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Ukrainian president Volodymyr Zelensky sought to wrong-foot Moscow’s usual line for Putin’s address today by directly appealing to Putin to meet one-on-one in Donbas to discuss how to de-escalate the situation and advance the process so far held hostage to the Minsk protocols. They are, in political terms, impossible to implement at this point in time. Ramming through a law on decentralization in Kyiv for the breakaway regions that have been extended citizenship rights in the Russian Federation is one thing, another to see Russia willfully accept an OSCE presence backed by peacekeepers on its border while withdrawing all material aid and any forces acting without insignia is another. There’s no way you can force Ukraine to withdraw heavy weapons from the border when Russia can mobilize large columns of tanks next door in weeks’ time. Zelensky knows well that Minsk II is a dead end, and doing his utmost to win more support in Washington (and Brussels), he’s made the first diplomatic move with the buildup now a settled fact both to win the high ground and also to challenge the narrative, and perhaps the perception to more hardcore nationalists in Moscow, that Kyiv is the one holding up implementation. The buildup’s drawn more scrutiny from OSINT/satellite watchers and reached a sufficient level to increase worries about Russian intentions despite the continued consensus that it’s a coercive signal and not plan to invade:
Putin completely ignored his entreaty in his address and sources in Moscow have leaked that unless the heads of breakaway republics are included in talks, they’re a non-starter. Zelensky’s gamble has pushed Moscow back into a corner trying to ram through Minsk, but left it little room to respond otherwise for now. The implication is that diplomacy isn’t really what Moscow’s looking for at the moment, but rather a partner in Kyiv willing to agree to all its terms so long as the Normandy format keeps failing to deliver. That’s an untenable negotiating position, one that looks reasonable when there’s saber-rattling and nationalist calls in Kyiv. Zelensky’s not pursuing that line, even if he’s had to placate harder-line nationalists domestically. His approach has delayed the inevitable end that Russian strategy has bet on for years: the West would simply tire of the conflict and of paying Ukraine any mind.
What’s going on?
I missed this yesterday, but data for business tax deductions for investment from Jan.-Sept. 2020 are pretty grim — only 77 companies in all of the regions that instituted the tax policy in response to a 2019 presidential decree wrote off tax obligations based on their investments. The policy proposal was intended to increase investment levels into modernization — they continued their post-2014 fall last year — by allowing firms to write off up to 90% of their regional tax obligations and up to 10% of their federal obligations claiming their investments as deductions against any taxes on their profits. Per Vedomosti's account, MinFin’s onerous requirements prevent businesses from taking full advantage and stopping more regions from using the policy. So long as debt repayment and deficits are a sensitive matter, there’s no political incentive at the regional level to offer tax write-offs given they require some other offset that would most likely come at the expense of households. Firms also aren’t currently able to carry over losses from the initial investment period when losses are realized, and therefore no profit tax can be deducted, into future years. Without a fix, that kills any incentive to claim the deduction in the first place. There are also conditions applied to the type of economic activity, further reducing the attractiveness of the policy. Lastly, as usual, the article sidesteps the biggest problem for investment in the private sector — the lack of demand. These deductions may help investment levels if they’re expanded, but they’ll still need other policy help to be truly effective.
In 2020, the number of municipal infrastructure development projects launched under public-private partnership (PPP) schemes almost halved compared to 2019. There were 72 new projects vs. 131 the prior year at a market value of 91.5 billion rubles ($1.19 billion) vs. 212 billion rubles ($2.76 billion) in 2019:
Light Blue = general volume of investment Green = volume of private investment Red = number of projects
There’s a total of 2.1 trillion rubles ($27.3 billion) invested into these municipal projects, 80.9% of which is private money. The question is how those projects are allocated — I’d guess that the cost basis for works in Moscow and St. Petersburg skews the figures somewhat, but don’t have granular data handy. But to keep pace with projected urban infrastructure needs in Russia, a whopping 1.6 trillion rubles ($22 billion) are needed annually through 2025. Shortfalls of that scale can’t be plugged by ‘mobilizing’ more local and regional elites to fork over cash for favor. Regional budgets can’t absorb a massive spending increase without higher debt levels or higher tax revenues and greater fiscal powers, so ultimately it’s a matter of federal spending. Levels may well tick up after Putin’s address today since these projects are useful for fostering local support for United Russia in particular, but relative spending increases won’t be as significant no matter what’s included in the address, but rising price levels for construction imports and labor costs will affect the efficacy of any announced increase.
The effects of import substitution and the food counter-sanctions program tick on. Small cheesemakers are being run out of the market over time due to consolidation, with the top 20 firms now accounting for 70% of all production:
Yellow = production Green = import
It’s expected that in 5 years’ time, the top 20 producers could account for 90% of all output. Demand ticked up last year thanks to the effect of lockdowns and COVID — more time at home increased the relative demand for cheese among households, while also rising for the country’s dynamic restaurant scene post-2014. 90% of imports come from Belarus, which has benefited from the EU counter-sanctions and continues to develop its own production. This story isn’t terribly interesting from a market perspective — no one would say that blessed are the cheesemakers in Moscow — but reflects a long-term problem with the national approach to import substitution: policy interventions and the large role of state financing and spending tend to encourage consolidation, reducing competition further among industries that either don’t have to compete with imports or else are doing so within the EAEU, where they have access to trade institutions to lobby for policy if they so wish. In the case of cheese, however, various indirect and direct subsidy measures have stimulated demand and changed tastes. That’s a good thing for quality of life that can’t be well captured by traditional economic measures.
Deputy Gazprom director Viktor Zubkov gave an interview with TASS confidently asserting that China wants more Russian gas. He left out that Gazprom’s proven a fantastic partner for Beijing because it’s so bad at negotiating prices. Export prices to China in 1Q fell to $118.50 per thousand cubic meters, less than even a heavily subsidized Belarus pays and a far cry from the European price level at $170. Increasing supply levels is chiefly about chasing LNG cargoes off the market where possible since China’s natural gas demand outlook is in question though growing for now, a dynamic that will eventually drag down earnings for Novatek as LNG pricing is increasingly hedged and linked between the Atlantic and Pacific. Low gas export prices coincide with a push to finish a $10 billion rail route from Yakutia to expand coal exports to the Chinese market, a commodity that nets RZhD little in the way of revenue while taking up a great deal of rolling stock capacity. It turns out that serving China’s voracious appetite for commodities doesn’t bring much in the way of long-run economic benefits if prices aren’t high and can be negotiated down. Though nowhere near the scale of the opportunity cost and investment crisis posed by Soviet oil & gas in the 70s and 80s, the relative profitability of investing in these projects that end up consuming lots of real economy resources while netting lower import prices (and facing higher input costs during the peaks of commodity price cycles) only reinforces the negative trends in Sino-Russian trend — last year’s bilateral trade deficit should be a warning that unless Russia can attract Chinese manufacturers to set JVs in Russia, it has a long-run problem as China’s R&D efforts reduce the need for Russian tech over time.
COVID Status Report
8,271 new cases and 399 deaths reported. Watching Putin address the Federal Assembly, many of whom weren’t wearing masks, was all the more odd given rising calls from medical professionals in Moscow that a 3rd wave has begun. Putin’s direct appeal to get vaccinated, bizarrely late given just how long the vaccination program has now been running, suggests that the default policy preference to handle the fallout is to go full steam ahead on vaccines and hope for the best. The cost of supporting businesses and families from restrictions is not an option. 62% of Russians are against COVID passports, not that there was any substantive policy support to begin with. The hospitalization rate in Crimea is apparently up 19% week-on-week (could be a one-off, but suggests otherwise). I didn’t find comparable data elsewhere from a few quick keyword searches, but given the underlying trend, I’d expect to see similar stories emerge in the next week or two assuming the warnings about a third wave.
Misha and the Terrible, Horrible, No Good, Very Bad Day
Before diving into some of the specifics — I need a little more time to sit with the text and policy points, and will be writing up a reaction piece for Riddle, but have them pulled up for some initial reactions — the biggest ‘surprise’ is how completely insignificant Putin’s address proved to be. There was quite literally nothing substantively addressing the regime’s biggest problem, investment levels, from the policy side. Take Putin at his word:
“Corporate sector profits this year promise to reach record levels despite the problems we’ve run into . . . we’ll see how they’re used and based on the results this year, we’ll make a decision on how to tweak the tax code. I’m waiting for a concrete proposal from the government. I’ll speak, as they say, off the record: dividends — someone keeps dividends, and someone invests in the development of their own enterprise and the entire sector. We’ll encourage, of course, those who invest.”
Transformed into managerial speak, Putin will make sure the right people know to do the right thing and the government is still getting it together. I was surprised at the lack of a more concrete plan given the supposed urgency of the address for September and, frankly, the regime’s plans to maintain its ability to play geopolitical spoiler into the near future. A week ago, Putin rather demonstratively visited Mishustin’s coordination center following up on a spurt of news stories suggesting an intensifying policy process around the PM. At the start of April, they demanded MinFin and Anton Siluanov sort out what to do with regional debts ASAP, there was policy messaging that money from the National Welfare Fund would help launch a new economic recovery plan, and Putin’s business roundtable calling for means to increase investment paralleled a variety of policy initiatives running back to 2019 intended to improve the investment climate and increase levels of business activity. None of this is to say that Mishustin is on the outs as a result or even necessarily ‘failed’ his brief, but the address was an opportunity to give the boss a platform from which to communicate a clear plan, a stage he used to call for every Russian to be vaccinated for the first time and a stage otherwise used to promote the softer social spending proposals tied to policy leaks from late January. Investment levels aren’t just a matter of changing the tax code, though. They require higher levels of public spending to crowd in private money and more work to arrest income decline. If the renewed policy pressure created potential for a “coming out” moment for the new look economic plan drafted by Mishustin, that opportunity has been lost to the vagaries of policy lobbying in Moscow. The impasse is commonplace for the policy process in Moscow, but that it remains so sclerotic with so much political interest in making a splash ahead of September is surprising and, I think, reflects the abiding reality that Mishustin is unable to forge a consensus on large spending plans without input from Putin. Concerns from the deflationist austerity bloc led by MinFin, always concerned about the efficacy of spending due to corruption and limited institutional capacity, generally win out and steer policymaking towards tax breaks and hopes of an ‘investment boom’.
On that front, everyone expected social spending to be upped as a fairly direct way of buying apathy or votes come September. The proposals tossed out in the speech are a lifeline to people truly struggling, but substantively inadequate to resolving major problems. Oleg Deripaska’s comments that about 80 million Russians live in poverty prompted immediate pushback from the presidential administration and the spin machine concerned with containing the impression that standards of living keep falling. When Aleksei Kudrin talks up creating new criteria to define poverty, and he’s otherwise a systemic liberal, you know things are getting bad. Let’s consider the stylized macroeconomic effect of the proposal to pay out 10,000 rubles to families with children of school age or else about to start school and maintain it in years to come:
Because I was pulling straight from Rosstat data and didn’t have usefully granular data in hand breaking down families by children’s age, I just plugged in people of working age as a rough proxy to see what the macroeconomic effect would be if every individual in that age group received the equivalent of 10,000 rubles annually spread out over 12 months going back to 2013. That tiny sliver adjusted upwards for the net average nominal income (assuming the 10,000 rubles are constant and not inflation adjusted, which I could have done but would take a bit more time to get right) is all you get backcasting that change. In today’s environment, that’s a paltry sum, less than one-fifth of the average nominal monthly wage nationally to get through a whole year. The more significant plus up is the introduction of monthly payments up to 5,650 rubles a month for families with children from the ages of 6-18. If you consider the pre-COVID data on the balance of incomes to expenditures and savings, that figure is a fairly significant help for a lot of families despite the limited macroeconomic impact. LHS is millions of rubles:
The savings right pre-COVID was around 4% amid declines in real income, a rate that has risen in response to the COVID shock. Since the domestic consumer recovery is lagging the industrial/export recovery, one would expect it’ll take more time for those jobs to recover. Since the dominant sources of new job creation since 2014 have been retail related, the additional income transfer for these families is positive. If we imagine a family with a single earner at the national average of about 50,300 rubles a month, let’s assume based on the national average that about 38% of that goes to food and basics and 34ish% goes to shelter. Note that at the national average earnings, the savings rate is probably minimal compared to people slightly above it and higher at a time when consumer price inflation and housing prices are rising. That additional 5,650 rubles goes a long way, more so as a cushion with two earners rather than just covering rising expenditures as a result of rising consumer prices. It’s a targeted policy staving off worse on the cheap. They want to offer a 6,350 rubles a month to pregnant women as an additional stimulus to get pregnant given the demographic problems facing the workforce were worsened by the high excess mortality rates since COVID hit the country. Collectively, these are insignificant macroeconomically, but a bigger deal when considering the labor market. The loss of migrant labor is already forcing industries to consider paying more and increasing the flexibility that households have to work or not depending on their financial situation, even if in limited fashion, could marginally increase labor power to demand higher pay. That would then feed inflation, and weaken the value of the social transfer.
I also found it funny that Putin felt the need to include a promise that direct administrative control over consumer prices wasn’t being introduced. On the one hand, it’s an assurance to the Central Bank that they aren’t reconstructing the Soviet system and are still committed to markets. On the other, it’s an artful dodge hiding how much the problem’s gotten away from the government. Mishustin’s failure to find an adequate policy compromise to handle sugar price inflation, for instance, led 2 days ago to the decision to create an effective state monopoly for sugar imports. MinSel’khoz wants a rule that only companies with at least 50% state ownership can import sugar without tariffs. The approach is to create preferential conditions for state firms and encourage firms to get closer to the state in order to reduce the power of private market actors to set prices through spot bids and their own contracts and pricing mechanisms. They’re introducing a de facto price control measure, but without direct controls in the strictest sense. Imports matter all the more this year since domestic production fell 20.7% last year due to poorer harvests and production for January-February is down over 40% year-on-year.
There may be some comfort taken in the fact that oil & gas revenues only accounted for 30% of all revenues for the consolidated budget, particularly as prices have finally stabilized somewhat. But even that stabilization faces renewed risks:
The rising caseload in India is a particular blow for the market’s recovery hopes. More broadly, it’s easy to be too complacent for oil & gas given the COVID situation globally. For that reason, the absence of a major economic announcement save targeted fiscal support for families is a bit baffling. The slow recovery of some imports is going to create new pricing pressures, particularly for intermediate goods that are imported like chips used for cars:
Altogether, I took what was overall a humdrum announcement as evidence that the economic policy process, chaotic in ‘normal’ times, has become so unwieldy that it can’t deliver reliably for PR purposes. Social policy is easier to tweak so long as reserves are available. Policy failures will make the regime’s default business policy to be resource mobilization without many carrots anyone wants to eat. That’s a risky proposition when the seductive allure of stability has ceased to deliver politically.
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