Russia to run 5.1% federal budget deficit if oil averages $40 this year

Russia to run 5.1% federal budget deficit if oil averages $40 this year
By bne IntelliNews February 8, 2016

The Russian Economy Ministry has publicly dished up a reality check for President Vladimir Putin, saying Russia is on course for a 5.1% of GDP federal budget deficit (RUB3.9 trillion) if oil prices settle as like on an average $40 per barrel, Vedomosti daily reported on February 8.

Putin previously set a 3% deficit "red line" that should not be crossed – an achievable target if oil averages $50 in 2016, according to the assumptions of the initial budget approved in December.

However, after a jarring January, when oil prices slid to a new level of under $30, the two- month-old assumptions already look wildly optimistic. Finance Minister Anton Siluanov is currently revising the budget and is due to release a new version in March.

The Russian economy is hurting. The Economy Ministry's baseline scenario for 2016 is a GDP decline of 0.8%, a fall in industrial output by 0.3%, and with inflation running at 8-8.5%. The reduction in investment in 2016 is forecast at 6% (in 2015 it fell 8.4%), a fall in the volume of services of 1.5% (-2.1% in 2015), real wages down by another 3% (the fall in 2015 was 9.5%), while the fall in retail turnover is projected to slow from 10% in 2015 to 2.9%.

Siluanov has already called for 10% cuts across the board (worth RUB513bn, or $6.6bn), although military and social spending are sacrosanct (a third and a quarter of spending respectively) thanks to Russia's bombing campaign in Syria and general elections to parliament slated for this autumn.

However, it looks increasingly unlikely that those in charge of Russia's public purse will be able to meet Putin's 3% target without cutting into the more politically sensitive parts of the state's expenditure - areas Putin has previously warded them away from. The only alternative will be to carry a much larger deficit than planned.

The game is to fill the spending gap. The December version of the budget had a 3% budget deficit (and Russia finished 2015 with a better than expected 2.6% deficit) or a RUB1.7 trillion hole. However, the 5.1% scenario represents a RUB3.9 trillion hole, or rather chasm. The other schemes to raise extra revenue without more spending cuts are unlikely to work.

Russia recently relaunched its 2008 privatisation plan, which foresees revenues of RUB1 trillion. However, investors have widely pooh-poohed the plan, saying no one will be willing to buy that many Russian assets in this climate, especially after Putin put a raft of restrictions on the sales. These include a equirement that buyers of any of these assets must be Russian domiciled legal entities. He also banned state-owned banks from participating in the deals, and without this funding even Russia's oligarchs will struggle to come up with the cash to buy some of the bigger juicer companies on offer.

Likewise, the state budget has earmarked $3bn worth of Eurobond issues (RUB230bn) for this year (down from the traditional $7bn Russia issues every year up to 2013), but here too investors have scoffed at the state's ability to raise even this much. Even if this bond issue does come off, it is still way short of the estimated $52bn budget shortfall.

The latest wheeze is talk of increasing the tax on oil exports, which the government says could raise RUB1 trillion – but here too this assumes that oil averages $50 a barrel and if it is less then the revenue will still not be enough to cover the shortfall.

The Ministry of Finance proposes to reduce military spending by RUB200bn and wants to increase dividend payout rate of state-owned companies from 25% to 50%, which will bring another RUB175bn, VAT collection growth of another RUB173bn. 

This all said, Russia's deficit is not going to cause a crisis. The state still has some RUB9 trillion in its two rainy day funds that is enough to cover even a 5% deficit. But the problem is that if the state spends all this money it will go into 2017 with almost nothing in reserve – a scenario the government is desperately trying to avoid as the consensus prediction for oil prices is they will stay at under $70 for at least another two or three years, while the break-even price for Russia's budget today is $85.

The Ministry of Economy is also adopting a "conservative scenario" of $25 per barrel of Urals oil, although it is the Ministry of Finance's version of the budget that will actually determine spending. In January, the price of oil hovered around $28. Minister of Economy Alexei Ulyukayev said that in this case, inflation will be 8.8-9.2%. The drop in investment in this scenario is projected at 6.7% against 8.4% in 2015, while retail trade turnover will decrease by 5.9% (about half the fall registered in 2015).

But the biggest hit in this scenario is the impact on the population that will see the rate of falling income accelerate to 4.7%, and the rate of decline in real wages will be reduced to 4.8% per annum.

The average ruble exchange rate against the dollar in the baseline forecast is RUB68.2 to the dollar and RUB75.7 to the dollar in the conservative case.