Training on securitization, July 2–3

Corporate sector to drive surpluses of regional budgets, and federal center to save overleveraged regions

2017 regional budgets execution overview

  • Growing regional revenues resulted in more surplus budgets. 45 regions finished the year of 2017 with a surplus. Corporate income tax contributed one third of budget revenue growth.
  • Capped losses carried forward have driven up corporate income tax. Corporate income tax revenues grew irrespective of a change in corporate income tax distribution shares between federal and regional budgets. The reason is a temporary restriction on the ability of taxpayers to reduce their tax bases by the amount of previous losses, which will remain effective until 2020.
  • Total debt of the Russian regions has decreased for the first time ever recording a 2% decline year-on-year, or RUB 37.8 bln. Its structure has also changed: the amount of bank loans contracted by RUB 141.6 bln, or 18% with concurrent bond offerings being in full swing (a 20% gain, or plus RUB 91 bln). The total bond debt of the regions reached RUB 547 bln representing an all-time record, while many first-time issuers tapped the bond market.
  • The federal center provided aid to some over-indebted regions. In 2017, many regions with heavy debt load (Mordovia, Khakassia, Kostroma and Ivanovo Regions) managed to secure substantial fiscal loans. However, not all of them used the funds provided to refinance their debt.
  • Regions might continue breaching their agreements with the Ministry of Finance. Some regions increased their debt more than their fiscal loan agreements with the Ministry of Finance allowed. As fiscal loan restructuring is subject to performance of agreements that were in force in 2017, such regions stand for early repayment of newly restructured loans.

Growing regional revenues resulted in more surplus budgets

The year of 2017 was successful for Russian regions: the aggregate deficit of regional budgets increased slightly and amounted to only RUB 15.5 bln. For comparison: the deficit was RUB 2.4 bln in 2016 and RUB 108.2 bln in 2015. The total revenues of the regions increased by 9% or RUB 775 bln.

Figure 1. A third of regional revenues came from corporate income tax (2017)

Source: Federal Treasury, ACRA estimates

One third of the increase came from corporate tax (+ RUB 248 bln, or +11%), a quarter came from personal income tax (+RUB 193 bln, or +8%), and 15% of the increase was generated by property taxes (+RUB 115 bln, or +12%). The reduction in rates of taxes on goods and services caused by a temporary change in the distribution of excise taxes on fuel led to a RUB 80 bln decline in regional revenues.

Amid growing tax revenues, more than a half (45 out of 85) of Russian regions reached a surplus budget, while such share was one third in late 2016 and 16% in late 2015.

Table 1. Regions with budget surplus (2017)

Source: Federal Treasury, ACRA estimates

Capped losses carried forward have driven up corporate income tax

The growth in corporate income tax revenues—the primary revenue source for regions which comprises a third of their own revenues—occurred despite a change in the proportion of its distribution between the federal and regional budgets. In 2017–2020, inclusive, the federal budget will get the corporate income tax at a rate of 3% (previously 2%), while regions will receive 17% unless a lower rate is applied (earlier 18%). As a result of such redistribution, the federal budget revenues based on corporate income tax increased by 55% (RUB 271 bln) in 2017 vs 2016.

The Government of the Russian Federation plans to return withdrawn funds to regional budgets as transfers. However, transfers are not categorized as own budget revenues and do not contribute to the ratio of debt to own revenues ratio (regions must maintain such ratio as set forth in the relevant agreements with the Russian Ministry of Finance).

A positive effect of changes in the loss carry forward scheme was noted by ACRA in its rating press release on the Kemerovo Region dated August 29, 2017.

This effect negative for the regions was offset by a temporary change in the loss carry forward scheme, according to which in 2017-2020, the taxable base for a current tax period may not be reduced by more than 50% of losses in previous periods.

Table 2. Decreasing budget losses amid restricted loss carry forward, RUB bln

Source: FTS of Russia, ACRA estimates

Thus, despite the withdrawal of 1% of the corporate income tax into the federal budget as well as the reduction in the taxable base (by 11%, data for 9M2017), the corporate income tax revenues of regional budgets have grown.

At the same time, the amount of loss that reduces the taxable base and the amount of shortfall in corporate income tax caused by the reduction in the taxable base by the loss received decreased 4.5 times in the 9 months of 2017 as compared to the same period of 2016 (by RUB 2,150 bln and RUB 430 bln, respectively).

In 9M2017, the taxable base increased only in 29 regions, but the corporate income tax grew in 65 regions, therefore, in 36 regions, revenues increased due to a change in the legislation.

The most significant increase in corporate income tax revenues occurred in mineral extraction-intensive and financially secure regions. The shortfall of tax revenues in their budgets connected with the reduction of taxable base by taxpayers at the expense of losses from previous periods became noticeably lower.

Table 3. Corporate income tax trends after the change in the loss carry forward scheme (2017)

* Tax shortfall caused by the reduction of tax base by losses carried forward.
Source: FTS of Russia, Federal Treasury, ACRA estimates

In 20 regions, the corporate income tax decreased. The most noticeable decrease was in the Sakhalin Region—by RUB 37.4 bln against the backdrop of 5% decrease in the corporate income tax distribution proportion in the performance of product-sharing agreements in 2017 and fluctuations in the liquefied natural gas prices. Budget revenues also declined significantly in the Khanty-Mansiysk Autonomous Okrug - Ugra (by RUB 20.3 bln), which is explained by the effect of the high base of 2016, and in fact, the tax has returned to its stable level. 

According to ACRA estimates, the share of organic growth on account of tax base before losses in the total increase of corporate income tax revenues (about RUB 0.5 trillion) amounted to mere one fifth. The rest is a result of other factors including temporary changes in the legislation with respect to tax accounting of losses.

The total debt of regions has decreased for the first time ever

Owing to increase of surplus budgets the total debt of the regions decreased by 2% year-on-year (by RUB 37.8 bln) in 2017, which has never happened before. This is a success for regional authorities, as the policy of the Ministry of Finance pursued in the regions by entering into loan agreements, and now by restructuring these loans, is aimed at lowering debt of the budgets (tied to own revenues). 

Figure 2. The total debt of regions has decreased for the first time ever in 2017

Source: Ministry of Finance, ACRA estimates

ACRA projected this scenario in its research titled Russian regions to favor bonds published on February 14, 2017.

The debt decreased by virtue of reduction of bank loan amount (by RUB 141.6 bln, or 18%), with concurrent bond offerings being in full swing (a 20% gain, or plus RUB 91 bln) and fiscal loans amount increasing slightly (by 2%, or RUB 19.8 bln). 

Bonds issued in 2017 totaled RUB 199.3 bln – one third higher than in the previous year, and the total bond debt of the regions reached RUB 547 bln - an all-time record. Owing to lower interest rates in the market and the regions rushing to fix cheap debt for a long period, the regions that have never placed bonds before or those that made a bond offering a long time ago tapped the bond market: Karachay-Cherkess Republic, Yamalo-Nenets Autonomous Okrug, Kursk, Oryol, Saratov, and Ulyanovsk Regions, and St.Petersburg. The above secured a substantial increase in offerings.

Figure 3. Debt structure rearrangement towards bonds

Source: Russian Ministry of Finance, ACRA estimates

The federal center provided aid to some over-indebted regions

According to the interim report on federal budget performance, the regions obtained RUB 333.8 bln in loans in 2017. That said the initial plan was to provide RUB 200 bln in loans. The bulk of that difference are fiscal loans repaid by the regions early in the above-stated year due to violations of their obligations assumed in compliance with contracts with the Ministry of Finance. Last year these funds returned to the regions, but this time in form of new loans with a five-year maturity and further repayment rescheduling. 

As a result, restructuring of fiscal loans in many regions with high debt load would stretch over seven years, which would partially release them from both refinancing risk and interest burden.

Figure 4. Many over-indebted regions obtained more funds from the budget in 2017

*debt to own revenues ratio 
Source: Ministry of Finance, ACRA estimates

The largest share of budget funds was provided to Khakassia (used primarily to refinance bank loans), Rostov Region (used for the same purpose), Mordovia (the region has substantially increased its debt), Ulyanovsk Region (that spent funds to replace a portion of the bank loans), and Kostroma Region (replacement of bank loans). Some of the regions repaid their fiscal loans. The largest fiscal loan repayments came from Moscow and the Kemerovo Region (by virtue of higher corporate income tax revenues driven by high coal prices the region managed to significantly reduce its debt).

Regions are likely to continue breaching agreements with the Ministry of Finance

In the context of loss offsets, the regions have the opportunity to significantly improve their financial standing in the period to 2021. Distributing 1% of the corporate income tax to be collected in 2017-2020 among the regions that are the most in need would also help with the above. The restructuring of fiscal loans coupled with distribution of fiscal loans among regions in 2017 enables a significant portion of regions to save on interest expenses and mitigate refinancing risks. However, the debt load of specific regions continues increasing despite the overall positive trend.

The regions are forced to comply with fiscal loans agreements entered into with the Ministry of Finance. Breaching the covenants led to early fiscal loan repayments in the past (however, experience has shown that early repayments are often followed by issue of new equable loans). Now a region would have to return a portion (below 20%) of the total debt.

As a result, some regions that saw their respective ratios rise (excluding those allowed to grow their debt within the 50% limit) could have breached the covenants as set forth in fiscal loan agreements as at end-2017.

New terms for fiscal loan restructuring are coming into force in 2018; however, one should have observed the current agreement terms in 2017 in order to qualify for restructuring.

Covenants that the regions are obliged to comply with include controlling debt to tax and non-tax revenues ratio (own revenues). Those regions the debt to own revenues ratios of which was below 50% as at January 1, 2016 were not allowed to have that ratio above 50% the next year. Other regions undertook an obligation to avoid increasing the above ratio over the next year. The experience shows that agreements often set forth conditions for lowering the debt to own revenues ratio by 1% to 3% or more a year. 

As a result, some regions that saw their respective ratios rise (excluding those allowed to grow their debt within the 50% limit) could have breached the covenants as set forth in fiscal loan agreements as at end-2017.

Table 4. Regions with debt to own revenues above 50% 

* According to the rules for fiscal loans provision in 2017. 
** Constitutes no violation of the current restructuring agreement. 

Source: Federal Treasury, Ministry of Finance, ACRA estimates

As fiscal loan restructuring took place in December 2017 (when annual budget performance could already be assessed) ACRA does not include that debt covenants may be changed in restructuring agreements with those regions that increased their debt.

 

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