Russian regions risk defaults unless Kremlin stages rescue

MOSCOW (Reuters) - Four years ago, Russia’s federal government cleaned up its finances by shifting responsibility for a chunk of social spending to regional administrations. Now it faces the consequences, with some regions deep in debt and heading towards default if they don’t get help from Moscow.

A cashier of a private company, which specializes in the wholesale trade of sweets and confectionery products, places 5 rouble coins into a counting machine at an office in Krasnoyarsk, Russia, in this January 22, 2016 file photo. REUTERS/Ilya Naymushin/Files

That presents President Vladimir Putin with difficult choices: Moscow can bail out the regions, but to do so it may have to go deeper into debt itself at time of recession, weak oil prices and international sanctions over the Ukraine crisis.

Or it could leave them to their fate and risk unrest among workers likely to lose their government jobs if a region slashes spending or goes under - just as Russia heads into a cycle of elections culminating in a 2018 presidential vote.

Collectively, the regions - which number more than 80 - ran a budget deficit of one trillion rubles ($14.6 billion) last year on spending of 10 trillion, according to the state Audit Chamber.

The chamber’s head, Tatiana Golikova, has repeatedly urged a compromise on supporting the regions. “Radical changes in the treatment of regional budgets are long overdue,” she told the lower house of parliament late last year.

The federal finance ministry did not respond to Reuters requests for comment, although previously it had ruled out an amnesty for regions’ debts.

If the ministry refuses to help, some of the regions will be in trouble. “I am not saying that there is going to be a massive amount of defaults,” Karen Vartapetov, an economist with Standard and Poor’s ratings agency said. “But the situation will be moving in that direction.”

Russia’s top level finances are relatively robust despite the economic slump. The federal budget deficit is within 3 percent of gross domestic product, proportionately less than in a number of European Union states, and sovereign debt is low.

But this is built partly on accounting that has pushed economic pain off the national balance sheet and onto the regions.

Their total debt has doubled since 2012, according to the finance ministry, after a period of very modest growth. S&P forecasts it will more than double again to 5.5 trillion rubles by the end of 2018.

That would be bearable but for the fact that the regions’ revenues are shrinking and yet they must keep on spending to honor promises imposed on them by Putin.


The worst case is Mordovia, a region in the central part of European Russia that produces little and needs funds to host rounds of the 2018 football World Cup in its capital, Saransk.

Its debt rose 30 percent last year to 33.7 billion rubles, or 46,000 rubles for every resident - equal to two months’ salary for the average worker there, according to finance ministry data.

Mordovia’s debt exceeds 180 percent of the regional government’s annual revenue and yet its Prime Minister Vladimir Volkov says it will keep on spending as ordered by the Kremlin in May 2012. “The objectives set in the presidential May decrees must be met,” Volkov told his parliament in December, according to local agencies.

While other regions’ problems may not be so deep, more than 90 percent of them were in deficit last year and their debt burden will grow to an average 60 percent of revenues by the end of next year, up from 27 percent in 2014, according to S&P.

That leaves their governments with no cash to keep servicing their debts, raising the prospect of default for some of them.

While the federal government can fall back on its foreign currency reserves if needed to pay off sovereign debt - it has enough to cover the entire amount and still have a quarter of a billion dollars left over - the regions have no such safety net.

Moscow does offer cheap loans to the regions but these are not enough to repay their maturing debts, let alone any other spending. Therefore, regional governments have to turn to domestic bond issues and loans from Russian commercial banks, with borrowing aboard not an option due to the sanctions.


Under his May 2012 decrees, Putin ordered that large parts of state spending on healthcare, education and utilities be transferred to regions, to keep the federal budget healthy.

Local governments were also told to raise pay for healthcare and education workers by at least 100 percent by 2018 - the year of the next presidential election. With social spending accounting for 60 percent of regional governments’ expenditure, they rushed to borrow.

At first, there seemed to be no risks. Back in May 2012 the price of oil, Russia’s main export earner, was over $100 a barrel and the government expected annual economic growth of 6 percent throughout the decade. Now, oil is at $40 and Russia is in recession, with the economy shrinking 3.7 percent last year.

Due to the crisis, regions are generating much less cash and have become dependent on financial markets to refinance debts. Most of the loans from commercial banks are short-term, with about a third having to be repaid annually.

Last year, the federal government tried to slow the build-up of debt, and the rise in regional spending slowed to a consolidated 1 percent in 2015, according to S&P.

But with inflation at 12.9 percent, keeping spending flat means a cut in real terms. That won’t go down well with Russians who vote in a parliamentary election in September.

Moody’s rating agency estimates that the regions’ total operating expenditure will increase by 2-4 percent this year.

The government has assigned 310 billion rubles in very low-interest budget loans to the regions this year, but S&P estimates this covers only 60 percent of refinancing needs.

“They have in fact only postponed the debt service peak to 2018-2019, when most of budget loans are due,” S&P said in a report.


The Kremlin’s fear, political analysts say, is that if regional governments cut spending, that could drive angry people into the streets to protest.

So far, there have been only small, isolated protests without any political agenda, but as the recession bites deeper, demonstrations could grow, especially in rust-belt provincial cities with few economic opportunities.

Given that risk, the Kremlin will probably choose to bail out the regions. “Most likely aid from the federal budget will be required and most likely (the regions) will get it,” said Alexander Ermak, head debt analyst at Region brokerage.

But that would in turn force more uncomfortable choices on the government.

With federal revenues falling too, the government will have to prioritize whom it wants to support: sanctions-hit banks, the regions or state-owned enterprises.

Opting to help all of them could exhaust all the reserves Russia has built up as a safety cushion.

Vartapetov said the government must make its choice: “It will have to find a balance between the political and financial costs of dealing with the regional financial difficulties.”

Additional reporting by Kira Zavyalova; editing by David Stamp