Russia bites the budget bullet as "new normal" hurts

Russia bites the budget bullet as
By Nick Allen in Warsaw January 15, 2016

2015 was the year Russia declared it can handle what its leaders call the "new normal" - low oil prices and revenues, sanctions, isolation from the West, and shoddy import substitutions.

Now, after waking from a 10-day New Year blow-out, the country faces the stark new reality of oil hovering at $30 per barrel and a budget gauged to $50 that is coming apart at the seams.

Sobering comments came from the top, starting with President Vladimir Putin's admission in Germany's Bild newspaper on January 11 that both the oil price and "the [Western] sanctions are severely harming Russia".

The same day, as the country got back to work, the ruble also had to face the music, falling to 77 against the US dollar for the first time since December 2014.

Two days later, Finance Minister Anton Siluanov warned at the Gaidar Forum on economics in Moscow that Russia must learn to live within its greatly reduced means or face an economic crash such as that which wrecked the economy 18 years ago.

"Our task is to adapt our [2016] budget to the new realities," Siluanov said as he and other ministry heads now look to cut 10% and save $6.5bn. "If we don't do that, we will see a repeat of what happened in 1998-99," he added, referring to the debt default and economic crash that followed.

Crisis peak passed vs. worst yet to come

While the numbers get crunched, at a grass roots level 52% of Russians believe the hardest times are still ahead, according to a new survey by the state-run Vtsiom pollster. Despite Putin's sky-high popularity, this is the greatest level of public pessimism about Russia's future since 2009, even if previously the talk at the top was generally upbeat.

"The peak of the crisis in the Russian economy has passed," Putin told his year-end press conference on December 17, citing government forecasts of 0.7% GDP growth this year, 1.9% in 2017, and 2.4% in 2018.

According to an unpublished forecast of the Ministry of Economic Development cited by Vedomosti on January 15, the Russian government is now revising 0.7% growth to an 0.8% decline, on the back of a 3.7-3.8% decline in 2015. As a basis for the budget's revision, oil is projected at $40 per barrel, annual inflation at 8.5%, with a $50bn capital outflow, and an average exchange rate of RUB68.2 to the dollar.

However, Siluanov's ministry has warned that even $40 oil will inflate the deficit to around 5% and exhaust Russia's Reserve Fund of around $60bn by the end of 2016. Other estimates circulating say that if oil drops to $24 per barrel, Russia’s deficit can increase to 7.5% of GDP, more than double the 3% "red line" drawn by Putin.

Sacred cows for the chop?

Former finance minister Alexei Kudrin, who is tipped to return to high office in the government or Kremlin administration this year, calls the hunt for 10% budget reductions "optimistic".

"I do not know where to direct these cost cuts. We have already cut education and health costs ... The Russian economy is in a vicious circle," Kudrin said at the Gaidar Forum. Serving as finance minister from May 2000 to September 2011, the finance veteran is regarded as both a liberal and a long-time ally of Putin, and he is one of the weightiest figures questioning government policy and calling for a new economic model.

With $368mn in overall reserves (albeit with only around $220bn immediately usable), Russia is in no real danger of running out of money this year. Rather it will have to plug holes in spending in ways the Kremlin finds distasteful, such as privatising prize assets such as Rosneft, Sovkomflot and Alrosa. Even 25% of the strategic military giant Russian Helicopters is expected to be sold this year.

And while Siluanov was warned off meddling with the defense budget last year, when Russia spent $40bn rearming and refitting its military, this former no-go area is coming under increasing scrutiny.

If the economic situation remains as bad, then the generals will also have to cut spending in 2-3 years, Kudrin predicts. "Defence spending reductions cannot be avoided ... I don't think that defence spending is a sacred cow untouchable in any circumstance," he said.

Other participants at the Moscow forum also sounded the alarm. "If the oil price stays at $30 per barrel, we are going to spend about $100bn of national reserves before the end of 2016," liberal politician Vladimir Ryzhkov told The Daily Beast. "In fact, we are now in a much worse position than we were in 2008, when our reserves were actually over $600bn and we had only 15mn people living in poverty. Now we have a bit over $300bn in reserves and fast-growing poverty." (Around 23mn of 146mn Russians now officially live in poverty.)

Shame was so 1990s

Politically, the plight of the economy doesn't yet threaten the status quo in Russia, so effective has the Kremlin been in directing public ire towards the West. Pro-Kremlin forces will sweep the polls in parliamentary elections in September, and calamity notwithstanding, Putin will sail into power for a last five-year term in 2018. For most people, he is still firmly identified with restored national pride and muscle on the world stage.

A Levada Center poll in December revealed that despite low (but rising) pride in economic achievements, the number of Russians who feel ashamed at the state of the country has fallen from 81% in 1996 to just 18% in November.

But old malaises of the 1990s are also reappearing, such as wage arrears that blighted life for millions in the new free market. Addressing the cabinet on January 14, Prime Minister Dmitry Medvedev said "total arrears in salaries are still substantial" and warned that given the state of the economy, "this process may accelerate and mount".

Some effects of the new times are only just percolating through and will test resolve in the long-term. Favorite holiday destinations Egypt and Turkey are off the menu because of terrorism risks and the dispute with Ankara over its shooting down of a Russian bomber. Amid continuing EU and US sanctions, Russians said goodbye to quality European food products and have to buy often shoddy and fake products like cheese as domestic producers fill the gap.

Now even some quality home-made items might yield to cheap ersatz products, such as Russia's fine confectionary. Ruble prices for basic raw materials for chocolate production grew by 40-80% in 2015, meaning that a further slide in Russia's currency can start to shut down plants.

"A further devaluation would make the production of quality chocolate unprofitable," said Elizaveta Nikitina, director of the Russian Centre for Confectionery Market Research. If the situation doesn't change, the first quarter of 2016 can even mean "halting production at a number of enterprises".

That would leave millions of Russians using their sweet tooth too to bite the bullet of the new normal.