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INSTITUTE FOR THE ECONOMY IN TRNSITION http://www.iet.ru Table Budget laws and administration of the federal budget in 1999, 2000, 2001, and 2002 (in constant prices) 1999 2000 2001 2002 Budget Admini- Budget Admini- Budget Admini- Budget Admini- Budget law stration law stration law stration law stration law State administration and local government 13747 14832 21541 20816 28550 29434 34538 34223 Judiciary 4848 4987 6758 6887 7950 8280 11492 11858 International activities 36594 58080 46688 19171 15561 20820 28433 19622 National defense 93703 116127 117181 158737 150597 173015 171845 179897 Law enforcement and state security 51325 55445 66391 87684 92329 104284 101168 116010 Basic research and promotion of scientific and 11635 11197 13250 14588 15498 16613 17916 18922 technologic advance Industry, power engineering and construction 14583 16921 16698 29139 31329 30964 32527 64260 Agriculture and fisheries 9284 9068 9572 11109 14591 16629 13571 16942 Protection of the environment and natural resources, hydrometeorology, mapping and geodetic 2904 2895 3110 3421 3349 3465 5859 6027 surveying Transportation, road maintenance, communica902 942 1364 1541 21466 26033 3233 4550 tions and information technology Market infrastructure development 0 0 42 63 63 12 12 Prevention and/or elimination of the effects of 7345 7374 7510 7862 4443 4863 5120 5355 emergencies and natural disasters Education 20866 20945 26705 31714 34234 38219 47612 49780 Culture, arts and cinematography 3062 2877 3893 4321 4479 4722 6184 6217 Mass media 2087 2000 4763 5072 4371 5278 6028 6049 Health and physical fitness 10239 10141 13306 14044 15577 16189 18707 19259 Social policy 41871 49096 52410 55187 75605 78740 247588 295429 Public debt servicing 166844 162583 183086 143280 168209 162056 176578 136294 Replenishment of state stocks and reserves 97 93 140 138 304 209 321 412 Financial aid to budgets of other levels 43444 62145 57528 84214 130914 161287 149530 193905 Utilization and liquidation of armaments, includ1736 3566 1722 2883 4234 4596 6235 6298 ing under international treaties Mobilization preparedness of economy 450 555 416 536 351 660 305 387 Military reform 2976 0 2853 0 3220 0 5919 5934 Research and use of outer space 0 0 0 0 2972 0 10083 8763 Other expenditures -9532 0 0 0 0 0 33227 23604 Road network 0 -2472 3401 10500 -2748 13075 -1692 7377 -Targeted budgetary funds 44038 55275 50404 80929 9746 10187 6203 9185 TOTAL EXPENDITURE 575047 664674 711375 793815 705898 929680 1140805 1246571 Tax revenues of the federal budget make Rub. 1 trillion 892 billion, or 14.5 per cent of GDP, what is by 1 p.p. below the respective indicators of 2002. Tax revenues declined due to the redistribution of profit tax revenues (since 2003, the federal share of this tax makes 6 %), half of the revenues from excises on oil products (gasoline, diesel fuel, and motor oil), and the full amount of the land tax in favor of territorial budgets. At the same time, since 2003 the federal budget shall receive the full amount of excises on tobacco products.

The aforesaid changes resulted in a decline in profit tax revenues to 1.4 per cent of GDP (1.9 per cent in accordance with the law on the budget for 2002, 1.6 per cent of GDP in accordance with the results of 2002), while excise generated revenues decreased to 1.7 per cent of GDP (2.1 per cent and 2.0 per cent respectively). Besides, it is assumed that in 2003 revenues from taxes on foreign trade may decline to 2.6 per cent of GDP (from 3 per cent registered in 2001 and 2002) in relation to the expected decrease in world oil prices and planned reduction of export customs duties.

At the same time, it is expected that VAT revenues will increase somewhat (up to 7.per cent of GDP from 7.1 per cent of GDP targeted in the budget for 2002 and 6.9 per cent of GDP according to the results of 2002).

RUSSIAN ECONOMY in trends and outlooks In the course of elaboration of the budget, the Government proceeded from tax collection being at the level of the current year (95 per cent). Besides, VAT repayment budgetary target was increased by one fourth as compared with the respective indicator registered in 2002 and made Rub. 240 billion.

The federal budget expenditures for year 2003 are planned at the level of 17.97 per cent of GDP, estimated GDP making Rub. 13050 billion. Certain changes were introduced in the structure of expenditure classification as concerns the sub-item Social assistance (resources due to extra-budgetary funds were transferred to the section Financial aid to other budgetary levels) and the section Law enforcement (expenditures for fire protection were moved to the section Prevention and elimination of the effects of emergencies, some expenditures for national defense, which were transferred to other sections, and other changes.

The most considerable increase in expenditures as compared with the law on the budget for 2002 was registered in expenditures for social policy (by 1/4 of GDP point in terms of comparable classification and by almost 40 per cent in comparable prices), law enforcement (by almost 0.4 GDP point, or 30 per cent in comparable prices). The expenditures for judiciary were also raised (by 0.06 p.p. in terms of GDP and more than 20 per cent in comparable prices). Expenditures for national defense increased by 0.15 p.p. in terms of GDP and by per cent in real terms. As concerns the structure of social expenditures, there were raised expenditures for culture and arts (by 0.02 p.p. in terms of GDP, or by 25 per cent in comparable prices), education (by 0.03 p.p. or 13 per cent respectively), and health (0.02 p.p. or 15 per cent respectively).

Table Certain expenditure items in the draft federal budget for year 2003 and the law on the federal budget for 2002 in comparable classification 2002 budget law in % 2002 budget law in % 2003 budget law in % of 2003 budget law in of GDP, comparable of GDP comparable prices classification and classification International activities 0,45 0,34 81,National defense 2,50 2,64 114,Law enforcement and state security 1,53 1,88 132,Basic research and promotion of scien0,30 0,31 110,tific and technologic advance Industry, power engineering and con0,57 0,49 91,struction Prevention and/or elimination of the effects of emergencies and natural dis- 0,14 0,16 126,asters Social policy 0,90 1,15 138,Financial aid to budgets of other levels 5,46 5,48 108,The major factors behind the growth in expenditures were the rise in cash allowances for military personnel, increase in wages of employees of the budgetary sphere, and higher scholarships raised in the beginning of 2003 / 2004 academic year. Increasing expenditures for road network is related to the growth in subsidies to territorial budgets in order to compensate for the loss of revenues generated by the tax on motor road users. In 2003, expendi INSTITUTE FOR THE ECONOMY IN TRNSITION http://www.iet.ru tures for the judiciary system include additional financing of newly created jobs across the whole structure of the judiciary system.

A decline in expenditures of the federal budget was most pronounced in the section International activities (by 0.11 p.p. in terms of GDP and by 18 per cent in comparable prices).

Besides, the 2003 budget envisages a decline in financing of expenditures for support of industry, power engineering, and construction by almost 0.1 p.p. of GDP, or by 10 per cent in real terms in comparison with the current budget in comparable classification, as well as a number of other items, including the military reform, research and use of outer space, mobilization preparedness of economy, and utilization and liquidation of armaments. The aggregate reduction of these expenditures made 0.07 p.p. in terms of GDP or 15 per cent in real terms.

Interest expenditures as set forth in the budget for 2003 were reduced by one fifth of percentage point in GDP terms, or by 14 per cent in comparable prices in comparison with the respective targets of the budget for 2002.

On the whole, it seems that the revenue section of the 2003 budget was worked out proceeding from the optimistic scenario. First, the results of the execution of the budget do not allow to draw definite conclusions as concerns the Tax Ministry ability to meet the tax revenue targets in 2003 taking into account the fact that it collected less taxes than set forth in the law by Rub. 30 billion in 2002. Second, revenues at Rub. 23 billion in repaid indebtedness look questionable taking into account lack of positive trends in the preceding year (tax arrears increased by about 2 per cent in real terms, while deferred payments decline by less than 1 per cent).

Expenditures set forth in the budget for year 2003 do not require any serious changes in the structure of the expenditures of the federal budget, with exception of change in the amount of financing of certain items because of the reclassification of certain types of expenditures. On the whole, it may be concluded that two major problems the Government tried to address in the budget for 2003 were raise in wages and salaries of employees of budgetary organizations and repayment of external debt due in 2003.

Scenario Based Macroeconomic Forecast for Three scenarios of the development of the economic situation in Russia in 2003 determined by different dynamics of world oil prices over the year seem most probable. The estimates proceed from the assumption that world oil prices will remain the decisive factor for the development of Russias economy in the short term in spite of the fact that at some moments the role of other variables (for instance, domestic demand) may gather in importance.

Two scenarios envisage a growth in oil (Brent) prices up to US $ 40 over the first six months of 2003 due to the escalation of tensions relating to Iraq and North Korea, higher risks to extract and export oil from the Persian Gulf countries, and falling oil production in Venezuela. Both scenarios presume the US attack against Iraq or replacement of the countrys leadership in the second quarter of 2003. Further these scenarios diverge.

The first scenario envisages a fast and successful military campaign or a coup resulting in the replacement of the countrys leadership and resumption of Iraqi oil export in large volumes already in 2003. In this situation it is expected that oil prices will rapidly decline in the 3rd and 4th quarter of 2003 to US $ 20 to 25 per barrel.

The second scenario is based on a prolonged war or instability in Iraq (over six months), what would prevent the resumption of Iraqi oil export and result in higher volatility on world raw materials markets. It is assumed that in this case oil prices will also go down by the end RUSSIAN ECONOMY in trends and outlooks of the year due to higher quotas of OPEC member countries, growing exports from other countries, and development of new deposits rendered profitable by high oil prices. However, the decline will be more smooth and Brent oil prices will be at or above US $ 30 per barrel by the end of the year.

The third scenario envisages that the US either will not start the military campaign against Iraq, or delay it until 2004. However, persisting instability in the Persian Gulf region and the threat of military action will result in higher oil prices (at about US $ 32 per barrel) over the year.

For the dynamics of oil prices in 2003 according to all scenarios described above and two scenarios elaborated by the Ministry for Trade and Economic Development in the course of planning the budget for year 2003 see Fig. 2615.

Oil prices (Brent) in Scenario Scenario Scenario Optimistic scenario Conservative scenario Q1 Q2 Q3 QFig. The scenario based forecasts based on the model of medium term prognostication elaborated by the Russian European Center for Economic Policy at the request of the RF Ministry for Economic Development and Trade. The model consists of 8 equations and 3 identities.

Modeled variable Explanatory factors Real GDP with a lag, real investment in fixed assets with a lag, real household Real GDP incomes with a lag, oil prices Exports Oil prices Scenarios of the RF Ministry of Trade and Economic Development (MTED) are based on the Urals oil prices, therefore for comparability purposes these prices were increased by US $ 2 per barrel, what corresponds to the average difference in Urals and Brent prices over the last years.

$/bbl INSTITUTE FOR THE ECONOMY IN TRNSITION http://www.iet.ru Inflation with a lag, increase in money supply M2 with a lag, real GDP with a Inflation (CPI) lag Tax revenues Nominal GDP, exports Imports Real GDP, real Ruble rate Gold and currency reserves Exports, imports, nominal Ruble rate Change in the Ruble nominal rate Gold and currency reserves It is assumed that changes of exogenous variables (the rate of increase in real investment and the rate of increase in real household incomes) will also depend on the level of oil prices due to the fact that a considerable share of domestic demand for investment goods is formed in the export sector, while growth in household incomes is secondary to the growth of incomes in the economy at large. Therefore, it is assumed that in 2003 there will take place the following changes of exogenous variables:

Oil prices Real investment in fixed assets Real household incomes 7-8% 7% Scenario 1 20-Scenario 2 30-40 7-9% 8% Scenario 3 32 7-8% 8% Conservative scenario 20,5 6,3% 5,0% Optimistic scenario 23,5 7,5% 6,0% The model has been built basing on the quarterly data for the period from the 1st quarter of 1995 to the 4th quarter of 2002. The data were obtained from official publications of Goskomstat, Bank of Russia, and International Monetary Fund (International Financial Statistics). Alongside with variables shown above, there was used a number of dummies, for instance, for seasonal effects (quarter, years), the crisis of 1998, etc.

The predicted values of variables were obtained in two stages. At the first stage, in order to better evaluate the predictive power of the model, equations were tested basing on the period from the 1st quarter of 1995 to the 4th quarter of 2001 and prognosis was made for 2002. The best specification of the model was chosen on the basis of the minimal discrepancy between predicted values of this model and actual values of variables.

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