Commodities | Emerging Markets | Europe | Fiscal Policy | FX
Fiscal rules are used in several commodity-exporting countries to avoid pro-cyclical fiscal policy. It can ensure that only a portion of revenues are spent, while the balance accrues into a sovereign wealth fund. Future generations can therefore benefit from the country’s resource revenues while long-term growth stability improves. Indeed, it mitigates oil revenue volatility by stimulating demand during downturns and by restraining it during booming times. For example, Norway has implemented a fiscal rule, which decouples government expenditure from oil price revenues. By contrast, government spending in Venezuela is highly correlated to the oil price.
Russia’s first fiscal rule was introduced in 2004 and has undergone many changes since then. From 2004 to 2007, the government targeted a balanced budget based on a fixed oil price of $20. From 2009 to 2012, the rule was removed to allow the government to implement sizable fiscal stimulus to fight the recession. From 2013 to 2014, the government targeted a 1% public deficit using a dynamic oil price based on the moving average from 2008. From 2015 to 2017, the rule was not appropriate to respond to the oil crisis and therefore was again not applied.
The current fiscal rule was implemented in January 2017 and included in the Budget Code in 2018. Initially, the rule required the government to target a balanced primary budget based on fixed oil revenues and an estimate of the non-oil revenues. The oil revenue threshold was initially calculated using an oil price of $40, stable oil production and an estimate of the USDRUB exchange rate. Every year, the $40 limit increases by 2% (the Fed’s inflation target) to keep the real value constant. The structural primary budget target has now been revised to -1% of GDP for 2018 and to -0.5% for 2019-2024.
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Summary
- Russia introduced a new fiscal rule in 2017 to preserve wealth across generations
- It implies FX interventions by the central bank on behalf of the Finance Ministry
- The fiscal rule was eased in 2020 but FX sales have continued
Market Implications
- Medium term, positive RUB. Ongoing FX sales and an improving C/A should mean further RUB appreciation ahead
Russia’s Fiscal Rule Has Undergone Several Changes
Fiscal rules are used in several commodity-exporting countries to avoid pro-cyclical fiscal policy. It can ensure that only a portion of revenues are spent, while the balance accrues into a sovereign wealth fund. Future generations can therefore benefit from the country’s resource revenues while long-term growth stability improves. Indeed, it mitigates oil revenue volatility by stimulating demand during downturns and by restraining it during booming times. For example, Norway has implemented a fiscal rule, which decouples government expenditure from oil price revenues. By contrast, government spending in Venezuela is highly correlated to the oil price.
Russia’s first fiscal rule was introduced in 2004 and has undergone many changes since then. From 2004 to 2007, the government targeted a balanced budget based on a fixed oil price of $20. From 2009 to 2012, the rule was removed to allow the government to implement sizable fiscal stimulus to fight the recession. From 2013 to 2014, the government targeted a 1% public deficit using a dynamic oil price based on the moving average from 2008. From 2015 to 2017, the rule was not appropriate to respond to the oil crisis and therefore was again not applied.
The current fiscal rule was implemented in January 2017 and included in the Budget Code in 2018. Initially, the rule required the government to target a balanced primary budget based on fixed oil revenues and an estimate of the non-oil revenues. The oil revenue threshold was initially calculated using an oil price of $40, stable oil production and an estimate of the USDRUB exchange rate. Every year, the $40 limit increases by 2% (the Fed’s inflation target) to keep the real value constant. The structural primary budget target has now been revised to -1% of GDP for 2018 and to -0.5% for 2019-2024.
CBR Intervenes on Behalf of the Finance Ministry
Extra oil revenues are automatically invested abroad via the National Welfare Fund (NWF), while assets are sold during any revenue shortfall. The Central Bank of Russia (CBR) acts as the agent of the Finance Ministry. If Russia’s crude oil trades below the threshold, CBR sell foreign currency and buys RUB. The proceeds are then transferred to the Finance Ministry account and used by the government. The FX operations are implemented in equal daily instalments, evenly through the trading day.
FX Sales Have Supported RUB Through 2020
The Covid-19 crisis and the oil price downturn created a severe shock to the Russian economy leaving the budget deficit around 5% of GDP, the highest in more than a decade.
Strictly speaking, Russia’s fiscal rule does not prohibit extra spending but it should be financed with non-oil revenue or borrowing. However, the structural primary deficit limit of 0.5% GDP significantly reduces borrowing flexibility. Therefore, the government had two options when the crisis hit: temporarily remove the 0.5% limit, or allow the use of the NWF to not only compensate the shortfall from $42 but to support the economy. The government opted to suspend the fiscal rule for 2020-2021 and allow the primary deficit to rise above 0.5% of GDP to accommodate higher spending.
Furthermore, the CBR continued FX sales on behalf of the Finance Ministry, to repatriate earlier savings.
In response to the sharp oil price drop in March, the CBR brought forward FX interventions related to asset repatriations, based on the ‘live’ oil price. Indeed, FX interventions used to be based on the previous month oil price. From March 10 until April 10, the CBR pre-emptively sold more than $2.1bn, well above the Finance Ministry’s guidance of a purchase of $0.8bn, based on February oil price.
Since April, oil prices have recovered. However, Russia significantly decreased its oil production as required by the OPEC+ agreement, and net oil revenues remain below the fiscal rule threshold. Therefore, the CBR has continued to sell foreign currency to make up for the shortfall. But FX intervention is backward looking and once again based on the previous oil price.
However, the CBR did not scale back FX sales to compensate for the March / April operations. From May to October, the CBR sold on average $1.8bn on a monthly basis, depending on the oil price and Russian oil production. These recurring FX sales, which corresponds to a daily sale of around $80mn, roughly 4% of the average daily trading, have been a key factor for demand for the Ruble.
Reduced RUB Volatility and Strong BoP Outlook
From 2015 to 2107, the relationship between RUB and oil was tight due to the lack of fiscal rule. Since the implementation of the fiscal rule in 2017, the CBR has sold RUB when oil prices are high and bought RUB (sold FX) when oil prices are low. The RUB / oil relationship is therefore now significantly weaker.
During the height of the Covid crisis, the RUB / oil relationship tightened again due to the dramatic drop in oil prices. Nevertheless, the recent oil price recovery and the consistent FX sales by the CBR should keep this relationship lower than during 2015-17 period. MinFin has announced $30mn in daily FX sales for December reflecting the higher oil revenues in November. Ongoing support from FX sales combined with an improving current account outlook and positive risk sentiment point to further RUB appreciation ahead.
Reuven is a macro strategist. He currently works for a private bank in Geneva on the strategy & advisory side. He has previously worked 4 years at Harness Investment, a $1bn global macro hedge-fund. His areas of interest are G10 & EM currencies. He holds a master of finance from Bocconi University.
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