Russia mulls fiscal belt-tightening
Hello! Welcome to your weekly guide to the Russian economy, written by Alexandra Prokopenko and Alexander Kolyandr and brought to you by The Bell. This week, our top story is a look at a suggestion by Finance Minister Anton Siluanov that there could be a change to fiscal rules that would require reduced government spending. We also examine how those close to Putin are acquiring profitable assets in Russian e-commerce.
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Reducing the oil ‘cut-off’ price could lead to spending reductions
Amid increased global economic uncertainty and falling oil prices, it was reported this week that Russia is preparing for potential spending cuts. The instrument for reducing spending is likely to be a lowering of the “cut-off” oil price that Russia uses to determine how much money should be stashed away in its National Wealth Fund (NWF). However, it’s unlikely that this budget optimization will affect the level of military spending.
What’s going on?
Finance Minister Anton Siluanov called Wednesday for a review of the oil cut-off price, which is specified by Russia’s self-imposed budget rule. The current level of $60 a barrel no longer “meets the challenges of the times,” he said, and should be adjusted “to minimize external risks.” According to sources cited by media outlet RBC, the government is considering reducing the cut-off price to $50.
The budget rule is a key component of Russian fiscal policy. Introduced in the 2000s to mitigate the impact of oil price fluctuations, this means that when oil prices exceed the cut-off point and the revenue from energy exports are above the planned, the windfall is redirected to the NWF. When prices are under the cut-off price, foreign currency is converted and taken out of the NWF. The cut-off point is determined by the government.
In 2017, the cut-off point was set at $40 with an annual indexation of 2%. After the full-scale invasion of Ukraine in 2022, however, the government had to abandon the budget rule as the financial pressure of war and Western sanctions meant it needed all the oil revenue it could get its hands on. The NWF was even used to cover a budget deficit, which had been prohibited before.
Eventually, though, the budget rule was re-introduced in 2024 at a higher cut-off of $60 a barrel. In effect, this meant that the government was allowing itself a higher level of spending than in peace time. Now, Siluanov is angling for a reduction in the cut-off price, and a return to something like the conservative pre-war budget rule.
Why is this happening?
On the one hand, this is a reflection of the oil market. Russia’s Urals blend is currently trading at about $50 a barrel, while this year’s budget balances on an annual average oil price of $69.7 per barrel. Given current oil prices and exchange rates, the ruble cost of a barrel of Urals is currently about a third less than what is required for a balanced budget.
Theoretically, Russia could tap the 3.5 trillion rubles worth of liquid assets, mostly Chinese yuans, currently in the NWF to make up the shortfall (the NWF is due to receive foreign currency worth further 1.2 trillion rubles in the summer).
However, neither the government nor the Central Bank want to empty the NWF – this would make it impossible to compensate for any future shortfall in oil-and-gas revenues. Instead, Siluanov is calling for a return to the practice of growing the NWF to “cover government expenses for three years even with a negative situation on the oil market.” Moreover, the less money the NWF has, the harder it is to smooth over exchange rate fluctuations. For the moment, NWF currency sales are the only way of influencing the value of the ruble (as long as Russia wants to maintain a free floating currency).
Reducing the cut-off price will fix these problems. To avoid taking any more cash from the NWF in the future, given the prices remain where they are now, and the fiscal spending doesn’t shoot through the roof, a reduction of the cut-off price by $5 will suffice. To start topping up the NWF again, the cut would need to be bigger.
All this is part of a perennial choice faced by the Russian government. Should oil revenue be used to top up the NWF, or spent? To do both at the same time, the government would need to impose unpopular tax hikes. For the moment, this is not on the cards.
Where is this heading?
If the cut-off price is reduced, government spending will fall – regardless of the oil price. If oil prices go up, the flow of oil-and-gas revenue into the NWF will rise; and if oil remains cheaper, the NWF will not be raided to cover budget shortfalls.
If the cut-off price were reduced by $10 to $50 per barrel, for example, it would result in a reduction of about 0.8% of GDP in government revenue. This would further chill an already cooling Russian economy. Government spending has been the key driver of growth since 2022.
Another possible consequence would be a fall in NWF currency sales, as the drawdowns form the fund would start at lower oil prices, which effectively will be weakening the ruble. However, given the current decrease in imports, the net impact of reduced spending and a weaker ruble would be anti-inflationary. This, in turn, could enable the Central Bank to lower interest rates more quickly. But the changes are unlikely to happen anytime soon. The Finance Ministry is not expected to make drastic changes in the middle of a financial year, so, not much is likely to occur before 2026.
It’s also unclear what spending the government might cut. Military expenditure is a holy cow: the war, either hot or cold, will continue to take priority. Social expenditure is already lagging behind and would be politically challenging to cut further. The easiest cuts to make would be to infrastructure projects, and the level of various state subsidies.
Why the world should care
Siluanov’s proposal would mean reduced spending, a weaker ruble and a further slowdown in economic growth. And this would require sacrifices that are above Siluanov’s pay grade to implement – they would have to be approved by President Vladimir Putin.
Putin’s pals snap up lucrative e-commerce assets
Leading figures with government connections appear to be trying to take over Russia’s e-commerce market. In recent weeks, it has emerged that three key assets in this sector are being transferred out of private hands: online marketplaces Wildberries, Ozon, and Avito. The growing state role in the e-commerce sector, which was once purely commercial, is likely to be an essential feature of Russia’s economy going forward.
- Last week, RBC reported that 27.7% of Ozon, Russia’s fastest-growing marketplace, had been sold. Three markets sources, as well as a source close to one party in the deal, told The Bell that the new owners were backed by Yuri Kovalchuk (a close friend of Putin), and that the deal was brokered by Putin’s influential deputy chief of staff, Sergei Kiriyenko (you can read The Bell’s Russian-language analysis here). Companies linked to Kovalchuk already have stakes in the leading Russian marketplace Yandex.Market.
- Kovalchuk might also be interested in market leader Wildberries. As a result of a conflict last year between the co-founders of the company, the Mirzoyan brothers became co-owners of Wildberries. They are regarded as proxies for billionaire Suleiman Kerimov. Now, according to two of The Bell’s sources, Wildberries could be acquired by groups linked to Kovalchuk.
- Finally, groups controlled by state-owned agricultural lender Rosselkhozbank announced Thursday the purchase of 50% of Avito, which has been dubbed “Russia’s eBay,” from businessman Ivan Tavrin. Between 2015 and 2022, Avito was owned by South African group Naspers. After the full-scale invasion of Ukraine, however, Naspers decided to sell up. Rosselkhozbank is considered to be the domain of the powerful Patrushev family (the son of Putin’s confidante Nikolai Patrushev, Dmitry, is the chairman of the bank’s supervisory board).
Why the world should care
Between 2019 and 2024, the value of Russia’s e-commerce market grew from 1.7 trillion rubles to 12.6 trillion rubles, according to consulting firm Yakov and Partners. This obviously caught the eye of those close to Putin. For them, the war, a poor investment climate, and ties to the Kremlin mean such assets come with big discounts.
Figures of the week
As expected, the Central Bank kept interest rates on hold at 21% at its rates meeting Friday. The regulator noted that there had been a fall in inflationary pressure (although inflation remains high), and that “the economy is steadily starting to return to a balanced growth path.” The Central Bank stated that it expects inflationary pressure to continue declining in the coming months. The new base case scenario is slightly lower than the one issued in a previous statement, projecting an average interest rate of between 19.5% and 21.5% through 2025, and between 13% and 14% in 2026.
Inflation in Russia continues to slow. Between April 15 and April 21, prices went up by 0.09%, compared with 0.11% from April 8 to April 14, and 0.16% from April 1 to April 7. If we use the Central Bank’s preferred methodology, annual inflation remains at 10.34%. The Economic Development Ministry’s preferred methodology gives an annual rate of 10.35%, however, which is down from 10.38% last week.
Russians appear to be buying fewer expensive cars. In the first quarter of this year, the Russian auto market was down 25%, and purchases of premium brands fell twice as fast as the overall rate. Thus, the premium sector now makes up 8.7% of the market (compared with 12.9% in the first quarter of 2024).
Further reading
