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The 2017–2019 budget offers an opportunity to analyze both the prospects of the Russian economy and the plans of the government, and as usual, the most telling part is spending plans, which reflect the government’s priorities.
Not much will change for the Russian economy in 2017, though the stock market promises to be more stable. Conservative forecasts put the oil price fluctuating between $40 and $60 a barrel, which will ensure sufficient stability for the Russian budget.
It is reasonable to expect the gradual but gentle decline of all major economic indicators in 2017. Inflation will probably be higher than the government projection of 4 percent, but due to generally depressed economic conditions, it is not likely to exceed 6–7 percent, Russia’s standard inflation level at times of stagnation (this was the level in 2011, 2012, and 2013).
As before, the dollar exchange rate will track oil prices and inflation. GDP will continue its gradual decrease, or at best remain unchanged, given the absence of growth drivers and declining entrepreneurial activity. Budget infusions cannot replace private-sector investments, which are likely to decline 10–20 percent. Long-term investments, including capital construction, are in for a steeper decline: according to some estimates, capital and housing construction in particular may decrease by as much as 50 percent.
A higher tax burden in 2017 (through benefit reductions, property tax increases, new fees and service charges, etc.) will contribute to the further decline of business activity and add more small and midsize businesses to the shadow economy. According to government statistics, the number of small businesses has decreased by 70,000 (about 25 percent) since the start of 2016. Of course, some businesses were reclassified as midsize and micro-businesses, but many were simply officially closed and now operate underground.
Since it is much easier to avoid taxation in retail than in manufacturing, retail businesses will disappear faster, giving way to low-quality gray imports. Production will fall across the board, although there may be some islands of growth in export-oriented sectors (due to lower costs) and in domestic consumption (due to the loss of affordable imports and declining purchasing power). Product quality will continue to fall precipitously in 2017 in a wide array of Russian industries as the proportion of counterfeit ingredients and final products increases. This is how manufacturers will try to save on production costs, and weak regulation and high regulatory corruption will aid the process.
Russia’s return to three-year budget plans—an apparent attempt to emphasize the return of stability—entails no new methods of managing the state or the economy. Essentially, the plan applies the current trends to the budget cycle and injects some optimism into the picture, as the Finance Ministry likes to do. The budget is based on the assumption that Russia’s GDP will start growing again in 2017, even at oil prices of $40 per barrel.
The government traditionally has problems with three-year budgets. Revenue projections have been off by an average of 11 percent during the last six years (about 30 percent in 2011 due to an incorrect estimate of the oil price). Adjustments to three-year budgets average as much as 18 percent during the first two years, and 2016 revenues are 21 percent lower than forecast in 2013. So there is no reason to believe that the current budget plans are accurate or will not change.
There is an alternative way to estimate future budgets. The Russian budget remains heavily dependent on oil prices. In fact, federal budget revenues and expenditures and consolidated budget revenues correlate with the oil price by as much as 99 percent, and consolidated budget expenditures correlate by 98 percent.
Federal budget revenues historically include the equivalent of 4 to 5 billion WTI oil barrels a year (there were technically 5.33 billion barrels in 2015, since the retail price declines were slower than wholesale, but the number will decrease to 4.8 billion barrels in 2016). So far, there is no reason to believe that the revenues will be outside of the historical range in the near future.
Expenditures are less flexible: they have grown from 4.5 billion barrels a year to 6.1–6.2 billion barrels. Judging by the budget configuration, the magic numbers will hold and the federal budget deficit will remain in the range of 1–1.3 billion barrels a year, provided oil prices remain at $40–$60 per barrel. This corresponds to approximately $50–$60 billion a year, or at least 4 percent of GDP.
The most telling part of the budget, however, is spending.
There will be substantial cuts in defense spending. Even in 2016, Russia spent less than Saudi Arabia; in 2019, spending will amount to $40 billion, which is at the level of Germany and Japan and 20 percent less than in France. This seems to suggest that Russia doesn’t intend to engage in serious military conflict and isn’t concerned with foreign threats, despite the government whipping people up into a patriotic frenzy. It also points to the diminishing role of military-industrial complex lobbyists.
National security spending will remain virtually the same in 2017, and in 2019 will fall to the 2009 level in real terms. Its increasing proportion of the budget means little in reality, since payments are made in rubles or dollars, not proportions.
Education spending will decrease slightly and stabilize over three years, which means it will fall 20 percent in real terms. It comes as no surprise that a government whose budget revenues correlate 99 percent with oil prices treats educating people as an item in its optimization plan rather than possibly the most lucrative investment opportunity in today’s economy.
Healthcare spending will face significant cuts (to about the 2007 level in real terms) and will be 25 percent lower in 2019.
The government needs all these massive cuts in military, healthcare, and education spending (as well as more modest cuts in law enforcement and national security) in order to keep social spending at reasonable levels. These expenditures, which have been consistently increasing in previous years, will grow in 2017 even in real terms and are expected to stabilize during the three-year budget. Most likely, social expenditures will also be adjusted upward in the coming years.
The budget plan clearly reveals its authors’ thinking. They fear popular discontent and so don’t want to risk taking unpopular steps. The regime’s main goal is short-term stability, so it keeps supporting the paternalistic governing model, which is increasingly trapped in the cycle of social spending. Meanwhile, the workforce is contracting, GDP is falling, and the number of seniors is growing.
In the event that government handouts aren’t enough to keep people from protesting, this will be done by well-financed law enforcement agencies, although they will also feel the budget crunch to some degree. No economic development is possible in this situation: reforms and attempts to diversify the economy would require a radical overhaul of the social portion of the budget and higher education spending, while government stimulation of the economy—a clearly erroneous but quite popular ideology in Russia—would necessitate much greater spending.
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