The plague year of the regions

The pandemic year of 2020 battered regional budgets. Some went through a double crisis due to the oil slump in the first half of the year. However, official figures released in January show a somewhat rosier picture than many feared. But aggregate numbers hide significant disparities between various regions, as well as the fact that the more reassuring numbers came at a price: the federal government used the crisis to tighten its grip on regions’ finances and thus also their politics.

Of Russia’s 83 regions and the two occupied territories in Ukraine 58 were in deficit in 2020. The total deficit of these regions was 762 billion rubles or 5 percent of total regional incomes, according to a Treasury report quoted by RBC. The differences between regions were significant and showcased the extent as well as the nature of last year’s crisis. Regions with extractive industries – Kemerovo, a coal region and Tyumen, an oil region that saw deficits of 21 and 20 percent of their total income, respectively – lost the most money as global demand collapsed. Other industrial regions – Udmurtia, Chelyabinsk, etc. – also suffered, albeit to a lesser extent. And while industrial production rebounded in late 2020, low oil prices and falling coal demand are seemingly here to stay, impacting not only the accumulation of budgetary reserves that the federal government was so reluctant to spend in 2020, but also investments into infrastructure.

Russian regions cannot go bankrupt: deficits ultimately have to be covered by loans or by federal money. And while transfers from the federal to regional budgets grew by 56 percent in 2020 relative to 2019, this was not exactly free money. There are three main types of budgetary transfers in Russia: grants represent money collected from regions at the federal level and redistributed, according to a set formula, in order to reduce inequalities between resource-rich and poorer regions, and which regions are theoretically free to use as they see fit; subsidies represent money given by the federal government to regions specifically to support budgetary functions that regions otherwise spend their own funds on; subventions are transfers allowing regions to carry out various functions that the federal government entrusts them with. Of these, the amount of subsidies, which come with strings attached, have grown faster than grants. Recent years have also seen a growth of transfers in the “other” category, mostly discretional transfers that depend on the political lobbying power of individual regions.

Additional budgetary transfers to the regions in 2020 were also lopsided and somewhat intransparent. Based on Treasury data, economist Natalya Zubarevich followed additional budgetary transfers to regions throughout the year, comparing them with the regions’ lost revenue. It seems that while some regions – Chechnya, the Altai Territory, but also bigger regions such as Bashkortostan and the Sverdlovsk Region – were overcompensated, additional transfers to oil- and gas-producing regions, coal producing regions as well as Russia’s biggest cities amounted only to a fragment of lost revenues.

Unclear envelopes

In a way, this makes sense as the regions that received proportionally less compensation were either expected to get back to growth when lockdowns were lifted and demand started rising again, or they were in a better position to take out loans on the market to tide them over (as Moscow and St. Petersburg actually did). On the other hand, it is difficult to see why other regions were overcompensated to the degree that they were, and why some of them still managed to run significant deficits (as Bashkortostan did) or run up significant debt (as the Sverdlovsk Region did). (Allowances to regions based on the deferment of budgetary loan repayments – which disproportionately benefited indebted regions, regardless of how severely they were hit by the pandemic – were similarly difficult to comprehend, even for governors – but this is a different story). 

It is quite likely that, to some degree, key performance indicators (KPIs), which the federal government uses to evaluate the performance of governors, have to do with the discrepancies. While the deadline of the National Projects, twelve big development projects launched in 2018, was pushed back from 2024 to 2030, the government did not remove the KPIs related to the projects and thus governors were compelled to keep spending on the projects throughout the year, even as priorities shifted, because doing so put them in a better position to lobby for additional funds. According to the Finance Ministry’s numbers, the federal government actually spent 97.4 percent of the funds allocated to the National Projects in 2020 – a significant improvement on 2019, which was one of the major political goals of prime minister Mikhail Mishustin. This does not reveal how effectively regional governments fulfilled their own spending plans (on average, regional budgets are expected to cough up roughly 19 percent of the funds), but there are indications that these expenses were indeed prioritized and with federal stewardship. In January the Finance Ministry announced that the amount of lost revenue in the regions was only 220 billion rubles, almost four times smaller than originally estimated, even as on the whole regional government spending was 15 percent higher than in the previous year. However, as Nick Birman-Trickett pointed out, the catch is that this mostly due to a massive increase in investment expenses through these budgets. On the same week, Putin instructed the government to “analyse” the National Projects from the point of view of falling regional revenues, which suggests that the federal budget may put more money into them in the form of additional transfers to the regions.

KPIs and IOUs

Let’s return for a moment to the question of debt. Earlier this week Kommersant published a telling chart, which showed how the debt burden of regions changed in recent years. As expected, after years of slow reduction, the overall debt grew by 18 percent in 2020 in nominal terms. This is almost as significant as debt growth in 2015-16 (20 and 11 percent respectively), which led to a near-miss debt crisis and prompted the federal government to intervene. Regional debt will almost certainly keep growing this year as the pandemic is expected to cast a long shadow and economic recovery is expected to be sluggish, especially in regions that rely on revenues from enterprises depending on domestic demand (which the Kremlin has so far not seemed inclined to support significantly). However, the situation differs from 2015-16 in at two important ways. First, the significant growth of regional debt in 2020 was mostly due to Moscow and St. Petersburg taking out large loans, and these regions are liquid. Second, the structure of regional debt has changed: five years ago, a significant proportion of regional debt was held by banks. Due to the Finance Ministry’s intervention then, there has been a major shift towards budgetary loans and government bonds since.

On the one hand this means that debt servicing costs are smaller and even though regional debt will likely grow this year, this will not necessarily lead to a crisis. On the other hand, this strengthens the grip of the federal govt on regional governments. The problem with loans guaranteed by the budget is that one never knows when they will dry up; meanwhile, only few regions can borrow on favourable terms on the market.

Unhealthy federalism

As long as the system of budgetary transfers is not made more transparent and predictable, as long as regions’ own revenues do not grow significantly, this is going to be a major factor of uncertainty for regional governments and a significant leverage on regions for the Kremlin. If regions become illiquid – which may happen, if debt servicing costs spiral out of control, revenues dry up due to a sluggish recovery and the regional budget is not compensated sufficiently – their fiscal policy can end up under the direct control of the Finance Ministry, as it happened to Ingushetia last year. It is likely that we will know more about this around mid-summer as regional budgets are squeezed from two sides by the repayment of loans and political pressure to spend before legislative elections in September.

One thing that may change this is if the government decides to loosen the purse strings, after all, and provide a more significant income support to Russian citizenss and small- and medium-sized enterprises, most of whom would otherwise face yet another year of falling real incomes, and perhaps even a debt crisis. This is not completely unlikely: after all, many have warned the Kremlin that the protests that followed Alexey Navalny’s return to Russia in January had to do, to a significant extent, with people being fed up, rather than their devotion to Navalny. Surveys conducted among protesters seem to have corroborated this analysis. It is very likely that proponents of direct income support will point at these figures in the following month. Whether the Kremlin will go down this road is far from certain. There are worrying indications that instead of “political technology” the authorities are planning to rely primarily on rigging to deliver the desired distribution of Duma seats in September, and that the Kremlin increasingly regards the protest movement as an enemy plot rather than the manifestation of popular dissatisfaction.

Thus the Kremlin’s growing paranoia does a disservice to Russian federalism.

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