10.05.23 Review

Stagnation and Resilience: 2023 will pose significant challenges for Russia’s regional budgets, but the problems will be passed on to the federal budget

Against a backdrop of high budget inequality, regional budgets in Russia remain stable and stagnant. Although most regions were in deficit in 2022, the aggregate annual budget saw a small surplus due to the success of just five regions. The stability of the system can largely be explained by the safety cushion that was built up during the post-coronavirus period. However, experts have noted that the regional budgets are facing a shortage of development funds, as their own revenues average around 70% and the majority of their expenditures have been allocated to supporting social programs. The decline in profit tax revenues — the primary source of revenue for regional budgets — has been the result of falling prices for Russian exports and the fact that sanctions have impacted a number of industries particularly hard. The situation is expected to worsen in 2023, which will result in an increase in inter-budgetary transfers. In addition, an additional burden will be placed on the already-strained federal budget by transfers to the occupied regions of Ukraine (the so-called ‘new entities’).

Despite increased spending, supply chain disruptions, and a contracting economy, the regional budgetary system demonstrated resilience in 2022. Yet according to experts from the Center for Macroeconomic Analysis and Short-Term Forecasting (CMASF), ‘the domestic budget system’s safety margin, created during the 2020-2021 period as the country exited the coronavirus crisis, may have played a decisive role in solving this problem.’ In contrast to the federal budget, which ended 2022 with a significant deficit of 3.3 trillion rubles, the consolidated budgets of the regions saw a slight surplus of 50.6 billion rubles.

Behind this neat and tidy facade lies Russia’s characteristic budget inequality. 60% of the total surplus came from the budgets of just the top five regions, while the deficits of the weakest five regions accounted for half of the total deficit. Moreover, there are more regions experiencing deficits than surpluses, with 50 regions in deficit compared to 35 in surplus.

Income tax revenue growth for the top performing and bottom performing regions, 2022, %

Nominal budget revenues rose by 12.1% in 2022. Consequently, there was a slight decline in real revenues due to high inflation (with an average annual value of 13.75%). Income tax revenues, which represent the primary source of income for the majority of regions, increased by 3.5% in nominal value, but decreased by 9.1% in real terms.

The dynamics of regional budget revenues reflect trends typical of the Russian economy as a whole. The increase in income tax revenues was evident in the first half of the year when commodity prices were high, the ruble was weak, and there were no significant export restrictions. This growth was concentrated in regions specialising in the extraction and processing of minerals. Conversely, in regions where the largest taxpayers are mining and metallurgy enterprises (such as Lipetsk, Kursk, and the Belgorod region) income tax revenues decreased due to export restrictions and the forced increase in the discounts on relevant goods. The largest decline was observed in regions specialising in the mining and forestry industries, metallurgy and mechanical engineering. Therefore, the effect of sanctions was felt particularly keenly by these industries, and on the whole, revenues became increasingly reliant on low value-added raw product exports. From July onwards, when the growth in commodity prices began to decline, the trend of income tax revenues became negative. The consulting company FinExpertiza has calculated, on the basis of Rosstat data, that in the second half of 2022, the total profits of large and medium-sized Russian enterprises declined by 45.4% compared to the same period in the previous year.

Personal income tax — which represents the second most important source of revenue for regional budgets — saw a 16.4% increase in annual revenues. This growth was primarily due to an increase in revenues in the IT sector (+40.4%), trade (+25.1%), construction (+20.9%), and manufacturing (+18.8%). In contrast, the extractive industries and public administration sectors demonstrated the least growth.

Interbudgetary transfers rose by 6.5% in nominal terms, but this increase was not enough to keep up with inflation. The boost was primarily driven by higher subsidies for the financing of national initiatives (+39.8%), resulting in an increase in their proportion of total transfers from 30.5% to 42.6%. Overall, the share of transfers in GDP was 2.6%, which is lower than in 2021. The surplus, however, was also insignificant, meaning that the safety cushion for next year has shrunk. 

Main parameters of the consolidated budgets of the federal subjects of the Russian Federation, 2016–2022, % of GDP

Regional budget expenditures grew by 16.2% year-on-year in nominal value, but only by 2.4% in real terms. Growth above the average rate of annual inflation was recorded in 54 regions. The largest growth in spending in relative terms was seen in two areas: defence (+52.5%, or +128 billion rubles) and the national economy (+12.1%, or +968 billion rubles). Social spending increased by 10.4%, reaching 9.9 trillion rubles. Health care spending fell the most dramatically (-15.4%, or -75 billion rubles), which was mainly due to the end of the COVID-19 pandemic.

Overall, the stability of regional budgets has remained stagnant. The share of own budget revenues in most regions stands at just 70%. At the same time, the lion’s share of expenses are directed to social programs, housing and communal services. This has ‘not only reduced the financial stability of the regions, but also their ability to solve long-term developmental problems,’ experts at the CMASF state. They have also called attention to the fact that the economies of the subjects of the Russian Federation need to be diversified ‘by developing the existing reserves and focusing on promising areas with high added value.’ However, similar recommendations have been given over the course of the last 20 years and now look less likely to be implemented than ever before. The opportunity for Russian enterprises to integrate themselves into international value chains has decreased as a result of sanctions, while domestic consumption has stagnated.

According to the experts from the CMASF, 2023 is going to be a challenging year for regional budgets due to a decline in income tax revenue, a trend which was already observed at the end of 2022. This may force regions to tap into their reserves, which serve as a safety net to cover potential deficits. The Expert RA rating agency has predicted that roughly a third of the accumulated 2.28 trillion rubles (a significant portion of which was amassed in 2021) may need to be spent in 2023. At the same time, it is safe to say that there will be an increase in the volume of interbudgetary transfers. Nevertheless, transfers allocated to the budgets of the so-called new federal subjects of the Russian Federation (in other words, the occupied regions of Ukraine) pose a separate challenge and will add pressure to the already strained federal budget.