MinFin Impossible: Russia’s self-inflicted regional debt crisis

By Chris Jarmas

Domestic policies in Russia can sometimes feel immune to change – until Vladimir Putin intervenes, that is. At a late-October meeting with government officials, Putin again voiced his concerns about growing debts on regional balance sheets. Turning his attention towards regions in which debt substantially exceeds annual revenues, Putin cautioned, “At this level of debt, regions will not be able to effectively deal with the challenges of development.” Worse yet, failing to address sub-sovereign indebtedness stands to “lead to serious financial imbalances” between the regions. Putin is right to pay attention to domestic fiscal problems – especially as the March 2018 presidential election approaches. But this is a case of “too little, too late” and obscures that federal government policies sparked the regional debt boom in the first place.

As the Russian economy lurched into stagnation in late 2012, then tumbled downward as low oil prices and Western sanctions combined in 2014 to slash tax revenues, the Kremlin was busy pressuring ill-resourced regional governments to boost expenditures. Within hours of his third inauguration, Putin delivered on populist campaign promises and unleashed a program which included, among other costly endeavors, a decree mandating that public-sector salaries be increased by 50 percent by 2018. Regional governments were tasked with executing the orders, known collectively as the May Decrees, but were not provided adequate funds to do so without turning to commercial banks for high-interest loans. Total regional debts have increased fivefold over the last decade, but consolidated figures mask an even more dire reality in many regions. Mordovia’s debt-to-revenue ratio stands at a mind-boggling 185 percent, but the republic is hardly alone; twelve regions have debt-to-revenue ratios between 80 and 100 percent, while seven worse-off regions are burdened with debts equal to between 100 and 125 percent of their revenues.

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Federal policy with regard to this issue has been reactive rather than proactive. The Ministry of Finance managed to decelerate the growth rate of consolidated regional liabilities by 2015 by replacing high-interest commercial debt with practically zero-interest loans from the federal budget (“budget loans” or “budget credits”) which had a maximum maturity of three years.

As the maturity date of the budget loans approached, regional coffers remained starved of funds, and the Kremlin again kicked the can down the road. In September of this year, Putin announced a “restructuring” program which would begin January 1, 2018, and would allow regions an additional seven years to repay their debts to Moscow. Some regions, Putin said, would have as long as twelve years to fulfill their obligations. The details of the restructuring program suggest a twofold strategy from the Kremlin: to avoid regional defaults by delaying repayment as long as possible and to hope in the meantime that Russia’s economy will recover. The first two years of the restructuring program limit the regions’ pain – they will only need to repay 5 percent of their debt per year. Repayment requirements increase to 10 percent in 2020, then 20 percent in 2021. The back-loaded repayment scheme is just another way for Russia’s leadership to delay the pain, but it risks applying the most pressure at the most inopportune time, just as the Kremlin begins the difficult process of managing Putin’s succession.

Seeking to ensure that the regions comply with their repayment obligations, the Ministry of Finance announced new sanctions on regions threatened by default. According to the new rules, if a region misses an interest payment (unlikely, since the federal budget loans have just a .1 percent annual rate) or miss a repayment on principal (more likely), the region will theoretically be forced to repay the rest of their debt to the center all at once. Theoretically, at least, as some doubt Moscow’s preparedness to stick to its own rules. Moody’s analyst Vladlen Kuznetsov told RBC that he expects the Ministry of Finance to take “a rather flexible stance in these cases to avoid a regional default.” The Director of the Independent Institute of Regional Policy, Natalya Zubarevich, is also skeptical. “2018 will pass, and we’ll see if it’s possible, for example, for Mordovia and Khakassia to reduce their deficit and debt. While they have only been building them up, no one has been held responsible,” she says, adding that she does not interpret the Ministry of Finance’s statements literally. “Final decisions on imposing financial sanctions on debtor-regions,” Zubarevich notes, “will not be made by the Ministry of Finance. Rather, they will be made in the Kremlin.”

“Final decisions on imposing financial sanctions on debtor-regions,” Zubarevich notes, “will not be made by the Ministry of Finance. Rather, they will be made in the Kremlin.”

The regional governors find themselves caught between a rock and a hard place. The Kremlin continues to pressure even the most indebted regions to fulfill the May Decrees – but the Ministry of Finance’s new rules also limit the regions’ maneuverability. Regions with debt problems are officially prohibited from seeking new loans from banks at interest rates higher than the “key rate + 1 percent” formula. This restriction could prove problematic for some of Russia’s most underwater regions. In September, notes RBC, Mordovia took a loan at 11.5 percent, despite a key rate of 8.5 percent. The federal government’s simultaneous demand of decree fulfillment and fiscal responsibility bodes poorly for Russia’s economy, says Zubarevich: “Some regions will simply cut down all expenditures on the national economy, where possible, and not invest in development at all – but they will fulfill the decrees.”

At least officially, the Kremlin has made clear that governors will now be held accountable for debt problems in their regions. On November 15, Putin signed a decree doubling the number of indicators with which the central authorities will assess regional governor performance. Debt, for the first time, features prominently. Governors must report their region’s debt-to-revenue ratio (without counting fiscal transfers as revenue) annually. Superficially, additional indicators mean added scrutiny for regional governors. But Russian political observer Nikolay Petrov sees a different logic: “In fact, it seems to me that the more indicators, the less rigid and strict evaluation becomes…when you have 24 indicators, the picture is less straightforward.” More flexible evaluation, Petrov adds, means greater flexibility for the Kremlin to replace regional governors. “On one hand, your hands are untied and any governor can be accused and changed because some indicators look worse than they ought to. And on the other hand, it is impossible to objectively assess the performance of a governor using these metrics.”

Since 2012, the Kremlin has pushed the cost of national policy initiatives onto regional balance sheets. Thus far, they have managed to put off absorbing the liabilities – but their day of reckoning will eventually come, barring a recovery of the Russian economy. However, the same May Decrees that have bankrupted regional treasuries have also weakened the prospects for dynamic growth by prioritizing salary increases over productivity increases. Putin may claim a desire to solve the regions’ fiscal difficulties, but unless the Kremlin realizes that its own policies are the problem, the eventual cost of absorbing regional liabilities will continue to rise.


Chris Jarmas is a columnist covering regional news and politics in the daily news brief. He is a second-year master’s student at Harvard University’s Davis Center for Russian and Eurasian Studies. Previously, he interned at the U.S. Department of State in Moscow and Kiev, and has also lived in Kyrgyzstan.

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