Ivan Tchakarov of Renaissance Capital -

As the year draws to a close, it is natural to ask what was the key achievement of the new Russia government in 2012. It has been in power now for about seven months and, for us, without a doubt it's most notable accomplishment is the introduction of the new fiscal rule, which was officially adopted by the Duma on December 15, and which confirms, at least on paper, the executive's renewed commitment to an overall fiscal envelope that focuses on fiscal probity.

We outline below the most salient features of the fiscal rule and the key fact that the break-even oil price is set to decline significantly from $107 in 2012 to $93 in 2015:

Why is this important?

In 2008, Russia entered the crisis with a strong stock and flow fiscal position, allowing it to pursue (correctly) aggressive countercyclical policy. However, this led to a significant increase in the break-even oil price from $50 per barrel in 2008 to around $112/b in 2010 and $107/b this year. This suggests that Russia has now become much more vulnerable to downward movements in oil prices than it was in 2008-2009.

How will it work?

Addressing this key macroeconomic vulnerability has become of paramount importance for overall macroeconomic stability. Finance Minister Siluanov has argued convincingly that the first priority of his ministry is to reduce budget dependency on oil via introducing a new fiscal rule.

The rule envisions that future budgets will not be based on current oil prices, but on estimates of longer-term oil prices that average over periods of low and high oil prices. In particular, this rule would imply a 2013 oil price estimate that averages over oil prices from 2008-2013, a 2014 oil price that averages over oil prices from 2008-2013 and all the way to a 2018 estimate that averages over oil prices from 2008-2017.

Once the overall revenues have been determined on the basis of the new fiscal rule-based oil price, an upper bound for overall expenditures is set at revenues plus a maximum of 1% of GDP federal budget deficit as per below:

Expenditure/GDP ≤ [Revenues/GDP (using fiscal rule-based oil price) + 1% of GDP]

If the oil price is higher than fiscal rule-based oil price, additional oil and gas revenues are transferred to the Reserve Fund until it reaches 7% of GDP. After the Reserve Fund reaches 7% of GDP, not less than 50% of the additional oil and gas revenues are transferred to the National Welfare Fund and the rest of the additional revenues can be spent on infrastructure and other projects.

What will be the fiscal rule-based oil prices during 2013-2018? The chart below shows (in pink) the oil price implied by the new fiscal rule (Figure 1), showing that it rises gradually from about $91 in 2013 to $98 by 2018. In other words, the fiscal-rule based oil prices are lower than the current forecast for the evolution of the oil prices in the future, which imparts a much more conservative fiscal stance in the federal budgeting process.

What is then the fiscal rule based break-even oil price? Figure 2 above shows the historical evolution of the break-even oil price as it soared from only $13/b to $112/b in 2010. 2011 saw a moderation to $101/b, but the election-driven spending will lead to an increase to $107/b this year. As the 2013-2015 fiscal framework envisions a balanced 2015 budget at the fiscal-rule based $93/b, this implies that the 2015 break-even will be $93/b. We also estimate that the break-even will be $98/b in 2013 and $94/b in 2014.