Shortly after the Russian government submitted its 2016 budget proposal to the State Duma on October 23, critics began to refer to it as the “stagnation budget,” or the “last budget.” Indeed, rather than reassuring observers of Russia’s trajectory, the budget has cast doubt on its authors’ competence and the overall strategy of the Russian regime.

The initial proposal is based on state revenues of 13.58 trillion rubles and expenditures of 15.76 trillion rubles, which puts the 2016 budget deficit at 3 percent of GDP (forecast to be 78.67 trillion rubles in the coming year). But if the Finance Ministry’s past projections are any indicator, this budget is unlikely to have much bearing on reality.

In 2014, in the midst of a currency crisis, a drastic decline in oil prices, and a substantial decrease in economic activity, the Finance Ministry’s 2015 budget proposal nonetheless forecast 5.5 percent inflation, a GDP of 77 trillion rubles, and an exchange rate of 37.5 rubles to the dollar. In reality, inflation may hit 20 percent by the end of the year, the GDP will be less than 66 trillion rubles, and the exchange rate has averaged around 59 rubles to the dollar thus far (and rising). The Finance Ministry’s projected GDP was off by 45 percent (in dollars), while its revenue estimates were 44 percent above actual revenues.

In December 2014, the Finance Ministry predicted that inflation would hit 4.5 percent in 2016, but it has since revised its estimate to 6.4 percent. In reality, inflation is likely to exceed 10 percent, as prices have yet to fully adjust to the 55 percent increase in the dollar exchange rate. But this doesn’t bother the Finance Ministry; in fact, it may be deliberately underestimating inflation to keep inflationary income (derived primarily because of higher price-based taxes as a result of increased prices) in reserve. Still, high inflation may hurt GDP by keeping interest rates high and decreasing domestic consumption, thus depressing investment and business activity. Anticipated attempts to suppress inflation would trigger a money supply deficit and further stagnate consumption, which would in turn negatively impact GDP growth.

The budget’s GDP projection is also puzzling. Russia is still absorbing the shock from the decline of oil prices; when consumer demand—which has stalled due to this shock—returns, it will likely be accompanied by some inflation, but not an increase in output and services. Russia is also likely to experience a financial crisis brought on by the gradual decline in the quality of private borrowers, with incomes and wages under serious threat as a result of the blow to oil prices.  Furthermore, next year there will be significantly less construction as old projects are completed and new ones are abandoned, and more bankruptcies in the tourism, shipping, and retail industries as demand decreases.

But even without accounting for these factors, Russia’s GDP is still likely to stagnate or decline in the coming year, following a pattern that we have observed since 2011: GDP growth has been decelerating by 2 percent per year, falling below zero in 2014. The total profits and taxable income of Russian companies can also be expected to fall by 10 to 15 percent next year, as they have since 2012. As a result, even by conservative estimates, non-oil budget revenues will decline below 6 trillion rubles, while total revenues will drop to between 12 and 12.5 trillion rubles.

The 2016 budget reflects the government’s misguided belief—which it has made widely known to the Russian people—that the country’s dependence on oil can be reduced. The budget forecasts that revenues from oil as a share of all revenues will be reduced from 51 to 44 percent (5.97 trillion rubles), while Brent crude will remain close to $50 dollars per barrel. Though it is difficult to predict oil prices with a high degree of certainty, we can expect that Brent crude may even fall below $40 in 2016 if oil reserves exceed their capacity and owners decide not to keep the excess in tankers but rather to sell it off at any price.

The correlation between federal budget revenues and the price of oil has been close to 100 percent recently. This is because the natural resources tax and export duties hinge on oil prices; taxes associated with imports are determined by import volumes, which depend entirely on how many petrodollars are earned; and revenue-producing taxes are mostly paid by oil and gas companies (accounting for over 80 percent of federal revenue). As there have been no obvious changes to the country’s economic structure, it is reasonable to expect that, as has been the case in the past, direct oil-related taxes will constitute 50 percent of federal revenue, resulting in total revenue of close to 12 trillion rubles (an estimate close to the above figure, but derived differently).

Budget spending in 2016 is expected to be similar to 2015 levels. Defense spending will continue to rise, while science, healthcare, and education spending will be cut again. Pensions will be increased 4 percent in the spring in the midst of 20 percent inflation, and a further 4 percent increase in the fall will be discussed later in the year. Moreover, spending on wasteful bureaucratic programs will remain high in the coming year: for example, a program entitled “Developing federative relations and creating conditions for the effective and responsible management of regional and municipal finances” will receive 656 billion rubles in 2016, two times the budget for scientific research. Such “effective” spending would stretch any budget thin.

In response to criticism that science, healthcare, and education are underfunded and that Russia’s economy cannot be competitive under such conditions, the government has fallen back on the free market, arguing that business should finance science. However, 97 percent of the $35 billion earned by Russia’s 500 largest corporations in the past year was made in the oil and gas sector, which refuses to invest in any science that is not directly related to oil and gas. (The industry itself lacks resources for modernization and technological improvement, meaning that it may have trouble maintaining current production levels.)

Thus, the 2016 budget openly declares that Russia will not compete with the rest of the world in science and technology—at least not outside the defense sector. Judging by the pace of global technological progress, this choice may be irreversible. A closer look at Russia’s economic indicators and 2016 budget suggests that the Kremlin has chosen to wait for oil and gas prices to increase (regardless of the likelihood of this actually happening) while continuing to support the military-industrial complex. This is a budget of militarism and inaction. 

By:
  • Andrey Movchan