BOFIT Weekly Review 2015/10
Financial woes of Russian regions begin to bite
Researchers at the Development Centre at Moscow’s Higher School of Economics report combined regional budget deficits this year could reach as much as 1.8 % of GDP. While the finance ministry forecasts a deficit of about half of that this year, even that would be fairly substantial. After the 2009 recession, the deficit was typically a few tenths of a per cent of GDP, but in the past two years it has risen to around 1 % of GDP.
While there is large variation across regions, most of Russia’s regions (74 of 83) are unable to cover their spending obligations with existing revenues.
The regional budget deficits are largely structural; regional expenditures mandated by law now exceed regional revenues. A big driver of increased spending has been the large public sector pay rises mostly paid out of regional budgets, which were demanded by president Vladimir Putin in his 2012 inaugural address. Under the president’s decrees, wages of public sector workers are to be increased substantially, and real wages across the country are to grow 1.4–1.5 times by 2018. Regional spending on housing construction is also mandated to rise.
As spending on wages has risen, regions have been compelled to cut other spending. Investment has been the first to go, which weakens long-term regional development possibilities. Regions have also had to compromise on education and healthcare spending. Regions are responsible for 80 % of all spending on education and half of all healthcare spending.
Even though the government last year increased support paid out from the federal budget, the share of federal transfers to regional budgets has been declining over the past few years. Last year it was about 19 %.
Regions have had to finance their deficits by borrowing from the federal budget or banks. Bank loans were used last year to finance nearly half of regional budget deficits, which has made debt servicing a large component of budget spending. Interest on regional bank loans can go as high as 25 % p.a. depending on the region’s creditworthiness. The biggest lender to regions is Sberbank, which accounts for about 75 % of loans to regions. The number-two financier is VTB Bank, accounting for 17 % of loans.
Several regions demand that the government forgive their federal budget loans and provide cheap budget financing to pay off their expensive bank loans, because they claim that federal-level budget policy is the reason regional budgets have been forced so far into the red. In response, the government is now offering regions budget financing at an interest rate of 0.1 % p.a. on the condition that commercial banks commit to lending to regions at rates no more than 1.5 percentage points above the CBR’s current reference rate (15 %).
The government is also considering modification of how wage increases are calculated under the 2012 presidential decrees on wages in order to reduce future wage hikes. Regional spending obligations could also be reduced by focusing social support on the most needy, rather than providing support to everybody in some form. A targeted needs-based approach would, however, require a complete overhaul of the social support system.