Russia Economics - Finance Ministry To Change the Budget Rule for 2018

The Finance Ministry has announced that it intends to modify the budget rule in 2018. In the current version, the amount of FX acquired on the market is equal to the difference between actual and expected oil and gas (O&G) revenues in rubles. We have pointed out that this approach made the rule too dependent on cycles. In the February Russia Economic Monthly, we explained how this budget rule works in the context of three scenarios.
> Scenario 1: No change in oil price, capital outflow increases. Higher capital outflow would push the ruble lower. But this would mean higher ruble-denominated O&G revenues. Insofar as the amount of interventions is linked to additional O&G revenues in ruble terms (i.e. the base-case revenues are fixed in rubles), a weaker ruble amid a stable oil price would increase interventions in FX terms. Thus, in addition to increased capital outflow, the market would see higher absorption of FX liquidity. If the interventions are in fact conducted in accordance with the currently in place Finance Ministry's guidelines, this could turn into a self-perpetuating process.
> Scenario 2: No changes in oil price, capital outflow decreases. The logic described above works in the opposite direction as well: a decrease in capital outflow strengthens the ruble, which reduces additional O&G revenues - and thus interventions. The potential for ruble appreciation, however, is limited in this case, as the interventions will tend toward zero. That is to say, when acquisitions end, the ruble will stabilize.
> Scenario 3: Oil prices change. If the oil price drops unexpectedly, the ruble will depreciate as the balance of payments deteriorates. This process will only be encouraged by the FX buying, the amount of which is fixed in rubles at the start of the month. Though the weaker ruble will reduce FX-denominated purchases, the very fact of there being purchases of FX may look inappropriate if the oil price moves sharply lower. Interestingly, if oil grows, the effect would be less dramatic, as investors react differently to potential ruble appreciation than to the risk of depreciation.
The second scenario has actually already come to pass. Thanks to the stronger ruble, O&G revenues in rubles are already close to the target (though the oil price is higher). As a result, interventions were stopped in July.
The new mechanism for next year, meanwhile, will minimize the effect of the exchange rate. While the Finance Ministry will continue to look at the difference between the actual and forecast ruble-denominated O&G revenues, the forecast will be made using the current exchange rate (rather than the Finance Ministry's forecast rate, as is done now). This means that the exchange rate will become a negligible factor and that FX acquisitions will depend only on the oil price. In other words, the amount of FX bought will not change if the oil price is flat but the ruble volatile.
All of this will have important implications for the FX market. No longer dependent on the exchange rate, interventions will become more predictable. For example, if the oil price in 2018 is at $50 bbl/Brent, acquisitions will be at around $15-17 bln - an amount large enough to push the ruble toward depreciation from the current level of around USD/RUB 59.