Jan 22, 2014 | 11:35 GMT

5 mins read

Russia Weighs Its Options for Managing Regional Debts

Russia's New Crisis: Regional Debt

Editor's Note: The following is the third installment of a three-part series on growing debt for Russia's regional governments.

Russian President Vladimir Putin has plans to help stabilize the regions' economies. Given the social tensions within Russia and the global economic situation, allowing the regions' economic problems to go unchecked could create challenges for the Kremlin on many levels.

The growth and stability Putin fostered in Russia is starting to erode, and the Russian regions' economic and financial stability is at risk. Of course there are stark differences between the country's current position and its situation in 1998; the federal government is relatively strong and has cash reserves to work with, and most of the regional governments are politically loyal to Putin. However, should certain regional economies continue to deteriorate and regional governments become unable to pay their bills, things can change quickly, as seen in 1998. Given the ongoing economic weakness in Europe and slowdown in China, the global economic environment is risky enough to cause concern in Moscow.

Russian Regional Governments' Debts

Russian Regional Governments' Debts

There is already growing opposition among many regional leaders to the federal policies on taxation and division of the income between the regional and federal governments. In December 2013, the federal government organized an advisory group to start looking at how to respond to the growing regional stresses without harming the federal government financially.

Despite the economic slowdown, Russia's federal government is relatively stable. The federal budget had a deficit of only 0.1 percent in 2012 and a surplus of 0.9 percent for 2013. The Kremlin seems more inclined to keep the federal budget healthy than the regional budgets, nearly all of which are dealing with skyrocketing debts.

In addition, the Kremlin has currency reserves of $512.8 billion, its sovereign wealth fund sits at $86.9 billion, and the reserve fund holds $85.3 billion — a total of $685 billion. The problem is that the Kremlin rarely touches such money, even in crisis. During the 2009 financial crisis, the government was forced to inject $210 billion of its foreign exchange reserves, $14 billion from the sovereign wealth fund and $16 billion from the budget surplus into the economy. In addition, the Kremlin forced many of the Russian oligarchs to pump tens of billions into the markets. It is unclear just how bad the regional economic situation must get before the Kremlin opens up its reserves as it did in 2009.

The Kremlin's Plans

This does not mean the Kremlin is not trying to help the regions. Putin knows better than most how important regional stability is to the country and to his regime. Regional heads and the Kremlin are discussing the resettlement of the regions' obligations to the federal government. As previously mentioned, the Kremlin is postponing the presidential edict on housing replacement for the regions. More compromises on such edicts could take place, and Moscow could ease its taxation on the regions.

Russia Regional Debt Types

Russia Regional Debt Types

Some of the federal loans to the regions are being renegotiated, such as Tatarstan's recent loan repayment to the federal government, which was extended by 20 years. The government has also arranged for state-owned banking behemoth Sberbank to open talks with the regions on their banking debts. Much of the regions' banking debts are to Sberbank. However, the Kremlin has already ordered Sberbank to restructure many of the debts and future loans to the privately owned metals firms in a bid to bail out that sector, which is struggling. It is unclear how much burden Sberbank can take on if it is writing off debts and giving further loans to everyone.

The Kremlin has another plan in mind: building up the economic foundation of the regions by expanding large-scale industrial production. Russian Prime Minister Dmitri Medvedev announced in December 2013 that over the next five years such an expansion will be the Kremlin's top priority, with plans to increase the number of factories and plants to spur the economy (and diversify the government's income away from energy). The goal is to create 25 million industrial jobs by 2020 by building new plants for food, meat, milk, canned goods, construction, mining, metals and the auto industry.

Russia plans to do this with a regional and federal investment plan — the details of which have yet to be seen — as well as inviting foreign investment. It is an ambitious strategy, but the Kremlin is attempting to create a long-term plan for economic stability for Russia that is not mostly dependent on energy revenues. This will require further financial demands on the regions, though — something the Kremlin is betting on to be a short-term discomfort that paves the way for long-term stability. The only way to make a new industrial push is with federal-level funding, forcing the federal government to finally start accruing debt. Since most regions are already bearing heavy financial burdens, the regions' stability would be at risk without federal funding.

Russia's Escalating Stresses

This tenuous strategy comes as Russia is already experiencing heightened social tensions. In 2011 and 2012, large political protests swept the country, with hundreds of thousands on the streets marching against Putin and his re-election. The Russian population is deeply divided over the issue of race, and ethnic protests have been occurring in the country since 2011. Both xenophobic and Russian nationalist groups and the pro-diversity Muslim and immigrant groups have held demonstrations.

During the political and ethnic protests over the past year, there have been more protesters calling for economic relief. The economic stagnation in Russia is already starting to develop into a theme of the various protest movements. The political protesters believe it is the Putin regime's fault that the economy is slowing. The Russian nationalists blame the government subsidies for Russia's Muslim North Caucasus republics as well as the immigrants in Russia for taking what they see as Russian jobs. 

The economic strains on the regions are escalating at a time when the people are willing to mobilize on the streets, presenting a dangerous equation for Putin and the Kremlin. However, if the regions do start to default on their debts or become rebellious once again, Putin has the tools to pull them back in, such as the current federal cash reserves and, as seen in 1998, brute force.

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