Difficult to invest while reducing debt load

New stage of restructuring budget loans

The terms of the new restructuring agreement, which, however, are still unknown, could mean increased debt or financing by the regions of projects that are far from the real needs of a particular region. Full debt write-off under the proposed procedure does not seem realistic.

The law on the federal budget for 2020 and for the 2021–2022 planning period provides regions with another opportunity to prolong repayment on budget loans from the federal budget until 2029 in order to finance the budget deficit.

According to the law, regions will be able to take advantage of this opportunity only if they assume obligations to finance infrastructure projects (new investment projects) using funds freed up as a result of reducing the annual volume of debt repayment on budget loans.

It should be noted that the terms of restructuring in 2017* already assumed the possibility of re-postponing loan repayment for another five years, also until 2029**.

* At the end of 2017, budget loan repayment was extended until 2024. To participate in this stage of restructuring, the regions had to commit themselves to reducing their debt loads relative to internal revenues according to the schedule of the Ministry of Finance and stay under the deficit limit of 10% of internal revenues. The restructuring, which actually meant writing off part of the regions’ debt to the federal budget in terms of current value, reduced the risks of refinancing regional debt and partly reduced regions’ debt loads. From November 1, 2017 to November 1, 2019, the total debt of the regions decreased by 9%, from RUB 2,173 to 1,984 bln, including budget loans by 6%, from RUB 1,049 to 991 bln.

** In 2018 and 2019, Russian regions had to achieve general budget TNTR growth at levels higher than actual inflation in order to extend budget loan repayment until 2029. According to ACRA’s assessments, in 2018 practically all regions were able to achieve this, while in 2019 more than 60 regions will be able to meet this condition. At the same time, we note that not all regions took part in the budget loan restructuring in 2017, and as of November 1, 2019, seven regions had no budget loan debt.

It is not clear from the law whether we are talking about a new budget loan restructuring agreement, which does not cancel the previous agreements, or about changing the terms of the 2017 agreement and extending budget loan repayment until 2029. According to ACRA, since the law does not assume changes to the regulations establishing the terms of the 2017 agreement, the regions will be offered a new restructuring agreement. This proposal will be of interest primarily to regions that have failed to increase tax and non-tax revenues (TNTR) enough to extend budget loan repayment until 2029. ACRA believes that there will be no more than 15–20 such regions.

However, the new restructuring terms could contribute to the growth of regional budget expenses and debt load contrary to the requirements established by the Ministry of Finance in 2017. If a region is unable to repay budget loans by increasing budget revenues or reducing its expenses, it takes out commercial debt on market terms in order to refinance budget loans. As a result, the total debt of the region does not change. In order to raise funds for new investment projects, the volume of which would equal “savings” from reducing annual budget loan payments via repayment extension, the region will attract debt financing in the market. Therefore, instead of replacing some debt obligations with others, there will be an increase in the total debt of the region and its expenses.

Currently there is no information about the criteria according to which investment projects are selected or the possible consequences for regions should projects produce losses and, as a result, fail to generate a stable flow of tax revenues. It is also unclear as to whether regions will be able to use freed-up funds to finance projects that have already been planned but financing has not yet begun. On the one hand, this would allow regions to adhere to the new restructuring conditions without increasing commercial borrowings, which is a positive factor. On the other hand, this would not lead to growth in investment relative to the target level. It’s possible that increasing investments in regional infrastructure is indeed the goal of this proposed measure. If regions decide to take up this offer as part of the new restructuring without looking in detail at every potential consequence, they may risk investing funds simply to fulfil the new restructuring conditions instead of carrying out vital projects.

Regions that are able to extend the repayment of budget loans until 2029 under the 2017 restructuring conditions will be able to halve repayments of principal debt on budget loans in 2021–2024 should they decide to take part in the new restructuring. However, the size of payments will grow in 2025­–2029. Participation in the new restructuring extends the average repayment period for budget loans by approximately one year. We assume that the new program will only be of interest to the aforementioned regions if a complete write-off of budget loan debt is possible. However, the size of written-off debt should be equal to the tax revenue generated by the new projects. The Russian government will determine the projects that regions will invest freed-up funds in as well as the debt write-off procedure.

As the size of debt to be written off will be determined based on tax revenues paid to the federal budget, investments will be made in commercially successful projects that are capable of rapidly generating cashflow and tax revenues. However, all projects require time for documentation, construction and commissioning stages. In connection with this, the repayment schedule for restructured debt involves an amortization scheme: like with the current conditions, the remaining budget loan debt can be returned by a region in full when a project starts generating tax revenues for the federal budget. In addition, when assessing project effectiveness solely in terms of tax revenues, a number of socially oriented projects (such as the construction of schools, kindergartens, and hospitals) and projects that only start operating after a few years may not be of interest to regions. Monitoring the fulfilment of obligations that regions will undertake as part of the new restructuring seems rather complicated, especially in the terms of accounting tax revenues from new investment projects.

Potential debt growth as part of the new restructuring agreement

Source: ACRA

According to ACRA, the total amount of regional debt on budget loans restructured in 2017 could amount to RUB 0.7 tln. In the most conservative scenario, which assumes financing only new and previously unplanned projects exclusively using commercial debt (if no region can find reserves of internal funds for new projects), the total debt of Russian regions may increase by RUB 0.5 tln by the end of 2024.

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