Russian Finance Minister Anton Sulianov was speaking to the Duma yesterday and announced a pretty radical new direction. What he's proposing to do is to move the budget away from its traditional addiction to oil and gas export revenue and make Russia a consumption-based economy, (with a useful, but not essential, raw materials export subsidy).

The way this works in practice is that he is going to lower the threshold for the so-called budget rule by one dollar every year over the next five years. Currently the threshold is at $59 per barrel of oil which means that all the revenue earned above that price doesn't go into the budget, but it is siphoned off into the National Welfare Fund.

It builds up a rainy day fund to cover budget deficits in bad years. Obviously, it's been heavily tapped during the war because for the first time Russia is running budget deficits every year, and the fund has been drained. It's started the war with RUB8.8 trillion in the liquid part which has been halved. But that's still enough to cover this year’s expected budget deficit of RUB3.8 trillion. However, the Ministry remains very reluctant to run it down to zero, hence the plan to drop the threshold and start replenishing it.

At the same time oil and gas revenues are plummeting. Last year the revenues fell by a quarter and this year they're expected to fall by another fifth. Prewar Russia earned 40-50% of its income from taxes on oil and gas exports, but that's now fallen to 20% of the total as of the start of this year, according to Siluanov.

The sharp fall in oil and gas income has been hailed as a victory in Brussels and inspired hope that finally Russia’s economy will brought to its knees.

There is an economic war raging and the key battle is over oil and tax revenues. The central plank of the new twentieth sanctions package is to ban all the EU tankers from carrying Russian oil (Brussels is looking at Greece and Malta in particular) in order to kill off the funds to pay for the war. At the same time Brussels just announced a total ban on oil and gas imports from Russia starting from the beginning of 2027 (Brussels is looking at Budapest and Bratislava here).

Siluanov can see this coming and is already reengineering the budget to make Russia a “normal” country that subsists on VAT tax, not oil and gas revenues, or at least heavily reduce that dependency.

And it's going pretty well. VAT already accounts for 40% of budget revenues making it by far the largest source of income and following the two percentage point hike in VAT at the start of this year it's going to generate even more money.

People like EU foreign policy chief Kaja Kallas are encouraged by the drop in oil and gas revenues and seemed convinced Brussels needs only do a little more and Russia will collapse. But thanks to the work Siluanov has already done, Russia’s economic sanctions pain rates somewhere between a stubbed toe and banging your funny bone so far; not the stage-four pancreatic cancer that will kill Russia off that everyone in Brussels seems to assume at the moment.

Stepping back and looking at the bigger picture: one of the ironies of the war is that it has forced on Russia many deep and structural reforms it's been putting off for years because it had too much oil money to be bothered. The favourite criticism of the Russian economy is John McCain's famous quote of it being nothing more than “a gas station dressed up as a country.” That's why Siluanov’s proposal is so radical. He's proposing to remake Russia as a “supermarket dressed up as a country.” Indeed, this shift to a consumption-based economy rather than an export-orientated one is something that's been going on not only in Russia but across all of the leading emerging markets.

McCain, if he was still alive, would criticize China for being a “factory dressed up as a country” which it was during the 1990s. That's how China made its first round of money: by setting up factories that could produce widgets extremely cheaply based on insanely low wages. However, over the last decade it's been going up the value chain and increasingly it's producing not widgets but state-of-the-art equipment the rest of the world needs with EV's and solar panels being the most obvious examples.

This is not a blip or a short-term trend. This is a radical and permanent strategic shift in the makeup of the global economy. The Global South countries are all going up the value chain thanks to two decades of FDI coupled with heavy investments into R&D and education. They have learnt the skills to start to match the incumbents in places like Germany. Indeed, they're starting to overtake them on cool stuff as the income delta - the difference between wages that determine the unit cost of these products between the Global North and South - remains significant. Germany’s “Vorsprung durch Technik” made it a leader since WWII but now it’s struggling to remain competitive. Maybe it’s time to learn a new Chinese phrase: “Yi yanfa lingxian” (Leapfrog through R&D).

Europe’s technological backwardness was highlighted in the Draghi report last year where he says Europe has fallen badly behind the US, and by implication China. He recommended that €800 billion a year be invested in innovation. That hasn't happened. All the money is going into modernizing Europe defence sector and funding Ukraine. So, this problem is just going to get worse.

There's been lots of commentary that Russia is on the path to stagnation but given the reforms and the reengineering of Russia as a consumption-based economy it's entirely sensible and at least the plan is correct. The problem with Russia as always is it always falls down on the implementation. This year’s end of year budget deficit, currently forecast to be 1.6% of GDP (RUB3.8 trillion), will be a good indicator of how well the new plan is going. FYI January’s monthly deficit is already 1.7% of GDP.

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