On the sustainability of regional fiscal policy

Abstract

The objective of this work is to examine fiscal sustainability of the Russian regions by means of Bohn test based on the idea that strictly positive and statistically significant reaction of the primary budget balance to changes in public debt is a sufficient condition for fiscal sustainability. To that end we assembled panel data covering 81 subjects (regions) of the Russian Federation for 2006–2017, examined descriptive statistics and used LSDV method to estimate the two-way fixed effects model. Descriptive statistics show that in regional finance large and frequent deficit prevailed over long-term surplus for reasons rooted in fiscal relations between the federal government and regional authorities. The test revealed negative and statistically significant reaction of the primary balance to regional debt, which casts doubt on the ability of regional authorities to pursue sustainable fiscal policies. Their fiscal problems, however, do not boil down to official default on financial and expenditure commitments because the federal center provides generous financial support to the regions and absorbs much of their cost of financing through the system of soft budget constraints cultivated at both levels of government. The ultimate creditor is all tax-paying Russia and, if tax revenues are not enough, the holders of Russia’s public debt.