Economic asphyxiation puts Russia in China’s orbit
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.
By Pierre Briancon
LONDON, March 20 (Reuters Breakingviews) -The Russian economy only shrank by 2% in 2022, defying more pessimistic forecasts. Instead of a meltdown, it entered an era of slow suffocation. Cut off from foreign markets by sanctions, Vladimir Putin’s government is at pains to finance budget deficits that would have been manageable in peacetime. It will struggle to meet funding needs that may reach $90 billion this year. The financial difficulties are pushing Russia further into the sphere of influence of China’s President Xi Jinping, who visits Moscow this week.
Russia’s fiscal deficit stood last year at 2.3% of GDP, according to official numbers. The government forecast for 2023 is for a reduction to 2% of GDP, which would put the state’s financing needs at some $40 billion.
That sum would not be hard to fund in normal times, but an invasion of Ukraine that triggered a slew of financial punishments from the West means these are not normal times for Putin.
For a start, the forecast looks optimistic.
The government’s plans were based on oil trading at $70 a barrel. Taxes on energy exports account for more than 40% of the government’s revenue. After an EU oil embargo, linked to a G7 price cap, Russian crude oil prices fell to less than $50 a barrel in the first two months of the year. They are now around $46.
According to estimates from the Institute of International Finance, each $10 movement in the price of a barrel is worth $15 billion a year to the state budget. So, in the first two months of 2023, the government has already lost $5 billion. According to Russian economist Alex Isakov, the budget deficit this year could even reach $90 billion – the equivalent of 4.5% of GDP – because the fall in oil prices is only part of the problem: non-oil revenue, such as VAT, could stagnate due to the economic recession, while spending keeps increasing.
Even this would be manageable in peacetime. Russia, however, has lost access to world capital markets, and because of sanctions, the rouble is convertible in name only. Global investors, who once held up to 30% of its sovereign debt, are now gone. One way to cut the deficit would be to reduce spending, but the government doesn’t want to touch two major budgets. Welfare payments and pensions, which amount to nearly a third of spending, are indexed to inflation and ringfenced by law. And after repressing political protests against the war, the Kremlin may be wary of stoking popular economic anger ahead of a presidential election scheduled for 2024. The other major source of spending – defence – is up by more than a third in 2022 to $60 billion because of the war in Ukraine and will not shrink any time soon.
Barring spending cuts, the government has three ways to fund its budget needs. The first is to issue bonds that the country’s banks refinance at the central bank. That would fuel inflation. The Bank of Russia, with interest rates at 7.5%, has a 4% inflation target that it missed last year, when prices jumped 12%. It has estimated that inflation will run at around 7% this year. Its indirect financing of the budget deficit increases the inflationary pressure it wants to suppress.
The second is a form of “financial repression”, channelling money from companies to the government’s coffers. New taxes on the country’s energy giants and big mining companies are in the works.
Moscow has tweaked the way it calculates taxes on oil exports to extract more revenue from the sector. Gazprom GAZP.MM, the state-owned energy group, already had to pay an extra $20 billion at the end of last year, taking its total tax bill for 2022 to some $80 billion. And Finance Minister Anton Siluanov told Russia’s businesses last week that they will have to contribute the equivalent of nearly $4 billion to the state budget through a special tax on “excess profits”.
Banks, on the other hand, will be spared windfall taxes but state-controlled lenders like Sberbank SBER.MM or VTB VTBR.MM will have to keep paying the fat dividends long demanded by the government.
Finally, Moscow can use the resources of the National Wealth Fund, the rainy day facility once set up to use part of the oil revenue to finance pensions. The fund held $147 billion on March 1, down 23% since its August 2021 peak. In the last few months, sales of its gold and currency holdings have helped finance the state’s budget.
Dipping into the fund, though, will push Moscow further into China’s financial orbit, Russian economist Alexandra Prokopenko has noted. Moscow upped the Chinese currency’s share of the NWF’s holdings to 60% last year. A draft bill would allow the government to increase that share to 80%. Russia has become the fourth largest offshore trading centre in yuan outside Hong Kong, and already its citizens can only use China’s UnionPay system if they want to pay with cards when travelling abroad.
Trade between Russia and China jumped 34% last year and continued to soar in the first months of 2023, with a nearly 50% increase in Beijing’s oil and gas imports. China’s resulting trade deficit with its neighbour increases the share of yuan in Russia’s foreign currency reserves, and the role it plays in domestic finance. But the yuan is a managed currency, whose level is determined by Beijing’s economic and political interests. Moscow is plunging deeper into an asymmetric relationship that will limit its economic sovereignty. Meant as a sign of a new partnership between the two countries, this week’s visit of Xi could instead underscore this new dependency.
In the short term, financial hope for Russia can only come from a significant increase in oil and gas prices. But this is not likely to happen. The U.S. Energy Information Administration sees Brent crude stabilising this year around its current level and falling by 7% in 2024. That would see Russian crude trading at around $55 a barrel, assuming the current 30% discount to the benchmark.
If the forecasts are right, Russia is facing the prospect of two long years of fiscal suffocation, with the main source of relief coming from Beijing. Submission in the East looks like the price to pay for aggression in the West.
Follow @pierrebri on Twitter
Chinese President Xi Jinping is expected in Moscow on March 20 for talks with his Russian counterpart Vladimir Putin, who hopes to make the visit a show of solidarity more than a year after the start of the war in Ukraine.
Beijing published last month a 12-point paper calling for dialogue and a settlement in Ukraine, but it contained no concrete proposal for how the conflict might end.
Trade between China and Russia increased by 34% last year as Chinese imports of oil and gas jumped 50%.
Editing by Francesco Guerrera and Oliver Taslic
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