RUSSIA

Following the Russian military invasion of Ukraine on 24 February 2022, governments around the world imposed sweeping and sizable financial and economic sanctions on the Russian economy and individuals, including partial export embargoes on hi-tech goods exports, sanctions against the largest Russian banks, the removal of multiple Russian banks from the SWIFT messaging system and the freezing of around one half of the Central Bank of Russia’s (CBR’s) foreign exchange (FX) reserves held in G-7 and other Western countries. Meanwhile, many countries have also imposed an oil-import embargo. Counter-sanctions from Russia have included FX controls for business transactions, stringent capital controls regarding payments abroad (including sovereign debt service and banning foreigners from selling securities), the nationalization of foreign companies deciding to exit Russia after the start of the war as well as selected export embargoes to the West (especially on most natural gas exports to the EU). The capital controls also led to a selected default of the Russian government on its sovereign debt in mid-2022. As long as the Russian war against Ukraine continues, further escalation cannot be excluded, which could result in even harsher sanctions and counter-sanctions. The overall environment for doing business in and with Russia is now very unfavorable.

Russia’s fiscal deficit will widen in 2023 due to rising military spending and declining energy export revenues. The government posted a sizeable fiscal surplus in the first half of 2022, thanks to surging energy receipts and seasonally low public spending. However, that surplus was nearly wiped out in Q3 and moved into a large deficit in Q4, owing to declining gas revenues (as gas exports plunged) and rising expenditure, including a seasonally peak in spending in December. Eventually the fiscal deficit amounted to -2.2% of GDP in 2022. In 2023, we expect military spending and social expenditures to rise while spending cuts on infrastructure and administration are intended to keep the overall rise in budget expenditures in check. We further expect budget revenues to decline, mainly because of projected falling energy receipts. The government plans to levy a one-off "voluntary" tax on big business and expects RUB0.3trn thereof. But even if realized, that will be only a drop in the ocean. In the first five months of 2023, the budget deficit amounted to RUB3.4trn, exceeding the full-year 2022 shortfall. We forecast a deficit of around RUB6.7trn in 2023 as a whole, equivalent to about USD80bn or -4.2% of GDP. Our tentative forecast for 2024 is a deficit of -2.7% of GDP.

Russia will finance the fiscal deficits through domestic bond (OFZ) issuance and withdrawals from the National Wealth Fund (NWF, a sovereign wealth fund). The Ministry of Finance restarted OFZ issuance in September 2022 and was able to finance most of that year’s fiscal deficit through this channel. Large domestic banks, mostly public ones, took up over 90% of the bonds issued until end-2022 since they had limited investment opportunities while having ample liquidity. In early 2023, however, Russian banks' share in government bond purchases fell significantly and the government began to tap the NWF to finance (in part) the monthly fiscal shortfalls. At the beginning of 2023, the NWF assets were estimated at RUB10.8trn, equivalent to around USD155bn. Since about one-third of these assets is estimated to be frozen due to Western sanctions, liquid NWF assets amounted to approximately RUB7trn, or USD100bn, equivalent to 4.5% of GDP or so. It is worth noting that the RUB exchange rate functions as an automatic stabilizer. If the RUB depreciates, as we forecast for 2023, the RUB value of export revenues received in foreign currency will increase and thus fiscal revenues will also rise in RUB terms. Overall, we can conclude that the projected fiscal deficits in 2023-2024 should be manageable for the government and allow it to fund military activities for at least another year. That said, it should be noted that a substantial drawdown of the NWF, as well as planned expenditure cuts in 2023, would have crucial medium- and long-term effects for the economy and the welfare of the Russian people.

Russia’s foreign exchange (FX) reserves have recovered since September 2022 and we expect the Russian economy from this perspective to be able to cope with Western sanctions in 2023 and beyond. FX reserves (excluding gold) fell from USD498bn in January 2022 (i.e. just before the war) to a temporary low of USD417bn (including frozen FX reserves due to Western sanctions) in September, about half of which was due to the USD’s strength weighing on the valuation of assets in other currencies. Since then, they have recovered somewhat and stood at to USD440bn in mid-2023. A reversal of the valuation effect played a role in the recovery, but the record-high current account surplus of USD236bn (equivalent to +10.3% of GDP) in 2022 and the de-dollarization of external trade have likely been more important. The Chinese renminbi is gaining increasing popularity in Russia’s external trade so that forthcoming export earnings cannot be frozen by Western sanctions anymore. Under the assumption that frozen FX reserves have remained roughly stable at USD238bn (half of total FX reserves in February 2022) since the war began, available FX reserves fell from USD238bn in February 2022 to a temporary low of USD179bn in September and then recovered to USD215bn in January 2023, before falling back gradually to about USD200bn as of June 2023. This level of reserves was sufficient to cover a healthy 6.8 months of imports. However, the current account surplus has shrank rapidly since Q4 2022, mainly due to lower energy export revenues, and we forecast the annual surplus to fall sharply to around USD35bn (+2% of GDP) in 2023 and to remain close to that level in 2024. Yet these surpluses should help to moderate the expected decline in available FX reserves over the next year. In a more conservative but less likely scenario where available FX reserves fall to USD160bn at some point in 2024, import cover would still exceed five months. And in a worse scenario, Russia would still have the possibility to monetize part of its gold reserves, which stood at around USD143bn in mid-2023.