World Economy

Cheap Oil Weakens Russia GDP

Cheap Oil Weakens Russia GDPCheap Oil Weakens Russia GDP

When Vladimir Putin first became Russia’s president back in 2000, oil traded at an average $28.40 a barrel. After spending much of the past five years above $100 a barrel, crude prices have come nearly full circle.

In just the past few weeks, oil prices have fallen about 16%. That’s poised to squeeze an economy that’s heavily dependent on the commodity for its revenues. The finance ministry in Moscow has already warned about a higher deficit if spending cuts and other austerity measures aren’t implemented in the face of cheaper crude, news outlets reported.

Gross domestic product fell 3.7% in 2015, according to a preliminary estimate from the Federal Statistics Service. That was the steepest decline since 2009.

Russia’s oil-dependent economy is facing the second year of contraction as oil prices have dropped more than 70% from its mid-2014 peak to around $30 a barrel, and Ukraine-related western sanction against Moscow, which shut out Russian companies of global capital markets, remain in place. The International Monetary Fund predicts that the Russian economy would contract by a further 1% this year before a return to 1% growth in 2017. Sberbank, Russia’s largest bank, predicts that the economy would fall more than 2%.

  Budget Deficit

Russia, which relies on oil and natural gas for almost half its fiscal revenue, ran a budget deficit of 2.6% in 2015, the highest in five years. It’s now at risk of topping that level as prices drop even further, Finance Minister Anton Siluanov warned the government.

This year’s budget was initially planned around oil averaging $50 a barrel and a deficit of 3% of gross domestic product. Belt-tightening measures totaling 1.5 trillion rubles ($18.9 billion) are needed to avoid a shortfall of over 6% of output this year, Siluanov said.

  Weak Currency Driving Inflation

While consumers were the main drivers of Russia’s economy for more than a decade, soft domestic demand has now become a primary hindrance to growth.

As cheap oil weakens the Russian economy, it also causes its national currency, the ruble, to depreciate. That means Russian consumers have to shell out more rubles if they want to maintain their consumption levels.

The ruble dropped to a new record low of almost 86 to the dollar on January 21st. The Russian currency has strengthened since that day, helped by the slight rebound in oil prices. It was trading at 79.78 on January 25.

Having lost 20% of its value in 2015, the ruble has lost about 8% against the US dollar so far this year, making it the worst-performing emerging-market currencies. The currency fall, which reflects weaknesses in Russia’s economy, has pushed up the price of imports, fuelling inflation.

  GDP May Shrink

“Where is the bulk of money made? In oil, gas, metals, other commodities,” Putin said in his address to the Russian parliament in April 2001, calling for greater diversification of the Russian economy. At the time, oil and gas generated some 30% of federal budget revenues. In 2015, the figure reached 44%, according to the finance ministry—so much for good intentions.

Greater dependence on oil and gas means Russia’s GDP is even more linked to the crude-price dynamics. With the current oil rout, the country’s economy risks shrinking for a second year. It declined 3.7% in 2015, the deepest contraction since 2009, and may shrink 0.5% this year, according to economists surveyed by Bloomberg in December.

The weakness in the economy is hitting ordinary Russians particularly hard. Consumer spending has withered. Retail sales fell 15.3% from a year earlier in December. Real wages dropped 10% year-on-year, the most since Putin came to power in 2000. Fixed-capital investment fell 8.7% from a year earlier.