The price cap on Russian crude oil exports is starving President Vladimir Putin’s budget of income, though it likely won’t force him to ratchet down spending for years thanks to a $45 billion buffer of yuan reserves.
Revenue plunged when the Group of Seven’s $60 per barrel limit came into effect last month. It combined with Putin’s spending increases since the invasion of Ukraine to contribute to a record deficit in December, with Russia’s flagship blend Urals trading just around $50, or nearly a third less than a year earlier.
Still, should it average the same price, Russia has enough to cover its shortfall for the next three years, according to Bloomberg Economics. Citigroup Inc. sees the stash depleted in 2 1/2 years with Urals at that level.
If Urals trades in the range of $40 to $50, revenue will fall as much as 2.5 trillion rubles ($36 billion) short of what the government budgeted, meaning monthly yuan sales would have to be more than triple the amount expected in January, according to Natalia Lavrova of BCS Financial Group.
The jolt to the budget turned the spotlight on a fiscal mechanism revived this month and involving sales of yuan from Russia’s wealth fund when revenues are below the target set by the government.
The yuan is the only currency remaining in Russian reserves that can be used for interventions in the foreign-exchange market following the seizure of about $300 billion in holdings that included dollars and euros after the war began almost a year ago.
The calculus of how long the 310 billion yuan ($45 billion) in reserves might last provides a measure of Russia’s fiscal distress and allows its economic stamina to be gauged as the war drags on. And although the squeeze has become acute, Russia won’t burn through its stock of yuan assets this year unless Urals halves and averages $25, according to Bloomberg Economics.
Citigroup estimates it would only take an average price of $35 to deplete the available yuan resources already in 2023.
Other scenarios for Urals suggest Russia should tolerate pressure on the budget for much longer without reducing expenditure. An oil price above $60 would even allow the government to start adding to its yuan reserves.
What Bloomberg Economics Says...
“Russia might not want to run yuan reserves all the way down to zero, which could mean that FX sales will slow as reserves dip. In any case, these FX sales might buy authorities enough time to adjust to permanently lower energy-export revenues.”
Putin has said Russia is putting “no limitations” on military spending for the war in Ukraine, with budget expenditure surging by about a third in 2022 from what it planned before the invasion of Ukraine. Outlays are on track to remain around the same level in the coming year even as revenues come under pressure.
Russia’s budget hasn’t been so reliant on high oil prices for about a decade. It needed Urals to average $104 to balance the books last year and the break-even will decline to $90 in 2023 only if the government avoids spending increases, Bloomberg Economics estimates.
Though Russia faces narrowing options in shoring up public finances, oil prices and the drawdown of the wealth fund won’t alone determine Putin’s choices.
Recent proposals include higher dividends from state companies and a “one-time payment” by fertilizer and coal producers, alongside a plan to trim some non-defense spending. A windfall tax paid by Gazprom PJSC already helped sustain a budget surplus late last year.
For the full year 2022, the fiscal gap reached about 3.3 trillion rubles, or 2.3% of gross domestic product. This year’s deficit is forecast at 2%, based on an oil price of $70 per barrel.
Russia is also considering changes to the way it calculates taxes on oil to limit the plunge in budget revenue. The local bond market is another recourse available to the Finance Ministry, which staged record debt sales late last year to use up less of its wealth fund.
Other factors at play include a push by some European Union member states for a price cap even lower than the current $60. The US has so far argued in favor of keeping the threshold unchanged ahead of additional curbs on the trade in refined Russian fuel.
And while the price cap triggered record discounts on Russia’s oil-export blend — pushing it to trade at roughly half the price of international benchmark Brent — the effect may prove temporary, according to Dmitry Polevoy, a strategist at Locko-Invest in Moscow.
“The discount will remain, but will probably gradually decrease,” he said. “Logistical chains were already being redirected last year and they will change further this year amid the restrictions imposed.”