Freedom fighting for rubles: Russia’s cash-strapped regions are imposing economic separatism to survive

Freedom fighting for rubles: Russia’s cash-strapped regions are imposing economic separatism to survive
Russia’s cash-strapped regions reach for every extra kopek to meet budget obligations.
By Nicholas Trickett in London, Chris Jarmas in London March 12, 2018

On February 10, Russia’s Federal Anti-Monopoly Service (FAS) complained that regional protectionism is a growing problem for the Russian economy, particularly for agricultural products.

The report comes as Russia’s cash-strapped regions reach for every extra kopek to meet budget obligations. Many regions are in crisis after President Vladimir Putin ordered them to significantly hike wages and social spending in his 2012 May decrees. The Ministry of Finance has been on their case, pushing to reduce the amount of financial support flowing out to the regions from the federal budget.

In mid-December, Finance Minister Anton Siluanov complained that the regions had hidden their budget problems for years, most vigorously pointing a finger at Mordovia and Khakassia. At the end of the month, he called on the regions to tighten budget policies, blaming irresponsible policies for declining trust and confidence in Moscow and among investors. At the Gaidar Forum in January, he spoke to the fact that Russia’s current political economy encourages regions to try to get more money out of the federal centre. For Moscow, it’s a case of “good tsar, bad boyars”. But Siluanov’s tune is a tired one and nothing new politically.

Fights over regional dependence on federal money have been going on for more than five years. As more obligations have been kicked towards regional budgets unable to raise enough revenues, debts have exploded. Part of the problem is that while the federal government enjoys revenues earned from taxes on oil and gas exports, the regions earn their money from VAT, income and corporate profit taxes. They are a lot more dependent on the economic health of the economy and that has not been good for the last few years, although the situation has improved somewhat recently thanks to the end of a two-year long recession.

The Kremlin is now trying to have it both ways by giving regional governments seven to 12 years to restructure debts while threatening to sanction regions that are too indebted. The growing regularity of regional schemes to support their own industries are largely rooted in budget policies.

Moscow has opted to buy itself a pass for now but is looking to reduce spending going forward, turning budget consolidation into a slow-moving train wreck rather than a fast and painful manoeuvre. Budget transfers to the regions are set at RUB645.1bn for this year, with transfer increases for 47 regions and decreases for another 26. This may not prove sustainable. FAS’s complaint exposes a serious problem: the ostensible stabilisation of the economy is pushing regions to privilege their own companies in pursuit of revenues. In other words, stabilisation isn’t proceeding evenly at a time when Moscow wants to spend less on regional subsidies going forward – a goal that necessitates regional convergence.

Roots of the wage and budget problem

The May decrees of 2012 built a social reform plank that depended on increasing state employee wages. Considering that public sector employees comprise nearly a quarter of Russia’s workforce, this was a costly promise. Naturally, the collapse in oil prices, effects of sanctions, and structural problems in Russia’s economy have made it hard to meet the bill: 77% of 1,600 Russians polled by the National Agency of Financial Research said that high wages were most important in finding their ideal job. Average wages in Russia for 2016 stood around RUB32,600 ($573) a month and grew an estimated 3% last year in real terms, 7% in nominal terms, reaching RUB38,275 rubles a month. But the distribution of wages at the regional level shows a more complicated story than one of stabilisation and recovery after the economic crisis hit in 2014.

Median wages by region as of April last year are far from evenly distributed: only nine of the 85 regions (including Crimea and Sevastopol) surveyed had median wages higher than the national average. Of those nine, four are oil and gas production sectors and four either supply other raw materials and resources, are slowly developing their hydrocarbon reserves, or receive large subsidies due to higher costs of living. Moscow isn’t the top region either, with both Yamalo-Nenets and Chukhotka’s regional nominal wages higher on average.

The lack of high-earners paints a starker regional breakdown. In 72 of 85 regions, fewer than 5% of the workforce earns more than RUB100,000 ($1,757) a month. By share of high-earners, Moscow is in the lead (17.05%), followed by Chukhotka (20.98%), and Yamalo-Nenetsk (23.47%).

More than 10% of the population earns less than RUB10,000 a month in 53 regions and more than 20% of the population earns less than RUB10,000 a month in 22 regions.

Of course, when one accounts for population density, things are much more complicated. Varying wage levels, in part, speak to structural issues in Russia’s economy going back to the Soviet period. Much of the country was unsustainably developed without concerns for market logic, creating supply chains and structures that require heavy subsidisation to this day. But the link between wages and regional budget troubles can help explain why concerns about regional protectionism are popping up now.

A fraying social contract

In many regions, wages are artificially inflated by coefficients pegged to national averages, a practice begun in the Soviet period when the state sought to reward people, particularly skilled labour, for living in harsh and remote conditions.

The laws also alter the amount added to wages if one moves to the region – life-long residents receive greater benefits. As bne IntelliNews has reported, the country’s poorest regions were pushed into debt because most of the cost of the 2012 May Decrees fell onto regional budgets. Back in 2015, Natalia Zubarevich calculated that 70% of the May Decree expenditures had been shoved onto regional budgets. The balance of expenditures has most likely tilted even more heavily towards the regions since.

As a result, it makes less sense for regional governments to provide subsidies to businesses if they’re registered outside of the region and don’t contribute corporate taxes to already-stretched regional budgets. Excise taxes on alcohol are a particularly prized revenue stream lost if the company that manufactures it isn’t registered within the region.

FAS’s concern is that these manoeuvres to deny subsidies raise costs for consumers. In the wake of Putin’s address filled with promises to improve living standards and create economic growth, it ought to be noted that only 28% of respondents polled by Gallup at the end of last year expected major improvement in the economy this year. What’s happening with regional budgets directly impacts the Kremlin’s contract with regional elites and governments.

Declining federal budget transfers to the regions leave regional authorities with an array of bad choices. Average wages for regional state employees can be raised, but often with the caveat that some workers must then be let go. Another ruse that has emerged is wages are raised but then so are working hours, or per hour wages are increased but the number of hours are then reduced.

Improvements in credit ratings to please Moscow entail cutting spending that is obligated by social programmes launched in 2012. Most of all, macroeconomic stability is not leading to greater investments or budget transfers from Moscow for regions in serious need. Excluding a one-time pension payout, real incomes declined 7% year-on-year this January. But rising consumer spending is being driven by a growing willingness to take on debt.

If the regions are going to increase their revenues amidst an ostensible stabilisation of the economy with declining real incomes, it’s in their interest to capture revenues locally and cease taking part in complicated transfers of their own budgets to aid businesses elsewhere. “Economic separatism” makes sense. Already by August 2016, then-governor of Samara Nikolai Merkushkin warned that the time had come “to fight for every ruble from the federal budget.” It’s unlikely Putin 4.0 has much to offer to change that.