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SBERBANK OF RUSSIA New Realities of Russian Public Finances Аpril 23, 2015 Serious deterioration in macroeconomic conditions in 2015 required a major adjustment of the budget, but its priorities remain the same Loss of income will amount to 2.5 trillion rubles. (at a price of oil on average $ 50/bbl), mainly due to the loss of oil and gas revenues Loss of oil and gas revenues may increase due to the strengthening of the ruble, but the additional revenues from the VAT are very likely Redistribution on the expenditure side is not always valid, especially the reduction of expenditure on education and health Total reduction amounted to 298 billion rubles, which is considerably less than the original plans. Reduction moderation should be the cause of effectiveness for the budget in the economy At the same time additional costs should not be ruled out due to increased transfers to the regions because of the loss of income tax Expansion of the budget deficit to 3.7% of GDP seems very modest, sources of finance are available But new budget revisions are likely to be due to the rapidly changing conditions and serious budgetary risks Two-thirds of available funds of the Reserve Fund will be allocated at the deficit financing, which will reduce its ability to 2016-2017 But overall stability of public finances seems certain in 2015-2017 Budget Revenues Reduced Will Be Dramatically New Federal budget parameters The significant deterioration in the external economic and political factors in the second half of 2014 led to necessity for changes of the Federal budget. Challenges, such as the terms of trade shock due to falling oil prices, the economy going into a recession, a devaluation of the ruble, a sharp acceleration of inflation – led to the need for a radical revision of the revenue and expenditure sides of the budget. Anti-crisis measures are needed to integrate into the budget without excessive inflation of costs due to reduced revenues. The project is based on conservative macroeconomic forecasts This week the President signed adjusted project budget for 2015, which entered into force. Amendments to the budget developed by the Ministry of Finance in the new conservative assumptions of the forecast of the Ministry of Economic Development. According to the forecast, the average price of Urals crude oil will be $ 50/bbl in 2015 and GDP will decrease by 3% yoy in real terms, which will lead to an adjustment of the volume of nominal GDP in 2015 to -5.4% compared © Macroeconomic Research Center of Sberbank of Russia 1 SBERBANK OF RUSSIA New parameters of the Federal budget with the budget adopted in December 2014. Higher inflation (15.8% yoy on average in 2015 and 12.2% at the year-end) and the devaluation of ruble (the average exchange. rate of 61.5 rubles/$) will sustain the ruble tax revenue, but the effect of the fall in prices oil and deep recession will not be fully compensated. The macroeconomic situation is changing rapidly, that is why the government needs some flexibility. A new revision of the macroeconomic parameters in the coming months and the corresponding budget adjustments cannot be excluded. Expected Reduction in Oil and Gas Revenues Lost revenues of 2.5 trillion rubles. In these circumstances, the Ministry of Finance estimates the loss of revenue of 2.54 trillion rubles. Most of the losses occur in the loss of oil and gas revenues (2 trillion rubles.). In our analysis we came to a similar conclusion. There is nothing special about it: the big shocks in oil and gas production are not expected, calculation formula of oil and gas revenues is transparent and the macroeconomic assumptions are not very different. Non-oil and Gas Revenues Can Hatch a Surprise Non-oil and gas fiscal revenues will be reduced by 512 billion rubles… … of which 390 billion will come from the VAT reduction … … but revenues may be higher Budgeted tax increase on income seems unlikely ...… But non-oil and gas revenues loss calculations are somewhat unexpected. According to the amendments, non-oil and gas revenues will be reduced by 512 billion rubles with respect to the budget law adopted in December. The main reduction is the loss of VAT revenues, which will diminish by 389.8 billion rubles. This reduction is largely due to overly optimistic assumptions about the growth of VAT revenue in the December version of the budget law. Then it was assumed that the VAT revenues would amount to 4.1 trillion rubles and it would exceed the level of 2014 by 175 billion rubles. Now, however, estimation revenue appears too low, even taking into account the provision of tax relief (for instance, air carriers by 25 billion rubles). According to our estimates, revenues from the VAT related to the import, will remain almost at the level of 2014, as the drop of the ruble fully compensates the effect of the reduction in dollar import. And accelerate inflation can be the reason of decreasing of internal VAT revenues. That means additional revenue from this tax, estimated by 200 billion rubles, cannot be excluded. But it is hard to believe in the growth of tax revenues on income which increased by 6.2 billion rubles in the Federal budget in the new version of the law. Income tax is one of the main sources of incomes of regional budgets. 2pp ascribed in the Federal budget, the other part, up to 18pp, goes to the regional. Although in the Basic parameters changing of the economic projection The main characteristics changing of the budget Federal law on the Amendments budget (Dec. to the budget 2014) (April. 2015) The price of URALS oil, $/bbl Ruble exchange rate (average per year), rub./$ Economic growth, % GDP, trillion rub. CPI (at period’s end),% 100 50 37.7 1.2 77.3 5.5 61.5 -3.0 73.1 12.2 Источник: Минфин, МЭРResearch Center of Sberbank of Russia © Macroeconomic Revenues Oil and gas revenues Non-oil and gas revenues Expenses VAT СальдоМинфин, бюджета Источник: МЭР Federal law on the budget (Dec. 2014) 15082 Amendments to the budget (April. 2015) 12540 7717 5687 7365 15513 4105 -431 2 6853 15215 3715 -2675 SBERBANK OF RUSSIA first two months there was a positive trend for revenues of this tax, but soon it is likely to change significantly. Revenues from income tax in the consolidated budget decreased by 39% yoy in 2009 in the event of significant ruble devaluation and greater reduction in GDP (7.8% yoy). However, only part of the effect can be attributed to the reduction of the tax rate from 24 to 20%. Accumulated losses of the previous period, which reduced the estimated tax base, were the main reason for the decrease revenues. There were also accumulated losses amounted to 3.7 trillion rubles (+ 93% yoy) in 2014. .. We forecast a reduction of the federal tax on 100 billion. It is very likely that the dynamics of receipts of income tax in 2015 will be closer to the dynamics of 2009 than the government believes. According to our calculations, the decline of income can reach 25%. Thus, the revenue lost in income for income tax will reach 590 billion rubles in 2015 (-25% yoy), of which 100 billion rubles will have shortfall in profits by the Federal budget. Reduced revenues from personal income tax in the consolidated budget is also very likely Consolidated budget may receive less income tax and personal income. We estimate that these losses are 130 billion rubles. Indeed, inherent payroll growth (+ 4% yoy) seems overly optimistic in terms of the actual non-indexation of public sector wages. Since October 1, 2015 indexing has been canceled for most groups, including doctors and teachers. We believe that the payroll rather fall to 0.5-0.6% due to rising unemployment and informal employment, which will cause a reduction in tax revenues. …and regions will recognize it first We are not accidentally identified further shortfall in income not only federal, but also of the consolidated budget. Its fall (about 650 billion rubles.) is needed to be taken into account due to the fact that ultimately the problem of financing of the regional budgets would be a new overhang/issue of the Federal budget. Reduction and Redistribution of Expenses Structure of Budget Expenditures The priority of the Federal budget is defense spending Regional budgets handle social expenditures We consider that the structure of the Federal budget and before decision on the budget sequestration in recent years has not been optimal. The share of expenses of the Federal budget, directed to national defense, increased rapidly, rising from 13.9% in 2011 to 16.7% in 2014. It should be noted that the national defense is the only item of expenditure with sustainable growth. Even within the framework of the consolidated budget the share of expenses for national defense increased from 7.6% in 2011 to 9.1% in 2014. It describes the government's priorities. In contrast, during the same time expenses of the Federal budget on education fell from 5.1% to 4.3%, health care from 4.6% to 3.6%, housing and communal services from 2.6% to 0.8%. Regional budgets “tried” to make up for the part of the financing loss of human capital. Total funding for these items is still able to maintain almost unchanged, although trend on a slight increase in their funding was observed in 2011-2012. © Macroeconomic Research Center of Sberbank of Russia 3 SBERBANK OF RUSSIA Amendments Between Items Strengthened Disproportion The reduction and redistribution of expenditures increase the disproportion The usual anti-crisis measure is increasing budget expenditures. But the current challenges cannot be limited to one year, therefore, the decision was announced on the annual 5% reduction of budget expenditures in real terms 2015-17. In 2015 reduction is accompanied by a significant redistribution of expenditure items, and, unfortunately, it did not diminish the disproportion in the structure of expenditures. The planned expenditure reduction of 10% turned out to be impossible Initially all unprotected budget items were planned to reduce evenly by 10%, which was impossible to do. Defense expenditures decreased by only 4.8% compared to the budget law, approved in December. However, their growth was still impressive 26%. On the same 4.9% against the previous plans for 2015 expenditures on education have been reduced, but compared to 2014 they decreased by 5.7% yoy in 2015. But public health article has been reduced much more drastically - by 8.2% compared to the previous law on the budget and 28% yoy with respect to 2014. Of course, part of this reduction was possible by the sectoral reform which is gaining momentum. But this reform is extremely unpopular among the population, and in general there is no certainty that the growth of the use of resources corresponds to the reduction in funding. Article of housing and utilities services was reduced by 10.8% relative to the sample budget in December 2014, but relative to 2014 expenditure will increase by 7.9% yoy. Expenditures decreased by 298 billion compared to the previous version of the budget Share of defense expenditures will increase by 20.5% in 2015 As a result of the reduction of items and reinvesting funds between items expenditure portion has been reduced by 298 billion rubles against the budget law adopted in December 2014. How is the structure of budget expenditures affected? The share of defense expenditure will increase by 20.5% of the Federal budget, while the share of expenditure on education and health is 4% and 2.5%. All this make the country avoid the expenditure structure, which is typical for developed countries, where the priorities are just on health and education expenditures. We believe that the cost optimization by reducing investments in health and education, with an Expenditure structure of the Federal budget in 2011 and 2015 Source: The Central Bank of the Russian Federation, MRC settlements © Macroeconomic Research Center of Sberbank of Russia 4 SBERBANK OF RUSSIA increase in defense expenditure is not the right way to achieve budgetary savings. Refusal of indexation of wages reduces GDP growth by 0.1 pp Reducing some items may be resonant. For example, non-indexation of public sector wages and pensions of servicemen (saving 87.6 billion rubles.), and an additional blow to consumption - lost 0,7pp growth in the 4th quarter of 2015 (the period of the planned indexation). For the whole 2015 this represents a loss of 0.2 pp for consumption and about 0.1 pp for economic growth. Investments in infrastructure are not sufficient - only 4% of expenditures The share of infrastructure investment expenditures does not seem sufficient and it will be only 4% of the expenditures. Although the growth of these expenditures nominally looks very impressive (17.7% yoy), extreme degree of underinvestment in infrastructure requires a more serious investment. These expenditures of productive group can lead to a medium-term acceleration of economic growth. Budget Revision Risks Remain Reducing of oil revenues due to ruble strengthening is the risk for the budget There are risks of expenditure growth and transfer of regions Additional capitalization of banks did not eliminate the system risks Reducing of oil revenues due to ruble strengthening. A significant increase in the ruble exchange rate cannot be ruled out in 2015, even with a relatively low oil prices in $ 50/bbl. This may be due to the strengthening of the geopolitical situation stabilization. However, such dynamics are generally positive for consumer demand, will lead to a further reduction in oil and gas revenues. For example, the strengthening of the ruble to 55 rubles/$ will reduce the price of a barrel of oil in rubles to 3075 rubles, included into the budget estimates, up to 2750 rubles per barrel. Simple estimations show that in this case the reduction in oil and gas revenues will increase by another 600 billion rubles and the financial gap funding will be on the reserve fund. Transfer of the regions may be increased. From our point of view, the formation of the expenditure side of some risks did not take into consideration. For example, the transfer of the regions is likely to have increased due to falling revenues from income tax and personal income tax. The transfer is reduced to 619.4 billion rubles in the new version of the budget, but the loss of revenues of regional budgets may reach 650 billion rubles, as it was mentioned above. It is difficult to expect that the regions will be able to fund additional loss of income due to market sources. First, the bond market cannot provide the required volumes to the regions: in the past year, the regions were able to place securities for 111 billion rubles when refinancing of repayments is needed in the amount of 121 billion. Net debt banks of regions has increased rapidly in recent years and reached a record 1.076 trillion rubles in 2014. Providing budget loans to regions have been sharply increased: + 300% in 2014. Therefore, the Federal budget will have to increase support of regional budgets - through the budget credits and through transfers. It is possible that part of the region will also require the support of accumulated debts service, which may extend the need for support. That means that in 2015 the transfer of regions can easily increase from 619.4 billion rubles to 1.2-1.3 trillion. State Support of Banks and Companies. Although the situation in the banking sector returned to normal in comparison with the end of the acute phase of the 2014 crisis, it may need additional support from the state for recapitalization. In December of 2014 series of prudential measures was urgently adopted, the amount of the security deposit was increased and bank recapitalization program is approved through the Federal Loan Bond. 1 trillion © Macroeconomic Research Center of Sberbank of Russia 5 SBERBANK OF RUSSIA rubles were planned to send on the program and to allow banks only with the capital exceeding 50 billion rubles. By February of 2015 830 billion rubles have been reserved for the 27 largest banks, while the remaining 170 billion rubles were planned to be used for additional capitalization of regional banks or in the event of a new aggravation of the situation in 2015. However, in March 2015 it became clear that the banking sector is still coping with challenges. At the same time other problems became more urgent. A number of companies required additional funding for the development of import substitution. Of the remaining for additional capitalization of banks of 170 billion rubles United Aircraft Corporation will receive 100 billion rubles on the civil aviation development. Considering the low domestic demand and the low competitiveness of domestic products in foreign markets, we expect the growth of applications for state support. The list of strategic enterprises of the Economic Development Ministry includes 199 organizations. The experience of 2009 confirms that the actual expenditure may be higher than it was planned Financing of Crisis Bailout Plan. Current crisis bailout plan has been developed by analogy with the anti-crisis program in 2009. During that period the amount of additional expenditure of the budget on economy support amounted to 2.2 trillion rubles, of which 495 billion rubles were sent to maintain the stability of the financial system (and another 900 billion rubles were on additional capitalization of banks by the Central Bank and VEB). That is all the support in 2009 has cost somewhere 3.1 trillion rubles. Thus, the current version of the anti-crisis plan will provide the much fewer resources to support the economy and overcome the crisis (2.3 billion rubles.). But the current crisis has a more underlying reason. In addition to the external factor the accumulated structural problems have an adverse effect on the economy. There is every reason to believe that the crisis will be protracted, while the recovery began in the second half of the year in 2009. That means that the additional expenditure on support of the economy cannot be denied. Net debt of regions for the banking sector has substantially increased at the beginning of the year (billion rubles) Source: The Central Bank of the Russian Federation, MRC settlements © Macroeconomic Research Center of Sberbank of Russia 6 SBERBANK OF RUSSIA Financing the Deficit: the Reserve Fund The Reserve Fund is the main financing source Plan to attract domestic debt market appears very optimistic It is difficult to expect the maintaining of a low budget deficit in the new economic environment. The Ministry of Finance sees its expansion with the previously planned 0.6% of GDP to 3.7% of GDP. In the context of difficult access to external financing and limited capacity of the internal debt financing the majority share of the budget deficit financing (3.1 trillion rubles.) will be given from the Reserve Fund. On April 1 of 2015 its size was 4.4 trillion rubles. The weakening of the euro against the dollar and the strengthening of the ruble led to a decrease in the ruble equivalent fund of 545 billion rubles since the beginning of the year. The ruble equivalent of the Fund may continue the weakening in the coming months if oil prices start to rise faster, and the ruble will continue to strengthen. Thus, more than 2/3 of the fund will be used in 2015. From our point of view, there are risks and a much greater use of the Reserve Fund in the structure of the budget deficit financing. We have no doubt that will be able to fully implement the plan to raise funds from the market of domestic debt. It was left unchanged at 1 trillion rubles. Probably, this plan will have to be adjusted down so as not to displace from the market of corporate borrowers. And past experience says that placement plans never carried out: in 2011-2013 layouts were 58%, 54% and 20% respectively from the planned law on the budget. In 2014, placement for financing the deficit amounted to 300 billion rubles from 1025 billion of planned volume with amendments for capitalization of banks through the Federal Loan Bond. Nevertheless, the great attraction of the Ministry of Finance can be achieved through the use of new tools. If plans of issue bonds with inflation revenue will be implemented, these securities will be in demand among institutional investors. In this case, the placement volume can increase substantially relative to volume in 2014. The cost of implementation of anti-crisis programs in 2009 and 2015 (billion rubles) Source: The Central Bank of the Russian Federation, MRC settlements © Macroeconomic Research Center of Sberbank of Russia 7 SBERBANK OF RUSSIA There is the reserve of economic strength for the next two years As a result, even budget expenditures financing of the budget deficit will be reduced it will require more than half of the Reserve Fund in 2015. However, there is the reserve of economic strength in the budget and the Reserve fund (at the end of the year the fund will be about 1.5 trillion rubles at the equivalent), ensuring fiscal stability in 2015-2015 and allow the government to ensure the implementation of anti-crisis measures. Dynamics of the planned and actual drawings of the Russian Federation on the domestic market (billion rubles) Source: The Central Bank of the Russian Federation, MRC settlements © Macroeconomic Research Center of Sberbank of Russia 8 SBERBANK OF RUSSIA The Review Is Created By Yulia Tseplyaeva The director of Macroeconomic Research Center [email protected] Yulia Sonina [email protected] Aleksandra Philippova [email protected] Danir Zulkarnaev [email protected] For all questions related to sections of this review you can contact us by the telephone of MRC (495) 747-38-79 or by email. Standard clause on limitation of liability compulsorily attached to all analytic products. 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