Russia’s Only Escape From Its Budget Pain Is Economic Growth

  • Economic growth is the ‘only way out,’ Uralsib’s Dudkin says
  • Seven-month deficit widened as downturn persists, survey shows

Russia is running down its wealth funds and the budget is deep in the red for years to come. It’s something only economic growth can cure.

Saddled with social outlays and spending on security and defense that are at almost 60 percent of this year’s total expenditure, and oil prices going nowhere fast, the room for fiscal maneuver is limited. The seven-month deficit widened to 1.5 trillion rubles ($23.7 billion), an increase of more than 6 percent from June, the Finance Ministry said on Monday. An economic upswing is “the only way out,” said Dmitry Dudkin, head of fixed-income research at Uralsib.

As Russia muddles through its longest recession in two decades, it racked up a budget deficit of 3.3 percent of economic output as of end-July, on track for the widest in six years. The prospect of fiscal relief is growing distant, with oil in a bear market after closing below $40 a barrel in August for the first time in almost four months.

“There are grounds for moderate optimism,” Dudkin said by e-mail. “At the same time, the main risk is, of course, the budget. The monetary sphere already managed to adapt to a new reality, while the budget hasn’t yet.”

Some economic growth is already trickling through. Almost two years of quarterly contraction ended in April-June, paving the way for a recovery that will extend into the second half and beyond, according to Citigroup Inc. If Russia can reach growth of 1 percent to 1.5 percent next year, the budget deficit will shrink to 1.5 percent to 2 percent, or about half the level proposed by the Finance Ministry, Dudkin said.

Budget Pinch

President Vladimir Putin’s government has already resorted to measures from spending cutbacks to sales of debt and state assets to cover a shortfall estimated at about 3 percent of output this year. With parliamentary elections a month away, followed by a presidential ballot in 2018, authorities are under pressure to ease the plight of households after a currency crisis and a spike in inflation eviscerated their earning power over the past two years.

What’s making things is that the ruble’s 3.1 percent drop in July hasn’t kept up with the decline in Brent, which plunged more than 14 percent the same month. Such a mismatch hurts the budget because the government receives fewer rubles per barrel of oil sold for dollars abroad.

The Russian currency is the fourth-worst performer among its emerging-market peers this quarter. It traded 1.1 percent stronger at 64.02 versus the U.S. currency as of 5:44 p.m. in Moscow.

Growth Outlook

Gross domestic product lost 0.6 percent in the second quarter from a year earlier after a decline of 1.2 percent in the previous three months. GDP will shrink 0.8 percent this year before gains of 1.3 percent in 2017 and 1.5 percent in 2018, according to the median estimates in Bloomberg polls of economists. At an average oil price of $40 a barrel, output will slip 0.5 percent this year, Citigroup estimates.

“While our forecast implies that Russia will return to positive year-on-year growth in the fourth quarter of 2016, the recovery is likely to be muted by historical standards amid elevated global uncertainty, persisting geopolitical risks and domestic structural constraints,” Citigroup economists Ivan Tchakarov and Ekaterina Vlasova said in a report.

Central bank Governor Elvira Nabiullina in June put Russia’s potential growth at no more than 2 percent in the medium term and called for improving the business climate and structural reforms to harness the nation’s potential. Should there be no additional shocks, growth may turn positive in the coming months, with GDP expanding 0.4 percent in the third quarter from the previous three months, the central bank’s research and forecasting department said last week.

Fiscal Austerity

Russia is preparing its budget for the next three years after the Finance Ministry proposed the fiscal gap at 3.2 percent of economic output in 2017. It then plans to reduce it by one percentage point each year to balance the budget by 2020.

Given plans to freeze spending next year in nominal terms, inflation will “eat away” at the deficit even if the economy runs up zero growth in real terms, according to Dmitry Shagardin, an analyst at Bank Saint-Petersburg PJSC.

Under the Finance Ministry’s proposals for drafting a 2017-2019 budget program, the government will fully deplete its $38 billion Reserve Fund next year, while another 783 billion rubles will be taken from the National Wellbeing Fund, originally created to cover long-term outlays for social spending such as supporting the pension system.

A resumption of growth will support revenue that’s not linked to oil and gas, helping narrow the budget gap, and the Finance Ministry’s plans to narrow the deficit are “realistic,” said Oleg Kouzmin, an economist at Renaissance Capital in Moscow.

“But it’s impossible not to speak about the risks,” he said. “Outside risks mainly have to do with the dynamics of oil prices, and domestic -- with expenditure before 2018 elections.”

Before it's here, it's on the Bloomberg Terminal.