Oil prices crashed again in the first week of January, falling to an 11-year low of about $32 per barrel. The Russian federal budget was already going to struggle under the official $50 oil price assumption, and finish this year with a forecast 3% deficit. But if oil prices stay this low, won't Russia's budget balloon and burn up all the Kremlin's lauded reserve funds in the process?

The World Bank reiterated its 0.7% contraction of GDP in 2016 on January 9 as economic black clouds rapidly gathered in the first week of the New Year. That stands against the Russian Ministry of Finance's official forecast of 0.7% growth, if average oil prices come in at $50 at the end of this year.

"The global economy will need to adapt to a new period of more modest growth in large emerging markets, characterized by lower commodity prices and diminished flows of trade and capital," World Bank Senior Vice President and Chief Economist Kaushik Basu said in a report titled "Global Economic Prospects in 2016: Spillovers amid Weak Growth."

With the renewed tumble in oil prices that assumption of oil at $50 is looking shakier than ever. If oil falls to an average of $40 then even the Ministry of Finance doesn't expect any economic growth this year, but a contraction of 1.5% instead. And if oil falls to an average of $30 the contraction would be 2.4%, according to analysts at Bank of America Merrill Lynch, which is in the middle of the range for most investment banks' predictions.

All said and done, a 1-3% economic contraction would be unpleasant but manageable as Russians have built up a large income buffer over the years as wages were running well ahead of inflation for most of the last decade and corporates have amassed their own war chests of cash. The more difficult problem will be financing the federal budget deficit.

The 2016 budget assumes a deficit of 3% of GDP, or RUB1.7 trillion ($28.32bn), a level that President Vladimir Putin has declared a "red line". However, this target will almost certainly be missed even if oil does average $50, as the state will have to bail out its de facto development bank VEB, which needs a RUB1.2 trillion ($20bn) injection of fresh capital to deal with bad loans incurred from cases like underwriting investments for the Sochi Olympics.

And even counting VEB's bail-out (the government is still trying to find a way to give it money that won't come out of the public purse) the Ministry of Finance has already warned that the current budget assumption with $50 oil may be too optimistic: according Finance Minister Anton Siluanov's calculations, revenues could be RUB750bn less than the forecast in the current official budget, which would lead to a deficit of 4.1% of GDP.

And it all gets worse as the average oil price in 2016 sinks: with oil at $40 the deficit becomes 5.2% (again without counting in the VEB cost), or a revenue shortfall of RUB4.1 trillion.

Where’s the cash?

So it looks very likely that the government will have to find between RUB1.7 trillion and RUB4.1 trillion to fund the deficit (and add RUB1.2 trillion for VEB and if possibly another RUB2.5 trillion if the state gives the same support to the banking sector if gave in 2015).

Where is this money going to come from? The state is reluctant to borrow at home due to high interest rates (the budget has RUB300bn of borrowing against the RUB 1 trillion in "normal" years) and can't borrow internationally thanks to the West's financial sanctions (the budget assumes $1.5bn of international borrowing, presumably from the Chinese).

The only resource left are the two reserve funds: the Reserve Fund that is specifically meant for plugging budget deficits in hard times; and the National Welfare Fund that is earmarked for pension payments in the future.

At the end of 2015, the funds held RUB3.4 trillion and RUB4.6 trillion respectively. The state has already said it will spend at least RUB2.5 trillion from the Reserve Fund to supplement the 2016 budget spending, which leaves a reserve of RUB1.1 trillion. But Siluanov already admitted in December that he expects the Reserve Fund to be fully exhausted by the end of 2016.

If oil ends 2016 at $50 then the state will scrape through the year with RUB1 trillion in reserve, but if oil falls to $40 then there will still be at least a RUB2 trillion short fall (not counting the extra costs). The temptation to tap the National Welfare Fund will almost certainly become overwhelming and at least half of that fund, if not all of it, could be burnt up too. The bottom line is Russia can get through 2016 even with oil at $40 with the resources it has in hand but it would go into 2017 flying on fumes.

Austerity Russian style

The financial headaches the government is facing are made much worse by the political calendar. There are parliamentary elections slated for this autumn and crucial presidential elections in 2018 where Putin can stand for the last time (under the rules of the current constitution). If anything the government will want to increase spending, not cut it.

But that will be hard. Russia's regions are already under pressure to up spending as part of the 2012 'May decrees'. But unlike the centre they don't have buckets of petrodollar revenues flooding into their coffers and are already under severe financial pressure, which could come to a head in 2018 according to international ratings agency Standard & Poor's (S&P).

Social spending already accounts for a quarter (27.6%) of expenditure, which so far has largely remained untouched as much of this goes to the blue collar workers that are Putin's core constituents. The government could make entitlements more difficult to get, but that would represent a big political risk and test exactly how fragile Putin's sky-high popularity really is, as some have suggested.

Pensioners were the recipients of significant budget largess in the 2012 elections, but this time round they have already been sacrificed after index rate for pension hikes were cut to 4%, way below inflation.

Cutting military spending is the most obvious and least painful cut the state will make and will almost certainly not happen. Indeed, during the budget debates the Ministry of Finance pushed hard to curtain military spending – and was promptly slapped down.

Putin has made it crystal clear that the modernisation of the armed forces is sacrosanct and is willing to lay the economy on the sacrificial alter to his geopolitical goals – whatever those may be. A third of budget expenditure (32%) will go to the military with very few cuts (and $1.2bn for the Syria campaign).

Increasingly the government seems to be grasping at straws to fill the gap. In December, Siluanov announced an ambitious RUB1 trillion privatisation programme for 2016 with some big sexy names on the mooted list, including stakes in oil major Rosneft, shipping giant Sovkomflot and oil minor Rosen. Deputy Finance Minister Alexei Moisseev told investors in London that Sovkomflot will be sold "come what may". But the privatisation plan is exactly the same one that was floated in the summer of 2008  at the end of the boom years, which came to nothing then before the global crisis broke. Even if the privatisation target was hit, that could still leave the state RUB1 trillion short to close the budget deficit.

The most likely scenario for 2016 is that the Kremlin runs down its reserves and lets more ruble devaluation take the rest of the strain. Despite all its problems, Russia is still running a trade and current account surplus with the latter bringing in a profit of about $60bn in hard currency in 2015. As the government has significant revenues in dollars but expenditures in unadjusted rubles, letting the value of the ruble slide absorbs much of the oil price shock. Analysts estimate the ruble will end 2016 at about RUB80-85 to the dollar from the current RUB70, but if oil prices continue to fall then RUB100 is not impossible.