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Contrary to the situation observed in 2003 and 2002, in 2004 the aggregate surplus of consolidated budgets of RF subjects was registered at 0.2 per cent of GDP. This surplus resulted in an increase in the balance of the budget by 0.6 p. p., what made 1.2 per cent of GDP by the end of the reporting period. Among the sources of financing used by regions in 2004 there were the issue of state and municipal securities, attraction of credits on behalf of RF subjects and municipal entities, and privatization of state and municipally owned property. It should be noted that both in 2003 and 2004 at the national level there were ob served negative balances of such a source of financing of the budget deficit as federal budgetary loans (i.e. in 2004, across the country RF subjects repaid their liabilities associ ated with these loans in amounts exceeding new respective borrowings). These develop ments may be seen as the turning point with respect to the negative trend observed up to 2003.

An analysis of qualitative characteristics of the financial aid to subjects of the Fed eration from the federal budget (see Table 10) reveals that in spite of a considerable growth in the tax revenues of the federal budget the amount federal financial resources transferred to subnational budgets on free basis increased only insignificantly in nominal terms and made about Rub. 401 billion, or 2.39 per cent of GDP (as compared with 2.Section 2.

Monetary and budgetary spheres per cent of GDP observed in 2003) in 2004. At the same time, in real terms the financial aid to regional budgets declined by 3 per cent in comparison with the figures registered in 2003.

In 2003, the expenditures of the federal budget associated with financial aid provided to RF subjects and municipal entities did not change as compared with the figures regis tered over a number of preceding years. In spite of the implementation of reforms, the specific features of this type of federal budgetary expenditures still are significant amounts of funds distributed in the course of interbudgetary regulation without any methodological, financial, and economic justification. In the total amount of transferred resources, the share of financial aid allocated on the formalized basis makes about 60 per cent. Similarly to the situation observed in the preceding years, on the formalized basis there was formed and allocated only a limited amount of financial aid (Federal Fund of Financial Support, Compensatory Fund, Fund of Co financing of Social Expenditures, and Fund of Reform of Regional Finances). At the same time, no procedure governing the formation and alloca tion of even a portion of the said funds was approved in the framework of official regulatory and legal acts. The only exception was the Fund of Reform of Regional Finances, since the respective methods of formation and distribution of this fund were approved by a resolu tion of the RF Government, what was a condition set forth by the World Bank, which spon sored the financing of this type of financial aid. At the same time, in 2004 there became perceptible a positive trend as concerns the approval of the methodologies of formation and distribution of the funds of financial support of regions by the resolutions of the RF Government. However, the decisions with respect to formalization of financial aid to re gions taken in 2004 will enter into force only in 2005.

All other types of financial support have been formed and allocated outside of any clear methodological procedures (with the exception of the grants for support of the measures aimed at the ensuring of the balanced nature of the budgets of RF subjects).

In 2004, similarly to 2003, the specific feature was the revision of the law on budget and an increase in the initially allocated amounts of financial aid to regions by Rub. 73 bil lion. It should be noted that over the last 4 years such changes have become rather cus tomary, what challenges the efficiency of the reform, which had been implemented in the sphere of distribution of financial aid to regions.

The problem of annual revisions of the budget laws and increases in the initially planned amounts allocated to regional budgets is not only that the additionally allocated amounts are not subject to the formalized procedures underlying the elaboration of the law on federal budget for next financial year. The annual rises of the amounts of financial aid in comparison with the originally envisaged transfers, as well as the lack of clear and well known rules of distribution of such additional amounts result in a significant softening of budgetary constraints on subnational authorities, what is discussed in more details below.

In other words, in the case the regional authorities in advance assume that in the course of allocation of additional financial aid the federal authorities will orient towards such indica tors of needs as the wage and salaries arrears, the amount of creditor indebtedness in the sector of housing and public utilities, etc, and not the objective characteristics of regional tax potential and expenditure needs of regions used for the distribution of transfers from the Fund of Financial Support of Regions, it will fail to facilitate implementation of meas ures aimed at enhancement of efficiency of budgetary expenditures and conduct of reform of the public sector.

As examples of the existing procedures and principles of distribution of additional fi nancial aid there may be cited the following decisions:

RUSSIAN ECONOMY in trends and outlooks 1) In 2004, the Compensatory Fund was increased from Rub. 49.9 billion to Rub. 56.2 bil lion, i.e. by 13 per cent;

2) The Fund of Co financing of Social Expenditures was increased from Rub. 3.3 billion to Rub. 6.3 billion, i.e. by 91 per cent;

3) The grants for equalization of regional budgets were increased from Rub. 20.2 billion to Rub. 21.8 billion, i.e. by 8 per cent.

The considerations discussed above indicate that over the last years the process of the reform of interbudgetary relations started in 1997 and 1998 has been apparently slow ing down, and in some cases (for instance from the viewpoint of the ratio between the fed eral resources distributed across regions on the basis of formalized and discretional prin ciples) in 2002 through 2004 there was observed a certain regress. This situation may be explained by several factors.

First, at present the objective overburdening of the budget sphere with federal ex penditure obligations not backed by the respective financing persists. In the situation, where the total amount of expenditure obligations exceeds the financial resources avail able to the authorities, the government naturally strives to have available some financial reserves, which could be immediately transferred to regions depending on the arising needs.

Second, the powers to distribute financial aid among regional budgets outside trans parent procedures fixed by regulations are the most important lever of influence on the decisions and policies of subnational authorities. In the situation, where the degree of in terregional unevenness of budgetary security is high (what is a specific feature of Russia), it is needed to support a rather high degree of centralization of tax revenues in the federal budget, and, respectively, a larger amount of the budgetary resources redistributed among regions. Therefore, due to the use of financial mechanisms the degree of influence on regional authorities, which to a certain degree are formally independent as concerns the decisions they take within their competence, may be rather significant. From the point of view of the authors, this situation is one of the key reasons, why the methods of distribu tion of the major types of financial aid used over the last years have not been fixed in the budgetary legislation as yet.

In any case, as it is demonstrated by the recent practices the reform of the principles underlying the distribution of the federal financial aid is still on the agenda, since the exist ing system is insufficiently transparent, what does not permit to draw any conclusions about its efficiency and provides grounds to surmise that it may be used in order to create negative incentives as concerns budgetary policies pursued by regional and local authori ties. However, in 2004 there was taken a number of decisions permitting to assert that in terbudgetary relations become more transparent and there are observed certain changes in their substantive characteristics. These changes will be discussed below.

Table Financial aid provided from the federal budget to the consolidated budgets of RF subjects in 1992 through 2004 (in % of GDP) 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005* Grants and subventions 0.00 0.02 0.09 0.06 0.09 0.13 0.10 0.06 0.15 0.54 0.28 0.29 0.27 0.Including:

Grants and subventions to CATEs and the town of 0.11 0.12 0.11 0.11 0.09 0.Baikonur Grants and subventions to 0.11 0.06 0.06 0.CATEs Section 2.

Monetary and budgetary spheres 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005* Grants to the town of 0.00 0.00 0.00 0.Baikonur Capital investment subven 0.03 0.02 0.tions to CATEs Resettlement subventions to 0.01 0.01 0.CATEs Subventions to CATEs for financing of CATE develop 0.01 0.00 0.ment programs Other subsidies and subven 0.04 0.42 0.17 0.18 0.18 0.tions Grant to the town of Sochi 0.01 0.01 0.01 0.Grants compensating losses relating to maintenance of HPU objects transferred to 0.08 0.08 0.03 0.jurisdiction of local govern ments Other grants to budgets of RF subjects (for support of 0.07 0.09 0.13 0.the equilibrium of budgets and compensation of losses) Other subsidies and subven tions to budgets of RF sub 0.01 0.01 0.01 0.jects and municipal entities Subventions 0.79 0.69 0.42 0.12 0.12 0.09 0.02 0.Transfers from FFSR 0.00 0.00 0.36 1.17 1.04 1.22 1.12 0.99 0.96 1.14 1.36 1.30 1.05 1.Including:

Transfers 0.00 0.00 0.36 0.86 0.68 0.86 1.00 0.99 0.96 1.14 1.36 1.30 1.05 1.Of which: state support of seasonal deliveries to the 0.06 0.08 0.08 0.North Transfers at the expense of 0.00 0.00 0.00 0.31 0.36 0.36 0.VAT Subsidies and subventions from the Compensatory 0.37 0.38 0.36 0.34 0.Fund Including:

Subsides for implementation of the law on social security 0.13 0.12 0.06 0.of disabled persons Subventions for implementa tion of the law on state family 0.24 0.21 0.16 0.allowances Subventions for compensa tion of privileges related to payment for HPU services in 0.02 0.10 0.accordance with the federal legislation Other subventions and sub sidies from Compensatory 0.02 0.04 0.Fund Resources of the Fund of Co Financing of Social 0.15 0.11 0.04 0.Expenditures Resources of the Fund of 0.03 0.05 0.10 0.10 0.15 0.01** Regional Development State support of road net 0.18 0.11 0.27 0.27 0.31 0.22 0.works Resources of the Fund of Reform of regional fi 0.00 0.01 0.01 0.01 0.nances Funds transferred as mu 0.61 1.95 2.54 0.42 0.81 0.43 0.36 0.14 0.28 0.05 0.20 0.14 0.tual payments Loans minus repayment to 0.09 0.03 0.02 0.04 0.23 0.64 0.03 0.10 0.08 0.02 0.09 0.01 0.other levels of authorities RUSSIAN ECONOMY in trends and outlooks 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005* Arrears of transfers from budgets of RF subjects to 0.00 0.00 0.00 0.02 0.target budgetary funds Other types of financial aid 0.00 0.13 0.18 0.23 0.19 0.Including:

Funds transferred to the budgets of other levels for 0.00 0.11 0.implementation of state pro grams Measures in the sphere of regional development, tar 0.18 0.23 0.13 0.30*** geted federal and other pro grams Total funds transferred to 1.49 2.70 3.4 1.8 2.3 2.5 1.60 1.36 1.54 2.56 3.03 2.84 2.39 2,budgets of other levels * In accordance with federal law on the federal budget for year 2005 No. 173 FZ of December 23, 2004.

** Since 2005, only the financial resources associated with the program Reduction of differences in the social and economic development of regions of the Russian Federation should be included in the Fund of Regional Development *** Including the grants to Tatarstan and Bashkortostan aimed for implementation of measures envisaged by federal targeted programs of social and economic development until year 2006.

2.3.2. The problem of soft budgetary constraints on Russian regional authorities As it has been noted in the survey Russian Economy in 2003. Trends and Outlooks, the amount of financial resources distributed in the form of financial among the budgets of RF subjects in the recent years has significantly exceeded the amount of financing initially envisaged by the laws on the federal budget for respective financial years and brought to the notice of regional authorities. Thus, according to the authors point of view, in 2003 the allocation of additional financial aid to regions across different channels was carried out in line with the striving to ensure the favorable for the federal center outcomes of the Parlia mentary elections held in December of 2003.

In 2004, these practices were continued. Throughout the year, there were approved legislative acts concerning the amendments to the law on the federal budget aimed at the allocation of additional revenues of the federal budget for the purposes including in creases in expenditures across financial aid budget items. In the Fig. 13, there are pre sented the data characterizing the differences between the amounts of financial aid to re gions as envisaged in the law on the federal budget approved by the Parliament and signed by the President immediately prior to the beginning of the respective financial year, and the amount of financial aid registered in the law on the federal budget as in force at the end of the respective financial year, i.e. adjusted for the amendments made to the law during the year.

As it is demonstrated by the data presented in Fig. 13, in 2003 and 2004 the increase in the amount of financial resources distributed in addition to the amount envisaged in the initial version of the law on the federal budget was significant. While the law on the federal budget for year 2002 at the end of that year envisaged the amount of resources for distri bution among the budgets of RF subjects only by 4.2 per cent exceeding the targets made public prior to the beginning of the financial year, at the end of 2003 this indicator made 34.8 per cent, and at the end of 2004 26.7 per cent of the amount initially envisaged by the law on the federal budget.

Section 2.

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