COMMENT: Russia considers how to impose austerity in a time of recession

COMMENT: Russia considers how to impose austerity in a time of recession
Protesters during the last demonstrations against the Russian leadership.
By Christopher Miller of Yale University March 23, 2016

The oil price may have climbed off its low recently, but Russia’s government budget remains a shambles. Russia’s political class is beginning, slowly, to come to terms with a new reality: hitting this year’s budget deficit target of 3% of GDP without increasing debt levels will require significant tax hikes or spending cuts. For the first time since Russian President Vladimir Putin took power, the political class has to work out how to impose austerity in a time of recession. 

The need for austerity could not have a come at a worse time on the Kremlin’s political calendar. A new Duma will be elected in September, with the governing United Russia party seeking to retain its parliamentary majority. The last time Russia held Duma elections – amid a growing economy and a benign foreign policy environment – vote rigging on behalf of United Russia sparked huge protests in Moscow and other cities.

The discontent was mitigated by hiking pensions and the salaries of state employees. But given current budget projections, the next two years are likely to see not wage hikes, but wage cuts. Pensions may well fall in real terms this year. Public sector salaries are being squeezed. Neither of these trends is likely to produce voter enthusiasm for the ruling party, which is widely perceived as corrupt.

Poorly designed budget cuts and tax hikes risk inflaming popular sentiment on the eve of the Duma elections. It is easy – and not inaccurate – to blame the recession on uncontrollable foreign factors, above all the oil price. But if the government hikes taxes or cuts spending, voters will know who to blame. And everyone in Moscow sees the Duma vote as a dress rehearsal for the reelection of President Vladimir Putin, which is scheduled to take place in 2018.

Budgetary realities mean that some belt-tightening is inevitable. Political realities – including the fact that many individuals and inefficient state-owned companies are perceived to be untouchable – mean that a portion of this belt-tightening will fall on society at large. Yet it is already proving harder than some had hoped.

Take tax increases. Late last year, the government introduced a new highway tax system, called Platon, to fund road construction. Collection of the tax was privatized and given to a company owned by Arkady Rotenberg, a billionaire businessman and former judo partner of Putin.

The tax raised only minor amounts of revenue, but it created a huge political storm. Truckers, who were hit hardest by the tax, revolted. They stopped their trucks in the middle of highways, obstructing traffic and creating miles of clogged roads. Many other Russians supported them. Some alleged that the collection mechanism – via a firm owned by the president’s friend – was evidence of high level corruption. Despite Russia’s relatively low tax burden, the new tax was seen as illegitimate, and the government backed down. But that raised a worrying question: if it cannot impose a relatively small tax on truckers, can the Kremlin count on new taxation to raise even a fraction of the billions of rubles that would be necessary to balance the budget?

Not so loyal

If tax increases are out, spending cuts are the other option. Pensions may fall this year in real terms, though the government may decide to hike them in the second half of this year, perhaps in advance of elections. Yet other spending cuts look likely to be no less controversial than pensions. The problem is not only the elderly. Other groups that once loyally supported the government are beginning to raise questions about austerity.

Industrial workers are one potential source of political uncertainty. If you look at unemployment figures, which have only barely increased since the crisis began, the labour market looks healthy. But low unemployment has been maintained only because firms held nominal wages constant and let inflation cut the real value of their wage bill. As the crisis grinds on, many firms face pressure to cut more sharply, either by furloughing workers or laying them off.

Uralvagonzavod, a firm that makes train cars and tanks, highlights the risk that spending cuts spark industrial unrest. The company, whose factories are based in Nizhny Tagil in the Ural region, has seen demand for train cars plummet given the recession, and cut working hours in response. The industrial workers of the Urals were once a bastion of support for Putin, but now some are protesting wage cuts – and blaming the government for their plight. Government plans to cut defense spending by 5% will put new pressure on Uralvagonzavod’s tank production. Yet any move to furlough tank workers risks inciting new protests, and further eroding government support.

The political calculus about the upcoming elections suggests that now is not a good time for spending cuts or tax hikes. Putin’s approval rating may be well above 80%, but the Kremlin is wary of being seen to impose economic pain. And budgetary austerity has only just begun to bite.

Chris Miller is Associate Director of the Program in Grand Strategy at Yale University. Follow him on twitter @crmiller1