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Breaking even: Russia is becoming increasingly vulnerable to drops in the oil price

The oil price rally earlier this year should have left Russia in an enviable state of fiscal health, had it stored the money sensibly in reserve funds as it did before the 2008 crisis. But the spending spree opted for instead leaves the country in a vulnerable position ­ with a smaller cushion to fall on if the oil price drops.

Russia has always been hostage to price fluctuations in the commodities market due to its heavy dependence on oil and gas exports. But the government's addiction to oil and gas is on the rise.

The budget's breakeven oil price ­ the price per barrel of oil that the government balances its budget ­ is increasing, reaching $120 a barrel for this year compared to around $60 in 2007.

Although such forecasts were acceptable earlier this year when global oil prices were soaring on instability in the Middle East, the drop to $101 a barrel for Urals at the beginning of August exposed Russia's vulnerability to jitters on the global market.

Analysts are currently forecasting an average oil price of around $105 a barrel for this year and $100 a barrel in 2012. Given that the budget's breakeven price is expected to rise to at least $125 a barrel next year, the government is looking to run sizeable deficits. Deficits are already forecast for 2012-14, but Putin said in July that he hoped this year's deficit would be "minimal."

"We do not expect significant drops in the oil price, but oil at $100 a barrel is no longer enough given the budget and current account breakeven prices," said Alfa Bank Chief Economist Natalia Orlova. "This means that by 2013, the budget situation will become more difficult."

With elections fast approaching and the ruling tandem's popularity ratings lagging, it was inevitable that this period would be marked by higher spending than normal. Most of the cash is being pumped into social projects, with pensions a particular priority due to the aging population and the retired making up a large chunk of the electorate.

Bruce Bower, a partner at Verno Capital, said that while spending is likely to increase toward the end of this year, the government will compensate by leveling it out after the elections, as it has done in previous years.

Much of the windfall from high oil prices ahead of the 2008 crisis was stored in a welfare fund, designed to cushion the blow of a drop in the oil price. But the fund has now been chipped down to $27 billion from its peak of $143 billion in August 2008.

These are still sizeable savings compared to the reserves of many developed countries and Russia's GDP/debt ratio is also relatively low. However, as an emerging market with a perceived high risk of political instability, investors need a higher incentive to invest in Russia and poor fiscal discipline is likely to be a strong deterrent.

"The fact that the breakeven point is high is not a big concern because of the low debt to GDP ratio and the fact that there is a fund, but when you think that Russia may be forced to borrow quite soon to finance its pensions, it is definitely not an appropriate policy option," Orlova of Alfa Bank said.

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