Budget sequestration and tariffs freeze mean a new economic reality for the state and businesses
Issue:
October 2013, Vol. 10
Tags:
Medvedev
The Kremlin and businesses are seeking more effective optimization of their overhead costs and other obligatory expenses as a marked slow down or even stagnation in economic recovery trends threaten to truncate the economy by almost RUB1.3trln over the next two years, according to experts’ forecasts.
The deficit in the state budget is expected to deepen further in 2014 with expenditures forecast to overshoot revenue not by 0.4% of GDP, as previously extrapolated from July 2013 data, but by 0.6% of GDP. The negative trends are also expected to continue in 2015, when the deficit will fall not by 0.6%, but by 1.0% of GDP and in 2016, when the deficit increase is expected to plateau at 0.6% of GDP. In other words, the state budget is expected to remain in deficit over the next three years.
As a part of the adopted measures to mitigate the expected negative spillovers from the stunted economic growth and recovery trends, the Russian government has adopted a raft of fiscal policies and austerity measures, including budgetary sequestration, optimization of state procurement orders. It also intends to freeze monopolists’ tariffs on their services and products so as to stem inflation and associated price hikes. According to the Economic Development Ministry’s calculus, revoke of indexation of Russian Railways and other monopolists’ goods and services will generate a minimum of RUB420bn for the state coffers in 2014-16.
The government intends to fund its priority programs from in-house resources as it plans to reduce the budget by 5%, or between RUB100bn and RUB 300bn, each year. However, there are no plans to use the Reserve Fund to finance these deficits. One of the ways to generate revenues could include privatization of state assets, with the government expected to sell a 19.5% stake in Rosneft for not less than RUB420bn by 2016. Also, internal borrowings will be used to augment these other revenue sources.
“Going by the severity of the fiscal policy measures adopted by the government, one can aptly say that the Kremlin has opted for maintaining the country’s macro-economic and financial stability over keeping the current spending policy.”
The government intends to retain social expenditures and major capital-intensive transportation infrastructure projects such as the overhaul of the Transsib and BAM as well as the development of the Moscow-Kazan high-velocity express and Central Ring Auto Road in the Moscow Region. However, the government has down-scaled defense budget, postponing some of the already adopted military-focused expenses to a later period.
The government intends to raise taxes on a raft of properties and services. Thus effective from 2014, the government plans to introduce a new real-estate tax based on cadastre valuation, instead of the current one based on so-called inventory value. The new tax rate is expected to several times higher than the current one. Also, the government is contemplating on phasing out the 10% VAT on socially vital goods and services, such as children’s wares, medicines and press, compared to a VAT of 18% slapped on all other goods and services.
Despite these negative trends and tariffs freeze, the Economic Development Ministry still expects the country’s GDP to increase by 3% in 2014, up from the 2.8% previously forecast. Investment is expected to be at 3.9%, while industrial output is projected at 2.2%. In 2014, price increase is expected in the 4.6% range, down from 5% previously forecast. The monopolists’ tariffs will be indexed by 4.6% in 2015.
Experts’ assessments of the proposed austerity measures
These policy measures being adopted by the government mean the Kremlin has opted for macro-economic and financial stability over keeping the current spending policy. “It has become clear that it would be impossible to keep both policies, and the fact that the government has opted for macro-economic and financial stability is a good sign,” Evsei Gurvich, director of the government’s Economic Expert Group, said according to reports carried by the local media. “This is not about whether the budget will become better or worse. Similarly, this is also not an issue of budget improvement, but a forced measure in conditions of economic slow down and loss of revenues. The choices under these conditions include violation of the budgetary rules, increase deficit funding or reduction of budgetary expenses.”
However, if the budget expenditures sequestration will be done mechanically, the outcome will be negative; the same result will be obtained in case of increasing deficit funding. The only difference is that in the former case, the negative manifestations will be instantaneous, while they will manifest in the future in the latter case. The same result will be obtained if, monopolists, in response to the tariffs freeze, decide to reduce their investment budgets. But a positive outcome will only be obtained if in conditions of limited resources both the government and monopolists will seek boosting financial efficiency.
The proposed economic measures are very painful, but are, at the same time, vital, irrespective of the prevailing economic trends, Andrei Chenyavsky, an economist at the Higher School of Economics Development Center, said, according to local media reports. Consequently, these measures should be welcome, as they on their own cannot compromise the budgetary or the economic stability, he added.
The risks are in other places, including further slowing of the economy, which could grow into a full-blown crisis. In such scenario, even these tough fiscal measures could prove helpless, the expert noted. The other risks include possible worsening of oil price volatility and the depletion of the National Reserve Fund resources as a result of increase in infrastructure projects financing. The fund is one of the foundations of the current fiscal and macro-economic stability and hence its depletion will undermine this stability.
The logic behind infrastructure projects financing, according to experts, is sound as it could catalyze growth across several sectors of the economy and hence activate a much faster rate of economic recovery. But the risk and concern are that such resources might not be effectively used as fraud, corruption and financial mismanagement that usually accompany such huge capital-intensive programs could undermine the policy’s best intentions.
Infrastructure monopolists’ mixed reactions
Despite the tariffs freeze, infrastructure monopolists will not be allowed to decrease their investment budgets, Economic Minister Alexei Ulyukaev said. They will have to mobilize their internal reserves and other sources as well as adopt economy regimes and other measures aimed at optimization procurement orders and other expenditures, he added.
The reactions from key infrastructure monopolists, such as Russian Railways Corp. and Russian Grids Network, the newly created power generation and supply giant, have been mixed. Thus, commenting on these austerity measures and their expected negative impacts on businesses, Russian Railways Corp. President Vladimir Yakunin noted the policies will cost the railways monopolist over RUB 77bn.
Consequently, Russian Railways intends to reduce its investment budget, estimated at RUB389.4bn, by three times, to RUB129.1bn; its projected capital expenses by four times and drop the plans to attract RUB150bn from the National Welfare Fund. This is because Russian Railways, under the current conditions, will not be in a position to effectively service such borrowings, the executive said. Other negative spillovers include possible of laying-off up to 62,000 employees, or about 5% of the total workforce, and/or put them on shortened work regimes without wage loss compensations, according to the railways giant.
“As a part of the adopted measures to mitigate the expected negative spillovers from the stunted economic recovery trends, the government has adopted a raft of drastic fiscal measures, including budgetary sequestration and freezing of monopolists’ tariffs.”
Despite these complaints, Yakunin has so far resisted the temptation to directly ask the government to compensate these envisioned losses, as had been done several times in the past. He, however, noted that the tariffs freeze will have devastating impacts on Russian Railways’ operations, especially if the losses will not be compensated for by state subsidies.
However, on the other hand, Russian Grids Network sees the austerity measures as an opportunity, sort of “a blessing in disguise,” to bring an order to the power industry as a whole as well as seek optimization of resources and reduction of the company and its subsidiaries’ management apparatuses in particular.
“These measures will be an additional stimulus to increase the company’s efficiency and reduce production and management expenditures,” Russian Grids Network CEO Oleg Budargin said. “However, such optimization cannot be done by simply reducing the workforce,” the company said in an official statement.
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