Section 2. The Monetary and Budget Spheres Текст научной статьи по специальности «Экономика и бизнес»

Section 2. The Monetary and Budget Spheres

2.1. The Monetary Policy

The main developments in the monetary sphere in 2011 can be nominally divided into two periods: from January till August and from August till the end of the year. In the first six months, continuation of the trends typical of the year 2010 was observed, that is, a smooth recovery of the financial sector of the economy with simultaneous growth in the money supply, international reserves of the Bank of Russia and moderate inflation rate. In the above period, the Bank of Russia kept scaling down its anti-crisis support of the financial sector. In August, the second period began and it formally resembled to a great extent the beginning of the crisis of 2008-2009: due to the outflow of the private capital and closing of foreign markets to Russian borrowers the banking sector started to experience again difficulties in attraction of liquid resources, interest rates went up, while the international reserves decreased. It is to be noted that the growth in the outflow of the capital took place in a situation where global prices on the main commodities of the Russian export remained high. The main factors behind that outflow were the negative trend in the global economy (the debt problems in the EU and the USA in a situation of slow economic growth in those countries).

In all appearances, the development of the global economy will be inconsistent within quite a long period of time, so, the above mentioned fluctuations on the Russian financial market are likely to remain in the next few years. In such a situation, the Central Bank of the Russian Federation gradually gave up its substantial interference in the functioning of the foreign exchange market by means of currency interventions and concentrated its efforts to reduce the inflation rate in the Russian Federation by trying to use the interest rates as the main instrument of the monetary and credit policy.

2.1.1. The Money Market

From the beginning of the year till August 2011, as well as in 2010, growth in the international reserve assets of the Bank of Russia was observed (see Fig. 1). The main factor behind such growth in reserves became rising oil prices which in the Q2 2011 reached the record-high levels in the past three years. In addition to the above, due to the volatile situation on the global financial markets in the first six months of 2011 prices on gold which is a part of the international reserves of the Bank of Russia rose dramatically. As a result, in August the international reserves amounted to $544bn which is a 13.2% increase from the beginning of the year. The above value was the maximum one since autumn 2008.

Intensification of the capital outflow in September was related to the aggravation of the global financial crisis, that is, downgrading by Standard & Poor's, an international rating agency of the US credit rating from AAA to AA+ and the subsequent fall of international stock markets and oil prices. Investors started to withdraw funds from risk assets worldwide, including the Russian Federation. However, a dramatic decrease in the reserves was primarily related to depreciation of the Euro exchange rate against the USD as a drop in the Euro/USD exchange rate resulted in a decrease in the USD value of the portion of the Euro-denominated reserves. The Russian Central Bank's interventions on the foreign exchange market were insignificant: the mere $7.5bn and Euro 0.6bn were sold (see Fig. 2).

6800

6400

6000

5600

3 5200 c

ä 4800

m

4400

4000

3600

590 570 550 530 510 490 470 450 430 410 390 370

The monetary base in the narrow definition (billion rubles) The gold and foreign exchange reserves (billion $)

Source: The Central Bank of the Russian Federation.

Fig. 1. The dynamics of the monetary base in the narrow definition and the international reserve assets of the Central Bank of the Russian Federation

in the 2008 - 2011 period

LT1"

Rr

iL^.n n nJl,

[[IT

s s s s S I I I-

g g S â

I 1 I i 1 i I i ! i 1

□ USD ■Euro

Source: The Central Bank of the Russian Federation.

Fig. 2. Net purchases by the Bank of Russia of foreign exchange in the 2008-2011 period

After the 2008 crisis, the monetary base in the broad definition grew at a higher rate than the international reserves, however, in 2011 the expansion of the monetary base virtually

7200

stopped. The rapid recovery of the monetary base in 2009 and 2010 was related primarily with utilization of the resources of the Reserve Fund to finance the budget deficit (see Fig. 3). It is to be noted that commercial banks returned loans received during the crisis to the Bank of Russia which situation led to a shrinkage of the money supply.

In 2011, the budget was administered with a surplus and there was no need to spend the resources of the Reserve Fund. In addition to that, the surplus of the budget accumulated in the accounts of the Government of the Russian Federation restrained growth in the monetary base. As was stated above, in 2011 the currency interventions by the Bank of Russia happened to be insignificant as well.

During the 2008-2009 crisis and the post-crisis period, operations of the Central Bank of the Russian Federation as regards provision of funds to commercial banks had a considerable effect on the money supply (see Fig. 4). In autumn 2011, when credit institutions were in need of liquid resources again the Bank of Russia increased the volume of funds extended to commercial banks and that situation became the main factor behind the growth in the monetary base. It is to be noted that on a year on year basis the monetary base increased by the mere Rb 0.5 trillion (+5.5%) with the December growth in the monetary base amounting to Rb 1.2 trillion. In 2010, the monetary base grew by Rb 1.7 trillion (+26.6%).

5000

-6000 J

20OS (August-December) 2009 2010 2011 (Januaiy-Tsovember)

□ Other

■ Change in the gross credit to the banking system

■ Change in the net credit to government authorities

Currency interventions ofthe Central Bank of theRussian Federation

Source: The Central Bank of the Russian Federation, the IEP calculations.

Fig. 3. The main factors behind the change in the monetary base (in the broad definition) in the 2008-2011 period1

1 The period under review in 2008 and 2011 is determined by availability of the data on the currency interventions by the Bank of Russia and the balance of the Bank of Russia as of the date of preparation of this review.

Table 1

The balance of the Bank of Russia in the 2010-2011 period

01.01.2010 01.01.2011 01.12.2011

Billion % of assets/ Billion % of assets/ Billion % assets/

rubles liabilities rubles liabilities rubles liabilities

Funds deposited with non-residents and securi- 12383.3 80.3 13272 85.5 14142 76,4

ties of foreign issuers

Loans and deposits 1705.8 11.1 514 3,3 1657 8.9

Precious metals 764.6 5.0 1 201 7.7 1602 8.7

Securities 465.9 3.0 441 2.8 421 2.3

Other assets 100.3 0.7 99 0.6 697 3.8

Total assets 15420 100 15526 100 18519 100

Cash in circulation 4629.9 30 5792 37.3 6150 33.2

Funds in accounts with the Bank of Russia 7979.7 51.7 6431 41.4 8532 46.1

Including those of the Government of Russia 4980.2 32.3 3270 21.1 5263 28.4

Resident-credit institutions 1731.3 11.2 1817 11.7 1328 7.2

Funds in settlements 8.4 0.1 7 0.0 33 0.2

Issued securities 283.1 1.8 589 3.8 0 0.0

Other liabilities 168.3 1.1 145 0.9 1397 7.5

Capital 2099.1 13.6 2359 15.2 2407 13.0

Profit of the reporting year 251.4 1.6 204 1.3 0 0.0

Total liabilities 15420 100 15526 100 18519 100

The source: The Bank of Russia.

Source: The Central Bank of the Russian Federation, the IEP calculations.

Fig. 4. The commercial banks' debt to the Central Bank of the Russian Federation on individual instruments of refinancing in the 2008-2011 period

Here is a more detailed analysis of the structure of the monetary base in the broad definition (see Table 2). In 2011, the growing components of the monetary base were the cash funds and mandatory reserves. Growth in the mandatory reserves was related to a threefold increase by the Central Bank of the Russian Federation of mandatory reserve requirements in the first six months within the frameworks of return of such requirements to the pre-crisis level. At the same time, lack of channels for such a sustained expansion of the monetary base as was stated

above, as well as problems in the global economy which resulted in the capital outflow and difficulties in refinancing of Russian companies caused a reduction in liquidity in the banking sector. As a result, bank's excessive reserves fell within a year: correspondent accounts of commercial banks with the Central Bank of the Russian Federation remained virtually unchanged at on a year-on-year basis (-1.3%), however, banks' deposits decreased by 38.7%, while credit institutions' investments into bonds of the Central Bank of the Russian Federation dropped from nearly Rb 600bn as of the beginning of the year to zero.

Table 2

The dynamics of the monetary base in the broad definition in 2011 (billion rubles)

01.01.2011 01.04.2011 01.07.2011 01.10.2011 01.01.2012

Monetary base (in broad definition) 8 190.3 7 514.2 7 410.3 7 407.9 8644.1

- cash funds in circulation with cash 5 785.2 5 482.7 5 787.8 6 059.5 6895.8

balances at casher's offices of credit

institutions taken into account

- correspondent accounts of credit 994.7 597.2 786.5 781.6 981.6

institutions with the Bank of Russia

- mandatory reserves 188.4 244.1 331.3 347 378.4

- deposits of credit institutions with 633.2 786.7 486.4 209.5 388.3

the Bank of Russia

- bonds of the Bank of Russia with 588.9 403.4 18.3 10.3 0

credit institutions

Source: The Central Bank of the Russian Federation.

In 2011, the M2 money supply in the national definition increased by 22.6% and amounted to Rb 24.5 trillion as of January 1, 2012 or 45.1% of the GDP. In 2011, monetization of the GDP rose by 0.8%. In 2011, as the financial system of Russia developed the growth of the money multiplier continued; within a year it grew by 16% and was equal to 2.8 as of January 1, 2012 as compared to 2.4 as of January 1, 2011.

Thus, in 2011 the main factors behind slow growth in the money supply became insignificant interventions by the Central Bank of the Russian Federation on the foreign exchange market; the stable and positive balance of payments which was formed as a result of a positive current account balance and negative capital and financial instruments account balance (see the relevant section of the review) contributed to limitation of such interventions. It is to be noted that the Reserve Fund was not spent, but replenished. In such a situation, the main sources of the money supply growth became the Russian Central Bank's operations related to refinancing of the banking sector. At present, it can be asserted that the existing trends are likely to continue in 2012 which factor results in a slow expansion of the money supply in case of absence of external shocks.

2.1.2. Inflationary Developments

At year-end 2011, the inflation rate in the Russian Federation turned out to be the minimum one in the entire latest history of the Russian Federation. Such a result became feasible thanks to a good combination of both monetary and non-monetary factors. It is to be noted that judging by the inflation rate in January-May it was difficult to predict such a slowdown of the growth rates of prices because the growth in prices in that period in general was the same as in the corresponding period of 2010. A drop in the inflation rate against 2010 was achieved in the second half of the year.

As seen from Fig. 4, the growth rates of the money supply began to fall from autumn 2010 which situation could not but have an impact on inflationary developments in 2011. Non-

monetary factors behind the rate of inflation include, among other things, the stable exchange rate of the ruble (see the section which deals with the analysis of the balance of payments of the Russian Federation), slow economic growth and a good yield of agricultural products. It is to be noted that despite some weakening of the ruble at the end of summer and in autumn the nominal effective rate of the ruble on a year on year basis did not change much (+2.4%) which situation means that with all other things being equal ruble prices on imported goods remain stable.

— — M2 money supply -CPI

Source: Rosstat, the Central Bank of the Russian Federation and the IEP calculations

Fig. 5. Growth rates of consumer prices and M2 money supply in the Russian Federation

in 2008-2011 (on a year-on year basis)

Here is a more detailed analysis of the dynamics of inflationary developments in 2011. As seen from Table 3, the main factor behind the slowdown of the inflation rate was the fact that growth rates of prices on food products were slower as compared to the previous years. Price rises on meat and fowl (+9.2%), fish and seafood (+10.3%), as well as bread and bakery products (+8.9%) made the main contribution to the growth in prices on food products.

Prices on housing and utilities services continued to grow (+11.7%), but at a slower rate than in 2010. A noticeable growth in prices on pre-school education services (+11.3%), health and recreation services (+9.1%) and services rendered by entities of culture (+11.3%) was observed.

In 2011, prices on non-food products grew at a higher rate than in 2010. It can be partly explained by the growth in prices on gasoline (14.9%), tobacco products (21.1%) and building materials (7.9%).

It is to be reminded that in 2012 the annual raising of the tariffs (regulated by the government) on paid services to the households was postponed from January 1 to July 1. Due to the above, in the first six months the inflation rate on a year on year basis is likely to go down. If the Central Bank of the Russian Federation goes ahead with its policy of limited interference into functioning of the foreign exchange market provided that no serious external shocks take

place and a reasonable budget policy is carried out a further drop in the inflation rate may be expected in the Russian Federation by the year-end 2012.

Table 3

The annual growth rates on individual types of goods and services in the 2008-2011 period (% of December of the previous year)

2008 2009 2010 2011 2008 - 2011

CPI 13.3 8.8 8.8 6.1 42.3

Food products 16.5 6.1 12.9 3.9 45.0

Cereals and bean products 25.8 -2.5 58.8 -8.0 79.2

Butter 10.5 7.9 23.3 6.6 56.7

Sunflower oil 22.1 -19.8 27.6 4.6 30.7

Pasta 33.8 1.6 4.7 3.4 47.2

Milk and dairy products 12.2 2.3 16.7 6.3 42.4

Bread and bakery products 25.9 2.4 7.6 8.9 51.1

Meat and fowl 22.2 5.0 5.3 9.2 47.5

Fish and sea products 15.1 10.6 4.8 10.3 47.2

Non-food products 8.0 9.7 5.0 6.7 32.7

Building materials 11.3 2.1 4.6 7.9 28.3

Motor gasoline 1.2 8.0 6.5 14.9 33.7

Services 15.9 11.6 8.1 8.7 52.0

Housing and utilities services 16.4 19.6 13.0 11.7 75.7

Pre school education services 20.7 16.2 7.7 11.3 68.1

Health and recreation services 21.2 9.5 5.4 9.0 52.5

Passenger transport services 22.5 6.5 8.7 9.1 54.7

Services of entities of culture 15.5 11.3 8.6 11.3 55.4

Source: Rosstat.

2.1.3. The main measures in the sphere of the monetary and credit policy

Early in 2011, after numerous cuts in the interest rate on its instruments during and after the crisis the Bank of Russia made its monetary and credit policy tough again. Last year, the rate of refinancing was raised twice. It is to be noted that it took place in the first six months (on February 28 and May 3); within that period the rate of refinancing rose from 7.75% to 8.25%. Simultaneously, with raising of the rate of refinancing by a comparable value the interest rates on operations related both to absorption and provision of liquidity increased. Late in May, the rates on deposit operations of the Central Bank of the Russian Federation were raised by 0.25% with other rates (including the rate of refinancing) remaining unchanged.

In the same period, the Central Bank of the Russian Federation raised three times the mandatory reserve requirements. Starting from February, for three months running the Bank of Russia declared about toughening of the reserve requirements: as regards ruble and foreign currency liabilities of credit institutions to non-resident-legal entities the reserve requirements were raised from 2.5% to 3.5% from February 1, then, from 3.5% to 4.5% from March 1 and, for the third time, from 4.5% to 5.5% from April 1; as regards liabilities to individuals and other ruble and foreign currency liabilities of credit institutions the reserve requirements were raised from 2.5% to 3% from February 1, then, from 3% to 3.5% from March 1 and, for the third time, from 3.5 % to 4% from April 1. It is to be noted that reserve requirements as regards liabilities to non-residents were raised to a greater extent which factor reflects the intentions of the Bank of Russia to discourage borrowings from abroad in a situation of financial instability in order to reduce foreign exchange risks. As a result of raising of the reserve requirements, they returned to the level of the first half of 2008.

Additional efforts as regards toughening of the monetary and credit policy and scaling down of anti-crisis measures included the following:

• On January 31, 2011, the Central Bank of Russia made a decision to raise requirements to the ratings of issuers whose securities were included in the Lombard list of the Bank of Russia. From April 1, 2011, the minimum rating was raised from B-/B3 to B/B2, while from July 1, 2011, from B/B2 to B+/B1 according to the classification of rating agencies Standard & Poor's, Fitch Rating and Moody's Investors Service.

• From February 10, 2011, the Bank of Russia suspended operations as regards extension to credit institutions of loans (secured with assets or sureties) for the period from 91 days to 180 days, as well as Lombard loans at a fixed interest rate for the period of 30 days.

• From July 1, the Bank of Russia suspended conclusion of direct REPO deals with credit institutions in which deals equities of Russian companies were used as a collateral.

The main reason for toughening of the monetary and credit policy was a speed-up of the inflation rate in the beginning of the year. In addition to that, the above decision was aimed at sterilization of such an accumulated excessive liquidity in the banking system as was formed due to banks' huge profits which were received as a result of reduction of loan loss reserves, growth in the value of investments in securities as a result of the post-crisis recovery of stock markets and increase in the interest margin. To attract banks' available funds into deposits with the Central Bank of Russia, the latter kept raising interest rates on such deposits. It is to be noted that the Central Bank of the Russian Federation narrowed the spread between the rates on provision and absorption of liquidity (see Fig. 6). Such a policy contributed to greater role of interest rates as PSA instruments within the frameworks of a switchover to the inflation targeting regime. It is to be noted that in a situation of excessive liquidity the market interest rates were primarily influenced by the rates on deposits with the Bank of Russia (for instance, in 2010), while in the periods of a shortage of liquidity (autumn - winter 2011), by the rates on the Russian Central Bank's liquidity provision instruments. Thus, by changing interest rates and setting limits on provision of loans to commercial banks, the Bank of Russia has a significant impact on the situation on the money market and actually determines both the volume of the supply and the cost of money.

In mid-September, in a situation of the growing financial instability the Bank of Russia reduced by 0.25 % the minimum rates both on operations related to provision of liquidity on the open market (Lombard auctions and direct REPO auctions) and most of its permanent operations (Lombard loans, direct REPO operations, gold-secured loans, non-market assets or sureties). Simultaneously, the Bank of Russia increased interest rates on permanent deposit operations by 0.25 %. Thus, the Central bank of Russia reduced ever more the spread between the rates on loans and deposits which factor is to contribute to higher efficiency of its interest rate policy.

Also, as the situation with liquidity on the banking market was getting worse the Bank of Russia made a decision to expand the banks' refinancing opportunities. From November 1, the Central Bank of Russia resumed extension of loans secured with non-market assets or sureties for the period from 91 days to 180 days at the rate of 7.5%. In addition to that, from the above date the term of the gold-secured loans was extended to 180 days. Thus, the instruments of refinancing which the Bank of Russia used for backing the liquidity of banks during the 2008-2009 crisis became available again to commercial banks.

i 1 _ —i jrrj Wr I J JduMl -V 1 -Li

-r W^L , . - ^--------

o — —

- The MIACR rate on loans with a term of one day

The minimum rate on REPO auctions for the term of one day ■The rate on one-day deposits with the Central Bank of Russia

Source: Rosstat, the Central Bank of the Russian Federation, the IEP calculations.

Fig. 6. The rates of the Central Bank of the Russian Federation on the main operations related to provision and absorption of liquidity, as well as the rate on the inter-bank lending market in the 2008-2011 period

On November 25, the Bank of Russia declared that from December 5, 2011 the minimum ratings which the securities issuers were required to have in order to be included in the Lombard list of the Central Bank of Russia would be lowered. Also, starting from December 1 the Bank of Russia stopped applying a discount in calculation of the cost of a security in direct REPO operations for the period of up to six calendar days with federal loan bonds and bonds of the Bank of Russia. And finally, from December 1 the adjustment ratio which is applied for adjustment of the cost of the federal loan bonds which are accepted as security for loans of the Bank of Russia was raised from 0.98 to 1. The decisions made were aimed at providing commercial banks with more opportunities to attract refinancing from the Bank of Russia.

The activities of the Bank of Russia in the second half of the year were aimed at support of the banking sector and demonstrated that in case of worsening of the global economic situation the Central Bank of Russia was prepared to make up promptly for the shortage of liquidity.

In general, to our opinion, judging by the results of 2011 the Bank of Russia has made progress in its switchover to inflation targeting by means of interest rates. However, it is to be noted that the external factors were favorable for doing that. In particular, the total surplus of the balance of payments was insignificant, a good harvest contributed to reduction in prices on agricultural products and no urgent measures to support the financial sector or "cool" the economy were required. At the same time, the efficiency of further steps in introduction of inflation targeting will depend to a great extent on the global economic situation which remains highly uncertain. However, it is believed that the policy of the Bank of Russia aimed at both reduction of its interference in the functioning of the foreign exchange market and management of the money supply by means of the interest rates is a correct one.

In conclusion of this section, it is to be noted that early in November the Bank of Russia submitted for consideration to the State Duma the draft Guidelines for the Unified State

Monetary and Credit Policy in 2012 and the 2013-2014 period. In the next three years, the Central Bank of Russia is planning to complete the switchover to inflation targeting. Within the frameworks of the strategy of the consistent reduction of the growth rates of prices, a goal was set to reduce the inflation rate to 4%-5% a year by 2014. According to the Central Bank of the Russian Federation, the main objective of its interest rate policy consists in reduction of its direct interference into the exchange rate mechanism and creation of conditions for a switchover to the floating exchange rate regime. With interference of the Central bank of the Russian Federation into functioning of the foreign exchange market becoming less substantial, the interest rate management policy will have a key role to play in the process of monetary and credit regulation. The decision on changing of interest rates will be normally passed on a monthly basis with the analysis of inflationary developments taken into account.

Other important objectives set by the Bank of Russia in the mid-term prospect are as follows:

• Support of financial stability (for that purpose the Bank of Russia will pay a particular attention to a timely identification and evaluation of the risks taken by banks and ensuring of transparency in credit institutions' activities); it is believed that within the frameworks of attainment of the above goal a particular attention is to be paid to the issues of the macro-prudential regulation and counter-cycling supervision over commercial banks;

• Development of the infrastructure of the financial markets and expansion of their capacity; it is believed that the best contribution of the Central Bank of the Russian Federation in solution of that issue is ensuring of financial stability and the low rate of inflation which prompts economic agents to saving;

• Raising of information openness by the Bank of Russia in the sphere of the monetary and credit policy; in the past few years the Bank of Russia has made large progress in making its policy transparent and at present it is catching up with the world's best prototypes; at the same time it has got the potential for upgrading the quality of the analytical work and analysis of the macroeconomic situation.

2.1.4. Balance of Payments1 and the RUR Exchange Rate

In 2011, continuation of the soft monetary and credit policy by leading global economies and rising tensions in the Middle East and North Africa prompted growth in prices on primary products. As a result, the export of products of the fuel and energy complex from the Russian Federation rose by 34% as compared to the previous year. At the same time, at year-end the capital outflow from Russia turned out to be much higher than it was expected by the Government and the Bank of Russia which situation points to the fact that the risks of investment into the Russian economy are high. As a result, at year-end the country's balance of payments was quite strong, however, in the mid-term prospect its vulnerability to the foreign economic market situation is apparent.

According to the preliminary evaluation of the 2011 balance of payments of the Russian Federation published by the Central Bank of the Russian Federation, the current account balance amounted to $ 101.1bn, which is an increase of 44% as compared to 2010 (Table 4). The trade balance rose by 31% (from $151.7bn to $198.1bn) with export of goods increasing by

1 Analysis of the balance of payments was carried out on the basis of preliminary data of the Central Bank of Russia. http://cbr.ru/statistics/print.aspx?file=credit_statistics/bal_of_payments_est.htm&pid=svs&sid=opb

30% (from $400.4bn to $ 21.4bn) and import, by the same 30% (from $248.7bn to $323.3bn). The share of the export of oil, petroleum products and natural gas amounted to 65.3% of the total value of export and increased by 1.9 % as compared to 2010. It is to be noted that in 2011 the volume of both the export and import turned out to be the record-high in the entire latest history of the Russian Federation.

Thus, as in the previous years the main factor which determined the value of the current account balance was the trade balance which in its turn depended to a great extent on movement of prices on energy carriers and other important goods of the Russian export on global markets. On the basis of the data shown in Fig. 7, it is seen that such a relation between the global prices on oil and the trade balance as was observed in the 2002-2010 period was evident throughout 2011 as well.

The deficit of the balance of services amounted to $37.1bn and rose (in absolute value) by 27% as compared to 2010. The export of services amounted to $55bn and rose by $9.9bn as compared to the previous year (+2%). In 2011, the import of services rose by 24% and amounted to $92.1bn.

In 2011, the balance of labor remuneration increased in absolute value and amounted to $9.4bn (as against $8.5bn in 2010). In 2011, the deficit of the balance of investment income rose by 18% as compared to 2010 and amounted to $47.3bn. Investment income receivable rose from $ 3.7bn to $39.3bn. Growth in income receivable as regards non-financial institutions from $ 61.7bn to $73.1bn determined the growth in the total income receivable from $73.8bn to $ 86.6bn.

In 2011, the balance of current transfers1 amounted to $3.2bn (against $3.6bn in 2010).

So, in 2011 the main factor behind preservation of a considerable current account balance of the balance of payments of the Russian Federation was growth in prices on the main commodities of the Russian export. In particular, the average annual price on Brent oil increased by 40%. It is to be noted that in 2011 growth in the external private sector debt of the Russian Federation renewed (see Table 4). If in 2010 the external debt of banks and the non-financial sector decreased by $27bn, in 2011 the growth in their debt amounted to $51.3bn. As regards the external public debt, it did not change much within the year and decreased by $1.3bn. A favorable situation on the market of energy carriers permitted to form the state budget with a surplus and do virtually without borrowings on the foreign market. In the short-term prospect, growth in the external debt, both private and public, due to a shortage and high cost of financial resources on the domestic market, as well as the budget deficit can be expected.

1 According to the information of the Central Bank of Russia, the current transfers increase the level of the disposable income and consumption of goods and services on the part of recipients and decrease the disposable income and potential consumption opportunities of the donor, for instance, humanitarian aid in the form of consumer goods and services. The current transfers are recorded in the current account. Transfers which are not current by definition are capital ones. Capital transfers result in changes in the volume of assets and liabilities of the donor and the recipient and are recorded in the capital account. If the donor and the recipient are residents of different countries the capital transfer results in a change in the level of national wealth of the economies they represent. An example of capital transfers may be a free of charge transfer of the title to property to capital assets and debt forgiveness.

Table 4

The main items of the balance of payments and the dynamics of the foreign debt in the 2009-2011 period (billion $)

Index 2009 2010 2011

I Q. II Q. III Q. IV Q. Year I Q. II Q. III Q. IV Q. Year I Q. II Q. III Q. IV Q. 1 Year2

Current account 9.7 8.0 15.1 15.9 48.6 33.6 18.5 5.5 12.7 70.3 31.2 21.9 18.4 29.6 101.1

Capital and -32.4 3.3 -26.7 12.2 -43.5 -11.6 9.2 -6.6 -16.5 -25.5 -15.9 -8.7 -20.2 -30.5 -75.3

financial in-

struments ac-

count3

Change in the 30.5 -14.2 9.1 -28.8 5.1 -16.6 -26.1 -2.7 8.6 44.8 -10.1 -12.9 1.8 8.6 -12.6

foreign exchange reserves

("+" means

reduction, while

"-", growth in the reserves)

Net errors and -7.8 2.9 2.6 0.6 -1.7 -5.5 -1.6 3.8 -4.8 -8.0 -5.2 -0.3 0.1 -7.7 -13.1

omissions

Change in the 19.1 51.5 6.3 -60.3 16.6 -34.2 19.6 7.9 -6.7 -13.3 20.7 29.2 -11.8 11.9 50.0

external debt of

the RF ("+"

means growth, while "-", debt

reduction)

Change in the 0.2 -1.5 -2.0 -3.7 -7.1 -2.4 4.1 9.4 2.5 13.7 1.3 0.0 -2.7 0.0 -1.3

external public debt of the RF

Change in the 19.0 53.0 8.4 -56.6 23.7 -31.8 15.5 -1.5 -9.2 -27.0 19.4 29.2 -9.1 11.8 51.3

external private sector debt of

the RF

Source: The Central Bank of Russia.

Source: The Central Bank of the Russian Federation, ICE Stock Exchange and the IEP calculations.

Fig. 7. Trade balance of the Russian Federation and the global oil price index in 2006-2011

1 Preliminary evaluation.

2 Preliminary evaluation.

3 Without taking into account foreign exchange reserves.

40

In 2011, capital and financial instruments account balance grew considerably in absolute value and amounted to $75.3bn. In 2011, the balance of capital transfers amounted to $0.1bn. So, in 2011 the deficit of the financial account amounted to $75.2bn.

Growth in liabilities of Russian economic agents to foreign economic agents amounted on a year-on-year basis to $ 65bn which figure is 50% higher than the index of the previous year ($ 44.4bn).

In 2011, external liabilities of federal regulatory authorities rose by the mere $ 0.3bn, while the reduction in external liabilities by the constituent entity of the Russian federation amounted to $0.8bn. A reduction in liabilities of monetary regulation authorities did not exceed $0.3bn.

In 2011, liabilities of the non-financial sector of the Russian Federation to non-residents increased by $58.2bn as compared to + $24.9bn in 2010. Consequently, foreign investors believe that investments in Russia are quite attractive with the existing level of return. Noteworthy, in 2011 direct investments into the non-financial sector amounted to $48.5bn as against $37.8bn in 2010, while portfolio investments decreased by $4bn ($5.1bn a year before). In 2011, the volume of the loan debt of the non-financial sector to non-residents increased by $15bn.

In 2011, it is to be noted that the liabilities of the banking sector to non-residents rose by $7.6bn, while in 2010 the growth in liabilities of the banks exceeded $17.6bn. The main factor behind the slower growth in liabilities was the reduction in the value of the attracted loans from $19.3bn in 2010 to $11.8bn in 2011. Taking into account the high demand of Russian banks in resources of the Central Bank of Russia and the non-financial sector of the Russian Federation, such a dynamics of liabilities points to difficulties of Russian banks in attraction of external financing which situation can be explained by the fact that investment in the financial sector worldwide is becoming less attractive.

In 2011, foreign assets of residents (foreign economic agents' liabilities to Russian economic agents) rose by $140.2bn (in 2010, by $70bn.). It is to be noted that foreign assets of monetary regulation authorities virtually did not change, while those of federal regulatory authorities rose by $2.6bn.

In 2011, foreign assets of the banking sector increased by $33.8bn. It is to be noted that growth in Russian banks' loans and deposits provided to foreign economic agent accounted for $25.5bn of the above amount. In 2010, growth in foreign assets of Russian banks amounted to $1.8bn.

As compared to 2010, the outflow of capital from the sector of non-financial enterprises and households rose by 54% and amounted to $103.8bn of which amount direct and portfolio investments accounted for $70bn. ($19bn more than in 2010). Households and the non-financial sector reduced their investments into cash foreign currency whose volume of import to Russia amounted to $2.7bn.

In 2011, the situation on the foreign exchange market of the Russian Federation was determined by the inflow of the foreign exchange into the country through the current account with a simultaneous outflow of funds in the capital and financial instruments account. As was stated below, the Central Bank of Russia reduced to a great extent its interference in the functioning of the foreign exchange market by permitting the ruble exchange rate to be formed mainly under the impact of market factors and limited its role to smoothing of sharp fluctuations of the exchange rate. In the first six months, the ruble appreciated both in nominal and real terms under the impact of the considerable trade balance surplus despite the large outflow

of capital. However, in August-October a considerable depreciation of the exchange rate took place and it was justified by a decrease in the current account balance due to a drop in prices on energy carriers and growth in the outflow of the capital from Russia as a result of worsening of the global economic situation.

Generally, in January-December the real effective exchange rate of the ruble grew by the mere 4.7% (at year-end 2010 it was +9.6%) and by the end of the year remained at the level of the mid-2008 (see Fig. 8). In 2011, the official USD/RUR exchange rate grew by Rb 1.72: by the end of December the USD exchange rate amounted to Rb 32.20 against Rb 30.48 as of December 31, 2010. It is to be noted that the ruble depreciated against the bi-currency basket1: in the same period the cost of the bi-currency basket appreciated by Rb 1.55 from Rb 34.91 to Rb 36.46. Late in December the Euro/RUR exchange rate amounted to Rb 41.67 and increased by Rb 1.34 on a year on year basis.

40

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i ^ s- e s

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T T "T T -T

I & 3 é-e a S a ^ ™ z -

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-The official USD exchange rate as of the end of the period - The officialEURO exchange rateas of the end of the period -The on-t of Mi." bi-cutrency basket

■The index of the real effective RUR exchange rate (the riaht-hard axis)

Source: The Central Bank of the Russian Federation and the author's calculations.

Fig. 8. Indices of the RUR exchange rate in January 2005 - December 20112

In 2011, the situation with the balance of payments developed in such a way that on a year on year basis the RUR exchange rate both in nominal and real terms did not change much with virtually no interference by the Central Bank of Russia into functioning of the foreign exchange market. In other words, the situation was favorable to the Bank of Russia and permitted it to switch over to the inflation targeting regime with absence of fundamental changes in the RUR exchange rate. At the same time, the Central bank of the Russian Federation let the RUR exchange rate depreciate in August-October, however, thanks to growing surplus of the balance of payments at the end of the year the RUR exchange rate started to grow again.

1 Bi-currency basket is an operating benchmark of the Central Bank of the Russian Federation in carrying out of the foreign exchange policy. At present, the share of the Euro in the basket amounts to 45%, while that of the USD, to 55%.

2 The level of January 2002 is equal to 100. 42

In 2011, a trend which determined the dynamics of the balance of payment was the dynamics of the net flight of capital from the non-financial sector; on a year on year basis the capital flight amounted to $85bn (in 2010 it amounted to $34.5bn) (see Fig. 9). It is to be noted that the flight of capital was observed throughout the year: the minimum flight of capital was registered on the basis of the results of the 2nd quarter (- $7.3bn), while the maximum one, on the basis of the results of the 4th quarter (- $37.6bn). The factor behind the flight of capital was in all appearances the prevalence of high economic and political risks related to investment in the Russian Federation with a level of return comparable to that in other developing countries.

Source: The Central bank of Russia; the IEP calculations.

Fig. 9. The dynamics of the net flight of capital in 2005-2011

Another evidence of the unfavorable situation with the inflow of capital is the speed-up of the so called capital flight1 in 2011. According to our evaluations, in 2011 the flight of capital (Fig. 10) amounted on a year on year basis to $ 42.6bn which figure is $ 3.9bn higher than in 2010.

Summing up the result of the analysis of the balance of payments, it is to be noted that in general the insignificant total balance of payments is favorable to the Russian economy as it contributes both to stability on the foreign exchange market and sustained development of the financial system. At the same time, due to the fact that the current account of the balance of payments of the Russian Federation depends to a great extent on the export of several commodities the existing situation with the balance of payments is unlikely to be stable in the long-term prospect due to the unpredicted dynamics of prices on energy carriers and, consequently, the situation of the Russian foreign trade. As regards the capital and financial instruments account balance the flows of capital both to and from Russia are likely to remain quite volatile due to, among other things, uncertainty about the global economic development. However, in case of absence of efforts by the Government of the Russian Federation to reduce

1 The capital flight was calculated on the basis of the IMF methods and represents the amount of "trade loans and advance payments", "export revenues which failed to be received timely and goods and services which failed to be delivered against remittance of funds under import contracts" and "net errors and omissions".

investment risks in the Russian Federation with all other things being equal (primarily, in case of stability of prices on energy carriers) the inflow of private capital to the country can hardly be expected on the basis of the results of 2012.

Source: The Central Bank of the Russian Federation, the IEP calculations.

Fig. 10. The dynamics of the flight of capital in the 2005-2011 period

2.2. State Budget

Throughout 2011, it still was a favorable state of affairs in the foreign economic area which was a major driver of increase in budget revenues: international carbohydrate prices proved at one-third above the projections made while crafting the draft federal budget for 2011-13. As well, the revenue part of the budget found itself under spurred by increasing business activity which manifested itself in the economy's growth rates notably outpacing the earlier anticipated ones (the 2011growth in GDP was projected at a level of 3.4%, while Rosstat's preliminary estimates suggest it actually accounted for 4.3%).

There also were other factors fueling the increase in budget revenues: arrears before the budget system were down 12% on a year-on-year basis and hit their lows over the past 78 years; wage arrears were also down from Rb 2.4bn in 2010 to 1.8bn in 2011; the registered unemployment rate slid by 10.9%.

At this juncture, even the pre-election boost to expenditure obligations failed to "overweight" the increase in the revenue part of the budget. Thanks to that, at the federal level, the 2011 budget posted a surplus, while the public debt remained under 9.6% of GDP. However, many expenditure obligations are deferred and going to manifest themselves in full only in 2012.

So, on the one hand, against a miserable global economic backdrop (the EU member states sharing a -6.2% deficit of the Eurozone's aggregate budget, the US suffering from a deficit of -9.6% of GDP and Japan a deficit of -10.3% of GDP) and a huge public debt (over 80% of GDP across the Eurozone, 69% of GDP - in the US and 208% of GDP - in Japan1) Russia's economy appears pretty healthy; however, on the other hand, more and more pre-election ob-

1CIA - Central Intelligence Agency. 44

ligations and expenditure vows were made (e.g. the decision to raise military and law-enforcement agencies personnel's pay proved very costly; meanwhile, the government is facing the challenge of footing the bill for indexation of the social and the public sectors employees' pay) compels one to reassess risks and consequences of the said managerial decisions from the perspective of the national budget system's sustainability.

2.2.1. The General Characteristic of the Budget System of Russian Federation

The 2011 dynamics of main parameters of the enlarged government budget exhibits retention of the trends launched in 2010 - namely, boosting revenues while constraining budget expenditures relative to GDP (see Table 5).The 2011 revenue volume to the enlarged government budget accounted for 38.4% of GDP, or up 2.9 p.p. of GDP vis-à-vis the 2010 level. The volume of federal budget revenues hit 20.9% of GDP, or 2.5 p.p. up compared with 2010. The increase was fueled mostly by oil-and-gas revenues boosted by a favorable foreign economic situation. In 2011, international prices of Urals stabilized at a level of USD 109/b (in 2010- USD 78/b) under a 30.3% expansion of foreign trade turnover calculated by the bal-ance-of-payments methodology1. In 2011, the recovery of the industrial output continued to advance, with the index of industrial output accounting for 104.7%. The share of the federal budget revenues in overall revenues to the enlarged government budget posted a slight growth on a year-on-year basis - from c 51.8% in 2010 up to 54.5% in 2011.

Table 5

Revenues to and Expenditures of the Budgets in 2008-2011

2011 2010 2009 2008 Bias in p.p. of GDP, 2011 vs. 2010

Rb bn % of GDP Rb bn % of GDP Rb bn % of GDP Rb bn % of GDP

Federal budget

Revenues 11 365. 9 20.9 8305.4 18.4 7337.7 18,9 9275.9 22.5 +2.5

Expenditures 10 935. 2 20.1 10 117. 5 22.4 9660.90 24.9 7570.8 18.3 -2,3

Deficit(-) / Surplus(+) +430.7 +0.8 1 812.1 -4.0 -2322.3 -6.0 1705.0 +4.1 +4.8

Consolidated budgets of RF Subjects

Revenues 7643.9 14.1 6537.3 14.5 5926.6 15.3 6253.1 15.1 -0.4

including interbudgetary transfers 1644.0 3.0 1398.9 3.1 1487.4 3.8 1132.6 2.7 -0.1

Expenditures 7679.3 14.2 6636.9 14.7 6255.7 16.1 6253.5 15.1 -0.6

Deficit(-) / Surplus(+) -35.4 -0.1 -99.6 -0.2 -329.0 -0.8 -54.4 -0.1 +0.1

The enlarged government budget

Revenues 20 853.6 38.4 16 031. 9 35.5 13 599.7 35.0 16 169.0 39.2 +2.9

Expenditures 20 004.8 36.8 17 616. 6 39.0 16 048.3 41.3 14 157.0 34.3 -2.2

Deficit(-) / Surplus(+) +848.8 + 1.6 -1584.7 -3.5 -2448.6 -6.3 +2012.0 +4.9 +5.1

For reference: GDP, as Rb bn 54 369 45 166 38 809 41 277 -

Increase in Russia's public debt (including issued government guarantees) over the year + 1190.3 +2.2 +921.9 +2.0 +583.1 + 1.4 +289.6 +0.7

Source: Rosstat, the RF Ministry of Finance, IEP ca

culations.

!At year-end 2010 Russia still was one of the largest exporters, after China, Germany and Japan, in the CIA Sovereignty Rating which is based on assessment of current external balance.

At year-end 2011 the RF Subjects' consolidated budgets received Rb 7,643.9 bn in revenues (14.1% of GDP), or 0.4 p.p. of GDP down compared with the prior year (14.5% of GDP), which should be ascribed both to a drop in revenues noted across most tax and non-tax revenues, as well as a fall in the volume of interbudgetary transfers (by 0.1 p.p. of GDP). An alarm bell was the fact that the last year saw the lowest level of collection of tax revenues to the RF Subjects' consolidated budget since 2008. The fall was most intense with respect to the corporate profit tax (by 0.3 p.p. of GDP), PIT - 0.2 p.p. of GDP, property tax - 0.2 p.p. of GDP. Transport tax revenues remained at a level of 0.1% of GDP thanks to greater contributions by private individuals, while amounts collected from corporate taxpayers were down. In all, the share of tax revenues in the aggregate volume of the RF Subjects' consolidated budgets shrank by 1.2% vs. the previous year's figures.

As to non-tax revenues, when compared with the 2010 figures, there was noted a decline in asset management revenues to the RF Subjects' budgets equivalent to 0.1 p.p. of GDP. At this point, exacerbation of asset management problems at the regional level is quite visible, as collection of the revenues in question was supposed to increase due to annual investment by the Subjects' budgets in creation of state property objects equivalent to up to 2.0% of GDP. Meanwhile, the other non-tax revenues remained unchanged since 2010.

Despite a two-year-long tendency to increase in revenues to Russia's budget, the nation failed to clear the pre-crisis bar of revenues to the enlarged government's budget (39.2% of GDP in 2008). Meanwhile, the enlarged government budget expenditures were being trimmed consistently: from 41.3% of GDP in 2009 to 36.8% of GDP in 2011, or 2.2 p.p. below the 2010 figures, but still above (2.5p.p. of GDP) the pre-crisis 2008 level. That said, expenditure cuts were uneven across the tiers of the budget system: thus, in 2011, federal budget expenditures were slashed by 2.3 p.p. on a year-on-year basis and made up Rb 10, 935.2bn (20.1% of GDP), while expenditures of the RF Subjects' consolidated budget slid by 0.6 p.p. of GDP vs. the previous year's figures and accounted for Rb 7,679.3bn (14.2% of GDP).

The decline in the volume of the budget system's expenditures can be partly ascribed to low pace of spending throughout the year. For example, by results for the first 8 months of the year, expenditure-wise, cash execution of the federal budget was 58.4%, while that of consolidated budgets of RF Subjects - 51.7%. The last month of the year saw spending of some 20% of all the federal budget outlays (in 2010 r. - 17.7%, in 2009 - 15.0%).

At year-end, the situation with cash execution of the federal budget and consolidated budgets of RF Subjects was as follows (see Table 6).

Table 6

Cash Execution of the Federal Budget and the RF Subjects' Consolidated

Budget in 2010-2011

Federal budget RF Subjects' consolidated budget

2011 2010 2011 2010

Commitments, as Rb. bn Cash execution, % Commitments, as Rb. bn Cash execution, % Commitments, as Rb. bn Cash execution, % Commitments, as Rb. bn Cash execution, %

1 2 3 4 5 6 7 8 9

Expenditures, total including 11 126.0 98.3 10 301.5 98.2 8400.7 91.4 7175.1 92.5

Non-excludable costs 815.0 96.6 990.3 89.4 510.8 91.8 523.1 92.0

National defense 1524.4 99.5 1288.8 99.1 3.6 95.9 3.3 97.0

National security and law-enforcement activities 1258.1 100.0 1094.6 99.2 291.3 96.8 260.5 97.5

National economy 1861.7 96.2 1253.3 97.5 1485.5 88.6 1256.7 87.8

Public utilities sector 282.9 98.9 236.9 99.2 1335.8 72.5 974.4 85.8

cont'd

1 2 3 4 5 6 7 8 9

Environmental protection 17.8 98.9 13.5 100.0 24.0 90.8 16.5 89.7

Education 556.0 99.5 444.8 99.5 1791.3 96.5 1497.5 96.9

Culture, motion picture 86.9 96.0 126.4 99.2 282.9 95.1 240.1 94.9

industry, mass media

Health care, physical cul- 513.0 97.3 356.8 97.5 1502.0 89.1 853.5 93.4

ture, sports

Social policy, pension 3185.9 98.2 346.9 99.4 1273.8 93.6 1237.5 94.3

system

Source: the RF Ministry of Finance, the IEP calculations.

Despite the national leadership's regular calls to improve payment discipline, the situation with cash execution of the federal budget remained practically unchanged, while in the case of the RF Subjects' consolidated budget it even exacerbated, with the budget having been executed, expenditure-wise, only by 91.4% (92.5% in 2010). In terms of functional sections the worst performance in executing consolidated budget expenditures over recent years was noted across the following sections "Public utilities sector", "National economy", "Health care, physical culture and sports". Factors behind a low dynamic of spending of budget funds are: inclusion in the Budget Act of costs of construction of objects not backed with necessary documents and materials (approved in accordance with the established procedure design documentation on capital construction objects, decisions to make budget investments in the frame of the approved federal target program, etc.) and, according to the RF MinFin, the launch of the system of open e-auctions in the course of placement of public orders, which required setting up an e-document flow system.1.

At year-end 2011 the enlarged government budget was executed with a surplus of 1.6% of GDP thanks to a positive balance of execution of the federal budget (+0.8% of GDP) and budgets of extrabudgetary funds (+0.8% of GDP), including a surplus of the Pension Fun totaling 0.6% of GDP. To ensure the budget balance of the Pension Fund of Russia's budget, during the year, the government injected therein Rb 924.4bn out of the federal budget (1.7% of GDP), while the gap between pension insurance premiums collected into the Pension Fund and payments of the labor and savings parts of pension, less other expenditure items of PFR, accounted for 2.7% of GDP2.

The consolidated budget of RF Subjects was executed with a negligible deficit (-0.1% of GDP). According to data as of 1 January 2012, as many as 57 RF Subjects executed their regional budgets with deficit. Atop the list of such Subjects were the Republic of Tatarstan, Samara oblast and Krasnodar krai.

According to the RF MinFin, the volume of the public debt (with account of issued government guarantees) posted an insignificant increase - from 9.2% of GDP as of late 2010 up to 9.6% of GDP as of 01.01.2012. The major driver behind the surging public debt was the soaring volume of domestic debt - by 1.2p.p. of GDP, up to 7.7% of GDP. By contrast, the volume of foreign debt was down 0.8p.p. of GDP. It should be noted that the ballooning of public debt under a budget surplus (see Table 5) is explained by peculiarities of the national budget law. The fact of the matter is that according to Art. 184.2. of the Budget Code of Russian Federation, along with the bill on the budget the government should submit a draft program of borrowings for next financial year. Meanwhile, in accordance with the schedule approved in the beginning of the financial year, a public offer of government bonds is run

1 http://bujet.ru/article/121904.php

2 For details, see Section 2.3.

proceeding from the ongoing situation on financial markets, regardless of an actual securing of current expenditures and cash balances. Hence, focus on the current budget balance does not always seem justified in a situation of a continuous anticipation of the budget deficit by the end of the year.

Meanwhile, in anticipation of revenues above the budget projections and of a budget surplus, the MinFin has the right to make decisions to cut back on volumes of borrowings, which may be implemented in the form of an actual suspension or reduction of volumes of bond placements and redemption of earlier placed bonded loans. The Ministry used the right to implement all the planned bond issuances and, consequently, instead of the set in the budget act marginal debt volume of 13.7% of GDP, as of late-2011, the actual figure remained under 10% of GDP.

During the 11 months 2011, the volume of RF Subjects' public debt shrank by Rb 34.1 bn and made up Rb 1,071.9bn (2.0% of GDP). The biggest contraction in the public debt was noted in Moscow oblast (Rb 50bn), the city of Moscow (Rb 36bn). Meanwhile, the figures were on the upsurge in 40 Subjects of RF, with the biggest one - Rb 23bn - reported by the Republic of Tatarstan.

So, while certain positive trends continued to unfold in the nation's budget system in 2011 (e.g. rise in revenues along with a concurrent slashing of expenditure and the enlarged government budget once again in the black), symptoms of challenges to the budget system's stability exacerbating are there. We believe the most critical risk in this regard is the continuous high reliance of budget revenues on the state of affairs on the global markets for energy sources. As a consequence, the budget surplus becomes attainable only under extremely high oil prices. Our estimates show that in 2011 the structural component of revenues to the budget system of RF which takes place under an average long-standing oil price (USD 67/b.) accounted for 32.4% of GDP. This means that with regard to the amount of budget expenditures (36.8% of GDP) the 2011 structural deficit made up 4.4% of GDP.

A critical challenge facing the budget system is a broad employment of opaque and un-competitive conduits, as far as channeling budget resources to contractors is concerned, which manifests itself in a high proportion of use of subsidies. By contrast, developed nations vigorously employ more transparent procurement procedures (across OECD nations, an average 18% of GDP is assigned through public procurement procedures vs. 10-11% in Russia). Clearly, given a sizeable budget sector, the use of subsidies as an instrument of financing the public order for public institutions appears a justified move; however, their vigorous employment to support the real sector1 is, in our view, an unjustified measure and should be reduced just to individual cases of subsidizing interest rates on loans to agrarian producers and the framework of procedures of rehabilitation or an intense restructuring of backbone corporations.

Another example of employment of opaque budget instruments is contribution to corporate statutory capital (the 2011 spending on boosting stock and other forms of participation in equity capital on the federal level alone accounted for 0.8% of GDP, or 3.7% of the aggregate federal budget expenditures). Not only do investments in a corporation's authorized capital fail to guarantee a target spending of budget allocations for investment purposes, as the state

1 More specifically, the volume of federal budget spending on subsidizing commercial organizations under the Section "National Economy" remained on a fairly high level: in 2011 - Rb 166.8bn (0.3% of GDP), in 2010 -Rb 175.7bn (0.4% of GDP).

may not directly determine directions of their use, but they engender a conflict between the government's mission to become an arbiter in economic relations and its interests as a stockholder of a given enterprise. Whereas the main advantage of the instrument in question is acquisition of the right to participate in managing the economic agent's operations, we believe that it should be appropriate to limit the practice of contributing to corporations' authorized capital (i.e. a de-facto irrevocable financing) to economic companies with the 100% government participation. That said, while investing in their authorized capital, the government's interest should lie in control over the economic agent's long-term strategy, rather than in implementation of a concrete investment project.

Another recently noted distinctive feature of the state budget became implementation of huge construction projects (eg. the 2014 Olympics, the APEC Summit 2012, the World Cup-2018). They have put a mounting pressure on the federal budget, while effectiveness of such costs does not appear evident.

Thus, reserves to bolster efficacy of budget spending should be sought in a change of the whole system of budget spending control mechanisms and approaches to selection of funding priorities.

2.2.2. Analysis of Revenues from Major Taxes into the Budget System of RF

In 2011, the tax burden was up 12%, resulting both from a favorable foreign economic environment and, accordingly, increase in the oil-and-gas revenues, and improvement of business activity and rise of consumption in Russia's economy, which entailed an increase in collection of corporate profit tax and VAT vs. the prior year.

Table 7

Revenues from Major Taxes into the Budget of the Enlarged Government of Russian Federation in 2007-2011, as % of GDP

2007 2008 2009 2010 2011 Change in 2011 relative to 2010

As p.p. of GDP in 2011 prices, %

Level of tax burden 36.1 35.7 30.8 31.9 35.8 3.9 16.9

Corporate profit tax 6.6 6.1 3.3 3.9 4.2 0.3 10.9

PIT 3.8 4,0 4.3 4,0 3.7 -0.3 -3.4

UIT/insurance premiums* 5.1 5.1 5.5 5.0 6.5 1,4 34.2

VAT 6.9 5.1 5.3 5.5 6.0 0.4 12.8

Excise taxes 1.0 0.8 0.9 1.0 1.2 0.2 24.8

Mineral tax 3.6 4.1 2.7 3.1 3.8 0.7 29.1

Customs duties and fees 7.3 8.6 6.8 7.0 8.5 1.5 27.1

* Since 2010 UIT was transformed into insurance premiums collected directly to extrabudgetary funds. Source: the RF Ministry of Finance, Rosstat, the IEP calculations.

The data presented in Table 7 evidence that in 2011 the level of aggregate tax burden on the economy was practically back to the pre-crisis one. Meanwhile, as far as revenues from individual taxes are concerned, it can be noted that corporate profit-tax and VAT revenues remained at a level notably below the 2007 one, while those from PIT and the mineral tax were close to the 2007 level. In this context, due to the rise of their rates, insurance premiums (earlier known as UST) secured revenues equivalent to 6.5% of GDP vs. 5.1% of GDP in 2007, but posted an disproportionally lesser increase vis-à-vis the rise of the rates, nonetheless. Let us consider in every detail the situation with collection of main taxes.

The structure of tax revenues to the enlarged government budget is presented in Fig. 11. It was PIT which proved to be the only tax that posted a clearly negative dynamic in 2011.

r

1

pprl

■ 2009 12010 ■2011

Tax revenues Corporate profit tax PIT

UIT/insurance VAT

premiums

80,0

70,0

60,0

50,0

40,0

30,0

20,0

10,0

Source: FTS of RF.

Fig. 11. Proportion of Tax Revenues in Aggregate Revenues to the Enlarged Government Budget in 2007-2011, %

The fall in question should be attributed to its shrinking tax base: the main indicator which characterizes the dynamic of the PIT tax base - namely, the residents' monetary incomes less social payments - tumbled from 58.4% of GDP in 2010 to 53.2% of GDP in 2011 (see Fig. 12).

Source: FTS of RF, Rosstat.

Fig. 12. Dynamics of PIT Revenues to the Budget System of RF and Residents' Monetary Incomes less Social Payments in 2007-2011, as % of GDP

The main factor driving the PIT tax base downwards in 2011 became the increase in social contributions rates, including the raising of the basic rate from 26% to 34% in particular.

According to surveys run by OPORA Rossii1, in 2011, small- and medium-sized businesses responded to the move by:

1) using various mechanisms to diminish amounts of insurance premiums (paying a part of salaries "in envelopes", etc.) (83% of the surveyed);

2) abandoning earlier planned pay rises or cutting down salaries (90% of the surveyed);

3) dropping plans to expand operations (equipment modernization, other investment in development) (83% of the surveyed).

As a result, being a major component of the PIT tax base2, the labor compensation fund, less social contributions, plunged in 2011 by 2.1 p.p. of GDP (see Fig. 13), which in turn explains a 0.3 p.p. of GDP fall in PIT revenues in 2011 vs. the 2010 figures. By contrast, the volume of collection of social contributions surged by 1.44 p.p. of GDP, as the effect from the increase of their rates proved far in excess of consequences from the shrinkage of the tax base.

Source: FTS of RF, Rosstat.

Fig. 13. The Dynamic of Collection of UST/Social Contributions vs. the Dynamic of the Labor Compensation Fund less Social Contributions 2007-2011, % of GDP

Preferential insurance premium rates were foreseen for a closed list of taxpayer categories,

which decreased the effective taxation rate on the whole:

1) for self-employed, attorneys-at-law and notaries - 31.1%;

2) for domestic corporations and self-employed individuals involved in production and publication of printed media, UST payers producing food staffs, footwear, rubber and plastic items, furniture, means of transportation, equipment, etc. - 26%;

3) for corporations operating in IT, economic companies established by public research institutions and universities after 13 August 2009; residents of special R&D economic zones, participants in the Skolkovo project - 14%.

1 http://opora.ru/legal/analysis/research/polls/#survey/25/

2 According to Rosstat data, in 2008-11 the share of labor compensations in residents' incomes less social contributions was steadily at a level of 78-83%.

According to the RF MinFin, the overall volume of revenue shortfalls by exemptions and benefits accounted for some Rb 300bn, or some 9% of the 2011 aggregate volume of revenues from insurance contributions.

As to oil-and-gas budget revenues, they posted a notable growth compared with 2010 (see Table 8). More specifically, the year of 20l1 saw a 0.7p.p. of GDP surge in tax revenues from the mineral tax, fueled both by a notable rise of the tax rate on natural gas and a favorable state of affairs on the global market for energy sources (the 2011 average price of Urals was USD 109.6/b vs. 78.1 in 2010).

That said, despite soaring natural indicators of oil production and a significant price rise for oil, the 2011 level of mineral-tax withdrawals proved to be below the 2008 one. This can be ascribed, first, to the raising in 2009 of the non-taxed threshold with regard to the mineral tax from USD 9/b to USD 15/b and, second, to introduction in the same year of the decreasing coefficient to the mineral tax rate at fields with a high degree of depletion of reserves.

Table 8

Volume of Oil-and-Gas and Mineral-Tax Revenues in 2008-2011

2008 2009 2010 2011

Oil-and-gas revenues, % to GDP 10.6 7.7 8.6 11.0

Mineral tax, % to GDP 4.1 2.7 3.1 3.8

Oil output, including gas condensate, m.t. 488 494 507.2 509.4

The average annual price level for Urals, USD/b. 94.0 60.7 78.1 109.6

Source: Rosstat, FTS of Russia, IEP calculations.

The price rise for energy sources and growth in output had a positive effect on the dynamic of export duties on energy sources. In 2011, the aggregate revenues from export of energy sources practically caught up with their 2008 level (see Table 9). The share of export duties on energy sources in the overall amount of tax duties was oscillating around 76-78% over the period between 2008 and 2011.

Table 9

Collection of Customs Duties in 2008-2011, as % of GDP

2008 2009 2010 2011

Export duties on:

- crude oil 4.3 3.1 3.7 4.3

- natural gas 1.2 1.1 0.4 0.7

- goods manufactured of oil 1.3 1.0 1.3 1.7

Customs duties and fees, total 8.6 6.8 7.0 8.5

Source: Rosstat, the Federal Treasury data, the IEP calculations.

As concerns non-oil-and-gas revenues, those from the corporate profit tax were on the rise primarily because of a more robust business activity in Russia. Specifically, the specific weight of loss-making organizations in the economy was down, while net balance of corporate financial performance (less small-sized businesses) in shares of GDP equivalent was up compared with the same period of 2010, thus evidencing the expansion of the corporate profit tax (see Fig. 14). As a result, the 2001 corporate profit-tax revenues stood at 4.2% of GDP, or at 0.3 p.p. of GDP above the prior year's level.

* According to preliminary estimates by Rosstat. Source: FTS of RF, Rosstat.

Fig. 14. Dynamic of Corporate Profit Tax Collection into the Budget System of RF, Balance of Corporations' Financial Performance and the Specific Weight of Loss-Making

Enterprises in 2007-2011

Reinvigoration of Russia's economy also led to growth in volume of final consumption which forms the tax base of indirect taxation. Thus, in 2011, the tax base of VAT kept on reviving after its compression during the crisis period. That fueled an increase in collection of this tax up to 6.0% of GDP vs. 5.5% in the previous year. Yet another explanation of the increased collection of VAT is an improved quality of its administration: specifically, the 2011 VAT collection ratio1 posted a 6 p.p. increase vis-à-vis the 2010 figure and hit the 53% level, thus basically having closed the gap with its pre-crisis values (See Table 10).

Table 10

Dynamic of Final Consumption, Import and VAT Collection in the Budget System of RF in 2005-2011, as % of GDP

2005 2006 2007 2008 2009 2010 2011

Revenues from VAT (less revenues from YUKOS) 6.17 5.62 6.13 5.17 5.28 5.53 5.98

VAT on goods sold within RF 4.11 3.44 3.51 2.42 3.03 2.94 3.23

VAT on goods imported in RF 2.06 2.18 2.62 2.75 2.25 2.59 2.75

Tax collection ratio, % 57.0 51.5 56.7 46.6 42.3 47.0 53.0

Import* 12.9 13.9 15.3 16.1 13.7 15.4 16.5

* The share of import in GDP was defined as the value of import data by the customs statistical data to the USD-equivalent GDP value ratio, on the basis of values of the average nominal USD/Rb nominal rate over the respective year.

Source: Rosstat, the RF Ministry of Finance, IET calculations.

'This index is calculated as-p- and shows which share of the base (final consump-

VAT rate x (final consumption)

tion less the tax) is effectively taxed. A more detailed discourse on economic interpretation of the index in question can be found in: Kazakova M., Knobel A., Sokolov I. The Quality of VAT Administration in OECD Countries and Russia. Reforming the Russian System of Collection of the Tax/ed. by S.G. Sinelnikov-Murylev. M.: IET, 2010.

It is taxation of imported goods which still secures nearly a half (46%) of the structure of VAT collection. The figure remained at the previous year's level, which evidences a match between the dynamic of revenues from VAT on imported in RF goods and the dynamic of import of goods.

In 2001, revenues to the budget system from excise taxes were on the rise - from Rb 501.5bn to Rb 650.5bn in current prices, which in relative terms secured an increment equivalent to 0.2p.p. of GDP. It should be specifically noted that, as evidenced by Fig. 15, the increment in question was driven by soaring revenues from excise taxes on oil products (from 0.37% of GDP in 2010 to 0.52% in 2011). Collection of revenues from liquors and spirits plunged in relative terms (from 0.46% of GDP in 2010 to 0.37% of GDP in 2011), while revenues from taxation of sales of two other excised categories of goods stabilized at the 2010 level: the increase with respect to tobacco goods was negligible (from 0.24% up to 0.26% of GDP) and the same can be reckoned with respect to excise revenues from sales of passenger cars and motorcycles (up from 0.03% to 0.05% of GDP).

Excises on liquors

Excises on tobacco goods

Excises on oil products Excises on passenger cars and motorcycles

12007 Li 2008 U 2009 id 2010 =2011

Source: FTS of RF.

Fig. 15. Collection of Excise Taxes over 2007-2011 by Groups of Excised Goods,

as % of GDP

The rise in collection of excise taxes on oil products was caused by a fairly considerable raising of their rates - from 30 up to 100%, depending on a specific kind of the il product, vis-à-vis the 2010 level. The tax base changed insignificantly relative to the 2010 level, while oil-refining plants reported a 1.7% increase in shipments of gasoline, 0.9% - diesel fuel and 4.9% - of fuel oil.

The average value of indexation of excise rates with regard to tobacco products accounted for 17-43%, the one of excise rates for liquors - 12-23%. In 2011, consumption of all kinds of liquors changed insignificantly, while consumption of tobacco goods was in decline (see Table 11). The increase in excise rates for tobacco products compensated for the fall in the volume of their consumption, while a poorer administration of excise taxes on liquors, even under indexation of the rates above the inflation rate and the volume of consumption remaining on its 2010 level, resulted in the dynamic of collection falling behind the GDP one.

Table 11

Volume of Consumption of Liquors and Tobacco Goods in RF in 2005-2011

Type of product ZOO5 ZOO6 2007 2008 ZOO9 ZOlO ÏOll

Liquors, as dcl m

Vodka and liquors 203.5 197.2 184.6 177.2 166.1 157.8 159.0

Grape and fruit wine 84.9 81.1 94.9 102.9 102.5 103.4 103.0

Cognacs 6.8 7.6 8.9 10.8 10.6 11.1 12.0

Champaign and sparkling wine 19.4 20.6 24.1 26.0 25.5 27.3 29.8

Beer 892.1 1002.8 1155.3 1138.2 1024.7 1004.0 1077.5

(Russian cigarettes), bn. pcs 395.8 424.1 398.2 393.6 394.3 370.6 366.1

Source: Rosstat.

2.2.3. Budget System Expenditures

The year of 2011 saw expenditures contract by 1.7 p.p. of GDP vs. the prior year by section "Social policy" and by 0.1-0.2 p.p. of GDP across each of the following sections: "General public administration matters", "National security and law-enforcement activity", "Housing and utilities", "Education" and "Culture, motion picture industry, and mass media" (see Table 12).

Table 12

Expenditure of the Enlarged Government Budget in 2008-2011, as % of GDP

ZOll ZOlO ZOO9 ZOOS ZOll figures bias from ZOlO, p.p. of GDP

EXPENDITURE 36.8 39.0 41.3 34.3 -2.2

General public administration matters* 2.5 2.6 2.8 2.7 -0.1

National defense 2.8 2.8 3.0 2.5 0.0

National security and law-enforcement activity 2.8 3.0 3.2 2.6 -0.2

National economy 5.1 5.1 7.1 5.5 0.0

Housing and utilities 2.2 2.4 2.6 2.8 -0.2

Environmental protection 0.1 0.1 0.1 0.1 0.0

Education 4.1 4.2 4.6 4.0 -0.1

Culture, motion picture industry, and mass media 0.7 0.8 0.8 0.7 -0.1

Health care, physical culture and sports 3.9 3.8 4.3 3.7 +0.1

Social policy 12.0 13.7 12.1 9.1 -1.7

Public debt servicing 0.6 0.6 0,6 0.5 0.0

* Except for expenditures on public debt servicing. Source: The RF ministry of Finance, IEP calculations .

The volume of expenditures across sections "Public debt servicing", "National defense" and "National economy" in shares of GDP remained unchanged in 2011. The past two years saw volumes of financing by the section "National security and law-enforcement activity" contract by 0.2 p.p. of GDP annually. Despite that, Russia is still ahead of all the OECD member states in terms of level of spending on domestic security and law-enforcement activity, as well as by the number of law-enforcement personnel (for reference: In Russia, this index is 9.8 per 1,000 residents, while in second to Russia Turkey - twice as low). So, there is a certain potential to further reduce spending by this particular expenditure item.

When it comes to the section "National defense", the 2011 volume of the enlarged government budget expenditure relative to GDP remained at the prior year's level - that is, 2.8% of GDP. That said, Russia's defense spending is one of the highest worldwide and second to

the US and Israel's1. A high level of defense spending in the US has been steadily in decline over the past fifty years, except for periods of the US's military engagement2.

There was an insignificant increase by 0.1p.p. of GDP in 2011 vs. 2010 by the section "Health care, physical culture, and sports", which should be ascribed to the bolstering of the volume of funding of objects for the World Student Games-2013 and 0lympics-2014. By the Accounting Chamber's estimates3, the initial budget of the latter event was nearly 4-fold greater than those of the Vancouver 0lympics-2010 and Torino 0lympics-2006, while the cost overrun exceeded all reasonable limits, as costs surged 3-fold and hit USD 29.8bn (the ultimate budgets of the Vancouver and Torino 0lympics were USD 6bn and 3.6bn, respectively). That said, there are grounds to assume that the construction budget and, accordingly, volumes of budget outlays for implementation of the Sochi-2014 project in 2012-13 may likewise be increased more than once.

The 2011 volume of spending on health care per se remained on the prior year's level and posted some growth vis-à-vis the 2008 figures, which can be explained by a greater spending on financing health care modernization programs. The RF Subjects' 2011 consolidated budget expenditures on this item posted a 0.07p.p. of GDP increase vs. the previous year thanks to a 0.3 p.p. of GDP increase in expenditures on physical culture and sports, a 0.1p.p. of GDP increase in spending on the ambulance service and a 0.3 p.p. of GDP increase in spending on other kinds of medical assistance. In the structure of the enlarged government spending, the share of expenditures across this item surged up to 10.6% of all the expenditures of the enlarged government vs. the previous year's 9.7%.

The enlarged government budget expenditures on the section "National economy" in 2011 were on the level of 2010, that is, 5.1% of GDP, but when compared with the 2009 figures, they slid considerably - by 2.0p.p. of GDP, because of scaling back on volumes of anti-crisis support to the economy.

Expenditure item-wise, spending was boosted across the following sectors: the fuel and energy complex - by 0.2 p.p. of GDP, agriculture and fishery - by 0.3p.p. of GDP, forestry -by 0.1p.p. of GDP, the public road system - by 0.1p.p. of gDp and subsections "General economic matters" and "Other matters in e the national economy area" - by 0.2p.p. of GDP. The volume of budget appropriations for applied research in 2011 remained at the prior year's level of 0.3p.p. of gDp. As to other subsections, including "Exploration and use of space", "Reproduction of the mineral base", the 2011 enlarged government budget expenditures in shares of GDP equivalent contracted vis-à-vis the previous year.

1 In 2010, Israel's defense spending accounted for 6.7% of GDP. However, in contrast to the RF budget, that section included both defense expenditures per se along with costs of pensions to, and social rehabilitation programs for, the military and their family members, the border infrastructure maintenance costs, and costs of purchasing weaponry from the US at the expense of the latter's military aid. So, it may well happen that in reality Israel's military spending does not exceed Russia's. Source: http://www.inss.org.il

2 The US started cutting down its national defense spending back in the Cold War era from 14.2% of GDP in 1953 to 9.2% of GDP in 1962, 6.7% - in 1972, 5.7% - in 1982. The defense spending shrank sizably since the collapse of the USSR: from 5.2% of GDP in 1990 to 3.0% of GDP in 2001 (except for 1992 - 4.8% of GDP due to the War in the Gulf). The figures have been on the rise ever since 2002: from 3.3% of GDP up to 4.0% of GDP in 2005 and further to 4.7% of GDP in 2009 and 5.1% of GDP in 2011, due to financing of military operations in Iraq and Afghanistan. It is planned to scale back on military expenditures post-2011 and bring them down to 3.4% of GDP by 2016. Source: www.whitehouse.gov

3 On the basis of data provided by the Accounting Chamber of RF in its conclusions on draft budget acts.

Expenditures on the section "Education" have been in decline since 2009. In 2010, they shrank by 0.4 p.p. of GDP and in 2011 - by 0.1p.p. of GDP on a year-on-year basis. The proportion of spending on education in the enlarged government budget accounted for 11.1%, or up 0.3 p.p. vs. the 2010 level.

Since 2008, the volume of financing by the item "Education" has been in decline: in 2010 - by 0.4 p.p. of GDP and in 2011 - by 0.1 p.p. of GDP on a year-on-year basis. The proportion of spending on educationin the aggregate volume of the enlarged government expenditures stood at 11.1%, or up 0.3 p.p. vs. the 2010 figures.

The volume of financing by the item "Housing and utilities sector" likewise has been in decline since 2008 by 0.2 p.p. per annum. In 2011, the enlarged government expenditures were cut practically across all the items, except for expenditures on settlements development (up 0.1 p.p. of GDP thanks to the respective increase in regional budgets' expenditures) relative to GDP on a year-on-year basis. The cuts are associated with a gradual completion of such measures as provision of housing to veterans of WWII and individual categories of residents. Meanwhile, reserves for further cuts in the sector are unlikely to be huge, despite the fact that Russia on average spends on the housing and utilities sector twice as much as OECD member states. More specifically, at end-year 2011, as many as 99.4m2 of housing in the country fell under the category of slum and dangerous structures (up 1.5 times over the decade). As it is, as a rule, regions with poor socio-economic performance indicators or those classified as the "Northern" ones (where climatic conditions predetermine high housing deterioration rates) it is inappropriate to cut down the state financing, as availability of adequate housing is a critical component of residents' living standards. At the same time, given the magnitude of the challenge, development at the federal level of new approaches to assessment of the need in, and provision of, social housing, perhaps, appears justifiable1.

In 2011, the item "Culture, the motion picture industry and mass media" saw cuts amount to 0.1 p.p. of GDP compared with 2010; however the share of expenditures on culture in the enlarged government budget remained at the level of 2%.

As to the item "Environment protection", the respective expenditures have remained unchanged since 2009 and accounted for 0.06 - 0.07% of GDP. In its absolute terms (Rb 38bn, or up 10.3bn vis-à-vis 2010) the 2011 spending on environmental programs is comparable to the enlarged government revenues generated by payments for adverse impact on environment (Rb 22.1bn in 2011).

It should be noted that the volume of budget outlays for environmental measures rose 3.5 times between 2009 and 2011 in nominal terms, but shrank more than twice in the shares of GDP equivalent (from 0.16% of GDP in 2000 to 0.07% of GDP in 2011). Individual moves in this area (eg. implementation of a countrywide energy-saving program in the frame of the energy strategy) does bring about some positive effects, but still appear incapable of reversing the destructive trends in the environmental area.

The 2011 appropriations on the section "Social policy" appear impressive - 12.0% of GDP (Rb 6,512.3bn), including those on pensions provision (8.0% of GDP, or Rb. 4,379.6bn), albeit down 1.3 p.p. on a year-on-year basis. The share of the expenditure item in the aggregate volume of the enlarged government expenditure was likewise down 2.5 p.p. compared with

1 Expenditures are incurred both by the federal budget and RF Subjects' budgets; however the procedure of provision of social housing is established at the latter level. The federal budget does not finance provision of housing; rather, social payments, eg. to young academics, in compliance with Resolution of the RF Government of

17.12.2010 No. 1050.

the prior year. In the RF Subjects' consolidated budget, the 2011 social spending was cut down in absolute terms by 28.5% (1.5 p.p. of GDP) relative to 2010, because of cuts in expenditures on the social provision of the population totaling 0.4 p.p. of GDP.

During last three years, the 2011 enlarged government budget expenditures on servicing the public debt remained at a level of 0.6% of GDP; the RF Subjects' consolidated budget expenditures on this section were down 0.1 p.p. of GDP on a year-on-year basis.

An analysis of recent changes in the structure of the enlarged government budget expenditures allows identification of two negative tendencies:

1. Boosting expenditures on financing public goods (social policy, defense and law enforcement and public order) against cuts in expenditures on ensuring economic growth. So, despite the political leadership's declarations about the budget's modernization nature, actual expenditures encourage public and individual consumption, rather than economic development. At this point, emphasis should be made on government support of backbone national infrastructure objects (meaning investment projects and programs in the innovation development area, such as education, research, technoparks, business incubators, special economic zones, technology transfer centers) and upgrade of the production infrastructure (transport, communications, the FEC infrastructure), which would bolster economic stability, fuel innovation, breakthroughs in the technological sphere and environmental safety. That said, the government should scale back on its participation in business and semi-business investment.

2. A notable surge in the number of public and municipal servants1 and public employees, which, first, evidences an excessive presence of the state in the economy and the social sphere. The volume and the number of public functions and services in tandem with antiquated procedures of their delivery exhibit current defects in their organization and, therefore, preserve the problem of huge public costs in the said areas. Second, it must be admitted that in contrast to temporary effects from boosting the financing of individual directions, which serves just as a temporary remedy, it is a funding of institutional transformations that gives a fillip to entrepreneurial activity and attraction of capital into an economy, and its structural diversification on the basis of innovation-driven technological development2. Thirdly, a high proportion of public employees evidences that by hiring an insufficiently qualified workforce to carry out public functions, a state exercise the "social sponsorship" function. As a result, the state budget is engaged in an implicit "subsidizing" of the populace (ie. the government pays salaries for an inefficient exercise of public functions).

2.2.4. Analysis of main Parameters o f the Federal Budget of RF in 2011 and for the Period of 201 2-2014.

The budget Act for the upcoming three years does not suggest maintaining the 2011 federal budget revenue increase rates (see Table 13): the federal budget revenues should contract by 0.8 p.p. in 2012 and further by 1.3 p.p. in 2013 and 1.5 p.p. in 2014 vs. their 2011 level, with projections of oil-and-gas revenues suggesting their even greater decline - from 10.2% of GDP in 2011 to 7.2% of GDP in 2014.

1 The 2010 data suggest that in Russia the number of public employees per capita (108 per 1,000 residents) is greater than across OECD and emerging economies (eg. the average figure across 22 OECD nations is 75, Brazil - 45, South Korea - 29 per 1,000 residents).

2 According to development priorities established by the Long-Term Development Concept approved by Resolution of the RF Government of 17 November 2008 No. 1662-r.

Table 13

Main Characteristics of the Federal Budget in 2008-2014, as% GDP

Actual The budget Act

2008 2009 2010 2011 2012 2013 2014

Revenues 22.5 18.9 18.4 20.9 20.1 19.6 19.4

Including oil-and-gas 10.6 7.7 8.5 10.2 7.7 7.1 7.2

Expenditures 18.3 24.9 22.4 20.1 21.6 21.2 20.1

Including provisionally approbated - - - - - 0.5 1.2

Deficit (-) /Surplus (+) +4.1 -6.0 -4.0 +0.8 -1.5 -1.6 -0.7

Non-oil-and-gas deficit -6.4 -13.7 -12.5 -9.4 -9.2 -8.7 -7.9

For reference: GDP 41277 38809 45166 54369 58683 64803 72493

Source: the RF Ministry of Finance.

The 2012 federal budget expenditures should surge by 1.5 p.p. of GDP vs. 2011 and subsequently slide back to the 2011 level again. So, the federal budget for the upcoming three years should be executed with a deficit oscillating within the range of 0.7 - 1.5% of GDP. That said, the value of the basic oil price which ensures a balanced federal budget has been increased for the medium term: while in 2011 the value matching the budget balance was an oil price of USD 115/b1, already in 2012-13, according to MinFin's estimates, the balance would be secured by a price not lower than USD 120-125/b. So, the budget will become yet more prone to price fluctuations on the global market for carbohydrates.

It should be noted that while crafting main parameters of the 2012-14 federal budget, its authors employed optimistic forecasts of macroeconomic indicators: thus, the forecast with regard to the volume of GDP for 2012 was increased by more than Rb 5bn vs. the figure used while shaping up the 2011-13 federal budget.

Meanwhile, projections of the value of oil-and-gas revenues in the 2012-14 federal budget were based upon a more conservative scenario. On the one hand, that would allow rejecting the need to sequester expenditures during a fiscal year, should budget revenues decline; on the other hand, extra revenues, particularly due to exercising caution while planning them, allow revision of the expenditure part towards increases in individual items, which does not add accuracy to the medium-term budget planning.

Should the 2012 oil-and-gas revenues prove greater than planned, the Budget Act for 2012-14 comprises a clause which holds that extra revenues should be spent on replacement of public borrowings and/or revenues from sales of equity or other form of participation in capital owned by Russian Federation.

In the medium term, main sources of the federal budget revenues should remain collection of indirect taxes, the mineral tax, and customs duties (see Table 14).

The data in Table 14 evidence that the proportion of revenues from main taxes and duties in the aggregate volume of revenues to the federal budget in the shares of GDP equivalent is going to be in decline in the period of 2012-14, because of falling revenues from the mineral tax and export customs duties, which is going to be caused by a downfall in international oil prices and slowdown of growth rate in taxable volumes of oil and oil products.

The budget's reliance on the foreign economic situation can be lowered by stabilizing non-oil-and-gas revenue growth rates. This necessitates maintaining economic growth in the first place, including, in particular, at the expense of reallocation of federal budget revenues from

1 In 2005-2007, the federal budget surplus was secured under average annual nominal oil prices as follows: in 2005 - USD 50/b ( surplus equivalent to 7.5% of GDP); in 2006 - USD 61/b (7.4% of GDP),; in 2007 -USD 69/b (5.5% of GDP).

defense and domestic security in favor of economy restructuring programs, providing there are efforts in place to bolster the efficacy of their implementation.

Table 14

Actual and Envisaged Revenues from Main Taxes to the Federal Budget of Russian Federation in 2008-2014 (% of GDP)

Actual The Budget Act

2008 2009 2010 2011 2012 2013 2014

Corporate profit tax 1.8 0.5 0.6 0.6 0.6 0.6 0.6

VAT - total: 5.2 5.3 5.5 6.0 6.3 6.4 6.5

On domestic produce 2.4 3.0 2.9 3.2 3.2 3.2 3.2

On imports 2.7 2.3 2.6 2.8 3.1 3.2 3.3

Excise taxes, total: 0.4 0.3 0.6 0.5 0.7 0.9 1.0

On domestic produce 0.3 0.2 0.5 0.4 0.6 0.8 0.9

On imports 0.1 0.1 0.1 0.1 0.1 0.1 0.1

Mineral tax 3.9 2.5 3.0 3.8 3.6 3.4 3.3

Customs duties, total: 8.4 6.5 6.8 8.2 7.4 6.8 6.7

Import 1.5 1.2 1.2 1.4 1.4 1.4 1.4

Export 6.9 5.3 5.6 6.8 6.0 5.4 5.3

Proportion of aforementioned taxes and duties in the federal budget revenues, % 93.3 86.5 89.6 91.4 89.4 92.3 93.3

Source: the RF Ministry of Finance.

Modernization and restructuring of Russia's economy in the medium- and longer-run are closely associated with abrogation of export duties whose presence means subsidizing domestic consumers of minerals and energy sources at the expense of the rent from the use of state-owned natural resources. Preserving, throughout the new Russia's history, lowered domestic prices of carbohydrates, and export duties on oil products at a level below the one of export duties on crudes has failed to ensure a qualitative modernization of its economy, nor it boosted its competitiveness.

Recent moves to encourage the volume of domestic oil refining and increase exportation of oil products by setting respective export duties at a level lower than the ones on crudes did not help bolster intensity of oil processing which made up just 71.2%, or matched the 2000 level. That is to say, the index in question has posted practically no growth over the past decade (for reference, in developed economies, the oil refining intensity rate is 90-95%).

With revenues from the mineral tax and export duties on energy sources in decline and volumes of collection of the corporate profit tax having stabilized (revenues to the federal budget from the corporate profit tax in 2012-14 should remain at their 2011 level - namely, 0.6% of GDP), reserves for increase in tax revenues should be sought in taxation of consumption.

It is forecast to increase collection of VAT from taxation of imports in 2012 by 0.3 p.p. of GDP on a year-on-year basis and further annually by 0.1 p.p. of gDp in 2013-14. Meanwhile, the volume of revenues from the domestic VAT will be soaring just at a rate equal the GDP growth rate.

The annual increase of collection of excise taxes to the federal budget over the period of 2012-14 is planned at a level of 0.2p.p. of GDP, which should be secured by indexation of their rates and reassignment of revenues from these taxes between the federal and regional budgets1. Revenues to the federal budget from excise taxes levied on imports in 2012-14 should remain unchanged (0.1% of GDP).

1 For greater details see Section 2.3. 60

The dynamic of the federal budget expenditures in 2010-2014 in terms of functional classification is presented in Table 15.

Table 15

Expenditure Obligations of the Federal Budget in 2010-2014, % ВВП

Name Actual The Budget Act

2O1O 2O11 2O12 2O13 2O14

TOTAL 22.4 20.1 21.6 21.2 20.1

General government matters* 1.5 1.4 1.4 1.3 1.1

National defense 2.8 2.8 3.2 3.6 3.8

National security and law-enforcement activity 2.4 2.3 3.1 3.1 2.9

National economy 2.7 3.3 3.1 2.7 2.3

Housing and utility 0.5 0.5 0.2 0.2 0.1

Environment protection 0.0 0.0 0.0 0.0 0.0

Education 1.0 1.0 1.0 0.9 0.7

Culture, the motion picture industry** 0.2 0.2 0.1 0.1 0.1

Health care*** 0.8 0.9 0.9 0.8 0.6

Social policy**** 0.8 5.8 6.6 6.4 5.7

Physical culture and sports 0.1 0.1 0.1 0.0

Mass media 0.1 0.1 0.1 0.1

Public and municipal debt servicing 0.4 0.5 0.7 0.7 0.8

Interbudgetary transfers of general nature 9.2 1.2 0,9 0.8 0.7

Provisionally approbated expenditures - - G.5 1.1

* In 2010 - without regard to expenditures on the public debt servicing.

** In 2010 - with regard to expenditures on mass media.

*** In 2010 - with account of expenditures on physical culture and sports.

****In 2011 and onwards - this item includes profile interbudgetary transfers, including those across ex-trabudgetary funds.

Source: Memorandum on the 2012-2014 federal budget.

The year of 2011 saw the biggest increase in federal budget expenditures (by 0.6 p.p. of GDP on a year-on-year basis) with respect to the item "National economy". One of the drivers of such an increase in budget allocations became financing of projects across five priority avenues: "Energy efficiency", "Nuclear technologies", "Strategic computer technologies and software", "Space and ICT", "Medical equipment and pharmaceuticals" approbated by the Commission on Modernization and Technological development of Russia's Economy under the RF President. The increase in spending was also fueled by implementation in 2011 of new sub-programs aimed at boosting the domestic production, such as "Development of the domestic machine-tool manufacture and the tooling industry for 2011-2016", "Establishment and organization of production of industrial diesel engines and their next-gen components in Russian Federation in 2011-2016".

That said, we believe that budget expenditures on the national economy should ensure much-needed institutional and infrastructural conditions of the real sector restructuring in the first place, rather than substitute for the private sector's funding. Where there is a direct budget support to backbone and strategic corporations, there emerge risks of preservation of the technological backwardness of manufacture and a low quality of management.

Since 2012 expenditures on the economy should slide by 0.2 p.p. of GDP and further by 0.4 p.p. of GDP in 2013 and 0.4 p.p. of gDp in 2014, on a year-on-year basis. The process should be driven by cuts across individual directions of subsidizing the economy, completion of a string of federal target programs and placement in operation of objects of capital construction.

Since 2012 expenditures on the item 'National defense" should be up 0.4 p.p. of GDP vs. 2011 and subsequently up by another 0.4 p.p. of GDP on a year-on-year basis in 2013 and

0.2 p.p. of GDP in 2014. The increase is associated in part with the military's monetary allowance reform which should result in a more than double rise of the military's material security, which should also affect the level of pensions of the retired military and persons equaled to them, as their pensions should increase 1.6 times on average.

The increase in spending on the item "National security and law-enforcement activity" is driven by the indexation since 2012 of labor compensation funds of employees with federal public institutions, monetary allowance (salaries) of judges and prosecutors, federal public civil servants, monetary allowances of the military and persons equaled to them (except for employees with the RF Ministry of Defense and the RF Ministry of Interior, as both agencies are facing a monetary allowance reform in 2012), and payments linked to the amount of the military allowance. Between 2012 and 2014 the number of law-enforcement agencies' personnel should be optimized, with thus freed funds to be spent on the monetary allowance reform.

Specifically, the volume of budget appropriations for the said reform, including compensations linked to monetary allowances and with account of a 15% reduction in the military and law enforcement personnel (except for RF Ministry of Defense and the RF Ministry of Interior) until 1 January 2014, in 2012 alone should account for Rb 389.3bn, in 2013 - 610.7bn, and in 2014 - 679.2bn.

The 2011 public debt servicing costs posted a 0.1p.p. of GDP increase vs. the previous year. The costs in question (Rb 195.0bn in 2010 and Rb 262.7bn - in 2011) were partly compensated by the federal budget interest revenues from placement of cash balances on the single account of the federal budget which form an extra amount to sums spent on securing a current budget balance per the cash budget (Rb 130.0bn in 2010 and 129.0bn - in 2011).

Cuts in spending by the item "Health care" in 2013-14 are associated with reassigning budget funds to implementation of a sector modernization plan out of the RF Ministry for Health Care and Social Development's budget to the Compulsory Medical Insurance Fund's.

It is foreseen to scale back on budget appropriations by the item 'Housing and utilities" in 2012-2013 with respect to implementation of the Federal Target Program and its non-program part, including providing the military with department and permanent housing.

As to other functional directions of federal budget expenditures, the main factor behind changes in their volume are budget outlays provided for implementation of FTPs and their non-program sections.

The dynamic of the federal budget revenues and expenditures in the 2008 constant prices (see Fig. 16) matchs the 2008-14 trends of changes in revenues and spending in current prices - that is, substantial revenue cuts in 2009-10 and their annual increase post-2012, and a substantial expenditure increase in 2009, as well as in 2012-14, with a slight decline intermezzo in 2010-11.

The dynamic of main parameters of the federal budget in 2008-14 allows ascertaining that the task to maintain the budget balance is going to fall by the wayside, with priority given to the financial securing of earlier adopted and newly set expenditure obligations. However, a haphazard increase of obligations in a given field of socio-economic development propagates a ripples effect in the form of imbalances throughout other fields, and precise regulation of such imbalances will require extra budget costs. To cite a particular example, the increase in monetary allowance for the military and prosecutors between late 2011 and early 2012 was followed by a debate on the need to raise the university faculty's pay. In the upcoming future, there cannot help but emerge the need for pay rises for such a low-paid category of budget

employees as librarians, museum staff, social employees, etc. Clearly, the 2012-14 budget continues the recent trend and is becoming more and more centered on ensuring the public (defense and law-enforcement spending) and individual (expenditures on education, health care, social support) consumption, rather than on giving fillip to economic transformation.

Fig. 16. Dynamic of revenues, expenditure and the federal budget deficit, billion Rb in 2008 constant prices

The share of closed budget items is on the upswing. While in 2006-11 the level of closed expenditures was maintained at the level of 12% of the aggregate budget expenditures (according to IBP, open budget-wise Russia notably trails behind developed nations1), by 2014 the respective proportion should account for 22%.

The volume of the Reserve Fund posted a slight growth in 2011 (by Rb. 3.63bn), and so did the National Welfare Fund's (up by Rb. 98.9bn). As of 1 January 2012, cash balances of the Reserve Fund stood at Rb. 811.5bn, or 1.5% of GDP, while those of the National Welfare Fund - at Rb 2,794.4bn, or 5.1% of GDP. The volume of the Reserve Fund is envisaged to gradually increase in 2012-14, with oil-and-gas revenues being a major driver of the process, up to 3.8% of GDP in 2012, 4.3% of GDP and 5.4% of GDP in 2013 and 2014, respectively. Due to exchange rate differences and co-financing of pension savings, the volume of revenues to the National Welfare Fund should likewise increase in 2012-2014; however, the volume of spending of its resources should be greater, thus resulting in a fall of its volume to 3.9% of GDP in 2014.

The federal budget deficit should be covered by public borrowing and revenues from privatization of federal assets2. Hopefully, Russia, with its "sound credit record"3 and credit rat-

1 In January 2012, the International Budget Partnership published findings of the 2010 Open Budget Survey, which evidence that Russia scored 60 out of 100 open budget-wise (for reference: the US scored 82, Germany -68, Italy - 58, Brazil - 71, China - 13 out of 100).

2 According to Roskomimuschestvo, as of 1 January 2012, the government controlled 2,822 joint-stock companies with state-owned stakes in them.

3 Russia's sovereign investment rating has been on the rise under a stable since 2005. The nations enjoying a roughly similar rating were Bahrain, Brazil, Hungary, Kazakhstan, China, Latvia, Mexico, Thailand, and South

ings no lower than BBB and Baal (stable or positive1) unchanged since 2010, would face no real problems with placement of debt instruments in the years to come. Plus, a possibility to have extra revenues from privatization (Rosneft, Gazprom, Russian Railways, etc.) should be factored into, too.

2.2.5. Prospects of RF Budgetary and Tax Policy

In recent years, Russia's budgetary policy has been exhibiting a number of trends pointing to her defiance of the rules that countries with resource-based economies typically abide by. At the same time, the resource dependence factor imposes rigid constraints on this country's budgetary policy: as the oil and gas sector generates a very considerable portion of budget revenue, the size of budget revenue becomes susceptible to unpredictable fluctuations.

The government's efforts to mitigate the consequences of the crisis have so far resulted in a higher degree of imbalance in Russia's budgetary policy. During the 2008-2009 crisis the authorities effectively abandoned the budgetary rules adopted in 2004-2004: budget revenues generated as a result of high current oil prices, instead of being transferred to the Reserve Fund and the National Welfare Fund, were now allocated to current expenditure in the federal budget.

The structure of general government expenditure also demonstrates a rise in the current cost of financing the pension system and in expenditures on national defense, national security and law-enforcement activities. The authorities made some costly political decisions with regard to the financing of a number of large-scale projects implemented within the framework of preparations to the 2014 Winter Olympic Games in Sochi, to the September 2012 APEC Summit in Vladivostok, and to the 2018 FlFA World Cup Russia. Considerable resources, in the form of subsidies and contributions, are allocated to the charter capital of state corporations and companies with state participation.

All these circumstances have significantly increased the existing risks of the budgetary system becoming unstable. The risk factors are as follows:

- the possibility that the federal budget will show a deficit even if current oil prices remain high;

- the impossibility to significantly reduce the existing social liabilities, and the prospects of a further rise in budget expenditures owing to the negative demographic trend and the persisting imbalance of the Pension Fund;

- the inadvisability of any increase in the tax load on the economy, and a possible reduction in budget revenues in a medium-term perspective;

- limited opportunities for a structural maneuver needed in order to achieve the economy's modernization.

In the context created by these challenges, the key tasks in the field of budgetary and tax policy should are to maintain Russia's macroeconomic stability, implement the assumed liabilities in a responsible and most effective manner, and create incentives for stable economic growth through the use of the tax and budgetary mechanisms.

Africa. Despite the fact that due to a considerable contraction of foreign reserves and inflow of foreign investment, in December 2008 and February 2009 two agencies downgraded Russia's rating to BBB with negative forecast (and one of them changed the forecast for stable in December 2009), the rating is at a level far higher than many developed European economies'.

1 Standard&Poor's, Fitch, and Moody's.

In our opinion, the first-priority task associated with maintaining this country's macroeco-nomic stability should be a return to the 'budgetary rule' that regulates the procedure for the use of those budget revenues which depend on fluctuations in the prices of energy resources, while at the same time imposing restraints on the growth of expenditures and government debt.

The unpredictable character of oil and gas revenues makes it imperative that Russia should adopt a conservative approach to determining the level of allocations from that source that may be safely used in order to maintain proper stability of the state budget. We believe that an adequate estimate of the 'guaranteed' level of budget revenue can be obtained on the basis of revenue calculation at the 'base' price of oil. Accordingly, the federal budget should be balanced at the 'base' price of oil.

We suggest that the 'base' price of oil should represent the settlement price of Urals crude estimated as the moving average price of oil for the past 10 years. For example, in 2012 the 'base' price of oil amounts to about $ 60-65 per barrel. It is evident that at that level of oil prices Russia cannot achieve a balanced budget in 2012 (according to our estimates, the 2012 federal budget can be deficit-free only if the average prices of oil do not slide below $ 115 per barrel). However, we believe it possible for Russia to reintroduce the 'budgetary rule' from 2016, when the 'base' price will amount to $ 90-95 per barrel, provided that the behavior of oil prices entered in the RF Ministry of Economic Development's forecast may indeed be materialized. As regards the transition period, the 'base' price of oil, for the purposes of properly drawing up the federal budget, may be set at $ 105 per barrel in 2013, $ 100 per barrel in 2014, and $ 95 per barrel in 2015.

In that case, the upper limit of expenditure should be determined as the sum of the amount of revenues estimated at an established 'base' price of oil and the amount of net debt financing at a level of no more than 1% of GDP. So, if the actual price of oil becomes the same as the 'base' one, the budget will have a deficit under 1% of GDP, thus making it possible to prevent the volume of state debt from climbing above 25% of GDP. Such levels of state debt can be considered safe from the point of view of the size of the debt load on the budget and the economy in the event of short-term drops in oil prices (a period up to 1 to 2 years) and in Russia's country risk level. We believe that, in order to minimize foreign exchange risks, it would be advisable for Russia to issue bonds exclusively denominated in the national currency, although the form of issuing can vary between federal domestic bonds and ruble Eurobonds.

If there occurs a rise in the actual price of oil and, consequently, in the level of revenues, the proceeds should be primarily allocated to the Reserve Fund until the moment when it reaches its prescribed volume (8-10% of GDP, which will enable Russia to smoothly descend, over the course of three years, to a lower level of budget expenditures in the event of a 20% fall in oil prices). The next steps should be a reduction in net drawings (if deemed necessary by the Government) and a replenishment of the National Welfare Fund.

When the price of oil is relatively low, the loss of revenue should be compensated from the Reserve Fund. At the same time, the amount of funds drawn from the Reserve Fund over the course of one year should be determined with taking into account the total volume of the Reserve Fund and the risk of revenue losses in the following years.

As the alternative 'budgetary rules' one may suggest either the concept of oil and gas transfer (applied in Russia prior to the 2008 crisis), or the rule that the 'base' price of oil should be adjusted when the actual oil prices drop below their forecasted values.

At the same time, we believe that for Russia to return to the concept of oil and gas transfer in the current circumstances, when there exists a strong probability of sharp fluctuations in oil prices, would by no means be an optimal solution because, although the oil and gas transfer is equivalent to the 'base' price of oil (which is constantly increasing so as to compensate for the continuing shrinkage of the oil and gas sector's share in Russia's GDP), it cannot be adapted to changes in current prices.

However, the adjustment of the 'base' price level in a situation of declining oil prices - for example, if the previous year's price is taken as the 'base' price for the next budget year (when it is below forecasts) - increases the volatility of budget expenditure.

In order to provide adequate financing for the modernization of the Russian economy and a higher level of investments in human capital, it is necessary to alter not only the structure of government expenditure, but also the approaches to the allocation of budgetary funding.

In fact, the majority of the budget-funded public sectors use rather inefficiently the financial resources allocated to them, and so budgetary funding should be allocated to those sectors on condition that they carry out all the necessary transformations. In other words, this means discontinuation of the practice of increasing the size of budget allocations to the items sensitive to the quality of the institutions that act as recipients of those allocations.

In addition to these measures, it is necessary to gradually diminish the role of the federal budget as the principal source for covering the Pension Fund's deficit; to implement a program of further job cuts in the budget-funded sector; to achieve optimization of the expenditures on national defense and national security, rigidly linking this country's foreign policy strategy with the available resources; to abandon the practice of large-scale involvement of budget resources in 'image-making' construction projects; to limit the use of subsidies strictly to the purposes of recovery of or restructuring of strategic enterprises in the real sector, etc.

According to our estimations, altering the structure of financing in the direction of priority treatment of the issues of infrastructure and human capital development, with a simultaneous improvement of the cost-effectiveness of budget resources allocation, will result in an increase in the size of funding allocated to these items by 4% of GDP over the period until 2020. At the same time, reductions in the budgetary system's ineffective and excessive expenditures will make it possible, as early as 2014, to obtain additional resources in the amount of approximately 2% of GDP, resulting from cuts in the expenditures on national defense and law-enforcement activity by 0.9% of GDP, those on the national economy and the housing and utilities system - by 0.8% of GDP, and those on nationwide issues - by 0.3% of GDP.

In order to provide adequate financing for the modernization of the Russian economy and a higher level of investments in human capital, it is necessary to alter not only the structure of government expenditure, but also - and most importantly - the approaches to the allocation of budget funding.

Besides, it will be feasible, in order to enhance the incentive-creating function of taxes and the reliability of financial coverage of government obligations, to abstain, for as long as possible, from increasing the tax load on the economy, by expanding instead the structural component of the tax system. As demonstrated by the world's experience, when taxes on consumption are raised simultaneously with a cut in the tax load on labor and capital, it becomes possible for a country to substantially increase the competiveness of its economy. With regard to Russia's taxes on consumption, acceleration of upward adjustment of the rates of excises on alcohol and tobacco products will be advisable.

In an event of a stable surplus displayed by the general government budget, the best-substantiated measure aimed at achieving a well-balanced budget will be to cut down the rate of insurance contributions - say, to 26%, and to simultaneously increase the revenue margin above which the rate of 5% is to be applied.

Besides, if a truly just and effective taxation system is to be created in Russia, it will be necessary to gradually abolish the export duties on oil and petroleum products and compensate for the resulting loss of revenues by increasing the rate of the Mineral Resources Extraction Tax (MRET), introducing the Tax on Extra Income (TEI) in the oil extraction sector, establishing progressive tax rates in metallurgy, mineral fertilizers production, etc.

The progressivity of income and property taxes should be increased, and the taxation system should be made more environment-friendly (by means of increasing the fines for environment pollution and introducing a tax on carbon emission).

Special attention must be paid to the issues of improving the quality of customs and tax administration. In particular, it is necessary to implement reform of customs administration through introducing selective control based on the results of risks analysis and to complete that process in the sphere of tax administration; and to promote further computerization of the administration procedures and implementation of 'contactless' methods for dealing with taxpayers.

Tables 16 and 17 contain forecasts of the aggregate balances of the general government budget and the federal budget for the period of 2012-2020 if the new budgetary rules are introduced and the aforesaid budgetary and tax policy measures are implemented.

The structural deficit peak (the difference between expenditure and the estimated revenue volume at the 'base' price of oil) will be achieved in 2016 (1.9% of GDP), and then by 2020 it will decline to 0.8% of GDP. This type of deficit is covered by net borrowings from the federal budget. By 2020, the volume of government debt will effectively reach its marginal value of 25% of GDP (22.6% of GDP), which will necessitate balancing the federal budget, from 2021 onwards, at the level of revenue structure.

The aggregate federal budget deficit will reach its peak (1.7% of GDP) in 2013 and then decline to 0.4% of GDP by 2020; it should be noted that between one-third and one-half of this deficit is covered by revenues from privatization of state property. Since the forecasted oil prices are higher than the 'base' ones, and the actual deficit is lower than the structural deficit, part of federal budget revenue is transferred to the Reserve Fund whose size, nevertheless, in 2020 fails to achieve its normative value of 6% of GDP (5.6% of GDP). Consequently, the opportunities for transferring a part of the extra revenues to theB National Welfare Fund will emerge only after 2020.

Over the greater part of the period under consideration, the general government budget appears to be properly balanced, with due regard to the estimated size of revenues from privatization.

Table 16

Parameters of the General Government Budget, % of GDP

2012 2013 2014 2015 2016 2017 2018 2019 2020

1 2 3 4 5 6 7 8 9 10

Revenue, including: 38.1 37.7 37.2 37.0 37.0 36.8 36.6 36.4 36.5

VAT 5.7 5.7 5.5 5.4 5.4 5.4 5.4 5.5 5.5

Tax on profit 6.3 6.5 6.3 6.3 6.1 6.2 6.3 6.1 6

PIT 4.0 3.8 3.8 3.8 3.9 3.9 4 3.9 4.0

Insurance contributions 5.7 5.8 5.9 5.9 6 6 6.1 6.1 6.2

cont'd

1 2 3 4 5 6 7 8 9 10

MRET/TEI (Tax on Extra Income) 3.3 3 2.9 2.8 2.8 2.7 2.7 2.6 2.6

excises 1.4 1.5 1.6 1.8 1.9 1.9 1.9 1.9 1.9

taxes on property 1 1.1 1.2 1.2 1.3 1.3 1.3 1.4 1.4

customs duties 7.7 7.3 7.0 6.7 6.5 6.3 5.9 5.9 5.9

other revenues 3.0 3.0 3.0 3.1 3.1 3.1 3.0 3.0 3.0

Expenditure, including: 38.0 38.1 37.9 37.6 37.3 37.2 37.1 36.5 35.9

nationwide issues 2.65 2.5 2.5 2.2 2 1.8 1.7 1.6 1.5

national defense 2.8 2.6 2.4 2.4 2.4 2.4 2.4 2.4 2.4

national security 2.6 2.5 2.3 2.3 2.3 2.3 2.3 2.3 2.3

national economy, including 5.8 5.9 6.0 5.9 5.7 5.6 5.2 4.9 4.6

road system 1.5 1.8 2.1 2.3 2.5 2.7 2.9 2.9 2.9

agriculture and fishery 0.4 0.4 0.4 0.4 0.4 0.4 0.4 0.4 0.4

communications and informatics 0.3 0.3 0.3 0.3 0.3 0.3 0.3 0.3 0.3

national economy, less road system, agriculture, communications and informatics 3.6 3.4 3.2 2.9 2.5 2.2 1.6 1.3 1.0

housing and utilities system 2.2 2.1 2.1 1.9 1.7 1.5 1.3 1.1 0.9

environment protection 0.1 0.1 0.1 0.2 0.2 0.2 0.2 0.2 0.2

education 4.1 4.1 4.2 4.3 4.5 4.8 5.3 5.3 5.3

culture, cinematography 0.6 0.6 0.6 0.6 0.6 0.6 0.6 0.6 0.6

mass media 0.2 0.2 0.2 0.2 0.2 0.2 0.2 0.2 0.2

health care 3.7 4.0 4.2 4.2 4.2 4.2 4.2 4.2 4.2

physical culture and sports 0.3 0.3 0.3 0.3 0.3 0.3 0.3 0.3 0.3

social policy, including 12.0 12.0 12.0 12.0 12.0 12.0 12.0 12.0 12.0

aggregate expenditures on labor pensions (less social pensions and budget-funded compensations) 7.9 7.6 7.6 7.7 7.7 7.7 7.6 7.5 7.5

social policy, less expenditures on labor pensions 4.1 4.4 4.5 4.3 4.3 4.3 4.4 4.5 4.5

government debt servicing 1 1.2 1.1 1.2 1.3 1.4 1.5 1.5 1.4

Deficit /surplus 0.1 -0.4 -0.7 -0.6 -0.3 -0.4 -0.5 -0.1 0.6

Revenues from privatization 0.3 0.5 0.5 0.4 0.4 0.4 0.3 0.3 0.3

Source: Estimates made by the Ye. T. Gaidar Institute for Economic Policy and the Higher School of

Economics - National Research University.

Table 17

Parameters of the Federal Budget, % of GDP

2012 2013 2014 2015 2016 2017 2018 2019 2020

1 2 3 4 5 6 7 8 9 10

Revenue, including: 20.1 19.5 18.9 18.4 18.2 17.9 17.4 17.4 17.4

VAT 5.7 5.7 5.5 5.4 5.4 5.4 5.4 5.5 5.5

domestic 3.0 3.0 2.9 2.8 2.8 2.8 2.8 2.8 2.8

on imports 2.7 2.7 2.6 2.6 2.6 2.6 2.6 2.7 2.7

tax on profit 0.6 0.6 0.6 0.6 0.6 0.6 0.6 0.6 0.6

MRET/TEI (Tax on Extra Income) 3.3 3.0 2.9 2.8 2.8 2.7 2.7 2.6 2.6

on oil 3.1 2.8 2.6 2.5 2.4 2.3 2.3 2.1 2.1

on gas 0.2 0.2 0.3 0.3 0.4 0.4 0.5 0.5 0.5

excises 0.8 0.9 0.9 0.9 0.9 0.9 0.9 0.9 0.9

export duties 6.3 5.9 5.6 5.2 5.0 4.8 4.4 4.4 4.4

oil 3.8 3.5 3.3 3.1 3.0 2.8 2.6 2.5 2.4

petroleum products 1.6 1.5 1.4 1.3 1.2 1.2 1.0 1.0 1.0

gas 0.9 0.8 0.9 0.8 0.8 0.8 0.8 0.9 1.0

import duties 1.4 1.4 1.4 1.5 1.5 1.5 1.5 1.5 1.5

other revenues 2.0 2.0 2.0 2.0 2.0 2.0 1.9 1.9 1.9

Expenditure 21.5 21.2 20.1 19.7 19.4 19.1 18.7 18.4 17.8

Deficit/ surplus -1.4 -1.7 -1.2 -1.3 -1.2 -1.2 -1.3 -1.0 -0.4

Revenues from privatization 0.3 0.4 0.4 0.3 0.3 0.3 0.3 0.2 0.2

RF government debt 12.4 13.8 14.7 15.8 17.6 19.1 20.5 21.9 22.6

cont'd

1 2 3 4 5 6 7 8 9 10

Revenue at 'base'price of oil (estimate) 21.8 21.5 20.6 19.4 17.5 17.5 17.1 16.9 17.0

Structural deficit 0.0 0.0 0.0 0.3 1.9 1.6 1.6 1.5 0.8

Reserve Fund 2.7 2.6 2.5 2.4 3.3 4.0 4.5 5.1 5.6

National Welfare Fund 4.8 4.4 4.0 3.0 2.8 2.7 2.9 2.8 2.7

Source: Estimates made by the Ye. T. Gaidar Institute for Economic Policy and the Higher School of Economics - National Research University.

2.3. Intergovernmental Fiscal Relations and Subnational Finances

2.3.1. Subnational budgets in 2011

Principal trends regarding relations between different levels of power are reflected in the structure of revenues and expenditures of the consolidated budget of the Russian Federation. Table 18 shows 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.

Table 18

A share of the selected items of subnational budgets in the consolidated budget of the Russian Federation in the period between 1996 and 2011 (%)

1996 t— » » 1 1998 9 № № 1 2000 1 O O 2 2002 M o o 2 o o 2 ifi 0 0 2 2006 t— o o 2 8 o o 2 9 o o 2 2010 1 1 O 2

Tax revenues 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 33.1

Tax revenues net of mineral payments and customs duties 55.8 59.5 59.9 55.0 49.0 42.6 40.1 41.9 47.5 49.1 52.0 50.5 53.7 54.8 57.1 56.0

Expenditures 45.4 48.1 54.1 51.9 54.4 51.2 49.3 50 50.8 49.5 43.4 48.3 49.2 43.4 43.2 46.5

Source: Federal Treasury, Gaidar Institute's estimates.

The data in Table 18 shows that from 2001 a share of tax revenues of the constituent territories of the Russian Federation in tax revenues of the consolidated budget of the Russian Federation decreased below 40% and remained as such over the following decade (a minimum value of 30.9% was reached in 2005). Such a distribution of tax revenues among the budget system levels over the recent decade has to a large extent resulted from a higher growth rates in federal budget revenues generated from oil and gas1 vs. growth rates in tax revenues of subnational budgets. Furthermore, the global recession which came to a boil in 2009, resulted in a bigger share, an increase to 36.6% in 2009 from 33.2% in 2008, of tax revenues of the constituent territories of the Russian Federation in the respective consolidated budget revenues of the Russian Federation. It resulted basically from a slump of the federal budget revenues from mineral production tax and customs duties. Meanwhile, a share of re-

1 Pursuant to Clause 2, Article 96.6 of the Budget Code of Russia, the following federal budget revenues shall be deemed to be revenues generated from the production of oil and gas: tax on the production of minerals as crude hydrocarbons (crude oil, flammable natural gas extracted from all types of raw hydrocarbon deposits, gas condensate extracted from all types of raw hydrocarbon deposits); export customs duties on crude oil; export customs duties on natural gas; export customs duties on petroleum products.

gional budgets, net of mineral payments and customs duties, also increased a bit by 1.1 p.p., to 54.8% from 53.7% in 2009, which was basically conditioned by steady inflow of revenues from personal income tax during the period of recession (Rb 1666,2bn in 2008 and Rb 1665,8bn in 2009).

In 2011, however, a share of tax revenues of subnational budgets in the consolidated budget of the Russian Federation decreased once again by 4.1 p.p. to 33.1% vs. 2010 (the value is close to a pre-recession value of 33.2% in 2008) as prices of exported energy recourses increased. In 2011, revenues from mineral production tax increased by 44.7% in nominal terms while revenues from customs duties, including the revenues generated within the framework of agreements concluded within the Customs Union, increased by 57.5% against 2010. As a result, tax revenues of the federal budget increased in general almost by 40% in nominal terms. Meanwhile, tax revenues of consolidated regional budgets increased merely by 16.7% in 2011 against the percentage reported in 2010. Therefore, in 2011 the decrease in a share of tax revenues of subnational budgets in the consolidated budget of the Russian Federation was basically conditioned by higher growth rates of tax revenues payable to the federal budget vs. the growth in taxes payable to subnational budgets. A share of tax revenues of consolidated regional budgets, net of mineral payments and customs duties, decreased less, by 1.1 p.p., to 56.0% from 57.1%.

However, a share of expenditures of subnational budgets in the consolidated budget expenditures of the Russian Federation increased significantly to 46.5% in 2011 from 43.2% in 2010, which, however, was by 2.7 p.p. less than the relevant value recorded in the pre-recession period of 2008. Budget expenditures of the constituent territories of the Russian Federation accounted for 15.05% of GDP in 2008 and by 0.93 p.p. or 14.12% less in 2011. A share of regional expenditures decreased gradually in gDp from 2009 (max. value of 16.13% of GDP). It should be noted, however, that in 2011 subnational budget expenditures increased in real terms by 9.0% and federal budget expenditures by 1.9% against the relevant percentage reported in 2010. Meanwhile, federal budget expenditures tended to decrease in percentage of GDP (to 20.1% in 2011 from 24.85% in 2009) from the beginning of 2009, the same is true of consolidated budget expenditures of the constituent territories of the Russian Federation. The decrease in expenditures in percentage of GDP in the post-recession period was therefore partially conditioned by outrunning growth in the GDP itself.

Let us examine in detail the situation with subnational budget revenues. Fig. 17 presents the dynamics of the principal components of consolidated budget revenues of the constituent territories of the Russian Federation in the period between 2007 and 2011.

In 2011, consolidated budget revenues of the constituent territories of the Russian Federation increased in real terms by 9.9% y-o-y. A share of such revenues in total regional budget revenues decreased a bit to 69.4% from 69.6%. In spite of growth in tax revenues in the period between 2010 and 2011, the pre-recession level of 2008 was not regained. Tax revenues decreased in real terms by 4.3% in 2011 vs. the percentage reported in 2008. Hence it is a reflection of the fact that tax revenues of regional budgets failed in general to regain the pre-recession level both in terms of inflow volume and a share in total revenues (the value stood at 70.7% in 2008). In spite of a 13.5% growth in real terms in 2011 vs. 2010, non-tax revenues also failed to regain the pre-recession value (a decrease of 16.5% against 2008). High level of non-tax revenues in 2007-2008 was secured basically by increased revenues generated from the use of state- and municipally-owned property assets against 2009-2010. In 2011, these revenues increased in real terms by 17.9% against 2010 but failed to regain the

level of 2008 (a decrease of 17.0%). In general, this type of revenues accounted for at least 43.1% of non-tax revenues in the period between 2007 and 2011. As a result, while a share of non-tax revenues accounted for 9.8% of total revenues of the budget of the constituent territories of the Russian Federation in 2008, it decreased down to 8.7% in 2009 and 7.7% in 2010, but increased to 7.9% in 2011. The amount of transfers from the federal budget also increased in real terms and stood at 10.5% in 2011 against the percentage reported in 2010 (budget transfers decreased by 13.5% in the post-recession period of 2010 against 2009). As a result, the amount of transfers in 2011 was bigger in comparable values by 15.6% vs. 2008, which, however, was by 4.3% less than in 2009. Other non-repayable revenues grew in real terms by 3.9% in 2011 against the percentage reported in 2010 It should be noted that in spite of growth in this type of revenues, they have been accounting for 1.7% or less of the total revenues generated over the recent two years. Like in the preceding year, revenues from the Foundation for Support to the Housing and Community Amenities Reform accounted for a major part of other non-repayable transfers. In general, subnational budget revenues increased in real terms by 10.3% in 2011 vs. the percentage reported in 2010, but decreased by 1.2% vs. 2008.

Source: Federal Treasury, Gaidar Institute's estimates.

Fig. 17. Consolidated budget revenues of the constituent territories of the Russian Federation in the period between 2007 and 2011, by component (at 2007 values)

The dynamics of principal taxes payable to the consolidated budget of the constituent territories of the Russian Federation in the period between 2007 and 2011 is shown in Table 19.

In general, tax revenues of consolidated budgets of constituent territories of the Russian Federation in percentage of GDP decreased from 10.01% of GDP in 2010 to 9.70% of GDP in 2011, which was even less than by 0.07 p.p. of GDP in 2009. The dynamics of specific taxes was multidirectional. Historically, there are two taxes which account for a major part of tax revenues of subnational budgets, namely corporate tax and personal income tax which accounted for about 74.4% of total tax revenues in 2011, a bit higher than in 2010 (73.2%) but lesser than in 2008 (78%). This can be explained basically by that profit tax revenues were much less than the revenues generated in 2008 (4.24% of GDP), although they increased by 0.19 p.p. of GDP and reached 3.55% of GDP. It should be taken into account that the regional

rate of this tax increased from 19.5 to 20% from January 1, 2009. Therefore, though the trend towards economic recovery continued in 2011 thereby resulting in more profit tax revenues, its share in GDP still remained too far from the pre-recession values. The dynamics of another principal type of tax - personal income tax - was not the same. Revenues from personal income tax were found to be most stable among other types of tax revenues of consolidated regional budgets amid recession. In 2011, revenues from this tax saw a decrease by 0.29 p.p. down to 3.67% of GDP vs. 2010. The decrease in revenues from personal income tax in percentage of GDP from 2009 (when a maximum value of 4.29% of GDP was reported) can be explained basically by outstripping growth rates in GDP in the post-recession period against growth in the average gross nominal wages in the economy (which increased by 12.2 in 2011 against 2010, according to the Rosstat's preliminary data). Furthermore, nominal GDP increased in 2011 by 17.8% y-o-y. Personal income tax increased by merely 11.4% in nominal terms over the same period.

Table 19

Tax revenues payable to the consolidated budget of the constituent territories of the Russian Federation in the period between 2007 and 2011 (% of GDP)

2007 2008 2009 2010 2011

Tax revenues, total 10.88 10.62 9.77 10.01 9.70

including:

Corporate tax 4.60 4.24 2.76 3.36 3.55

Personal income tax 3.81 4.04 4.29 3.96 3.67

Excise duties on products sold on the territory of the Russian Federation 0.54 0.46 0.63 0.73 0.68

Gross income taxes 0.37 0.39 0.39 0.40 0.40

Property taxes 1.24 1.20 1.47 1.39 1.25

Taxes, duties and regular payments for the use of mineral resources 0.23 0.25 0.19 0.07 0.07

For reference: GDP, trillion Rb 33.24 41.27 38.80 45.16 54.36

Source: Federal Treasury, Gaidar Institute's estimates.

The following should be noted through examination of the dynamics of other types of tax revenues of the consolidated budget of the constituent territories of the Russian Federation. Revenues from excise duties decreased a bit by 0.05 p.p. in percentage of GDP in 2011 against 2010. Moreover, pursuant to the adopted amendments to the Tax Code of the Russian Federation, the rates of excise duties will grow in the ensuing years1, which is likely to change the recently visible downward trend in the relevant revenues. A share of taxes payable by small businesses (on their gross income) remained almost the same over the period under review and stood at 0.4% of GDP, like in the preceding year. Property tax revenues also tended to decrease from 1.47% in 2009 to 1.25% of gDp in 2011 (which, however, is 0.05 p.p. above the level reported in 2008). A share of mineral production tax and other payable mineral payments in the regional budget revenues stabilized at the level of 0.07% in period between 2010 and 2011 after a stable downward decrease in 2009-2010. Such a small value of revenues from this source of revenues can be explained by centralization from 2010 of revenues from the tax imposed on the production of minerals as crude hydrocarbons payable to the federal budget2.

1 Refer to Clause 1, Article 193 of the Tax Code of the Russian Federation.

2 The standard for payment of the tax on the production of minerals as crude hydrocarbons to the federal budget (save for flammable natural gas) has been increased from 95 to 100% since January 1, 2010 (under Federal Law No. 218-FZ, dd. 22.09.2009 "On the Amendments to the Selected Legal Acts of the Russian Federation and Cancellation of the Selected Provisions of Legal Acts of the Russian Federation").

The foregoing dynamics refers in general to tax revenues of the consolidated budget of the constituent territories of the Russian Federation. However, it would be reasonable to make analysis by region, because the constituent territories of the Russian Federation differed largely in the depth of recession and the degree of economic recovery. It should be noted that differentiation of tax revenues between regional budgets decreased in 2009, but then increased again in 2010. The relevant variation of per capita tax revenues adjusted for the budget expenditure index stood at 87.2% in 2008 (75.0% in 2009), increased to 91.3% in 2010, but decreased to 77.7% in 2011. The following factors were responsible most to this dynamics. It was the economically developed regions that were hit hardest (they experienced a deeper recession) by the crisis, which resulted in a decrease in the interregional differentiation. From the end of 2009, the Russia's economy began to recover, but the constituent territories of the Russian Federation differed largely in the degree of such recovery and, consequently, growth rates of tax revenues, which resulted in increase of differentiation of per capita tax revenues. In 2011, the differentiation declined as a result of a certain equalization of recovery rates in the economies in different groups of regions.

Tools which allow profit tax revenues to be distributed more evenly among the constituent territories of the Russian Federation, began to work from 2012 in order to reduce differentiation of tax revenues in various regions. This refers to the amendments to the Tax Code of the Russian Federation which concern the control of transfer pricing and introduction of the concept of consolidated group of taxpayers1. The amendments imposed a higher degree of control among related companies in order to create extra obstacles against using transfer pricing for the purpose of moving the "profit center" through various regions. However, the amendments allow taxpayers to form a consolidated group thereby allowing them to make special consolidated reports. The advantage of this approach is that corporate profit tax is to be paid on the basis of financial performance results of the consolidated group of taxpayers. In doing so, profit tax is to be accrued and tax revenues are to be distributed between various regions in which companies within the consolidated group operate pursuant to the regulations set forth in Clause 6, Article 288 of the Tax Code of the Russian Federation. A share in the profit of a specific company is to be measured as an arithmetical mean of a share of the average number of workers (wage costs) of the company and a share of depreciation value of amortizable assets in relevant values for the entire consolidated group. The amount of profit tax itself is to be measured on the basis of a tax rate applicable in the constituent territory of the Russian Federation where a certain member (and/or its stand-alone unit) of the consolidated group is located. Therefore, the aforesaid regulations allow the profit tax base to be more evenly distributed among the regions of Russia.

However, legislative regulations concerning transfer pricing and consolidated group of taxpayers, which have been in effect since 2012, impose strict requirements to such consolidated group. This is why the number of companies, i.e. potential members of consolidated groups of taxpayers is not going to be large, up to 40-50, in the short-term period. It should be emphasized that it will be Moscow which will incur most losses from the application of the new regulations vs. other regions, because head offices of most of large Russian companies are located in Moscow. However, considering high fiscal capacity of this region (3,232 in

1 Federal Law No. 321-FZ, dd. November 16, 2011 "On the Amendments to Part 1 and Part 2 of the Tax Code of the Russian Federation Due to the Creation of the Consolidated Group of Taxpayers"; Federal Law No. 227-FZ, dd. July 18, 2011 "On the Amendments to the Selected Legal Acts of the Russian Federation Due to Perfection of the Pricing Principles for the Purpose of Taxation".

20111), there is no point to expect any significant deterioration of its revenue potential, which disputes the need for large-scale compensatory arrangements. It should be understood that the larger the scale and longer is the duration of such compensations, the lesser the "equalizing effect" of taken measures will be in the short-term period.

Let us examine in detail the situation with tax revenues by constituent territory of the Russian Federation. Table 20 presents a breakdown of Russia's regions by change in tax revenues in the period between 2008 and 2011.

Table 20

A breakdown of Russia's regions by change in tax revenues of the consolidated budget of the constituent territories of the Russian Federation

Number of regions in which tax revenues in 2011 In nominal terms In real terms

2011 vs. 2010 2011 vs. 2008 2011 vs. 2010 2011 vs. 2008

Increased by more than 25% 8 55 4 6

Increased from 10 to 25% 61 20 20 21

Increased by less than 10% 12 5 53 27

Decreased by less than 10% 1 1 4 20

Decreased from 10 to 25% 0 1 1 7

Decreased by more than 25% 0 0 0 1

Source: Federal Treasury, Gaidar Institute's estimates.

The foregoing data shows that tax revenues of the consolidated regional budget increased in real terms in 54 of 822 constituent territories of the Russian Federation in 2011 (the second year of economic recovery) against 2008. The following regions were leading in terms of growth rates: the Republic of Ingushetia, the Karachay-Cherkessia Republic, the Chechen Republic, the Magadan Region, the Chukot Autonomous Area, the Republic of Adygeya. At the same time, tax revenues decreased by 30.41% in the Vologda Region. Comparing the data on 2011 and 2010, one may note that 77 regions saw an increase in tax revenues in real terms. Furthermore, almost all the regions saw an increase in nominal terms, save for the Republic of Altai. The Tyumen Region and Vologda Region experienced a decrease in nominal terms in 2011 vs. the percentage reported in 2008.

Let us examine the changes which took place in the consolidated budget expenditures of the constituent territories of the Russian Federation. Aggregate expenditures of the consolidated budge of the constituent territories of the Russian Federation increased in nominal terms by 15.6% in 2011 against 2010. However, their growth in real terms was merely 9.0%. The structure of expenditures of the consolidated budget of the constituent territories of the Russian Federation saw certain changes as well {Table 21).

The following should be noted on the basis of analysis of changes in regional budget expenditures by item. A share of expenditures on 'National Economy' and 'Education' increased a bit and stood at 17.1% and 22.5% respectively in 2011 against 16.6% and 21.9% in 2010. On the contrary, a share of expenditures on 'Social Policy' deceased to 15.5% of total expenditures in the same period (17.6% in 2010). Expenditures on 'National Security and Law Enforcement', 'Environmental Protection' and 'Culture, Cinematography and Mass Media' remained the same vs. 2010.

1 According to the Method for allocation of grants for fiscal capacity equalization of the constituent territories of the Russian Federation for 2011.

2 The Arkhangelsk Region and the Nenets Autonomous Area are regarded as the single constituent territory of the Russian Federation.

Table 21

Structure of consolidated budget expenditures of the constituent territories of the Russian Federation in the period between 2008 and 2011 (%)

2008 2009 2010 2011*

Nationwide Issues 7.1 7.3 7.3 7.1

Including State and Municipal Debt Service 0.6 1.0 1.1 1.0

National Defense 0.0 0.0 0.0 0.0

National Security and Law Enforcement 4.1 3.9 3.8 3.7

National Economy 19.6 18.1 16.6 17.1

Housing and Community Amenities 16.3 13.7 12.6 12.6

Environmental Protection 0.3 0.3 0.2 0.3

Education 20.8 21.5 21.9 22.5

Culture, Cinematography and Mass Media 3.5 3.4 3.4 3.5

Healthcare and Sports 12.7 12.1 12.0 11.1

Social Policy 12.2 15.3 17.6 15.5

Interbudget Transfers 3.3 4.4 4.5 6.5

*Expenditures in 2011 are presented in a comparable classification which was in force until 2011. Source: Federal Treasury, Gaidar Institute's estimates.

Expenditures on 'Healthcare and Sports' saw a more considerable change, with a downward trend over the recent four years, from 12.7% in 2008 to 11.1% in 2011. Expenditures on healthcare saw a marked decrease in 2011 basically due to an increase in a share of regional budget transfers to territorial funds for compulsory medical insurance. Examining this dynamics, it should be taken into account that contributions (transfers) for economically enactive population have become standardized and mandatory since 2011, in other words, regions no longer may reduce considerably the amount of such contributions (which resulted in their marked increase also as a result of a certain cut-off in direct regional budget expenditures on healthcare). As a result, the accumulative share of the two items - 'Healthcare and Sports' and 'Interbudget Transfers' - increased to 17.6% in 2011 from 16.5% in 2010. A share of expenditures on 'Nationwide Issues' decreased by 0.2 p.p. to 7.1% in the last year, and a share of expenditures on 'State and Municipal Debt Service' also decreased a bit from 1.1% to 1.0% of total regional expenditures.

A special focus should be placed on 'National Economy'. The dynamics here should be examined both for the item as a whole and its sub-items, because this type of expenditures is quite homogeneous vs. other types. After a stable upward trend, a share of expenditures on agriculture decreased for the first time to 3.0% of total expenditures (a max. of 3.4% was reached in 2010). In general, expenditures on 'General Economic Issues', 'Fuel and Power Sector', 'Applied Research in the Field of National Economy' saw a decrease against 2010. Such sub-items as 'Water Industry' (83.4%) and 'Forestry' (69.4%) were leading in terms of growth rate. However, a share of these expenditures still remains insignificant. A special emphasis should be placed on such sub-items as 'Transport' and 'Road Facilities', which in 2011 accounted for 8.3% of total expenditures on 'National Economy', a growth of 0.4 p.p., 7.9% against 2010 (refer to Section 2.3.4for more details on the expenditures on road facilities).

In 2011, a combined subnational budget deficit remained unchanged, but its volume decreased to 0.5% of total expenditures, which is much smaller vs. 5.3% in 2009 and 1.5% in 2010. Analyzing the budget deficit value by constituent territory, it should be noted that only 26 of 83 regions saw a surplus of their consolidated regional budget at year-end 2011. As a result, the need for borrowing was maintained at the subnational level. It should be noted that the need for fundraising might have emerged also because of the need for refinancing of the existing debt. The data on volumes of government debt of the constituent territories of the

Russian Federation in the period between 2007 and 2011 and municipal debt in period between 2010 and 2011 is shown in Table 22.

Table 22

Government debt due by the constituent territories of the Russian Federation in the period between 2007 and 2011 and municipal debt in the period between 2010 and 2011 (Rb, billion)

Debt amount, Rb, billion

as of January 1, 2008 as of January 1, 2009 as of January 1, 2010 as of January 1, 2011 as of January 1, 2012

All constituent territories of the Russian Federation 456,9 599,6 889,6 1096,0 1071,9

including:

Moscow 89,3 121,5 243,1 299,3 263,0

Moscow Region 92,1 156,1 163,7 146,8 96,1

Constituent territories (net of Moscow and the Moscow Region) 275,4 322 482,8 649,9 712,7

Municipalities n/a n/a 134,9 169,8 197,7

Source: Ministry of Finance of Russia, Gaidar Institute's estimates.

The data on changes in absolute volumes of government debt by constituent territory of the Russian Federation in 2011 show some decrease in borrowings (a decrease of Rb 24,1bn). However, such a decrease resulted basically from a considerable decrease in volumes of government debt in Moscow and the Moscow Region. In addition, these two regions accounted for more than 30% of total government debt due by the constituent territories of the Russian Federation. Examining the dynamics of regional debt amounts, net of Moscow and the Moscow Region, the picture would be different. The amount of government debt due by the other constituent territories of the Russian Federation increased to Rb 712,7bn by January 1, 2012, a growth of Rb 62,8bn vs. the beginning of 2011. Total municipal debt increased by Rb 27,9bn of the period.

The following should be noted on the basis of the results of the second year of Russia's economic recovery. The situation with the fulfillment of subnational budgets in 2011 improved visibly. However, a series of the principal parameters describing the situation with subnational finances remained lower than the pre-recession values. For example, tax revenues decreased in real terms by 4.3% in 2011 vs. the pre-recession values of 2008. No pre-recession values were regained for a series of the principal taxes, namely profit tax (a decrease of 12.4%), personal income tax (a decrease of 4.6%). The level of expenditures failed to reach the pre-recession values (a 2.3% cut-off), above all, through a lower level of capital expenditures. At the same time, expenditures on 'Social Policy' (which is ranked third in size after the 'National Economy' and 'Education') increased in real terms by 24.4% (vs. the percentage reported in 2008). A major part of the regions failed to fulfill their budget without a deficit. As a result, in spite of general easing of the economic situation (growth in GDP and industrial output), a certain tension still remains in place with regard to the budget fulfillment in certain regions.

2.3.2. Financial support from the federal budget

The total amount of federal budget transfers to subnational budgets increased in nominal terms by 4.8% in 2011, but decreased in real terms like in the preceding year (by 1.2% in 2011; 14.4% in 2010 vs. the percentage reported in 2009). The balance of extended and re-

paid budget loans decreased by 51.5%, from Rb 164,4bn to Rb 79,8bn. It should be noted that in 2011 the amount of extended federal budget loans to the regions decreased by Rb 41,7bn to Rb 128,4bn. The balance decreased visibly as a result of a substantial growth in repayments for budget loans by the regions, from Rb 5,4bn in 2010 to Rb 48,6bn in 2011, which was basically conditioned by repayment of 3-year budget loans extended in 2009.

Let us examine in detail the dynamics of certain types of federal budget transfers (refer to Fig. 18).

Source: Federal Treasury, Gaidar Institute's estimates.

Fig. 18. Federal budget transfers to Russia's regions in the period between 2008 and 2011 (at 2008 values)

Subventions and other interbudget transfers (hereinafter - "other IBTs") decreased in real terms in 2011 vs. 2010. Subventions decreased most, by 16.0%, other IBTs by 8.9%. However, comparing the amounts of these transfers in 2011 with 2008, it should be noted that subventions increased in real terms by 75.4% whereas other IBTs decreased by 56.2%. Subsidies in 2011 increased by 10.2% vs. the percentage reported in 2010 (however, it was 12.1% less than in 2008). The amount of grants decreased markedly and stabilized at Rb 563,5bn in 2011 over the recent two years (a growth of 1.6% in real terms vs. 2010) after a substantial growth in 2009.

The foregoing dynamics resulted in certain changes in the structure of transfers in the period between 2008 and 2011 (refer to Table 23).

As evident from Table 23, the amount of grants increased in 2011 against 2010 mostly through an increase to Rb 154,3bn from Rb 105,9bn in the amount of grants allocated for the provision of support to budget balancing measures. As a result, a share of grants for fiscal equalization increased from 7.7% to 10.7% of total amount of transfers. However, a share of grants for budget balancing decreased to 27.5% from 28.8%. Grants accounted for 39.0% total interbudget transfers in 2011, a growth of 1.1 p.p. vs. 2010. In general, the data on changes can't be single-valued, because grants for budget balancing are allocated through a more transparent method based on objective factors against grants for fiscal equalization. In spite of the fact that a certain part of grants for budget balancing are allocated on the basis of publicly available methods and rules, many applicable criteria and indicators are less grounded and intrinsic vs. allocation of grants for fiscal equalization. A new type of financial support to the

regions appeared in 2011, namely grants to the constituent territories of the Russian Federation which achieved best results in increasing the regional taxable capacity, which are also allocated as grants for budget equalization (refer to Section 2.3.3 for details).

Table 23

Federal budget transfers to Russia's regions in the period between 2008 and 2011, in nominal terms

2008 2009 2010 2011

m Rb % of total m Rb % of total m Rb % of total m Rb % of total

Transfers to the 1,094,680 100.0 1,480,385 100.0 1,378,337 100.0 1,445,581 100.0

regions, total

Grants 390,398 35.7 578,277 39.1 522,685 37.9 563,500 39.0

including:

grants for fiscal 328,648 30.0 375,485 25.4 396,996 28.8 396,996 27.5

capacity equalization

grants for the 46,035 4.2 191,886 13.0 105,955 7.7 154,270 10.7

provision of support to budget balancing

measures

Subsidies 435,867 39.8 530,073 35.8 411,439 29.9 481,252 33.3

including:

subsidies for road 101,799 9.3 104,304 7.0 61,437 4.5 57,643 4.0

facilities

agricultural subsidies 73,593 6.7 90,641 6.1 87,930 6.4 98,509 6.8

Subventions 153,170 14.0 284,440 19.2 378,650 27.5 337,467 23.3

including:

subventions for 37,413 3.4 77,414 5.2 87,090 6.3 74,193 5.1

exercising the powers in employment

promotion

subventions for GPW 0 0.0 45,825 3.1 116,851 8.5 46,054 3.2

veteran housing

Other interbudget 115,245 10.5 87,595 5.9 65,562 4.8 63,362 4.4

transfers

Source: Federal Treasury, Gaidar Institute's estimates.

A share of subventions decreased from to 23.3% in 2011, 27.5% in 2010 in total amount of transfers. The decrease in the amount of subventions was conditioned basically by a decrease in subventions for exercising the authority in promotion of employment and subventions for the Great Patriotic War veterans housing due to the 65th Anniversary of the Victory in the Great Patriotic War (1941-1945)1 which appeared in 2009. It is the latter type of subventions that resulted in a substantial decrease in 2011, when a share of this subvention became twice as little, i.e. they decreased from 8.5% to 3.2% of total amount of transfers.

A share of subsidies in total amount of transfers decreased continuously in 2009-2010 from 39.8% in 2008 to 35.8% in 2009, and stood at mere 29.9% in 2010. On the contrary, a share of subsidies increased by 3.4 p.p. to 33.3% in 2011.

Following are the principal lines of co-financing of subnational budget expenditures in 2011:

- the state program on agricultural development and regulation of the markets of agricultural products, raw materials and food products for the period of 2008-2012 (20.5% of total amount of subsidies, 21.4% in 2010);

1 Pursuant to Edict of the President of the Russian Federation No. 714, dd. 07.05.2008 "On the Great Patriotic War (1941-1945) Veterans Housing". 78

- construction and modernization of motor roads (12.0%; 14.9% in 2010)1;

- financing additional medical assistance provided by district general practitioners and pe-diatric physicians, general practitioners (family doctors) (4.5%; 5.1% in 2010).

- implementing additional measures aimed at easing the tension in the labor market of the constituent territories of the Russian Federation (3.7%, in 2010 - 9.4%).

In general, speaking of the principal parameters of federal budget transfers to the regions in 2011, the following should be noted. A share of grants and subsidies increased a bit and a share of other IBTs and subventions decreased in total amount of federal budget transfers vs.

2010. Comparing the transfers made in 2011 with those in 2008 (the 'pre-recession' period), it should be noted that a share of subventions increased substantially and a share of other IBTs decreased in the total amount allocated to subnational budgets transfers. In general, the federal center made efforts concerning intergovernmental fiscal relations in 2011 which were intended to keep gradually curtailing principal "counter-recession" channels of aid to subnational budgets and simultaneously create additional stimuli for increasing the tax base (this refers, above all, to "stimulus" grants whose allocation method is described in detail in the next section).

2.3.3. Stimulating the constituent territories of the Russian Federation which achieved best results in enhancing regional taxable capacity

There has been a visible trend over the last few years towards wider use of the practice of federal budget allocations to the regions on the basis of their economic and financial performance results. Since 2007, the Ministry of Regional Development of Russia has been measuring effectiveness of executive branches of the government of the constituent territories of the Russian Federation2, and grants are allocated to regions which are found to be most "efficient" based on such measurement. In addition, at the end of 2011, the federal government bodies made a decision on creating a stimulus arrangement for those constituent territories of the Russian Federation which managed to achieve best results in their economic development and fundraising. A total of Rb 10bn was allocated from the federal budget for this purpose in

2011. Ten billion rubles is planned to be allocated in 2012, however the amount may increase in the future based on the development process of the stimulus arrangement. However, a wider use of such tools of intergovernmental fiscal relations is exposed to serious risks which will be examined below.

Russian Government Ordinance No. 798, dd. February 18, 2011, "On the Allocation of Grants in 2011 to the Budget of the Constituent Territories of the Russian Federation to Support Measures of Balancing of the Budget of the Constituent Territories of the Russian Federation Which Achieved Best Results in Enhancing regional taxable capacity" formalized the method of resulting figure calculation and the mechanism of allocation of such stimulus grants. According to this document, a final comprehensive measurement which takes account of economic performance results over the last three year, is to be made to measure the performance of each region. In addition, this comprehensive measurement includes the performance results of the constituent territories of the Russian Federation on the basis of six eco-

1 The amount of these subsidies includes relevant expenditures as part of all federal special purpose programs.

2

Edict of the President of the Russian Federation No. 825, dd. 28.06.2007 "On the Measurement of Effectiveness of Executive Government Bodies of the Constituent Territories of the Russian Federation" (as revised on 28.04.2008 No. 606).

nomic performance indicators which are grouped into three segments: investments, taxation, industrial output. Two economic performance indicators are to be calculated for each segment so that each segment be measured both in terms of dynamics and value. As a result, both regions with a low value but high growth rates and those with a high value but without pronounced dynamics may equally be qualified for federal support.

It should be emphasized that according to the Ordinance, all economic performance indicators which are considered for allocation of stimulus grants, are to be calculated without regard to the regions' financial and economic performance results in the industries relating to mineral production. This condition was imposed by the federal government bodies even before February 2011, when the idea of allocation of such grants was advanced, however the focus was originally placed on the oil and gas sector rather than the entire extractive industry1.

A total of three Draft Ordinances of the Russian Government were considered over six months, which differed mostly in the expression of specific economic performance indicators while the list itself remained unchanged. The only thing that should be emphasized is the Ministry of Economic Development and Trade's initiative to widen the scope of assessment, which suggested that the innovation production segment should be assessed as well (in addition to the aforesaid three segments). The following parameters were selected as indicators: level and growth rate of innovative goods, works, services for all types of economic activity. However, this idea failed to receive the required support. A potential reason is that the notion of "Innovative goods, works and services " is not well-defined in the federal legislation2, which might result in incorrect statistics from both organizations and enterprises and government bodies of the constituent territories of the Russian Federation.

A total of 20 Russian regions received stimulus grants in 2011. Financial support varied within a range of Rb 206,8m to Rb 2bn on the basis of the results obtained through the final comprehensive measurement. The Kaluga Region was ranked first, which managed to be qualified for 20% of total stimulus grants. The Tyumen Region was ranked second and received a significant amount of budget funds (Rb 1,9bn or 19.1% of total), which is a historical recipient of grants for fiscal capacity equalization, as against the Kaluga Region. For example, the Tyumen Region's fiscal capacity stood at 2,347 after Moscow and St. Petersburg in 20113. The Tyumen Region's consolidated budget tax and non-tax revenues totaled Rb 147,9bn, aggregate income Rb 184,7bn at year-end. Comparing these figures with the amount of allocated grants, proves that this amount is unlikely to have any effect whatsoever on the regional government bodies' goal-setting. Other 18 winners received less than Rb 1bn. In addition, it should be emphasized that a total of 13 constituent territories of the Russian Federation received no grants for equalization in 2011, eight of which received the foregoing stimulus grants at the end of the year. Therefore, such grants can hardly be regarded as a serious stimulus instrument. Allocation of stimulus grants within the framework of the applicable arrangement results more likely in dispersion of a part of the federal budget funds.

As noted above, such stimulus tools of intergovernmental fiscal relations are not regarded as novelty for the practice in Russia. Since 2007, the Ministry of Regional Development of

1 http://www.minfin.ru/ru/press/speech/index.php?pg4=13&id4=12089 - based on A. G. Siluanov's interviews to in agencies at the 8th Krasnoyarsk Economic Forum.

2 http://www.gks.ru/free_doc/new_site/business/nauka/minnov3.htm - Rosstat defines this notion as products manufactured by applying various types of technological innovations in the accounting year.

3 According to the Method for allocation of grants for fiscal capacity equalization of the constituent territories of the Russian Federation for 2011.

Russia has been measuring the effectiveness of executive branches of the government of the constituent territories of the Russian Federation, which serves as a framework for allocation of grants to most "efficient" regions (based on their performance measured in 2010, 10 constituent territories of the Russian Federation received grants within a range of Rb 63m to Rb 116m in 2011). The experience gained over the previous periods shows that performance measurement of government bodies is a challenge. A monitoring of 329 parameters is currently under way, which is subject to annual changes in methods. For example, in 2007-2008, the regions were ranked on the basis of an effectiveness achieved by regional government bodies. As a result, a group of 10 regions was formed, whose composition remained unchanged for two years. Later, in 2009, a decision was made to measure the effectiveness of regional government bodies through the dynamics of indicators. Such an approach also failed to stand up for criticism, and from 2010 they started measure the effectiveness on a comprehensive basis, i.e. both in terms of dynamics and level. Today, the Ministry of Regional Development of Russia highlights the following top-priority lines in the development of methodology: reducing the number of applicable indicators; taking more account of regional specifics; providing a more flexible approach towards materiality of factors which have an effect on the comprehensive assessment; enhancing ways of encouragement of the regions1.

The developers of the method of measurement of the effectiveness of regions which have achieved best results in increasing taxable capacity, appreciated the weaknesses of the method of the Ministry of Regional Development of Russia. However, federal government bodies may face the same problem in using this method, namely it is impossible within the framework of a specific method to take account of all the specifics of a parameter to measure (taxable capacity in this context). As a result, efforts in making the most adequate measurement would result in increased number of indicators in the method thus making it overloaded, complex and non-transparent.

The method of the Ministry of Regional Development of Russia employs 329 parameters whereas the taxable capacity measurement method has only six parameters. Both methods basically employ economically objective parameters. However, regardless of the applicable methods of measurement of the performance of regional government bodies, the same results will be obtained annually. Today about 10 constituent territories of the Russian Federation can be highlighted, which eventually will be found in the group of leaders regardless of the activities of certain governors in the field of regional economics. Such regions as Moscow, St. Petersburg, the Republic of Tatarstan, the Tyumen Region, etc., initially had favorable opportunities for a good start in their development, therefore most of other regions would not be able to catch up with them by virtue of objective factors.

In general, both measurement of the effectiveness of executive bodies of the constituent territories of the Russian Federation and measurement of regions which have achieved best results in increasing taxable capacity, have a series of critical weaknesses. First, such measurements can't reflect the current status of regional economic policies, because the results of decisions made by government bodies are normally not short-term (e.g., the results of current large investments can be seen in five years), or assessed economic indicators depend little from the decisions made by federal government bodies. Second, stimulation through allocation of grants to financially successful constituent territories of the Russian Federation is ex-

1 http://www.minregion.ru/press_office/news/1763.html - The Ministry of Regional Development of the Russian Federation.

posed to extra risks of increasing differentiation among the regions and generating interregional contradictions. In addition, a small amount of allocations with a relatively small number of the constituent territories of the Russian Federation subject to rewards, results in dispersion of budget funds. This arrangement can't have a significant effect on the creation of priorities for regional government bodies. Third, the federal government bodies' efforts in improving a specific method would result in making constant updates thereto thereby preventing the regions from defining correct priorities in the long-terms period.

It should be emphasized that the practice of financial support to the regions on the basis of their economic and financial performance is quite disputable. For example, to obtain more reliable measurements of the performance of government bodies, the system of indicators would be widened. More indicators will result in distortion of the real system of goal-setting on the side of government bodies of the constituent territories of the Russian Federation, which would replace the performance-based work with the indicator-based work. As a consequence, regional government bodies would tend to achieve currently high indicators (better vs. the previous period) without actually working on long-term strategic development plans. It should be emphasized that the aforesaid effects are similar and result from efforts to introduce different systems of result-based budgeting in the public sector both at the government level and at the level of certain ministries and departments1. To reduce the likelihood of facing the aforesaid issues, it is necessary to give up financing of the constituent territories of the Russian Federation on the basis of their economic and financial performance results, but keep up enhancing the measurement systems themselves. The measurement system is needed to build up a data bank which allows regional processes to be detected in terms of different aspects of regional development for the purpose of identifying, disseminating and applying the best regional practice among the constituent territories of the Russian Federation. Furthermore, it should be noted that revival of the institution of direct elections and early resignation of governors may become the best stimulus and measurement of the performance of regional government bodies, including taxable capacity improvement.

2.3.4. Establishing road funds of the constituent territories of the Russian Federation in 2012

Under Federal Law No. 68-FZ, dd. April 6, 2011, "On the Amendments to the Budget Code of the Russian Federation and the Selected Legal Acts of the Russian Federation", a provision on the establishment of road funds at all tiers of authority was set up for the purpose of financing road activities with regard to public motor roads from 20122. To observe the federal legislation requirements, each region had to develop till January 1, 2012 a regulatory act providing for the establishment of the road fund of a constituent territory of the Russian Fed-eration3. In addition, regional government bodies had to approve a procedure for financing and use of road fund budget allocations as well as update their regional long-term programs

1 For details refer to, e.g., de Bruin H. Performance-Based Management in the Public Sector. M.: The Institute for Complex Strategic Studies, 2005.

2 The Russian legislation requires mandatory creation of the Federal Road Fund (it was stipulated in 2011 under Federal Law No. 357-FZ, dd. December 13, 2010, "On the Federal Budget for 2011 and Planning Period for 2012 and 2013") as well as road funds of the constituent territories of the Russian Federation, since 2012. In addition, municipal road funds may be created by a decision of the representative body of a municipality.

3 Sixty eight of 83 constituent territories of the Russian Federation adopted special laws on the creation of regional road funds while the other 15 updated their effective regulations for budgetary process.

on road facilities (their parameters were to be brought in accordance with the amounts of financing from the road fund of a constituent territory of the Russian Federation). Pursuant to Clause 4, Article 179.4 of the Budget Code of the Russian Federation, the following revenues are considered as sources of financing of regional road funds:

- revenues from excise duties on motor gasoline, straight-run petrol, diesel fuel, oils for diesel and gasoline (injection) engines manufactured on the territory of the Russian Federation, payable as revenues to the budget of a constituent territory of the Russian Federation;

- transport tax revenues.

While working on the draft law, some of the regions encountered a problem which was conditioned by the fact that transport tax was included into the sources of financing of the road fund of a constituent territory of the Russian Federation. This tax, however, was long ago placed under the jurisdiction of local government bodies. In analyzing Article 179.4 of the Budget Code of the Russian Federation, one may infer that two specified sources of revenues (transport tax and excise duties on oil products) must be mandatory sources of financing of the road fund of the constituent territories of the Russian Federation. This is because under Clause 1, Article 56 of the Budget Code of the Russian Federation transport tax revenues shall be 100% paid to the budget of a constituent territory of the Russian Federation. Moreover, Article 179.4 of the Budget Code of the Russian Federation specifies that the size of a regional road fund shall be established under the budget law of a constituent territory of the Russian Federation for the ensuing fiscal year (the ensuing fiscal year and planning period) in an amount which should be at least equal to the forecast amount of budget revenues of a constituent territory of the Russian Federation. This leads to the conclusion that if the transport tax single standard is transferred to municipal budgets, this source will cease to be a regional budget revenue and, consequently, may not be a souce of financing of the road fund of a constituent territory of the Russian Federation1. Following are the regions in which transport tax was assigned to the municipal level: the Vladimir Region, the Voronezh Region, the Kaluga Region, the Lipetsk Region, the Vologda Region, the Krasnodar Territory, the Orenburg Region, the Perm Territory, Khanty-Mansi Autonomous Area, the Republic of Tyva, the Republic of Dagestan, the Republic of North Ossetia (Alania), the Stavropol Territory and the Chechen Republic.

As a rule, the decision on assignment of transport tax (in full or in part) from the regional to the municipal level of authority was made to maintain fiscal capacity at a certain level and create additional stimuli to enlarge the tax base in municipalities. The practice shows, however, that regions which initially assigned transport tax to municipalities, included afterwards transport tax as a source of financing of such funds, through amendments to already adopted laws on road funds. Therefore, forced abolition of transport tax single standards since 2012 in a series of Russia's regions can be regarded as an adverse effect of the adopted legal regulations concerning road funds. At the same time, transport tax revenues assigned to municipalities could be sources of financing of municipal road funds (however, local government bodies are only entitled rather than obliged to create road funds).

In general, the idea to revive road funds was initiated by the Government of Russia on the basis of analysis of the situation in the road construction sector over the recent 20 years. Advocates of this idea (above all, the Ministry of Transport of Russia and the Federal Road

1 http://bujet.ru/article/153917.php - Creation of Road Funds: Pros and Cons.

Agency under the Ministry of Transport of Russia) often provide the following data. In 199120011, when a system of financing of road facilities through road funds was in place, about 6,000 to 7,000 km of roads was constructed annually vs. about 2,000 km after the transfer to budget financing. It should be noted that road funds were abolished basically because of a great deal of corruption schemes and reports on improper use by government bodies of accumulated financial resources. Refusal of this type of financing was a logical stage in enhancing the budget policy. However, advocates of road fund revival believe that in spite of a great deal of road funds' inherited problems, volumes of construction and financing of road facilities were bigger when road funds were in place. In general, over the recent 11 years without road funds, expenditures on road facilities have decreased to 0.7% from 1.6% of GDP and even a bigger decline to 0.6% from 2.7% of GDP took place at the regional level. The data presented in Fig. 20 shows that expenditures on road facilities decreased in real terms after the Federal Road Fund of the Russian Federation was liquidated in 2001. However, these expenditures increased in the period between 2005-2008 and reached the max. value in 2008. Therefore, steady downward trend in expenditures on road facilities was overcome long before road funds were established in 2012. Furthermore, the following should be emphasized. The single undisputable advantage of special purpose road funds against budget financing is a higher degree of "transparency" for car owners - actual taxpayers who form a road fund, because such approach allows them to "see" a price of the actual benefit as motor roads. Financing of road facilities could have been increased without creating special purpose road funds, as partially evident by the "pre-recession" dynamics of the relevant expenditures.

140% j-120% 100% 80% 60% —-40° o 20% —-0% —

1996 1997 199S 1999 2000 2001 2002 200.} 2004 200^ 2006 2007 200R 2009 2010 2011 Source: M.Y. Blinkin. Strategy - 2020. Development of the Transport Infrastructure.

Fig. 19. Amounts of financing of road facilities from the budgets at all levels in comparable prices (1996 = 100%)

It was the financial and economic crisis that was basically responsible for interfering with further increase in expenditures on road facilities (after 2008). Subnational budget expendi-

1 The Federal Road Fund was abolished in 2001. Regional road funds existed until 2003, when they were liquidated upon the abolishment of road tax.

tures on the development of road facilities decreased in real terms by 24.0% in 2009 against 2008 (refer to Fig. 20), which was conditioned by both a slump of tax revenues in regional budgets (by 13.5% in nominal terms vs. the percentage reported in 2008) and a decrease in federal subsidies for road facilities (the relevant allocations were cut off within 2009 by 33% against the initial budget projections). Expenditures on road facilities continued to decrease in 2010, but as early as 2011, expenditures on road facilities of the consolidated budget of the constituent territories of the Russian Federation grew up substantially to Rb 424,5bn, a 9.6% growth in real terms against 2010, as the regional economics recovered. It should be noted, however, that the level of related expenditures was much lower in 2011 than the pre-recession level of 2008 (a decrease of 26.1% in real terms). It is hard to make an ambiguous assessment of the decrease in expenditures on road facilities both at the regional and federal levels amid economic recession. International practice proves that increase in expenditures on road construction amid economic recession may be an efficient "counter-recession" channel of expenditures which facilitate (besides direct effect as newly constructed roads) creation of new jobs and recovery growth in industries relating somehow to the road construction sector.

Source: Federal Treasury, Gaidar Institute's estimates.

Fig. 20. Expenditures on road facilities and principal sources of financing of road funds of the consolidated budget of the constituent territories of the Russian Federation in the period between 2008 and 2011 (in real terms)

The following should be noted through a detail examination of the dynamics of federal budget allocations on the development of road facilities for subnational budgets in 2008-2011, (refer to Fig. 20). A share of road subsidies decreased gradually to 12.0% in 2011 from 23.4% in 2008 in the structure of federal budget subsidies. In addition, subsidies for roadway replacement and repair of public motor roads will cease to exist from 2012 at the administrative centers of constituent territories of the Russian Federation and administrative centers of Moscow and Leningrad Regions, as well as subsidies for full repair and repair of the territory and facilities adjacent to blocks of flats, access roads to the territory and facilities adjacent to blocks of flats. Moreover, subsidies on the development of road facilities allocated within the framework of various federal special purpose programs (a 2.4-fold decrease in real terms) de-

creased substantially in the period between 2008-2011. In addition, it should be emphasized that special budget loans to finance road facilities will no longer be extended from 20121.

In Russia at large, given the amount of expenditures on road facilities which were allocated in the period between 2008 and 2011 (refer to Fig. 20), they would have been covered 64.9% in 2011 from 29.8% in 2008 (had regional road funds existed in that period) by principal taxes - transport tax and taxes on oil products. Considering the fact that Rb 47,6bn of federal subsidies for road facilities is expected to be paid to the regional budgets in 20122, a decrease of Rb 10bn vs. the level of 2011, no substantial increase in expenditures on road facilities is expected in all regions without a visible increase in the relevant taxes. This will be implemented in part. Article 193 of the Tax Code of the Russian Federation provides for a stagewise increase in the rates of excises payable to the road fund of the constituent territories of the Russian Federation. However, the planned increase is unlikely to be sufficient for all regions. Analysis of regional expenditures on road facilities and revenues from transport tax revenues and excises on oil products revealed that creation of road funds in a series of the constituent territories of the Russian Federation may give rise to serious risks in terms of implementing a balanced budget policy. Had regional road funds (with relevant rates) existed in 2011, 53 constituent territories of the Russian Federation would have had to increase their expenditures on road facilities, with more than double increase in 19 of the regions (refer to Table 24). As a result, it would have required an involuntary reallocation of cash flows towards the development of road facilities, which would have forced a major revision of other budget expenditures and regional priorities.

Table 24

A breakdown of Russia's regions by the ratio of the amount of certain excises and transport tax to the amount of expenditures on road facilities in the consolidated budget of a constituent territory of the Russian Federation (net of subsidies)

2008 2009 2010 2011

More than 200% 0 4 20 19

From 150% to 200% 1 4 10 18

From 100% to 150% 2 22 14 16

From 75% to 100% 9 14 16 8

From 50% to 75% 28 19 6 8

From 25% to 50% 24 13 13 6

Less than 25% 19 7 4 8

Source: Federal Treasury, Gaidar Institute's estimates.

As noted above, only 26 of 83 regions showed consolidated regional budget surplus at year-end 2011. Creation of road funds may result in growth in total amount of regional budget expenditures and the need to look for extra reserves to generate budget revenues or reduce financing of other important items, namely healthcare or education. As a result, one may detect some "tricks" concealed by the government bodies of certain constituent territories of the Russian Federation in the adopted regional laws on road funds. For instance, the government bodies of the Republic of Khakassia updated the standards for payments by source of financ-

1 Russian Government Ordinance No. 1062, dd. December 18, 2010, "On the Approval of Rules for the Extension (Use, Repayment) of Federal Budget Loans to the Budget of the Constituent Territories of the Russian Federation for 2012" (as revised on 30.12.2011).

2 Now it includes subsidies for road facilities only within the frameworks of a federal special purpose program. 86

ing of the road fund1. It was established that 60% for revenues from excises on oil products were to be paid to the budget the Republic of Khakassia, while 40% to the regional budget and allocated to other items which have nothing to do with road facilities.

In should be emphasized that regions which have insufficient funds to finance the road fund and road facilities are entitled to special subsidies under Russian Government Ordinance No. 293, dd. April 18, 2011 "On the Amendments to the Federal Special Purpose Program "The Development of Transport System of Russia (for the period of 2010-2015)". However, these subsidies only can be allocated to co-finance property assets designed to increase the number of rural settlements which have a year-round access to public hard-top motor roads, as well as regional and municipal property assets of national or regional importance being under construction (reconstruction) in pursuance of regulations and orders issued by the President and the Government of the Russian Federation.

In spite of ambiguous nature of creation of road funds in the Russian Federation, such funds have long been existing in many foreign countries. Furthermore, the international practice classifies all road funds into first generation road funds and second generation road funds. First generation road funds are a budget form, as a budget-funded entity or, like in Russia, funded from the budget of a government authority. Second generation road funds may have founders represented by the state or social agencies, organizations of road users which may provide an extra control of spending and take part in discussions of projects. International experience shows that first generation road funds lack of effectiveness to be able to stepwisely develop the road construction sector. However, road funds in Russia are currently based on this form. More questions arise with regard to sources of financing of road funds. Expenditures on road facilities could be 'linked tighter' to revenues from car owners by introducing a motor road toll (i.e. imposing a charge on road users rather than a tax). Furthermore, advanced technologies allow administration costs to be reduced by using GPS navigation technologies intended to accurately measure the distance covered by a specific car driver over a certain period of time.

In general, the following should be noted. Creation of special purpose road funds results in bigger amount of administration costs against budget financing, lower degree of transparency in spending, poor flexibility of the budgetary process. In addition, creation of road funds may have a heavy impact on the balancing of the consolidated budget of the constituent territories of the Russian Federation in 2012. Should funds' revenues undergo substantial reallocation, the regions would have to either reduce their expenditures or increase fundraising, or wait for support from the federal budget.

2.3.5. The Federal Law "On the Federal Budget for 2012

and the Planning Period of 2013 and 2014" with regard to allocation

of interbudget transfers to other levels of the budget system

Federal Law No. 371-FZ, dd. November 30, 2011, "On the Federal Budget for 2012 and for the Planning Period of 2013 and 2014" provides for a total of Rb 1275,0bn of federal budget transfers allocated to the budget of the constituent territories of the Russian Federation, a decrease in nominal terms of 13.4% vs. the year-end 2011. The following types of transfers are to be reduced in 2012: a decrease of 11.5% for grants, 24.1% for subventions,

1 Law of the Republic of Khakassia No. 93-ZRX, dd. 8.11.2011, "On the Road Fund of the Republic of Khakassia".

42.4% for other interbudget transfers. The decrease was related to both allocation of large amounts of transfers to the regions as part of the governmental counter-recession program, which was almost completed in 2011, and reallocation of spending powers between the federal center and the regions as a result of the transfer of powers of financial provision of the police force from 2012. On the contrary, from 2012 subsidies are planned to see a small increase of 0.5% in the amount of financing against the level of 2011.

The amount of grants in 2012, as noted above, must be reduced in nominal terms by 11.5%, to Rb 498,9bn from Rb 563,5bn (in 2011). This dynamics is maintained through the planned reduction of 40.9%, to Rb 91,2bn in 2012 from Rb 154,3bn in 2011 of grants for the provision of support to measures of budget balancing. During 2012, however, the amount of this type of grants is likely to increase like in 2011 (the initial amount totaled Rb 115,6bn, i.e. an increase of Rb 38,7bn or by 25.0% took place within the fiscal year). It should be noted that allocation of grants for budget balancing still remains one of the least transparent tools of intergovernmental fiscal relations. The following expenditure items specified in the Federal Law "On the Federal Budget for the Period of 2012-2014" (which are recognized as a separate entry beyond any methodological framework of allocation of remaining sums of grants for budget balancing) is a good illustration of non-transparency of this arrangement is This refers to the following transfers:

- Rb 26994,1m grants for balancing of the Chechen Republic budget in 2012,

- Rb 1000,0m grant for balancing of the Omsk Region budget (and the same amount in 2013-2014 ),

- Rb 20000,0m grants to the budget of St. Petersburg for the purpose of increasing the charter capital of OJSC Zapadny Skorostnoi Diametr in 2012 (as well as Rb 20000,0m in 2013, Rb 10709,7m in 2014).

The latter amount allocated to the budget of St. Petersburg arises more questions. Though this is definitely a special purpose transfer, as may be seen by its title, it was allocated in the form of no-purpose transfer, i.e. grants.

The amount of grants for fiscal capacity equalization of the constituent territories of the Russian Federation in 2012-2014 is to be maintained at the level of 2010-2011, i.e. Rb 397,0bn. Therefore, no indexation of the amount of the Fund for Financial Support for Regions (FFSR) is planned within the entire 5-year period, i.e. visible reduction in real terms of the amount of this Fund was actually planned. It is obvious, however, that the need to narrow interregional differences at least remains the same. This issue is related to the effective legislative regulations under which "total amount of grants shall be determined on the need to achieve the minimum degree of estimated fiscal capacity of a constituent territory of the Russian Federation, which shall be determined as an arithmetic mean value of total indicators of the degree of estimated fiscal capacity prior to allocation of grants among the constituent territories which are ranked neither among the 10 constituent territories with the maximum degree of fiscal capacity, nor 10 constituent territories with the lowest degree of fiscal capac-ity"1. Furthermore, the FFSR's size must not be reduced in nominal terms.

In the period between 1994 and 2002, the FFSR's size was determined as a share of tax revenues in the federal budget (initially, as a share of VAT, a share of all tax revenues, save

1 Pursuant to paragraph 1 of the Method of Allocation of Grants for Fiscal Capacity Equalization of The Constituent Territories of the Russian Federation approved by Russian Government Ordinance No. 670, dd. November 22, 2004 (as may be amended). 88

for customs duties, since 1996). In the period between 2003 and 2007, the FFSR's size was determined by multiplying the last year's Fund's size by the inflation rate forecasted for the ensuing fiscal year (consumer price index). This regulation was established in the Budget Code of the Russian Federation in 20051. Since actual inflation rate often was equal to or lower than the forecast, this method of measurement of the FFSR's size resulted in a visible decrease in real terms over the period under review. Furthermore, this approach failed to take account of the real need of the regions for fiscal capacity equalization. To overcome this problems, the measurement procedure was changed in 2008. However, a new approach also had some serious weaknesses.

The following arrangement is offered to enhance the measurement procedure:

1) first, the amount of grants should be determined for equalization by using the procedure in effect;

2) if a resulting amount of grants is bigger than that of the preceding year multiplied by a forecast consumer price index, the amount of grants for equalization should be determined based on the following procedure;

3) if the amount is less than the previous year's amount of grants multiplied by the forecast consumer price index, then the amount of grants for equalization for the planning year should be determined by multiplying the amount of grants for the current year by a planned growth in consumer prices;

4) beginning with the 3rd year of application of the new procedure for measurement of the Fund's size, it would be possible to adjust calculation of the size given the difference between actual inflation and budgeted figures.

Such approach will prevent any substantial reduction in real terms of the Fund's size and make, with a certain lag though, adjustment given the difference between actual and forecast inflation. As a result, the proposed method combines the advantages of the effective approach towards measurement of the FFSR's size and the method of indexation of its size in 20032007, and a combination of these approaches allows one to a large extend to cope with the weaknesses of the methods severally.

Total amount of subsidies is planned to increase to Rb 483,5bn in 2012 from Rb 481,3bn in 2011 or by 0.5% in nominal terms.

It should be noted that no subsidies are provided for several lines of co-financing of regional expenditures in 2012:

- subsidies for roadway replacement and repair of public motor roads at the administrative centers of the constituent territories of the Russian Federation and the administrative centers of the Moscow and Leningrad Regions, as well as subsidies for full repair and repair of the territory and facilities adjacent to blocks of flats, access roads to the territory and facilities adjacent to blocks of flats;

- measures of social support to rehabilitees and persons recognized as victims of political repressions;

- child support in the foster family and home, as well as remuneration payable to the adopting parent.

Complete cessation of co-financing of road facilities in this line was related to the establishment of regional road funds from 2012. The other two lines relate to redivision of powers

1 In Clause 2, Article 131 of the Budget Code of Russia.

within the framework of a balanced package on assigning of financing of the police force to the federal budget from 2012.

Let us examine in detail the redivision of revenue and spending powers among the federation and the regions within the framework of delegation of financing of the police force under the federal jurisdiction. The following amendments will take effect from 2012:

- federal secondary vocational education institutions and disinfection institutions, as well as the powers to promote employment (save for social benefits to the unemployed) and the powers to pay a lump-sum benefit for adoption of orphan, will be placed under the jurisdiction of the constituent territories of the Russian Federation;

- the state due on vehicle registration (which is currently payable to budgets municipal and urban districts), as well as 60% of revenues from excise duties on alcoholic products with a.b.v. of more than 9% (100% of such excises were payable to the budget of the regions until 2012) will be payable to the federal budget;

- financial aid to child support in foster families and homes, as well as measures of social support to rehabilitees will be covered by exclusively with the budget of the constituent territories of the Russian Federation.

The aforesaid redivision of powers seems to be disputable from the point of view of both the fiscal federalism theory and the practice of intergovernmental fiscal relations in most of the developed countries with multilevel budget systems. First of all, there are doubts regarding the rationale of placing all powers of ensuring public security as part of law enforcement under the jurisdiction of federal branch of power. Police services constitute a local benefit whose primary recipient is, above all, the local community. In addition, international practice shows that financing of the police force normally falls under the jurisdiction of regional/local government bodies, not the central government (United States, Canada, etc.). It should be noted that Paragraph b), Article 72 of the Constitution of the Russian Federation reads that the joint jurisdiction of the Russian Federation and the constituent territories of the Russian Federation includes: "... ensuring the rule of law, law and order, public security ..."; and Paragraph 1, Article 132 thereof reads that "the local self-government bodies shall independently ... ensure the protection of public order ...". Therefore, the Constitution of the Russian Federation already laid the ground for law enforcement powers of regional and municipal government bodies. In addition, there are questions regarding the cessation of federal budget co-financing of measures of social support to rehabilitees and persons recognized as victims of political repressions. These categories of persons entitled to benefits emerged by virtue of decisions made in due time by the central government. From this point of view, it would have been more logical to place these powers under the federal jurisdiction. Generalizing the aforesaid, it should be noted that effectiveness of implementation of the proposals within the framework of placing all powers of financing of the police force under the jurisdiction of the federal government is disputable.

In accordance with budget projections, total number of federal budget subsidies allocated to the budget of the constituent territories of the Russian Federation must decease to 94 in 2012 from 105 in 2011 and then keep deceasing gradually to 70 in 2013 and 62 in 2014. In general, this trend should be regarded as positive. The effective system of large number of odd subsidies with the amount being less than (or slightly more than) Rb 1bn for some items is responsible for a visibly lower degree of effectiveness and transparency of the Russia's system of intergovernmental fiscal relations, above all, in terms of restricting the freedom of decision-making on the side of regional government bodies amid non-conformity of federal and

regional priorities in some cases. However, the proposed decrease in the number of subsidies seems to be insufficient.

It should be noted that transition to a result-oriented method of formation of the federal budget creates certain obstacles on creating an intersectoral consolidated (block-based) subsidies. Even this fact, however, fails to explain 62 subsidies planned for 2014. Russian Government Ordinance No. 1950-r, dd. November 11, 2010, approved a list of 40 public programs of the Russian Federation (as amended and updated). These programs cover more than 97% of the federal budget expenditures in 2012-2014. It is also obvious that not every program provides for federal budget co-financing of regional expenditures, simply because relevant powers fall exclusively under the jurisdiction of the federal government. This refers to such programs as "Russia's Space Activity" (No. 21), "Development of the Nuclear Power Generation Complex" (No. 22), "National Defense Capability" (No. 31), "Federal Property Management" (No. 37), "Foreign Policy" (No. 40), etc. Therefore, one may say that the number of subsidies planned for 2014 is twice as much as the number of public programs. The aforesaid proves that the proposed measures of streamlining the system of subsidies in the Russian Federation are insufficient.

Total amount of subventions is planned to decrease in nominal terms by 24.1%, to Rb 256,0bn in 2012 from Rb 337,5bn in 2011. Again, the decrease is conditioned mainly by redivision of powers among the federal center and the regions due to the fact that the police force will be financed by the federal budget from 2012. As noted above, a part of the powers will be placed under the regional jurisdiction (lump-sum benefit payable for any type of adoption of children with are deprived of parental care; promotion of employment, save for unemployment benefits). In addition, in 2012, no subventions will be allocated for exercising powers of preparation and carrying out statistic censuses, because relevant measures have been completed.

Total amount of other interbudget transfers must be reduced to Rb 36,5bn in 2012 from Rb 63,4bn in 2011, or by 42.4% in nominal terms, mostly due to the cessation of allocation of interbudget transfers providing an increase, which is equal to that in the Ministry of the Interior of Russia, in the money allowance payable to the personnel and wages of the employees of public security police units (the amount of this transfer accounted almost 35% of the total amount of other interbudget transfers allocated in 2011).

The following regulations stipulated in the Federal Law "On the Federal Budget for 2012 and the Planning Period of 2013 and 2014" should be noted. First, an increase in the cost of budget loans (Clause 2, Article 13 thereof) from 1/2 to 2/3 of a refinancing rate quoted by the Central Bank of the Russian Federation (save for financing of measures relating to natural and man-made disaster management). Second, a new regulation appeared, under which transfers can be allocated exclusively pursuant to legal acts issued by the Government of the Russian Federation rather than federal executive bodies (Clause 2, Article 12 thereof). These changes can be regarded as positive and improving the effectiveness of the effective system of intergovernmental fiscal relations. It should be noted, however, that the second regulation must, strictly speaking, be applicable to the Budget Code of the Russian Federation on a long-term basis.

In general, it should be noted that the parameters of the Federal Law "On the Federal Budget for 2012 and the Planning Period of 2013 and 2014" with regard to intergovernmental fiscal relations with the constituent territories of the Russian Federation give rise to a series of serious questions in terms of enhancing the effectiveness of the Russian's system of federalism.