In a Riddle article on the Russian fiscal buffers last month, I concluded that Russia’s previously accumulated reserves would suffice for five years while economic growth would amount to about 0.5% in 2020. However, the situation has changed suddenly and dramatically, with some of the forecasts got outdated almost immediately. In mid-March, only a few dozen people in Russia had contracted the coronavirus; there was no nationwide lockdown. And the price of Urals oil was falling, yet it was only to $30 a barrel, a low price that now seems high. On April 21, it dropped to the once unimaginable price of $12: a level from 1999, when Vladimir Putin embarked on his journey to the summit of politics.
The biggest mistake was to think that the Russian economy would grow at all in 2020. Current forecasts signal a 4-5% decline in real GDP this year (see the table below). More pessimistic scenarios do not rule out a 10-11% drop. Once again, as in 2014, Russia is reeling from a double exogenous shock. Back in 2014 it was sanctions and tumbling oil prices. Today, it is the coronavirus pandemic and a cratering demand for oil. The impact of each factor on GDP is difficult to estimate, and experts’ views vary. For example, Evghenia Sleptsova of Oxford Economics reckons Russian GDP (given Brent crude oil selling at $25 a barrel, which currently corresponds to circa $17 for a barrel of Urals) will decrease by almost 7% this year. The separate impact on GDP from the public lockdown, with the closure of many sectors of the economy, will be greater than the impact of cheap oil and curtailed crude extraction, at a ratio of about 60% to 40%, she estimates. The oil crash alone is affecting major adjacent sectors of the Russian economy — transport, pipe production and petrochemicals — and hits investment and exports the hardest.
*The ministry decided not to update its forecast citing high uncertainty over the economy
Otherwise, my month-old predictions turned out to be quite accurate. First of all for the estimated dollar/rouble FX rate performance, and to a lesser extent for Russia’s rainy day reserves.
The rouble has been holding relatively steady
The rouble, perceived as a typical commodity currency a few years ago, has been holding surprisingly steady against the backdrop of the catastrophic situation on the oil market. The currency, in a free-float since 2014, depreciated by 13% between the beginning of March and April 21, a noticeable change, but incommensurate with the Urals price slump of 76% during the same period.
The rouble is now fluctuating in a range of 75-77 roubles per dollar. Its depreciation halted on March 19 at 82 roubles, when the Central Bank of Russia (CBR) launched extra interventions and started selling foreign currency from its reserves. Although no threshold for rouble slide was indicated by the CBR, it, in fact, appeared to show that 80 roubles per dollar was that mark, the rouble would not be allowed to fall beyond.
The CBR interventions are arranged as follows: the Central Bank has recently received about $28bn from the Ministry of Finance for a controlling stake in Sberbank, which it sold to the government (Riddle described this deal here). The CBR will be gradually selling this currency until the end of September so far as the price of Urals stays below $25 a barrel. Since the onset of these interventions, the Urals price has never exceeded the threshold, and the CBR sold more than $2bn in April. The more Russian oil deviate from $25, the higher the amount of currency sold by the CBR. Thus, the central bank is effectively compensating for the shortfall of export earnings, supplying the domestic market with that amount of currency as if the Urals price was $25.
The pressure on the rouble is growing with the decline in oil prices, and the CBR’s currency sales automatically protect the rouble from depreciating too much. At $25 per barrel, the estimated fair value of the rouble is 75-76 to the dollar. Yet, the exact CBR’s algorithm for calculating the volume of these sales is unknown.
This is one example of how such low oil prices have forced the Russian authorities to adjust their economic policy. Besides the CBR’s own operations, foreign currency is also sold by the Ministry of Finance. The CBR’s statistics aggregate data on both mechanisms, since it is the CBR which is the currency sales agent in both cases. Unlike the CBR’s variable sales, the Finance Ministry’s operations are fixed one month in advance. In April, its daily foreign currency sales amount to the equivalent of RUB 3.5bn (circa $46mn). From March 10, when the CBR launched currency interventions on behalf of the Ministry of Finance, until April 22, more than $5bn was sold using both channels (you can find the statistical data here). Sales under the fiscal rule (which are carried out when Urals prices is below $42) and extra sales under the informal ‘auxiliary fiscal rule’ (when Urals drops below $25) are the main reason the rouble has not followed oil prices in their dramatic plunge.
Reserves may suffice for 2.5-3 years
The Ministry of Finance and Central Bank of Russia sell currency from the government’s and CBR’s reserves, respectively. Together, these constitute ‘Russia’s international reserves’, which currently amount to $570bn. As of April 1, 27% (about $152bn) was owned by the Ministry of Finance – i.e. the National Wealth Fund (NWF) plus Ministry of Finance currency on the central bank account, not yet transferred to the NWF. The remaining $411bn was owned by the CBR. Since the Finance Ministry’s reserves are deposited in the CBR, which manages and invests them, the state’s official reserves comprise both kinds of funds.
Sometimes we encounter a misconception: when experts speculate about how long Russia’s reserves will suffice to offset the effect of low oil prices, they sometimes take into account the total amount of reserves, of more than $500bn. Yet like the vast majority of countries, Russia cannot use reserves in the narrow sense (those which belong to the CBR) to finance the budget deficit or repay the government’s foreign debts. There has been no such precedent in Russian history.
This brings us to the second key question of this article: for how many years will the current reserves owned by the government suffice to finance the budget spending, given current oil prices? In my March article for Riddle I estimated this period at 4-5 years, which was based on average oil prices of $30. But now Russian oil costs $11-12 a barrel.
The point of departure would be the current volume of the NWF’s liquid assets. These amount to approximately $125bn, including foreign currency purchased early this year when oil was still above $42 and which is yet to be transferred to the NWF. In April, the Finance Ministry’s reserves shrank after the $28bn for the controlling stake in Sberbank was transferred to the CBR accounts. Meanwhile, the weaker the national currency, the higher the value of the reserves in rouble terms. At the current exchange rate, NWF reserves amount to about RUB 9.5trn.
The second key parameter is the average price of Russian oil. Although analysts scrutinise tough scenarios assuming that the Urals oil trades at $10-15 for the rest of the year, I believe one can assume that the most negative scenario is a Urals price of $20. Global demand for oil should start to recover in H2 2020. The announced production cuts will curtail some of the excess supply: oil prices will pick up slightly, probably reaching $30-35 a barrel. A price of $15 would be disastrous for the Russian budget, since it resets the budget revenue from export duties on crude to zero.
Finally, the dollar/rouble exchange rate plays a role here. When the Ministry of Finance compensates for the shortfall in oil and gas revenues from the NWF, it exchanges foreign currency to the roubles which then spends to cover budget deficit. Assuming that oil costs $20 for a lengthy period of time, the exchange rate is likely to adjust to RUB 80-83 per dollar, especially after the Central Bank sells all the currency from the Sberbank deal in autumn (and unless it replaces this mechanism with direct currency interventions).
It is impossible to precisely calculate the NWF’s annual spending needed to cover shortfall in oil and gas revenues; according to the Finance Ministry’s formulas, it depends not only on the average monthly Urals price and the rouble rate, but also on volumes of oil and gas production and actual exports of oil, gas and petroleum products. We have to rely on the Ministry estimates presented in March (which should be adjusted to take into account the reduction in oil extraction after the OPEC+ deal) as well as analysts’ estimates. Russian customs data show that in January-February alone, oil exports decreased by 4% in real terms year on year; petroleum products by 10%; and pipeline gas by 25%. All this happened before the March price tumble and the April OPEC+ deal (on reducing oil production). Russia’s oil and gas exports could drop by 60% this year, equal to $165bn, as forecasted by Nordea Bank economist Tatiana Yevdokimova.
At an average oil price of $20, NWF spending will amount to about RUB 2trn in 2020, as Minister of Finance Anton Siluanov announced on April 16. On an annualised basis, this sum will reach about RUB 3trn. Given decline in oil production and exports, the NWF will presumably spend RUB 2-2.5trn this year and RUB 3.3-3.5trn next year (with oil prices unchanged at $20).
As assessed by Deutsche Bank analysts, at $15 a barrel for Urals, the NWF reserves will suffice for just over two years. Most likely, if the oil price remains at $20, the NWF’s liquid reserves (about RUB 9.5trn) will be depleted in approximately three years, before the end of 2022.
Why do the Russian authorities hold back on fiscal stimulus?
This does not mean the NWF’s resources will be enough to meet Russia’s budgetary needs over the next three years. Under the current rules, NWF funds can only be spent to make up the shortfall in oil and gas revenues. At the same time, the budget is also short of other revenues due to the economic downturn. According to Siluanov’s assessment, non-oil and gas revenues will shrink by RUB 1trn this year compared to the pre-crisis forecast. Losses will most likely be even deeper, since these revenues depend on the economic conditions (CIT, VAT, customs duties on goods other than commodities, state company dividends etc.) while the economy may shrink by 4-6%, according to the CBR’s projection.
As a result, the Russian budget deficit in 2020 will reach RUB 5-6trn (circa 5% of GDP), the highest since 2009. The authorities do not have many options apart from cutting spending outright which is virtually ruled out. Realistic options will probably need a change or suspension of the fiscal rule which was the bulwark of financial stability before 2020. To significantly increase domestic borrowing, the so-called primary structural deficit (the difference between total expenditure and revenues, without taking into account additional oil and gas revenues, which will be null this year) has to be increased. Currently, the primary structural deficit is set at 0.5% of GDP. Another option is to allow the use of the NWF not only to compensate for the shortfall of oil and gas revenues but also to provide anti-crisis measures to support the economy. A combination of both approaches is possible. In this case, RUB 3-4trn instead of RUB 2trn from the NWF can be spent this year. If so, the NWF will be depleted in less than three years.
Such decisions will need strong political will. At present, the fiscal rule practically rules out the possibility of a significant increase in government spending. Thus it limits the size of the fiscal stimulus which can be provided by the authorities against the backdrop of the crisis. The government’s economic support measures are so far estimated at RUB 2.1trn (1.9% of GDP), with a minimum share of direct net spending. The support package mainly takes the form of redistribution of earlier approved budget expenses, government loan guarantees and tax breaks and deferrals. The authorities are trying to save as much as possible on anti-crisis measures, and they do have a formal ground for this which is the fiscal rule.
Source: Bruegel, Finance ministry of Russia (April 17)
* Russia’s Finance Ministry estimated total support measures will amount to 2.8% GDP while the government has said actual support from the budget so far is 1.9%
However, this is fraught with negative consequences; namely, GDP growth might still be negative next year (there are warnings that Russia’s recovery will not be V-shaped and a two-year recession is possible), which means that non-commodity budget revenues will not recover. This is a vicious circle: the government does not want to use reserves in breach of the fiscal rule, so it saves the NWF funds for later. However, by this it restrains fiscal stimulus. Consequently, the prospects for 2021 GDP growth and non-oil and gas revenues will be worse.