Revenues Forced to Match Spending

At the end of September, the Russian government submitted next year’s draft budget to the State Duma. According to formal policies, the project is meant to describe the budget’s next three years, but this now comes off as nothing more than a symbolic gesture from a time when the government actively imitated being both in control of the budget’s stability and was also able to predict what was going to happen next. Today, this is no longer applicable, as both the budget and tax laws undergo changes every year. The most intriguing question of 2023 remains whether the Russian government will abandon its conservative approach to its budgetary and macroeconomic policy under the pressure of sanctions and war spending. Will it print more money to stimulate import substitution, cover the needs of the war and provide social support for those groups it deems necessary to maintain political stability in the country?

The draft budget submitted to the Duma includes a 2% deficit of GDP, which is supposed to be made up for mostly through domestic borrowing. In the event of a protracted war and further sanctions, the government will fund the necessary recurrent expenditure anyway, and the amount will almost certainly end up being higher than planned. However, the final size of the looming deficit also depends on whether the government will be able to collect the budgeted revenues. The West announced its price cap on Russian oil only after the draft budget was submitted to the Duma. Its effects could turn out to be quite serious. Several things stand in the way of the 2% deficit prediction: the global economy’s impending recession, revenue in the Russian budget depending on oil prices, the effect of new sanctions, as well as economic activity within the country.    

Oil and Gas Revenues: How Much Does Toxic Oil Cost?

In 2023 revenues will amount to 26.13 trillion rubles according to the draft federal budget, and expenses to 29 trillion rubles, meaning that expenses will exceed the planned revenues by 2.9 trillion rubles. Export revenues in 2023 will decrease by 10% to $529 billion. Oil and gas revenues, primarily from the export of oil and petroleum products, should account for 34.2% of all budget revenues next year. Thus, oil prices account for a third of all budget revenues. The prices depend on both market prices and on the price at which Russia will be able to sell its own oil.

The government expects that oil and gas revenues will bring $130.9 billion in revenues for the budget, and the price of Russian oil will be at $70.1 per barrel. This means that from every dollar of the oil price, the government can expect $1.9 billion in revenue. The last time such figures were observed were in 2019, before COVID. Although this can be partially achieved through increasing the oil industry’s tax burden, the real price of oil remains the most important part of this plan’s workability.

Meanwhile, as central banks around the world hike interest rates to fight rising inflation, the global economy is plunging into a recession. This process is already putting pressure on oil prices and will continue to do so. At the same time, OPEC+ countries are trying to support oil prices; on October 5, the alliance announced an agreement to reduce oil production by 2 million barrels per day from August quotas and continue to reduce it in order to keep oil prices above $90 per barrel. The alliance’s decision does not imply Russia actually reducing production. “Our output will be reduced from 11 million to 10.5 million barrels per day,” Deputy Prime Minister Alexander Novak has said.

The real price of oil and the way in which Russia will adapt to the oil embargo remain the crucial unknown parameters in the budget. Two months before the oil embargo came into force, exports of Russian tanker oil to the EU fell by 60% from February levels (from 1.5 million to 600 thousand barrels per day), and exports to Asia plateaued. Russian oil after the start of the war was being discounted by around $30. However, the average discount from mid-August to mid-September was $21.5 per barrel, against $18.7 a month earlier.

According to Marcel Salikhov, Head of the Economic Department of the Institute for Energy and Finance at the Higher School of Economics, “The current price of Urals is about $65 per barrel. The forecast for 2023 suggests that the average price next year will be higher than the current quotes, which is quite optimistic, given the possible recession in the global economy.” In order for the budget to work, not only do the OPEC + countries need to keep prices above $90 per barrel, but the discount on Russian oil should not exceed 25%.

Since budget expenditures are calculated in rubles, the ruble equivalent of export earnings is also relevant for revenues, that is, they will also depend on the exchange rate. According to Renaissance Capital economists (Re: Russia have seen their forecast), the most likely range for the ruble exchange rate for 2023, taking into account the possible effects of the oil embargo, will be 73–77 ₽/$ in the event of partial redirection of Russian supplies to Asia and 63–69 ₽/$ with full redirection. Plus, in addition to the effect of the embargo on the devaluation of the national currency, the ongoing recovery of imports will also play a role.

Non-oil and Gas Revenues

In order to fulfil the budget plan, the government must also collect non-oil and gas revenues. The forecast of economic dynamics plays a fundamental role in determining the tax levels of such revenues. According to current government projections, the Russian economy is estimated to decline by only 0,8% in 2023. This optimism is based on business activity recovering at a post-COVID pace, notes Alexander Isakov (an economist at Bloomberg Economics for Russia) in his comments regarding the draft budget for Re: Russia. With this forecast, the risk of a shortfall in income is about 1.5 trillion rubles, Isakov states. 

The Russian economy contracted much less this year than spring estimates had predicted. It is expected to actually contract to about 2.9% of the GDP. But here a fundamental issue arises: while the Russian government is projecting an "optimistic trajectory" into the future, Western forecasting agencies believe that a recession is inevitable, although it may be postponed by a few years. Thus, the World Bank predicts a 3.6% reduction in Russia's GDP in 2023. The government estimate does not take into account the effects of the president’s mobilisation announcement, which could negatively affect the volume of the tax base and, as a result, budget revenues. According to Isakov, if 300,000 people are called up (about 0.9% of the 33.9 million men in Russia aged 20 to 55), the decline in GDP this year will be sped up by 0.25 percentage points to 3.75%, as the workforce will shrink.

The War and Structural Adjustment Budgets

According to Finance Minister Anton Siluanov, next year's deficit could exceed the projections of the current budget, which he calls the "most difficult" of his career. It is also very likely that the extremely optimistic forecasts of the government regarding budget  revenues are due to the government having formed the budget “from expenses”, that is, from expenses that are considered the necessary minimum to support and stimulate the economy in the face of sanctions and “structural adaptation”.

In the conditions of a partial isolation of the economy, the government will be forced to use internal state investments to fund both import substitution and the building of new technological and production chains focused on imports from Asian countries. The idea of such investments enjoys support from influential lobbies in the Russian government and political elite. Thus, in early August, the Center for Macroeconomic Analysis and Short-Term Forecasting (CMASF), which has close ties to Deputy Prime Minister Andrei Belousov, published a statement pointing out that in the context of lower rents and continued sanctions against Russia, a less conservative policy will be required to stimulate investment growth than the one seen in the last 15 years. According to the CMASF’s calculations, this will ensure economic growth in 2025–2030 at an average rate of 2.5–2.7% per year.

Of course, in any scenario (with the possible exception of a change of head of state), Russia will extensively use its budgetary funds to continue the war in Ukraine and maintain stability in the occupied territories. On one hand, export niches are shrinking, and on the other hand, the need for domestic investment is growing. Will the Russian government manage to maintain its principled focus on macroeconomic stability, or will more risky strategies be adopted that could undermine the conservative budget structure? Under mounting political pressure, officials are being forced to respond to short-term risks, even if they are well aware of the delayed negative consequences of these responses.