The government met yesterday to discuss the first draft of the budget for 2016-18 and accompanying macroeconomic projections in the guidelines for fiscal policy. The budget contains several proposals to bring spending in line with lower projected oil and non-oil revenues, including the sub-inflation indexation of pensions, the freezing capex expenditure, and downsizing of public employees.
The discussion of the budget is still in the early stages: the first draft is to be submitted to the State Duma by 1 October, so in the three months until then we are likely to see further details and possibly corrections to the current version. However, the government’s decision to support the current version is promising. Although it is easy to overstate the disinflationary effects of the lower public wage and pension indexation proposals in the approved budget draft, it contains many of the key ingredients to achieve a structurally lower inflation rate. The automatic indexing of the public sector’s disbursements to the past inflation is a significant contributor to the ‘stickiness’ of inflation and inflation expectations. This effect is particularly significant in the aftermath of the one-off inflation shocks akin to the one experienced in late 2014-early 2015. The approach suggested by the Ministry of Finance – aside from its significance for cementing the fiscal discipline and respect for hard budget constraints – breaks this vicious feedback loop. From this standpoint, the proposed 5.5% indexation of pensions in 2016 is close to the consensus estimate of price growth.
The suggested spending reduction measures are also positive for the adjustment of the growth structure favouring investment-oriented growth to the traditional consumption-led model, which will likely lose support from growing real wages, while consumer lending might remain subdued in the coming year. The proposed increase of the pension age for public employees and another year without pay indexation might help release scarce labour resources from the public sector and direct it to the private sector where wage growth at present is more dynamic and expected to remain so in the medium term.
From the monetary policy standpoint, support for the current budget means less aggregate demand pressure for the coming years on price levels and will help bring down inflation expectations due to lower wage growth. This provides more arguments and indeed more room for further normalisation of monetary policy, which on our estimates is expected to result in a 50bp cut at the CBR's next BoD meeting.