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Tightening the belts: 2018 financial and legislative results

The year 2018 has not become a turning point either in Russia’s economic development or its economic policy; however, it was marked by several very notable events, the retirement age increase being the most prominent. In an attempt to calm the public outrage, the authorities announced the decision to raise the retirement age (as well as the value-added tax) during the World Cup, but the attempts to make the unpleasant news go unnoticed failed and it produced an extremely disturbing impression on the society. Its effect on the public opinion still endures, lowering the authorities’ ratings and affecting the results of regional elections. According to Armen Gevorkyan, Managing Director of VTB Bank’s Department of Oil and Gas Industry, Financial Institutions, Real Estate and Construction Materials, among all methods of budget replenishment (tax increase, pension reform, using the National Welfare Fund finances, state debt growth, structural reforms) the government chose the first two – namely, VAT and pensions, thus making a decision to meet expenditures at the expense of citizens and businesses.

Preparing for lower investments

Russia has actually found itself in a situation of a long-term ‘reduced ambitions’ in the budget sector. In accordance with the federal budget approved for 2019-2021, its expenditures will be reduced from 17.5% of the GDP in 2018 to 16.1% in 2021, while capital investments in government properties will decrease from 3.7% of the total federal budget expenditures in 2018 to 2.7% in 2021. The problem is that there are no plans to compensate for the reduction in state investments with private finance: the amount of aggregate domestic investments in the basic capital will decrease to 9.2% of the GDP in 2021 against 11.4% in 2018. Commenting on these figures, Svetlana Solyannikova, associate professor and Head of the Department of Public Finance at the Financial University under the Government of the Russian Federation, noted that citizen’s finance cannot become an economic growth driver either: according to the data provided by the Federal Service for State Statistics (Rosstat), on the average, citizens’ savings amount to about 8% of their income, while real income growth rate does not exceed the rate of inflation. In addition, a high degree of uncertainty as regards a number of external parameters of Russia’s economic performance, as well as the low capacity and high volatility of Russia’s financial market, result in a high risk of the Ministry of Finance failing to attract the planned volume of public borrowings and to finance the development and implementation of national projects and priority state programs through the budget, the expert says.

“In this regard, a question arises whether the [presidential] executive order of May 2018 will meet the same fate as the implementation of the executive orders of May 7, 2012”, Solyannikova says.

According to Ruslan Dzarasov, head of the Department of Economic Theory and History at Plekhanov Russian University of Economics, the oil price volatility contributes to the consolidation of the budget austerity policy, meaning that the Government will continue to cut spending on economic growth, science and education.

“Strict compliance with the so-called fiscal rule leads to withdrawal of a significant part of state revenues from economic circulation. Along with keeping the Central Bank’s key interest rate high, this makes it difficult for the economy to achieve sustainable growth,” Ruslan Dzarasov believes.

Accelerating the tax maneuver

As federal revenue sources are becoming increasingly problematic, the authorities have resorted to accelerating the tax maneuver in the oil industry – a simultaneous increase in the mineral extraction tax and reduction of the oil export duty. The primary purpose of this maneuver is to stabilize the oil revenues, even with volatile global oil prices. Accordingly, the tax burden gets shifted from exports to the domestic market for oil and petroleum products. The changes come into effect on January 1, 2019. The decision provides for a gradual (over six years) zeroing of the export duty on oil by introducing a correction factor into its formula and annually reducing its value.

To compensate the declining budget revenues, the base MET rate for oil and gas condensate will be raised and the formula for calculating this tax changed. Vadim Ponkratov, Director of the Financial Policy Center at the Financial University, is sure that zeroing the export duties will increase domestic prices for commodities and lead to a decrease in the profitability of oil refining in Russia. The situation will be aggravated by a serious rise in excise taxes on petroleum products in 2019: from RUR 8,200 ($120) to RUR 12,300 ($180) per ton of gasoline, and from RUR 5,670 ($83) to RUR 8,540 ($125) per ton of diesel fuel. A new excise tax on oil with a damping component and a logistic factor for remote refineries will be introduced in an attempt to avoid a surge in domestic fuel prices.

Legislative novelties

In addition to the tax news, 2018 will be remembered for changes in economic legislation. The pension reform was not just about raising the retirement age; it also included many smaller regulatory innovations. As Alexander Vyunitsky, board member at Soglasiye non-state pension fund, told Invest Foresight, an important change for the non-state pension market in 2018 concerned the pension funds’ entitlement to a fixed remuneration of 0.75% of the average net asset value per year. Previously, the funds received only a variable amount of no more than 15% of the income generated from investing the pension savings, paid out at the end of each year.

Smaller players continued leaving the market in 2018; the market became further consolidation; the number of insured persons moving from one NPF to another reduced; and the market prepared for the introduction of an individual pension capital system.

Professor at the Department of Public Finance at Financial University Marina Sedova points out the importance of this year’s changes in the social security legislation. Russia’s ratification of most sections of ILO Convention No. 102 will gradually lead to a change in the formula for calculating social payments to a percentage of the average salary, whereas now, the Russian legislation sets them in absolute figures on the basis of the minimum wage or subsistence level in the relevant population group. Furthermore, in 2018, proceeds from the sale of confiscated property in corruption cases were legally assigned as income of the Pension Fund of Russia; the indexation of insurance pensions from 2019 to 2025 above the CPI was also codified in law. Prior to the adoption of this law, one could not estimate their potential monthly retirement benefits if they planned to retire in two years.

What never happened

Many experts mention legislative novelties that were expected in 2018, but never actually adopted, such as the bill legalizing operations with cryptocurrencies and tokens. Although adopted in the first reading, the digital financial assets law came under sharp criticism of the Presidential Council for Codification and Enhancement of Civil Legislation and, apparently, will be sent back to the first reading stage. Anyway, this year’s hype around cryptocurrencies is clearly over.

According to Ivan Rykov, CEO of Rykov Group and Chairman of the Subcommittee on the Development of Financial Literacy of the RF CCI Committee on Financial Markets and Credit Organizations, the main negative result of 2018 was Russia’s failure to adopt the new bankruptcy code. The expert believes the current version of the insolvency (bankruptcy) law does not correspond to economic realities.

“I think we need a new comprehensive bankruptcy code and a code of laws on debt recovery. The absence of such systematic state initiatives has led to overdue debts becoming almost uncontrollable and threatening to provoke a new economic crisis,” Rykov says.

According to the Rosstat state statistics service, the total corporate sector debt climbed to RUR 3 trln ($43.55 bln) in 2018, he said. Therefore, with no significant reforms or legislative innovations in 2018, the shortage of money at the state level has become more pronounced, and everyone will have to pay for it eventually.

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