5Section 2. Monetary-Credit and Budgetary Spheres
2.1. The Monetary and Credit Policy
A major trend in the monetary and credit sphere of the Russian Federation in 2010 was the cutting-down of support to anti-crisis Russian financial system by the Bank of Russia in the course of the gradual recovery of the Russian economy. Herewith, the resumption of monetary supply growth by monetizing the total balance of payments, as well as a significant negative shock of aggregate supply in summer (as a result of the drought) again caused an acceleration of inflation in autumn. Reduced dependence of the banks of the RF Central Bank and the sustained net flow of currency to the country once again bring the Bank of Russia at a choice between reducing inflation and managing the exchange rate. At the same time, representatives of the Central Bank of Russia declare the inflation reduction as their priority goal.
2.1.1. The Monetary Market
During 2010, there was again observed a substantial increase in the RF international reserves (Fig. 1). The main factor of growth were relatively high prices for Russia main exports, primarily oil, gas and metals. Furthermore, the reduction for the year Euro against the USD in the global currency markets brought about a decline in the dollar value of the reserves denominated in Euro. As a result, there was a trade surplus of the Russian Federation, and the national international reserves were growing, as the Bank of Russia bought foreign currency to slow down the growth of the nominal exchange rate.
By the end of the volume of international reserves amounted to 479.4 billion dollars, while at the beginning of the year they accounted for 439.5 billion dollars, i.e., during the year reserves grew by 9.1%. The volume of the RF international reserves remains sufficiently large by international standards: they are in the third place in the world in absolute value after the reserves of China and Japan. However, the experience of winter 2008/2009 showed that the sharp deterioration in external economic conditions and massive capital outflows, even such large reserves can be quickly spent in case of maintenance of the RF Central Bank rate. In addition, the rapid growth of imports, while maintaining net capital outflows from Russia caused by the persistence of high economic and political risks of investments in Russia, as well as the need to service a large external debt, reducing the supply of currency in Russia. Therefore, with the stable energy prices in 2011, international reserves will probably grow more slowly than in 2010.
ö
8100 -7100 -6100 -5100 --
^ 4100 -3100 +
2100 -1100 --
100
755
705
655
605
555
505
455
405
355
305
255
205
155
105
55
5
(N (N m
3 s X =s <u
< S O g Q
in in ^o
■O a £ > c c W W ^ O 3 =3 ft M < g ^ ^
00 00
3 S X =3 <U
< S O g Q
Ö
Q
m £
Monetary Base
International reserves (right scale)
Source: RF Central Bank.
Fig. 1. The Dynamics of the Monetary Base and Foreign Reserves
in 2000-2010
As one can see from Fig. 1, after the crisis, the monetary base was growing at progressive rate as compared to international reserves. An important source of monetary supply growth in 2010, in addition to the operations of the Central Bank of Russia in the foreign exchange market was the use of the Reserve Fund to finance the budget deficit. During 2010, the accounts of the Ministry of Finance of Russia declined by 1.7 trillion rubles. In fact, the monetization of fiscal deficits causes expansion of monetary supply to Russia
Herewith, the constraint of the growth of the monetary base at the beginning of the year was the reduction of the net debt of credit institutions to the RF Central Bank (see Table. 1 and Fig. 2). However, already in summer of 2010 credit to the banks on the part of the RF Central Bank has been reduced to the pre-crisis level and further had no significant effect on the balance sheet of monetary regulation. Therefore, in case of continued balance of payments and budget deficit of 2011, one can expect a significantly higher rate of growth of money supply, which increases the risk of inflation.
Table 1
Bank of Russia Balance, 2009-2010
01.01.2009 01.01.2010 01.12.2010
RUR. bn. % assets/ liabilities RUR. bn. % assets/ liabilities RUR. bn. % assets/ liabilities
Funds placed with non-residents and 12091.1 71.3 12383.3 80.3 13752.2 85.8
foreign issuers' securities
Credits and deposits 3871.3 22.8 1705.8 11.1 551.4 3.4
Precious metals 450.3 2.7 764.6 5.0 1172.0 7.3
Securities 441 2.6 465.9 3.0 446.6 2.8
Other assets 110 0.6 100.3 0.7 105.1 0.7
Assets, total 16963.7 100 15420 100 16027 100
Cash in circulation 4378.2 25.8 4629.9 30 5153.0 32.2
Cash on accounts with the Bank of 10237.6 60.4 7979.7 51.7 6978.7 43.5
Russia
Including the government of Russia 7093.9 41.8 4980.2 32.3 4434.2 27.7
Those of resident-credit institutions 2010.1 11.8 1731.3 11.2 934.2 5.8
Cash in settlements 16.1 0.1 8.4 0.1 44.8 0.3
Securities issued 12.5 0.1 283.1 1.8 870.8 5.4
Other liabilities 319.2 1.9 168.3 1.1 818.8 5.1
Capita 1902.4 11.2 2099.1 13.6 2161.1 13.5
Profit by the reported year 97.8 0.6 251.4 1.6 0 0.0
Profit by the reported year 16963.7 100 15420 100 16027.3 100
Source: the Bank of Russia.
3000
oo oo oo oo oo oo en en en en en en 0 0 0 0 0 0
0 0 0 0 0 0 0 0 0 0 0 0
0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0
CM CM CM CM CM CM CM CM CM CM CM CM CM CM CM CM CM CM
t-^ CO en T^ CO en t-— T-" co r^ en t~
o o o o o T'- o o o o o t— o o o o o T'-
en O) O) O) en en en en en en en en en en en en en en
0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0
ISUnsecured credit □ Other credits ■ Lombard, Day-time credit, Overnight credit
Source: the Bank of Russia.
Fig. 2. Debts of credit institutions under the loans of the Bank of Russia in 2009-2010.1
1 "Other" credits include loans secured by the Bank of Russia under promissory notes, rights of claim under loan agreements with organizations or guarantees of credit institutions.
Dynamics of the assets of the Central Bank of Russia has led to the expansion of the monetary base during 2010 the monetary base (in wide terms1) increased by 1.7 trillion rubles - up to 8.2 trillion rubles (26.6%) (Table 2). Recall that in 2009, this figure rose by 15.9%. Cash in circulation, with the account of credit institutions' cash balances accounted on January 1, 2011 amounted to 5.8 trillion rubles (25.1% as compared with January 1, 2010), the correspondent accounts of credit institutions with the Bank of Russia - 1 trillion rubles (10.5%), compulsory reserves - 188 billion rubles (+24.4%), deposits of credit institutions with the Bank of Russia - 633.2 billion rubles (+24.4%), the value of Bank of Russia bonds with credit institutions - 588.9 billion rubles (grown in 2010 by 2.1 times).
Table 2
The Dynamic of the Monetary Base in Broad Terms in 2010 (RUR. Bn.)
01.01.2010 01.04.2010 01.07.2010 01.10.2010 01.01.2011
Monetary base (in broad terms) 6467.3 6 363.90 7 195.00 7 126.00 8190.3
Including:
Cash in circulation, with account of credit organiza- 4622.9 4 411.20 4 828.10 5 024.50 5785.2
tions' cash balances
Credit organizations' corresponding accounts with 900.3 579.5 603.6 590 994.7
the Bank of Russia
Compulsory reserves 151.4 167.7 175.5 182.2 188.4
Credit organizations' deposits with the Bank of 509 469.6 637 519.4 633.2
Russia
The bonds of the Bank of Russia held by credit 283.7 735.9 950.8 810 588.9
organizations
Source: the Bank of Russia
Monetary supply M2 in national terms has increased over the 2010 by 28.5% and amounted on January 1, 2011 to RUR 20173.5 bn or 45.3% of GDP (on January 1, 2010 monetary aggregate M2 amounted to RUR15,697.7 billion (40.5% of GDP). Consequently, in 2010, the monetization of the Russian GDP was growing due to a rapid increase in the monetary base and expanded lending to the economy from commercial banks. In the conditions of high uncertainty about the RF future prospects of economic development, the monetary growth in the medium term will be largely determined by foreign economic situation, as well as the volume of the budget deficit, on the one hand, and speed economic recovery and credit activity of the banking sector on the other hand.
2.1.2. Inflationary Processes
One of the important consequences of the 2008-2009 economic crisis for the Russian economy as a significant slowdown of inflation due to the decline in aggregate demand and due to the reduced monetary supply (within September 2008 - February 2009 M2 monetary supply decreased by 17.3%). In the first half of 2010 inflation continued to reduce, but in the
1 According to the RF Central Bank methodology, the monetary base in wide terms characterizes the Bank of Russia's monetary and credit liabilities denominated in the national currency, which determine growth in money supply. The monetary base in wide terms comprises cash the RF Central Bank issued in circulation (with account of credit institutions' cash balances), balances of the compulsory reserves accounts which credit organizations deposit with the Bank of Russia, monies on correspondent accounts (including averaged balances of compulsory reserves) and deposit accounts the credit organizations have with the Bank of Russia, their investments in the Bank of Russia's bonds, backup funds by forex transactions deposited with the RF Central Bank, as well as the Bank of Russia's other liabilities bywith respect to operations with credit organizations in the currency of the Russian Federation. 28
beginning of the year conditions were created for the acceleration of inflation in the form of rapid monetary supply growth (see previous section) (Fig. 3). A drought, which hit Russia in summer of 2010, has made practically inevitable the acceleration of inflation in autumn. Let us consider inflation in 2010 in more detail.
—■ — 2009 —•—2010
Source: Russian State Statistical Service.
Fig. 3. The Dynamics of CPI of the RF in 2009-2010
In January - December 2010 food prices grew on average across the country by 12.9% (versus 6.1% in 2009) (Table 3). The main contribution to the growth of food prices has made a rise in cereals and beans (+58.8%), fruit and vegetables (+45.6%), sunflower oil (+ 27.6%), butter (+23.3%) and sugar (+22.5%). The rapid increase in food prices has made the most significant contribution to the CPI growth in 2010. Prices for commercial services have grown in 2010 by 8.1% (against 11.6% in 2009). During January - December the utmost growth in prices were observed in housing and utilities (+13%) for passenger transport services (+8.7%), services of cultural organizations (+8.6%) for medical services (+8. 4%). Non-food products have increased in price in 2010 by 5% on average (against 9.7% in 2009). During the year the utmost growth took place in the price of tobacco products (+19.5%) for knitwear (+7.8%), clothing and underwear (+7.1%) and motor gasoline (+6.5%) . The rate of increase basic consumer price index for 2010 made 6.6% (against 8.3% for the same period of the last year). Therefore, the main factors of inflation dynamics in 2010 were the effect of a low base in 2009, on the one hand1 and monetary supply growth against the background of a slow recovery of economic activity and aggregate supply shock in the summer - on the other hand.
From the Table 3 one can see that the major component of inflation in 2007-2010 was the growth in food prices, the expenses for which are the substantial share of household expenditures. At the same time, in 2010 food expenses growth was twice faster than in 2009. The
1 In early 2009 accelerated inflation was recorded in Russia.
main reason for this was the summer drought. Such a conclusion can be drawn basing on the fact that a significant acceleration of growth in food prices began in the fall, while the growth in price was faster for the products, affected by the drought. At the same time, we would like to note that the rapid rise in food prices in 2010 took place all over in the world, but the CPI in the most developed countries remained at a low level. This may indicate either the great possibilities of Russian companies to raise prices due to low competition, and the effects of faster growth in monetary supply in late 2009 - early 2010, as well as the mature high inflationary expectations.
In the sector of commercial services sector one should note the continued growth in prices for housing services. At the same time, in 2010 housing services rose much less than in 2009, whereas in 2008-2009 accelerated pace of appreciation of service were observed. A further slowdown in price increases for housing and communal services in view of the alignment of their prices for population and industrial enterprises, as well as reducing the level of subsidy rates for utility services from the state will decrease the contribution of higher prices of housing services in inflationary pressures.
Non-food products in 2010 rose in price more slowly. Herewith, a rapid increase in tobacco prices was due to primarily an increase excise taxes on them, and the price for knitwear, clothing and underwear - rise in price for cotton due to low yield.
Table 3
The Annual Price Rise Rates for Some Kinds of Goods and Services in 2007-2010 (as% December/ to December of the preceding year)
2007 2008 2009 2010 2007-2010
CPI 11.9 13.3 8.8 8.8 50.1
Food stuffs 15.6 16.5 6.1 12.9 61.3
Grits and beans 24.7 25.8 -2.5 58.8 142.9
Butter 40.3 10.5 7.9 23.3 106.3
Sunflower- oil 52.3 22.1 -19.8 27.6 90.3
Pasta 23.6 33.8 1.6 4.7 75.9
Milk and dairy products 30.4 12.2 2.3 16.7 74.7
Bread and bakery 22.4 25.9 2.4 7.6 69.8
Meat and poultry 8.4 22.2 5.0 5.3 46.5
Fish and seafood 9.0 15.1 10.6 4.8 45.4
Non-food goods 6.5 8.0 9.7 5.0 32.5
Construction materials 16.2 11.3 2.1 4.6 38.1
Gasoline 8.5 1.2 8.0 6.5 26.3
Services 13.3 15.9 11.6 8.1 58.4
Housing and utilities 14.0 16.4 19.6 13.0 79.3
Preschool education services 11.8 20.7 16.2 7.7 68.9
Sanatorium and rehabilitation services 15.6 21.2 9.5 5.4 61.7
Passenger transportation services 13.6 22.5 6.5 8.7 61.1
Cultural institutions' services 14.5 15.5 11.3 8.6 59.8
Source: Russian Statistical Service.
In conclusion, let us compare the consumer price rise rates in the RF with those in other CIS Countries (Table 4).
Table 4
Consumer Price Indices in the CIS Countries in 2000-2010, % versus Relevant Period of Preceding year
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010*
Azerbaijan 2 2 3 2 7 10 8 17 21 1 5,2
Armenia -1 3 1 5 7 1 3 4 9 3 7,8
Belarus 169 61 43 28 18 10 7 8 15 13 7
Kazakhstan 13 8 6 6 7 8 9 11 17 7 7
Kyrgyzstan 19 7 2 3 4 4 6 10 25 7 4,9
Moldova 31 10 5 12 12 12 13 12 13 0 7,2
Russia 20 22 16 14 11 13 10 9 14 12 6,4
Tajikistan 24 37 10 17 7 8 12 21 20 6 5,6
Ukraine 28 12 1 5 9 14 9 13 25 16 9,3
*Data for January-September.
Source: The CIS Intergovernmental Statistics Committee (http://www.cisstat.org/).
Inflationary processes in the CIS countries in the recovery period after the economic crisis were determined mainly by two groups of factors. On the one hand, in many countries, the crisis led to depreciation of the national currency, which in early 2009 contributed to higher prices by raising import prices and inflationary expectations. In early 2010, there was an effect of a low base, stimulated some moderation in inflation. In addition, economic recovery in the most CIS countries is still rather slow, which imposes constraints on inflation from aggregate demand.
On the other hand, in 2009-2010 the monetary supply was growing. In addition, the resumption of increasing consumer demand also increases the inflationary pressure. As a result, the combination of the above factors determines the rate of price growth in the CIS countries.
In the Russian context recovery in prices for the Russian main export goods (despite the outflow of private capital), a negative supply shock, as well as financing the budget deficit at the expense of the Reserve Fund have caused inflation in the second half of the year. Due to the low inflation in the first half of 2010, in general, CPI remained at the level of 2009 However, in case of continuation of these trends, inflation up to 2011 may not show further decrease and remain at 8-9%.
2.1.3. The State of the Balance of Payments1 and Foreign Currency Market
Balance of payments stability of the Russian Federation in 2010 was ensured at the expense of exports, especially fuel and energy complex products. Global economic recovery after the crisis, as well as the preservation of mitigated monetary and credit policy in the US and the EU have inspired growth in commodity prices, resulting in the growth of fuel and energy exports from Russia by the year-end by 32% as compared with the previous year. At the same time, the outflow of capital from the country within the year was much greater than expected by the Government and the Bank of Russia, which reflects the high risks of investing in the Russian economy. In view of combination of the above factors, the balance of payments appears to be quite stable, but in the medium term such stability of the balance of payments would be in danger as a result of the rapid growth of imports in Russia compared to
1 The analysis of the balance of payments was conducted on the basis of the RF Central Bank's preliminary data:http://cbr.ru/statistics/credit_statistics/print.asp?file=bal_of_payments_est.htm
exports from the country, and continued growth of the balance of account deficit of operations with capital and financial instruments.
According to the published by the Bank of Russia preliminary assessment of the balance of payments of the Russian Federation in 2010, positive current account balance amounted to 72.6 billion dollars, i.e., increased by 47,1% as compared with 2009 (Table 5). Herewith, trade balance surplus grew by 33.7% (from 111.6 billion to 149.2 billion dollars), while exports of goods increased by 31.2% (from 303.4 billion to 398 billion US dollars), and imports of goods increased by 29.7% (from 191.8 billion to 248.8 billion dollars). The share of exports of oil and natural gas amounted to 63.3% in the total value of exports, having increased by 0.4 percentage points as compared with 2009 (Fig. 4). Therefore, as in previous years, the main factor determining the scope of the balance of current account, was the balance of trade, which, in turn, largely depends on the changes of energy prices and other major Russian export commodities in the global markets. The data presented in Fig. 5, shows that the relationship between oil prices and the trade balance of Russia, observed in 2002-2009, was demonstrated within 2010 as well.
Source: RF Central Bank .
Fig. 4. The Dynamics of Commodities Export and the Share of Fuel and Energy Complex Products in 1999-2010
Deficit in the balance of services reached 27.3 billion dollars and increased (in absolute value) compared with 2009 by 37.3%. Exports of services amounted to 44.1 billion dollars, an increase against the previous year by 2.6 billion dollars (+6.1%). Imports of services for 2010 has increased by 16.2% and reached 71.4 billion dollars. Balance of labor compensations in 2010 has increased in absolute value and amounted to -9.2 billion dollars (in 2009 it made -8.6 billion dollars). Deficit of balance of investment revenue in 2010 as compared with 2009 increased by 6.9% and reached 36 billion dollars. Investment gains due rose from 30.7 billion to 32.8 billion dollars, which is based on a significant decline in non-financial companies revenues (from 15.1 billion to 20 billion dollars). The rise of income receivable was due to
the global economic recovery and growth of investment abroad. Increased revenues receivable by non-financial enterprises from 46.6 billion to 56.4 billion dollars has identified the growth of general income receivable from 61.5 billion to 68.8 billion dollars.
The balance of current transfers1 in 2010 accounted for -4.1 bn US dollars, having decreased by 8.8% as compared with 2009.
Table 5
Main Items of the Balance of Payments and the Dynamic of External Debt
in 2008-2010 (USD bn.)
Balance Item
2008
2009
2010
I Q. II Q. III Q. IV Q.
I Q. II Q. III Q. IV Q.
I Q. II Q. III Q. IV Q.*
Current account
Capital and financial instruments account2 Change in forex reserves ( «+» -"decline of reserves", «-» - growth in reserves) Net mistakes and omissions Change in external debt of RF ( «+» growth in debt, «-» - decrease of debt) Change in the external public debt of RF Change in the external debt of the private sector in RF
38.7 26.8 -20.5 35.2
-12.1
-6.1 19.1
0.2
-64.9
2.9 51.5
-1.5
29.6 -15.9
-8.9
-4.7 6.3
.5
-130
103.7 9.7 -131.3 -32.4
124.8 38.9
30.5
-2.0
-3.3 -60.3
-3.7
-11.3 -7.8 16.6 -34.2
-7.1
-2.4
8.2 3.1
-14.2
2.9 19.6
4.1
15.4
-27
9.1
2.6 7.9
9.4
16.1 12.1
49.4 33.3 -44.3 -11.2
-28.8 -3.4 -16.6
0.6 -1.7 -6.7 -13.3
2.5
13.7
-5.5 -3.5
-2.4
-26.1
-1.1 -7.3
3.8
-2.7
2.7 19.1
-0.3
14.3 -21.4
8.6
-1.5 7.4
-0.2
72.6 -30.5
-36.8
-5.4 15.7
0.9
* Preliminary estimates. Source: The Bank of Russia.
Thus, it was high prices for major Russian exports that were behind a huge positive balance of current accounts of the Russian balance of payments in 2010. Let us note that at the end of the year, the debt of has resumed its growth again (see Table 5). As to foreign debt, it has changed slightly for the year, having increased only by 0.9 billion dollars. In the medium term, one can expect recovery rates of external debt growth, both, in private and public sector of economy, due to the lack and high cost of financial resources domestically, as well as the continuing budget deficit.
19
6
19.0
53.0
8.4
56.6
23.7
31.8
15.5
1.5
9.2
27.0
1.1
11.1
19.4
7.6
14.9
1 According to the RF Central bank, the current transfers bolster the level of disposable income and consumption of the recipient's goods and services and decrease the donor's disposable income and possibilities for consumption, for instance, humanitarian aid in the form of consumer goods and services. The current transfers are reflected in current accounts. Transfers other than current are conceived of as capital ones. They lead to a change in the volume of the donor or recipient's assets or liabilities and are reflected in capital accounts. In the event the donor and the recipient are non-residents to each other, the capital transfer engenders changes in the level of national wealth of the economies they represent. Examples of capital transfers are a free-of-cost transfer of property rights for capital assets or debt forgiveness.
2 Less foreign currency reserves.
Q 3
60000 - -
50000 --
40000 - -
30000 - -
20000 -
10000 -
] Balance of trade
Oil Price Index (Q I 2005 = 100%, right axis)
♦
fS ^ fO
© fS fO
o
2005
2006
A
O
©
2007
—
V
H
m m
m 00
t> m
T 00
fS fS
00
> (D (D tr CD
tT CD CD CD
3 O m
2008
2009
2010
850%
750%
650%
550%
450%
350%
250%
150%
50%
-50%
0
Source: the RF Central Bank, IEP estimates.
Fig. 5. RF Balance of Trade and the World Oil Price Index in 2005-2010
In 2010, the balance of operations with capital account and financial instruments has significantly declined in absolute terms, amounting to USD -30.5 billion. The balance of capital transfers in 2010, amounted to USD 0.2 billion. Therefore, in 2010 the deficit of financial account amounted to USD -30.7 billion.
Increase of liabilities of the Russian economic agents against foreign economic agents as per the year results totaled to 36.6 billion dollars, which is 5.5 times more than in the previous year (6.6 billion dollars).
Like in 2009, the federal administrative bodies likewise became net payers in relation to non-residents. Their external liabilities have grown by USD 3.6 bn, resulting from repayment of Russia's external public debt.
Their external liabilities rose by 3.6 billion dollars, which resulted from sales of the newly issued debt securities of the Government of Russia by non-residents. The balance of external liabilities across the RF Subjects remained unchanged. Reduction of monetary regulation authorities' commitments in 2010 reached 2.1 billion dollars.
The resumption of the global economy growth after the financial crisis, demonstrated, among other things, in gradual recovery of the global capital markets and the growing interest of investors to risk by maintaining low interest rates in developed countries has resulted in the fact that the banking sector of the Russian Federation obligations to non-residents once again began to grow, increasing within the year to 18.1 billion dollars. At the same time, invest-
ments of economic agents of other countries in the non-financial sector of Russia accounted to only 16.4 billion dollars as compared with 34.4 billion dollars in 2009. Therefore, nonresident investments in non-financial sector of 2010 decreased compared to 2009, despite the resumption of economic growth in Russia. Consequently, foreign investors consider investing in Russia quite risky at the current level of profitability. Direct investments in non-financial sector accounted for USD 28.6 billion over 2010, as compared with 30.3 billion dollars in 2009, and the growth of portfolio investments has expressly declined by 1.6 billion dollars, as compared with the growth of 2 billion dollars a year earlier. The volume of non-financial sector under the debt on loans to non-residents declined in 2010 by USD 10 billion as a result of earlier received credits redemption.
Foreign assets of residents (liabilities of foreign economic agents to the Russian ones) increased within 2010 by 67.2 billion dollars (against 39 billion dollars within 2009).
Herewith, foreign assets of the federal government and monetary-credit regulation authorities have practically unchanged, and banks rose by 6.7 billion dollars.
Export of capital from the sector non-financial enterprises and households, as compared with 2009, has decreased by 1.2% and amounted to 60.3 billion dollars. Herewith, it is important to note that significant changes have occurred in the dynamics of the article "cash in foreign currency", which indicates, that in 2010 the export of foreign currency from Russia amounted to 14.4 billion dollars as compared with 4.1 billion dollars in 2009 Therefore, due to the stability of the national currency and foreign currency savings of population, converted into rubles, made during the fall of the ruble in winter of 2008/2009, the public and non-financial sector reduced their investments in foreign currency.
The situation in the foreign exchange market of the Russian Federation in 2010 was determined by the inflow of currency into the country via the current account operations, the outflow of capital account and financial instruments and the actions of the RF Central Bank. Herewith, a key factor in the dynamics of the course was the dynamics in the imports of the Russian Federation. With minor changes in exports, nearly constant increase in imports caused a reduction in current account balance of payments, which, when private capital outflows from the country became the only channel of foreign currency inflow to the Russian Federation. As a result, with a relatively large current account balance (see above), in January - April there was strengthening of the ruble in nominal terms (in real terms the ruble was strengthening in January - May). Then, till the year end, ruble was continuously depreciating, both in nominal and real terms. Only a renewed rise in oil prices late in the year, which came close to the level of USD 100 per barrel, caused the ruble strengthening in nominal and in real terms as of December results.
In general, as a result of January - December, the real effective exchange rate of RUR rose by 9.6% and almost reached pre-crisis level of the mid-2008 (see Fig. 6)1. The official dollar rate against ruble in 2010 increased by 24 kopecks: by the end of December, the dollar made 30.48 rubles as compared with 30.24 rubles on December 31, 2009. Herewith, ruble strengthened against the two-currency basket2: the value of the two-currency basket has declined over the same period by 1 rub. 25 kopecks: from 36.16 rubles. up to 34.91 rubles. Within the year, there was a gradual strengthening of the US dollar to Euro at the background of the situation
1 The level of January 2002 is accepted as 100 per cent.
2 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.
improvement in the US economy and worsening of the debt problems in the EU. As a result, the Euro rate against the ruble at the end of December amounted to 40.33 rubles.
---Official USD/RUR exchange rate (end of period)
-Official EUR/RUR exchange rate (end of period)
—•— Value of the two-currency basket
Real effective exchange rate index (right scale)
Source: the RF Central Bank, IEP estimates.
Fig. 6 Indicators of RUR Exchange Rate between January 2005 and December 2010
Thus, in 2010 due to favorable foreign economic situation, strengthening of the ruble was continued. We would like to recall that the rise in energy sources prices in the 2000-s before the crisis also led to a rapid increase in the surplus current account balance of payments in Russia and inspired ruble strengthening. To prevent nominal RUR strengthening, the RF Central Bank was buying foreign currency and increased monetary offer. Even the formation of the Stabilization Fund in 2004, which often helped to sterilize intervention of the Central Bank interventions in the foreign exchange market, did not allow to stop the real ruble strengthening, observed up to the crisis in 2008. Herewith, the main reason of ruble strengthening restriction to the Russian authorities was the reluctance to allow the loss of the national companies' competitiveness. However, with the significant monetization of the trade balance and the lack of opportunity for the sterilization, the inflation in Russia still remained high, despite the rising monetary demand. A rise in prices, in turn, resulted in a real strengthening of the ruble (See in the insert the description of a similar situation in the foreign exchange market in China).
The issue of the Bank of Russia interest rate policy efficacy is still open. It is not excluded that in the absence of the Bank of Russia interference in the functioning of the foreign currency market ruble would be much stronger in nominal terms, but due to lower inflation the dynamics of the real exchange rate would be only slightly different from the current one. Restraining of the ruble, even in view of a partial sterilization, has inspired a rapid growth in monetary supply and inflation, still remaining at the high level in terms of the world standards. Herewith, an important role in expanding the monetary supply has played a capital inflow in 2006-2007, which, in contrast to foreign currency exchange inflows from trade operations could not be sterilized in the Stabilization Fund, which was formed through taxes. One should note, that a possibility of further sterilization, including through the emission of the RF Central Bank bonds and the accumulation of even a larger scale of the government accounts
with the RF Central Bank (i.e., in the Reserve Fund), also raises doubts as to the economic and political reasons.
At first sight, the current situation is similar. However, we believe that an important difference lies in the instability of the global economic recovery. In the event of new problems or tightening of monetary and credit policy in the US and the EU (as the economy recovers), energy prices may fall down, which will inevitably result in an outflow of capital from Russia and create conditions for the weakening of the ruble. In our opinion, under conditions of high uncertainty about the future situation in the global and Russian economies, the Bank of Russia, one should not actively intervene in the domestic foreign exchange market and should focus on reducing inflation.
The dynamics of the National Currency of China
We would like to note that the problem of yuan exchange rate, which is recently under discussion, is relevant to our country as well, because Russia, like China, is heavily dependent on commodity exports. Herewith, the sharp devaluation of the ruble after the 1998 crisis along with rising energy prices and a recovery growth has caused the process of import substitution, which was an important factor in rapid economic growth in Russia in the early 2000's. It is considered that China also supports the competitiveness of their exports by an undervalued yuan.
However, as we have seen above, during the 2000-s and until the crisis ruble was strengthening in real terms, whereas it can be seen in Figs. 7 and 8, that the real effective exchange rate of the yuan over the past 10 years has not changed. With control over the nominal exchange rate by the People's Bank of China, a stable real effective exchange rate means similar inflation in the USA (the main trading partner of China) and China.
45 40 35 _ 30 <u 25 * 20 15 ^ 10 5 0 -5
140 120 100 80 60 40 20 0
2 1 2 3 4 5 CD 00 CO
1 M M M M M M M M M
M 1 2 3 4 5 CD oo CO
CO 0 0 0 0 0 0 0 0 0
CO 0 0 0 0 0 0 0 0 0
CO 2 2 2 2 2 2 2 2 2
15 13 11 9 7 5 3 1 -1 -3
S S CN CO 0 1 0 0 0000 0022 22
■IPC
M1
M2
Fig. 7. The monetary instruments growth rate and CPI in China in 1999-2010 (% to the relevant period of preceding year1)
-Yuan real effective exchange rate (left
CPI in China (% to the relevant period — — CPI in the USA (% to the relevant peri
Fig. 8. Yuan real effective exchange rate (01.1999=100) h CPI in China and US in 1999-2010.
Achievement of a moderate level of inflation in China was made possible by a large sterilization through purchased by the Central Bank reserves, accumulated not only in the government accounts in the People's Bank of China, but also (to a much larger scale) by selling bonds of the Central Bank to credit institutions (see Figs. 9 and 10). Such policy, coupled with the rapid economic growth, as well as restrictions in capital inflows, limiting further inflow of foreign currency to China, has allowed the Chinese authorities to curb monetary supply growth and inflation.
1 The same period last year.
o o
ra >-
300
250
200
150
100
50
2 mini llllllllll 0 CO oo CD 5 •St
5 T— T— T— o o o "0 "0 "0
CM CM CO LÍ5 CD h-" OD a>" 0"
0 0 0 0 0 0 0 0 0 T—
0 0 0 0 0 0 0 0 0 0
2 2 2 2 2 2 2 2 2 2
□ Other
□ Requirements to non-financial sector
□ Requirements to financial sector
□ Requirements to the Government
□ Foreign assets
Fig. 9. People's Bank of China assets dynamics in 2002-2010
>
300 250 200 150 100 50
0 0 0
o "1 "0 "0 "0 "1 "0 "0 "0 "1 "0 "0
CM" 2" 3" ■cf 5" 5" CD" r-" oo" oo" a>" 0"
0 0 0 0 0 0 0 0 0 0 0
0 0 0 0 0 0 0 0 0 0 0 0
2 2 2 2 2 2 2 2 2 2 2 2
□ Reserves
□ Central Bank bonds
□ Foreign liabilities □ Government deposits
□ Capital □ Other
Fig. 10. People's Bank of China liabilities dynamics in 2002-2010
0
0
One of the major trends in the dynamics of balance of payments in 2010 was the dynamics of net capital outflows from non-financial sector, which reached USD 37.9 billion as of the year results (in 2009, due to the crisis, the outflow amounted to USD 58.7 billion) (See Fig. 11). After the outflow of capital in the I quarter in the amount of USD 13.8 billion, in II quarter the inflow (USD 2.6 billion) was recorded. However, in the second half of the year the outflow of capital has accelerated (USD 3.8 billion and 22.8 billion in the III and IV quarters, respectively). At first glance, it might seem that the outflow of capital is gradually decreasing at the background of the Russian economy recovery from the crisis.
However, a comparative analysis shows that while private capital inflows were growing to many developing countries, where investors were ready to run the risk and where low interest rates were sustained, private capital is still flowing away from Russia. The reasons for this situation, apparently, is the maintained strong economic and political risks of investments in the RF with the level of profitability comparable to other developing countries.
Another evidence of the unfortunate situation with the inflow of capital is acceleration of the so-called capital flight1 in 2010. As a result of capital flight in 2010 (Fig. 12) reached, according to our estimates, 35.8 billion dollars, which is by 11.6 billion dollars more than in 2009. In 2010, respectively, an increase was recorded in the share of capital flight in foreign trade turnover from 4.9% in 2009 to 5.5%.
1 We estimate the capital flight by the methodology of the IMF, which represents the sum of "commercial loans and advances", "delayed receivable export revenue and receivable goods and services on the account of remittances under import contracts" and "net errors and omissions". 38
100 50 0
53,6
A
-150
60% 40% 20% 0% -20% -40% -60% -80% -100%
S
a
S3 >
ö ö
<D
a
2004
ü 1 i U 1 S—i _
<y ^oo ^oo
2005
2006
a 2007
a 2008
a 2009
<D h ^
Kg £
3 a 2010
ram Capital net outflow (USD bn) —Capital net outflow/external trade turnover (%)
Source: the RF Central Bank, IEP estimates.
Fig. 11. Capital net outflow dynamics in 2004-2010.
5 0 -5
HH HH > HH HH > HH HH > HH HH > HH HH > HH HH > HH HH
<D VH <D Vh Vh <D Vh Vh <D
S <JJ n <D I S S I n S S H <D I S S I I S I I £ I I <JJ n I S S I
a a a a a a a a a a a a a a a a a a a a a a a a a a
£ s
a 2004
2005
2006
2007
2008
2009
2010
4%
2% 0% -2% -4% -6% -8% -10% -12% -14% -16%
I Capital flight(USD bn)
■ Capital flight/ external trade turnover (%)
Source: the RF Central Bank, IEP estimates.
Fig. 12. Capital flight dynamics in 2004-2010.
Summarizing the analysis of the balance of payments, we should note that the decline in energy prices during the crisis has demonstrated the vulnerability of the domestic balance of payments. Restoration of oil prices in 2009-2010 helped to stabilize the balance of payments. However, with improvement of the Russian economy, imports began to recover. In addition, if during the III quarter of 2009 - II quarter of 2010 the restoration of imports was slower than exports, in the second half of 2010 the growth rate of imports has nearly twice exceeded the growth rate of exports. As a result, despite the continued rise in oil prices, late in the year, at the background of accelerating capital flight, in order to stabilize the balance of payments, it was needed to reduce Russia's international reserves amounting by 8.6 billion dollars. In the case of preservation of this trend, declining in the current account balance will continue, which will create downward pressure on the ruble.
As for balance of capital operations account and financial instruments, the capital flows apparently will remain quite volatile. However, with other terms being equal (especially in the case of stability in energy prices), in the absence of efforts on the part of the Russian government to reduce the risks of investments in Russia, one can hardly expect private capital inflows into the country as per 2011 results.
2.1.4. Main Measures in the Monetary and Credit Policy Area
Measures taken by the Bank of of Russia in order to ensure the stability of the financial system can be divided into two groups: the interest rate policy and other measures.
If we talk about interest rate policy of the RF Central Bank in 2010, then in the first half of the Bank of Russia continued the policy of 2009 addressed to mitigate the monetary and credit policy. In particular, in January - May, the RF Central Bank reduced interest rates four times. During this period, the refinancing rate (together with the rates on Bank of Russia) was reduced from 8.75 to 7.75% per annum. The reason for such action of the RF Central Bank was that lending to the real sector of the economy has been dramatically slowed down with the reducing inflation. Slowing inflation enabled the Bank of Russia to reduce the cost of resources provided to commercial banks, slightly amending the interest rate in real terms, as nominal rates were maintained at the level of inflation. The reasons to reduce the rates, published in the RF CB press release, were in all cases approximately the same. In particular, among the reasons for lower rates there were mentioned the decline in inflation and the need to promote the recovery of the unstable economic growth.
However, as we noted earlier, the summer slowdown in inflation has stopped, and in autumn it was accelerated. Herewith, already on June 30 the Bank of Russia decided to terminate interest rate reductions. We believe that the termination of interest rate reductions was a timely decision. Moreover, the acceleration of inflation in late 2010, it is expedient to raise the issue of tightening monetary policy, as the current low interest rates t the background of excessive liquidity in the banking system encourages credit institutions to take additional risks, despite the fact that the economic situation in Russia is still far from favorable. In addition, a soft monetary policy is not helpful in inflation curbing, which acceleration is based on both, non-monetary and monetary factors. We believe that this low inflation at the level of no more than 4-5% per year should be an important factor in the growth of savings and investments in the Russian economy.
We should also note that during the crisis, interest rates of the Central Bank first began to work as a tool of monetary policy. This proved to be the result of increasing share of credits, provided by the Bank of Russia in the form of liabilities to commercial organizations, to
whom the crisis resources, available to the RF Central Bank, were practically the only source of relatively inexpensive funds. However, by mid-2010, commercial banks have returned to the Bank of Russia nearly all borrowed funds. ^Therefore, the possibility of the RF Central Bank to take the situation in the monetary market under control with interest rate policy once again declined. In this situation, to reduce inflation, the Bank of Russia should reduce its intervention in the foreign exchange market, smoothing only the exchange rate volatility, but not increasing (or decreasing) the volume of international reserves, thereby affecting the monetary supply. We should also note, that the sterilization of the Central Bank intervention in the foreign exchange market also provokes problems (see an insert), a detailed discussion of which is beyond the scope of this review.
The Problems of the effectiveness of the Central Bank Sterilized Interventions
The basic macroeconomic models suggest the ineffectiveness of sterilized interventions of the Central Bank1 (i.e., the interventions in which the operations of the Central Bank in the foreign currency market do not lead to a change in the monetary base) to control the exchange rate, since such interventions domestic interest rates do not change, and according to the classical model of the formation of the exchange rate in the foreign exchange market rate also remains unchanged2. However, there are entire classes of models, which showed that sterilized intervention can influence the foreign currency market. Herewith, there are two main channels of influence - the portfolio balance channel and the channel of expectations (or signaling channel).
Portfolio balance channel is usually considered in the model determining the exchange rate on the market based on comparing the economic agents profitability of investments in domestic and foreign financial assets (with the expected exchange rate changes). The differential yield is the inflow of capital to the country, which is more attractive in terms of asset returns, that leads to a strengthening of the national currency. However, in contrast to classical models of the countries, in which the assets of different countries are perfect substitutes, when considering the portfolio balances, it is assumes that economic agents pay attention to other characteristics of assets, other than returns. For example, sterilized intervention of the Central Bank in developing countries, aimed at preventing the national currency strengthening and at purchasing foreign currency in the market, may become effective due to the fact that investors consider the assets of developing countries as more risky than the assets of the developed countries.
The channel of expectations (or information channel, signaling channel) consists in the fact that sterilized intervention, without causing changes in the monetary supply, is still able to exert significant influence on the expectations of economic agents, as an intervention enables market participants to have information about the current (and future) behavior of the Central Bank. In other words, as the behavior of the players in the foreign exchange market is largely determined by their expectations about future dynamics in exchange rates, changes in expectations can significantly adjust the behavior of investors. In particular, if the national Central Bank holds sterilized interventions to support the national currency and market players believe in its ability to keep the exchange rate, then its actions may be successful, despite the fact that the interventions did not affect the monetary supply.
Other measures of monetary and credit policy, implemented by the Bank of Russia in 2010, include the following basic steps.
1. On March 19 the Bank of Russia reported that since May 1 limits for credit risk established for credit institutions to provide loans without collateral will be lowered. In other words, the Bank of Russia has reduced the maximum amount of loans granted to credit insti-
1 See, for instance: Krugman P., Obstfeld M. International Economics: Theory and Policy. 8th ed. 2009.
2 See: Sarno L., Taylor M.P. Official Intervention in the Foreign Exchange Market: Is It Effective and, If So, How Does It Work? // Journal of Economic Literature Vol. XXXIX. September 2001.
tutions. This step was aimed at cutting down the anti-crisis measures to support the banking sector.
We would like to note, that at the background of the economic situation stabilization in the country the indebtedness of lending institutions under the loans without collateral has decreased as it is. The majority of credit institutions have tried to reimburse the unsecured loans because of their high cost and the opportunity to attract market financing on better terms. Thus, we can assume that most of the remaining debt belongs to the banks that are still in a difficult situation. With the account to consolidation in the Russian banking sector, the measures taken will contribute to force out inefficient banks from the market.
2. On June 3, The Bank of Russia reported on the approval of Bank of Russia regulation № 2459-U of 03.06.2010, "On the Specifics of credit risk on some outstanding credits, loans and similar debts". In accordance with that Regulation, the Bank of Russia is slowly returning to the pre-crisis requirements to in the credit risk assessment. The mitigated reserve requirements to the loans, imposed during the crisis, were aimed at supporting Russian banks and allowed them to form a smaller volume of reserves in a crisis situation. Currently, the state of the banking sector has improved, and it allows the regulator to tighten the requirements to credit risk assessment, bringing them in line with general regulations.
3. On June 7, the Bank of Russia has informed on improving its information policy : from the above date the RF Central Bank started to disclose the information not only on the aggregate amount of intervention in the foreign exchange market, but also on the amount of so-called targeted interventions. We would like to recall, that the volume of targeted interventions are not considered by the Bank of Russia for adjusting the boundaries of floating exchange rate threshold, and are regulated by the situation with the Russian main exports in the world market. In fact, while maintaining oil prices at the current or higher level, the target interventions are the main channels for the formation of the monetary supply in the Russian Federation (like it was before the crisis).
Subtracting targeted interventions from the total amount of interventions, one can get the value of interventions, committed in excess of the established volume. Herewith, the Bank of Russia in its statement officially informed about the rules of such interventions: in case of the volume excess over the planned interventions in the value of USD 700 million, adjustment of the permissible threshold of the two-currency basket is made by 5 kopecs.
We believe that increasing the information transparency of the Bank of Russia is welcome. Such measures increase the confidence of economic agents to monetary policy the Bank of Russia, and help to increase its effectiveness. However, the establishment of clear rules of the exchange rate policy of the Bank of Russia is not quite justified in terms of high dependence of the Russian economy on foreign economic conditions, as the predictability of Bank of Russia in the foreign exchange market can create the preconditions for increasing the volatility of the exchange rate. For example, increasing the inflow of foreign currency to Russia the players of the foreign exchange market will know that the Bank of Russia will buy a certain amount of currency, and then increase the ruble rate. At the same opportunities to gain on ruble strengthening will rise in comparison with the situation in which the Bank of Russia are less predictable. It is reasonable to transfer to a free floating exchange rate of the ruble coupled with the smoothing of a sharp exchange rate fluctuations.
4. From October 13 the Bank of Russia has symmetrically extended operating range of valid value the two-currency basket from RUR 3 to 4 and reduced the amount of accumulated interventions, leading to the shift in the operational thresholdl by 5 kopeks, from UDF 700
million to 650 million. In addition, the RF Central Bank has revoked the fixed threshold for the allowable fluctuations of the two-currency basket (RUR 26 and 41), which were est-blished on January 23, 2009.
Thus step of the RF Central Bank has demonstrated its commitment to stop intervention in the foreign exchange market situation and the transition to a regime of free floating of the ruble rate. At the same time, the Bank of Russia intends to continue to mitigate the significant ruble fluctuations. We would to note, that this step can be generally welcomed, as the maintenance of the ruble, coupled with the transition to inflation targeting (see the insert), as well as the free movement of capital is a difficult challenge. We believe that in future the Bank of Russia should further reduce the scale of its operations in the foreign exchange market. In this case, the RF CENTRAL BANK in a volatile export prices will inevitably be present in the foreign exchange market, smoothing out fluctuations. Herewith, the RF CENTRAL BANK will inevitably interfere in the foreign exchange market in a stable situation there. There is concern that in case of a sustained trend towards the strengthening or weakening of the national currency, the Bank of Russia may revert to targeted exchange rate, which would nullify its actions on the transition to inflation targeting with the help of interest rates.
Inflation Targeting
Inflation targeting is a relatively new regime of monetary policy, which nevertheless is now widespread in the world. For the first time about the transition to a direct inflation targeting was informed by New Zealand in 1990, later the regime was adopted by the monetary authorities in Canada, Britain, Sweden, Finland, Australia, Spain, Israel, the Czech Republic and Chile. In Russia, some elements of inflation targeting were declared by the RF CENTRAL BANK in 1996.
In most cases, the transition to inflation targeting was the answer to those difficulties the country faced in conducting monetary policy with exchange rate monetary instruments targeting. For several years, inflation targeting was used exclusively in developed countries, but at the end of 1990 it started to be be applied by developing countries and countries with economies in transition.
Inflation targeting involves several elements. These include:
1) public announcement of medium-term target inflation indicators;
2) the institutional choice of price stability as the primary long-term goal of monetary policy;
3) the communication strategy that pays less attention to the intermediate goals;
4) greater transparency in the execution of monetary policy and plans of the monetary authorities;
5) increasing the responsibility of the central bank in achievement the target inflation indicators.
Inflation targeting has several important advantages. Firstly, like the targeting of monetary aggregates, it
allows the monetary authorities to focus on internal problems of the economy. Since the authorities of monetary and credit regulation in this case do not establish rigid relationship between the dynamics of monetary aggregates and the rate of price growth, inflation targeting enables more flexible reaction to changes in the macro-economic situation. Secondly, inflation targeting is more obvious and understandable to the public than the exchange rate targeting. Setting specific targets of inflation indicators increases the responsibility of the central bank for its performance and helps to solve the problem of inconsistency in monetary policy.
However, it should also be noted that the inflation targeting regime is often criticized. First, inflationary processes are not always under complete control of the monetary and credit regulation authorities. In periods of economic shocks (financial crisis, external price shocks), non-monetary factors play an important role in the dynamics of inflation and the instruments of control, available to monetary authorities, may be insufficient to achieve targeted levels of inflation. This disadvantage is particularly important for developing countries and economies in transition, where after reaching the medium and low inflation rates, the impact of the exchange rate, structural changes in the economy and prices, external shocks, etc. increases dramatically.
Second, inflation targeting implicitly assumes that the monetary authorities focus on one of the macroeco-nomic targets (on inflation), not paying much attention to the dynamics of other target variables (in the first place, employment and production output growth).
Third, there is a fairly long lag between the actions of monetary authorities and the change in price growth. If during periods of stable economic development that does not matter, under conditions of economic shocks (when government actions are the most important), inflation targeting leads to the need of the monetary authorities to address the problem of intermediary optimization with rigidly defined local conditions, and herewith, they have to take into regard the consequences of their previous decisions.
5. On October 18, the RF Central Bank reported on the recovery from January 1, 2011 of the approaches to the formation of a list of the Bank of Russia, which were in force until February 2009. We would like to recall, that the companies included in this list, enjoy the majority of the Central Bank credits, granted to commercial banks.
Like before the crisis, the List of the Bank of Russia will include organizations, whose rating of the long-term creditability in foreign currency under the assessment of at least one of the foreign rating agencies is at the level not less than "B-" by rating agencies Standard & Poor's or Fitch Ratings or "B3" under classification rating agency Moody's Investors Service. In addition, the Bank of Russia will excluded from the listing the entities, included in the list of strategic organizations, approved by the Governmental Commission on Sustainable Development of the Russian economy. Herewith, the liabilities of systemically important institutions, which will serve as loans to the Bank of Russia as of January 1, 2011, will remain in the pledge before their maturity.
Thus, the Bank of Russia took another step on the "exit" from the crisis management measures to support the banking system, increasing quality requirements for collateral under the loans granted to them, which can be considered correct and timely measure. At the same time, due to a small number of systemically important institutions included in the List and at the same time having to use a significant amount of debt liabilities, this move will hardly have a serious impact on the Russian economy.
6. In early November, the RF Central Bank has submitted to the RF State Duma the "General Directions of monetary policy in 2011 and for 2012 and 2013". In that document the Bank of Russia has clearly outlined its major task for 2011-2013, which should be inflation curbing within 5-7% per year. Herewith, the RF Central Bank does not set quantitative indict-ors in the dynamics of the ruble rate and declared the continuation of the movement toward a free exchange rate, while smoothing the volatility of the exchange rate. In our view, such a formulation of the purposes of the Bank of Russia allows it to conduct monetary policy more effectively without trying to simultaneously achieve two largely conflicting goals: reducing inflation and maintaining exchange rate. At the same time, it is obvious that in the medium term the Bank of Russia will be unable to restrain from interfere in the exchange rate (in addition to smoothing volatility), due to the high dependence of the Russian economy from external economic situation. Herewith, the intervention of the RF Central Bank is likely to increase in periods of abrupt changes in supply and demand in the foreign exchange market. We believe that namely in such periods the willingness of the Bank of Russia to the free exchange rate regime will be tested in practice.
Among other monetary and credit policy indicators in the medium term are the follows: • enhancing the role of the RF Central Bank interest rate policy in reducing inflation and inflationary expectations (the narrowing interest rate corridor) within the framework of this purpose, the RF Central Bank plans to gradually reduce the difference in interest rates on credits provided to banks and resources attracted from them, in case of significant volumes of transactions between the Bank Russia and banks and the restriction of the corridor will more accurately affect the interest rates in the RF;
• cutting down counter-crisis measures;
• consolidation and capitalization of the banking sector;
• taking into account the situation on financial markets when conducting monetary and credit policy, the question is, in particular, about the decision to change monetary policy, taking into account the dynamics of not only inflation, but also prices in financial markets;
• increased transparency and improvement of monetary and credit policy analysis.
With regard to the macroeconomic forecast, included in the "Guidelines", the growth of the monetary base in narrow definition in 2011, according to the forecast the RF Central Bank will make 7.7-19.4%. International reserves at the end of 2011 could reach from 478 to 576 billion dollars. The forecast is based on three versions, with an intermediate variant, based on the price of oil in 2011 at the level of 75 dollars per barrel, which is consistent with macro-economic forecast of the Russian government. In general, the forecast of the Bank of Russia, in our opinion, is fairly realistic and roughly coincides with the IEP assessments. Implementation of the Central Bank estimates in terms of monetary growth will largely depend on the dynamics of capital flows. In the version of "Guidelines", submitted to the RF States index of private capital outflows from Russia for 2010wqszxd has been increased from 9 to 22 billion dollars, which demonstrates once again the volatility and poor predictability of this index, as its outlook has changed several times in During the year, and actual results for the year several times differed from the forecast of the Bank of Russia, given at the beginning of the year.
2.2. National budget
2.2.1. Assumptions of the 2010 budget policy
An international crisis of 2008 - 2009, ever growing debt challenges in Greece, Spain, Ireland and Portugal in 2010 prompted the Government of the Russian Federation to revise the approach to the policy of irresponsible build-up of government expenses and obligations. A trend to curb budget expenses emerged back in 2010 while the budget was corrected and has continued while a budget was shaped for the next three year- period.
We have to confess, however, that our national budget system remains in an extremely unstable condition and strongly depends on the world market prices on energy carriers. Regardless of the planned cuts in expenses expressed in GDP per cent shares, the level of these expenses is still very high exceeding that of 2008. In this situation, a budget crisis objective possibility should be accounted for as early as possible; to prevent such a crisis, to sustain the balance of the national financial system in a long-term perspective must become an inherent condition of formulating a present-day budget policy. Otherwise a future Russia can as well repeat its experience of the 1998 crisis should external economic parameters change unexpectedly.
A main cause of the 1998 financial crisis was inability of any of the Russian governments during three years after the USSR had collapsed to approve and execute a realistic budget: government expenses exceeded government revenues from year to year manifesting a sustained trend. Impossibility to cover the expenditures by the tax revenues led to monetary financing (up to 1995) and growing borrowings at the internal and external financial markets thus making the national economy vulnerable and sensitive to internal and external shocks.
Restructuring expenses including their serious reduction should have become a key factor in budget balancing. The RF Government being fully aware of political and social implica-
tions of such a decision made punctured attempts to streamline expenses of the federal and local budgets; in June-July 1998, Cabinet led by S. Kirienko developed a special program in this area that was duly approved.1 However, these actions were targeted at streamlining of some expenditures only; they looked like attempts to identify and remove inefficient expenditures while the problem was much more complicated: the government had to refuse implementing a considerable portion of its commitments that were impossible to be executed without a dangerous build-up of government debts; the government also had to seriously reform the budget funding system. No such action was done. As a result of the Government hesitancy to cut down the expenditure obligations, a financial crisis developed, and the national budget system collapsed.
The following years up to 2008 went by in a favorable external market situation; it helped improving budget revenues and running a considerable budget surplus (see Table. 6).
Table 6
Implementing budget revenues and expenditures at all the government levels in 1999-2009 , in GDP %
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
Federal budget
Revenues 12,7 15,5 17,8 20,3 19,5 20,1 23,7 23,3 23,4 22,5 18,9
Expenditures 14,0 14,2 14,8 18,9 17,8 15,8 16,3 15,9 18,0 18,3 24,9
Deficit (-) /Surplus (+) -1,3 1,4 3,0 1,4 1,7 4,3 7,4 7,4 5,4 4,2 -6,0
Consolidated budgets of the RF subjects
Revenues 13,4 14,1 14,5 15,1 14,6 14,1 13,9 14,1 14,6 15,0 15,3
Expenditures 13,3 13,4 14,5 15,5 14,9 13,9 13,6 13,6 14,4 15,1 16,1
Deficit (-) /Surplus (+) 0,1 0,7 0,0 -0,4 -0,3 0,2 0,3 0,5 0,2 -0,1 -0,8
Budget of the enlarged government
Revenues 33,8 38,3 38,4 37,8 37,1 37,5 39,7 39,6 39,8 38,6 35,1
Expenditures 35,3 34,3 35,2 36,3 36,0 32,9 31,6 31,2 33,8 33,8 41,4
Deficit (-) /Surplus (+) -1,5 4,0 3,2 1,5 1,1 4,6 8,1 8,4 6,0 4,8 -6,3
Source: Federal Treasury, IEP estimates.
Consolidated expenditures continued growing till 2003 inclusively against the sustained growth of the budget revenues; after 2003, they reduced by 4-5 p.p. of GDP. There were two reasons behind such correction of the budget policy.
First of all, any further step up of the budget expenditures would have been against the task of financial stability assurance in the country by curbing inflation. The task of sustaining mac-roeconomic stability and further de-regulation of economic relations within the administrative
1 Federal Government resolution No 600 "On approval of the program of government expenditures saving" passed on June 17, 1998 in pursuance of Decree of the President of the Russian Federation of May 26, 1998 No 597 "On measures to ensure government expenditures saving" was targeted to cut down inefficient social benefits, state investments and subsidies to certain sectors. According to the assumptions of the program developers, the implementation of the program would have decreased budget expenditures by RUR 41.9 billion (1.6% of GDP). To resolve this issue, Hother governmental resolutions were adopted, among them: RF Government resolution of May 12, 1998 No 438 "On measures to strengthen financial discipline", Decree of the President of the Russian Federation of May 14, 1998 No 554 "On measures to strengthen financial discipline and implementation of the Budget laws of the Russian Federation", Resolution of the RF Government of July 17, 1998 No 970-r and others. 46
reform could not be implemented because of the previous budget policy. To reduce inflation to 4%-5.5% per year and to maintain stability and predictability of the Ruble exchange rate, a well-thought budget policy was required together with restrained growth of federal budget expenditures (not exceeding 16.5 - 17 p.p. of GDP); besides such policy was to be combined with slower growth rates of tariffs on gas, electricity, railway transportations, utilities (within 5% - 8% per year) that were controlled by the government.
Secondly, there was an acute need in inventory and reduction of the created, in the previous years, enormous burden of social obligations that could never be realized or that inadequately reflected the then social, economic and demographic situations; this manifested in development of tougher requirements to budget allocations, implementation of an end-result oriented budgeting process and attempts to optimize the network of budget funded institutions.
In 2004 there was a major cut in budget expenditures when the share of federal budget expenditures (as a % share of GDP) fell down by 2 percent points. Such major reduction occurred in a situation when the decision to pursue a conservative budget policy (establishment of a Stabilization Fund, among others) coincided in time with a sharp and unexpected improvement of the external economic environment.
Table 7
Federal budget in 1998 - 2009: actual and forecasted parameters
GDP, in current prices, in RUR bln
Federal budget expenditures, in RUR bln
Federal budget expenditures as a % share of GDP
Inflation, in %
Urals price/barrel, in
USD
forecast actual forecast actual forecast actual forecast actual forecast actual
1998 2 840 2 629,6 499,9 379,4 17,6 14,4 5,7 84,4 16,0 17,0
1999 4 000 4 823,2 575,0 677,2 14,4 14,0 30 36,5 12,0 20,0
2000 5 350 7 305,6 855,0 1 034,9 16,0 14,2 18 20,2 16,4 27,5
2001 7 750 8 943,6 1 193,4 1 324,1 15,4 14,8 12 18,6 21,2 24,0
2002 10 950 10 830,5 1 947,3 2 046,0 17,8 18,9 12 15,1 23,5 23,7
2003 13 050 13 243,2 2 345,6 2 354,9 18,0 17,8 10-12 12 21,5 27,0
2004 15 300 17 048,1 2 659,4 2 695,6 17,4 15,8 10 11,7 22,0 34,5
2005 18 720 21 625,4 3 047,9 3 514,3 16,3 16,3 7,5-8,5 10,9 28,0 50,8
2006 24 380 26 903,5 4 270,1 4 281,3 17,5 15,9 7-8,5 9 40,0 61,2
2007 31 220 33 258,1 5 463,4 5 983,0 17,5 18,0 6,5-8,0 11,9 61,0 68,4
2008 35 000 41 444,7 6 570,2 7 566,6 18,8 18,3 7 13,3 53,0 89,0
2009 51 475 39 063,6 9 024,6 9 636,8 17,5 24,7 8,5 8,8 95,0 59,4
Source: Ministry of Finance of Russia, Federal Service of State Statistics
One can see from Table 7, that in 2004 the revenues of the federal budget were estimated following the macroeconomic forecast estimates that were based on the average annual price of Urals crude for the last 10 years (1994-2004) - 22 USD/barrel. At the same time, the expenditures of the federal budget were estimated from the crude price of 20 USD/barrel. In reality the 2004 price of crude reached its maximum for the previous 30 years hitting an average annual of 34.2 USD/barrel. As a result, the Stabilization Fund that began functioning in January 1, 2004, was considerably replenished reaching RUR 522.3 bln (or 3.1% of GDP) following the 2004 year results.
Another important factor causing the expenditure reduction (as a % of GDP) was an understated forecast of inflation which initially was planned at 10%. In reality the inflation rate was 11.7%. Thus the expenditures reduced both in real terms and as a per cent of GDP.
Due to the understated forecast of the crude price and inflation, budget expenditures in % of GDP could be restrained for the entire period of the 2000'es. But beginning from 2007, due to abnormally high prices on crude and the mitigated budget policy, the curbing effect of the conservative macro-economic forecasts could not further prevent a budget expenditures growth (in % of GDP).
The budget policy has been relaxing since 2007; this was related to adoption by the government of additional social obligations to the national community, also within the framework of implementation of national projects of priority; and to the approval of new investment programs connected with the election of President. The year of 2007 actually made a start of a "soft" budget policy when the growth of expenditures at all the budget levels in Russia outpaced the growth rates of budget revenues; as a result the budget surplus of the enlarged government reduced for the first time in the last five years, regardless of favorable internal and external environment.
In 2008, the dynamic trend of the main parameters of the Russia's budget system strikingly differed from those in the previous year. Based on the 2007 year end results, all budget expenditures and revenues grew considerably vs the same indicators of 2006, however, in 2008 changes were multidirectional: in the context of emerging economic crisis and fall of prices on energy carriers, the federal budget revenues reduced by 0.9 % of GDP; simultaneously the revenues of the consolidated budgets of the RF subjects increased by 0.4 % of GDP. This may suggest that a crisis mostly hit financial stability of the federal budget, leading to reduction of oil and gas revenues and indirect taxes revenues.
While the financial crisis was hitting economies of many countries, functioning of the Russian economy radically changed in the 2H of 2008. This period was characterized mainly by relatively low prices and demand on Russian exported goods, by a sharp fall in output and unemployment growth. By the beginning of 2009, the Russian economy entered a recession period, with devaluation of the national currency (Ruble) and cuts in investment programs. Such aggravation of the economy affected the national budget system: given considerable reduction of revenues in the budgets of all the levels and the growth of expenditure obligations, in 2009 the budget of the enlarged government showed a deficit for the first time in the last decade (see Table 6). The imbalance of the budget system and the lengthy world crisis created risks of expanding the scale of debt borrowings in the near future.
The largest fall of revenues and growth of expenditures was observed at the federal level which relied largely on market revenues. The revenues of the federal budget reduced by 23 p.p. in real terms while the expenditures increased almost by 25 p.p.; in 2008 the budget surplus of 4.1p.p. of GDP was replaced by a deficit at 5.9 p.p. of GDP in 2009.
The Federal Government managed to implement, under a very tight schedule, a wide range of anti-crisis actions, unprecedented both in terms of a number of forms and directions of the government impact on the economy and the volume of tapped resources. If in the fall of 2008, the measures of "pin-point" responses were implemented under extremely tight time restrictions and by using mainly "manual management tools", by March 2009 a comprehensive Program of Anti-Crisis Actions of the RF Government for 2009 was developed.
To finance the priority areas of this Anti-Crisis Program, changes in the Federal Budget Law were to be made. As a result, the budget acquired a clear recessional character: the ear-
lier approved budget allocations were cut down by 2.4% of GDP; and 4.1% of GDP including the released funds were allocated mainly to support financial stability and maintain strategic sectors and enterprises, and to a lesser extent, to support vulnerable groups of the population. The anti-crisis actions were funded both from the federal budget and off-budget sources which share was estimated at 2/3 of the respective expenditures.
The 2008 anti-crisis package, according to our estimates, valued RUR1.1 trillion (2.7% of GDP) and included mainly investments to support the financial system. In 2009, RUR2.4 trillion (6.2% of GDP) of the budget and off-budget funds were allocated to support the anticrisis actions.
In Russia, the macroeconomic risks of the Anti-Crisis Program were partially mitigated by using the Reserve Fund: about RUR3 trillion (7.7% of GDP) of the Reserve Fund were allocated to balance the federal budget. There are three aspects specifically related to the "reserve" nature of these allocations.
Firstly, the use of the Reserve Fund to liquidate the budget deficit was a standard issuance of money by the RF Central Bank since practically such transaction means moving the Central Bank liabilities from the special account of the RF Government and including them in the monetary base (using the current account of the Government). Such transaction could not have been considered an emission if the Russia's Bank simultaneously sold the currency received during the period of the Reserve Fund acruals; however the international reserves of the Russia's Bank having reduced to minimal in January 2009 continued growing steadily in future. If the formation of the Reserve Fund were not accompanied by the reduction of the monetary base (its funds would have been accrued not at the Government accounts in the Central Bank but at the accounts of commercial banks), then its reserves and spending would not be associated with the emission. Thus, in terms of the monetary policy, the Fund is not a reserve but a separate channel of money inputs into the national economy.
Secondly, the described emission effect in using deposits from a budget account is observed every time when the government spends money in the current Treasury system that keeps its budget accounts in the Bank of Russia. Within this system, the funds received at a budget account are drawn outside the monetary stock. The monetary stock is fluctuating constantly during a year. There is a sharp growth of monetary aggregates in December when the budget implements its expenditure items, or there is a reduction of the monetary base in the last days of a month when taxes are remitted to the budget.
However, in view of the adopted budget period which is a budget year, in terms of the budget policy, only the final impact of budget transactions on the monetary stock is normally considered. If to extend the term of budget planning to up, e.g. five years, then the use of the Reserve Fund money will stop being a pure emission since the accrued funds during such period can be viewed as temporally drawn from (similar to fluctuations of the monetary base caused by a time asymmetry of implementation of the revenue and expenditure budget items) and returned to the national economy.
Thirdly, in the budget and debt policies perspective, the Reserve Fund deposits can be absolutely considered as a reserve of the RF Government since its availability helps financing the budget shortage with no market borrowings and with no increase of the government debts. This can be done by emission and simultaneous "sterilization" of the monetary stock at the expense of currency interventions and using external reserves accumulated as a counter-part of the Reserve Fund. The practices of such countries as the EU countries, the USA, Japan, Great Britain and others show that it is the growth of the national debt used to finance anti-
recession actions that becomes a key issue at the stage of economic recovery. Therefore the Reserve Fund in Russia is a factor that prevents debt burden to increase and to carry the current budget expenditure load over to the next period (generations).
Simultaneously with the growth of expenditures, tax benefits of anti-crisis nature were adopted: a Profit Tax rate was reduced, a new procedure for non-linear depreciation introduced, a bonus depreciation increased, MET non-taxable price exemption increased, etc. In 2009, the "tax package" overall cost was about 1.5 p.p. of GDP.
The list of the budget anti-crisis actions taken in Russia in 2008 - 2009 is very like similar international programs: unemployment benefits, support of the retired, assistance to strategic enterprises in various sectors of economy, financial rehabilitation of banks, support to small and mid-size businesses. The actions differed by scope of allocations dependent on emergency and scale of problems faced by the governments.
In general, the anti-crisis policy in Russia was quite successful though with some deficiencies:
- in implementation of the Anti-Crisis program decisions were often delayed;
- the actions of government support had low transparency, in particular, there were no fixed rules of allocations among the enterprises;
- at the initial stage of the crises, insufficient focus was made on giving support to the community, thus reducing effectiveness of the government measures;
- cash execution of the expenditure obligations was irregular and therefore impeding efficient and timely spend of the budget allocations.
Main developments of the budget policy in the 2000'es
In the 2000'es, regular efforts were taken in Russia to assure stability of the budget system, efficiency of budget allocations and their spending. The budget policy of that period was characterized by the following:
In 1998, Budget Code was adopted and made effective since January 1, 2000, manifesting a considerable success in the area of the budget reform. The new law established legal foundations of the budget system of the Russian Federation, the position of the subjects of the budget legal relations, the procedure for regulating inter-budget relations, the foundations of the budget process in the Russian Federation, and accountability for violation of the RF budget laws.
The Reserve Fund was established in 2004 as a tool of accumulating some of the revenues generated by customs duties imposed on oil and from the Mineral Extraction Tax (oil) when the Urals price exceeded the base price1. The purpose of the Reserve Fund was to assure the balance of the federal budget in cases where the oil price was lower than the base price and to neutralize extra liquidity by offsetting interventions of the Central Bank caused by increase of external reserves. Thus the expenditure obligations were maintained at a predictable and stable level and did not depend on uncontrolled external situation. As a result of growing prices on oil in 2004-2007, the Stabilization Fund could accumulate sufficient funds that allowed
1 Since 01.01.2004, the base price was established at $20/bbl for Urals (Federal Law No 184-FZ of 23.12.2003, while since January 1, 2006 this threshold price was raised to $27 (Federal Law of 12.10.2005 No 127-FZ). Regardless of that the oil prices continued growing, further increase of the "cut-off price" likewise the use of funds of the Stabilization Fund inside the country was stopped due to a risk of inflation and larger dependency of the budget on external economic environment. 50
the Fund to perform a priority task of maintaining stability of the Russian state finance and in addition to early repay some of the national external debts. Moreover, due to the application of the Stabilization Fund tool, the budget policy of 2004-2007 acquired features of a counter-cycle. The Stabilization Fund starting February 2008 was split into Reserve Fund and National Welfare Fund. In 2009 - 2010 it was the Reserve Fund that functioned as a main source of financing the federal budget deficit;
In 2003-2004, the introduction of results-oriented budgeting (ROB) began as a tool to improve quality of managing budget funds and allowing distribution of budget funds not by the budget items but by strategic targets and tactical objectives aimed at reaching certain end results. As complex management procedures and processes including target programming and results-oriented budgeting were implemented in the environment where such fundamental budget issues as reforming of the budget network, improvement of incentives at the bottom level to use budget funds more efficiently remained unsettled, no breakthrough in the effective management of the budget funds could be expected. A low quality of the institutional environment considerably discredited the very idea of ROB in Russia regardless of its good potential. As a result, the application of the programmed and targeted planning was actually limited to planning, analysis and monitoring for assessment of efficient use of the budget funds while those mechanisms were designed to become inherent elements of the budget process substantiating the needs of the ministries and departments declared in the Budget Law.
Improvement of the legal foundations for procurement to meet federal and municipal demands was prompted by Federal Law No 94-FZ effective of July 21, 2005 "On placement of orders for supplies of goods, execution of works and rendering services for federal and municipal needs" and a number of amendments thereto. The new procurement system had a lot of advantages vs the previous one: application of direct legal regulation of the procedures for placing orders at all the levels of the budget system, limitation of corruption risks by narrowing the area of application of non-competing procedures (close bids, placement of orders with a sole supplier), introduction of more transparent ways of order placement (auctions, procurement at commodity exchanges, etc.) At the same time these innovations having failed to ensure a considerable reduction of the corruption scope, created certain problems for "fair" providers.
A review of the applicable international experience shows that the government needs in goods, works and services are satisfied more efficiently and adequately if all procedures of a process cycle of a government order (planning, formation and placement) are built into unified institutional environment, aligned with common for all the procedures milestones and streamlined in terms of structure and element composition. At present, however, the Russian legislation does not provide for a unified approach to regulation of the entire cycle of the government order placement. Thus, at the planning stage, the budget legislation is called to ensure targeted and effective spending of the budget funds. Regulation of the implementation of government contracts is limited to the application of general provisions of the Civil Code, and no specific regulation tools are actually applied. Though the stage of placing a government order is most effectively regulated as a result of on-going refinement of FZ-94, the following issues are not settled yet: carry-over of the budget funds allocated to payment for government contracts from the current to a future budget period, broader independence in spending of the saved budget funds generated by effective procurements, application of price monitoring data to justify the start-up procurement prices, prospects of centralization of state procurements,
improvement of the procedure for setting prices in construction sector, possibility to engage specialized companies to perform control over contract compliance, in terms of targeted spending of funds, effective work organization, implementation of technologies (banks and engineering companies), methods of procurement of highly specialized services (R&D and pilot), etc.
Implementation of national projects of priority (NPP) as an alternative way of programmed governance of budget expenditures. A new approach to resolve the task of improvement of the Russian community life quality was demonstrated in development of four national projects of priority in the areas of education, healthcare, housing and agribusiness industry. Within each such project problems, objectives and actions were formulated. A specific focus was made on development trends of education and healthcare as these sectors have provided traditionally a wide range access to their services for the citizens and have always been extremely significant in terms of investments into human capital.
A review of the implementation results of NPP shows that the project target indicators have been delivered and over-delivered. However, these deliverables have not been supported by any institutional reform and therefore limited to additional budget allocations to alleviate acute problems in the key social sectors.
As there were no system approach to project shaping, the list of areas and actions of government support had to be extended every year thus leading to additional budget expenditures (to finance new "bottlenecks", e.g. schools were connected to Internet, later the Internet traffic was paid for, since municipal budgets had no such expenditure items). Besides, the implementation of the national projects created additional expenditure obligations for the regional authorities. It is the regional authorities that are accountable mainly for the areas identified as national priorities. Therefore the national projects being included in the regional scope of competences created for the regions the so called hidden non-financed expenditure mandates:
- in the projects "Education" and "Healthcare" additional benefits and increase of salaries of certain categories of budget employees took place while labor remuneration in the education and healthcare sectors in general have been maintained at the levels planned by the government. Thus a gap in individual revenues was created, and some of the human resources moved to jobs that were highly paid for. The regional authorities had to respond by unplanned increase of salaries of other employees in the education and healthcare sectors.
- as the national projects of priority were implemented, it was found that they did not provide funds for maintenance of high-tech medical equipment, retraining of employees so that they could work with such high-tech equipment, etc.
The process of establishment of development institutions in order to create a unified national innovation system for development began in 2005. For several years, several dozens of organizations were established in Russia with the aim to incentivize investments and transfer to an innovative-performance model of the Russian economy, among them: Bank of Development and External Economic Activity, Investment Foundation of the Russian Federation, OJSC Special Economic Zones, Russian Venture Company, Russian Corporation of NanoTechnologies and other institutions. Each of them enjoyed a sizable support from the federal budget. Budget allocations were granted to organizations called development institutions, mainly in the form of contributions to their charter capital. Development institutions are granted such forms of private business support as loans, insurance of export risks, acquisition
of securities of legal entities, participation in their capital and in concession agreements, and direct subsidizing.
The development institutions in spite of the considerable government support have not become catalysts of investment growth of the Russian economy, partially because there were no effective interface system for the institutions, their competences were vague, the applied tools were not aligned with those of established budget support, and the institutions did not have access to main sector strategic documents, etc.
Transition to a mid-term budget planning. In 2007, the 2008 - 2010 federal budget for 2008 - 2010 was formed (for a three-year period) for the first time in the contemporary Russia history. This development indeed was designed to improve predictability of the mid-term budget and fiscal policy of the RF Government, to enhance financial assurance of the adopted expenditure obligations for a three-year term and also to improve requirements to the budget quality and accountability for mistakes made in planning. According to the Budget Law, budget allocations were approved separately for each year of the three-year period, and chief executives of the budget were granted the right of re-allocation of funds in the course of the federal budget implementation between the current and future years. However, early 2009, as a result of rather high mid-term uncertainties caused by further recession in the world and in the Russian economy, the Federal Government elected not to follow the new practice of 3Y budgeting in 2010-2012. This decision was justified in the then economic environment, and the return to budgeting on a one-year basis was considered a temporary measure, therefore in 2010 the RF Government returned to federal budgeting on a three- year basis.
Thus the review of most important measures to improve the budget policy performed in the 2000"es shows that most of them remained on paper. The results-oriented budgeting was not developed up to a level of becoming a tool of effective management of expenditures; the system of the development institutions can hardly be described as completely developed, the reform of the budget network was slow, etc. A lot of issues remain unattended and unsettled; they can form an urgent agenda to be dealt with in the near future.
We can assume that these insignificant results have been a consequence of mistakes made in selection of priorities of the budget reform. Since early 2000'es, complicated management tools (the results-oriented budgeting, targeted programming) have been implemented to improve the budget process; they proved to be quite effective in such countries as Great Britain, the USA, New Zealand, Australia; however they were hardly used in the countries with weak institutional environment. In a country where such fundamental issues of the budget sphere as restructuring of the budget network, creation of incentives for more efficient use of the budget funds at the bottom level, and improvement of a government order remain unresolved, it is difficult to expect a fast breakthrough in the quality of budget management.
2.2.2. Budget policy at the stage of recovery
In the context of improving macro-economic situation, with a stable growth of oil world prices in 2010, common trends for all budget levels have been: revenue growth, reduction of expenditures vs the previous year and consequently reduction of the budget deficit (see. Table. 8). In particular, the budget expenditures of the enlarged government fell down by 2.5 p.p. of GDP, of the federal budget by 2.p.p. of GDP, of the consolidated budget of the RF subjects by 1.2 p.p. of GDP. At the same time, with re-calculation into real prices, the saving of the budget funds looks quite modest vs 2009 figures and fluctuates within 2-5% range -
thus we can hardly speak of the efficiency of the announced intentions to implement the "responsible" budget policy.
In 2010, the revenues of the budget system changed insignificantly vs the similar parameters of the previous year. Thus the budget revenues of the enlarged government grew by 0.3 p.p. of GDP (equivalent to a 4.8% surplus). This is mainly a result of the change of the procedure of remitting revenues from insurance contributions1 the federal budget revenues made 18.7% of GDP in 2010 - this is by 0.2 pp. of GDP lower than in 2009.
Table 8
Implementation of revenues and expenditures of the budgets of all power levels in 2010
2010 Change vs 2009
in bln in % of nominal value real value
RUR GDP bln of RUR. % bln of RUR %
Federal budget
Revenues 8303,8 18,7 966,1 13,2 208,9 2,6 -0,2
Incl. from oil & gas sector 3830,7 8,6 846,7 28,4 538,8 16,4 0,9
Expenditures 10115,6 22,7 455,6 4,7 -541,2 -5,1 -2,2
Deficit (-) /Surplus (+) -1811,8 -4,1 510,5 750,1 2,0
Consolidated budgets of the RF subjects
Revenues 6537,0 14,7 610,3 10,3 -1,2 0,0 -0,6
Expenditures 6636,9 14,9 381,2 6,1 -264,3 -3,8 -1,2
Deficit (-) /Surplus (+) -100,0 -0,2 229,1 263,1 0,6
Budget of the enlarged government
Revenues 15715,9 35,3 2116,2 15,6 712,9 4,8 0,3
Expenditures 17301,0 38,9 1252,7 7,8 -403,3 -2,3 -2,5
Deficit (-) /Surplus (+) -1585,1 -3,6 863,5 1116,2 2,8
For reference: 44491,4
GDP, in bln RUR.
Source: Ministry of Finance of the Russian Federation, IEP calculations
It should be noted that the tax burden in 2010 exceeded that of 2009 by 1.6 pp of GDP reaching 32.4% of GDP. Such increase was substantiated mainly by the positive trend of the tax revenues (see Table 9). Thus in 2010, Profits Tax, MET and indirect taxes dominated in their effect on the budget revenues of the enlarged government.
The revenues from the oil & gas sector that secure about one fourth of all the national budget revenues, have fluctuated depending on the world prices trends and demands for the goods of the fuel and energy complex. The main reason of the oil & gas sector revenues growth was the increase of the world prices on oil vs the similar period of 2009 ($75.9 against $56.7 $/bbl), accompanied with monthly indexation of the export duties from $253,6 per a ton in March up to $303.8 per a ton in December. As a result of the growth of physical volumes of production and export of hydrocarbons and the growth of world prices on energy carriers, the surplus of oil & gas revenues was 0.9 pp. of GDP vs 2009. A non-zero beneficial export duty on the supplies of oil from the East Siberia fields2, implemented in July 2010, positively affected the situation; the duty rate is re-calculated monthly depending on the world market prices and the demands for oil on the world markets.
1 If in 2009 UST revenues were partially remitted to the federal budget and then to the RF Pension Fund, since 2010 insurance contributions have been directed to off-budget funds.
2 The beneficial rate applies to 22 fields of the East Siberia. 54
Table 9
Main taxes revenues to the budget of the enlarged government of the Russian Federation in 2007 - 2010 in % of GDP
2010 change vs 2009 Tax elasticity
2006 2007 2008 2009 2010 in % of GDP in 2010 prices, in % for GDP in 2010, by times
Tax load 35,9 36,1 35,7 30,8 32,4 1,6 9,3 2,4
Profits Tax 6,2 6,6 6,1 3,3 4,0 0,7 27,2 6,9
Personal Income Tax 3,5 3,8 4,0 4,3 4,0 -0,3 -2,6 -0,6
Uniform Social Tax/ /insurance con- 4,8 5,1 5,1 5,5 5,1 -0,3 -2,6 -0,7
tributions*
VAT 5,6 6,9 5,1 5,3 5,6 0,3 10,5 2,6
Excises 1 1 0,8 0,9 1,1 0,2 23,1 5,8
MET 4,1 3,6 4,1 2,7 3,2 0,4 21,0 5,3
Customs duties and fees 8,6 7,3 8,6 6,8 7,1 0,3 9,2 2,3
* since 2010, UST has been converted to insurance contributions remitted to off-budget funds directly.
Source: RF Ministry of Finance, Rosstat, IEP calculations.
The following factors were suppressive for the oil and gas revenues trend in 2010: firstly, the slowdown of oil production growth rates in 2H 2010 vs 2009 and secondly, strengthening of the ruble currency which reduced revenues from external trade in the ruble equivalent.
The Profits Tax and indirect taxes, among other main oil and gas revenue sources, demonstrated a more pronounced trend to increase revenues both in % of GDP and in real prices; the Personal Income Tax revenues and revenues from insurance contributions, however, reduced by 0.3% of GDP.
In particular, the Profits Tax revenues by the year end reached 0.4% of GDP which is by 0.7% higher vs 2009. In real prices, the growth was 27.2% - this is the highest value among the considered taxes. Such positive growth of the Profits Tax revenues was mainly prompted by a better financial situation in the real sector. Thus, for 11 months of 2010, the consolidated financial effect of organizations (without small businesses, banks, insurance companies and budget-funded agencies) reached RUR 5.54 trillion (in current prices); this by 49.6% exceeds the value of this indicator for the respective period in 2009; the share of lossmaking enterprises reduced to 29.7% against 32.0% in 2009.
In 2010, the budget revenues from VAT grew by 0.3% vs 2009 at the expense of the tax imposed on the imported goods only. The VAT revenues from the goods sold inside the Russian Federation in real prices increased by 2.4% only while in the case of imports taxation -by 21.4%. Therefore in 2010, in the VAT revenue structure a continuation of the trend (since 2006) to reduce the share of the internal VAT has been observed in favor of the VAT revenues from the imported goods (if in 2004 the ratio between the revenues from the taxation of the internal sales and the taxation of the imported goods was 70:30, in 2010 such ratio was 53:47). It is explained by two factors mainly: the internal demand has shifted towards consumption of the imported goods (the share of imports in GDP increased from 12.8% in 2004 to 16.9% in 2010) and the legislation regulating internal VAT administration has changed recently; according to our conservative estimates1, both factors resulted in annual under-receipt of budget revenues in the amount of at least 1.5% of GDP.
1 Quality of VAT administration in OECD countries and in Russia/A. Knobel. S. Sinelnikov_murylev, I. Soko-lov - M. Journal "Applied Econometrics" No 4 (20), 2010.
In 2010, a considerable growth of excise revenues to the budget of the enlarged government by 0.2% of GDP vs the respective value of 2009 was recorded. The reason behind such growth was a sizable increase of the rates on alcohol products, on beer specifically (by 3 times), and indexing for inflation of other groups of excisable goods. If in the 2000'es, the growth rates of the tax base were behind the real GDP growth for all the excisable goods besides the alcohol products, since 2010 this trend has become pronounced for the alcohol products as well, which production volume reduced by 2.9% vs 2009 in physical terms.
The revenues from the Personal Income Tax (PIT) to the budget of the enlarged government reduced to 4.0% of GDP; this is by 0.3% of GDP lower than the 2009 value. In absolute terms the revenues grew by 7.5% only vs the previous year making RUR1,790.5 billion. In real prices the PIT revenues reduced by 2.6% vs the respective values of 2009. Such reduction of the PIT revenues occurred following the reduction of the taxable base (in GDP shares): in 2010 the growth rates of monetary revenues of the population (less social payouts) were lower than the rates of rehabilitation of the national economy; as a result, their share in GDP decreased by 4.6% of GDP for nine months of 2010 vs the respective period of 2009.
Since 2010, UST has been converted to insurance contributions administered by state offbudget funds1. Before 2010, insurance contributions were paid on the insured and cumulative portion of the state pension and administered by the Federal Tax Service of Russia. These contributions were not a portion of UST, however the UST obligations were reduced by the amount of the paid insurance contributions (the UST portion subject to payment to the federal budget). In 2010, the summary rate of the insurance contributions was maintained at the level of the UST base rate of 26% of the payroll budget, however it was the taxable base that changed. Thus, if before 2010, the UTS was imposed at the regressive scale, and the base rate applied to the annual wage not exceeding RUR280,000, in 2010 the rate of 26% applied to the wage of RUR415,000, and any wage above that level was exempt from insurance contributions (actually two rates were applied: 26% and 0%).
It is important to note that Federal Law No 212-FZ of 24.07.2009 stipulated annual indexing of the marginal base for insurance contributions in line with the growth of the average wage in the Russian Federation2. The changes described above should be taken into consideration by comparing the UST dynamics (including the insurance contributions) with the revenues from the insurance contributions in 2010. As Table 9 suggests, the collection of the insurance contributions made about 0.3% of GDP vs the previous year. It is partially related to the reduction of the payroll fund in GDP by 2.5% of GDP.
Note that more important changes associated with insurance contributions have been effected since January 1, 2011, namely, the increase of the overall rate from 26% to 34%. According to our estimates, this action does not ensure the balance of the pension system of Russia in a long-term period, and there is a considerable negative influence on the pace of economic growth; this may enlarge a scale of tax evasion by the business (the share of the "shade wages" would increase).
With an insignificant growth of revenues to the budget of the enlarged government in GDP shares, in 2010 the budget expenditures reduced vs GDP (by 2.5 pp of GDP) but actually did
1 Federal Law of July 24, 2009 No212-FZ On insurance contributions to the Pension Fund of the Russian Federation, Social Insurance Fund of the Russian Federation, Federal Fund of Compulsory Medical Insurance and Territorial Funds of Compulsory Medical Insurance".
2 By Resolution of the RF Government of November 27, 2010, No 933, the taxable base limit was set at RUR463,000 for 2011.
not change in real terms; this conforms to the earlier accepted concept of their growth restraint (Table. 10).
Table 10
Implementation of the expenditure obligations of the budget of the enlarged government in 2009 - 2010, in % of GDP
2010_2009_Change
RUR, billion. % of GDP RUR, billion. % of GDP in pp. of GDP %, real assessment
Expenditures, total 17301,0 38,9 16048,3 41,4 -2,5 -2,3
including
General government issues 1438,9 3,2 1313,8 3,4 -0,2 -0,7
incl. servicing federal and municipal debts 261,0 0,6 236,3 0,6 0,0 0,1
National defense 1279,7 2,9 1191,2 3,1 -0,2 -2,6
National security and law enforcement 1339,4 3,0 1245,9 3,2 -0,2 -2,5
National economy 2323,9 5,2 2782,1 7,2 -1,9 -24,3
Housing and utilities 1071,5 2,4 1006,1 2,6 -0,2 -3,5
Protection of natural environment 28,3 0,1 29,6 0,1 0,0 -13,2
Education 1893,9 4,3 1783,5 4,6 -0,3 -3,7
Culture, cinematography, mass media 353,4 0,8 324,4 0,8 0,0 -1,2
Healthcare and sports 1708,7 3,8 1653,0 4,3 -0,4 -6,3
Social policy 5863,2 13,2 4718,8 12,2 1,0 12,6
Source: RF Treasury, IEP calculations
The reduction of the government expenditures was mostly related to such budget items as "National economy" (by 1.9 pp. of GDP), "Healthcare and sports" (by 0.4 pp. of GDP) and "Education" (by 0.3 pp. of GDP). The only item of the budget of the enlarged government which enjoyed increase of funding was "Social policy"; this is mostly connected with pension indexation, three times during the reviewed year. Thus, from January 1, 2010, social supplementary pays to the pension were established to raise the pension up to the cost of living. Therefore, in 66 subjects of the Russian Federation payouts in the form of federal extra pays to the pension (for 2,403. 7 thousand people) and in 17 subjects of the RF in the form of regional extra pays to the pension (2,441.1 thousand people) were made.
From April 1, 2010, work pensions were additionally indexed by 6.3% and social pensions by 8.8%. Besides, from July 1, 2010, social pensions have been increased by 3.41%. With account of all 2010 actions (valorization, indexation) the work pension (old age pension) has grown by 23% amounting to RUR8,177.
At the same time one should mind that such increase of the social obligations requires a well-thought approach since in the context of a sustained shortage of the RF Pension Fund it becomes an extra load on the national budget. Expenditures for funding the additional pension increase in January 2010 were estimated at RUR502 billion (about 1.2% of GDP) while for the April indexation the Federal government had to find another RUR 150 billion. The aggregate pension expenditures grew by RUR1.3 trillion (2.4% of GDP) vs 2009, and a result, the pension system shortage increased to 5.2% of GDP in 2010.
In such context, to revise the current national pension policy is absolutely required. Otherwise, to maintain the replacement ratio at the current level (36%) a choice between the two options will have to be made:
• Step up additional financing (0.5% of GDP for 2011 1% of GDP in 2016, 2% of GDP in 2022, etc) to compensate the pension system shortage; or
• Increase the rates of the insurance contributions by 0.5% on the average every year.
Thus we believe it reasonable to come back to the social tax scale that had been in effect before 2010, to carry our moderate indexation that would not increase the tax burden on the labor market in 2011 - 2012. In a mid-term, to secure the pension system, extra funds should be engaged in addition to standard insurance contributions for compulsory pension insurance. Alongside with the reserve funds, privatization of state property may help, also by way of passing the property over to the RF Pension Fund and non-state (private) pension funds in consideration of current contributions under the cumulative component of the pension insurance.
2.2.3. Main events in the budget area in 2010.
In the last year, in spite of the crisis and the need to cut down budget expenditures, the RF Government continued making transformations that started in the second half of the 2000'es to improve the quality of the budget governance and to implement the social obligations that had been assumed before. In 2010, the following events in the budget area can be considered as significant:
1. Development and approval of the RF Government Program to improve efficiency of the budget expenditures1. The need to ensure a long-term balance and stability of the budget system in the form of an absolute fair limitation of the "irresponsible" annual increase of the budget expenditures is a fundamental condition for the Program implementation success.
An innovation in the Program is introduction of another program targeted tool - "a government program" designed to set aims, objectives and instruments of the government policy aimed at the implementation of the priorities of the Concept of a long-term social and economic development or large-scale actions of national or international significance. Last August the RF Government approved the procedure for development, implementation and assessment of efficiency of such government programs2, while in November the RF Government passed a resolution where a list of the government programs was approved3. All the programs are structured by the following areas:
- New quality of life (13 programs);
- Innovative development and upgrade of the economy (17 programs);
- National security assurance (2 programs);
- Well-balanced regional development (4 programs);
- Effective government (5 programs).
The funds for the programs will be determined during national budgeting for 2012-2014. Other significant areas of budget governance quality improvement in the Program are:
- Considerable increase of the target programs share (currently the budget expenditures under a targeted program method are covered by about 15%) in the budget;
- Reforming the mechanism of state order implementation;
- Improvement of the budget network;
- Reforming institutions of the federal (municipal) government control;
- Delineation of authorities between various levels of power, etc.
In spite of the fact that the Program is oriented at the improvement of the budget process at the federal level, the success of its implementation depends on the alignment and effective-
1 Order of the RF Government of June 30, 2010 No 1101-r
2 Resolution of the RF Government No 588 of August 2, 2010
3 Order of the RF Government of November 11, 2010 No 1950-r 58
ness of the efforts at all the levels. Therefore the RF Government recommended the executive authorities of the RF subjects and the local government bodies to develop and implement similar regional and municipal programs for improving efficiency of expenditures of the respective budgets according to the key provisions of the Federal Program. Also a decision was taken to grant federal subsidies to the regional budgets for the implementation of the regional programs1.
2. In 2010, amendments 2 in the RF Budget Code were adopted to be effective since 2011. These amendments primarily changed the structure of functional classification of the budget expenditures and increased the number of budget items from 11 to 14. The following expenditures now have become separate items:
- servicing of the federal government and municipal debts. Before this expenditure item was included in the section "General Government issues". This innovation aims at the improvement of control effectiveness over government debts specifically in view of its future increase in the mid-term;
- physical culture and sports expenditures. Earlier this budget item was included in the section "Healthcare";
- expenditures on mass media including TV and radio broadcasting; periodical press and publishing houses, applied research in the area of mass media and other mass media issues. Earlier the mass media expenditures were included in section "Culture and cinematography".
"Inter-budget transfers" section was also modified. Now it is called "Inter-budget transfers of general nature to the budgets of the RF subjects and municipal establishments". In this section the targeted transfers such as subventions and subsidies are united in item "subsidies for alignment of the budget provision of the subjects of the Russian Federation and municipal establishments". All other transfers are grouped into- "other subsidies" and "other inter-budget transfers of general nature". Transfers to off-budget funds are included in other sections. Thus, since 2011 transfers to the national Pension Fund will be included in section "Social policy"; as a result, the expenditures under "Inter-budget transfers" will be considerably reduced in 2011 - 2013 while the expenditures under "Social policy" will grow (see Table 13).
"National security and law enforcement" section was supplemented with an item called "modernization of the inferior troops, rescue military crews of a federal executive body authorized to resolve problems of the civil defense and of the law-enforcement and other bodies". The desire to localize expenditures in the expenditure structure is explained by the coming (since 2012) transition to the program-based budget where each expenditure area will be shaped as a government program.
In July 2010, according to the amendments 3 in the Budget Code, the date of submission of the draft federal budget to the State Duma was moved from August 26 to October 1st. Such decision was made with a view to improve accuracy of the main forecast parameters of the federal budget when it is formed later in the year since by the first of October updated macro-
1 Resolution of the RF Government if December 31, 2010 No 1203.
2 Federal Law of 30.09.2010 No 245-FZ.
3 FZ of 27.07.2010 No 216-FZ " On amendments in the Budget Code of the Russian Federation with regards to specification of the dates of compiling, reviewing and approving draft budgets and reports on their implementation".
parameters are usually available, main directions of the tax policy approved, and the Federal Target program scope is corrected.
3. Legal framework for road funds activity. In December 2010, the State Duma reviewed the first version (reading) of a bill aimed at development of the legal framework for establishment (since January 1, 2011) of road funds both at the federal and regional levels 1.
The RF Government initiated creation of a target budget fund for road construction and repair back in May 2010. In particular, the road fund notion was suggested as a portion of the budget funds to be used for financing road activities2, and to set up Federal Road Fund as part of the federal budget.
To create this asset, the following revenues will be accumulated:
- excises on gasoline, diesel fuel and motor fuels;
- use of property that is part of the motor roads of general use of federal importance;
- tolls on motor vehicles registered in foreign states when they drive by motor ways in the Russian Federation;
- subsidies from the RF budget system to finance roads of general use of federal importance;
- uncompensated receipts from legal entities and individuals to finance road activity;
- other receipts from fines and damage compensations.
With account of increased rates on the said excisable goods, since 2011 this mechanism will help accumulating about RUR500 billion annually, according to the estimates of the RF Ministry of Finance.
The rationale of the creation and functioning of the road funds raises serious concerns by a number of reasons. Firstly, the Audit Chamber of Russia has systematically focused on non-efficient use of the budget funds of the federal and regional road funds that were functioning earlier. Secondly, a road fund having its own fixed sources of revenue does not meet the principle of general consolidated coverage of the budget expenditures stated in Article 35 of the Budget Code. Thirdly, with the creation of road funds, the issue of a single-channel model of financing the needs of the sector remains unresolved: there are still several channels of bringing budget funds to the road sector organizations. In particular, a sub-program "Development of the Russia's transportation system (2010 - 2015)" of the Federal Target program is still being implemented as well as co-financing of auto-concession from the Investment Fund.
2.2.4. Analysis of the main parameters of the federal budget of the Russian Federation in 201 1-2013.
The world economic crisis brought about significant changes in the environment of the formation of the government budget in Russia. First, a sharp reduction in budget revenues took place - from 22.5% of GDP in 2008 to 18.7% of GDP in 2010 (see Table 11). Besides, in a long-term perspective a further reduction of the share of oil and gas revenues in the budget is expected which will not be compensated by high oil prices. This will occur due to several factors: non-raw material sectors will have an outrunning growth, greenfields subject
1 Some subjects of the Russian Federation e.g. Tatarstan, Lipetsk and Samara regions announced their intention to set up regional road funds in 2011.
2 The road activity is activity for designing, construction, modernization, capital repair and maintenance of the motor roads (according to FZ of November 8, 2007 No 257-FZ "On the motor roads and the road activity in the Russian Federation, and amendments in separate legislative acts of the Russian Federation").
to tax holidays will increase in number as well as brownfields (exhausted) that also enjoy tax benefits, the ruble currency is expected to strengthen. A development scenario is likely to happen where budget revenues will decrease while GDP will continue growing. According to our estimates, in the near decade oil and gas revenues may fall down by 2% of GDP as a result of the said factors.
Secondly, during the crisis the federal government has assumed many additional expenditure obligations causing expenditure growth from 18.3% in 2008 up to 22.7% in 2010. Though the implementation of the Anti-Crisis Program was quite justified and successful, currently optimization of the budget expenditure structure and reduction of redundant and inefficient areas of the budget finance has become a priority.
Thus, the Law on the Federal Budget for 2011 and for the planning period up to 2013 was developed in a revised context of the budget system, and this context predetermined the tasks: to ensure financial stability of the budget system, to cut down the shortage of the federal budget and to improve efficiency of the budget expenditures. The main parameters of the said Law are given in Table 11.
Table 11
Main parameters of the federal budget in 2008-2013 in % of GDP
Actuals Budget Law
2008 2009 2010 2011 2012 2013
Revenues 22,5 18,9 18,7 17,6 17,0 16,8
including from oil and gas 10,6 7,7 8,6 8,1 7,9 7,5
Expenditures 18,3 24,9 22,7 21,2 20,1 19,7
incl. tentatively approved - - - - 0,8 1,3
Deficit (-) /Surplus (+) 4,2 -6,0 -4,1 -3,6 -3,1 -2,9
Other than oil and gas deficit -6,4 -13,7 -12,6 -11,7 -10,9 -10,4
Source: Ministry of Finance of Russia, IEP calculations
As the Table suggests, the federal budget deficit will reduce to 2.9% of GDP in 2013, however this reduction can be less due to a number of assumptions. Primarily, there are more optimistic estimates of the oil prices in the mid-term (when the budget was shaped, a conservative forecast was used with the prices at 75-78 $/bbl). A high dependency of the budget revenues on oil and gas revenues remains. Besides, a growth of the budget revenues is possible if the macro-economic situation improves in the mid-term and the world economy revives after the crisis, and the demand for goods on the Russian and international markets will increase together with the growth of foreign investments. Finally, a positive trend of reduction of the budget expenditures as a result of the implemented reforms of 2009 - 2010 may be expected.
It is also obvious that with a less favorable development of the economy and a change of the ratio between the basic parameters of the social and economic development (oil prices, GDP volume, inflation rates, the ruble exchange rate) the budget deficit can become so high that new issues may appear challenging the growth of the economy and the stability of the budget system as a whole.
For the near three years, receipts from the indirect taxes, MET and customs duties will remain the main sources of revenue for the federal budget (see Table 12). Note, that according to the forecast of the RF Ministry of Finance, in 2013, with comparable volume of the real GDP, the revenues of the federal budget will be by 5.7 pp. of GDP lower than in 2008. According to our estimates, approximately 2.5 pp. of GDP cuts are caused by changes in the tax
legislation (UST is replaced with insurance contributions, and the Profits Tax rate is reduced), 1.0 pp. - caused by reduction of revenues from the oil producing sector (MET and export duty reliefs) and 2.1 pp. - by reduction of revenues from taxes related to a lower (in 2013 vs 2007) level of profitability and changes in the economic activity structure.
During 2012 - 2013, a "pin-point" policy to increase fiscal burden on certain sectors of economy, especially, on the oil and gas sector, will be carried out. Since 2011 the MET rate on gas is expected to increase by 61% - from RUR147 to RUR237 for 1,000 cu. m, in 2012 the rate will be indexed for the expected growth of prices (5.9%) up to RUR251; while in 2013 - by 5.5% up to RUR265/1,000 cu. m. The increase of the fiscal burden on the producing sector the national budget system is going to receive additional RUR50-70 billion every year in 2011 - 2013. (see Table 12). As for MET on oil, the MET rate will not change in 2011; however in 2012 it is expected to increase from RUR419 to RUR446 for one ton, and in 2013 - up to RTUR470. This measure will annually bring to the budget about RUR75 and RUR150 billion respectively. However, this measure may negatively affect the sector efficiency.
Abolishment of the reduced rate of the export customs duty on oil produced at the specific fields of East Siberia will ensure a surplus revenue to the federal budget of RUR97 billion in 2011 and about RUR30 billion in the following two years. Besides, last December the increase of the export duty on oil products continued to be discussed. Russia as a member of the Customs Union has reserved this right and can use it as early as in the mid-term period. Two options of the duty increase are considered:
• gradual equation of the duties on light and dark oil products by bringing them to 60% of the duties on crude by 2013;
• increase of the average weighted rate at the external border of the Customs Union.
• If the export duties increase, the government will search for other methods of support of the national "oil refining", meaning not primary treatment but deep crude conversion.
Regardless of the total increase of the tax burden on producing companies, a gradual reduction of oil and gas revenues (as shares of GDP) is expected caused by objective (lower rates of growth of the Urals prices and taxable exports vs GDP dynamics and ruble strengthening) and sector problems (reduced production volumes and lower profitability rates).
As for revenues other than those from oil and gas, an insignificant growth of the VAT receipts is expected related to the growth of sale volumes at the internal market and receipts from excises caused by the annual increase of the rates on excisable goods (mainly on tobacco and alcohol products) in the coming three years (see Table 12).
As for revenues other than from the taxes, their growth is forecasted as a result of setting tasks on dividends generated from the stocks of joint-stock companies being in federal ownership, and a portion of profits of federal unitary enterprises.
The federal budget expenditures show a tendency for reduction (in % of GDP), but their volumes in constant prices of 1998 and expressed as % of GDP remain at a sufficiently high level that obviously surpass the level reached in the successful 2008 (see Fig 13). Besides, in real terms the trend of their reduction will change for the opposite one as early as in 2013.
Table 12
Actual and expected revenues to the federal budget of the Russian Federation from the main taxes in 2008-2013 (% of GDP)
Actuals Law on budget
2008 2009 2010 2011 2012 2013
Profits Tax 1,8 0,5 0,6 0,5 0,5 0,5
UST/Insurance contributions 1,2 1,3 0,0 0,0 0,0 0,0
VAT- total: 5,2 5,3 5,6 5,6 5,6 5,7
internal production 2,4 3,0 3,0 3,0 3,1 3,1
imports 2,7 2,3 2,6 2,6 2,5 2,6
Excises - total: 0,4 0,3 0,3 0,5 0,6 0,7
internal production 0,3 0,2 0,3 0,5 0,5 0,6
imports 0,1 0,1 0,1 0,1 0,1 0,1
MET 3,9 2,5 3,1 2,8 2,7 2,6
Customs duties - total: 8,4 6,5 6,4 6,7 6,5 6,3
import duties 1,5 1,2 0,8 1,2 1,2 1,2
Export duties 6,9 5,3 5,6 5,5 5,3 5,0
The share of the said taxes and duties in the federal budget revenues in % 93,3 86,5 85,6 92,0 93,4 93,7
Source: Ministry of Finance of Russia, IEP calculations.
-r 400
300 200 100 0
-100 -I- -200 -I- -300 -400
1998199920002001200220032004200520062007200820092010201120122013 mum Revenues [2221 Expenditures ^^^Federal budget balance (right line)
Source: Ministry of Finance of Russia, IEP calculations.
Fig. 13. Dynamic trend of the revenues, expenditures and deficit of the federal budget, in RUR billion, and in 1998 constant prices
The growth of expenditures as GDP shares is planned in such sections as "National defense" and "Servicing of the government debt" 1 (see Table. 13), while in other sectors the expenditures are going to fall down vs GDP; this can be explained by GDP higher growth rates as compared to the growth rates of expenditures in absolute terms, measures taken to optimize the network of budget institutions, and reduction of the number of implemented federal target programs ( 43 in 2011 down to 37 in 2012 ) and the volumes of allocated funds (from RUR 1364.8 billion in 2011 down to RUR1 080.6 - in 2013). The review of the expenditure structure for open federal target programs shows that with a general reduction of the allocations, in 2010 - 2013 an increase in expenditures is observed in "Innovative development and upgrading of economy" only (from RUR436.5 billion in 2010 to RUR 579.3 bln in 2013); this is in full line with the Budget Code provisions.
1 For the reasons of such growth of expenditures under "Social policy" see above.
Table 13
Dynamics of the expenditure obligations of the federal budget in 2010-2013 in % of GDP
2008 2009 2010 2011 2012 2013 Variance of 2013 vs2010, in %GDP
Expenditures (without tentatively 18,3 24,9 22,7 21,2 20,1 19,7 -3,1
approved) total
including 1,7 1,7 1,6 1,7 1,4 1,2 -0,3
General government issues
Servicing municipal and federal 0,4 0,5 0,4 0,8 0,9 1,0 0,5
debts
National defense 2,5 3,1 2,9 3,0 3,0 3,4 0,5
National security and law enforce- 2,0 2,6 2,4 2,4 2,1 1,9 -0,5
ment
National economy 2,5 4,3 2,7 3,4 3,0 2,5 -0,2
Housing and utilities 0,3 0,4 0,5 0,4 0,2 0,1 -0,4
Protection of natural environment 0,0 0,0 0,0 0,0 0,0 0,0 0,0
Education 0,9 1,1 1,0 1,0 0,9 0,8 -0,2
Culture, cinematography, mass media 0,2 0,3 0,3 0,3 0,3 0,2 -0,1
Health care and sports 0,7 0,9 0,8 1,0 0,9 0,7 0,0
Social policy* 0,7 0,8 0,8 6,0 5,8 5,6 4,9
Inter-budget transfers of general 6,5 9,3 9,3 1,1 0,8 0,7 -8,6
nature *
Tentatively approved - - - - 0,7 1,3 -
* Specifics of re-distribution of funds between these two items relate to the changes of the functional classification of the budget expenditures effected in 2011 (see above). Source: RF Treasury, IEP calculations.
The growth of expenditures is also prompted by some governance decisions which may be considered as doubtful in terms of the budget policy priorities. Thus, e.g. from 2011, five new federal target programs and three state programs will be financed, and part of these are not included in the priorities of the budget policy as set by President of Russia. Many experts believe, e.g. that the "Clear water" FTP developed under the influence of the Parliament lobby, likewise "Development of the domestic and international tourism" can hardly be described as priorities that require additional financing given the budget deficit; moreover the expenditure share for the new FTP makes almost 20% of the FTP general expenditures for 2011 - 2013.
In 2011-2013 the federal budget expenditures will be cut down in the following sections and areas:
- "Healthcare" - from RUR 375.6 billion in 2011 to RUR 356.1 billion in 2013: at the expense of increasing funds for the implementation of the sector modernization project from the Fund of Compulsory Medical Insurance. The major portion of the allocations from the said Fund will be distributed among regions in the form of grants;
- "Housing and utilities" - in 2012 and 2013 there will be a reduction of the budget allocations for the implementation of the federal target programs and a FAIP part not covered with the programs, including the provision of service and permanent housing to the servicemen (RUR125.9 billion in 2010 to RUR25.3 billion in 2013) in connection with completion of the respective efforts. Besides in 2011 there will be budget allocations to finance subsidies to a state corporation Fund of Assistance to the Housing and Utilities Reform in the form of a property contribution to rehabilitate the Fund property that had been transferred to the ownership of the Russian Federation in 2009 in the amount of RUR15.0 billion; no such actions are planned for 2012 and 2013.
More than double expenditures to service the government debt - from 0.4% of GDP in 2010 to 1.0% in 2013 - require special attention. The growth of the government debt (8.3% of 64
GDP as of 01.01.2010 up to 18.2% of GDP as of 01.01.2014 - see Table 14) may negatively affect the stability of the national fiscal system. At the same time stepping up the government debt will take place primarily through a growing share of internal borrowings (in 2010 - 2013 the internal debt will grow from 5.4% of GDP to 14.3% of GDP, while the external debt will remain within 4% of GDP) which is quite justified in terms of national security and manageability of the debt.
Table 14
Federal debt of the Russian Federation in % of GDP
Law on budget*
2005 2006 2007 2008 2009 2010 2011 2012 2013
Federal government debt (as of the year end) 14,3 9,1 7,2 6,5 8,3 9,4 13,7 16,1 18,2
including:
internal debt 4,1 4,0 3,9 3,6 5,4 6,6 10,2 12,5 14,3
external debt 10,2 5,1 3,3 2,9 2,9 2,8 3,5 3,6 3,9
*top limit of the federal government debt is shown
Source: RF Treasury, IEP calculations.
The period when the Reserve Fund was a key source of financing deficit of the federal budget ended in 2010, when the Fund allocated RUR1,119.5 billion (2.5% of GDP) for the said purpose. The Reserve Fund allocations have not been spent fully as the expected federal budget deficit was reduced; the non-spent funds as of January 1, 2011 amounted to RUR775.2 billion. (Table 15).
Table 15
Dynamic trend of the formation and use of oil and gas funds in 2010, in RUR MM
Receipts in 2010 Spent in 2010 for:
Indicator Balances as of the end of 2009 * oil and gas revenues Assets management receipts Financing of the federal budget deficit Financing of the budget deficit of offbudget funds Balances as of the end of 2010 *
Reserve Fund 1830.5 - - 1119.5 24.5 775.2
(4.7% of GDP) (1.7% of GDP)
National Welfare Fund 2769.0 (7.1% of GDP) — — — 2.5 2695.5 (6.1% of GDP)
Total 4599.5 - - 1119.5 27.0 3470.7
(11.8% of GDP) (7.8% of GDP)
* the balances are recalculated at the exchange rate as of January 1, 2010 and 2011 respectively. Source: RF Treasury.
In 2010, the RF Government elected not to use the National Welfare Fund, and the Fund balance in absolute terms remained at the 2009 year-end level. The Fund's assets in the amount equal to the population's pension accruals (RUR5.0 - 10.0 billion per year) will continue to be further used in 2011 - 2013 thus ensuring safety of the accumulated assets of the Fund. It is worth noting that given the considerable reduction of spending or full spending of the oil and gas funds' assets, by 2012 the national financial system could be exposed to external shocks having no financial coverage.
To cover the budget deficit, receipts from privatization (RUR298 billion in 2011 up to RUR309.0 billion in 2013) will be actively used.
2.2.5. Prospects of the fiscal policy development
In 2010, the structure of the Russian economy (fuel and energy sectors generate up to 9% of GDP) and the exports oriented at raw materials (2/3 of the exports are produced in the fuel and energy sectors) ensured, through the system of oil and gas revenues, up to 46.5% of the federal budget revenues and 24.6% of the budget revenues of the enlarged government. However, world market prices on fuel and raw materials are highly volatile. The issue of such dependency was partially resolved by establishing in the 2000'es a tax system with graduated MET rates and export duties depending on oil prices and Stabilization Fund. When in 2009 the federal budget revenues in real terms decreased by 22%, the Government managed to increase expenditures up by 25% by tapping assets accrued in the Reserve Fund. Nevertheless, according to IEP, tax revenues fluctuate in the range of ±3-4% depending on the external market situation; besides, at various stages of the business cycle an additional fluctuation of the tax revenues can happen within ±2-2,5%. In other words, with an average long-term price on oil of 70 $/bbl, the enlarged government budget can receive about 34% of GDP, but this figure may vary from 28% to 40% of GDP.
With account unpredictable generation of budget revenues from oil and gas, a conservative approach is required to define the level of their spend that would ensure budget stability. The current application of the oil and gas transfer which size is linked to GDP does not limit expenditures to a safe level in terms of the budget balance. To reduce the dependency of the budget revenues on the external economic situation, we should abolish the current procedure of the oil and gas transfer and return to the procedure effective in 2004 - 2007: the procedure was based on the cut-off price, and MET contributions to the Reserve Fund and the export duties were in direct proportion to the excess of the actual tax rate over the rate calculated with account of the average long-term price. In other words, the size of the oil and gas revenues open for use should be limited by a certain threshold oil price kept unchanged during the entire period of budget planning (i.e. three years).
All oil revenues above the established limit should be channeled to oil and gas funds. A budget deficit should be funded from the Reserve Fund only if budget revenues are under-received as a result of the oil price being lower than the oil price estimated in the respective macro-forecast which was used as a basis for estimation of the main parameters of the federal budget.
Such approach can assure budget stability since the threshold level of the budget allocations for spending is fixed as early as the budget planning stage. To use the cut-off price would be reasonable (similar to the price used as a basis for establishment of the Stabilization Fund in 2004 - 2007) for estimation of tax revenues from production and export of oil and gas.
In the context of limitation of government expenditures, efficiency of their spending should be improved. The quality of budget governance can be improved by using a comprehensive approach only that will help to cover the broadest range of the applied regulating tools and to align their application in time. With this in view, in the near future a focus should be placed on resolution of the issues of budget system restructuring, higher transparency of the state procurement system and optimization of certain budget procedures. As a favorable institutional environment evolves in the country, any further development of such governance tools as the result-oriented budget, target program activities, state and private partnership can become an important factor of budget expenditures streamlining and improvement of efficiency of the entire budget process. 66
2.3. Intergovernmental Fiscal Relations and Subnational Finances
2.3.1. Subnational Budgets in 2010
Basic trends concerning relations between different levels of power are reflected in the structure of revenues and expenditures of the consolidated budget of the Russian Federation. Data on a share of tax revenues and expenditures of the constituent territories of the Russian Federation in the relevant items of the consolidated budget of the Russian Federation is shown in Table 16.
Table 16
A share of specific values of the budget of the constituent territories of the Russian Federation in the consolidated budget of the Russian Federation in 1992 - 2010 (%)
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 33.2 36.6 37.2 47.7 61.7 61.4 56.0 55.8 59.5 59.9 53.0 49.0 42.6 40.1 41.9 47.5 49.1 52.0 50.5 53.7 54.8 57.1
Tax revenues Tax revenues, net of natural resource charges and customs duties
Expenditures 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 49.2 43.4 43.2 Data Source: The Federal Treasury, the estimates were made by the Gaidar Institute.
The following is worth highlighting in analyzing the data presented in Table 16. A share of tax revenues of the constituent territories of the Russian Federation in the consolidated budget decreased considerably from 56.6 to 30.9% over the period between 1998 and 2005. This trend was conditioned by economic situation (growth in prices of energy resources resulted in increase of revenues from customs duties and natural resource charges due to the federal budget), rather than redistribution of sources of revenues between different levels of the budget system. The fact that a share of subnational budgets in tax revenues of the consolidated budget, net of natural resource charges and customs duties, decreased less during the same period, from 59.9% in 1998 to 49.1% in 2005, can be used as evidence. A share of subnational budgets in tax revenues of the consolidated budget of the Russian Federation was reported to increase in the period between 2006 and 2007, because revenues from taxes payable to regional budgets increased faster than tax revenues of the federal budget. In 2008 this share slightly decreased but remained at a much higher level than in 2005. A share of regional budgets in tax revenues of consolidated budget, net of natural resource charges and customs duties, increased visibly in 2008 over the level of 2007.
The economic downturn of 2009 had an effect on the relations under review. A share of tax revenues of the constituent territories of the Russian Federation increased considerably from 33.2 to 36.6% in the relevant revenues of the consolidated budget of the Russian Federation, which was conditioned to a large extent by a slump of federal budget revenues from mineral extraction tax and customs duties. A share of regional budgets, net of natural resource charges and customs duties, increased as well: by 1.1 p.p., from 53.7 to 54.8%, which was conditioned
to a large extent by steady revenues from personal income tax paid to regional budgets during the recession (RUB 1666,2 bln in 2008 and RUB 1665,8 bln in 2009 ). A certain economic recovery was reported in the Russian industries in 2010. According to the data published by Rosstat, GDP increased by 4% in real terms. A share of regional tax revenues in the consolidated budget of the Russian Federation increased from 36.6 to 37.2% due to a faster growth in volumes of taxes payable to subnational budgets. A share of tax revenues, net of natural resource charges and customs duties, increased more by 2.3 p.p., from 54.8 to 57.1%. On the other hand, a share of subnational budgets in revenues of consolidated budget of the Russian Federation decreased considerably from 49.2% in 2008 to 43.4% in 2009, and remained almost the same, 43.2%, in 2010. The foregoing trends was indicative of a marked reduction in the vertical gap in the Russian budget system by aligning shares of tax revenues and revenues of subnational budgets in the consolidated budget of the Russian Federation. It is well to bear in mind that this trend was reported due to a drastic decrease in federal budget revenues in 2009 accompanied by a substantial growth in the federal government expenditures (by 27.4% in nominal terms against the level of 2008) which were covered with accumulated financial reserves.
In light of the recent trends, the Russian expert community's traditional point of view on that the budget system is vertically unbalanced through excessive concentration of tax revenues in the federal budget. The following arguments may cast some doubt on this point of view :
- federal budget revenues include a big share of "natural resource rent" which is extremely unstable and likely to keep reducing as percentage of GDP ;
- the federal budget includes the largest cost-related obligation - financing of the pension system deficit. Ageing of the population will result in growth in expenditures on pension provision and demand for "grants" from the federal budget;
- regional and local budgets include almost all of the taxes, save for "natural resource rent", namely personal income tax, a "lion's share" of profit tax (18% of 20%), corporate property tax. Should the country follow the post-industrial (non-primary) scenario, a share of these taxes would be increasing in total revenues of the consolidated budget of the Russian Federation. On the other hand, the federal budget has only one large source of tax revenues, VAT, which would remain relevant under the non-primary sector development model.
Therefore, any substantial tax revenues are unlikely to be allocated to the subnational level.
Let's take a closer look at the situation with revenues of subnational budgets. Dynamics of basic elements of revenues of the consolidated budgets of the constituent territories of the Russian Federation in the period between 2008 and 2010 is presented in Fig. 14.
7000
CO Z>
cr
6000
5000
4000
3000
2000
1000
H other non-repayable transfers
□ transfers from the federal budgets
□ non-tax revenues
tax revenues
2008
2009
2010
Data Source : The Federal Treasury, the estimates were made by the Gaidar Institute.
Fig. 14. Revenues of the consolidated budget of the constituent territories of the Russian Federation in 2008 - 2010, by component (in nominal terms)
Tax revenues of consolidated budget of the constituent territories of the Russian Federation increased by 19.2% in nominal terms in 2010 against the previous year, their share in overall revenues of regional budgets increased from 64.0 to 69.1%. Tax revenues increased in volume by 9.5% in real terms against the level of 2009 whereas kept decreasing by 12.9% against the level of 2008. One may say that in general tax revenues of regional budgets therefore failed to catch up with the pre-recession values both in volume terms and as percentage of overall revenues of the consolidated budget of the constituent territories of the Russian Federation (this share was 70.7% in 2008). Tax revenues tended to decrease in volumes by 1.8% in nominal terms. As a result, while in 2008 these revenues accounted for 9.8% of the overall revenues of the budget of the constituent territories of the Russian Federation, they decreased to 8.7% in 2009 and 7.7% in 2010. Transfers from the federal budget also decreased in volume to 6.0% in nominal terms against the level of 2009. In spite of a slight reduction, however, volume of transfers remained beyond the level of 2008 in comparable prices (a 4.3% growth in real terms). A similar situation developed with regard to other non-repayable transfers to the consolidated budget of the constituent territories of the Russian Federation: a 14.1% reduction in nominal terms against the level of 2009 and a 32.3% growth in real terms against the level of 2008. It should be noted that most of the other non-repayable transfers from the Fund for the Promotion of the Reform in the Housing and Public Utility Sector. As a result, though a share of non-repayable transfers in revenues of subnational budgets reduced from 27.0% in 2009 to 22.8% in 2010, it kept outstripping the value of 2008 (19.1%). In general, revenues of the consolidated budget of the constituent territories of the Russian Federation increased by 1.4% in real terms in 2010 against the level of 2009 whereas reduced by 10.9% against the level of 2008.
Dynamics of basic tax revenues payable to subnational budgets in the period between 2007 and 2010 are shown in Table 17.
Table 17
Tax revenues inflow to the consolidated budget of the constituent territories of the Russian Federation in 2007 - 2010, (as % of GDP)
2007 2008 2009 2010
Tax revenues, total 10.88 10.63 9.78 10.16
including:
Corporate profit tax 4.60 4.25 2.76 3.42
Personal income tax 3.81 4.04 4.29 4.02
Excise taxes on goods sold on the territory of the Russian Federation 0.54 0.46 0.63 0.74
Lump-sum taxes 0.37 0.39 0.39 0.40
Property taxes 1.24 1.20 1.47 1.41
Natural resource taxes, dues and regular charges 0.23 0.25 0.19 0.07
For reference: GDP, t RUB 33.25 41.26 38.80 44.49
Data Source : The Federal Treasury, the estimates were made by the Gaidar Institute.
In general, tax revenues of consolidated budgets increased from 9.78% of GDP in 2009 up to 10.16% of GDP in 2010, however, failed to catch up with the level of 2008 (as 10.63% of GDP). Specific types of taxes were multidirectional. Traditionally, there are two taxes which provide basic tax revenues to consolidated regional budgets, namely corporate profit tax and personal income tax, which accounted for about 73% of the total tax revenues in 2010, slightly outstripping the level of 2009 (72%) but being far behind the level of 2008 (78%). The main reason is that though profit tax revenues increased by 0.66 p.p. of GDP to reach 3.42% of GDP, it was markedly below the revenues of 2008 (4.25% of GDP). It should be taken into account, however, that regional rate of this tax raised from 19.5 to 20% from January 1, 2009. Therefore, though a certain recovery in the Russian economy in 2010 resulted in growth in profit tax revenues, the revenues remained far from the pre-recession values as percentage of GDP. Another key tax - personal income tax - showed different dynamics. As reported in the previous review1, personal income tax was found to be one of the most stable types of tax revenues in consolidated regional revenues amidst the economic downturn. In 2010, personal income tax almost caught up with the level of 2008 as percentage of GDP (as 4.02 and 4.04% of GDP, respectively). The decrease of personal income tax against the level of 2009 can be explained by the fact that it slumped as percentage of GDP in 2009 amidst the economic downturn and increased in the period of recovery of the Russian economy in 2010. The following may be highlighted by examining the dynamics of other tax revenues of the consolidated budget of the constituent territories of the Russian Federation. Excise tax revenues grew steadily as percentage of GDP in the period between 2009 and 2010, mostly because a part of excise tax revenues was transferred from the federal budget to regional budgets in 2009 and excise tax rates in increased in 2010. A share of taxes payable by SMEs (lump-sum tax) remained unchanged over the period under review, accounting for 0.4% of GDP in 2010. Property tax revenues, which increased visibly from 1.20 to 1.47% of GDP in 2009, slightly decreased down to 1.41% of GDP in 2010. Nevertheless, the revenues were visibly beyond the value of 2008. The role of mineral extraction tax and other natural resource charges in regional budget revenues decreased in the period between 2009 and 2010. Mineral extraction tax revenues decreased considerably in 2010, which was
1 The Russian Economy in 2009. Trends and Outlooks., M. IET, 2010 70
connected mostly with centralization of mineral extraction tax revenues as hydrocarbon material in the federal budget1.
Dynamics of tax revenues in the consolidated budget of the constituent territories of the Russian Federation have been considered in general above. However, analysis by region is also of interest, because the constituent territories of the Russian Federation differed in recession severity and degree of economic recovery. It should be noted that differentiation of tax revenues in regional budget revenues decreased in 2009 and then increased again in 2010. The relevant coefficient of variation of per capita tax revenues given the budget expenditures index was 87.2% in 2008 and 75.0% in 2009, but increased up to 91.3% in 2010, thus outstripping the level of 2008. Such a dynamics were to a large extent linked with the following aspects. As already noted in the previous review, it was the economically developed regions that were hit most by the economic recession, which resulted in some decrease in interregional differentiation. Late in 2009 the Russian economy began to recover but the constituent territories of the Russian Federation differed largely in degree of recovery and, consequently, growth rates of tax revenues, which resulted in increase of differentiation of per capita tax revenues. To better understand the situation with tax revenues by constituent territory, let's take a look at a breakdown of Russian regions in terms of changes in per capita tax revenues in the period between 2009 and 2010 (see Table 18).
Table 18
A breakdown of the Russian regions in terms of changes in tax revenues of the consolidated budget of a constituent territory of the Russian Federation
Number regions in which In nominal terms In real terms
tax revenues in 2009 against the level of 2008 in 2010 against the level of 2009 in 2010 against the level of 2008 in 2010 against the level of 2008
Increased by more than 25% 3 23 25 3
Increased by 10 to 25% 9 52 30 13
Increased by less than 10% 18 4 13 29
Decreased by less than 10% 28 1 10 14
Decreased by 10 to 25% 18 2 3 21
Decreased by more than 25% 6 0 1 2
Data Source : The Federal Treasury, the estimates were made by the Gaidar Institute.
As may be seen from the presented data, a share of tax revenues in consolidated regional revenues decreased in nominal terms in 52 of 822 constituent territories of the Russian Federation amidst the economic downturn in 2009. Exactly the converse situation was observed in 2010, when the Russian economy began to recover: tax revenues in 79 regions increased in nominal terms against the level of 2009. However, since tax revenues decreased at more than a half of the constituent territories in 2009, it was the base effect that had a serious impact on growth figures in 2010. Of special interest, therefore, is comparing volumes of tax revenues
1 The regulation for crediting the mineral extraction tax revenues as hydrocarbon material (save for the flammable natural gas) to the federal budget was increased from 95 to 100% from January 1, 2010 (The Federal Law dd. September 22, 2009, No. 218-FZ "On the Amendments to Certain Legislative Acts of the Russian Federation and Annulment of Certain Provisions of the Legal Entities of the Russian Federation").
2 The Archangelsk Region and the Nenets Autonomous District are regarded as a single constituent territory of the Russian Federation.
with the level of 2008 in both nominal and real terms in order to assess how the situation with regional budget revenues is improved in 2010. Tax revenues increased in nominal terms against the level of 2008 at 68 regions and by more than 10% at 55 constituent territories of the Russian Federation. However, after allowing for inflation in the period between 2009 and 2010, the picture would change substantially. Tax revenues increased in real terms in 2010 against the level of 2008 at 45 regions, accounting for a bit more than a half of the total. Therefore, almost 50% of the constituent territories of the Russian Federation were facing problems with tax revenues inflow in their budgets, of which 16 constituent territories experienced a 10% decrease in tax revenues, at 2008 values, against 2008. The following constituent territories of the Russian Federation experienced most a negative decrease in real terms in 2010 against the level of 2008: the Tyumen Region (- 42.7%), the Vologda Region (33.3%), Moscow (- 24.8%), the Perm Territory (- 24.3%), the Kemerovo Region (- 23.3%), the Lipetsk Region (- 22.5%) and the Khanty-Mansi Autonomous Area (- 18.9%). Hence, in 2010, tax revenues decreased in real terms against the level of 2008 mostly at the high-fiscal-capacity economically developed constituent territories of the Russian Federation, which reinforces the foregoing opinion on that these regions were hit most by the economic downturn.
Let's consider the changes which took place in consolidated budget revenues of the constituent territories of the Russian Federation. In 2009, overall expenditures of the consolidated budget of the constituent territories of the Russian Federation remained at the level of 2008 (RUB 6,256.3 bln and RUB 6,253.5 bln, respectively). In 2010 regional expenditures increased by 6.1% in nominal terms against the level of 2008-2009 whereas decreased by 2.5%. in real terms against the level of 2009 and by 10.3% against the level of 2008. The structure of expenditures of the consolidated budget of the constituent territories of the Russian Federation was changed as well (see Table 19).
Table 19
Structure of expenditures of the consolidated budget of the constituent territories of the Russian Federation in 2008 - 2010, ( % )
2008 2009 2010
Nationwide issues 7.1 7.3 7.3
Including state and municipal debt servicing 0.6 1.0 1.1
National defense 0.0 0.0 0.0
National security and law enforcement 4.1 3.9 3.8
National economy 19.6 18.1 16.6
Housing and public utility sector 16.3 13.7 12.6
Environmental protection 0.3 0.3 0.2
Education 20.8 21.5 21.9
Culture, cinematography and mass media 3.5 3.4 3.4
Healthcare and sports 12.7 12.1 12.0
Social policy 12.2 15.3 17.6
Intergovernmental fiscal transfers 3.3 4.4 4.5
Data Source : The Federal Treasury, the estimates were made by the Gaidar Institute.
The following can be highlighted by examining changes in major subsections of regional budgets. In general, the trends which emerged as early as the pre-recession year of 2009, continued in 2010. Expenditures under "national economy" and "housing and public utility sector" kept decreasing to reach 16.6% and 12.6% (against 18.1% and 13.7% in 2009 ), respectively, whereas expenditures on social policy increased even more to account for 17.6% of the overall expenditures in 2010 (against 15.3% in 2009). Expenditures under "education" as well as "healthcare and sports" changed insignificantly in 2010: the former kept increasing
gradually to reach 21.9% in 2010, whereas the latter kept decreasing gradually down to 12.0%. A slight decrease in expenditures under "healthcare" was also related to increase in transfers from regional budgets to territorial funds of compulsory medical insurance. As a result, in 2010 a cumulative percentage of sections "healthcare and sports" and "intergovernmental fiscal transfers" remained at the level of 2009 (16.5%). Expenditures under "nationwide issues" also remained at the level of 2009 (7.3%), and expenditures on servicing public and municipal debt increased insignificantly from 1.0 to 1.1% of the total regional expenditures.
With the regard to expenditures under "national economy", it is important to consider dynamics of both the entire section and subsections, because this type of expenditures is heterogeneous as opposed to most of the other expenditure sections. Examining the dynamics for certain major subsections under "national economy" in 2010, we see once again that the trends of 2009 continued developing. Expenditures allocated to support the agricultural industry continued to grow to account for 3.4% of the overall expenditures (3.1% in 2009), whereas expenditures under "road facilities" and "other national economy issues" decreased even more to 5.5% and 2.8% (against 6.0% and 3.9% in 2009), respectively.
Overall deficit of the consolidated budget of the constituent territories of the Russian Federation remained unchanged in 2010, but its scope decreased to 1.5% of the total expenditures, which was much less than in 2009 (5.3%). Examining the value of budget deficit by constituent territory, it should be noted that only 20 of 82 regions had a surplus of the consolidated regional budget at 2010 year-end. As a result, the need for borrowings remained at the subnational level. In addition, it should be noted that the need for borrowings could arise from the need for refinancing of the existing debt. Data on volumes of the public debt owed by the constituent territories of the Russian Federation in the period between 2007 and 2010 and municipal debt in 2010 is shown in Table 20.
Table 20
Volumes of public debt owed by the constituent territories of the Russian Federation in 2007 - 2010 and municipal debt in 2010 (bln RUB)
Debt size, bln RUB
as of January 1, 2008 as of January 1, 2009 as of January 1, 2010 as of July 1, 2010 as of January 1, 2011
All constituent territories of 456,9 599,6 889,6 934,5 1096,0
the Russian Federation
incl. :
Moscow 89,3 121,5 243,1 264 299,3
Moscow Region 92,1 156,1 163,7 151,2 146,8
Constituent territories of 275,4 322 482,8 519,3 649,9
the Russian Federation
(net of Moscow and the
Moscow Region)
Municipalities n/a n/a 134,9 143,6 169,8
Data Source : Ministry of Finance of Russia, the estimates were made by the Gaidar Institute.
The data on changes in volumes of the public debt owed by the constituent territories of the Russian Federation in 2009 (an increase by RUB 290,0 bln) and in 2010 (an increase by RUB 206,4 bln) shows a slight decreased in borrowings in 2010. It is, however, the substantial decrease in growth rates of borrowings and loans in Moscow as well as of public debt in the Moscow Region in 2010, that was most responsible for the said decrease. The two above mentioned regions accounted for more than 45% of the total amount of public debt owed by
the constituent territories of the Russian Federation as of January 1, 2010. The picture would be different if we examine dynamics of volumes of the regional debt, net of Moscow and the Moscow Region. Volumes of public debt of the other constituent territories of the Russian Federation increased by RUB 167,1 bln by the end of 2010 against the level of the beginning of the year, and were a bit less (RUB 160,8 bln) in 2009. More than 78% of growth in volumes of the public debt were reported in H2 2010. It is noteworthy that balances of repaid federal loans totaled RUB 127,2 bln in 2010 for the regions (net of Moscow and the Moscow Region). By comparing the data, we can see that most of the borrowings were obtained as federal budget loans (see the next paragraph for details on federal financial assistance). In 2010, debts grew both at the regional and municipal levels. Municipal debts increased from RUB 134,9 bln as of January 1, 2010 to RUB 169,8 bln as of January 1, 2011.
To summarize, the following can be highlighted. The situation with execution of subnational budgets improved visibly in 2010. Tax revenues in the consolidated budget of the constituent territories of the Russian Federation increased in volume. However, many parameters, which describe the situation with subnational finances, were found to be much lower than the pre-recession values. Most of the Russian regions still had a deficit-ridden budget, which gave rise to the need for extra borrowings. Federal financial aid, including budget loans, kept playing an important role, like in 2009, in the provision of financial stability at the subnational level.
2.3.2. Financial Support from the Federal Budget
In general, the volume of funds (budget loan balances) allocated from the federal budget to the budget of the constituent territories of the Russian Federation decreased by 4.1% in nominal terms in 2010. A total volume of federal transfers decreased by 6.9% from RUB 1,480.4 bln to RUB 1,378.3 bln, whereas balances of obtained and repaid budget loans increased by 28.9% from RUB 127,5 bln to RUB 164,4 bln. It should be noted that the volume of federal budget loans allocated in 2010 to the regions remained at the level of 2009 (RUB 169,8 bln and RUB 170,0 bln, respectively). The balances increased considerably as a result of considerable decrease from RUB 43,2 bln in 2009 to RUB 5,4 bln in volumes of repaid budget loans by the regions in 2010, which may be connected with increase in the number of federal budget loans issued for a period of more than one year.
Let's examine dynamics of certain types of federal transfers (see Fig. 15).
All types of transfers, save for subventions, which increased in nominal terms by 33.1%, decreased in 2010 against 2009. Other intergovernmental fiscal transfers decreased by 25.2% and subsidies by 22.4% decreased most against the level of 2009. Grants also decreased in volumes by 9.6%. However, if we compare the amounts of transfers to the regions with the amounts transferred in 2008, the picture would be slightly different. In general, total volume of transfers (at 2008 values) increased by 6.4% in 2010 against 2008. On the other hand, other intergovernmental fiscal transfers substantially decreased in real terms by 51.9% and subsidies by 20.3% against the level of 2008. At the same time, subventions in 2010 (at 2008 values ) more than doubled subventions in 2008 (a 108.8% growth in real terms). In addition, in 2010 grants increased in real terms by 13.1% against the level of 2008.
The foregoing dynamics resulted in specific changes in the structure of transfers in the period between 2009 and 2010 (see Table 21).
1600 1400 1200 1000
§ 800 Ou
[■■_■■ ■■■■■ ■■■■■ ■■■■■ 'i
A A A A A
600 400 200
H other
intergovernmental fiscal transfers
□ subventions
□ subsidies
grants
2008
2009
2010
Data Source : The Federal Treasury, the estimates were made by the Gaidar Institute.
Fig. 15. Transfers to the regions from the federal budget in 2008 - 2010 (at 2008 values ).
Table 21
Transfers to the Russian regions from the federal budget in 2008 - 2010, in nominal terms
2008 2009 2010
mln RUB as % of total mln RUB as % of total mln RUB as % of total
Transfer by region, total 1,094,680 100.0 1,480,385 100.0 1,378,337 100.0
Grants 390,398 35.7 578,277 39.1 522,685 37.9
including:
fiscal capacity equalization transfers 328,648 30.0 375,485 25.4 396,996 28.8
grants on the provision of support to fiscal 46,035 4.2 191,886 13.0 105,955 7.7
equalization
Subsidies 435,867 39.8 530,073 35.8 411,439 29.9
including:
subsidies on road facilities 101,799 9.3 104,304 7.0 61,437 4.5
subsidies on agriculture 73,593 6.7 90,641 6.1 87,930 6.4
Subventions 153,170 14.0 284,440 19.2 378,650 27.5
including:
subventions on exercise of powers for pro- 37,413 3.4 77,414 5.2 87,090 6.3
motion of employment
subventions on the provision of housing to 0 0.0 45,825 3.1 116,851 8.5
veterans of WWII
Other intergovernmental fiscal transfers 115,245 10.5 87,595 5.9 65,562 4.8
Data Source: The Federal Treasury, the estimates were made by the Gaidar Institute.
As shown in the Table, grants decreased in volumes in 2010 in nominal terms against the level of 2009 mostly due to a reduction from RUB 191,9 bln to RUB 105,9 bln in the amount of grants on the provision of support to fiscal equalization. As a result, a share of grants on fiscal equalization decreased in the total amounts of transfers from 13.0 to 7.7%, whereas a share of fiscal capacity equalization transfers increased from 25.4 to 28.8%. In general, these
changes should be regarded as positive ones, because fiscal capacity equalization transfers are allocated by using the most transparent method based on impartial factors. It is important to emphasize that decrease in volumes of grants on fiscal equalization was accompanied by a substantial growth in balances of budget loans. In general, however, the amount of grants fiscal equalization and balances of budget loans decreased by 15.4% in nominal terms from RUB 319,4 bln in 2009 to RUB 270,3 bln in 2010. The decrease reflects the above mentioned ease of tensions in subnational finances in 2010 against 2009.
A share of subventions increased considerably in the total amount of transfers in the period between 2009 and 2010, from 14.0% in 2008 to 27.5% in 2010. Growth in volumes of subventions was conditioned mostly by a consistent increase in subventions on exercise of powers for promotion of employment due to escalating tensions in the labor market, and a subvention on the provision of housing to veterans of WWII on the occasion of the V-Day 65th Anniversary1 which was introduced in 2009. It is the latter type of subventions that was responsible for most of the growth in subventions in 2010: the subvention on the provision of housing to veterans of WWII increased from RUB 45,8 bln to RUB 116,9 bln, accounting for more than 30% of the total subventions in 2010. Furthermore, it should be noted that in 2010 housing utility subventions for specific categories of individuals increased by 17.8% from 84.8 to RUB 99,9 bln.
A share of subsidies in the total amount of transfers gradually decreased in the period between 2009 and 2010, from 39.8% in 2008 to 35.8% in 2009, to 29.9% in 2010. A visible reduction in cofinancing from the federal budget as part of federal special-purpose programs and budget investments which were not included into federal special-purpose programs, was most responsible for substantial reduction in the amounts of subsidies in 2010. In general, the reduction accounted for about 35% against the level of 2009. Furthermore, subsidies to the Federal Road Agency were reduced from RUB 104,3 bln in 2009 to RUB 61,4 bln in 2010. As a result, a share of these subsidies decreased from 7.0 to 4.5% in the total amount of transfers. Subsidies on agriculture decreased too, but not that much, by 3% against the level of 2009. Nevertheless, a share of these subsidies increased from 6.1 to 6.4% against a much bigger decline in the total amount of transfers. In addition, it should be noted that a series of federal budget subsidies were discontinued in 2010, of which most relevant were :
1) subsidies on the provision of individuals with rent and utility subsidies (RUB 11,7 bln in 2009);
2) subsidies on compensation for a part of payment which parents pay for maintenance of their kids at public and municipal educational institutions operating under the basic preschool general education curriculum (RUB 8,2 bln in 2009 ) ;
3) subsidies on public support to introduction of integrated modernization of education (RUB 5,3 bln in 2009 ) ;
4) subsidies on training of labor force and specialists for high-tech enterprises, which includes purchase of modern training-laboratory and training-production equipment (RUB 1,9 bln in 2009 ).
In addition, it is noteworthy that subsidies on purchase of motor and municipal vehicles decreased by nearly 50%, from RUB 19,7 bln in 2009 to RUB 9,96 bln in 2010. It should be noted, however, that a subsidy of RUB 1,02 bln on purchase of school buses manufactured on
1 Pursuant to the Order of the President of the Russian Federation dd. May 7, 2008, No. 714 "On the Provision of Housing to Veterans of WWII, 1941-1945". 76
the territory of the Russian Federation for general educational institutions was introduced at the same time in 2010.
In spite of decline in the total amount of subsidies in 2010, cofinancing was increased for specific subsidies, including the following major subsidies :
1) subsidies on additional measures aimed at easing tensions in the labor market of the constituent territories of the Russian Federation (by RUB 2,9 bln or 8.2%) ;
2) a subsidy to the budget of the Krasnodar Territory on measures aimed at developing the infrastructure at the city of Sochi (by RUB 9,3 bln or more than 4 times) ;
3) subsidies on medical rehabilitation of children (by RUB 2,8 bln or more than 3 times against the level of 2009 ).
In general, referring to the basic parameters of transfers from the federal budget in 2010, the following can be highlighted. The trends of 2009 continued in 2010, namely increase in a share of subventions and decrease in a share of subsidies and other intergovernmental fiscal transfers in the total amount of transfers from the federal budget. Though the total volume of grants on fiscal equalization and budget loans increased in 2010, it exceeded considerably the level of 2008, which was to a large extent due to certain sustained tensions regarding the execution of the consolidated budget of the constituent territories of the Russian Federation. Increase in a share of fiscal capacity equalization transfers in the total amount of transfers from the federal budget became a positive trend in 2010.
2.3.3. Federal Law "On the Federal Budget for 2011 and Planning Period of 2012 and 2013" as Related to Allocation of Intergovernmental Fiscal Transfers to Other Budget System Levels
A total of about RUB 1,252.4 bln was scheduled for allocation to regional and local budgets in 2011, which is 9.1% less in nominal terms than in 2010. Overall federal budget expenditures are expected to increase by 5.4%. A share of intergovernmental fiscal transfers to other levels of the budget system will eventually decrease from 13.6 to 11.7% in the federal budget expenditures against 2010.
The grants scheduled for allocation from the federal budget in 2011 will total RUB 523,3 bln, which is almost equal to the level of 2010 (RUB 522,7 bln). In 2011, the main channel of financial aid to regional government authorities - fiscal capacity equalization transfers from the Fund for Financial Support of the Regions (FFSR) - is expected to be maintained at the level of 2010 (RUB 397 bln). It should be noted that the 2010 upward trend in a share of the FFSR in total amount of transfers from the federal budget is expected to continue in 2011. Under the Federal Law "On the Federal Budget for 2011-2013", a share of fiscal capacity equalization transfers must increase from 28.8% in 2010 to 31.7% in 2011. It should be emphasized, however, that the scheduled increase in a share of the FFSR is to be reached by reducing the total amount of transfers and maintaining the volume of fiscal capacity equalization transfers at the level of 2010. Given that the Fund accounted for 73% of the intergovernmental fiscal transfers in 1999, and fiscal capacity of the Russian regions became more unbalanced since 1999, the scheduled volumes of grants from the FFSR in 2011 - 2013 seem to be insufficient if maintained at the level of 2010 (i.e. without any indexation whatsoever within three years).
Since 2005 the Compensation Fund (CF) has been accumulating funds to finance all of the existing in the legislation federal expenditure mandates established in an explicit form, which are financed through subventions to subnational budgets. The Federal Law "On the Federal Budget for 2011 and for the Period till 2013" provides for a material decrease in the
volume of subventions from RUB 378,7 bln in 2010 to 246,2 in 2011 or by 35% in nominal terms. Such a substantial reduction in the amount of subventions was conditioned primarily by completion of the program on the provision of housing to veterans of WWII which was financed with federal budget subventions of RUB 116,9 bln or about 30% of the total volume of subventions in 2010.
With regard to subsidies, the Federal Law "On the Federal Budget" provides for an increase of RUB 24,5 bln in relevant allocations to total RUB 435,9 bln in 2011 (by 5.9% in nominal terms against 2010). As a result, a share of subsidies will be increased in 2011 from 29.9% in 2010 to 34.8% in the total volume of intergovernmental fiscal transfers allocated to lower levels of power. Following are the main targets of cofinancing of regional and municipal expenditures in 2011:
- government-sponsored program on the development of the agricultural industry and regulation of agricultural markets, raw material markets and food markets for 2008 - 2012 (22.8% of the total subsidies);
- motor road (highway) building and modernization (12.8%)1;
- additional measures aimed at easing the tensions in the labor market of the constituent territories of the Russian Federation (6.4%);
- financing supplementary medical aid from district primary care doctors and pediatricians, general practice doctors (family doctors) (5.0%).
It should be noted that while cofinancing expenditures on federal support of the agricultural industry remained one of the federal top priorities in the period between 2009 and 2010 (in 2008-2009 a share of relevant allocations accounted for about 17% in the total volume of subsidies, and increased up to 21% in 2010), subsidies on road facilities were substantially reduced at the onset of the economic recession (the relevant allocations in 2009 were reduced by 32.6% against the initial version of the Federal Law "On the Federal Budget for 2009" ). As a result, a share of subsidies on road facilities reduced in total subsidies from 23.4% in 2008 to 19.6% in 2009 and 14.8% in 2010. These subsidies are scheduled for further reduction to eventually account for 12.8% of the total subsidies in 2011. It should be noted that the volume of federal budget subsidies on road facilities is to be reduced together with creation of a federal road fund and regional road funds. Relevant amendments have not yet been made to the federal legislation to date.
In addition, it should be noted that efficiency of subsidies as part of the government-sponsored program on promotion of the development of the agricultural industry and regulation of agricultural markets, raw material markets and food markets for 2008-2012 gives rise to a serious doubt. Delegation of powers to support agricultural production at the regional level may result in better support to the regions which can afford such a policy rather than those which have favorable climatic and natural conditions. This trend may be strengthened through allocation of federal budget funds in support of the agricultural industry based on the principle of cofinancing. To be more exact, more financially stable regions may benefit from such a support in their "trade wars" for agricultural markets with less financially stable regions.
In 2011, substantial volumes of funds will be allocated to implement measures aimed at easing the tensions in the labor market of the constituent territories of the Russian Federation (RUB 27,8 bln), as well as promoting the development of SMEs (RUB 16 bln). It must be
1 These subsidies include relevant expenditures as part of federal special-purpose programs. 78
borne in mind, however, that it is the authorities of a constituent territory of the Russian Federation that are responsible for efficient utilization of the funds.
2.4. Possible scenarios of social and economic development of the Russian Federation in 2011-2013
The following factors will determine main macro-economic parameters of the development of the Russian economy in 2011 - 2013: the situation in the world economy, the status of the internal institutional environment and business climate, the budget policy of the RF Government and the monetary policy of the Bank of Russia. In this section we focus on the analysis of the external development factors (the world economy) and the budget (general parameters of the budget and the national debt) and monetary policy.
In the world economy perspective, the main factors and sources of economic growth of Russia are: the level of prices and physical scope of demand for basic raw materials of the Russian export on the world market (oil and other raw materials), the access to capital on the world financial market for Russian borrowers, growth rates of the world economy and demand for non-raw materials exported from Russia.
Risks and restrictions of the economic growth in Russia are determined by the lengthy recovery of the leading world economies from the crisis, suspended expansion of the physical demand for raw and non-raw materials of the Russian export, a faster growth rate of new emerging markets and enhancement of competition between the BRICS countries on the world capital market; all these can reduce the access to capital for Russian companies and minimize opportunities for expansion of the Russia's internal market; this, in turn, makes impossible for Russia to develop with a focus on the internal market only (as China and India), without being involved in the global economy, and may cause emergence of new centers of recession on the developing and developed markets.
Should the world economy demonstrate successful development, the leading economies might overcome the crisis of 2007-2009 by 2012, and in 2013 the growth rates of the world economy can reach 4.0-4.5%.
The main conditions for implementation of this scenario are:
A responsible and tough policy of the leading world countries to cut their budget deficits and to carry out a coordinated monetary policy. However, in the mid-term, the leading countries will come out of the crisis and develop in the environment of an extremely high debt burden on their national budgets; this means they will have to reduce expenditures for their social programs and maintain internal demand; also they may face new challenges in their economies. The higher debt load and the growth of pension costs may become a long-term problem for the world economies to sustain their economic growth.
Reaching agreements within G8 and G20 regarding new requirements to the global financial market, improvement of quality of regulation of financial institutions, formation of a new system of setting and supporting exchange rates of the key world currencies and, possibly, transformation of the "reserve" notion towards more flexible and broader currency portfolio and other financial assets.
Resolution of the issue of global macroeconomic imbalances on the principles of mutual benefits, consideration of interests of all parties concerned and objective economic conditions and competitive advantages; removal of non-market restrictions on capital reallocation, and adherence to non-discriminative terms in the international trade.
We believe, in such context the world oil prices will remain almost unchanged in terms of constant prices or will have a slight positive trend. The developments of the Arabic countries early 2011 may have a short-term uplifting effect, and by the mid of the next year the "Arabic factor" will cease to play an important role in the setting prices on the world oil market.
There is an alternative scenario associated with pessimistic developments in the world and in the Russian economy, as a consequence. The main assumption underpinning this scenario is possible implementation of the mentioned risks and emergence of a new crisis in the world economy. The assumptions include:
1. Mistakes made by the developed economies at the stage of recovery, the absence of coordination of actions, inability of the governments to lever a further step up of the budget deficit, etc.
2. Low efficiency of the fiscal incentives in China: with account of stagnating external demand, this can lead to a sharper slowdown of the development of the Chinese economy with possible negative social and political implications, and to a decline of the aggregated demand for raw materials on the world market.
3. Development of significant, for the financial world, local or regional crisis on the developing markets, and/or a"traditional" crisis (as in the 1990'es) in the developing countries.
Regardless of specific reasons and the time of a new recession, if this scenario is realized, it would reduce average annual growth rates of the world economy in 2011 - 2013 (down to 3% - 4%). .
For Russia, the development of this scenario would mean high volatility of prices on raw materials, lower volumes of exported raw materials and an extremely limited access to the world market. Note that in terms of the ratio of the leading world currencies, this scenario may demonstrate the highest degree of uncertainty since one of the possible conditions for its implementation is a crisis of a reserve currency in one of the issuing countries.
The budget policy of the RF Government affects the prospects of the economic growth by the following channels:
shaping expectations of economic agents (a degree of a long-term budget balance under various levels of oil prices, the size and ways to finance the Pension Fund deficit, etc.); formation of the macro-economic environment (affecting the interest rate, inflation rate, etc.);
meeting budget social obligations;
implementation of most important strategic infrastructure projects. .
Let us review three possible cases of the social and political development of the Russian Federation in 2011 - 2013:
1. Base case
2. Optimistic case
3. Budget expansion case.
The base case in a number of its parameters corresponds to an innovation case (Inn2 option) of the project "Main scenario terms and main parameters of the long-term forecast of the social and economic development of the Russian Federation for the period up to 2030" developed by the Ministry for Economic Development of Russia. In particular, the nominal price on Urals is gradually increasing from 81 $/bbl in 2011 to 84 $/bbl in 2013, the USD/Euro exchange rate is fixed at 1.3 USD/Euro. However, unlike in the "Main scenario terms..." we suppose that the capital inflow into Russia under this scenario will not exceed 3% of GDP (equal to $45 billion in 2010) and the world economy growth rates will make up to 4.5% per year, as said before.
We believe that under this scenario, the federal expenditures in 2011 - 2013 will not exceed 19-20% of GDP; this is in line with Federal Law "On the federal budget for 2011 and the planning period of 2012 and 2013".
Under this scenario, the federal budget deficit is financed by the state market borrowings (the funds of the RF Reserve Fund will be exhausted in 2011 while the funds of the National Wealth Fund (NWF) will not be used for this purpose). We do not review an option to finance the federal budget deficit by the state property privatization proceeds since the terms and possible scope of proceeds from privatization cannot be assessed with a sufficient accuracy.
In the optimistic case, the Urals price is expected to be at 100 $/bbl in 2011 prices for the entire period and corresponds to 104 $/bbl in 2013 (the dollar devaluation rate is 2% per year). We assume here that the world economy growth rate can be as high as 5% per year while the capital inflow into Russia can reach 3.5% of GDP (corresponds to $50 billion in 2010). In 2011-2013, the federal budget expenditures are in line with the base case in nominal terms.
The budget expansion case is an option with additional federal budget expenditures related to possible adoption, in the pre-election period of 2011 - 2012, of new budget obligations, the beginning of full scale implementation of the announced State Program of weaponry procurement, the increase of monetary allowance of the servicemen, additional expenditures for the reform of the Ministry of Interior Forces, the increase of finances for the current federal target programs, etc. According to our estimates, the additional budget expenditures may reach 4-5% of GDP. In this case we also assume that the RF Central Bank will ensure, in spite of monetization of the federal budget deficit, a gradual decline of the growth rates of monetary supply at the expense of raising rates for deposits of commercial banks in the Bank of Russia and rates for reverse repo transactions and reserve requirements, etc.
A forecast of dynamic trend of the macroeconomic and financial variables and the indicators of the Russia's federal budget has been developed based on the structural econometric model of the Institute of Economic Policy named after E. T. Gaidar. The model presents a system of regression equations and identical equations describing dynamics of the main indicators of the social and economic development of Russia.
The calculation results of the main macroeconomic and financial indicators for the reviewed cases are shown in Tables 22-24.
Table 22
Base case
2010 2011 2012 2013
1 2 3 4 5
Oil prices (Urals, in $/bbl) 78,2 81,0 83,0 84,0
Real GDP growth rate, % 4,00 2,80 2,90 2,90
GDP in nominal terms (RUR Billion) 44491 50183 55702 60928
GDP ($MM) 1465 1707 1934 2101
Investment surplus into fixed capital, % 6,00 3,90 3,50 2,90
Surplus of real income of the population, % 4,30 3,00 2,90 2,70
Federal budget revenues (% of GDP) 18,65 18,80 18,70 18,80
Federal budget expenditures (% of GDP) 22,67 21,24 20,18 19,98
Surplus (+) /deficit (-) of federal budget (% of GDP) -4,02 -2,44 -1,48 -1,18
Exports ($billion) 398,0 411 422 430
Imports ($ billion) 248,8 313 359 388
Trade balance ($ billion) 149,2 97 63 42
Balance of current accounts ($ billion) 72,6 42 13 -18
Balance of capital transactions ($ billion) -30,5 0,0 15,0 30,0
Balance of payments ($ billion) 36,8 37,3 22,6 7,2
External debt of the private sector ($ billion) 436,1 440,0 450,0 490,0
(continued) table 22
i 2 3 4 5
Debt/GDP ratio, % 29,8 25,8 23,3 23,3
International reserves ($ billion) 479,4 522 549 561
Nominal exchange rate RUR/USD 30,36 29,40 28,8 29
Nominal exchange rate RUR/EURO 40,27 38,22 37,44 37,70
Index of the real effective ruble exchange rate (July 1998 = 100) 122,6 134,0 141,8 145,5
CPI growth rate, % 8,8 8,1 6,8 6,3
Reserve funds growth rate, % 26,64 17,33 16,04 14,43
M2 growth rate, % 28,51 19,09 20,68 18,83
Monetization (M2/GDP), % 45,3 47,9 52,0 56,5
National debt (% of GDP) 8,8 11,5 12,8 13,9
Table 23
Optimistic case
2010 2011 2012 2013
Oil prices (Urals, in $/bbl) 78,2 100,0 102,0 104,0
Real GDP growth rate, % 4,00 3,20 3,80 4,30
GDP in nominal terms (RUR Billion) 44491 51218 58186 64693
GDP ($MM) 1465 1742 2020 2270
Investment surplus into fixed capital, % 6,00 4,50 5,00 5,90
Surplus of real income of the population, % 4,30 3,50 3,50 4,00
Federal budget revenues (% of GDP) 18,65 19,40 19,60 19,90
Federal budget expenditures (% of GDP) 22,67 20,81 19,31 18,82
Surplus (+) /deficit (-) of federal budget (% of GDP) -4,02 -1,41 0,29 1,08
Exports ($billion) 398,0 460 473 488
Imports ($ billion) 248,8 316 368 418
Trade balance ($ billion) 149,2 144 106 70
Balance of current accounts ($ billion) 72,6 89 56 10
Balance of capital transactions ($ billion) -30,5 0,0 15,0 30,0
Balance of payments ($ billion) 36,8 84,2 65,5 35,5
External debt of the private sector ($ billion) 436,1 440,0 450,0 490,0
Debt/GDP ratio, % 29,8 25,3 22,3 21,6
International reserves ($ billion) 479,4 569 639 680
Nominal exchange rate RUR/USD 30,36 29,40 28,8 28,5
Nominal exchange rate RUR/EURO 40,27 38,22 37,44 37,05
Index of the real effective ruble exchange rate (July 1998 = 100) 122,6 134,2 142,7 149,3
CPI growth rate, % 8,8 8,3 7,3 6,6
Reserve funds growth rate, % 26,64 22,67 16,71 15,52
M2 growth rate, % 28,51 24,51 23,71 19,88
Monetization (M2/GDP), % 45,3 49,0 53,4 57,6
National debt (% of GDP) 8,8 9,3 8,5 8,0
Table 24
Budget expansion case
2010 2011 2012 2013
1 2 3 4 5
Oil prices (Urals, in $/bbl) 78,2 100,0 102,0 104,0
Real GDP growth rate, % 4,00 3,10 3,60 4,10
GDP in nominal terms (RUR Billion) 44491 51452 58883 66139
GDP ($MM) 1465 1750 2045 2281
Investment surplus into fixed capital, % 6,00 4,20 4,50 4,90
Surplus of real income of the population, % 4,30 3,90 3,90 4,40
Federal budget revenues (% of GDP) 18,65 19,40 19,40 19,30
Federal budget expenditures (% of GDP) 22,67 24,80 23,55 24,65
Surplus (+) /deficit (-) of federal budget (% of GDP) -4,02 -5,40 -4,15 -5,35
Exports ($billion) 398,0 460 473 487
Imports ($ billion) 248,8 319 377 425
Trade balance ($ billion) 149,2 141 95 62
Balance of current accounts ($ billion) 72,6 86 45 2
Balance of capital transactions ($ billion) -30,5 0,0 0,0 0,0
Balance of payments ($ billion) 36,8 80,5 40,1 -2,8
External debt of the private sector ($ billion) 436,1 440,0 450,0 460,0
(continued) table 24
1 2 3 4 5
Debt/GDP ratio, % 29,8 25,1 22,0 20,2
International reserves ($ billion) 479,4 565 610 612
Nominal exchange rate RUR/USD 30,36 29,40 28,8 29
Nominal exchange rate RUR/EURO 40,27 38,22 37,44 37,70
Index of the real effective ruble exchange rate (July 1998 = 100) 122,6 134,9 144,8 150,9
CPI growth rate, % 8,8 8,9 8,3 7,9
Reserve funds growth rate, % 26,64 22,05 20,08 20,53
M2 growth rate, % 28,51 21,40 17,63 18,01
Monetization (M2/GDP), % 45,3 47,6 48,9 51,4
National debt (% of GDP) 8,8 13,0 16,9 21,4
Under the base case, the quantitative values of the main indicators of the social and economic development of Russia and the monetary sector show that the positive growth rates of real GDP will not exceed 3% by the end of 2013. By the end of 2013, the real GDP of Russia will exceed the level of 2008 by 4.3% only. In 2013, the per capita GDP (at the current exchange rate) with account of the growth of the ruble exchange rate and the forecasted reduction of the population is going to exceed the 2008 level by approximately 20%.
The economy will revive due to stable oil prices (in the comfortable range for Russia) and the renewed inflow of foreign capital thus ensuring financing of the investment demands of the Russian companies. As for investments into fixed capital, the recession will not be overcome by the 2013 end. In 2013, the investments into fixed capital will reach 98.3% vs the 2008 figure. At the same time, in 2011 - 2013, the real incomes of the population are going to increase by approximately 15.9% vs the pre-crisis level.
We assume that the oil prices will be within a sufficiently "comfortable" range (that would not trigger a currency or a financial recession) but not in the best range possible, and therefore the national financial situation will remain tense, under this case. Assuming that the nominal federal expenditures are kept at the level set by Federal Law "On the federal budget for 2011 and for the planning period of 2012 and 2013", the budget deficit is likely to remain in the entire period of consideration. The Reserve Fund can support financing of the budget deficit in 2011 only.
We do not suggest using NWF funds to finance the budget deficit, and believe NWF will accumulate funds worth about 5% of GDP.
One of the most important assumptions for restoring the positive growth rate of real investments into fixed assets and the GDP real growth is that Russian companies and banks will return to the world capital market, and the inflow of direct foreign investments into Russia will be sustained. According to the estimates made, to support the set rates of investment growth, a stable net flow of private foreign investments into Russia should start not later than 2012 and reach $15 - 30 billion per year.
We forecast, for the reviewed period, that the services negative balance will go up as well as payments balance for production factors and interest payments. Accordingly, in 2013 we expect a negative current accounts balance of $15 - 20 billion in Russia.
As we assume that the RF Central Bank while moving to inflation targeting policy reduces its presence on the currency market, the Bank of Russia will accumulate its international reserves but very slow. By the end of 2013, according to our estimates, the reserves will reach $550 -600 billion - this is below the maximum levels of 2007 - 2008.
Before 2013, the positive payment balance (in 2011 - 2012 due to the positive balance of the current accounts while in 2013 - due to the capital inflow) will support a stable exchange
rate of the ruble currency in the currency basket (we believe that in the bi-currency basket, USD and EURO ratio remains at 0.55:0.45). In such case, a change of the USD/EURO ratio may be triggered by a change in mutual quotations of the reserve currencies on the world market. As a result of a softer influence of the Bank of Russia on the exchange rate, the growth of ruble volatility vs USD and EURO currencies would not be reflected in the summary annual exchange rate values as the differently directed fluctuations absorb each other. Simultaneously, the reduction of the annual CPI growth rates to 6.0 - 6.5% will obviously slow down the rates of the real strengthening of the ruble currency. In particular, by the end of 2013, the real effective rate of the ruble will strengthen by 20% vs the mid of 2008 or by 25% vs the end of 2008. We expect that the positive dynamics of the Russian exports against stagnation of world prices on raw materials will be maintained. Imports will grow faster than exports during the considered period and will exceed the record breaking values of 2007 as early as in 2011.
The model predicts serious changes in the monetary sector of the Russian economy. As mentioned before, the model demonstrates a visible slow down of inflation.
Secondly, the change of the monetary policy by the Bank of Russia means that the Bank will expand transactions on the market of state securities (prompted by necessity to finance the federal budget deficit not only by the Reserve Fund or external borrowings) and will actively re-finance commercial banks against securities (e.g. corporate bonds) bought for the Bank portfolio and issue credits secured by pledge to commercial banks for long terms (at least for one year).
As a consequence of such change of the main fiscal tools, real interest rates in the economy must grow. Thus, real interest rates for credits issued to a non-financial private sector for up to one year will fall within the range 1.5-2.0% in 2011-2013. We expect the growth of a monetary multiplier up to 2.6 - 2.7% (M2/reserve money). In other words, the bank sector is going to resume its credit expansion most actively as it was before the 2008 crisis.
Summarizing the base case, the following characteristics should be outlined:
1. The real GDP volume will be restored up to the pre-crisis level by the end of 2012 only; the volume of real investments will not return to the 2008 indicators;
2. Russian companies will come back to the world capital markets;
3. An obligatory transition to new mechanisms of security of the monetary supply of the RF Central Bank, and the growth of real money value in the economy will occur;
4. The conditions for keeping the federal budget deficit, the full use of the Reserve Fund and an extremely slow accumulation of funds in the NWF will be maintained;
5. Inflation rates will obviously fall down against strengthening of the real effective rate of the ruble currency and high growth rates of the monetary stock and monetization of the Russian economy.
The optimistic case provides for increase of average oil prices (Urals) up to 100 $/bbk in 2011 and 102-104 $/bbl in 2012 - 2013. This will allow increasing the growth rates of the Russian economy up to 3.5-4.5% per year. Thus, by the end of 2013, the real GDP will be approximately by 7% higher than in 2008. In 2012, the per capita GDP (in USD at the current rate) will increase by about 40% up to $16 - $16.5 thousand vs 2007.
Under this case, the real volume of investments into fixed assets will be restored to the pre-crisis level in 2012-2013.
High prices on the world raw markets will generate federal budget revenues sufficient to fund the federal expenditures at the target level. Moreover, in 2012 - 2013, a surplus of the 84
federal budget (up to 1% of GDP) may occur, and funds will continue to be accumulated in the Reserve Fund.
A favorable foreign economic situation under this case creates conditions that will sustain the stable situation with the national payment balance. The payment balance and its two main components will remain positive during the entire period of review. In particular, the payment balance will be from $35 to $85 billion per year, and the annual inflow of private capital into Russia will reach $ 30 billion.
With this scenario, the Bank of Russia will not be able to avoid a sizable growth of international reserves returning to the policy of curbing the nominal strengthening of the ruble. Thus, by the end of 2013, the international reserves of the Central Bank of Russia will exceed the 2008 level growing up to $670 - 680 billion.
The nominal exchange ruble rate will increase up to 28.0 - 28.5 RUR/USD or approximately by 10% vs the 2010 average annual rate in 2011 - 2013. At the same time, the inflation (CPI) l continues to decrease but still remains at a higher level than in the base case (6.5 - 7.0%). As a result, the ruble will continue to be stabilized successfully, and by the end of 2013, the real effective ruble rate will exceed the 2008 summer level by 26% - 27%.
In this case, we assume that the RF Central Bank will move to inflation targeting policy and use interest rates as a main working tool (though with a greater focus on the currency market), the real money value is expected to grow as well. According to our estimates, the real interest rate for one-year credits issued to the non-financial sector may be 1.0 - 1.5%. Monetization of the economy is going to build up to approximately 60% of GDP as in the base case.
Thus the main differences between the optimistic and the base case are:
1. A faster recovery of the GDP real volume that will exceed the pre-crisis level in terms of investments into fixed assets.
2. A favorable situation with the payment balance and its constituent components, fast accumulation of international reserves.
3. Return to the policy of the federal budget surplus and concentration of funds in the Reserve Fund.
4. Slow decline of the inflation rates, fast real and nominal strengthening of the ruble currency against high growth rates of the money stock and monetization of the Russian economy.
5. Restricted opportunities of the Bank of Russia in moving to inflation targeting policy, the need to place a greater focus on the currency market situation.
The budget expansion case, in spite of the favorable external situation, will preserve the budget deficit at 5 - 5.5% of GDP which may negatively impact the economic growth rates and real investments. Thus, the real GDP growth rates and investments into fixed assets are by appr. 0.5 - 1.0% lower than in the optimistic case.
Financing of the federal budget deficit at the expense of the market borrowings leads to a higher real interest rate for the borrowers (up to 2.5 - 3 pp. at the internal market), higher rates of inflation (due to final monetization of the debt by the authorities) and a slow credit activity of the banks. The CPI growth rates in this case will not drop below 7.9%. Even if the Central Bank curbs the nominal strengthening of the ruble currency, the real exchange rate of the ruble will exceed by 28% the level of 2008 summer by the end of 2013. The national debt will reach 21 -21.5% of GDP late 2013, this is close to critical values (in terms of the ability to serve the debt if the market situation changes) for such country as Russia whose national finances and the assessment of the country risks greatly depends on the oil price fluctuations.
The strengthening of the ruble also negatively influences the national payment balance. Due to the fast growth of imports, the current accounts balance expects to become zero in 2013; given the absence of inflow of capital (as a result of low investment activity inside the country and enhancement of risks associated with the debt growth) this may lead to a negative payment balance and stabilization of the international reserves volume close to the pre-crisis maximum - $610 billion.
Summarizing the budget expansion case, we can note that this scenario suggests dependency of the RF economy on the oil prices and creation of conditions for a budget crisis in future. The imbalance of the RF budget system within the period under review (up to 3 years) is going to negatively affect the rates of economic growth, the payment balance, the speed of inflation reduction and the situation in the money circulation sector.
