Russia 2010. Part 4. Government Finance

(the part of book "Russia 2010. Report of Transformation")

Part 4. GOVERNMENT FINANCE

In 2010, the budget policy was established in the short-term forecast perspective for no more than 12 months. The earnings and cost items were reviewed, in average, every three months both in the federal and in the regional budgets. A major part of economic decisions were made ‘manually’ using the simplified system for money allocation. The main purpose of the federal government was maintaining the production rates with minimum unemployment and performance of social obligations.

The government has started to change the ‘anti-crisis development model.’ Despite the budget deficit, the expenditure in the main financial document on certain infrastructure projects and strategic sectors was still increased. The government is planning to spend money on establishment of high-tech production facilities with a high rate of processing and added value. An extensive privatization program will provide some funding for that. At the same time, the government has prepared foundations for a transition from a cost estimate system to a program target system, which is intended to raise the governance quality and cure the chronic illnesses of the Russian economy including ‘the unspent budget’ at the end of the year and the dependence on raw materials in the basic sectors.

Budget policy

2010 has become a breaking year for Russia’s budget policy. The main financial document is planned for three years again like it was done before the crisis. Despite the obvious conventionalism of the forecasts in the long-term budget, the peaks of state funding for the main capital-intensive projects will be after the elections (2012-2015). The budget deficit in 2011 is planned in the amount of 1.814 trillion rubles (3.6% GDP), in 2012, 1.734 trillion rubles (3.1% GDP), and in 2013, 1.795 trillion rubles (2.9% GDP). The budget income in 2011 is planned in the amount of 8.844 trillion rubles (17.6% GDP), in 2012, 9.503 trillion rubles (17% GDP), and in 2013, 10.379 trillion rubles (16.8% GDP). Of that amount, proceeds from raw materials will amount to 4.090 trillion rubles (8.1% GDP) in 2011 and 4.39 trillion rubles (7.9% GDP) and 4.653 trillion rubles (9.3% GDP) respectively in 2012 and 2013. The budget is based on a moderate yearly growth of the Urals oil price, which is the main part of the Russian exports; it is expected that the price will grow from 75 dollars per barrel in 2010 and 2011 to 78 dollars in 2012 and 79 dollars in 2013. The budget expenses in 2011 are approved in the amount of 10.658 trillion rubles (21.2% GDP), in 2012, 11.237 trillion rubles (20.1% GDP), and in 2013, 12.175 trillion rubles (19.7% GDP). GDP in 2011 is predicted in the amount of 50.389 trillion rubles (4.2% growth), in 2012, 55.95 trillion rubles (3.9% growth), in 2013, 61.92 trillion rubles (4.5% growth). Inflation in 2011 is planned at the rate of 6.5%, in 2012, 6.0%, and in 2013, 5.5%.

Next year, the government will bet on maintaining its social obligations and developing strategic regional projects. Just like last year, the 2014 Olympics are on the agenda, now an individual budget item for the first time, and the APEC summit in Vladivostok. Both projects are mainly funded from special federal target programs (FTP) and extra expenses by the main state companies. Preparations for the 2018 World Football Cup will be funded in a similar way. The Ministry of Finance will design a FTP for it already in early 2011 by reallocating the budget cash flows. However, even if all the available resources are mobilized, the government will still need about 200 billion rubles of extra funding. And this is just the infrastructure costs.

Some part of the extra costs may be compensated with a major privatization program that the government adopted in November 2010. In the last decade, the government sold little of its property. Low privatization rates were explained by high oil and gas revenues, which left no need for extra earnings from government asset sale. For example, in 2008 privatization proceeds were less than 10 billion rubles, and in 2009 they fell down to 1.93 billion rubles. It should be mentioned that only small-size companies or real estate were sold.

The situation began to change in 2009. A budget deficit made the government look for extra income. One of the fastest ways to get significant cash is selling government assets. Unlike 2009, in 2009 the privatization plan was drafted by Igor Shuvalov himself and not the Minister of Economic Development, Elvira Nabiullina. The First Deputy Prime Minister hoped to include major state companies like Rosneft, Sovkomflot, Aeroflot, RusGidro and others in this document. However, last year the main groups of influence objected to the official’s initiative and managed to delete some companies from the privatization plan.

Despite the 2010 defeat, Shuvalov continued the campaign for large-scale sale of assets.

This time, the resistance was separated and weak, while the oil and gas funds have shrunk, and the economy showed slow recovery rates. As a result, with the Ministry of Finance’s support, the Deputy Prime Minister had succeeded in including the main state companies on the long-term privatization plan, which was presented in November. According to the plan, the biggest privatization transaction in the next five years will be reduction of the state share in Rosneft down to the controlling stake in 2011-2015, which means that up to 15% of the company shares may be sold on the market in 2012-2015. The other block of shares may be disposed by asset exchange transactions. After 2015, the government intends to make its share in Rosneft lower than the controlling share. In addition, there are plans of selling 7.97% RusGidro shares by 2013 and possible reduction of Russia’s share in the company down to 25% plus one share in 2014-2015. The government may part with 4.11% of the Federal Network Company (FSK) shares at 50 kopecks or more per share and push forward Sovkomflot privatization. The state-owned 25% block of shares in this company may be sold in 2011, while another 25% minus one share will be sold in 2012-2013, and the government may lose control over the company in 2014-2015. According to long-term plans, in 2013-2015 the government may also sell a major share (25% minus one share) in OJSC Russian Railways. In addition, according to the privatization plan, in early 2011 10% of VTB shares will be sold to a pool of foreign investors, 10% more may be offered on the market in 2011, and up to 15%, after 2012. Afterwards, the government may also make its share in the bank less than the controlling share. At the same time, the Central Bank intends to reduce its share in the Savings Bank down to the controlling share in the next two years. The government is planning to sell 25% of Rosselkhozbank shares (by 2015), 100% of the United Grain Company (by 2013) and 50% minus one share in Rosagroleasing (in 2013-2015).

The sale of the Russian bank number two was the first on the agenda. The sale of VTB has been planned for a long time. However, until recently, the Ministry of Finance objected to the sale. Alexey Kudrin’s agency hoped to keep control over the strategic asset in 2011, but the crisis interfered in the Ministry’s plans. The financial institution will be bought by TPG Capital, a subsidiary of the US TPG (Texas Pacific Group), one of the biggest private investment funds of the world whose assets are worth 40 billion dollars in total. This non-resident has been active in Russia for a long time. Since last year, VTB has had a joint project with TPG Capital, namely, the US fund and TVB-Capital together own a 30.8% share in Lenta, the fifth biggest grocery retailer in Russia. It is with the support of the Russian partner, namely, the head of the state bank, Andrey Kostin, that 10% of VTB shares may go to a non-resident. As a result of the transaction, TPG Capital will get a strategic partner to go into Russian retail, and the credit institution will lay hands on cheap foreign funding.

Even though most big state companies of Russia are on Shuvalov’s list, the privatization of some of them is still a question. The fate of two business structures, Russian Railways and Rostekhnologii, is the least clear. Deletion from ‘Shuvalov’s list’ will cost both companies control over their key subsidiaries. Russian Railways will have to sell the First Cargo Company (PGK). Sale of 75% minus one share in PGK is planned for the first half of 2011. The transport monopoly is considering two options, namely, an IPO or selling to a strategic investor, Gennadiy Timchenko. The latter is already negotiating the PGK purchase but has not yet had his initiatives approved by the Ministry of Transport. However, Russian Railways is planning to keep control over the Second Cargo Company (VGK) and avoid privatization of the parent company. The Ministry of Transport insists on a major sale of the transport monopoly’s assets. Igor Levitin’s agency has long been lobbying for mass privatization of the strategic business entity and will not be satisfied with just PGK.

The situation with Rostekhnologii is similar. The head of this company, Mr. Chemezov, announced a sale of the military industry complex assets. The Minister of Economic Development is lobbying for the sale of military industry companies systemically. Elvira Nabiullina heads the Strategic Committee in the Supervisory Board of the state corporation and has many times endorsed less presence of Rostekhnologii in the economy. The sale will not begin until the second half of 2011. The reason is that military assets may not be sold until they are consolidated in several Oboronprom’s military industrial holdings. Endorsement of the privatization plan will enable Rostekhnologii to strengthen its position in the uneasy struggle with Igor Sechin. The Deputy Prime Minister has long been interested in weapon exports, which are most profitable part of the state corporation. To push Rostekhnologii away from the strategic market, the official has used the United Shipbuilding Corporation that he controls to propose that the right to export military shipbuilding products be transferred to this corporation. Backed up by the pressure of the Ministry of Economic Development, Igor Sechin’s demarche may be quite painful for Rostekhnologii.

Along with increasing the revenues through the tax burden growth and privatization, the Ministry of Finance is continuing to lobby for a state expense efficiency raising program. Alexey Kudrin’s agency has been lobbying for this project for several years but until recently, nearly all the federal agencies and Deputy Prime Ministers opposed the Ministry’s strategic initiatives. According to the Ministry’s proposals, the government will state a clear government policy, which will then be implemented in budget-funded state long-term target programs (SLTP). The latter, according to the Ministry, should bring together the target programs of individual agencies, which are smaller in coverage area and scale and bring certain results, such as granting a certain amount of subsidies, providing a certain amount of services, supporting a certain group of the public, etc. These specific results will be a form of reporting and will be used for checking the efficiency of the completed work and evaluating the efficiency of the SLTP existence in the future. The transfer to the new funding principles will concern all the budget-funded entities, and in some time they will be funded with subsidies and not according to cost estimates as it was before. The powers of the heads of state institutions will be expanded, and they will have to work like top managers whose work efficiency will be evaluated for budget expense planning. This way, the Ministry of Finance is trying to build the result-oriented budgeting ideology that was first announced several years ago. According to the Ministry’s concept, this should be the budget format since 2012.

Alexey Kudrin’s proposals will add to the finance agency’s weight, as all the SLTP will be approved by the Ministry. According to preliminary data, the amount in question may be 1.5-2 trillion rubles. In the future, the financial control of the Ministry of Finance may increase substantially. Alexey Kudrin’s agency has suggested transferring all the budget to the target program principles in 2012-2014. Considering that this year just 8% of all the government expenses will be used to fund 73 target programs, the financial control of the Ministry of Finance may increase by 92%. Basing on the 2012 forecast, flows of about 7-7.5 trillion rubles will get under direct jurisdiction of the Ministry of Finance.

It is the growth of revenues from the increased tax burden, privatization expansion, and state expense cuts due to the transfer to the target program funding are intended to reduce the budget deficit. This is especially important for covering the social obligations of the government, which account for a major part of state funding.

Social policy

Social obligations to certain groups of the public will remain the cornerstone of Russia’s social policy. In 2010, the government increased pensions and budget-funded salaries substantially. This left the budget with no big reserves for raising the social expenses, and in order to keep the achieved rates, the Ministry of Finance and the Ministry of Healthcare and Social Development tried to raise the efficiency of social expense management by reducing the deficit of extrabudgetary funds.

To bring their revenues and expenses into balance, the tax burden will be increased, and their total structure reformed. The extrabudgetary fund structure includes the Pension Fund, the Fund of Compulsory Medical Insurance, and the Social Insurance Fund. These entities (with the exception of the Fund of Compulsory Medical Insurance) are the main recipients of state expenses, which in 2013 will exceed a quarter of all the federal budget.

The revenues of the Pension Fund’s budget in 2011 are planned in the amount of  5.137 trillion rubles, in 2012, 5.654 trillion rubles, and in 2013, 6.245 trillion rubles, and the expenses, 4.822 trillion rubles, 5.301 trillion rubles, and 5.843 trillion rubles respectively. Transfers from the federal budget to the Pension Fund in 2011 will amount to 2.341 trillion rubles, in 2012, 2.561 trillion rubles, and in 2013, 2.803 trillion rubles. The revenues of the Fund of Compulsory Medical Insurance in 2011 will amount to 336 billion rubles, in 2012, 369.2 billion rubles, and in 2013, 403.5 billion rubles. The revenues of the Social Insurance Fund in 2011 will amount to 458.8 billion rubles, in 2012, 500.9 billion rubles, and in 2013, 552.6 billion rubles. Transfers from the federal budget to the fund will be 69.88 billion rubles, 74.52 billion rubles, and 77.57 billion rubles respectively.

Alexey Kudrin won the fight for replacing the united social tax (ESN) with social contributions as early as in summer 2009. He was then opposed by Igor Shuvalov, Arkadiy Dvorkovich, and the Minister of Economic Development, Elvira Nabiullina. Kudrin’s position prevailed in this struggle. The Minister of Finance warned that the budget might not have enough funds to cover the Pension Fund deficit in 2011 – 2012, and the pension system would face serious problems unless ESN were reformed. The threat of the pension system getting out of balance enabled Alexey Kudrin to lobby for a transition to insurance contributions.

In 2010, opponents to the raise of social contributions made a counterattack against Alexey Kudrin’s positions. The Ministry of Economic Development proposed to raise the tax burden to 32% and not 34%. However, the Ministry of Finance withstood Elvira Nabiullina’s demarche with the support of the Ministry of Healthcare and Social Development. A moratorium for a frontal tax relief was presented in Dmitry Medvedev’s Budget Message. However, the document declared individual tax preferences for innovative and energy-efficient companies.

As the insurance contributions went up, the Ministry of Finance and the Ministry of Healthcare and Social Development began working on proposals for reforming the extrabudgetary funds. The problem is that these entities do not work according to their intended functionality. They have numerous social obligations, all of which create a great consolidated deficit. For example, the most capital-intensive function of the Pension Fund is issue of maternity (family) capital certificates. At first it was intended that this money would be granted through a special FTP. However, in the legislative adoption of the maternity capital it was proposed to use the Pension Fund infrastructure. The Fund has a branched network in every region of Russia. It is in charge of pension payments and has an extensive database for working with the public. The efficiency of this scheme was criticized intensively after a number of corruption scandals in the Pension Fund that happened in the last few years. The other functions that are not inherent to the Pension Fund, according to the proposal, should also become information programs. These include social allowances to some categories of the public and bringing pensioners’ total income up to the minimum subsistence level for pensioners.

A similar project of reforming the Federal Security Fund is discussed intensively at the Ministry of Finance and the Ministry of Healthcare and Social Development. Like the Pension Fund, this fund is getting budget transfers, which will keep growing in the next three years. Pregnancy and maternity allowances, sanatorium and resort treatment for privileged categories of the public, and technical rehabilitation facilities for the disabled are regarded as functions that are not inherent for the Federal Security Fund. It is also proposed to move these fields into individual FTP in order to raise the spending efficiency.

The proposals are so far being discussed on Ministry level and have not been submitted to the government for general approval year. Their realization will largely depend on the raw material prices and consumer price growth. Detailed discussion of the initiatives will not begin before 2012, since changing the established system may raise social tension and political risks.

In actual fact, in 2010, the social policy has stayed the most conservative element of the economic policy. The upcoming Parliamentary and Presidential elections have played a role. The government is not planning to make serious changes to the system before the elections, and the social obligations will remain on the level of 2010. The rest of the reforms (as with the budget policy) will be in 2012 and 2013.

Monetary policy

In 2010, there were some serious changes in the monetary policy of the Russian government. While during the crisis the Bank of Russia withstood the numerous attacks of foreign currency speculators and tried to keep the national currency rate high, in the last 12 months the regulator was caught into a trap by the strong ruble and intensified inflation.

The consumer price growth is putting serious pressure on the Central Bank. In the last year, Sergey Ignatyev’s office has been reducing the refinance rate steadily. This created an effect that enabled the major credit institutions to bring their credit rates down. However, the Central Bank could only implement a steady policy of raising the ruble’s liquidity while the inflation was relatively low, which was always mentioned in its reports. As the prices grow, the Bank of Russia may go back to the policy of strict ruble strengthening and growth of the refinance rate. The latter’s growth will make borrowing more expensive. This will cause a liquidity shortage on the market, which can bury the quite weak economic growth and provoke a frontal wave of unemployment.

In late 2010, the number of unemployed people was relatively low.

The real unemployment rate in Russia is just 6.7%. In November 2010, the number of unemployed people in Russia reduced from 5.1 million people down to 5 million in comparison with October. Compared to November 2009, the number of employed people increased by 881 thousand people or 1.3%, whereas the number of unemployed people reduced by 1,148 thousand people or 18.6%. At the end of 2010, the economically active population of Russia amounted to 75.3 million people, which is 53% of the total population. The rate of employment has reached 63.1%. It should be kept in mind that the real number of unemployed people is 3.3 times greater than the number of people who have registered with the state unemployment agencies. Since October, the rate of registered unemployment nationwide has not changed with over 1.5 million people on the register. 65% of the unemployed are looking for a job on their own without the help of the state unemployment agencies. 

Despite the stabilization of unemployment, in 2011 it may start growing intensively as demand on foreign markets declines. This is when the government will have to wrap some anti-crisis programs up and raise the tax burden. The lending decline and impairment of external circumstances may make this process much faster. The growth of unemployment will raise social tension in the regions, especially in single employer towns.

The inflation and unemployment growth risks are putting the Bank of Russia in a difficult position. Retaining a soft monetary policy will push the price growth but making it stricter may make unemployment grow. The Ministry of Finance keeps demanding restriction of the inflation while the Ministry of Economic Development and the Ministry of Healthcare and Social Development insist on intensifying the economic growth and unemployment stabilization.

In 2010, the Central Bank managed to maintain the opportunities window in the monetary policy. However, in the mid-term prospect, the Bank of Russia will have to choose its main strategy on the Russian market. In view of the elections, the regulator will make inflation fighting its priority. It is the growth of consumer prices that may become a power catalyst of social discontent. The strengthening of the ruble will be slow in order to keep the residents’ competitiveness and employment.

In fact, the financial policy of the government has remained extremely careful. Budget funding is based on moderately negative forecasts of oil, gas, and metal prices. Budgeting disproportions will cause intensive correction of the main national financial document in 2011. Since this is an election year, most corrections will be about raising the social expenses.

Mass state funding of the social sector may have a negative effect on inflation. It has been gaining speed with the food and petrol price growth. The strengthening of the ruble may compensate for some of the inflation, but it will depend on the current circumstances.