Special issue: Federations and the Economic Crisis
Hit late by the slump – Russia responds
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.
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
Domestic missteps, inflated expectations
The overestimates of profitability were due to many factors, among them:
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.
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 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 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
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 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.
Alexander Deryugin is the deputy director for consulting services of the Center for Fiscal Policy in Moscow.