As you might have noticed over the past several days, the Russian ruble is in a veritable tailspin. The inexorable decline in crude has pressured the currency as have expectations of an uptick in year-end budget spending.
The ruble fell to a record low against the dollar on Monday and depending on crude’s trajectory, could well fall further in the new year. 2015 will likely mark the third annual decline for the currency which is under pressure not only from low oil prices, but from biting economic sanctions tied to Moscow’s alleged role in Ukraine.
“The wish to hedge potential risks from geopolitics and commodities may well push the ruble to 75,” Evgeny Koshelev, an analyst at Rosbank PJSC in Moscow, told Bloomberg by e-mail this week. “It will be interesting to see if there’s a reaction from the central bank, government and households to this weakening.”
Yes, it will be “interesting”, especially if crude slides even further. Here are Goldman’s projections based on three different prices for oil:
- At an oil price of US$35/bbl, we think the Ruble will be around Rub72 or close to current levels. Under that scenario we think inflation could be around 6% at end 2016.
- At an oil price of US$30/bbl, we think the Ruble will depreciate to about Rub77 or 10% below current levels and end-year inflation in 2016 could be up to 6.7%.
- At an oil price of US$25/bbl, the Ruble is likely to depreciate to the mid-80s and inflation is more likely to be up to 8% in December 2016.
While Goldman is fairly optimistic about what the future holds for the Russian economy – which, you’re reminded, is in the midst of its deepest recession since 2009 – the Central Bank of Russia isn’t so sure. In fact, according to the bank’s “risk scenario,” oil prices could hover around US$35/bbl in 2016 while GDP could contract by 5% or more and inflation might be stuck at 7-9%.
Russia’s 2016 budget assumes oil prices at $50/bbl. If that proves correct, Moscow will run a deficit of about 3%. However, as Citi noted earlier this month, “a $10bbl decline in oil prices worsens the fiscal position by about 0.7% of GDP.”
As Citi goes on to point out, the deterioration in the fiscal position “already incorporates the secondary positive effect of the weaker currency.” In other words, the widening budget deficit associated with falling crude prices takes into account the effect a concomitantly weaker ruble has on RUB-denominated oil revenues.
So, combining this with the CRB’s risk scenario as outlined above, we’re to understand that with oil at $35/bbl, Russia’s projected deficit jumps 23% to 3.7% of GDP which will itself decline 5% from a year earlier while inflation runs at between 7-9%.
If, however, oil were to fall to $30/bbl, the situation worsens materially. Here’s Citi again:
A fall of the oil prices to $30bbl will thus widen the fiscal deficit to 4.4% of GDP. Given that the 2016 budget is based on an oil price of $50bbl, this implies that the fiscal position may deteriorate to -4.4% (-3.0% -2 times 0.7%) of GDP at oil of $30bbl.This is a significant fiscal gap that would be the second largest over the last 20 years (largest deficit of 6.0% of GDP was recorded in 2009).
The fiscal outlook is further darkened by the trials and travails of Vnesheconombank (VEB), the troubled state bank that’s been crippled by economic sanctions and is laboring under more than $15 billion in foreign currency debt (which is of course a disaster given the ruble’s slide). As Bloomberg reports, VEB may need a massive state bailout that could end up costing upwards of $18 billion. Here’s more:
VEB got its start under Soviet founder Vladimir Lenin as a bank to finance foreign trade. Putin overhauled it in 2007. Flush with cash from high oil prices, he pumped 180 billion rubles (worth about $7.3 billion at the time) in to boost capital and took over at chairman of the board a year later.
When the global financial crisis struck in 2008, VEB became Putin’s main tool for managing the shock. It got 1.25 trillion rubles (worth about $50 billion at the time) from the government and central bank to shore up the plunging stock market, help failing banks and bail out tycoons who were facing the loss of their companies to foreign creditors.
By the end of 2009, its balance sheet had more than tripled from before Putin’s overhaul began.
Behind the facade of western-style accounting and international credit ratings, the bank’s decisions were often driven more by politics than business, officials now admit.
“The bank, because of its status, took on certain tasks that can at times hurt its balance sheet,” VEB chief Vladimir Dmitriev said Dec. 22. “We’re talking about the so-called special projects.” Neither VEB nor a Kremlin spokesman responded to requests for comment for this article.
Starting in 2009, VEB spent $8 billion to finance deals allowing unnamed Russian investors to buy up steel plants in eastern Ukraine and keep them running
The legacy of the 2014 Sochi Winter Olympics, which at about $50 billion were the most expensive such games ever, is another big burden on VEB [which ended up] taking control of more than 200 billion rubles of money-losing hotels, ski resorts and other projects.
The takeaway here is that much like the Novo Banco and Banif bailouts are set to add several percentage points to Portugal’s deficit, Moscow may be forced to foot the bill for VEB. “Losses on the bank’s huge catalog of Kremlin-mandated projects could reach 1.2 trillion rubles, according to the Finance Ministry, or nearly half the expected budget deficit for next year. VEB faces $7.3 billion in debt repayments over the next few years and effectively has only one source of significant funding — the state,” Bloomberg continues, citing government officials.
Speaking of the Finance Ministry, former FinMin Alexei Kudrin – who unceremoniously quit in 2011 after a famous spat with then President Dmitry Medvedev – warns that the situation in the economy “isn’t very good.” According to comments Kudrin made to Interfax, inflation in 2016 will be ~150bps above the official 6.4% forecast and with oil prices below budgeted level of $50/bbl, Russia may witness significant reduction of government expenses in several industries, or tax increases. What would Kudrin do to ameliorate the situation you ask? Well, we may be about to find out because now, he looks set to return to the government to assist in pulling Russia out of recession.
“Former Russian Finance Minister and investor favorite Alexei Kudrin is in talks with Vladimir Putin and other top officials about returning to a senior post to help deal with worsening economic troubles,” Bloomberg reported earlier today, citing unnamed officials. “Kudrin has met privately with the Russian president and Prime Minister Dmitry Medvedev as recently as last week to discuss the plans, though no formal offer has yet been made.”
“Markets will like Kudrin’s return to government as they will assume this means serious fiscal consolidation and some significant and much-needed structural reform — if Putin lets him take on the ‘power vertical,'” Tim Ash, head of emerging-market strategy at Nomura in London said.
As is the case in a number of emerging markets, the worry is that eventually, the public will become fed up with rapidly deteriorating economic circumstances even if, as is the case with Russia, part of the blame can be placed with outside antagonistic forces. On that note, we’ll close with one last quote from Bloomberg:
Speaking on condition of anonymity, one senior government official warned earlier this month that the government has only a few months before worsening economic conditions begin to fuel social unrest.
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