Oil and gas in the capitals
The impact of oil prices has been obvious on Russia’s economy. To begin with, Russian hydrocarbons may not seem that dominant, accounting for only 10% to 12% of global production. They are, however, playing a major role in the Russian budget, as they represent nearly 37% of all budget revenues, Table 1. This could lead to a simple relation between oil and gas prices, and the rate of exchange. While taxes are paid in rubles to cover expenditures, one solution would be to let the ruble depreciate while prices are falling, or to appreciate when they are rising. But this view of the relations between hydrocarbons and the economy is simplistic to the extreme.
First, when Russia imports, a depreciation (or appreciation) of the ruble has a direct impact on consumption. Of course, high-income households are proportionally consuming a higher amount of imported goods than those with lower incomes. So, any depreciation of the ruble, following a drop in oil prices, will generate a drop in global consumption, and hit the non-hydrocarbon producing sectors.
This crunch in global consumption is usually going to be accompanied by a bout of inflation. Not only are the prices of imported goods going up with ruble depreciation, but locally produced goods are seeing a price increase, as well, as producers take the opportunity to increase their margins.
Moreover, oil prices are used as a benchmark in the financial sector to judge the solvency and liquidity of Russian firms. The second indirect link between oil prices and the economy is financial. When prices drop, the ruble depreciates. When the ruble depreciates, economic agents with foreign denominated currency credits have a tough time paying principals and interest. And, sorry to say, indebtedness to non-residents is quite high in Russia.
As a direct result, the drop in oil prices is putting indebted agents in a hot spot. However, this is not the only problem. Because of financial sanctions, Russian enterprises and banks have been denied some traditional sources of funding. They cannot refund outstanding debts, and the amount of debt repayments is growing as a result. The exit flow of foreign currencies for these repayments is also having a negative effect on the exchange rate.
The Central Bank of Russia (CBR), however, is committed to an “inflation targeting” policy. Wise or unwise, it’s a fact. The CBR will then increase its interest rates. If the ruble depreciation is taking a fast dive, it will increase its rates, as it did in December 2014, when the CBR raised its primary rates to 17%. High interest rates have not prevented speculation on the ruble, and the drop in oil prices is creating a very adverse financial environment for households and enterprises, alike. Households are reducing their debts linked to consumption, and enterprises are reducing investments. This parallel reduction in investment and consumption is having a very negative impact on economic activity.
But how can we estimate the link between oil prices (usually in the Brent index) and the exchange rate of the ruble? The exchange market correlation regarding oil prices is an important point for all forecasts. Previously, the market was falling at RUB 1 per $1/bbl, with RUB 85 corresponding to $30/bbl. But it is true that rumors could spread, leading to a run on an already illiquid market. Incidentally, financial sanctions have certainly destabilized the ruble exchange rate during first-quarter 2015, as opposed to December 2014. However, some research has been done on the precise connection, showing no linear correlation. It also shows that the robustness of this relationship has been decreasing since 2012-2013.
Still, there is reason to believe that movements in exchange rates can be predicted, and may be levelled by using some kind of capital control. The main problem facing forecasters is the massive expectation instability, induced by speculation. Once major causes of short-term fluctuation disappear, the ruble will stabilize at RUB 70 for US$1, if oil prices (in Brent index) move back to $45/bbl. If oil prices come up to $55/bbl, the ruble will move up to 60-62 RUB/US$.
Compared to the current situation, this would ease repayment of debts considerably, both on principals and interests. If oil prices stay around $40/bbl, we then could forecast a move in Russia to substitute foreign finance for an internal source. This would imply some dramatic measures, and certainly lead to a much more pervasive role of the State, but it would ultimately lead to Russian finances being much less vulnerable to Western sanctions. Some of these measures are already discussed in Moscow, and one can guess that a $45-50/bbl price is probably a threshold for them.
If we look at consequences of the current situation from a Westerner’s point of view, this would not be a positive trend, as a much-less-vulnerable Russia would imply a much-more-interventionist Putin in world affairs. But if oil prices are to move up next month, leading to a return to the 60 RUB/US$ level, this would also benefit President Putin. The end result is then that low oil prices have changed the world in quite an unpredictable way. 
