OREANDA-NEWS. April 18, 2012. Vladimir Putin’s speech:  Ladies and gentlemen, Mr Siluanov (Anton Siluanov, Minister of Finance) and I talked about your courtyard just now – it looks pretty somber, actually, and crossing it may be quite a chilling experience. Mr Stepashin (Sergei Stepashin, Chairman of the Audit Chamber) is smiling, though – he seems to like it.

Jokes aside, yours is a serious agency, probably one of the most serious in the Russian government – in any government, for that matter. So I suggest that today we should not just sum up your performance in the financial sector, which takes a lot of effort and commitment to manage, but also discuss our problem-solving strategies for the future.

A state’s rapid development and resistance to shocks depend in no small measure on the quality of its budget and tax policies, of its fiscal policies as a whole. Russia, like other countries, was hit by the 2008 global crisis, whose aftermath continued into 2009 and 2010. As we pointed out more than once earlier, and as I said in a recent speech at the State Duma, we coped with it quite effectively thanks largely to our economic agencies and the Finance Ministry. We managed to stay the course, retaining our financial and economic sovereignty, our steady macroeconomic indicators and our balanced public finances.

Of course, we couldn’t have possibly foreseen that crisis, nor how it would develop. But it was obvious that Russia had the stamina to weather it. In any case, it’s obvious now that we can see the outcome.  In pre-crisis years, we managed to achieve substantial economic growth and to consolidate the country’s financial institutions – public and private alike; we got rid of the national debt burden and formed cushion funds, including the Reserve Fund and the National Welfare Fund.

Admittedly, much of the credit should be given to the Finance Ministry. I would like to thank all of your ministry’s staff, as well its former long-serving chief, Alexei Kudrin. He did a great deal, proving his professionalism, his resolve, his commitment, and his strategic and tactical consistency.

Now that we’ve overcome the crisis, we’ve seen inflation drop to its lowest rate in twenty years – 6.1%. Our total sovereign debt is currently under 10% of GDP, which, as we know, is far less than in Europe and the United States. Our foreign exchange reserves are now the world’s third largest. This country is on the threshold of a new era. We can see new challenges looming on the horizon; we’re aware of those challenges, as well as of the fact that we’ll have to work toward our national development goals with the world’s economy and finances facing turbulent times. This is why macroeconomic stability is crucial to all our plans and initiatives.

Let me identify some of the priority tasks for you. I won’t break any new ground here, though. I’m going to talk about things we discuss every now and then with the leadership of the Ministries of Finance and Economic Development, things that stay at the centre of our attention. First and foremost, we should continue along our path to a balanced budget, to eliminate budget deficit by 2015. We have no deficit this year thanks to particularly high oil and natural gas revenues. But, as you know all too well, we are projecting a small deficit in the years to come, which we must bring down to zero again. Even a small budget deficit is a risk to Russia, given its dependence on the global economic situation, and we should try therefore to minimise that risk.

Second, we should not lose sight of the fact that we’re running a serious non-oil and gas deficit. It was minimal in 2005, but began to rise afterward, only to reach menacing proportions during the economic crisis (13.7% of GDP as of 2009); it then began to fall gradually again, and reached 9.5% mark 2011.

Now that the crisis is behind us, we should make a principled decision as to how big a non-oil and gas deficit we can actually afford. We should revisit our special oil and gas excess profit spending practices, determining just how much should be spent on current consumption and on covering the deficit and how much should go to replenish our reserves. We’ll get down to work shortly in order to find an appropriate deduction formula. New budget rules should arise from our assessment and vision of long-term prospects. By the end of April, the government should consider scenarios for Russia’s socio-economic development up to the year 2030. And the Finance Ministry should use these scenarios as a basis for its long-term budget strategy, to be elaborated in three months’ time, in association with relevant government officials and members of the expert community.

Third, to be able to cover the non-oil and gas deficit, we will have to borrow money. But we should be careful not to accumulate debt. A safely low sovereign debt is what gives us our competitive edge, so keeping our debt burden low should be a strategic priority for us. This applies both to foreign and domestic borrowing.

According to Finance Ministry forecasts, the national debt can be allowed to grow to 15% of GDP in three years’ time. A growth of five percent within three years – this doesn’t seem to be a great deal. But we’d be better off without it. Anyway, we should try to keep our debt within that range, reducing our foreign borrowing to a minimum.

Borrowing on the domestic market should also be done with the utmost care. We’re all aware of this, aren’t we? The budget should not compete with the economy, nor with private companies operating on the financial market.

While maintaining macroeconomic stability, we should try to fulfil our national modernisation goals. That’s why we should give fiscal and budget policies a bigger role to play in stimulating development and economic growth.

We invest heavily in infrastructure, in regional development, in upgrading welfare and the utilities and housing sector, and in equipping the armed forces. The public should stand to benefit from all these expenditures. Maximising the efficiency of budget spending is what we should focus our energies on, I think. Crucial to meeting this goal will be the transition to federal budget schemes built around state programmes, with precise targets and the possibility of performance monitoring by the public. Once the E-Budget project is launched, it will be possible to monitor the execution of the federal budget in real time.

We must have our first programme package finalised before the year’s end so that we can form the 2014-2016 federal budget in accordance with the new target-programme principle. Unfortunately, we still have a lot of problems and inconsistencies to deal with here. Forming the entire budget on the target-programme principle is something we still have to learn.

We should be especially meticulous about forming welfare programmes. Over the last four years, social spending in absolute figures has increased by a factor of 1.5. In 2011, it hit 11 trillion roubles, or almost 20% of GDP.

On the other hand, though, more money does not necessarily produce better results, unfortunately. At times, people can see no direct connection between higher spending and better quality of life and better functioning of the social and other sectors.

As I’ve emphasised repeatedly, resources should be invested in reforms that are beneficial to the public. State and municipal institutions should be oriented toward results that their end users – individuals, that is – will find satisfactory. This is what Federal Law No. 83 is aimed at. Developed by the Finance Ministry, this law came into force on January 1 this year. Thanks to it, more than 80% of local government institutions on the ground have gained greater authority.

I’d like the Finance Ministry to sum up application practices for this law and then, in cooperation with other agencies, submit proposals on further improvements to social legislation. At the regional level, we constantly discuss this issue with governors.

Also, we need to dramatically increase the efficiency of development spending. This applies to all kinds of instruments, ranging from federal targeted programmes to inter-budgetary relations. The efficiency and the implementation quality of development instruments such as federal targeted programmes (FTPs) are not yet high enough. A month ago, we held a special session on this. The Ministries of Finance and Economic Development were then instructed to make an inventory of all existing FTPs before June 1 of this year.

There’s fierce competition among agencies for FTP allocations, which sometimes results in fighting and tears. And then, halfway into a year, we can see that some of the programmes have made no progress whatsoever. But what was all that fuss about then? Instead of being rechanneled into some other development projects, the allocated funds have been wasted on programmes at a standstill.

We need to bring the funding of priority programmes to a level that would ensure the unconditional achievement of target goals. On the other hand, if a programme provides neither well-grounded justifications nor clear-cut goals and its implementation is slow and inefficient, we should either abandon it or review its financing schemes.

Wrapping up the FTP issue, I think it’s clear to everyone, including the Finance Ministry staff: Money earmarked for a federal target programme should be disbursed on time. An underfunded programme or one suspended over funding delays just loses its relevance. And then again, money is wasted, with none of the target goals achieved.

Now on to inter-budgetary relations and our allocations to the regions. Admittedly, under the existing system, regional administrations are better off living off [federal] subsidies than developing their own economies and expanding their own tax bases. We should therefore work to enhance the role of inter-budgetary relations as an incentive.

We’ve begun introducing standards for creating a favourable business climate in Russia’s provinces. I believe the performance of regional and local government agencies should be assessed using indices such as investment, tax revenue, and job creation. And decisions on the co-funding of regional development projects should be made based on that kind of assessment.

We should be sensible about transferring funds to the provinces, along with authority and responsibility. Such policies will become a real incentive for raising the competitiveness of regional administrative teams.

It takes heavy investment to advance domestic production and to create millions of new well-paying and high-productivity jobs. This should be about private investment, above all. As we know, private investors tend to put their money into lucrative [sectors and projects]. This is why we’ve set ourselves the task of getting into the top twenty most business-friendly countries, including in terms of tax administration. The logic behind our steps is that taxes on manufacturing, modernisation and investment should not be burdensome.

To encourage the upgrading of capital assets, we’ve decided to lift the property tax on new equipment, machine tools, and other hardware – movable property, that is. According to preliminary estimates, enterprises will be able to save up to 80 billion roubles thanks to this measure alone.

On the other hand, there are sectors that unfairly enjoy tax privileges. The mining industry is one example. We used to have disputes about this with the previous head of the Finance Ministry and keep having them with the current finance minister. Overall, I agree that this is part of the gas sector. It’s imperative that we proceed cautiously here. Of course, there are reserves, but we need to act so as not to undermine the investment plans of our producers. We need to be extremely careful.

Now, a few words about excise taxes on tobacco and alcohol. As you are aware, we have assumed certain commitments regarding the coordination of our activities, including in the sphere of taxation, in connection with Russia’s accession to the Customs Union and the Common Economic Space of Russia, Kazakhstan and Belarus. I would like the Finance Ministry to keep this in mind and weigh everything that’s going on in neighbouring countries and in Russia. My point is that we need to be viable and competitive operators across all areas of the economy. Do you see what I’m trying to say? Make sure that certain manufacturing activities and services don’t flee to the Customs Union countries, as is already the case. This is also true of excise taxes, so we need to be cautious here as well.

Most importantly, we shouldn’t believe that higher excise taxes will resolve all our fiscal problems. We fully realise that if we increase excise taxes, prices for alcohol and tobacco will follow. What’s next? People in the countries of the Customs Union will start buying someone else’s products or just revert to moonshining. We’ve been there, so we need to be cautious this time around. Of course, inflation is there, and we should think about the health of the nation as well. That’s the right thing to do, and I share this approach. But it’s hard to agree with the assumption that sharp tax increases will solve all our problems. No, they will not. To be sure, we need to raise taxes, but we need to do so gradually and never forget about economic realities in our country and internationally. I’m referring to the unions that I mentioned before. Certainly, in addition to increasing excise taxes, we need to stop trafficking in counterfeit, contraband and surrogate products.

As was announced earlier, there are plans to increase taxes on excessive consumption. Please note that this tax needs to be applied carefully so that it doesn’t affect households with median incomes. All specific steps in the fiscal sphere should be outlined in the Key Areas of Taxation Policies in 2013-2015, which are currently being finalised.

Now, with regard to tax administration, we need to stay the course of drastic simplification of tax return preparation. In particular, we need to reduce the volume and complexity of the paperwork and the number of inputs. We also need to radically simplify the maintenance of tax records and bring tax calculations as close to accounting rules as possible. We have spoken about this with the Finance Ministry and the Tax Service on many occasions. Of course, we need to use electronic forms during the initial stage of tax preparation that have so far been filled out on paper. 

I believe it is likewise imperative to promote pre-trial reviews of tax disputes. This should become a mandatory procedure and be applied to all actions by tax authorities and to actions or inactions of their officials.

There’s one more important topic. The Finance Ministry received additional authority with regard to financial market regulation. With regard to this, I would like the ministry to step up its oversight of loan interest rates for both individual and corporate loans. The Finance Ministry has already been charged with quarterly inspections of interest rates. However, we shouldn’t just monitor the situation. Instead, we should look into how interest rates are being inflated by banks, including through hidden commissions. There must be a system-wide solution to this problem, since individual borrowers are now paying hidden commissions alongside corporate borrowers.

In addition, I would like to ask the Finance Ministry to speed up the submission of the draft law On Consumer Loans to the government. It’s imperative that we enshrine the unconditional right of borrowers to know the real and final cost of the loan, so that we don’t have situations where the front page of the loan agreement shows one figure, but hidden commissions and mark-ups in the fine print result in totally different figures.  Of course, borrowers should be able to repay loans early without any penalties. You and I realise what’s going on here: banks slam customers with certain terms and conditions that are very hard to change later. Is that the kind market that we have built in Russia? If borrowers want to switch to another lender, the original bank won’t let them go: they have their customers by the throat. Let them cut their expenses, too. We keep telling manufacturers to cut their expenses. Bankers need to do the same thing.

In closing, I would like to say the following. We are entering a very important period of forming the 2013-2015 budget. The priorities that we will put into it will determine the quality of life of our people, as well as economic and social growth. As a matter of fact, the budget for the next three years will become the financial basis for the strategic programme that we proposed to our society and that was approved by millions. I expect that the Finance Ministry will continue to be at the top of their game, as always… I’m aware that many of your employees spend nights working in the ministry, especially during the budget formation. Few people know about this heroic labour, but I do, and I’m very grateful to you. I wish you every success. So long! 

Anton Siluanov: Mr Putin, with your leave, I would like to report on the results of the implementation of the financial system tasks for 2012.

Mr Putin, colleagues. In my presentation I’d like briefly to sum up the major results of the past year and identify the range of tasks on which the Ministry of Finance and financial bodies of the Russian Federation, the whole financial system, must work.

The main result of 2011 is the return of the financial system's indicators to pre-crisis levels. In 2011, the budget system incomes in real terms practically reached the same level as the best year in the history of the Russian financial system since 2008: the expenses in real terms exceeded it by 25.1%, the incomes of the federal budget as the part of the budget system in 2011 in real terms were 2.4% lower than in 2008. However we expect that this year this indicator will exceed the pre-crisis 2008 level by 2.6% in real terms.

As for federal budget expenses, in 2011 they exceeded the 2008 level in real terms by 15%. In 2009, to implement anti-crisis measures we abruptly had to increase federal budget expenses by 17.3%. And between 2010 and 2011, this level was decreasing gradually but not by much. Our task is to gradually reduce this anti-crisis canopy that was created during the crisis, thereby bringing the level of expenses down to a realistic level for the federal budget that will not depend on the risks of changes in the foreign economic situation.

In 2011, Russia pursued a policy of containing the growth of budget expenses. Practically all oil and gas income additionally obtained due to high oil prices was channelled to the Reserve Fund. This was done primarily to ensure the stability of the macroeconomic situation. This made it possible to reduce inflation to the minimum levels in recent years, this made it possible to do without foreign loans. Last year we did not employ our right to take loans on foreign markets because we had an additional reserve, additional budget resources.

Thirdly, and this is even more important: in 2011, for the first time since the crisis, we returned to conserving a share of oil and gas income due to the high prices. The next slide shows that the Reserve Fund, which initially in 2009 shrank by practically 80%, has now grown in 2011, and we can see its continuing growth. This is important because the growing reserves, the growing federal budget insurance, improves our investment rating. The improving investment climate means lower lending rates, lower rates on loans taken by the Russian Federation, and so this leads to further sources of economic growth. According to the results of 2011, the Reserve Fund grew by 1.1 trillion roubles to 3.4% of the GDP. So last year we practically returned to observing budgetary rules by saving oil and gas incomes conditioned by our economic situation.

In 2011, the implementation of budget reforms continued. We managed to advance in many areas, but simultaneously we are falling behind our initial plans on a number of positions such as a transition of the federal budget to programme format formation, improvement of procedures of state financial control and other positions. However, last year we succeeded in implementing a number of serious structural reforms.

With the participation and coordinating role of the Ministry of Finance, we reformed the system of service pay and retirement pensions of servicemen and law enforcement agencies, and we conducted work on reducing the personnel of the federal executive bodies. In 2011, we carried out a serious structural reform with the constituent territories of the Russian Federation. We transferred to them from the federal budget the expenses for certain subsidies, incomes, taxes, and raised to the federal budget the expenses for police and public security. This was a serious structural reform that involved all constituent territories of the Russian Federation.

Last year we launched a system of rewarding regions for increasing their own taxation potential, which is very important especially when we see that the constituent territories of the Russian Federation have developed a growing welfare mentality. We implemented major decisions in the area of taxation policy, we have prepared and are currently implementing draft laws on transfer pricing, on consolidated taxpayer groups. This has made it possible to implement the task that was set long ago, of calling for a more equal distribution of the tax potential between the constituent territories of the Russian Federation and a transition of taxation bases from large financial centres to the constituent territories of the Russian Federation.

The regulation of financial markets has improved, and the following key laws were adopted: on clearing, on tender organisation, on the central depositary, on insider dealing and on the national payment system. The Ministry of Finance has made a considerable contribution to strengthening Russia’s positions in the G8, the G20, BRICS, APEC and so on.

But these are all results. What are the short-term tasks that we and our financial system need to solve? There are ten of them. Above all, we need to restore the budget regulations; without this it is impossible to define the priorities that we set in terms of the state policy, and it is impossible to define the resources that we can manage in terms of the implementation of these priorities. In his address, Mr Putin noted the growing share of oil and gas income, the growing federal income. This slide shows that the dynamics and indicators in the last ten years reflect a growing federal budget dependence on the foreign economic situation. This is the highest point – oil and gas incomes as a percent of the federal budget. If in 2000, this share was 24.7% for Russia, and in 2004 it was 30%, the share in Russia of oil and gas income is currently 49.6%, that is, almost half of total income is based on the foreign economic situation.

If in 2006 the federal budget deficit could be avoided with a price of oil at USD 24.6 per barrel, in 2011 the price of oil was USD 101 per barrel, and in 2012, it was USD 116; and this shows significant risks resulting from the implementation of additional spending obligations, which Russia had to adopt in the crisis period.

Before the mid-2000s, the non-oil/gas deficit did not exceed 3.5% of the GDP, while in 2009 it grew to practically 14%, and this year we expect it to be 10.6%. I would like to say that this is a very significant risk, a considerably high non-oil/gas deficit which needs to be reduced year after year. According to our estimates, a USD 10 reduction in the price of a barrel of oil will lead to an income reduction of 600 billion roubles, which is comparable to the expenses for education. This is why our primary goal is to ensure budgetary stability, the stability of the budget system. To achieve this, we need to formalise the budgetary rules so that federal expenditures are calculated based on the basic, that is, the average, oil price over the past 10 years, so that the potential budget deficit does not exceed 1% of GDP.

If the actual oil price is higher than the basic price, additional revenues will be channelled into the Reserve Fund. If the oil price falls, the Reserve Fund will be used to cover our expenditures. In essence, this is a countercyclical fiscal policy whose implementation is vital for Russia. Of course, the bigger the Reserve Fund, the longer we will be able to cope with falling oil prices.

We believe that the Reserve Fund needs to be 7% of GDP for us to be able to honour budget spending commitments and fulfil Russia’s obligations in a crisis for two or three years if oil prices fall to USD 70 per barrel. This would be enough to adjust spending to suit the new circumstances. Just to remind you, the level of the Reserve Fund is currently only half of what is required. According to our proposal, if the Reserve Fund is greater than 7% of GDP, we could transfer 50% of foreign trade revenues to the National Wealth Fund and invest 50% in those infrastructure projects that do not have permanent spending obligations attached to them.

We propose introducing these budgetary rules from 2016, with a transition period before that to prepare for their gradual introduction. The budget should be deficit-free in 2015, a goal that can be achieved using the proposed transition period. Using this mechanism, we could reduce the non-oil and gas deficit to approximately 8% by 2020, even though this figure may look high compared to the pre-crisis level. But it will be extremely difficult to drastically reduce the non-oil and gas deficit in a short timeframe.

There are alternatives for working out the budgetary rules, based on the oil price over a 3-year period instead of 10 years, but these options as the slide shows... You can see that the risk of changes in the foreign economic situation and the insurance of these budgetary rules are less effective in the 3-year version than in the 10-year one. We are in favour of the more conservative approach to the implementation of these budgetary rules.

By the way, I would like to say that when we were placing Eurobonds...  Mr Putin, our Eurobond placement this year was exceptionally successful, the best ever in Russia in terms of price and profitability. We placed 10-year bonds at a 4.5% yield and offered 30-year bonds on foreign markets. Most importantly, demand focused on the long-term, 30-year bonds, which accounted for about USD 11 billion of the USD 24 billion demand. This means that investors, including foreign investors, believe in our financial policy and are ready to invest in the bonds of a state they trust.

However, when we held our road shows, almost all investors asked about our [large] non-oil and gas deficit. When will you get it down to the pre-crisis level? Let me remind you that before the crisis, the non-oil and gas deficit was 4.7% of GDP. We had to tell them that we would do it gradually, and that our first step should be to adopt budget rules to help limit spending and lower the risks of us failing to honour our spending commitments.

Our second goal is to draft and adopt a long-term budget strategy which should define the parameters of the budget system, according to which the resources for each state programme could be outlined. This will encourage the ministries responsible for fulfilling the state programmes to formulate their budget priorities within the allocations approved for each of the said programmes.

Given the need to extend the budget planning horizon, we consider it expedient to draft a budget strategy until 2024. The requirement on drafting a long-term budget strategy should be stipulated in the Budget Code, including in relation to the Russian regions.

The third goal is to develop a budget based on state programmes. This work started at the federal level in 2010. We defined the procedure for drafting state programmes, and approved the list of these programmes and the first analytical distribution of funds among them. However, in 2011 these efforts stalled. As a result, the Finance Ministry believes that only eight of the 41 state programmes are ready for approval, 21 could be completed fairly quickly, and the government needs to define and take a conceptual decision regarding nine programmes.

To resolve these issues, we suggest that the government expedite the submission to the State Duma of comprehensive amendments to the Budget Code, which should create the legal foundation for a transition to a programme-based budget. Any unresolved issues still under government review could be removed from the Code, but the basic bill allowing the Federation and the regions to move over to programme-based budgets should be submitted without unnecessary delay. Mr Putin, we are asking you to do this as soon as possible.

Some regions have surged ahead of us in this respect and have already started working on programme-based budgets. The Komi Republic, the Republic of Sakha (Yakutia), and the Bryansk, Vologda and Sakhalin Regions are already drafting state programmes, while the city of Moscow is implementing a programme-based budget. I am asking fiscal agencies to analyse this experience and to organise work in their respective regions to accelerate the introduction of programme-based budgets.

The transition to a programme-based budget is not an end in itself but a way of launching a comprehensive reform of the entire system of government, to realign it towards measurable, socially important results, and to enhance the responsibility of programme coordinators and customers for achieving the targets set out in these programmes. Unfortunately, we are lagging far behind other countries in this respect. The world has surged ahead and now assesses the performance of ministries, agencies and the government in terms of such programmes. There is a project and a ministry responsible for implementing it, so this ministry must implement the project and be held responsible for the specific results. The whole world is using the project-based approach, and we should too.

The next task is to improve the efficiency of state services. Federal Law No. 83 is the tool for achieving this goal. The bulk of the responsibility for implementing this law rests with the fiscal agencies, but this work is not over yet. There are two issues to be resolved in 2012. The first concerns giving the federal ministries the power to approve the basic lists of work and services included in the state order – the relevant law has been drafted by the Finance Ministry.