The price is right Why Russia’s economy appears to be booming in the face of sanctions
Last week, Russia’s Finance Ministry released its preliminary report on the federal budget indicators for the first quarter of 2024, revealing results that surpassed expectations. Government earnings are soaring above last year’s figures, a surprisingly positive outcome partially attributed to high oil prices and increased consumer spending. With more money in its coffers and the war in Ukraine still raging on, the Russian government is only increasing its spending. However, this upward trend raises concerns about continued inflation. Meduza explains what led to this sudden influx of funds and what economists think about the Russian economy’s outlook.
Why are Russia’s oil and gas revenues up?
In the first quarter of 2024, oil and gas earnings surged by nearly 80 percent compared to the same period in 2023, injecting 2.9 trillion rubles ($31 billion) into Russia’s federal budget. There are a number of factors that led to this sizeable increase. Firstly, oil prices are on the rise. At the beginning of the year, a barrel of Brent crude oil was trading at $80; now, it’s going for more than $90. The U.S. has been replenishing its raw material reserves as OPEC countries cut production, leading to a shortage that’s driven up prices. Furthermore, the conflict between Israel and Hamas has threatened shipments through the Red Sea, raising concerns among investors about potential disruptions to the supply chain. Moreover, Iran, one of the world’s major oil suppliers, has now entered the conflict.
Secondly, Russia has revised its method for calculating the mineral extraction tax (MET). In 2023, revenues were collected based on actual prices for Urals oil, the blend used as the price benchmark for Russian oil exports. However, the returns were unpredictable: discounts on raw materials constantly fluctuated in response to sanctions pressures. Starting this year, there’s a new system in place. If the price difference between Urals oil and Brent isn’t too significant, the authorities still use the actual Urals oil price for tax calculations. However, if the gap widens, the Russian Finance Ministry imposes a maximum discount of $20 per barrel in its calculations. This means that if a barrel of Brent is selling at $100 and a barrel of Urals is selling at $50, the ministry disregards the actual price and levies taxes based on a price of $80 per barrel. This maneuver has proven effective: analyst Kirill Rodionov calculated that at the beginning of last year, the average price used for tax calculations was $51 per barrel. Now, with the new calculations, the average is closer to $70.
The Russian government has also seen an increase in revenues from its quarterly profit-based tax (NDM). Unlike MET, which is paid based on the volume of extracted raw materials, NDM is levied on profits from sales. This allows companies to defer their tax burden until after they’ve become profitable, which, in theory, encourages them to invest in developing new reserves. Likewise, when an oil deposit begins to deplete, the tax starts to drop off, incentivizing companies not to abandon the project. The more companies increase their overall production, the more tax revenue the government stands to make once the companies turn a profit.
When a company transitions to paying NDM, it continues to pay MET, albeit at a heavily reduced rate. Nevertheless, due to the advantages of tax deferral, the profit margins for certain companies remain higher under the combined scheme than when paying only MET at the full rate. Russia has been steadily expanding this profit-based tax regime, growing its share of the federal budget’s oil and gas revenue from 9 percent to 52 percent over the last five years. According to Rodionov’s calculations, federal revenue from NDM went from 211 billion rubles ($2.3 billion) in the first quarter of 2023 to 587 billion rubles ($6.3 billion) in the first quarter of 2024.
The Finance Ministry’s report also highlights a one-time revenue boost from a temporary increase in the MET rate mandated in January 2024. In the fall of 2023, the Russian government halved damper payments, a type of subsidy that compensates oil companies for selling fuel on the domestic market. Unsurprisingly, this led to a sharp increase in gas prices in Russia. The government quickly abolished the unsuccessful reform but decided to compensate for the damper payments through a higher MET.
Since Russian tax legislation doesn’t allow for MET to be applied retroactively, a higher MET rate was imposed on companies in January of this year, allowing the Finance Ministry to make up for last fall’s budget losses. Although the report doesn’t disclose the exact amount, Interfax’s sources estimated it at around 190 billion rubles ($2 billion).
The ruble’s depreciation could also have impacted the statistics. At the beginning of 2023, the Russian ruble was stronger, trading at around 70 to the U.S. dollar, meaning fewer rubles for every dollar of oil earnings, notes Evgeny Nadorshin, the lead economist at PF Capital. The ruble weakening to 90 to the dollar automatically led to an increase in budget revenues from oil sold abroad.
Taking all of these factors into account, Russia’s Finance Ministry predicted that oil and gas revenues will continue to exceed the baseline level, saying it observes a “stable positive trend.”
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Where else is the money coming from?
While government earnings from oil and gas have certainly gone up, Egor Susin, the managing director at Gazprombank Private Banking, highlights other revenue streams as the primary positive contributors to the budget. Over the course of a year, non-oil and gas revenues have risen by 43 percent, bringing in 5.8 trillion rubles ($62 billion) in the first quarter alone.
The Finance Ministry attributed much of these gains to turnover taxes: taxes levied on the volume of business activity or turnover of goods and services rather than on profits. For instance, value-added tax (VAT), brought in 3.4 trillion rubles ($36.3 billion) in three months. Russia is experiencing a growth in domestic demand, as analysts at Raiffeisen Bank have pointed out, and consumer spending is increasing despite inflation.
As a rule, Russia’s Central Bank sees high demand as a risk for further inflation. For the Finance Ministry, however, the situation is beneficial — at least in the short term. While the government’s budget also suffers due to inflation (e.g. with the cost of infrastructure projects going up), the ministry can acquire funds immediately and then distribute the rise in expenses over time.
The ministry also mentions “planned receipts of one-time non-tax revenues.” Generally speaking, “non-tax revenue” refers to things like fees for the use of state property, customs duties, environmental levies, and so on. It’s possible that in this case, the ministry is referring to the sale of state-owned assets. In 2023, the Russian authorities initially aimed to generate 1.8 billion rubles ($19.2 million) through privatization. However, due to urgent budgetary needs, they ultimately sold off 29 billion rubles ($309.7 million) worth of property. This year, the ministry has set a significantly higher target from the outset: selling 100 billion rubles ($1.07 billion) worth of state-owned assets.
Although the Finance Ministry acknowledged that last year’s low baseline facilitated such noticeable growth, it views the current situation with non-oil and gas revenues as stable and anticipates “continued rapid revenue growth.” Raiffeisen Bank analysts concurred, predicting that consumer activity in Russia will likely remain high “in the coming months.”
Will Russia start spending more?
The Russian government has already ramped up its spending. Compared to the first quarter of 2023, budgetary expenses have increased by 20 percent.
With the onset of the full-scale war in Ukraine, federal budget expenditures acquired a pronounced seasonality, rising sharply at the beginning of the year when the government pays out advances on state contracts. In the first two months of 2024 alone, expenditures amounted to 6.5 trillion rubles ($69.4 billion) while revenues totaled only five trillion ($53.4 billion), resulting in the Finance Ministry nearly exhausting the deficit limit for the entire year. Last year, the same trend raised concerns; in the end, however, the deficit didn’t stray too far from the target.
With current oil prices, Russia’s situation has already begun to improve. While the first quarter saw an overall deficit, March’s budget boasted a surplus of 860 billion ($9.2 billion). Analysts from Raiffeisen Bank say the Russian government’s spending spree at the beginning of the year “shouldn’t be perceived as a risk factor” to the budget. According to their forecasts, the deficit will remain this year, but it will be smaller than in 2023: no more than 2.5 trillion as opposed to last year’s 3.2 trillion ($26.7 billion versus $34.2 billion, respectively). Analyst Semyon Novoprudsky thinks the deficit could be even lower, despite the increase in government spending.
The budget for the current year includes expenditures totaling 36.6 trillion rubles ($390.9 billion). However, this figure was approved before President Vladimir Putin announced five new national projects and numerous other social welfare programs during his annual address to Russia’s Federal Assembly. Economists estimated the cost of their implementation at 1.2 trillion ($12.9 billion) per year. This will be likely offset by tax increases, which, just a month ago, was raising concerns among economists.
Now, analysts from the Telegram channel MMI posit that “with current oil prices, there’s no threat to deficit stability.” Egor Susin from Gazprombank concurs, saying that “the budget appears to be in good shape for the next few months.” Faridaily, run by journalists Farida Rustamova and Maxim Tovkailo, predicts that the Russian government “will be able to finance extravagant military spending, social payments, and infrastructure development without any problems.” Meduza couldn’t find any pessimistic comments from experts.
So, Russia’s economy is just fine?
There are certainly still risks for the Russian economy. In theory, an increase in revenue allows the Finance Ministry to spend more than planned — as it did last year. This injects more money into the economy, further fueling consumer demand in the face of limited supply. Russia’s Central Bank consistently stresses that this has adverse effects on price inflation. And while it aims to keep inflation at 4–4.5 percent in 2024, economists have expressed doubts that this target is feasible.
Elvira Nabiullina, the head of the Central Bank, has noted that maintaining a high key rate helps curb inflation. (Currently, the Central Bank has the key rate set at 16 percent.) With interest rates higher, saving becomes more attractive and credit becomes more expensive, which, in turn, cools demand. In the second half of the year, the Central Bank plans to wait for a slowdown in price growth and then begin to reduce the key rate; however, it might postpone the process. Previously, analysts at the government-owned bank Promsvyazbank expected the key rate to be brought down as early as June; now, they’re predicting a decrease no sooner than August.
Increasing budget expenditures also heighten risks for the national currency exchange rate. The Finance Ministry supports Russian businesses by providing them with funds for production, which often requires imported components and equipment. This means companies have more capital to purchase foreign currency for such transactions. Russia’s Economic Development Ministry officially predicts that the average exchange rate for this year will hover around 90 rubles to the U.S. dollar. However, SberCIB Investment Research predicts the ruble will weaken to 95 against the dollar by the second quarter, while the Moscow-based investment company Tsifra Broker expects the exchange rate to hit 100 rubles to the dollar by the end of April.
Government spending won’t be the only influence on this, of course. The overall state of Russian exports will also impact the ruble: declining overseas shipments of raw materials are reducing foreign currency inflow, creating a deficit. Meanwhile, the population is buying more and more dollars and euros. In February, Russians spent 100 billion rubles (the equivalent of $1 billion) on these currencies; in March, that figure rose to 155 billion ($1.66 billion).
The situation may worsen if sanctions on Russian oil begin to take effect. So far, both lax monitoring and loopholes involving third-party sales have largely enabled Russia to bypass the G7 and E.U.-imposed $60 “price cap” on Russian crude oil. Even so, G7 nations have yet to propose an alternative to the price cap; they’ve only threatened to lower it even further. And while Western governments have imposed sanctions on a few companies for circumventing the ban, such measures are not widespread.
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