Russia looks beyond its oil reserves

By Konstantin Rozhnov
Business reporter, BBC News

Image caption,
The Kremlin has done much to avoid protests similar to the Greek ones

It had long been a talking point amongst Russia watchers, yet it came as a shock when the country's finance minister, Alexei Kudrin, declared that the reserve fund of accumulated oil revenues was running out.

The fund, which has helped the country to weather the global crisis and finance its budget deficit, would be exhausted by the beginning of 2011, he said recently.

Mr Kudrin said that as of next year, Russia would have to adjust to being a country, just "like everyone else", having to operate without extraordinary economic advantages - such as strong earnings from oil exports.

Coming at a time of serious economic turbulence in the European Union (EU), his prediction raised fears about Russia's economy, in part because the EU is Russia's main export market - and not only for its oil.

But beyond weakness in the export markets, there are even greater problems at home in Russia.

Critics say that too little has been done to implement necessary structural reform and reduce the economy's dependence on energy resources after Russia, a leading oil exporter, defaulted on its debt in 1998.

Oil, gas and mineral exports account for some 70% of Russia's exports, so the economy is hostage to sharp price fluctuations commonly seen in the commodity markets.

And Russia's dependency on such exports has been made more acute by rising social spending, according to Natalia Orlova, chief economist, Alfa Bank.

Cheaper borrowing

So it is clear that Russia faces some serious fiscal risks, though they are different from those faced by Greece.

Soon after the Russian financial crisis just over a decade ago, the two countries' economic and financial situations were relatively similar, but since then, they have taken different paths.

While Greece saw its debts balloon over the next decade, Russia was able to cut its government debt to less than 10% of its GDP, thanks to a boom in both energy prices and the volume of oil and gas exports.

Image caption,
Mr Kudrin believes the state could spend money more effectively

Indeed, even though Russian companies and banks amassed hundreds of billions of dollars of foreign debt during the period, the nation's overall debt stands at no more than 50-60% of GDP, much less than Greece's government debt of 115% of GDP in 2009.

Moreover, the Russian government is able to borrow money on attractive terms, which was not the case in 1998 and which is not the reality for Greece now.

In April, Russia raised $5.5bn (at the time 4bn euros; £3.5bn) in its first international debt sale since 1998.

Doing so was crucial for Russia, if for no other reason than at least because it demonstrated that lenders still had faith in Russia's ability to service its loans, explains Julia Tsepliaeva, chief economist at BNP Paribas in Moscow.

"Even in the most difficult moments, Russia will be able to borrow," she says.

Which poses a crucial question: will the Russian government try to raise more money now, in the next few months before the oil revenue savings have dwindled away, or will the Kremlin wait?

Social spending

Among the many challenges facing Russian policymakers is a need to balance the country's budget, although to do that, it will need the oil price to rise significantly, perhaps to levels not seen since 2008.

The government and experts agree that this year's average price of crude oil must top $100 a barrel to help Russia bounce back into the black, though they also agree that this is unlikely to happen.

Instead, the average could come in as low as $60 a barrel, predicts Neil Shearing, senior emerging markets economist at Capital Economic.

Consequently, Russia may well be in for some painful belt-tightening.

Though perhaps not just yet. In recent years, much of the country's oil earnings have been used to pay for social spending, especially during the parliamentary and presidential campaigns in 2007-2008.

And with another election period starting in 2011, right after the reserve fund will have been emptied, we may well see the government continue its spending for some time yet.

Hence, few experts believe Russia will achieve its aim of a balanced budget by 2015.

Funds vs debt

But being in debt is expensive.

In April alone, the government spent more than $12bn from the reserve fund to finance the deficit, reducing the fund's worth to 1.2 trillion roubles, or about $40bn - a third of what it was worth a year ago.

Yet, in spite of such payments, the government expects its budget deficit to come in at 5% of GDP by year-end.

So the search is on for other sources of funds.

And one has been identified: an additional oil reserves fund, named the National Welfare Fund (NWF), which stands at about $90bn.

Now, ideally the NWF should not be spent in the same way the reserve fund had been used, because the NWF was created to finance a deficit in the state pension fund, triggered by demographic problems. Indeed, Mr Kudrin said so himself in a recent interview with the Russian business daily Vedomosti.

However, if the government would be using the NWF for big pension spending, it would indirectly help to reduce the budget deficit as well, points out Ms Tsepliaeva.

Most experts agree that Russia needs to preserve at least some money in its reserve fund, while at the same time, it needs to start borrowing quite aggressively.

Ms Tsepliaeva believes that making the reserve fund last as long as possible "would help Russia borrow abroad". Indeed, Ms Orlova estimates that even if the budget deficit stays at 5% of GDP for several years, Russia's government debt would climb to no more than 15% of GDP.


In turn, Mr Shearing says, such low levels of Russia's government debt would leave it room for manoeuvre in terms of implementing fiscal policies.

There have been debates within the Russian government about how to tackle the fiscal problems: by reducing spending and using any extra money to cut the budget deficit fast, or by financing the economic recovery.

There is a consensus, though, that there is a lot of inefficiency in terms of government spending.

"We could execute the same number of task we do now, but spend much less money," Mr Kudrin says.

There are also ways to stimulate investment without spending vast amounts - for instance, by implementing an investment-stimulating policy and taking steps to boost competitiveness.

Whichever method the government agrees on eventually, experts point out that it should start acting before the accumulated oil money runs out, rather than wait till afterwards.

"Time is running out, and the EU situation [triggered by Greece's problems] does not create a favourable environment for us," Ms Orlova says.