with a 119% budgetary sufficiency level would receive a 8.4% level of co-financing of its budgetary expenditures, while the one with a 120% level of budgetary sufficiency would be granted only with a 4.1 level of co-financing of its social expenditures.
It seems more efficient:
1) not to divide l'gotniks (individuals eligible for benefits - Transl.) into federal and regional ones and secure the "monetization" of benefits at the expense of subventions to regions out of the federal budget;
2) Allocation of financial resources across all the above categories of citizens should be made with account of the regional price scale;
3) Provision of subsidies and subventions out of the federal budget should not be dependent on a given region's level of budgetary sufficiency. If, however, by some reason such a dependence emerges, it may not exert an adverse influence on the subnational authorities' fiscal behavior - the region that has enjoyed a greater budgetary sufficiency level prior to the receipt of the financing from the federal budget should retain its advantage after receiving it, too.
2.3.4. Methodology of Allocation of Subventions from the Federal Fund
for Compensations between Subjects of the Russian Federation on Payments for Housing and Communal Services to Individual Categories of Citizens and on Provision of measures of Social Support to Individuals Awarded with the "Honorary Blood Donor of the USSR" and "Honorary Blood Donor of Russia" signs for 2006
Like the above methodology, this particular one was approved at the same meeting of the same Task Force on August 9, 2005.
The computation of subsidies to the RF Subjects on payments for the housing and communal services for single categories of citizens rests upon three indicators: 1) the number of citizens eligible for benefits with respect to payments for the housing and communal services in a given Subject of RF; 2) the federal social housing standard employed for computation of interbudgetary transfers is 18 square meters per person; 3) the federal standard of the costs of the provision of the housing and communal services per 1 square meter of the overall living area per month for 2006 set by the Resolution of the RF government with respect to a given Subject of RF (this indicator takes into account the interregional price differentiation with regard to costs of the housing and communal services.
The subsidies to Subjects of RF on provision of measures of social support to individuals awarded with the "Honorary blood donor of the USSR" and "Honorary Blood Donor of Russia" are computed basing on two indicators: 1) he number of citizens awarded with the noted signs in a given Subject of RF, and 2) the amount of the annual cash allowance to such citizens, which was set for 2006 at the level of Rb. 6, 420.
As far as the computation of the subsidies on social support of blood donors is concerned, it appears imperative to consider the inter-regional price differentiation. As the donors are in need primarily of additional foodstuffs, to account the inter-regional price level differentiation, it would be rational to employ the price index for foodstuffs.
2.3.5. Application of a New Methodology of Allocation of Subsidies on equalization of Budgetary Sufficiency of Subjects of the Russian Federation
In compliance with the new budget law, the new Methodology of allocation of resources of the Federal Fund for Financial Support of Regions has become effective as of January 1, 2005. The Methodology was designed and consequently approved with the RF
government Resolution of November 22, 2004, No. 670. In the 2004 review of the Russian economy30, we provided a detail description of the new Methodology and highlighted on its pluses and minuses. The present section specifies the allocation of subsidies from FFFSR for 2006, as well as some recommendations with regard to strengthening their equalizing features, which are necessary to ensure a full refusal of the subsidies on supporting measures on getting the RF Subjects' budgets balanced in favor of an increase of subsidies from FFFSR.
In 2006, 65 regions should receive subsidies from FFFSR, which is at 4 regions less than in 2005. This modification was caused by the following reasons:
1) The 2006 subsidies to Koryaksky, Ust-Ordynsky Buryatsky and Aginsky Buryatsky okrugs will not be separated from the subsidies to the oblasts in which the okrugs belong. That is why they are not formally specified in the methodology of allocation of subsidies from FFFSR;
2) Chelyabinsk and Tomsk oblast will no longer receive subsidies from FFFSR in 2006, as their budgetary sufficiency level has exceeded the average nationwide level;
3) The Republic of Udmurtia will receive the FFFSR subsidies in 2006, as its budgetary sufficiency rate has proved to be below the average nationwide level.
Fig. 19 represents the dynamics of the disparity between the RF Subjects in terms of the budgetary sufficiency level over 2001-2006.
Fig. 19. The Dynamics of Disparity of the Level of Budgetary Sufficiency of th Rf Subjects between 2001 and 2006
30 See: Russian Economy: Trends and Outlooks. Issue 26. M., IET, 2005.
90
As evidenced by Fig. 19, the coefficient of variation of budgetary sufficiency prior to equalization has grown from 67% in 2001 up to 83% in 2004, while the coefficient of variation of budgetary sufficiency after equalization has grown from 62 to 78%, respectively. This testifies to the fact that despite all the federal center's efforts to equalize budgetary sufficiency of the RF Subjects in 2001-04, the disparity in question was growing, anyway. The year of 2005 saw for the first time over the period in question the disparity and computation budgetary sufficiency of the RF Subjects significantly decline. The decline continued in 2006 as well, however, it is hard to judge if it occurred because of a change in the formula of allocation of subsidies from FFFSR. For instance, a considerable equalization effect in 2006 became possible, because the budgetary sufficiency of Koryaksky, Ust-Orynsky Buryatsky and Nenetsky autonomous okrugs was not computed separately, as it had been noted over the prior years. Rather, it found itself incorporated into the respective indices of the oblasts in which the okrugs in question belong. The equalization effect proved to be the strongest one under the consolidation in the framework of allocation of subsidies from FFFSR of Nenetsky autonomous okrug, whose budgetary sufficiency is considerably greater than the average nationwide one, and Arkhangelsk oblast that appear subsidies from the perspective of the Methodology of allocation of subsidies from FFFSR. As a result, the latter's budgetary sufficiency grew from 56.4% in 2005 up to 70.5% in 2006 and the Oblast received at Rb. 810 mn. less in the 2006 subsidies vs. 2005.
The 2006 volume of FFFSR grew by 8.3% in real terms vis-à-vis 2005. Meanwhile, 18 regions will receive smaller amounts of subsidies from FFFSR in 2006 vs. 2005. The regions are: Belgorod, Kaluga, Kursk, Orel, Ryazan, Tula, Tomsk, Magadan, Amur, Omsk, Novosibirsk, Arkhangelsk, Kemerovo, Kurgan and Chelyabinsk oblasts, Republic of Khakassia, Altay krai and Primorsky krai. Interestingly, the decrease in subsidies from FFFSR in real terms does not appear associated in any way with their level of budgetary sufficiency.
The FFFSR volume appears clearly insufficient to enable the subfedereal authorities, providing they undertake the same tax efforts, to enjoy an equal opportunity to provide the same level of comparable public goods to their citizens. As well, the minimum level of budgetary sufficiency after the FFFSR subsidies are allocated remains extremely low. Fig. 20 presents the dynamics of the level of the minimum budgetary sufficiency after allocation of subsidies from FFFSR.
As the data of Fig. 20 shows, the 2005-06 minimum budgetary sufficiency of the RF Subjects accounted for 64%, which is an intolerably low level that necessitates employment of additional transfer mechanisms to ensure equalization the vertical and horizontal budgetary imbalances. In other words, one can reckon that an insufficient volume of FFFSR and a low degree of equalization of budgetary sufficiency levels indirectly necessitate employment of subsidies on supporting measures on getting the RF Subjects' balanced, soft budget constraints and the whole set of the aforementioned negative phenomena.
A modification of the formula of allocation of the FFSR subsidies might reedy the problem, provided such a modification has to meet a few requirements:
1) to increase progressiveness of the equalization;
2) to keep the regional authorities' keen to boost their budgetary sufficiency by themselves, i.e. regions with a greater budgetary sufficiency prior to equalization should keep on enjoying a certain advantage post-equalization, too;
3) the modification should affect as little parameters in the equalization formula as possible, to keep the continuity with the previous formula, but the pattern of computations should not grow more sophisticated.
Fig. 20. The Dynamics of Minimum Budgetary Sufficiency of the RF Subjects over 2001-2006
With that in mind, one of indisputable merits of provision of interbudgetary transfers is their predictability and stability in time. If the methodology of allocation of the FFSR subsidies is frequently modified, there will be no stability. Rather, a revision of the current methodology of allocation of subsidies from FFFSR is appropriate in the medium-term perspective.
2.3.6. The Impact of the New System of Elections of heads of Subjects of RF on Interbudgetary Relations
The IET review "Russian Economy in 2004: Trends and Outlooks" contains an analysis of the impact of the new system of election of heads of the RF Subjects on organization of interbudgetary relations and fiscal federalism on the whole. The year 2005 allows to conclude some interim outcomes of the introduction of the new system of federalism in Russia. Our forecast that the decision of an actual abolition of appointment by election of heads of executive power of the RF Subjects would affect the state of interbudgetary relations and subnational finance in the medium-term perspective has been quite accurate.
All the interim outcomes can be divided into three groups: 1. Immediate political modifications resulting from the introduction of the new system of election of heads of the RF Subjects. On 15 December 2004 the national media published amendments to the federal statute "On general fundamentals of organization of legislative (representative), executive bodies of state power of Subjects of the Russian Federation". The statute contained a decision on an actual cancellation of appointment by election of heads of the executive power of the RF Subjects. According to the new election arrangements, direct elections of heads of the executive power in regions are cancelled and replaced by appointment of an individual who pretends for the post by the legislative body of the Subject of the Federation, with the RF President proposing a candidature. Originally it could be suggested that the federal center would not be employ the new arrangement too often, to reserve it as a certain strategic administrative resource which should not be misused for the sake of political stability in the country. However, in 2005 the federal center has used this instrument vigorously:
- overall, 44 governors in 43 regions were appointed according to the new procedure (in Tyumen oblast, the governor was appointed twice, as Mr. S. Sobyanin was appointed the Head of the presidential Administration);
- as many as 7 governors have failed to be re-appointed for the new term;
- finally, 1 governor was dismissed.
There exist two major reasons for "electing" governors nearly in a half of the RF Subjects according to the new arrangement. First, some 80% of the newly appointed governors were heads of the executive power of the respective subjects that had been elected prior to the political reform and they raised the "matter of confidence" before the RF President. Confidence was granted to them and they continued to exercise their duties, but already as appointed, rather than elected, governors. This trend can be recognized as tentatively positive, for a high proportion of governors adjudicated by the federal center increases stability of the regional political system. Second, a relatively great number of governors who have failed to be re-appointed or who were dismissed can be attributed to the specificity of the President's cadres policy - appointments are made by cadres packages. This allows assumption that in the future the federal center will be pursuing a sound cadres policy in the regions, avoiding mess, but not feeling awkward to dismiss disobedient or notoriously inefficient regional heads.
We suggested that the noted decisions with regard to modification of the election arrangement of heads of the executive power in the RF Subject appeared consequent upon the experiment with the introduction of the institution of presidential envoys in the federal okrugs, whose positive outcomes had been fairly modest vis-à-vis original expectations. However, the suggestion has been inaccurate so far, for 2005 saw no change in the envoys' status, despite an obvious need for such modifications. First of all, the new status of the supreme authorities of the RF Subjects is determined by a greater level of legitimacy compared with the presidential envoys, for the former are appointed de-facto by the RF President and the respective legislature, while the latter only by the RF President. Whereas the granting of the supreme regional authorities with powers is made by the RF President's initiative, they essentially become his representatives in the regions. This inevitably generates a legal dualism and parallelism and duplication of their and the envoys' powers. It means that a substantial adjustment of the envoys institution in the federal okrugs will be required over time, otherwise the envoys would soon turn into "halved" representatives. In all likelihood, they would be given a role of supervisors over governors' actions.
The new governor election arrangement does not appear a self-sufficient measure and it will require new steps to intensify control over activities of the heads of the executive power of the RF Subjects. A consistent implementation of these measures will lead to an eventual emergence of the Russian national model of federalism discussed above. The system can be conditionally labeled as a corporate-commanding federalism. To ensure its more or less efficient functioning, it will greatly necessitate a system of the federal center's control over the governor's economic activity, as it is the federal center that holds politically responsible for the socio-economic situation in the territories under the new election arrangement.
2. Attempts to create a methodology of assessment of governors' activities in 2005. The year 2005 proved our assumptions31 that in the event of a modification of the governor elections procedures the federal center would be compelled to search for new instruments that would be based upon enforcement and hierarchic control over the inter-budgetary regulation mechanism. During the year the presidential Administration, the Task
31 See: "Russian Economy in 2004. Trends and Outlooks." Issue 26. M., IET, 2005.
Force led Mr. D. Kozak, by the presidential envoy in the Southern federal okrug, the RF Ministry of Finance, and some other government bodies have been attempting to formulate criteria of assessment of governors' activities and a methodology of monitoring of their meeting the criteria. It has become possible now to single out three interim outputs of the work:
1. The RF Ministry of Finance has designed Procedures of carrying out the monitoring of the RF Subjects' compliance with requirements of the Budget Code of RF32. The distinctive feature of the order became an attempt to assess the RF Subjects' compliance with requirements of the Budget Code and the quality of management of their budgets on the basis of biases from the pre-set by the federal center parameters. While as far as the control over compliance with the Budget Code requirements is concerned, such criteria are evident and the need in control over them does not raise any doubts, the suggested procedures with regard to assessment of th quality of management of the RF Subject's budget appears fairly disputable.
According to the noted Order, the respective monitoring is to be carried out every quarter by the Department of Interbudgetary Relations along two avenues - that is, compliance with requirements of the Budget Code of RF and conditions of the quality of management of the RF Subjects' budgets.
Compliance with requirements of the Budget Code of RF comprises meeting the following criteria:
BC1 - the marginal amount of the public debt of a given RF Subject may not exceed the volume of revenues of the budget of the RF Subject, without regard to financial assistance from budgets of other levels of the budgetary system of RF;
BC2 - the marginal amount of deficit of the budget of the RF Subject without account to proceeds from sales of property may not exceed 15% of the volume of revenues of the RF Subject's budget, without regard to financial assistance from the federal budget33;
BC3 - the maximum ratio of current expenditures of the RF Subject's budget to the volume of its budget revenues (the current expenditures of the RF Subject's budget may not exceed the volume of its budget revenues);
BC4 - the marginal volume of expenditures on servicing the public debt may not exceed 15% of the volume of expenditures of the RF Subject's budget;
BC5 - conditions of labor compensations payable to civil servants in the RF Subject (for the RF Subjects that receive subsidies on equalization of the level of budgetary sufficiency the amount of labor compensations payable to civil servants may not exceed amounts of labor compensations set for the respective categories of civil servants of the federal level).
Conditions of the quality of management of budgets of the RF Subjects are assessed by 11 parameters:
QM1 - execution of the budget by revenues (without account of free receipts from other budgets of the budgetary system) as per cent of the originally approved value shall exceed 95%.
The following three criteria are related to a given region's accounts payable and partly duplicate each other:
CM2 - accounts payable with regard to wages and salaries payments to budget employees. The criterion is computed according to the formula:
QM2i = Ai * 12 / Bi,
32 See : The RF Minfin Order № 98 of 11 May 2005.
33 See: Art. 92 of the Budget Code of RF.
Where
QM2i - the value of the indicator by the RF Subject;
Ai - accounts payable on salaries and wages payments by the RF Subject, as of the end of the reporting period;
Bi - the annual volume of expenditures on paying salaries and wages from the budget of the RF Subject approved by its budget statute.
The value of QM1 may not exceed 1;
QM3 - accounts payable on taxes on labor compensations; it is computed by analogue to QM 2 and partly duplicates it, as the region that experiences problems with wage debts is most likely to be as well in an unfavorable situation with regard to taxes on wages;
QM4 - accounts payable on payments for communal services by budget institutions; it is computed by analogue to the previous two kinds of accounts payable;
QM5 - the set level of the population's payments for housing and communal services shall equal or exceed 95%;
QM6 - the actual level of the population's payments for housing and communal services shall equal or exceed 85%;
QM7 - the maximum affordable share of the citizens' own expenses on payments for housing and communal services in the household's aggregate income. Strangely, according to the methodology, the value of K7 shall be equal to or exceed 21%, while the Housing Code requires that the maximum affordable share of citizens' own expenses on housing and communal services in the household's aggregate income may note exceed 22%, while regional authorities can lower the value at their discretion. We believe QM7 not only mismatch requirements of the RF law, but fails to characterize the quality of management of the RF Subjects' budgets. This criterion can be excluded from the methodology without affecting its comprehensiveness;
QM8- the electricity tariff for industry to the electricity tariff for the population (across the region) ratio shall not exceed 1.35;
QM9 - the heating power tariff for industry to the heating power tariff for the population (across the region) ratio shall not exceed 1.35;
QM10 - the level of repayment of subsidies due to the population for housing and communal services payments shall be over 90%;
QM11 - the amount of outstanding (unregulated) debt on debt obligations of the RF Subject shall be absent. The formulation of this criterion can be questioned, for it is not just the fact of the presence of an outstanding debt, but its volume that matters. According to the current procedures regions that have an outstanding debt of 1 Rb. and 1 bn. Rb. will be recognized as equal abusers of the QM 11 requirement.
While in the first case economic and social consequences of such an outstanding debt do not require the federal center's interference, the other case demands for an immediate and full-scale action of all the tiers of government. This can be proved by the data on outstanding accounts payable of the RF Subject as of January 1, 200534. According to the data, the outstanding accounts payable of Tver oblast was Rb. 1,000, while that of Kamchatka oblast - Rb. 3.58 bn. Despite the fact that in the first case that was a "regrettable confusion" and a "budgetary catastrophe" in the other case, both regions are recognized as absuesrs of the aforementioned procedures. In conjunction with this, the current formulation of the QM11 criterion appears poorly informative, as far as managerial decision- making on the federal level is concerned.
34 Source: the RF Ministry of Finance.
The year 2005 saw the first attempt to conduct a monitoring, according to the MinFin procedures (Table 19).
Table 19
Results of the Monitoring of the Compliance by the RF Subjects with Requirements of the Budget Code of RF and the Quality of management of Budgets of the RF Subjects, as of January 1, 2005
Criteria of monitoring Compliance with the Budget Code (BC) The score of quality of management of budgets of the RF Subjects (QM) Total
1 2 3 4 5 1 2 3 4 5 6 7 8 9 10 11
The number of the Subjects with the respective abuses 5 2 6 0 58 18 0 3 9 67 80 19 57 35 28 43 88
Abuses, total 71 359 430
Source: The RF Ministry of Finance.
As evidenced by the data of Table 19, the greatest number of abuses (83%) falls on the mismatch between the Subjects' performance and criteria of assessment of the quality of their budgetary management. As concerns abuses of the Budget Code requirements, the only considerable one is an excess of the amount of labor compensations due to civil servants in the RF Subjects that receive subsidies on equalization of their budgetary sufficiency level and amounts of labor compensations set for the respective categories of the federal-level civil servants - 13% of the total number of abuses.
The most widespread abuses fall on the quality of management of the RF Subjects' budgets:
- the actual level of the populations' payments for the housing and communal services in 80 regions is under 85% - 19% of abuses;
- the set level of the populations' payments for the housing and communal services is under 95% in 67 regions - 16% of abuses;
- the electricity tariff for the industrial sector to electricity tariff for the population (across a given region) ratio is over 1.35 in 57 regions - 13% of abuses.
Overall, regions have had 5 abuses of the set requirements on average. The only region that had none was the Republic of Khakassia, wile other regions had between one to ten abuses. Hence, the question is, how should one apply the results? Does they mean that all Russian governors, except for that of Khakassia, should be replaced? Or should one undertake any measures to improve the sitiations in the regions with the number of abuses over the average nationwide one? Obviously, in the absence of an assessment of the degree to which a given criterion has been abused, assessment of significance of the criterion and ambiguity of the selection of the criteria, the RF MinFin's procedures of monitoring of the RF Subjects' financial state is poorly applicable.
2. In late 2005, the RF MinFin conducted a comparative evaluation of performance by 9 Subjects of RF by 13 blocs:
1) Economy.
2) Debt burden.
3) Compliance with the Budget Code.
4) Management of the expenditure mandate.
5) Financial policy and relations with lower-tier budgets.
6) Budgeting and expenditure management reform.
7) Result-oriented budgeting.
8) Administrative reform.
9) Th public sector reform.
10) Improvement of the investment system.
11) Creation of conditions of the tax base development.
12) Improvement of the debt policy.
13) Improvement of interbudgetary relations.
Each bloc comprises several indicators, with every indicator being given a certain weight. The sum of all weights in a given bloc shows the significance of the bloc.
Without a detailed analysis of the quality of the methodology, it is possible to note a systemic defect of practically any methodology the federal center creates to evaluate the subfederal authorities' performance. The mission of the latter is to deliver a certain set of necessary public goods at a certain cost in the form of taxes for the sake of maximization of the public function of usefulness of citizens in the territory. By contrast, all the methodologies the federal center designs will take into account, intentionally or incidentally, its interests in regions.
Thus, the avenues the federal center selected as priority ones have become critical or its assessment of subfederal authorities. For example, the federal center is keen on the regions' debt policies, as it affects the aggregate volume of the public debt and stability of regional finance. That is why the weight of the two blocs that concern the debt policy accounts for 24%. The federal center considers it important to have regions honor the Budget Code requirements, pursue result-oriented budgeting, be less dependent on the federal financial assistance, etc. Hence, the 41% weight of the budgetary policy. By contrast, the indicators that have no immediate relation to the RF MinFin's operations in regional terms - that is, economic growth, local employment rate, investment, etc. - are either absent in the methodology, or their weight is little (the "Economy" bloc weighs a meager 3%).
2. The third attempt to design criteria of assessment of governors' performance and a methodology of matching the criteria became proposals by the task Force led by Mr. D. Kozak, the presidential envoy in the Southern Federal okrug. The Task Force has submitted to the presidential Administration a bill that contained strict criteria of assessment of the governors' performance. The bill is aimed at tightening control over governors' activities and provides for restriction of powers exercised by heads of subsidize regions. Thus, along with submission of the budget bill to the regional parliament, the governor will have to provide projections of the dynamics of the region's development by 30 criteria and report on the performance by the end of the year. Basing on that, President and his envoys will make a decision to keep, or dismiss him. In addition, should the regional budget for two straight years be formed at more than a half by transfers from the federal center, the Federal Treasury will assume control over its expenditures. Given the above conditions, the share of transfers from the federal budget accounts for 80%, or the region has accumulated a debt before the federal center that would exceed 30% of its own revenues, it is proposed to introduce a temporary financial administration, like it has been done now in Chechnya. Governors may refuse the introduction of the external management, but they will consequently have to refuse federal subsidies as well. Plus, they will be prohibited to establish any off-budget funds, which currently constitute a legal from of extraction of money from local businesses. The governors should be assessed according to the following criteria: 1. The annual rate of change in GRP. 2. The volume of GRP per capita. 3. To what degree the regional budget is subsidized. 4. The volume of investment in fixed assets per local resident. 5. The rate of change in the volume of collection to the federal budget of taxes
and levies per local resident. 6. The rate of change in areas of land in the agricultural turnover. 7. The rate of change of the volume of collection of revenues from the use of the region's property. 8. The rate of change of the length of general- use blacktop roads with of inter-municipal significance . 9. The rate of change in the proportion of loss-making public unitary enterprises owned by the region. 10. The volume of the outstanding debt of the region's budget to the revenue volume ratio. 11. The pace of change of real monetary incomes of local residents. 12. The correlation between the local residents' average pre capita incomes and the subsistence level. 13. The pace of change of the size of budget employees' salaries funded from the regional budget. 14. The housing area average per capita. 15. The level of unemployment. 16. The number of jobs created. 17. The decline rate of wage arrears. 18. The migration increment (loss). 19. The pace of change in the volume of small businesses' output. 20. The retail trade turnover. 21. The pace of change in the number of economic partnerships and companies, and self-employed individuals. 22. The average life expectancy rate 23. The birth and mortality rates. 24. The natural rise (decline) of the populace. 25. The mortality at birth rate. 26. The average length of the local residents' stay at stationary therapeutic and rehabilitation institutions. 27. The correlation between the number of senior citizens provided with all kinds of in-house social services and the number of those in need for such services. 28. The proportional weight of children aged 7 to 15 educated at the general education institutions in the total number of children of this particular age category. 29. The proportional weight of students at general education institutions and those of primary and secondary vocational training that study in the "second shift". 30. The annual crime decline rate in the sphere of public administration committed by local civil servants.
Despite quite a broad array of criteria of assessment of the governors' performance, this methodology also suffers from certain drawbacks that take their roots in a universal approach to regions. Thus, for example, in a region with a low crime rate in the sphere of public administration will find it hard to ensure a high rate of decline in the index, while its possible insignificant rise may also become absolutely non-representative, as far as cadres decisions on the region's leadership are concerned. As concerns regions that enjoy certain favorable indicators, it will be hard to ensure their further rise. Rather, the indicators would fluctuate around a certain level, the change of which would require an improvement of the situation nationwide. Hence, the application of the suggested criteria may result in unjust scores to regions.
In conclusion, it is possible to suggest that:
1. The abolition of elections of heads of the RF Subjects has challenged the federal center with a hard task of formalization of the process of assessment of the governors' performance.
2. All the currently available methodologies suffer from certain defects. Their common defect is that they describe an etalon of the governor's behavior from the perspective of the federal center, rather than local residents. Time will show how significant this defect is.
3. The question remains unanswered as to whether it is possible to realize even an ideal methodology, as it is associated with two hardly resolvable problems:
a) the problem of informational distortion. The governor enjoys considerable possibilities to distort information on the basis of which the federal center will assess his performance. There arises the need in creation of a data collection system independent of heads of the RF Subjects.
b) The problem of political choice between the governor's loyalty and his political weight, on the one hand, and the degree to which his performance meets the federal center's criteria, on the other. Hence, an inevitable question as to what if a politically and/or loyal to the federal center governor failed to match the criteria, what would the federal center do? Will it change its assessment criteria, grant the region with additional financial resources to make it match the criteria, or would it keep its eyes shut, or, would it take the risk of political instability and dismiss the governor? This is the most difficult question in today's Russia.
Consolidation of regions. Yet another significant political result of 2005 that affected interbudgetary relations and subnational finance became an intensifying process of consolidation of regions. In the aftermath of the consolidation of Komi-Permyatsky autonomous okrug and Perm oblast in 2003 the 2005 consolidation processes embraced Krasnoyarsk krai, Taymyr and Evenk autonomous okrugs; kamchatka oblast and Koryak-sky autonomous okrug; as well, discussions on consolidation of some other regions have been under way.
There exist several reasons in favor of enlargement of Russian regions:
1. a consolidation will result in a lower economic polarization. For instance, should Krasnoyarsk krai (whose budgetary sufficiency is greater than the average nationwide one) "merge" with two autonomous okrugs whose budgetary sufficiency level is lower than nationwide, there would appear a single region with the budgetary sufficiency still greater than the average one nationwide. This would enable the federal center to spent far less resources on equalization of budget sufficiency and socio-economic development levels of regions;
2. the consolidation of regions will result in diversification of their economies and regional budgets being less vulnerable to non-economic shocks. A greater sustainability of regional budgets and the regional economy on the whole would enable the federal center not to spend financial resources on stabilization of the regional finance, which appears extremely important in the light of the absence in today's Russia of efficient transfer instruments of stabilization of regional budget revenues;
3. Consolidation of regions would allow abandonment from the non-rational administrative-territorial division of the country by the national principle. The division had been caused by the national policy of the USSR and it did not provide for independent sub-federal bodies of powers that would be able to most efficiently satisfy the need of citizens residing within a given territory in public goods and services. Furthermore, such a division of the country appears extremely dangerous from the perspective of political stability;
4. Larger administrative-territorial entities will enjoy economies of scale, at least, with respect to administrative costs;
5. Larger and richer regions, as a rule, secure a greater degree of financial independence for local self-governance35. In any case, they have far greeter opportunities for that and they are more keen to establish bodies of power within the closest local citizens' reach.
Meanwhile, in Russia the consolidation of regions can bear quite evident drawbacks associated with the fact that the process is artificially promoted by the federal center. To highlight on this, suffice it to cite a few facts that prove that such a consolidation is extremely desirable for the federal center and it is ready to pay the respective costs:
35 See: Paying for Cities. The Search for Sustainable Municipal Revenues, Institute for Public Economics. Western Studies in Economic Policy No. 9, 2003.
1. In 2005, Krasnoyarsk krai received Rb. 2.2 bn. in subsidies to get its budget balanced, while there was no clear evidence of deterioration of its financial situation that year.
2. In 2006, the Krai should receive the respective subsidies worth a total Rb. 140 mn., while Art. 44 of the 2006 federal budget law reads that its budget will receive a 2bn. worth subsidy.
3. It would be logical, while allocating certain financial resources to Krasnoyarsk krai to avoid possible budget imbalances, because of its consolidation with two autonomous okrugs, to discontinue allocating subsidies on equalization of the okrugs' budget sufficiency levels36. That has not happened in 2006, and Taymyr and Evenk autonomous okrugs have received Rb. 1.8 and 1.2 bn., respectively, in subsidies from FFFSR.
4. In 2005, President Putin signed Decree № 1227 of October 21, 2005 " On measures on socio-economic development of Kamchatka oblast and Koryak autonomous okrug" and Decree № 412 of April 12, 2005, "On measures on socio-economic development of Krasnoyarsk krai, Taymyr (Dolgano-Nenetsky) autonomous okrug and Evenk autonomous okrug". In compliance with the Decrees, it is planned:
for Kamchatka oblast and Koryaksky autonomous okrug:
- to provide the government support to construction of local heating and electricity plants of small capacity in the village of Tilichki and urban-type settlement Palana (to be put in operation in 2006), in the village of Manily, village of Tigil and settlement Ossora (to be placed in operation in 2008), as well as to formation of the infrastructure to ensure the supply of local coal;
- to provide the government support to carrying out emergency works on restoration of electricity networks in settlements of Koryaksky autonomous okrug;
- to construct a highway Milkovo-Klyuchi-Ust-Kamchatsk;
- to construct runways and an airport in the urban-type settlement Palana;
- to complete the reconstruction of a sea station in the city of Petropavlovsk-Kamchatsky;
- to supply the public unitary enterprise "Koryaksky aviapredpriatie" with aircraft for the purpose of organization of air passenger transportation in remote and hardly accessible localities using local air ways;
- to provide the government support with respect to procurement of automobile transportation vehicles of increased cross-country ability for the purpose of developing an inter-settlement ground transportation system;
- to reinforce the seismic characteristics of objects of the social sphere in Kamchatka oblast;
- to remove citizens from the tumbledown housing fund;
for Krasnoyarsk krai, Taymyr and Evenk autonomous okrugs:
- to provide assistance to implementation in 2005-09 of an investment project on development of Vankor oil and gas deposit;
- to provide the government support to ensure the start of operation of Boguchanskyaya hydroelectric power station in 2010 and preparation of the reservoir zone for its flooding;
- to implement in 2005-10 a complex of measures on development of the transportation and social infrastructure of Krasnoyarsk krai, Taymyr (Dolgano-Nenetsky) autonomous okrug and Evenk autonomous okrug by providing for:
36 For example, as noted above, the 2006 computations of budget sufficiency of Arkhangelsk oblast included Nenetsky autonomous okrug and the 2006 funding of the Oblast from FFFSR was cut down drastically.
- reconstruction of runways of Emelyanovo airport (the city of Krasnoyarsk) (to be placed in operation in 2006) and Khatanga aiport (settlement of Khatanga (to be placed in operation in 2007);
- construction of the first stage of the detour around the city of Krasnoyarsk with a bridge passage across Yenisei (to be put in operation in 2009);
- construction of the first stage of the highway Kansk-Aban-Boguchany (208th-220th kilometer) (to be pout in operation in 2006);
- moving in 2005-10 from the Far-North areas and areas equaled to them the residents of taymyr (Dolgano-Nenetsky) autonomous okrug, Evenk autonomous okrug and Krasnoyarsk krai to whom housing subsidies are to be provided first of all.
According to the noted Decrees, the RF Government is bound to allocate, as per the set procedures, resources to finance the noted measures in the course of formation of the 2006 federal budget and those of next years.
Basing on the above data, it is possible to conclude that the federal center vigorously intervenes with the process of consolidation of regions. This may entail certain unfavorable economic effects. It would be desirable to have a "bottom-up" consolidation instead, with citizens of Subjects of the Federation deciding that an administration of a consolidated administrative-territorial entity will better satisfy their needs. Once the process of consolidation is subsidized by the federal center, there arises eagerness to consolidation for consolidation, to attract the federal center's financial resources.
2.4. Financial Markets in Russia
2.4.1. National Debt Market
In 2005, the internal debt of the Russian Federation grew in volume by nearly 12.5% from Rb 756.8 billion up to Rb 851,2 billion ( in terms of GDP, the national debt reduced from 4.45% to 3.93% of the GDP ).
Over the period between Q1, Q2 and Q3 of 2005, the external debt of the Russian Federation ( government authorities and monetary control authorities ) reduced from $105.6 billion to $81.4 billion US dollars ( according to the data of the Central Bank of Russia ). Thus the absolute value of the external debt of the Russian Federation reduced by 22.9%. Two Eurobonds issues were redeemed in March and July 2005. At the same time, the private sector increased its debt to non-residents from $108.9 billion to $146,9 billion US dollars ( +34.9% ) over the same period. Thus the external debt of the Russian Federation grew from $214.5 billion to $248,3 billion US dollars in total within nine months in 2005.
Internal Debt
In 2005, a substantial reduction in average weighted yield of the traded issues was noted in the ruble government debt market. The average weighted yield reduced to reach 6.49% p. a. as opposed to 7.18% p. a. early in 2005, according to the data at closing on December 23, 2005. In some periods, especially in the first half of the year, the reduction in yield was accompanied by high volatility within the range of 6.41% an 8.02% p. a., while it changed within 6.29% and 7.55% p. a. in the second half of the year. A special emphasis should be placed on the fact that in 2005 the parameters of investment activity remained almost the same as those in 2004. The total trading volume of GKO/ OFZ bonds was about Rb 345,06 billion in 2005 as opposed to Rb 350.8 billion in 2004 .
Table 20
Russian Federation's Internal Debt Structure (Rb, billion)
Type of securities As of 01.01.2005 As of 01.01.2006
GKO 0.02 0.02
OFZ— PK 0.001 0.001
OFZ - PD 43.31 123.64
OFZ - FK 171.22 131.13
OFZ - AD 542.24 596.33
ORVVZ1992 0.03 0.03
OGSZ 0.0002 -
Total 756.82 851.15
Source : the Ministry of Finance of Russia.
In spite of small decrease in the total trading volume, the average weekly parameters grew to Rb 6.9 billion in 2005 as opposed to Rb 6.74 billion in 2004. The maximum weekly trading volume reached nearly Rb 24,2 billion in 2005 ( as opposed to nearly Rb 35,87 billion in 2004 ), while the minimum was nearly Rb 1 billion ( as opposed to nearly Rb 350 million in 2004 ). Thus, in 2005, the maximum trading volume parameter fell considerably against the growth in the minimal weekly trading volume parameter in the market of government bonds denominated in rubles.
Source : Finmarket Asset Management Company, estimates made by the authors.
Fig. 21. Market Movements for GKO/ OFZ bonds in 2005
In analyzing the annual market movement, it should be noted that market quotations periodically moved up and down throughout the year. The yield of the government bonds fell slightly early in the year. The level of liquidity in the banking sector was high enough to
be able to support the market. In addition, Standard & Poor's, one of the leading credit rating agencies, upgraded the sovereign credit rating of Russia up to the investment rating, which, according to comments, was governed by a favorable situation with external liquidity and state finances. Furthermore, early repayment of $3.3 billion US dollars as part of the Russian debt due to the IMF also stimulated investment demand for Russian bonds. However, still high level of political risks discouraged buying of these bonds in substantial volumes. The market was slightly effected by a statement made by the Ministry of Finance of Russia regarding a domestic borrowing program for 2005 which provides for some growth in securities offer as opposed to the figures reported in 2004 (net borrowing to the amount of nearly Rb 125 billion as opposed to Rb 96 billion in the previous year). The situation deteriorated in February. First, investment activity still remained low as evidenced by a 1.7 fall in trading volumes in the secondary market as compared to the average monthly figures in. The market was adversely affected by the outcomes of the negotiations between Russia and the representatives of the Paris Club of Creditors. Not only did they refuse to discount the debt which was anticipated to be repaid early, but also demanded a premium for early repayment of its part.
In the period between March and May, the market was dominated by a slow upward trend in yield which gave way to correction sometimes. It is late in May that the average weighted weekly yield reached its highest peak in 2005, 8.02% p. a. In March, the market liquidity still remained at an acceptable level, which prevented quotations from significant fall. The situation with liquidity slightly deteriorated as early as at the end of the month, when trading participants needed additional funds to pay taxes. In April, market quotations of most of issues showed an upward correction resulted in some reduction in yield. The market was positively effected excessive banking liquidity denominated in rubles, relatively stable foreign exchange of the Ruble, and favorable market situation in the sector of Russian bonds due to expectations of Russia's early repayment of its debt to the Paris Club of Creditors. The market positively responded to the statement of the representative of the Central Bank of Russia saying that the monetary authorities are ready to allow the Ruble to gain more than it was planned ( 8% per year ) in order to attain the target inflation rates of 8.5% to 10%. Expectations of high inflation rates, as well as volumes of primary placements of government and non-government bonds restrained the demand for second market securities. In May, price fluctuations were insignificant, while quotations fell slightly in general. Favorable market situation with Russian Eurobonds which grew steadily throughout the entire month, was the only positive factor which supported the internal debt market. In May, on the contrary, the market was further affected by adverse factors. It should be noted that growing expectations of devaluation and inflation in the market, as well as significant deterioration of the situation with liquidity in the banking sector ( MIBOR ( Moscow Interbank Offer Rates ) grew from 2% to 8% p. a. per month on average ) constrained the investors' demand for bonds.
The period between June and late in September 2005 is the second one to be focused on in terms of price movement of Russian government bonds. The average weighted market yield, as well as its volatility, reduced significantly from the maximum annual figure late in May to 6.29% p. a. late in September. While the growth in yield was always followed by fall in the period between June and July, as seen in Fig. 21, quotations were falling almost evenly throughout the period between August and September.
In June, investors were adversely affected by the factors similar to those in the previous month, namely losing ruble exchange rate against other currencies in the domestic market, declining liquidity in the banking sector due to tax payments, and considerably large volumes of primary placements, as well as growing inflation expectations caused by
actual inflation rate that exceeded the estimated one in the budget. Under the lack of attractiveness in the secondary market, investors focused on primary actions, where premiums were anticipated. In June, long-term bonds started to grow in price, while prices of short-term securities varied within a great range. However, investment activity remained poor due to a holiday season. Liquidity was limited, official data on inflation rates evidenced inflation growth in the economy, which inevitably reflected on investors expecting higher rates of inflation. However, the adverse factors that affected the market were limited under a very low level of investment activity.
In August, the yield continued to fall. In spite of the fact that it is typical of the Russian financial market to fall to the lowest levels in all segments in August, the monthly trading volume reached its maximum peaks in the previous 2005 period. Such a significant improvement in the market situation resulted from general growth in the demand for the instruments denominated in rubles under the conditions when the Ruble is gaining vs. the US dollar, early repayment of a part of the Russian Federation's debt due to the Paris Club of Creditors, as well as Fitch upgraded sovereign credit rating on Russia. In September, the news was more positive in general. Early in the month, Moody's published a statement that it anticipated to revise Russia's sovereign credit rating for upgrading. The experts of the agency noted that the Russian Federation continued to improve its creditworthiness not only by building up its gold and foreign exchange reserves and revenues generated from raw materials price rise, but also prudent financial management and active debt service management. A combination of substantial amount of rubles in the market and high oil prices resulted in growing interest in government bonds and falling yield of a series of issues to their hysterical minimum levels, while the demand exceeded several times the offer in primary market.
Throughout the Q4 of 2005, quotations of the bonds denominated in rubles consolidated at the levels attained. Investors refrained from further purchases, since the yields rate attained by the end of September was not attractive enough for active purchases. This was reasonable given other market factors: growth of inflationary expectations and unstable foreign exchange market interfered with the growth. Moody's upgrade of the Russian sovereign credit rating one step up to Baa2 was a fundamentally important event for the market, but it did not came as a surprise for investors and thus had no actual significant impact on the market. Other rating agencies, however, were in no haste to upgrade Russian credit rating. According to the statement made by Standard & Poor's, the government of the Russian Federation takes no advantage of high oil prices to implement structural reforms: "In relative terms the situation with reforms is more like getting worse, and this is the main reason for the Russian credit rating remaining at the current level".
In November, the demand for government bonds was stable, but not heavy enough. In spite of the gaining US dollar and extremely unfavorable situation with cash liquidity, investors restrained from active sales. At the same time, the demand in the primary market was poor, and the bonds were placed with premium to the second market. It should be noted, however, that the government managed to take under control the initially unfavorable situation with inflation which had a certain effect on the market of debts denominated in rubles. This was attained by way of artificial "freezing" of motor gasoline prices and regulating rates of the municipal housing economy (public utilities). Upward trend in government bonds quotations remained weak throughout the last month of 2005. Domestic news remained positive in general thus supporting the demand for the assets denominated in rubles. The macroeconomic statistics testified of fall of inflation rates and growth, even faster that it was anticipated, in economic rates in the Russian Federation. The fact that Standard & Poor's upgraded the Russian Federation's sovereign credit rating from BBB-104
to BBB also provided a certain support to quotations. In December, however, a share of funds of the government debt market was spent on corporate bonds, whose primary offering was good enough in December. Hence the average weighted yield fell insignificantly to amount to 6.5% p. in the market of debt denominated in rubles under the influence of the foregoing factors by the end of 2005.
During 2005, the Ministry of Finance of Russia held successfully 20 auctions on placement of GKO/ OFZ bonds to the amount of nearly Rb 165.7 billion, which is slightly smaller than that in 2004. The actual volume of placement amounted to Rb 116.6 billion. The yield at the average weighted price varied from 6.22% to 8.85% p. a. at the auctions. As of December 30, 2005, the volume of GKO/ OFZ bonds market amounted to Rb 721.57 billion at par value and Rb 724.62 billion at market value. Duration of the GKO/ OFZ market portfolio was 1892.63 days.
External Debt
According to the outcomes in 2005, there was an upward trend for some bonds and downward trend for the others in the market of bonds denominated in foreign currency. In particular, as of the end of December, 2005, the yield of the fifth tranche MinFin Bonds amounted to 5.27% p. a. (as opposed to 5.24% early in the year) and the sixth tranche 6 MinFin Bonds - 4.71% p. a. (as opposed to 4.35% early in the year ). During the year, however, the yield of RUS-30 and RUS-28 bonds varied within the rage between 6.77% and 7.35% to 5.50% and 6.08% p. a., yield to maturity of RUS-07 bond amounted to nearly 5.0% p. a. ( as opposed to 4.72% early in the year ), while RUS-18 bonds were traded at prices corresponding to the yield of 5.67% p. a. ( as opposed to 7.21% early in the year ).
Several most significant positive factors regarding the movement in the Eurobonds market can be highlighted. The first one is extremely favorable conditions in the world oil and metal markets, as well as stable macroeconomic situation in the country. The second factor is the early repayment of a share of the Russia's sovereign debt ( $15 billion US dollars) due to the Paris Club of Creditors. The third factor: it is essential that Standard & Poor's upgraded the Russia's credit rating up to BBB, as well as Fitch upgraded the Russia's sovereign credit rating to BBB. The key adverse factor for the market throughout the year was the movement of the yield of the US Treasury Bonds which was influenced by periodical increases of the discount rate by the US Federal Reserve System, as well as the growth in inflationary processes in the US economy.
Source : Finmarket Asset Management Company.
Fig. 22. MinFin Bonds Yield to Maturity in 2005
Several periods in the movement of quotations should be highlighted. Quotations grew throughout the first month and the first half of the second month of 2005, but since the mid February the upward movement gave way to downfall, as a result the yield of most series reached the maximum annual peaks by the end of March. In January, the market situation was fairly favorable. Quotations of Eurobonds grew as the yield of the US Treasury Bonds declined. The news on the likelihood of early repayment of a share of the Russia's debt due to the Paris Club of Creditors was essential for the market. However, the negotiations between the parties held in January resulted in disagreement on this issue, mainly because of the amount of the discount which Russia would expect for the early repayment. The news on that Lehman Brothers investment bank was considering an option of accepting the Russian Federation's Eurobonds into the listing of bonds traded under its index, which is taken into account in developing strategies by major foreign funds, was fairly positive. In February, prices ceased to grow, and quotations changed insignificantly. The market was supported by rising world oil prices, while their stabilization and even fall was caused by the decision of the Paris Club of Creditors which not only refused to discount the debt but also demanded a premium to be paid for early repayment.
The world debt market was influenced by several developments, in particular, investment activity in the market of Russian Eurobonds at the end of February, as well as a February statement of the head of the US Federal Reserve System A. Greenspan, who stressed the need to further increase the basic interest rate. As early as in March, a 2.75% increase in the discount rate of the US Federal Reserve System provoked active sales of Russian Eurobonds, which resulted in substantial growth in yield. Increasing inflationary expectations on the ground of official statistics should be highlighted among the domestic factors that led to aggravation of the market conditions in March. Consumer prices grew by 5.3% by the end of Q1 as opposed to 10% of the annual forecast.
7.5% 7.0%
6.5% 6.0% 5.5% 5.0% 4.5% 4.0% 3.5%
Source : Finmarket Asset Management Company.
Fig. 23. Russian Eurobonds Yield to Maturity due 2030, 2018 and 2007, in 2005
The fall of quotations that took place throughout the entire March, stopped in April to give way to an upward trend which lasted till the beginning of September. The favorable market conditions over the period under review were governed by a series of external and internal factors. First, the market participants were watching carefully the negotiations on early repayment of a share of the Russia's debt due to the Paris Club of Creditors. As a result, the information available on certain developments concerning this issue and subsequently the fact of an agreement on the likelihood to repay $15 billion US dollars at par value supported the interest of investors in Russian bonds denominated in foreign currency. Second, in spite of the fact that an increase in the discount rate by the US Federal Reserve was initially a negative factor for the debt market, it had no significant adverse impact on prices in the period between April and August. The level of interest rate over this period was gradually increased up to 3.5%, but any increase was expectable, i.e. included in prices long before the relevant decisions were made. In addition, while the comments made by the US Federal Reserve System in April - June regarding its intention to further gradually increase interest rates, the US monetary authorities noted the likelihood of recession in the US economy and that it could be possible to pause the interest rate increase after publication of negative macroeconomic statistics and a hurricane in the Gulf of Mexico in August. As a result, the US market responded by price rise, which automatically improved the market conditions in the Russian Eurobond market as well. It should be noted that the Russian market became less dependant on price movement of the US debt securities throughout the period between April and August 2005. So, Russian Eurobonds grew as the yield of US Treasury Bonds declined, while they showed no clear movement or declined insignificantly as the later fell.
Third, investors also felt optimistic as they anticipated the Russian sovereign rating to be upgraded. In April, Fitch published comments which were favorable Russia by giving a high credit to Russia due to high oil prices. In June, Moody's upgraded credit rating on Gazprom and some other Russian companies, whose rating was higher than that of the Russian Federation, which was interpreted by investors as the likelihood of upcoming upgrade for Russia, and consequently had a positive effect on quotations.
There were several negative factors which should be highlighted in this period, namely General Motors and Ford were downgraded to junk status, which resulted in mass sales of corporate bonds in the United States and could be considered a potential threat to the debt markets. However, these events had no serious effect on the movement of the Russian segment of Eurobonds. In July, the debt markets were effected by China's transition to a floating exchange rate of its national currency Yuan within a corridor instead of pursuing the fixed exchange rate policy. The US market responded by a downward trend, because any significant gain of Asian countries' currencies is likely to lessen their demand for US debt instruments.
In September, the movement of quotations of various instruments was quite different. While during the month the yield of MinFin Bonds consolidated with a weak upward trend, the yield of Eurobonds continued to fall. The market was supported by high oil prices in the world market, as well as a statement of President Putin who highlighted "a good positive strengthening of the economy" and provided a forecast of at least 5.9% for the GDP on the basis of the outcomes of 2005. At the same time, the investment demand for Russian bonds denominated in foreign currency was adversely affected by yield growth of the US debt securities after a new increase of 3.75% p. a. in the interest rate, as well as growing inflationary expectations in the United States.
The Russian market of bonds denominated in foreign currency was falling throughout the October and first half of November, which was governed mainly by the movement in the US government debt market which traditionally serves as a guidance for other developed and emerging markets. Most evident were risks of accelerating inflation in the United States, as well as planned increase in the US interest rate of up to 4.25% p. a. by the end of the year. In November, Russian securities were affected by a growth in the USD exchange rate both in the external and internal markets. On the one hand, the growth in USD exchange rate obviously was caused by a new increase in the interest rate of up to 4% p. a., as well as concern of government about growing inflation processes. Under a stable economic growth it meant that the US Federal Reserve System were very likely to further pursue the course aimed at increasing the value of borrowings. The similar effect was produced by an OECD statement which contained recommendations to keep on increasing the interest rate. Under a stable interest rate in the European community, such steps of the US Federal Reserve System promoted attractiveness of USD assets in terms of investment, which, on the one hand, stimulated the demand for US bonds and could have a favorable effect on the markets of other countries, but, on the other hand, could result in outflow of funds from emerging markets in a medium-term period, and thus a decline. Eventually, however, the former effect was found to be prevailing, which caused correction movement in the US market, and subsequently the Russian market, which continued until the end of November to result in some decline in the yield of traded instruments.
In December, quotations changed in opposite directions with a prevailing weak upward trend. The market was stabilized by mainly the news from the United States, where the interest rate reached the anticipated 4.25% p. a., while the comments made by the US Federal Reserve System evidenced some changes in the official position of the US monetary authorities. In particular, it followed from the document that any further increase in the 108
interest rate would depend largely on the nature of published macroeconomic statistics. Favorable US statistical data, which evidenced reduction in the inflation risk, had an additional positive effect on prices. There are several internal factors that should be highlighted, namely favorable statistical data on economy of the Russian Federation and, in particular, the readiness of the Russian government to early repay additional $12 billion US dollars to the Paris Club of Creditors in 2006. As a result, quotations of some series of Eurobonds declined by year end, while other series of bonds showed the yield equal to average annual figures or less at closing on December 23.
2.4.2. The Market for Subfederal and Municipal Borrowings The Dynamics of Market Development
According to the 2005results, the consolidated regional budget was executed with surplus of Rb 57.1 bn, i.e. 1.6% of its expenditure part, or 0.26% of GDP. Budgets of the Federation's Subjects were executed with a surplus of a. Rb 53.8 bn (2.3% of the expenditure part), while the municipal entities' budgets - with a surplus of Rb 9.4 bn (0.8% of the expenditure part).
In 2004, the consolidated regional budget was executed with a surplus of Rb 31.9 bn, i.e. 1.1% of its expenditure part, or 0.19% of GDP. The budgets of the Federation's Subjects were executed with a surplus of neraly Rb 28.7 bn (1.6% of the expenditure part), the municipal entities' budgets - with a surplus of Rb 2.2 bn (0.2% of the expenditure part). Meanwhile, the 2003 and 2002 consolidated regional budgets were executed with a deficit (Table 21).
Table 21
The Territorial Budgets' Surplus (Deficit) to Budgetary Expenditures (%) Ratio
Consolidated Regional Budget Regional Budgets Municipal Budgets
2005 1.6 2.3 -0.8
2004 1.1 1.6 0.2
2003 -2.6 -2.3 -3.2
2002 -2.7 -3.0 -2.8
Source: Author's calculations basing on the data of the Ministry of Finance of the RF.
As of January 1, 2006, the consolidated budget in was executed with surplus33 Subjects. An aggregate volume of the budget surplus in the regions made up Rb 1050.7 bn., or 5.4% of the amount of the revenue part of their budgets. The median value of the budget surplus made up 2.6% of the revenue part of the budget.
The greatest surplus to level of consolidated budget revenues ratio was reported by Tyumen oblast - 25.1%, Yamal-Nenetsky autonomous okrug - 8.3%, Khanty-Mansy autonomous okrug - 6.6%, Chechen Republic - 6.4%, Perm oblast - 5.1%. More than a half- that is, 59.3% of the aggregate surplus of the regional budget was secured by three Subjects of the Federation: Tyumen oblast 34.3%, or Rb 36.0 bn, Moscow - 18.6%, or Rb 19.5 bn and Khanty-Mansy autonomous okrug - 11.8%, or Rb 12.4 bn. The surplus of the consolidated budget of Yamal-Nenetsky autonomous okrug amounted to Rb 6.7 bn. A considerable level of surplus noted in budgets of the oil-producing regions can be explained primarily by a notable increase of export prices for energy sources.
In 2005, as many as 54 RF Subjects executed their consolidated budgets with deficit37, the aggregate volume of which made up Rb 48.0 bn, or 2.9% of the revenue part of the budgets in question.
The median value of the budget surplus made up 2.0% to revenues of the respective budget. The highest deficit to budget revenues ratio was noted in the Republic of Sakha (Yakutia) - 18.3% and Republic of Kalmykia - 11.3%.
Roughly as much as 50.3% of the aggregate deficit fell on 5 Federation's Subjects: the Republic of Sakha (Yakutia) - 26.5% ,or Rb 12.74 bn, Krasnoyarsk krai - 9.9%, or Rb 4.75 bn, Lipetsk oblast - 5.4%, or Rb 2.6 bn, Khabarovsk krai - 4.3%, or Rb 2.06 bn, Moscow oblast - 4.2% ,or Rb 2.01 bn (Table 24).
Change in the structure of the accumulated debt
In 2005, the value of the accumulated debt of the consolidated regional budget soared up to Rb 20163.43 mn., or by 0.09% GDP. The rise of the debt was fueled by the growth of the domestic debt (i.e. the debt denominated in rubles). The foreign debt of the consolidated regional budgets decreased by Rb 2168.8 mn., while the domestic debt grew by Rb 22332.2 mn (Table 22).
Table 22
Net Borrowings of Regional and Local Budgets (as % to GDP)
Year
1995 1996 1997
January-August
1998 cember 1998 1998
January-
De- 1999 2000 2001 2002 2003 2004 2005
Borrowings of
subfederal and local govern- 0.38 0.87 1.43 0.71 0.33 0.15 -0.29 -0.04 0.47 0.37 0.26 0.09
ment 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 -0.03
of other levels
Subfederal (mu- H.fl. 0.16 0.22 0.08 -0.01 -0.05 -0.27 -0.07 0.16 0.31 0.29 0.09
nicipal) bonds
Other borrowings 0.31 0.48 0.55 0.58 0.43 0.31 0.01 -0.02 0.19 0.6 0.03
Reduction in
balances of the 0.03 -0.18 0.09 0.02 -0.19 -0.30 -0.05 -0.04 -0.18 -0.62 -0.48
budget accounts
Financing of
deficit using
borrowings and cutting the bal- 0.38 0.9 1.25 0.8 0.35 -0.04 -0.59 -0.09 0.38 0.19 -0.36 -0.38
ances of the
budget accounts
Source: Author's calculations, basing on the data of the Ministry of Finance of the RF.
37 In the 2005reporton execution of the budgets of the Russian Federation's Subjects for published by the Ministry of Finance of Russia (Federal treasury) the data on Evenk autonomous okrug and Taymyr (Dolgano-Nenetsk) autonomous okrug are not singled out as separate items.
The structure of borrowings
The 2005 total volume of borrowings of the consolidated regional budget amounted to Rb 227153.92 mn, of which the external borrowings accounted for Rb 1 403.8 mn. The biggest domestic borrowers became Moscow - Rb 131.1 mn and Bashkortostan - Rb 1, 272.8 mn.
The aggregate volume of domestic borrowings made by regions and municipalities made up Rb 225750.08 mn. The list of the biggest borrowers on the domestic market was topped by: Moscow oblast - Rb 39.1 bn, followed by Novosibirsk oblast - Rb 26.0 bn, Moscow - Rb 21.4 bn, Krasnoyarsk krai - Rb 11.1 bn, Saint-Petersburg - Rb 9.8 bn, Niz-hny Novgorod oblast - Rb 9.7 bn, Khabarovsk krai - Rb 8.9 bn. When compared to 2004 the volume of borrowings in nominal terms decreased by Rb 31.9 bn or by 20.9% in real terms. The contraction of regions and municipalities' borrowings can be explained by a healthier state of their budgets, which enabled many of them to repay the accumulated loans from current budget revenues.
In the total volume of domestic borrowings of the consolidated regional budget the securities issuance accounted for 36.0%, loans from the federal budget - 1.2%, other borrowings (primarily banking credits) - 62.59%. It should be noted that according to the data of the Ministry of Finance of Russia, budgetary loans practically discontinued to play a significant part in the financing of municipal budgets deficits. They contracted for a year in the structure of municipalities' borrowings from 46.4% practically to 0. Meanwhile, the role of banking credits and papers rose. Thus, the share of papers in the volume of municipal administrations' borrowings increased 2.6 times, from 4.0 to 10.2%, while the share of other borrowings grew from 49.6 to 89.8%.
The continuous trend towards growth of securitization of the regions' debt was still there: the share of papers in the Federation's Subjects' borrowings in 2005 increased vis-à-vis the prior year by 4.5 percentage points - from 41.0 to 45.5%, Thus, over the last 2 years the level of securitization of the market for regional borrowings increased by more than one-third, while the market for domestic municipal borrowings - by more than 4 times (Table 23).
Table 23
The Structure of Domestic Borrowings of Subnational Budgets in 2003 (%)
2005 2004 2003
Consolidated Regional Budget Regional Municipal Budgets Budgets Consolidated Regional Budget Regional Budgets Municipal Budgets Consolidated Regional Budget Regional Budgets Municipal Budgets
Securities issuance 36.0 45.5 10.2 32.5 41 .0 4.0 26.9 33.8 2.5
Budgetary loans 1.2 1.6 0.03 3.0 4.0 46.4 7.9 10.6 48.9
Other borrowings 62.9 52.9 89.8 64.5 55.1 49.6 65.3 55.6 48.6
Source: Author's calculations based on the data of the Ministry of Finance of the RF.
The largest value of net borrowings to budget revenues ratio was demonstrated by: Astrakhan oblast - 8.2%, Khabarovsk krai - 7.9%, Moscow oblast - 6.5%, Kostroma oblast - 6.3%, Kamchatka oblast - 5.7%, Belgorod oblast - 5.3% (Table 24).
The largest net borrowers became: Moscow oblast - Rb 11.3 bn, Khabarovsk krai -Rb 3.2 bn, Krasnoyarsk krai - Rb 2.3 bn, Nizhny Novgorod oblast - Rb 1.7 bn, Saratov oblast - Rb 1.7 bn.
The following regions have succeeded in cutting down the accumulated debt to the greatest extent: Moscow - Rb 12.6 bn, Saint-Petersburg - Rb 1.5 bn, Chukotka autonomous okrug - Rb 992 million, Rostov oblast - Rb 758 million, Ulyanovsk oblast - Rb 641 million.
Execution of the RF Subjects' Consolidated Budgets
in 2005 (%)
Table 24
Budget revenues, (thou. rub.)
Budget surplus (deficit) (thou. rub.)
Surplus (deficit) to revenues ratio
Attracted borrowings to revenues ratio
Net borrowing to revenues ratio
Interest expenditures to revenues ratio
Net borrowings to surplus (deficit) ratio
1 2 3 4 5 6 7 8
Central Federal okrug
Belgorod obl. 29 798 847.24 -1 059 256.98 -3.55 7.27 5.32 1.95 -149.64
Bryansk obl. 18 637 546.07 -652 508.82 -3.50 10.62 4.41 6.21 -125.85
Vladimir obl. 20 289 765.93 539 481.72 2.66 0.50 -0.91 1.41 -34.25
Voronezh obl. 29 648 020.67 739 110.79 2.49 8.38 -0.43 8.82 -17.43
Ivanovo obl. 23 709 266.03 -315 138.14 -1.33 7.47 3.62 3.86 -272.30
Kaluga obl. 18 542 143.22 -348 719.97 -1.88 3.81 1.08 2.72 -57.54
Kostroma obl. 10 703 331.42 -689 094.19 -6.44 17.76 6.31 11.44 -98.05
Kursk obl. 17 364 372.92 418 685.07 2.41 0.58 -0.68 1.26 -28.32
Lipetsk obl. 28 330 844.25 -2 596 769.99 -9.17 1.06 1.06 0.00 -11.55
Moscow obl. 174284 317.12 -2 007 935.29 -1.15 22.42 6.47 15.94 -561.79
Oryol obl. 11 881 015.96 -95 519.96 -0.80 0.03 -0.12 0.15 14.67
Ryazan obl. 17 740 286.26 -644 916.05 -3.64 6.45 3.63 2.82 -99.79
Smolensk obl. 14 624 830.31 391 517.12 2.68 2.57 -1.39 3.97 -51.99
Tambov obl. 16 786 396.54 86 859.93 0.52 1.55 0.08 1.47 16.07
Tver obl. 18 542 143.22 -348 719.97 -1.88 3.81 1.08 2.72 -57.54
Tula obl. 25 649 733.16 239 447.99 0.93 21.71 -0.45 22.16 -48.05
Yaroslav obl. 30 289 315.33 -395 580.93 -1.31 9.24 1.92 7.32 -147.17
Moscow 523 763 314.80 19 517 527.17 3.73 4.11 -2.40 6.52 -64.53
Total 1 029 527 650.1 13 196 040.06 1.28 3.58 0.34 7.67 26.31
North-Western Federal okrug
Republic of Karelia 17 866 888.79 974 160.59 5.45 5.00 -0.44 5.44 -8.05
Komi Republic 34 241 139.93 220 025.49 0.64 3.16 2.59 0.57 403.26
Arkhangelsk obl. 27 416 063.26 -1 722 086.02 -6.28 1.88 -1.54 3.42 24.57
Vologda obl. 32 822 517.04 -19 367.33 -0.06 1.53 -0.26 1.79 434.90
Kaliningrad obl. 19 347 710.51 -1 145 324.53 -5.92 5.29 -0.06 5.35 0.98
Leningrad obl. 33 365 908.44 -20 427.77 -0.06 8.11 2.14 5.97 -3 487.89
Murmansk obl. 23 726 314.68 551 852.40 2.33 4.22 0.17 4.05 7.51
Novgorod obl. 15 032 256.94 529 129.20 3.52 0.17 -0.28 0.45 -8.09
Pskov obl. 12 500 112.56 6 451 156.55 51.61 5.67 -2.36 8.04 -4.58
St.-Petersburg 143 245 334.75 -610 750.42 -0.43 6.88 -1.02 7.90 239.19
Nenetsky autonomous okrug 6 132 412.82 -662 962.51 -10.81 0.00 0.00 0.00 0.00
Total 365 696 659.74 279 381.79 0.08 1.88 -0.21 5.21 -270.22
1 2 3 4 5 6 7 8
Southern Federal okrug
Republic of Adygeya 6 261 626.05 1 342 591.37 21.44 3.25 -0.57 3.83 -2.68
Republic of Dagestan 32 170 224.32 -548 100.11 -1.70 0.00 -0.08 0.08 4.60
Republic of Ingou-shetia 6 773 784.54 -289 766.72 -4.28 0.00 0.00 0.00 0.00
Kabardino-Balkar Republic 10 770 466.49 -541 194.21 -5.02 22.06 3.60 18.46 -71.63
Republic of Kalmykia 4 875 687.38 -105 254.38 -2.16 4.14 4.11 0.04 -190.26
Karachai-Chircassian Republic 6 404 227.75 3 199 566.90 49.96 26.45 -0.18 26.63 -0.36
Republic of North Os-setia -Alania 12 761 232.22 1 524 406.11 11.95 5.38 3.31 2.07 27.70
Chechen Republic 20 929 668.63 -8 627.63 -0.04 0.00 0.00 0.00 0.00
Krasnodar krai 76 861 809.11 -746 385.01 -0.97 0.53 -0.15 0.68 15.34
Stavropol krai 38 282 639.99 -500 251.78 -1.31 2.72 1.37 1.35 -104.98
Astrakhan obl. 13 801 959.57 759 572.42 5.50 22.39 8.19 14.20 148.90
Volgograd obl. 34 326 922.59 72 086.11 0.21 9.79 1.84 7.95 876.80
Rostov obl. 68 372 055.92 -27 469.10 -0.04 0.11 -1.11 1.22 2 758.79
Total 332 592 304.57 -125 772.63 -0.04 3.41 0.71 3.24 -1 870.93
Volga Federal okrug
Republic of Bashkortostan 69 339 694.21 -569 667.08 -0.82 1.85 -0.03 1.88 3.69
Republic of Mary-El 10 449 407.42 -153 154.81 -1.47 3.90 0.47 3.43 -32.13
Republic of Mordovia 22 115 964.76 -677 839.16 -3.06 0.00 -0.60 0.60 19.73
Republic of Tatarstan 109 074 903.58 -811 912.67 -0.74 5.44 1.19 4.25 -159.31
Udmurt Republic 28 437 879.47 -987 375.44 -3.47 5.97 2.94 3.03 -84.67
Republic of Chuvashia 19 857 833.86 2 758 159.84 13.89 7.99 3.27 4.72 23.53
Kirov obl. 48 800 527.07 -19 176.65 -0.04 19.96 3.52 16.44 -8 948.72
Nizhny Novgorod obl. 24 037 095.83 -424 422.80 -1.77 5.58 3.36 2.22 -190.28
Orenburg obl. 66 787 840.97 3 116 824.16 4.67 6.21 2.21 4.00 47.36
Penza obl. 36 362 965.68 -1 147 503.49 -3.16 0.60 -0.50 1.10 15.90
Perm obl. 19 041 044.49 668 127.51 3.51 8.82 0.63 8.18 18.01
Samara obl. 60 863 054.33 54 608.17 0.09 0.30 -0.08 0.38 -85.74
Saratov obl. 34 961 574.06 243 977.72 0.70 9.42 4.78 4.64 684.84
Ulyanovsk obl. 17 882 979.16 2 842 977.63 15.90 0.75 -3.59 4.34 -22.56
Komi-Permyatsky autonomous okrug 3 739 542.58 36 041 258.65 963.79 0.64 -0.24 0.89 -0.03
Total 571 752 307.47 -449 385.11 -0.08 4.00 1.33 4.21 -1 687.65
Ural Federal okrug
Kurgan obl. 16 010 092.77 12 424 218.38 77.60 0.59 -0.35 0.94 -0.46
Sverdlovsk oblast 80 456 112.12 6 714 466.30 8.35 0.81 0.00 0.81 -0.06
Tyumen oblast 143 747 556.72 -232 161.80 -0.16 0.03 -0.25 0.27 152.13
Chelyabinsk oblast 63 038 860.59 118 763.17 0.19 0.01 -0.15 0.17 -81.98
Khanty-Mansy autonomous okrug 189 430 325.90 1 097 514.31 0.58 0.40 -0.19 0.59 -32.88
Yamal-Nenetsky autonomous okrug 81 224 713.26 -4 753 688.07 -5.85 2.41 -0.01 2.41 0.09
Total 573 907 661.35 -747 503.40 -0.13 0.59 -0.15 0.76 117.22
1 2 3 4 5 6 7 8
Siberian Federal okrug
Republic of Altai 7 829 171.46 578 333.61 7.39 5.53 0.72 4.81 9.73
Republic of Buryatia 20 363 837.59 -447 707.87 -2.20 12.15 1.07 11.09 -48.50
Republic of Tuva 9 761 282.53 -1 074 205.89 -11.00 0.00 -0.29 0.29 2.68
Republic of Khakassia 8 991 398.88 -2 059 017.85 -22.90 0.41 -0.06 0.47 0.26
Altai krai 41 473 013.99 -138 485.45 -0.33 4.72 -0.33 5.06 99.86
Krasnoyarsk krai 90 367 875.40 -67 702.48 -0.07 12.28 2.57 9.71 -3 435.50
Irkutsk obl. 54 236 003.38 -569 977.04 -1.05 8.75 3.24 5.51 -307.86
Kemerovo obl. 72 196 077.74 -210 675.09 -0.29 0.53 -0.66 1.18 224.59
Novosibirsk oblast 51 942 823.30 138 961.59 0.27 50.06 1.50 48.56 559.38
Omsk obl. 49 567 495.72 -293 343.03 -0.59 7.81 -1.39 9.19 234.19
Tomsk obl. 25 576 122.91 -15 372.33 -0.06 14.72 0.35 14.37 -585.80
Chita obl. 23 394 157.97 -12 743 534.66 -54.47 3.17 1.87 1.30 -3.43
Aginsky Buryatsky autonomous okrug 3 011 760.13 371 315.07 12.33 0.53 0.00 0.53 0.00
Ust-Ordynsky Buryat-sky autonomous okrug 3 234 026.34 -891 383.32 -27.56 0.02 0.02 0.00 -0.06
Total 461 945 047.35 -1 617 738.97 -0.35 9.78 0.94 11.08 -267.40
Far Eastern Federal okrug
Republic of Sakha (Yakutia) 69 480 303.81 -47 875.04 -0.07 6.67 2.02 4.64 -2 936.33
Primorsky krai 41 660 325.20 -573.38 0.00 1.63 -0.77 2.40 56 269.97
Khabarovsk krai 40 128 724.81 -1 887.98 0.00 22.30 7.86 14.44 -167 57.21
Amur oblast 25 676 885.92 -902 574.26 -3.52 4.42 -0.86 5.28 24.49
Kamchatka oblast 16 293 961.91 -663 104.62 -4.07 18.61 5.72 12.89 -140.51
Magadan obl. 12 386 243.35 -2 607.01 -0.02 2.23 1.16 1.07 -5 495.63
Sakhalin oblast 20 594 340.72 209 680.45 1.02 8.27 0.18 8.08 18.15
Jewish Autonomous obl. 4 275 051.95 32 712.57 0.77 1.08 -0.51 1.58 -66.26
Koryaksky autonomous okrug 4 615 760.68 -37 120.26 -0.80 17.77 3.94 13.83 -490.15
Chukotka autonomous okrug 16 405 049.33 -761 028.22 -4.64 0.00 -6.05 6.05 130.35
Total 251 516 647.66 -97 251.83 -0.04 7.23 1.71 6.75 -4 420.83
Total federal okrugs 3 622 522 716.23 57 132 014.22 1.58 6.27 0.56 5.71 35.29
Source: Author's calculations based on the data of the Ministry of Finance of the RF.
Domestic bonded loans
In 2005, 25 Federation's Subjects and 13 municipal entities registered bonded loans (vis-à-vis 24 regional and 10 municipal loans in 2004). In 2005, the total volume of placed bonds made up Rb 81.2 bn vis-à-vis Rb 79.4 bn in 2004, thus decreasing for a year from 0.47 to 0.37% GDP (Table 25).
Despite the fact that the growth of the volume of issuance of regions and municipalities' securities was lagging behind inflation rates, the volume of the market for subfed-eral bonds had grown for the first eleven months of 2005 in real terms by 11.8%, from Rb 128.2 to Rb 158.9 bn. In parallel with that, the volume of monthly secondary exchange-traded turnover of subfederal and municipal bonds, after reaching its maximum in September 2005 (Rb 70.7 bn vis-à-vis Rb 37.0 bn in December 2004) began to decline and amounted to Rb 55.6 bn in November 2005.
Table 25
Volume of Issuance of Subfederal and Municipal Papers (as % to GDP)
Year 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
Issue 0.63 0.77 0.47 0.31 0.19 0.17 0.27 0.46 0.47 0.37
Repayment 0.47 0.56 0.48 0.36 0.46 0.23 0.10 0.15 0.19 0.28
Net financing_0.16 0.22 -0.01 -0.05 -0.27 -0.07 0.16 0.31 0.29 0.09
Source: Author's calculations based on the data of the Ministry of Finance of the RF.
In 2005, the Ministry of Finance of the RF registered issue prospectuses by: Moscow, St.- Petersburg, Republic of Chuvashia, Volgograd obl., Tomsk obl., Komi Republic, Leningrad, Irkutsk obl., Moscow obl., Khabarovsk krai, Republic of Sakha (Yakutia), Novosibirsk obl., Yaroslav obl., Krasnoyarsk krai, Republic of Bashkortostan, Republic of Karelia, Lipetsk obl., Nizhny Novgorod obl., Voronezh obl., Belgorod obl., Tver obl., Kostroma obl., Samara obl., Kabardino-Balkar Republic, Kirov obl., Udmurt Republic, Ekaterinburg, Yuzhno-Sakhalinsk, Krasnoyarsk, Novosibirsk, Novocheboksarsk, Volgograd, Cheboksary, Kazan, Angarsk, Klin and Odintsovo districts of Moscow oblast, city of Shumerlya, and Vurnar district of Republic of Chuvashia .
The largest issuers of the securities became: Moscow, ( for Rb 21.2 bn or 26.2% of the volume of total issuance of the territories), Moscow obl. - Rb 18.7 bn (23.0%), St.- Petersburg - Rb 9.8 bn, or 12.1%, Novosibirsk obl. - Rb 4.1 bn, or 5.1%. Thus, the share of the four largest issuers accounted for 66.3% of the total volume of issuance of placed regional and municipal bonds.
As well, large volumes of issuance was placed by: Krasnoyarsk krai - Rb 2.6 bn, Irkutsk oblast - Rb 2.6 bn, Nizhny Novgorod oblast - Rb 2.5 bn, Republic of Sakha (Yakutia), Republic of Tatarstan, Belgorod obl. and Samara obl. - Rb 2.0 bn each (Table 26).
Table 26
Placement of Subfederal Papers in 2005
Federation's Subject „ . Issuer's Share in Volume of Is- .. the Total Volume suance ,, .. of Issuance, (thou. rub.) ( Volume of Issuance to Domestic Borrowings Ratio, (%)
1 2 3 4
Central Federal okrug
Belgorod oblast 2 000 000.0 2.5 92.4
Voronezh oblast 500 000.0 0.6 20.1
Tver oblast 800 000.0 1.0 45.1
Kostroma oblast 793 840.0 1.0 41.8
Lipetsk oblast 300 000.0 0.4 100.0
Moscow oblast 18 665 784.0 23.0 47.8
Yaroslavl oblast 1 342 470.0 1.7 48.0
Moscow 21 242 274.0 26.2 99.2
North-Western Federal okrug
Republic of Karelia 350 000.0 0.4 39.2
Komi Republic 950 000.0 1.2 87.7
Leningrad oblast 300 000.0 0.4 11.1
St. - Petersburg 9 849 248.7 12.1 100.0
Southern Federal okrug
Kabardino-Balkar Republic 500 000.0 0.6 21.0
Volgograd oblast 1 294 331.7 1.6 38.5 115
_1_2_3_4_
Volga Federal okrug
Republic of Tatarstan 2 000 000.0 2.5 33.7
Udmurt Republic 1 000 000.0 1.2 58.9
Chuvash Republic 875 130.0 1.1 55.2
Nizhny Novgorod oblast 2 500 000.0 3.1 25.7
Kirov oblast 400 000.0 0.5 29.8
Samara oblast 2 000 000.0 2.5 48.2
Ural Federal okrug
Sverdlovsk oblast 120 000.0 0.1 18.5
Siberian Federal okrug
Krasnoyarsk krai 2 600 000.0 3.2 23.4
Irkutsk oblast 2 550 000.0 3.1 53.7
Novosibirsk oblast 4 127 000.0 5.1 15.9
Tomsk oblast 1 059 028.3 1.3 28.1
Far Eastern Federal okrug
Republic of Sakha (Yakutia) 2 000 000.0 2.5 43.2
Primorsky krai 1 433.0 ... 0.2
Khabarovsk krai 1 000 000.0 1.2 11.2
Sakhalin oblast 100 000.0 0.1 5.9
Total 81 220 539.8 100.0 36.0
Source: Author's calculations based on the data of the Ministry of Finance of the RF.
As of today, it was mostly the largest issuers that demonstrated a high level of securitization: Moscow - 99.2% and St.- Petersburg - 100%. Lipetsk oblast conducts borrowings exclusively in the form of securities issuance. The level of securitization of the Belgorod oblast borrowings made up 92.4% and that of Komi Republic - 87.7%.
In 2005, the total volume of net borrowings on the market for subfederal and municipal papers made up Rb 20.9 bn, thus demonstrating a more than two-fold fall vis-à-vis 2004 (Table 27).
Table 27
Volumes of Net Borrowings on the Market for Domestic Subfederal Municipal Papers, thou. rubles
Consolidated Regional Budget Regional Budgets Municipal Budgets
1 2 3 4
2005
Net borrowings 20 887 596 16 939 894 3 947 703
Attraction of funds 81 220 540 75 016 756 6 203 783
Repayment of the principal debt body 60 332 944 58 076 863 2 256 081
2004
Net borrowings 47 880 300 44 470 128 3 410 172
Attraction of funds 79 436 708 74 995 965 4 440 743
Repayment of the prin- 31 556 408 30 525 837 1 030 571
cipal debt body
2003
Net borrowings 41 908 199 40 043 511 1 864 688
Attraction of funds 61 712 635 59 012 901 2 699 734
1 2 3 4
Repayment of the prin- 19 804 436 18 969 390 835 046
cipal debt body
2002
Net borrowings 17 696 530 17 153 760 542 770
Attraction of funds 29 141 777 28 169 158 972 619
Repayment of the prin- 11 445 247 11 015 398 429 849
cipal debt body
2001
Net borrowings 6 601 447 6 667 592 -66 145
Attraction of funds 15 123 785 14 226 931 896 854
Repayment of the prin- 8 522 338 7 559 339 962 999
cipal debt body
2000
Net borrowings -1 877 328 -2 286 175 408 847
Attraction of funds 13 042 220 10 090 208 2 952 012
Repayment of the prin- 14 919 548 12 376 383 2 543 165
cipal debt body
Source: Ministry of Finance of the RF.
The majority of regions that issue debt securities on a regular basis continued their issuance in 2005. Since 1999, the yearly bond issuance has been conducted by Moscow, St. Petersburg, Chuvash Republic, Volgograd obl. Since 2000, - Toms oblast. and Komi Republic, Ekaterinburg. Since 2001 they were also joined by Irkutsk oblast (Table 28).
Table 28
Issuance of Subfederal and Municipal Papers in 1999-2005_
Issuer Issuer Issuer Issuer Issuer Issuer Issuer Issuer
Federation's Subjects 1999 2000 2001 2002 2003 2004 2005
1 2 3 4 5 6 7 8
Moscow * * * * * * *
St. - Petersburg * * * * * * *
Chuvash Republic * * * * * * *
Volgograd oblast * * * * * * *
Tomsk oblast * * * * * *
Komi Republic * * * * * *
Irkutsk oblast * * * * *
Moscow oblast * * * *
Khabarovsk krai * * * *
Republic of Sakha * * * *
Novosibirsk oblast * * * *
Yaroslav oblast * * *
Krasnoyarsk krai * * *
Republic of Bashkortostan * * * *
Republic of Karelia * *
Lipetsk oblast * *
Nizhny Novgorod oblast * *
Voronezh oblast * *
Belgorod oblast * * *
Tver oblast * * *
Kostroma oblast * * *
Samara oblast * *
Kabardino-Balkar Republic * *
1
* * * * * *
Kirov oblast *
Udmurt Republic *
Leningrad oblast * *
Republic of Mary-El *
Yamal-Nenetsky autonomous okrug
Krasnodar krai *
Kaluga oblast *
Bryansk oblast *
Khanty-Mansy autonomous * *
okrug *
Murmansk oblast * *
Tambov oblast *
Republic of Mordovia *
Sakhalin oblast *
Kursk oblast *
Stavropol krai *
Primorsky krai *
Municipalities
Ekaterinburg * * * * * *
Yuzhno-Sakhalinsk * * *
Krasnoyarsk * * *
Novosibirsk * * *
Novocheboksarsk * * * *
Volgograd * * * * * *
Cheboksary * *
Kazan *
Klin district of Moscow oblast *
Angarsk *
Odintsovo district of Moscow *
oblast
Vurnar district of Chuvash Re- *
public
Shumerlya-city of Chuvash Re- *
public
Ufa * * *
Tomsk * *
Barnaul *
Perm *
Noginsk district of Moscow *
oblast
Nizhny Novgorod *
Kostroma * *
Arkhangelsk *
Dzerzhinsky_*_
Source: Ministry of Finance of the RF.
2
3
4
5
6
7
8
Solvency of Territorial Governments
Credit rating
A considerable contraction in the accumulated sovereign debt to GDP ratio (driven by high economic growth rates in Russia, early repayment of foreign debt by the federal government, and a real appreciation of the ruble exchange rate), as well as a boost in the volumes of stabilization fund and foreign reserves over the last few years have ensured a steady rise in the country's credit rating. In 2005, Standard&Poor's raised Russia's sovereign rating by two degrees, up to level "BBB"; while Fitch also granted the country with the "BBB" level - by and Moody' - to the "Baa2" level-s. In parallel with that, there continued the process of raising of credit ratings of territtorial governments. In 2005, the international credit rating of the city of Moscow was growing together with the sovereign rating of the Russian Federation. It hit the "BBB" level according to Standard&Poor's and Fitch, and "Baa2" - according to the Moody's.
The Moody's also estimated St. - Petersburg to be at the level of the sovereign credit rating. Though the Fitch agency granted St.- Petersburg with a level by one degree lower than the sovereign ("BBB-") rating, the agency's credit rating level made it possible for the city bonds to be upgraded from the category "speculative" to the "investment" one: the investment credit rating granted by the two international rating agencies opens the way for a broad array of institutional players' investing in the city's papers.
Thus, of the three international rating agencies only the Standard&Poor's considered that the risk level on St. Petersburg bonds was too high to grant them with investment rating (Table 29).
Table 29
International Credit Rating of the Standard&Poor's as of Beginning of 2006
Issuer name In Foreign Currency/Forecast In National Currency/Forecast
1 2 3
Sovereign Ratings
Russian Federation "BBB"/Stable "BBB+"/Stable
Ratings of Local and Regional Administrations
Balashikha district "B-"/Positive
Bashkortostan "BB-"/Positive "BB-"/Positive
Vologda oblast "B+"/Stable
Klin district "B-"/Stable
Krasnodar krai "B+"/Positive "B+"/Positive
Leningrad oblast "B+"/Positive
Moscow "BBB"/Stable
Moscow oblast "B-"/Positive
Samara oblast "BB-"/Stable
St.-Petersburg "BB+"/Positive "BB+"/Positive
Sverdlovsk oblast "BB-"/Stable "BB-"/Stable
Stavropol krai "B"/Positive "B"/Positive
Surgut "BB-"/Stable
Tatarstan "B"/Positive "B"/Positive 119
2
3
Ufa
Khanty-Mansy autonomous okrug
Yamal-Nenetsy autonomous okrug
"B"/Stable "BB+"/Positive
"BB-"/Positive
"B"/Stable
Source: Standard&Poor's.
The outstanding debt restructuring problems
The process of the outstanding debt restructuring was gaining its momentum against the background of improvement of the budgetary situation in most of the Russian Federation's Subjects. According to the RF Ministry of Finance, as of October 2005, the volume of outstanding (non-restructured) debt, decreased by more than twice (by Rb 14.8 bn in nominal terms) vis-à-vis October 2004 - from Rb 29.0 to Rb 14.2 bn, amounting to 0.39% of the revenue part of the consolidated regional budget, or 0.07% GDP.
Of the problems associated with outstanding debt are particularly plumbing in the following regions: Kamchatka oblast - Rb 3.6 bn, or 22.0% of the revenue part of the local budget, Orel oblast - Rb 1.8 bn, or 15.2%, St. Petersburg - Rb 1.1 bn, or 0.8%, Republic of North Ossetia-Alania - Rb 0.6 bn, or 4.9% (Table 30).
Table 30
Outstanding Non-Restructured Bonded Debt of the Federation's Subjects
Volume of Outstanding Non- Outstanding Non-Restructured
Federal Okrug Restructured Debt, Thos Debt to Budget Revenues Ratio,
rubles38 %39
1 2 3
Central Federal okrug
Belgorod oblast 128 891 0.43
Bryansk oblast 39
Vladimir oblast 9 921 0.05
Kursk oblast 77 982 0.45
Moscow oblast 7 346
Orel oblast 1 807 900 15.22
Tambov oblast 1 297 0.01
Tver oblast 1
Yaroslav oblast 717 606 2.37
Moscow 23
North-Western Federal okrug
Republic of Karelia 12 680 0.07
Arkhangelsk oblast 61 375 0.22
Kaliningrad oblast 35 868 0.19
Novgorod oblast 8 793 0.06
Pskov oblast 418 999 3.35
St.-Petersburg 1 127 979 0.79
Southern Federal okrug
Republic of Adygeya 35 700 0.57
38 As of October 1, 2005 data.
39The ratio of restructured outstanding bonded debt as of October a 1, 2005 to the revenues of regional (non-consolidated) budget for 2005.
1 2 3
Kabardino-Balkar Republic 184 742 1.72
Republic of North Ossetia-
Alania 627 940 4.92
Krasnodar krai 362 918 0.47
Volgograd oblast 268 971 0.78
Volga Federal okrug
Republic of Bashkortostan 12 432 0.02
Udmurt Republic 655 556 2.31
Chuvash Republic 14 450 0.07
Kirov oblast 65 520 0.13
Nizhny Novgorod oblast 2 190 0.01
Orenburg oblast 246 151 0.37
Samara oblast 326 170 0.54
Saratov oblast 1 170
Ulyanovsk oblast 177 245 0.99
Ural Federal okrug
Kurgan oblast 8 4781 0.53
Sverdlovsk oblast 2 318
Tyumen oblast 2214414 1.54
Siberian Federal okrug
Republic of Tuva 100 435 1.03
Krasnoyarsk krai 10 2 68 0.01
Novosibirsk oblast 326 296 0.63
Taymyrsky (Dolgano-Nenetsky)
autonomous okrug 21 840 no data
Evenk autonomous okrug 8 930 no data
Far Eastern Federal okrug
Primorsky krai 398 050 0.96
Kamchatka oblast 3 582 261 21.99
Magadan oblast 16 850 0.14
Jewish autonomous oblast 254 0.01
Chukotka autonomous okrug 35 970 0.22
Total 14 200 521 0.68
Source: Author's calculations based on the data of the Ministry of Finance of the RF.
2.4.3. Stock Market
According to the outcomes in the Russian Stock Market in 2005, it grew significantly and the RTS index almost doubled. Such a rapid growth of the Russian Stock Market was produced by several key factors, namely fairly favorable conditions in the world markets of oil and metals, which allowed the revenues of the budget system of the Russian Federation to significantly exceed the estimates, the same is true with regard to the Stabilization Fund of the Russian Federation. The macroeconomic situation was also favorable, - according to the outcomes of 2005, the Russian economy grew at the rate of 106.4% to overpass the initial forecast - except for inflation which went beyond the forecasted range throughout the entire 2005, which had an adverse affect on investment behavior. Nevertheless, the Russian government managed, by freezing prices of gasoline and regulating the rates of services provided by natural monopolies, to restrain significant growth of prices which by year end amounted to 10.9% as opposed to a 10% forecast for the year.
Internal corporate news played a significant role as well. So, according to the outcomes of Q1, Q2 and Q3 of 2005, financial performance results of most companies involved in the raw materials, telecommunication and some other sectors were considerably beyond those of 2004, which made such companies more attractive in terms of investment. In addition, Gazpom became of the key newsmakers in 2005. In 2005, the Russian government increased its share in gas monopoly by purchasing a block of shares for cash, thereby completing acquisition of Sibneft oil company. However, it is the liberalization of Gazprom's shares that was the key event that marked the previous year, which had a significant influence on the upward movement of the market throughout the entire second half of 2005.
In the past 2005, the Russian RTS Stock Market grew by 518.03 points from 607.57 to 1125.6 points, which accounts for 85.26% of the index value at closing on January 11, 2005. Thus, in 2005, the stock market demonstrated a fairly impressive growth as opposed to 2004 when the RTS index grew by mere 28.3 points (by 4.78%) in terms of absolute value. The minimum growth of the RTS index in the last year - 590.62 points - was recorded on January January 21, while the historical maximum - 1139.04 points - was attained on December 23. Regarding investment activity in 2005, it grew as opposed to the previous year of 2004. In particular, the trading turnover in the classic stock market in the RTS amounted to nearly $7.9 billion US dollars in 2005, which was far beyond the corresponding figure of 2004 (nearly $5.7 billion US dollars). Hence the trading volume grew by nearly 38.5% in 2005 as opposed to the corresponding parameter in 2004. In addition, in 2005, 51.6 thousand transactions were entered into as opposed to 48.8 thousand transactions in the previous year, which also testifies in favor of a higher investment activity. The average annual trading volume on shares listed for the RTS index trading in 2005 amounted to $30.86 million US dollars, which exceeds by 43% the corresponding parameter of 2004 ($21.15 million US dollars) .
Several distinctive periods can be highlighted in the market movement. In the period between January and the beginning of April the market grew insignificantly from 607 to 719 points under the RTS index, which was followed by a short-term correction until the mid May, when the RTS index rolled back to reach 633.69 points. As illustrated in Fig. 24, the movement of the RTS index was accompanied by a relatively low trading volume during that period.
For example, while the monthly trading volume in the classic RTS market averaged $960 million US dollars in the period between July and December, it remained at the level below $500 million US dollars throughout the period between January and June. In January, quotations moved in random - for example, while the market fell in the beginning of the month, the fall eventually gave way to growth due to a series of favorable factors, namely high financial performance results of LUKOIL over nine months in 2004; information on a framework agreement between Russia and the Paris Club of Creditors on early repayment of approximately $45 billion US dollars within a period of three years; the decision of Lehman Brothers investment bank to include Russian bonds in the listing of securities traded under its index; high oil prices in the world market; as well as Standard & Poor's upgrade of the sovereign rating of the Russian Federation up to the vestment level on January 31, 2005 . Early in February, the market was at the stage of consolidation, which was governed by technical factors after the upgrade of the sovereign rating. By the end of the month, however, the market movement was dominated by bullish trend. The market was supported by favorable news from the telecom sector in which the government refused to change the structure of acquired Svyazinvest and, in particular, to separate Rostelecom from it. In addition, Standard & Poor's upgraded the long-term rating for Ros-122
telecom, which also was a favorable news for investors. An emphasis should be made of a statement made by President Putin on the need to streamline the tax audit system, which, when implemented, should reduce tax risks for companies and consequently increase their market value. In addition to the internal factors, Russian shares were supported by further growth in oil prices and bullish trends in many world stock markets as well.
Source : the RTS Stock Exchange.
Fig. 24. The RTS Stock Exchange and Trading Volume in 2005
Then, the market was corrected during the first two decades of March, which was followed by a new growth. The fall was mainly caused by uncertainty about merger of Rosneft and Gazprom, as well as reduced activity of nonresidents on the threshold of an increase in the US interest rates. The market only was supported by a statement of President Putin on the need to reduce the term of limitation from 10 to 3 years for transactions лет, as well as still high oil prices in the world market. Neither did the deteriorated market conditions in the developed stock markets support any growth in the Russian stock market. Early in April the market started to grow upon the news on the likelihood that Gazprom shares would be allowed for trades without any restrictions, as well as the date of a merger of Gazprom and Rosneft were confirmed. Share of the telecom sector were found to be in great demand after the news on a draft resolution on privatization of Svyazinvest had been submitted to the Governement and deleted from the list of strategic enterprises. High oil prices provided additional support to the market. However, this market trend had be changed under the pressure of negative news by the end of the month. The news that was first to cause quotations to fall concerned tax claims against TNK to the amount of Rb 22 billion for 2001. Later on, the President of LUKOIL V. Alekperov also stated that tax claims might just as well be laid against his company for the period between 2002 and 2003. Finally, another tax-related statement was made by Deputy Ministry of Finance S. Shatalov on that tax claims would be laid not only against YUKOS but also other companies. There were external fac-
tors that increased the likelihood that the monetary policy would be tightened, which consequently would result in cash outflow from emerging markets. These factors were growing inflation risks in the United States.
In the first half of May, the market continued to fall which was partially due to uncertainty about the issues of merger of Gazprom and Rosneft and privatization of Svyazinvest, as well as a court verdict was about to be announced in respect of the managers of YUKOS. A combination of all these factors and the period of closing of the registers of many large companies stimulated sales or, at least, restrained the market from active transactions. In the middle of the month, however, the market trend was changed due to a statement of the gas monopoly's representatives on that the government interest in the company would be increased without Rosneft, and the required block of shares would be redeemed by cash at the market value.
It is this news that caused the downward trend of the Russian shares to slow down in mid - May, which gave way to a sharp boost for the entire range of securities to continue until the beginning of October and make the RTS index to grow up to 1045.02 points - the highest ever in the history of th RTS trading system. In spite of the fact that early in June the market was dominated by some weak negative trends - namely the comments made by a Deputy General Prosecutor of the Russian Federation on the likelihood that criminal case would be initiated against some of the tycoons; uncertainty about privatization of Svyazinvest, as well as interest rates were very likely to be further increased in the United States - the market continued to grow in the second decade of the month. The growth was promoted by the news on transfer of 100% Rosneft shares in favor of Rosneftegaz by the Federal Agency for Federal Property Management ( Rosimuszhestvo ), which was indicative of the fact that the government began to implement its plan on taking control over the gas monopoly and liberalizing transactions with shares. Growth rates in the Russian stock market was further promoted by a very good information on financial performance results of Norilsky Nickel in 2004, as well as a statement made by A. Chubais, who said that the reform in the electric power sector had reached its final stage. In addition, an emphasis should be placed on favorable conditions in the world oil and metal markets, as well as upward trends in the sock markets of the most developed countries, and developing ones as well.
In the period between July and August, the market continued to grow steadily as supported by growing investment activity. While in July the trading volume in the RTS Stock Market amounted to nearly $680 million US dollars, it increased up to $998 million US dollars as early as in August.
The growth in July was influenced by several key factors:
• the Russian Federation started early repayment of its debt due to the Paris Club of Creditors;
• a statement made by ConocoPhillips that it would increase by 20% its share in LUKOIL by the end of 2006;
• successful IPO of a major Russian independent gas producer, Novatek company, during which 19% of the authorized capital were placed in the form of GDR ( global depositary receipts ). As a result, the IPO was ranked No. 2 by the amount of borrowed funds in the list of Russian corporations.
A special emphasis should be placed upon the new on terrorist acts that took place in London on July 7, which forced the stock markets at developed countries to fall, but the Russian stock market only responded by a short-term price fall within a day. The growth in the Russian market in August was effected by several key factors, namely high prices of oil and metals; improved liquidity in the banking sector; the new on agreement between the Ministry of Economic Development and Trade and the RF Ministry of Internal Affairs on a 124
draft ordinance concerning privatization of Svyazinvest; Fitch's upgrade of the Russia's credit rating up to BBB, as well as the similar upgrade on the credit rating of Sberbank of Russia. In the middle of the month, the market was supported by several good news, namely on good financial performance results gained by Gazprom in exports; transition by of Polyus company into a separate gold mining under Norilsk Nickel; high dividends allocation by Sibneft; as well as favorable financial performance results of Sberbank of Russia. At the end of the month, the stock market experienced active growth which was heavily supported by the investors from developed western countries. Not only the shares issued by the companies operating in the oil and gas sector that were in great demand, but also securities issued by Sberbank of Russia, which had a direct relationship with early repayment of a share of the Russia's debt due to the Paris Club of Creditors. Record-breaking high oil prices had a significant effect on the market as well, in August. On the contrary, the situation in world stock markets was not as much insignificant.
In September, the Russian stock market continued to grow rapidly showing record-breaking trading volumes which amounted to nearly $1,3 billion US dollars at the end of the month. This development was promoted by several factors, namely an excellent financial reports made by LUKOIL in the first half of 2005 in accordance to the International Financial Reporting Standards; an agreement entered into between Rosneft and a syndicate of international banks ($7,5 billion US dollars ) on payment for the Gazprom shares purchased by the government; as well as Rosneft's IPO plans. The good news flow was further enriched with new good news by the end of the month, namely V. Christenko announced that a decision had been made to liberalize the Gazprom share market till year end; documents were signed on selling of 72.6% of Sibneft shares to Gazprom at a value of $13,1 billion US dollars, which came to be very close to the market value of the company at that time. The likelihood of correction was reduced by still high oil prices in the world market as well as favorable conditions in stock markets in most countries.
In October, after the market reached its historical peak, the market experienced logical correction after a non-stop growth for almost six months, when the level of trading activity was even higher than in September. The correction was caused by falling world prices of oil and stock markets. Some internal factors should be noted as well, namely news on new searches at YUKOS office; statement of a representative of the RF Ministry of Internal Affairs on criminal investigation with regard to a number of major Russian companies and banks in respect of criminal income laundry. Even positive factors such as a discussion by the RF Governemnt on VAT reduction to 13%, and high valuation ($50 billion US dollars) of Rosneft by Deloite&Touche audit company, failed to support share prices of Russian issuers. Some negative news came from abroad: there was a new concern about another increase in the US interest rates and inflation growth.
However, the correction lasted for a short period of time to gave way to resumed active purchases as early as at the end of October and early November. The market broke one historical record after another, which was governed by a series of factors. Early in November, the situation developed more or less quietly due to lack of significant internal news and falling world oil prices. The demand for Russian shares resumed to grow shortly after a rise of the prices of oil futures contracts. The market responded upwardly to the news on growth (almost by 50% to Rb 87 billion ) of the retained profit of Surgutneftegaz, as well as a statement made by L. Reiman, the Ministry of Communications and Information technologies, that Svyazinvest would be privatized concurrently with adoption of legal regulation documents on protection of special users' rights. It is, however, obvious that adoption of a law on liberalization of the Gazprom shares market at first reading was the most significant factor for the market. Neither unstable situation in the world oil market, nor dete-
riorating liquidity in the banking sector could have any significant adverse affect on the prices of Russian shares at the end of November.
Throughout the entire last month of 2005, the market experienced no significant movements: share prices continued to grow to allow the market to break the psychological 1000 points. Trading activity was relatively high, which, on the one hand, was governed by that investors were waiting for the outcomes of a meeting at the US Federal Reserve System in the Unite States, and, on the other hand, deteriorating liquidity in the banking sector. It should be noted, however, that the US interest rate was finally raised, but it was not a surprise for investors, so this development had already been taken into account in the prices in emerging markets. Nevertheless, the market did not fall due to support by the news on a 7% growth of the GDP of the Russian Federation in Q3, which was found to be far beyond the forecast, as well as that Standard & Poor's upgraded the Russia's sovereign credit rating up to BBB. As a result, the RTS index hit a new historical maximum of 1128.51 points at closing on December 22, 2005, while it grew beyond to 1139.04 points on December 23 as well.
Unlike the previous year, 2004, which became the year of relatively stable share prices, in 2005, most liquid Russian shares grew significantly in value (Fig. 25). Last year, for example, returns on investments in OJSC YUKOS were most profitable, with the yield being 185.07% (as opposed to -93.82% in 2004). Such high growth rates were caused mainly by technical factors after a drastic and long fall throughout the entire year of 2004 rather than improved situation in the company itself. The second to YUKOS were shares of OJSC Sberbank of Russia, which gained 156.92% (as opposed to 83.46% in 2004) to its value during the year. Relatively high growth rates were demonstrated by the shares issued by OJSC Tatneft and OJSC LUKOIL, which gained in value by 127.87% and 100.34% respectively in 2005 as opposed to 32,31% u 24.39% in 2004. The shares issued by RAO "UES of Russia" (53.07% as opposed to -1,72% in 2004), OJSC Surgutneftegaz (49.23% as opposed to 21.95% in 2004), OJSC Rostelecom» (28.18% as opposed to -13,72% in 2004), OJSC Sibneft (24.92% as opposed to 4.11% in 2004) and OJSC «GMK Norilsky Nickel (12.36% as opposed to -18.67% in 2004) showed much less growth rates. OJSC Mosenergo was the sole company among the blue chips, whose shares lost in value in 2005, - 4.76% as opposed to 117.52% in 2004 .
In 2005, Vozrozhdeniye Bank, OJSC Uraltrubstal, OJSC Sinarsk Trubny Zavod (Si-narsk Ripe and Tube Mill) were among the "second echelon" companies whose shares gained maximum values, 677.78%, 444.26%, and 383.33% respectively. However, trading activity with regard to the above listed companies remained low. For example, 28 transactions were entered into on the shares of Vozrozhdeniye Bank, 107 transactions on the shares of OJSC Uraltrubstal, and 40 transactions on the shares of OJSC Sinarsk Trubny Zavod (Sinarsk Ripe and Tube Mill).
The shares of OJSC LUKOIL were ranked No. 1 by trading turnover to account for 29.55% of the total trading volume in the RTS in 2005, as opposed to 21.2% in 2004. The shares of RAO "UES of Russia" were ranked No. 2 to accout for nearly 20.39% in 2005, as opposed to 25.86% in 2004. The shares of Norilsky Nickel were ranked No. 3 among the blue chiups to account for 9.7% of the total trading volume in the RTS in 2005, as opposed to 10.55% in 2004. Transactions on the preferred shares of OJSC Transneft accounted for 6.04%, but the shares were not ranked high by trading volume in the RTS . Finally, the shares of Sberbank of Russia were ranked No. 5 to account for 5.6% in 2005. Hence, in 2005, transactions on the shares of the five abovementioned issuers accounted for nearly 71.28% of the total trading volume in the RTS, which exceeded the corresponding paramerter of 2004 (nearly 72.44%). 126
Data source : the RTS Stock Exchange .
Fig. 25. Blue Chips Price Movement in 2005
According to the data as of December 30, 2005, the top-five list of companies by capitalization was as follows: LUKOIL - $50.5 billion US dollars (as opposed to $26.01 billion US dollars in 2004), Surgutneftegaz - $38.5 billion US dollars (as opposed to $26.65 billion US dollars in 2004), Sberbank of Russia - $24.89 billion US dollars (as opposed to $9,33 billion in 2004), Sibneft - $17.99 billion US dollars (as opposed to $14,22 billion US dollars in 2004), u RAO "UES of Russia" - $17.32 billion US dollars (as opposed to $11.70 billion US dollars in 2004). Hence, the lineup of companies in 2005 differed from that in 2004. For example, LUKOIL was ranked No. 1 in 2005, while it was ranked second to Surgutneftegaz in 2004. In addition, Sberbank of Russia was ranked No. 3 by capitalization in 2005 by forcing Sibneft to give up its No. 3 scored in 2004. It should be noted that the three most capitalized companies of Russia belonged to the oil and gas sector40, as well as in the previous year. Such a stable position of primary industry companies was governed by an extremely favorable conditions in the primary commodity markets in 2005 Sberbank of Russia had the highest capitalization among the companies that do not belong the primary commodity market, as well as in the previous year.
Futures Contracts Market
In December 2005, the FORTS market (Futures and Options on the RTS ) celebrated its 4.5 anniversary since the commencement of transactions at this segment of the financial market in Russia. Since the trading turnover in the Russian futures market has increasingly been growing, the year of 2005 was not an exclusion. For example, the turnover of futures and options contracts in the futures market totaled nearly Rb 711,54 billion in the previous year, as opposed to Rb 336,37 billion in 2004. In other words, the turnover of the
Capitalization of OJSC Gazprom is taken into account in this review.
futures contracts (FORTS) market in 2005 doubled the corresponding figures attained in the previous year. Participants of the market entered into nearly 1.96 million transactions to amount to 54.87 million contracts (nearly 1.5 million transactions and 41.5 million contracts in 2004). Hence the foregoing data testify that investment activity in this segment of the stock market was found to be much higher than in the previous year, 2004. In 2005, the average daily volume of open positions on standard contacts was Rb 18 billion, 1.63 million contracts, to grow 2.5 times as denominated in rubles and 1,9 times in contracts as compared to 2004. During 2005 the volume of open positions reached maximum volumes to the amount of Rb 30.93 billion (on December 12) and 2.43 million contracts (on September 12).
A share of futures transactions was biggest in the segment of futures contracts in 2005, like in the previous year, to account for nearly 89% (as opposed to 91.95% in 2004) of the total trading volume or Rb 630,53 billion (as opposed to Rb 309.3 billion in 2004), while the value of option transactions amounted to mere Rb 81.01 billion (as opposed to Rb 27.06 billion in 2004). Hence a share of options transactions increased considerably by trading volume in the last year as opposed to that in 2004. Futures contracts on the market value of the shares of RAO "UES of Russia" still remained most attractive for investors in 2005. In spite that, their share reduced significantly in the total trading volume from 54% in
2004 to 27.37% (Rb 188 billion) in 2005. Futures on market value of the shares of OJSC Gazprom were ranked No. 2, like in the previous year: in 2005, transactions on this instrument accounted for nearly 21.62% (Rb 148.5 billion) as opposed to 19.6% (Rb 66 billion) in 2004. Transactions on NK LUKOIL futures accounted to 17.59% (Rb 120.8 billion) in
2005 as opposed to 12.8% (Rb 43 billion) in the pervious year. In 2005, a few new instruments emerged in the market. One-month option contracts on the shares of OJSC Gazprom, OJSC Rostelecom, RAO "UES of Russia" and OJSC LUKOIL were launched on March 5. The futures contract on Moscow three-year bonds denominated in rubles was launched on June 1, which is currently the sole interest rate derivative in Russia. Futures contract on the basic index of the Russian stock market - the RTS index - were launched on August 3, 2005, and options on this contract were launched on September 15. Finally, futures contracts on the common share of OJSC Sberbank of Russia were launched on October 10, after which a full set of derivatives was formed for all blue chips of the Russian stock market. Hence, for the time being, FORTS participants can enter into transactions on 10 futures and 6 option contracts.
Corporate Bonds Market
In 2005, the market of corporate and regional bonds was stable in general. However, the corporate bonds market grew insignificantly in 2005 as compared with the stock market. This is evidenced by the movement of corporate bonds indices assessed by Zenit Bank on the basis of market prices of bonds traded in the MICEX41 (Moscow Interbank Currency Exchange). In 2005, the ZETBI-Corp index grew by 1.06 points (0.96%) from 110.59 to 111.65 points. However, the ZETBI-Corp10 index, which is assessed on the basis of quotations of most liquid corporate bonds, grew by mere 3.99 points (3.46%) from 115.13 to 119.12 points in the preceding year of 2005.
There were several periods that could be distinguished by upward and downward trends of market quotations in the corporate bonds market, which in general corresponded to the similar period of ups and downs in the stock market. However, the corporate bonds market demonstrated much higher volatility than the stock market.
41 The ZETBI-Corp and ZETBI-Corp10 indices have been assessed by Zenit Bank since 03.01.2002 128
105.0%
102.5%
100.0%
97.5%
95.0%
Source : Zenit Bank.
Fig. 26. Corporate Bonds Price Index Movement in 2005 ( January 5, 2005 = 100% )
Throughout a period between January and February 2005, quotations of corporate and regional bonds remained the same. In January, investment activity slowed down drastically due to holidays, while most liquid series of bonds demonstrated an upward trend in the beginning of the month. External environment for the bond markets remained quiet enough. In January, the yield of the benchmark of the world bond market - the US Ten-Year Treasury Bonds - varied insignificantly within a small range. The market was supported by a favorable situation in the Russian Eurobonds market. The news that Standard & Poor's upgraded the sovereign credit rating of the Russian Federation up to the investment level was most significant in the second half of the month. In general, quotations changed under the impact of the factors that affected the both markets of government bonds denominated in rubles and foreign currency. In February, investors resumed their activity, and series of most liquid bonds showed growth. There were some external factors that are worth noticing, namely a slow growth of the US securities as a result of an 2.5% p. a. increase in the interest rate in the United States, as well as comments made by the US Federal Reserve System that it would continue to raise the interest rate in the future. Liquidity in the banking sector remained fairly low, which in combination with gaining ruble foreign exchange rate in the forex market supported prices.
In March, investment activity continued to grow in the market, which, however, was accompanied by falling quotations. In general, the external environment remained moderately negative: the US market continued to fall because of negative statistical data on inflation, and the foreign exchange reserves in Japan were likely to be diversified, which might result in sales of US assets. The internal forex market had an additional impact on the
prices of corporate bonds. It is the relatively high level of liquidity that restrained quotations from falling.
Then, in the period between April and September, the market of corporate and regional bonds was growing continuously. Trading activity increased significantly in April: the total trading volume in April amounted to nearly Rb 206 billion to exceed by 16.6% the corresponding parameter in March. The growth was partially caused by a significant improvement in the foreign economic situation and, in particular, the growth in the US market of government bonds. The outcomes of a meeting at the US Federal Reserve System showed that the US Government was ready to gradually increase the interest rates, which had a positive effect on market quotations. There were some internal factors that had an effect of positive movement of the market, namely a decline in the USD/ RUR exchange rate and still high level of liquidity in the banking sector.
In spite of an insignificant correction that took place as early as in May, the market continued to grow. In the beginning of the month, the US debt market remained stable, even after the news on a 0.25% increase in the interest rates, but the yield of government bonds increased shortly after the news on that the credit rating of General Motors and Ford had been downgraded to junk status. At the same time, however, the growth in the Russian Eurobonds, due to an agreement on early debt repayment between Russia and the Paris Club of Creditors, supported to a certain extent the market of corporate and regional bonds. With regard to internal factors, these were mostly negative, since a combination of deteriorated situation with liquidity and the USD gaining against the RUR stimulated sales of the instruments denominated in rubles.
In June, prices of most liquid series moved up and down, but the general trend was upward. The yield of the US Ten-Year Maturity Bonds varied in the range of 4.01-3.94% with the highest monthly peak being 4.13%. This was partially governed by a new increase in the interest rate in the United States and comments made by the US Federal Reserve System that the interest rates were very likely to be increased in the future. During the month, however, investors focused on the world forex market, where the USD lost drastically against the Euro, by an average of 4%, which was reflected in the internal forex market as well - the USD gained 2% against RUR in June. Such a violent fluctuations in the foreign exchange rate was an evidence of increasing foreign exchange risks for the investors that were interested in the instruments denominated in rubles, which couldn't but have an effect on quotations. There were some internal economic factors that are worth mentioning, namely high inflationary expectations caused by the revision of annual target figures (up to 10%), and deteriorated situation with liquidity.
During the entire Q3 of 2005, the market showed a sustained growth on most series. In July, investment activity slowed down as compared to June, and quotations of most liquid series grew moderately. The movement was governed by interaction of negative (growth of the US Treasury Bonds due to the information on the US GDP, which was found to be better than the forecast figures, thus increasing the likelihood of the interest rates to be raised, and the US dollar gained against the Russian Ruble in the first half of the month) and positive factors (stabilization of liquidity). In August, trading activity developed much better as compared to that in July. Quotations of most liquid series of bonds grew considerably due to several factors, namely the yield of US bonds reduced; Fitch upgraded the Russian's sovereign credit rating; early repayment by Russia of a share of its debt due to the Paris Club of Creditors; positive situation with liquidity; and the Russian Ruble gained against the US dollar. In September, again investment activity grew considerably on the market of corporate and regional bonds due to a drastic growth of quotations of most liquid series of bonds. The foreign economic environment slightly improved: the yield in the 130
US debt market grew up as a result of a new increase in the US interests rates, as well as threats concerning the impending Rita hurricane in the United States. The market was slightly supported by growth in quotations of the Russian Eurobonds due to the anticipated upgrade of the sovereign credit rating of the Russian Federation by Moody's after it was entered into the list of countries whose rating is to be revised. Not only did the excess of ruble liquidity support the secondary market, but also promote a successful placement of a series of issues in the primary market as well. The RUR/ USD exchange rate moved up and down, thus having no significant effect on investment activity.
In October, the upward trend that had been lasting for nearly six month gave way to downward trends in price movement. The fall of quotations was caused, first of all, by continuing increase in the yield of the US Treasury Bonds, as well as subsequent deterioration of the situation in the Russian Eurobond market. Further fall in the corporate and regional debt market was restricted by a fairly good liquidity in the banking sector as well as lack of explicit upward or downward trends in the RUR/ USD exchange rate. In November, the foreign economic situation slightly improved, but the US dollar gained against the Russian Ruble in the foreign exchange market following its rise in the world Forex Market. Additional problems with liquidity resulted in a slow fall of the quotations of most liquid series of bonds in November. In December, however, the market quotations became stable. The internal debt market regained on the price rise in the Russian Eurobonds after a decline in the yield of the US Tresury bonds. Investors considered positively the comments made by representatives of the US Federal Reserve System, due to completion of a cycle of interest rate rise. However, the growth was restrained by adverse affects of internal economic factors, i.e. still unstable situation with liquidity, and the Russian Ruble lost some points in favor of the US dollar.
In 2005, issuers became much more active in the primary market, though their behavior differed largely during the year. For example, the maximum volume of placements of corporate and regional bonds in the primary market was recorded in December to amount to nearly Rb 75,1 billion (as opposed to nearly Rb 27.93 billion in 2004), while the minimum one amounted to Rb 9.05 billion in August (as opposed to Rb 4.81 billion in 2004), let alone zero activity in the primary market in January 2004. The total volume of placement of corporate bonds amounted to nearly Rb 313 billion for the entire year of 2005 as opposed to Rb 194.87 billion in 2004. Hence one may find a substantial increase in primary offering in the market of corporate and regional debt.
Factors that Have an Effect on the Movements in the Russian Stock Market
In 2005, the Russian Stock Market was governed by a series of factors which conventionally can be broken down into the groups as follows :
• Internal politica situation;
• Relations with international financial organizations;
• Situation in the international financial markets;
• Situation in the world raw material markets (especially oil).
Each of the foregoing groups of factors had a different effect on the movement of different segements of the Russian financial market during the year of 2005. In spite of the fact that most of these factors have already been mentioned in the analysis of differnet segments of the Russian financial market, it is appropriate to focus on them несколько более подробно.
Internal political situation. While the year of 2004 was marked by the Russian business society as the year of tighter pressure on the Russian businesses by the Gov-
ernment and subsequent increase in political risks, in 2005 the situation improved to some extent. There were some negative factors in the previous year that are worth mentioning, namely termination of the court case against the YUKOS management, who were sentenced different terms of imprisonment; tax service authorities continued to exert pressure on the disgraced company; and tax claims were laid against several companies (TNK, LU-KOIL and some other companies) as a result of tax audits of their performance for the recent years.
However, all these negative events took place mostly during the first half of the year, while the second half of it was found to be quiet enough. Furthermore, the Russian Government took a series of measures which had a direct or indirect effect on investment activity. For example, the government settled the issue of uncertainty about increasing its share in the gas monopoly, i.e. the government purchased a block of shares for cash. Finally, in December, amendments were made to the law of gas supply, whereby allowing the Gazprom shares market to be liberalized.
In sprite of some reduction of political risks which resulted in a substantial growth in the Russian stock market, some steps of the Russian Government aimed at increasing its role in the economic life of this country cause certain concern. For example, that the Government strengthened its participation in the oil and gas sector after Gazprom purchased Sibneft at the value comparable to its market value, shortly after the YUKOS's main production asset - Yuganskneftegaz - had been sold with a considerable discount, is indicative of the fact that the Russian Government applied methods that are not supposed to be applied in a true market economy. All these steps, however, were taken against the background of huge revenues the country generated from export of energy sources and metals which could have been utilized to enhance structural and economic reforms and improve investment environment in Russia.
Relations with international financial organizations. Relations between Russia and international financial organizations developed successfully enough throughout the entire year, which depended largely upon a favorable macroeconomic situation in the country available over the last two years, and effective management of the external debt of Russia. For example, on 31 January 2005, Standard & Poor's upgraded the Russia's sovereign credit rating denominated in foreign currency from BB+ to BBB-. In August, Fitch upgraded the Russia's sovereign credit rating one step up, c BBB- to BBB. In October, another agency, - Moody's - upgraded the Russia's sovereign credit rating one step up to Baa2. As early as in December, Standard & Poor's again upgraded the Russia's sovereign credit rating from BBB- to BBB .
Another important event for the Russian bond market was a statement made by Lehman Brothers investment bank on that Fitch's credit ratings would be considered equal to those of Moody's and Standard&Poor's in entering securities into the listing of bonds traded under its index, thereby the Russian securities were listed for trading under the Lehman US Credit/Aggregate index, benchmark for the US funds with a total value of about $1.5 to 2 trillion US dollars .
In 2005, Russia followed the previously approved schedule to observe its debt commitments in full. In addition, last year, Russia managed to successfully repay a share of its external debt. In February, for example, Russian effected an early repayment of $3.3 billion US dollars as part of the debt due to the IMF, as well as repaid nearly 1.6 billion Euro as part of the principal and accrued interests due to the member-countries of the Paris Club of Creditors. Besides, during the first half of 2005, Russia conducted negotiations with the Paris Club of Creditors on early repayment of a share of its debt due to the latter. In spite of that the creditors rejected to discount the debt and demand a premium at the initial stage 132
of the negotiations, later on Russia managed to attain an interim agreement on repayment of $15 billion US dollars at par value in the period between July and August 2005 .
Situation in the international financial markets. The year of 2005 was characterized by a substantial improvement of the situation in the world stock markets. In particular, the US stock market indices demonstrated a mixed behavior in 2005. For example, while the Dow Jones fell by 11.93 points (-0.11%), the Nasdaq Composite gained 53.17 points (2.47%) by end-2005. A special emphasis should be paced on that volatility of the US stock market was generally comparable with that in the Russian stock market, which was mainly caused by reduced volatility of the latter. In 2005, the US stock market was mainly effected by extremely high oil prices which restrained the US economy growth and encouraged inflation to grow. While the economic growth rates caused no concern, the threat of growing inflation stimulated the federal authorities to revise the monetary policy's priorities, which resulted in multiple growth of the interest rate in the United States which reached 4.25% p. a. by year end. However, though the increase in the US interest rate had some shot-term effect on the market during the year, the decisions of the US Federal Reserve System always were predictable by inventors. Hence the effect of such increase was, at least partially, reflected in prices prior to a new increase. The statistical data on the US labor market and imbalance in trade were another essential factor which had a substantial effect on investors' behavior. All these factors together with the policy pursued by the US Federal Reserve System, had an effect on foreign exchange rates in the world Forex market and consequently made USD assets more attractive, or less. Finally, as before, financial performance results of US corporations were effected by the aforementioned factors, as well as the behavior of those who participated in the US stock market.
With regard to stock markets of other countries, in particular, the European stock indices grew at much faster rates than their US counterparts in general in 2005. The situation in developing countries was even better, whose stock markets' growth measured more than a dozen of per cent per year in 2005. As a result, the Morgan Stanley's aggregate stock market index in developing countries grew by nearly 30%.
In general, the developed markets had a greater effect on the Russian stock market either when there was no essential internal news, or oil prices were stable. On the contrary, when there were enough internal news available in the market from the both corporate and public sectors, this news has a greater effect than world markets' fluctuations. It is the policy of the US Federal Reserve System that was the sole factor considered by investors from any country, which could have a medium-term effect on market liquidity in these countries due to outflow of major US funds and institutional investors from these countries.
Situation in the world oil market. In 2005, the world oil market grew at very fast rates to become one of the key factors that allowed the Russian stock market to recover and grow reaching its historical peaks. It should suffice to mention, for example, that while prices varied around $45 US dollars per barrel as early as in the beginning of the year, oil prices hit $70 US dollars per barrel, even beyond, in the United States in the second half of the month.
During the year of 2005, a sharp rise in oil prices was effected by several traditional factors, which investors normally focus on, the data on oil and oil products stock in the United States, weather conditions on the territory of the country, level of activity of major funds conducting operations in the oil market, as well as OPEC countries position concerning the market conditions, as well as a series of factors which were specific with regard to the previous year.
Fig. 27. Dow Jones and NASDAQ in 2005 (December 31, 2004 = 100%)
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For example, in February, the market growth was driven by a forecast made by the International Energy Agency, in which production growth rates of independent producers were revised to slow down. Statements made by major investments companies and banks, such as Goldman Sachs, also had an impact on price movement: in April, experts made an analytical report, in which they forecasted that Brent oil would cost around $105 US dollars per barrel by end 2007 .
In July, oil prices depended largely on weather conditions in the Gulf of Mexico. Two hurricanes, Syndy and Dennis, interfered with oil production to a certain extent - up to 12% of shelf-based oil platforms had to be shut down, while gas production and refining used to drop down to 8% in some of those days. As early as in August, the Hurricane Katrina, which caused substantial damages in the United States and a drastic fall in oil production in the Gulf of Mexico, resulted in a new rise oil prices. Furthermore, the aftermaths of these acts of God were far more devastated than it was predicted. As result, the head of the International Energy Agency expressed his concern about the possibility of a large-scale energy crisis caused by the Hurricane Katrina, if the aftermaths would have an adverse affect on oil product manufacturing, especially on the threshold of another impending tropical hurricane, Rita, which was approaching towards the United States in September. Late in the year, prices dropped slightly to lower levels as compared to the maximum peaks reached in August. However, these levels still remained high enough.
Hence, the situation in the world oil market was extremely favorable for Russia during the entire year of 2005. Oil companies did the best they could to increase oil production and export by any possible means, and consequently increase their net profit. Given the situation, investors found shares of Russian companies quite attractive, thereby keeping up fairly high prices. It should be noted, however, that high oil prices may have a potential negative affect on the world market movement. This may be caused by, firstly, possible restriction of growth rates of the world economy, which may result in substantial redistribu-
tion of funds between the markets in different countries, especially through outflow of funds from emerging markets. Secondly, the year of 2005 demonstrated that high oil prices are unable to boost inflation substantially in countries - net importers - most of which are leaders in the world economy (above all in the United States). Tightening of the monetary policy in the United States and other countries above all may have an adverse affect on emerging markets.
Corporate News
Some of the Russian corporations improved significantly their positions after having been assigned long-term credit ratings or revised for upgrade.
For example, early in February, OJSC Rostelecom announced that Standard & Poor's, the international credit rating agency, decided to upgrade its long-term credit rating from B to В+, Outlook Stable. Standard & Poor's reported that the upgrade reflected a reduction of company's financial risks of the company, strengthened market positions, as well as improved financial performance. According to Standard & Poor's, OJSC Rostelecom enhanced is creditworthiness through efficient measures taken by management in order to reduce company's costs and retain leading market positions. The "Outlook Stable" reflects anticipation that the company would further improve its capital structure, as well as increase its idle cash in the short-and long-term periods.
On April 26, 2005, Moody's Investors Service, the international credit rating agency, upgraded the basic rating of OJSC LUKOIL from Ba2 to Ba1. At the same time, Moody's upgraded the OJSC LUKOIL's rating of the issuer on unsecured borrowings from Ba3 to Ba2. По всем рейтингам прогноз стабильный. According to Moody's, the upgrade mainly reflected LUKOIL's very good financial performance results and, in particular, a substantial growth in operational efficiency, growth in EBITDA (Earnings before Interest, Taxation, Depreciation and Amortization) over the first 9 months in 2004, improved structure of company's credit portfolio, as well as enhanced corporate management, especially after ConocoPhillips purchased a 7.6 per cent interest in LUKOIL in September 2004 and further increased its interest up to 10% in January 2005 .
On August 4, 2005, Fitch Ratings, the international credit rating agency, upgraded the long-term rating of Sberbank of Russia from the status ВВВ- to ВВВ shortly after the Russia's sovereign long-term rating denominated in foreign currency was upgraded. The Outlook for Sberbank of Russia remained Stable. At the same time, the short-term rating of the bank was confirmed F3, and support rating 2. The priority unsecured Eurobonds, 1 billion US dollars with maturity in 2006, issued by Sberbank of Russia were upgraded from ВВВ- to «ВВВ». The subordinated debentures, 1 billion US dollars with maturity in 2015, of the bank was upgraded from ВВ+ to ВВВ-.
On 10 August, 2005, Standard & Poor's, the international credit agency, announced an upgrade of the long-term credit rating of GMK Norilsky Nickel from ВВ to ВВ+. The national scale credit rating was upgraded from ruAA to ruAA+, Outlook Stable. According to the report made by Standard & Poor's, "The assigned rating reflects the leading position of GMK Norilsky Nickel in the world market of nickel, palladium, platinum and copper, a unique resource base and stable financial situation of the company. While the situation with the business environment in Russia is the key constraint for upgrading credit ratings of Russian companies, GMK Norilsky Nickel has demonstrated high financial and operational performance results, and positioned itself as one of the straightest corporate borrowers in this country". The Outlook Stable includes Standard & Poor's assessment of the gold-mining assets on allocation program considered by Norilsky Nickel, which is, accord-
ing to the rating agency, unlikely to have a significant effect on diversification of the group and result in a considerable cash outflow.
Finally, on December 21, 2005, Fitch Ratings, the credit rating agency, announced an upgrade of the credit rating of the company. Norilsky Nickel был was assigned ВВВ-long-term credit rating denominated in foreign currency; Outlook Stable. Hence, at present, Norilsky Nickel is the first and the sole Russian company which has ever been assigned an international rating with the investment status.
In the period between October and December 2005, most companies published their financial performance statements for 2005. The following companies should be mentioned.
On August 2, 2005, OJSC Rostelecom disclosed the results of its performance in the first half of 2005. For example, its earnings totaled Rb 19 501.4 million in the first half of 2005 to grow by 8.3% year on year. The EBITDA increased by 5.6% year on year to Rb 7 735.5 million. Profitability amounted to 39.7% in the first half of 2005, according to EBITDA. As a result, net profit net profit in the first half of 2005 amounted to Rb 5 661.0 million to increase by 28.2% year on year.
On September 20, 2005, LUKOIL published its consolidated financial statement for the first half of 2005 prepared in accordance with the US generally accepted accounting principles (US GAAP). According to the results disclosed for in the first half of 2005, net profit of the company amounted to $2 590 million US dollars to grow by 52.7% year on year. The EBITDA parameter reached $4 298 million US dollars to grow 45% year on year. Sales revenues grew up to $24 049 million US dollars to increase by 66.1% year on year. In addition, total tax expenses exceeded $7 billion US dollars to double the level of 2004. Cost per unit of oil production grew by 6.3% year on year to $2.69 US dollars per barrel.
In October, OJSC Sibneft published its financial performance statement for the first half of 2005 . According to the financial statement prepared in compliance with the US GAAP on October 4, 2005, net profit of Sibneft grew by 44% to $1.42 billion US dollars as compared to $988 million US dollars in the corresponding period of 2004. The company's profit growth was governed by the growth in prices of oil and oil products in the both international and internal markets, in spite of growth of electric power costs, transport costs, taxes and export duties. The revenue of the company increased by 43% year on year to $5.73 billion US dollars. The EBITDA parameter in the first half of 2005 amounted to $1.94 billion US dollars, which grew by 29% as compared to $1.50 billion US dollars in 2004. As of 30 June, 2005, the value of credit portfolio of Sibneft group amounted to был равен $1.50 billion US dollars.
On November 16, 2005, a meeting was held in Sberbank of Russia, in which the Principle Deputy Chairwoman of the Board of Sberbank of Russia А.К. Alioshkina made a report summarizing performance of the bank over the period of 9 months in 2005 and making a forecast for 2005 . According to the presented data on the foregoing period, net-assets of Sberbank of Russia grew by 20% to Rb 2.4 trillion. Balance-sheet profit amounted to Rb 63.3 billion, which was by 20% above the corresponding parameter over the entire year of 2004. Net profit totaled Rb 48.3 billion, which was by 11% above the corresponding parameter over the entire year of 2004. Net worth grew by 38% to Rb 239.3 billion. Return on assets and capital increased up to 3.0% and 29.5% respectively. High financial performance data resulted in heavy demand for the shares issued by Sberbank of Russia in the market: within 9 months of the current year, common shares of the bank grew more than 1.9 times in value to $960 US dollars per share, while preferred shares grew more than 2.7 times to $13.6 US dollars (the RTS index grew by more than 1.6 times
over that period). As a result, market capitalization of the bank increased from $9.7 billion to $18.9 billion US dollars.
On November 25, 2005, OJSC Gazprom published its non-audited interim consolidated financial statement for the first half of 2005 prepared in accordance with the International Financial Reporting Standards. Within six months of 2005, sales proceeds (less excise, VAT and customs duties) increased 30%, or by Rb 139 759 million, year on year, to Rb 611 233 million. Operating expenses over the same period grew by 15 %, or by Rb 53 106 million, year on year to Rb 402 178 million. Return on investments of the OJSC Gazprom's shareholders totaled Rb 152810 million in the first half of 2005, which grew or 66%, or by Rb 60552 million, year on year.
In 2005, several Russian companies continued to purchase new assets, including foreign ones, as well as establish long-tem relations allowing them to expand and enhance efficiency of their business. In addition, some of these companies implemented business reorganization and restructuring.
For example, late in March, an information emerged that LUKOIL-Finlandia (a company incorporated in LUKOIL Group) had entered into a share purchase agreement with Finnish companies Oy Teboil Ab and Suomen Petrooli Oy. As a result, the former gained a sole control over these two companies. The value of the transaction was $160 million US dollars. The transaction was approved by the Eropean Commission. The core business of Oy Teboil Ab and Suomen Petrooli Oy is to manage a network embracing 289 gas filing stations and 132 D-points (free standing ground based reservoirs and diesel filling stations), wholesale selling of oil products, as well as lubricant production and sale. By having entered into this transaction, LUKOIL managed to enter the Finnish market of ultimate oil product consumption. The company intends to generate additional profit by supplying to Finland pollution-safe low-sulfur diesel fuel EN-590 which is produced by a new hydro-creking unit, Perm Oil Refinery. The capacity of Oy Teboil Ab and Suomen Petrooli Oy in the Finnish furnace oil market will also allow LUKOIL to expect additional export of fuel oil and gas-oil produced by Russian Oil Refinary companies.
On April 15, 2005, the Board of Directors of GMK Norilsky Nickel made a decision to approve an action program which provides for allocation of Russian gold-mining assets consolidated under CJSC Polyus and its subsidiaries, as well as a 20% interest held by the company in Gold Fields Limited. The reorganization was expected to result in establishment of a new large independent gold-mining company which would have a potential of further growth and substantial assets in Russia. A preliminary stage of reorganization became consolidation of all gold-mining assets of the Company (including a 20% interest in Gold Fields Limited) under CJSC Polyus. The reorganization of GMK Norilsky Nickel was consulted by Deutsche Bank AG London (financial advisor) and Debevoise & Plimpton LLP (legal advisor). In the context of the reorganization, the management of GMK Norilsky Nickel made a decision to increase the authorized capital of CJSC Polyus by closed subscription to additional common nominal uncertified shares. Additional issuance of CJSC Polyus's shares provided for placement of common uncertified shares at nominal value of Rb 400 each to the amount of 126 shares at a value of Rb 290609959 per share. The revenues generated from placement of shares were panned to allocate to CJSC Polyus for consolidation of a 20% block of shares of Gold Fields Limited, South-African gold-mining company in compliance with a decision made by the Board of Directors of GMK Norilsky Nickel on allocation of gold-mining assets .
In July 2005, LUKOIL and ConocoPhilips established a joint venture, OOO Narian-marneftegaz, intended to develop hydrocarbons at Timano-Pechiorsky oil & gas-bearing area in the North European Russia. ConocoPhilips holds 30% of economic share in the
joint venture. The value of purchase of the foregoing share amounted to about $500 million US dollars. The joint venture will be managed by LUKOIL and ConocoPhilips on a basis of parity. Top oil production volume of the joint venture is expected to reach nearly 200 000 barrels daily. To be delivered to international markets, oil will be shipped to oil tankers through a LUKOIL's terminal located at Varandei town on the cost of the Barents Sea (Nenets Autonomus Area). In 2007, LUKOIL plans to implement a project on increase of the current capacity of the terminal up to 240 000 barrels daily which ConocoPhilips participating in designing and financing of the project. The joint venture was established as part of a large-scale strategic alliance entered into between ConocoPhilips and LUKOIL on September 29, 2004, under which ConocoPhilips purchased more than 11% common shares of LUKOIL.
Shortly after that, in October 2005, LUKOIL, entered through its 100% subsidiary LUKOIL Finance Limited (Gibraltar) into a loan agreement at a value of $2 billion US dollars with a six-month maturity in order to purchase a controlling interest of Nelson Resources Limited. This is an unsecured loan extended at Libor + 0.5% p. a. Citigroup is the sole arranger, book runner and creditor on this loan. The warrantor is represented by OJSC LUKOIL. Within six months, LUKOIL refinances the loan by syndicated loans. Nelson Resources Limited takes part in the projects on hydrocarbons production in the Western Region of the Republic of Kazakhstan, Akibekmola, Kozhasai, Karakuduk, Sevenuye Buz-chi and Arman fields. Nelson Resources Limited is a cooperator in most of the projects. In addition, the company is a party of an option agreement in respect of two geological exploration blocks in the Kazhakh sector of the Caspian Sea, namely Yuzhny Zhambai and Yuzhnoye Zaburuniye. Proved and undiscovered deposits of hydrocarbons at Nelson Resources Limited составляют 269.6 million barrels.
On October 21, 2005, 72.663% of OJSC Sibneft shares were transferred to by affiliated companies of Millhouse Capital to Gazprom Finance B.V. (100% subsidiary of OJSC Gazprom) in accordance with the terms and conditions of a share purchase agreement entered into September 28, 2005. To purchase Sibneft's shares, Gazprom borrowed $13.079 billion US dollars from a consortium of international banks. The consortium comprised Dresdner Kleinwort Wasserstein (DrKW), ABN AMRO, Citigroup, Credit Suisse First Boston (CSFB), Goldman Sachs and Morgan Stanley. Prior to that, Gazprom purchased a 3.016% interest in Sibneft from JS Gazprombank (CJSC). Hence Gazprom gains control over a 75.679% interest in OJSC Sibneft.
In addition, OJSC Gazprom received an expert report prepared by the London branch of Doutche Bank AG in respect of a purchase value of 72.663% shares of OJSC Sibneft, $13.079 billion US dollars, by Gazprom Finance B.V., the affiliated company of OJSC Gazprom. Doutche Bank conducted an expertise to come to a decision that a premium of 13.079 billion US dollars for 72.663% shares of OJSC Sibneft is reasonable for OJSC Gazprom from the financial point of view. The final amount was therefore reduced against the initial amount of 13.091 billion US dollars as a result of additional negotiations between the purchaser and the sellers.
In addition, in December 2005, Gazprom also purchased 22.43% of interest in OJSC Silovyie Machiny on the basis of a decision made by the Board of Directors on October 4, 2005. The value of the transaction was $101.4 million US dollars with the upper level of the market value of $107 million US dollars as determined by KPMG, an independent appraiser and approved by the Board of Directors. Hence, considering the interest held by OJSC Le-nenergo in OJSC Silovyie Machiny, holding company RAO "UES of Russia" accumulated a blocking package (25% + 1 share) of shares of the concern.
Last year, domestic companies pursued quite an active policy aimed at additional borrowing, including foreign financial markets, as well as strengthened their position in the world capital markets.
For example, on January 24, 2005, Sibneft announced a change in the proportion of its own shares as per American Depository Receipt (ADR). Since January 24, 2005, one ADR became equal to 5 Sibneft common shares. Prior to that, one ADR was equal to 10 common shares of the company. Hence, the number of ADR doubled, and their holders received one additional ADR per share held. The company took this measure to increase liquidity of its shares traded in international markets. At present, Sibneft ADRs included in the first-level listing are traded in the Frankfurt and Berlin Stock Exchanges.
At the end of January 2005, GMK Norilsky Nickel reported the results of the bids made by its shareholders in connection with purchase by the company of its outstanding shares in accordance with a decision of the Board of Directors of GMK Norilsky Nickel dated December 2, 2004. On December 3, 2004, GMK Norilsky Nickel announced that it intended to purchase up to 12 500 000 its shares (5.8% of the authorized capital of the company) to the amount of up to Rb 21 billion at Rb 1 680 per share. A total of 372 binds were made by the shareholders to CJSC National Registration Company in connection with selling of the shares they held, of which 207 bids were made by shareholders represented by legal entities and 165 ones by those represented by physical bodies. Number of the shares specified in the applications made by the shareholders totaled 59761360, of which 57965450 shares related to the shareholders representing legal entities and 1 795 910 shares related to those represented by physical bodies. Since the total amount of shares which were offered for sale to the company was 59761360 with an excess of 12 500 000 shares, the final number of shares to be purchased by the company from a shareholder was determined in a pro rata basis.
During 2005, OJSC Gazprom placed successfully several issues of bonds. For example, on February 3, 2005, it placed A3 series of three-year maturity bonds denominated in rubles to the amount of Rb 10 billion, at par value of Rb 1000. The coupon rate, payable every 180 day, was determined at 4% of the par value. The placement was determined to the amount of 100.69% of the nominal value by an auction held in the MICEX (Moscow Interbank Currency Exchange), which corresponds to effective yield to maturity of 8% p. a. Investors made applications to the amount of Rb 15.88 billion. Later on, in summer 2005 (on August 11), OJSC Gazprom placed A6 series of four-year maturity bonds denominated in rubles d объеме Rb 5 billion, at par value of Rb 1000. The coupon rate, payable every 182 day, was determined at 6.95% p. a. by an auction held in the MICEX. Investors made 158 bids to the amount of more than Rb 12 billion. Forty five bids were accepted during the auction. The securities were placed with a record-breaking low yield as compared to that corporate bonds placed for the similar periods. Finally, on October 12, 2005, OJSC Gazprom placed A5 series of three-year maturity bonds denominated in rubles to the amount of 5 billion at par value of Rb 1000. The coupon rate, payable every 182 day, was determined 7.58% p. a. by an auction held in the Moscow Interbank Currency Exchange. Investors made 120 bids to the amount over Rb 9 billion. Seventy three bids were accepted at the auction. The funds borrowed during the placement were planned to finance the investments required for maintaining current production facilities, implementing new promising projects, as well as refinancing a short-term debt and optimizing the debt portfolio structure.
On October 21, 2005 RAO "UES of Russia" redeemed its second series of interest bearing bonds in time and in full to the amount of Rb 3 billion, as well as paid a total of Rb 225.63 million of the yield for the sixth coupon period. The coupon yield totaled Rb 75.21
payable per bond at par value of Rb 1000. Trast investment bank is the paying agent and and underwriter of the issue. The bonds had six coupons payable at an interest of 15% p. a. The previous five coupons with a total volume of Rb 1.12 billion were also paid in time and in full . As of October 22, 2003, RAO "UES of Russia" made its annual offer which provided for early retirement of bonds at 102.36% of the par value (Rb 1023.6 per share), but none of the investors executed this right. The decision on issuance of bonds to the amount of Rb 3 billion was made at a meeting of the Board of Directors of RAO "UES of Russia" on June 21, 2002. The bonds were placed on October 22, 2002 in the MICEX. The report of the outcomes of the placement was registeed with the Federal Financial Markets Service on November 19, 2002. The maturity of the securities is 1095 days. The funds borrowed through the placement of RAO "UES of Russia" bonds were intended to finance the day to day operations.
It is well known that a sound dividend policy is one of the means to improve attractiveness of shares, which should be aimed at improving wellbeing of the shareholders.
For example, a general meeting of the shareholders of OJSC Gazprom was held on June 24, 2005, which approved the annual statement and balance sheet of OJSC Gazprom for the year of 2004, including an asset and liabilities report of the Company. Decisions on profit allocation according to the results of the financial year were made as well, including annual dividend payout. In particular, the meeting approved the size of dividends -Rb 1.19 per share - on the basis of performance results of OJSC Gazprom in 2004. This was the biggest size of dividends that has ever been paid in the history of the company. The amount of allocated dividends totaled Rb 28 171.5 million or 17.5% of net profit as a result of performance in 2004. The final date of dividend payout was set on 31 December 2005 . Those decisions were made in line with the recommendations given by the Board of Directors.
On June 25, 2005, OJSC Rostelecom announced the results of its annual general meeting of shareholders which was held on June 25, 2005 . The meeting approved annual statement, annual balance sheet, including the asset and liabilities account of OJSC Rostelecom, allocation of profit and assets and losses according to the results of the financial year reported on (2004). The meeting approved size of dividends, namely Rb 2.9738 per preferred share, and Rb 1.4593 per common share. The amount of dividends on preferred and common shares totaled Rb 722.1 million and Rb 1 063.4 million respectively, which accounted for 10.0% and 14.7% respectively against the total amount of net profit in accordance with the Russian Accounting Standards (RAS) .
In July 2005, the balance was stroke of the annual general meeting of the shareholders of RAO "UES of Russia", which was held on June 29, 2005. The company's dividend policy was described on the basis of the performance results attained in 2004. It was decided to allocate dividends for 2004 as follows: common shares - Rb 0.0559 per share, which is equal to Rb 2294230816.18; preferred shares - Rb 0.2233 per share, which is equal to Rb 463380239.58.
An extraordinary meeting of the OJSC NGK Slavneft shareholders, which was held on September 20, 2005, approved dividend payout on the basis of the company's performance within the first half of 2005 . The size of dividends totaled Rb 7 654 323 180 or Rb 1.61 per each common share at par value of 0.1 kopeks.
