TEXT-S&P report:Budget constraints restrict Russia's fiscal policy

(The following statement was released by the rating agency)

Oct 15 - Budgetary constraints are restricting the Russian government's fiscal policy options at a time of waning popularity, says Standard & Poor's Ratings Services today in the report: "Can Russia Drop Its "Spend To Befriend" Fiscal Policy?"

Over the past decade, Russia's federal government has been able to use its ample spending power to solve or alleviate problems and gain popularity among voters. But countercyclical spending during the economic crisis of 2008-2009 has erased past fiscal surpluses, while slower economic growth and less buoyant commodity prices will limit future government revenue growth, the report says. On top of this, the government's funding options--such as tapping accumulated assets in its reserve funds, privatizing state-owned enterprises, or borrowing from the capital markets--are clearly finite and, in our view, can only fund moderate government deficits over the long haul.

"This more restrictive fiscal environment also comes at a point when the government's popularity is at its lowest in the Putin era," said Standard & Poor's credit analyst Kai Stukenbrock. "We therefore see a risk that policymakers may be tempted to prop up the government's standing through additional spending, as they have in the past."

Nevertheless, the report says there are also signs that policymakers might resist the urge to "spend to befriend". One is the government's repeated commitment to a balanced budget by 2015. Another is the upcoming introduction of a new fiscal rule that ties expenditure to long-term average oil prices. The recent resumption in replenishing the government's Reserve Fund by borrowing in excess of the government's funding needs, and the decision to allow foreigners to invest in domestic government bond markets should also expand the government's ability to finance potential deficits. This extra fiscal space is needed given the vulnerability of public finances to swings in oil prices, and the growing spending pressures that will eventually result from Russia's aging society.

"We therefore consider that preserving fiscal space by running balanced budgets or even surpluses, by having reserve assets that can be tapped, and by being able to fall back onto (domestic) bond markets for deficit financing is essential," said Mr. Stukenbrock.

"If, however, any gains in fiscal space, and potentially beyond, were to be used to accommodate extra, and possibly populist government spending, this would accentuate the risks and vulnerabilities of public finances and could eventually lead us to a downward reassessment of Russia's creditworthiness."