January’s figures for Russian budget spending look so alarming that they have prompted talk of the impending collapse of the economy. The first month of 2023 saw the deficit reach a record 1.8 trillion rubles. Spending grew by 58 percent compared with January 2022, when there was a budget surplus of 125 billion rubles ($25 billion), while revenues fell by over a third.

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Yet it would be premature to write off the Russian economy based on the figures from a single month. Despite wide-ranging sanctions, the Kremlin still has plenty of opportunities to export hydrocarbons, and the country’s economic life is gradually returning to normal. Major spending in January may make it possible to economize in coming months. That’s not to say that the Russian economy has fully adapted to the new conditions and has stopped feeling the effect of sanctions altogether, simply that their effect will be a drawn-out one.

The Finance Ministry has offered several reasons for January’s revenues falling by 35 percent. Income from oil and gas decreased to 426 billion rubles, the lowest level since 2020, because of a fall in the price of Urals crude (to $49 per barrel in January: 40 percent cheaper than Brent, while the budget is calculated based on a price of $70), and also a decline in gas exports. For now, the government can close the gap by borrowing and tapping the National Wealth Fund, Russia’s sovereign wealth fund.

Non-oil and gas revenues also decreased: by 28 percent down to 931 billion rubles. The most serious drop was seen in internal VAT and profit tax payments, though it’s primarily a technical issue linked to changes in the collection of those taxes.

Budget spending grew a record 58.7 percent to 3.1 trillion rubles. This was partly a result of advance payments being issued on state contracts, whose total value quintupled compared with the year before, from 249 billion to 1.3 trillion rubles. Previously, the Finance Ministry paid ministries and other government agencies—the main disbursers of budget finances—gradually, peaking in the final quarter of the year. Last year, for example, more than a third of all spending took place in the final quarter. The Finance Ministry had come under fire for this uneven spending, both from the Accounts Chamber and even President Vladimir Putin himself.

This year, the Finance Ministry took note, and processed 11 percent of annual planned spending in January alone. If state contracts are excluded from the equation, then budget spending grew just 6 percent. Since a significant portion of advance payments was made at the beginning of the year, it’s reasonable to expect remaining government expenditure to be distributed more evenly throughout the year.

Using open-source data alone, it’s hard to track exactly where the dramatic increase in state spending in January was directed. It’s likely that the advance payments went primarily to defense and security (for which about 9.5 trillion rubles was allocated in the 2023 budget), as well as to developing the new territories Moscow has annexed from Ukraine.

The Finance Ministry stopped publishing its quarterly budget breakdown back in the spring. Spending is set at 29 trillion rubles in 2023, but judging by last year, when an additional 2 trillion rubles—a not inconsiderable sum—was allocated in December, the government is unlikely to keep its spending within budget this year either.

For this reason, there is no point in guessing what the budget deficit will be at the end of this year based purely on figures for the first month. Last September, for example, the government and analysts expected the budget deficit to not exceed 1.5 trillion rubles—and then came the additional spending surge in December.

For now, the hole in this year’s budget equals 2 percent of GDP. It already looks doubtful that everything will go as planned, but Russia’s reserves, combined with borrowing, will enable the country to cover a budget deficit for at least two more years.

Even if there were to be a sharp shock to the budget, there would be no threat to military or social spending (together worth about 17 trillion rubles), which are protected and would be the last to see cuts. Their limits are calculated based on what budget revenues can be counted on, regardless of the situation on commodities markets (about 11.5 percent of GDP in 2023, or 17 trillion rubles).

Social spending—state salaries, pensions, and healthcare—is ring-fenced by law, while the only aspect of military spending that cannot be cut is the purchase of weapons and military technology. In practice, however, there is an understanding that all spending on defense and security is ring-fenced: even the parsimonious Finance Ministry is wary of proposing cuts in this area.

The Russian economy is entering 2023 stronger than expected thanks to high oil and gas prices in the first half of 2022, and the swift pivot of Russian energy suppliers to Asian markets. Hard currency inflows resulting from the favorable situation on energy markets combined with the lack of a need for borrowing enabled the government to avoid any spending cuts.

Not all of these factors will apply in 2023, however. The energy markets already look very different: no price records are expected this year; the West has embargoed Russian oil and petrochemicals; and pipeline gas exports are at a low. At home, the overall uncertainty is affecting consumer demand. In some sectors, salaries are growing at an exponential rate, yet despite surges in consumer spending, it doesn’t yet look confident or adapted to the new market structure.

There is also the prospect of further risks from sanctions. Most possible restrictions have already been introduced, but some sanctions, such as the embargo on petrochemicals, have yet to be reflected in the financial data. In addition, Russia is currently managing to get essential microchips and other technology via Turkey and China with the help of proxy companies. Whether it will continue to do so depends on what export controls Western countries apply to these products.

Nor have the external economic risks to export revenues disappeared. Sanctions have exacerbated the fragmentation of the markets that took place during the pandemic, and transactions in reserve currencies are getting more and more difficult, despite businesses increasingly turning to alternative currencies. Here, too, there could be problems: for example, if exporters move over to alternatives faster than importers do. Previously, such ebbs and flows were evened out by inflows of capital. Russia’s closed capital account means that’s no longer an option.

The Russian economy’s adaptation to the new reality is far from over. The reduction in export revenues and restoration of imports will put pressure on the ruble’s exchange rate. Regressive import substitution remains the most likely prospect for the Russian economy: when imported components reach the end of their lifespan, they will be replaced by less advanced alternatives. Many manufacturing enterprises have already adopted this practice. Slowly but surely, the sanctions noose is tightening.

By: Alexandra Prokopenko