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12 April 2016

Robbing Peter to pay Paul

The Russian budget already cannot be met for two consecutive years 

The actions of the Russian government resemble those of the protagonist of a Russian fable by Ivan Krylov, about the peasant Trishka, who cut off a quarter of the sleeves of his tunic to patch the worn out elbows, and then shortened the tunic to lengthen the sleeves. In the end, Trishka had a patched tunic that was too short. Similarly, in the face of economic crisis, rather than cutting expenditures, the Russian government is increasing spending. Putin’s friends and influential lobbyists are behind the expenditure items of the budget, but maintaining social commitments is also important for the popularity of the authorities: the sharp rise in social expenditure - more than two-fold in real terms (adjusted for inflation) – ensured their popularity in the first half of the 2000s.

Statistics paint a bleak picture of the Russian economy. Real wages (wages adjusted for inflation) fell by 9.5% in 2015, and average wages have seen a nearly two-fold drop from just over $900 USD to less than $500 due to devaluation over the last two years. Ordinary citizens are undoubtedly not happy about the decrease in their incomes, particularly so because there will be no indexation of wages of public sector employees at all this year (unlike during the 2008-2009 crisis when substantial funds were justifiably spent on that), whereas indexation of retirement pensions is planned at a level below inflation, at 4%. At the same time, inflation in Russia exceeded 12% in 2015, and many believe that it will not see a two-fold decrease this year   either, as is assumed for some reason, in the 2016 budget.

Budget revenues depend to a large extent on oil prices, and Moscow does not accurately calculate these figures. In the budget, the price of oil is assumed to be $50 per barrel, but the reputable U.S. Energy Information Administration provides a figure of less than $40. Deterioration compared to the previous year is forecasted. Last year’s average price was $51 per barrel, when the price dropped below $45 in early 2015, and reached almost $70 in May, to again fall below $40 by the end of the year. Prices dropped below $30 during the first two months of this year, reaching $40 for a couple of days. Some place great hope in the meeting of OPEC and Russia in Doha, but their expectations are unlikely to be met, as the meeting is only about the freeze on oil output at January 2016 levels (a historically record-high both for Saudi Arabia and Russia). And OPEC’s share – even together with Russia – will comprise only half of global oil production, as opposed to the cartel situation in the 1970s.

Against the backdrop of the existing situation, 2 trillion rubles from Russia’s Reserve Fund is planned to be spent to close the budget. That will almost halve the Reserve Fund in this year, since it totalled 3.42 trillion rubles as of early April 2016. There is also the National Wellbeing Fund, theoretically earmarked for long-term investments and the pension system’s balance. However, under Russian governance it can immediately be spent on anything – even on a loan to Viktor Yanukovych’s falling regime in Ukraine, as happened in 2013. But this fund is also not infinite: it amounts to 4.3 trillion rubles at the moment. And, mind you, this is at prices of $50 a barrel. If we average them based on the results for three months at a level of almost $35, this means that almost the entire Reserve Fund will be spent in 2016.

To be fair, there are a number of “nest eggs” in the budget. The annual pension savings (estimated at 342 billion rubles), earmarked for the additional indexation of pensions to the level of inflation, can be pilfered. The unused balance (150 billion rubles) of a special presidential fund, the spending of which Putin personally decides is also available. The exact figure of idle balances will be known in April 2016. According to some estimates, it is much higher due to the failure to fulfill the state defense order. There is also a chance of external loans reaching up to $3 billion (approximately 200 billion rubles).

However, oil prices are falling. So what does Putin’s government suggest? That’s right, not to decrease, but increase spending! An amazing document was born out of a two-month discussion – the 2016 bailout package of the government of Russia. It elicits sheer bewilderment on behalf of those used to working with government paperwork. After all, half of the expenditure items (for example, the very indexation of pensions, medicine for seriously ill patients, new agricultural subsidies and many more) have been scrubbed. Nevertheless, even the approved plan exceeds 650 billion rubles. Apart from obvious expenditure, such as the necessary replacement of expensive loans from commercial banks to regional budgets with cheap budget loans, the majority of the remaining items still reflect the lobbyists’ success. For example, the largest amount of resources (137 billion rubles) is earmarked for support of the automotive industry. Undoubtedly, this is a pro-cyclical sector. Is it nevertheless more important than, let’s say, subsidies for the unemployed (5.5 billion rubles)? Or mortgage support (16.5 billion rubles in total; housing is not a less pro-cyclical sector than the automotive industry). The reason is all too obvious: there is one “AvtoVAZ” in Russia owned by the state-owned “Rostekhnologii” corporation, and it is constantly bankrupt and will be receiving most of this money. The bulk of the items in the plan need budgetary spending, too. For example, the provision of various tax allowances which are not being accounted for at all.

The fate of the state-owned Vnesheconombank (VEB) corporation is not provided for in the plan, either. It also has actively incurred loans, and as a result of continuous lending to all sorts of Olympics activities and purchases abroad based on political instructions, its losses for 2014 and the first half of 2015 totalled 322 billion rubles, according to the VEB’s own data. Unofficially, none of the officials cite figures below a trillion rubles. VEB’s default can be considered a sovereign default, judging by its consequences. Therefore, the government is going to save it.

Hence, should oil prices remain at approximately their current level, resources from both sovereign wealth funds will clearly only suffice to maintain current budgetary spending in 2016-2017. And surprises (for example, further recapitalization of the banking system, since not only VEB, but also the Deposit Insurance Agency, face the problem of a rise in insurance claims) can occur not only in 2016, but in 2017 too.

Furthermore, Russia is holding presidential elections in 2018. The government can still always resort to the Belarusian and Venezuelan scenario of solving budgetary problems, that is, large-scale monetary emission followed by inflation. For example, by raising wages in 2010 (the year of the presidential election in Belarus), Lukashenko had inflation exceeding 100% the following year. In fact, the Russian president’s economic advisor, Sergey Glazyev, or Presidential Commissioner for Entrepreneurs’ Rights Boris Titov, the co-authors of the recent report, insist on such a scenario. This old populist idea of “printing a lot of money and distributing it” is partially understandable - it is much easier than protecting business from government interventions.

It is noteworthy that the M2 monetary aggregate in Russia (domestic cash in circulation plus rubles in the accounts of Russian residents and organizations domiciled in Russia) increased 10-fold from 3.2 to 35.8 trillion rubles over the last twelve years. (In comparison, it doubled in the U.S. and the Eurozone). Additional printing of money will therefore not improve the monetization of the economy at all, if one buys foreign currency using it, which is what will most probably happen. Glazyev and Titov do not provide a convincing explanation of how the newly printed money is going to be isolated from the exchange market. However, thanks to the efforts of the government economic bloc, such developments can be avoided.

Supporters of the Russian opposition sometimes argue that from the point of view of the opposition, “the worse the economy, the better it is for the opposition”. True, or not? Well, no. It may turn out that under the conditions of a sharp economic downturn, people will not be concerned about abstract notions such as “freedom”, since they are focused on survival. For example, the 2011 protests unrolled against a backdrop of decent economic growth of 4.3%, whereas in 2004, in neighboring Ukraine, revolution burst out under conditions of 12% economic growth – unseen either before or since. Economic growth was zero in Ukraine in 2013, that is, the situation was neither worse nor better than it had been previously. On the other hand, a period of non-drastic yet protracted economic turmoil, as in the late USSR, can form an unfavorable background for the authorities.

Russia is obviously unable to withstand enormous military and police-related expenditure (the military gets 19% of the expenditure, and 32% counting law enforcement too). This cannot be reconciled even with the present-day, meagre level of social spending, since Russia is eating up its reserves at the moment. For example, in 2012, the federal budget spent 554 billion rubles on healthcare, and as little as 490.6 billion in 2016, regardless of inflation. Military spending grew from 1.9 trillion to 3.1 trillion rubles over the same period of time. Half of the defense budget is secret, which also means that it is supposed to meet not only military, but also the quite prosaic needs of the Russian leadership. The share of secret expenditure in the budget has increased from 11.7% to 24.8% in total.

It is noteworthy that the share of defense spending was similar (18-19%) in the final budgets of the USSR. They were included as separate items – before that, the “peace-loving communists” simply scattered the money across other expenditure items, masking their high proportion. Failure to live within its means and a concentration of resources on military spending at the expense of living standards triggered mass protests and the collapse of the communist regime fairly quickly, within a couple of years. But will history repeat itself in today’s Russia? It absolutely cannot be ruled out. Indeed, in November 2011, for example, just a month before the rallies in Moscow when a hundred thousand people took to the streets, the situation seemed depressed but outwardly calm. But it is also important that even if the authorities manage to successfully live through the electoral cycle (due to the complete disbursement of sovereign wealth funds), they will nevertheless still have to choose between military and social spending. 

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