The intensifying tax debates over recent weeks underscores that the government has run out of easy fixes on the budget policy and that difficult choices will have to be made to keep the fiscal pattern on a sustainable medium-term path. Constant tax manoeuvres in the oil and gas industry cannot be a sustainable fix and, therefore, fiscal consolidation either in non-oil revenues or on the spending side will be required at some point. There remains significant scope to scale down inefficient spending and reform the pension system, but both are politically complicated and so tax hikes cannot be ruled out.
That being said, we believe currency weakness has bought the government some time and as yet there is no urgency to increase taxes in 2015. The general government's budget surplus over the first five months of this year is almost twice as big as last year (RUB 1,050bn vs. RUB 570bn). Moreover, next year looks a particularly undesirable time for tax increases given the cyclical picture and stagflationary environment. Therefore, we do not think a VAT tax hike is likely next year, but the degree of policy uncertainty has increased substantially since the start of the year, lowering our conviction.
Were it to be implemented, we estimate that a 2pp rise in VAT might bring 0.6% GDP worth of additional budget revenues, but the impact on business confidence and GDP growth is most likely to be fairly negative. Moreover, a VAT hike would be fully passed through into final prices (+1.6-1.8pp to the headline CPI), significantly complicating the shift to inflation targeting, preventing inflation expectations from being anchored and undermining the CBR's ability to deliver on its price stability mandate. This clearly creates risk to our outlook on both inflation and rates.