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Financing of the RF Federal Budget in 2005-(in per cent of GDP) 2005 October 06 2006 October Federal issues 2,58% 2,51% 2,19% 2,29% Including expenditures associated with the servicing of federal and municipal 1,06% 0,83% 0,65% 0,55% debt National defense 2,71% 2,96% 2,57% 3,08% National security and law enforcement 2,05% 2,34% 2,08% 2,41% National Economy 1,17% 1,31% 1,31% 1,63% Housing and public utilities 0,04% 0,21% 0,20% 0,19% Environmental protection 0,02% 0,03% 0,03% 0,03% Education 0,73% 0,82% 0,78% 0,95% Culture, cinematography and mass 0,22% 0,22% 0,21% 0,25% media Health care and sports 0,42% 0,63% 0,56% 0,69% Social policy 0,88% 0,93% 0,81% 0,84% Inter-budgetary transfers 5,77% 6,49% 5,68% 6,72% Total expenditures 16,58% 18,46% 16,40% 19,09% Source: RF Ministry of Finance, IET estimates.

Let us consider the data on federal budget execution in terms of revenues and expenditures on cash basis in percentage of budget estimates (see Table. 3). It is worth noting that generally, in the course of the year, the results of the federal budget execution on cash basis in terms of both, revenues and expenditures, were gradually approaching the estimates for the relevant period. Herewith, while the revenues in the third quarter of the year have already exceeded the budget estimates, the amount of expenditures fell behind the planned values by 16.2 per cent.

A more detailed analysis allows to point out the following facts. Exceeded indicators versus the estimated values are observed only in some revenues, administered by certain government bodies. Thus, the revenue, administered by the Federal Customs Service made only 96,6 per cent versus the planned level. In terms of the federal budget expenditures, the backlog from the budget forecast is observed (to variable extent) in all budget lines without exception. It is necessary to emphasize that there is significant irregularity in expenditure of budgetary funds by government bodies within the year. Even according to the results of the third quarter, the expenditures under such budget lines as housing and public utilities, healthcare and sports have reached only 63.9 per cent and 66.3 per cent, respectively. The gap between expenditure and budget estimates for the third quarter should result in explicit increase in the level of expenditures at the end of the year, which is confirmed by the tentative data, provided by the Ministry of Finance. As mentioned above, in October a significant increase in expenditures is observed as compared with preceding months.


Execution of the RF Federal Budget on Cash Basis in (in % versus Budget Financing Targets for the Relevant Period) Quarter I Quarter II Quarter III 72,38% 81,91% 83,8% EXPENDITURES Federal issues 65,71% 78,87% 74,25% Including expenditures associated with the servicing of federal and 86,59% 93,08% 97,29% municipal debt National defense 65,34% 85,52% 81,57% National security and law enforce69,55% 83,50% 87,51% ment National Economy 55,37% 67,35% 72,83% Housing and public utilities 19,58% 41,23% 63,94% Environmental protection 60,48% 76,85% 81,91% Education 61,01% 71,17% 81,43% Culture, cinematography and mass 60,52% 69,06% 74,74% media Health care and sports 44,98% 59,26% 66,29% Social policy 60,35% 76,80% 81,81% Interbudgetary transfers 94,24% 92,33% 92,46% 90,50% 97,79% 100,2% REVENUES Taxes and other payments adminis86,52% 99,37% 100,38% tered by the Federal Tax Service Taxes and other payments administered by the Federal Customs Ser- 90,80% 91,52% 96,63% vice Receipts administered by the Federal Agency for Management of 120,90% 110,26% 148,90% Federal Property Revenues of the federal budget administered by other federal struc- 159,52% 149,67% 133,59% tures Source: RF Ministry of Finance, RF Treasury, IET estimates Fig. 4 presents monthly data on tax arrears to RF the budget (regardless the arrears on penalties and sanctions) for 2007. The data on four types of taxes is presented below: corporate income tax; VAT on goods produced in the territory of the Russian Federation; severance tax and uniform social tax (including mandatory deductions to Pension Fund).

Reviewing the charts, provided below, one can be point out the following issues. The arrears under uniform social tax and of severance tax were sustained throughout the year at approximately the same level.

However, an explicit upsurge was observed in arrears under corporate income tax, while a slight decline was noted in terms of VAT arrears.

January March May July September Corporate income tax VAT (for the goods, produced in the RF) Severance tax Uniform social tax (including deductions to Pension Fund) Fig. 4. Tax arrears to the RF budget in 2007 . (RUR, mln) As of October 1, 2007 the cumulative volume of the RF Stabilization Fund in RUR equivalent amounted to RUR 3,649.25 billion, or 11.7 per cent of GDP (in annual terms). Fig. 5 presents monthly dynamics of Stabilization Fund (in per cent of GDP). As shown in the diagram, in 2007 there was observed a trend to some extension of Stabilization Fund share in GDP. It is worth noting, that Stabilization Fund share in GDP in the current year has substantially exceeded the indicators, observed in preceding year.

14% 12% 10% 8% 6% 4% 2% 0% January March May July September November Fig. 5. The RF Stabilization Fund in 2006-2007 (in % of GDP) Note: Data for April and May is not available.

In November, the Central Bank of Russia has proposed to perform the exchange operations with the RUR portion of the Stabilization Fund into foreign currency in the open market. Currently, tax proceeds, designated for Stabilization Fund are transferred to the foreign currency deposit account of the RF Central Bank, avoiding the Russian foreign currency market.According to the statement of Aleksey Ulyukayev, the Central Bank First Chairman, those operations in the foreign currency market can serve as an element of the exchange rate policy.

Inflation, Monetary and Credit Policy P. Trunin In October the upsurge of inflation continued in the Russian Federation: the CPI reached 1.6 per cent as compared with 0.3 per cent in the relevant period of the preceding year. Herewith, foreign currency assets were being accumulated in the country, having exceeded USD 455 bln. Significant reduction of commercial banks reserves with the RF Central Bank was noted in October due to unfavorable situation in the interbanking credit market.

The consumer price index in October made 1.6 per cent (against 0.3 per cent in October 2006 (see Fig.

1.). Such high rates of consumer prices growth were observed for the last time only in September 2000, when monthly CPI exceeded 2.1 per cent. The greatest contribution to the prices growth in September (+ 3.per cent) was made by an upsurge in prices for food stuffs. Herewith, regardless of fruit and vegetables, which prices are traditionally getting lower in autumn, the upsurge of prices for other food products reached 3.5 per cent. It is worth noting that in October prices for fruit and vegetables were downgrading far less than in September, which reduced their impact in cumulative CPI.

The utmost growth was noted in prices for oil (+ 26.3 per cent), butter (+ 12.7 per cent), milk and dairy products (+ 9.6 per cent), pasta (+ 3.1 per cent), cereals and beans (+ 2.9 per cent). Prices for granulated sugar went down by 2.1 per cent.

In October, high rates of growth were observed also in regard to non-food items, which average nationwide prices have increased during the month by 0,9per cent (versus + 0,6per cent in October 2006). The growth of a wide range of non-food items is remarkable, as it supports the idea that the inflation acceleration in autumn 2007 was provoked not only by the global upsurge of food products prices. One can see alternative grounds for accelerated inflation, such as extended monetary supply at the beginning of the year, or low monetary demand as a result of slowed-down economic activities in August-September. The highest growth rates were noted in October for footwear (+ 18 per cent), knitwear (+ 1.4 per cent), clothes and underwear (+ 1.3 per cent), construction materials (+ 1.2 per cent) and medical supplies (+ 1per cent). Downgrading was not observed in any type of non-food items.

Commercial public services have grown in price in October by 0.1 per cent (+ 0.4 per cent in October 2006). The utmost growth was observed in regard to fitness and sports services (+ 2.6 per cent), culture organizations (+ 2.4 per cent), utilities (+ 1.4 per cent), as well as healthcare services (+ 1.3 per cent). Downgrading was noted in October for public transportation, international transport ( 2.3 per cent), international tourism ( 0.9per cent), health-care and resort services ( 0.5 per cent) communication services ( 0.1 per cent).

Therefore, the trend of accelerated inflation, started in September of the current year, was sustainable in October. It pushed the RF government to take a number of administrative measures to restrain the prices growth rates, such as an agreement between the government and retail trade networks to freeze prices for socially significant products. As mentioned in earlier survey, such measures could provide only a short-term effect: according to tentative estimates, in November inflation rates were noticeably lower than in October.

Nevertheless, we are still convinced that those measures will be ineffective in mid-term prospective, as they are addressed to the symptoms, rather than to the source of disease.

In October 2007 the basic consumer price index2 amounted to 2.1 per cent (against 0.5 per cent in the relevant period of preceding year), which is an absolute record for the past four years. According to the World Bank forecast, published in November, in 2008 the inflation in Russia will exceed the government estimates of 7 per cent and reach 7.5 per cent. Herewith, the World Bank experts regard the vast-scale capital inflow to the RF as the basic source of accelerated inflation. In our opinion, that inflation rate is rather optimistic. Basing on the current inflation trends, one could expect the CPI to overcome the level of 11 per cent as of the year results. With regard to significant inertia of inflation process, the slow-down of prices growth rates by one third looks unlikely. The inflation pressure will be aggravated not only by considerable capital inflow, noted by the World Bank experts, but also by the planned growth of budget expenditures and higher export proceeds in case of further upgrading of energy sources. All the above factors provide grounds for CPI assessment for the year of 2008 at the level of 8.5 9.5 per cent.

Basic index of consumer prices is an indicator of the inflation level without regard to seasonal price reduction (fruit and vegetable products) and to administrative measures (tariffs for government-regulated services, etc.). It is estimated by the RF Statistics Service The Growth Rate of the CPI in 2002 - 2007 (% per month).

3,5% 3,0% 2,5% 2,0% 1,5% 1,0% 0,5% 0,0% -0,5% Fig. 1.

Source: RF Statistical Service Within October 2007 the volume of monetary base (in broad definition3) has been decreased by RUR 182.1 bln to the amount of RUR 4,405.1 bln (- 4 per cent). The volume of monetary base in broad definition as of October 1, 2007 was RUR 4587.2 bln. Let as consider the dynamics of monetary base in broad definition by components.

The volume of cash in circulation, including the cash balances of credit institutions, as of November 1, 2007 was RUR 3.51 trillion (+ 1.2 per cent as compared with October 1), the correspondent accounts of credit institutions with the Bank of Russia made RUR 510.6 bln (-11.4 per cent), mandatory reserves RUR 260.5 bln (-18.3 per cent), credit organizations deposits with the Bank of Russia RUR 102.1 bln (+41.per cent), the value of the Bank of Russias bonds held by credit institutions RUR 19.3 bln (-87.1 per cent).

Therefore, further reduction of commercial banks reserves with the RF Central Bank took place in October, based on assets insufficiency in the world credit market, as well as in the RF inter-banking market. Moreover, considerable decrease of commercial banks mandatory reserves was noted as of October results due to the reduced rate of mandatory reserve amount. In October the Central Bank credits, guaranteed with securities, remained in demand of credit organizations; in late October the volume of direct daily REPO operations reached RUR 200 bln. During November the volume of those operations stayed at a rather high level, which was a sign of the sustained tension in the Russian financial market. Herewith, an inflow of private capital to the RF was renewed, what should serve to the benefit of liquidity assets growth in the economy.

The growth of cash in circulation in October of the current year (by 1.2 per cent) at the background of increased mandatory reserves (by 1.2 per cent) coupled with reduced mandatory reserves (-18.3 per cent) has resulted in extension of the monetary base in narrow definition (cash + mandatory reserves)4 by 1.5 per cent The RF monetary base in broad terms with no regard to the cash issued by the Bank of Russia and the balance of Compulsory Reserve Accounts on credit organizations in national currency, deposited in the Bank of Russia, taking into account the assets of correspondent accounts and bank deposits, allocated in the Bank of Russia..

4 Monetary base in a narrow definition is a monetary instrument (an indicator of monetary supply volume), which is fully controlled by the RF Central Bank. The Monetary base in narrow definition includes the cash in circulation, issued by the Bank of Russia (and the balance on the accounts of credit organizations), balances on the accounts of mandatory reserves of the funds in the national currency attracted by credit institutions in national currency, deposited with the Bank of Russia.

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