RUSSIA'S 2007 BUDGET: A QUICK OVERVIEW

C O N F I D E N T I A L MOSCOW 013005

SIPDIS

SIPDIS

STATE FOR EUR/RUS
TREASURY BAKER/GAERTNER
NSC FOR MCKIBBEN AND GRAHAM

E.O. 12958: DECL: 12/19/2015
TAGS: ECON EFIN PGOV RS
SUBJECT: RUSSIA'S 2007 BUDGET: A QUICK OVERVIEW

REF: SEPARATE UNCLASS EMAIL ATTACHMENT

Classified By: ECON M/C Pam Quanrud, Reasons 1.4 (b/d).

Summary
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1. (SBU) Despite considerable chatter to the contrary,
Russia's 2007 Federal Budget (signed into law December 20 by
President Putin) continues to reflect substantial fiscal
restraint, with expenditures set to rise by just 1.5 percent
of GDP and the primary surplus targeted at 5.3 percent of
GDP. The restraint is all the more noteworthy in light of
the 2007-08 election cycle here and the pressing need to
improve Russia's collapsing physical and social
infrastructure. Of note, and the source of some debate, has
been the relatively high budget assumption for Urals crude --
at USD 61 a barrel, the Russian Government is at the top end
of consensus forecasts (USD 55-61). With this initial foray,
Finance Minister Kudrin appears to be trying to soften the
ground for the next budget, which he hopes to make "oil
free," or independent of oil export revenue. This year's
budget balances at a per-barrel price of Urals of USD 37 --
making it fairly bullet-proof from a fiscal perspective.
Further details and charts are being sent via separate
unclass email attachment. End Summary.

SIPDIS

Salient Macro Features
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2. (SBU) The budget for 2007 marks a departure from recent
budgets in being relatively optimistic in many, but not all,
its assumptions, with the per-barrel price of Urals crude oil
set at USD 61, at the top of the consensus forecast range,
and natural gas pegged at USD 294, up 60 percent on 2006.
Both the CPI assumptions (from 6.5 to 8 percent) and the
ruble-dollar exchange rate (at RUB 26.5 per dollar) reflect
an anticipated easing of so-called "Dutch disease" pressures
in 2007, based on relatively good performance on both
indicators in H2 2006. That said, most experts believe that
current account surpluses, combined with increased government
expenditures, will continue to exert inflationary pressure in
2007, and that to contain the upward pressure, monetary
authorities are likely to allow the ruble to appreciate. At
the G-20 meeting in Melbourne, Kudrin said that real
effective ruble appreciation would not exceed 5 percent in
2007 provided that the Urals price does not exceed USD 61 per
barrel. To really keep inflation in check, prices in the
mid-50's would be welcome. Interestingly, the GDP forecast
for 2007 contained in the budget calls for only a 6 percent
increase, which is lower than consensus forecasts, but may
only reflect the fact that the budget process began in July
-- long before the H2 2006 pick-up in the economy.


3. (C) There has been widespread speculation regarding
Finance Minister Aleksey Kudrin's acceptance of the
relatively high USD 61 per-barrel assumption put forward by
the Ministry of Economic Development and Trade. Some
commentators, including Renaissance Capital Chief Economist
Vladimir Pantyushin, suggest that Kudrin has his sights set
on a non-oil budget for 2008 (Kudrin has warned against undue
reliance on oil revenues to finance budget programs) and this
year's overshoot assumption will help set the stage.
Pantyushin notes that if actual revenues were to fall below
budgeted revenues because of a lower than expected price for
Urals, Kudrin would be able to argue the dangers in a budget
dependent on oil export revenues. Kudrin's chief of staff,
Vadim Grishin, has confirmed this analysis with us in private.

Revenue
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4. (SBU) The 2007 budget provides for revenue of RUB 6.97
trillion (USD 265 billion, or 22.3 percent of GDP),largely
in line with 2006 actual revenue flows (in percent of GDP
terms). The Ministry of Finance believes that "non-oil
revenue" will grow by 1.2 percent of GDP in 2007 -- a
positive trend, since in recent years this figure has been in
decline. To achieve growth in "non-oil" revenue, the GOR
will need to enhance its collection and administration of
taxes, which is clearly a double edged proposition in Russia.

Expenditure
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5. (C) President Putin has called for higher spending in
2007, and in the medium-term "at a pace adequate to the pace
of economic growth." Expenditures in 2007 are slated to
remain constant in percent of GDP terms, with the 1.5 percent
of GDP in spending falling solely on the non-interest
expenditure side of the budget. Transfers to regional and
local governments still dominate the budget. Cynics will say
that this represents a serious slackening of fiscal
federalism discipline, but economic reformers says they need
this ability to reward and punish as part of the process of
enforcing both budget discipline and new mandates on
sub-federal actors -- a kind of necessary evil on the way to
a more stable fiscal federal system in the long term.
Defense, national security and law enforcement will see
slight increases in percent of GDP terms compared with 2006,
but while higher spending is on tap for healthcare and
education -- two of the four National Priority Projects -- no
one walked away with any serious spending boost for 2007.
Grishin says that the pressure to spend is greater than ever,
but Kudrin managed to keep Economic Minister Gref's
Investment Fund, which finances infrastructure and industry
development projects on the basis of public-private
partnerships (PPP),to a modest RUB 110 billion (USD 4.2
billion) in 2007, and the new Venture Fund, aimed at spurring
PPP investments in IT and the high-tech sector, to RUB 15
billion (USD 570 million).

Stabilization Fund
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6. (SBU) The Stabilization Fund will continue to see
contributions from the mineral extraction tax and export
duties generated by the price of Urals crude over USD 27 per
barrel as well as the overall budget's surplus. By the end
of 2007, it is expected to almost double to USD 165 billion.
As if to vindicate Pantyushin's argument about the Finance
Ministry's interest in the non-oil budget concept, Kudrin
submitted a proposal to Prime Minister Fradkov on December 5
that calls for all oil and gas revenues be collected into a
new Oil and Gas Fund. According to Kudrin's plan, the Oil
and Gas Fund would consist of a "reserve" component and a
"savings account." It would also replace the Stabilization
Fund. The Oil and Gas Fund's reserve component would be used
to finance budget deficits and, once it reaches 7-10 percent
of GDP, would finance the savings account, which would pay
for pensions and other social programs. Kudrin's proposal
specifies no timeline, and would need GOR approval before
going into effect.

Comment
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7. (SBU) The 2007 budget is not exactly internally
consistent in its assumptions, but perhaps we can understand
why. (Most obviously, a high Urals price implies demand for
rubles will be equally high, which would put pressure on the
ruble-dollar exchange rate and inflation.) If Kudrin's
volley works, next year will not witness the revenue
overshoots we are seeing this year, and at least the
"perceived" shortfall in the budget may prove useful in
making his bold argument for a future budgeting process
independent of oil revenue. In the meantime, at a minimum, it
may prove a useful brake on election-year spending
temptations.
RUSSELL