The global economy seems set to pour some salt onto Russia’s Ukraine-related economic wounds.
The cost of Brent crude oil, the global benchmark, has fallen more than 13 percent since the start of July to trade near a two-year low at $97.25 a barrel on September 29. By comparison, Russia needed an average Brent price of about $117 to balance its budget last year. That break-even point has risen from about $50 in the mid-2000s as President Vladimir Putin’s government has hiked spending on social programs, the military and salaries for public sector workers.
Brent’s decline below the $100 level would appear to spell fiscal trouble for the Kremlin at a time when lenders are especially reluctant to finance Russian debt. The government canceled nine straight weekly domestic bond auctions following the downing of Malaysia Airlines Flight MH17 over Ukraine in mid-July. But Moscow’s Ministry of Finance has been able to avoid a budgetary squeeze thanks to a secret weapon: the ruble.
Russia generates about half of state revenues from taxes on oil and gas sales, and crucially for the Treasury, those sales are priced in dollars. Every ruble increase in the exchange rate to the dollar boosts government revenues by about 1.4 percent, or R200 billion ($5.2 billion), according to the Finance Ministry. The ruble was trading at 39.44 to the dollar in late September, compared with 32.77 at the start of the year. That decline of more than 16 percent has produced a windfall of oil revenue and generated a budget surplus of about 2 percent of GDP in the first eight months of this year.
“The Russian budget this year has performed very well,” says Tatiana Orlova, chief Russia economist for Royal Bank of Scotland in London. “It is hard to say what the break-even oil price is now thanks to a much more flexible FX policy.”
A further 10 percent drop in Brent’s price, to about $90, might leave the Kremlin feeling less comfortable, says Yaroslav Lissovolik, chief economist for Deutsche Bank in Moscow. Russia has become more dependent on hydrocarbon revenue since the global financial crisis, with the government’s nonoil budget deficit swelling to some 10 percent of GDP currently from 4 percent in 2008, he estimates. That gap is bound to increase this year, as Russian corporate profits look set to fall by 30 to 40 percent from 2013, shriveling the Treasury’s tax take. Meanwhile, Putin is moderating but not eliminating increases in discretionary expenditure. State sector salaries will rise 2 to 3 percent in real terms this year and more than 10 percent in nominal ruble amounts, Lissovolik predicts.
The weaker ruble has its downside — notably, a rising inflation rate, which stood at 7.6 percent in August, above the central bank’s 5 percent target. “The fact that weaker dollar oil may translate to more rubles is an accounting windfall, not a paradigm for addressing Russia’s ills,” Lissovolik says.
One more medium-term threat to the Kremlin’s well-stocked coffers is banking sector weakness. The authorities spent R239 billion in August to bolster the capital of state-owned VTB Bank and state-owned agricultural lender Rosselkhozbank. That may not be the last banking injection, says Natalia Orlova, chief economist at Alfa-Bank in Moscow (no relation to RBS’s Orlova). “Slow GDP growth and rate hikes will increase the risks of nonperforming loans and later may force the cabinet to recapitalize state-owned banks,” Orlova says. “I think the risk of this scenario is material.”
Finance Minister Anton Siluanov has until now defended his “fiscal rule” to limit any budget deficit to no more than 1 percent of GDP, based on average oil prices for the previous seven years, despite demands for greater spending from “the media, academia and industrial circles,” Lissovolik notes.
Russia entered the Ukraine confrontation with abundant savings, but these bulwarks cannot last forever if Putin keeps cutting bigger slices of a diminishing pie. “The cabinet is trying to manage in a tactical way,” Alfa’s Orlova says. “But there is no strategy to address the long-term issue related to high social obligations and modest income growth.”
See also “Putin Is on a Mission to Develop Ties With China.”