By: Tanvi Johri, Hu Si Ying
Research Head: Tanvi Johri
Editor: Praharsh Mehrotra
Illustration by KJ Shakti
After years of austerity, Russia is looking to loosen its fiscal reins to stimulate its economy. In this article, we share how Russia implemented stricter austerity following the 2014 Ruble crisis to sustain fiscally, and how the threat of stagnation is prompting the country to loosen its fiscal policy.
With the fall of the Soviet Union in 1991, Russia assumed responsibility for its foreign debt of over US $70 billion. This led to Russia placing severe austerity measures to collect enough money to pay off the debt. Russia had $26.7 billion of debt in 2014 and almost up to $80 million of debt in 2015 (Kuepper, 2019). To make matters worse, oil prices fell from $100 per barrel in June 2014 to $60 per barrel in December 2014 (Chung, 2014). As oil and gas make up more than 30% of Russia’s GDP, the price plummet meant that government revenue was significantly affected (Depersio, 2019). The fall in commodity prices and rise in geopolitical risks led to a fall in investors confidence and they began pulling capital out of Russia which led to a devaluation of the Ruble (Ruble Crisis). As some companies were prevented from rolling over debt, they were forced to exchange Rubles for US dollars or other currencies to pay interest on existing debt (Albanese & Edwards, 2014), which further exacerbated the devaluation. Instinctively, a depreciation of the Ruble led to inflation as imports became more expensive. Russia has managed to build a national wealth fund since 2004. It accumulates windfalls from oil revenues to protect them against oil price falls or crisis and totaled around 8.6% of GDP in 2014. Even with the ‘rainy day’ fund as a source to finance debt, the government did not want the budget deficit to worsen (Aleksashenko, 2015). This led to the government slashing spending on social projects to maintain high surpluses as a means to pay off debt and ward against oil price shocks. As a result, healthcare and education expenditures were cut to less than 10%. Between 2015 to 2017, land, real estate and transport taxes have increased by 28% and income tax has increased 15% (Zubacheva, 2019). Moreover, Russia has been imposing high tax rates to deter consumption, increase domestic savings and government revenue and as a means to finance the debt (refer to figure 1). VAT rates also increased from 18% to 20% in 2019 (Baker Mckenzie, 2018). The accumulation of oil revenues in the ‘rainy day’ fund has helped drive external debt to 0, while increase in taxes and dramatic spending cuts has lowered domestic debt to 15% of GDP (Aris, 2019).
Figure 1: Main Tax Receipts
Despite the debt and Ruble Crisis, Russia has managed to maintain decent economic growth rates - to grow at an annual average rate of 7% in the 2010s although currently it grows at 3-4% in recent years
(Focus Economics, 2020). This is mainly because of its export market primarily focused on a highly valued commodity like oil which allowed Russia to maintain large surprise.
Figure 2: Russia’s Current Account Surplus over the years The ability for Russia to grow also lies in its monetary policy. In November 2014, Russia shifted from a fixed exchange rate policy to a floating exchange regime. The Economic Trilemma tells us that Russia is able to have an independent monetary policy, free capital flows but no fixed exchange rates. The independent monetary policy works as an ‘automatic stabilizer’ for capital inflow and outflow from reduced speculation (The Central Bank of the Russian Federation, n.d.) In December 2014, with the ability to set interest rates, the deposit rate was raised to lower the inflation that ensued from the Ruble crisis. High interest rates to lower inflation help create price stability, which would reduce uncertainty and attract sources for long-term investments (The Central Bank of the Russian Federation, n.d.) Russia has realized that a paradigm shift is necessary to progress its economy further. Years of austere measures has led to dire negative economic impacts. Russia has been dealing with high crime rates (refer to figure 3) due to lack of regulation and insufficient spending for the general public. The lack of spending has also led to low standards of living. Russia reportedly has lower standards of living than both India and China (Rapoza, 2017). Despite free healthcare, its poor organizational structure and outdated medical equipment due to a lack of government funds undermine its quality (Expatica, 2020). In addition, the rising income inequality in Russia is concerning (refer to figure 4), partially due to regressive tax rates in Russia (Zubacheva, 2019).
Figure 3: Crime Rates in Russia Amidst these problems, austerity is also known to contract the economy severely. With higher taxes placed on the economy and a cut in government spending, domestic demand is significantly reduced. While Russia has been able to offset these negative effects with a strong export market and monetary policy approaches, breaking out of austerity will allow Russia more room to boost other areas that contribute to growth such as consumption and government spending. In recent years, Russia has been facing slowing economic growth rates. While a lack of fiscal stimulus is a reason, the decline in consumption and investment accompanies it. Despite Russia maintaining relatively high interest rates to attract investments (refer to figure 5 & 6), inflation and depreciation risks are resulting in sluggish demand for the Rouble as it still emerges from the effects of the financial crisis (Dolgin & Krpata, 2020). The Rouble still remains undervalued (refer to figure 7).
Figure 5: Russia’s Economic Growth
Figure 6: RUB benefits from relatively high interest rates
Figure 7: Rouble still remains modestly undervalued against the USD
This weak economic outlook has pushed Russia to cut interest rates to 6% so as to spur borrowing and consumption to stimulate economic growth for the time-being (The Moscow Times, 2020). However, this would also mean short-term capital outflows from Russia, due to decreased attractiveness of Russian capital in the eyes of investors. Considering that consumption rates have been declining due to high tax rates and that lower interest rates may not stimulate consumption due to lacklustre economic sentiments, the monetary policy may not be the best measure to boost economic growth (The Moscow Times, 2020).
Figure 8: Private Consumption As seen in GDP equation where Y = C(Y-T) + I + G + CA(EP*/P, Y-T), an already declining I and C has caused Russia to lose steam in its path to economic growth. Alternatively, if Russia is able to tap on G, it can boost its economy further. Moreover, fiscal policy is known to be a more sustainable economic policy since it addresses the root cause of the problem such as improving infrastructure or income inequality that pushes a country to long term growth rather than providing artificial economic boost through monetary policy. With all 4 components of the GDP being tapped on, Russia can definitely progress better. In addition, Russia now has huge amounts of government surplus due to years of austerity. Russia’s foreign currency reserves are at an all-time high of $550 billion, and its national “rainy day” contingency fund has over $125 billion (Weir, 2020).The figures below show the increase in reserves as well as Russia running a surplus at the expense of economic growth. The accumulated reserves puts Russia in a good position to increase its fiscal spending. Therefore, it is time Russia considers fiscal stimulus as a means to boost growth.
Figure 9: Accumulated reserves
Figure 10: Running a surplus at the expense of growth The paradigm shift consists of providing a fiscal push by accelerating an existing plan of a $400 billion investment on infrastructure -- building highways, ports and housing. These national projects made little progress due to slow processes and red-tape. The more important elements include a proposed $65 billion through 2024 on “expanding benefits for families and the poor” (Doff and Pismennaya, 2020). These spendings would increase output by increasing Aggregate Demand (AD) of the economy, shifting the curve to the right and hence increasing economic output.
Figure 11: Increase in output with increased G While expansionary fiscal policy may be more sustainable and apt for long term economic growth, Russia does not have the necessary structural reforms in place for the spending to show any real benefits (Doff and Pismennaya, 2020). With high bureaucracy, corruption and poor business regulation, an increase in government spending may not necessarily increase output (Weir, 2020). These reforms are not in place although Putin claims to support them. Thus, Russia has to be mindful to impose structural reforms alongside the fiscal maneuver for the desirable outcomes to surface. References 1.4 questions (and answers) to help you understand Russian taxes—Russia Beyond. (n.d.). Retrieved 20 March 2020, from https://www.rbth.com/business/330124-tax-system
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