“The hole is expanding”: Russia’s National Welfare Fund will be exhausted to the bottom

“As of December 1, 2022, the volume of the NWF amounted to 11.3 trillion rubles, or 8.5% of GDP, and the volume of the fund’s liquid assets (funds in foreign currency bank accounts with the Bank of Russia) amounted to 7.6 trillion rubles,” the statement reads. Ministry of Finance announcement. Meanwhile, already in 2024, the NWF could be completely exhausted, the participants of the September (2022) joint meeting of members of the government and the Central Bank warned.

Officials discussed how to finance the recovery of the economy, which, according to closed forecasts, is threatened by three years of continuous decline. The Ministry of Finance and the Central Bank advocated the use of private investment, but this sound idea is crossed out by the lack of a favorable investment climate in the country. The remaining scenario is to spend the NWF, where oil prices above $42 a barrel have accumulated for years. Today it becomes practically uncontested.

Yuan bet

Meanwhile, the very formation of the National Welfare Fund has undergone cardinal changes. On the eve of the New Year, the Ministry of Finance excluded the euro, yen and pounds sterling from the currencies in which the NWF is formed. Now the department is going to place up to 60% in yuan and up to 40% in gold. And from January 13, the Central Bank resumed operations for buying and selling foreign currency (read – yuan) in the domestic market as part of the updated budget rule.

As Finance Minister Anton Siluanov said in the fall, his department would proceed from the oil cut-off price of $62-63 per barrel. But since the price of the Russian Urals grade subsequently fell below $50 per barrel, the budget rule was reworded: “All amounts of oil and gas revenues that exceed 8 trillion rubles a year go to the NWF.”

The problem is that with the current price environment and strict sanctions restrictions, it is extremely difficult to get that kind of money. And now the budget rule in Russia de facto does not work: all oil and gas revenues go directly to the treasury, without saving it from scarcity.

In the opinion of analysts, the decision of the authorities to sell the yuan is a symptom of rapidly growing budgetary risks: the hole is expanding much faster than the forecast indicators of the Ministry of Finance. So the Kremlin instructed Deputy Prime Minister Novak to deal with the high discount on Russian oil, which is pernicious for the treasury. It is not clear, however, how to do this: would you not order India to buy raw materials at a higher price than she wants?

“The role of the yuan should not be exaggerated,” notes Igor Nikolaev, chief researcher at the Institute of Economics of the Russian Academy of Sciences. — On the one hand, it is currently the only currency from the list of world reserve currencies with which the Central Bank can work. And the prospects for it are quite good because of the size and strength of the Chinese economy. At the same time, the yuan is not comparable in importance and liquidity to the dollar and the euro: its share in international settlements is only 3.2%, while the “American” has about 40%, the “European” has 36%. This gap will not close soon, and Russia must solve its financial problems now. The yuan is difficult to use to support the foreign exchange market during a decline in commodity prices (due to the small capacity of the ruble-yuan market). In addition, its exchange rate is not quite market-based, as it is regulated by the People’s Bank of China.”

Will have to raise taxes

“Since the FNB is the main state fund, the issue of its replenishment is extremely important,” says Igor Nikolaev. — The sale of the yuan under the new fiscal rule does not solve this problem, just as its export earnings do not solve it, which sharply accelerated the fall under the December sanctions on Russian oil. Moreover, the upcoming (from February 5) embargo on the supply of petroleum products from the Russian Federation may further aggravate the situation.”

Today, the Urals brand is sold at prices significantly lower than those expected by the Ministry of Finance in the fall. Accordingly, the interlocutor of MK argues, in 2023 a hole of 5 trillion rubles, or 3.5% of GDP (and not 2.9 trillion, or 2% of GDP, as the authorities expect), may form in the treasury, and already to the end year, the NWF will lose at least several trillion rubles. It turns out that, although the “pod” was saved for years, at the most necessary, critical moment for the country, hopes for it may not be justified, since they turned out to be initially overpriced.

In order to thoroughly understand the situation with the NWF, it is necessary to understand the relationship between several points: firstly, how and for what purposes the state spends reserves, secondly, how the budget rule works, thirdly, how much the treasury receives raw material income and, finally how all this fits in with oil prices, says private investor Fyodor Sidorov.

The domestic economy depends on oil and gas exports, and with the current sanctions, sales to non-CIS countries will most likely continue to decline. China, India and Turkey are buying Russian oil at such a large discount that it undermines budget revenues, which the Ministry of Finance is forced to compensate at the expense of the NWF.

“That is, as deliveries abroad fall and the price of Urals becomes cheaper, the state will increasingly use the once inviolable reserve,” says Sidorov. – So, in December alone, the treasury received 33% less revenue from oil sales, and 49% less from gas sales compared to the same month of 2021. And for January, the Ministry of Finance predicts a shortfall in raw material revenues by 54.5 billion rubles (for this amount, yuan will be sold from the NWF). In February, when the embargo on the supply of Russian oil products to the EU comes into force, the amount may increase two to three times. With an average cost of Urals of $50 per barrel, the NWF is conditionally enough for the current year.”

Apparently, taxes will have to be raised. Partially, this has already been done: the severance tax has been increased for the oil and gas industry, and in the future we can expect an increase in the fiscal burden for the population and businesses. As Sidorov recalls, in the structure of non-oil and gas revenues of the federal budget, personal income tax (personal income tax) and income tax, which is paid by all companies in the country, have the largest share.

The budget rule no longer works

The total federal budget revenues in 2022 amounted to 27.77 trillion rubles, expenditures – 31.11 trillion rubles, deficit – 3.35 trillion, which is equivalent to 2.3% of GDP. There were more only in the pandemic year of 2020 — 4.1 trillion rubles.

Compared to 2021, revenues grew by 10% and expenses by 25.6% (with their peak in December) with an average annual inflation of 14%. As for the details of last year’s spending, it is not publicly available: the Ministry of Finance has classified the directions of budget spending. The 2023 budget provides for an increase in defense spending to almost 5 trillion rubles (17% of total spending) compared to 3.6 trillion originally planned in the fall of 2021, security and law enforcement spending – up to 4.4 trillion (15%) compared to with the original 3 trillion.

It is clear that at least two trends that emerged by December will continue this year: an increase in expenses that is not always predictable and incomprehensible in terms of structure, and a reduction in oil and gas revenues. For one year, the Ministry of Finance will definitely have enough margin of safety to survive the price of $40 per barrel – at the expense of the National Wealth Fund and large-scale borrowings in the debt market.

“In the next couple of years, the NWF will not be completely spent, although this year the fund will lose at least 3 trillion,” says Vladislav Inozemtsev, director of the Center for Post-Industrial Society Studies. – After the entry into force of the price ceiling of $60 per barrel, Russian oil quotes fell sharply, the volume of commodity exports decreased. But in recent weeks it has been rising again.

Let’s say sea shipments have increased by 30-50% from many ports. The Central Bank’s assets denominated in yuan were not subject to any seizures, and this is the largest share of the NWF. The Central Bank has not sold currencies from the fund for a long time, and today market conditions are ripe for this. If we want to receive budget revenues from the NWF, we must use one of the assets that it has. It’s all logical here.”

But with the budget rule that has been in force in Russia since 2017, the problems are much more serious. In August 2022, it was actually canceled, since the base volume of oil and gas revenues of 8 trillion rubles each year was included in the federal budget for the next three years. It was envisaged that the profit earned in excess of this amount would be spent on the purchase of the same yuan and currencies of “friendly” countries for subsequent placement in the NWF. However, this is not happening: in 2022, raw material revenues amounted to 13 trillion rubles, of which nothing went to the NWF.

Accordingly, Inozemtsev argues, the budget will retain its deficit status, since the budget rule has become a fiction: it is unrealistic to get 8 trillion rubles from oil and gas exports this year. At best, it will be 6 trillion, and no replenishment of the NWF is expected either this year or next.

“In December alone, the liquid part of the NWF decreased by almost 20%: the Ministry of Finance sold the currencies of “unfriendly” countries – completely pounds sterling and yen, as well as three-quarters of the available euros, – said Mark Goykhman, chief analyst at TeleTrade. – The funds were received in rubles to cover the budget deficit. Moreover, it is interesting that these currencies were on accounts that fell under the sanctions blocking. Therefore, it was impossible to sell the currency on the market. As a result, their implementation was purely accounting. That is, these funds were formally (with the help of internal operations) transferred from the accounts of the National Welfare Fund to the accounts of the Central Bank, which in return transferred rubles to the Ministry of Finance for the corresponding amount. In fact, this is close to replenishing the budget with new issuance money.”

With a planned treasury deficit of 2.9 trillion rubles in 2023, it will hardly be possible to replenish the NWF. On the contrary, the fund will be actively spent precisely for the purpose of partial financing of the deficit. For this, not only liquid funds (“live” money in accounts), but also investments can be involved. According to the Ministry of Finance, as of January 1, 2023, 10.5 billion euros, 309.7 billion Chinese yuan, 554.9 tons of gold in impersonal form, 274.8 million rubles were placed as part of the NWF with the Bank of Russia. In addition, Goikhman recalls, large amounts of funds have been invested in securities, for example, in the shares of Russian companies implementing infrastructure projects from budget funds.

How long will the FNB last?

“In the coming years, the funds of the NWF will not be fully spent due to the ratio of the volume of the fund and the expected budget deficit,” says Goykhman. – A variety of sources will be used to cover it, in particular, the active attraction of funds in government bonds (OFZ), dividends from state-owned companies, a likely increase in taxes, and even the emission of money by the Central Bank in one form or another. In 2023, the liquid part of the fund may be reduced by 2–2.1 trillion rubles. The new structure of the NWF (60% yuan and 40% gold) is less liquid and safer than the previous diversified investments in hard currencies. But since they are now “toxic”, the accounts are frozen, nothing else remains.”

How much longer will the FNB last in the end? According to Vladislav Inozemtsev, this is primarily an arithmetic question. On the one hand, the 54.5 billion rubles that are now being spent on the sale of yuan (to compensate for the lost oil and gas revenues in January) is a mere trifle on the scale of the Russian budget of more than 30 trillion rubles.

At the same time, some part of the NWF is permanently “stuck” in infrastructure projects. And given the steady decline in oil and gas revenues, the forecast of the Ministry of Finance regarding a deficit of 2% of GDP by the end of 2023 looks utopian. It will be at least twice as much, the economist argues, the hole in the budget, which will grow to about 6 trillion rubles, will have to be partially closed with the help of borrowing on the domestic market, partially due to tightening fiscal policy, and partially from the NWF.

However, even the most stressful scenarios for the Russian economy, budget and National Wealth Fund will not turn into a disaster. In any case, the system will have enough margin of safety in the next two or three years.

How the volume of the NWF has changed over the past 10 years (in trillion rubles):

2012 – 2.7

2013 – 2.9

2014 – 3.9

2015 – 4.7

2016 – 4.6

2017 – 3.9

2018 – 4.5

2019 – 7.9

2020 – 13.4

2021 – 13.8

2022 – 11.3

Source: Ministry of Finance.