October 1, 2019

Budget 2020: Smaller Surplus – Fewer Distortions

BY Alexander Kudrin, Evgeny Gavrilenkov

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( 9 mins)

The Russian Ministry of Finance released an updated draft version of a three-year rolling budget, which indicates a shift from a kind of austerity and strong federal budget surplus toward a more generous spending policy, which should be generally supportive for economic growth. The economy is going to benefit not only from some additional government spending on various national projects, but also from less distorted environment on the money markets, including elevated interest rates and the fact that money market rates are below the key rate. The latter implies banks have no demand for refinancing from the CBR.

A much smaller surplus will discourage Minfin from pumping unnecessary cash into the system – even though the Ministry will keep buying FX, there will be less spare cash to deposit in banks. Moreover, assuming a lower oil price, Minfin’s interventions on the FX market are set to subside which will cause a convergence between the key rate and the money market rates.

In such an environment banks’ demand for the CBR refinancing may start growing, which in turn may increase the banks’ demand for OFZs, i.e. collateral with no haircut. Even though next year’s government borrowing program looks quite ambitions, it will be supported by the demand from banks.

 

  • Running a surplus of around several trillion rubles means liquidity absorption. A combination of a budget surplus and net domestic borrowing implies even greater liquidity absorption. In order to soften this effect, the Ministry of Finance returns part of this liquidity back to the system by offering banks to deposit some part of its spare funds. Buying FX on the market to top up the National Wealth Fund also implies injection of liquidity in the system.
  • As Minfin’s ruble interventions recently subsided while the CBR cut the key rate by cumulative 50 bps, RUONIA and the key rate started to converge gradually, implying that the environment on the money markets is becoming less distorted and banks have fewer incentives and opportunities to benefit from simply pumping money back and forth between Minfin and the CBR.
  • It looks as though elimination of such distortions on money markets will continue in 2020 as well as amid falling inflation in Russia and monetary easing worldwide the CBR will have to continue cutting rates. Greater convergence of the key rate and RUONIA is expected in 2020, especially due to the fact that the CBR will most likely continue rate cuts delivering at least 150 bps in the next fifteen months would not be a surprise.

The Russian Ministry of Finance released an updated draft version of a three-year rolling budget, which indicates a shift from a kind of austerity toward a more generous spending policy, which should be generally supportive for economic growth. Meanwhile, the economy is going to benefit not only from some additional government spending on various national projects, but also from less distorted environment on the money markets, including elevated interest rates. As those issues have been broached by the GKEM Analytica on several occasions in the past it may make sense to provide a brief summary of a kind of distortions which currently keep interest rates elevated and economic growth at bay.

In 2018, the fiscal surplus exceeded R2.7 trln (around 2.6% of GDP) and expenditures grew by less than 2% in nominal terms relative to the previous year, which meant contraction in real terms. As the revenues in 2018 exceeded expectations and increased by nearly 29% compared to 2017, the budget balance turned into surplus. Despite this surplus, the government followed the “party line” and did its best to borrow on the local markets in line with the annual borrowing plan. In 2019, the situation looks largely the same – the budget runs a surplus (albeit smaller than in 2018), while the government continues borrowing (even on a larger scale). This borrowing orchestrated amid fiscal surplus was supposed to support accumulation of international reserves as an integral part of the fiscal rule arrangements.

Running a surplus of around several trillion rubles means liquidity absorption. Indeed, the money supply (M2 aggregate) fluctuated between R42 trln and R45 trln in 2018. This year it climbed above R47 trln. A combination of a budget surplus and net domestic borrowing implies even greater liquidity absorption (assuming other factors being equal). In order to soften this effect, the Ministry of Finance returns part of this liquidity back to the system by offering banks to deposit some part of its spare funds. The amount of such deposits fluctuated around R2.5 trln in recent years and stayed around this level in September 2019. Buying FX on the market to top up the National Wealth Fund also implies injection of liquidity in the system. As a result, Minfin became one of the most powerful players on the FX market as well as on the ruble money markets.

As a result of the liquidity oversupply by Minfin, the money market rate, namely RUONIA, stays below the key rate – a clear signal that Russia’s money markets are not immune to distortions. Meanwhile, the CBR stands on the other side of this complicated liquidity management process. As Minfin oversupplies the system with liquidity, the CBR sterilizes it by offering its own deposits and bonds. As seen from the chart below, in the past couple years banks’ claims on the CBR fluctuated around R3.5 trln. Another chart (on the right) illustrates that RUONIA indeed stayed below the key rate recently.

Budget 2020: Smaller Surplus – Fewer Distortions 7

One of the GKEM Analytica reports released this summer mentioned that banks (mostly state- controlled) benefit from such arrangements in various ways. Indeed, as the interest paid by banks to Minfin on the deposited money is lower that RUONIA (discounted on reservation requirements) while the CBR bonds offer an interest equal to the key rate, this option looked quite appealing for banks as a rather easy way to make money. This report also mentioned that the CBR could reduce and possibly eliminate these and some other distortions by lowering the key rate and issuing less bonds. As seen from the above chart both steps have been taken by the CBR recently – the stock of bonds decreased and the key rate was cut by combined 50 bps.

What can be also derived from the above chart is that RUONIA and the key rate are gradually converging, which may be a signal that the environment on the money markets is indeed gradually becoming less distorted. As seen from the chart below, the average gap between RUONIA and the key rate in 2019 is not as wide as it was in 2018, which means that banks have fewer incentives and opportunities to benefit from simply pumping money back and forth between Minfin and the CBR.

Budget 2020: Smaller Surplus – Fewer Distortions 8

It looks as though elimination of such distortions on money markets will continue in 2020 as well as amid falling inflation in Russia and monetary easing worldwide the CBR will have to continue cutting rates. More signals will come from the budget as well. The table below illustrates the current Minfin thinking on the macroeconomic situation in 2019 – 2020 and the budget figures. As seen from the table, expenditures are set to rise in 2020 by around 6.5% in nominal terms following a 9.5% growth this year, while nominal revenues are not expected to rise much. Hence the budget surplus is expected to be smaller this year than in 2018 and will shrink further next year.

 

Budget 2020: Smaller Surplus – Fewer Distortions 9

One may set doubts and argue about particular numbers, but in any case the overall picture presented in this table is quite straightforward – amid decelerating global economy and decreasing oil price (on the average annual basis) Russia’s budgetary oil revenues are not going to rise. Some growth of the non-oil-and-gas tax revenues is expected as inflation decelerates while the economy crawls at a snail’s pace. Hence the total federal budget revenues grow slowly, thus causing the federal budget surplus to shrink.

As mentioned above, an increase in budgetary spending will support domestic demand next year as this increase will be positive in real terms, while a much smaller surplus will discourage Minfin from pumping unnecessary cash into the system – even though the Ministry will keep buying FX, there will be fewer spare cash to deposit in banks. Moreover, assuming a lower oil price, Minfin’s interventions on the FX market are set to subside. Amid the assumptions shown in the table, Minfin’s average daily spending on FX purchases is not expected to exceed R10 bn. Therefore, the ministry’s total ruble interventions are not going to exceed R2.5 trln next year, while they already exceeded R2.7 trln in 9M19.

As a result, the convergence of the key rate and RUONIA cannot be ruled out, especially due to the fact that the CBR will most likely continue rate cuts – delivering at least 150 bps in the next fifteen months would not be a surprise. In such an environment banks’ demand for the CBR refinancing may start growing, which in turn may increase the banks’ demand for OFZs, i.e. collateral with no haircut. Even though next year’s government borrowing program looks quite ambitions, it will be supported by demand from banks.

Data provider: Cbonds

 

The Russian Ministry of Finance released an updated draft version of a three-year rolling budget, which indicates a shift from a kind of austerity and strong federal budget surplus toward a more generous spending policy, which should be generally supportive for economic growth. The economy is going to benefit not only from some additional government spending on various national projects, but also from less distorted environment on the money markets, including elevated interest rates and the fact that money market rates are below the key rate. The latter implies banks have no demand for refinancing from the CBR.

A much smaller surplus will discourage Minfin from pumping unnecessary cash into the system – even though the Ministry will keep buying FX, there will be less spare cash to deposit in banks. Moreover, assuming a lower oil price, Minfin’s interventions on the FX market are set to subside which will cause a convergence between the key rate and the money market rates.

In such an environment banks’ demand for the CBR refinancing may start growing, which in turn may increase the banks’ demand for OFZs, i.e. collateral with no haircut. Even though next year’s government borrowing program looks quite ambitions, it will be supported by the demand from banks.

 

  • Running a surplus of around several trillion rubles means liquidity absorption. A combination of a budget surplus and net domestic borrowing implies even greater liquidity absorption. In order to soften this effect, the Ministry of Finance returns part of this liquidity back to the system by offering banks to deposit some part of its spare funds. Buying FX on the market to top up the National Wealth Fund also implies injection of liquidity in the system.
  • As Minfin’s ruble interventions recently subsided while the CBR cut the key rate by cumulative 50 bps, RUONIA and the key rate started to converge gradually, implying that the environment on the money markets is becoming less distorted and banks have fewer incentives and opportunities to benefit from simply pumping money back and forth between Minfin and the CBR.
  • It looks as though elimination of such distortions on money markets will continue in 2020 as well as amid falling inflation in Russia and monetary easing worldwide the CBR will have to continue cutting rates. Greater convergence of the key rate and RUONIA is expected in 2020, especially due to the fact that the CBR will most likely continue rate cuts delivering at least 150 bps in the next fifteen months would not be a surprise.
  •  

The Russian Ministry of Finance released an updated draft version of a three-year rolling budget, which indicates a shift from a kind of austerity toward a more generous spending policy, which should be generally supportive for economic growth. Meanwhile, the economy is going to benefit not only from some additional government spending on various national projects, but also from less distorted environment on the money markets, including elevated interest rates. As those issues have been broached by the GKEM Analytica on several occasions in the past it may make sense to provide a brief summary of a kind of distortions which currently keep interest rates elevated and economic growth at bay.

In 2018, the fiscal surplus exceeded R2.7 trln (around 2.6% of GDP) and expenditures grew by less than 2% in nominal terms relative to the previous year, which meant contraction in real terms. As the revenues in 2018 exceeded expectations and increased by nearly 29% compared to 2017, the budget balance turned into surplus. Despite this surplus, the government followed the “party line” and did its best to borrow on the local markets in line with the annual borrowing plan. In 2019, the situation looks largely the same – the budget runs a surplus (albeit smaller than in 2018), while the government continues borrowing (even on a larger scale). This borrowing orchestrated amid fiscal surplus was supposed to support accumulation of international reserves as an integral part of the fiscal rule arrangements.

Running a surplus of around several trillion rubles means liquidity absorption. Indeed, the money supply (M2 aggregate) fluctuated between R42 trln and R45 trln in 2018. This year it climbed above R47 trln. A combination of a budget surplus and net domestic borrowing implies even greater liquidity absorption (assuming other factors being equal). In order to soften this effect, the Ministry of Finance returns part of this liquidity back to the system by offering banks to deposit some part of its spare funds. The amount of such deposits fluctuated around R2.5 trln in recent years and stayed around this level in September 2019. Buying FX on the market to top up the National Wealth Fund also implies injection of liquidity in the system. As a result, Minfin became one of the most powerful players on the FX market as well as on the ruble money markets.

As a result of the liquidity oversupply by Minfin, the money market rate, namely RUONIA, stays below the key rate – a clear signal that Russia’s money markets are not immune to distortions. Meanwhile, the CBR stands on the other side of this complicated liquidity management process. As Minfin oversupplies the system with liquidity, the CBR sterilizes it by offering its own deposits and bonds. As seen from the chart below, in the past couple years banks’ claims on the CBR fluctuated around R3.5 trln. Another chart (on the right) illustrates that RUONIA indeed stayed below the key rate recently.

Budget 2020: Smaller Surplus – Fewer Distortions 7

One of the GKEM Analytica reports released this summer mentioned that banks (mostly state- controlled) benefit from such arrangements in various ways. Indeed, as the interest paid by banks to Minfin on the deposited money is lower that RUONIA (discounted on reservation requirements) while the CBR bonds offer an interest equal to the key rate, this option looked quite appealing for banks as a rather easy way to make money. This report also mentioned that the CBR could reduce and possibly eliminate these and some other distortions by lowering the key rate and issuing less bonds. As seen from the above chart both steps have been taken by the CBR recently – the stock of bonds decreased and the key rate was cut by combined 50 bps.

What can be also derived from the above chart is that RUONIA and the key rate are gradually converging, which may be a signal that the environment on the money markets is indeed gradually becoming less distorted. As seen from the chart below, the average gap between RUONIA and the key rate in 2019 is not as wide as it was in 2018, which means that banks have fewer incentives and opportunities to benefit from simply pumping money back and forth between Minfin and the CBR.

Budget 2020: Smaller Surplus – Fewer Distortions 8

It looks as though elimination of such distortions on money markets will continue in 2020 as well as amid falling inflation in Russia and monetary easing worldwide the CBR will have to continue cutting rates. More signals will come from the budget as well. The table below illustrates the current Minfin thinking on the macroeconomic situation in 2019 – 2020 and the budget figures. As seen from the table, expenditures are set to rise in 2020 by around 6.5% in nominal terms following a 9.5% growth this year, while nominal revenues are not expected to rise much. Hence the budget surplus is expected to be smaller this year than in 2018 and will shrink further next year.

 

Budget 2020: Smaller Surplus – Fewer Distortions 9

One may set doubts and argue about particular numbers, but in any case the overall picture presented in this table is quite straightforward – amid decelerating global economy and decreasing oil price (on the average annual basis) Russia’s budgetary oil revenues are not going to rise. Some growth of the non-oil-and-gas tax revenues is expected as inflation decelerates while the economy crawls at a snail’s pace. Hence the total federal budget revenues grow slowly, thus causing the federal budget surplus to shrink.

As mentioned above, an increase in budgetary spending will support domestic demand next year as this increase will be positive in real terms, while a much smaller surplus will discourage Minfin from pumping unnecessary cash into the system – even though the Ministry will keep buying FX, there will be fewer spare cash to deposit in banks. Moreover, assuming a lower oil price, Minfin’s interventions on the FX market are set to subside. Amid the assumptions shown in the table, Minfin’s average daily spending on FX purchases is not expected to exceed R10 bn. Therefore, the ministry’s total ruble interventions are not going to exceed R2.5 trln next year, while they already exceeded R2.7 trln in 9M19.

As a result, the convergence of the key rate and RUONIA cannot be ruled out, especially due to the fact that the CBR will most likely continue rate cuts – delivering at least 150 bps in the next fifteen months would not be a surprise. In such an environment banks’ demand for the CBR refinancing may start growing, which in turn may increase the banks’ demand for OFZs, i.e. collateral with no haircut. Even though next year’s government borrowing program looks quite ambitions, it will be supported by demand from banks.

Data provider: Cbonds

 

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