COMMENT: Putin restructures Russia’s regional debt

COMMENT: Putin restructures Russia’s regional debt
Russia is quids in thanks to rising oil prices, but the regions have to live entirely on corporate and personal income tax revenues and many of the poorest are close to bankruptcy. During his State of the Nation speech President Vladimir Putin promised some debt relief, but will it go far enough?
By Andras Toth-Czifra in New York April 26, 2021

Russian President Vladimir Putin’s proposals to restructure the debt of Russia's regions in his State of the Nation speech on April 21 will likely provide them with some much-needed fiscal relief in an election year. Putin expects governors to come up with ideas, spend on them and take responsibility for their implementation. But don’t get too excited: the federal government will remain in charge and the proposals foresee no major structural change, be it political or economic. Indeed, debt relief is likely to remain uneven, and without significant investment growth, Putin’s proposals will just kick the can further down the road, while leading to further fiscal and political centralisation.

In his remarks to the Federal Assembly this week Putin made three proposals to address the problem of ballooning regional debt in times of falling revenues and rising spending. First, the maturity of cheap budgetary loans that regions took out over the past year for pandemic-related needs will be extended to 2029. Second, regions with commercial debt exceeding 25 percent of their own income will be able to replace this debt with budgetary loans. Third, the government will allocate infrastructure loans to regions of at least RUB500bn ($6.7bn) by 2023. In addition, the government was tasked with preparing proposals to “increase regions’ independence and financial stability” by July this year. The proposals build on the structure of regional debt was the following: RUB809bn in budgetary loans, RUB433bn in various government bonds and obligations, and RUB965bn in bank credits. Today, five years later, the size of the overall debt is comparable (RUB2.438 trillion today vs. RUB2.319 trillion in January 2016), but the structure is markedly different: RUB1,109bn in budgetary loans, RUB767bn in bonds and obligations and RUB499bn in bank credits (of which an overwhelming majority are from Sberbank). In just five years, the share of bank credits went from 41.6% to 20.4%, while the amount of budgetary loans grew by 37% and now makes up almost half of regional debt, and the share of bonds and obligations also grew.

Due to this structural change and higher revenues, before 2020, regional debt was on a slowly decreasing trajectory, although the obligations stemming from Putin’s “National Projects” – RUB4.9 trillion in regional budgets over six years – started causing problems already before coronavirus ~(COVID-19) hit. The pandemic then wiped out this progress completely: over the past year regional debt has grown by RUB382bn, even as transfers from the federal budget to regional budgets also grew by approximately 50% on 2019. The majority of this new debt is short-term budgetary loans provided practically for free (but with a maturity in 2021), but given the elections coming up this year as well as plans to reduce direct budgetary transfers coupled with an uncertainty about the future availability of cheap budgetary loans, several regions started taking out further debt earlier this year.

That a new debt crisis might be looming was on the political agenda in late 2020 already as Ingushetia got to the verge of what the press labelled “bankruptcy” (but which was not exactly that, as I then explained). Governors were pushing for debt relief or restructuring; the government extended the maturity of budgetary loans to allow regions to take out more debt; later it suggested forgiving part of the debt from budgetary loans equal to the amount of taxes collected from specific new investment projects. Putin raised the possibility of lifting the debt ceiling of regions and the government was tasked with working out a plan. It was obvious, however, that the government wanted to avoid two things: forgiving debt (as it would undermine the principle of frugality championed by the Ministry of Finance) and ceding more control over regional incomes to regional governments. This is the mindset from which Putin’s proposals were born.

What will change?

The proposal to replace further commercial credit with budgetary loans will likely help a handful of regions that are both heavily indebted and where the share of commercial credits is high. Different estimates put the number of such regions to between 11 and 28, including regions like the Republic of Udmurtia, the Republic of Mordovia or the Khabarovsk Territory, but not those that are mostly indebted to the federal budget, (e.g. the Republic of Khakassia).

The Ministry of Finance now says that the total restructuring will mean RUB176bn worth of cheap budgetary loans. Original estimates by experts were lower because it was not clear whether bonds were also going to be counted in “commercial credit” (it now seems that they will be). However, this sum itself is only about half of the amount of commercial debt that surpasses 25% of these regions’ own revenues, according to the calculations of ACRA, a credit rating agency. This suggests that the government will have other conditions – and perhaps political interests and favouritism will also play a role, as they presumably did last year when the federal budget compensated regions for their lost revenues in a confusingly unequal manner. Putin himself suggested in his address that frugal regions would be rewarded.

However, this still means real money, given that budgetary loans are essentially free while commercial loans are expensive – according to Nikolay Kharitonov, a Duma deputy, some regions had to take out loans with an annual interest rate of 20% to plug holes on their budgets last year. Overall, the Ministry of Finance estimates that the impact will be RUB20bn or more per year until 2029. Add to this the short-term panacea of extending the maturity of roughly RUB220bn worth of budgetary loans that regions would need to pay back by July 2021, to 2029.

In short, the government will not cut the fiscal leash of the regions, but it will give them a moderate short-to-mid-term boost, enlarging their fiscal space at the expense of the federal budget, to spend more now, in the hope of kick-starting growth and a noticeable improvement in social infrastructure before the Duma election. The Kremlin also expects governors to take bigger responsibility for the planning and the implementation of these projects (this is likely how one can translate Putin’s call on governors to be more “self-reliant”).

How about the infrastructure loans?

A propos infrastructure: the planned infrastructure loans, amounting to at least RUB500bn over the next three years, with a maturity of fifteen years and a 3% annual interest, are likely intended to serve the same purpose, even though the fact that the projects eligible for these loans are subject to a rigorous federal review is slightly at odds with the principle of “self-reliance”. Note also that RUB500bn, while a significant amount, is not that much. Before the pandemic hit, in early 2020, the government was discussing putting RUB300-400bn from the National Welfare Fund towards infrastructure in 2020 and that was considered a cautious and conservative proposal.

Putin also said that these projects should “serve the people”, and again it is unclear what he means by this. He mentioned, for example, the construction of metro lines in Nizhny Novgorod and Chelyabinsk – which would presumably serve urban commuters in mid-sized cities – but also the development of the Northern Latitudinal Railway in the Yamal-Nenets Autonomous District, which is a large industrial project in an oil and gas-producing region.

And this brings me to one additional important point: at this juncture we know little about the exact conditionality of these loans. If, however, a region’s indebtedness is a negative factor (as Putin suggested it would be), then oil and gas-producing regions and regions relying on federal grants rather than loans (e.g. the Republic of Chechnya or the occupied Crimea) will have an advantage over other regions. And if this is so, then it is difficult to see how these loans are supposed to make a major structural difference.