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In 2011, it is to be noted that the liabilities of the banking sector to non-residents rose by $7.6bn, while in 2010 the growth in liabilities of the banks exceeded $17.6bn. The main factor behind the slower growth in liabilities was the reduction in the value of the attracted loans from $19.3bn in 2010 to $11.8bn in 2011. Taking into account the high demand of Russian banks in resources of the Central Bank of Russia and the non-financial sector of the Russian Federation, such a dynamics of liabilities points to difficulties of Russian banks in attraction of external financing which situation can be explained by the fact that investment in the financial sector worldwide is becoming less attractive.

In 2011, foreign assets of residents (foreign economic agents liabilities to Russian economic agents) rose by $140.2bn (in 2010, by $70bn.). It is to be noted that foreign assets of monetary regulation authorities virtually did not change, while those of federal regulatory authorities rose by $2.6bn.

In 2011, foreign assets of the banking sector increased by $33.8bn. It is to be noted that growth in Russian banks loans and deposits provided to foreign economic agent accounted for $25.5bn of the above amount. In 2010, growth in foreign assets of Russian banks amounted to $1.8bn.

As compared to 2010, the outflow of capital from the sector of non-financial enterprises and households rose by 54% and amounted to $103.8bn of which amount direct and portfolio investments accounted for $70bn. ($19bn more than in 2010). Households and the nonfinancial sector reduced their investments into cash foreign currency whose volume of import to Russia amounted to $2.7bn.

In 2011, the situation on the foreign exchange market of the Russian Federation was determined by the inflow of the foreign exchange into the country through the current account with a simultaneous outflow of funds in the capital and financial instruments account. As was stated below, the Central Bank of Russia reduced to a great extent its interference in the functioning of the foreign exchange market by permitting the ruble exchange rate to be formed mainly under the impact of market factors and limited its role to smoothing of sharp fluctuations of the exchange rate. In the first six months, the ruble appreciated both in nominal and real terms under the impact of the considerable trade balance surplus despite the large outflow RUSSIAN ECONOMY IN trends and outlooks of capital. However, in August-October a considerable depreciation of the exchange rate took place and it was justified by a decrease in the current account balance due to a drop in prices on energy carriers and growth in the outflow of the capital from Russia as a result of worsening of the global economic situation.

Generally, in January-December the real effective exchange rate of the ruble grew by the mere 4.7% (at year-end 2010 it was +9.6%) and by the end of the year remained at the level of the mid-2008 (see Fig. 8). In 2011, the official USD/RUR exchange rate grew by Rb 1.72:

by the end of December the USD exchange rate amounted to Rb 32.20 against Rb 30.48 as of December 31, 2010. It is to be noted that the ruble depreciated against the bi-currency basket1: in the same period the cost of the bi-currency basket appreciated by Rb 1.55 from Rb 34.91 to Rb 36.46. Late in December the Euro/RUR exchange rate amounted to Rb 41.67 and increased by Rb 1.34 on a year on year basis.

Source: The Central Bank of the Russian Federation and the authors calculations.

Fig. 8. Indices of the RUR exchange rate in January 2005 December In 2011, the situation with the balance of payments developed in such a way that on a year on year basis the RUR exchange rate both in nominal and real terms did not change much with virtually no interference by the Central Bank of Russia into functioning of the foreign exchange market. In other words, the situation was favorable to the Bank of Russia and permitted it to switch over to the inflation targeting regime with absence of fundamental changes in the RUR exchange rate. At the same time, the Central bank of the Russian Federation let the RUR exchange rate depreciate in August-October, however, thanks to growing surplus of the balance of payments at the end of the year the RUR exchange rate started to grow again.

Bi-currency basket is an operating benchmark of the Central Bank of the Russian Federation in carrying out of the foreign exchange policy. At present, the share of the Euro in the basket amounts to 45%, while that of the USD, to 55%.

The level of January 2002 is equal to 100.

Section The Monetary and Budget Spheres In 2011, a trend which determined the dynamics of the balance of payment was the dynamics of the net flight of capital from the non-financial sector; on a year on year basis the capital flight amounted to $85bn (in 2010 it amounted to $34.5bn) (see Fig. 9). It is to be noted that the flight of capital was observed throughout the year: the minimum flight of capital was registered on the basis of the results of the 2nd quarter ( $7.3bn), while the maximum one, on the basis of the results of the 4th quarter ( $37.6bn). The factor behind the flight of capital was in all appearances the prevalence of high economic and political risks related to investment in the Russian Federation with a level of return comparable to that in other developing countries.

Source: The Central bank of Russia; the IEP calculations.

Fig. 9. The dynamics of the net flight of capital in 2005Another evidence of the unfavorable situation with the inflow of capital is the speed-up of the so called capital flight1 in 2011. According to our evaluations, in 2011 the flight of capital (Fig. 10) amounted on a year on year basis to $ 42.6bn which figure is $ 3.9bn higher than in 2010.

Summing up the result of the analysis of the balance of payments, it is to be noted that in general the insignificant total balance of payments is favorable to the Russian economy as it contributes both to stability on the foreign exchange market and sustained development of the financial system. At the same time, due to the fact that the current account of the balance of payments of the Russian Federation depends to a great extent on the export of several commodities the existing situation with the balance of payments is unlikely to be stable in the long-term prospect due to the unpredicted dynamics of prices on energy carriers and, consequently, the situation of the Russian foreign trade. As regards the capital and financial instruments account balance the flows of capital both to and from Russia are likely to remain quite volatile due to, among other things, uncertainty about the global economic development.

However, in case of absence of efforts by the Government of the Russian Federation to reduce The capital flight was calculated on the basis of the IMF methods and represents the amount of trade loans and advance payments, export revenues which failed to be received timely and goods and services which failed to be delivered against remittance of funds under import contracts and net errors and omissions.

RUSSIAN ECONOMY IN trends and outlooks investment risks in the Russian Federation with all other things being equal (primarily, in case of stability of prices on energy carriers) the inflow of private capital to the country can hardly be expected on the basis of the results of 2012.

Source: The Central Bank of the Russian Federation, the IEP calculations.

Fig. 10. The dynamics of the flight of capital in the 20052011 period 2.2. State Budget Throughout 2011, it still was a favorable state of affairs in the foreign economic area which was a major driver of increase in budget revenues: international carbohydrate prices proved at one-third above the projections made while crafting the draft federal budget for 2011-13. As well, the revenue part of the budget found itself under spurred by increasing business activity which manifested itself in the economys growth rates notably outpacing the earlier anticipated ones (the 2011growth in GDP was projected at a level of 3.4%, while Rosstats preliminary estimates suggest it actually accounted for 4.3%).

There also were other factors fueling the increase in budget revenues: arrears before the budget system were down 12% on a year-on-year basis and hit their lows over the past 7 8 years; wage arrears were also down from Rb 2.4bn in 2010 to 1.8bn in 2011; the registered unemployment rate slid by 10.9%.

At this juncture, even the pre-election boost to expenditure obligations failed to overweight the increase in the revenue part of the budget. Thanks to that, at the federal level, the budget posted a surplus, while the public debt remained under 9.6% of GDP. However, many expenditure obligations are deferred and going to manifest themselves in full only in 2012.

So, on the one hand, against a miserable global economic backdrop (the EU member states sharing a -6.2% deficit of the Eurozones aggregate budget, the US suffering from a deficit of -9.6% of GDP and Japan a deficit of -10.3% of GDP) and a huge public debt (over 80% of GDP across the Eurozone, 69% of GDP in the US and 208% of GDP in Japan1) Russias economy appears pretty healthy; however, on the other hand, more and more pre-election obCIA Central Intelligence Agency.

Section The Monetary and Budget Spheres ligations and expenditure vows were made (e.g. the decision to raise military and lawenforcement agencies personnels pay proved very costly; meanwhile, the government is facing the challenge of footing the bill for indexation of the social and the public sectors employees pay) compels one to reassess risks and consequences of the said managerial decisions from the perspective of the national budget systems sustainability.

2.2.1. The General Characteristic of the Budget System of Russian Federation The 2011 dynamics of main parameters of the enlarged government budget exhibits retention of the trends launched in 2010 namely, boosting revenues while constraining budget expenditures relative to GDP (see Table 5).The 2011 revenue volume to the enlarged government budget accounted for 38.4% of GDP, or up 2.9 p.p. of GDP vis--vis the 2010 level.

The volume of federal budget revenues hit 20.9% of GDP, or 2.5 p.p. up compared with 2010.

The increase was fueled mostly by oil-and-gas revenues boosted by a favorable foreign economic situation. In 2011, international prices of Urals stabilized at a level of USD 109/b (in 2010- USD 78/b) under a 30.3% expansion of foreign trade turnover calculated by the balance-of-payments methodology1. In 2011, the recovery of the industrial output continued to advance, with the index of industrial output accounting for 104.7%. The share of the federal budget revenues in overall revenues to the enlarged government budget posted a slight growth on a year-on-year basis from 51.8% in 2010 up to 54.5% in 2011.

Table Revenues to and Expenditures of the Budgets in 2008 2011 2010 2009 2008 Bias in p.p. of % of % of % of % of GDP, 2011 vs.

Rb bn Rb bn Rb bn Rb bn GDP GDP GDP GDP Federal budget Revenues 11 365. 20.9 8305.4 18.4 7337.7 18,9 9275.9 22.5 +2.Expenditures 10 935. 20.1 10 117. 22.4 9660.90 24.9 7570.8 18.3 2,2 Deficit() / Surplus(+) +430.7 +0.8 4.0 2322.3 6.0 1705.0 +4.1 +4.1 812.Consolidated budgets of RF Subjects Revenues 7643.9 14.1 6537.3 14.5 5926.6 15.3 6253.1 15.1 0.including interbudgetary 1644.0 3.0 1398.9 3.1 1487.4 3.8 1132.6 2.7 0.transfers Expenditures 7679.3 14.2 6636.9 14.7 6255.7 16.1 6253.5 15.1 0.Deficit() / Surplus(+) 35.4 0.1 99.6 0.2 329.0 0.8 54.4 0.1 +0.The enlarged government budget Revenues 20 38.4 16 031. 35.5 13 35.0 16 39.2 +2.853.6 9 599.7 169.Expenditures 20 36.8 17 616. 39.0 16 41.3 14 34.3 2.004.8 6 048.3 157.Deficit() / Surplus(+) +848.8 +1.6 1584.7 3.5 2448.6 6.3 +2012.0 +4.9 +5.For reference: 54 369 45 166 38 809 41 277 GDP, as Rb bn Increase in Russias public +1190.3 +2.2 +921.9 +2.0 +583.1 +1.4 +289.6 +0.7 debt (including issued government guarantees) over the year Source: Rosstat, the RF Ministry of Finance, IEP calculations.

At year-end 2010 Russia still was one of the largest exporters, after China, Germany and Japan, in the CIA Sovereignty Rating which is based on assessment of current external balance.

RUSSIAN ECONOMY IN trends and outlooks At year-end 2011 the RF Subjects consolidated budgets received Rb 7,643.9 bn in revenues (14.1% of GDP), or 0.4 p.p. of GDP down compared with the prior year (14.5% of GDP), which should be ascribed both to a drop in revenues noted across most tax and non-tax revenues, as well as a fall in the volume of interbudgetary transfers (by 0.1 p.p. of GDP). An alarm bell was the fact that the last year saw the lowest level of collection of tax revenues to the RF Subjects consolidated budget since 2008. The fall was most intense with respect to the corporate profit tax (by 0.3 p.p. of GDP), PIT 0.2 p.p. of GDP, property tax - 0.2 p.p. of GDP. Transport tax revenues remained at a level of 0.1% of GDP thanks to greater contributions by private individuals, while amounts collected from corporate taxpayers were down. In all, the share of tax revenues in the aggregate volume of the RF Subjects consolidated budgets shrank by 1.2% vs. the previous years figures.

As to non-tax revenues, when compared with the 2010 figures, there was noted a decline in asset management revenues to the RF Subjects budgets equivalent to 0.1 p.p. of GDP. At this point, exacerbation of asset management problems at the regional level is quite visible, as collection of the revenues in question was supposed to increase due to annual investment by the Subjects budgets in creation of state property objects equivalent to up to 2.0% of GDP.

Meanwhile, the other non-tax revenues remained unchanged since 2010.

Despite a two-year-long tendency to increase in revenues to Russias budget, the nation failed to clear the pre-crisis bar of revenues to the enlarged governments budget (39.2% of GDP in 2008). Meanwhile, the enlarged government budget expenditures were being trimmed consistently: from 41.3% of GDP in 2009 to 36.8% of GDP in 2011, or 2.2 p.p. below the 2010 figures, but still above (2.5p.p. of GDP) the pre-crisis 2008 level. That said, expenditure cuts were uneven across the tiers of the budget system: thus, in 2011, federal budget expenditures were slashed by 2.3 p.p. on a year-on-year basis and made up Rb 10, 935.2bn (20.1% of GDP), while expenditures of the RF Subjects consolidated budget slid by 0.6 p.p. of GDP vs.

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