Russia's federal budget deficit is in danger of swelling under pressure from rising expenditures, particularly on the military, and falling revenues, partly because of the falling oil price.
In January-November 2015, the budget posted a deficit of RUB897bn ($12.7bn) or 1.3% of GDP, according to preliminary data from the finance ministry. For the same period of 2014, the federal budget ran a surplus of almost RUB1.3 trillion or 1.9% of GDP.
The budget deficit in 11 months has exceeded the RUB560bn expectation of Alfa Bank analysts, the bank said in a note to clients on December 14, with November's fiscal performance disappointing on both the revenue (RUB140bn below expectations) and spending side (RUB200bn above expectations).
Notably, military spending increased by 37% y/y in November compared with 23% y/y growth in the first 10 months of 2015. Together with oil prices falling below $50/barrel in November and $40/barrel in December, this has presented renewed fiscal challenges.
Oil prices, even despite the ruble devaluation, will result in revenue being about RUB300bn lower tha initial expectations, according to Alfa Bank (January-November revenues stood at RUB12.2 trillion).
"Mounting foreign policy tensions force us to start doubting Russia's ability to stay within the initial 4% y/y (spending) growth target for this year; 6% y/y (an extra RUB300bn) appears more appropriate," Alfa adds.
As a result, Russia can lose space for fiscal manoeuvre that was accumulated in the summer, with Alfa Bank revising the full-year deficit expectation from an initial 2.3% of GDP to RUB2 trillion (2.8% of GDP).
Because of the weakness in oil revenues, Uralsib Capital analysts in November forecasted the federal budget to run a deficit of 2.6% of GDP this year compared with an initially expected deficit of 2.1% of GDP.
This is still better than the conservative official forecast of 2.9% of GDP for 2015 recently announced by Finance Minister Anton Siluanov.
Meanwhile, "high appetite for defense spending, potential extra social indexation due to above expected inflation, and proposals to inject cash into VEB [Vnesheconombank)" complicates the ministry's fiscal targets for 2016, Alfa Bank warns.
Alfa adds that the ability to finance extra spending without deterioration of the nominal budget balance depends on further ruble deprecation, which lies beyond the finance ministry's area of direct control.
It is not clear how the government is going to account for the RUB1.2 trillion (about $20bn) bail out of state development bank VEB, directly sanctioned and burdened by bad assets.
As the government considers both an issue of sovereign Eurobonds and domestic OFZ federal bonds, various unconfirmed reports indicate it is also under the pressure from the presidential administration not to account for VEB recapitalisation in the 3% 2016 deficit, which is a "red line" marked by President Vladimir Putin on numerous occasions.
Economic Development Minister Alexei Ulyukayev said in the December 7 issue of Vedomosti daily that "there is no other way [to recapitalise VEB] other than the budget", and suggested it be done through an OFZ issue this year still.
Finance Ministry head Siluanov insists that VEB will have to exhaust all options of selling its assets before turning to budget-financed support. But the budget is already looking to be severely underfinanced, having been planned for an average oil price of $50/barrel in 2016 budget, which looks overly optimistic. If oil were to stay at $40/barrel through 2016, Russia's budget deficit could be as large as RUB4.1 trillion or 5.2% of GDP, according to the ministry.
The government and parliament have now approved the 2016 budget with a 3% deficit after switching to the so-called manual control mode in fiscal planning. As of 2016, Russia will resort to one-year budgeting instead of three years, and abandon the budget rule benchmark setting the average oil price for capping expenditure levels.
Fiscal adjustments in the new budget include a higher tax burden on big oil, prolonging freezing pension accumulations, and slowing indexation of age pensions and public salaries. Military spending remained intact and was adjusted upwards on the last days of budget drafting.