Sustainability of Russia’s Regional Budgets When Subjected to Macroeconomic Shocks

Abstract

The article examines the effect of growth rates for gross regional product (GRP) and of fluctuations in oil prices and currency exchange on the sustainability of Russia’s regional budgets from 2005 to 2019. Sustainability estimates for various regions are calculated with the sectoral structure of their GRPs taken into account. The hypothesis that the response of the primary budget balance to changes in macroeconomic variables depends upon the amount of a region’s debt is also explored. In order to test that hypothesis, a fiscal reaction function is arrived at using both a two-way fixed effects model and also a dynamic model on panel data. The results demonstrate that regions specializing in agriculture and those with emerging economies exhibit relatively weak fiscal sustainability when sustainability is judged by how the accumulation of debt during the previous period affects the primary budget balance. However, regions with extractive and manufacturing industries, as well as those without obvious specialization, have a significant positive fiscal reaction, which indicates that their budgets are sustainable. The primary budget balance reacts positively to increasing oil prices regardless of the amount of regional debt in any of the regions, except for the regions with emerging economies. The response to changes in the exchange rate (currency depreciation) is negative for all regions on average, while there is no significant response in the primary budget balance to changes in GRP growth rates. The robustness of these results is tested by evaluating alternative specifications for models. The findings of the study can be useful in making recommendations for improving the resilience of regional budgets when faced with external macroeconomic shocks or with the possible development of fiscal rules at the subnational level.