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To solve the problem of unsupported expensedemands the Budget federalism development programme suggests to introduce a newlegislative term: expense powers of authorities, which implies a combinationof rights and obligations in the following three dimensions: legislativeregulation of budget expenses, support of expenses by financial means andadministration of budget expenses.

The Programme says that one of its aims isto legally provide public authorities at each level with expense powers, whiledistribution of expense powers shall be accomplished in compliance with givencriteria. It also said in the document that all three elements of expensepowers shall be provided to one and the same authority level if possiblesimultaneously. When the powers cannot be given simultaneously one should beguided by the principle that prescribes that decisions on expenses paid bysubordinate authorities shall only be taken simultaneously with a decision ontransfer of financial resources that correspond to the expenses.

The budget federalism development programmealso views ways to reform the system of distribution of tax powers and taxreceipts among public authorities of different levels. In particular it saysthat an effective inter-budgetary relations system that distributes tax powersshall include a higher level of independence of regional and local budgets inquestions of taxation, to achieve that budget receipts that originate fromtheir own taxes on different levels shall be considerably increased.Concurrently the stability of the system of distribution of tax receipts andtax powers shall be ensured for public authorities of different levels and oneshould give up the customary differentiation of norms of payments originatingfrom control tax revenues to local budgets when an adopted differentiationmethod is lacking.

At the same time the document in questiondoes not provide any concrete ways to solve the issue of increasing revenuesshare of own taxes in total tax amounts of sub-national budgets. In spite ofthe fact that the text provides certain principles of tax powers distributionamong public authorities of different levels and some changes in the tax andbudget legislation in the period until year 2005 that presumably will help tomake the current system of tax powers and tax sources distribution moreeffective, it is viewed as highly improbable that such measures can have aconsiderable influence on the revenue base pattern of regional and especiallylocal budgets. It is quite evident that substitution of the currently collectedproperty taxes on organisations and natural persons for a local real estate taxcould considerably influence both revenues of local budgets and their taxpowers. It should be admitted though, that at present there are nopreconditions for an effective real estate tax and it is quite improbable thatsuch conditions will appear before year 2005. One more measure suggested in theProgramme is a transfer of a considerable part of powers and revenues fromtaxation of small-scale business to the local level. On the one hand, ifconsiderable restrictions on revenues of self-employed and enterprises as acriterion of transfer to imputed earnings tax were introduced, this kind ofmeasure could be effective. On the other hand, though, its effectiveness liesin lower administration costs of the current tax regime and an incentive tobuild up a more profitable business climate in municipalities, while thismeasure’s budget effectis not that evident (taking into consideration both the amount of revenues fromthe imputed earnings tax in budgets of all levels at present and the totalamount of expenses obligations of municipal budgets). In this connection wethink that a higher level of budget independence of municipal units shall bereached by both taking decisions in the sphere of redistribution of tax powersand a simultaneous revision of the expenses powers distribution pattern.

A separate section of the Budget federalismdevelopment programme deals with the problem of how to make the financialsupport system of other power levels more effective. As was said before effortto reform the system of inter-budgetary relations in the past yearsconcentrated on giving a higher effectiveness to federal financial aid tobudgets of territories of the Federation, which ensured that at present thereexists a sufficiently effective mechanism of distribution of subsidies from theFund of Financial Support of Regions. That is why the adopted Budget federalismdevelopment programme makes only qualitative demands to the system of federalfinancial support to budgets of lower levels. In particular, the Programmepoints out that it is necessary to legalize the currently used procedure ofdistribution of means from the Fund of Financial Support of Regions, to refrainfrom using budget expenses returns and revenues of support receivers whenmaking calculations for amounts of financial aid, but to use assessments ofobjective differences in revenue possibilities and expense requirements ofterritories of the Federation and (or) municipal units. It is also necessary tomake calculations of financial aid amounts based upon verifiable methods equalfor all calculations’participants and to build up rigid budgetary restrictions for receivers offinancial aid. Moreover the present document envisages that granting andcalculation of financial aid also to budgets of municipal units from budgets ofterritories of the Federation shall be based on the abovementioned principlesas well.

Besides the financial aid calculationrequirements the Programme also makes demands to the pattern of financial aidto territories of the Federation. On the whole one can say that this pattern isalready built up in the federal budget law for year 2002 discussed above and wewill not dwell on it here. On the whole assessing the Programme section onfinancial aid one should say that its objectives represent the facts in thissphere of today and correspond to the possibilities of changing the legislationin the nearest years.

A new subject for documents in the sphere ofbudget federalism in Russia is control of public finance (budget management) onsub-national level. The Programme of budget federalism development contains aseparate section on it. It defines objectives in the field of legislativehandling of the system of public finance control for medium-term future. Amongthe most important provisions in this section of the Programme can be named thesuggestions about introduction of restrictions on use of their tax and budgetauthorities by government bodies of highly subsidised regions and territoriesof the Federation (municipalities) that fail to follow requirements of thefederal budget legislation and their budget commitments to the population andother budget means receivers. The public finance control provisions of theProgramme also pose the problem of working out of obligatory and recommendedfederal norms in public finance control, budget services quality requirements,interrelations of sub-national governments and federal government bodies onterritories of the Federation etc.

Summing up the results of studying theProgramme of development of budget federalism in the period until year 2005 oneshould note that implementation of its objectives will promote solving of manyproblems in the sphere of effectiveness of the system of public finances on thefederal, regional and local levels. At the same time though one should takeinto account the current political and economic conditions that will influenceimplementation of the Programme. In particular the current conditions of thetax and budget reforms will not allow implementation of a number of key issuesof the Programme in the sphere of tax and expense authorities distributionamong different levels of the budget system. The majority of suggestions onlegislative changes shall be implemented taking into account decisions in otherspheres. Thus, assessing the Programme as a rather far-reaching one, one cannotbut mention that large-scale planning is not quite relevant to the currentsituation, it would be more correct to make a plan of specific acts for amedium-range outlook that would be associated with other programmes and plansof the Government in the sphere of reforms of the budget sphere, taxationpolicy, social policy etc.

1.4. The Russian financial markets

1.4.1. The public debtmarket

The external debtmarket

There was a clear-cut trend toward decliningyields on all security types in the market of Russia’s external debt obligations in 2001(see fig. 17 and 18). The plummeting OVVZ yields were most significant in thisrespect: specifically, while the yields on tranche IV (maturing in May 2003)dropped within a year from 32 to 10 percent per annum, the yield on theeurobonds maturing in 2003 declined from 15 to 6.5 percent per annum. Thus, theyield range on the Russian Government forex bonds narrowed in 2001 from 11-32percent to 5-13 percent per annum while the prices for the Russian forex bondsreached historically maximal values.

In our view, growing quotations for theRussian securities in 2001 were explained by a number of positive factors,mainly complementing each other, though the impact of certain factors becamemore significant during some periods.

Specifically, declining yields on theRussian bonds early in the year were to a great extent explained by the effectof a deferred demand for the Russian securities in the portfolios of majorinternational investors. It is obvious that, despite the good indicators ofRussia’s economicdevelopment in 2000, the quota for this security type in the portfolios waschanged only since January 1, 2001. This fact could ensure growing prices forthe Russian bonds, despite a worsening world economic situation (a high degreeof uncertainty in the US capital markets, declining oil prices) and internalproblems of Russia’seconomy (a breakdown of the talks on the restructuring of the Paris Clubdebt).

Taking into account a relatively unfavorablemarket situation (a currency crisis in Turkey, declining exchange rates of thecurrencies of developing and developed economies against the US dollar, amounting financial crisis in Argentina, falling crude prices), one can pointout that, overall, the interest of the world financial market participants tothe Russian forex-denominated securities remained fairly high during the year.Similar external negative shocks in 1999-2000 caused a significantly biggerquotation volatility and an increased interest spread between the yields on theRussian bonds and the basis rates.

At thesame time, continued relatively high oil prices (practically during the wholeyear) made it possible to assess the situation in Russia’s economy as more sustainablecompared with other developing countries. Against this backdrop, a worseningsituation in Argentina, one of the major developing financial markets, was onemore positive factor for Russia, promoting the movement of capital flowsbetween developing markets toward the Russian obligations. The fact of risingattractiveness and reliability of the Russian securities was confirmed by anupgrading of Russia’ssovereign rating to B+ (Standard & Poor’s and Fitch IBCA) and Ba3(Moody’s).

The cuts in the basis interest rates in theUSA and Europe also positively impacted on the quotations for the Russianbonds, exerting a downward pressure on the yields on all debt instrumentsdenominated in US dollars and euro.

Lower yields on the Russian debt instrumentsat the end of the year may be explained, among other, by a political factor:improved relations between Russia and the USA and the European countries is aserious signal for international investors to increase the share of Russianassets in their portfolios. In addition, redemption of the first eurobondtranche on November 27,2001 became a factor which positively impacted on theprices.

The temporary fluctuations of the bondprices were caused mainly by external factors. Thus, the currency crisis inTurkey at the beginning of the second decade of February, which triggered off acapital outflow from all emerging markets, led to a drop in the OVVZ andeurobond quotations by approximately 2 percentage points of the face value.However, already a day or two later the price growth resumed and by the end ofthe month the prices for the Russian securities had come back to the previouslevel.

The market of Russia’s foreign obligations sufferedstrong swings in July 2001 due to a worsened situation in Argentina where athreat of default on the sovereign and municipal debt had increased. Thistriggered off a capital outflow from all emerging markets, though themacroeconomic situation in Russia and its external financial position had beenamong most favorable and sustainable for the last years. At the same time thescale of price drops demonstrated that investor confidence in the Russianobligations is somewhat higher than in the securities of other countries withthe same international rating.

The upheavals in the international financialsystem in the second week of September (suspension of trading in the USA and atthe London Stock Exchange, a drop in most stock indices) as might be expected,had a negative influence and the prices for the Russian obligations continuedto decline till the end of September.

The domestic debtmarket

2001 witnessed a smooth decline of the bondyields with relatively low trading volumes being retained (fig. 19). Overall,during the year, the weighted average yield to maturity on GKO/OFZs declinedfrom 20 percent to 14-15 percent per annum. An average weekly trading volumestood at about 2-2.25 billion rubles. During the whole year the effective yieldto maturity on GKO/OFZs remained negative with a demand for these securitiesbeing rather low.

There were few significant developments inthis segment of the Russian financial market in 2001. Thus, the RF Ministry ofFinance in April 2001, for the first time since May 1998, made an earlyredemption of bonds for the total value of about 1.4 billion rubles (OFZ #25030issue maturing in December 2001).

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