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With revenues from the mineral tax and export duties on energy sources in decline and volumes of collection of the corporate profit tax having stabilized (revenues to the federal budget from the corporate profit tax in 2012-14 should remain at their 2011 level namely, 0.6% of GDP), reserves for increase in tax revenues should be sought in taxation of consumption.

It is forecast to increase collection of VAT from taxation of imports in 2012 by 0.3 p.p. of GDP on a year-on-year basis and further annually by 0.1 p.p. of GDP in 2013-14. Meanwhile, the volume of revenues from the domestic VAT will be soaring just at a rate equal the GDP growth rate.

The annual increase of collection of excise taxes to the federal budget over the period of 2012-14 is planned at a level of 0.2p.p. of GDP, which should be secured by indexation of their rates and reassignment of revenues from these taxes between the federal and regional budgets1. Revenues to the federal budget from excise taxes levied on imports in 2012-should remain unchanged (0.1% of GDP).

For greater details see Section 2.3.

Section The Monetary and Budget Spheres The dynamic of the federal budget expenditures in 2010-2014 in terms of functional classification is presented in Table 15.

Table Expenditure Obligations of the Federal Budget in 20102014, % Actual The Budget Act Name 2010 2011 2012 2013 TOTAL 22.4 20.1 21.6 21.2 20.General government matters* 1.5 1.4 1.4 1.3 1.National defense 2.8 2.8 3.2 3.6 3.National security and law-enforcement activity 2.4 2.3 3.1 3.1 2.National economy 2.7 3.3 3.1 2.7 2.Housing and utility 0.5 0.5 0.2 0.2 0.Environment protection 0.0 0.0 0.0 0.0 0.Education 1.0 1.0 1.0 0.9 0.Culture, the motion picture industry** 0.2 0.2 0.1 0.1 0.Health care*** 0.8 0.9 0.9 0.8 0.Social policy**** 0.8 5.8 6.6 6.4 5.Physical culture and sports 0.1 0.1 0.1 0.Mass media 0.1 0.1 0.1 0.Public and municipal debt servicing 0.4 0.5 0.7 0.7 0.Interbudgetary transfers of general nature 9.2 1.2 0,9 0.8 0.Provisionally approbated expenditures - - 0.5 1.* In 2010 without regard to expenditures on the public debt servicing.

** In 2010 with regard to expenditures on mass media.

*** In 2010 with account of expenditures on physical culture and sports.

****In 2011 and onwards this item includes profile interbudgetary transfers, including those across extrabudgetary funds.

Source: Memorandum on the 20122014 federal budget.

The year of 2011 saw the biggest increase in federal budget expenditures (by 0.6 p.p. of GDP on a year-on-year basis) with respect to the item National economy. One of the drivers of such an increase in budget allocations became financing of projects across five priority avenues: Energy efficiency, Nuclear technologies, Strategic computer technologies and software, Space and ICT, Medical equipment and pharmaceuticals approbated by the Commission on Modernization and Technological development of Russias Economy under the RF President. The increase in spending was also fueled by implementation in 2011 of new sub-programs aimed at boosting the domestic production, such as Development of the domestic machine-tool manufacture and the tooling industry for 20112016, Establishment and organization of production of industrial diesel engines and their next-gen components in Russian Federation in 20112016.

That said, we believe that budget expenditures on the national economy should ensure much-needed institutional and infrastructural conditions of the real sector restructuring in the first place, rather than substitute for the private sectors funding. Where there is a direct budget support to backbone and strategic corporations, there emerge risks of preservation of the technological backwardness of manufacture and a low quality of management.

Since 2012 expenditures on the economy should slide by 0.2 p.p. of GDP and further by 0.4 p.p. of GDP in 2013 and 0.4 p.p. of GDP in 2014, on a year-on-year basis. The process should be driven by cuts across individual directions of subsidizing the economy, completion of a string of federal target programs and placement in operation of objects of capital construction.

Since 2012 expenditures on the item National defense should be up 0.4 p.p. of GDP vs.

2011 and subsequently up by another 0.4 p.p. of GDP on a year-on-year basis in 2013 and RUSSIAN ECONOMY IN trends and outlooks 0.2 p.p. of GDP in 2014. The increase is associated in part with the militarys monetary allowance reform which should result in a more than double rise of the militarys material security, which should also affect the level of pensions of the retired military and persons equaled to them, as their pensions should increase 1.6 times on average.

The increase in spending on the item National security and law-enforcement activity is driven by the indexation since 2012 of labor compensation funds of employees with federal public institutions, monetary allowance (salaries) of judges and prosecutors, federal public civil servants, monetary allowances of the military and persons equaled to them (except for employees with the RF Ministry of Defense and the RF Ministry of Interior, as both agencies are facing a monetary allowance reform in 2012), and payments linked to the amount of the military allowance. Between 2012 and 2014 the number of law-enforcement agencies personnel should be optimized, with thus freed funds to be spent on the monetary allowance reform.

Specifically, the volume of budget appropriations for the said reform, including compensations linked to monetary allowances and with account of a 15% reduction in the military and law enforcement personnel (except for RF Ministry of Defense and the RF Ministry of Interior) until 1 January 2014, in 2012 alone should account for Rb 389.3bn, in 2013 610.7bn, and in 2014 679.2bn.

The 2011 public debt servicing costs posted a 0.1p.p. of GDP increase vs. the previous year. The costs in question (Rb 195.0bn in 2010 and Rb 262.7bn in 2011) were partly compensated by the federal budget interest revenues from placement of cash balances on the single account of the federal budget which form an extra amount to sums spent on securing a current budget balance per the cash budget (Rb 130.0bn in 2010 and 129.0bn in 2011).

Cuts in spending by the item Health care in 2013-14 are associated with reassigning budget funds to implementation of a sector modernization plan out of the RF Ministry for Health Care and Social Developments budget to the Compulsory Medical Insurance Funds.

It is foreseen to scale back on budget appropriations by the item Housing and utilities in 2012-2013 with respect to implementation of the Federal Target Program and its non-program part, including providing the military with department and permanent housing.

As to other functional directions of federal budget expenditures, the main factor behind changes in their volume are budget outlays provided for implementation of FTPs and their non-program sections.

The dynamic of the federal budget revenues and expenditures in the 2008 constant prices (see Fig. 16) matchs the 2008-14 trends of changes in revenues and spending in current prices that is, substantial revenue cuts in 2009-10 and their annual increase post-2012, and a substantial expenditure increase in 2009, as well as in 201214, with a slight decline intermezzo in 201011.

The dynamic of main parameters of the federal budget in 2008-14 allows ascertaining that the task to maintain the budget balance is going to fall by the wayside, with priority given to the financial securing of earlier adopted and newly set expenditure obligations. However, a haphazard increase of obligations in a given field of socio-economic development propagates a ripples effect in the form of imbalances throughout other fields, and precise regulation of such imbalances will require extra budget costs. To cite a particular example, the increase in monetary allowance for the military and prosecutors between late 2011 and early 2012 was followed by a debate on the need to raise the university facultys pay. In the upcoming future, there cannot help but emerge the need for pay rises for such a low-paid category of budget Section The Monetary and Budget Spheres employees as librarians, museum staff, social employees, etc. Clearly, the 2012-14 budget continues the recent trend and is becoming more and more centered on ensuring the public (defense and law-enforcement spending) and individual (expenditures on education, health care, social support) consumption, rather than on giving fillip to economic transformation.

12000 8000 -4000 ---0 -2008 2009 2010 2011 2012 2013 Revenues Expenditures Federal budget balance (right axis) Source: the RF Ministry of Finance, the IEP calculations.

Fig. 16. Dynamic of revenues, expenditure and the federal budget deficit, billion Rb in 2008 constant prices The share of closed budget items is on the upswing. While in 2006-11 the level of closed expenditures was maintained at the level of 12% of the aggregate budget expenditures (according to IBP, open budget-wise Russia notably trails behind developed nations1), by the respective proportion should account for 22%.

The volume of the Reserve Fund posted a slight growth in 2011 (by Rb. 3.63bn), and so did the National Welfare Funds (up by Rb. 98.9bn). As of 1 January 2012, cash balances of the Reserve Fund stood at Rb. 811.5bn, or 1.5% of GDP, while those of the National Welfare Fund at Rb 2,794.4bn, or 5.1% of GDP. The volume of the Reserve Fund is envisaged to gradually increase in 2012-14, with oil-and-gas revenues being a major driver of the process, up to 3.8% of GDP in 2012, 4.3% of GDP and 5.4% of GDP in 2013 and 2014, respectively.

Due to exchange rate differences and co-financing of pension savings, the volume of revenues to the National Welfare Fund should likewise increase in 2012-2014; however, the volume of spending of its resources should be greater, thus resulting in a fall of its volume to 3.9% of GDP in 2014.

The federal budget deficit should be covered by public borrowing and revenues from privatization of federal assets2. Hopefully, Russia, with its sound credit record3 and credit rat In January 2012, the International Budget Partnership published findings of the 2010 Open Budget Survey, which evidence that Russia scored 60 out of 100 open budget-wise (for reference: the US scored 82, Germany 68, Italy 58, Brazil 71, China 13 out of 100).

According to Roskomimuschestvo, as of 1 January 2012, the government controlled 2,822 joint-stock companies with state-owned stakes in them.

Russias sovereign investment rating has been on the rise under a stable since 2005. The nations enjoying a roughly similar rating were Bahrain, Brazil, Hungary, Kazakhstan, China, Latvia, Mexico, Thailand, and South RUSSIAN ECONOMY IN trends and outlooks ings no lower than BBB and Baa1 (stable or positive1) unchanged since 2010, would face no real problems with placement of debt instruments in the years to come. Plus, a possibility to have extra revenues from privatization (Rosneft, Gazprom, Russian Railways, etc.) should be factored into, too.

2.2.5. Prospects of RF Budgetary and Tax Policy In recent years, Russias budgetary policy has been exhibiting a number of trends pointing to her defiance of the rules that countries with resource-based economies typically abide by.

At the same time, the resource dependence factor imposes rigid constraints on this countrys budgetary policy: as the oil and gas sector generates a very considerable portion of budget revenue, the size of budget revenue becomes susceptible to unpredictable fluctuations.

The governments efforts to mitigate the consequences of the crisis have so far resulted in a higher degree of imbalance in Russias budgetary policy. During the 2008-2009 crisis the authorities effectively abandoned the budgetary rules adopted in 2004-2004: budget revenues generated as a result of high current oil prices, instead of being transferred to the Reserve Fund and the National Welfare Fund, were now allocated to current expenditure in the federal budget.

The structure of general government expenditure also demonstrates a rise in the current cost of financing the pension system and in expenditures on national defense, national security and law-enforcement activities. The authorities made some costly political decisions with regard to the financing of a number of large-scale projects implemented within the framework of preparations to the 2014 Winter Olympic Games in Sochi, to the September 2012 APEC Summit in Vladivostok, and to the 2018 FIFA World Cup Russia. Considerable resources, in the form of subsidies and contributions, are allocated to the charter capital of state corporations and companies with state participation.

All these circumstances have significantly increased the existing risks of the budgetary system becoming unstable. The risk factors are as follows:

the possibility that the federal budget will show a deficit even if current oil prices remain high;

the impossibility to significantly reduce the existing social liabilities, and the prospects of a further rise in budget expenditures owing to the negative demographic trend and the persisting imbalance of the Pension Fund;

the inadvisability of any increase in the tax load on the economy, and a possible reduction in budget revenues in a medium-term perspective;

limited opportunities for a structural maneuver needed in order to achieve the economys modernization.

In the context created by these challenges, the key tasks in the field of budgetary and tax policy should are to maintain Russias macroeconomic stability, implement the assumed liabilities in a responsible and most effective manner, and create incentives for stable economic growth through the use of the tax and budgetary mechanisms.

Africa. Despite the fact that due to a considerable contraction of foreign reserves and inflow of foreign investment, in December 2008 and February 2009 two agencies downgraded Russias rating to BBB with negative forecast (and one of them changed the forecast for stable in December 2009), the rating is at a level far higher than many developed European economies.

Standard&Poors, Fitch, and Moodys.

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