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 -------------- ¶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 -------------- ¶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 -------------- ¶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 -------------- ¶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 -------------- ¶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 -------------- ¶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