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The growth of expenditures is also prompted by some governance decisions which may be considered as doubtful in terms of the budget policy priorities. Thus, e.g. from 2011, five new federal target programs and three state programs will be financed, and part of these are not included in the priorities of the budget policy as set by President of Russia. Many experts believe, e.g. that the Clear water FTP developed under the influence of the Parliament lobby, likewise Development of the domestic and international tourism can hardly be described as priorities that require additional financing given the budget deficit; moreover the expenditure share for the new FTP makes almost 20% of the FTP general expenditures for 2011 2013.

In 20112013 the federal budget expenditures will be cut down in the following sections and areas:

- Healthcare - from RUR 375.6 billion in 2011 to RUR 356.1 billion in 2013: at the expense of increasing funds for the implementation of the sector modernization project from the Fund of Compulsory Medical Insurance. The major portion of the allocations from the said Fund will be distributed among regions in the form of grants;

- Housing and utilities - in 2012 and 2013 there will be a reduction of the budget allocations for the implementation of the federal target programs and a FAIP part not covered with the programs, including the provision of service and permanent housing to the servicemen (RUR125.9 billion in 2010 to RUR25.3 billion in 2013) in connection with completion of the respective efforts. Besides in 2011 there will be budget allocations to finance subsidies to a state corporation Fund of Assistance to the Housing and Utilities Reform in the form of a property contribution to rehabilitate the Fund property that had been transferred to the ownership of the Russian Federation in 2009 in the amount of RUR15.0 billion; no such actions are planned for 2012 and 2013.

More than double expenditures to service the government debt from 0.4% of GDP in 2010 to 1.0% in 2013 require special attention. The growth of the government debt (8.3% of Section 2.

Monetary-Credit and Budgetary Spheres GDP as of 01.01.2010 up to 18.2% of GDP as of 01.01.2014 see Table 14) may negatively affect the stability of the national fiscal system. At the same time stepping up the government debt will take place primarily through a growing share of internal borrowings (in 2010 the internal debt will grow from 5.4% of GDP to 14.3% of GDP, while the external debt will remain within 4% of GDP) which is quite justified in terms of national security and manageability of the debt.

Table Federal debt of the Russian Federation in % of GDP Law on budget* 2005 2006 2007 2008 2009 2010 2011 2012 Federal government debt (as of the year end) 14,3 9,1 7,2 6,5 8,3 9,4 13,7 16,1 18,including:

internal debt 4,1 4,0 3,9 3,6 5,4 6,6 10,2 12,5 14,external debt 10,2 5,1 3,3 2,9 2,9 2,8 3,5 3,6 3,*top limit of the federal government debt is shown Source: RF Treasury, IEP calculations.

The period when the Reserve Fund was a key source of financing deficit of the federal budget ended in 2010, when the Fund allocated RUR1,119.5 billion (2.5% of GDP) for the said purpose. The Reserve Fund allocations have not been spent fully as the expected federal budget deficit was reduced; the non-spent funds as of January 1, 2011 amounted to RUR775.2 billion. (Table 15).

Table Dynamic trend of the formation and use of oil and gas funds in 2010, in RUR MM Receipts in 2010 Spent in 2010 for:

Assets Financing of Financing of Balances as of the Balances as of the Indicator oil and gas manage- the federal the budget end of 2009 * end of 2010 * revenues ment re- budget defi- deficit of offceipts cit budget funds 1830.5 1119.5 24.5 775.Reserve Fund (4.7% of GDP) (1.7% of GDP) 2769.0 2.5 2695.National Welfare Fund (7.1% of GDP) (6.1% of GDP) 4599.5 1119.5 27.0 3470.Total (11.8% of GDP) (7.8% of GDP) * the balances are recalculated at the exchange rate as of January 1, 2010 and 2011 respectively.

Source: RF Treasury.

In 2010, the RF Government elected not to use the National Welfare Fund, and the Fund balance in absolute terms remained at the 2009 year-end level. The Funds assets in the amount equal to the populations pension accruals (RUR5.0 10.0 billion per year) will continue to be further used in 2011 2013 thus ensuring safety of the accumulated assets of the Fund. It is worth noting that given the considerable reduction of spending or full spending of the oil and gas funds assets, by 2012 the national financial system could be exposed to external shocks having no financial coverage.

To cover the budget deficit, receipts from privatization (RUR298 billion in 2011 up to RUR309.0 billion in 2013) will be actively used.

RUSSIAN ECONOMY IN trends and outlooks 2.2.5. Prospects of the fiscal policy development In 2010, the structure of the Russian economy (fuel and energy sectors generate up to 9% of GDP) and the exports oriented at raw materials (2/3 of the exports are produced in the fuel and energy sectors) ensured, through the system of oil and gas revenues, up to 46.5% of the federal budget revenues and 24.6% of the budget revenues of the enlarged government. However, world market prices on fuel and raw materials are highly volatile. The issue of such dependency was partially resolved by establishing in the 2000es a tax system with graduated MET rates and export duties depending on oil prices and Stabilization Fund. When in the federal budget revenues in real terms decreased by 22%, the Government managed to increase expenditures up by 25% by tapping assets accrued in the Reserve Fund. Nevertheless, according to IEP, tax revenues fluctuate in the range of 34% depending on the external market situation; besides, at various stages of the business cycle an additional fluctuation of the tax revenues can happen within 22,5%. In other words, with an average long-term price on oil of 70 $/bbl, the enlarged government budget can receive about 34% of GDP, but this figure may vary from 28% to 40% of GDP.

With account unpredictable generation of budget revenues from oil and gas, a conservative approach is required to define the level of their spend that would ensure budget stability. The current application of the oil and gas transfer which size is linked to GDP does not limit expenditures to a safe level in terms of the budget balance. To reduce the dependency of the budget revenues on the external economic situation, we should abolish the current procedure of the oil and gas transfer and return to the procedure effective in 2004 2007: the procedure was based on the cut-off price, and MET contributions to the Reserve Fund and the export duties were in direct proportion to the excess of the actual tax rate over the rate calculated with account of the average long-term price. In other words, the size of the oil and gas revenues open for use should be limited by a certain threshold oil price kept unchanged during the entire period of budget planning (i.e. three years).

All oil revenues above the established limit should be channeled to oil and gas funds. A budget deficit should be funded from the Reserve Fund only if budget revenues are underreceived as a result of the oil price being lower than the oil price estimated in the respective macro-forecast which was used as a basis for estimation of the main parameters of the federal budget.

Such approach can assure budget stability since the threshold level of the budget allocations for spending is fixed as early as the budget planning stage. To use the cut-off price would be reasonable (similar to the price used as a basis for establishment of the Stabilization Fund in 2004 2007) for estimation of tax revenues from production and export of oil and gas.

In the context of limitation of government expenditures, efficiency of their spending should be improved. The quality of budget governance can be improved by using a comprehensive approach only that will help to cover the broadest range of the applied regulating tools and to align their application in time. With this in view, in the near future a focus should be placed on resolution of the issues of budget system restructuring, higher transparency of the state procurement system and optimization of certain budget procedures. As a favorable institutional environment evolves in the country, any further development of such governance tools as the result-oriented budget, target program activities, state and private partnership can become an important factor of budget expenditures streamlining and improvement of efficiency of the entire budget process.

Section 2.

Monetary-Credit and Budgetary Spheres 2.3. Intergovernmental Fiscal Relations and Subnational Finances 2.3.1. Subnational Budgets in Basic trends concerning relations between different levels of power are reflected in the structure of revenues and expenditures of the consolidated budget of the Russian Federation.

Data on a share of tax revenues and expenditures of the constituent territories of the Russian Federation in the relevant items of the consolidated budget of the Russian Federation is shown in Table 16.

Table A share of specific values of the budget of the constituent territories of the Russian Federation in the consolidated budget of the Russian Federation in 1992 2010 (%) 44.2 53.1 53.4 47.6 49.5 53.1 56.6 49.2 43.5 37.4 35.1 39.6 36.1 30.9 31.8 33.9 33.2 36.6 37.Tax revenues Tax revenues, 47.7 61.7 61.4 56.0 55.8 59.5 59.9 53.0 49.0 42.6 40.1 41.9 47.5 49.1 52.0 50.5 53.7 54.8 57.net of natural resource charges and customs duties Expenditures 34.0 40.3 37.7 43.4 45.4 48.1 54.1 51.9 54.4 54.2 49.3 50.0 50.8 49.5 43.4 48.3 49.2 43.4 43.Data Source: The Federal Treasury, the estimates were made by the Gaidar Institute.

The following is worth highlighting in analyzing the data presented in Table 16. A share of tax revenues of the constituent territories of the Russian Federation in the consolidated budget decreased considerably from 56.6 to 30.9% over the period between 1998 and 2005. This trend was conditioned by economic situation (growth in prices of energy resources resulted in increase of revenues from customs duties and natural resource charges due to the federal budget), rather than redistribution of sources of revenues between different levels of the budget system. The fact that a share of subnational budgets in tax revenues of the consolidated budget, net of natural resource charges and customs duties, decreased less during the same period, from 59.9% in 1998 to 49.1% in 2005, can be used as evidence. A share of subnational budgets in tax revenues of the consolidated budget of the Russian Federation was reported to increase in the period between 2006 and 2007, because revenues from taxes payable to regional budgets increased faster than tax revenues of the federal budget. In 2008 this share slightly decreased but remained at a much higher level than in 2005. A share of regional budgets in tax revenues of consolidated budget, net of natural resource charges and customs duties, increased visibly in 2008 over the level of 2007.

The economic downturn of 2009 had an effect on the relations under review. A share of tax revenues of the constituent territories of the Russian Federation increased considerably from 33.2 to 36.6% in the relevant revenues of the consolidated budget of the Russian Federation, which was conditioned to a large extent by a slump of federal budget revenues from mineral extraction tax and customs duties. A share of regional budgets, net of natural resource charges and customs duties, increased as well: by 1.1 p.p., from 53.7 to 54.8%, which was conditioned RUSSIAN ECONOMY IN trends and outlooks to a large extent by steady revenues from personal income tax paid to regional budgets during the recession (RUB 1666,2 bln in 2008 and RUB 1665,8 bln in 2009 ). A certain economic recovery was reported in the Russian industries in 2010. According to the data published by Rosstat, GDP increased by 4% in real terms. A share of regional tax revenues in the consolidated budget of the Russian Federation increased from 36.6 to 37.2% due to a faster growth in volumes of taxes payable to subnational budgets. A share of tax revenues, net of natural resource charges and customs duties, increased more by 2.3 p.p., from 54.8 to 57.1%. On the other hand, a share of subnational budgets in revenues of consolidated budget of the Russian Federation decreased considerably from 49.2% in 2008 to 43.4% in 2009, and remained almost the same, 43.2%, in 2010. The foregoing trends was indicative of a marked reduction in the vertical gap in the Russian budget system by aligning shares of tax revenues and revenues of subnational budgets in the consolidated budget of the Russian Federation. It is well to bear in mind that this trend was reported due to a drastic decrease in federal budget revenues in 2009 accompanied by a substantial growth in the federal government expenditures (by 27.4% in nominal terms against the level of 2008) which were covered with accumulated financial reserves.

In light of the recent trends, the Russian expert communitys traditional point of view on that the budget system is vertically unbalanced through excessive concentration of tax revenues in the federal budget. The following arguments may cast some doubt on this point of view :

- federal budget revenues include a big share of natural resource rent which is extremely unstable and likely to keep reducing as percentage of GDP ;

- the federal budget includes the largest cost-related obligation financing of the pension system deficit. Ageing of the population will result in growth in expenditures on pension provision and demand for grants from the federal budget;

- regional and local budgets include almost all of the taxes, save for natural resource rent, namely personal income tax, a lions share of profit tax (18% of 20%), corporate property tax. Should the country follow the post-industrial (non-primary) scenario, a share of these taxes would be increasing in total revenues of the consolidated budget of the Russian Federation. On the other hand, the federal budget has only one large source of tax revenues, VAT, which would remain relevant under the non-primary sector development model.

Therefore, any substantial tax revenues are unlikely to be allocated to the subnational level.

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