Sergey Aleksashenko

Economist. Director of Macroeconomic Research Department of State Research University – Higher School of Economics in Moscow

Aug 25, 2016
Sergey Aleksashenko: will Russia’s reserves deplete by the elections of 2018?

Experts and officials constantly discuss the upcoming depletion of Russian state reserves. However, it is not very clear that reserves –fiscal or some other resources, will deplete soon.

The availability of statistic data about state reserves on the Russian Ministry of Finance’s website does not help to  make this clear. In this study, I am going to examine statistical data from the beginning of 2010. Due to this focus, I will put aside an analysis of the historical background, politics, and economics.

To begin with, we have to know that the Bank of Russia publishes financial reports of foreign currency reserves from the Russian Federation on its website every Thursday. In August 2008, the reports showed a historical record – $ 598 billion. During the crisis, in the middle of March 2009, foreign exchange reserves fell to $ 376 billion. By  mid-August of 2011, this figure jumped up to $ 544 billion. Then, until 2014, the federal reserves fluctuated between $ 500-550 billion per month. Given the fact that Russian reserves include the euro, gold, pound sterling, and Swiss franc, these fluctuations depended upon the value of these currencies against the US dollar.

In fact, at that time, the Bank of Russia had not carried out foreign exchange intervention – buying or selling currency.  From the beginning of 2013, the level of state reserves steadily declined. At that moment, the growing demand for imported goods and services increased demand for foreign currency in the market.

Simultaneously, fresh blood appeared in the Bank’s administration. Elvira Nabiullina, the new chairman, decided to support the ruble, selling foreign exchange reserves. As a result, this selling strategy was practiced during the next two years. In May 2015, the federal reserves reached their  lowest point – $356 billion, however, this number soon began to rise once more Nowadays, they are up to $ 400 billion.

валюта

In Russia, Foreign Exchange Reserves are made of gold and a specific currency.  Gold accounts for 16% of the reserves. Worth noticing is the fact that in 2010, the gold share was only 5%.  Hence, the gold reserves during this time almost tripled, reaching 1555 tons. On one hand, the huge gold reserve delivers some troubles in terms of convenience (storage needs, liquidity is low, etc). On the other hand,  gold contributes to the reserves’ diversification and, most importantly, guarantees security from external threats. As long as Russia is one of the main gold manufacturers in the world, the Bank of Russia is comfortable enough buying two hundred tons of gold each year.

In fact, the Bank of Russia and the Ministry of Finance have full control over state currency reserves. Traditionally, the Ministry of Finance holds its foreign exchange reserves, which consist of the Reserve Fund (RF) and the National Welfare Fund (NWF) on the accounts at Central Bank.   Undoubtedly, the Ministry of Finance also has its own foreign currency balance on the Treasury government   accounts, which conducts foreign exchange payments every day.  While the total sum of these operations is not very large, I will include them in the Bank’s reserves.

золото

This graph clearly shows that the Ministry of Finance’s foreign exchange reserves continued to increase until the beginning of 2014, when it reached  $176 billion.  In the second half of 2014, the reserves started to decline due to a sharp drop in the value of the euro against the dollar; since 2015, the reserves have become a last financial resort for the government. In light of this, the foreign exchange reserves of the Ministry of Finance diminished, whereas foreign exchange reserves of the Bank   grew. According to the agreement, all foreign exchange operations were conducted within the Ministry of Finance and the Bank, reducing the pressure on the foreign exchange market.

Foreign exchange reserves of the Bank of Russia are around $ 220 billion, and here comes the first issue of their adequacy.   In the first half of this year, import of goods and services in Russia was less than $ 117 billion. This gives an impression that the current reserves of the Central Bank is high enough according to the IMF standards.  It is important to remember that the country will have to repay its foreign debts – about $ 90 billion; international sanctions are still in power. In this situation of global isolation, the Russian government will not be able to borrow money.  Worth noting is the fact that a third part of this debt is so-called “technical” debt when Russian corporations move capital between their companies. Also, the external debt, which is near $ 70 billion, is loans, and in the case of financial troubles on the currency market, a significant part of this amount can be paid back.

How big are the reserves in the Bank of Russia? The answer to this question depends on the Bank’s strategy. There are two options. 1). The Bank can continue to throw billions of dollars at the problem in  order to maintain the stability of the ruble, wasting around $ 110 billion.  2). The Bank also can allow the ruble to collapse, hoping for financial stability that would help to preserve the reserves. Nowadays, the Bank of Russia has switched to a floating exchange rate of the ruble with no intention   Of spending foreign exchange reserves for maintaining rate stability.  The Bank could change its approach in 2017 in light of the upcoming presidential election.

How long can Russian rely on the reserves?

Let’s talk about the two reserve funds of the Ministry of Finance, which were created during the high-oil-prices-period. Now they are the only source of stability, not only in the public sector, but also in the whole country. On August 1st,  these funds, theReserve Fund and the National Welfare Fund had, in total,  about $110 billion, or 7.4 trillion rubles. At first glance, this amount accounted for nearly 50% of the annual expenditure budget and should guarantee stability, but …

In order to assess how big are these reserve funds are, I need additional information about oil prices and the dollar exchange rate fluctuation. It is necessary to know the future economic policy in Russia’s economy (Will it continue to decline or begin to grow?). In addition, in light of the upcoming presidential election, the way  the government spends the state budget will be very crucial. However, it is not clear  whether the President is ready to make a serious cut in military expenses or if he will  squeeze our economy further in order to satisfy  the military-industrial elites.

It is impossible to predict government decisions and due to this fact I can only create several hypotheses:

1) Oil price will be around $45 dollars per barrel

2) The dollar value will be 65 rubles

3) The Russian economy will stop declining, but its annual growth will be no more than 1%.

4) The government will reduce its spending, but military spending will not be drastically diminished

All of these hypotheses mean that the state budget’s deficit will reach 3.8 billion per year.

Now, let’s count the numbers. During the seven months of 2016, the budget deficit is up to 1.5 trillion rubles. this tendency will lead to an upsurge of the deficit, which will increase to 2.5 trillion rubles by the end of 2016. This is roughly equivalent to the balance in the Reserve Fund on August 1st, 2016.  Perhaps the Reserve Fund will cease to exist by the end of 2016. But the situation can be changed if the government sells the Bashkir Oil company (“Bashneft”); this deal would bring around 250 billion rubles to the state budget.   Another solution is to sell 19% of “Rosneft”, which could add 700 billion rubles. As long as the owner of “Rosneft” is the company shares “Rosneftegas”, the money will go into the budget as an income tax and dividend, then this will be shown as revenue and reduce the deficit accordingly. However, in there is a delay in these deals, the budget will not receive additional resources.

In this situation, against all odds, I hope that the government will sell these companies by the end of   2017 and the state will sell the stakes of both companies and receive 1 trillion rubles. Therefore, out of the aggregate deficit of the 2016-2017 period, which will be equal to 7.6 trillion rubles, we subtract 1.5 trillion (already financed) and 1 trillion from the sale of oil state-owned shares. The leftover 5.1 trillion rubles will be financed by the reserve funds.  This means that the 7.4 trillion rubles which are left will be enough for 2016 and 2017, and for seven or eight months of 2018.

However, another important factor emerges. Since 2008, the government has spent the National Welfare Fund, calling these actions “temporary investments”. So far, not one recipients –  VEB, VTB, Gazprombank or Rosselkhozbank, returned money to the Fund.  Almost 1/3 of the Fund’s resources was spent, that means that out of $ 72 billion (We can see this from the graph), the state can actually only rely on $47.7 billion.

Thus, the two Ministry of Finance’s funds embrace 5.8 trillion rubles of “live” money, where 5.1 trillion will be spent on financing the budget deficit by the end of 2017. The remaining 700 billion rubles will be spent during the two and half months of 2018 (by the presidential election).

Theoretically, there are two options: the government has to print money or reduce government spending. The latter option is barely possible because 56% of the state budget is used for salaries for dignitaries, pensions, and social benefits. Therefore, in order to diminish spending by 25%, for instance, the government will be forced to cut expenses on salaries for dignitaries, pensions, and social benefits by 60%.

This article first appeared at the Slon Magazine site.

Images: Slone Magazine.