The outlines of Russia’s next three-year budget are emerging as the State Duma revs up to debate its spending plans until 2019 later in October. Two themes emerge: Russia’s next budget will impose austerity on the government, but pave the way for the 2018 presidential election with big increases in social spending.
What is already clear is the ministry of finance intends to put a hard cap on spending of RUB15.7 trillion irrespective of what happens to the prices of oil – the main unknown that will significantly affect the amount of money the Kremlin has to spend. In its recent three-year forecast the economy ministry said the government would assume $40 per barrel of oil over the next three years as its base case, but even in the more optimistic “plus” scenario the most oil would rise to is $55.
That leaves the finance ministry with a tough job on its hands. Russia is likely to run a 3.7% of GDP deficit this year, or about RUB3 trillion ($48bn), which is more than it was hoping for at the start of this year when 3% of GDP, or RUB2 trillion ($32bn) was set as the target.
Moreover, the ministry’s plan is to reduce the deficit by about 1% each year over the next three years. The only way these goals are achievable is if through austerity; VTB capital drew up a table detailing some of the spending plans and assumptions for the next three years that fleshes out the policy choices that are likely to be made in the new budget.
This year, the budget allows the state to spend RUB16.1 trillion, a lot of which has gone on defence spending to fund Russia’s wars in Ukraine and Syria, as well as the ongoing modernisation of the Russian army.
However, the military spending high-water mark has been reached and the plan is to reduce the amount by a third over the next three years, from RUB3.1 trillion in 2016 to RUB2.3 trillion in 2019. Indeed, spending on everything will be steadily cut over the next three years, with a few exceptions, with some of the biggest cuts slated for the last quarter of this year.
The one big exception is social spending, which is the only item that will see an increase – and a big one: social spending will rise by a third from RUB4.4 trillion in 2016, the largest line item in the budget after the federal government’s general expenditure bill, to RUB6.2 trillion. Spending on everything else will decrease to keep the spending inside the RUB15.7 trillion cap; to a large extent the increase in social spending will be financed by the cut in military spending.
Sberbank CIB sees the budgetary framework for 2017-2019 as remaining “realistic, on the whole”, noting that the planned decline in nominal expenditures “will improve the resilience of the financial system and will help the CBR achieve its inflation target of 4% in 2017”.
The bank warns on October 10, however, that “assuming taxation of the oil sector does not change significantly, the budget will remain very sensitive to any drops in the oil price”, with the deficit potentially spiking rapidly if the Brent oil price drops below $40/barrel.
On the other side of the coin, the government is looking for ways to raise more revenue, but is still very reluctant to take the most obvious action and just raise taxes on companies and the population. Clearly there is room to raise the tax rate from the extremely low 24% corporate profit tax and 13% income taxes, but as this is an “election budget” the Kremlin is hunting for new revenues elsewhere first. President Vladimir Putin vetoed any tax hikes until 2019 at the end of September, effectively tying one of Finance Minister Anton Siluanov’s hands behind his back.
The ministry recenlty announced it would increase domestic borrowing this year from RUB300bn to RUB500bn, in addition to the $3bn Eurobond it has issued this year. Next year could see an even more dramatic increase in borrowing: Siluanov said in September Russia intends to resume issuing the $7bn of Eurobonds it used to issue every year, but he also suggested that domestic borrowing could soar to RUB1,200bn. As long as the western financial sanctions remain in place the Russian government has few alternative sources of credit.
“The deficit will cause the local debt to grow from RUB9.1 trillion as of end of this year to RUB12.8 trillion by the end of 2019,” Alfa Bank’s Natalia Orlova estimates on October 10, while warning that “such aggressive borrowing may cause around 4-5pp increase of the local interest rate all things being equal”.
Taxes on the oil and gas sector are being continuously revised and more increases to the mineral extraction tax (MET) are being bounced around. The state expects to raise RUB12.6 trillion in tax revenues this year, including RUB4.9 trillion from oil and gas companies and another RUB2.9 trillion from the MET.
Privatisation is one source of ready cash and plans to sell off the state’s 50% stake in oil company Bashneft recently came back to life. But even if the moot sales of a 19% stake in Rosneft is also closed then this will only raise about RUB1 trillion, which will help but remains insufficient to fill the deficit hole.
Another option the Kremlin seems to be pursuing is to http://pro.intellinews.com/moscow-blog-unveiling-the-kgb-school-of-economic-management-106489/?source=russiahttp://pro.intellinews.com/moscow-blog-unveiling-the-kgb-school-of-economic-management-106489/?source=russiato the problem every year, by some estimates. But the bottom line is the best solution remains to implement deep structural reforms that would underpin faster growth and those are unlikely to start until after the presidential elections – if then.