Russia’s federal budget is groaning under the weight of sanctions. Earlier this month, Prime Minister Mikhail Mishustin’s government announced plans to use 1 trillion rubles ($16.25bn) from the country’s sovereign wealth savings in the National Welfare Fund – a rainy-day fund consisting of hard currencies, reserves, and gold – to finance the ballooning deficit.  

Government plans show that the fund will be raided for another 5 trillion rubles in the next two years. The effect, in Russia’s sanctions-bound economy, is much like printing rubles; it is quintessentially inflationary. The alternative – withdrawing the rest of the government’s reserves from banks – comes with its own risks. 

At the same time, faced with military mobilization and partial martial law, the federal government is again outsourcing a growing number of tasks — together with the political responsibility and the fiscal consequences — to the regions. These tasks range from keeping local economies and supply chains stable, to equipping draftees and making social payments. These are critical governmental tasks. 

In Russia’s multi-tiered fiscal system, regional budgets finance a range of state functions. Roughly 90% is spent on five broad areas: health care, housing, and communal services, social policies, “national economy” (which includes capital investments), and education (see Figure 1.) Regions also heavily subsidize municipal budgets, and are expected to carry out various federally designed policies, from development priorities to raising the salaries of public employees.  

Income is sourced from three main areas: personal income tax, corporation tax, and — in most, but not all regions — subventions from the federal budget, which essentially redistribute income from a handful of wealthy regions to the rest. The two taxes make up roughly 65%-70% of the so-called “own revenues” – revenues without the central government transfers.  

Regional budgets had a very good start to the year. The economic recovery that followed the deep slump triggered by the covid crisis was continuing, energy prices were high, with beneficial spillover effects on other parts of the economy, and spending on the “National Projects” — 13 grand development programs designed after Putin’s 2018 inauguration, though substantially revamped in 2021 — picked up again. This came after 2021 when, as a whole, regions accumulated 640 billion rubles ($10.5bn) of surplus (even though much of this benefitted the federal authorities.)  

Initial budgetary plans for 2022 built on this surplus, and expected similarly smooth sailing over this year. Factoring in inflation – which grew from just under 9% in January to more than 14% in September — the consolidated budgets of the 83 regions envisaged a modest growth in housing and national economy headings spending, while the other areas were projected to grow either slightly above inflation, or under it (Figure 2.) 

As of late October, official data suggests that things are going well. Recorded income in regional budgets is around 79% overall for the first nine months of the year, which is comparable to 2021.  

But trouble lurks below the surface-level data, suggesting difficult months ahead. 

Look at corporation tax receipts (Figure 3), where it is obvious that while most regions recorded a hefty increase in the first half of the year over the comparable period in 2021, revenue fell precipitously in the third quarter of 2022 relative to the same period in the previous year, even without accounting for inflation. Some of the worst performers over the past months are regions that have lost export markets: regions whose dominant industry is metallurgy, e.g. Lipetsk, Belgorod, Chelyabinsk, and Kursk, and western timber-producing regions, e.g. Karelia and Arkhangelsk. Even beyond these, regions where extractive industries turned bumper profits in the first half of the year — such as coal-producing Kemerovo and Khakassia, the oil and gas-producing Yamal-Nenets Autonomous District, or St. Petersburg where Gazprom is headquartered — saw their earnings significantly drop as sanctions started to bite.  

Income tax receipts have so far not followed this trend. Overall, they have slightly outpaced inflation over the first nine months of the year. However, this is partly because of the heightened role of the state and state-owned enterprises in the economy, and because mass layoffs have not started yet; Russian enterprises have historically preferred to furlough personnel or withhold pay, rather than layoffs. There was a very similar fiscal picture in 2020 when economic activity suffered during the pandemic.  

This crisis, however, will be much longer-lasting, and short of a Russian decision to end the war in Ukraine, or a Western decision to end sanctions, there is little officials can do about it. Open-ended and indiscriminate military mobilization, a policy that takes hundreds of thousands of people out of the workforce either through drafting or by forcing them into hiding, will further exacerbate economic disruption and tax income. This in turn will complicate the financing of an ever-growing list of tasks by the regions. Several recent examples, for instance, indicate that many regions are already struggling to find the money to equip mobilized citizens without cutting expenses elsewhere.  

In the current, volatile circumstances it is increasingly difficult to raise funding for budgets on the market – through bonds or commercial loans — especially for poorer regions reliant on the federal government for much of their financing. Therefore, if the above trends worsen further, and credit worthiness along with it, regional budgets may either have to cut their expenses significantly – up to 15%-20% or more – or hope that the federal government picks up the bill.  

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With the federal budget tightening, borrowing may not always be an option, and even when it is financially feasible, it will not be automatic. The past two decades have seen a relentless centralization of fiscal and political power. Some of the most recent steps in this process — are a system of financial stewardship for heavily indebted regions by the Finance Ministry, tightly supervised loans, and the proliferation of transfers that come with strings attached, leaving regions with little spending freedom.  

Thus, in order to process the growing pile of tasks and meet the performance indicators on which they are judged, governors will increasingly either need to have influential friends in Moscow who can provide back channels to funds, or provide a good “story” to catch the attention of the ultimate arbiter (be it Putin or Mishustin). Alternatively, they will have to pressure local businesses to pick up part of the bill.  

Russia’s highly centralized system of governance was built to manage crises proactively and prevent the emergence of strong regional leaders and grassroots movements. But despite institutional innovations in recent years, it has failed to shake itself free from its primary goal —the short-sighted personalist autocracy for whose benefit it is designed. Under the double stress of a protracted economic crisis and low government capacity, it faces a crisis it is ill-equipped to solve.   

András Tóth-Czifra is a Non-resident Fellow at the Center for European Policy Analysis (CEPA.) He is a political analyst from Hungary, based in New York City.  

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