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Oil muddles Russia's budget debate

Russia's high dependence on oil prices threatens its 2011 budget targets, essential to supporting the government's promises ahead of parliamentary and presidential elections. Finance minister Alexei Kudrin has previously stated that Russia needs an average annual price of $115 per barrel to make the budget self-financing.

Experts' opinions are split on the issue of whether the average 2011 oil price will enable the finance ministry to achieve its goal, as the oil price is especially hard to predict. "At the start of the year Alexei Kudrin said the budget would have no deficit at $105 per barrel, then he raised the bar. But we conservatively estimate that it will be at $95, with about a three per cent deficit by the year end," said an analyst with Rye, Man & Gor Securities who preferred not to be named.

Yaroslav Lissovolik, the Deutsche Bank Russia chief economist, said his bank forecasts an average for the year of $ 117.5 per barrel. "And we are forecasting a budget net surplus for Russia of about 1 per cent of GDP by the year's end."

Other analysts are similarly sanguine. "I wouldn't worry about Russia not being able to finance the increased election promises of all candidates in next year's elections. I am looking at around $100 a barrel into the second half of 2011," said Simon Fentham-Fletcher, director of global asset allocation at Renaissance Asset Managers.

But the sharp fall in commodity prices this past week, which saw Brent crude drop from $127 to $111, may cost the Russian budget about $36 billion in lost revenues, according to estimates in the Wall Street Journal.

Renaissance's Fentham- Fletcher observed that politicians tend to think in election terms rather than business cycles, and a positive surprise on the upside could give them an advantage.

On the other hand, tensions in Africa and the Middle the Middle East have added a risk premium to the oil price, estimated at $10 to $15 a barrel and that may give way to a downturn driven by economic policy in South-East Asia. "We have both China and India tightening fiscal policy to combat inflation and to protect the low and middle classes," said Fentham-Fletcher. "This willingness to sacrifice a couple of percentage points of growth will see a massive reduction in demand from the oil vacuum that is Asia," he said.

To deal with any drop in the oil price and a resulting increase in the budget deficit, the finance ministry is trying to expand the mineral extraction tax. "They emphasize natural gas, trying to increase the extraction tax for this segment for the fourth year in a row," said the Rye, Man and Gor securities analyst. The question is: how strong will Gazprom's lobbying power will be? Lately the gas monopoly has been able to hold the extraction tax at 270 to 300 roubles per thousand cubic metres.

Last year Gazprom announced a record profit at 364.6 billion roubles (about $13 billion) and, according to media reports, the government wants the monopoly to contribute an extra 150 billion roubles to the budget ($5.4 billion). The extraction tax was raised by 61 per cent in January this year and is scheduled to increase next in 2012.

"The Russian government extracts some 70 per cent of each dollar upswing in prices in the form of tax revenues," said Fentham-Fletcher of Renaissance Asset Managers. "Russia may have a small shortfall in revenues below oil at $100/barrel but, unlike its prof ligate friends in the G8, it has virtually no debt burden and can easily raise any shortfall," he added.

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