UPDATE 1-Russia shutters rainy-day fund as it switches to new budget rule

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MOSCOW, Jan 10 (Reuters) - Russia drained its Reserve Fund to plug budget holes by the end of 2017, the finance ministry said on Wednesday, ahead of switching to a new budget mechanism that would insulate the oil-dependent economy from swings on global commodity markets.

The finance ministry tapped its rainy-day fund in 2014 to cover budget shortfalls amid a sharp drop in prices for oil, Russia’s key export. As the fund was running dry, the ministry had already embarked on topping its coffers with fresh petro-dollars.

In December, the finance ministry converted funds denominated in foreign currency it held in the Reserve Fund into roubles, it said. It then channelled more than 1 trillion roubles ($17.54 billion) of those funds to the budget.

The ministry said it will now terminate the Reserve Fund, which was a part of the country’s gold and forex reserves. Russia’s reserves stood at $432 billion as of Dec. 22.

The Reserve Fund was created by Russia’s former Finance Minister Alexei Kudrin in early 2008. The fund, designed to plug budget holes if oil and gas revenues fall, was topped up if oil prices exceeded a certain level for some time.

Since 2014, when Russia took a hit from a drop in oil prices and Western sanctions over its actions in Ukraine, the Reserve Fund shrank considerably. The fund fell to $17.05 billion as of Dec. 1, 2017 from level of nearly $90 billion seen in late 2014.

The termination of the Reserve Fund poses no substantial risks, Citi Chief Economist Ivan Tchakarov said.

“After all, the Reserve Fund was used exactly for the purpose it was created to smooth government spending when oil prices are volatile. Now that oil prices are going up, we will see larger accumulation of forex purchases,” he said.

To replace the Reserve Fund in its former guise, the finance ministry adopted a so-called budget rule, a move praised by the International Monetary Fund and the World Bank.

Under the rule, the ministry will buy dollars and other foreign currency when Russia's crude blend Urals URL-E trades above $40 per barrel, the level factored into the budget. The higher the oil price, the bigger the forex purchases will be.

Finance Minister Anton Siluanov said in late 2017 the ministry planned to prop up reserves with the equivalent of around 2 trillion roubles this year if Urals prices hover at $54-55 per barrel.

As Urals blend URL-E prices last stood above $70 per barrel, the finance ministry is expected to increase purchases of foreign currency this month, limiting upside for the rouble, a Reuters poll of analysts showed. ($1 = 57.0095 roubles) (Reporting by Andrey Ostroukh and Polina Nikolskaya; Editing by Jack Stubbs/Jeremy Gaunt)