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Swiss cheese budget. Because of the war Russians will face health care, housing and utilities budget cuts and currency devaluation in 2023

Russia enters the new year with the most fantastic budget in 20 years - almost no one believes it will be fulfilled. Oil and gas revenues are falling, the national debt is growing, and the reserves, so much cherished during the pandemic, are running out. This time it is not only ordinary Russians who will suffer, but also the oligarchs and the billionaires who will become the main sponsors of military spending. The Kremlin is sparing no expense on the war; 50% more money will be spent on security and law enforcement agencies, while health care and utilities spending will be cut back. Experts believe the government will have to raise taxes again while the ruble exchange rate will continue to decline, which will lead to higher prices in the long run.

  • A record deficit: the war has boosted spending

  • “Untouchable” NWF gutted to meet army needs

  • Everything for security, nothing for the economy: what will Russia spend money on in 2023?

  • Oil and gas companies will pay

  • “Price cap” and oil embargo will lead to a hole in the budget

  • Bit by bit. Where else can the Finance Ministry look for money?

  • A super hard task: how to deal with the deficit?

  • “Printing press” risks

  • Waiting for a new devaluation

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A record deficit: the war has boosted spending

The foundation of Russia's 2023 budget turned out to be fragile: instead of the initially planned $18 billion surplus by the end of 2022, the government will face a record deficit of 2% GDP, or $39 billion. Finance Minister Anton Siluanov had to adjust his estimate of the budget deficit several times during the year. The reason is the war, or the “new challenges” as the members of the Russian government prefer to call it. But even the new estimate is considered to be too optimistic: experts admit that by the end of the year the deficit will rise to 3.5% GDP ($830-920 million), which is comparable with the 2009 budget of the global financial crisis era.

The Russian budget dynamics in 2022 perfectly demonstrates the appetites of the “new goals”: the positive balance has been evaporating since spring. Increased military spending has been systematically “eating up” the budget surplus: to $19 billion in May, $18 billion in June, $6.5 billion in July, $1.86 billion in August and $0.75 billion in September. The trend reversed in October, due to a temporary increase in oil prices and supply volumes as well as the one-off increase in the mineral extraction tax (MET) for Gazprom.

This maneuver led to a surplus in October ($1.74 billion) and November ($7.55 billion), and the total effect of the maneuver for the budget is estimated at $17 billion (with $5.64 billion expected in December). “Without them (the revenues from Gazprom), October and November would have looked bad, if that's the right word - but the oil and gas revenues for the year as a whole look quite nice without additional contributions. There has been an over-performance with a large excess against what was budgeted for the year,” Evgeny Nadorshin, chief economist of the consulting company PF Kapital, said in an interview with The Insider.

Without the additional revenues from Gazprom, the federal budget would have closed with a deficit of about $4.75 billion in January-October. “In the fourth quarter, the budget will receive about $27 billion from Gazprom, and Gazprom's payments are the factor that determines why our budget ended up with a surplus at the end of the year's 11 months. Of course, it is not the key factor, but if we ask ourselves why the budget is in surplus despite the economic downturn, well, it's the Gazprom factor that's keeping it in surplus,” Alfa-Bank's chief economist Natalia Orlova says.

The deficit is driven by the strong increase in spending: in the first 11 months of the year spending has increased by 21% compared to the same period of 2021 and exceeded $330 billion. If by November 2021 spending reached 93% of the plan, and revenues 120%, in 2022 those indicators were 102% and 99%, respectively. The surpluses recorded in October and November don't mean that the government has a chance to close the budget with a smaller deficit than the Ministry of Finance has suggested. As a rule, a substantial part of the budget is spent in December, with spending in that month sometimes two to three times higher than the monthly average. It's the end of the year when inter-budgetary transfers, debt servicing, contract payments and social payments are being made. To compare, the budget surplus was $31 billion in November 2021 dropping to $7 billion in December. Monthly expenditures increased by 23% - from $270 billion to $330 billion.

Spending in December will grow at a faster rate than in 2021: the government is forced to finance military needs and increase social benefits amid economic recession. In November, spending has already exceeded the annual target of $370 billion and reached $340 trillion. Siluanov himself has already stated that by the end of the year, spending will exceed $410 billion - an absolute record. $64 billion will be spent on national defense in 2022, which is almost $16 billion higher than plan. Taking into account the chaotic mobilization, defense spending may reach $75-76 billion.

“General government-related spending”, including the money spent on the presidential staff, legislative and executive bodies, judiciary and electoral officials, has increased from the initially expected $26 billion to $35 billion. “National economy” spending grew by 24%, from $46 billion to $58 billion, with spending aimed at the “structural transformation” of the economy. Social policy expenditures increased by 9.5%, amounting to $87 billion against the planned $79 billion. The increase is most likely due to military operations, including payments to mobilized soldiers and their families.

“Untouchable” NWF gutted to meet army needs

Budget revenues have failed to keep pace with the increase in expenditures, but they are still growing - mainly due to the favorable situation in the oil and gas industry. In January-November 2022, total revenues were 10.4% higher than last year's figures, while oil and gas revenues increased by 30% (8.1 trillion in January-November 2021 compared to $140 billion in the first 11 months of 2022). The plan for oil and gas revenues has already been 111.7% fulfilled, over and above the initial expectations of $130 billion. However, in December budget revenues are likely to be hit by a drop in oil and gas revenues due to lower exports. The oil embargo, which banned deliveries of Russian oil to the EU by sea, and the “price cap” on Russian oil entered into force on December 5.

Oil and gas revenues account for nearly 40% of the 2022 budget revenues. But by the end of the year, the positive dynamics has come to an end: in November the budget was $1.22 billion short, in October - $100 million, and in September - $310 million. The decline is associated with the average price of Urals oil, which was $57.49 per barrel in mid-December - even below the Western “price cap” for oil. A generally good year for the oil and gas industry alone will not be able to compensate for the growth in expenditures or to cover the budget deficit. Military spending in 2022 and in subsequent years will have to be covered by Russia's main “safety cushion”, the National Welfare Fund (NWF).

The government was reluctant to spend the NWF money even during the covid years, 2020-2021, when business was expecting the government's help. But it's not afraid to spend it on war: by the end of the year, according to the Finance Ministry's forecasts, the fund will be reduced from $180 billion to $120 million. The finance minister, however, has promised that the government will do “everything necessary to minimize the use” of the NWF for covering the deficit.

So where will the money come from? It will be borrowed. Back in April, Anton Siluanov complained it was too expensive, but the Finance Ministry returned to the debt market in the fall and exceeded its borrowing plan in just a few months, having issued 44 billion dollars' worth of bonds.

Everything for security, nothing for the economy: what will Russia spend money on in 2023?

The next year, the Finance Ministry expects a budget deficit of around $41 billion (2% of GDP), although a year ago it hoped to be in surplus by $4.06 billion. The new version of the budget suggests a $52 billion increase in spending (to $390 billion), while revenue will increase only by $8 billion to reach $350 billion. Contrary to the Russian president's statements about his reluctance to put the economy on military tracks, most of the money will be spent on law enforcement agencies.

Analysts are confident that the real budget deficit next year will significantly exceed the expectations of the Finance Ministry.

“Many factors will influence the size of the final deficit, but according to our basic assumptions and given the spending plan remains unchanged, the final deficit may be in the range of 3-4% of GDP, i.e. one and a half to two times higher. Formally, a larger deficit would mean a more stimulative fiscal policy, which is logical as the economic recession continues. But this scenario may also mean higher inflation and, as a consequence, higher Central Bank refinancing rate, which will be bad for an economy going through structural adjustment,” believes Dmitry Polevoy, Investments Director at Loko-Invest.

Natalia Orlova also expects the budget deficit to grow significantly. According to her estimates, it may reach $41 to $68 billion, but even such a large figure is not going to be a huge problem for the Russian budget, as the Finance Ministry is able to manage cash flows and regulate expenditure. But the ministry may have difficulties with spending cuts because of the upcoming 2024 presidential election.

“We need to understand that there is a question of where the fiscal policy will be directed, because we have a pre-election year ahead of us, because we'll have a presidential election in March 2024 and it is difficult to tighten the budget ahead of the election, although if we imagine a scenario for reaching an agreement on Ukraine, it could lead very quickly to a reduction in direct spending on the SMO which will support the budget. There is a lot of uncertainty on the spending side,” Orlova says.

Spending on “national defense” and “national security and law enforcement” will increase by 40% and 52%, respectively, compared to what was planned in the previous draft version of the budget. Defense and security spending will reach nearly $130 billion, which is about one-third of all budget expenditures. Compared to 2022, defense spending will increase only slightly, by $4.07 billion, while spending on law enforcement will climb by $22 billion (+58%). The Finance Ministry has not just increased war spending, it also wouldn't say on what exactly the money will be spent: the government has classified a record amount of 2023 spending, about a quarter of it ($88 billion). Besides the traditional spending on uniformed agencies, the authorities wouldn't disclose how much money will be spent on the annexed territories.

Spending on national security and law enforcement agencies accounts for one third of the new budget's expenditures

Social policy spending will increase by $14 billion (17%) compared to the previous draft version of the budget and almost $12.2 billion (13%) compared to 2022. This is all due to the indexation of social benefits based on the inflation rate, which, according to the Central Bank's forecasts, will be 12-13% this year, the target being 4-4.5%. In addition, the increase in spending is partly due to the war, because “social policy” includes disability benefits as well as payments to the mobilized soldiers and their families.

Next year, it was decided to save on the “national economy” and “general government-related” expenses that turned out to be significantly higher than planned in 2022. Spending on “general government-related matters” is to be decreased by $8.14 billion to the level of $26 billion. The same 3.5 trillion will be spent on “national economy” as in the recent draft version of the budget, as if there are no sanctions or international isolation. The reduction will amount to $10.9 billion (almost 20%) compared to 2022.

Spending on environmental protection will be slightly reduced compared to both the previous draft version of the budget and 2022 spending, while education expenses will remain approximately the same, $18 billion. Spending on housing and utilities, culture, health ($19 billion), media, physical education and sports is expected to be higher than in the previous draft version of the budget, but lower than in 2022. The document does not envisage any significant changes in financing those items.

Oil and gas companies will pay

Budget revenues are projected at $350 billion for 2023, of which about 34% will come from the oil and gas sector. Revenues are expected to be at a relatively modest level of $120 billion, which is 2.7% lower than what was planned in the previous draft law ($120 billion out of $350 billion revenues), and 23% lower than the 2022 figures ($160 billion out of $370 billion, according to a preliminary estimate). The drop in revenues, as the document says, is primarily due to a decline in oil production.

The government intends to compensate for the decline in production and, consequently, in exports by increasing the tax burden on the oil and gas sector. The budget envisages an increase of the mineral extraction tax (MET) on natural gas and the tax on profits earned by liquefied natural gas (LNG) exporters, as well as more taxes on the oil industry. “Gazprom” will pay $680 million a month to the budget - that's $8.14 billion a year. The revenues from adjustments to the MET calculation mechanism itself will amount to approximately $770 million in 2023. LNG exporters will also have to pay a higher profit tax - the rate will go up from 20% to 34%. Half of this amount will go to the federal budget and the other half to regional budgets.

The increase in the tax burden on the oil industry is expected to bring an additional 208 billion to the budget in 2023. The government also intends to reduce spending on the crude oil damper mechanism, thanks to which the budget will save about $2.87 billion. The Ministry of Finance justifies those measures by the irrelevance of the current mechanism, which works in the context of overpriced oil products on the European market, while its importance for domestic oil product pricing is declining.

In total, the new taxes on oil companies will bring more than $16 billion to the budget. However, the increase in taxation will be accompanied by a drop in revenues due to lower production and exports.

“Price cap” and oil embargo will lead to a hole in the budget

The oil embargo will presumably reduce Russia's oil production by 0.5-1 million barrels per day, while the International Energy Agency (IEA) forecasts a 2-million-barrel decline in daily production by March 2023. It is unlikely that oil flows will be effectively rerouted from Europe to Asia due to risks of harsh sanctions. The only hope that remains is an increase in demand for oil or a sharp reduction in production by OPEC - both scenarios could trigger a price spike.

Another factor that may affect budget revenues is the “price cap” for Russian oil set by the coalition of Western countries. A $60 per barrel threshold has been agreed upon, a level acceptable to Russia in general, which will allow the country to continue supplying oil to the international market and make a profit but will deprive it of super profits. Russian oil is already trading at a significant discount compared to Brent: the average price per barrel of Urals was $66.47 in November, falling to $57.49 per barrel over the period between November 15 and December 14.

The key buyers of Russian oil - China and India - have not joined the restrictions, but now they will obviously be seeking substantial discounts: after the introduction of the “price cap” and the embargo India has started buying Russian oil for less than $60 per barrel.

Russia has formally refused to supply oil to the countries that approved the “cap”. Vladimir Putin signed a decree that was supposed to be a tough response but in fact its vague wording leaves the door open for continuing supplies.

The budget is based on the price of Russian crude of $70.1 per barrel, above the “cap”. In September, the Finance Ministry set the minimum acceptable price of oil for Russia at $50 per barrel - but only subject to the condition that the production rate stayed at 11 million bpd. The IEA estimates the average level of production at 9.6 million barrels a day for 2023, a return to the level of the late noughties. Natalia Orlova believes that under such conditions, tax hikes are unavoidable, otherwise it will not be possible to balance the budget:

“The budget has returned to its pre-2014 condition. There is such an indicator - the budget-balancing price of oil. It was $120 per barrel before 2014. This year, if we subtract those one-off revenues from Gazprom, the budget-balancing price will be $115-120 for 2022. We are back to the heavy reliance on oil revenues that we observed before 2014. The oil price cap and the reduction in Russian exports have significantly increased budget vulnerability. On the other hand, they were high even before 2014 and the Finance Ministry has successfully reduced them. It seems to me that the main problem of getting out of these risks is that the Finance Ministry will have to consider raising taxes, because it is very difficult to regain balance just by managing expenditures, without raising taxes.”

The oil embargo and the price cap will become “a new economic shock capable of significantly reducing the level of economic activity in the coming months,” according to Central Bank analysts. Even if Russia manages to find new buyers, rebuild supply logistics and negotiate with China and India, the short-term effect of the sanctions will affect budget revenues.

The situation with gas exports does not look better: Russia has lost its main market – of all the working routes to Europe only Turkish Stream and the pipeline through Ukraine (Sudzha station) have remained. Gazprom reported that since the beginning of the year, exports to non-CIS countries fell by 45.1% and production fell by 19.6%. High prices on energy resources helped to compensate for dwindling supplies: the price of gas in Europe was $3,000 per 1,000 cubic meters at its peak. In 2023, the situation may not be as good for the Russian budget and it is still not clear what kind of customers Gazprom wants to replace Europe with. “Gazprom will not be able to save the budget this time,” Nadorshin says.

“There are huge problems with revenues from the so-called non-resource economy, and it is obvious that the current levels of economic activity are already insufficient to comfortably fill the federal budget with revenues. In recent months, only payments from Gazprom have been smoothing out the overall picture, but in December even they are unlikely to help (especially since they will stop in December), because oil prices have fallen. There is no reason to expect such large payments next year, there will be $680 million in additional payments agreed by the Finance Ministry. This is ridiculous, given the amounts paid by Gazprom to the budget this year”.

Bit by bit. Where else can the Finance Ministry look for money?

Apart from oil and gas companies, other exporters will also feel the effects: from January 2023, export duties will be imposed on fertilizers, and the MET rate on coal will be temporarily increased. The rate for fertilizers will be 23.5% for prices above $450 per ton, and if the price is lower, the export duty will be zero. By introducing this measure, the Ministry of Finance wants to collect nearly $1.42 billion from the chemical industry.

Until 2023, chemical companies managed to shirk the duties, although the Ministry of Agriculture repeatedly advocated this initiative. With the increase of the tax burden the companies may end up losing 8-12% of export revenues - a significant reduction in the context of the sanctions and logistics problems. At the same time, exports are dwindling: by the end of 2022, fertilizer shipments from Russia are expected to decrease by 17%.

The MET rates on coal (except brown coal) will be temporarily increased by $5.15 per ton, effective from January 1 to March 31, 2023, and will bring an additional $410 million to the budget. At the same time, it has been decided to forego export duties on coal - the industry is already in deep crisis due to the inability of the Russian transport system to re-orient towards the East. The Finance Ministry has stated that the higher MET rate for coal will cover every need, at least for the time being, but promised to “monitor the situation” in the first quarter of 2023.

As of April 2023, the government wants to abandon preferential treatment for a number of imports that fall into the “critical” category (from plastics and rubber to medicines and medical equipment). Zero import duties and tariff exemptions were in effect throughout the Eurasian Economic Union (Russia, Belarus, Kyrgyzstan, Kazakhstan and Armenia). It was decided to zero out the duties in spring 2022 due to the Western sanctions, and at Russia's request, the Eurasian Commission in September extended the preferential treatment until March 2023. After that date, the government will phase out zero rates and tariff benefits - the transition will bring $1.71 billion to the budget.

The government wants to get an additional $1.36 billion by tightening control over the tobacco industry. The Finance Ministry believes that the tobacco market currently lacks “effective mechanisms” to combat counterfeit cigarettes. The ministry has proposed a number of steps that would reduce the volume of illegal market - and at the same time replenish the budget, while the indexation of excise tax on tobacco products will bring an additional $500 million. Also, excise tax on sweet beverages will be introduced in 2023 - in the amount of $0.1 per liter, after which the budget will receive an additional $470 million; it is promised that the funds will be spent on combatting diabetes mellitus.

From 2023, a new tax regime, the “Automated Simplified Taxation System”, designed for small and medium-sized businesses, will become fully operational. The government plans to attract new taxpayers through a system that is alleged to be more convenient. The introduction of the “Automated Taxation System” should bring nearly $270 million to the country's budget.

It was decided to collect more taxes at the expense of agriculture as well: in 2023, VAT exemption for import and sale of pedigree livestock will expire, which will add $66 million to the budget. The preferential rate was introduced in 2016 and extended for two years in 2020. In 2021 the State Duma was offered to renew the exemption until 2025, because Russia, contrary to the Food Security Doctrine, failed to achieve 90% self-sufficiency in “dairy products”. As a result, the 2022 crisis turned out to be serious enough to unpack the NWF, but not enough to reduce the tax burden on livestock production.

The increase in the tax burden has left domestic business unhappy. The report written by the Russian Union of Industrialists and Entrepreneurs (RUIE) timidly pointed out that the initiatives introduced by the State Duma during the discussion of the draft budget were not agreed upon with concerned parties. Business representatives complained that the burden on business was being regularly increased through tax base adjustments, caps, changes to the tax calculation procedures and other indirect semi-administrative measures. Raising taxes in the current environment, according to the Union, will affect companies in a bad way, and therefore the in the end budget will receive less taxes. “The trend towards “sneaky” increases of the tax burden should stop,” the RUIE said.

The Business Russia organization has been a bit bolder in expressing its opinion about the budget. The new taxes will affect all industries and will have a negative impact on businesses by slowing down the growth of the national economy, the organization said. “The planned increase in the tax burden on business does not appear to be productive,” the organization said in a statement. The statements by the lobbying groups were partially heard: the government eventually refused to introduce a number of taxes - for example, export duties on gas and coal. However, the Finance Ministry is still considering other steps: the government has been discussing an increase in the MET on iron ore and coking coal, which could help the authorities confiscate excess profits from companies during the period of high commodity prices.

A super hard task: how to deal with the deficit?

The cumulative effect of the measures taken should bring the Russian budget nearly $23 billion in 2023, although these measures will not cover the budget deficit of $66 billion. Reserves of the National Welfare Fund and new borrowings will come to the rescue. Siluanov promises to minimize spending from the main “treasure chest”: the government will focus on domestic borrowing to finance the deficit as long as there is demand for federal loan bonds (OFZ).

The government will get nearly $23 billion from tax hikes

The hole in the budget, however, may turn out to be larger than the estimated $39 billion: the deficit estimate has almost doubled in 2022. The government's forecasts also changed dramatically: back in April 2022, Siluanov had said the government “had no need to borrow on the markets”:

“We are not planning to enter the domestic market or any foreign markets this year. It makes no sense because the cost of such borrowings would be cosmic”.

However, experts don't believe that the amounts of borrowings declared in the budget will suit the Finance Ministry. Firstly, the government doesn't want the NWF to be fully exhausted, as evidenced by Siluanov's rhetoric. Secondly, the borrowing mechanism allows the government to build up its debt at the rate of $40 billion a year for a few more years.

“The Finance Ministry can borrow at such a rate without noticeable or significant consequences in terms of the economy, and it can be doing it for 10 years without any problems. It all depends on how to manage such a resource and how it will be digested by the local financial market, which is not used to such volumes,” Evgeny Nadorshin says.

The key challenge in building up borrowings is to create demand for government securities.

“The Finance Ministry can issue absolutely any amount of OFZs, the only question is the rate at which banks and other investors will want to buy them. For example, it's hardly possible to raise $14-28 billion at the current rate of just over 10%, while there could be a demand at 12%. Therefore, the matter of the Finance Ministry's appetite is always a compromise between the volume and the cost of this debt and the market,” Dmitry Polevoy says.

However, the Finance Ministry's sudden wish to increase borrowing raises the question of who would be able to meet the government's demands in the conditions of economic isolation. In 2021 the government issued 35 billion dollars' worth of OFZs; the share of non-resident holders of government debt fluctuated around 20% over the last 7 years, now the government will have to find new buyers in the domestic market. Private investors will not be able to provide such a high demand for OFZs - the share of individual domestic holders of government debt does not exceed 3%. The main holders of government bonds are banks and pension funds, the largest of them Sberbank (accounting for 17.7% of OFZs in 2021).

“There are three groups of players inside the country - banks, pension funds and households, but households' investments in government debt are unlikely to be large, because traditionally bank deposits and government debt bonds are instruments of the same order, give or take. Individuals are not a significant factor, while banks and pension funds are two key players on the public debt market. Banks played a key role in the past as well, it just that back in the day the share of non-residents was 20-30%, and now non-residents will not be buying in such volumes, just a few percent of the debt market, so we are actually talking about an increase in the role of banks,” says Orlova from Alfa-Bank.

However, in the context of the international sanctions, the state-controlled banks themselves are not doing very well: this year, Sberbank managed to show net profit only in October. In the first ten months of 2022, Russia's largest state-controlled bank earned $680 million (versus $14 billion a year earlier). Therefore, the state banks will most likely receive funds for purchasing OFZs from the Central Bank, as they did in 2022. In early November, the regulator poured $19 billion in repo loans (loans secured by pledged securities, including bonds, i.e. a bank must buy OFZs to use them as collateral for a loan from the regulator) into the banking system. Using this scheme, the Central Bank can allocate funds to banks, which, in turn, can help in filling the budget hole - in fact, the Finance Ministry uses the money printed by the regulator, which could create certain problems in the future.

State-controlled banks will have to finance the budget through the most ambitious borrowing program

“Printing press” risks

Experts are divided on the possible risks. Switching on the “printing press” implies an inevitable rise in inflation, but so far the amount of funds that the Central Bank has poured into the banking system is small, says Professor of Higher School of Economics and investment analyst Yevgeny Kogan. If the Finance Ministry does indeed rely mainly on borrowing to finance the deficit, inflation will gradually increase, and the regulator may have to raise the key rate again, he says.

“This is a very popular “scare story” right now about Russian QE (quantitative easing). But everything is much more prosaic: by borrowing significant amounts via OFZs, the Finance Ministry takes away liquidity from the system until it comes back through budget expenditures. If there were no repo transactions with the Central Bank, the volatility of rates in the money market would be very high, which would have been contrary to the Central Bank's goal of keeping short-term interest rates close to the key rate and making it difficult for banks to set interest rates for their main transactions. Therefore, for the Finance Ministry's auctions the Central Bank lends money to banks using securities as collateral, and when liquidity flows back to the banks via budget expenditures, the banks repay these loans to the Central Bank. It has worked in the past without creating any significant risks, it will work in the future. Inflation is affected by the mere existence of the budget deficit, not by its financing mechanism. Had the Central Bank been buying OFZs itself, it would have been a different story altogether, but this is not, and, hopefully, will not be the case,” Polevoy says.

Orlova agrees with Polevoy, saying that the Finance Ministry and the Central Bank are using a common market mechanism, which reduces the risks to the stability of the financial system. She believes that saying “money is being printed” is incorrect in relation to the scheme proposed by the government and the regulator. “Money is being printed when the government comes to the Central Bank and says, “We need to finance expenditures,” and the Central Bank gives the money. That's not what happens, the Central Bank doesn't issue money directly to finance budget spending. The Central Bank provides refinancing to the banks taking securities as collateral, and this is a normal market mechanism practiced by all central banks in the world,” Alfa Bank's chief economist says.

Evgeny Nadorshin of PF Kapital, as well as Kogan, still sees certain risks in this scheme. However, in his opinion, they depend on the conditions and volumes that the key players will be dealing with. “It depends on the rate of borrowing, what strategies the main players will be following and what conditions the Finance Ministry and the Central Bank will be offering them. Certainly, as a tool to increase revenues repos will be used in this manipulation. Even if three or five times leveraged. Yes, it will be a small Ponzi scheme. What follows will depend on how carefully the banks, the Finance Ministry, and the Central Bank will be using financial instruments. Given the present volumes, this scheme can work for years”, he says.

Waiting for a new devaluation

The ruble exchange rate, which showed unexpected volatility at the end of 2022 and literally collapsed by almost 20% in just three days, may play a significant role in the formation of the budget: the dollar has exceeded 72 rubles and the euro has gone above 77 rubles. According to the Finance Ministry forecasts, the dollar exchange rate should be 68 rubles in 2023, going up to 71-72 rubles in 2024-2025.

The oil embargo imposed by Western countries may lead to a reduction in the supply of Russian oil on the market and, consequently, to a reduction in the inflow of foreign currency into the country, thereby weakening the ruble. Experts expect the exchange rate to be 64-67 rubles per dollar, and with additional pressure 65-70 rubles, which generally corresponds to the estimates of the Finance Ministry. This summer, First Deputy Prime Minister Andrei Belousov said that the exchange rate of 70-80 rubles per dollar was optimal for the Russian economy and that the government was ready to target the rate of the national currency rather than inflation. A weak ruble helps Russian exporters and might the budget, but probably at the price of provoking higher inflation.

Evgeny Nadorshin believes that a weaker ruble in 2023 is very likely, as a weak currency could potentially save the both the budget and the economy. However, while in the short term a ruble collapse could be a solution for the Russian authorities, in the long run it could lead to serious problems, such as a sharp acceleration of inflation, which would trigger a host of negative processes.

“The ruble depreciation scenario is one of the best in terms of meeting all spending commitments. For the short term, the Russian authorities used to follow a similar scenario, because the budget benefitted from it in the short run, but not in the long run. It cannot be ruled out that next year will bring us some surprises with regard to the rate of the national currency, which may turn out to be quite impressive,” the expert says.

Russia enters 2023 with the most unrealistic budget of the entire Putin era and the most uncertain outlook for the economy. Oil and gas revenues are likely to continue to fall, and the government will have to go deeper into debt or make drastic moves to depreciate the ruble. An increase in the tax burden on the country's leading industries is unlikely to have a positive effect on the development of businesses that have already suffered during the war year.

The Ministry of Finance and the Central Bank are balancing between a bad and a very bad scenario, both of which are designed to maintain at least the appearance of stability of the financial system, because 2023 is a pre-election year, so reductions in social spending, combined with another surge in prices could create social tensions, which the Kremlin would rather ease. At the same time, even the most stressful scenarios for the Russian economy will not turn into a catastrophe, at least right away - the system still has a margin of safety. However, this margin is not infinite, and the price of such a policy is a decades-long rollback. Avoiding the negative consequences is very easy: it is enough to reduce spending on the war with Ukraine.

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