15Section 2. Monetary and Budgetary Spheres
2.1. Monetary and Credit Policy
The major development in the Russian monetary and credit policy in the year of 2007 was an explicit inflation acceleration in autum, as well as tensed situation in interbanking credit market in August-November. As of 2007 results, for the first time upon 1998, when the RF economy was struck with a vast-scale financial crisis, the CPI exceeded the relevant indicator of preceding year. It is worth noting, that there were no signs of such development at the beginning of the year, and only in autumn it became clear that the downward trend of inflation was broken. Moreover, in August the attributes of instability were noted in the world credit market, provoked by the crisis in the US mortgage securities. Hereinafter we will try to analyse the grounds of those developments, review the trends and interrelations at the national monetary market, the interbanking credit market, inflation processes, and outline major developments in the RF monetary and credit sphere in 2007.
2.1.1. Monetary Market
In 2006 a considerable growth of gold and foreign currency reserves was observed in the RF (See Fig. 1). The basic factors of growth were the peak prices for the major Russian export commodities, primarily oil prices, as well as massive capital inflow. Some reduction of reserves (as per results of the month) was noticed only in August and was caused by the outflow of capital from domestic market due to the global financial crisis. By the end of the year the volume of gold and foreign currency reserves has reached an absolute peak record in the history of Russia and amounted to USD 476.4 bln (+56.8 per cent within 2007).
However, in order to restrain the accelerated stabilization of the national currenc exchange rate, the Bank of Russia was compelled to buy the foreign currency flowing into the country, thereby increasing monetary supply. Let us take a closer look at the monetary supply dynamics.
In 2007 the monetary base (in a broad definition1) increased by RUR 1.4 trillion and reached RUR 5.5 trillion (+33.7 per cent). It should be reminded, that as per results of the year of 2006, that indicator has grown by 41.4 per cent. The monetary base volume in broad definition as of January 1, 2008 was RUR 4.1 trillion (See Table 1). The cash in circulation volume, including the cash balances of credit institutions, as of January 1, 2008 was RUR 4.1 trillion (+34.5 per cent as compared with January1, 2007), the correspondent accounts of credit institutions with the Bank of Russia made RUR 802.2 bln (+25.7 per cent), mandatory reserves -RUR 221.6 bln (+ 0.2 per cent), credit organizations' deposits with the Bank of Russia - RUR 270.3 bln (1.8 times growth), the value of the Bank of Russia's bonds held by credit institutions made RUR 100.7 bln (-2.3 per cent).
1 Monetary base in broad definition reflects the Bank of Russia monetary and credit liabilities in national currency, which serve as a basis of money supply growth. The RF monetary base in a broad definition, 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, reserve funds for foreign currency operations, as well as other; liabilities of the Bank of Russia under operations with credit organizations in national currency of the Russian Federation.
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"Monetary base in narrow definition (bln rubles)
■International reserves
Source: RF Central Bank.
Fig. 1. Dynamics of Monetary Base and International Reserves in 2006-2007
In 2007 the growth of cash in circulation (by 34.5 per cent at the background of sustained level of mandatory reserves (+0.2 per cent) have resulted in extension of the monetary base in narrow definition (cash + mandatory reserves) by 37.5 per cent (See Fig. 1). At the same time, the gold and foreign currency reserves of the RF Central Bank also grew within the year by 56.8 per cent and amounted, as of January 1, 2008 to USD 476.4 bln. A greater portion of the liquidity inflow to the domestic market was accumulated in the RF Stabilization Fund, which volume as of January 1, 2007 amounted to RUR 3849.1 bln. (USD 156.8 bln, 11.8 per cent of GDP, i.e., the growth was RUR 1502.2 bln against January 1, 2007). On January 1, 2007 the volume of Stabilization Fund accounted to RUR 2346.9 bln (USD 89.1 bln, 8.7 per cent of GDP). Monetary supply M2 in national terms has grown in 2006 by 47.5 per cent and made as of January 1, 2008 RUR 13272.1 bln, or 40.2 per cent of GDP (as of January1, 2007 the monetary indicator M2 was equal to RUR 8995.8 bln (33.8 per cent of GDP).
Therefore, as of results of the year of 2007, the growth rate of monetary supply was rather high. However, it could be still higher in case there were no shortage of liquidity in interbanking credit market, observed in August - November. Thus, in June the bank deposits with the RF Central Bank exceeded RUR 1.2 trillion, while the value of the Bank of Russia's bonds held by commercial banks made RUR 350 bln. In December, due to the inflow of the budget assets, addressed to development institutions to the banking system, the tensed situation in the interbanking credit marked got improved, though the level of excessive reserves in the banking sphere has not returned to the peak values, observed in summer.
2 Monetary base in a narrow definition is a monetary instrument (an indicator of monetary supply volume), which is fully controlled by the RF Central Bank. The Monetary base in narrow definition includes the cash in circulation, issued by the Bank of Russia (and the balance on the accounts of credit organizations), balances on the accounts of mandatory reserves of the funds in the national currency attracted by credit institutions in national currency, deposited with the Bank of Russia.
Table 1
Dynamics in Monetary Base in Broad Definition in 2007 (RUR bln)
01.01.2007 01.04.2007 01.07.2007 01.10.2007 01.01.2008
Monetary base (in broad definition) 4,121.60 4,210.2 5,139.1 4,587.2 5,513.3
Including:
Cash in circulation with regard to balances in 3,062.10 2,942.6 3,254.6 3,470.2 4,118.6
credit organizations
Correspondence accounts of credit organizations 638.1 518.1 528.7 576.3 802.2
of the Bank of Russia
Mandatory reserves 221.1 209.6 244.8 318.8 221.6
Deposits of credit organizations in the Bank of 98.1 245.8 758.6 72.2 270.3
Russia
Securities of the Bank of Russia in credit organi- 102.2 294.2 352.4 149.6 100.7
zations
Reserve funds in foreign currency, deposited with the Bank of Russia
Source: RF Central Bank.
It is worth noting, that the extension of monetary supply was based largely on accelerated growth of budgetary expenses. However, with regard to relatively insignificant monetiza-tion of the RF GDP as compared with other highly developed and developing countries, the growing monetary demand in the RF economy required an accelerated monetary offer as compared with prices. In other words, in case the lower level of budget expenditures, apparently, the Bank of Russia would extend the monetary base.
To assess the success of efforts taken by monetary and financial institutions with the aim to increase liquidity sterilization, an analysis is made of the correlation between monetary demand and supply3. The dynamics in monetary demand and supply is shown in Fig. 2.
One can note, that within 2007 monetary supply was exceeding the demand for money, which can cause excessive inflation pressure in 2008, caused by a delayed impact of changes in the monetary supply over the inflation processes. In our estimates, the lag of the monetary supply changes impact on consumer price index is one-two calendar quarters4.
It should be also noted, that despite the increased monetary supply, the money multiplier in the RF remains at a low level as compared with the countries of Eastern Europe, where, as a rule, its index value considerably exceeds 3. Against this background, the index value of 2.6, achieved by late 2007, appears rather insignificant (See Fig. 3). Herewith, since mid-2004, the multiplier is characterized by an upgrading trend, reflecting the gradual development of the RF banking sphere. Up to mid-2004 the multiplier' value was varying within the range of 1.5-1.9.
3 We assess the demand for money equation of the type Mt = n + aY + aAp + aJ + £
GDP t t 3 t
where Mt - money supply M2, GDPt - nominal GDP, value, Yt - GDP volume in prices of 1995, Apt - consumer price index, t - time. The assessment was based on the quarterly data of the years 1999-2006 with no regard to seasonal data. The resulting residual values can be interpreted as excess of money supply, as the left par of equation shows the actual money supply and with the help of indicators of the right part the demand for money can be estimated.
4 Ref: "Some Approaches to Economic Indicators' Estimates", published by IET, Section 3.2.2, the CPI No. 89P, M.: IET, 2005.
Source: RF Central Bank, IET estimates.
Fig. 2. Dynamics of Demand for Monetary and Monetary Supply (Money Aggregate M2) in Quarter IV, 2007
Source: RF Central Bank, IET estimates.
Fig. 3. Money Multiplier in the RF in 2002-2007
Therefore, basing on the obtained results of the estimates, the increased monetary supply, provoked by the extensive purchases of foreign currency by the RF Central Bank, was
73
exceeding the demand for money in 2007. In our view, under those conditions further slowdown of the inflation base rate will be rather difficult, especially in view of the RF GDP low monetization ans accelerated monetary demand growth. Let us review the inflation processes in detail and try to detect non-monetary inflation factors in the RF.
2.1.2. Inflation Processes
Early 2007 saw explicit acceleration in the rate of inflation (Fig. 4). As a result, there were expectations to stay within the threshold of 8 per cent, estimated by the government. However, as early as in April, the CPI has exceeded the estimates and in September an expressed upsurge of inflation happened, bringing at risk the medium-term estimates. As of the year results, CPI made 11.9 per cent. We are going to take a closer look at the dynamics of inflation rates throughout the year.
Source: RF Statistic Service.
Fig. 4. Dynamics of CPI in the RF in 2006-2007
In the category of food products prices rose by 15.6 per cent (8.7 per cent in 2006) (see Table 2). Thus, for the first time since 1999 food products made the greatest contribution to the growth of the annual CPI: in the preceding few years, the fastest growth was observed in commercial public services. Within January-December 2007 the basic contribution in food prices upsurge was made by sunflower oil (+52.3 per cent), butter (+40.3 per cent), milk and dairy products (+30.4 per cent), cereals and beans (+24.7 per cent), pasta (+23.6 per cent), bread and bakery products (+22.4 per cent), as well as fruit and vegetables (+22.2 per cent). Herewith, downgrading in prices was noted in 2007 for granulated sugar (-4.3 per cent). Commercial public services went up by 13.3 per cent within the year (against 13.9per centin
2006). For the twelve months of 2007, the outmost growth in prices was observed in fitness and sports (+17.5 per cent), health resorts services (+15.6 per cent), education (+17.5 per cent), hotels and recreational services (+15.6per cent), education (+15.4per cent), services of cultural organisations (+ 14.5 per cent), utilities (+14.4 per cent). In general, in the twelve months non-food items prices have grown on average by 6.5 per cent (as compared with the 12 months of 2006, when that growth made 6 per cent). In January-December the utmost growth took place in prices for construction materials (+16.2 per cent) and gasoline (+8.5 per cent), whereas prices for audio-video items were downgraded within the year by 1.2 per cent on average. The growth of basic consumer price index5 amounted to 11per cent in 2007 (versus 7.8 in the relevant period of 2006).
Therefore, the basic reasons of expressed inflation as per 2006 results was the rapid upsurge of food products prices, construction materials, gasoline and a number of commercial public services.
As one can see from Table 2, the core inflation element in 2004-2007 was the growth of tariffs for housing utilities and pre-school education: their prices within that period have grown more than twice. The next largest contribution to the overall inflation was made by prices for the services of cultural organisations (+86.8 per cent) and gasoline (+83 per cent). Rapid growth was noted in public transport prices (+77.3 per cent), milk and dairy products (+76.7 per cent) and butter (+73.2 per cent).
A review of the dynamics in prices and charges for the commodities and services, provided by monopolies in natural resources (electricity, gas), as well as freight services in 20022007 shows that in the period under review the highest rates of growth were noted in prices for gas and freight services. The rate of electricity tariffs growth in 2002-2006 was only slightly higher than the growth rate of consumer prices, but in 2007 it has reached 14,6 per cent over January-November, while the CPI for the same period was at the level of 10.7 per cent.
It is worth mentioning that in 2008, the Central Bank of Russia is planning to reduce the inflation rate to the level of 6-7 per cent. This task seems to be quite unrealistic in view of the significant acceleration of inflation in the last six months of 2007 and excessive budget expenditures, planned for 2008. According to the IET model forecast, the CPI in 2008 should make 10-12 per cent.
Table 2
Yearly Price Growth Rates as per Types of Goods and Services in 2004-2007 (% per year)
2004 2005 2006 2007 2004-2007
1 2 3 4 5 6
CPI 11.7 10.9 9.0 11.9 51.1
Foodstuffs 12.3 9.6 8.7 15.6 54.7
Milk and dairy products 12.8 10.5 8.7 30.4 76.7
Butter 6.8 8.2 6.8 40.3 73.2
Bread and bakery products 16.7 3 11.1 22.4 63.5
5 Basic index of consumer prices is an indicator of the inflation level without regard to seasonal price reduction (fruit and vegetable products) and to administrative measures (tariffs for government-regulated services, etc.). It is estimated by the RF Statistics Service.
Table 2 (continued)
1 2 3 4 5 6
Meat and poultry 19.6 18.6 5.9 8.4 62.8
Sunflower oil 2.1 2.1 -1.2 52.3 56.9
Grits and beans 11.6 0.2 12.1 24.7 56.3
Pasta products 14.6 1.9 4.7 23.6 51.1
Fish and sea food 11.5 12.7 7.8 9 47.7
Non-food products 7.4 6.4 6.0 6.5 29
Petrol 31.3 15.8 10.9 8.5 83
Construction materials 8.4 9.1 11.5 16.2 53.2
Commercial services 17.7 21 13.9 13.3 83.8
Pre-school education 21.6 32.1 28.5 11.8 130.8
Housing utilities 23.5 32.7 17.9 14 120.3
Culture organizations services 19.9 17.7 15.6 14.5 86.8
Public transportation 18 15.8 14.2 13.6 77.3
Health resort services 12.8 11.2 15.2 15.6 67
Source: RF Statistical Service.
At the end of this section, let us compare the growth rates of consumer prices in the RF and other CIS countries (See Table 3).
Table 3
Indices of Consumer Price Growth in CIS in 2000-2006,%
2000 2001 2002 2003 2004 2005 2006 2007
Azerbaijan 2 2 3 2 7 10 8 16.7
Armenia -1 3 1 5 7 1 3 4.4
Belarus 169 61 43 28 18 10 7 8.4
Georgia 4 5 6 5 6 8 9 9.2
Kazakstan 13 8 6 6 7 8 9 10.8
Kyrgyzstan 19 7 2 3 4 4 6 10.2
Moldova 31 10 5 12 12 12 13 12.3
Russia 20 19 15 12 12 11 9 11.9
Tadjikistan 24 37 10 17 7 8 12 21.5
Ukraine 28 12 1 5 9 14 9 12.8
Source: CIS Interstate Statistical Committee. (http://www.cisstat.com/).
One can notice that the inflation rate in the RF is still high even in comparison with other CIS countries. As mentioned above, the reasons for sustained high rates of consumer prices in the RF might be both, high growth rates of monetary supply (See Fig. 2), caused by the trend to maintain a stable rouble rate and non-monetary factors, such as high market monopolization, accelerated growth of food products prices, a as well as other reasons, not quite clear at this point.
2.1.3. State of Balance of Payments6
The RF stable situation with the balance of payments in 2007 as in years before was supported largely due to the peak volumes of the Russian main exports, first and foremost its fuel and energy resources. However, for the first time since 2002, positive balance of trade and balance of payments have been reduced by 7.6 per cent and 18.7 per cent, accprdingly. At the background of growing prices for energy resources, the Russian export growth has exceeded 16 per cent.
However, the rates of export sales growth have been reduced by one third as compared with the year of 2006, which was based on some decline of oil prices in early 2007. At the same time, the RF Central Bank has been accumulating gold and foreign currency reserves. Moreover, a remarkable factor in 2007 was that the balance of capital transactions and financial instruments account has exceeded the current account balance due to extremely large amount of net capital inflow from private sector, which was nearly doubled as compared with the relevant indicator of preceding year, when for the first time a great capital inflow was also recorded.
According to the tentative estimates of the RF balance of payments in 2007, published by the Bank of Russia, the surplus balance of current account made USD 76.6 bln, i.e., it has declined by 18.7 per cent versus the level of 2006 (See Table 4). Trade account surplus in particular was downgraded by 7.6 per cent (from USD 139.2 bln to USD 128.7 bln), while exports have grown by 36.8 per cent (from 303.9 bln to USD 354 bln) and imports also grew by 36.8 per cent (from USD 164.7 bln to USD 225.3 bln).
Therefore, as in preceding years, balance of current account largely depends on its trade component, which in its turn is mostly determined by changes in prices for energy resources and other major Russian export commodities, brought out to the world market. The data presented in Fig. 5 demonstrates, that the correlation between the Russian trade account balance and the world market energy prices observed within 2002-2006, continued in 2007 as well.
Deficit in services account made USD 19.7 bln and has grown by 42.6 per cent as compared with 2006. Russian exported services amounted to USD 38.6 bln, having grown by USD 7.7 bln (+24.8 per cent) versus the level of preceding year. At the same time, the imported services also grew by 30.3 per cent in 2007 and reached USD 58.3 bln.
Labor cost balance in 2007 continued to decline and made USD 7.1 bln (against USD 4.4 bln in 2006). Deficit of the RF investment income in the balance of payments in 2007 as compared with its 2006 level has declined by 13.6 per cent (to USD 21.8 bln). The investment income increased from USD 27.9 bln to USD 43.7 bln due to considerable growth of the indicators of monetary and credit supervision authorities (from USD 410.7 bln to USD 17.2 bln) and non-financial organizations (from USD 12.8 bln to USD 20.8 bln). Similar growth was noted in terms of investment income payments at the non-financial sector (from USD 44.2 bln to USD 53.1 bln) and banks (from USD 4.6 bln to USD 9.9), what has contributed to larger overall income payments (from USD 53.1 bln to USD 65.6 bln).
The balance of current transfers in 2007 has accounted to USD 3.5 bln (growth times 2.3 as compared with 2006).
6 The analysis of the state of balance is made on tentative data of the RF Central Bank.
7
The high level of income of monetary and credit control authorities is based on the investments in the international debt securities.
Table 4
Major Components of the RF Balance of Payments and Dynamics of External Debt in 2005-2007 (USD bln)
Balance sheet items 2005 2006 2007
I Q II Q III Q IV Q Year I Q II Q III Q IV Q Year I Q II Q III Q IV Q 8 Year9
Current Account Transactions 20.1 22.3 20 22 84.4 30.3 24.3 23.8 15.9 94.3 22.9 15.9 15.8 22.1 76.6
Capital Account Transactions10 -3.5 -2.4 -11.3 2.6 -14.6 -5.9 1 7.1 -14.9 9.5 5.8 13.5 47.3 -1.6 15.7 75
Changes in Gold and Foreign Currency Reserves («+»- a decrease, «-» -growth of reserves) -14.4 -18 -8.1 -21 -61.5 -21.4 -40.9 -13.8 -31.3 -107.5 -32.9 -65.5 -7.9 -42.5 -148.9
Net Errors & Omissions -2.2 -1.9 -0.6 -3.6 -8.3 -3 -0.5 5 5.9 7.5 -3.5 2.3 -6.3 4.8 -2.7
Changes in the RF external debt («+» - growth,«-» -decrease of external debt) 6.0 8.4 -1.1 30.6 43.9 16.0 15.6 -19.5 41.3 53.4 37.3 43.8 39.2
Changes in the RF external government debt -4.8 -0.6 -18.9 1.2 -23.1 4.0 -7.6 -24.5 -5.1 -33.2 3.5 -3.1 3.7
Changes in the external debt of the RF private sector 10.8 9.1 17.8 29.4 67.1 12.1 22.7 5.1 46.9 86.8 33.9 47 35.3
Source: Bank of Russia.
Therefore, the basic reasons for the decline in surplus of the current account balance in 2007 was the large import volume, exceeding the exports, as well as accelerated growth of deficit in labor cost balance. Herewith, despite the RF private sector external debt and its interest growth, the deficit of investment income balance has somewhat decreased in 2007 due to significant investment income, obtained by monetary and credit supervision authorities from gold and foreign currency investments and non-financial organizations.
Tentative estimates.
9
Tentative estimates.
10 Minus changes in foreign currency reserves. 78
50000 45000 40000 35000 30000 25000 20000 15000 10000 5000 0
1 Trade balance + Oil price index (I quarter 1995 = 100%, on the right axis)
B B B CD
CO CO CO CO
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2004
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—
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Source: RF Central Bank, IFS, IET assessments.
Fig. 5. RF Balance of Trade and Index of World Oil Prices for 2004-2007
In 2007, like a year before, a surplus of balance of capital transactions and financial instruments was observed, which has reached USD 75 bln. The balance of capital transfers in 2007 made USD 11.8 bln. Therefore, regardless capital transfers, made in 2007, the surplus of financial account has amounted to USD 86.8 bln.
Growth of the RF external liabilities as per the year results made USD 186.9 bln, i.e., 165 per cent higher than in preceding year (USD 70.5 bln).
As a year ago, federal government was still a net borrower to non-residents. Their external liabilities have been declined by USD 6.9 bln, basically due to early redemption of the RF external debt. The external liabilities of the RF Subjects made USD 0.1 bln. Liabilities of monetary and credit control organizations have increased to USD 0.7 bln. The expansion of activities of banking sector in terms of foreign capital involvement has resulted in the growth of liabilities of this sector by 37.4 per cent (+ USD 70.3 bln) against the 2006 indicator. Nonresidents' investments in the real sector made USD 122.9 bln (USD 54.6 bln in 2006). Therefore, non-residents investments in non-financial sector in 2007 have significantly exceeded investments in the banking sector. Herewith, 38 per cent of overall investments in non-finacial sector were direct investments (USD 47.1 bln), 61 per cent of investments were made in the form of loans and credits (USD 75.3 per cent).
Foreign assets held by Russian residents have been increased in 2007 by USD 100.2 bln (in 2006 that indicator was USD 64.9 bln). Practically all surplus is derived from the operations in private sector.
Foreign assets held by the RF federal government have decreased by USD 8.7 bln. Foreign assets held by credit and monetary supervision authorities have grown by USD 0.4 bln and by banking sector by USD 29 bln.
Assets taken out of country by non-financial sector and households have grown by 67 per cent versus 2006 and made USD 79.4 bln. Value of export earnings not received timely, imported goods paid for under import contracts but not delivered and asset transfers under non-existing contracts has increased as compared with 2006 to the level of USD 27.6 bln. At the background of growth in "direct and portfolio investments" (USD 47.8 bln), as well as in "non-delivered commodities under intergovernmental agreements" (USD 0.1 bln), a significant decline was observed in the amount of cash held in foreign currency (USD 13.3 bln). In other words, in the continued strengthening of RUR in nominal terms in 2006, both, individuals and non-financial sector actively disposed foreign currency.
Growth of foreign currency supply was based on both, its continued inflow to the country and the sales, made by the RF non-financial sector. As a result, the ruble real effective exchange rate was raising again and by the end of the year it has grown by 4.2 per cent. In 2007 there was observed further USD decline in the global market and in the RF: in late December USD exchange rate against RUR made 24.55 as compared with 26.33 at the beginning of the year. Despite significant RUR strengthening against USD, the Bank of Russia supported the value of two-currency basket11 at the same level: from December 2006 through December 2007 that value was downgraded only by 1 kopeck. In view of those developments, in late December EURO rate has grown to RUR 35.93, against RUR 34.7 as of January 2007 (see Fig. 6).
Official USD rate for the end of the period
-Official EUR rate for the end of the period
—•-Value of the two currency basket
Index of the real effective ruble exchange rate (right scale) Note. In calculating the real effective exchange rate the level of the year 2002 is regarded as 100. Source: RF Central Bank, IET assessments.
Fig. 6. RUR Exchange Rate Indicators in January 2005 - December 2007
11 Two-currency basket is the RF Central Bank operational indicator in its foreign currency policy. Currently the share of EURO in the currency basket makes 45 per cent, USD - 55 per cent. 80
In our view, the most important trend in the balance of payments dynamics in 2007, in line with reduced balance of payments of current operations, one should consider substantial net capital inflow in the non-financial sector in the amount of 82.1 billion dollars (in 2004 there was an outflow of capital from non-financial sector in the amount of USD 9 bln, in 2005 an inflow of USD 1.9 bln was observed, while in 2006 the net inflow of capital amounted to USD 42.1 bln) (see Fig. 7).
I Net capital outflow (bin dollars) - Net capital outflow / foreign trade turnover (%)
Source: RF Central Bank, IET assessments.
Fig. 7. Net Capital Outflow Dynamics within 2003-2007
It has to be noted that as per results of the third quarter, there was observed an outflow of capital in the amount of USD 6.9 bln. Total capital inflow within the year was ensured during the I, III and IV quarters, when the net inflow of capital to non-financial sector made USD 89 bln. These capital inflows were attracted from national companies and banks' active involvement in attraction of foreign credits, as well as foreigners' enthusiasm in lending money to Russian companies in the face of the country sound macroeconomic dynamics. Capital outflow in the III quarter was attributable to the crisis factors in the global financial market, which started in August. At the same time, in the IV quarter capital inflow was resumed and reached USD 23.5 billion, which exceeds the level of the I quarter. We should note also, that the significant capital inflow in the II quarter (USD 52.4 billion) was attracted primarily by IPO, arranged by Sberbank RF, Vneshtorgbank and a number of energy companies.
In 2007, the inofficial capital uotflow from the country (capital flight) (see Fig. 8), has grown again as compared with 2006, and reached, according to our estimates12, about USD 29.5 billion, which is exceed by USD 15.7 billion the indicator of 2006. A relevant increase in the share of capital flight in external trade turnover was observed from 2.9 per cent in 2006 to 5.1 per cent in 2007. It should be noted, that the greatest volume of capital flight was taking place in the III quarter, whereas in the IV quarter no capital flight was recorded.
5%
o%
-5% -10% -15% -20%
2003 2004 2005 2006 2007
i i capital flight (bin dollars) —♦— capital flight / foreign trade turnover (%)
Source: RF Central Bank, IET estimates.
Fig. 8. Capital Flight Dynamics within 2003-2007
Among other specifics of balance of payments of 2007, one should note high, as before, share of income from energy sources in export sales, once again demonstrating high level of dependence of the Russian economy on natural resources export and market prices. However, in 2008 stabilization in oil prices can be expected in the backdground of growing import supply, which apparently will lead to further reduction of current account surplus balance of payments. Therefore, in the background of further growth of net capital inflow to the RF and reduced capital outflow, the stability of balance of payments will be maintained both, by the surplus balance of current account and by the account of capital transactions and financial instruments (accompanied by accumulation of gold and foreign currency reserves).
12 "Capital flight" is assessed in accordance with IMF methodology as a grand total of "trade credits and advance payments", "export earnings not received timely, imported goods paid for under import contracts but not delivered", and "net errors and omissions". 82
-5
-10
-15
2.1.4. Global Credit Market Crisis and its Impact over the Russian Monetary Market
Russian financial system sensitivity to the dynamics in capital flows was demonstrated by the crisis in the USA mortgage securities market, started in August 2007, which affected the Russian financial sector, provoking capital flight from the country and problems to credit organizations in attracting resources from the external market. The problems in the US financial sector and some other developed countries have significantly limited the amount of free capital, addressed at the markets (credit, stock, and others) of developing countries, including Russia. Therefore, the international financial market has been practically inaccessible to the Russian banks, which has disabled the refund of foreign loans in the short-term prospective, as well as the attraction of foreign interbanking credits for liquidity inflow in the Russian interbanking market. A similar situation in Kazakhstan, where the share of foreign liabilities reached 70 per cent of the total banks liabilities, instigated in October 2007 a downgrading of national credit ratings by global rating agencies.
Growing uncertainty in the international markets has provoked capital outflow from Russia due to the "flight from the risk", which resulted in increase of demand for ruble resources among banks clients for the purchase to exchanging in foreign currency and with-
13
drawal outside the country13. In this situation, to meet the requirements if their clients, the banks have increased their demand in the domestic interbanking credit market, which encouraged interest rates growth (see Fig. 9). The Bank of Russia, as before, was supporting the level of liquidity in the monetary market only by crediting a limited number of the largest banks.
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iflH^Hino^o^O'iOi't^'t^'iOi'iOi't^nMriosmMmMmM '—CNCNr^iO'—i'—iCNCNr^iOO'—'—CNCNOO'—'—CNCNOO'—'—CNCNOO'—'—i
Fig. 9. MIACR Rate Dynamics over July-December 2007
13 At the same time, due to sustained significant surplus of the current account balance of payments, USD decline against RUR continued in the background of USD downgrading versus ther basic foreign currencies.
A number of banks failed to cover the demand for liquidity in the interbanking credit market (either due to the increased interest rates, or because of low assessment of their financial state by other banks with sufficient liquidity), which provoked a general decline in confidence in the banking sector and further restrictions in an access to liquidity for the majority of small and medium-sized banks.
A similar situation was observed in May-June 2004, when a number of medium-sized banks were cut off from all refinancing channels, have closed thair business. However, in 2007 the Bank of Russia provided far more significant refinancing to the largest banks and under relatively low interest rate, what enabled to support general level of liquidity in the banking sector, while some banks even derived profit from the interest rates difference. In the past year there were no external negative attributes in the banking sector (such as the withdrawal of licences from "Sodbiznesbank" or Rosfinmonitoring "black list" of banks, compiled in 2004), what enabled to keep up relatively peaceful situation. It is worth noting, that in crisis situations the Central Bank credits enjoyed strong demand, in particular those provided in the framework of direct REPO operations. In crisis conditions such credits became attractive to the banks and hence, the interest rates of the Bank of Russia started to play a greater role in the monetary market. This situation is an example of enhancement of the role of the Bank of Russia interest rate strategy in its monetary policy. Herewith, in the background of the interest rates volatility in the interbanking market, the Bank of Russia has considerably expanded the list of securities, accepted as a guarantee under REPO operations, reduced collateral discounts, as well as increased the number of direct REPO auctions.
All those measures have promoted an easier access the Central Bank credit. In other words, an upsurge in the volume of direct REPO operations in August-September 2007 (see Fig. 10) was the result of both, the growth in demand for refinancing on the part of credit institutions, and increased Central Bank offer in the credit market. In particular, during the crisis with liquidity in the RF banking market in 2004, the volume of direct REPO transactions did not exceed RUR 40 billion per day, whereas in autumn 2007 that indicator reached RUR 300 billion per day.
350
300
250 --
¡S 200 --=
e 150 3
100 4-
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Fig. 10. Direct REPO Volume over August-December 2007
Despite the increased availability of Central Bank credits, downgrading of the interest rate on foreign currency swap transactions and the reduction of the threshold of mandatory reserves, the tense situation in the interbanking market of Russia was sustained till December. At the end of each month the interest rates in the interbanking market were rapidly growing, as well as the volume of direct REPO operations (see Fig. 10): in particular, in late November the volume of direct REPO operations has exceeded the relevant levels, achieved in August. Herewith, since October the Bank of Russia started to provide credits not only under security of bonds, but also under promissory notes and credit agreements, though the situation got stabilized in the interbanking credit market only in the first half of December with the help of the assets, allocated by the Government to the Bank of Development.
It is worth noting, that from macroeconomic point, the volatility in global financial markets should not enspire serious consequences to Russia thanks to a large volume of accumulated reserves, substantial capital inflows, persistent surplus of current account balance and meanwhile reasonable amount of private sector external debt. Thus, on January 1, 2007, the Russian external debt accounted to USD 309.7 billion (30.4 per cent of GDP), the share of government foreign debt made USD 48.6 billion (4.8 per centof GDP), whereas the private debt amounted to USD 261.1 billion (25.6per centof GDP). At the same time, by October 1, the volume of public debt was increased to USD 52.7 billion (4.3 per centof GDP), while private debt has grown to USD 378.1 billion (30.8 per centof GDP). Consequently, the total national external debt increased to 430.9 billion (35.1 per centof GDP). This level of external debt can be regarded as steady and fairly average by international standards. However, it is noteworthy that a substantial share of private debt is quasi-public: as of October 1, 2007 the external debt of corporations with significant government participation14 accounted to USD 132.7 billion, i.e., more than 35 per cent of the total of the external debt is the liability of private sector. It is obvious that creditors of those corporations require inexplicit warranties under such debts from the government, what enables such companies with government participation to increase external debt rapidly and relatively cheaply. At the same time, apparently the quality of risk management in such companies is not at the highest level, which implies a poor quality of projects, financed by credits. Consequently, the expansion of such debt increases the risks to the RF economy, creating grounds for monitoring the dynamics in kvazi-public external debt and to introduce restrictions, if necessary.
It is interesting to note, that since 2006, the monetization of current account surplus (see Table 5) with regard to the Stabilization Fund sterilization function is no longer the primary source of national liquidity replenishment. Currently, this function is performed by the balance of account of capital transactions and financial instruments, which is far more volatile and less predictable.
14
Banks and non-financial enterprises, where the government or monetary and credit supervision authorities' share directly or indirectly accounts to or exceeds 50 per cent or otherwise otherwise under control of those authorities, are regarded as corporations with significant government participation.
Table 5
Sterilization Volume of Current Account Surplus within 2006-2007 (USD bin)
2006 2007
Balance sheet items I Q II Q III Q IV Q The year I Q II Q III Q IV Q15 The year
Current Account Transactions 30.5 24.8 23.8 16.2 95,3 22.9 15.9 15.8 22 76.6
Balance of trade 36.4 37.7 37.1 28.0 139,2 28.9 31.6 31.6 36.6 128.7
Balance of account of capital transactions and financial instruments16 -6.1 16.6 -14.6 10.2 6,1 13.5 47.3 -1.6 15.8 75
Private sector capital net inflow -6.3 20.3 11.9 15.1 41 13.5 52.9 -7.6 23.5 82.3
Dynamics in sterilization volume of assets in the RF Stabilization Fund 17.6 16.2 17.017 18.4 69,2 19.0 13.6 19.5 22.818 74.9
«Non-sterilized» balance of current accounts 12.9 8.6 6.8 - 2.2 26.1 3.9 2.3 - 3.7 - 0.8 6.2
Source: The Bank of Russia.
As one can see from Table 5, the current account balance surplus has downgraded from the level of USD 30.5 billion in the I quarter of 2006 to USD 22 billion in the IV quarter of 2007. Herewith, the amount of assets, sterilized in the Stabilization Fund of Russia, during the same period rose from USD 17.6 billion to USD 22.8 billion. Thus, liquidity replenishment in the economy through monetization of the current account balance at the end of 2006-2007 was virtually cut down.
In case of the further reduction of the current account balance due to volatility of capital inflow volume, there will be a need for new refinancing tools in the banking system. Herewith, the Stabilization Fund will continue its growth, thus withdrawing the liquidity from economy. In case private capital outflow, such scheme of Stabilization Fund formation can create additional difficulties with liquidity to the economy in general and to the banking system in particular.
One should take into account exchange rate strategy in monetary and credit policy, as strengthening of the ruble, observed in recent years has urged expectations among economic agents, both in Russia and abroad, for further ruble growth against dollar. This encourages the inflow of short-term capital to the RF, contributes to the growth of the monetary supply, increases "dedollarization" and inspires inflationary expectations, which hinders the slow-down of price growth.
It should be noted, that in the face of negative effective interest rates in Russia, its usage as an intermediate objectives of monetary and credit policy is virtually not applicable. Therefore, the government authorities should make a serious effort to combat inflation. Herewith, the Central Bank could be advised to increase gradually the cost of refinancing to the banks,
15 Tentative estimates.
16 Regardless changes in foreign currency reserves.
17 With regard to the assets, addressed to early redemption of external government debt.
18 With regard to the assets, addressed to capitalization of government corporations "Bank fod Development" and "Russian Nanotechnologies Corporation", Stabilization Fund extension and external debt redemption, regadrles proceeds from investments, made from Stabilization Fund.
what would enable as to upgrade the interest rates, as well as to inspire credit organizations to pursue more accountable credit policy. Furthermore, in the background of reduced growth of foreign credits in the Russian banking sector due to general instability in the global financial market, some restrictions can be introduced as to the share of foreign assets in the liabilities of credit institutions, which will enable to reduce foreign currency risks. The example of Kazakhstan, the economy of which was faced with a decline of sovereign credit ratings due to the high dependence of the banking sector on external funding, showed, that limiting the amount of loans, attracted from abroad is a rather logical measure for the Bank of Russia.
Thus, in the next few years, there are several possible scenarios for the dynamics in the situation with the current account balance, and therefore, monetary policy in Russia. One scenario is based on the sustained surplus of current account balance. In case of continued capital inflow into the country, the Bank of Russia, apparently, will be strengthening the exchange rate of national currency. However, capital flows are highly volatile. In the event of a significant capital outflow, which could be urged virtually by any adverse event in the national economy, the continuing replenishment of the Stabilization Fund may result in a shortage of liquidity in domestic economy. In this case, the RF Central Bank will face an urgent problem of development an adequate system of commercial banks refinancing. It is worth noting, that the formation of such a system should be started (along with the implementation of measures of enhancement bank supervision and the criminal banks liquidation) as soon as possible, so that in case of financial instability, it would be effectively functioning.
Along with the scenario of surplus current account balance (or its insignificant reduction), there is a high probability of its decline as a consequence of energy prices downgrading, higher import volumes in the background of ruble strengthening, as well as the growth of interest rates, paid by domestic companies outside the country. In this case, two situations are also possible. While sustained volume of capital inflow is kept up at the level, sufficient to maintain a normal level of liquidity in the economy, the Bank of Russia will be able to continue the current monetary policy. At the same time, given the volatility of capital flows, it will nevertheless have to be prepared to provide the required resources to commercial banks any time. In the event the net capital inflow gets substantially reduced or even negative, the RF Central Bank of Russia is likely to face the necessity of prompt ruble depreciation, as well as of the search for new mechanisms to meet monetary demand of economic agents.
2.1.5. Basic Measures in the Sphere of Monetary and Credit Policy
1. Early in 2007, the Russian Statistical Service has published for the second time in history the basic structure of consumer expenditures of population, used to estimate the consumer price index. This measure is a serious move towards higher transparency in the CPI estimation methodology. According to the disclosed information, in 2008 the share of food products will be somewhat reduced at the expense of increased share of non-food items and services. In our view, those changes are adequately reflecting the actual structure of consumption expenditures, as throughout the world the growth of incomes inspires greater demand for non-food items and services consumption and lower demand for foodstuffs.
2. From February 8, 2007 the RF Central Bank has restructured the two-currency basket, which is used by the Bank of Russia as an effective indicator in monetary policy. The share of EURO in the basket was increased from 4per cent to 45 per cent, while the share of USD was
respectively reduced from 60 per cent to 55 per cent. It should be noted, that earlier the Central Bank had already amended the structure of the two-currency basket in favor of EURO.
3. Since February 12, 2007 the Russian ruble has been included in the lists of international currencies of Euroclear, the International Depository-Clearing Centre. Moreover, the ICAP broker company has approved on February 14 the decision to make RUR e-commerce transactions on the basis of EBS platform, which allows to perform operations with ruble-dollar pair with a one-day deadline for enrollment. In our view, these developments reflect the increasing demand of market participants in the ruble transactions, that will inevitably lead to greater RUR liquidity as payment instrument.
4. In 2007, the RF Central Bank continued to publish reports on the structure and results of the foreign currency and gold reserves investments. In general, this step can be evaluated positively, as it is aimed at increased transparency of the Russian Bank operations. However, it should be noted that the results of the assets investments were disclosed with more than a six-month delay, which in our view, is beyond reasonable limits. Moreover, the reports provide no information on the revenues derived from all financial instruments used for investments, as broken down by individual foreign currencies. Such information would enable us to make better assessment of the results of the assets management. The most interesting part of the report is the information on the outcome of national gold reserves management. According to the latest report, within April 2006 - March 2007, the reserve assets of the Bank of Russia have been increased by USD 129.4 billion, including the interest yield and revaluation of securities by USD 10.9 billion (8 per centof the total growth). Therefore, currently, in the background of significant inflow of foreign currency to the country, the interest yield is an insignificant factor in gold reserve dynamics. Nevertheless, in case of external economic environment deterioration and decreased capital inflow, the results of national reserves management will doubtlessly play a significant role.
To evaluate the RF Central Bank performance in the reserve funds management, it is proposed in the report to use the so-called standard portfolios, which in fact are the indeces of those markets, in which the assets are invested. It is worth noting, that the application of the standard portfolios for the yields comparison with the common actual yields is largely in line with the international best practice in assessment of portfolio management efficiency.
Reserve currencies of the Bank of Russia are distributed between operational and investment portfolios. Apparently, the operatinal portfolio is designated to maintain high level of reserves liquidity, required for the implementation of the RF Central Bank functions in monetary-credit and foreign currency policy. The investment portfolio, as is indicated in its name, was created for investments in less liquid, but more risky financial instruments.
Within April 2006 - March 2007, the returns on investments made 5.3 per cent in USD, 3.1per centin EURO, 4.2 per cent in GBP and 0.3 per cent in JPY.
5. In 2007 the RF Central Bank has decreased the refund rate twice, on June 29 it was decreased from 11 per cent to 10.5 per cent, and since July 19 it was established at the rate of 10 per cent. It should be noted, that the decrease of the refund rate was implemented at the background of growing interest rates on deposits of credit organizations with the RF Central Bank. The decline of refund rate was aimed at raising the significance of interest rate role in monetary and credit policy. It is worth noting, that in the deteriorated situation in the interbanking credit market, the demand of commercial banks for the RF Bank credits has significantly grown, what has promoted the role of the Bank of Russia interest rate policy. At the
same time, in late 2007, the information was obtained, that the Central Bank of Russia intends to terminate the long-term cycle of refinancing rate reduction. The expected increase of the refinancing rate is explained by inflation upsurge in autumn of this year, which led to a decline in refinancing rate in real terms. Given that due to the crisis in the global financial market, in autumn the demand for credits, provided by the RF Central Bank has increased sharply on the part of credit institutions, the growth of refinancing rate was supposed to prevent excessive bank borrowings and hence, the possibility of surplus monetary supply in the background of reducing tension in the Russian the inter-banking credit market. Herewith, we should mention that, until recently, refinancing rate had rather little impact on the Russian financial market due to the lack of demand for refinancing on the part of Russian banking system.
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Source: RF Central Bank, RF Statistical Service.
Fig. 11. RF Central Bank Refinancing Rate in Real Terms over 2000-2007
6. In 2007, the RF Central Bank continued to raise interest rates on the instruments of attraction monetary assets from credit organizations: to 2.75 per cent per annum on the deposits, made under standard conditions "tom-next", "spot-next" and "on demand", to 3.25 per cent per annum on the deposits of "one week" and "spot-week" type. The rates increase has been implemented in order to sterilize the excessive liquidity in summer and was introduced in view of the changes in national and external economic environment. Through this measure the Bank of Russia continued its policy of raising interest rates role in monetary policy. At the same time, as a result of the lack of liquidity in the Russian market, in the background of financial instability in the world markets, there was a downfall in the volume of deposits of commercial banks with the Bank of Russia in July, which was sustained at an insignificant level till the end of the year.
7. In July the RF Central Bank has submitted to the RF State Duma the "Major Trends of Consolidated Monetary and Credit Policy for 2008". For the second consecutive year, the
89
Bank of Russia has outlined its primary task for the year of 2008, namely - combating of inflation (bringing it to the level of 6-7 per cent as per 2008 results, to 5.5-6.5 in 2009 and to the level of 5-6 per cent as of 2010 results). As concerns the index of inflation targeting in regard to the ruble rate in real terms, it should be held within the range of 0-10 per cent. In our point of view, those measures will help the Bank of Russia to pursue more efficient monetary and credit policy, avoiding attempts to achieve several conflicting targets. In fact, such a wide range of real ruble rate means that the RF Central Bank facilitates this target, while focusing on inflation suppression. According to the Central Bank estimates, the surplus of monetary base in narrow definition will make 18.7-22.9 per cent in 2008. Gold and foreign currency reserves by the end of 2008 should reach USD 456-486 bln.
With regard to the inflation upsurge in autumn of 2007, the achievement of the RF Central Bank milestones in 2008 is unlikely: according to our estimates, in 2008 the CPI will make from 8 to 10 per cent. We consider that gold and foreign currency reserves to the end of 2008 are also underestimated, given the volume of international reserve assets as of January 1, 2008 amounted to USD 476.4 billion. The performance of the planned objectives for the growth of monetary assets will largely depend on the dynamics of currency inflow to the Russian Federation. Unless oil prices get declined and the rate of capital inflow is sustained at the level of 2007, the growth of monetary supply will also exceed the indicators, outlined in the "Major Trends of Consolidated Monetary and Credit Policy for 2008".
8. Since July 1 of the year, the threshold of mandatory reserves for the RF commercial banks were increased. For credit institutions liabilities to the non-resident banks in national currency of the Russian Federation and in foreign currency, as well as on other liabilities of credit institutions, in national currency of the Russian Federation and in foreign currency, the threshold will be 4.5 per cent, and under the liabilities to physical persons in the national currency of the Russian Federation or in foreign currency it will make 4 per cent. Earlier the threshold of mandatory reserves under those types of liabilities made to 3.5 per cent. Therefore, the Central Bank is trying to reduce the rapid growth of domestic credits, and thus reduce inflationary pressure. We would like to remind, that in autumn 2006, the Bank of Russia has increased the threshold of mandatory reserves under the liabilities of credit institutions to nonresident banks from 2per cent to 3.5 per cent, while increasing the averaging ratio from 0.2 to 0.319, what partially neutralized the growth of reserve threshold.
As we have mentioned in previous sections, in the second half of 2007, Russian banks faced with a shortage of liquidity resources, which has forced the Bank of Russia to take a number of measures to avoid instability in the Russian banking sector. Thus, since October 11, the RF Central Bank has reduced for three months the threshold of mandatory reserves under the liabilities of credit institutions to physical persons in the national currency of the Russian Federation from 4 to 3 per cent, and under the liabilities to non-resident banks in the national currency of the Russian Federation and in foreign currency, as well as on other liabilities of credit institutions in the currency of the Russian Federation and in foreign currency from 4.5 to 3.5per cent. Herewith, a possibility was provided to credit organizations, which had an intention to recalculate the threshold of mandatory reserves on the basis of the newly established regulations, to make an extra recalculation within October 11-15.
19 The banks could withdraw up to 30 per cent of their assets at the beginning of the month and refund their installments to the Mandatory Reserve Fund at the end of the month. 90
Since October 11, the interest rate on the ruble assets, used for "foreign currency swap" transactions with the Bank of Russia, has been reduced from 10 to 8 per cent per annum. In other words, the cost was reduced for credits, which can be obtained by commercial banks from the RF Central Bank under security of foreign currency.
From October 15, the list of securities, accepted to ensure direct REPO operations was significantly expanded, as well as that one for lombard credits. Since November 29 Eurobonds of a number of Russian companies have been included in the Lombard List of the Bank of Russia. Since November 1 the averaging ratio for calculation average amount of mandatory reserves has been raised from 0.3 to 0.4, which enabled commercial banks to use the basic share of their mandatory reserves within the month. From November 28, the Bank of Russia started to provide its lombard credits at a fixed interest rate for a period of one calendar day at the rate of 8 per cent per annum. MICEX started a session of direct REPO operations at a fixed rate of 8 per cent per annum for 1 day and under 7 per cent per annum for 1 week. Finally, in October, the RF Central Bank started to provide credits not only under securities, but also on a bail of credits and promissory notes.
In our view, all of those measures will enable the RF banking system to go through the period of financial instability without serious losses. Moreover, we believe that the reduction of the threshold of mandatory reserves could have been avoided, as this is one of the most inefficient instruments of monetary policy, which brings an effect with some delay. At the same time, the volume of untied reserves is not enough to cover the drastic shortage of liquid resources in the event of a serious crisis, whereas an excessive monetary offer can provoke further inflationary pressures.
2.2. Forecast Models of the RF Economic Development over a Medium-Term Prospective with Regard to the Trade Balance Dynamics
One of the key indicators of 2007 were the acceleration of the Russian economy growth rate, as well as the expansion of real investments in fixed assets. Herewith, those factors were inspired as by extremely high oil prices and the surplus of the current account, as well as by high surplus balance of capital account over the greater part of the year.
In the previous edition of the IET annual survey20 we have reviewed several forecast models of economic development in Russia, based on certain assumptions in terms of economic policy of the Central Bank and the Government of Russia. Distintions between the models were primarily based on the level of global prices for energy sources and relevant dynamics in the RF trade balance. It was assumed, that the net capital flow in and out of the RF would be insignificant in macroeconomic terms.
Over the past year the situation has changed, and capital inflow in Russia has turned into an important source of financial resources for the investment in real sector and, consequently, for the support of high economic growth rates. Accordingly, we will hereby review four models of the RF economic development in the medium-term prospective (for 5 years till 2012), with regard to volatile dynamics in both components of the RF balance of payments: balance of current account and balance of capital account.
The first three models are based on the current situation with sustained high oil prices in the world market: the average annual price for 2008 is estimated at the level of USD 75 per
20 Russian economy in 2006. Trends and Outlooks. Issue 28. M., IET. 2007.
barrel (for Brent), and although prices are expected to be decreasing in subsequent years, they should stay at the level of about USD 60 per barrel, which corresponds to the indicator of no lower than USD 45 per barrel in 2005-2006 prices, in case of USD strengthening in the global market up to USD 1,27-1,30 for EURO 1.
The first model of the RF economic development is inertia-based as a matter of fact. The government will prevent the federal expenditures growth in excess of 18.5 per cent of GDP after the presidential elections in 2008. The current tax system will remain unchaged, the standards of replenishment of the RF Reserve Fund and the National Welfare Fund will not be amended, the annual growth rates of prices and tariffs for the goods and services, produced and provided by natural monopolies will exceed the inflation rate by no more than 2-2.5 p.p. The RF Central Bank will keep up the policy of accumulating foreign currency reserves, which will make for the relevant expansion of monetary supply, including the volume, required to maintain the high GDP growth rate, as well as the policy of restraining the rates of RUR effective exchange rate strengthening in real terms. Favorable external economic market situation and positive domestic macroeconomic indicators will attract both, foreign direct investments and capital inflow to the country.
Model II differs from the first one, it is based on assumption of sustained instability in the global financial system due to the crisis indicators, observed in the second half of 2007 as a result of problems in the USA mortgage market. Therefore, the ability of the Russian companies to attract inexpensive external resources will be restrained, which in turn will lead to a reduction in investment activities in Russia due to limited external resources of funding and growing interest rates in the domestic market. In particular, we anticipate in this situation, that the annual volume of capital inflow will be twice lower than under the first scenario.
Model III is based on the assumption of capital outflow from the country for the reasons, not associated with the trends in the Russian economy and Russian investment environment. This model is crisis-based or, at best, neutral. The situation at the "turning point" will depend on "safety reserve" of economy and financial authorities policy in the face of deteriorating financial crisis. Nevertheless, there is a rather high probability for the developments under such a scenario in the nearest future: due to the USA credit market crisis, the global investors lose interest to the new highly risky markets, including Russia.
It should be noted, that to review the consequences of this scenario, it is not crucial for us to find the basic reason (the "trigger"), that provoked capital outflow (significant deficit of the balance of capital transactions account). The following factors can be related to those resons:
- problems in the USA credit and other financial markets;
- downgraiding of growth rates in the global economy;
- upgrading of interest rates in developed countries;
- financial crisis in one or a number of developing markets.
However, in this scenario, we do not anticipate an abrupt downfall of oil prices. In other words, the situation of the balance of current account will remain favorable, while the outflow from the balance of capital account transactions is expected in the amount up to USD 200 billion (in 2009). In general, under this scenario, we have estimated the total balance of capital flows to/from the Russian Federation, basing on the assumption of the reduction and stabilization of the private sector external debt in 2011-2012 at the level of February-March 2007 (prior to massive capital inflows in the second quarter of 2007), i.e., USD 340-350 billion.
Model IV is based on anticipated decline in oil prices in the world market to the average level, sustained for many years, i.e., USD 20-25 per barrel (for Brent) in prices of 2005-2006, what approximately accounts to USD 30-35 per barrel in 2012.
To avoid arbitrary interpretations of qualitative changes in the economy and in the behaviour of economic agents (for example, a sharp change in prices and the foreign currency exchange rates dynamics in case of oil price downfall, the "swing" of exchange rate in nominal terms, etc.). Due to the application of formal economic-mathematical algorithms for quantitative assessment of the forecast models, we expect responsible and conservative behaviour on the part of economic agents. Thus, in every model, we apply the "equilibrium" variables in certain conditions, though it is unlikely to create such conditions in practice. In particular, this is relevant in regard to the forecast models, based on oil prices downfall.
Therefore, our assumptions provide fairly prudent assessments of the dynamics of macro-economic indicators in the Russian economy in case of both, high and low oil prices. In reality, the situation, with regard to the expectations of economic agents, might be developed in a more negative way. In such a case the authorities should be prepared to take measures aimed at least at mitigation of the estimated negative consequences. Similarly, for the situation of high oil prices, the forecast models are also conservative and demonstrate the bottom level of economic development options.
Modeling of the Russian economy major indicators dynamics in general, and in monetary sphere in particular, was perfomed on the basis of the IET approximation of medium-term
21
socio-economic indicators modeling . For the purpose of this study, the model was based on a longer time series, and moreover, revised by a number of additional indicators.
The preliminary estimates of final values for 2007 were used as initial indicators.
Thr dynamics in the basic macroeconomic indicators as per the models are presented in Table 6. Hereafter, we will review the basic trends in the Russian economy for each model in detail.
According to the obtained results, in the inertia-based situation in the economy of Russia (model I), the total GDP growth in real terms within 5 years (over 2008-2012) will reach about 35 per cent, while the annual growth rate of GDP in real terms will decline by the end of the period to 5.5-5.7 per cent. The decline in growth rate is attributed to the lower level of cost efficiency and stabilization in the export volumes of oil and gas, whereas the existing industry structure (raw materials in particular) is sustained. Ruble exchange rate growth in real terms will enable Russian economy to reach the volume of GDP, equal to USD 2.2 trillion (according to the current exchange rate) by 2012.
Despite some decrease of federal budget revenues (approximately to 20,5-21 per cent of GDP as a result of lowered level of taxation in the oil sector and the overall cost efficiency downgrading in economy), the federal budget balance remains positive (minimum indicator is 1 per cent of GDP). An expressed effect of the above is the accumulation of assets in the Na-
21 Model description in detail is published in the works by M. Turuntseva, A. Yudin, S. Drobyshevsky, P. Ka-dochnikov, S. Ponomarenko, P. Trunin "Some approaches to economic indicators modeling", "Research Works", No. 89P, M.: IET, 2005, and some model elements are provided also in the works by S. Drobyshevsky, V. Nosko, R. Entov, A. Yudin "Economic Analysis of Basic Macroeconomic Indicators Dynamic Series" "Research Works" No. 34P, M.: IET, 2001; R. Entov, V. Nosko, A. Yudin, A. Kadochnikov, S. Ponomarenko "Some Macroeconomic Indicators Approximation", "Research Works" No. 46P, M.: IET, 2002.; G. Karasev, S. Chetverikov "Structural Models of RUR Exchange Rates", No. 88P, M.: IET, 2005.
tional Welfare Fund in the volume of 7,5-8 per cent of GDP (USD 170-180 billion) by the end of 2012.
The RF Central Bank polisy on accumulation foreign currency reserves and restriction of annual rates of ruble strengthening in real terms through the inflow of foreign currency sterilization enabled to reach the level of USD 690-700 billion of reserves in foreign currency. Total growth of effective ruble exchange rate in real terms for a 5-year period makes approximately 16 per cent (+31 per cent to the level prior to the 1998 crisis). Herewith, ruble exchange rate in nominal terms will reach approximately 29,0-29,5 rubles against dollar by the end of 2012.
As mentioned above, the key distinguishment of this models from the other ones is continued expressed capital inflow to the RF. According to the forecast model, the support of the desired level of investments in fixed assets requires an extension of the Russian private sector external debt to USD 1.05 trillion (about 47 per cent of GDP) by the end of 2012.
In our estimates, trade balance surplus, supported by the high prices for raw materials in the global market can be sustained practically over all period under review (insignificantly negative indicators are expected only in 2012). However, due to the growth in services import and the upgraded interest rates on the growing external debt, the balance of current account may become negative as early as in 2010-2011 and will overlap the surplus balance of capital account, i.e., the RF balance of payments will be negative. Our estimates are based on the assumptions, that the balance of payments deficit will be funded from the RF gold and foreign currency reserves, while maintaining smooth dynamics in ruble exchange rate in nominal terms against two-currency basket "USD-EURO".
Proceeding to the review of the situation in the monetary sphere, it is worth noting, that with the anticipated volume of capital inflow in 2008 (corporate and banking sectors debt is expected to be extended up to USD 545 billion), the Central Bank will probably actively use additional instruments of sterilization, rather than face the liquidity shortage problem (in financial system in general). According to our estimates, while federal budget expenditures are sustained at the level of 18.1 per cent of GDP, in order to maintain the annual growth rate of monetary supply (M2) at least within 30-35 per cent (versus 47.5 per cent in 2007), financial authorities will have to sterilize minimum RUR 200 billion, obtained from monetization of balance of payments surplus.
By 2012, the monetary supply growth rates will be declined to 15-16 per cent per annum, exceeding the inflation rates, which will enable to achieve the level of monetization at about 58-59 per cent of GDP. However, in 2009, due to fairly rapid reduction of the balance of payments surplus, in the background of sustained conservative fiscal policy (federal budget expenditures will not exceed 18.5 per cent of GDP), the problem of replenishment of the monetary supply with the help of refinancing instruments of the Bank of Russia becomes rather aggravated. According to our assessments, in order to maintain the real interest rates on credits to non-financial sector not in excess of 3-3,5 per cent per annum, what enables to keep up the investment growth rate, the RF Central Bank in 2012 will have to provide refinancing to the banking sector in the amount of minimum RUR 4 trillion (6.6 per cent of GDP).
According to our estimates, under this scenario, it is impossible to reduce inflation below 5.0 per cent in 2012. The total prices growth over the five years will reach at least 40 per cent.
Table 6
Dynamics in Economic Development of Russia as per Forecast Models
within 2008-2012
Model
I
II
III
IV
GDP in real terms (growth 33-35 27-28 5-6 1-2 within the period), %
Investment index in capital assets (growth 85-90 62-67 -9-10 -11-12 within the period), %
Inflation (2012), % 5.0-5.5 4.5-5.0 10-11 14-15
Balance of current account surplus (% of GDP, 2012) -4.4 -0.7 5.5 2.722
Balance of capital account surplus (% of GDP, 2012) 2.2 1.3 -4.6 -3.5
Nominal exchange rate RUR/USD (2012) 29.0-29.5 30 46-48 50-55
Real effective exchange rate, % (growth against July +30-32 +24-25 +4-5 -20-25 1998), %
Gold and foreign currency reserves (2012), USD bln 690-700 670-680 205-215 180-190
GDP monetization (2012), % 58-59 56-57 32-33 33-34
With lower volume of external financing (model II), growth rate of investment in fixed assets and the RF GDP in real terms will be lower. However, the share of foreign debt in GDP will also not not exceed 37.5 per cent of GDP. Our assessments demonstrate, that basing on the given assumptions of capital inflow to Russia, the refinancing volume to the banks, provided by the RF Central Bank as early as in 2008 should reach about RUR 800 billion. Otherwise, real interest rates on credits to non-financial sector can exceed 5 per cent per annum (currently they are practically negative), which means a sharp decline in the availability of investment resources in the economy. Nevertheless, the average annual growth rate of GDP in real terms will remain high enough, at least 4.5-5.0 per cent per annum, while inflation may be decreased to 4.5 per cent in annual terms by the end of 2012.
Thus, this forecast model, although presumes a slight decline in the growth of Russian economy in comparison with the first one, in our view does not bring any threat to the long-term continuous development and is quite favourable.
Comparison of the third and fourth forecast models, which, as a matter of fact are options of crisis scenario, demonstrates that in the current context of increasing dependence of the GDP growth in real terms on investment dynamics in fixed capital, the restriction on external financing over 2-3 years (model III) can provoke the consequences, comparable with the situation of sharp and sustained decline in oil prices (model IV). In both cases, in 1-2 years after the beginning of negative developments (2010-2011), Russia will face the need to quite drastic devaluation of the national currency and equalization of the balance of payments by reducing the attractiveness of imports. However, at least for 2-3 years, the rate of growth in real economic indicators (GDP, investment, incomes) will be experiencing a serious decline, down to negative values.
22 The surplus of the current account balance, in the background of low oil prices, planned in this in this forecast model is based on the assumption, that the ruble devaluation, as well as the reduction of import for the purpose to equalize the RF balance of payments will already take place by 2012.
2.3. State Budget
2.3.1. A General Overview of the Budgetary System of the Russian Federation
When analyzing the main parameters of the Russian Federation's budgetary system in 2007, it should be noted that, while the level of revenue as a share of GDP changed only slightly last year by comparison with that in 2006 (Table 7), federal budget expenditure demonstrated noticeable growth, amounting to 2.2 p.p. of GDP, while the budget expenditure of RF subjects increased by approximately 1.0 p.p. of GDP, and the general government's budget expenditure - by 2.9 p.p. of GDP. This growth of expenditure resulted both from the fulfillment of the State's increased social obligations with regard to the population, including within the framework of the implementation of priority national projects, and from the State's expanded participation in investment processes all over this country's territory.
However, this growth of expenditure at all the levels of the RF budgetary system was not accompanied by a comparable increase in the volume of a revenue base, which, in the final analysis, produced a diminished surplus. Thus, according to the data concerning the actual execution of the RF federal budget in 2007, its revenue amounted to 23.6% of GDP, which is only by 0.3 p.p. higher than the same index in 2006. It should be specifically noted that the level of revenues received by the federal budget from the single social tax (SST), which in 2002-2006 had been steadily on the decline, finally became stabilized.
Revenue of the RF consolidated budget of RF subjects in 2007 was registered at the level of 14.7% of GDP, which is by 0.6 p.p. higher that the previous year's index. A similar growth was noted in respect of the RF general government's revenue.
Due to the accelerated growth of the general government's expenditure, coupled with the relatively modest increase in its revenue, surplus in the general government's budget as seen by the results of 2007 decreased by 2.3 p.p. of GDP against the index of the previous year and amounted to 6.1% of GDP.
Tax revenues in the budgets of all levels displayed a tendency to grow after their fall in 2006, which had resulted predominantly from decreased revenues from VAT and functioned as a key growth factor for this country's budgetary system's aggregate revenues.
In view of the sufficiently favorable situation of the global oil and metals market, the stabilization of the budget revenue resulted from changes in the revenues in respect of individual taxes, which will be discussed in more detail later in the text.
The rise of oil prices on the level determined in the 2007 budget, just as a year previously, resulted in overfulfilment of the budgetary system's revenue plan, and so on 23 November adjustments were introduced into the law on the federal budget, in accordance with which its revenue was increased to 7,443.9 billion rubles (against 6,965.3 billion rubles in the initial version), and its expenditure - to 6,531.4 billion rubles (against 5,463.5 billion rubles in the initial version).
Table 7
Execution of Revenue and Expenditure in Budgets of all Levels of Authority (as % of GDP)
2000 2001 2002 2003 2004 2005 2006 2007
Federal budget
Tax revenues* 10.2 12.5 15.8 14.7 13.5 14.5 13.4 14.0
Including SST23 - - 3.13 2.75 2.60 1.24 1.18 1.18
Revenue 15.5 17.8 20.3 19.5 20.1 23.7 23.3 23.6
Expenditure 14.2 14.8 18.9 17.8 15.8 16.3 15.9 18.1
Deficit (-) /Surplus (+) 1.4 3.0 1.4 1.7 4.3 7.4 7.4 5.5
Territorial budgets
Tax revenues* 10.5 9.9 10.2 10.0 10.5 10.3 10.3 11.0
Revenue 14.1 14.5 15.1 14.6 14.1 13.9 14.1 14.7
Expenditure 13.4 14.5 15.5 14.9 13.9 13.6 13.6 14.6
Deficit (-) /Surplus (+) 0.7 0.0 -0.4 -0.3 0.2 0.3 0.5 0.1
Budget of general government
Tax revenues* 28.0 27.7 27.0 25.6 24.8 25.5 24.5 25.8
Revenue 38.3 38.4 37.8 37.1 37.5 39.7 39.6 40.2
Expenditure 34.3 35.2 36.3 36.0 32.9 31.6 31.2 34.1
Deficit (-) /Surplus (+) 4.0 3.2 1.5 1.1 4.6 8.1 8.4 6.1
* Tax revenues are determined in accordance with the provisions stipulated in the current wording of the RF Budget Code (less insurance contributions to compulsory pension insurance (CPI), revenues from foreign economic activity, and revenues of target budget funds).
Source: RF Ministry of Finance; calculations by the IET.
The most important development in the domain of budgeting policy in 2007 were the amendments introduced into the RF Budget Code (by Federal Law of 26 April 2007, No. 63-FZ), whereby the content of many fundamental articles of the Code was dramatically changed. The following innovations can be noted in the Code's new version:
1) the switchover of all budgets within the budgetary system to medium-term financial planning, including the federal budget and state off-budget funds of the Russian Federation, with the formation of budgets for a three-year period;
2) distinct linking of budget allocations to the state (or municipal) services being provided to physical and juridical persons to the carrying out of state (or municipal) assignments, the introduction of the mechanisms of financial backing for the activity of entities of new organizational-legal forms, and the creation of appropriate conditions for restructuring the budgetary network;
3) the regulation, in accordance with uniform organizational principles, of the budgeting process's organization (the preparation, consideration, approval and execution of budgets; the preparation, external auditing, consideration and approval of budgeting reporting documents), including the consolidation of single requirements to budget planning, the switchover to the approval of a federal law on the federal budget in three readings, and a more precise and transparent regulation of the execution of budgets;
23 From 2001 onward, SST replaced the previously existing deductions to state social off-budget funds. Since 2002, a certain percentage of the aggregate SST rate is being transferred to the federal budget.
4) the planning of expenditure on the basis of delimitation of the existing and newly adopted obligations;
5) a systemic description of the composition and powers of the participants in the budgeting process, and first of all its main executors (or executors) and recipients of budget resources, principal administrators (or administrators) of budget revenues and principal administrators (or administrators) of the source used to cover budget deficit;
6) the confirmation of the fundamental principles and items of the budget classification of the Russian Federation by special provisions in the Budget Code, with a simultaneous expansion of the powers of bodies of state authority and bodies of local self-government to make the classification more detailed, as well as the integration of budget classification and budget accounting.
Special attention should be given to the amendments concerning the use of the "oil and gas" revenues of the federal budget. From the year 2008 onward, Chapter 13.1 "The Stabilization Fund of the Russian Federation" is abolished, to be replaced by Chapter 13.2 "The use of oil and gas revenues of the federal budget". The category of oil and gas revenues encompasses the revenues from: the tax on the extraction of mineral resources (hydrocarbon raw materials); export customs duties on crude oil; export customs duties on natural gas; and export customs duties on oil products.
A part of oil and gas revenues is earmarked for financing the current expenditures of the federal budget (the oil and gas transfer), while another part can be saved. In order to estimate the situation-linked risks from the point of view of stability of state finances, it is important to know the index of deficit not linked to oil and gas, represented by the difference between the revenues not linked to oil and gas and the aggregate budget expenditure. According to the Budget Code, its value cannot be higher than 4.7% of the value of GDP forecasted for a given financial year.
As is seen from Fig. 12, the share of oil and gas revenues in the federal budget as a percentage of GDP in 2007 was displaying a trend toward a gradual decline, which is demonstrative of the budget's somewhat decreased dependence on the raw materials sector of the national economy. At the same time it should be noted that the share of oil and gas revenues, despite its slight reduction, still remains high. Besides, the federal budget's average monthly deficit not linked to oil and gas throughout the year 2007 remained within the range of 2-5% of GDP, with the exception of the last two months, when the traditional upsurge in the deficit not linked to oil and gas was observed, which was associated with the specificity of the execution of spending obligations in cash terms. The amplitude of growth displayed by the deficit not linked to oil and gas at the end of a budget year has a tendency of dramatic growth, which points to the presence of serious risks threatening the state financial system's stability and requires that the government should take special measures aimed at strengthening cash discipline and promoting a more evenly distributed execution of the assumed spending obligations.
In their turn, the transfer linked to oil and gas represents a part of the federal budget's resources used to cover its deficit not linked to oil and gas by means of drawing on the oil and gas revenues and the Reserve Fund's resources. The size of the "oil and gas" transfer is limited to 3.7% of GDP. It should be stressed that these norms be applied only beginning from 1 January 2011. In the period of 2008-2010 the marginal size of the "oil and gas" transfer will be: 6.1% of GDP in 2008; 5.5% of GDP - in 2009; and 4.5% of GDP - in 2010.
25% 20%
15%
—♦—deficit not linked to oil and gas -*—revenues linked to oil and gas
Fig. 12. Average Monthly Revenues Linked to Oil and Gas and the Deficit not Linked to Oil and Gas in the 2005-2007 Federal Budget (as % of GDP)
New Chapter 13.2 of the Budget Code has also introduced some changes into the the procedure for forming the RF Stabilization Fund, which will be replaced, from the year 2008 onward, by two new funds: the Reserve Fund and the National Welfare Fund. It is noteworthy that as of 01.01.2008 the residuals of the Stabilization Fund on the accounts of the RF Federal Treasury amounted to 3,849.1 billion rubles.
The Reserve Fund represents a part of the federal budget's resources earmarked for separate accounting and management in order to make the "oil and gas" transfer, if oil and gas revenues are not sufficient to cover the amount of the transfer. The normative size of the Reserve Fund is established at the level of 10% of GDP. The Reserve Fund is formed from the oil and gas revenues of the federal budget in an amount higher than the size of the "oil and gas" transfer approved in a given financial year, on condition that the accumulated volume of the Reserve Fund is not higher than its normative size; and from the revenues from the management of the Reserve Fund's resources.
In its turn, the National Welfare Fund is formed from the oil and gas revenues of the federal budget in an amount higher than the size of the "oil and gas" transfer approved in a given financial year, if the accumulated volume of the Reserve Fund's resources is equal to its normative size (or exceeds it); and from the revenues from the management of the National Welfare Fund's resources.
The Reserve Fund and the National Welfare Fund differ in their functions and governance rules. The goal of the Reserve Fund is to ensure stability of federal budget expenditure and the fulfillment in full of the assumed spending obligations in a situation of a potential drop in international prices of oil and gas; whereas that of the National Welfare Fund is to preserve a part of oil and gas revenues for future generations and to ensure long-term stability of the budgetary system. In this connection, it is intended that the volume of the Reserve Fund should be maintained as a constant percentage of GDP.
The resources of the Reserve Fund are to be managed by applying a conservative investment strategy. Thus, these resources must be invested in reliable and highly liquid short-and medium-term debt obligations of foreign governments, state agencies, central banks, international financial organizations, and in foreign currencies. Besides, the Reserve Fund's resources can be invested in deposits and residuals on the accounts at foreign banks and credit institutions, as well as on the accounts of the RF Central Bank (CB). Thus, the principles of this investment strategy and the mechanism of its implementation are on the whole compatible with the procedure for managing the Stabilization Fund's resources.
When managing the resources of the National Welfare Fund, it is planned to apply a strategy involving investments of the Fund's resources, on a long-term basis, not only in highly liquid government securities, but also in certain less liquid financial instruments with higher yields and higher associated risks, such as shares, corporate bonds and stakes in investment funds.
In our opinion, such a strategy of managing the Reserve Fund and the National Welfare Fund is on the whole compatible with best practices of managing national welfare funds. In particular, it is evident more strict requirements in terms of liquidity should be applied to the Reserve Fund's resources, and so there is, in fact, no alternative to them being invested in the highly reliable bonds issued by foreign governments. As for the National Welfare Fund, the investment of its resources in instruments with higher yields also appears to be quite justified. In this connection, it would be feasible to rely on the long-term yield potential of such investments, because in a short term stock markets are prone to serious fluctuations in profitability. The best strategy in such a situation, in all probability, would be to gradually expand the list of instruments suitable for investing the resources of the National Welfare Fund, as well as to assign their management to highly professional asset managers.
From the point of view of expanding the list of securities for investing the resources of these two Funds, an important role is played by the investment portfolio's structure as established by legislation. It should be reminded that in 2007 the resources of the Stabilization Fund were invested with regard to their safety and liquidity as the main priorities. Similar priorities, most obviously, should be applied when investing the Reserve Fund's resources. When making the decision as to the most appropriate structure of the National Welfare Fund's investment portfolio, priority should be given to the size of yield on the invested capital, with due regard for ensuring an acceptable level of involved risks. The international practical experience of managing national welfare funds have demonstrated that the distribution of their assets should be compatible with:
1) the structure of imports in the country where a fund is created;
2) the structure of its foreign debt;
3) the share of GDP of the country (or region), in whose financial instruments the resources are invested, in global GDP;
4) the national market's financial instruments' share of the regional or global market for a given type of instruments, with due regard for the country-linked risks.
When investing the resources of the Reserve Fund and the National Welfare Fund, much attention should be given to the issues of their activity's transparency. In our opinion, it would be reasonable that control over the activity of the "oil and gas fund" should be exercised by a Supervisory Board consisting of representatives of the authorities, investment companies and the academic community. Besides, we believe that it is necessary to involve external consult-
ants on investments in the development and adjustment of an investment strategy, because their experience may prove to be very useful in making the best choice of a strategy for managing the Funds' resources.
2.3.2. An Analysis of the Execution of the RF Federal Budget in 2007
In accordance with the initial version of the 2007 law on federal budget, its revenue was set at the level of 22.3% of GDP, which is by 1 percent point lower than the actual value of the executed budget revenue as demonstrated by the results of 2006 (see Table 8). The planned decrease in the GDP share of revenue 2007 by comparison with the actually executed revenue in the previous year can be explained by changes in RF tax and budget legislation, as well as by the extremely cautions forecasts of the principal macroeconomic indices of the RF for the year 2007. At the same time, without taking into account the deductions to the RF Stabilization Fund, the federal budget revenue in 2007 remained at the level of its actual execution in 2006.
Table 8
Main Parameters of the RF Federal Budget in 2007
Reference value: 2006 - executed 2007 - law 2007 - adjusted budget 2007 - executed
billion rubles % of GDP billion rubles % of GDP billion rubles % of GDP billion rubles % of GDP
Revenue 6,276.3 23.3 6,965.3 22.3 7,443.9 23.2 7,779.1 23.6
Including:
tax revenues 3,595.7 13.4 4,243.0 13.6 4,532.0 14.1 4,633.7 14.0
non-tax revenues* 2,680.6 9.9 2,722.3 8.7 2,911.9 9.1 3,145.4 9.6
Deductions to Stabili- 1,720.7 6.4 1,690.7 5.4 1,550.5 4.8 1,903.1 5.8
zation Fund
Revenues, without re- 4,555.6 16.9 5,274.6 16.9 5,893.4 18.4 5,876.0 17.8
sources earmarked for
transfer to Stabilization
Fund of Russian Federa-
tion
Expenditure 4,281.3 15.9 5,463.5 17.5 6,532.3 20.4 5,983.0 18.1
Including:
interest 1,69.1 0.6 156.9 0.5 149.1 0.5 143.1 0.4
non- interest 4,112.2 15.3 5,306.6 17.0 6,383.2 19.9 5,839.9 17.7
Federal budget surplus 1,995.0 7.4 1,501.8 4.8 911.6 2.8 1,796.1 5.5
Surplus /deficit (without 274.3 1.0 -188.9 -0.6 -638.9 -2.0 -107.0 -0.3
resources earmarked for
transfer to Stabilization
Fund of Russian Federa-
tion)
Sources for covering -598.0 -2.2 52.9 0.2 119.1 -0.4 -33.4 -0.1
federal budget deficit
Including:
domestic 1,56.3 0.6 2,14.3 0.7 3,14.2 1.0 147.1 0.4
foreign -754.3 -2.8 -161.4 -0.5 -195.1 -0.6 -180.5 -0.5
GDP 26,882 31,220 32,100 32,989
* Including uncompensated receipts.
Source: RF Ministry of Finance; calculations of the IET.
On the basis of the existing dynamics of the receipt of revenues in the first 9 months of 2007 and the estimation of revenues received in Q IV of the same year, the federal budget
revenue was increased by 6.9% against the level approved by the Law "On the 2007 Federal Budget". In this connection, one cannot overlook the fact that, despite the more than by 20% decline in the receipts of export customs duties as a percentage of GDP, the main factor determining the growth of revenue was, nevertheless, the amount of non-tax revenues. This was achieved due to a considerable growth of revenues from sales of property (the sale of "Yukos"'s assets) and uncompensated receipts.
If the dynamics of receipts of revenues in the federal budget are to be viewed on the whole, the following features can be noted. The greatest drop, in terms of percentage of GDP, was observed in 2007 with regard to the following revenue sources: export customs duties (-1.52% of GDP) and the tax on incomes of enterprises and organizations (TIEO) (-0.69%), which could be explained by changes in oil prices, the USD exchange rate, output volumes of exported goods, as well as by changes in the growth rate and structure of GDP throughout the year 2007. It is the decline in revenues against these four items, which constituted 38.0% of the aggregate federal budget revenue in 2007, that was acting as the main factor restricting the growth of federal budget revenue.
The decline in the receipts of the value added tax levied on the goods sold in the territory of the RF early in the year was caused by the switchover, from 1 January 2007, to the notifying procedure for VAT refunds. However, from mid-year onward, this drop in the tax revenues from VAT was in part compensated for by a considerable rise in the volumes of imports, increased profits of enterprises, increased volumes of output and sales of excisable goods, increased volume of the extraction of mineral resources, and other volume-linked indices, as well as by growing prices of energy resources and a high growth rate of wages and salaries. The impact of these factors had a positive effect on the growth of receipts of the profits tax, SST, excises and VAT levied on the goods imported into the territory of the Russian Federation. The highest growth, in terms of percentages of GDP, was observed in respect of the following items: VAT levied on the goods (or works, or services) being realized in the territory of the Russian Federation (+0.76%, predominantly generated by the receipt, in redemption of the oil company "Yukos"' debts, of 239.7 billion rubles), and VAT levied on the goods imported into the territory of the RF (+0.45%).
Another problem associated with federal budget revenue was the uneven schedule of receipts in 2007, as compared to that in the previous years. Thus, the level of revenue as % of GDP in the first few months of 2007 was noticeably lower than that in 2005-2006 (Fig. 13).
The main reason for the diminishing share of federal budget revenue in GDP in January-April 2007 against that in the same periods of the previous years was the accelerated growth of GDP. The acceleration of GDP growth (by comparison with its growth in January-April 2006) was produced by three factors. Firstly, the unusually warm winter made it possible to continue construction works without interruption. Secondly, in early 2007 the activity with regard to investments and consumption became higher. Thirdly, a significant role was played
24
by the effect of base (GDP in early 2006 was growing at a rather low rate) .
24 GDP in Q I 2007 is by 7.9% higher than GDP in Q I 2006; the corresponding index of the same period in 2006 amounted to 4.6%; and in 2005 - to 5.0%. 102
Fig. 13. RF Federal Budget Revenue in 2005-2007 (as % of GDP)
In its turn, the falling of the rate of growth of federal budget revenue behind that of Russia's national economy as a whole in the first four months of 2007 was caused by the following circumstances:
• federal budget revenue strongly depends on receipts from the raw materials sector of the national economy (approximately a half of the federal budget revenue in 2006 was generated by import duties and the tax on the extraction of mineral resources). In Q I 2007, the volume of industrial output exceeded that in the same period of 2006 by 8.4%. As for the extraction of mineral resources, its volume could not grow at the same rate. As a result, the slower growth of the raw materials sector induced a drop in the share of export duties and TIEO in GDP;
• in the first few months of 2007, by comparison with the same period of 2006, oil prices were on the decline. This trend on global markets disappeared as early as mid-2007;
• the switchover to the notifying procedure for VAT refunds.
During the remaining months until the end of 2007, federal budget revenue were, on the whole, repeating the pattern of the two previous years, an exception was represented by June and October, when two peaks of revenues to the federal budget were seen. In June the growth of revenue was produced by 80% rise of VAT receipts on the previous month, as well as by uncompensated receipts from other budgets of the RF budgetary system in the amount of 54.2 billion rubles
October 2007 was a record month, by the size of monthly revenues of the federal budget, of the whole period of 2005-2007, which was primarily due to the receipts of uncom-pensated payments from other budgets of the RF budgetary system already in the amount of
176.9 billion rubles, was well as to the doubling of VAT receipts and those of the profits tax in the first 9 months of 2007.
In face of a stabilizing level of budget revenues as a percentage of GDP, the liberalization of the budgeting policy resulted in a planned increase of budget expenditure. Thus, in the 2007 Law on Federal Budget, the size of expenditure was set at the level of 17.5% GDP, which is by 1,6 p.p. higher than the same index in 2006. In this connection, as can be seen from Table 8, the aggregate growth of budget expenditure can be explained exclusively by that of non-interest expenditures, which increased to 17.0% of GDP against 15.3% of GDP as actually executed in 2006. One of the main reasons for such noticeable growth of non-interest expenditures of the federal budget in 2007 was the RF President' Message to the Federal Assembly, which specified several priority directions for the state policy in 2007. In particular, as priorities were categorized several goals to be achieved in the spheres of social policy and the population's standard of living, the national economy and the further improvement of inter-budgetary relations. The budget's orientation toward the social sphere was reflected, in particular, in the increased size of the Federal Fund for Co-Financing of Social Expenditures - by more than 35%, with its final size in the year 2007 determined in the amount of 355 billion rubles For the first time, the 2007 budget expenditure incorporated allocations earmarked for the implementation of a set of measures aimed at improving Russia's demographic situation.
As a result of the changes introduced into the budget in 2007, its expenditure was increased by nearly 3 p.p. of GDP. The adjustment of the budget revenues and expenditures was mainly aimed at investment-type expenditures. Thus, additional subsidies were allocated to the budgets of the Federation's subjects for developing the motor road infrastructure in the amount of 30 billion rubles; and those for capital repairs of the housing and utilities fund - in the amount of 10 billion rubles, as well as to cover applied scientific research - in the amount of 2.9 billion rubles.
However, it was decided that the main bulk of the additionally received situation-linked revenues (approximately 300 billion rubles) should be spent on increasing the capital of the existing development institutions:
• 180 billion rubles - to the State Corporation "Bank for Development and Foreign Economic Activity (Vneshekonombank)";
• 30 billion rubles - to the State Corporation "The Russian Nanotechnologies Corporation" (Rosnanotekh);
• 90 billion rubles to the Investment Fund, including 15 billion rubles to be subsequently transferred to the Russian Venture Company.
Moreover, another 340 billion rubles allocated from the resources received from the sale of "Yukos"'s assets was distributed in the following way: 240 billion rubles - to cover the activity of the Fund for Promoting Reform of the Housing and Utilities Sector; and the remaining 100 billion rubles - to Rosnanotekh.
Thus, the additional investments made by the State in recent years in development institutions were covered by resources in the amount of 2% of GDP. It is noteworthy that the set of instruments applied in federal investment policy has recently been considerably expanded, while the State began to be more actively involved in the investment processes. However, the necessity to maintain macroeconomic stability, as an indispensable condition for the efficient use of government investments, predetermines the need for a very careful policy aimed at increasing the size of investment-type expenditures, in order to prevent any inflation-generating
pressure on the ruble's exchange rate. In this connections, it appears quite natural that the RF Ministry of Finance desires to "spend the resources additionally allocated to development institutions evenly over three or four years", so that not to trigger the inflation spiral.
It should be noted that the dynamics of expenditures was similar in the last three years. In 2007, just as before, there persisted a trend toward a growth in expenditures by the end of a year, caused by the uneven pattern of spending of budget resources by state agencies over a year (see Table 9). In 2007, one additional factor was the political component - the elections to the State Duma in December and the presidential election in March 2008.
On the whole, it can be said that the curve of expenditure in 2007 is for the most part plotted higher than that of 2005 and 2006, that is, there occurs a gradual growth of the federal budget expenditure, with a simultaneous increase of its share in GDP (see Fig. 14).
Table 9
The Execution of the 2007 Federal Budget in Cash Terms (as % of Budget Revenue and Expenditure in that Year)
Q I 1st half-year 9 months Year
EXPENDITURE 14.5 33.2 53.0 91.6
General state issues 10.0 23.0 38.3 75.2
Of these: government debt servicing 28.6 42.2 78.2 96.0
National defense 17.6 42.2 62.5 98.9
National security and law enforcement activity 18.2 41.6 64.4 98.9
National economy 8.3 21.4 35.8 90.2
Housing and utilities 1.0 5.5 10.5 99.4
Environment protection 13.1 36.5 59.4 99.0
Education 13.3 38.3 59.7 101.2
Culture, cinematography and mass media 12.8 34.1 56.9 99.7
Health care and sport 8.3 22.0 37.5 70.6
Social policy 13.5 31.7 50.9 75.7
Interbudgetary transfers 20.1 41.9 67.8 97.8
Source: RF Ministry of Finance financial RF; calculations of the IET.
The problem of the execution of federal budget expenditure in cash terms began to be felt acutely as early as in the beginning of 2007. Thus, federal budget expenditure in the 1st half-year 2007 was executed only in the amount of 1/3 of its annual size, as determined in the budget revenues and expenditures. The situation with regard to the housing and utilities sector seemed catastrophic indeed, when by the results of the 1st half-year it became clear that only 5.5% of the resources envisaged in the budget had actually been implemented. As before, extremely low was the level of implemented expenditures on priority national projects (less than 30% of their annual amount).
The main reasons for the existing situation were, firstly, the late conclusion of contracts for the placement of government orders for the procurement of goods (or works, or services) for state needs, and the failure to fulfill their terms in due time; secondly, the absence of government decrees necessary for the execution of the federal budget; and thirdly, the continuing trend of resources being transferred by the principal administrators of budget funds to their recipients at the end of the year.
B 2005 □ 2006 □ 2007
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
Fig. 14. RF Federal Budget Expenditures in 2005-2007 (as % of GDP)
Since, as seen by the results of the first 9 months of 2007, spending obligations had been fulfilled only by 50%, the upsurge in expenditure at the year's end was very dramatic. As seen by the year's results, the expenditures on such items as "General state issues", "Health care and sports" and "Social policy" were executed only by % of the planned amount.
2.3.3. An Analysis of Revenues from the Main Taxes Received by the RF Budgetary System
One of the most important problems is that represented by the interrelation between the tax burden and economic growth. On the one hand, as economic growth produces an expansion of the taxation base, the customs and tax revenues will grow in absolute terms. On the whole, depending on either a regressive or progressive character of the tax system, this may result either in an increasing or a decreasing percentage of taxes in GDP (or its maintenance at a currently existing level). On the other, an excessively heavy tax burden may become an impediment to comprehensive economic development.
As seen from the data presented in Table 10, the tax burden on Russia's economy in the last years of the period under consideration was stable, fluctuating within 36-37 % of GDP.
In 2007 the volume of tax revenues received by this country's budgetary system increased by 1.4 p.p. of GDP, by comparison with the previous year. Among the main factors determining the growth of tax revenues, there were the favorable situation with regard to Russian exports, and first of all oil, gas and metals; the expansion of the bases for many taxes resulting from growth of the Russian national economy; and improved tax administration.
Table 10
Changes in the Levels of the Tax Burden and the Revenues from the Main Taxes Received by the Budget of the Russian Federation's General Government in 2000-2007 (as % of GDP)
2000 2001 2002 2003 2004 2005 2006 2007
Level of tax burden (1+2+3) 38.46 33.91 32.74 31.97 32.63 36.20 36.52 36.75
Tax revenues (1) 28.02 27.69 26.99 25.61 24.79 25.55 24.46 25.84
Including:
Profits tax 5.39 5.75 4.28 3.98 5.09 6.16 6.21 6.58
PIT 2.37 2.86 3.31 3.44 3.37 3.27 3.46 3.84
UST* - 5.79 4.13 3.68 3.49 1.99 1.96 1.99
VAT 6.20 7.17 6.96 6.66 6.27 6.81 5.62 6.86
Excises 2.27 2.72 2.44 2.59 1.43 1.17 1.01 0.95
TIEO** - 0.74 2.55 2.50 2.99 4.20 4.07 3.63
Contributions to compulsory pen- 7.30 2.51 2.76 2.94 2.80 2.88 3.48 3.61
sion insurance (2)
Revenues from foreign economic 3.14 3.71 2.99 3.42 5.04 7.77 8.58 7.30
activity (3)
* Less contributions to compulsory pension insurance.
** In 2001, instead of TIEO, the amount of fees for the extraction of mineral resources is stated. Source: RF Ministry of Finance; Rosstat; calculations of the IET.
The structure of tax revenue in the general government's budget is shown in Fig. 15.
70,0% 60,0% 50,0% 40,0% 30,0% 20,0% 10,0% 0,0%
!
<u
X ro
<u >
<u
X ro
o CL
l
< >
EsaiiB
o X LU
o
LU
MUL
iO ZD
□ 2005 Q2006 B 2007
* Less contributions to compulsory pension insurance.
Fig. 15. The Share of Tax Revenues in the Aggregate Revenue of the General Government's Budget in 2005-2007, in %
The structure of tax revenue in 2007 demonstrated noticeable changes only in respect of the revenues from VAT, which returned to the level of 2005. This circumstance was the deci-
sive factor determining the situation when the tax revenues of the general government, having overcome their fall in 2006, once again reached the 2005 level. Besides, it should be noted that the share of revenues from TIEO, similarly to that of the revenues from foreign economic activity, for a second successive year continued to decline. As for the shares of the revenues from the profits tax and the personal income tax (PIT), these, on the contrary, during the same period were displaying trends towards growth.
Profits Tax
According to the results of 2007, the revenues from the profits tax somewhat increased by comparison with the previous year and amounted to 6.58% of GDP. The dynamics of the tax on profit of organizations was displaying its traditional seasonality associated with the timelines for its payment, resulting from which the revenues are always higher in Q II and IV of each year.
19,00% T 17,00% 15,00% + 13,00% 11,00% 9,00% 7,00% 5,00% 3,00%
43,0%
17,5%
50,0% 45,0% 40,0% 35,0% 30,0% -- 25,0% 20,0% -- 15,0% 10,0% 5,0% 0,0%
2003
2004
2005
2006
2007*
'"""' Revenues from the profits tax, as % of GDP Irs** Aggregate financial result of organizations' operation, as % of GDP A Percentage of loss-making organizations, as % of total number of enterprises (right-hand scale)
* The values of aggregate financial result of organizations' operation and the percentage of loss-making organizations correspond to the results of the first 9 months of 2007.
Fig. 16. The Dynamics of the Revenues from the Tax on Profit of Organizations Received by the RF Budgetary System, the Aggregate Financial Result of Organizations' Operation and the Percentage of Loss-Making Organizations in 2003-2007
The main factors determining the growth of revenues from the profits tax were economic growth and the continuing increase in oil prices. The further decline in the percentage of loss-making organizations in the national economy and the renewed growth of the net aggregate financial result of organizations' and enterprises' operation as a percentage of GDP are indicative of an expanding tax base for the tax on profit of organizations (see Fig. 16).
The factors restricting the growth of revenues from the profits tax in 2007 were the following changes introduced into tax legislation:
• the lifting of limitations on the size of carried-forward losses. Thus, in 2007 organizations were granted the right to decrease, in full, the tax base for a current tax period by the
amount of losses incurred in the previous tax periods (Item 2 of Article 283 of the RF Tax Code (TC));
• changes in the timelines for writing off the expenditures on research and development. Thus, irrespective of whether research and development have yielded a positive result or not, the expenditures of an organization relating to research and development should be charged to costs for purposes of taxation during the period of one year, from the 1st day of the month following the month in which such research was completed;
• the recognition, for purposes of taxation, of the expenditures on purchase of the land plots from lands in state or municipal ownership, on which buildings, structures, and installations are situated, or which are purchased for purposes of capital construction;
• the granting to the organizations operating in the field of information technologies of the right to include the value of computer equipment in the amount of material costs on a lumpsum basis, at the time of it being put in operation;
• changes in the depreciation procedure for payers of tax on profit of organizations in respect of their fixes assets being depreciated, which are used only for scientific and technological research, namely the possibility to apply a special coefficient (but not higher than three) to the basic depreciation norm.
Personal Income Tax
Revenues from the personal income tax in real terms continued their upward trend, which had first emerged in 2006, and by the results of 2007 amounted to 3.84% of GDP, which is nearly by 0.4 p.p. higher than the level of the previous year.
At the same time, in 2007 the money incomes of the population less social deductions (as a percentage of GDP), which represent a baseline macroeconomic index explaining the dynamics of revenues from PIT, increased by 1.8 p.p. of GDP, that is, in 2007 the value of the real effective rate of PIT turned out to be higher than that in 2006. Growth in the share of the tax base for PIT in GDP occurred for the first time in the last 5 years.
As seen from Fig. 17, the dynamics of real incomes of the population less social deductions largely explains the peculiarities of the dynamics of the revenues from this tax.
The main restricting factor with regard to the growth of revenues from PIT received by this country's budgetary system in 2007 was the expansion (or indexation) of the existing tax deductions. In particular, from the year 2007 onward, the maximum sum of the deduction from the social tax was increased from 38,000 to 50,000 rubles, and the deductions are granted in the amount of the actual expenditures, but their total cannot be more than 100,000 rubles in a given tax period.
At the same time, Federal Law No. 269-FZ, of 30 December 2006, "On a simplified procedure for declaring the incomes of physical persons" influenced the growth of revenues from PIT only slightly. Thus, the "tax amnesty" in Russia, which took place from 1 March through 31 December 2007, yielded only 3.67 billion rubles as additional budget revenues, or slightly more than 0.01% of GDP.
-- 10,0%
2,00%
2000
2006
2001 2002 2003 2004 2005
B revenues from PIT, as % of GDP (left-hand scale) money incomes of population less social deductions, as a percentage of GDP
2007
Fig. 17. The Dynamics of the Revenues from PIT Received by the RF Budgetary System, and of the Money Incomes of the Population less Social Deductions, in 2000-2007
Unified Social Tax (UST)
Beginning from the year 2001, the revenues from UST (less the amount of contributions to compulsory pension insurance (CPI)) received by the RF budgetary system have been displaying a downward trend (see Table 11), which can largely be explained by changed normative standards for the distribution of tax revenues and social payments between the federal budget and the Pension Fund of the Russian Federation. In 2006, some stabilization of the revenues at the level of 2005 was achieved, the same also being noted by the results of the year 2007.
Table 11
A Comparison between the Dynamics of Revenues from UST
2001 2002 2003 2004 2005 2006 2007
Revenues UST (less contributions to CPI) 5.79 4.13 3.68 3.49 1.99 1.96 1.99
Contributions to compulsory pension insurance - 2.76 2.94 2.80 2.88 3.48 3.61
Revenues from taxes and social payments 5.79 6.89 6.62 6.29 4.87 5.44 5.60
Wages and salaries fund 35.83 40.88 42.12 41.05 39.22 41.80 44.80
Source: RF Ministry of Finance, Rosstat.
Considering the fact that, in accordance with Article 243 of the RF TC, the amount of UST due to be paid to the federal budget is subject to deduction, to be made by taxpayers on their own, in the amount of the sum of contributions to compulsory pension insurance charged to them for the same period, from the point of view of economics it would have been more 110
feasible to deal with the aggregate sum of revenues from all the taxes and social payments being transferred to the budget. The dynamics of the aggregate social payments was fully consistent with that of the salaries and wages fund, the latter serving as base for calculating both UST and the contributions to CPI.
However, due to the regressive character of the SST scale and no specified intervals for computing its rate, the growth rate of aggregate revenue from social payments during the whole period of 2001-2007 was lower than that of the wages and salaries fund. The year 2007 was no exception.
Excises
In 2007, the tax revenues from excises as a percentage of GDP continued to display their downward trend which had first appeared in 2004, amounting to 0.95% of GDP, against 1.01% of GDP in 2006. Since excises are levied predominantly on the basis of specific rates, budget revenues strongly depend on the level of indexation applied to their rates in a given year. The rates of excises, as determined in the Tax Code, in 2007 were not indexed at all with regard to oil products; the excises on alcohol-containing beverages were indexed on the average by 8.5-9.3%. An exception was represented by wines and other alcohol-containing beverages with ethyl alcohol content less than 25%, their excise rates being indexed by 35-45%. The level of indexation of the rate of excise on passenger cars varied within the range of 8.312.5%.
The greatest changes in 2007 occurred with regard to the rates and the procedure for calculating the excises on tobacco products. Thus, from 1 January 2007 onward, for purposes of levying excises, a fixed maximum retail price of tobacco products was established, to serve as a base for calculating the ad valorem component of the excises. The switchover to the application of a fixed maximum retail price established by manufacturers was necessitated by the need to prevent tax evasion through establishing transfer prices, as part of control over the retail trade in tobacco products. The manufacturing and importing of filter-tipped cigarettes, without indicating on the package their maximum retail price, as well as the month and year of manufacture, was prohibited from 1 January 2007, and their retail sale - from 1 January 2008. In respect of cigarettes without filter and cigarettes with cardboard mouthpieces, their manufacture and imports without indicating such information on the package were prohibited from 1 July 2007, and retail sale - from 1 July 2008 r.
One more important event in 2007 was the approval, by Federal Law No. 75-FZ, "On introducing changes to Chapter 22 of Part Two of the Tax Code of the Russian Federation", of the indexation regime to be applied to the rates of excises levied on excisable goods in 20082010. The dynamics of the indexation patterns applied to different excise rates vary greatly: thus, while it is not planned to change the rate of excise on oil products during the next three years, the rates of excises on alcohol-containing products and passenger cars will be increased during the same period, on the average, by 21-22%, and the excise on tobacco products will be nearly doubled. The indexation of the rates of excises on tobacco products was motivated by several factors: firstly, rapid increase of the tax component in the price of cigarettes, and predominantly that of low-quality brands, always results in an upsurge in prices of cigarettes, especially cheaper segments, which is quite compatible with the general logic of the health protection policies all over the globe. Secondly, rapid adjustment of the tax to the EU stan-
dards and unification of excise policy across the CIS community represents a valid instrument of reducing the scope of the shadow tobacco business.
On the whole, against the backdrop of slight indexations of the rates of excises, the dynamics of the tax base of excisable goods serves as the main factor determining the existing volumes of resulting revenues. It should be noted separately that the general trend characterizing the period of 2000-2006 was the falling of the growth rate of the tax base in respect of all groups of excisable goods, except alcohol-containing products, behind the dynamics of real GDP, which largely explains the declining share of the revenues from excises in this country's budgetary system. In 2007 this trend, on the whole, persisted, while displaying certain variations depending on specific groups of excisable goods.
Fig. 18. Revenues from Excises in 2005-2007, by Group of Excisable Goods
The data presented in Fig. 18 make it possible to assume that the raised excises on tobacco products and the introduction of a minimum retail price (MRP) had a favorable effect on the budgetary system. The excises were increasing at an accelerated rate, by comparison with the excises on other groups of excisable goods The experiment with the introduction of MRP can be estimated as quite successful, since it does not only make it possible to influence the "upward" shifts in consumer preferences and to peg the volumes of revenues to changes in the market situation, but also to improve the quality of administering the excise on tobacco products.
The significant increase in the share of revenues from the excise on tobacco products in the overall structure of revenues from excises was simultaneous with a decline in the share of excises on oil products.
Excises on tobacco products. While the year 2006 can be regarded as "peak" in terms of both output and sale of tobacco products, in 2007 there occurred a certain stabilization, and sometimes even decline in the demand for tobacco products per capita, which was in the main associated with this country's negative demographic dynamics, as well as increasing retail 112
prices, predominantly of cheaper brands, as a result of changes in the rates and the procedure for collecting excises. Manufacturers responded to changes in the demand for tobacco products by diminishing the volumes of output by 3.9% against the level of 2006 (see Table 12).
Table 12
Output of Cigarettes, including Cigarettes without Filter and Cigarettes with Cardboard Mouthpieces, in 2000-2007, billion
2000 2001 2002 2003 2004 2005 2006 2007
Production of cigarettes with and without filter 348 367 390 383 383 407 414 398
Source: Rosstat.
Excises on alcohol-containing products. In Russia, the dynamics of demand for alcohol-containing products, although having objective reasons for reproducing, with a certain lag, the situation characterizing the consumption of tobacco products, in 2007 was generally displaying an upward trend. In this connection, a slowdown in the growth of production of alcohol-containing beverages in Russia that has occurred in recent years, predominantly in connection with the changes in the state regulation of this market occurring in 2005-2006, was seen no more in 2007, when all the types of alcohol-containing products were characterized by growing output volumes (see Table 13). Regional authorities have been making every effort in support of the development of their own production of vodka, other products of spirits-making, and wines, including through the introduction of various restrictions on imported products. As a result, in the second half of 2007, according to experts, the market for legal alcohol-containing products was very "overheated", which was demonstrated by overproduction and inrensifying competition.
Table 13
Outputs of Legal Alcohol-Containing Products in Russia in 2000-2007 (million deciliters)
Type of product 2000 2001 2002 2003 2004 2005 2006 2007
Food alcohol 62.4 63.9 71.4 71.5 76.0 70.0 54.6 55.9
Vodka, other products of spirits-making 123.0 131.0 140.0 135.0 136.6 132.4 119.6 131.0
Cognac 1.8 2.1 2.7 3.5 3.9 4.5 6.4 8.0
Champagnes and sparkling wines 6.8 7.7 8.1 8.8 12.1 14.1 15.4 21.6
Vintage wines 24.1 27.4 33.3 36.5 39.1 31.7 47.0 51.2
Fruit wines 2.8 3.5 2.6 3.2 4.2 4.1 3.0 3.4
Beer 516 638 703 755 838 910 999 1 160
Source: Rosstat.
Excises on oil products. When analyzing the dynamics of the base for excisable oil products, it should be borne in mind that a dominant role in generating revenues from the excises on oil products is being played by the excises on motor gasoline (less straight-run gasoline) and diesel fuel, which in recent years have been accounting for no less than 92% of revenues. In this connection, it would be reasonable to focus attention on the trends being displayed by the domestic markets of these types of oil products in 2007. Thus, the volume of sales of motor gasoline on the domestic market increased in 2007 only by 1.7%.
Table 14
Dynamics of Output and Sales of Motor Gasoline and Diesel Fuel in 2000-2007, million tons
2000 2001 2002 2003 2004 2005 2006 2007
Production of motor gasoline 27.2 27.6 29.0 29.3 30.5 32.0 34.4 35.1
Of this, realized on domestic market 23.5 24.4 25.8 25.5 26.5 26.1 28.0 28.5*
Production of diesel fuel 49.2 50.2 52.7 53.9 55.4 60.0 64.2 66.4
Of this, realized on domestic market 25.1 25.3 24.0 23.4 25.2 25.3 27.2 28.2*
* Estimate.
Source: Rosstat.
With regard to the excises on oil products, the year 2007 saw return to the pre-2003 tax regime, when the payers of taxes were persons engaged in the manufacture and realization of oil products. In this connection, the procedure for the payment of excises on the basis of a statement of operations with oil products was preserved only in respect of straight-run gasoline. There were several reasons for the reestablishment of the old system. Firstly, the currently applied system for the payment of excises gave rise to numerous schemes of tax avoidance, which had also been made easier by the growth in the number of payers from several dozens of oil refineries to 13,000 entities. When payments were distributed along the retail chain, this tax was quite often lost, because neither the buyer nor the supplier were paying it. Besides, there emerged yet another problem: the vertically integrated companies were choosing on their own the regions where it was most convenient for them to register their subdivisions and pay the excise. As a rule, the choice of a region was motivated by opportunities to be granted tax exemptions by local authorities. Thus, the procedure for computation and payment of the excises on oil products existing since 2003 was failing not only to ensure an even distribution of taxes, but also to increase the inflow of revenues into this country's budgetary system.
Excises on passenger cars. The dynamics of the tax base for the excises on passenger cars in 2000-2006 was steadily on the rise, the highest input in the rate of growth being produced by imports with regard to this group of commodities, which over 7 years increased by 4.6 times. By the results of 2007, imports also became a major factor determining the growth of revenues from excises in this group of excisable goods: over 2007, the volume of import of passenger cars increased by more than 1.5 times, by comparison with 2006.
In face of rapid increase in the volume of import, the domestic production of cars with typically low-powered engines in recent years has been stagnating, the overall growth being achieved owing to the increasing volumes of industrial assembly output. However, the downward trend in the growth rate of the output of domestic cars is insignificant from the point of view of analysis of tax base for the excises on passenger cars, because excisable rates vary depending on engine power. For cars with engine power of no more than 90 hps (this parameter being true for nearly all the types of Russian-made passenger cars, with the exception of GAZ), tax legislation envisages a zero rate of excise.
Besides, it should be noted that over the period under consideration the growth in the volumes of sales of cars on the domestic market was roughly corresponding to the rate of changes in the real disposable money incomes of the population, and was nearly twice as high as that of real GDP.
Table 15
Dynamics of Tax Base for the Excises on Passenger Cars in 2000-2006, thousand units
2000 2001 2002 2003 2004 2005 2006 2007
Production of passenger cars Import of passenger cars 969.0 226.2 1,022.0 475.0 981.0 697.0 1,012.0 573.0 1,110.0 525.2 1,069.0 773.7 1,175.0 1,049.5 1,290.0 1,601.0
Source: Rosstat, Federal Statistics Service.
Value Added Tax
A substantial share in the tax revenues of the general government's budget has traditionally belonged to the revenues from the value added tax. In terms of percentages of GDP, an upward trend in their growth rate had been prevalent only prior to 2002, after which began a steady decline. A slight improvement was demonstrated only by the results of 2005, which was mostly due to the additional revenues resulting from the redemption of the debts of the oil company "Yukos", and then later, in 2006, the volume of revenues once again noticeably dropped.
In 2007 the share of revenues from the value added tax increased to 6.86% of GDP (from 5.62% of GDP in 2006). However, if one corrects the bias produced by revenues received from the Oil Company "Yukos", VAT growth will become much more modest (by 9.0%, by comparison with 2006) and on the whole correspond to the dynamics of the tax base (see Table 16)25.
Table 16
Dynamics of Final Consumption, Imports and Revenues from VAT Received by the RF Budgetary System in 2000-2007 (as % of GDP)
2000 2001 2002 2003 2004 2005 2006 2007
Revenues from VAT, less 6.20 7.17 6.96 6.66 6.27 6.17 5.62 6.13
revenues from "Yukos"
Final consumption (less VAT н/д 59.1 61.5 61.4 60.8 60.1 60.6 60.1
charged by declarations)
Imports* 13.0 13.7 13.4 13.3 12.8 12.9 13.9 15.5
* The share of imports in GDP was determined as ratio of the amount of imports according to customs statistics to GDP estimated in USD on the basis of average nominal USD/ruble exchange rate in a given year.
Source: Rosstat, RF Ministry of Finance, RF Federal Statistics Service, calculations of the IET.
Final consumption in prices less VAT in 2007 amounted to 60.1% of GDP, which is by 0.5 p.p. of GDP lower than in 2006. In the last years the share of final consumption as a percentage of GDP, cleared of VAT, has been fluctuating within the range of 1 percent point of GDP, thus making it possible to speak of a relative stability of tax base of the VAT levied on the realization of goods (or works, or services) on the domestic market. The dynamics of imports are characterized by higher volatility over the whole period under consideration, despite
25 In our opinion, it is more feasible to apply as the macroeconomic characteristic of the VAT base the value estimate of final consumption in market prices less the amount of tax, and not the total value added or GDP. This approach is quite justified, because the value added tax is a tax on consumption and is not applied for taxing the investment activity (the amount of tax on capital goods is subject to refund (or deduction), the results of which are also reflected in a country's GDP.
the level of imports in 2007 amounting to 15.5% of GDP, against 13.0% of GDP in 2000. Thus, the tax base of VAT levied both on domestic operations and on imports indeed somewhat increased, as demonstrated by the results of the 8-year period, and consequently, macro-economic factors create positive preconditions for growth of the revenues from VAT within this particular time interval.
Growth of the revenues from VAT could have been even higher. However, increased tax deductions, resulting from changes in legislation introduced in 2006-2007, acted as one of the main restricting factors in this sphere.
In 2007, the consequences of the switchover from a permitting to a notifying procedure for refunding the amounts of VAT to exporters paid by them in connection with purchases of goods and material resources were still being felt. As shown by taxation statistics, the refunds against this item in 2007 amounted to 312.4 billion rubles.
Besides, the tax deductions claimed by subcontractors carrying out capital construction works in connection with the switchover to a general procedure for paying the tax (1.03% of GDP in 2007 against 1.12% of GDP in 2006 and 0.52% of GDP in 2005) have remained at a high level. As a consequence, the revenues from the VAT levied on the goods realized in this country's territory diminished by 341.2 billion rubles.
On the whole, as seen by the results of the year 2007, the percentage of deductions in the total amounts changed increased by 3.96 p.p. of GDP, which is the consequence of the changed procedure for VAT refunds when the zero rate is applied.
From the year 2007, the list of operations exempted from VAT was augmented by two more items:
• the realization of items used for religious purposes and religious literature produced and realized by religious organizations (or unions) and the organizations whose sole founders (or participants) are religious organizations (or unions);
• the import, into the customs territory of the Russian Federation, of pedigree cattle, pedigree swine, sheep and goats, semen and embryos of the aforesaid stock, pedigree horses and pedigree eggs, in accordance with the list of codes as indicated in the Foreign Trade Commodity Nomenclature, established by the RF Government.
From the year 2008, exemptions from VAT are extended to services relating to the transfer and granting of exclusive rights to inventions, utility models, industrial designs, software, databases, topologies of integral microcircuits, production secrets (know how), as well as the rights to use the aforesaid products of intellectual activity on the basis of a licensing agreement.
Besides, the decision was adopted concerning the exemption from VAT, from 2008 onward, the performance by organizations of the following types of research, research-and-development, and technological engineering works: the development of a construction design for an engineering object or a technological system; the development of new technologies; the creation of utility models of machines, equipment, and materials, characterized by certain fundamental features specific of innovations, when these items are not intended for sale to third persons; and the testing of such items during a period of time appropriate for obtaining data, accumulating experience, and reflecting it in technical documentation.
Tax on the Extraction of Mineral Resources
One important source of revenues for the budgetary system of the Russian Federation is the payments for the use of natural resources, a substantial part of which is constituted by revenues generated by the tax on the extraction of mineral resources (TIEO). The revenues from TIEO received by the federal budget have been displaying, since 2003, a stable trend toward growth due to increasing global prices of energy carriers. Since the rate of TIEO directly depends on the level of the international price of oil, the improving situation on the international market of energy carriers was automatically being reflected by the level of revenues from this tax.
The main bulk of the aggregate revenues from TIEO is constituted by the revenues from the extraction of oil. In 2002-2007 these accounted for 85-90% of all revenues. Accordingly, the dynamics of the total revenues from TIEO is very strongly determined by the same factors that determine the level of tax revenues from oil extraction. The most important among such factors are the volume of oil extraction and the level of global oil prices.
The extraction of oil in 2007 increased by 2.1%, while its average annual price - by 14.6% (see Table 17).
Table 17
Dynamics of Revenues from TIEO and of the Main Macroeconomic
Indices in 2002-2007
2002 2003 2004 2005 2006 2007
TIEO, as % of GDP 2.55 2.50 2.99 4.20 4.07 3.63
Extraction of oil, including gaseous condensate, 379.6 421.4 458.8 470.0 480.5 491.0
million tons
Average annual level of price of Urals, USD /barrel 23.43 27.07 34.57 49.63 60.32 69.12
Source: RF Ministry of Finance; Rosstat; data published by the Energy Information Administration (EIA) under the US Department of Energy (DDE); calculations of the IET.
On the basis of the estimated regressive dependence of the index of TIEO revenues on the indices of the baseline TIEO rate, oil extraction volume, price of Urals, and the USD exchange rate, it was possible to generate quantitative parameters for estimating the impact of the main structural and situation-linked factors on the dynamics of TIEO revenues in the period under consideration. The results of our estimations are presented in Table 18.
Table 18
The Contributions of Different Factors to Changes in the Revenues from TIEO, as % of changes in GDP
2002 2003 2004 2005 2006 2007
Tax on the extraction of mineral resources, total 7.65 2.31 4.71 7.65 5.86 0.57
Including:
Baseline rate of TIEO applied to oil extraction 0.95 0.00 0.05 0.45 0.00 0.00
Volume of oil extraction 2.28 2.36 1.34 0.33 0.28 0.23
Price of Urals 1.11 2.83 4.32 7.72 4.60 2.79
USD exchange rate 4.69 -1.16 -1.98 -0.46 -0.86 -1.06
Other factors -1.37 -1.72 0.98 -0.39 1.84 -1.39
Source: calculations of the IET.
As seen from these data, the main impact on changes in the amount of revenues from TIEO over the period under consideration was produced by rising global oil prices: the share of change in the price of Urals that occurred during that period corresponded to more than 81% of the change in the amount of revenues from TIEO. Besides, the contribution of this main situation-linked factor to TIEO dynamics may, to an important degree, be regarded as one of the effects of tax reform, because the TIEO rate actually applied to oil extraction was made to be directly dependent on the dynamics of the global prices of Russia's Urals.
A sufficiently significant influence on changes in the revenues from TIEO in 2002-2007 was exerted by changes in the volumes of oil extraction - one of the main structural factor, which accounted for nearly 24% of the total change in TIEO revenues over this period.
The change in the baseline rate of TIEO applied to oil extraction had a very slight effect on the amount of TIEO revenues, while the dynamics of USD's exchange rate had an altogether negative impact on it: the overall drop in the revenues from TIEO as a result of a lower USD's exchange rate amounted to only 2.9%.
2.3.4. Expenditures in the Budgetary System
The main expenditure characteristics of RF budgets of all levels in 2005-2007 are shown in Table 19.
Table 19
Expenditures of the General Government in 2005-2007, as % of GDP
2005 2006 2007 Growth 2007, as compared to 2006
EXPENDITURE 31.54 31.19 34.09 +2.90
General state issues 3.49 3.07 3.54 +0.47
Of these: government debt servicing 1.11 0.74 0.53 -0.21
National defense 2.69 2.54 2.53 -0.01
National security and law-enforcement activity 2.71 2.66 2.62 -0.04
National economy 3.53 3.53 4.73 +1.20
Housing and utilities 2.18 2.35 3.34 +0.99
Environment protection 0.10 0.09 0.08 -0.01
Education 3.71 3.84 4.07 +0.23
Culture, cinematography and mass media 0.71 0.70 0.75 +0.05
Health care and sports 3.69 4.00 4.20 +0.20
Social policy 8.74 8.40 8.24 -0.16
Interbudgetary transfers X X X X
Source: RF Treasury.
Traditionally, high volumes of financing were allocated to the following budget sections: "General state issues", "National defense", "National security and law-enforcement activity", "National economy", "Education", "Health care and sports", and "Social policy".
Although the expenditure structure of the RF budgetary system in 2007 did not change in any fundamental way by comparison with the previous year, on the basis of that year's results growth can be noted with regard to the sections "National economy" (by 1.2 p.p. of GDP), "Housing and utilities" (by 1,0 p.p. of GDP), and "General state issues" (less the cost of government debt servicing) (by 0.7 p.p. of GDP). Slight growth was also displayed by the "social package" - "Education" (by 0.2 p.p. of GDP) and "Health care and sports" (by 0.2 p.p.
of GDP). Evidently, the increased expenditures on these sections of the functional classification can be explained by the fulfillment of the State's increased social obligations to the population, including within the framework of priority national projects.
The indices of the other sections either demonstrated a slight decline in expenditures, or remained at the previous year's level. The greatest drop was seen with regard to the section "Social policy", where the amount of expenditures decreased from 8.40% to 8.24% of GDP. One positive feature is the strengthened trend toward a reduction in the share of expenditures relating to state and municipal debt servicing.
Simultaneously, it should be noted that the government's tendency to slacken its budgeting policy results in a very rapid increase in the amount of long-term budget liabilities, the servicing of which in an event of a changed macroeconomic situation is fraught with the risks of financial instability of the State. Moreover, if expenditures are increased at a rate higher than that of the Russian economy's growth, this will give rise to additional problems in a situation of excessive inflation pressure, which will be diminishing the anti-inflation effect of the measures undertaken by the government. In 2007 the government did not succeed in maintaining the inflation rate at a predetermined level (8.0-8.6%), and it leaped to 11.9%, and so any further increase in the amount of non-interest expenditures as a share of GDP must be rigidly pegged to the government's policy.
2.3.5. An Estimation of Budget Parameters Cleared of the Contribution of the Oil and Gas Sector and of the Influence of Global Oil Prices
In order to ensure a well-balanced state budget in countries where tax revenues strongly depend on exports of raw materials and the situation on international markets, it is of fundamental importance, when estimating the situation-linked risks for the state budget and the margins for lowering the tax burden on the national economy, to distinguish within the latter its structural and situation-linked components.
The situation-linked component incorporates the part of tax revenues dependent on a favorable situation on foreign markets. The structural component reflects the level of taxes being transferred to the budgetary system at a certain average level of parameters characterizing the foreign economic situation over many years.
Different approaches can be applied to separating the structural and the situation-linked components of the tax burden. Because the dynamics of global oil prices represents one of the most important factors determining the situation-linked component of changes in the levels of GDP and tax revenues in Russia, one of the possible ways to do it would be to determine the situation-linked component through separating the "oil and gas" revenues in the budget. This approach has been applied by the RF Ministry of Finance since 2007. In effect, it is based on the principle of distinguishing between "structural" and "situation-linked" taxes. In this particular case, the term "situation-linked" is applied to the taxes that directly depend on the prices of oil and gas. An indisputable advantage of such an approach is its simplicity, as well as the methodologically definite character of the necessary estimations. At the same time, this approach does not take into account the influence of foreign economic situation on the volumes of revenues from other taxes. For example, it is quite obvious that the level of the prices of oil and gas depends on the profitability of the oil and gas sector, which, in its turn, influences the tax collection aspect of the profits tax.
This disadvantage is eliminated when a fundamentally different approach is applied to separating the structural and situation-linked components of the tax burden. This second approach is based not on distinguishing between the two groups of taxes, but on separating the structural and situation-linked parts within the revenues from the main taxes, based on statistical modeling of the dependence of GDP and tax revenues on the main situation-linked factors26, such as:
• factors of domestic demand (in our model these are represented by real investments in fixed assets);
• factors of the international price of oil;
• other factors (including fluctuations of the ruble's real effective exchange rate, and accidental factors determining short-term fluctuations).
In this connection, structural GDP represents the volume of GDP that could have been achieved at the average values of explanatory variables. Any deviations from the average level represent the situation-linked component of GDP. In order to estimate the structural component of GDP, the leveled values of the model's explanatory variables were calculated. In view of the different nature of each variable, for leveling such factors as real investments in fixed assets and real effective exchange rate, we applied the Hodrick-Prescott filter. The average price of oil over many years was obtained by applying the method of 25-year sliding average.
On the basis of the obtained coefficients, we calculated the shares of a situation-linked GDP explainable by different factors, which were determined earlier (see Table 20).
Table 20
Dynamics of the Structural and Situation-Linked GDP Parameters: Estimates
over the Period of 2000-2007
2000 2001 2002 2003 2004 2005 2006 2007
Structural GDP, as % of GDP 98.5 97.1 97.1 96.2 90.3 86.1 83.5 81.0
Situation-linked GDP, as % of GDP 1.5 2.9 2.9 3.8 9.7 13.9 16.5 19.6
Including factors influencing changes in situation-linked GDP parameters:
domestic demand, as % of GDP 1.2 1.6 -0.9 -1.1 0.0 0.0 0.8 0.9
oil prices, as % of GDP 1.0 1.2 3.1 4.6 8.1 12.6 14.0 16.6
other factors, as % of GDP -0.7 0.1 0.4 0.4 1.6 1.3 1.7 2.0
Source: RF Ministry of Economic Development and Trade; Rosstat; IMF; MEA; calculations of the ET.
26 The equation applied for determining separately the structural and situation-linked components of GDP is as follows: Yt = a0 + a1 Re vt + a2Invt + a3POILt + a4REERt + et, where Y - GDP; C - consumption;
Rev - real disposable incomes of the population;
Inv - investments in fixed assets;
POIL - nominal prices of Urals (USD/barrel);
REER - real effective exchange rate of the ruble (based on CPI);
NEX - net exports.
Variables Yt, Revt and Invt in real terms - in the prices of Q IV 1998, deflator index - CPI. As a result, we obtained dependence Yt = 239,75 +1,38 * Invt + 8,69 * POLt + 3,19 * REERt + cot (the positive sign of the coefficient applied to variable REER can probably be explained by the model's incomplete specification).
In this analysis we applied the quarterly data published by Rosstat and the International Monetary Fund (International Financial Statistics) over the period of 1999-2007. 120
Table 21
Dynamics of the Structural and Situation-Linked Components of Tax Revenues
27
Received by the RF Budgetary System : an Estimation over the Period
of 2000-2007, as % of GDP
2000 2001 2002 2003 2004 2005 2006 2007
Tax revenues of the federal budget
Structural component 10.6 10.9 15.0 14.0 11.8 12.3 12.0 13.7
Situation-linked component 3.9 5.5 3.9 4.2 6.8 9.9 10.0 7.6
Including: domestic demand 0.2 0.3 -0.1 -0.3 0.0 0.0 0.2 0.1
oil prices 3.8 5.1 3.9 4.4 6.4 9.7 9.5 7.3
other factors -0.1 0.0 0.1 0.1 0.4 0.3 0.4 0.2
Tax revenues of general government's budget
Structural component 30.2 29.9 32.6 31.0 28.2 26.2 25.7 28.2
Situation-linked component 5.5 5.8 3.0 3.6 7.1 10.6 11.0 8.6
Including: domestic demand 0.4 0.6 -0.2 -0.4 0.0 0.0 0.3 0.2
oil prices 5.3 5.2 3.1 3.8 6.5 10.2 10.1 8.1
other factors -0.3 0.1 0.2 0.1 0.6 0.5 0.6 0.4
Personal income tax
Structural component 2.8 3.2 2.4 2.8 2.4 3.0 2.4 3.1
Situation-linked component 0.1 0.1 0.1 0.3 0.4 0.5 0.4 0.7
Including: domestic demand 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
oil prices 0.0 0.1 0.1 0.2 0.4 0.4 0.4 0.7
other factors 0.0 0.0 0.0 0.1 0.0 0.1 0.0 0.0
Unified social tax28
Structural component - 6.0 6.9 6.5 5.8 1.7 1.7 2.8
Situation-linked component - 0.2 0.2 0.2 0.6 0.3 0.3 -0.8
Including: domestic demand 0.1 0.0 -0.1 0.0 0.0 0.0 0.0
oil prices - 0.1 0.2 0.3 0.5 0.2 0.2 -0.7
other factors - 0.0 0.0 0.0 0.1 0.0 0.0 -0.1
Tax on profit of organization
Structural component 5.6 4.2 3.8 4.7 5.5 5.4 5.4 4.8
Situation-linked component 0.1 0.1 0.2 0.4 0.6 0.8 0.1 1.8
Including: domestic demand 0.1 0.0 0.0 0.0 0.0 0.0 0.1 1.3
oil prices 0.1 0.1 0.2 0.3 0.6 0.7 0.1 1.3
other factors 0.0 0.0 0.0 0.1 0.1 0.1 0.0 -0.8
Value added tax
Structural component 5.2 6.8 6.4 5.7 5.4 4.8 4.8 7.2
Situation-linked component 0.2 0.2 0.3 0.6 0.8 0.9 0.1 -0.3
Including: domestic demand 0.1 0.0 -0.1 0.0 0.0 0.0 0.1 -0.3
oil prices 0.1 0.2 0.3 0.5 0.7 0.7 0.1 -0.3
other factors 0.0 0.0 0.0 0.1 0.1 0.1 -0.1 0.3
Note. «-» - SST not levied.
Source: RF Ministry of Finance; RF Ministry of Economic Development and Trade, RF Federal Tax Service; Rosstat; MEA, calculations of the IET.
The tax revenues received by the RF budgetary system were divided into structural and situation-linked components on the basis of previously obtained shares of structural and situation-linked GDP, as well as by calculating the share of revenues dependent on oil prices
27 For purposes of our estimations, the tax revenues of the federal budget and the general government's budget throughout the whole period under consideration include: contributions to compulsory pension insurance; revenues from foreign economic activity; and revenues of targeted off-budget funds.
28 From the year 2005 onward, the data presented here do not include the contributions to compulsory pension insurance.
(within the framework of building a model of paired regressions of tax revenues from nominal oil prices).
It should be noted that the high share of the situation-linked component of tax revenue in the general government's budget and the federal budget was ensured by growing oil prices (Table 21): in 2006, the situation-linked component accounted for the transfer of 11.0% of GDP into the general government's budget (including the contribution of oil prices in the amount of 10.1% of GDP), and 10.0% of GDP into the federal budget (including the contribution of oil prices in the amount of 9.5% of GDP), and in 2007 - 8.6% (the contribution of oil prices in the amount of 8.1%) and 7.6% (the contribution of oil prices in the amount of 7.3%), respectively.
A similar logic of separation into components is also applicable to the personal income tax. As seen from Table 21, the share of situation-linked component of PIT in 2006 amounted to 0.4% of GDP, and in 2007 it increased to 0.7% of GDP. The situation-linked component of the revenues from the single social tax in 2006 amounted to 0.3% of GDP (of which 0.2% is accounted for by the positive dynamics of oil prices); in 2007 the sign applied to this component became negative (-0.8% of GDP), which can be explained by the regressive SST scale (in other words, a lowering effective rate of this tax in face of increasing wages and salaries) and, consequently, by an increasing role of structural factors in the revenues generated by SST (2.8% of GDP) in that year.
It is noteworthy that in 2006 the share of the situation-linked component of the revenues from the tax on profit of organizations was not high, amounting to 0.1% of GDP, while the main bulk of revenues was generated by growing oil prices and the domestic demand factors. In 2007, on the contrary, it increased to 1.8%, which can be explained by the positive dynamics of oil prices in the second half-year of 2007.
At the same time, as demonstrated in Table 21, VAT depends least of all on the situation-linked factors: in 2006, the situation-linked component of the revenues from this tax amounted to only 0.1% of GDP, whereas in 2007 the sign applied to it became negative (0.3%), which can be explained by a certain falling behind of the rate of growth of the raw materials sector within the structure of GDP, and by substantially increased tax deductions as a result of changes introduced into the procedure for VAT refunds to Russian exporters.
2.3.6. The Federal Budget for 2008 and for the Period until 2010
At the end of July, the President of Russia signed Federal Law of 24 July 2007, No. 198-FZ, "On the federal budget for the year 2008 and the planned period until the years 2009 and 2010" (hereinafter - the Law). The federal budget indices were approved separately for the years 2008, 2009, and 2010, because it was intended for the indices established for the planned period (2009, 2010) to be further adjusted during the elaboration and approval of the draft federal budget for the years 2009 and 2010. Besides, this Law confirmed several appendices whereby budget allocations from the federal budget were established (separately for 2008, 2009, and 2010) by sections and subsections, target items and types of budget expenditure classification; the departmental structure of the federal budget expenditure; and the aggregate volume of allocations to the fulfillment of public normative obligations. The main administrators of budget resources were granted the right, from the year 2008 onward, to redistribute allocations between a current financial year and the planned period in the course of execution of the federal budget.
It should be noted that, for the first time in Russia's practice of budget planning, the federal budget was drawn for a three-year period which, on the one hand, will certainly be conducive to public understanding of the medium-term budgeting and taxing policy pursued by the RF Government, and will increase the definitiveness of financial backing for the spending obligations assumed for a three-year period; but on the other, will also result in more strict requirements to the quality of budgets being drawn, and in a higher responsibility for errors in planning. Below, we are going to present our analysis of the federal budget's revenue and expenditure for the years 2008-2010, as well as of the sources for covering federal budget deficit.
An Analysis of the Main Parameters of the RF Federal Budget
On the basis of the available data on the actual execution of the RF federal budget over the period of 2000-2006 (see Table 22), several general trends can be pointed out: firstly, there has been stable growth in federal budget revenue, which during that period increased by more than 1.5 times; secondly, in the last three years the share of expenditure has become stabilized at the level of 16% of GDP; thirdly, the federal budget surplus has been demonstrating an unprecedented growth rate: between 2002 and 2006, its amount increased by 5.3 times - to 7.5% of GDP in 2006; and fourthly, the persisting high dependency of budget revenue on exports of energy carriers reveals itself in an equally persistent budget deficit (not linked to oil and gas), its value fluctuating within the range of 1.7-3.8% of GDP during the period under consideration.
Table 22
An Analysis of the Actual and Expected Execution of Revenue and Expenditure of the Federal Budget over the Period of 2000-2010, as % of GDP
Actually executed Law on budget
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Revenue 15.5 17.8 20.3 19.5 20.1 23.7 23.4 23.6 19.0 18.8 18.1
Including: revenues 11.7 13.1 15.1 14.1 13.5 13.5 12.3 14.6 12.2 12.9 12.9
other than "oil and
gas" ones
"oil and gas" 3.8 4.7 5.2 5.4 6.6 10.2 11.1 9.0 6.8 5.9 5.2
revenues
Expenditure 14.2 14.8 18.9 17.8 15.8 16.3 15.9 18.1 18.8 18.8 18.1
Including: "oil and 2.5 1.9 2.9 3.7 2.0 2.3 3.0 4.7 6.1 5.3 4.5
gas" transfer
savings of "oil and 1.3 2.8 2.3 1.7 4.6 7.9 8.1 4.3 0.7 0.6 0.7
gas" revenues
Balance of RF fed- 1.3 3.0 1.4 1.7 4.3 7.4 7.5 5.5 0.2 0.0 0.0
eral budget, as % of
GDP
Not linked to oil and 2.5 1.7 3.8 3.7 2.3 2.8 3.6 3.5 6.6 5.9 5.2
gas deficit
Source: RF Ministry of Finance, calculations of the IET.
As seen from Table 22, the RF Ministry of Finance intends to introduce, in 2008-2010, changes that will make a strong impact on all the trends described above. First of all, in response to the forecasted decline in international prices of oil and gas, a slower rate of growth of the extraction and exports of hydrocarbons, and a higher ruble/USD exchange rate, a more than twofold drop is expected in the share of the "oil and gas" revenues in the federal budget
as a percentage of GDP - from 11.1% in 2006 to 5.2% in 2010. This decline in "oil and gas" revenues is not going to be adequately compensated for by growth of structural revenues. Resulting will be a drop in total budget revenue by 5.5 p.p. of GDP by 2010, by comparison with the level of 2006.
A substantial reduction in the volume of budget revenue in face of rising expenditure must produce a zero balance as early as 2009. However, in our opinion, if the existing 7-year cycle of budget surplus growth is taken into consideration, together with the slower rate of exports of hydrocarbons and the ruble's strengthening in 2006-2007, such a rapid fall in the amount of surplus (from 5.5 % of GDP in 2007 to 0.2 % of GDP in 2008) would not look very probable. More doubtful, obviously, appears the dynamics of budget revenue. However, in this connection one may ask if indeed the forecasted indices of Russia's socio-economic development, prepared by the RF Ministry of Economic Development and Trade, are reliable enough for such a conclusion to be made.
Of course, the rather strong dependence of the Russian budgetary system on exports of energy carriers and, consequently, on the situation on global markets is fraught with serious risks of a potential destabilization of the state balance. Thus, the importance of structuring oil and gas revenues, and of their further efficient use for the benefit of the Russian national economy, with due regard for their important role in the formation of the state budget, becomes obvious. If long-term macroeconomic stability can be indeed maintained, an attempt will be made in 2008 to make use of oil and gas revenues (as part of budget resources) by means of transforming the Stabilization Fund into the Reserve Fund, whose purpose will be to compensate for the loss of budget revenue in an event of a drop in the price of oil, and the National Welfare Fund, designed to ensure an adequate long-term budget balance. As a result, in the period of 2008-2010 the use of "oil and gas" revenues will be increased, on the average, from 4.7% of GDP in 2007 to 5.3% of GDP in 2008-2010, while the savings of "oil and gas" revenues during the same period will be no more than 0.7% of GDP, against 4.3% of GDP in 2007.
An Analysis of the RF Federal Budget Revenue
A decline, in 2008-2010, in the GDP share of budget revenue, as compared to the level of 2007, can primarily be explained by the diminishing contribution of revenues from the tax on the extraction of mineral resources and export customs duties, as well as by changes in RF tax legislation which, as estimated by the RF Ministry of Finance, in 2008 will result in a decrease in revenue by 0.68% of GDP. However, these estimates of budget revenue, in our opinion, do not take into account all the possible consequences of certain changes in tax legislation. There have been overlooked such possibilities as, for example, the introduction, from 1 January 2008, of a system for special registration of persons as payers of VAT proposed by the RF Ministry of Finance; shortening of the list of operations to be exempt from VAT, from 1 January 2009; and the annual - from 1 January 2008 onward - indexation of the rate of tax on the extraction of mineral resources applied to the extraction of natural gas, the coefficient being significantly higher than the forecasted inflation rate.
Besides, some doubts arise in connection with the fact that, although there occurred a noticeable decline in the amount of revenues to be received by the federal budget from TIEO and export customs duties in the period of 2008-2010, the share of the main taxes in budget
revenue has remained almost unchanged, the only changes being those that occurred in the structure of tax revenues, as shown in Table 23.
Table 23
Dynamics of the Federal Budget's Structure of Tax Revenues over the Period
of 2004-2010, as % of GDP
Actual execution Law on budget
2004 2005 2006 2007 2008 2009 2010
Tax on profit of organizations 1.2 1.8 1.9 1.9 1.5 1.5 1.4
VAT 6.3 6.2* 5.7 6.1* 6.2 7.0 7.2
Excises 0.7 0.5 0.4 0.4 0.4 0.4 0.4
TIEO 3.0 4.2 4.1 3.6 2.5 2.1 1.9
Share of aforelisted taxes in federal budget 55.5 53.2 51.4 51.4 55.8 58.5 60.2
revenue, %
Reference value: 5.0 7.8 8.6 7.3 5.9 5.3 4.8
Revenues from foreign economic activity
* Less revenues from "Yukos".
Judging by these data, it can be assumed that, with the exception of the value added tax, all the other main taxes will be demonstrating either a decreasing amount of revenues (as a percentage of GDP), or its stabilization. And, while the estimated amount of the situation-linked tax revenues, as noted earlier, directly depends, firstly, on the accuracy of the forecast of expected changed in the prices of hydrocarbons, and only secondly on the rate of their extraction and the ruble's exchange rate, the amount of structural revenues (which is not linked to the "oil and gas" factor) should be dependent on the objective changes going on in the domestic economy.
An arguable point in the forecasting of tax revenues is represented by the expectations of a considerable reduction in the amount of revenues from the tax on profit of organizations, which in recent years, on the contrary, has been demonstrating an upward trend. Even in view of the expected decline in the share of the extracting sector of the national economy, the budding growth of the physical production volumes in the manufacturing industry and in the tertiary sector, rising manufacturing prices and the stabilization of net balance of the financial results of enterprises' activity, there are still some reasons to expect that at least the 2007 level of revenues from the tax on profits of organization may be maintained.
Equally doubtful is the forecasted level of revenues from VAT, given the continual on-year expansion of the list of exemptions from the tax, coupled with the increasing demands to lower the rate of the tax.
On the whole, in the medium term, in a situation of structural reforms and economic growth, one can also attempt to structure, in the following way, the risks that may give rise to problems with regard to individual taxes:
1. A strong dependence of tax revenues on oil prices and the risk of a dramatic drop in an event of a worsening foreign economic situation requires adequate planning and the adoption of measures aimed at diminishing the dependence of the budgetary system's tax revenues on international oil prices. With due regard for the existing downward trend of the structural component of the budgetary system's revenues (that is, the component independent of international oil prices), this will involve at the least the preservation of the current level of tax ad-
ministration base and the rates of those taxes that are less dependent on international oil prices (the value added tax, excises).
A lowered rate of the value added tax, coupled with the absence of any indexation of the rates of excises will, on the contrary, dramatically increase the risk that tax revenues may drop as a result of declining international oil prices. In case of a necessity to adopt the decision to further decrease the tax burden, all other conditions being equal, it would be more feasible to lower the rates of those taxes that strongly depend on oil prices, such as the tax on the extraction of mineral resources, or the tax on profit of organizations, with the preservation on the same level of the rate and base of the value added tax, as well as the rates of excises in real terms.
2. Another set of potential risks associated with the strong dependence of the Russian tax system, as well as of the national economy on the whole, on the oil sector is represented by the potential decline in revenues in this sector as a result of diminishing yield and increasing costs of developing natural oil fields. Since oil-extracting enterprises generate more than 1/3 of all tax revenues received by the budgetary system, when natural resources are gradually exhausting their potential and extraction is becoming more costly, it will be necessary to plot long-term forecasts of budget revenue with due regard for a decline of the share of this type of revenues.
One of the key problems associated with TIEO is the estimated feasibility and opportunities for a switchover to applying differentiated rates of this tax. In modern conditions, when oil prices are high, the differentiation of the rates may be fraught with the threat of unsubstantiated discretionary decisions being made, aimed at applying lower tax rates to certain individual oil companies. However, as tax administration, as well as control over the extraction conditions, are becoming stronger, it probably will become necessary to switch over to differentiated rates, and to find some solution to the problem of their justification with regard to the existing differences between oil fields.
3. The future trends in the Russian national economy's development in the medium term will be, most probably, those of a relatively slower development of the manufacturing sector, coupled with a more rapid growth of the construction and retail sectors. This will mean an increasing share, in the national economy, of those sectors where tax administration is most difficult. Besides, it can also be pointed out that transformations aimed at further development of financial institutions will, most probably, also result in a strengthened role of the financial sector in the national economy. In this case, in addition to a more complex administration, the risks faced by the tax system will also necessitate the introduction of special provisions concerning tax revenues and operations in the financial sector.
When planning tax revenues, all these risks will have to be investigated in more detail and estimated in quantitative terms, in order to improve the quality of medium-term federal budgeting
An Analysis of the RF Federal Budget's Expenditure
The changes observed in the share of federal budget expenditure in GDP in 2008-2010 continue the upward trend of the 2007 budget. In this connection, as can be seen from Table 18, the aggregate growth of budget expenditure resulted exclusively from increased non-interest expenditures, which will amount, on the average, to 18.0% of GDP in 2008-2010, against 16.0% in 2005-2007.
Table 24
The Expenditure Parameters of the Federal Budget in 2005-2010, in billion rubles
2005 2006 2007 2008 2009 2010
billion rubles % of GDP billion rubles % of GDP billion rubles % of GDP billion rubles % of GDP billion rubles % of GDP billion rubles % of GDP
Expenditure -total 3,514.3 16.3 4,281.3 15.9 5,983.0 1 8.1 6,570.3 1 8.8 7,451.2 1 8.8 8,089.9 1 8.1
Including: 3,306.0 15.3 4112.3 15.3 5,839.9 17.7 6,382.4 1 8.2 7,238.6 1 8.2 7,842.8 17.5
non-interest expenditures interest 208.3 1.0 169.1 0.6 1 43.1 0.4 1,87.9 0.5 212.6 0.5 247.1 0.6
expenditures
Reference value: GDP 21,625 26,883 32,989 35,000 39,690 44,800
Source: RF Ministry of Finance; calculations of the IET.
One of the reasons for such noticeable growth in the amount of non-interest expenditures in the federal budget in 2008-2010 has been the RF President's Message to the Federal Assembly, which pointed out a number of priority directions for government policies in the period under consideration. In particular, priority was assigned to several goals to be achieved in the sphere of social policy, namely an improved standard of living of the employees of the organizations belonging to the budget-funded sphere and the federal-level public sphere; servicemen and persons equated thereto; an improved standard of living of pensioners and other citizens in respect of which there exist financial obligations at the federal level; the removal of limitations to the development of the national economy associated with transport and energy supply shortages; and the promotion of growth in the nanoindustry and the aircraft industry. Besides, as part of budget expenditure in 2008-2010, special resources were earmarked for implementing the provisions of the RF President's Message aimed at improving Russia's demographic situation.
The structure of RF federal budget expenditure in the period of 2008-2010, by comparison with the previous years, has also demonstrated some changes (see Table 25).
Table 25
Dynamics of Changes in the Structure of Federal Budget Expenditure in the Period of 2005-2010, as % of GDP
Actual Law on budget
2005 2006 2007 2008 2009 2010
Expenditure - total 16.3 15.9 18.1 18.8 18.8 18.1
Including:
General state issues 2.3 2.0 2.5 2.5 2.4 2.4
Of these: government debt servicing 1.0 0.6 0.4 0.5 0.5 0.6
National defense 2.7 2.5 2.5 2.7 2.7 2.7
National security and law-enforcement activity 2.1 2.0 2.0 2.2 2.3 2.2
National economy 1.2 1.3 2.1 2.1 2.0 1.2
Expenditures on social policy and social sphere 2.2 2.5 3.3 2.5 2.5 2.6
Interbudgetary transfers 5.8 5.6 5.8 6.5 6.1 6.1
Source: RF Ministry of Finance; calculations of the IET.
In face of an overall growth of expenditure, the most noticeable changes, by comparison with the 2005-2007 budgets, are produced by a reduction in the financial measures applied in the social sphere, as well as by fluctuations in the GDP share of the expenditures on nationaly economy: in 2008 it remains at its historic high of 2.1% of GDP (over the period of 20052010), and then, by 2010, declines to 1.2% GDP, which is largely associated with the round-ing-up of several federal target programs. In this connection, it should be emphasized that these are directly aimed at the development of infrastructure and aircraft-building: "Motor Roads", "The Modernization of Russia's Transport System", "Sea Transport", "Domestic Water Routes", and "The Development of Russia's Exports of Transport Services".
A special mention should be made of the diminishing expenditures on general state issues (less the expenditures on government debt servicing) - from 2.1% of GDP in 2007 to 1.8% of GDP in 2010, - and of the increasing amount of interbudgetary transfers in 2008 (by 0.7 p.p. of GDP), at the expense of increased deductions to off-budget funds.
The other sections of federal budget expenditure in 2008-2010, when estimated as a percentage of GDP, either demonstrated slight changes (within the range of ± 0.1 p.p. of GDP), or remained unchanged.
Just as a year earlier, substantial volumes of financing were traditionally earmarked for such sections as: "Interbudgetary transfers", "General state issues", "National defense", "National security and law - enforcement activity", and "National economy", as well as for social issues.
The situation with regard to budget expenditure in the period of 2008-2010 seems to be rather controversial. On the one hand, federal budget expenditure was orientated toward the financing priorities stated in the RF President's Message to the Federal Assembly. On the other, such substantial increase in budget expenditure (nearly by 3 p.p. of GDP by comparison with 2006) may have a negative impact on the Russian economy, because in a situation of excessive inflation pressure this is fraught with additional problems that may diminish the effect of the government's anti-inflation measures. The consequences of such growth of expenditure, as demonstrated by the example of the year 2007, have already resulted in the inflation rate surging higher than its planned value, and therefore any further increase of non-interest expenditures as a percentage of GDP will cast serious doubts onto the government's activity aimed at further decrease of the growth rate of consumer prices in the short- and medium-term perspective.
Moreover, the substantial obligations with regard to the financing of measures being implemented either within the framework of priority national projects, or through the RF Investment Fund, the Bank for Development, or other development institutions, have been assumed without proper analysis of their long-term financial effect on federal budget expenditure and on the budgetary system as a whole. As a result, no attention is given to the possibility of additional costs to be incurred during the implementation of these projects and programs. Therefore, when planning new spending obligations, it will be necessary to ensure comprehensive records of all costs, and thus to reflect in the budget all the potential financial consequences of the implementation of individual measures within the framework of these projects.
An Analysis of Debt Policy as Reflected in the RF Federal Budget
In the sphere of government debt administration at the federal level, the policy of replacing foreign sources of borrowings with domestic ones will be continued (Table 26).
Table 26
Dynamics of the Structure of the Russian Federation's Government Debt, as of End of Year, as % of GDP
2006 2007 2008 2009 2010
Government debt - total 9.0 7.5 8.4 8.7 9.1
Domestic debt 3.9 3.8 5.2 5.7 6.4
Foreign debt 5.1 3.7* 3.2 2.8 2.7
* Estimate.
Source: RF Ministry of Finance , calculations of the IET.
As seen from the Table 26, the share of domestic sources of borrowings in the total volume of RF government debt will be increased, by 2010, to 70%, against 43% in 2006. This ratio of domestic to foreign sources of borrowings is a consequence of the policy of a total refusal to attract new credits from foreign governments and from international capital markets, as well as an accelerated implementation of the majority of the current joint projects with international financial organizations, in order to complete the settlements against the previously assumed obligations and to minimize the volumes of new borrowings from international financial organizations. As a result, the budget envisages only the use of targeted tied credits granted by international financial organizations, whose volume in 2008 will amount to 718 million USD, and in 2009 and 2010 - to 510.6 and 413.6 million USD, respectively.
The main source of financing for the redemption of government debt obligations in the period under consideration will be the resources attracted through placing government securities on the domestic market. Thus, it is planned that in 2008 the placement of government securities on the domestic market will yield 369.0 billion rubles, in 2009 - 396.3 billion rubles, and in 2010 - 522.9 billion rubles. In this connection, the intended, more that twofold, growth in domestic borrowings by comparison with 2007, as well as their medium and long-term character (their share will amount to approximately 98% of the planned volume of borrowings), will not, in our opinion, result in the ousting of the investments needed for growth of the national economy, or in their becoming more expensive.
2.4. The Long-Term Sustainability of Russia's Budgetary Policy
2.4.1. Implementation of the Measures from the Conception for the Long-Term Socio-Economic Development in Russian Federation: Evaluating the Consequences to the Budget System
Debates on drafts of the currently designed Conception for The Long-Term SocioEconomic Development of the Russian Federation (below referred to as the Conception) engender a number of questions concerning the problem of a balanced budgetary policy. To examine budgetary implications of implementation of the Conception's measures we employed preset in the Conception scenario-based conditions of the world oil prices and design parame-
ters of the annual (2008-2020) growth rates of GDP and CPI under the innovation-based scenario. The respective data are given in Table 2729.
Table 27
Original Data for Calculations
2008 2009 2010 2015 2020 Averaged over the period 20082020
World oil prices (Urals), as USD/barrel, current prices30 62 57 56 60 65 60
GDP, as % to the prior year 106.2 106.2 106.2 106.3 106.8 106.4
CPI, as % to the prior year (December to December) 107.3 106.6 106.0 104.5 102.7 104.9
The population's real disposable incomes, as % to the prior year 108.6 108.6 108.6 106.8 106.7 107.5
In addition to the above data, we employed the following assumptions as original premises:
• The rates and collection rates of main taxes remain unchanged (with account of the oil prices declining in real terms over time);
• Greater revenues from the Personal Income Tax and the Uniform Social Tax along with a rise in the population's real incomes (without account of reduction in the UST-based revenues due to transition to higher schedules);
• Depletion of mineral fields wherein there are no the mineral tax benefits;
• The doubling of GDP over 10 years (2010-2020) and contraction in the proportion of the oil and gas sector from 19.7% in GDP in 2006 to 12.1% of GDP by 2020 will result in a considerable contraction of the share of the oil- and gas-related revenues to the federal budget. Hence the federal budget deficit and the one of the enlarged government's budget.
Whereas the Conception falls short of a detailed projection of the enlarged government's budget revenues, while the respective final values stipulated therein appear somewhat inflated, we have calculated dynamics of tax revenues to the enlarged government in 20062020 (Table 28) and the federal budget (Table 29)31.
29 It should be noted that the data given in Table 27 corresponds to the innovation-based scenario of the RF Ministry of Economic Development and Trade, according to which the nation will be maintaining high economic growth rates over the whole time interval in question. That the proportion of tax revenues in GDP will fall all the scenarios in question to a significant degree attribute to the process of an accelerated growth in GDP at a rate greater than the growth of the oil and gas sector.
30 We consider the current oil prices, as the forecast of these very prices is presented in the Concept. However, while examining the effect of the oil prices on GDP and tax revenues to the enlarged government's budget, one should consider real prices for energy sources, rather than the current ones. Translation of the latter into real prices is possible using deflator indexes whose choice appears largely related to the way proceeds from sales of energy sources are consumed. The set of the said indexes comprises the USD inflation (its appreciation against the basket of international currencies, the Russian CPI, Russia's GDP deflator, to name a few).
31 Here and hereafter the forecast of tax revenues is given on the basis of the IET's calculations, providing tangibility of macroeconomic indicators under the MEDT's innovation-based development scenario.
Table 28
Assessment of the Dynamics of Tax Revenues to the Budget of the Enlarged Government in Russia in 2008-2020, as % of GDP
2008 2009 2010 2015 2020
(1) Revenues to the enlarged government budget 37.48 37.4 33.91 31.52 29.97
(1)=(1.1.)+(1.2)
(1.1) Tax revenues to the enlarged government budget 34.28 34.2 30.81 28.52 27.07
UST, without indexation of the scale 4.81 4.78 4.72 4.2 3.78
VAT 6.11 6.14 6.18 6.34 6.5
Corporate profit tax 5.21 5.11 5.01 4.49 3.98
PIT 3.7 3.84 3.97 4.39 4.75
Mineral tax 3.75 3.7 2.33 1.59 1.17
Taxes on foreign trade 7.4 7.33 5.31 4.21 3.59
Other taxes 3.3 3.3 3.3 3.3 3.3
(1.2) Non-tax revenues 3.2 3.2 3.1 3 2.9
(2) The enlarged government budgetary expenditures (at the 2006 31.3 31.3 31.3 31.3 31.3
level=)
(3) Surplus prior to increase in expenditures 6.18 6.1 2.61 0.22 -1.33
(3)=(1)-(2)
Accumulated reserve of the budgetary system*prior to increase in expen- 16.55 20.84 21.35 19.82 15.32
ditures, as % of GDP (with account of the annual 4% nominal yields)
* Under the accumulated reserve of the budgetary system we understand savings resulting from the excess of the
enlarged government's budget revenues over its budgetary expenditures in the Reserve Fund and the Social Wel-
fare Fund.
Table 29
Main Parameters of the Federal Budget of RF in 2008-20, as % of GDP
2008 2009 2010 2015 2020
(1) Federal budget revenues 21.73 21.61 18.24 16.30 15.15
(1)=(1.1.)+(1.2)
(1.1.) Oil-and-gas 8.86 8.76 6.03 4.55 3.71
(1.2). Non-oil-and-gas 12.87 12.85 12.21 11.75 11.44
(2Federal budgetary expenditures (on the 2006 level) 16.00 16.00 16.00 16.00 16.00
(3) Non-oil-and-gas budget deficit -3.13 -3.15 -3.79 -4.25 -4.56
(3)=(1.2)-(2)
(4) Oil and gas transfer 3.13 3.15 3.79 3.7 3.7
(5) Oil-and-gas budget deficit 0.00 0.00 0.00 -0.55 -0.86
For reference:
The Reserve Fund 10 10 10 10 8.44
The Welfare Fund* 6.45 10.65 11.08 9.32 6.53
* With account of the co-funding of voluntary pension savings at the level of 0.1% of GDP until 2014 (these values are employed in the Conception).
The projected calculations of the dynamics of budgetary spending show that given the oil (Urals) prices hold at the average level of USD 60/barrel over the period 2008-20, as per the Conception, the proportion of the enlarged government budget revenues in GDP should fall from the 2008 GDP level of 37-38% to 30% in 20020. It will be the federal budget revenues that will plummet most dramatically (from 21-22% of GDP to 15% of GDP).
This means the rise and further growth of deficit of the enlarged government's budget, provided expenditures are kept at the 2006-07 level (as % of GDP) since 2016, while the oil-and-gas deficit arises substantially earlier, that is, in 2011. The assessment is made in an as-
sumption that the level of collection of main taxes and their rates remain unchanged, while the world oil prices are down in real terms (which constitutes a fairly moderate, rather than quite conservative, scenario)
Meanwhile the Conception provides for greater public spending to finance health care,
32
education, pensions, as well as other budgetary items, including public capital investment , by 2020.
Table 30
Estimation of the Dynamics of Budgetary Expenditures of Russia's Enlarged Government in 2006-20, as % of GDP
2006 2007 2010 2015 2020
Education 3.9 4.1 3.9 4.3 4.5
Health care 4.0 4.2 4.1 4.3 4.8
Fundamental research and support of the scientific-technical progress 0.7 0.9 1.1 1.3
Public investment 3.3 3.5 4.5 4.0
Pensions 4.8 5.9 7.0 8.1
(consistent increase in the replacement rate up to 30% by 2020)33
Other expenditures 14.7 14.7 14.7 14.7 14.7
The enlarged government's budgetary expenditures, total 31.3 34.1 33.0 35.9 37.4
Surplus/deficit after expenditures increase, as % of GDP 8.6 6.1 0.91 -4.38 -7.43
* Expenditure values as per the Conception are marked in color.
The above data evidence that the proposed measures to boost expenditures result in a general rise of the enlarged government budget expenditures at 6 percentage points by 2020 vis-à-vis 2006. The bulk of the rise will be formed by the health care and pension expenditures, and for the given variant the enlarged government budget deficit will account for over 4% of GDP by 2015 and over 7% of GDP by 2020.
Under such circumstances the federal budget will be in a far greater jeopardy. As the non-oil-and-gas deficit may not exceed 4.7% of GDP, a part of the RF Pension Fund's deficit should be funded out of the National Welfare Fund as early as in 2010, and the National Welfare Fund will have consequently exhausted by 20 1 6-1734 Since 2010 the oil and gas transfer
32 At this point it should be noted that according to the Concept, between 2010 and 2015, it is envisaged to cut down health care expenditures from 4.0% of GDP in 2006 to 3.3% of GDP by 2010 and to 3.8% of GDP by 2015. Between 2015 and 2020, on the contrary, the respective expenditures should be up to 4.8% of GDP. Analogously, expenditures on education should be cut back from 3.9% of GDP in 2006 to 3.5% of GDP in 2010, followed by their increase up to 4.5% of GDP by 2020. However, given the current trends in the dynamics of budgetary spending of the enlarged government, dramatic cuts in the healthcare and educational expenditures appear highly unlikely. That is why in Table 29 we provide expenditures across these items for the period 20102015, proceeding from the assumption of a linear rise in these expenditures as percentage of GDP at such a rate, so that to match the values stipulated in the Concept by 2020.
33 According to the Concept, the rise in the number of pensioners, as well as an assumption of the advanced indexation of pensions for the sake of an increase in the correlation between the average labor pension and the average salaries and wages (the replacement coefficient) up to 30% in 2020 should form the cause for a consistent growth in the volume of public obligations in the pension provision area. In conjunction with this, the RF MEDT projects a rise in the pension expenditures of the budgetary system up to 8.1% of GDP by 2020 against 6.1% in 2011. These values appear close to the IET experts' calculations, which evidence that a keeping of the replacement rate at the level of 30% will necessitate growth in the budgetary system's expenditures on pensions up to 8.2% of GDP by 2020 vs. 6.2% of GDP in 2010.
34 The current budgetary law seems to care much more of the Reserve Fund than the National Welfare Fund. The Reserve Fund may be consumed only for the sake of the oil-and-gas transfer in the event the oil-and-gas revenues fall short of financially securing the said transfer whose value is strictly limited by the Budgetary Code of RF. 132
will be short of closing the non-oil-and-gas federal budget gap, while to fund the oil-and-gas federal budget deficit since 2011 the nation will have to attract borrowings in a maximum permissible by the current law volume (1% of GDP). So, by 2017 it will have become impossible to fund the growing spending, complying, at the same time, with the budgetary law requirements not to transcend the oil and gas deficit equivalent up to 4.7% of GDP. Hence the need for either drastic cuts in spending (tax boost), or for raising the values of the permissible non-oil-and-gas deficit and the oil-and-gas transfer. Should the government opt for refusing to cut down budgetary spending (boost taxes), the Reserve Fund would be able to secure the balance of the federal budget just for two years.
Table 31
Main Parameters of the RF Federal Budget in 2008-20, as % of GDP
2008 2009 2010 2011 2015 2020
(1) Federal budget revenues (1)=(1.1.)+(1.2) (1.1.) Oil-and-gas 21.73 8.86 21.61 8.76 18.24 6.03 17.85 5.74 16.30 4.55 15.15 3.71
(1.2). Non-oil-and-gas 12.87 12.85 12.21 12.12 11.75 11.44
(2) Federal budget expenditures* 16.41 16.56 17.46 16.82 19.52 21.86
(3) Consumption of resources of the National Welfare Fund to cover the deficit of the pension system) 0.00 0.00 0.00 1.22 0.84 0.00
(4) Non-oil -and- gas budget deficit (4)=(1.2)-(2)** -3.54 -3.72 -5.25 -4.70 -7.77 -10.42
(5) Oil and gas transfer*** 3.54 3.72 4.50 3.7 3.7 3.7
(6) Oil -and- gas budget deficit 0.00 0.00 -0.75 -1.00 -4.07 -6.72
For reference:
The Reserve Fund 10.00 10.00 10.00 10.00 10.00 9.85
The national Welfare Fund* 6.04 9.71 9.50 8.63 0.00 0.00
* Calculated proceeding from the assumption that the increase in public expenditures, as per the Conception, is made at the expense of the federal budget, while the compensation for the Pension Fund's deficit is made at the expense of the federal budget revenues and, accordingly considered to be the federal budget expenditures (until the non-oil-and-gas deficit is in excess of 4.7% of GDP beginning 2011) and the National Welfare Fund (in the event the non-oil-and-gas deficit is in excess of 4.7% of GDP beginning 2011). The use of the National Welfare Fund to cover the Pension Fund deficit is not accounted in the federal budget expenditures (line 3). ** In compliance with the Budgetary Code of RF, the non-oil-and-gas deficit is in excess of 4.7% of GDP. *** Parameters of the federal budget whose projected values contradict requirements of the current budgetary law are marked in color.
Under moderate oil prices laid down in the Concept, the amount of oil and gas gains should be in excess of the value of the oil-and-gas transfer within the whole time interval in question, and it will be only in 2020 that they will match. Consequently, providing the current budgetary law is unchanged, it may happen that resources of the Reserve Fund would not be touched in the event of a budgetary crisis, unless it caused by a price downfall for energy resources.
By contrast, the National Welfare Fund's mission, save for other purposes, is to ensure the balanced pension system. As an increase in spending (which, in many ways, appears an objective factor) on the pension system poses the greatest threat to the budgetary system, the Fund may find itself under a serious fiscal pressure. An indirect evidence to this is the current provision, according to which, should the additional 2008 revenues to the federal budget be insufficient to secure the balanced budget of the National Pension Fund, the RF Government will have the right to spend as much as Rb. 138 bln out of the National Welfare Fund to bridge the gap. So, even without grave challenges facing the budgetary sphere, the current law does not prohibit a considerable voluntary consumption of the Fund's resources.
There are some other critical considerations. First, the above data on increase in spending constitute averaged landmarks, while actual figures may prove to be substantially greater, particularly when the respective large-scale project gains momentum. Second, the above calculations are unlikely to take into account a number of expenditures, such as for instance, Sochi-2014; finally, given the aging population factor, the health care expenditures, as well as some other kinds of expenditures, may substantially exceed the planned ones.
Third, in the event oil prices are down earlier than forecasted, the enlarged government budget will be challenged by the problem of the budget balance earlier than in 2020, as the mission of propelling economic growth (following the innovational scenario of the Conception) in 2013-17 would presumably demand for greater expenditures in 2010-15.
Fourth, in full appreciation of the size of the required increase in spending, the RF MEDT laid down proposals to cut other expenditure items (Table 32).
Table 32
Proposals to Cut Down Expenditures of the Budget of the Enlarged Government,
as per the Conception, as % of GDP
2007 2015 2020
General government matters 3.3 3.0 2.4
National defense, security, and law enforcement 5.5 5.3 5.0
National economy 4.0 3.9 3.3
Housing and utilities sector 2.3 1.3 1.0
Culture, cinematography, and mass media 0.7 0.4 0.3
Cuts on the above items to the 2007 level, total -1.9 -3.8
Source: the Conception data
So, it is cuts across the expenditure items by which the measures were not definitely estimated that the Conception identifies as one of major sources to compensate for a possibly arising deficit. It appears fairly unfeasible in practice, as out of the 12.1% of GDP these expenditures account for the bulk falls on items that can hardly be cut down, that is, 8.3% on
35
general government matters35, law enforcement, and national defense, while another 2.4% -on the housing and utilities sector. Thus, the landmarks given in Table 32 are fairly unrealistic and unlikely to be realized within the period in question, which, accordingly, would not allow one to balance the budgetary system under the noted circumstances.
Securing Russia's balanced budgetary system under the increase in public spending provided for by the Conception and maintenance of the current tax law is possible only under steadily high prices for energy sources. In its original draft, the Conception projected in 201020 the average oil price to be at the level of USD 60/barrel, but during consequent debates around the Conception everyone agreed this forecast was too low and should be revised. We calculated the oil price between 2008-2020 which will ensure a balanced budgetary system in 2020 under the condition of greater budgetary spending, as per the Conception (Fig. 19, Table 33). The calculations show that under the average annual oil prices of USD 68/barrel (and
35 Despite the fact the public spending on general state matters is down, thanks to lower public debt servicing figures, as of Sep.1, 2007, the share of spending on the public debt servicing in the aggregate public expenditures accounted for just 17%. Thus, the respective projected values referenced in the Conception appear substantially lowered. 134
given a significant price rise for oil up to USD 82/barell by 2020) the Russian enlarged governments budget should become balanced within the whole time interval in question.
a Oil prices needed to ensure the balance of Russia's budgetary system by 2020 ■ Oil prices according to the RF MEDTs original forecast
Source: IET's calculations.
Fig. 19. The World Oil Prices for Urals, USD / barrel
Table 33
Estimation of Main Parameters of Russia's Budgetary System in 2008-20 under the World Prices Forecasted at the Level of USD 68/Barrel,
as % of GDP
2008 2009 2010 2015 2020
(1) The enlarged government budget revenues 43.26 41.69 38.56 36.27 37.49
UST, without indexing the scale 4.4 4.4 4.4 4.1 3.6
VAT 6.11 6.11 6.11 6.11 6.11
Corporate profit tax 7.3 6.7 6.3 6.7 7.8
PIT 3.7 3.84 3.97 4.39 4.75
Mineral tax 4.97 4.6 4.45 2.72 3.36
Taxes on foreign trade 9.68 8.94 6.33 5.35 5.07
Other taxes 3.9 3.9 3.9 3.9 3.9
Tax revenues to the consolidated budget, total 40.06 38.49 35.46 33.27 34.59
Non-tax revenues 3.2 3.2 3.1 3 2.9
(2) Expenditures of the consolidated budget 32.1 32.4 32.7 35.9 37.4
(3) Surplus after increase in spending (3)=(1)-(2) 11.16 9.29 5.86 0.37 0.09
But as demonstrated by the data of Table 33, even under steadily high prices for energy sources (the nominal prices are constantly on the rise since 2013), the enlarged government budget surplus shrinks.
This modification of the prognosis of macroeconomic indicators can be viewed as a swing-back from the moderate estimation of the world prices for energy sources. At this point it should be noted there presently are no trustworthy methodologies of forecasting oil prices. The uncertainty in the future of the world oil market is also mirrored by medium-term forecasts of the world oil prices. The table below presents results of the December 2007 Reuters's survey on over 20 agencies that deal with forecasting the oil prices. They suggest the 2010 prices for Brent should be within the range between USD 55.75 and 86.8/barrel.
Table 34
Oil Prices in 2008-10, as Forecasted by Participants in the Reuters's Survey,
as USD/barrel
2008 2009 2010
Average 76.49 71.61 68.72
Peak 95.00 82.00 86.80
Minimum 61.75 64.00 55.75
Source: Reuters.
The further is the horizon of planning, the greater becomes dispersion in the oil price forecasts. According to the basic variant by OECD's International Energy Agency36 of November 2007, the world price for oil calculated as an average price for oil imported into OECD countries should fall to USD 60/barrel (in the 2006 prices), followed by its extremely slow growth up to USD 62/barrel (in the 2006 prices), or USD 108/barrel in nominal terms. A scenario of high economic growth rates suggests that in 2030 it should climb up as high as to USD 86/barrel (in the 2006 prices). Interestingly this IEA's forecast reference figures notably greater than the prior one, which suggested that in 2015 the world oil price should stand at USD 47.8/barrel and USD 55/barrel (in the 2005 prices) in 203037
Not quite in unison, the US Department of Energy suggested in 2007 that in the period through 2020 the world oil prices would be fluctuating within the range between USD 34.1 and 89.1/barrel.
Such a variety of opinions highlights the contemporary science's complete inability to foretell the state of affairs on mineral markets for any reasonably distant perspective. Under the present uncertainty in this area the budgetary planning should be scenario-based, in order to ensure a budgetary system is balanced, regardless of external developments.
All the above implies that as far as the budget expenditures are concerned, the Conception can be realized with a substantial budget deficit, and, only provided the world oil prices stick to the 2006 level in real terms (in the 2006 USD), the balanced budget system can be attained. Even under a slight decline in the oil prices the budgetary system appears unbalanced, and since 2011 the federal public debt begins to grow (at 1% of GDP annually), and the use of the accumulated funds to cover the deficit will result in a complete exhaustion of the National Welfare Fund by 2016 and the Reserve Fund - by 2018-20.
36 World Energy Outlook 2007. OECD/IEA, 2007.
37 World Energy Outlook 2007. OECD/IEA, 2006. 136
2.4.2. An Analysis of Possible Scenarios of Boosting Up the Balance of the Budgetary System in 2008-20
The analysis of possible options with regard to giving a boost to the balance of the RF budgetary system is conducted basing on the premise of a substantial rise in the pension-related expenditures. As evidenced by data of Table 30, the imperativeness to increase spending of the budgetary system to hold the replacement coefficient at a socially permissible level (not lower than 30%) will result in a consolidated budget deficit up to 8.1% of GDP by 2020, even providing the state of affairs in the foreign trade area remains relatively favorable. This can be explained by the fact that according to the Conception, the aging population and a rapid rise in salaries and wages will require, from year to year, an increasing proportion of GDP to maintain the replacement coefficient.
The balanced budgetary system can be secured by following means:
1. Prevention the budgetary spending from an accelerating escalation. Specifically, the 2007-to-2006 growth in the federal budget spending accounted for 2.2 percentage points of GDP, while revenues rose at 0.3 percentage points of GDP. In this respect, we mean the refusal to rise spending on capital investment. If the share of the enlarged government spending were maintained at the 2006 level (excluding of pension payments), this would allow one to cut the 2020 budgetary system deficit by 2.7% of GDP (Table 35).
2. Conduct of a systematic indexation of the UST scale. Table 35 presents results of its indexation since 2010 once in three years, with account of growth rates in salaries and wages. It is worth noting that this variant may prove to be unacceptable from the political standpoint (as it may be conceived of as a greater tax pressure on labor). So, a more plausible and, perhaps, even desirable means appears a soft indexation of the UST scale with account of the CPI. However, such an option does not allow one to substantially axe the consolidated government budget deficit (under such a variant, the UST-based revenues would fall from 4.81% of GDP in 2008 to 4.3% in 2020 against 3.87% of GDP in 2020, as suggested by the variant without indexation of the scale).
3. Increase of the mineral tax on natural gas. In compliance with Government Resolution of May 28, 2007, No. 333, it is assumed that since January 1, 2011 Gasprom and its affiliated entities will deliver natural gas at a price calculated by a formula which would ensure an equal profitability rate of domestic and overseas supplies, which would give a dramatic boost to the national gas corporations' gains. Meanwhile, the tax system lacks automatic regulators that would otherwise ensure an adequate rise in the sector's tax payments. Table 36 contains calculations that demonstrate that should the mineral tax on the natural gas be raised and the tax rate be subject to annual indexation with account of the domestic prices for natural gas, extension of the surplus (reduction of deficit) of the enlarged government's budget may account for 0.25% of GDP in 2008 and 0.43% of GDP in 2020.
4. Refusal to cut down the VAT rate and a partial substitution for the corporate profit tax with VAT. Against the above background, it seems to us proposals to significantly lower the VAT rate are overly provocative. One cannot help but admit that VAT is a complex tax to administer, particularly in Russia, and main challenges in this area most often concern VAT refunds to exporters. Equally challenging are various schemes involving a well-developed infrastructure formed by fly-by-night firms. All this calls for a serious work on refining the VAT administration technique - the developed economies' record in this area
has proved that if a success, this measure substantially diminish magnitude of such phenomena.
Today's heated debate exposed yet another argument in favor of lowering the VAT rate, that is, the statement that whereas the tax is levied on value added, the tax itself affects most seriously the very sectors with a high share of value added, which are most likely to form priority sectors in the future. This is mal-entendu, as the VAT burden is divided between producer and consumer according to the correlation between the demand price elasticity for, and the one of offer of the respective product, rather than by the proportion of value added in its cost.
It is a common knowledge that VAT's role in the budgetary system is huge: in 2007 alone, the respective revenues accounted for 6.68% of GDP, or a. 30% of all the budget revenues. Once the current VAT rate is cut down to 15% (along with abrogation of the 10% lowered rate), the budget losses would amount up to 0.8% of GDP. Accordingly, a 5% cut in the current VAT rate would be equivalent to a loss of 1.5% of GDP. It goes without saying, this is almost nothing against the current huge surplus figures (in 2006 - 7.4% of GDP, in 2007 -5.5% of GDP), but, as demonstrated above, one cannot help ignoring such losses in a longer run, when the budgetary system is started getting out of balance. That is why any proposal on the tax cuts should be concomitant with proposals on cuts in budgetary spending.
The willingness to lower taxes, thus improving corporations and individuals' financial stands, is quite explicable, particularly if one runs a budgetary surplus. It should be remembered, though, that such tax cuts in today's situation, when a tight budgetary policy forms a critical instrument of sterilization of the monetary issuance fueled by monetization of the positive balance of payments, will give a boost to monetary base and, accordingly, inflation. According to some estimations, the transition to the 15% VAT rate will result in a 0.9 p.p. surge of inflation, while the one to the 13% rate will accelerate inflation up to 1.5 p.p.
It should also be noted that proponents of tax cuts often argue that they ensure a quick return in the form of an accelerated economic growth, which in the circumstances does not form a credible assertion. The IET's business surveys show that since 2006 Russian enterprises began to face serious problems with labor force shortages, while since 2007 they were challenged by the shortage of production capacities. So, in the given circumstances it is quite naive to hope for the tax multiplier, for economic growth in the country can advance only under extension of production opportunities, which is associated with investment in production capital and human capital.
The problem of getting revenues and expenditures balanced under the conservative scenario of price dynamics for oil to some degree can be solved by modifying the structure of the tax system in favor of the taxes revenues from which are to a lesser degree tied with the situation on the world markets for energy sources. According to some estimations, in 2006-07 the proportion of the component (whose value is determined by oil price fluctuations) in corporate tax revenues accounted for some 15%, while in the VAT-based revenues - 1-2%. So, to secure the balance and ensure sustainability of Russia's budgetary system the tax reform should be pursued under the following scenario: raising VAT rates along with a simultaneous cut in the corporate profit tax. As the value of the latter's component (the aforementioned one) is significant, once the state of affairs on the foreign trade arena drakens, the share of the tax in GDP should plummet notably. In proportion to the fall in the share of this tax in GDP the budget system will suffer a lesser loss from its lower rates. In other words, under high oil
prices, it is appropriate to cut the rate of a tax which appears most vulnerable to a price downfall for energy sources.
The tax effect from the proposed reform depends on the degree to which revenues from the corporate profit tax will be substituted by those from VAT. The greater proportion of the corporate profit tax is substituted by the VAT-based revenues, the more sustainable is the budgetary system in the long run. However, in all likelihood, the respective rate of substitution presented in Table 35 appears ultimately permissible, as further cuts in the corporate profit tax rate may destabilize regional finance, while revenues from this tax become insignificant for the budgetary system. As the developed economies' experience shows, diversification of taxes exerts a positive influence on the tax system's stability, so far as external shocks and tax dodging are concerned.
Let us also note that in contrast to corporate profit tax cuts, those in the VAT rates mean a less effective level of tariff protection of the domestic producer. Indeed, under quite natural assumptions that the offer curve with regard to imports is horizontal (any quantity of goods can be supplied at a given price), while elasticity of offer of domestic goods that compete with the imports has a negative gradient (differs from perpetuity), cuts in the VAT rates will result in a greater price downfall for import, rather than for domestic goods.
Germany has recently launched a reform effort that implies modification of rates of basic taxes. Sensing a certain pressure on the part of eastern European countries (in Poland, the corporate profit tax is 17.4%, in Slovakia - 19%, Estonia - 23%), in 2008 Germany is to cut the respective tax rate from 25 to 15%, extending, at the same time, the tax base using revenues from taxing bank deposit interest rates, rental and leasing operations. These measures are complemented by the recently (in 2007) cut social tax, which is used for the sake of unemployment insurance, and the 3% increase of the VAT rate (from 16 to 19%). 5. Privatization, the growing capitalization and the rise in the share of profits transferred to the federal budget by federal public companies can form one of the most efficient and socially acceptable ways to boost assets of and, accordingly, revenues to the pension Fund of RF or the National Welfare Fund, and, at the same time, the means to lower the role the state plays in economic activities. The aggregate value of the national public companies is estimated at the level of 55% of GDP. Given the volume of foreign investment in Russia in 2005-07 and the peak volume of the federal budget revenues from the public property privatization (0.77% of GDP in 1997), it seems possible to ensure annual additional revenues from the public property (privatization, greater capitalization, dividends, placement of privatization proceeds to financial markets, etc.) which would roughly account for. 1% of GDP, without any risk of a drastic fall in the value of the public assets.
Table 35
Surplus (Deficit) of the Enlarged Government's Budget Under Realization of Different Scenarios of Reforming the expenditure and Revenue Components of the Budget in 2008-20*, as % of GDP
2010 2015 2020
1 2 3 4
1. Surplus (deficit) of the enlarged government's budget under increase in expenditures, as per the Conception, and the replacement coefficient being maintained at the level of 30% 2. Surplus growth (decrease of deficit) of the federal government's budget in the event: +0.91 -4.38 -7.43
2.1. The enlarged government budget spending is at the 2006 level +0.5 +2.3 +2.7
Table 35 (continued)
1 2 3 4
2.2. Indexation of the UST scale since 2010 once in 3 years, with account of the wages growth +0.39 +0.87 +1.22
rates
2.3. Increase of the mineral tax on natural gas +0.66 +0.66 +0.43
2.4. partial replacement of the corporate profit tax with VAT (cutting the corporate profit tax down to 17%, abolition of the 4% regional benefit with regard to the corporate profit tax, abolition of the beneficial 10% VAT rate, raising the basic VAT rate up to 20%) +0.07 +0.27 +0.37
2.5. additional privatization of public property +1.00 +1.00 +1.00
3. Surplus (deficit) of the enlarged government's budget under realization of the integrity of the scenarios of reforming the expenditure and revenue component of the budget over 2008-20** +3.53 +0.72 -1.71
4. The accumulated reserve of the budgetary system, as of GDP (with account of the 4%> annual nominal interest) *** 22.70 23.07 19.43
* Under costs of energy sources as per the RF MEDT's original forecast.
** Under the replacement coefficient being maintained at the level of 30%.
*** Understood as savings in the form of excess of revenues to the enlarged government budget over expenditures in the Reserve Fund and the National Welfare Fund, without account of the federal public corporations' assets assigned to the Pension Fund of RF or the National Welfare Fund, as it is only funds collected from sales of the assets in question or from management of them (dividends, profit, etc) that are taken into account.
Table 36
Main Parameters of the Federal Budget of RF in 2008-20 in the Event the Proposed Measures Have Been Realized*
2008 2009 2010 2015 2020
(1) Federal budget revenues 22.62 22.60 19.40 17.77 16.80
(1)=(1.1.)+(1.2)
(1.1.) Oil-and-gas 9.11 9.31 6.69 5.21 4.14
(1.2). Non-oil-and-gas 13.51 13.29 12.71 12.56 12.66
(2Federal budgetary expenditures (on the 2006 level) 16.41 16.37 16.51 16.57 17.27
(3) Non-oil -and- gas budget deficit -2.90 -3.09 -3.80 -4.01 -4.61
(3)=(1.2)-(2)
(4) Oil and gas transfer 2.90 3.09 3.80 3.7 3.7
(5) Oil and gas federal budget deficit 0.00 0.00 0.00 -0.31 -0.91
For reference:
The Reserve Fund 10.00 10.00 10.00 10.00 9.85
The Welfare Fund* 6.93 11.71 12.70 13.07 9.58
* Under costs of energy sources as per the RF MEDT's original forecast.
In conclusion, it should be once again stated that a responsible budgetary policy demands for a great deal of conservatism in assessing versatile scenarios of the economic dynamic, as a failure to duly consider effects from decisions made or overestimation of probability of a future favorable contour can entail dire, if not catastrophic, consequences for a
country.
2.5. Interbudgetary Relations and Subnational Finances
2.5.1. Main Trends in the Development of Relations between Budgets of Different Levels
The main trends existing in the sphere of relations between different levels of authority are reflected in the structure of RF consolidated budget revenue and expenditure. The data in Table 37 demonstrate the share of tax revenues and expenditures of the Federation's subjects, expressed in consolidated budget indicators.
Table 37
The Share of Some Indicators of the Federation's Subjects' Budgets in the Consolidated Budget of the Russian Federation in 1992-2007 (in %)
Tax revenue 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 31.8 33.9 Expenditure 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 43.4 48.3
Source: RF Ministry of Finance; calculations of the IET.
When analyzing the data presented in Table 37, one can point out the following features. Over the period of 1999-2005 there occurred a considerable degree of centralization of tax revenues; the share, in the consolidated budget, of this type of revenues received by RF subjects diminished from 56.6% to 30.9%. At the same time, in 2006-2007 this index began to demonstrate a slight growth, which is indicative of a certain adjustment of the trend toward centralizing tax receipts. It is necessary to note that this adjustment was caused not by a redistribution of tax sources between different levels budgetary system, but by a more rapid growth of receipts on the taxes consolidated to regional budgets, as compared to the tax receipts of the federal budget. Simultaneously, in 2007, in contrast to the situation observed in 2006, the share of regional expenditures in the consolidated budget of the Russian Federation substantially increased and amounted to the indices typical of the years 2002-2005. No important changes took place in the structure of tax revenues of RF subjects. As before, more than a half of the tax receipts was generated by two taxes: tax on profit of organizations (42%, or at the level of the year 2006), and personal income tax (PIT) (its share in the tax receipts of the consolidated budget of subjects of the Russian Federation somewhat increased - from 34% in 2006 to 35% in 2007). An analysis of the receipts of the main taxes as percentages of GDP has led to the following observations. The receipts from personal income tax were continuing an upward trend, amounting to 3.8% of GDP (against 3.5% in 2006). The receipts from tax on profit of organizations, which somewhat diminished in 2006 (as a percentage of GDP), by the results of last year, on the contrary, slightly increased - from 4.4% to 4.6% of GDP. Last year's regional budget revenue with regard to excises (similarly to the situation of several previous years) decreased and amounted to 0.54% of GDP (against 0.6% in 2006). The share of taxes on property somewhat increased (from 1.17% to 1.25% of GDP), similarly to the taxes on small businesses (from 0.36% to 0.37% of GDP). At the same time, there was a drop in the receipts from the payments for the use of natural resources - from 0.26% to 0.24% of GDP.
The year 2007 continued the trend toward leveling-down the interregional inequality in the distribution of RF subjects' per capita tax revenues. The value of the corresponding variance coefficient somewhat diminished - from 98.1% in 2006 to 97.6% in 2007. An even greater interregional equalization in the distribution of tax revenues can be observed when tax receipts are adjusted by regional prices (in order to measure the scale of regional prices, we applied the value of a fixed set of consumer goods and services, which is also applied for comparing the purchasing power of the regional population when distributing dotations aimed at equalizing the levels of budget sufficiency of subjects of the Russian Federation). The value of the variance coefficient decreased from 66.6% in 2006 to 61.8% in 2007. It should be noted that no serious changes in the distribution of revenue sources between the levels of authority occurred in 2006-2007 (in contrast to 2005, when a part of the unevenly distributed taxes (tax on profit and PIT) was centralized in the federal budget). The less uneven distribution of tax receipts can be explained as follows. Firstly, the tax revenues of RF subjects displayed a somewhat increased share of personal income tax, which (in contrast to profits tax) is sufficiently evenly distributed across regions. Secondly, the available data have confirmed the hy-
38
pothesis put forth in the IET's previous overview . Its main idea is that, after an economic crisis, the revival of economic activity begins at first in a small number of regions (in Russia these are the oil-producing regions and biggest economic centers). As a result, there occurs a stratification of regions by different indicators, including those of tax revenues. Such a trend could be observed in Russia in 1999-2004. Further economic growth encompasses more regions across the country and results in a more equalized distribution of tax revenues. This trend, most probably, will continue in the long run. The leveling-down of the interregional differentiation by the main socio-economic indicators will be conducive, on the one hand, to accelerated economic growth in some regions which are at present receiving high dotations, while on the other, to the population's migration from those regions where prospects are rather gloom toward rapidly developing economic centers. As a result of the combination of these ongoing processes, the presently underdeveloped regions will be either catching up with their economically better off neighbors, or will almost entirely "lose" their population. In both cases, the variance coefficient applied to the average per capita tax revenue of RF subjects will be becoming lower. The only factor capable of temporarily slowing down these processes is growth of the federal center's financial resources, which are, in effect, being spent on pinning down the population in the territories of regions "without prospects".
When taken in real terms, the tax revenues of the consolidated budgets of RF subjects have increased by 17.4%. At the same time, in 12 regions the amount of this type of revenue
39
has dropped altogether in real terms . It should be noted that in Magadan Oblast and Koryak Autonomous Okrug (AO) this decrease was only slight - by 0.7% and 0.2%, respectively. The greatest, in absolute terms, decrease in the value of this index was achieved in Tiumen Oblast, Agin Buriat AO, Khanty-Mansi AO, and Lipetsk Oblast. In the majority of cases the decline in regional budget revenue was associated with the "withdrawal" of big taxpayers and decreased payments of profits tax. Thus, receipts from the tax on profit of organizations diminished in real terms in Agin Buriat AO by 98%, in Tiumen Oblast by 54 %, in Lipetsk Oblast by 24%, and in Khanty-Mansi AO by 16%. It is also necessary to note that, in 2006, in all
38 The Russian economy in b 2006. Trends and outlooks. M. IET, 2007.
39 Tiumen Oblast, Agin Buriat AO, Khanty-Mansi AO, Lipetsk Oblast, Tomsk Oblast, Yamalo-Nenets AO, Chu-kotka AO, the Republic of Komi, Nenets AO, the Republic of Kalmykia, Magadan Oblast, and Koryak AO.
these regions the share of profits tax in the budget tax revenues was considerably higher than Russia's average. This index amounted to 97% in Agin Buriat AO, to 63% in Tiumen Oblast, to 62% in Lipetsk Oblast, and to 52% in Khanty - Mansi AO. Evidently, given such a strong dependence of the budgets of these RF subjects on the payments of profits tax, the "withdrawal" of big taxpayers could not but produce a significant drop in the amount of budget revenue. The maximum tax revenue growth in absolute terms was achieved in the city of Moscow, Moscow Oblast, the city of St. Petersburg, and Krasnoyarsk Krai, that is, in regions with high levels of budget sufficiency, and besides, with a high share of profits tax in the structure of tax revenue in 2006-2007.
A comparison between the regions characterized by the most pronounced fluctuations in the amount of budget revenue has led us to the conclusion that such fluctuations were caused in the main by the re-registration of big taxpayers. The high dependence of the regional budgets on the payments of profits tax results in an intensification of the struggle between regional authorities for the registration in their territories of big taxpayers. In this struggle the main emphasis is placed not on improving the investment climate in order to attract taxpayers into a given territory, but rather on drawing on the "administrative resource" or "bribing" big taxpayers by allocating budget subsidies to those projects the implementation of which would be profitable for certain individual companies.
In 2007, for a fourth year in succession, the consolidated budgets of the Federation's subjects demonstrated an aggregate surplus. In this connection, it is necessary to note an interruption in the trend toward a gradually increasing regional budget surplus. In 2007 it fell by 0.41 p.p. and amounted to 0.12% of GDP. This occurred due to a significant increase of RF subjects' consolidated budget expenditure - from 13.74% to 14.56% of GDP. This noticeable drop in surplus could not be prevented by a somewhat increased regional revenue - from 14.27% to 14.68% of GDP. One can point to the fact that at the level of regions (just as at the federal level) there can also be felt the same trend toward increasing state expenditure at a rate higher than that of economic growth.
Let us consider the quantitative parameters of the financial aid being transferred to regional budgets from the federal center. As can be seen from the data presented in Table 38, in 2003-2006 there was a trend toward a gradual decline in the volume of federal financial resources transferred to subnational budgets (from 3.03% to 2.17% of GDP). In 2007 this trend was interrupted, and the volume of interbudgetary transfers considerably increased - to 2.6% of GDP.
A more detailed analysis of the structure of interbudgetary transfers has yielded the following conclusions. As we have predicted earlier40, the amount of resources allocated from the Federal Fund for Financial Support of the Regions (FFFSR) to RF subjects decreased from 0.94% to 0.79% of GDP. This has been associated primarily with the procedure, introduced in recent years, for annual indexation of the FFFSR's size by the consumer price index. As was expected, the volumes of federal financial aid to regions (similarly to other expenditure items) were increasing in 2007 at a rate higher than that of GDP growth. As a result, the share of the FFFSR in the total volume of interbudgetary transfers became lower.
The year 2007 saw the continuation of the recent trend toward increasing the financing allocated from the Compensation Fund (CP). The total sum of subventions from this Fund in-
40 Ibid, p. 12b.
creased, by comparison with that in 2006, from 0.30% to 0.43% of GDP. This trend can be explained by the delimitation of powers between the levels of the budgetary system and the striving of the federal center to finance federal mandates in full. After a sharp increase in the size of the Fund for Co-Financing of Social Expenditures from 0.04% of GDP in 2004 to 0.12% of GDP in 2005, caused by the monetization of privileges (a substantial share of the Fund's expenditures was constituted by subsidies to a partial compensation for the expenditures on the measures of social support to veterans and other categories of citizens), the volume of transfers of this type has been gradually declining. In 2007, the share of the Fund for Co-Financing Social Expenditures decreased by 0.01 p.p. (just as in 2006) and amounted to 0.1% of GDP. The financing from the Fund for Reforming Regional Finances remained nearly unchanged, at approximately 0.01% of GDP. The volume of the Fund for the Development of the Regions somewhat increased - from 0.01% of GDP in 2006 to 0.02% of GDP in 2007.
As a negative trend, it should be noted that the dotations to maintain a well-balanced state of regional budgets increased from 0.16% to 0.17% of GDP. An active use of this financing mechanism, no doubt, is making more pronounced the problem presented by "soft budget constraints". At the same time, one cannot overlook the fact that in 2007 there occurred a decline in the volume of resources transferred by way of mutual settlements - from 0.05% to 0.02% of GDP. This instrument of interbudgetary relations is one of the least transparent, and therefore is decreased share can be estimated as a positive trend.
From the year 2004 onward, attempts have been made to increase the transparency of interbudgetary relations. At present, the resources of the Federal Fund for Financial Support of the Regions, the Compensation Fund, the Fund for Reforming Regional Finances, and the Fund for the Development of the Regions have been distributed in accordance with the methodology approved by the RF Government's Decree. The formation and use of the Fund for Co-Financing Social Expenditures has also been done on a formalized basis. Nevertheless, a substantial part of federal financial aid to the regions is still being distributed without applying any methodological, financial, or economic substantiation. The share of interbudgetary transfers distributed on formalized basis amounted, in 2007, to approximately 59% of the total sum of resources transferred from the federal center to RF subjects.
The year 2007 saw a continuation of the practice of revising, over a given year, the law on federal budget, in order to increase the volume of financial aid to the regions against that initially envisaged in the budget. The amount of additional aid (not earmarked at the beginning of a financial year) was approximately 65 billion rubles, which is twice as much as the same index in 2006. At the same time, in 2007 special dotations, in the amount of 54.8 billion rubles, were allocated to measures designed to maintain a well-balanced state of regional budgets Together, these two sources of "soft budget constraints" amounted to approximately 14% of the total volume of interbudgetary transfers, which casts doubt as to the real benefit of the completed reform in the sphere of distribution of financial aid between regions.
As an example of the existing procedure and principles applied in distributing additional financial aid, the following decisions can be referred to: dotations designed to ensure a well-balanced state of regional budgets were increased, during the year 2007, from 50 billion rubles to 55 billion rubles, or by 10%, and additional dotations in the amount of 19 billion rubles were transferred to the Republic of Chechnya.
Table 38
Financial Aid from the Federal Budget Transferred to the Consolidated Budgets of the Federation's Subjects in 1992-2006 (in % of GDP)
1_2_3_4 5_6_7_8_9 10 11 12 13 14 15 16 17
1. Finan- 1.8 2.3 2.5 1.6 1.18 1.43 1.79 2.2 1.94 1.7 1.65 1.52 1.79
cial aid to budgets of other levels
1.1. Fed- 0.05 0.15 0.39 eral target
programs, as well as subsidies to RF subjects in support of agriculture, measures to maintain the water systems, small
businesses, and children's health protection
1.2. Fed- 0.15 0.11 0.04 0.12 0.11 0.10 eral Fund
for Co-Financing Social Expenditures
1.3. Fed- 0 0 0.36 1.17 1.04 1.22 1.12 0.99 0.96 1.14 1.36 1.3 1.05 0.88 0.94 0.79 eral Fund
for Financial Support of the Regions, including:
dotations 0 0 0.36 0.86 0.68 0.86 1 0.99 0.96 1.14 1.36 1.3 1.05 0.88 0.94 0.79
to equalize
the level of budget sufficiency government support of "supplies to the North"
transfers at 0 0 0 0.31 0.36 0.36 0.12
the expense of VAT
0.06 0.08 0.08 0.07
Table 38 (continued)
1_2_3_4 5_6_7_8_9 10 11 12 13 14 15 16 17
1.4. Dota- 0 0.02 0.09 0.06 0.09 0.13 0.1 0.06 0.15 0.54 0.28 0.29 0.27 0.36 0.21 0.31 tions and
subventions, including:
dotations 0.11 0.24 0.16 0.17
to support
measures
designed to
ensure
well-
balanced
state of
budgets
1.5.Resour 0 0.01 0.01 0.01 0 0.01 0.01 ces of the
Fund for Reforming Regional Finances
1.6. Other 0.01 0.01 0.01 0.01 0.08 0.17 uncompen-
sated and non-
returnable transfers (subsidies and subventions)
1.7. Fund 0.03 0.05 0.1 0.1 0.15 0.01 0.01 0.02 for the
Development of the Regions
1.8. Trans- 0.61 1.95 2.54 0.42 0.81 0.43 0.36 0.14 0.28 0.05 0.2 0.14 0.12 0.01 0.05 0.02
fers by way
of mutual settlements
1.9. loans 0.09 0.03 0.02 0.04 0.23 0.64 -0.03 -0.1 -0.08 0.02 0.09 -0.01 -0.02 -0.03 -0.04 -0.01 and budgetary credits, less
redemption to other levels of state administration*
2. Corn- 0.37 0.38 0.36 0.34 0.17 0.30 0.43 pensation
Fund
3. Other 0.18 0.11 0.4 0.45 0.54 0.35 0.33 0.34 0.36 interbudg-
etary transfers, of these:
Table 38 (continued)
1_2_3_4 5_6_7_8_9 10 11 12 13 14 15 16 17
govern- 0.18 0.11 0.27 0.27 0.31 0.22 0.13 0.15 0.17
ment support of the road system**
Total 1.49 2.7 3.4 1.8 2.3 2.5 1.6 1.36 1.54 2.56 3.03 2.84 2.39 2.25 2.17 2.57
resources transferred to budgets of other levels of
authority_
* - From 2005 - only budgetary credits.
** - At present, the majority of transfers in support of the road system are listed in Section 1.1.
2.5.2. Changes Introduced into the Budget Code of the Russian Federation
The adopted Federal Law, of 26 April 2007, No. 63-FZ, "On introducing changes into the Budget Code of the Russian Federation in the part of regulating the budgeting process, and on bringing in conformity with budget legislation of the Russian Federation of individual legislative acts of the Russian Federation" has substantially increased the opportunities for subjects of the Russian Federation and for municipal formations to administer state and municipal finances, as well as created a legislative base that can on a new level regulate the most important aspects of relations between the budgets of all the levels of the budgetary system of the Russian Federation. The most important changes introduced in budget legislation with regard for the sphere of interbudgetary relations are as follows:
1. The switchover to a three-year federal budget has made it possible to increase the predictability of interbudgetary transfers for subjects of the Russian Federation. A substantial part of the interbudgetary transfers earmarked for subjects of the Russian Federation has been distributed between them for the period of three years, which creates favorable conditions for improving the quality of financial planning in regions.
2. The changes introduced into the Budget Code of the Russian Federation have provided subjects of the Russian Federation and municipal formations with opportunities for making choice between a three-year budget and a medium-term financial plan. The switchover to a three-year budget will make it possible for subjects of the Russian Federation and municipal formations to fully make use of their new opportunities for concluding medium-term contracts and to establish transparent and predictable rules for budgeting and tax policies in the medium-term perspective.
3. Within the framework of achieving the goal of strengthening the financial independence of subjects of the Russian Federation, the stability of tax legislation and interbudgetary relations has been ensured, so as to make possible reliable and objective medium-term budget planning. In accordance with budget legislation, it has become impossible to make any changes, at the federal level, to budget and tax legislation in the part of taxes and levies transferable to the budgets of subjects of the Russian Federation and to local budget are resulting in a decreased taxable base, or to change the spending obligations of regions budgets without allocating an adequate compensation from the federal budget.
4. Changes have been introduced into the procedure for determining the volume of resources of the Federal Fund for Financial Support of the Regions, in accordance with which the volume of dotations earmarked for equalizing the levels of budget sufficiency of subjects of the Russian Federation is to be determined on the basis of the need for achieving the minimum level of estimated budget sufficiency of subjects of the Russian Federation.
5. In order to create incentives for increasing revenue receipts by the budgets of subjects of the Russian Federation and local budgets, different conditions have been established for effectuating the budgeting process of subjects of the Russian Federation, depending on their level of dotations.
At the same time, the changes introduced into existing budget legislation have had almost no bearing to the interbudgetary relations between regions and municipal formations. In current budget legislation, several norms can be distinguished that create obstacles to efficient administration of finances at the regional and local levels:
- at present, by the Budget Code of the Russian Federation (Item 1 of Article 137), the possibility is consolidated to allocate dotations for equalizing the levels of budget sufficiency of settlements on the basis of the population's number and (or) budget sufficiency. However, by Item 2 of Article 137 of the Budget Code of the Russian Federation, it has been established that the size of this dotation should be determined, for each settlement of a subject of the Russian Federation with the right to receive such dotations, on the basis of the number of a settlement's residents and per resident. Evidently, in some subjects of the Russian Federation it would be more feasible to apply a per capita pattern for distributing the dotations earmarked for budget sufficiency equalization, whereas in other regions, due to a very uneven distribution of revenue base, it might be necessary to apply for the same purpose the criterion of settlements' budget sufficiency levels;
- in Item 3 of Article 138 of the Budget Code of the Russian Federation it is stipulated that the level of estimated budget sufficiency of municipal raions (or city okrugs) should be determined only on the basis of per capita tax revenue. However, at the municipal level, nontax revenues (for example, rent payments) may be comparable with the volumes of tax revenues. Consequently, in some subjects of the Russian Federation, when estimating budget sufficiency levels, it can be feasible to apply the information not only concerning taxes, but also non-tax revenues of municipal formations, if such revenues are received on a permanent basis;
- by Item 1 of Article 142.2. of the Budget Code of the Russian Federation, the possibility is consolidated for granting subsidies to the budget of a subject of the Russian from the budgets of those settlements and (or) municipal raions (or city okrugs) where in a given financial year the estimated tax revenue of a local budget (less the amount of tax revenue in accordance with additional normative deductions) were in excess of the level established by the law of the subject of the Russian Federation. However, in some subjects of the Russian Federation the settlements and municipal raions (or city okrugs) may significally differ not only by the volumes of their tax revenue, but also by the objective conditions influencing the cost of budget-funded services. Consequently, a situation may arise when municipal formations with a relatively high level of estimated per capita tax revenue will have a rather modest level of budget sufficiency, but nevertheless will be obliged to transfer subsidies to the Russian Federation's budget. In order to provide solution to this problem, it will be necessary to grant to a subject of the Russian Federation the right of choice
between the budget sufficiency, tax revenue, and aggregate amount of tax and non-tax revenues of a municipal formation, to be applied as a criterion for subsidies to be granted from local budgets to the budget of a subject of the Russian Federation; - in accordance with Item 3 of Article 138 of the Budget Code of the Russian Federation, the level of estimated budget sufficiency of a municipal raion (or a city okrug), with due regard for the dotations to equalize the budget sufficiency levels of municipal raions (or city okrugs) as established in the aforesaid Item, cannot be in excess of the level of estimated budget sufficiency supplemented by the corresponding dotations from another municipal raion (or a city okrug), which prior to the distribution of the aforesaid dotations, had had a higher level of estimated budget sufficiency. Although this requirement of budget legislation appears to be quite logical, it is necessary to note that it would be rather difficult to comply with this equalization principle (the so-called "monotonous" principle) after the switchover to a three-year budget and the distribution of equalizing transfers between municipal raions (or city okrugs). It is not accidental that a similar requirement in the RF Budget Code for the Federal Fund for Financial Support of the Regions was abolished. In order to eliminate the possibility of the emergence of additional factors serving as obstacles to the switchover to a three-year budget at the regional level, it seems necessary that this stipulation in the RF BC should be revised. It also appears necessary to apply, as a general rule, the following approach to regulating financial relations between subjects of the Russian Federation and municipal formations at the federal level. Federal legislation should offer a sufficiently broad range of patterns for organizing interbudgetary relations at the regional and local levels of the budgetary system. Each of these patterns must be established so as to exclude the possibility of dual interpretation by different subjects of the budgeting process. Subjects of the Russian Federation and municipal formations must be able to select, out of this list, the most appropriate pattern for organizing interbudgetary relations. In order to take into account the various specific details of the distribution of interbudgetary transfers at the regional and local level that cannot be determined by the Budget Code of the Russian Federation, special attention should be paid to developing a best practices code. This code of best practices of organizing interbudgetary relations and improving the quality of management of regional and municipal finances at the regional and local levels will be prepared by the Ministry of Finance of the Russian Federation, with the participation of independent experts, and will contain, among other things, a detailed description of a methodology for distributing interbudgetary transfers compatible with the set of general patterns for the distribution of interbudgetary transfers established by the Budget Code of the Russian Federation.
2.5.3. The Federal Budget for the Year 2008 and the Period until 2010, in the Part of Interbudgetary Transfers Allocated to Other Levels of the Budgetary System
The total sum of resources earmarked for transfers to regional and local budgets in 2008 is approximately 919 billion rubles. This is by 1.17 times higher than the volume of resources envisaged in the law on the 2007 federal budget, given that total federal budget expenditure will grow by 1.20 times. As a result of a slower growth of the amount of interbudgetary transfers to other levels of the budgetary system, their share in federal budget expenditure will be diminished by comparison with that in 2007 - from 14.2% to 14%. Later on, the downward
trend displayed by interbudgetary transfers as a percentage of federal budget expenditure will continue, this index being 12.1% in 2009 and 10.8% in 2010. Considering the fact that in the late 1990s the share of dotations from the FFFSR alone amounted to 14% of federal budget expenditure, and the main revenue sources are at present concentrated in the federal budget, is does not seem very certain that the share of interbudgetary transfers to other levels of the budgetary system in total federal budget expenditure has indeed diminished.
It is also necessary to note that the system of interbudgetary transfers is becoming increasingly complex and intricate. In developed countries with a federative state system there exist, as a rule, two channels for allocating interbudgetary transfers: by way of equalizing regions' budget sufficiency levels and by maintaining at a socially acceptable level the regional expenditures earmarked for priorities relevant for the whole federation. As a result, developed federative states usually allocate 1 or 3 major transfers from the federal budget to the budgets of territories, and from 3 to 15 smaller-sized transfers. In the Russian Federation, in accordance with the 2008 draft budget and the draft budget for the period until 2010, there exist nearly a hundred of different transfers (6 transfers in the subsection of dotations, 58 - in the subsection of subsidies, and 31 - in the subsection of subventions). The efficiency of such a system thus will inevitably be questioned. Similarly to the taxation pattern, the number of transfers must be appropriate for efficient administration. The total financing distributed among 24 directions amounts to less than 1 billion rubles, which means that one subject of the Russian Federation may be receiving financing with regard to several directions amounting to under a hundred thousand rubles, or to several hundreds of thousands rubles. It is evident, given the targeted character of the majority of directions (subsidies and subventions), that the cost of targeted use of such resources, let alone the estimated cost-effect ratio, may be higher that the benefit yielded by the allocated expenditures. It seems necessary to thoroughly revise the existing delimitation of powers between the federal center and regions in order to fully consolidate some of the powers to the regions, while to return the others to the Federation's level (for example, the financing of social benefits paid to the veterans of the World War II labor front and former victims of political repressions).
The main stream of financial aid to regional authorities - in the form of dotations to the equalization of budget sufficiency from the Federal Fund for Financial Support of the Regions - will in 2008 be increased by 26.2% (against the level of 2007) and amount to 329 billion rubles (or 0.94 % of GDP). It is necessary to note that in 2008-2010 an attempt will be made to overcome the downward trend displayed by the share of this Fund in interbudgetary transfers: in accordance with the draft law on the 2008 federal budget and the budget for the period until 2010, the share of FFFSR in the interbudgetary transfers to other levels of the budgetary system will grow from 33.6% in 2007 to 35.6% in 2008, to 38.8% in 2009, and to 42.7% in 2010. However, considering that in 1999 the share of this Fund in interbudgetary transfers was 73%, and the unequal character of the budget sufficiency levels of Russian regions since 1999 has become much more pronounced, the suggested increase in the amount of dotations from the FFFSR appears to be insufficient. Besides, the principal purpose of dotations from the FFFSR (to provide all regions with comparatively equal opportunities for receiving budget-funded services) is now being hindered by attempts to pursue other goals initially alien to that Fund: to improve the level of regional authorities' financial discipline, to prevent sharp changes in the level of dotations, and to create incentives for regional authorities to increase their tax potential on their own. Although all these secondary goals are also
important, the attempt to achieve them all by applying a single financial instrument may result in a failure to achieve any of them, while the procedure for distributing dotations from the FFFSR will become even more intricate and less transparent (see a more detailed discussion of the new methodology for distributing dotations from the FFFSR in Section 3).
Beginning from the year 2005, the Compensation Fund has been pooling the resources allocated to the financing of all the federal spending mandates explicitly established by legislation. The draft law on the 2008 federal budget and the budget for the period until 2010 has envisaged an increase in the FC's volume from 153.9 billion rubles in 2006 to 190.4 billion in 2010. The share of subventions in the interbudgetary transfers to other levels of the budgetary system remains high - 18-22 %. On the one hand, the desire of the federal center to finance all the spending mandates is an indisputable benefit for the whole budgetary system. On the other, in a medium-term perspective it might be feasible to test the efficiency of the existing delimitation of powers, and in case of necessary do the following:
a) to discontinue the delegation, to the regions, of some of the federal powers and to switch over to their financing from the federal budget;
b) to delegate some federal powers to the Federation's subjects in full, while correspondingly increasing the volume of non-targeted transfers and transfers with soft conditions for spending the allocated resources and/or expansion of regional budgets' own revenue;
c) to consider the possibility of delegating/centralizing some powers on a contractual basis, with precise terms of such contracts being consolidated by legislation. It is necessary to note that Russia has had, indeed, considerable negative experience of delimitating powers on a contractual basis, although foreign experience sometimes confirms the efficiency of this particular mechanism. Therefore it might be feasible to return to this issue in the long-term perspective, after thoroughly studying it from the point of view of law and economics.
In the part relating to subsidies, their marked growth had been planned in the draft budget for the year 2008 and the period until 2010: the subsidies allocated in 2008 are increased by 1.84 times against the volume planned in the 2007 budget, or up to 311 billion rubles. The main directions for spending these resources in 2008 are as follows:
- the Federal Target Program "Modernization of Russia's Transport System (2002-2010)" -15.2% of the total sum of subsidies;
- subsidies to the road system - 11.3% of the total sum of subsidies;
- subsidies to support agricultural production - 10.7% of the total sum of subsidies;
- social aid - 10.5 % of the total sum of subsidies.
The subsidies from the federal budget allocated to the road system and the Federal Target Program "Modernization of Russia's Transport System (2002-2010)" are of a high social importance, because they are designed to maintain the country's territorial and economic integrity and to promote the population's mobility. The corresponding obligations to implement large-scale motor road projects are rather high and in a majority of cases cannot be financed exclusively from regional (or regional and local) budgets. In this connection, it seems feasible to preserve the existing mechanisms for distributing these subsidies, which on the whole are quite compatible with the established requirements to such instruments.
At the same time, in order to improve the efficiency of planning and of the use of these resources, it would be necessary to pay attention to at least two specific features characterizing of the process of allocating subsidies to the road system. Firstly, it will be necessary to strengthen the linking of the subsidized projects to the general directions and priorities of ter-
ritorial development, the development of federal and territorial roads in a given region, as well as other mechanisms, and to the volumes of financial aid being allocated (the decision concerning the allocation of subsidies to the road system must take into consideration the level of budget sufficiency and the volumes of financial aid received by the region through other channels). Secondly, it will be necessary to toughen the formal procedure for considering applications and selecting projects on the basis of the criteria of social and economic efficiency, so that financing in the form of subsidies could be obtained with due regard for the opportunities in terms of co-financing on the part of regions.
As for the subsidies to agricultural production, the situation regarding these is fundamentally different. The transfer to the regional level of the powers to support agricultural production has resulted in this support being most actively provided not to those regions where the natural and climatic conditions are most favorable, but to those where the financial opportunities for implementing such a policy are greatest. The allocation from the federal budget of resources to support agricultural production on the basis of the principle of co-financing may make this trend even more prominent, and in particular, to result in the most financially "strong" regions being supported in their "trade wars" being waged for agricultural markets with "weaker" regions. Therefore, one may feel doubtful in respect of the true effect of such subsidies. This issue can be resolved by centralizing, at the federal level, the subsidies earmarked for the support of agricultural production, while minimizing the regional expenditures allocated to this direction. Simultaneously, the Federation's role in the co-financing of expenditures allocated to the social development of rural areas should be increased.
As for the Fund for Co-Financing Social Expenditures, the directions for allocating resources from it need to be somewhat adjusted. In particular, it would be feasible to gradually discontinue the co-financing of the social support of veterans of the World War II labor front, by establishing, say, a transition period of 5 years, after which no co-financing will be allocated to this direction. The title of "veteran of the labor front" is still being granted in Russian regions, the criteria for eligibility varying greatly from region to region (see Box 1). Thus, this direction of social support is not an objectively substantiated and just one, and so the co-financing of the corresponding expenditures from the federal budget in the long-term perspective cannot be estimated as feasible. It would be better to provide the social support of politically rehabilitated persons and persons recognized as victims of political repressions, as well as veterans of the labor front, from the federal level. Indeed, these categories of privileged persons have been created by decisions made by the country's leadership, and not by regional or local authorities. So, the granting of social aid to them must be within the competence of the bodies of state authority of the Russian Federation. However, in accordance with the existing delimitation of powers, the social supporta of these categories of the population belongs to the sphere of competence of subjects of the Russian Federation, and for these powers to be transferred to the federal level it will be necessary to make amendments to a number of federal laws41.
41 Law of the RSFSR, No. 1107-1, of 26 April 1991, "On the rehabilitation of the peoples - victims of political repressions"; Law of the Russian Federation No. 1761-1, of 18 October 1991, "On the rehabilitation of victims of political repressions", Federal Law No. 5-FZ of 12 January 1995, "On veterans", No. 184-FZ of 6 October 1999, "On the general principles of organization of legislative (representative) and executive bodies of state authority of subjects of the Russian Federation". 152
As for the subsidies allocated to the budgets of subjects of the Russian Federation with regard to the upkeep of a child in a guardian's family or a foster family, as well as the remuneration to foster parents, and the subsidies to the budgets of subjects of the Russian Federation for the provision with housing to orphaned children; to the children left without the care of parents; and to the children under guardianship (or trusteeship), who have no dwelling consolidated to them. It appears necessary to formalize both the procedure for distributing these subsidies and the procedure for determining the total volume of resources allocated to these purposes.
Box 1
Changes in the Procedure for Granting the Title of "Veteran of the Labor Front" in Cheliabinsk
Oblast
In Cheliabinsk Oblast, the regional authorities decided to change the procedure for granting the title of "veteran of the labor front". The right to this title will be enjoyed by all the retired persons who have employment history of 35 years (for females) and 40 years (for males). Until now, only the pensioners with government decorations and certificates of faultless work could become "veteran of the labor front". Today, 384 thousand persons in Cheliabinsk Oblast have the title of "veteran of the labor front". From 1 January 2008, the right to this title will be granted to another 270 thousand persons (approximately). Alongside the title, this category of population will also enjoy the right to privileges: the compensation for 50% of the cost of their housing and utilities, as well as solid fuel; free-of-charge use of city and commuter transport; and privileges with regard for the payment for dental services, postal services, etc. The sum of financial coverage of the privileges granted to "veteran of the labor front" from the oblast budget will be increased by 1 billion 550 million rubles. In connection with this decision of the leadership of Cheliabinsk Oblast, two groups of problems can be considered.
Firstly, this decision in many ways contradicts the logic of reform aimed at "monetization of privileges", because it extends the list of in kind privileges. Besides, the targeted character of the social support provided to the population becomes less pronounced, because these resources are allocated to pensioners irrespective of their level of living.
Secondly, certain problems arise in connection with the co-financing of this decision from the federal budget. At present, in accordance with the methodology for distributing subsidies among the budgets of subjects of the Russian Federation within the framework of co-financing of some of the social expenditures of subjects of the Russian Federation in 2008 and over the period until 2010, the size of subsidies allocated from the federal budget to the budgets of RF subjects for the social support of "veterans of the labor front" is determined on the basis of the following parameters: the number of citizens enjoying the right to receive social support in a given subject of the Russian Federation; the budget expenditure index in a region; the established norm for the volume of expenditure to be allocated per one recipient of privileges; and the level of co-financing which, in its turn, depends on a region's budget sufficiency level. If the number of "veterans of the labor front" is increased in a region, there arises a necessity to symmetrically increase the volume of co-financing. The level of co-financing of this type of social expenditures for Cheliabinsk Oblast in 2008 is established in the amount of 20.3% of the estimated need for social support of "veterans of the labor front". Most probably, the level of co-financing will be changed only slightly. Thus, for the year 2009 it is planned that the level of co-financing will constitute 18.8% of the estimated requirements for the social support of "veterans of the labor front"; and in 2010 it will be 19.1%. This means that this decision of the leadership of Cheliabinsk Oblast may result in an annual increase of the amount of federal budget expenditure by 138 million rubles, in the 2008 prices.
Thus "regional financial mandates" are created, that is, regional authorities make decisions that have a direct impact on the size of federal budget expenditure. This situation appears to be unacceptable, because it creates a precedent to be followed by the other Russian regions - to overestimate their spending obligations in order to receive additional financial resources from the federal budget.
In principle, it is doubtful whether it is indeed feasible to allocate small sums to the co-financing of some or other regional powers. It is evident that the negligible scale of co-
financing makes it impossible to grant to the Federation's subjects any substantial additional financial resources.
In this connection, one can borrow from the experience of those foreign countries where package transfers are allocated to whole sectors (public health care, public education), with
42
rather lax control over how the allocated resources are spent .
Besides, it can be feasible to replace with package transfers the greater part of financing allocated to priority national projects. In 2005-2007, in order to significantly raise the living standards of Russia's citizens, four priority national projects were developed and to a substantial degree implemented. The implementation projects helped to find solutions to many problems existing in the target areas and, which is most important, to focus on these problems the attention of society and bodies of authority of all levels.
The implementation of priority national projects has resulted in substantial investments of the federal budget's resources in the spheres of public education, public health care, and housing construction. However, in course of implementing these national projects there also arose certain problems:
1) the impossibility to fully take into account the preferences of the local population when allocating financing directly from the federal budget; thus, for example, in one region it may be necessary to increase the salaries of general physicians, while another region may have a greater need in medical specialists or in more medical centers to be constructed;
2) the spheres selected as national priorities are mainly consolidated to regional authori-ties43, which results in the creation of additional spending mandates for them:
- within the framework of the projects "Education" and "Health", the granting of additional remuneration and the raising of salaries of certain categories of employees in the budget-funded spheres takes place against the backdrop of a maintained planned growth of payment for labor on the whole across the education and health care sectors. Consequently, there emerge preconditions for an increasing differentiation in the levels of incomes between these categories and all the others. The inevitable result is an overflow of cadres into the better provided for categories, which diminishes the availability of other types of
42 A package transfer is applied in Perm Krai. Because of the conservative financial planning principles, the krai budget receives, on an annual basis, substantial additional revenues, which are used to finance priority regional projects. The package transfer accounts for 42% of the additional revenues being distributed per capita between municipal formations. Within the framework of this transfer, the directions for co-financing are determined. A municipality may independently make the choice of one or several directions from the established list.
43 See: 1) Article 11.1 of Federal Law of 22 August 2004, No. 122-FZ, "On the introduction of changes into the legislative acts of the Russian Federation and recognizing as null and void some of the legislative acts of the Russian Federation in connection with the adoption of the Federal Laws "On the introduction of changes and additions to the Federal Law "On the general principles of organization of the legislative (representative) and executive bodies of state authority of subjects of the Russian Federation", and "On the general principles of organization of local self-government in the Russian Federation";
2) Chapter 3 of Federal Law of 6 October 2003, No. 131-FZ, "On the general principles of organization of local self-government in the Russian Federation";
3) Article 26.3, Items 13 and 21, of Federal Law of 6 October 1999, No. 184-FZ, "On the general principles of organization of the legislative (representative) and executive bodies of state authority of subjects of the Russian Federation";
4) Federal Law of 31 December 2005, No. 199-FZ, "On the introduction of changes into individual legislative acts of the Russian Federation in connection with the improving of delimitation of powers";
5) Article 29 of Federal Law of 10 June 1992, No. 12-FZ, "On education". 154
specialists to the population in these sectors. The inevitable response on the part of regional authorities to this situation was the raising of salaries of the other categories in the spheres of public education and health care; - within the framework of implementing national projects, not only the financing of current expenditures, but capital investments are also envisaged. These investments may also create additional spending obligations for regional authorities. For example, when the supply of hi-tech (that is, expensive) medical technologies to medical institutions was provided, no consideration was given to issues like the availability of the necessary number of specialists capable of operating that equipment, or the supplies of expandable materials and replacement of parts, etc. This also applies to purchases of computers for schools and their connection to the Internet: the equipment will have to be upgraded at the expense of subnational budgets, and the access to the Internet will have to be paid for. Obviously, this will generate new expenditures for regional budgets.
Therefore it appears necessary, later on, to allocate, to the regions, package transfers in the form of subsidies to finance these sectors, with soft conditions for spending the received resources. In this case, the Federation will, on conditions of co-financing, allocate transfers to regions to cover the development of priority spheres, while regional authorities will independently decide on which individual programs and projects in a given sphere these resources should be spent.
Let us consider three variants of distribution of subsidies: per capita distribution; per capita distribution based on budget expenditure index; and per capita distribution based on regions' budget sufficiency levels. Foreign experience has demonstrated the desirability of distributing package transfers per capita, because such transfers, in fact, are aimed at equalizing vertical budget disbalances. In Russia, in a situation of considerable regional variances in the cost of budget services and the tax capacities of different regions, it would be, probably, most convenient to take into consideration the budget sufficiency of regions: the degree of co-financing of priority directions must depend on the level of budget sufficiency. However, it is necessary to emphasize once again that package transfers indeed equalize vertical budget disbalance by compensating to regions their expenditures associated with further implementation of priority national projects, which are typical of all Russia's regions. In this connection, a compromising solution would be to allocate package transfers with due regard for regions' budget sufficiency levels. However, the progressiveness of equalization must be significantly lower than that associated with the allocation of dotations from the FFFSR. It can be suggested that package transfers should be allocated in proportion to the gap between the budget sufficiency of a given region and that of the richest region. In this case, it is only the richest region (or the richest regions) that will be deprived of package transfers.
Such a pattern of distributing package transfers becomes especially important when the FFFSR's progressiveness is increased. If the majority of dotations from the FFFSR is spent on bringing the budget sufficiency level of the regions with high level of dotations to a certain guaranteed minimum (as it will be done beginning from the year 2008), the allocation of package transfers on a proportional basis will be compensating for the losses of those regions where the level of budget sufficiency was initially higher than the guaranteed minimum.
2.5.4. The New Methodology for the Distribution of Dotations to Equalize the Budget Sufficiency of Subjects of the Russian Federation
Decree of the RF Government No. 745 (of 3 November 2007) approved the changes introduced into the methodology for the distribution of dotations for the equalization of the levels of budget sufficiency of RF subjects allocated from the Federal Fund for Financial Support of the Regions. Among the most important changes introduced into this methodology, the following ones can be pointed out:
1) The determination of the total volume of dotations to the equalization of budget sufficiency of subjects of the Russian Federation on the basis of necessity to achieve the minimum level of estimated budget sufficiency of subjects of the Russian Federation. The minimum level of estimated budget sufficiency for a subject of the Russian Federation, with due regard for the dotations to the equalization of budget sufficiency of subjects of the Russian Federation for the next financial year, was determined as the mean level of estimated budget sufficiency prior to the distribution of these dotations among the subjects of the Russian Federation not included in the list of top ten subjects of the Russian Federation with the highest levels of budget sufficiency, and the ten bottom 10 subjects of the Russian Federation with the lowest levels of budget sufficiency. In contrast to the previously existing procedure for determining the volume of the FFFSR on the basis of a previous year's volume of the Fund multiplied by the consumer price index established by the law on federal budget, the new procedure makes it possible to largely take into consideration the real needs of regions to equalize their levels of budget sufficiency. Despite the somewhat artificial character of excluding the ten richest and ten poorest regions when determining the FFFSR's volume (which was done in order to somewhat underestimate its size), the changes introduced into the procedure for determining the Fund's volume can on the whole described as positive.
2) The application of indicators describing the tax bases for the taxes transferred to the consolidated budgets of subjects of the Russian Federation, instead of the value added indicators of different branches of the national economy, when calculating the index of a region's tax capacity. The previously applied method of estimating tax capacity by applying value added estimates by branch of the national economy had a number of limitations:
- absence of data on the structure of the value added. In the previously applied methodology for estimating tax capacity, the value added in industry was divided by subsectors in proportion to gross output volumes. This division is rather approximate and could have failed to reflect a region's real sectoral structure, since gross output is equal to the sum of intermediate consumption and value added, while the correlation of these two gross output components vary greatly in different sectors;
- absence of division into federal and regional taxes when determining the tax burden. In different sectors and regions the shares of different taxes in the structure of value added may also differ substantially;
- a disproportion between the amounts of tax revenues and value added, including for reasons of migratory tax bases (predominantly those for the profits tax);
- discrepancies between tax and statistical data. A comparison of the available data on the by-sector distribution of value added as stated in the reports published by the Federal Tax Service (FTS) and the Federal State Statistics Service (FSSS) has led to the conclusion that there exist some differences between the reported amounts of tax receipts and the
structure of value added when broken down by sector. In other words, there emerge situations when the actually generated value added is reflected in statistics reports as belonging to one sector, while the taxes paid on it are reflected with regard to another sector in the FTS' reporting forms. Thus the estimated tax loads of different sectors of the national economy may be distorted.
The application of indicators characterizing the tax bases for the taxes transferred to the consolidated budgets of subjects of the Russian Federation44 has largely provided solutions to all these problems and to estimate more accurately the regions' tax capacities.
3) The distribution of dotations to the equalization of budget sufficiency levels of subjects of the Russian Federation over a tree-year period, despite the existence of substantial undistributed reserves (the share of distributed dotations on budget sufficiency equalization in the total volume of the FFFSR at the beginning of the three-year budget period amounts to 100%, in 2009 - 85%, and in 2010 - 80%), is conducive to a better predictability of the volumes of interbudgetary transfers for regional authorities.
Despite the aforesaid merits of the new methodology for distributing dotations from the FFFSR, one can also point to some technical limitations of the formula applied to the distribution of dotations from the FFFSR, which considerably diminish its merits.
1) Attempts to create incentives for regions to independently expand their tax base for the tax on profit of organizations and the personal income tax with the help of dotations from the FFFSR have resulted in a situation when a region with a higher level of budget sufficiency prior to equalization fails to maintain its advantages after it, that is, a region's ranking in terms of budget sufficiency prior to equalization does not correspond to that same region's post-equalization ranking. As a result, the attempt to urge the regions to increase their tax base on their own develops into a de-stimulating measure from the point of view of improving the budget sufficiency level of some regions. In this connection, it has been suggested that the attempts to promote growth of the taxable base with regard to profits tax and personal income tax should either be discontinued altogether when distributing dotations from the FFFSR45, be aimed only at promoting accelerated growth of the personal income tax, since the incentives for increasing the taxable base for tax on profit of organizations work only to intensify the struggle between regions for the placement in their territory of the most profitable enterprises. As a result, enterprises apply transfer pricing in order to focus profits in that region where the highest preferences are offered in the form of exemptions and subsidies from the regional budget. It is by no means obvious that the promotion of such an activity is indeed the goal of the dotations allocated from the FFFSR.
44 The volume of profit of big and medium-sized organizations; the fund of salaries charged to employees of organizations; average annual value of fixed assets of big and medium-sized commercial organizations; retail turnover; public catering turnover; output of commercial services provided to the population through all the realization channels; the volume of delivered alcohol-containing products, ethyl alcohol, and wine to enterprises; output volumes of beer; oil extraction output (including gaseous condensate); the cost of extraction of natural resources by common type of mineral resources, in the form of natural diamonds and other mineral resources.
45 Any region would be by all means interested in increasing the amount of payments of these taxes, because these are transferred into its budget, while the potential reduction in the amount of dotations from the FFFSR as a result of growing tax base will occur with a lag of at least two years and will be substantially lower than the additional tax revenues. And in case additional incentives are necessary for promoting a region's efforts to increase its tax base, it would be much more logical to do this by increasing the region's share in the profits tax.
2) The tax capacity with regard to "other types of taxes" is calculated in proportion to the sum of tax receipts from profits tax, personal income tax, tax on property of organizations, and taxes on aggregate income. However, our calculations have demonstrated that it is feasible to estimate the tax capacity with regard to "other types of taxes" in proportion to that of personal income tax, because the latter is distributed more evenly between the regions of the Russian Federation than the sum of four taxes applied in the suggested distribution formula, and the payments of PIT are better correlated with those of "other taxes".
3) When calculating the tax capacity of a RF subject by type of tax, the forecasted revenues receipts in the consolidated budgets of RF subjects from each tax in the next financial year are applied. If the tax base of all taxes is distributed evenly between regions, such an approach appears well-justified. However, in the instances of the tax on the extraction of mineral resources, the profits tax and some excises in become obvious that a substantial share of the tax base is concentrated in a small number of the Federation's subjects, and so the forecasted receipts are very significant for these subjects from the point of view of dotations distributed from the FFFSR. Besides, the structure of tax revenues may also vary significantly in different subjects of the Russian Federation receiving equalizing dotations. As a result, some subjects and the federal center may wish to produce different forecasts of the amount of receipts from these taxes. In order to avoid complaint on the part of regions that their tax capacities are overestimated on the basis of forecasted tax revenues, it is suggested that the tax capacity formula should make use not of forecasted data concerning revenue receipts in the consolidated budgets of subjects of the Russian Federation, but of the actual data of the latest reporting period.
4) Resulting from the application of the new method for calculating tax capacities, the budget sufficiency levels of many regions have displayed marked changes. In order to avoid dramatic negative fluctuations in the amount of dotations allocated to the Federation's subjects, the new methodology for distributing dotations from the FFFSR envisages the creation of compensation mechanisms. The degree of compensation of losses to regions after the switchover to a new formula depends on the achievement by regions of certain indices indicative of a reduction in the amount of accounts payable and of increased revenue receipts in the budget of a subject of the Russian Federation. In this connection, it is suggested that certain allocation should be distributed in order to compensate, in part, to subjects of the Russian Federation the drop in the amount of dotations to the equalization of budget sufficiency by comparison with the 2007 level, so that the level of dotations should be increased to 100% if two or three requirements are fulfilled, to 90% when one requirement is fulfilled, and to 85% if none of the requirements is fulfilled. It is necessary to note that this dependency of the amount of compensation on the losses resulting from a drop in the dotations to budget sufficiency equalization on the fulfillment, by a subject of the Russian Federation, of certain requirements in terms of lowering payables and increasing budget revenue seems to be rather disputable. Firstly, it is contrary to the core idea of equalizing the level of budget sufficiency -that of providing all the regions with comparatively equal opportunities to receive budget-funded services, if equal tax rates are applied. Secondly, this dependency will certainly disrupt the "monotony principle", in accordance with which the region with a higher budget sufficiency level prior to equalization must preserve this advantage thereafter. Thirdly, higher compensation will be received by the better provided for subjects of the Russian Federation
(for example, Belgorod Oblast), which is also contrary to the core idea of financial equalization.
5) In order to ensure the aforesaid partial compensation to those regions where the amounts of dotations to equalize the level of budget sufficiency will be diminished by comparison with the 2007 level, it was decided that the amount of dotations should be decreased for the regions where the growth rate of equalizing dotations against the 2007 level would be higher than 7%. Many regions have been criticizing this proposal, because in terms of methodology these resemble negative interbudgetary transfers.
By way of summing up all the changes introduced into the methodology for distributing dotations from the FFFSR, the following conclusions can be drawn:
- the formula for the distribution of dotations has become more complex and less logical;
- the equalization proper of regions' budget sufficiency is becoming less and less relevant for the actual distribution pattern applied to the dotations from the FFFSR.
Thus, it is suggested that, when distributing dotations from the FFFSR, only one goal should be borne in mind - that of equalizing the budget sufficiency levels of regions, while the other goals (creating incentives for regions to expand their tax base, improve financial discipline, etc.) can be achieved by applying other instruments. Besides, if changes are introduced into the methodology for distributing dotations from the FFFSR every year or two, it is by no means conducive to better stability of the budgetary system.
2.5.5. Issues Relating to the Redistribution of Taxes between Levels of State Authority
When addressing the All-Russian Conference of Councils of municipal formations of subjects of the Russian Federation, the President of Russia V.V. Putin, among other things, touched upon the issue of distributing tax revenues between regional and local levels of au-thority46. Although the RF President in his speech emphasized the necessity to "provide
47
municipalities with sufficient financial and material base"47, without specifying the sources to be drawn upon in achieving this goal, in some media organs this was interpreted as a proposal to return to municipal formations a part of the profits tax.
At present, in accordance with Article 284 of the Tax Code of the Russian Federation, the rate of the tax on profit of organizations is established at the level of 24%. The sum of this tax calculated at the rate of 6.5% is transferred to the federal budget, while the rest, calculated at the rate of 17.5%, is transferred to the budgets of subjects of the Russian Federation. In 2002-2004 the amount of the profits tax calculated at the rate of 2% was transferred to local budgets. Then the tax on profit of organizations was redistributed for the benefit of the federal center and regions because of the very uneven character of the tax base's distribution across the country.
The desire to redistribute the tax in favor of municipal formations can be explained by two reasons.
Firstly, there can exist a vertical budget disbalance between the budget of a subject of the Russian Federation and the consolidated budget of municipal formations. A vertical budget disbalance emerges if spending obligations are consolidated to certain levels of
46 Newspaper Business&FM , "Nalog na pribyl' poshel po gorodam i vesiam " [Profits tax is on the loose, at last"]. 24 October 2007.
47 http://www.rosbalt.ru/print/424809.html.
authority disproportionably in terns of revenue sources. In other words, if the bulk of revenue in the consolidated budget of subjects of the Russian Federation is consolidated to the regional level of authority, while the bulk of expenditure is executed at a local level, the result would be vertical budget disbalance. This vertical budget disbalance exists between the federal
48
center and regions . However, an analysis of the execution of the consolidated budget of subjects of the Russian Federation in 2006 has demonstrated that between the regional and local levels of authority there is no lack of proper vertical budget balance: the share of regional budget revenue in the consolidated budget revenue of subjects of the Russian Federation is nearly identical to the share of regional budget expenditure in the consolidated budget expenditure of subjects of the Russian Federation (83.67% and 83.22% respectively)49. Consequently, there is no need, on a national scale, to withdraw any considerable part of financial resources from regions in favor of municipal formations in order to better balance the Russian budgetary system. This fact is indirectly50 confirmed by similar figures indicative of the existence of a deficit in regional and local budgets: in 2006, 36 regions of the Russian Federation executed their budget with a deficit, while aggregate deficit in the budgets of city okrugs was registered in 37 regions, in the budgets of municipal raions - in 28 regions, and in the budgets of urban and rural settlements - in 13 regions51.
Secondly, there can be a political and economic goal - that of increasing the independence of bodies of localoro local self-government. Local authorities have at their disposal more information concerning local conditions and preferences than the national government, or even regional authorities, and consequently - more opportunities for better decision-making. The more versatile the preferences of the population of some territories and the less capable the center, or even the regional level of authority, by comparison with local self-government, of identifying the population's priorities in terms of budgeting policies, the
52
higher may be the benefit from decentralization . By contrast with the necessity to eliminate a vertical budget disbalance, increased financial independence of local self-government can be a fairly important reason why it may be feasible to transfer some of the tax sources from the regional level of authority to local self-governments. Thus, in 2006, the revenue proper of municipal formations constituted only 42% in their total revenue. The rest was represented by transfers from regional budgets, nearly a half of which were targeted (subventions and
53
subsidies) . Evidently, these indices are not sufficient for ensuring the fiscal autonomy of an elected level of authority, which is also closest to the population.
In this connection, it seems quite justifiable that the share of taxes in the revenues of bodies of local self-government should be increased. However, the profits tax, especially in
48 Nazarov V.S. Nuzhny li regional'nye stabilizatsionnye fondy? [Are regional stabilization funds really needed?] // Bankovskoe delo. - M., 2007 - No. 2.
49 Source: RF Federal Treasury; calculations of the IET.
50 It should be noted that the considerably lower deficit in the budgets of municipal formations can be explained not only by their financially favorable situation, but also by the rigidity of requirements imposed by budget legislation. In accordance with Article 92 of the Budget Code of the Russian Federation, the size of deficit of a local budget approved by a normative act issued by a representative body of local self-government with regard to a given year's budget cannot exceed 10% of the volume of local budget revenue less financial aid from the federal budget and the budget of subject of the Russian Federation.
51 http ://www. roskazna. ru/reports/mb.html.
52 Oates W.A., 1972, Fiscal Federalism, NY: Harcourt Brace Jovanovich. - 810 p.
53 http ://www. roskazna. ru/reports/mb.html. 160
conditions of modern Russia, is by far not the most appropriate source of increasing the financial independence of local self-government. Although some disputes are going on concerning the choice of appropriate criteria for selecting a tax transferable to local budgets, everybody agrees as to the importance of complying with the following criteria 54:
- the tax base should be relatively immobile;
- the tax base should be evenly distributed among municipal formations;
- tax revenues should be stable and predictable;
- the tax should not promote "harmful" competition between municipalities.
The profits tax, if consolidated to the local level of authority, will satisfy none of the aforesaid criteria:
- due to the application of transfer pricing, the profits tax is very mobile even at the level of regions;
- the tax base is distributed very unevenly. For example, in Krasnoyarsk Krai the variance coefficient of per capita revenues across municipal formations was 234% for the profits tax, as compared to 72% for the personal income tax;
- the profits tax is extremely unstable, in the Russian Federation is strongly depends on the situation on foreign markets;
- the consolidation of the profits tax to municipalities will result in the emergence of "harmful" competition between municipalities, including by means of granting subsidies to enterprises in order to attract them into their territory.
In this connection, it does not appear feasible, on a national scale, to return to the practice of transferring the tax on profit of organizations to local budgets.
The alternative ways to increase the financial independence of bodies of local self-government will be as follows:
1. The introduction of a tax on immovable property. Among all the alternatives available to local bodies of authority, the tax on immovable property will best of all satisfy the aforesaid criteria. Its tax base has practically no mobility, and receipts are, as a rule, predictable and stable55, because they are less prone to respond to fluctuations in economic activity that the receipts of the personal income tax and the consumption-based taxes. A part of the tax on immovable property can hardly be exportable. This tax is transparent and fair, as far as it covers the cost of services beneficial for an entire local community. If the tax on immovable property is collected exclusively at the local level (without the participation of higher levels of authority), no problems should arise with regard to harmonization or "harmful" tax competition. Although this tax, most probably, will be more difficult to administer than a local tax built into an already existing tax system at a federal or regional level, this rather low price, quite possibly, will have to be paid by municipalities in exchange for autonomy and flexibility in the sphere of tax policy, which are the most important attributes of responsible, efficient and accountable local bodies of authority.
54 Charles E., McLuer Jr. (2001), "The Tax Assignment Problem: Ruminations on How Theory and Practice Depend on History", National Tax Journal, Issue LIV, No. 2, 339-363.
55 Even in an event of considerable fluctuations of prices of immovable property, in some economically developed countries local authorities enjoy broad opportunities for regulating the tax rate. As a result, the tax on immovable property represents, in effect, a tax on households differentiated by the level of prosperity, the measure of which is immovable property. In other words, the volume of revenues from this tax in some countries is dictated by the level of local budget expenditure, and not by changes in property value.
2. A certain increase is possible in the amount of the personal income tax transferred to the budgets of municipal formations, because the personal income tax is one of the most evenly distributed taxes in Russia. Besides, this may make local bodies of authority more interested in encouraging growth of the population's incomes, which can be possible only in conditions of a favorable business climate in a given municipal formation. Perhaps it would be feasible to consolidate additional norms for deductions from the personal income tax to be transferred to municipal formations, and/or consolidate in budget legislation a region's responsibility with regard to an additional distribution of PIT receipts between municipal formations in the form of single or additional normative standards. In this connection, it may be feasible to expand revenue sources at the level of municipal raions because, according to our estimations, the pattern of consolidating revenue sources to settlements is closest to being ideal. As has been noted earlier, the budgets of municipal raions are much more prone to generate deficit than those of settlements.
A separate note should be made in respect of the problems associated with the replacement of dotations to equalize the levels of budget sufficiency of municipal formations by additional PIT deductions. At present, it is envisaged in the Budget Code of the Russian Federation (Articles 137, 138) that it is possibly to fully or partially replace these dotations to municipal formations (settlements and municipal raions (or city okrugs)) by additional normative deductions from the personal income. However, this possibility is not being fully taken advantage of by regional authorities56. Besides, the procedure itself for replacing the equalizing dotations by additional PIT deductions, both the existing one and the one to come into force from 1 January 2009, appears to be far from perfect. The methodology for forecasting the amount of receipts from PIT can be arranges in such a way that the forecasted values will be overestimated. This may result in the additional PIT deductions being inadequate for compensating for the loss of equalizing dotations. The procedure for calculating and replacing the equalizing dotations by the additional normative deductions from the personal income tax to local budgets is to be established by the law of a subject of the Russian Federation. However, there is no mention (or written stipulation) anywhere of the necessity to obtain the consent of a municipal formation to such a replacement beginning from 1 January 2009. It seems necessary that a municipal formation should indeed agree for the equalizing dotations to be replaced by PIT deductions after 1 January 2009, because this replacement directly influences the level of its revenue.
Besides, in accordance with the current wording of the RF BC, the switchover to the procedure of normative deductions from the personal income tax to the budgets of settlements and municipal raions (or city okrugs) is not allowed only for the period of one financial year. If the purpose of replacing the equalizing dotations with PIT deductions is to create incentives for local bodies of authority to implement their own measures designed to increase their tax base, it seems quite insufficient to simply consolidate the additional normative standards for one year. During one financial year local authorities will, at best, be able to adopt some measures to improve the investment climate, attract investors, create additional jobs, develop infrastructure, etc. However, these decisions will have a positive effect on growth of the population's incomes only in a medium-term perspective. Therefore it is quite probable that local
56 We have investigated the legislative base of 32 subjects of the Russian Federation, of which in only 22 subjects it was envisaged that a part of the dotations to equalize budget sufficiency levels could be replaced by additional PIT deductions. 162
authorities will simply not be interested in increasing the tax base of PIT, because in the next financial year the normative standards for PIT deductions may be reduced in view of the growing tax base (or if its growth is forecasted), with a simultaneous drop in the amount of equalizing dotations, as the municipality's tax capacity will be growing. Thus, it appears correct to consolidate these norms for additional deductions from PIT for a minimum period of 3 years within the framework of a three-year budget. The best solution, however, would be to consolidate these standards deductions from PIT to municipal formations for 5 years.
3. To transfer to municipal formations a part of the tax on property of organizations seems to be less desirable than to increase the share of municipalities in PIT receipts, due to the very uneven distribution of this tax. As a palliative measure, it can be suggested that the right to provide solutions to this issue should be granted to subjects of the Russian Federation, including for the purpose of replacing the equalizing transfers by receipts from this tax in the medium-term perspective (3-5 years).
2.5.6. The Distribution of Subventions Transferred to the Budgets of Subjects of the Russian Federation to Cover the Dotations to the Budgets of Closed Administrative and Territorial Units
The regulation of the distribution of subventions between the budgets of subjects of the Russian Federation earmarked for the dotations to the budgets of closed administrative and territorial units (CATU), designed to support measures to ensure a well-balanced state of the budgets closed administrative and territorial units (hereinafter - the balancing dotations), is effectuated on the basis of laws on the federal budget and regulations of the Government of the Russian Federation. Thus, from Item 2 of Article 46 of Federal Law "On the 2007 federal budget", of 19 December 2007, No. 238, it follows that the distribution of subventions to the budgets of subjects of the Russian Federation to cover the dotations to the budgets of closed administrative and territorial units to support measures aimed at ensuring their well-balanced state, in the amount of 1 060 000.0 rubles, should be approved by the Government of the Russian Federation.
Thus, the law on federal budget established only the sum of these transfers, while their distribution among individual CATUs is regulated by the Government of the Russian Federation during the financial year. First of all, it is necessary to note that among all the types of financial support provided to the budgets of closed administrative and territorial units, the balancing dotations are the least transparent, because their distribution is carried out without applying any objective formulas and is consolidated not by a law on the federal budget, but by a regulation issued by the Government. As a result, the dotations to support the measures aimed at ensuring a well-balanced state of budgets represent the principal source of the problems arising in connection with soft budget constraints for CATUs.
As demonstrated by international experience, soft budget constraints imposed on regional and local authorities give rise to a number of negative economic effects, one of which is growth of budget expenditure in excess of an efficient level. Besides, there can be phenomena of a more general nature - obstacles to growth of private investments and a rising number of inefficient investments projects, fraught with increased risks. With regard to CATUs this may mean, in particular, a distortion in the choice between the investments in development infrastructure, increasing budget expenditure and resettling of citizens, and the investments in
the development of social and engineering infrastructure and increasing current budget expenditures, in favor of the latter.
In actual practice this will mean that the situations when a CATU's authorities have every reason to expect additional financial aid in excess of the initially declared amount will be fraught with negative effects of several types. Firstly, the authorities of a CATU may assume increased risks when implementing budget-funded programs. Secondly, the probability of receiving additional financing will make it possible for a CATU to take upon itself obligations in the form of payables, as well as to abstain from measures aimed at making budget expenditures more efficient. Thirdly, in anticipation of the factors that will serve as the criteria for federal authorities to distribute additional financial aid between CATUs, local bodies of authority may attempt to influence the values of certain indices - for example, the level of a CATU's accounts payable, the level of arrears of wages and salaries in the budget-funded sector, the level of budget-funded institutions' arrears of utilities fees, budget deficit, etc. As a result, the decision made by a CATU to grant additional financial aid, which at a first glance may seem to be beneficial for its population, may give rise to negative consequences.
It is necessary to note that the situation with regard to soft budget constraints imposed on CATUs has somewhat improved in recent years. Prior to 2006, all the interbudgetary transfers to CATUs could be redistributed by decision of the Government. From the year 2006 onwards, the situation became a little better: a large part of the financial aid to CATUs has been distributed in accordance with a law on the federal budget, while the Government enjoys only the right to distribute the subventions to the budgets of subjects of the Russian Federation to cover the balancing dotations to the budgets of closed administrative and territorial units. The share of these resources in the total volume of interbudgetary transfers to CATUs is small and amounts, as stated in the laws on the federal budget, to slightly more than 6% in 2006-2010 (Table 39).
Table 39
Financial Aid to CATUs' Budgets in 2006-2010
Forms of interbudgetary transfers to CATUs 2006 2007 2008 2009 2010
1. Dotations to budgets of closed administrative and territorial units, billion rubles 8.62 9.14 9.78 10.44 11.12
as % of total volume of financial aid to CATUs' budgets 54.4 54.3 52.7 54.4 54.4
2. Support of measures designed to ensure well-balanced state of budgets of closed administrative and territorial units (CATU), billion rubles 1.00 1.06 1.13 1.21 1.29
as % of total volume of financial aid to CATUs' budgets 6.3 6.3 6.1 6.3 6.3
3. Development and support of social and engineering infrastructure of closed administrative and territorial units, billion rubles 5.13 5.47 6.40 6.21 6.62
as % of total volume of financial aid to CATUs' budgets 32.4 32.5 34.5 32.4 32.4
4. Resettlement of citizens from closed administrative and territorial units, billion rubles 1.09 1.15 1.23 1.32 1.40
as % of total volume of financial aid to CATUs' budgets 6.9 6.9 6.7 6.9 6.9
Total financial aid to CATU budgets, billion rubles 15.84 17.37 18.54 19.18 20.43
Source: Laws on the 2006, 2007, and 2008-2010 federal budgets.
On the basis of the data presented in Table 39 one may assume that the dotations to CATUs' budgets to support the measures aimed at their well-balanced state do not play any
key role their budgeting policies, while the problem of soft budget constraints imposed on CATUs has in effect been adequately solved. However, this is far from being true. While in the total volume of financial aid transferred to the budgets of CATUs the share of the balancing dotations is indeed rather modest, for some individual CATUs their share may be consid-
57
erably higher. In accordance with the regulations issued by the RF Government , the balancing dotations were received in 2006 by 23, and in 2007 - already by 30 of the total number of 42 closed administrative and territorial units (see Table 40).
Table 40
Distribution of Dotations to Support Measures Designed to Ensure a Well-Balanced State of Budgets of Closed Administrative and Territorial Units (CATU) in 2006-2007
Dotations to support designed to ensure a well-balanced state of CATU budgets
2006 2007
CATU in thousand rubles as % of total sum of financial aid to CATU budgets in thousand rubles as % of total sum of financial aid to CATU budgets
1 2 3 4 5
Raduzhnyi 7,408 2.70 0 -
Poliarnyi 10,523 3.20 8,663 2.4
Mezhgorie 7,509 4.10 35,362 13.2
Vidiaevo 10,008 4.20 28,451 15.2
Uglegorsk 5,938 5.00 42,394 32.5
Svobodnyi 8,393 5.30 11,258 8.0
Seversk 65,027 5.40 44,109 3.5
Znamensk 20,013 5.70 30,165 7.2
Oziorsk 58,499 6.80 5,695 0.6
Mirnyi 32,256 6.80 11,477 2.3
Severomorsk 81,547 7.50 63,278 5.3
Snezhinsk 60,465 8.50 9,959 1.5
Zaoziorsk 27,510 10.70 0 -
Snezhnogorsk 43,531 11.90 39,701 10.5
Molodiozhnyi 5,502 14.00 8,703 18.0
Zelenogorsk 141,879 16.70 8,976 1.1
Zarechnyi 152,237 18.00 108,955 11.9
Skalistyi 52,484 18.50 34,012 11.2
Gornyi 5,609 19.40 0 -
Solnechnyi 58 14,107 23.10 22,927 32.5
Pervomaiskii 28,136 25.20 13,888 11.1
57 Of 9 June 2006, No. 855-r, and of 24 August 2007, No. 1121-r.
58 Tver Oblast.
Table 40 (continued)
1 2 3 4 5
Solnechnyi 59 56,672 30.40 21,829 14.5
Ostrovnoi 104,747 34.60 105,627 30.9
Bolshoi Kamen' 0 - 13,164 2.5
Viliuchinsk 0 - 129,481 20.2
Voskhod 0 - 5,678 19.0
Zheleznogorsk 0 - 87 674 6.4
Lokomotivnyi 0 - 1,266 1.1
Mikhailovskii 0 - 9,695 35.2
Oziornyi 0 - 44,145 16.3
Sibirskii 0 - 21,584 11.7
Fokino 0 - 82,301 16.4
Shikhany 0 - 9,583 13.5
Source: Regulation of the Government of the Russian Federation, No 855-r., of 24 August 2007.
From the data in Table 40 it can be seen that for many CATUs the balancing dotations in 2006-2007 became a significant source for softening budget constraints: the share of this type of financial aid in the aggregate volume of interbudgetary transfers was higher than 10% in 11 CATUs in 2006, and in 18 CATUs in 2007. Thus, the subventions to the budgets of subjects of the Russian Federation to cover the balancing dotations transferred to the budgets of CATUs for many of them represent a very important source of softening budget constraints and may result in the appearance of the negative effects described above. Besides, the possibility itself of obtaining substantial additional financial resources may give rise to the problem of soft budget constraints in the other CATUs.
The main reason for such an uneven distribution of additional resources transferred from the federal budget to CATUs is the imperfection of the financial planning procedure. For example, the volumes of subventions from the federal budget to the budgets of subjects of the Russian Federation to cover the dotations and subventions transferred to the budgets of CA-TUs is determined by multiplying the previous year's volume of these transfers by the consumer price index, which is considerably underestimated. Thus, the 2007 budget envisaged the indexation of these transfers by 6% against the 2006 level. And in Article 1 of the law on the 2007 federal budget the level of inflation (consumer prices) was determined in the range 6.5-8.0 %. As for the actual inflation rate, it amounted to 11.9%. Consequently, the volume of interbudgetary transfers to the budgets of CATUs decreased in real terms. Besides, the growth rate of consumer prices in a given CATU (as well as that of all the CATUs) may be higher than Russia's average growth rate of consumer prices. Such rigid constraints imposed on the growth rate of transfers to the budgets of CATUs have urged the Government to make exceptions for some of the CATUs with the gravest problems: to allocate balancing dotations, or to
finance some individual CATUs without applying this indexation procedure
60
59 Krasnoyarsk Krai.
60 For example, in 2007, in accordance with the assignment of the President of the Russian Federation (of 11 September 2006, No. Pr-1545), the estimated subventions to the development of the social and engineering infrastructure for the CATU Viliuchinsk were increased by 580 billion rubles, in order to improve the housing condi-166
One more drawback in the planning of transfers for CATUs is the failure to fully take into account the subventions to the budgets of subjects of the Russian Federation, designed to cover the balancing dotations to CATUs transferred in a previous year when calculating the amount of such subventions. As a rule, the allocation of balancing dotations implies that a CATU's actual revenues and/or expenditures have significantly deviated from the planned values, and the volume of interbudgetary transfers earmarked in the federal budget for covering the dotations to CATUs' budgets is clearly insufficient for ensuring the required level of budget sufficiency61. Then it would be logical to assume that in the next year it would be necessary to increase the volume of subventions to be transferred to subjects of the Russian Federation for covering the balancing dotations to CATUs' budgets by an amount comparable to that of the balancing dotations allocated in a given year. However, this does not happen (Table 41).
As can be seen from the data in Table 41, in many of the CATUs that received in 2006 the balancing dotations, the volume of dotations allocated in 2007 is markedly lower than the aggregate volume of dotations in 2006. This means that if the situation with regard to revenue/expenditure in these CATUs is not changed in any radical way, in 2007 they will once again receive the balancing dotations. This is confirmed by the data in Table 40. It should be noted that 20 of the 30 CATUs receiving this type of dotations in 2007 also received them in 2006. The regular allocation of the balancing dotations to the same group of CATUs makes the problem of soft budget constraints even more acute due to the "falling into the habit" of receiving additional financial aid from the federal budget.
It is not feasible to solve this problem by keeping annual records of the balancing dotations and applying these data to the allocation of the "ordinary" dotations to CATUs, distributed by applying the established formulas in accordance with Decree of the Government of the Russian Federation of 18 April 2005, No. 232. This will result only in a further aggravation of the problem of soft budget constraints: the greater deficit in the budget of a CATU in a current year, the higher the amount of the balancing dotations, and thus the more "ordinary" dotations to be allocated in the next year.
Most probably, this problem can best be solved in the following way: simultaneous recording of the balancing dotations in order to calculate the amount of dotations based on formulas, and then - complete elimination of the balancing dotations. At the same time, it would be feasible to alter the procedure for indexing the total volume of interbudgetary transfers to CATUs, making it necessary to adjust the overall volume of resources allocated to CATUs it the actual inflation level, as demonstrated by the results of a reporting year, is higher than the forecasted level. This adjustment must be similar to the procedure of indexing applied to the Federal Fund for Financial Support of the Regions.
It order to fully abolish the balancing dotations and to make more healthy CATUs' finances, it will be necessary to adopt a set of measures aimed at optimizing their revenues and expenditures.
tions of the servicemen and their families residing at the Pacific Navy's submarine base (to be spent on reconstruction of residential buildings).
61 In 2007 it is planned to cover the forecasted spending powers of CATUs by revenue in the amount of no less than 93.7%. - Materialy k zacedaniiu Rabochei (triokhstoronnei) gruppy po sovershenstvovaniiu mezhbiudzhet-nykh ornoshenii v Rossiiskoi Federatsii 17 oktiabria 2006 goda. [Materials for the meeting of the Task Force (Trilateral) for Improving Interbudgetary Relations in the Russian Federation on 17 October 2006].
Table 41
Changes in Dotations Allocated to CATU in 2007, as Compared to the 2006 Level (for those CATU that Received in 2006 Dotations Designed to Ensure a Well-Balanced State of Budgets)
Subventions to budgets
CATU Subventions to budgets of subjects of Russian Federation, to provide dotations to CATU budgets in 2006, thousand rubles of subjects of Russian Federation, to provide dotations to CATU budgets, to ensure a well-balanced state of budgets in 2006, thousand rubles Subventions to budgets . . ^ „r, ■ Ratio of dotations to CA10 of subjects of Russian budgets in 2007 to total Federation, to provide volume of dotations allodotations to CA1U , ,, , , . . . ^ . cated to CA1U budgets in budgets in 2007, thou- . & » ,, ' 2006, in % sand rubles
1 2 3 4=3/(1+2)
Mezhgorie 80,934 7,509 128,191 145
Mirnyi 236,665 32,256 274,419 102
Zaoziorsk 141,279 27,510 168,175 100
Raduzhnyi 130,300 7,408 125,259 98
Poliarnyi 205,188 10,523 211,961 98
Severomorsk 695,515 81,547 761,658 98
Seversk 798,930 65,027 841,509 97
Znamensk 145,983 20,013 161,452 97
Molodiozhnyi 9,069 5,502 12,872 95
Oziorsk 511,454 58,499 519,790 91
Zarechnyi 475,870 152,237 565,057 90
Snezhinsk 365,272 60,465 271,921 87
Skalistyi 142,031 52,484 169,299 87
Zelenogorsk 387,593 141,879 456,162 86
Snezhnogorsk 207,972 43,531 211,862 84
Svobodnyi 47,788 8,393 45,682 81
Pervomaiskii 46,957 2,8136 58,999 79
Uglegorsk 69,425 5,938 58,822 78
Solnechnyi62 36,830 14,107 28,986 77
Gornyi 3,141 5,609 6,604 75
Ostrovnoi 154,907 104,747 188,214 72
Vidiaevo 112,873 10,008 79,228 64
Solnechnyi 62 68,941 56,672 70,726 56
Source: Laws on the 2006 and 2007 federal budgets (as of 19 December 2006); Regulation of the Government of the Russian Federation of 9 June 2006, No. 855-r.
1. In order to increase CATUs revenue, it is suggested that some exemptions from the land tax and the tax on property of organizations should be abolished. In accordance with Item 2 of Article 389 of the Tax Code of the Russian Federation, tax is not to be levied on the land plots limired in their turnover in accordance with legislation of the Russian Federation and granted for purposes of national defense, national security and customs. According to Item 4 of Article 374 of the Tax Code of the Russian Federation, the property belonging by right of economic jurisdiction or operative management to federal bodies of executive authority, where military and (or) equal to military service in envisaged by legislation, and which is used by the aforesaid bodies for the needs of defense, civil defense, national security and law en-
62 Tver Oblast.
63 Krasnoyarsk Krai. 168
forcement in the Russian Federation, is not to be recognized as taxable. Considering the fact that practically all the CATUs are organized on the basis of military-industrial complexes, the abolition of these exemptions will result in increased receipts of the land tax and the tax on property of organizations in the budgets of CATUs. If this growth in receipts is substantial, it will be feasible to discontinue not only the subventions to the budgets of subjects of the Russian Federation to cover the balancing dotations to CATUs, but also the subventions to the budgets of subjects of the Russian Federation to cover all the dotations to the budgets of CA-TUs. This measure will help to improve the budget sufficiency status of CATUs and provide solutions to the problem of soft budget constraints.
2. In order to decrease CATUs' expenditures, it is suggested that additional resources should be allocated from the federal budget to the acceleration of the process of resettling those citizens who have lost any connections, in terms of production or service, with the organizations (or objects) located in the territories of CATUs. For these purposes, the balancing dotations to the budgets of CATUs can also be used64. According to the IET's calculations, if the number of permanent residents of CATUs is decreased by 7%, resunting economy for the federal budget will amount to approximately 1.4 billion rubles, or more than 7% of additional expenditure. Given the current volumes of financing, the problem of resettling citizens from CATUs will be finally solved no earlier than 202565, and so it appears feasible, in the next few years, to spend the additional financial resources on resettling. Such a solution seems reasonable, since thus the future obligations will be diminished. When the situation on foreign markets is favorable, it is necessary to increase mostly those expenditure items that can help to diminish impending obligations (debt repayment, etc.). The resettling of citizens from CATUs is also conducive to diminished future obligations. Besides, this may result in diminished CATUs' expenditure. If their expenditure is diminished in proportion to the decreased population numbers, this will save approximately 1.3 billion rubles per annum66.
Such a cut in CATUs' expenditure, coupled with their increased tax capacity67, will make it possible to completely discontinue the balancing dotations and to substantially decrease the amount of subventions transferred to the budgets of subjects of the Russian Federation to cover the dotations to CATUs' budgets, and finally tp provide an adequate solution to the problem of soft budget constraints with regard for CATUs68.
64 The possibility to use the balancing dotations transferred to CATUs for accelerating the process of citizens' resettling requires an additional legal substantiation, because the non-targeted nature of these dotations makes it impossible to oblige the authorities of CATUs to spend the received funds specifically on the resettling of citizens.
65 The needed funding to cover the cost of resettling, as of 01.01.2007, amounts to more than 21 billion rubles, while the average level of financing in 2007-2010 is only slightly higher than 1.2 billion rubles per annum.
66 The estimated spending powers of CATUs according to Law No. 131-FZ for the year 2007 amounted to 18.9 billion rubles. - Materialy k zacedaniiu Rabochei (triokhstoronnei) gruppy po sovershenstvovaniiu mezhbiudz-hetnykh ornoshenii v Rossiiskoi Federatsii 17 oktiabria 2006 goda. [Materials for the meeting of the Task Force (Trilateral) for Improving Interbudgetary Relations in the Russian Federation on 17 October 2006].
67 For more details, see above.
68 If for some reason it will be impossible to allocate substantial sums to the resettling of citizens from CATUs in the next few years, it will be necessary to redistribute the available funding so that to give priority in resettling to the citizens from those CATUs where the per capita dotations from the federal budget are substantially higher than this index' average across all the CATUs. For example, the average amount of dotations per CATU's citizen in 2007 amounted to 7.2 thousand rubles, while the value of this index in the CATU Ostrovnoi was 40.9 thousand rubles. Consequently, the citizens on the waiting list of this CATU must be given priority in resettling, primarily
2.6. Russian Financial Markets
2.6.1. The Market for Government Securities
By the 2007 results the volume of Russia's domestic public debt in the government securities grew by some 21.5% - from Rb. 1,028.04 bn to 1,248.85 bn (and declined insignificantly in the shares-of-GDP equivalent - from 3.86% to 3.79%) (Table 42).
Table 42
Volume of Government Papers on the Domestic Market, as Rb. bn*
Types of securities As of 01.01.2007 As of 01.01.2008
GKO 0.00 (0.00) 0.00 (0.00)
OFZ-PK 0.00 (0.00) 0.00 (0.00)
OFZ -PD 205.62 (0.77) 288.42 (0.87)
OFZ -FK 94.83 (0.36) 51.43 (0.16)
OFZ -AD 675.16 (2.54) 807.59 (2.45)
GSO-PPS 0.42 (0.002) 10.42 (0.03)
GSO-FPS 52.00 (0.19) 91.00 (0.28)
Total 1,028.04 (3.86) 1,248.85 (3.79)
* Values in % of GDP are given in brackets.
Source: The RF Ministry of Finance (MinFin).
In the period between January and September 2007, the volume of RF's public external debt (the one accumulated by government agencies and monetary and credit regulating agencies) soared from USD 48.6 bn to 52.7 bn (according to CBR). So, an absolute rise in the amount of the external debt accumulated by the RF government accounted for 8.4%. Meanwhile, over the same period the private sector (banks and other segments of it) increased their debt before non-residents from USD 261.9 bn to 378.1 bn (at 44.4%). Thus, by results of the 9 months 2007 Russia's aggregate external debt posted a considerable growth, that is, from USD 310.6 bn. to 430.9 bn, or at 38.7%.
The Market for Government Securities on the Domestic Market
The year of 2007 saw no drastic downfall in the weighted average yields on the market for the Rb-denominated public debt. More specifically, the data as of the closing of trades on December 28, 2007, showed some decline in the respective indicator - to 6.14% annualized vs. 6.39% annualized as of the early 2007 (Fig. 20). The situation remained volatile, albeit stable over the period in question, with the weighted average yields rates being within the range between 5.90 to 6.60% annualized. At the same time, while until the late-July 2007 the market experienced some periodical insignificant drops in the weighted average yields rates (they fluctuated between 5.90 and 6.36% annualized on average), they periodically were on the rise during the last two quarters of the year, while the range of their fluctuation extended and accounted for 5.97 - 6.60% annualized.
The investors' activity in 2007 against 2006 is worth a special notion. The aggregate turnover of trades on the GKO-OFZ market in 2007 made up some Rb. 1,405.13 bn vs. 333.04 bn reported in 2006, so the market grew more than 4-fold. Meanwhile, against the backdrop of
in order to more economically spend budget resources and then to spend the saved amounts of financial resources
on the resettling of citizens from other CATUs, as well as to solve some infrastructural problems, etc.
a dramatic rise in its 2007 aggregate volume, the average weekly indicators were on the rise, too - they accounted for some Rb. 27.5 bn. vs. 6.5 bn in 2006. The 2007 peak weekly volume of trades was a. Rb. 278.73 bn (vs. some 32.36 bn. in 2006), while the minimum one was a. 2.15 bn (some 993.8 m in 2006). So, in 2007 the market for Rb.-denominated government bonds posted a considerable growth in the volumes of trades vis-à-vis the prior year, and that manifested itself in far greater indicators of a peak turnover of trades.
I Turnover of the secondary GKO/OFZ market (as Rbm) - The weighted average yields (as% annualized) - the right axis
280 000 240 000 200 000 160 000 120 000 80 000 40 000 0
1 II 1 1
□ ldjOD n □□OnOnODoo i.iiLiIi JdLi.......Ill
r- r- r- r- h- r- r- r- h- r- r- h- r- r-
q q o o q q o o o o o o o o o q q o o o o q q q o o
.—: .—: c\i C\j CO CO •sr Tf iri in CD CD r^ CO CO cri cri o d T— .—: CM CM CM
o o o o o o o o o o o o o o o o o o o T— T— 7— 7—
«t CO ^ LO in CO c\i CD 6 CO in cri CM CD ai CO N •f 00 CM CD o
CM T— CM T— CM o <M o CM o o T— CM T— CM o CM o CM o T— o CO
CO OJ in en in CT> CN1 co 4 in yl CD ch CO CO o CO r^- 7-1 in o C\l ■A o
o CM o 1— o 1— o '— o T— o '— o o CM o CM o T— o 7— 7— 7— OJ
8,0% 7,0% 6,0% 5,0% 4,0% 3,0% 2,0% 1,0%
Source: IA Finmarket, the authors' calculations.
Fig. 20. Dynamics of the GKO-OFZ in 2007 Market in 2007
An analysis of the market dynamic exposed several periods when the nature of quotations' movements was distinct. Specifically, after a brief rise up to 6.3% annualized in the beginning of the year, the GKO-OFZ weighted average yields rate demonstrated a moderately negative dynamic with short-term fluctuations in both directions. That was continuing through the late-July, after which dominant on the market became the trend to a greater dynamic of yields rates, which ultimately stabilized at the level of 6.1-6.6% annualized. Let us examine, in a greater detail, monthly dynamics of the market for the Rb.-denominated public debt.
During the first month of 2007 the market went bullish, but the situation reversed in the late-January, and the dynamic became downwards, so the January cumulative change in the yields rate proved to be insignificant. The MinFin became far mor proactive with holding auctions on the market for government papers compared with December 2006. In January 2007 alone, the Ministry held three auctions on the primary market, which helped cash up a total of Rb. 29 bn (vs. some 13 bn. in December 2006). Given a great demand for the government papers, MinFin placed Rb. 28.5 bn of the face-value volume, or some 98% of the offer. In the early January, investors were back to business with much vigor, which told on their activity on this particular market. This can be explained by the fact that the first and second weeks of the month were dominated by sales of "long" issues - investors freed their capital to take part in the primary placements. Meanwhile, the excess of liquidity fueled a partial rise in sales in the
segment of short- and medium-term papers. During the third week of the month, quotations stabilized against the background of a langushing downward trend that reflected the continuous negative state of affairs on external markets steered by uncertainty with regard of the Fed's further policy twists as a lighthouse for agents operating on the world debt market, as well as everyone's anticipation of primary placements whose conditions MinFin found fairly lucrative at the end of the day, as the banking sector boasted a very beneficial situation with liquidity.
In February, again, investors switched most of their operations to the primary market, hence the demand for placed papers several times became greater than the respective offer, which helped MinFin place practically all the volume (Rb. 26.9 bn out of 27 bn). Meanwhile, the market for Rb.-denominated T-bonds was dominated by an insignificant rise in quotations, and prices were changing within a very narrow range. Overall, the market capitalized on a favorable external background and a fairly favorable situation with liquidity. Meanwhile, in the early February the Central Bank modified the composition of the bi-currency basket in favor of a greater fraction of the Euro in it, which automatically resulted in a notable appreciation of the Rb. against the US Dollar. Then the situation with liquidity deteriorated notably, which entailed a short-term drop in demand for the Rb.-denominated bonds. Then, in mid-February, the quotations changed in alternate directions, as some investors fixed their profit against the background of the situation with cash liquidity. A favorable state of affairs on external markets cushioned an otherwise more drastic price downfall. By the late-February the further rise in the interbanking market rates resulted in investors' halting their activity on the secondary market for public debt.
In the early-March, the situation on the market for Rb.-denominated public debt remained moderately negative. Notable problems with liquidity in the banking sector and the depreciation of the Rb. against the US Dollar, along with the upcoming placements on the primary market, fueled the rise in yields rate and regalvanized the market. It is a small wonder the OFZ placements were a success, practically without premiums to the secondary market. Quotations remained relatively stable through the middle of the month, which was still determined by liquidity problems. It was only by the late-February that the situation improved slightly and the yields rate resumed their rally.
Despite discontinuation of the rise in quotations in the early April, the market for the Rb.-denominated public debt remained fairly stable, which can be attributed, in particular, to the banking liquidity, as it had surged notably between the late March and the early April. The interbanking market rate plunged from 4-5% to 2-3% annualized. Liquidity in the banking system rose notably during the second week of April, which could be evidenced by a significant rise in funds on corresponding accounts and deposits with the Central Bank. Along with a notable appreciation of Rb. vs. USD, that back-upped the government bonds seriously. Meanwhile, demand was not aggressive, while the external segment began to react to the dynamic of basic assets, which did not help get yields rates down. As a result, the quotations of the federal debt instruments remained stable, while an additional proof of the market's sus-tainability became results of an auction on placement of GKO-OFZ at which demand was far greater than offer (Rb. 38 bn vs. 15 bn).
In the early-May, the market in question was in a fairly stable state, as there were no factors that would have boosted up a significant positive dynamic of quotations, while the level of liquidity in the banking sector was quite high, which ensured a notable back-up to the Rb-
denominated bonds. Since mid-May the market began to see prevalence of positive trends associated with a high level of liquidity in the banking sphere. Purchases across a number of series of GKO-OFZ issues were partly engendered by a flow of funds switching from the primary market, where the demand at an auction on an additional placement of OFZ proved to be far greater than offer.
By contrast, the first week of June opened with negative tendencies - after a minor rise in the late-May, prices were gradually declining in the frame of a technical correction, with the Rb-denominated liquidity inhibiting the pace of the decline. But it had accelerated by mid-June, partly because of rising yields rates on the external debt market and in part due to Min-Fin's announcement of its intention to place considerable volume of bonds shortly. In the second half of the month, the market was dominated by alternate trends, while its agents were very active. While in the beginning of the third week of the month the market continued to slide down, following the US bonds and Russian Eurobonds, the situation stabilized by the end of the month, and quotations slightly recovered from the fall.
Between July and August the market for the Rb-denominated public debt demonstrated prevalence of positive trends, which can be explained by excessive funds in the banking system and depreciation of Rb. against USD. Meanwhile, it was the most liquid issues with a long duration that enjoyed the greatest demand. Activity on the domestic securities market grew particularly notably during the second week of July, along with a substantial rise in issuers' auction activity (the August 2007 volume of placement of OFZ issues accounted for Rb. 30.6 bn).
In the early-September, however, the pressure on the part of external factors in concomitance with a considerable deterioration of the domestic liquidity inhibited the investor's activity on the market, albeit at the same time it displayed an upward dynamic of yields rates. Furthermore, to ensure a necessary degree of their liquidity, Russian banks were also keen to sell their papers, which resulted in an additional pressure on the market. The activity was stalled since mid-September, as the players anticipated the Fed's decision on cuts in the basic interest rate, which immediately soared in the wake of the Fed's decision to lower its rate and resulted in a significant rise in demand for the "long" issues of Russian bonds. That fueled a substantial price rise on the market and a yields rates downward trend on the secondary market. These tendencies persisted in October, too. By late-October CBR has managed to trigger some fall in rates on the interbanking market, which also supported government bonds. Some appreciation of Rb against the US Dollar also back-upped quotations of Russian Rb-denominated bonds.
In November the market for the Rb.-denominated securities demonstrated alternate dynamics of the yields rates and a considerable contraction in the overall volume of circulation of secondary trades. Underpinning a loose activity on the debt market largely were liquidity shortages. To improve the situation, the Central Bank announced the start of holding a direct REPO session under a fixed 8% interest for 1 day, which enabled banks to attract funds not only at an auction, but during the day. The appreciation of Rb. against the US Dollar also back-upped quotations of Russian Rb.-denominated bonds. The CBR's measures on extending the possibility for banks to attract additional resources designated to remedy the liquidity shortages breathed a new life into activity on the debt market, which consequently was several times up during December.
In 2007, MinFin successfully held 25 auctions on placement of GKO-OFZ whose volume totaled some Rb. 280.7 bn (vs. 36 auctions with a volume of some 208.1 bn held in
2006). The actual volume of placement accounted for Rb. 243.9 bn (vs. 186.6 bn in 2006). The level of return by the weighted average price at the auctions varied between 5.93 to 7.06% annualized (in 2006, the respective range was between 6.08 and 7.06% annualized). So, the year of 2007 saw a far greater growth in the volume of government borrowing on the domestic market than 2006, while the yields rate remained nearly the same. As of December 29, 2007, the volume of the GKO-OFZ market accounted for Rb. 1,047.4 bn by face-value and 1,056.5 bn -by market value. The duration of the GKO-OFZ portfolio on the market accounted for 5.77 years, or at 110.5 days longer than the respective index as of the early-2007 (5.46 years).
The Market for Government Papers on the External Market
By the 2007 results, the situation on the market for forex-denominated government bonds demonstrated a low volatility of the respective yields rates across most of traded papers (Fig. 21-22). More specifically, as of late-December 2007, the yields rate of papers of the 5th tranche of OVVZ made up 5.27% annualized (vs. 5.47% in the beginning of the year), those of the 7th tranche of OVVZ - 5.46% (5.48%). By contrast, the dynamic of yields rates of the 8th tranche of OVVZ had displayed sharp fluctuations in different directions until the moment VEB (that exercised the function of the paying agent and the servicing depository on MinFin's behalf) redeemed it on November 14, 2007. Meanwhile, the yields rate of RUS-30 changed insignificantly over the year (from 5.5% to 5.7% annualized), the ones of RUS-28 dropped from 5.96 to 5.88% annualized, while as of late-December, the yields rate of RUS-10 accounted for 4.93% vs. 5.16% as of the start of the year, while RUS-18 were traded at prices that corresponded to the yields rate of 5.60% annualized (5.64% as of the early 2007).
The advancement of the 2007 dynamic of the market for Russian Eurobonds was affected by several most significant factors, of which positive were: the impact of cuts in the Fed's interest rate on the US market, periodical price rallies on the world markets for oil and metals, and a stable macroeconomic situation in Russia. As concerns negative factors, the critical ones were deterioration of the state of the US debt market, intensification of inflationary processes in the US economy, dynamics of yields rates of the US T-bonds that reacted to periodical increases of the Fed's interest rates, periodical price downfalls on the world market for oil, which is one of the major factors of stability of Russia's economy, and revision by S&P and Moody's of their methodologies of ratings of risky mortgage-backed securities.
An analysis of the 2007 dynamic of Russian papers allows identification of several periods that appear of different nature in terms of the market situation. More specifically, yields rates had been gradually declining until early May, albeit undergoing occasional adjustments. Between early May and mid-June the yields rates were on the rise, while between mid-June and the end of the year their dynamic dominated by a gradual downward trend, thus winning back a part of the rise in the first half-year. Let us now focus on major factors that steered such dynamics on the market for Russian Eurobonds.
Between January and February 2007 the market for Russia's government Eurobonds displayed a downward dynamic, as these papers appeared very sensitive to updates from the US debt market. In the US, a number of publications in early January highlighted persistence of great inflationary risks which immediately and drastically battered quotations of the US T-bonds. Naturally, against such a background the Russian quotations followed the basic assets. Another negative factor that hit the Russian papers became the price downfall for oil on the world market. In late-January, Russian Eurobonds were swinging: their falls, that followed
those in the basic assets, would be changed by consolidation on certain levels, which can partly be explained by the price rise for oil on the world market. In February, some basic assets continued their price rise, which was fueled by macroeconomic statistics that evidenced
rd
sustained economic growth rates in the US economy in the 3 quarter 2006 and stability of inflation rates there. By contrast to most of other emerging markets, Russian bonds were on the rise against such a background. Meanwhile, their rise was inhibited by growing inflationary expectations in the wake of the publication of the CPI data, which at 0.1% exceeded expectations. In addition, highlighting problems on the US mortgage market, the continuous updates formed the background against which the yields rates of the Russian bonds in February sank vs. their respective indices as of late-January.
Source: IA Finmarket.
Рис. 21. Yields to Maturity of OVVZ in 2007
Analogous trends had been dominating the market until early May, when the downward trend reversed. Underpinning the upturn in the state of affairs on the market became an upwards dynamic of the US debt market and a number of updates evidencing favorable macro-economic performance indicators with regard to the housing market and industrial output, to which the US bonds responded by rallying. The need in an easing of the US monetary and credit policy has somewhat loosened, and investors reacted with some rise in demand. Russian Eurobonds, too, undergo a minor adjustment, but to a degree less than that in the US. Inspired by a new block of positive macroeconomic statistics, the rise in the US bonds' yields rates persisted by late-May, while Russian bonds experienced a slightly smaller price fall. In early June, the yields rates of the US T-bonds hoicked against the background formed by maximal values demonstrated by the US stock market, which determined the direction of the funds' overflow from less risky assets to more risky ones, and the Russian market strung along this dynamic.
Source: IA Finmarket.
Fig. 22. The 2007 Yields to Maturity of Russian Eurobonds with Maturity Dates in 2007, 2010, 2008, 2028 and 2030
2.6.2. The municipal and subnational borrowings market
The Dynamics of the Market's Development
By the results of the year 2007, the consolidated regional budget was drawn with a surplus amounting to 38.5 billion rubles (0.12% of GDP).
The budgets of the Federation's subjects were drawn with a surplus of nearly 25.2 billion rubles, the budgets of city okrugs - with a surplus of 12.0 billion rubles, the budgets of the intracity municipal formations in Moscow and St. Petersburg - with a surplus of 0.4 billion rubles, the budgets of municipal raions - with a deficit of 0.3 billion rubles, and the budgets of urban and rural settlements - with a surplus of 3.1 billion rubles.
In 2006 the consolidated regional budget was drawn with a surplus of 139.8 billion rubles, or 0.53% of GDP. The budgets of the Federation's subjects were drawn with a surplus of nearly 133.8 billion rubles, the budgets of city okrugs and the intracity municipal formations in Moscow and St. Petersburg - with a surplus of 0.3 billion rubles, the budgets of municipal raions - with a surplus of 9.8 billion rubles, and the budgets of urban and rural settlements -with a surplus of 2.2 billion rubles69 (see Tables 43-44).
69 In respect of five subjects of the Russian Federation (Moscow Oblast, the Republic of Ingushetia, the Republic of Chechnya, Koryak AO, and Chukotka AO), the budget statistics concerning municipal formation in 2006 was not broken up into the categories pf "city okrugs", "municipal raions", and "urban and rural settlements". The budgets of the municipal formations in these regions were drawn with a deficit of 2.2 billion rubles. 176
Thus, within one year the consolidated regional budget surplus, as a share of GDP, decreased by more than 4.4 times.
Table 43
Ratio of Surplus (Deficit) of Territorial Budgets to their Total Expenditure (in %)
Year Consolidated regional budget Regional budgets
2007 0.8 0.6
2006 3.7 4.4
2005 1.6 2.3
2004 1.1 1.6
2003 -2.6 -2.3
2002 -2.7 -3.0
Source: the IET's calculations based on the data of the RF Ministry of Finance.
Table 44
Ratio of Surplus (Deficit) of Territorial Budgets to their Total Expenditure in 2007 (in %)
Budgets of intracity municipal formations in Moscow and St. Petersburg Budgets of city okrugs Budgets of municipal raions Budgets of urban and rural settlements
5.34 1.23 -0.04 2.34
As of 1 January 2008, surplus was demonstrated by the consolidated budgets of 50 subjects of the Russian Federation (against 54 in 2006). The aggregate budget surplus in these regions amounted to 126.1 billion rubles, or to 4.1% of their budget revenue (in 2006 - 6.9%). The average budget surplus amounted to 2.9% of their budget revenue.
The highest surplus to revenue ratio in the consolidated budget was achieved in Koryak AO - 18.0%, Krasnoyarsk Krai - 13.5%, Chukotka AO - 11.4%, Sakhalin Oblast - 10.3%, Leningrad Oblast - 8.3%, and Khabarovsk Krai - 8.0%. More than a half (52.2%) of the aggregate consolidated regional budget surplus was accounted for by 3 RF subjects: the city of Moscow - 22.3%, or 28.1 billion rubles; Krasnoyarsk Krai - 15.0%, or 18.9 billion rubles; and the city of St. Petersburg - 14.9%, or 18.8 billion rubles.
The high surplus level demonstrated by the budgets of Moscow, St. Petersburg, and Krasnoyarsk Krai can be explained, first of all, by the considerable growth of export prices of energy carriers and non-ferrous metals (with due regard for the transfer to St. Petersburg of the tax revenues from Sibneft's enterprises taken over by the OJSC "Gazprom neft", which previously went to Omsk Oblast and Chukotka AO).
Deficit was demonstrated in 2007 by the consolidated budgets of 37 RF subjects (in
70
2006 - in 33 regions) , its aggregate volume amounting to 89.0 billion rubles, or to 5.0% of their budget revenue (in 2005 - 4.9%).
71
The average budget deficit amounted to 4.0% of a given budget revenue . The consolidated budget deficit of Tiumen Oblast amounted to 14.3% of its revenue, that of Moscow Oblast - to 8.8%, and that of Khanty-Mansi AO - to 7.1%.
70 In the reporting documentation published by the RF Ministry of Finance (the federal Treasury) with regard to the execution of the budgets of subjects of the Russian Federation in 2005-2007, the data referring to the Evenk and Taimyr (Dolgano-Nenets) Autonomous Okrugs (AO) are not specified separately.
More than a half (54.0%) of the aggregate deficit was accounted for by 3 Federation's subjects : Moscow Oblast - 24.0%, or 21.4 billion rubles; Tiumen Oblast - 18.7%, or 16.7 billion rubles, and Khanty-Mansi AO - 11.3%, or 10.1 billion rubles (Table 47).
Changes in the Structure of Accumulated Debt
The amount of accumulated debt in the consolidated regional budget increased in 2007 to 54,814.0 million rubles, or to 0.17 % of GDP (Table 45). External debt in regional consolidated budgets increased by 491.5 million rubles, internal debt - by 54,322.5 million rubles.
Table 45
Net Borrowings of Regional and Local Budgets (in % to GDP)
Year 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
Borrowings of subfederal and local authorities, incl.: 0.33 0.15 -0.29 -0.04 0.47 0.37 0.26 0.09 0.21 0.17
Reimbursable loans from budgets of other levels -0.09 -0.11 -0.03 0.04 0.12 -0.1 -0.02 -0.03 -0.04 -0.01
Subfederal (municipal) bonds -0.01 -0.05 -0.27 -0.07 0.16 0.31 0.29 0.09 0.14 0.08
Other borrowings 0.43 0.31 0.01 -0.02 0.19 0.6 0.03 0.11 0.10
Diminished residuals on budget accounts 0.02 -0.19 -0.30 -0.05 -0.04 -0.18 -0.62 -0.48
Funding of deficit at the expense 0.35 -0.04 -0.59 -0.09 0.38 0.19 -0.36 -0.38
of borrowings and cuts on the residuals on budget accounts
Source: the IET's calculations based on the data of the RF Ministry of Finance.
The Structure of Borrowings
The total volume of borrowings in the regional consolidated budget in 2007 amounted to 263,544.3 million rubles, of which external borrowings constituted 1,141.1 million rubles The only region which was receiving external loans became the Republic of Bashkortostan.
The aggregate volume of the internal borrowings made by regions and municipalities amounted to 262,403.2 million rubles. The biggest borrowers on the internal market were: Moscow Oblast - 59.9 billion rubles; the city of Moscow - 22.5 billion rubles; Omsk Oblast -17.8 billion rubles; and Irkutsk Oblast - 10.0 billion rubles By comparison with 2005, the volume of internal borrowings in nominal terms increased by 13.2 billion rubles, or by 5.2%.
Within the total volume of internal borrowings in the consolidated regional budget, the issuance of securities constituted 32.1%, the loans from budgets of superior levels - 3.8%, and the other borrowings (primarily bank credits) - 64.2%.
In a situation of a diminishing volume, in real terms, of subnational borrowings, the level of securities within the structure of borrowings displayed by the consolidated regional budget became somewhat higher, increasing from 29.4% in 2006 to 32.1% in 2007 (although never reaching the level of 2005 - 36.0%) (Table 46).
71 The highest deficit to budget revenue ratio was observed in the Agin Buriat AO (the deficit amounting to 107% of revenue there, which was associated with the Okrug's merging with Chita Oblast, including the use of the previously accumulated residuals on budget accounts, regarded as deficit financing of budget expenditure). 178
Table 46
The structure of internal borrowings in subnational budgets (as %)
2007 2006 2005
Regional consolidated budget Regional budgets Municipal budgets Regional consolidated budget Regional budgets Municipal budgets Regional consolidated budget Regional budgets Municipal budgets
Issuance of 32.1 39.5 7.1 29.4 37.1 9.7 36.0 45.5 10.2
securities
Budget loans 3.8 4.9 0.1 4.4 6.0 0.3 1.2 1.6 0.03
Other bor- 64.2 55.6 92.8 66.2 56.9 90.1 62.9 52.9 89.8
rowings
The highest net borrowings to budget revenue ratio was demonstrated by: Moscow Oblast - 12.3%, Kostroma Oblast - 8.1%, and Novosibirsk Oblast - 7.0% (Table 47).
The biggest net borrowers were: Moscow Oblast - 29.7 billion rubles, Samara Oblast -5.2 billion rubles, and Irkutsk Oblast - 3.7 billion rubles.
The greatest decline in the amount of accumulated debt was demonstrated by: Khabarovsk Krai - by 7.1 billion rubles, Novosibirsk Oblast - by 5.0 billion rubles, Krasnoyarsk Krai - by 3.1 billion rubles, and St. Petersburg - by 1.6 billion rubles.
Table 47
The execution of consolidated budgets by subjects of the Russian Federation in 2007
Budget revenue (thousand rubles) Budget surplus (deficit) (thousand rubles) Surplus (deficit) to revenue ratio, as % Attracted borrowings to revenue, as % Net borrowings Redemption of Net borrowings to revenue, as borrowings to to surplus (defi-% revenue, % cit), %
1 2 3 4 5 6 7 8
Central Federal Okrug
Belgorod Oblast 41,516,675.79 -849,797.09 -2.05 0.00 -0.07 -0.07 3.29
Briansk Oblast 22,268,644.70 -743,435.51 -3.34 12.32 3.06 -9.26 -91.55
Vladimir Oblast 29,537,901.60 210,899.77 0.71 0.12 -0.08 -0.19 -11.15
Voronezh Oblast 41,270,999.59 539,140.38 1.31 5.71 0.94 -4.78 71.62
Ivanovo Oblast 22,018,529.30 58,840.59 0.27 4.73 3.38 -1.35 1,264.63
Tver Oblast 32,338,589.03 -187,101.62 -0.58 8.97 5.06 -3.91 -875.00
Kaluga Oblast 25,679,425.90 -231,862.52 -0.90 8.74 5.49 -3.25 -608.04
Kostroma Oblast 13,678,918.13 -790,367.98 -5.78 21.99 8.08 -13.92 -139.77
Kursk Oblast 22,296,167.58 566,304.60 2.54 0.74 -0.55 -1.30 -21.69
Lipetsk Oblast 30,634,745.58 -1,681,032.39 -5.49 2.61 1.63 -0.98 -29.74
Moscow Oblast 242,477,456.25 -21,365,895.28 -8.81 24.69 12.25 -12.44 -138.99
Orel Oblast 14,191,047.90 717,296.81 5.05 0.78 -0.09 -0.88 -1.87
Riazan Oblast 22,393,664.50 -1,245,620.08 -5.56 13.83 7.05 -6.78 -126.72
Smolensk Oblast 17,494,525.94 429,165.91 2.45 1.72 -0.12 -1.84 -4.71
Tambov Oblast 19,860,720.49 -646,269.41 -3.25 6.00 4.34 -1.66 -133.23
Tula Oblast 32,769,990.30 889,561.24 2.71 13.20 0.09 -13.11 3.28
Yaroslavl Oblast 34,708,715.25 -1,386,325.58 -3.99 16.18 5.81 -10.37 -145.54
Moscow city 957,876,008.33 28,126,052.57 2.94 2.34 -0.09 -2.44 -3.22
Subtotal 1,623,012,726.16 2,409,554.41 0.15 6.92 2.44 -4.48 1,640.56
Table 47 (continued)
1 2 3 4 5 6 7 8
Northwestern Federal Okrug
Republic of Karelia 20,116,286.28 -958,639.79 -4.77 17.67 6.65 -11.02 -139.62
Republic of Komi 34,201,307.98 394,135.68 1.15 0.86 -1.17 -2.03 -101.61
Arhkangelsk Oblast 39,185,857.06 2,574,506.54 6.57 7.64 0.94 -6.70 14.31
Vologda Oblast 42,574,550.22 -34,464.78 -0.08 0.73 -0.63 -1.36 781.18
Kaliningrad Oblast 27,634,456.08 744,517.21 2.69 15.96 3.62 -12.34 134.24
Leningrad Oblast 48,573,044.24 4,016,122.75 8.27 0.10 -0.05 -0.15 -0.66
Murmansk Oblast 40,636,966.63 2,129,335.80 5.24 3.20 -0.65 -3.84 -12.35
Novgorod Oblast 14,851,444.00 227,420.89 1.53 2.15 1.93 -0.23 125.77
Pskov Oblast 14,381,736.29 818,364.02 5.69 0.35 -0.79 -1.14 -13.89
St. Petersburg 281,267,298.57 18,820,096.51 6.69 0.98 -0.58 -1.56 -8.64
Nenets AO 10,068,794.65 -315,664.03 -3.14 0.00 0.00 0.00 0.00
Subtotal 573,491,742.02 28,415,730.80 4.95 2.79 0.05 -2.74 1.03
Southern Federal Okrug
Republic of Dagestan 38,735,327.65 795,200.81 2.05 0.00 0.00 0.00 0.00
Republic of Kabardino-Balkaria 15,003,340.58 436,049.44 2.91 6.19 -2.13 -8.32 -73.13
Republic of Kalmykia Republic of North Osetia - Alania 6,737,062.14 14,218,358.28 -154,635.94 -821,745.58 -2.30 -5.78 11.57 8.47 6.79 3.85 -4.78 -4.63 -295.76 -66.57
Republic of Ingushetia Krasnodar Krai 9,245,258.78 106,475,691.51 336,525.76 1,925,320.78 3.64 1.81 0.00 2.12 0.00 0.84 0.00 -1.28 0.00 46.58
Stavropol Krai 47,466,761.32 1,628,644.62 3.43 2.47 -0.36 -2.83 -10.48
Astrakhan Oblast 27,613,338.51 -235,955.84 -0.85 27.54 4.81 -22.73 -563.08
Volgograd Oblast 55,409,702.78 1,555,758.69 2.81 6.14 1.97 -4.17 70.07
Rostov Oblast 81,573,705.93 145,944.38 0.18 0.15 -0.25 -0.41 -142.26
Republic of Adygeya (Adygeya) Republic of Ka-rachaevo-Cherkessia 8,048,619.05 8,508,898.49 106,407.85 97,710.03 1.32 1.15 1.24 10.75 1.24 0.19 0.00 -10.56 93.98 16.40
Republic of Chechnya Subtotal 63,540,510.39 482,576,575.41 2.934.414.27 8.749.639.28 4.62 1.81 0.00 3.83 0.00 0.77 0.00 -3.06 0.00 42.73
Volga Federal Okrug
Republic of Bashkortostan 92,579,551.71 699,470.26 0.76 2.84 1.64 -1.20 216.59
Republic of Marii El 13,128,022.11 -592,702.12 -4.51 7.00 4.80 -2.20 -106.31
Republic of Mordovia 20,478,226.97 783,279.89 3.82 0.00 -0.49 -0.49 -12.80
Republic of Tatarstan 106,132,531.90 -2,385,471.72 -2.25 5.19 2.53 -2.66 -112.45
Republic of Udmurtia 34,451,586.93 -914,877.78 -2.66 7.54 4.78 -2.76 -179.82
Republic of Chuvashia 28,244,757.03 -895,311.12 -3.17 4.99 2.17 -2.82 -68.45
Nizhnii Novgorod Oblast 80,358,704.38 468,145.91 0.58 5.43 0.95 -4.48 162.88
Kirov Oblast 29,611,687.81 926,000.43 3.13 4.60 -1.17 -5.77 -37.31
Samara Oblast 82,157,224.34 -4,716,132.03 -5.74 8.74 6.38 -2.35 -111.18
Orenburg Oblast 49,898,389.27 2,881,990.01 5.78 0.07 -0.57 -0.64 -9.78
Penza Oblast 27,879,268.45 -1,280,188.99 -4.59 7.61 6.14 -1.47 -133.71
Table 47 (continued)
1 2 3 4 5 6 7 8
Perm Oblast 78,652,551.17 1,076,649.20 1.37 2.39 -0.77 -3.16 -56.34
Saratov Oblast 42,816,991.64 -133,561.87 -0.31 13.72 4.16 -9.56 -1 333.37
Ulianovsk Oblast 27,924,513.67 1,334,045.68 4.78 0.00 -2.07 -2.07 -43.31
Komi-Permiak AO 92,579,551.71 699,470.26 0.76 2.84 1.64 -1.20 216.59
Subtotal 714,314,007.39 -2,748,664.24 -0.38 5.02 2.05 -2.97 -533.79
Urals Federal Okrug
Kurgan Oblast 19,031,588.33 571,480.95 3.00 0.11 -0.13 -0.24 -4.35
Sverdlovsk Oblast 128,361,459.90 -1,670,701.22 -1.30 0.33 -0.46 -0.79 35.67
Tiumen Oblast 116,758,959.86 -16,672,404.11 -14.28 0.00 0.00 0.00 0.00
Cheliabinsk Oblast 87,362,398.03 6,763,652.90 7.74 0.93 -0.12 -1.06 -1.59
Khanty-Mansi AO 142,436,701.77 -10,085,906.21 -7.08 0.32 0.10 -0.23 -1.34
Yamal-Nenets AO 70,970,620.06 -735,247.69 -1.04 1.59 -1.02 -2.62 98.57
Subtotal 564,921,727.95 -21,829,125.38 -3.86 0.50 -0.23 -0.74 6.03
Siberian Federal Okrug
Republic of Buriatia 28,166,969.65 279,499.78 0.99 10.89 1.50 -9.39 151.05
Republic of Tyva 10,000,762.46 84,731.85 0.85 1.00 0.94 -0.06 110.75
Altay Krai 47,086,857.66 751,679.61 1.60 2.94 -0.44 -3.38 -27.59
Krasnoyarsk Krai 139,602,541.41 18,876,253.80 13.52 0.50 -2.23 -2.73 -16.50
Irkutsk Oblast 65,743,409.77 -3,363,547.68 -5.12 15.27 5.59 -9.68 -109.18
Kemerovo Oblast 84,258,472.05 -384,086.34 -0.46 2.63 1.10 -1.53 -240.60
Novosibirsk Oblast 72,435,340.13 4,256,321.23 5.88 9.19 -6.96 -16.15 -118.37
Omsk Oblast 51,215,034.17 -3,146,814.32 -6.14 34.76 5.64 -29.11 -91.83
Tomsk Oblast 29,412,047.63 -1,909,180.66 -6.49 28.83 6.81 -22.03 -104.84
Chita Oblast 25,489,357.94 -1,544,476.30 -6.06 6.75 6.67 -0.08 -110.08
Republic of Altay 8,990,361.28 -68,771.17 -0.76 3.39 0.90 -2.49 -117.38
Republic of Khakassia 12,055,910.59 92,648.00 0.77 0.11 -0.06 -0.17 -7.56
Agin Buriat AO 3,725,405.08 -4,013,018.33 -107.72 0.00 0.00 0.00 0.00
Ust-Ordynskii Buriat AO 3,746,947.93 56,467.06 1.51 0.00 0.00 0.00 0.00
Subtotal 581,929,417.74 9,967,706.53 1.71 9.02 0.59 -8.43 34.29
Far-Eastern Federal Okrug
Republic of Sakha (Yakutia) Primorskii Krai 65,343,148.94 51,175,077.83 -751,060.87 1,967,008.04 -1.15 3.84 9.41 1.34 0.85 -0.62 -8.56 -1.95 -73.54 -16.03
Khabarovsk Krai 53,844,490.01 4,331,910.13 8.05 2.93 -13.31 -16.23 -165.39
Amur Oblast 28,129,335.38 235,319.21 0.84 9.52 3.08 -6.44 368.46
Kamchatka Oblast 22,469,025.07 1,325,675.00 5.90 27.62 1.51 -26.11 25.67
Magadan Oblast 11,837,588.15 -770,302.34 -6.51 13.47 6.33 -7.15 -97.23
Sakhalin Oblast 37,418,492.61 3,861,515.71 10.32 10.67 -0.97 -11.64 -9.38
Jewish AO 6,372,945.45 67,262.07 1.06 0.47 0.28 -0.19 26.76
Koryak AO 8,333,721.70 1,496,358.40 17.96 13.85 -1.01 -14.87 -5.64
Chukotka AO 14,946,804.60 1,708,345.49 11.43 10.04 -0.81 -10.84 -7.05
Subtotal 299,870,629.73 13,472,030.85 4.49 8.53 -1.84 -10.37 -40.98
Federal Okrugs, total 4,840,116,826.41 38,436,872.27 0.79 5.44 1.13 -4.31 142.61
Source: the IET's calculations based on the data of the RF Ministry of Finance.
Internal Bond Loans
In 2007, bond loan issue prospectuses were registered by 26 Federation's subjects and 13 municipal formations (against 27 regional and 16 municipal loans in 2005).
The total volume of bonds being placed in 2007 amounted to 84.2 billion rubles, against 73.3 billion rubles in 2006 (growth, in nominal terms, by 10,9 billion rubles, or by 14.9%). However, the increasing issue volumes, while being ahead of the inflation rate, still fell behind the rate of economic growth. Within one year, the issue volume of subfederal and municipal bonds decreased from 0.28% to 0.26% of GDP (Table 48).
On the whole, the volume of the subfederal bonds market increased, in real terms, by 5.2 % - from 189.8 billion rubles in 2006 to 223.6 billion rubles in 2007.
Table 48
Issue Volumes of Subfederal and Municipal Securities (as % of GDP)
Year 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
Issue 0.63 0.77 0.47 0.31 0.19 0.17 0.27 0.46 0.47 0.37 0.28 0.26
Redemption 0.47 0.56 0.48 0.36 0.46 0.23 0.10 0.15 0.19 0.28 0.14 0.18
Net financing 0.16 0.22 -0.01 -0.05 -0.27 -0.07 0.16 0.31 0.29 0.09 0.14 0.08
Source: the IET's calculations based on the data of the RF Ministry of Finance.
In 2007, issue prospectuses were registered at the RF Ministry of Finance by: the Republic of Chuvashia, the Republic of Sakha (Yakutia), the Republic of Bashkortostan, the Republic of Karelia, the Republic of Kalmykia, the Republic of Udmurtia, Krasnoyarsk Krai, Krasnodar Krai, the city of St. Petersburg, Volgograd Oblast, Tomsk Oblast, Irkutsk Oblast, Moscow Oblast, Yaroslavl Oblast, Lipetsk Oblast, Nizhnii Novgorod Oblast, Voronezh Oblast, Tver Oblast, Samara Oblast, Kaluga Oblast, Penza Oblast, Novosibirsk Oblast, Kostroma Oblast, Ivanovo Oblast, Ulianovsk Oblast, the cities of Yekaterinburg, Kazan, Tomsk, Blagoveshchensk, Lipetsk, Magadan, Tomsk, Krasnoyarsk, Cheboksary, Elektrostal, Balashikha, as well as Klin and Noginsk raions of Moscow Oblast.
The biggest placements of securities were made by: Moscow Oblast, which accounted for 22.5 billion rubles, or 26.8% of the aggregate volume of territorial issues; the city of Moscow - 22.4 billion rubles, or 26.6%; Irkutsk Oblast - 6.0 billion rubles, or 7.1%; Samara Oblast - 5.0 billion rubles, or 5.9%; Yaroslavl Oblast - 3.6 billion rubles, or 4.3%; and the city of St. Petersburg - 2.8 billion rubles, or 3.3%. Thus, the 6 biggest issuers produced 74.0% of the total volume of issues of regional and municipal bonds being placed.
Besides, big issue volumes were placed by Nizhnii Novgorod Oblast and the Republic of Sakha (Yakutia) - 2.5 billion rubles each; Tomsk Oblast - 1.8 billion rubles; Krasnodar Krai; Republic of Udmurtia and the Republic of Bashkortostan -1.5 billion rubles each (Table 49).
Table 49
Placement of subfederal and municipal securities in 2007
Federation's subject Issue volume (thousand Issuer's share in total issue rubles) volume (as %) Issue volume to internal borrowings (as %)
1 2 3 4
Central Federal Okrug
Voronezh Oblast 1,000,000.0 1.2 42.4
Ivanovo Oblast 1,000,000.0 1.2 96.0
Table 49 (continued)
1 2 3 4
Kaluga Oblast 872,132.0 1.0 38.9
Kostroma Oblast 100.0
Lipetsk Oblast 800,000.0 1.0 100.0
Moscow Oblast 22,535,327.5 26.8 37.6
Yaroslavl Oblast 3,593,539.9 4.3 64.0
Moscow (city) 22,384,959.5 26.6 99.7
Northwestern Federal Okrug
Republic of Karelia 985,950.0 1.2 27.7
St. Petersburg (city) 2,750,242.7 3.3 100.0
Southern Federal Okrug
Republic of Kalmykia 78,344.0 0.1 10.1
Krasnodar Krai 1,500,000.0 1.8 66.5
Volgograd Oblast 1,040,753.2 1.2 30.6
Volga Federal Okrug
Republic of Bashkortostan 1,488,150.0 1.8 100.0
Republic of Tatarstan (Tatarstan) 1,000,000.0 1.2 18.2
Udmurtia Republic of 1,500,000.0 1.8 57.8
Republic of Chuvashia 1,250,000.0 1.5 88.8
Nizhnii Novgorod Oblast 2,509,400.0 2.98 57.5
Samara Oblast 5,000,000.0 5.94 69.7
Penza Oblast 1,000,000.0 1.2 47.2
Urals Federal Okrug
Sverdlovsk Oblast 39,175.4 0.1 9.3
Siberian Federal Okrug
Krasnoyarsk Krai 150,000.0 0.2 21.6
Irkutsk Oblast 6,000,000.0 7.1 59.8
Novosibirsk Oblast 840,000.0 1.0 12.6
Tomsk Oblast 1,891,603.0 2.3 22.3
Far-Eastern Federal Okrug
Republic of Sakha (Yakutia) 2,500,000.0 3.0 40.7
Amur Oblast 89,519.3 0.1 3.3
Magadan Oblast 360,000.0 0.4 22.6
Russian Federation - total: 84,159,196.5 100.0 32.1
Source: the IET's calculations based on the data of the RF Ministry of Finance.
So far, a high share of securities was observed mostly in respect of biggest issuers: the city of Moscow - 99.7%, and the city of St. Petersburg - 100%. Lipetsk Oblast u Republic of Bashkortostan borrow exclusively in the form of securities issues.
The aggregate volume of net borrowings on the subfederal and municipal securities market, which are being spent both on covering budget deficit and on debt refinancing against bank credits, amounted in 2007 to 25.9 billion rubles, having decreased by comparison with 2006 (36.5 billion rubles) by nearly 1/3 (Table 50).
Table 50
The Volume of Net Borrowings on the Internal Subfederal and Municipal Securities Market, thousand rubles
Consolidated Regional Municipal
regional budget budgets budgets
2007
Net borrowings 25,867,011 23,691,970 2,175,041
Attracted resources 84,159,197 79,889,761 4,269,436
Principal debt redemption 58,292,185 56,197,791 2,094,394
2006
Net borrowings 36,489,742 35,161,627 1,328,115
Attracted resources 73,288,653 66,524,832 6,763,820
Principal debt redemption 36,798,911 31,363,205 5,435,706
2005
Net borrowings 20,887,596 16,939,894 3,947,703
Attracted resources 81,220,540 75,016,756 6,203,783
Principal debt redemption 60,332,944 58,076,863 2,256,081
2004
Net borrowings 47,880,300 44,470,128 3,410,172
Attracted resources 79,436,708 74,995,965 4,440,743
Principal debt redemption 31,556,408 30,525,837 1,030,571
2003
Net borrowings 41,908,199 40,043,511 1,864,688
Attracted resources 61,712,635 59,012,901 2,699,734
Principal debt redemption 19,804,436 18,969,390 835,046
2002
Net borrowings 17,696,530 17,153,760 542,770
Attracted resources 29,141,777 28,169,158 972,619
Principal debt redemption 11,445,247 11,015,398 429,849
2001
Net borrowings 6,601,447 6,667,592 -66,145
Attracted resources 15,123,785 14,226,931 896,854
Principal debt redemption 8,522,338 7,559,339 962,999
2000
Net borrowings -1,877,328 -2,286,175 408,847
Attracted resources 13,042,220 10,090,208 2,952,012
Principal debt redemption 14,919,548 12,376,383 2,543,165
Source: RF Ministry of Finance.
Most of the regions regularly issuing debt securities continued their issue in 2007. Since 1999, annual issues of bonds are placed by the city of St. Petersburg, the Republic of Chuvashia, and Volgograd Oblast; since 2000 - Tomsk Oblast and the city of Yekaterinburg; and since 2001 - Irkutsk Oblast (Table 51).
Table 51
Registration Issue Prospectuses of Subfederal and Municipal Securities in 1999-2007
Issuer 1999 2000 2001 2002 2003 2004 2005 2006 2007
1 2 3 4 5 6 7 8 9 10
Federation's subject
St. Petersburg (city) * * * * * * * * *
Republic of Chuvashia * * * * * * * * *
Volgograd Oblast * * * * * * * * *
Tomsk Oblast * * * * * * * *
Irkutsk Oblast * * * * * * *
Moscow Oblast * * * * * *
Republic of Sakha (Yakutia) * * * * * *
Yaroslavl Oblast * * * * *
Krasnoyarsk Krai * * * * *
Table 51 (continued)
1 2 3 4 5 6 7 8 9 10
Republic of Bashkortostan * * * * * *
Republic of Karelia * * * *
Lipetsk Oblast * * * *
Nizhnii Novgorod Oblast * * * *
Voronezh Oblast * * * *
Tver Oblast * * * * *
Samara Oblast * * * *
Kaluga Oblast * * *
Irkutsk Oblast * *
Penza Oblast * *
Novosibirsk Oblast * * * * *
Kostroma Oblast * * * *
Republic of Udmurtia * *
Krasnodar Krai * *
Ivanovo Oblast *
Republic of Kalmykia *
Ulianovsk Oblast *
Moscow (city) * * * * * * * *
Republic of Komi * * * * * * *
Belgorod Oblast * * * *
Kirov Oblast * *
Republic of Marii El * * * *
Tambov Oblast * *
Kurgan Oblast *
Tula Oblast *
Khabarovsk Krai * * * *
Republic of Kabardino- * *
Balkaria
Leningrad Oblast * * * *
Yamal-Nenets AO * *
Briansk Oblast *
Khanty-Mansi AO * *
Murmansk Oblast * *
Republic of Mordovia *
Sakhalin Oblast *
Kursk Oblast *
Stavropol Krai *
Primorskii Krai *
Municipalities
Yekaterinburg * * * * * * * *
Kazan * * *
Klin raion, * * *
Moscow Oblast
Tomsk * * * *
Table 51 (continued)
10
Noginsk raion, Moscow Oblast
Blagoveshchensk
Lipetsk
Magadan
Tomsk
Krasnoyarsk
Cheboksary
Elektrostal, Moscow Oblast
Balashikha, Moscow Oblast
Novosibirsk
Volgograd
Odintsovo raion, Moscow Oblast
Astrakhan
Briansk
Voronezh
Orekhovo-Zuevo, Moscow Oblast
Yaroslavl
Iuzhno-Sakhalinsk
Novocheboksarsk
Angarsk,
Vurnarskii raion, Republic of Chuvashia
Shumerlia,
Republic of Chuvashia Ufa
Barnaul Perm
Nizhnii Novgorod Kostroma Arkhangelsk Dzerzhinskii
Source: RF Ministry of Finance.
Credit Capacity of Territorial Bodies of Authority
Credit Rating
Despite the continuing decline in the accumulated sovereign debt to GDP ratio, in 2007 Russia's by-country credit rating in respect of its obligations in foreign currency was not increased by international credit rating agencies and remained at the 2006 level: "BBB+" by the
2
3
4
5
6
7
8
9
*
*
*
*
*
*
*
*
*
*
*
*
*
*
*
*
*
*
*
*
*
*
*
scale applied by Standard&Poor's and Fitch. Since 2005, its international sovereign credit rating "Baa2", as estimated by Moody's, also remained unchanged.
At the same time, the credit ratings of territorial bodies of authority continued to be on the rise. Thus, the rating of St. Petersburg was raised by Fitch to "BBB". Besides, the investment level credit rating of "BBB-" was assigned by Standard&Poor's to Khanty-Mansi Autonomous Okrug.
Three rating agencies estimated the credit risk of the city of Moscow against its international obligations as being at a by-country level. None among all the other Russian regions and municipal formations succedded in obtaining an investment-level credit rating assigned by any of the rating agencies (Table 52).
Table 52
Standard&Poor's International Credit Rating, as of early 2008
Issuer Denominated in foreign currency / Forecast Denominated in national currency / Forecast
Sovereign rating
Russian Federation "BBB+"/Stable/ "A-"/Stable/
Rating of regional and local bodies of authority
Balashikha raion "B"/Positive/ "B"/Positive/
Bashkortostan "BB"/Positive/ "BB"/Positive/
Bratsk "B"/Positive/ "B"/Positive/
Volgograd Oblast "BB-"/Stable/ "BB-"/Stable/
Vologda Oblast "BB-"/Stable/ "BB-"/Stable/
Irkutsk Oblast "B+"/Stable/ "B+"/Stable/
Klin raion "B-"/Positive/ "B-"/Positive/
Krasnodar Krai "BB-"/Positive/ "BB-"/Positive/
Krasnoyarsk Krai "BB+"/Stable/ "BB+"/Stable/
Leningrad Oblast "BB-"/Positive/ "BB-»/Positive/
Moscow (city) "BBB+"/Stable/ "BBB+»/Stable/
Moscow Oblast "BB"/Positive/ "BB»/Positive/
Nizhnii Novgorod "BB-"/Positive/ "BB-"/Positive/
Novosibirsk "B+"/Positive/ "B+"/Positive/
Omsk "B"/Stable/ --/--/--
Samara Oblast "BB"/Positive/ "BB"/Positive/
St. Petersburg (city) "BBB"/Stable/ "BBB"/Stable/
Sakha (Yakutia) "B+"/Stable/ "B+"/Stable/
Sverdlovsk Oblast "BB"/Positive/ "BB»/Positive/
Stavropol Krai "B+"/Stable/ "B+"/Stable/
Surgut "BB-"/Stable/ "BB-"/Stable/
Tatarstan "BB-"/Positive/ "BB-"/Positive/
Tver Oblast "BB-"/Stable/ --/--/--
Ufa "B+"/Positive/ "B+"/Positive/
Khanty-Mansi Autonomous Okrug "BBB-"/Stable/ "BBB-"/Stable/
Yamal-Nenets Autonomous Okrug "BB+"/Positive/ "BB+"/Positive/
Source: Standard&Poor's.
It should be noted that, in accordance with the new wording of Article 104 of the RF
72
Budget Code , those RF subjects whose estimated share of interbudgetary transfers received from the federal budget (except subventions) in the last two out of the last three reporting did not exceed 5 % of the volume of their own consolidated budget revenue, from 1 January 2011 will be granted the right to attract external borrowings not only for purposes of repaying their external debt, but also for covering their budget deficit, i.e., to make new borrowings in foreign currency.
Settlement of Regional Rudgets' Stale Debt
Against the backdrop of a stable improvement of the budget situation in the majority of subjects of the Russian Federation, the process of stale debt settling was continuing.
According to the data published by the RF Ministry of Finance (Table 53), the volume of stale (unsettled) debt of regions against their debt obligations as of October 2007 decreased against that in October 2006 by 2.0 billion rubles in face value - from 7.0 to 5.0 billion rubles. By comparison with October 2005 (14.2 billion rubles), stale debt in face value declined nearly threefold, constituting only 0.12% of RF subjects' total budget revenue ', or less than 0.02% of GDP.
The most serious situation in respect of unsettled debt obligations was observed in the following regions: Tiumen Oblast - 2.4 billion rubles, or 2.5% of its budget revenue; Kostroma Oblast - 0.6 billion rubles, or 6.0% of its budget revenue; Novgorod Oblast - 0.6 billion rubles, or 5.4% of its budget revenue; the Republic of North Osetia - Alania - 0.6 billion rubles, or 4.9% of its budget revenue; Orenburg Oblast - 0.5 billion rubles, or 1.4% of its budget revenue.
Table 53
Stale (Unsettled) Debt Against RF Subjects' Obligations
Federation's subjects Volume of stale (unsettled) debt (thousand rubles)73 Stale (unsettled) debt to budget revenue ratio (as %)74
1 2 3
Central Federal Okrug
Kostroma Oblast 631,449 6.01
Kursk Oblast 77,982 0.44
Moscow Oblast 8,675 0.01
Northwestern Federal Okrug
Kaliningrad Oblast 7,220 0.04
Novgorod Oblast 626,078 5.40
Pskov Oblast 26,538 0.23
St. Petersburg (city) 10,690
Southern Federal Okrug
Republic of North Osetia - Alania 612,987 4.87
Volga Federal Okrug
Republic of Bashkortostan 10,883 0.01
Nizhnii Novgorod Oblast 2,190
72 Envisaged by Federal Law of 26 April 2007, No. 63-FZ3.
73 As of 1 October 2007.
74 Ratio of stale (unsettled) debt as of 1 October 2007 to revenue of a regional (non-consolidated) budget in 2007.
Table 53 (continued)
1 2 3
Orenburg Oblast 537,872 1.37
Samara Oblast 8,765 0.01
Saratov Oblast 1,170
Urals Federal Okrug
Sverdlovsk Oblast 2,262
Tiumen Oblast 2,398,298 2.53
Siberian Federal Okrug
Novosibirsk Oblast 1,020
Far-Eastern Federal Okrug
Republic of Sakha (Yakutia) 4,276 0.01
Source: the IET's calculations based on the data of the RF Ministry of Finance.
Besides, the process of diminishing the volumes of accumulated arrears of payables in regional budgets continued as before. According to the data published by the Experts' Economic Group, in 2007 the aggregate volume of arrears of payables in the regions decreased by 16.3 billion rubles (or by 28.1% of its volume as of the end of 2006).
2.6.3. Stock Market
In contrast to the prior year, the 2007 Russia's stock market demonstrated alternate trends. The group of major factors that shaped them comprised negative situation on the US mortgage market and the dynamic of the US bonds, which are beacons for the world debt market, an intense volatility of prices on the world market for oil and metals over the year, and appreciation of Rb. against the US Dollar. Underpinning some fall on the stock market in the early-2007 was a decline in China's stock market after the national government let the world know it might introduce control over transactions involving Chinese companies' stock. That trumpeted the start for investors' quitting the national market, as well as other emerging markets, including Russia's. In addition, Russia's banking sector began to be challenged by a lower volume of liquidity, albeit CBR undertake some steps to boost it, which had a positive effect on the dynamic of the national market. Another boost to the world markets was given by the Fed's decisions to cut the interest rate, because of economic challenges facing the US economy. That was done several times over the year and helped boost the world markets and restore Russia's in particular. Plus, the situation in the macroeconomic sphere in Russia remained fairly favorable.
The market also capitalized on internal corporate news. More specifically, the financial performance by most corporations in the mineral, telecom, as well as other sectors, over the first and second quarters was far better than in 2006, so investors took a greater liking in them. As well, the awarding some public corporations with a higher rating also became a positive signal for the market.
Russia's 2007 MICEX's stock index rose at 316.93 points (from 1,571.93 to 1,888.86), or at 20.16% per cent to its value as of the moment of closure of trades on January 9, 2007 (the respective 2006 index was 59.03%). So, last year, the stock market once again demonstrated rather impressive growth rates, although notably less, in relative terms, than in 2006. The bottom value of the MICEX index in 2007 was registered on May 30 (1,516.09 p.), while the historical peak was reached on December 12 (1,969.91 p.). As concerns investors' activity, it grew notably vs. the prior year. More specifically, the 2007 turnover on the market of stock
included in the base of the MICEX index roughly accounted for Rb. 13,611.71 bn, with the average daily turnover being 55.33 bn, which was far greater than in 2006 (9.907,32 bn and 40.27 bn, respectively). So, the 2007 volume of trades soared at more than 35% vs. its respective index of 2006.
Meanwhile the dynamic of the market displayed a great deal of volatility and allowed identification of several characteristic up-and down-periods, so far as the MICEX index quotations are concerned. Specifically, between January and August 2007 the market passed through three such periods, with an upward trend being in place between January and February and, consequently, between mid-March and mid-April, and early June through mid-July. Interestingly, in these periods there occurred periodical downward adjustments. In the frame of the said interval (until late-August), the index was on the decline during the rest of the periods. In the period in question the peak value was 1,807.28 p. by the MICEX index (registered on July 23, 2007), while the bottom value was registered on May 30, 2007 and it accounted for 1,516.09 p. As seen on Fig. 23, while short-living, the adjustment moves were accompanied by a considerable rise in the volume of trade. The distinguishing feature of the next period - between September and December 2007 - became a sustained growth up to the next historical maximums which the MICEX index hit on 12 December (1,969.91 p.). Meanwhile, since mid-September the market was growing upon volumes of trade far greater than those registered in the middle of the year when it displayed a fairly intense volatility. The 2007 MICEX aggregate stock trade volume was some Rb. 13,611.7 bn.
Fig. 23. Dynamics of the MICEX Index and Trading Volume in 2007
While analyzing the monthly dynamic of the Russian stock market, it is worthwhile noting that since the opening trading session in January 2007 the stock market demonstrated a notable fall engendered by the declining world prices for minerals, which had occurred in the every early January when Russia's trading spots were on holidays. It was the banking sector's
stock, primarily that of Sberbank of Russia (affected by news on additional placement of its stock in the 1st quarter 2007), electricity (RAO UES Riussia), and Norilsk Nickel (in anticipation of the renewal of a upward trend in nickel prices on the world market) that weathered the fall better than others. An additional negative factor became a new fall on the US stock market. However, since the third week of January the set of the pricing factors underwent dramatic changes. Thus, oil prices discontinued to fall and began rising, which automatically affected quotations of the national oil and gas corporations' stock. Besides, a series of favorable corporate news (from RAO UES Russia, Severstal, and Rosneft) provided an additional support to these companies' stock and the market on the whole.
During February the locomotive of the dynamic of Russian stock remained the world oil prices. Specifically, in early February they found themselves within the range between USD 50 and 60/barrel, which engendered instability of the price rise for Russian stock. The situation was fairly favorable in the electricity sector, as investors were clearly in the mood to buy, and quotations were climbing up with much certainty. More specifically, RAO UES's stock was rallying steadily, which can be explained by S&P raising its credit rating from B+ to BB. Plus, except for a short-term adjustment in the middle of the month, the market was steadily on the rise, under the impact of some other factors, through the beginning of the last week of the month.
In early March, Russian stock plummeted on the news China's government let the world know it might introduce control over transactions involving Chinese companies' stock. That trumpeted the start for investors' quitting the national market, as well as other emerging markets, including Russia's. As a result, the MICEX index slid slightly in the first week of the month. The next week the decline ceased, and the market succeeded in winning back the fall a bit, with the help of steadily high oil quotations and thanks to renewal on the world markets. However, the positive adjustment was short-living, and, starting from the second half of the month it was external factors adverse to its rise that played a major part on the market. The world markets were down, and so were the world oil prices, while the price rise for nickel and a number of other metals helped to keep afloat only metallurgical corporations. The presence of uncertainty associated with expectations of the regular Fed's decision on interest rates exerted an inhibiting influence on stock prices. As concerns corporate news, it is worth noting a very successful placement of an additional issue of the OGK-3 stock that Norilsk Nickel bought well above market. That resulted in a notable rally of RAO UES's stock, which in turn propelled the dynamic of stock indices.
In early April, the situation remained fairly favorable, with main stock indicators rising smoothly and the most liquid papers consolidating at earlier attained levels. The consolidation was there, because indices were approaching their historical peaks when a part of investors can fix their packets, as well as because the world oil prices were down after the tension between UK and Iran had eased. It was the stock of the electricity and banking sectors that posted a sustained growth, which was driven by investors' increasing interest against the background of advancement of the electricity sector reform and the upcoming VEB's IPO whose ultimate objective was to extend the list of the blue chips and the one of the banking sector's papers, as investors were keen to buy those. The third week of the month passed under the sign of adjustment, and after some period of rise, Russia's stock market started rolling downhill. Despite a relative stability on the world stock markets, Russian stock prices were going down, driven by falling world prices for oil, as the tension around Iran's nuclear prob-
lem was easing, and, consequently, chances for a military conflict with the US were becoming much lower. It was the beginning of the last week of April that the quotations showed some rise.
In early May, the market was down again, steered by technical and seasonal factors associated with the traditional national holidays. But there also were a series of fundamental factors, the most critical of which became a new downfall in the world oil prices. Even a positive dynamic on the world stock-exchanges failed to keep Russian stock afloat. It was just Sber-bank of Russia's stock, which, after publication of its financial performance by IAS, as well as Norilsk Nickel's stock, due to a notable rise in the world nickel prices, that demonstrated a positive dynamic by results of the first week of May. Since the second week of the month quotations of a whole series of the blue chips were up at 1.5-5.5%, which was explained by a notable rise in the world oil prices and a fairly favorable situation on the main stock exchanges worldwide. As well, RAO UES Russia's stock was on the rise, which also had a certain effect on the market dynamic. By contrast, the oil-and gas corporations' stock were either stagnant or even down, as investors were anticipating their poorer performance indicators in the first half of the year. The dynamic was also shaken by such an additional negative factor as Mr. A. Greenspan's presentation: he voiced his concerns of a rapid growth of China's stock market and noted a high probability of its notable decline in the future. The integrity of the above factors aggravated the situation on Russia's market and drove the respective indices down to their early-2007 values.
June 2007 brought about a better mood, as the national stock market began to rise gradually from the beginning of the month. The oil companies' stock quotations found themselves on fairly attractive levels, thus bolstering the respective demand. Plus, the situation on the external market remained favorable, as the developed countries and emerging markets' main trading spots were on the rise, too. The beginning of the second half of the month was signified by a rise in main stock indicators, while by the end of the month the indices were moving in alternate directions. A price downfall for oil in the end of the month drove the oil-and-gas sector's quotations down, while anticipation of positive news of the Russian corporations' performance in early-2007 kept the quotations buoyant. As concerns papers that had a positive impact on quotations, Norilsk Nickel's ones are worth a particular notice, as their price was rising following the price rise for main metals on the world market. Overall, the absence of a clearly visible trend could be determined by investors' anticipating the Fed's meeting scheduled for June 28, 2007.
Since the very early July market was on the rise, steered by an increasing demand for oil, gas and metal companies' papers. While oil prices nearly hit their historical peaks, the investors' enthusiastic demand might have been a consequence of a fundamental reassessment of investment in Russia's oil and gas sector. The domestic news was positive, too. Thus, in July, Moody's raised Rosneft's credit rating from Baa2 up to Baa1. Plus, the national stock market capitalized on the developed nations and emerging markets' positive dynamics. But in the second half of the month the growth ceased, which was caused in part by technical factors, as main stock indices had hit their absolute peak values and a further dynamic required emergence of fundamental factors. In addition, the world stock markets were sending mixed signals, as during a week their rise could alternate with a fall. Overall, oil kept Russia's stock market afloat, which is why after a short-term drop quotations began to rally on the US data.
August became a bad month, with the situation on the national stock market deteriorating and market volatility growing notably. That the market was down in the beginning of the month can be explained by lower oil prices and the absence of significant positive domestic factors. Plus, the situation on the world stock spots was gloomy, due to negative news from the US mortgage and financial sectors, as well as a series of publications on Russian companies' poor performance in the 1st quarter 2007. And if it was not enough, the situation with liquidity in the Russian baking sector was far from ideal, too. In the second half of the month, the negative dynamic of Russian stock indices was replaced by their rise, which in part became possible thanks to the rise in the world oil prices and restoration of the world stock indices.
By the end of September it became evident that the Russian stock market posted a significant growth, despite the global financial turmoil and a dramatic aggravation of the situation with Rb.-denominated liquidity in the domestic banking sector. It goes without saying, main factors underpinning the rally became the cuts in the US basic interest rate, historically high oil prices, and a series of positive updates from the corporate sector. While investors' activity on the stock market was fairly low over the first half of the month, the stocks posted a notable rise in the wake of the Fed's decision. The upward trend was there until the end of the month.
In October, the stock market continued its rise. The Russian market closely monitored news form the world ones, which were soaring mostly under the impact of corporate news: while some European banks confirmed their writing off losses engendered by the US mortgage crisis, the rising US indices helped reverse the negative tendency. In mid-October, the growth continued against the background of a stable rise in the world oil prices, CBR's decisions to maintain the Rb.-denominated liquidity, and a number of positive corporate news. The general dynamic of the market found itself under a notable impact of the oil and gas sector, which once again became attractive to investors. After a minor adjustment in the middle of the month indices continued to surge closer to its end, which to a significant degree was determined by record-breaking oil prices and greater expectations of further cuts in the Fed's rate.
In November, market sensed loose performance of the biggest US mortgage operators, as there intensified the fear of yet greater losses associated with the US mortgage market and stagnation of economic growth. The Russian stock market displayed an obvious downward trend over the month. Meanwhile, the general market dynamic was affected by a growing interest in the oil and gas sector stirred by the rising world oil prices, the CBR's decisions to back-up the Rb.-denominated liquidity, and a series of positive corporate updates. As a result, on November 8, 2007, the MICEX index hit a new record-breaking level, that is, 1,917.29 points, or at 13.22% greater than its respective value as of the early-2007.
Once the Fed ruled to cut its key interest rate at 1.4 p.p., participants in Russian exchanges welcomed it with much gusto, and the Russian stock market enjoyed an upper hand over the month. Meanwhile, the general dynamic of the market was under the positive influence of activity in the oil and gas sector, the CBR's decisions to back-up the Rb.-denominated liquidity, and a series of positive political and macroeconomic factors. As a result, on 12 December the MICEX index once again broke a new record value of 1,969.91 p., or at 16.42% greater than in the early-2007, which mirrored the general trend to growth in quotations of Russian corporate stock.
As in 2006, the year of 2007 saw values of the most liquid Russian companies post a notable rise (Fig. 24). Specifically, it was Surgutneftegas' s stock investment in which ensured the greatest return rate of 73.5%, followed by Norilsk Nickel's (58.3% up) and OAO Rostelekom (48.2% up) ones.
The group of the most successful performers also included OAO Gasprom neft, whose stock posted a 27.5% growth in value over 2007, OAO Tatneft (21.2%), and a group of other corporations whose results appeared slightly less impressive - Gasprom (+13.2%), OAO Mo-senergo (13.1%), and RAO UES (10.5%). Meanwhile, quotations of some Russian corporations' stock displayed an opposite dynamic. More specifically, LUKOil suffered from the greatest decline in its stock quotations which last year plunged at 9.6%, while Sberbank and Rosneft's stock dropped at 6.3 and 4.8%, accordingly.
It was Gasprom's stock that became a leader in terms of turnover at MICEX (over 35% of the aggregate turnover at the exchange), which undoubtedly can be attributed largely to the start of their free circulation. Norilsk Nickel also was in the leading group with its proportion of slightly over 15% of the overall stock turnover at MICEX, Lukoil was the third with some 10%, while RAO UES and Sberbank were lagging far behind them (compared with the respective level as of the start of trades at MICEX in 2070), with their 2007 aggregate proportion accounting for some 15%. Hence, in 2007, the proportion of transactions involving the blue chips at MICEX was some 90% of the total turnover at the exchange.
80,00% 70,00% 60,00% 50,00% 40,00% 30,00% 20,00% 10,00% 0,00% -10,00%
iO
LU =>
o
I Price change (as%)
Source: Moscow Interbanking Stock Exchange.
Fig. 24. Dynamics of Quotations of the Russian "Blue Chips" by the 2007 Results
According to the MICEX data, as of December 28, 2007, the top five largest corporations by capitalization were: Gasprom - Rb. 7,448.4 bn (vs. 6,960.7 bn in 2006), Sberbank -2,1609 bn, Rosneft - 2,067.0 bn (2,269.9 bn in 2007), LUKOil - 1,883.3 bn (1,926.3 bn in
194
2006), and Norilsk Nickel - 1,362.1 bn (780.8 bn in 2006). So, the rating has not changed drastically since 2006, but it should be noted that 4 out of the top five companies represented the oil and gas sector, which is explained by a very favorable situation on the mineral markets in 2007. Like in 2006, Sberbank once again became the only representative of the non-mining sector with the greatest capitalization.
The market for Open Contracts
The turnover of the market for open contracts has posted an impressive growth from year to year, and 2007 has not become an exception in this regard. For example, by the 2007 results, the aggregate turnover of trade with futures and options in this particular segment of Russia's financial market at the RTS's market for open contracts roughly accounted for Rb. 7,531.2 bn (vs. nearly 2,708.5bn in 2006). In other words, this market has grown practically 3.5 times since 2006. Participants in the trades stroke over 11.7m deals and concluded 145.1 m contracts (vs. some 5 m deals and 89.6 m contracts reported in 2006). Like in 2006, the segment of open contracts was dominated by transactions with futures, whose proportion roughly accounted for 82.8% of the aggregate volume of trades, or Rb. 6,207.3 bn (2, 397 bn in 2006), while options deals were worth a total of Rb. 1,323.9 bn (311.4 bn in 2006), which means that in terms of turnover the 2007 share of transactions with options remained practically the same as in 2006.
As concerns the rating of popularity, investors clearly preferred the RTS index futures, followed by contracts on Gasprom, RAO UES and LUKoil's stock over others.
The Market for Corporate Bonds
In 2007, the market for corporate and regional bonds was by and large dominated by an upward trend, as evidenced, in particular, by the dynamic o the corporate bond index calculated by Zenit bank on the basis of market quotations of bonds traded at MICEX. Thus, by the 2007 results, the ZETBI-Corp index slid by 0.97 points (-0.85%) - from 111.01 to 110.04 points.
Meanwhile, the 2007 ZETBI-Corp 10 calculated on the basis of quotations of the most liquid corporate bonds demonstrated yet a greater fall - from 119.01 to 117.35 points (-1.39%).
When compared with the market for government bonds, quotations of the corporate debt in 2007 displayed somewhat greater volatility. Meanwhile, it is possible to identify several periods in 2007, during which prices behaved in different ways (Fig. 25). More specifically, a downward trend persisted between January and March, August and September (when it became more intense than in the first period), and in November, while during other periods the market dynamic appeared more positive.
An analysis of the monthly dynamic of quotations allows one to note that the market for corporate debt was characterized by alternate dynamics of quotations of trade issues and a poor activity by participants in the primary and secondary markets. Thus, given that in early January the quotations changed insignificantly in both directions, the downward trend manifested itself more distinctly in the second half of the month. A fairly favorable situation with liquidity in the banking sector and the absence of huge placements formed a supporting factor, while the investors' fairly low activity against the background of a deteriorating situation on
the external debt market, declining world prices for oil and the stock market did not encourage a rise in quotations.
Source: Zenit bank.
Puc. 25. Dynamics of Price Indices of Corporate Bonds in 2007 (9 January 2007 =100%)
By results of February 2007 the market for the Rb-denominated corporate debt saw some improvement of the state of affairs, as investors' activity rose significantly. In early February, the quotations posted some growth, capitalizing on a fairly favorable situation in the banking sector and a relative stability of the Russian Eurobonds that were following the US T-bonds' path. However, in late-February, because of the impact of the deteriorating situation with liquidity in the banking sector, most quotations of corporate bonds demonstrated a moderate decline, with just positive signals from the external market keeping them afloat.
The quotations of corporate bonds practically had not changed by the end of March, albeit their dynamics during the month were different. Thus, between the beginning of the month and mid-March their yields rates displayed alternate fluctuations. That took place against the background of a dramatic decline in quotations on the stock market, problems with liquidity in the banking sector, and the dynamic of the domestic forex market. The yields rates began to rise since mid-March.
Between April and the first half of June the situation on the market for corporate debt was being fairly favorable against the background of rising quotations of corporate bonds and investors' growing activity. The situation with liquidity stabilized and, along with appreciation of Rb. against USD, that helped boost demand for corporate debt instruments. Auctions held in that period proved that investors were keen to purchase the bonds, as many issues were placed without an additional premium to the secondary market.
The situation changed cardinally between mid-July and September, and like other segments of the national financial market, the one for corporate debt demonstrated a notable fall. 196
That was chiefly steered by the increasingly negative news from the US. Thus, the Russian market entered the period of a large-scale decline due to activation of the impact of negative factors. The crisis on the US subprime market compelled nonresidents to pull capital out of Russian bonds, which fueled the depreciation process of Rb. That in turn formed an additional factor that lowered attractiveness of investment in Rb-denominated assets. Plus, the deterioration of the situation on the domestic market for debt where interest on financial resources grew dramatically and banks axed volumes of mutual crediting battered heavily the quotations of the Rb-denominated corporate debt. So, most factors in that period fueled decline of the national market for debt.
October ended with some improvement of the situation on the market for Rb-denominated corporate bonds, as the Fed had ruled to cut the basic interest rate. The dynamic of quotations once again became upward, nonetheless, during the first decade of the month prices for bonds were sliding, which was chiefly determined by the continuous problems with liquidity. However, the timely cuts in the norm of compulsory reserves and interest rate by CBR's forex-denominated swaps, as well as extension of its lombard list and the list of instruments that CBR accepts as a collateral under REPO transactions partly improved the situation with liquidity, which propelled the rise in quotations of corporate bonds. But rates on the market for interbanking credits failed to drop lower than 5-6% annualized by the end of the month, thus mirroring not only the banks' need in liquidity to effect tax payments, but an incomplete restoration of the monetary market against the background of a greater uncertainty on external markets, either. As a result, these factors had an inhibiting effect on quotations of the bonds by the end of the month.
November 2007 witnessed a considerable decline in the aggregate volume of trades on corporate bonds (at some 30%) vs. the prior month. The aggregate volume of coupon payments also plunged by some 20%, while in December the market experienced a significant rise in the volume of trades on the corporate bonds (over 30%) vs. that in November.
Overall, in 2007, the aggregate volume of transactions on the market for corporate bonds roughly accounted for Rb. 570.7 bn vs. some 515.4 bn registered in 2006. Thus, it can be argued that there occurred a notable (at 10.7%) growth in offer on the market in question. Specifically, the peak volume of turnover of the section of corporate bonds on the market was registered in December (a. Rb. 58.6 bn vs. 85.8 bn in December 2006), while the minimum one was 23.5 bn - in January (vs. 13.9 bn in May 2006).
Factors of the Dynamics of Russia's Stock Market
The 2007 dynamic of Russian stock market was steered by a whole series of factors which, for a greater convenience, can be tentatively split into the following groups:
• The domestic political situation;
• Relationship with international financial institutions and organizations;
• Situation on international financial markets;
• Situation on the world mineral markets (the oil market in particular);
• Corporate news.
Each group exerted its specific impact on the dynamic of different segments of Russia's financial market in 2007, and most of them were already referenced while analyzing dynamics of different sectors of the national financial market.
Relationship with International Financial Institutions and Organizations
In September, S&P kept Russia's sovereign rating at the level of the "stable" forecast, and Fitch agreed with that, which gave a signal to investors to intensify their operations on the Russian markets. But S&P's report also suggested that Russia's economic stability might collapse in a not-so-distant future.
Situation on International Financial Markets
The year of 2007 saw some improvement of the state of affairs on the global stock markets (see Table 54), albeit not as notable as in 2006.
Table 54
Dynamics of the World Stock Indices in 2007
Data as of December 29, 2007 Code Value Change over 2007 (as %)
MICEX (Russia) MICEXINDEXCF 1,888.86 11.54
RTS (Russia) RTSI 2,290.51 19.18
Dow Jones Industrial Average (US) DJI 13,365.87 7.24
NASDAQ Composite (US) NASD 2,674.46 10.73
S&P 500 (US) SPX 1,478.49 4.24
FTSE 100 (UK) FTSE 6,476.9 4.12
DAX-30 (Germany) DAX 8,067.32 22.29
CAC-40 (France) CAC 5,627.25 1.54
Swiss Market (Switzerland) SSMI 8,484.46 -3.43
Nikkei-225 (Japan) NIKKEI 15,307.78 -11.13
Bovespa (Brazil) BUSP 63,886.1 43.65
IPC (Mexico) IPC 29,700.19 12.30
IPSA (Chile) IPSA 3,051.83 13.31
Straits Times (Singapore) STI 3,445.82 15.41
Seoul Composite (South Korea) KS11 1,897.13 32.25
ISE National-100 (Turkey) XU100 55,698.42 42.39
Morgan Stanley Emerging Markets Free Index EFM 1,005.66 10.19
More specifically, by the 2007 results the US stock indices demonstrated rather a firm growth. Thus, by results of the year Dow Jones Industrial gained 1,028 p. (7.24% up), NASDAQ Composite - 208.45 p (10.73% up) (see Fig. 26). The dynamics of the US stock indicators also allow identification of several up and down periods (Fig. 25). For example, the indicators were down sharply in April, July and October. Such an alternate movement characterized a strong volatility of the stock indices, however, such trends were noted across all the international stock indices, too.
While analyzing the factors, let us note that in 2007 the major ones became the situation on the US debt market, which was battered by the mortgage crisis, macroeconomic news, the dynamic of the world oil prices, corporate news, and fluctuations of USD and Euro against Rb.
At this point, it is worthwhile to emphasize the critical role of the US debt market in 2007. During the year, the Fed made several decisions to cut the basic interest rate, which affected quotations of the US papers. The decisions were dictated by the nation's macroeco-
nomic statistics, which in 2007 evidenced deceleration of its economic growth and increasing inflation risks. An additional factor propelling inflation became a significant rise in the world prices for energy sources, which was replaced by their decline at the end of the year. Between mid-year and its end a number of huge multinationals published negative financial performance reports, as they had suffered from huge losses with mortgage bonds, which formed yet another obstacle to quotations. Plus, the situation around Iran's nuclear program all but exerted a certain negative influence on the situation.
As concerns other nations' stock markets, they basically were on the rise in 2007, with some European indicators posting growth healthier than that in US. Thus, DAX-30 gained 22.29% over the year, while the French CAC-40 - just a meager 1.54%. It should be particularly noted that Japan's Nikkei-225 demonstrated an opposite tendency, as it plunged at 11.3% vs. the early-2007.
Emerging markets boasted a better situation, as in most cases their stock markets demonstrated a double-digit growth, and the Morgan Stanley's 2007 Emerging Markets Free Index gained some 10.19%.
Overall, in 2007, Russia's stock market found itself under the influence of both the developed and emerging markets, which would become particularly visible in the absence of important domestic news and stabilization of oil prices. On the contrary, once domestic news, from the corporate, as well as public sector would start to flow in the market, their impact on quotations was far more profound than fluctuations on the world markets. The only factor to which investors, regardless of a country, paid much attention, was the Fed's policy resulting from the US mortgage crisis, which in the medium term might have affected the markets' liquidity level, because of an outflow of huge US funds and other institutional investors' capital from those.
135,00% 130,00% 125,00% 120,00% 115,00% 110,00% 105,00% 100,00% 95,00%
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s o CA 1/1 o CN <N o <N 1/1 o Ov s 1/1 CN ro o m oo 1/1 o 3 CN ON CM oo
Fig. 26. Dynamics of Main US and Russian Stock Indices in 2007 (9 January 2007=100%)
Corporate news
Changes in credit ratings. As some Russian corporations notably improved their performance, the international agencies awarded them with long-term credit ratings or revised those in existence.
Thus, in May 2007, S&P raised OAO LUKOil's rating, along with its bonds, from BB+ up to BBB- with the forecast as "stable". S&P believes that this rating highlights LUKOil's position as the largest national vertically-integrated oil company, a high proportion of its export proceeds, international diversification, and stable financial indicators. So, LUKOil has now earned investment ratings from all the three leading rating agencies - S&P (BBB-), Moody's (Baa2), and Fitch (BBB-).
In August 2007, Fitch confirmed Norilsk Nickel's high ratings, namely, the long-term rating of the issuer's default RDE, the priority unsecured rating BBB-, and the short-term RDE F3, with the forecast on the long-term RDE being "stable". The ratings mirror the company's position as the world leading producer of nickel and palladium, as well as copper and platinum.
On February 5, 2007, S&P raised RAO UES Russia's credit rating from B+ up to BB, while along the Russian scale the rating was raised from ruA+ to ruAA, with the forecast being "stable". In addition, according to a S&P's research, RAO UES Russia held the fifth position in the list of the most transparent Russian companies in terms of information (in 2006, the company held the 33th position in the list). However, the research argued that the transparency index of Russian companies remained practically unchanged, and the agency's experts note that a significant enhancement in the electricity holding's transparency is explained by its desire to attract a broad array of minority stockholders to participation in the second (final) reorganization of the company. In addition, RAO UES takes steps to enhance its daughter companies' informational transparency, too.
In July, Moody's raised the credit rating of OAO OC "Rosneft" from Baa2 to Baal and awarded its Eurobond issuing program with the Baal rating. The change in the rating follows the increase in the basic credit assessment from level "13" (equivalent to Ba3) to level "11" (equivalent to Bal) along the 21-grade scale. According to Moody's, the fact that Rosneft had acquired new oil-refining assets to a significant degree highlighted the company's medium-term strategic goals. The agency prognosticates this should result in a substantial production diversification, as well as boost net profits and the free cash flow. The increase in the basic credit assessment was also made in a due consideration of other factors. More specifically, driven by a high inventory replenishment coefficient, low operational costs and being in possession of the biggest resource base nationwide, the company's operational and production efficiency is on the rise. Finally, the company's management has multiplied their efforts to ensure Rosneft's greater transparency and to improve its corporate governance system.
On September 20, 2007, Fitch Ratings confirmed Sberbank of Russia's ratings as follows: the long-term issuer default rating at the level of BBB+ with the forecast being "stable"; the short -term issue default rating "F2", the individual rating "C", the rating of support "2", the level of support of the long-term issuer default rating "BBB+".
Financial performance. Between August and December 2007 numerous companies published results of their 2007 financial performance, of which some are worth a special notice.
On December 5, 2007, OAO Gasprom presented the unaudited interim abridged financial report for the first half 2007 drafted according to ISA-34. In the period in question, the company's gains (less the excise tax, VAT, and customs duties) rose by Rb. 52,470 m, or at 5% vs. the respective period of the prior year, and accounted for Rb. 1,143.894 m. Meanwhile,
the net gains from gas sales rose at Rb. 36,408 m, or at the same 5% vs. the respective period of 2006 and totaled Rb. 758.293 m.
On December 21, OAO Gasprom neft made its debut as an issuer of the corporate consolidated financial report over the 3rd quarter and 9 months of 2007 drafted according to the US GAAP standards. According to the report, the company's gains in the 3rd quarter 2007 rose at 0.5% vs. the respective index of the prior year and accounted for USD 5,434 m. The company's EBITDA grossed USD 1,449 m, or at 7.2% up vs. the 3rd quarter 2006, while its gains over the 9 months of the year amounted to USD 14,677 m, or at 5.5% down vs. the respective index of the prior year, and the company's net profit over the 9 month period 2007 was USD 2,819 m, or remained unchanged vs. the respective period of 2007.
On December 12, 2007, OAO LUKOil likewise published its financial performance report over the 3rd quarter and 9 months of 2007 drafted according to the US GAAP standards. According to the report, the company's net profit in the 3rq quarter 2007 rose at 2.1% vs. the respective index of the prior year and accounted for USD 2.482 m. The company's net profit over the 9-month period 2007 was USD 6.298 m, while EBITDA grossed USD 10,370 m, or at 1.9% up vs. the 3rd quarter 2006,and gains from sales over the 9 months of the year amounted to USD 57.096 m, or at 11.0% up vs. the respective index of the prior year. The total volume of sales of crude and oil products over the 9 months of 2007 was 98.8 m t., or 4.6% up vs. the 9 months of 2006.
On December 27, 2007, RAO UES Russia published its interim consolidated financial report over the first half 2007 drafted according to the IAS. Over the first 6 months of 2007 profit of the Group RAO UES Russia doubled vs. the respective period of 2006 and totaled Rb. 103.8 bn. The dynamic of the indicator was driven chiefly by rise in revenues from sales of stock in RAO's daughter companies. The pretax profit accounted for Rb. 93.5 bn, i.e. doubled, too.
On November 1, 2007, OAO Rostelecom announced its unaudited performance results over the first 9 months 2007 drafted according to the Russian accounting standards (aka RSBU). The company's gains over the period in question made up Rb. 46.541.4 m, or at 6.4% more than in the respective period of the prior year; EBITDA grew by 21.8% (up to Rb. 11,044.7, the company's profit margin by EBITDA accounted for 23.7%, while its net profit over the 9 months of 2007 rose at 76.7% and totaled 8,844.8 m. vs. 5,004.6 m reported over the first 9 months 2006.
In October, Sberbank of Russia published its half-year financial report drafted according to IAS, which also contained its auditor, PWC's, account. According to the report, the bank's assets, by ISA standards, accounted for Rb. 4,282.7 bn as of July 1, 2007, while the pace of growth in assets over the first half of the year was 47.1% annualized. The stockholders' own capital grew by 87.3% and reached the level of Rb. 577.9 bn. The bank's net profit by IAS over the first half of the year amounted to Rb. 48.0 bn, or at 29.6% greater than in the respective period of 2006, while its ROAA rate made up 2.5%
On December 27, 2007, OAO Tatneft also published results of its operational and financial performance by US GAAP over the period of 9 months that had ended on September 30, 2007. In the period in question, the company's gains from sales grossed Rb. 258,436 m, while net profit stood at Rb. 29,531 m.
Mergers, acquisitions, and partnerships. In 2007, some Russian corporations continued to acquire new assets, including overseas ones, and to establish new long-term relations that would enable them to expand and enlarge their business, and boost up its efficiency. Also, some companies have completed the business restructuring process.
On April 18, 2007, the stockholders of Sakhalin Energy Investment Ltd, the operator of Sakhalin-2, signed an agreement with RAO Gasprom on completion of the process of the
Sakhalin Energy stock transfer in favor of Gasprom. The deal was concluded according to the protocol the companies signed on December 21, 2006, in Moscow. According to the terms and conditions of the protocol, Gasprom acquires 50% + 1 share in Sakhalin Energy worth a total of USD 7.5 bn. Each of the other three stockholders, that is, Royal Dutch Shell, Mitsui & Co., and Mitsubishi Corporation, reduces its package at 50% and receives a proportional share from the sales price. Now that the deal has been closed, the shares in Sakhalin energy will be as follows: OAO Gasprom - 50% + 1 share, Shell - 27.5%, Mitsui - 12.5%, and Mitsubishi -10%.
In May 2007, OAO Gasprom and the Belarus State Property Committee signed an agreement on sales of a stake in OAO Beltransgas. According to the agreement, Gasprom pays as much as USD 2.5 bn for the 50% stake in the company. Payments will be effected in equal installments in four stages over 2007-10, and at each stage Gasporm will be acquiring 12.5% of Beltransgas's stock. Until the completion of the deal the stock designated for sale to Gasprom should not be alienated, encumbered, nor they may be serve as collateral. Gasprom and the Belarus Government also signed a supplement to the Protocol of 31 December 2006 on establishment of a joint Russian-Belarus gas transportation company and organization of gas supplies, as well as gas transit via Belarus. Apart from other things, the Supplement particularly provides for a stage-by-stage (during 2008-10) increase in the level of the wholesale premium to the prices for natural gas Beltransgas sales to local customers, as well as the Bela-rusian party's obligation not to introduce the golden share on participation in control over OAO Beltransgas.
On July 13, 2007, Gasprom made its decision to pick Total as its foreign partner for the first stage of development of Shtokman field. The said stage provides for extraction of 23.7bn. cub. m of natural gas and launching its transportation, by means of gas pipeline, in 2013, while supplies of LNG are scheduled for 2014. To run the project design, funding and construction works, the parties agreed to establish a special company, which in the future will become an owner of the whole infrastructure of the first development phase. Gasprom's share in the authorized capital of the future company will be 75%, while that of Total - 25%. It was also announced that Gasprom was considering a possibility for attracting yet another one or several foreign partners, whose share would account for up to 24%, at Gasprom's expense. At any rate, Gasprom will retain possession of not less than 51% in the future company, as well as of the 100% stake in a company that holds the respective development license and will be the owner of all its future output.
In March 2007, Norilsk Nickel mining company closed a deal on acquisition of OM Group's nickel business. The Russian mining giant purchased a nickel- refining plant in Har-javalta (Finland), nickel producer Cawse in Western Australia, a 20% stake in MPI Nickel Pty. Ltd, that develops nickel mines there, the project developer Noneymoon Well, and a. 11.1% of participation in Talvivaaran Kaiveososakeyhtio in the form of ordinary shares and convertible debentures. Norilsk Nickel continues to expand its global production operations by adding new spots in Australia and Finland, which will enable the company to solidify its position in the world mining sector and bolster its nickel-refining capacity by 60,000 t. of nickel a year. Meanwhile, the company's own production of refined nickel (less tolling output) will rise at 35-40,000 t. annually.
On June 26, 2007, Norilsk Nickel announced the Canadian investment and regulatory authority had granted all necessary permits to complete a deal on acquisition of control over LionOre Mining International Ltd.
On September 4, 2007, the first stage of reorganization of the Head Company of RAO UES Russia was over. Two first generating companies - OAOOGK-5 and OAO tGK-5 were separated from RAO UES and became the pioneer private generating companies created in
Russia in the process of the electricity sector reform. Prior to their separation, the companies successfully placed issues of additional stock and attracted Rb. 12.28 bn and 11.63 bn in investment, respectively. As of today, their aggregate capitalization accounts for over Rb. 170 bn.
China's public oil and gas company Sinopec and OAOP Rosneft will start in 2008 joint operations on drilling for oil in the shelf oil land of Sakhalin-3. The partners were going to complete the seismic prospecting works at Veninsky bloc by the late-2007. According to the Chinese partner, the volume of oil production in Sakhalin should make up 21m t. by 2010, while that of natural gas - 31 bn cub. m.
On December 27, 2007, OAO Sberbank of Russia acquired the 100% stake in ZAO Bank NRB in Ukraine in a move to establish its daughter bank, OAO Sberbank Russia, on its base.
On December 28, 2007, OAO Gasprom neft and OAO LUKOil established a joint venture OOO Neftegazovaya kompania "Razvitiye regionov", with Gasprom neft holding the 51% share in the newly created company, why LUKOil's share accounts for 49%. The new company's authorized capital will be formed by the partners' cash, and they will be controlling it on parity basis. The profile of the newly created company will be implementation of versatile oil and gas projects.
Attraction of capital. In 2007, Russian companies vigorously attracted additional volume of investment, including those from overseas financial markets. They also solidified their positions on the world capital markets.
On February 21, 2007, OAO Gasprom placed Rb.-denominated bonds of A9 series in the volume of Rb. 5bn, with the face-value of Rb. 1,000 and maturity date of 7 years, By results of an auction held at MICEX the coupon rate by this series, payable every 182 days, was set at the level of 7.23% annualized. Investors submitted applications for the amount of over Rb. 9 bn. Underwriters of the loan became Renaissance Capital and OAO Rosbank, co-underwriter was Gorizont investment company, while OAO Federal Investment Corporation became financial consultant of the venture. The attracted capital will be spent on funding investment, implementation of Gasprom's new promising projects, a partial refinancing of the company's debt, and optimiziation of the structure of its debt portfolio.
On September 19, 2007, OAO Gasprom neft created a syndicate of international banks including ABN AMRO Bank N/V/, Caylon, Citigroup Global Markets Ltd, and Commerzbank Aktiengesellschaft to attract USD 2.2 bn in a new syndicated loan for the term of three years. The company is going to spend the attracted capital to fund its business expansion plans in the oil production and refinery segments. The loan is depreciable and was issued under the rate of LIBOR + 0.75% annualized.
In April 2007, OAO LUKOil successfully obtained a USD 250 m-worth unsecured syndicated loan organized by ABN AMRO and Calyon; some other huge international banks also joined in, and on 23 April, ABN AMRO and Calyon disbursed the first installment under the loan, whose term is 5 years and the annual rate equals LIBOR+0.4%. The same day, this sum was used to refinance a USD 765 m syndicated collaterized loan the company had been granted in 2003 against its export contracts. As the amount of applications for participation in the syndicated loan was twice as high as the volume of required funding, the market participants are evidently confident in the company's creditworthiness. Meanwhile, LUKOil decided not to raise the amount of the loan and lowered the banks' bids accordingly.
In addition, in June 2007 LUKOil placed Eurobonds worth a total of USD 1 bn. The papers were broken into two equal tranches with the maturity dates of 10 and 15 years, accordingly. The coupon rate of the USD 500m-worth 10-year tranche is 6.356% with the spread of +145 basic points to the US T-bonds, while that of the USD 500m-worth 15-year tranche accounts for 6.656% with the spread of +175 basic points to the US Treasuries. The placement
was organized by Deutsche Bank and Credit Suisse, and it should be emphasized that the company's bonds enjoy the highest rating ever awarded to papers issued by a Russian company. OAO LUKOil is going to use the borrowed capital on its general corporate needs, including refinancing its current debt, and on capital investment.
On February 22, 2007, Norilsk Nickel and a group of Western financial institutions signed a contract on opening a USD 450 m credit line organized, fully underwritten and syndicated by Barclays Capital, the investment subsidiary to Barclays Bank PLC, ING Bank N.V., and an investment division of Société Générale. SocGen also played the role of an agent with regard both to the loan and the respective documentation. The overall number of applications for participation in the syndicate significantly exceeded the original amount of USD 300 m, and Norilsk Nickel opted for boosting up the credit line to USD 450 m. The company pays a margin of 4.2 basic points over the LIBOR rate in the first three years, with a consequent increase of that up to 50 basic points in the 4th and 5th years.
On January 29, 2007, OAO Sberbank of Russia announced the launch of the so-called people's IPO, that is, placement of an additional issue of ordinary shares (3.5 m pcs) in RF available both to legal entities and private individuals. The placement was assisted by ZAO Credit Suisse (Moscow) and J.P. Morgan Bank International, which exercised the broker and book-running functions.
On January 18, 2007, OAO Sberbank of Russia signed an agreement on a syndicated loan totaling USD 750 m organized by The Bank of Tokyo-Mitsubishi UFJ, Ltd., Barclays Capital, Deutsche Bank AG, DZ BANK AG Deutsche Zentral-Genossenschaftsbank, ING Bank N.V., J.P. Morgan Plc, and Sumitomo Mitsui Banking Corporation Europe Limited. As many as 18 leading overseas banks with a broad geography of representation took part in the loan, including Commerzbank AG, Intesa Sanpaolo Bank, Nordea Bank Finland, The Bank of New York that provided the biggest fractions of the loan. The credit rate became LIBOR+0.45% annualized. The loan was arranged for the term of 3 years with a one-off payment at the end of the term, but the agreement also provides for the possibility for the loan extension for another 2 years without a change in the value of the attracted resources. The loan will be spent on general corporate purposes. Interestingly, it became the third syndicated loan Sberbank attracted over the past three years.
Dividend policy. It is a common knowledge that a sound dividend policy constitutes one of the most efficient means of bolstering attractiveness of a company's stock.
On July 22, 2007, at their general meeting stockholders in OAO Gasprom neft approved payment of the 2006 dividends at an amount of Rb. 8,0822 per 1 ordinary share, which means that the company will pay Rb. 38,320 bn in dividends until May 31, 2008.
According to the preliminary results of the voting that took place on December 21, 2007, an early general meeting of Norilsk Nickel's stockholders ruled to approve intermediate dividends totaling Rb. 108 per 1 ordinary share. The dividends are paid on recommendation of the company's Board, with account of its successful performance in the first 9 months of 2007. Norilsk Nickel is going to pay as much as some Rb. 19.8 bn in intermediate dividends.
2.6.4. Investment of Pension Savings in the System of Mandatory Pension Insurance
Value of assets within the funded component of the mandatory pension system
The assets within the funded component of the mandatory pension system are evolving at a very dynamic rate, which is natural for an early phase of the system's development. Over the year 2006, the total size of the mandatory pension system's funded component increased by more than one quarter, by early 2007 approximating the level of 350 billion rubles. However, so far Russia's funded system has been undergoing the initial phase of its evolvement,
and so, by international standards, its size is relatively small. In 2006 the assets within the mandatory pension system's funded component amounted to approximately 1.4 % of GDP, which is substantially lower than its level in developed countries (see Fig. 27) and behind the indices of many countries outside the OECD (Fig. 28).
Source: Pension Markets in Focus No. 4. OECD, November 2007.
Fig. 27. Assets of Pension Funds Against GDP in OECD Countries, 2006, as % of GDP
Note.
In brackets, see the value of pension funds' assets shown in billion USD. Source: Pension Markets in Focus No. 4. OECD, November 2007.
Fig. 28. Assets of Pension Funds Against GDP in Countries outside OECD,
2006, as % of GDP
The highest growth rate of pension savings was observed in independent pension funds (IPF). In the government asset manager's (Vneshekonombank's) investment portfolio the share of securities was diminishing, while the funds on the accounts of credit institutions were increasing. In the structure of investments held by private asset managers (PAM), a diminishing share of government securities and a simultaneously increasing share of corporate bonds have been very noticeable. The rate of return displayed by the leading PAMs in Q III 2007 became markedly lower. 206
By early 2007, the value of assets in which pension savings were invested by asset managers (AM), including the government asset manager (GAM) and independent pension funds (IPF) amounted to 286.2 billion rubles (see Table 55)75. In Q I 2007, the RF Pension Fund (PFR) was transferring pension savings in accordance with the applications submitted in 200676. While the overall investment activity of citizens remained low both in 2005 and 2006, the preferences of the overwhelming majority of those insured persons who effectuated their right of choice between an asset manager and an IPF were in favor of IPFs. Out of the 924 thousand applications received by the PFR in 2006, 796 thousand requested a transfer from the PFR to a IPF.
Table 55
Value of Assets in the Mandatory Funded Pension System, billion rubles
01.01.2007 01.04.2007 01.07.2007 01.10.2007
Value of net assets in which pension savings transferred to AMs were invested 276.2 270 274.5 340.1
including government asset manager 267.1 260.7 265.1 329
including private asset managers 9.2 9.4 9.4 11.1
Pension savings held by independent pension funds (IPF) 9.96 19.85 19.25 25.55
Total 286.2 289.85 293.75 365.65
The inflow of pension savings to IPFs on the applications of insured persons, submitted in 2006, produced a more than twofold growth of the mandatory pension insurance funds held by these organizations in Q I 2007 (during that quarter, the IPFs' pension savings increased from 9.96 to 19.85 billion rubles).
In the next two quarters the sum of pension savings held by IPFs rose by further 28%, amounting as of 1 October 2007 to 25.55 billion rubles. Its growth during Q III was also in the main conditioned by a seasonal factor - the transfer of insurance contributions from the PRF. As a result, as of the end of Q III, the IPFs engaged in mandatory pension insurance were accounting for 7% of the total sum of assets managed by the State and by private asset managers (PAMs), as well as by IPFs.
It should also be noted that the transfer from the PRF to an IPF does not necessarily entail the diminishment of the number of the so-called "lurkers" - insured persons who have failed to select a specific investment strategy (namely, a specific asset manager) or a nongovernment insurer (an IPF). Some of the insured persons were attracted by IPFs from among those who had previously made their choice of an asset manager. As a result, the private asset managers, which had been handling pension savings under their agreements with the PRF concerning the trust management of pension savings, also experienced in Q I 2007 a net
75 Hereinafter, the data from the official websites of the Pension Fund of the Russian Federation (PFR) and the Federal Service for Financial Markets (FSFM) are applied.
76 Due to amendments introduced to legislation, the schedule for transfers of pension savings on the applications of insured persons to the AMs and IPFs selected by them has been somewhat changed, the transfers now being executed by the PRF during the first quarter of the year following the year in which an application has been submitted by an insured person to the PRF, instead of the end of that year.
outflow of funds in the amount of 0.2 billion rubles, although to a lesser degree than that experienced by the GAM (Vneshekonombank).
The market value of the assets, in which pension savings had been invested by PAMs, as of the end of Q I 2007 amounted to 9.4 billion rubles. By the end of Q III this index went up to 11.1 billion rubles, while the share of pension savings managed by PAMs constituted 3% of the sum of pension savings transferred by the PFR to asset managers and IPFs.
The total share of pension savings invested by PAMs and held by IPFs by the end of Q III 2007 amounted to 10% against 6.7% at the year's beginning.
Resulting from the transfer of pension savings on the applications of insured persons, the volume of funds managed by Vneshekonombank in Q I 2007 slightly diminished. As of the end of the year 2006, the value of pension savings invested by Vneshekonombank was in excess of 267 billion rubles. By way of executing citizens' applications concerning their choice of an asset manager or an IPF, Vneshekonombank made a transfer of 9.6 billion rubles to the PFR. As a result, the value of assets held by the GAM as of the end of Q I 2007 amounted to 260.6 billion rubles. Over the next quarter, growth in the value of assets held by the GAM was determined by the results of actual investments and amounted to 1.7%. By the end of Q III, the market value of the assets in which the pension savings held by the GAM were invested became as high as 320 billion rubles, mainly due to a seasonal transfer of contributions to the funded component of labor pension from the PFR. The overall increase in the value of the GAM's assets during that quarter amounted to 63.8 billion rubles, of which the net inflow of funds from the PFR was 59.9 billion rubles.
Approximately one half of the pension savings transferred into trust management to PAMs is held by 5 companies (53% as of the end of Q III 2007). The leaders - the AM Posbank and the AM "Pensionnyi reserv" - accounted for 15% and 12%, respectively, of the total sum of pension savings managed by PAMs.
The structure of Investments
Investments of the Government Asset Manager
The structure of Vneshekonombank's investments in 2007 and of the aggregate investment portfolio of all the private asset managers as of the end of the year 2006, as well as of the end of Q III 2007, is shown in Fig. 29-34.
During the first quarter, the GAM's investment portfolio displayed a diminishing total share of monies invested in securities (the monies at credit institutions, in rubles, decreased from 7.7% to 2.5%). As a result, the share of ruble-denominated government securities went up (from 78% to 82%). The share of RF foreign-currency-denominated government securities in the government asset manager's investment portfolio was around 10% both at the beginning and at the end of Q I.
In Q II, GAMs' investment portfolio demonstrated a slight drop in the share of RF government securities denominated in foreign currencies (from 10.6% to 6.7%). Besides, the PFR for the first time disclosed the structure of pension savings invested in government savings bonds (GSO) - nonmarket securities issued by the RF Ministry of Finance for institutional investors. Their sum in the investment portfolio of GAMs in mid-2007 amounted to 66.2 bil-
77
lion rubles (41% of the total investments in ruble-denominated government securities), which constitutes 24.1% of the total value of assets held by asset managers (274,5 billion rubles), or 25% of the value of assets managed by Vneshekonombank (265.1 billion rubles).
In Q III the share of investments in GSO in GAMs' investment portfolio increased to 29.2%, against the backdrop of an overall drop in that investment portfolio's share of securities (from 85.6% to 82.8%) and an increase in the amount of deposits on the accounts of credit institutions (from 5.7 to 11%).
RF government
securities, denominated in Foreign currencies 10.0%
Monies at credit institutions, in rubles, 7.7%
Monies at credit institutions, in foreign currencies, 2.2%
Other 1.7%
RF ruble-denominated government securities 78.4%
Fig. 29. The structure of the Investment Portfolio of the Government Asset Manager (Vneshekonombank), as of the end of 2006
77 There are no such securities in PAMs' portfolios.
Fig. 30. The Structure of the Investment Portfolio of the Government Asset Manager (Vneshekonombank), as of the end of Q I 2007
RF government securities, denominated in foreign currencies 6.7%
Monies at credit institutions 5.7%
Other -2.0%
RF ruble-denominated government securities
Fig. 31. The Structure of the Investment Portfolio of the Government Asset Manager (Vneshekonombank), as of the end of Q II 2007
Fig. 32. The Atructure of the Investment Portfolio of the Government Asset Manager (Vneshekonombank), as of the end of Q III 2007
Investments of Private Asset Managers
Within the structure of investments held by PAMs, one cannot overlook the noticeable fall in the share of government securities and the increasing share of corporate bonds. The share of federal debt liabilities diminished from 10.4% as of the end of 2006 to 5.9% as of the end of Q III 2007 (see Fig. 31-32). As for the share of subfederal debt liabilities, it decreased during the same period from 23% to 13.8%. At the same time, the share of corporate bonds in the aggregate investment portfolio of PAMs increased from 21.8% to 33.8%.
The percentage of shares in the aggregate investment portfolio of PAMs was lowest as of the end of Q I 2007 (26.6%), and highest - as of the end of Q II (30%). As of the end of Q III the percentage of shares amounted to 28.2%. Over the period under consideration, the dynamics of Russian stock exchange indices was displaying high volatility, which was inevitably reflected in PAMs' investment policy. However, while in Q I the percentage of shares diminished in the wake of falling indices (see Fig. 35), no such correlation was observed any more in Q III: the percentage of shares was diminishing by the end of Q III by 1.8 p.p. against the backdrop of an unstable but nevertheless visible growth on the Russian share market.
-moines on-
accounts of credit institutions 0.8%
RF government securities 10.4%
Deposits
I— 6.6%
Other - 5.9%
Subfederal bonds 23.0%
Shares 29.4%
Bonds of Russian economic societies 21.9%
Municipal bonds 2.0%
Fig. 33. The Structure of the Investment Portfolios of Private Asset Managers,
as of the end of 2006
monies on accounts of credit institutions 2.0%
Deposits 7.2%
Other 8.3%
RF government securities 5.9%
Municipal bonds 1.1%
Subfederal bonds 13.8%
Shares 28.2%
Bonds of Russian economic societies 33.6%
Fig. 34. The Structure of the Investment Portfolios of Private Asset Managers
as of the end of Q III 2007
2500 2400 2300 2200 2100 2000 1900 1800 1700 1600 1500
Fig. 35. The RTS index in 2007
The structure of the investment portfolios held by PAMs - leaders with regard to the size of managed pension savings - is shown in Table 56. As seen from this table, the percentage of shares in the investment portfolios of these PAMs was fluctuating, as of the end of Q III, between 24.6% and 39.6%.
Table 56
The Structure of the Investment Portfolios Held by PAMs - Leaders in the Size of Managed Pension Savings (as % of assets)
Asset managers
Types of assets ROSBANK PENSIONNYI RE- SOLID MANAGE- URALSIB AK BARS
SERV MENT KAPITAL
Securities, total 74.5 75.9 76.8 92.5 90.7
including:
RF government securities 0.0 0.0 9.7 0.0 12.5
Securities of RF subjects 10.5 22.0 1.7 5.0 17.6
Municipal bonds 0.0 3.0 0.0 0.8 1.5
Bonds of Russian economic 33.2 26.3 25.8 47.4 33.6
societies
Shares issued by Russian 30.8 24.6 39.6 39.3 25.5
companies
Monies on accounts at credit 4.1 4.5 0.0 0.0 0.1
institutions
Ruble-denominated deposits at 17.5 16.9 8.1 0.0 3.2
credit institutions
Receivables, including: 3.9 2.7 15.1 7.5 6.0
funds on special broker ac- 3.0 1.6 14.5 6.4 4.8
counts
receivables against interest 0.9 1.0 0.6 1.1 1.2
income on bonds
other receivables 0.0 0.1 0.0 0.0 0.0
Total market value of portfolios 100 100 100 100 100
0\ 0\ CG 0\ 0\ 0\ 0\ 0\ 0\ 0\ 0\ 0\ 0\
The Rate of Return on Investments
The rate of return on the pension savings invested by the GAM, according to the results of the first three quarters, was at a level approximating that at the end of the year 2006 (see Fig. 36). However, while in 2006 and in the first half-year 2007 the rate of return on the GAM's investment portfolio remained at a level higher than that of the rates of return on the Federal Government's ruble-denominated bonds (OFZ) with maturities of up to one year, but lower than the rates of return on the securities with maturities of more than one year, by the results of the first three quarters of 2007 this index was found to be lower than OFZ's rate of return, which in August - September was displaying an upward trend.
----yield to maturity 90 days and 1 year -Vneshekonombank's rate of return
• yield to maturity more than 1 year
Source: RF CB, Vneshekonombank.
Fig. 36. Average Weighted Interest Rates on the GKO - OFZ Market and the GAM's Rate
of Return in 2006 and first half-year of 2007
For PAMs, Q III turned out to be unlucky in terms of the results of their investing. As already seen at the end of the first half-year, the average rate of return on PAMs' investment portfolios was 2.9%, while 14 investment portfolios managed by PAMs in Q III displayed negative results of investing, and only 2 investment portfolios were characterized by rates of return at a level similar to or higher than that of the GAM (those managed by the AM "Uni-ver-management" and "Region asset management"). However, the investment portfolios of these AMs fell outside of the category of big ones (24.7 and 19.3 million rubles, respectively). The results demonstrated by the leaders in the absolute size of their investment portfolios as of mid-2007 and the end of Q III can be seen in Tables 57-58. As shown by the Tables, the vola-
tile situation on the stock market was reflected by the investment results achieved by all the leaders. All these AMs displayed a negative rate of return in real terms, while two AMs in the first half-year and three AMs in the first three quarters also displayed a negative nominal rate of return. However, over a longer period of three years they all displayed rates of returns higher than the average per annum rate of return on the GAM's investments (which amounted to 7.98% as of mid-2007 and 8.11% as of the end of Q III 2007).
Table 57
The Rates of Return on Investments of PAMs with the most Substantial Investment Portfolios, as of end of June 2007
Asset manager Net asset value (NAV) Rate of return per annum, %
as of mid-2007, million rubles In 6 months In 12 months In 3 years
UK ROSBANKA 1,408.6 3.04 15.65 9.94
PENSIONNYI REZERV 1,071.7 3.90 14.89 16.92
SOLID MANAGEMENT 884.0 -0.48 23.27 19.15
URALSIB UK 799.3 -2.14 16.61 23.48
AK BARS KAPITAL 787.9 4.15 15.58 13.33
Table 58
The Rates of Return on Investments of PAMs with the most Substantial Investment
Portfolios, as of end of September 2007
Net asset Rate of return per annum, value (NAV) % Asset manager as of end of Q -
III 2007, mil- In 9 months of 2007 In 12 months In 3 years
lion rubles
UK ROSBANKA 1,656.7 -0.47 9.95 11.24
PENSIONNYI REZERV 1,322.2 3.94 11.46 17.26
SOLID MANAGEMENT 987.2 -3.09 13.83 16.43
URALSIB UK 946.2 -4.03 9.06 21.15
AK BARS KAPITAL 923.3 0.51 8.09 10.47
