Unable to find a missing RUB2.5 trillion ($32.5bn) of spending cuts or fresh revenue elsewhere, the Russian Ministry of Finance will cut military spending this year by 5%, Vedomosti reports, but this will not save anywhere near enough money to close the projected budget deficit gap. 

The Kremlin is struggling to balance Russia's budget with oil prices hovering around $30 when only in December the official plan assumed $50 oil. The ministry has forecast that the budget deficit would balloon out to 5.1% even with an average oil price this year of $40, or a RUB3.9 trillion shortfall ($50.1bn at prevailing exchange rates)

Finance Minister Anton Siluanov is currently revising the December budget law to take account of the lower than expected oil prices. President Vladimir Putin put cuts to military and social spending off limits as he fights a war in Syria and a general election in September. But it seems the Kremlin has caved into the inevitable: cut off from the international capital markets and suffering from sanctions that have wrecked Russia's investment climate, there was simply no way to close the hole between spending capped at RUB16.5 trillion this year and revenues without making politically painful cuts as well, according to a Vedomosti source in one of the ministries and a person close to the leadership of the Defence Ministry. 

The cuts are not set in stone yet, reports the Russian daily, and there has been no official response to enquiries. Siluanov had already pencilled in RUB200bn of military cuts to a revised budget that is due to be released in March and these look likely to happen now.

Stepping on and off the military spending accelerator, which will account for a third of spending this year, has already been used to adjust the size of the deficit. At the start of last year, Russia's deficit mushroomed to over 4% of GDP, but was quickly scaled back in the spring allowing the budget to end 2015 with a better than expected 2.6% deficit against the 3% forecast.

This January too the budget actually ran a 7.4% surplus y/y, or RUB390bn compared with the RUB216bn deficit in the same month a year earlier. However, the ministry says this was a one-off due to a change in the way prepayments are made.

The government took in just over RUB1 trillion in revenues in January with oil and gas duties accounting for a mere 34% against its traditional share of 50%. However, while tax collection has become more efficient in the last year as the government starts a concerted crackdown on malfeasance, overall the tax take this January was still down by 17.8% y/y. Oil revenues fell by more than a quarter (28.7%) in January from last year after the price of oil took another step down from its already low levels to reach a nadir of $27.88 a barrel in January, its lowest level since 2003. Oil was trading at $34.43 on February 19.

The Finance Ministry has been squeezing the military spend where it could and last year managed to shave 3.8% off the bill, reports Vedomosti, citing an interview with Deputy Defence Minister Tatyana Shevtsova. 

This year, from a total of RUB16 trillion of expenditure, the budget allocates RUB3.14 trillion to military spending, or 4% of GDP and $40.9bn. If Siluanov's proposed 5% cut goes into place this would be a RUB160bn saving. Experts say that most of the cuts will come in procurements – delaying updating some systems, R&D and purchase of new weapons that account for two thirds of military spending  – and won't affect the fighting ability of Russia's armed forces nor stymie its campaign in Syria.

That will help, but it won't close an official RUB2.3 trillion funding gap that remains in the budget, with a oil assumption of $50. The actual gap will be much higher and could be as much as RUB4 trillion.

At the moment, if the Kremlin really doesn't want to bite the bullet then the RUB3.74 trillion in the Reserve Fund as of January could cover almost all this shortfall. And there is another RUB5.35 trillion in the National Welfare Fund that can be tapped in an emergency. So one way or another Russia will get through this year. What the Kremlin worries about is how to then get through 2017 if oil prices stay this low.

Source: Ministry of Finance