The current Law on the Budget is based onunrealistic premises. First, the budget estimates proceed from an extremely lowforecast inflation rate. Given the scope of domestic financing through CentralBank loans as envisaged by the law, implementation of the declared steps torestructure the banking system, and the price growth rates observed inNovember-February 1998-1999, it is obvious that the inflation rate in 1999 willbe higher than the estimated 30 per cent.
Second, tax revenues as a share of GDP(about 10 per cent) envisaged in the federal budget appear significantlyoverestimated. As was mentioned above, 1999 tax revenues will plunge because ofthe reduced rates on profit tax and VAT, higher investment privileges inrespect of profit tax (amendments that will probably be enforced as from thesecond half of 1999), and the further slackening of financial disciplinecaused, above all, by the numerous signals on tax privileges sent by thegovernment. An important contribution could be made by the worsening financialposition of enterprises as a result of the general economic and financialcrisis. The amount of tax revenues will also be reduced by the rising rate ofgrowth of enterprises' arrears due to the continued banking crisis, the rise ofinflationary expectations, and the lower level of monetization of the economy.In our estimate, these factors could cause the revenues of the federal budget(which does not feel the impact of the lower tax rates) to fall between1.0 and 1.5 per cent of GDP in 1999 from 1997-the first half of 1998 (9.0-9.5per cent of GDP). As a result, after tax reform, the federal budget's taxrevenues will hardly exceed 8.0-8.5 per cent of GDP.
In this context, given higher inflationrates than are allowed by the draft budget, the government will manage, innominal terms, to collect the planned amount of taxes; in real terms, however,tax revenue will be 15-20 per cent lower. As a result, in the absence ofnon-monetary sources of financing the fiscal deficit, real budget expenditurewould go down at a commensurate rate. We see that the Law on the Budget restson an attempt to implement it in nominal terms (having redistributed theactually collected money from the constituent members of the Federation infavor of central government) by understating the inflation rate, which means areduction of the real volume of financing on all the budget items.
During the worsening financial crisis, thisbudget maneuver could be regarded as justified only on the condition ofsimultaneous structural reforms and reforms aimed at lightening the budget loadand raising the efficiency of budget expenditure. But the Cabinet's program ofaction does not provide for such steps. What is more, the government is hopingfor a chance to reduce the real expenditures of extrabudgetary funds without areform of pensions and social security and without compensating theextrabudgetary funds' losses from the federal budget. An outcome of such policycould only be lower real incomes of a large part of the households, first ofall, the people whose wages are paid from the budget, and pensioners.Implementation of the budget is bound to produce many undesirable socialconsequences.
To assess the implementation of the 1999federal budget in quantitative terms, we estimated the performance of the keymacroeconomic indicators for 1999 under two scenarios. We assumed that thevolume of expenditure and the sources of financing the fiscal deficit andrepayment of the RF government debt were based on numbers set by the Law on theRF Federal Budget for 1999.
The first, baseline scenario estimates theissue of money in March-December 1999 at Rb110 billion, with this sum comingfrom the following sources: (1) the RF Central Bank's loans to the governmentenvisaged by the Law on the Budget to the amount of Rb32.6 billion; (2)expenditure on the restructuring and modernization of the banking system (up toRb35-40 billion, according to the Central Bank leaders' statements, minus theamount of stabilization loans granted in January-February 1999; (3) raising theCentral Bank's gold and foreign exchange reserves by about $2 billion (Rb40-50billion - an estimate based on the minimum needed for foreign debt servicingand repayment with account of net external financing19).
In our view, due to a slacker taxdiscipline and based on the trend for the fourth quarter of 1998, tax revenuesfor the first half of 1999 will go down to 8 per cent of GDP (in 1997, 9.4 percent of GDP). But if the RF Federal Assembly adopts a package of laws on taxreform accompanied by a redistribution of taxes between different-level budgetsand the laws come into force in the second half of the year, tax revenues tothe federal budget would rise to 9 per cent of GDP. The volume of non-taxrevenues, which the Law on the Budget estimates at 1.875 per cent of GDP,appears realistic.
Our calculations assume that a newrestructuring of Russia's debts will take place as regards the servicing andregular repayment of the debts of the former Soviet Union. As regardsRussia’s domestic andforeign debts proper, the terms of the Law on the 1999 Federal Budget will beobserved. In this way, the RF Government would, first, implement the GKO-OFZrestructuring scheme announced on 15 December 1998. Second, foreign debtpayments would reach $4.935 billion, including $3.6 billion in principalpayments on IMF, World Bank and EBRD loans. It is also assumed that debts tothe international financial organizations will be refinanced. At the same time,if Russia fails to receive IMF and World Bank loans to the amount of $4.5billion, the results of our calculations would remain unchanged because in thiscase, we assume a default on Russia's debts to the international financialorganizations and on untied foreign loans in 1999. The servicing of thecountry's foreign debt will reach $4.3 billion (2.5 per cent of GDP). Thisamount will include, among other things, coupon redemption on Eurobonds andOVVZs.
The fact that expenditure on foreign debtservicing and repayment remains a stable percentage of GDP stems from ourassumption of a relative stability of inflationary expectations and the USdollar rate, because even under relatively low inflation confidence in thepresent monetary policy would not strengthen until after a year of itsimplementation. The money multiplier would remain at the December 1998 level,that is, 2.15, in the case of high inflation. If the inflation rate remainsunder 100 per cent per annum, the multiplier is expected to rise to 2.2 byend-1999. Correspondingly, in such a case some increase in money demand wouldbe observed. What is more, we assume that the real ruble rate remainsunchanged.20
This review is not going to examine theeffect of the current fiscal and monetary policy upon the state of the realsector and Russia's balance of payments.21 Our estimates envisage thatin 1999, the real GDP decline will constitute 2 per cent from 1998, with theGDP deflator rising commensurately with the consumer price index.
Our estimates of GDP, budget revenues andthe inflation rate22 show that, given theabove-mentioned volume of currency issue and the actual price growth rate forJanuary-February 1999, the inflation rate will be about 66 per cent, not the 30per cent as envisaged by the budget. Correspondingly, a higher nominal volumeof GDP would offer an opportunity to collect higher nominal revenues than theRb400 billion planned by the government. However, due to the lower tax revenuesthan the Law on the Budget envisages this opportunity would remainuntapped.
If this scenario is enacted, realnon-interest expenditure would stay at the 1998 level, that is, 9.0-9.2 percent of GDP. The dynamic of the principal macroeconomic indicators is presentedin Table 1.18.
It should be noted, however, that the1998 level of expenditure is that of a crisis period and cannot be maintainedfor a long time without provoking social and political upheavals. In 1999, realnon-interest expenditure of the federal budget will go down by 33 percent from 1997. Provided the indexation envisaged by the Law on the Budget isenacted, by year-end budget-supported wages and pensions will decrease by 20-25per cent in real terms as compared to December 1998, and by 55-60 per cent ascompared to July 1998. According to our estimates, the minimal level of thefederal budget non-interest expenditure that would not raise the debt tothe recipients of budget money at the current level of budget obligations is atleast 10-11 per cent of GDP (in 1997, non-interest expendituresconstituted 13.9 per cent of GDP).
When assessing social consequences, oneshould also take into account the reduction of the regional budgets' revenuesand, consequently, expenditures. Despite the amendment in the Law on the Budgetregarding the distribution of revenues between the Center and the regions atthe ratio of 49.5 to 50.5, as a result of tax reform the regional budgets willlose about 1.6 per cent of GDP as compared to 1997. We believe, therefore, thatin the second quarter of 1999, the federal budget expenditure on support forthe regions may already increase; this support may be essential for dealingwith the most pressing social problems. What is more, it will be necessary toincrease federal budget expenditure on making up for delinquent receipts of thePension Fund.
Key parameters of fiscal policy for199923
Law оn the Budget
1. Tax revenue (per cent ofGDP)
2. Nontax revenue (per cent ofGDP)
3. Total revenue (per cent of GDP)(=1+2)
4. Non-interest expenditure (percent of GDP)
5. Primary deficit (per cent ofGDP) (=3-4)
6. Domestic debt service (per centof GDP)
7. External debt service (per centof GDP)
8. Total expenditure (per cent ofGDP) (=4+6+7)
9. Overall fiscal deficit (per centof GDP)
10. Fiscal deficit lessexpenditures financed by tied loans (per cent of GDP)
11. External debt repayment (percent of GDP)
12. Quasi-budget expenditure onrecapitalization of the banking system
(per cent of GDP)
13. Shortfall of funds for fiscaldeficit financing, external debt repayment and quasi-budget expenditure onrecapitalization of the banking system (per cent of GDP) (=9+11+12)
Sources of finance:
14. Untied external loans (per centof GDP)
15. Tied external loans (per centof GDP)
16. Domestic nonmonetary financing(per cent of GDP)
14. Volume of currency issue (per cent ofGDP)24 (=13-14-15-16+currency issue to replenish gold and forex reserves)
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