Restraining social spending growth to shift regional budget problems to 2018

Regional social spending and inter-budget relations in 2016-2018

  • Easing social liabilities will ensure balance of regional budgets in 2017, as the year before. In terms of consolidated budget deficit, the year 2016 was the most successful of the last nine years for the Russian regions, with 27 of them posting a RUB 191 bln surplus, which almost compensated for the RUB 193 bln deficit shown by the other 58 federation subjects. The reduction of budget deficits in 2016 and 2017 is due to loosening parameters of social programs (by the so-called May decrees).
  • The share of inter-budget transfers in consolidated regional revenues reached a nine-year low. In 2016, transfers accounted for 16% of regions’ revenues versus over 20% for the period between 2009 and 2012. The federal government has been reducing regional transfers for the third year in a row. In nominal terms (excluding the transfers provided to the Republic of Crimea and the city of Sevastopol), they retreated to the level of 2009 settling at RUB 1486 bln, while in real terms, the volume of transfers dropped 41% last year versus 2009.
  • Non-balanced dotation allocation increases the number of regions with budget deficits. Last year saw twenty-three of twenty-seven ‘surplus’ regions receive federal dotations, with the latter exceeding the size of surplus in twenty regions. The total of excess dotations ran into RUB 57.3 bln, or 8.7% of the federal dotation amount in 2016 versus less than 2% in 2014 and 2015.
  • Social spending growth slowed down due to loosening the may decrees. In most regions, public sector wages grew slower than the average salary over the past year. Loosening target wages of public servants provided for some RUB 200 bln in savings for regional budgets. The timelines for enforcing the decrees have been shifted to 2018, which will allow the regions to save about RUB 240 bln this year, due to lower salary indexation in the public sector.
  • The consolidated regional budget deficit may climb to RUB 250–300 bln in 2018, stimulated by enforcement of the may decrees. ACRA expects public-sector wage expenditures to climb some RUB 690 bln against the 2016 level.

Slower social spending growth helped regions to cut budget deficits

The budget deficit total of the ‘deficit’ group of regions has shrunk from RUB 307 bln in 2015 to RUB 193 bln in 2016.

The total surplus of the ‘surplus’ group of regions changed less significantly squeezing from RUB 199 bln in 2015 to RUB 191 bln in 2016.

On consolidated basis, the Russian regions fared best in 2016 compared to the previous nine years in terms of their cumulative budget deficit, which ran into RUB 2.4 bln, with RUB 193 bln of deficit shown by the ‘deficit’ group of regions almost offset by RUB 191 bln surplus posted by the ‘surplus’ ones.

Figure 1. In 2016, the budget surplus shown by 27 regions almost offset the deficit posted by the rest 58

Source: Treasury of Russia, ACRA estimates

May decrees are the decrees signed by Vladimir Putin on the day of his inauguration as President of the Russian Federation (May 7, 2012) and envisaging an increase in public sector wages by 2018 to the level corresponding to 100% or 200% of the average salary in a region (depending on employee category).

In 2016, tax and non-tax revenues of regional budgets added RUB 611 bln, significantly outstripping expenditures that climbed RUB 452 bln. The was mainly the result of a modest increase in social spending (by just 3.4%) as a result of loosening the requirements of the so called May decrees that envisage wage increases in the public sector. Over the same period, regions’ own tax and non-tax revenues surged 9.6%.

Figure 2. In 2015 and 2016, tax and non-tax revenues of regional budgets grew much faster than their social expenditures

Source: Treasury of Russia, ACRA estimates

Of all tax and non-tax regional budget revenues, the greatest growth was posted last year by corporate and personal income tax proceeds, especially in the segment of financial activities, which was recovering after the slump seen in 2015, when many regions saw collections of income tax on financial intermediation drop almost to zero (due to a tax base reduction by the amount of losses).

Figure 3. In 2016, regional budget revenues growth was fueled by recovering corporate and personal income tax proceeds, and by increased excise duties on oil products

Source: Treasury of Russia, ACRA estimates

Figure 4. In 2016, social spending* contributed to only 40% of the total increase in expenditures by regional budgets

*Note. Social spending includes expenditures on social policy, education, healthcare, culture, physical culture and sports.
Source: Treasury of Russia, ACRA estimates

Around half of the increase in regional budget expenditures was fueled by the national economy section (spending on road construction and maintenance, and transport increased by RUB 119.6 bln and RUB 36.5 bln respectively, while regional agriculture funding declined by RUB 35.9 bln) and by the housing and utilities section.

See the ACRA February 14, 2017 research titled “Russian Regions to Favor Bonds.”

Last year, regions were slated to spend RUB 175.7 bln on debt servicing (interest payment). However, these expenditures in 2016 in fact remained at the 2015 level of RUB 128.5 bln, while regional budgets managed to save some RUB 47.2 bln.

Contrary to the Russian Treasury’s data, regional budget expenditures on healthcare not only did not decrease, but increased. Some Russian regions started accounting for contributions to the FCMIF1 for mandatory health insurance of the unemployed as part of budgetary expenditures on social policy. As a result, contributions to the FCMIF assumed the following structure: RUB 88 bln left the healthcare section for the social policy section, while the remaining RUB 529.7 bln continued to be regarded as healthcare expenditures.

1 Federal Compulsory Medical Insurance Fund

Federal transfers are declining, but the share of those bolstering surpluses is growing

Subsidies to regions ran into RUB 656 bln in 2016 (42% of non-repayable transfers to regional budgets from the federal budget).

In 2016, the number of ‘surplus’ regions largely depended on the allocation of federal dotations among regional budgets. Thus, of the twenty-seven regions boasting budget surpluses twenty-five received federal dotations, and twenty saw those dotations exceed their surpluses. To compare, in 2015, dotations fared above budget surpluses only in eight ‘surplus’ regions, and only in three of them the year before.

Overall, federal transfers amounted to RUB 1,578 bln in 2016 (RUB 39 bln less than in 2015).

Figure 5. The number of ‘surplus’ regions that receive dotations exceeding their surpluses has grown significantly

Source: Treasury of Russia, ACRA estimates

See the ACRA September 6, 2016 research “Waning Federal Transfers Widen Inequality Gap Between Regions.”

In 2016, the amount of dotations that did not reduce the deficit of regional budgets, but instead increased their surplus reached RUB 57.3 bln (8.7% of the annual federal dotations total). In 2015 and 2014, the volume of such dotations amounted to RUB 10.8 bln and RUB 5.1 bln respectively (1.7% and 0.7% of the federal dotations total).

Figure 6. The largest amount of excess dotations in 2016 was directed to the Republic of Bashkortostan and Altai Region

Source: Treasury of Russia, ACRA estimates

In 2016, twenty subsidized regions with a budget surplus reduced their debt market debt by RUB 41.6 bln, with repayment financed with budget loans and dotations that showed a net increase by RUB 22.2 bln and RUB 19.4 bln respectively. As a result, RUB 37.8 bln of dotations provided to ‘surplus’ regions were used to build up regional budget balances.

The fact that twenty five subsidized regions in Russia ran at a surplus does not mean that the federal government dramatically increased inter-budget transfers (dotations, subventions, dotations, etc.) and the regions thus found themselves with excess liquidity on balance. Contrarily, the Russian authorities have been cutting financial aid to the regions for the third year in a row. Net of transfers to the Republic of Crimea and the city of Sevastopol, both of which accounted for 6% of federal aid to the regions in 2014-2016, the total of federal transfers to the regions fell in 2016 to the level of 2009 in nominal terms, running into RUB 1,486 bln. Moreover, in real terms the year 2016 saw the volume of transfers shrink 41% against the 2009 level.

The fact that transfers almost stagnated and the net proportion of provided budget loans increased insignificantly shows that federal aid became the least important for the regions in nine years.

The regions’ share in collected taxes was calculated as the sum of:

- Regions’ tax revenues (including local tax collections);

- Federal transfers to regions;

- Net share of issued federal budget loans;

with this sum divided by taxes and levies collected by the Russian consolidated budget.

Figure 7. In 2016, inter-budget transfers provided for 16% of regional revenues

Source: Treasury of Russia, ACRA estimates

Budget loans were accounted for in the course of calculating this indicator, as in case of necessity they may be restructured, with repayment postponed for a decade or more.

During the 2008-2009 crisis, the federal government provided substantial support to regional budgets. In 2009, Russian regions received 86% of all taxes collected across the country (accounting for transfers and loans given out by the federal budget). Although the year 2010 saw this figure decline, it was still rather high at 78%.

Upon the outbreak of the 2014-2016 crisis, the Russian authorities decided not to provide regions with the aid of the same scale as before, so the regions’ share in collected taxes dropped to 64-66%, while in the more benign period of 2012-2013 it was even slightly higher standing at 67-68%.

Partial redistribution of income tax revenues through the federal budget may entail an annual increase in federal transfers in 2017 and 2018 by RUB 140-160 bln. As a result, inter-budget transfers may run into 17.5-18% of consolidated regional budget revenues.

Loosening May decrees in 2016-2017 helps regions to balance budgets

Average monthly salary in the region calculated under the new methodology underperforms by an average of 10.5% the region average wage, based on the data provided by employing entities.

Slow social spending growth in 2016-2017 is due to loosening the presidential May decrees.

The loosening steps that have already been taken include changing the region average wage calculation principle in 2015 (the region average wage is used as basis for setting target salaries in the public sector). The year 2016 also saw a downward adjustment of public sector target wages relative to the region average wage. As a result, public sector wages either declined or climbed slower than the average salary in most regions, thus saving regional budgets some RUB 200 bln (excluding personal income tax, which is returned to regions’ consolidated budgets).

Underperforming growth: wages in the public sector grew slower than the region average wage.

Outstripping growth: wages in the public sector grew faster than the region average wage.

Table 1. In most regions public sector salaries grew slower that the region average wage

Source: Treasury of Russia, ACRA estimates

The initial plan (refer to the government program on healthcare development) envisaged that wages of doctors and nurses were to equal 200% and 100% of the region average wage in 2017. After the timeline was moved to 2018, this year's targets have been set at 180% and 90% of the region average wage.

In a similar way, wages of social; and cultural workers are now to equal 80% and 90% of the region average wage in 2017 instead of 100% planned initially.

The policy aimed at loosening the May decrees will continue this year, with timelines for reaching target wages in the public sector moved from 2017 to 2018. In 2017, the regions should be able to save some RUB 240 bln thanks to a milder indexation of public sector salaries, which is to be partially funded by the federal budget, which is expected to distribute RUB 40 bln of dotations among eighty one Russian regions.

By ACRA’s estimates, loosening of the May decrees should run the consolidated deficit of Russian regions into some RUB 56 bln in 2017, with ‘surplus’ regions showing a reduced surplus of RUB 79 bln, while the ‘deficit’ ones seeing their deficits decline to RUB 135 bln.

Regional budgets to face increased pressure in 2018

Public sector wage expenditures include the payroll fund and accruals.

Accruals are insurance premiums paid to the Pension Fund of the Russian Federation, Social Insurance Fund of the Russian Federation, and the Federal Compulsory Medical Insurance Fund.

The amount of accruals equals to 30% of the payroll fund.

The regions will face a significant social burden increase in 2018 and 2019, when they will have to raise and sustain public sector wages on the target levels outlined in the May decrees. ACRA believes that the public sector payroll fund (with accruals) will climb from RUB 2.86 trillion in 2016 to RUB 3.55 trillion and RUB 3.75 trillion in 2018 and 2019 respectively.

See the ACRA February 14, 2017 research “Russian Regions to Favor Bonds.”

Figure 8. Enforcement of the May decrees will require a dramatic increase in public sector wage expenditures in 2018 and 2019

Source: Treasury of Russia, Federal State Statistics Service, Ministry of Labor and Social Protection, ACRA estimates

The impact of positive interest rates on regional budgets was gauged by multiplying the annual average volume of regions’ market debt by the difference between the real interest rate on regions’ market debt and the economic growth rate.

The real market debt interest rate was calculated as the difference between the nominal interest rate and the annual inflation average.

By ACRA’s estimates, enforcement of the May decrees may increase the consolidated deficit of regional budgets from the current RUB 2.4 bln to RUB 250-300 bln in 2018-2019.

In 2018 and 2019, the regions will repay previously received budget loans. Therefore, they will finance their deficits and partially refinance their debt using market instruments (mainly bonds). According to ACRA’s forecasts, in the next three to four years, the Russian monetary policy will remain reasonably stiff, with interest rates remaining in the positive territory. A reduction in the key rate during the period is to mitigate the expected increase in regional budget expenditures on debt servicing, but positive interest rates in the economy will cost regional budgets up to RUB 50-55 bln per year (in 2016, regional budgets lost RUB 39 bln for the same reason).

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