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Therefore, consumer price index growth rate has somewhat downgraded in February as compared with January, but nevertheless was higher than in 2007. In February the inflation was restrained by the decline of monetary offer in the fall of 200710. Hence, the sharp increase in budget expenditures at the end of 2007 will contribute to inflation in April-May this year, along with the termination of the moratorium on increasing prices for some socially important goods can result in the resumption of inflation acceleration. In March the Ministry of Economy of Russia increased the maximum target inflation to 9.5 per cent, but we believe that as of the year results, the CPI in Russia will exceed 10 per cent.

In February the CPI11 accounted to 1 per cent (versus 0.5 per cent in the relevant period of preceding year), what reflects high inflation rates, provoked by increased monetary offer in 2007. According to our estimates, the CPI in March made 0.9 1.1 per cent.

Fig. 1.

The Growth Rate of the CPI in 2002 - 2008 (% per month).

3,5% 3,0% 2,5% 2,0% 1,5% 1,0% 0,5% 0,0% -0,5% Source: RF Statistical Service According to our assessment, of monetary offer volatility comes into effect with the lag of three-four months.

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.

Jul Jul Jul Jul Jul Jul Jan Jan Jan Jan Jan Jan Jan Oct Oct Oct Oct Oct Oct Apr Apr Apr Apr Apr Apr Within February 2008, the volume of monetary base (in broad definition12) has been increased by RUR 22.7 bln to the amount of RUR 4954.5 bln (+ 0.5 per cent). Let us 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 March 1, was RUR 3.79 trillion (+0.8 per cent as compared with February 1), the correspondent accounts of credit institutions with the Bank of Russia made RUR 588.2 bln (+7.8 per cent), mandatory reserves RUR 316.bln (+5.6 per cent), credit organizations deposits with the Bank of Russia accounted to RUR 286.4 bln (+35.3 per cent), banks deposits with the Bank of Russia made 126.4 bln (-55.9 per cent), the value of the Bank of Russias bonds held by credit institutions RUR 129.2 bln (+27.5 per cent). Thus, in February, a slight reduction of excessive reserves of commercial banks was observed, which was the result of gradual deterioration of the situation with the liquidity in the banking system due to the payment of foreign debt and the tax payments to the budget. In March - April this trend will be undoubtedly sustained, but the Central Bank representatives have noted that the Bank of Russia is ready to provide liquidity resources to the banks, if necessary. Moreover, the Russian Ministry of Finance can make placement of untied budget surplus funds with commercial banks, which will also make for liquidity growth. In our view, because of the above mentioned circumstances, the banking system of Russia in the near future is not likely to face serious problems, caused by the shortage of liquidity.

The growth of the volume of cash in circulation in February of this year (+ 0.8 per cent), while the growth of mandatory reserves (+ 35.3 per cent) led to the expansion of the monetary base in narrow definition (+ mandatory cash reserves) by 0.6 per cent (see. Fig. 2). Herewith, the volume of foreign currency reserves of the Central Bank of the Russian Federation in February increased by 1.5 per cent and amounted to USD 490.7 billion by March 1. Within the following two weeks of March, their volume has grown by another 2.per cent to the level of USD 502.1 billion.

Fig. 2.

Changes in the Monetary Base and in the Gold and Foreign Currency Reserves in 2007 - 2940 Monetary Base (billion rubles) Gold and Foreign Currency Reserves (billion dollars) Source: RF Central Bank 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..

billion rubles billion dollars 3 - 9. 0 3. 0 1 - 7. 1 2. 0 2 - 8. 0 2. 0 5 - 1 1. 0 5. 0 7 - 1 3. 0 7. 0 8 - 1 4. 0 9. 0 20 - 2 6. 0 1. 0 10 - 1 6. 0 2. 0 24 - 3 0. 0 3. 0 14 - 2 0. 0 4. 0 16 - 2 2. 0 6. 0 18 - 2 4. 0 8. 0 20 - 2 6. 1 0. 0 10 - 1 6. 1 1. 0 22 - 2 8. 1 2. 0 12 - 1 8. 0 1. 0 23 - 2 9. 0 2. 0 15 - 2 1. 0 3. 0 2 6. 0 5 - 1. 0 6. 0 2 8. 0 7 - 3. 0 8. 0 2 9. 0 9 - 5. 1 0. 0 30. 1 2. 0 6 - 5. 0 1. 0 In February, the inflow of foreign currency to the country was continued as a result of sustained high oil prices. At the same time, according to the assessments of the RF Central bank, the outflow of capital was continued from the RF due to instability in the global financial market. As a result, the real effective exchange ruble rate of February has not changed versus January level and remained at the same level of 132.(See Fig. 3).

In February, downgrading of US dollar in the global currency market continued due to the new signs of further recession in the USA economy. The USD decline has resulted in its further downgrading in the RF foreign currency market: by the end of February the dollar rate was RUR 24.12, against RUR 24.48 as of February 1. Significant ruble strengthening of against US dollar was accompanied by increased value of the two-currency basket14 by 10 kopecks in February. As a result, EURO rate at the end of February has grown to RUR 36.41.

Fig. 3.

Indicators of Ruble`s Exchange Rate Dynamics 38 20 Official USD/RUR exchange rate (end of period) Official EUR/RUR exchange rate (end of period) Value of the two-currency basket Real effective exchange rate index (right scale) Source: RF Central Bank, authors estimates In March there appeared an official information that the Central Bank may involve investment companies to the management of a share of the national foreign currency reserves. In our view, this step is necessary due to a possible investment of the National Welfare Fund in the shares of private companies. It should be reminded, that currently the National Reserve Fund and the National Welfare Fund investments is made on behalf of the Ministry of Finance of Russia by the RF Central Bank in the framework of the foreign currency reserves management. At the same time, there is a lack of experience in equity investment in the RF Central Bank. Hereby, involvement of major investment companies (preferably international) to the management of foreign currency reserves could be helpful to solve the problem. It should be noted, that the investment of a part of the sovereign welfare funds in equities, as well as other financial instruments (derivatives, real estate, etc.) is an element of the best international practice in the management of such funds.

The level of January 2002 is accepted as 100 per cent.

Two-currency basket is the RF Central Bank operational indicator in its foreign currency policy. Currently the share of EURO in the currency basket makes 45 per cent, USD 55 per cent.

RUR Jul Jul Jul Jan Jan Jan Jan Sep Sep Sep Mar Mar Mar Nov Nov Nov May May May Budget and tax policies O. Kirillov In February 2008, federal budget expenditure, as well as revenue, was considerably increased by comparison with last years levels. The RF Ministry of Economic Development and Trade once again suggested that decision should be made to substantially lower, from the year 2009 onwards, the basic VAT rate - to the level of 12% - 13 %, while simultaneously abolishing the lowered rate of VAT and raising, by way of compensation, the rates of excises. The Ministry of Finance, as before, does not accept this proposal, and the outcome of the ongoing discussion is not clear as yet. According to the IETs estimates, if the rate of VAT is decreased to 10 %, budget losses will amount to up to 2.6 % of GDP.

In Table 1, the dynamics of the main parameters of the RF federal budget in 2006 - 2008 are shown.

Table 1.

The main parameters of the RF federal budget in 2006 - 2008 (as % of GDP) 2006 February 2007 2007 February Revenue 23.5 20.66 23.87 26.Expenditure 16.2 12.50 18.39 18.Deficit ()/ Surplus (+) 7.4 8.16 5.48 8.Source: RF Ministry of Finance; calculations of the IET.

As was expected, in January - February 2008 the spending of budget resources remained at a high level.

The governments course towards high state expenditure, which began in the last quarter of 2007, was associated with the political cycle. After the completion of the presidential election campaign, a certain lowering of the share of state expenditure in GDP can be expected.

As regards federal budget revenue, a much higher revenue level as a percentage of GDP can be noted, by comparison with the same period of 2007. The dynamics of receipts in the federal budget in January February 2008 are close to that observed in 2006.The structure of receipts in the RF federal budget, distributed between federal bodies - budget revenue administrators, is shown in Table 2.

Table 2.

Volumes of revenue receipts in the RF federal budget in 2006 - 2008 (as % of GDP) 2006 February 2007 2007 February Taxes and other payments administered by 11.27 9.81 11.50 10.Federal Tax Service Taxes and other payments administered by 10.76 9.98 9.98 12.Federal Customs Service Revenues administered by Federal Agency for 0.26 0.13 0.25 0.Management of State Property Revenues of federal budget administered by 1.25 0.74 2.14 2.other federal bodies Total revenue 23.54 20.66 23.87 26. Source: RF Ministry of Finance; calculations of the IET.

In face of the overall surplus by 5.6 %, in January February 2008, of revenue as a percentage of GDP over the level observed in the same period of 2007, the growth in receipts demonstrated by all the administrators appears to be quite logical. The amount of receipts of taxes and other payments administered by the Federal Tax Service is by 1.1 % of GDP higher than in January - February 2007; that demonstrated by the Federal Customs Service is higher by 2.8 % of GDP; the state budget revenues administered by other federal bodies increased by 1.7 % of GDP; and the receipts of the Federal Agency for Management of State Property increased by 0.1 % of GDP.The RF Ministry of Finance is planning, from the year 2009, to adjust the procedure for levying the tax on the extraction of mineral resources (TEMR) with regard to oil production. It is planned to adjust the scale Federal budget revenue in January 2008 29.92 % of GDP; in February 2008 24.57 %; in January 2006 28.08 %;

and in February 2006 24.48 %.

It might have beep possible to perform a more detailed analysis of these trends on the basis of the data published by the RF Treasury, but this month no such publication has been issued.

applied to calculating the amount of TEMR on oil so as to set the lower margin at $ 15 per barrel, and not at $ 9, in order not to levy the tax on prices under $ 15 per barrel. As estimated by the RF Ministry of Finance, the change in the lower TEMR margin will result in an aggregate loss of federal budget revenue, from early 2009 onward, in the amount of 100 billion rubles at the current level of oil prices, which corresponds to 9 % of TEMR receipts in 2007.

The RF Ministry of Economic Development and Trade submitted to the RF Ministry of Finance proposals concerning priority measures in the sphere of taxation. The main changes suggested by the Ministry of Economic Development and Trade are concerned with the value added tax, the tax on profit of organizations, export duties and the excises on oil products, and special tax regimes. Besides, it is intended to decrease the volume of tax reporting documentation to be submitted by taxpayers..

The corresponding letter concerning the priority measures of tax policy was sighed by head of the RF Ministry of Economic Development and Trade Elvira Nabibullina. As priority measures, the RF Ministry of Economic Development and Trade proposes to make the decision concerning a significant decrease in the basic rate of VAT to 12 % - 13 % from the year 2009 onwards, with the simultaneous liquidation of the lowered rate of VAT and the compensating increase in the rates of excises.

The RF Ministry of Finance, represented by Vice Prime Minister and Minister of Finance Aleksey Kudrin, did not accept the majority of the priority tax measures. Mr. Kudrin declared that at present there are no grounds at all for setting any precise timelines for lowering the rate of VAT. This tax will certainly be decreased, he assured, before 2020. But 12 years, in his opinion, is too long a period for offering any guarantees that the reform will have no negative effect on the well-balanced state of the budget. If the oil and gas component of the budget will begin to decline, the drop in the tax rate at least to 15 % will deprive the budget of one-sixth of its current receipts, the Minister reminded.

The Russian Union of Industrialists and Entrepreneurs fully supports the proposals put forth by the RF Ministry of Economic Development and Trade in the part relating to the priority measures of tax policy. Its representatives believe that the implementation of the innovative scenario of the Russian economys development will be impossible if not backed by such measures.

As estimated by the IET (Table 3), the introduction of a single rate of VAT at the level of 12 % -13 % will result in the following losses of budget revenue (see Table 3).

Table RF budget losses after lowering the basic rate of VAT billion rubles Single VAT rate % of GDP 2009 2010 10% -2.58 -1 148.1 -1 308.3 -1 470.12% -1.-831.5 -947.5 -1 064.13% -1.-673.2 -767.1 -861.18% 0.118.4 134.9 151.GDP, billion rubles 44 565 50 781 57 Source: calculations of the IET However, in terms of consequences for the budget, the lowered rate of VAT will result not only in direct budget losses in the amount of the potential VAT revenues, but also in growth of receipts from profits tax, the single social tax and personal income tax as a result of increased sales volumes of manufacturers (or in the trade sector) and the expanding tax bases of these taxes.

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