Oil market showdown: can Russia outlast the Saudis?

In Russia, the impact of low crude revenues on GDP has raised questions about Russia's long term economic prospects. Some see Russia's economic growth potential as 1 percent annually or less due to low energy prices, low productivity levels, and a shrinking population, while Alexei Kudrin, finance minister from 2001 to 2011, recently commented that Russia's growth model for the last fifteen years-using income from energy exports to drive up wages, domestic demand and therefore growth-will no longer work. With the government strapped for funds, and energy income no longer supporting domestic demand, some see investment as the sole possible driver of growth.

IMF WEO data: budget deficits as far as the eyes can see

Both the Saudi and Russian governments depend on energy revenues to fund their budgets-oil funds ~90 percent of the Saudi budget and oil and natural gas ~52 percent of the Russian budget. With the decline in prices, the Saudi budget anticipates a deficit of 20 percent of GDP in 2015 and the Russian budget a deficit of 3.3 percent of GDP. The April and October WEO budget projections in national currencies (Rubles and Riyals) show the deficits decreasing, but continuing through 2020 for both countries:

The following table shows that as a percentage of GDP, the deficits decline steadily through 2020. However, as a percentage of GDP, the WEO October projections show the Saudi deficits remain double-digit through 2020-the potential impact of which will be discussed in the section on currencies.

As planning for the 2016 fiscal year proceeds, fiscal reality is forcing both governments to scramble for new sources of revenues and/or opportunities to cut spending to reduce their budget deficits. The Russian government suspended the budget rule using a long term average of crude prices to set spending, since the resulting $80 average price would have dictated unreasonable spending in 2016.

President Putin ordered a 10 percent cut in Interior Ministry personnel, imposed a one million headcount ceiling on this ministry, and planned cuts in Kremlin headcount. The Finance Ministry sought a change in the mineral extraction tax formula to generate an additional 609 billion rubles in 2015 and 1.6 trillion through 2018, but pressure from the Economic and Energy Ministries and Russian producers forced the Finance Ministry to consider alternatives with less negative impact on crude production. In addition, the government reportedly is taking some $13 billion from national pension funds, while the Russian Central Bank is preparing proposals on government pension guarantees that would shift some pension funding burden from the government budget to companies and individuals.

The Saudi government is also scrambling. After an eight year hiatus from issuing sovereign debt, the Saudi government announced a plan during the summer to borrow $28 billion in 2015 and launched the borrowing with a $5 billion offering in August. The Ministry of Finance has banned contracts for new projects, hiring and promotions, and purchase of vehicles or furniture in the fourth quarter, while the newly created Council for Economic and Development Affairs must now approve all government projects worth more than $27 million. The Saudi government also is preparing to privatize airports and contemplating seeking private financing for infrastructure projects.

The budget situation puts the Saudi government in a difficult situation. On the one hand, the size of the deficits requires drastic cuts in spending, but such drastic cuts would impact politically sensitive areas such as energy subsidies, government employment opportunities for Saudi citizens, education, and economic development projects. On the other hand, depleting Saudi government reserves to finance the deficits will put the Saudi sovereign credit rating at risk, which would raise the cost of borrowing as well as pressure the Saudi currency (the consequences of which are discussed below).

IMF WEO data: lagging per capita income as far as the eyes can see