Kremlin’s Fiscal Strength Put To The Test By Plummeting Oil Prices

Oil Well file photo

(Article text ©2020 RFE/RL, Inc., Radio Free Europe/Radio Liberty – rferl.org – March 12, 2020 – article text also appeared at rferl.org/a/kremlin-fiscal-strength-put-to-the-test-by-plummeting-oil-prices/30484158.html?withmediaplayer=1)

Earlier this month, Russia’s finance minister had this to say about the health of the government’s budget and the global benchmark for oil prices, which was trading at around $50 a barrel: Even if prices dropped to $30 a barrel, Anton Siluanov said, the government would be able to operate without difficulty for four years.

The Kremlin is about to find out how true that is.

Global prices plummeted this week after the OPEC oil cartel and Russia failed to agree on production cuts as a way to bolster already slipping prices. Coronavirus fears, economic weakness in Europe and China, and a glut caused in part by the U.S. shale revolution had already pushed down prices.

On March 9, the first day of trading after the OPEC-Russia meeting in Vienna abruptly ended, prices dropped by 30 percent, the worst such fall in 30 years.

Russia and Saudi Arabia — OPEC’s largest producer and the largest in the world — then dug in their heels, waiting for the other to flinch.

Riyadh threatened to flood the market further with oil, and prices on March 11 dropped to as low as $36 a barrel for the global benchmark known as Brent crude.

Russia’s energy minister, Aleksandr Novak, said the country could increase production up to an additional 500,000 barrels a day – a substantial influx for global markets.

The Russian ruble has tumbled against the dollar amid the mass uncertainty on the oil markets.

On the day after oil prices careened downward, the ruble fell to levels not seen in a decade, reaching 75 rubles to the U.S. dollar and 84 to the euro, as of March 12.

Russia’s prime minister, Mikhail Mishustin, tried to project confidence as he convened a cabinet meeting on March 12. “The situation in the Russian economy is under control. We have all the instruments to make it through calmly, without any shocks,” he said. “We have enough reserves to preserve financial stability. We are promptly taking all necessary measures for stabilization.”

That, and Siluanov’s prediction, will now be put to the test, experts say.

Rainy-Day Funds

Russia’s economy continues to be driven by revenues from oil and gas exports, though less so than 18 years ago, during President Vladimir Putin’s first term in office.

For years now, budget hawks, including Siluanov, Central Bank Chairwoman Elvira Nabiullina, former Finance Minister Aleksei Kudrin, and others, have pushed the Kremlin to peg its budget at oil prices that are low by historical standards.

Revenues that exceed those low levels have then been salted away in so-called rainy-day funds like the National Welfare Fund, which will have around $170 billion once new 2019 revenues are factored in. That has served both as a sponge for excess oil money, which could fuel inflation, and has served to fill treasury coffers to help insulate the government from external forces — such as Western sanctions or macroeconomic shocks like an oil glut. Russia’s reserves are now more than $550 billion.

Currently, planners have pegged the budget to balance when the price of oil is about $40 per barrel. Until just two weeks ago, prior to the OPEC-Russia meeting, benchmark prices were around $60.

That forward thinking has made Russia’s budget and fiscal health the envy of many countries, Western or otherwise, and that’s what Siluanov had in mind when he predicted Russia could hold out for four years if global prices hit $30 a barrel.

“In the current situation, and with oil prices reduced, it shows that we always need to be prepared for such a situation. We are fully prepared,” Siluanov said on March 11.

“We are better prepared than other countries that have large revenues from oil production, which today have to cut their budgets, he said. We will fully fulfill all obligations. We will not cut or reduce budget adjustments that have been adopted.”

In the short term, that seems possible.

“Assuming that oil prices remain at $35 and budget spending is not reduced, the [National Welfare Fund] should be enough to support the budget for five to six years,” Vladimir Tikhomirov, the chief economist at BCS Global Markets, told RFE/RL. “This is a strong guarantee, given that many oil producers in the world are unlikely to withstand $35 for five years. Production will definitely fall, and then prices will rise.”

Karen Vartapetov, a Moscow-based analyst at S&P Global Ratings, said Russia could likely hold on for three, not four, years, if oil prices remained at $35 a barrel.

No Time For Austerity

Russia’s economy is less dependent on hydrocarbons than it was in the early 2000s, but it has larger structural problems that have kept it stagnant in recent years — and could continue to hobble it in future years.

That’s worried the Kremlin, which has seen Putin’s popularity slip amid stagnant wages, controversial changes to national pension rules, a tax increase, and general pessimism among, particularly, middle-class Russians.

In response, Putin has called for a sharp increase in federal spending: around $65 billion on everything from increased payments to families who have more than two children to hot meals for elementary school children.

The sputtering National Projects effort – a six-year, $400 billion plan to restructure and modernize Russia’s economy – is also supposed to ramp up spending this year.

The increased domestic spending will draw down, in part, the National Welfare Fund.

The shift to more spending led to the political shakeup that resulted in Mishustin, the head of the Federal Tax Service, being promoted to prime minister. It also resulted in a demotion for Siluanov, who retained his post as finance minister, but lost his simultaneous job as first deputy prime minister.

Kudrin, who is now the head of the Audit Chamber, a semi-autonomous government watchdog agency, predicted that an oil price of $35 per barrel would result in Russia’s economy slowing to near zero. But he also predicted that oil prices would creep up to $40 a barrel, or slightly higher. “The next two months will show us what scenario the whole global economy takes: are we able to stop the risks associated with the coronavirus,” he said on March 12, speaking before the upper chamber of parliament.

“That’s going to be a little better than the scenario that I just spoke of,” Kudrin was quoted by Russian news agencies as saying. “But, nevertheless, I’m assuming that we will be closer to zero economic growth anyway, positively closer to zero, and still get a budget deficit. Investments are most likely will decrease compared to the previous year. These are the new realities.”

Janis Kluge, a senior researcher at the German Institute for International and Security Affairs in Berlin, said Russia faced a similar situation in 2014. The economy was hit hard by Western sanctions following Moscow’s annexation of Ukraine’s Crimea Peninsula, and oil prices dropped precipitously.

But the annexation was popular among many Russians, which helped offset the immediate economic hardships.

Now, he said, Putin’s popularity has been slipping for a couple years — and the Kremlin is trying to prepare for a national vote on major changes to the constitution, tentatively set for April.

Under the current conditions of low popularity for Putin, and especially a few weeks before a crucial referendum in Russia, the Kremlin cannot afford a new round of austerity,” Kluge said. “There is no Crimea to celebrate like in 2014, instead there is a ‘corona-crisis’ today that will severely affect Russia’s economy on top of low oil prices. The Kremlin may need to spend a lot more than originally planned to address this crisis.”

Sergei Aleksashenko, an economist and former Central Bank deputy chairman, said five years was a long horizon for Russian budget planners. But he predicted no long-term damage to the Russian budget. “I responsibly declare that nothing terrible will happen to the Russian budget in terms of paying for expenditures,” he told RFE/RL’s Russian Service.

“Perhaps in the 2021 budget, someone’s appetite will need to be cut back or someone will receive less money than what they were promised six months ago, but the current budget plan will be funded,” he said. “No one should expect any shocks here.”