GOR APPROVES 2010-12 BUDGET PARAMETERS: ARE THEY

C O N F I D E N T I A L MOSCOW 002064

SIPDIS

C O R R E C T E D C O P Y (TEXT)

STATE FOR EUR/RUS, EEB/IFD
TREASURY FOR TORGERSON, WRIGHT
DOC FOR 4231/MAC/EUR/JBROUGHER
NSC FOR MCFAUL

E.O. 12958: DECL: 08/12/2019
TAGS: ECON EFIN RS
SUBJECT: GOR APPROVES 2010-12 BUDGET PARAMETERS: ARE THEY
SUSTAINABLE?

Classified By: CDA: ERUBIN, Reasons 1.4 (b)and(d)

Summary
--------------


1. (C) The GOR has approved the macroeconomic parameters of
the 2010-12 federal budget based on a moderately conservative
assessment that the oil price will remain at $55-57/bbl for
Urals. Revenues are expected to grow slightly in line with
nominal GDP and expenditures are planned at near current
levels. The GOR will run a deficit of 7.5% in 2010 -
dropping to 3% in 2012 - to be financed initially by the
shrinking Reserve Fund and eventually through international
borrowing: Eurobond issues, the World Bank and foreign
commercial banks. Analysts are concerned that financing the
deficit through an injection of ruble liquidity would be
inflationary and upset the forex market. Heavy borrowing on
the international markets would lead to a surge in sovereign
bond yields, thus crowding out the private sector. Moreover,
some experts criticize the budget for neglecting much needed
infrastructure development at the expense of social spending.
Lastly, many doubt the GOR has the political will to cut
expenditures, particularly in the social sphere and loss
making state sector enterprises. End summary.

Outline of the 2010-12 Budget Parameters
--------------


2. (SBU) On July 30, the GOR discussed and approved the
guidelines and main parameters of the 2010-12 federal budget.
Based on a realistic assessment that the oil price will
remain at a moderate $55-57 per barrel for Urals, revenues
are expected to grow slowly, almost in line with nominal GDP
(about 15.7% of GDP in 2010 and 2011 and 18.5% of GDP in
2012, or 9.961 trillion rubles compared with 9.980 trillion
rubles this year). This will result in a budget deficit of
3.2 trillion rubles - approximately 101 billion USD - or 7.5%
of GDP in 2010; 2 trillion rubles, or 4.3% of GDP in 2011;
and 1.6 trillion rubles, or 3% of GDP in 2012. (Note: Russia
is currently running a budget deficit of 9.4 percent of GDP,
which, in turn, has dropped 10.1 percent in the first six
months of this year. Russian officials have revised the
deficit forecast upward several times this year. Analysts are
divided as to whether Russia has passed the worst part of its
recession. End note.)


3. (SBU) The 2010 deficit will be financed mostly from the
Reserve fund (1.68 trillion rubles) and the National Welfare
Fund (682 billion rubles). In 2011, the GOR plans to take
5.6 billion rubles from the Reserve Fund, which will then be
practically depleted, and 74 billion rubles from the national
Welfare Fund. In 2012, another 712 billion rubles will be
drawn from the National Welfare Fund. Foreign borrowing
could become the secondary source of deficit financing in
2010 and the main one over the two following years.
According to Finance Minister Kudrin, after a 10-year hiatus,
Russia will issue Eurobonds worth $17.8 billion (613.6
billion rubles) in 2010; $20.7 billion (764.7 billion rubles)
in 2011; and $20 billion (784 billion rubles) in 2012. In
addition, Deputy Finance Minister Dmitriy Pankin recently
announced that the GOR may borrow from the World Bank and/or
foreign commercial banks in 2010 (between $2-4 billion),
although there are no plans to borrow from the IMF. Pankin
added that if the price of Urals oil holds above the $55-57
per barrel level figured into the 2010 budget, borrowing
plans would likely be scaled back.


4. (SBU) Given the global macroeconomic uncertainty and the
high volatility of the commodity markets, the GOR decided to
produce an itemized budget bill covering just 2010, while for
the following two years, the GOR approved the budget's
revenues and expenditures without breaking those down by
agencies. By November 1, all agencies are required to
develop programs for optimization of their expenditures.
(Note: The final version of the 2009 budget was approved in
March, only after - as many believe - the GOR was reasonably
confident about the oil price, since oil and gas-related
taxes comprise a large part of the government's revenues. End
note.)

Analysts Wary of Spending Priorities...
--------------



5. (C) Some analysts view a 7.5 GDP deficit next year as a
major threat to macroeconomic stability. Troika's chief
economist Yevgeniy Gavrilenkov argued in his monthly economic
report that given the Russian economy's low level of
monetization (M2/GDP is just 31%),running a 7.5 % of GDP
deficit implied that around 25% of the current level of M2
would be injected as ruble liquidity, which would undermine
the forex market and spur inflation. He contended that
eventually the GOR would be forced to start further cutting
expenditures. Thus far, he reported, spending on such items
as health care, education, culture as well as on some
investment and federal target programs (excluding
preparations for the 2012 APEC Summit and the 2014 Winter
Olympics) had been slightly trimmed, but spending on defense
and national security remained untouchable.


6. (C) CEO of BNP Paribas Russia Laurent Couraudon, among
others, was critical of the government's budget for
neglecting much-needed infrastructure development. The trend
seemed to be, he told us, that social spending was
increasing, so as to keep underperforming companies running,
while infrastructure was actually being cut. Chief Economist
of HSBC Aleksander Morozov voiced the same opinion, adding
that anti-crisis money was going for banks, for transfers to
the regions, and for direct subsidies, but not going to the
big infrastructure projects. "The efficiency of the stimulus
package is doubtful", he concluded, "and it doesn't
contribute to sustained growth in the future."


7. (C) Many of our interlocutors commented that another sign
of the GOR's turning away from fiscal prudence was its
decision to postpone increasing its pension tax until 2011.
To address the growing pension deficit, the GOR had decided
to increase the top rate of income tax from 26% to 35%. The
decision to delay this increase until 2011 (and some believe
it will be further delayed) will lead to a greater increase
in the pension deficit.

... And Cast Some Doubt On Revenue Figures
--------------


8. (C) While the government used a modest oil price as the
basis for its budget, there is some doubt about its
projections. HSBC Bank's Morozov said that if the GOR's
estimate of $55-57/barrel was correct, the deficit will in
fact be larger. But if oil hits $70/barrel, as some predict,
the deficit will be less. The numbers for 2011 and 2012, he
added, were unrealistic in that they assumed no growth in
nominal spending.


9. (C) Another important consideration shared by most
analysts is that Russia is not likely to be able (and
willing) to borrow internationally on a large scale (i.e.,$20
billion a year). Even if the situation in the global debt
markets continues to improve, an attempt to raise this much
would lead to a surge in sovereign bond yields, thus crowding
out the private sector. (Russia's EMBI-plus sovereign bond
index has already widened in recent days relative to Russia's
peers' indices). Troika's Gavrilenkov notes that it will also
be hard and harmful to borrow domestically as the government
will simply oust private borrowers from the relatively small
financial system - total ruble money supply being equivalent
to only about $400 billion).

Comment:
--------------


10. (C) We share the skepticism of the analysts that the
government's budget scenario is realistic and sustainable.
While the GOR has projected relatively conservative
parameters for economic growth and budget revenues, there is
no indication that it intends to make major cuts in
expenditures, particularly social spending. Massive
government spending - much of it slated to sustain employment
in loss making state owned companies - is inflationary and
will not spur economic growth. On the other hand, the
populist economic approach is perceived as a means to sustain
the high approval ratings of the president and prime minister.


11. (C) Putin's strong words to governors assembled on August
10 in Kislovodsk that they should not count on federal
authorities to meet regional budget shortfalls reinforces the
sense that a share of the tough decisions on belt-tightening


- and the political consequences - will need to be made not
only in Moscow, but in the regions as well. End Comment.

RUBIN