Hidden reserves, deferred budget reductions, and another key rate cut

This article is part of the Russia Economic Update series

Summary

• The Central Bank of Russia has cut the key rate, but this has not affected the mood of households or businesses.
• The monetary authorities' artificial manipulation drove the paradoxical strengthening of the rouble in 2025.
• Demand for foreign labour has increased, alongside capital outflows abroad.
• Putin refuses to significantly reduce public spending, despite the drawdown of well-concealed reserves.
• The construction sector is experiencing a sharp decline.

The Central Bank cuts the rate despite weak justification

At its meeting on 20 March, the Board of Directors of the Central Bank of Russia decided, as expected, to cut the key rate by 50 basis points to 15 per cent per annum. However, Elvira Nabiullina's statement did not provide a convincing justification for this decision.

On the one hand, inflation continues to decline rapidly, and the acceleration in price growth linked to the VAT increase proved short-lived. The probability of inflation falling to 4 per cent by the end of the year remains fairly high. This would appear to create room for a faster rate cut, particularly given the deepening recession in the civilian sector of the economy, and the mismatch between the available workforce and the economy's needs reported by headhunters (but not observed by Rosstat).

On the other hand, inflation expectations among households and businesses remain persistently high and are not responding to the decline in inflation and the lowering of the key rate. The Ministry of Finance's refusal to finance the budget deficit using resources from the National Wealth Fund led to a reduction in the Central Bank's foreign currency sales, and to a 9 per cent depreciation of the rouble since the beginning of March. This created the potential for faster price growth due to higher import costs.

The war in the Persian Gulf has introduced additional uncertainty for Russia's monetary policy. If it continues, this conflict will inevitably trigger a worldwide recession, reduce global demand for Russian commodities, and complicate efforts to generate federal budget revenues and financing for the rapidly growing deficit.

Overall, this situation indicated that the decision on the rate was likely to be deferred, especially as the Central Bank is expected to update its forecast by the next meeting. However, monetary policy remains extremely tight, and it seems that the Central Bank has begun to recognise this. At least, this is how one can interpret a passage from the summary of the discussion on the key rate decision published by the Central Bank.

'According to most participants, overheated demand is cooling even faster than assumed in the February forecast, making room for cutting the key rate. However, elevated uncertainty associated with the external environment and fiscal policy requires a cautious approach.'

In sum, the decision to cut the rate can be described as 'better late than never'. There are no strong arguments in favour of a rate cut, but there is an understanding that the rate is currently too high. In addition, the monetary authorities are well aware that a pause in rate cuts could trigger an increase in inflation expectations, which is clearly undesirable at present.

The rouble strengthens against fundamentals as capital outflows shift channels

The Central Bank of Russia has published the final balance of payments data for the past year, with three points standing out.

First, the dynamics of the current account and the trade balance in early 2025 do not correlate with the sharp appreciation of the rouble in the spring of last year. The chart shows a clear downward trend that began in mid-2024, which should have created conditions for a weakening of the national currency. However, the opposite occurred. The reason was the Central Bank's active foreign currency sales under the fiscal rule, as discussed in the previous issue.

In absolute terms, both indicators are approaching their lowest levels in the past twenty years. This trend will likely continue in the first quarter of the current year (the current account surplus in January amounted to only $0.4 billion, compared to $2.8 billion in January 2025), followed by a sharp reversal in the second quarter due to a rapid increase in oil prices. How sustainable this trend will be can only be conjectured, given that it will depend on when and how the military hostilities in the Persian Gulf end.

Second, the data clearly show that wage transfers from Russia to other countries, which fell sharply during the currency shocks of 2014–2016, have recovered from the 'Covid' shock and, since mid-2023, have returned to the pre-war trend of gradual growth. On the one hand, the volume of such transfers is half the level observed in 2008–2013. On the other hand, their renewed growth indicates a growing labour shortage in sectors that have traditionally relied on foreign workers to fill gaps. Whether the increase in remittances reflects a higher number of foreign workers or higher wages is immaterial. 

Third, data on the channels of capital outflows from Russia suggest that an increasing share of cross-border financial flows is no longer captured by the Central Bank staff responsible for compiling the balance of payments. It is relatively straightforward for them to track transactions related to the purchase of shares and bonds, as well as direct and portfolio investment, which pass through the bank accounts of Russian individuals, companies, and banks. However, they are unlikely to have adequate information on 'other investments'. Estimates of such flows can never be fully reliable, but the growing use of the 'other investments' channel, alongside the near disappearance of traditional investment channels, is indicative.

No decision on sequestration: the Ministry of Finance may reconsider it

At the very end of February, Minister of Finance Anton Siluanov stated that his ministry proposes to revise the principles governing the collection and use of oil and gas revenues.

Shortly afterwards, the Ministry of Finance announced that it would cease foreign currency sales from the National Wealth Fund to finance the budget deficit as early as March. A few days later, media reports indicated that the Ministry had sent instructions to all ministries and agencies to prepare proposals for cutting current-year budget expenditure by 10 per cent. It became evident that the sharp decline in oil and gas revenues in December–February, and the resulting growth of the budget deficit to twice the level set out in the law, had become a critical issue for the Russian authorities.

However, the Ministry of Finance's position was strongly criticised at a meeting between President Putin and senior economic officials on 23 March.

On the one hand, the war in the Persian Gulf led to a sharp rise in global oil prices, the lifting of US sanctions on Russian oil purchases, and, as a result, the disappearance of the discount on Russian crude. As the share of spot sales by Russian companies increased from the pre-war norm of 10–15 per cent to 35–40 per cent, many consumers deprived of Middle Eastern oil rushed to purchase whatever was available. As a result, Russian oil was at times sold at a premium.

Russian tax legislation is structured such that oil and gas revenues respond to changes in oil prices with a lag. At the beginning of each month, the Ministry of Economic Development announces the average export oil price for the previous month, which is then used to calculate the mineral extraction tax (MET) payable at the end of the month. Thus, the increase in oil prices in March will only be reflected in federal budget revenues at the end of April.

According to the Ministry of Economic Development, the average export oil price was $44.6 per barrel in February and rose to $77 per barrel in March. Each additional $10 per barrel increases MET revenues for the federal budget by $1.1–1.2 billion. Accordingly, in April, the Ministry of Finance's MET revenues will increase by 215–220 billion roubles ($2.7–2.75 billion). On the one hand, this is a substantial amount even for the Russian budget. On the other hand, in January–March (taking into account our forecast), the Ministry of Finance received around 950 billion roubles less than expected, as the rouble-denominated price of export oil was 40 per cent below the level assumed in the budget.

However, the effect of the sequestration proposed by the Ministry of Finance would have been very limited. A 10 per cent cut would have applied to less than a quarter of total budget expenditure, given that military and social spending, debt servicing, and a range of other items would have been exempt. Cutting budget expenditure would have dealt a significant blow to Putin's political standing and image, and doing so to save around 1 trillion roubles would not have made political sense.

As a result, the decision on sequestration has been postponed. The Ministry of Finance has been instructed to fund expenditure in line with the approved budget law, while exercising greater scrutiny when reviewing budget requests that can be deferred to a later date.

Tax revenues: the figures are striking, but the conclusions are premature

February data on federal budget revenues from taxes linked to the domestic economy (VAT, profit tax, and personal income tax) appear surprisingly strong at first glance. VAT receipts increased by 29 per cent compared to the first two months of the previous year, profit tax revenues rose by 12 per cent, and personal income tax by 59 per cent. However, this impression quickly fades once one recalls that last year the profit tax rate was increased (from 20 per cent to 25 per cent) and the personal income tax was made more progressive (reaching up to 22 per cent), with all additional revenues from the higher tax burden accruing to the federal budget. From 1 January this year, the VAT rate was also raised from 20 per cent to 22 per cent.

In short, a direct comparison of tax revenues, especially at the beginning of the year, is not appropriate. It will only be possible to speak of the disappearance of the base effect for profit tax from May onwards, and for personal income tax from August onwards.

The Ministry of Finance halts use of the National Wealth Fund and draws on Treasury balances

Although the president insisted that this year's budget expenditure be fully financed, he conceded to the finance minister on another point: the use of National Wealth Fund resources to compensate for shortfalls in oil and gas revenues has been halted. The reason for this decision is clear. By early April, the liquid portion of the Fund had fallen below 4 trillion roubles (1.7 per cent of GDP), and a fiscal reserve of this level appears to be regarded by the Ministry of Finance as a necessary 'rainy day' buffer.

In March, the Ministry of Finance withdrew only 60 billion roubles from the Fund to finance expenditure, compared with 400 billion roubles over the previous two months. This raises a reasonable question: what sources can the Ministry use to finance this year's budget deficit if it avoids drawing on the Fund and does not resort to fiscal dominance (under which banks would be required to purchase government bonds in significant volumes at below-market yields)?

To answer this, it is necessary to recall that, in addition to the well-known fiscal reserve in the form of the National Wealth Fund, the federal Ministry of Finance has another 'reserve wallet': the balances of funds held by the federal and regional budgets, the Social Fund, and the Mandatory Health Insurance Fund, which are placed with the Federal Treasury. This reserve began to form in late October 2020, when the Treasury was granted the right to place these balances in bank financial instruments (deposits and repo operations). Over time, legislation required regional budgets and extra-budgetary funds, which had previously held their resources with the Central Bank, to transfer their accounts to the Treasury. The Treasury's deposits in banks rose sharply in early 2023, when, on the one hand, the budget advanced a large share of defence procurement in January–February, and, on the other hand, many defence industry enterprises were instructed to take payments for defence orders, and make payments to subcontractors, through Treasury accounts. In 2025, income from placing these funds amounted to 1.17 trillion roubles (3.13 per cent of total federal budget revenues), while regional budgets received 328 billion roubles (1.25 per cent of their total revenues).

The volume of available Treasury funds fluctuated between 8 and 10 trillion roubles from mid-2023 to the end of 2025, reaching 9.1 trillion roubles at the start of this year. By the end of March, balances in Treasury accounts had declined by 1.8 trillion roubles. 

Output in civilian manufacturing is declining

Rosstat's release on industrial production dynamics for January drew mixed assessments from experts.

• Rosstat reported zero growth compared to December.
• The CMASF (Centre for Macroeconomic Analysis and Short-Term Forecasting) assessed the first month of the year very negatively, estimating a 1.7 per cent month-on-month decline (–18.5 per cent in annualised terms).
• The Development Centre, which excludes sectors linked to the military economy, identified solid growth of 0.7 per cent (8.7 per cent in annualised terms).

To a large extent, this divergence reflects the specifics of adjusting for the calendar effect in January, when roughly half the month consists of public holidays. The difference in the number of working days (17 in 2025 and 15 in the current year) has a significant impact. In addition, January estimates by non-government experts were influenced by Rosstat's data on strong industrial growth in December of the previous year. While CMASF accepted these figures, the Development Centre did not see sufficient grounds for them.

In this context, the February estimates were of particular interest, as they could have clarified the picture, but this did not occur. All three centres reported broadly similar industrial growth in February relative to January. However, the Development Centre excludes military-related sectors, whereas CMASF's estimate of industrial dynamics, excluding the defence-industrial complex, shows a decline. CMASF experts argue that the discrepancies can be explained by differences in the statistical methods used to smooth seasonal factors. It remains to be seen whether these divergences will narrow in the coming months.

Among sectoral developments at the start of the year, the acceleration of the decline in output in civilian manufacturing stands out, particularly in segments linked to investment demand. The contraction continues in the production of most key construction materials, especially building materials (down by 1.4–2.8 per cent per month). Output in ferrous metallurgy is also declining, albeit at a slightly slower pace (–1.1 per cent per month). The production of machinery and equipment continues to decline rapidly, falling in February to 75 per cent of the average monthly level in 2024. The automotive industry, which showed a recovery in growth in December–January, returned to decline in February.

The Ministry of Economic Development downgrades forecasts as construction declines sharply

Rosstat's summary of economic performance for the first two months of the year offers little ground for optimism in the Kremlin. Many indicators show a noticeable deterioration, prompting the Ministry of Economic Development to revise its forecast for overall GDP dynamics this year downwards. The updated forecast is expected by the end of April, at the same time that the Central Bank updates its own projections.

The most striking development is the dramatic contraction in construction, down 15 per cent from the beginning of last year. We previously noted the sharp divergence last year between the rapid decline in production of construction materials and the continued growth in construction activity. This lag now appears to have been exhausted. Moreover, given the ongoing collapse in the production of basic construction materials, it is possible to project that the decline in construction will continue throughout the year.

The completion of new housing fell by 30 per cent, with almost all of the decline concentrated in individual housing construction, which dropped by nearly 40 per cent.

On the one hand, this suggests that the industrial construction sector is holding up relatively well. On the other hand, the sharp contraction in individual housing construction indicates that household economic expectations have become less optimistic.

What else do we monitor?

• The Russian government has introduced a ban on petrol exports, to be in force from 1 April to 31 July. Preparations for this decision became known about a week before Ukrainian strikes on Russian ports in Ust-Luga and Primorsk. The damage to these ports temporarily halted exports of petroleum products produced by four refineries in European Russia. This will force them to reduce oil processing volumes and, consequently, petrol production.

  As the sowing season is currently underway in Russia, petrol demand has objectively increased, which has been reflected in retail prices rising faster than inflation. In addition, the risk of further Ukrainian strikes on oil processing and export infrastructure remains. In effect, these factors have converged, leaving the export ban as the only instrument available to the authorities.

  While this measure allows for short-term stabilisation of retail petrol prices, it negatively affects oil companies' long-term incentives to invest in refining. The export ban reduces company profits and the efficiency of investment in refinery modernisation, preventing the creation of a sufficient 'buffer' in petrol production.

• Rising household incomes and the sharp appreciation of the rouble have shifted Russian demand towards outbound tourism, affecting the dynamics of domestic and international air travel. In 2025, the total number of air passengers in Russia exceeded 105 million (up 1.4 per cent compared to 2024). At the same time, the number of passengers on domestic routes fell by 4 per cent, while international traffic grew by 11 per cent. Almost 93 per cent of the increase in international passenger traffic, which is significantly more profitable, was captured by foreign airlines. They were able to expand capacity quickly where intergovernmental agreements permitted this. Russian airlines are ceding this profitable market, as they are unable to purchase new aircraft, while their existing fleets are gradually shrinking as engine lifespans are exhausted.

• The Russian company Bureau 1440 has launched 16 satellites into orbit, intended as the first element of a low Earth orbit communications constellation. Since late 2020, Bureau 1440 has been developing an analogue of the Starlink system, named 'Rassvet'. The satellites are built in the company's own factory. They are equipped with a communications system based on 5G NTN architecture, an updated power system, next-generation inter-satellite laser communication terminals, and plasma propulsion units.

  Test satellites, which allowed key technologies to be verified, were launched in summer 2023 and spring 2024. Commercial operation of the broadband satellite service is expected to begin in 2027, when 250 satellites will have been deployed. The company plans to increase the constellation to 730 satellites by 2030 and to more than 900 by 2035. The target user base is estimated at 1.5–2 million users in Russia and up to 12 million in other countries.

• Transport Minister Andrey Nikitin stated that 183 kilometres of federal highway will be built or reconstructed by the end of this year. In 2019–2025, construction and reconstruction averaged 295 kilometres per year. The total length of federal highways in Russia is 66.4 thousand kilometres.

The views expressed in this publication are those of the author(s) and do not necessarily reflect the position of the NEST Centre.