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special issue: federations and the economic crisis
Hit late by the slump – Russia responds
REUTERS/RIA Novosti
Russian prime minister Vladimir Putin pays a surprise visit to a Moscow supermarket, telling startled managers to lower their prices. The visit was meants to show the public that the government is in control of the financial crisis.
By Alexander Deryugin
The current crisis has affected every country in the world that is part of the global economy. The Russian Federation, one of the largest exporters of oil, gas and other raw materials, is no exception.
However, the global crisis developed unevenly in Russia. Some symptoms began to appear as early as 2007, even though many in Russia then refused to believe the country would be affected.
Indeed, Russia seemed ready to repel the tide, with the third-largest central bank reserves in the world – US$ 582 billion on September 1, 2008. The federal government also had an impressive contingency fund – US$ 174.5 billion on September 1, 2008. So, even when the first signs of crisis, the flight of speculative capital and the decline of industrial production appeared, President Dmitry Medvedev and Prime Minister Vladimir Putin still were optimistic. They called Russia an “island of stability in the sea of the world crisis.”
Nevertheless, the inevitable has happened: Russia has not been merely brushed by the crisis but has felt the blow. The beginning of the crisis in Russia was no doubt caused by external factors that included
• a simultaneous decline in prices and demand for products that make up the larger part of exports: oil, metals, chemical and petrochemical products.
• a sharp deterioration in the terms of the nation’s bank loans due to lack of availability of cheap loans abroad, and, consequently, higher interest rates on loans and a general decline in lenders’ confidence.
Domestic missteps, inflated expectations
Still, the crisis would not have cut so deep had not the external factors been worsened by domestic ones. Domestic missteps included the inflated expectations of both government and business regarding the future status of the Russian economy. There was an unshakeable belief in their own strength that subsequently led to a tardy and confused reaction to the crisis by Russian authorities. Most industries had overstated profitability and major companies had overextended indebtedness.
The overestimates of profitability were due to many factors, among them:
• high world prices for natural resources;
• the existence of monopolies in local sales markets, keeping prices high;
• excessive demand caused in turn by a large influx of financial resources into the country;
• the inadequacy of measures to limit the injection of oil and gas revenues into the economy; and
• the relatively low cost of energy in the domestic market.
The debt problems of Russia’s major companies, many of which are owned or controlled by the state, can be traced in part to massive purchases of assets using funds borrowed against shares as collateral. This seemed fine during boom times, but now the value of these stocks has plummeted.
Business enterprises also failed to modernize. Wage hikes began to outpace the increase in labour productivity. Also, the high rate of economic growth was supported mainly by increasing the load on existing facilities rather than by building new ones.
As a result, a crisis became evident in export-oriented industries as early as October 2008, while a month later it began to affect the entire economy. This was accompanied by the forced devaluation of the ruble. The ruble’s exchange rate was pushed down by flight of speculative capital as well as by a sharp decline in foreign currency inflows. In the first quarter of 2009 relative to the fourth quarter of 2008, GDP fell by 23.2 per cent. (In the first quarter of 2008 it had fallen by only 9.5 per cent.) The unemployment rate grew from 5.3 per cent in September 2008 to 10.2 per cent in April 2009. At the same time, the interest rate on loans amounted to 30 to 35 per cent, clearly above the level of profitability for most types of economic activities.
Russian stock market falls first
The Russian stock market has long been the first to fall during an economic downturn, The index of the Russian Trading System Stock Exchange fell five times as much in the first few months of 2009 as it did in all of 2008. A gradual recovery started only after the end of the devaluation. The fear of capital outflows made the Central Bank raise the refinancing rate from 11 to 13 per cent, which, even so, did not stop the outflow. The net outflow in the fourth quarter 2008 totalled US$130.5 billion, as opposed to nearly zero in the first three quarters of 2008. In the first quarter of 2009, the outflow was US$38.8 billion. In 2007, a total of US$82.3 billion in capital flowed in, while in 2008 the trend was reversed with an outflow of US$130.5 billion. Direct support by the state in the form of financial injections of around US$ 6 billion did not help the stock market either.
The regional level of government was hardest hit. The federal government received most of the market revenue sources from oil and gas—100 per cent of the mineral extraction tax for gas and 95 per cent of the mineral extraction tax for oil, plus 100 per cent of export duty. So, when the crisis began, Moscow had a large Reserve Fund and a National Prosperity Fund made up of oil and gas revenues. The 83 regions of the federation had no such contingency funds because they were not allowed to make allocations that generate income. However, the regions were able to ease their budgetary strain when the crisis hit because by September 2008, many of them had large budget surpluses due to high oil prices. But then, in the belief that the crisis would not strike Russia, they increased expenditures. Only a few of the federation’s regions managed to keep their reserves until 2009.
Regions feel impact
The federation’s many regions felt the impact of the crisis differently. Most affected were the wealthiest with a single economic sector and an undiversified economy. These regions relied on mining, metallurgy and chemical industries. Their budgets were largely shaped by corporate profits tax, and tax revenues had fallen several times since the onset of the crisis. Their drop in revenues reached 50 per cent. Such a profound slide was due to the peculiarities of the corporate profits tax, which not only reduced its revenue to nearly zero but also forced regional treasurers to return the tax that had been already paid. That meant corporate profits tax accounts were in the red in some regional budgets for a number of months.
The fall in revenues was not as sharp in regions whose economies were more diversified, because the decline differed with each industry. Poor regions felt the impact of the crisis several months later, and the reduction in budget revenues was less severe compared to the wealthy regions. The budgets of smaller regions depended mainly on federal transfer payments, which were not cut. In general, the regions have reduced their investments while social spending on the whole remains untouched.
Moscow reacts vigorously
By and large, it was the federal government that took serious anti-crisis measures. In terms of social policy, it increased pensions, boosted unemployment benefits to 1.5 times their previous level and allocated funds for retraining those who lost their jobs. Moscow increased special-purpose grants to the regions for the social services they provided. General purpose grants to the regions were also increased.
In December 2008, the federal government approved a list of 295 strategically important companies that would be eligible for federal support (additional capitalization, direct support, state guarantees for loans) in the event they were hit by the crisis.
Taxes were cut, starting in 2009: the corporate profit tax rate fell from 24 to 20 per cent (its regional share increased from 17.5 to 18.0 per cent). Federal legislation provided tax relief for many taxes - a move that had a serious negative effect on regional budgets. More loans with subsidized interest rates were issued to export firms and agricultural enterprises. A subsidy was granted to offset interest rates on loans for new car purchases in the lowest price bracket, as long as the cars were assembled in Russia.
The total support provided by government anti-crisis measures, including tax and budget policies, will amount to between 5.2 and 5.4 per cent of GDP.
The Russian financial sector was seriously affected by the crisis and, to a large extent, dragged down those segments of the economy that obtained their working capital through credits. That is why strong financial injections into the financial sector seemed like the right moves. (Such injections amounted to approximately US$ 60 billion in 2008). The RF Central Bank appointed its authorized representatives to commercial banks that received loans from the central bank to control the issuing of these loans.
The tax powers of Russian regional authorities are extremely limited as they do not have control of most of their budget revenues. Actions by regional governments have been largely unco-ordinated and their anti-crisis measures amounted to finding ways to reduce their own expenditures and looking for additional transfers from the federal budget.
Russian budget legislation had been drafted, passed and then amended when economic growth was high. Not all its clauses are helpful during a crisis. A sharp decline in revenues has required an equally significant reduction in expenditures. But if investments are easy to cut, current social responsibilities cannot be reduced since they have been announced by the government as a top priority of its fiscal policy. Therefore, the government has no choice but to raise its limits on total public debt, as well as the size of budget deficits for all levels of government. 
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