Further falls in the oil price is forcing governments reliant on oil revenues to review and revise their budget estimates and target further expenditure cuts. Russia remains prudent announcing a further RUB700bn of cuts (~10%) targeting state investments and administrative expenses. The potential privatisation of some state assets is also under consideration. Details are still emerging but this prudent approach is credit positive.
Russia is less constrained than some governments as the exchange rate can adjust to offset some of the weakness in oil prices and keep the balance of payments in surplus. Plus, it has sizeable reserves and sovereign wealth funds it can tap into; the Reserve and Wellbeing Funds were USD50bn and USD71.7bn respectively at the end of December and gold and foreign exchange reserves were USD370.2bn as of 8 January. But even so with Brent crude prices now languishing in the low 30s further cuts are needed to keep the fiscal deficit from exceeding 3 percent of GDP.
Another issue is whether Europe and the US will repeal sanctions imposed on Russia for its involvement in the Ukraine which would be seen as positive by investors. The key to this most likely still lies in the successful implementation of the Minsk II agreement whose deadline for implementation has been extended into 2016 by the “Normandy Quartet” (Vladimir Putin, Francois Hollande, Angela Merkel and Pyotr Poroshenko). Minsk II still requires that local elections are held in the separatist areas but these have been pushed into 2016 to give enough time to comply with the terms of the agreement and make them legitimate. Once international observers declare the election legitimate, and powers have been decentralised to the separatist area as envisaged by the Minsk agreement, Russia and the separatists must then cede control of the border to Ukrainian forces.
One of the main areas of contention remains the interpretation of the form decentralisation should take in the separatist areas: the Russian Foreign Minister Sergey Lavrov noted that this should be on a “permanent basis” and that it “means the right to speak the Russian language on the territory of Donbass, the right for special economic ties with Russia, the right to take part in appointing prosecutors, judges, have their own law enforcement agencies, including people’s militia, and many more things that were personally signed by German Chancellor Angela Merkel together with French President Francois Hollande." But he notes that the Ukrainian interpretation is much weaker referring to “some special rules in the sphere of self-governing.” Vladimir Putin also noted in an interview with Bild “The Ukrainian Government introduced the law on the special status of those territories, a law that had been adopted earlier, into the transitional provisions. But this law, which they incorporated in the Constitution, was adopted for the duration of three years only. Two years have already passed. When we met in Paris, both the German Chancellor and the French President agreed that this law should be changed and included in the Constitution on a permanent basis. Both the President of France and the Chancellor of Germany confirmed that.”
If Minsk II does get implemented the removal of sanctions becomes more likely. One of the key attractions for Russia of seeing Minsk II implemented and the repeal of sanctions is easier access to international capital markets. Certain companies such as Gazprom and Norilsk Nickel have been able to raise funds with eurobond issues in the last quarter of last year but the sanctions are still constraining offshore capital raising. For the Europeans, Syria and the migrant crisis is a pressing issue and Russia remains a critical player in any resolution of the Syrian crisis. Clearly, keeping sanctions in place makes multilateral cooperation on international issues such as Syria, ISIS and tensions in the Middle East more challenging.