Three-way Fork: Declining revenues force the government to choose between dipping into the National Welfare Fund, sequestration, and devaluation
OPEC+ continues to pursue accelerated oil production expansion amid a global economic slowdown. This increases the likelihood of oil prices sliding towards $50 per barrel. An additional threat is the intensification of sanctions against Russian oil, which will push its actual price even lower.
The government hopes to partially offset the loss of oil and gas revenues with non-oil revenues. However, higher tax rates may not deliver the desired effect. The Russian economy has entered a period of stagnation, and its civilian sectors are close to recession. While in previous years, high export revenues and increased budget spending led to an expansion of the domestic tax base, its contraction will now be exacerbated by the reduction in expenditure.
In the first quarter, revenues were relatively high, largely due to the inertia of strong performance at the end of 2024. Although the deficit in the first quarter exceeded the annual target set in the budget, unlike in previous years, this situation cannot be corrected in the second and third quarters. The situation will worsen for both oil and gas and non-oil and gas revenues.
The government has three options. The first is to use the National Wealth Fund to cover the deficit. This seems natural, but the rapid depletion of the NWF would deprive the Russian authorities of their ‘safety net,’ which the Kremlin is very sensitive about. The second is to lower the ‘cut-off price’ to $50 per barrel. This scenario would preserve the ‘safety net’ but would imply a de facto sequestration of the budget and lower inflation.
This could become a problem with respect to military expenditures. The approved budget assumes minimal growth for these expenditures, but should active military operations continue and a new Russian offensive attempt take place, an increase in military spending will be required. Without this increase, it will be impossible to maintain the pace of replenishing ‘manpower’ while also not reducing spending on actual defence needs.
Finally, another traditional method for rebalancing budget spending and revenues is devaluation. This would fuel inflation and lead to an actual uniform reduction in real spending (excluding military spending). Given the strong ruble and the high growth rate of citizens' incomes in previous years, this scenario appears to be preferable for the Kremlin.
If active hostilities continue, this would lead to an even greater increase in the proportion of actual (including social payments) spending on the war, which would exceed the planned amounts. Meanwhile, sectors not related to military production would suffer from a reduction in state demand, and citizens would face stagnation or a decrease in real incomes.
The budget floats on oil
On 3 May, OPEC+ suddenly announced another increase in oil production – in June, supplies will rise by 411,000 barrels per day. Production was increased by the same amount in May. Initially, the cartel planned to expand production cautiously, by 135,000 barrels per day each month. Thus, in just two months, the supply will increase by volumes previously expected to be reached over a six-month period.
On 5 May, the first day of trading, the price of Brent crude fell to $60 per barrel, and this may not be the limit. According to Reuters sources, by the end of October, the alliance members may completely lift voluntary production restrictions. As a result, taking into account the production cuts that have already taken place, 2.2 million barrels per day will be thrown onto a market that is already in surplus. If Donald Trump's tariff wars slow down global economic growth, the new equilibrium price for Brent, as we have previously written, could drop to $50 per barrel (→ Re:Russia: Departing Prosperity). This would deal a serious blow to the Russian federal budget, which was planned for 2025 based on a price of $69.7 per barrel of Urals.
Even before this news emerged, the Russian Ministry of Finance sharply increased its forecast budget deficit for 2025 from 1.17 trillion to 3.8 trillion rubles, based on the revised macro forecast of the Ministry of Economic Development. As in the previous version, GDP growth was expected to be 2.5%, but the price of Russian oil was reduced from $69.7 to $56 per barrel. Inflation, on the contrary, was brought closer to more realistic values, to 7.6% instead of the initial 4.5%. The forecast exchange rate of the ruble strengthened from 96.5 to 94.3 rubles per dollar. Accordingly, oil and gas revenues, according to the Ministry of Finance's forecasts, will amount to 8.3 trillion rubles instead of 10.9 trillion rubles.
Oil and gas revenues in the first quarter were already about 10% lower than last year, when they exceeded 2.9 trillion rubles. However, in April, Russian oil, according to Bloomberg, was priced at only about $50 per barrel, which is even below the 'ceiling price' set by the budget rule ($60 per barrel). Meanwhile, the ruble exchange rate fluctuates in the range of 80-85 rubles per dollar. It is likely that the updated macroeconomic forecasts of the Ministry of Economic Development and the Central Bank will have to be revised again. However, it is very difficult to predict what the price of Russian Urals oil will be. According to Argus, quoted by Bloomberg, the discount was around $10 in April. However, Argus rarely revises its spread estimate, notes Sergei Vakulenko, an expert at the Carnegie Berlin Centre.
At the same time, the decline in the actual price of Russian oil below the $60 ceiling introduced by the G7 countries leads to the involvement of legal carriers, notes Bloomberg. The threat of secondary sanctions disappears, and as a result, the discount on Russian oil to Brent oil is reduced to a minimum. In this situation, the Western coalition has the potential opportunity to lower the price ceiling to $50 or $45 per barrel. With proper control, this could restore the discount on Russian oil to the usual 10-12%, which would mean that the price of Russian oil could fall below $50.
However, Donald Trump seems to have an aversion to the 'price ceiling' tool, which he associates with 'Biden's sanctions'. At the same time, Trump's proposed scenario of imposing duties on buyers of Russian oil seems somewhat unrealistic. On the one hand, it would put additional pressure on the already destabilised American economy, which is struggling due to Trump's tariff wars. On the other hand, if it were applied to all Russian oil, it would destabilise the oil markets. Overall, the threat of additional pressure on Russian oil, amid a general market surplus and falling prices, exists and appears to be a serious scenario for Moscow.
Will the tax manoeuvre work?
But that is not all the bad news for the Kremlin. According to the Ministry of Finance’s expectations, the reduction in oil and gas revenues will be compensated by an increase in non-oil and gas revenues – by 0.8 trillion rubles. As we wrote earlier, Moscow began preparing for a possible price drop last year and shifted part of the burden of high government expenditures, inflated by the war, onto Russian citizens and businesses by raising taxes (→ Re:Russia: The Non-Victory Budget). However, the effect of this manoeuvre may turn out to be significantly smaller than the government expects.
In the first quarter of 2025, according to preliminary data from the Ministry of Finance, the federal budget was reduced to a deficit of almost 2.2 trillion rubles, or 1% of GDP. The budget law initially envisaged a planned deficit for the whole of 2025 of 1.17 trillion, or 0.5% of GDP. Such a high deficit at the beginning of the year is traditionally associated with advance financing of expenditures. In the first quarter of 2025, the Ministry of Finance has already fulfilled 27% of the annual expenditure plan. In the first quarter of 2024, this figure was 25.4% of the planned and 23.2% of the actual annual expenditures. Over the past 15 years, an average of 22% of annual expenditures were fulfilled in the first quarter, according to calculations by Ilya Sokolov, head of the budget laboratory at the Institute for Economic Policy (IEP). According to his estimate, if the pace of expenditure growth observed in the first quarter continues, a monthly increase in the deficit of 1-1.5 trillion rubles can be expected throughout the second quarter.
In the first quarter, non-oil and gas revenues were still relatively high (+10.6% year-on-year), largely due to inertia from strong indicators at the end of 2024, notes Ilya Sokolov. Specifically, in the first quarter, VAT and profit tax, calculated based on the tax bases of previous periods, were collected. The mineral extraction tax revenues arrive with a one-month delay, meaning the factor of cheaper oil did not yet affect the revenues in the first quarter. In the second quarter, against the backdrop of an economic slowdown and worsening external trade conditions, pressure on budget revenues will increase. As a result, the growth in non-oil and gas revenues that the Ministry of Finance is counting on may not materialise.
Although in theory, raising the profit tax rate from 20% to 25% should lead to higher profits, in a recession or economic stagnation, profits will fall sharply, and raising the rate will only further limit the investment opportunities of enterprises. Certain deterioration in the financial position of enterprises is already being observed. And recession – at least in the civil sector of the manufacturing industry – looks like a fait accompli, according to experts at the Centre for Macroeconomic Analysis and Short-Term Forecasting (CMASF).
According to their data, the output of civilian products in the first quarter decreased on average by 0.8% per month, and in March – by 1.1% compared to February (seasonally adjusted data). As a result, the production level dropped to its lowest since April 2023. In annual terms, the industrial production index in March was 100.8% across all industries and 98.4% in sectors without significant participation from the defense industry. At the same time, CMASF experts note that in March, there was a frontal reduction in the production of finished metal products, where defense-related products traditionally have a significant share. Output fell by 5.5% after an 8% increase in February and a 17.1% drop in January.
While in the previous three years, high export revenues and expanded budget spending fuelled the economy, increasing the tax base for non-oil revenues, its sharp slowdown will now lead to a reduction in export revenues and a narrowing of the tax base for non-oil revenues, than the government had planned.
Three paths to rebalancing
When the price of Russian oil falls below $60 per barrel, according to the budget rule, the oil and gas revenue shortfall should be covered by the sale of liquid assets from the National Wealth Fund (NWF). As of the beginning of April, these assets amounted to just under 3.3 trillion rubles. The NWF has enough funds to ensure that the Ministry of Finance does not need to worry about covering the lost oil and gas revenues. However, if oil remains cheap and the ruble stays strong, these reserves could be depleted within a year, according to Sokolov from the IEP. While this scenario seems economically natural, it poses risks for the future if oil prices remain low. It is likely that the Kremlin will try to maintain some kind of 'safety net' by using its financial 'stash' sparingly this year.
An obvious alternative scenario for rebalancing the budget amid declining revenues is spending cuts. Finance Minister Anton Siluanov has already proposed amending the budget rule by reducing the 'ceiling price' from $60 to $50 per barrel, in order to 'minimise external risks and ensure that the liquid assets of the NWF can cover three years of uninterrupted financing for spending obligations under a stressful oil market scenario.' Thus, Siluanov essentially acknowledged that the budget situation is critical, comments former Central Bank Deputy Chairman Sergei Aleksashenko. According to Aleksashenko, spending cuts can be expected as early as this year. He points out that the topic was taken up by Central Bank Governor Elvira Nabiullina. At a press conference after the last meeting of the Central Bank's Board of Directors on the key rate, she noted that a reduction in the ‘cut-off price’ (i.e., the actual sequestration of spending) would be an additional disinflationary factor.
Lowering the ‘cut-off price’ to $50 per barrel is equivalent to a reduction in budget spending of approximately 0.8% of GDP per year, according to calculations by analysts at the Telegram channel ‘Hard Numbers.’ This does not necessarily require cutting spending in nominal terms – it is enough to simply abandon indexation of individual items or entire sections. However, this could also be a problem. As we recently wrote, the government has planned for a fairly modest growth in military spending for 2025, at only about 4% in real terms (→ Re:Russia: Budget for Meat Assaults). At the same time, if Russia continues its active attempts to advance in Ukraine and, accordingly, loses contract soldiers and recruits new ones at the same pace, defence spending will be insufficient to build up its military potential (purchasing weapons, developing the defence industry and maintaining nuclear forces). The current military budget has already been allocated in a way that requires either a reduction in arms production or slower replenishment of 'manpower.' As a result, in the scenario of continued active military operations, the Kremlin will be forced to increase military spending, not cut it.
Finally, the third traditional method for rebalancing budget revenues and expenditures is the devaluation of the ruble. Revenues in ruble terms automatically increase, while dollar-denominated expenses are significantly reduced. However, this approach simultaneously spurs inflation, and budget expenditures fall in real terms. The inflation that will most likely occur in this scenario will probably not be lower than last year’s, combined with higher import costs and a reduction in real expenditure – a rather unpleasant mix. The costs of rebalancing in this case will largely be borne by the population. However, the current overvalued ruble and the growth in citizens' income in recent years make this method more preferable and convenient for the government. In the scenario of continued active military actions and attempts at further offensives, it would lead to an even greater increase in the proportion of actual (including social payments) military expenditures in the budget. At the same time, sectors not directly related to military production will suffer from reduced government demand, while citizens will face stagnation or a decrease in real incomes.