12 min read

COBlues

COBlues

A Few Thoughts About OGs and OFZs

As I've come back to writing and been trying to figure out how to best space out content in relation to paywalls and what I'm working on for and outside of OGs and OFZs at the moment, I've come to the realization that in order to maximize the time efficiency of what I'm doing and the logic of the paywall, I need to slightly shift the format. By that, I mean that I'll do the usual first three sections of the newsletter every day – a lead story/bit of analysis, a roundup covering 4 major stories of the day (often citing multiple pieces for any individual story), and then a short COVID analysis that I will also swap out or else combine with a short foreign policy roundup. COVID isn't going anywhere, I'm just trying to anticipate what it'll look like when it becomes less of a story eventually. That type of writing is much faster to pull off because it's primarily about reacting to news, and also broken down into smaller chunks. That way, I can put out analytical pieces at a clip that better matches my non-newsletter workload and will also allow me to vary the content more easily. You won't scroll to the last column in the newsletter unsure of what you'll get. It helps with predictability, makes it easier to mix up what I'm doing as I also begin to look at guest content and other means of branching out, and avoids the inevitable challenge of coming up with an angle for an extended column on a daily basis. Time constraints lead to sloppiness, which leads to bad analysis. I totally blanked on Friday on the 2019 3rd party access decision that affected NS2, for instance, because of time pressure. It's not a huge deal, but I'd much rather focus on precision to do best what I want the newsletter/blog to do: cut through noise, challenge myths and misconceptions, and bring a different sensibility to Russia analysis that I think is lacking. Hopefully you still find this useful. Time is, unfortunately, the most precious commodity and I need to better manage mine for the sake of OGs and OFZs and the quality of the output for its readers.


Top of the Pops

One of the more interesting developments coming out of the worst of the COVID crisis in Russia has been the nominal decline in inequality based on Gini coefficient data and the interdecile ratio of the average income of the top 10% to the bottom 10%. Tatiana Evdokimova posted this back on August 19 and I've been thinking about it a fair bit since:

I find it quite strange on its face. There's loads of evidence that inequality is set to rise based on the differential experience of price inflation. As of Saturday, market researcher Unikom24 had published survey findings that 70% of Russians now admit to not having any savings, 30% doubt they'll be able to easily pay off debts if difficulties arise, and 20% can't predict their ability to pay off debt. That's all before looking at inflation perception indicators vs. the official data. What we can see from past explorations of the wealth impact of COVID is that Russian interventions did relatively little to bail out asset values outside of housing (which isn't really financialized) resulting in massive wealth losses on paper for the richest Russians. What this chart really shows is that everyone got poorer, but the poorest Russians benefited more from emergency redistributive and business measures.

That fits with the more unfortunate reality that the equality gains will be fleeting based on the size of Russia's spending measures – the AKRA estimates the 10-15,000 ruble payouts to pensioners and servicemen will raise their nominal incomes by more than 5% and average nominal incomes across the population by 0.8-0.9%. In other words, it'll be noticeable for the votes they need but quite small a macroeconomic effect. The following compares stimulus measures as a % of GDP:

That 4.7% figure is already a bit iffy since the Ministry of Finance intentionally included existing spending plans going ahead as stimulus in its accounting and a huge portion of the stimulus came in the form of credit guarantees for which money was assigned but not directly spent in the real economy. Either way, the fact that the one-off costs 500 billion rubles ($6.8 billion) which only accounts for 0.4-0.5% of GDP and is not expected to produce any inflationary burst proves that the economic logic governing the ongoing policy response is still pretty illogical and overtaken by political considerations. SuperJob data shows that 30% of Russians can't afford to even take one week off for vacation, comparable to problems in the EU but quite worrisome when factoring in differential costs, subsidies for transport, and the heterogeneity of the EU. These payouts are a good thing. It's unfortunate the leadership didn't realize they could afford trillions more in spending in monthly interventions had they actually spent more in 2020 and created a stronger market for OFZs among buyers. I suspect the Gini coefficient data isn't quite catching dynamics effectively, particularly when state employees or SOE managers keep raising their own salaries.


What's going on?

Aeroflot, S7, and other Russian airlines are preparing for regulatory changes put forward by the International Civil Aviation Organization's Carbon Offsetting and Reduction Scheme for International Aviation (CORSIA) that will require firms to pay for their emissions on international flights starting in 2027. The scheme is expected to cost the sector €250 million annually, about half of which will be paid by Aeroflot. It's already created an opening for Gazprom Neft – the company is in talks with Aeroflot to supply "green aviation fuel" that, for now at least, is significantly more expensive than standard fuel. The nitty-gritty details of how to swap fuels deserves its own column(s). The most obvious takeaway is that Russian policymakers' evolution in the last 18 months on climate change reflects an increasingly complicated commercial environment for Russian firms internationally, one in which even marginal and inadequate regulatory standards years away from implementation require immediate planning and preparation. CORSIA is intended to cap aviation emissions at 2019 levels, a far cry from what's needed but a realistic first step that can only have an adequate impact with the wider availability and use of competitive passenger rail in the US and the much more difficult process of expanding these types of transport in the Asia-Pacific where geography and borders are a far more difficult problem. Until we get electric planes or else are able to reasonably substitute traditional fuels with zero-emissions options, these steps are a race against likely growing demand for air travel based on basic development numbers. COVID has, however, 'shocked' the pre-crisis trends and there's a lot in the air to consider since India in particular is expected to drive middle class growth globally:

The transfer of low income to middle income population globally will increase international travel demand, and with that, aviation emissions. The Air Transport Action Group is quoted as expecting annual global sector spending on offsets to reach anywhere from $1.5-6 billion by 2025. Moscow is now in the process of building the state capacity necessary to be able to comply with these changes in other areas – 10s of facilities designed to support the measurement and tracking of emissions are planned to built in the next 3-5 years. They'll need it. Aeroflot alone might lose 2-3% of its EBITDA from relatively minor increases in the use of biofuels if CORSIA maintains a carbon cost of €50 a ton. If it goes any higher, the financials get quite complicated and planners may regret failures to build alternate HSR corridors out of other urban clusters in Russia, admittedly difficult because of the over-centralization of economic activity around Moscow and, to considerably lesser extent, St. Petersburg.

MinEkonomiki is in for an earful it seems. A series of investments agreed to within the framework of SZPK – one of the investment mechanisms that's filtered through the presidential administration to protect and encourage more capex across the economy – are now on hold because of a technical mixup. A bunch of agreements were operating under temporary rules to be switched over fully to the SZPK regime in April using the electronic portal and format intended. But the system isn't functional yet and won't be fully up and running until next June. The "pilot" system will be in use by December. No one is going down for the mistake by the look of it, but it's rather farcical to see such pains taken to talk up increasing investment when the capacity to launch a platform for said investment is so badly delayed from implementation. To my mind, it seems like a convenient excuse to explain lack of progress. Changes were made to the SZPK guidelines in July to lower the investment threshold at which investors were eligible – down to 1.5 billion rubles from 5 billion for airterminals, logistical complexes, and general transport, down to 500 million rubles for tourism projects, and 250 million rubles for regional development. The length of time contracts were guaranteed on stable terms was increased to 10 years from 6 years.

It's a fascinating microcosm of what's both so difficult for effective governance and wrong with the attempts to improve it. The absence of true rule of law or reliable property protection that can't be remedied by systemic reforms that undermine the political power of entrenched interest groups, individuals, and also a rent-seeking bureaucracy creates pressure to come up with these ad hoc measures. They may solve an immediate problem – in this instance by providing a guarantee backed by the federal center that terms won't change on the fly for capital being risked – but create a new one. Every intervention and new type of contract leads to a less coherent investment framework. Any time one group gets awarded preferences or benefits with the promise of political protection, others will demand the same. We also get a strange financial picture of what investment levels should look like from Rosstat's info-release comparing organizations' profits minus losses:

All in blns rubles, % vs. same period last year

There was a huge surge of money into companies' hands in the first 5 months of this year. Yet uncertainty over domestic consumer demand and the concentration of those earnings in exporting industries, many of which have to focus investment on 'greening' their operations in the years ahead, undercuts any potential investment boost. Long-story short, the weak institutional context in which investors operate is compounded by an export-led recovery. Most of the most lucrative potential growth on the Russian market should be coming from consumers, not exporters. Yet the economic response to COVID, able to paper over some of that till now, ensured that wouldn't be the growth arc coming out of 2021.

MinEkonomiki is imposing tighter limits on the subsidies given to banks who offered loans to SMEs and the self-employed above the 500 million ruble threshold per existing programs intended to encourage SME formation and grow their share of the economy. If banks lose income from higher-risk lending above that threshold, they won't get soft bailouts from state intended to support the exercise given higher rates of default and the chronically difficult environment these businesses face from lack of preferential access to tenders or else weak consumer demand. The implicit hope seems to be that by reducing the size of the loans being extended, they'll be extended more often and more effective while reducing banking sector risks. At the end of June, Putin made it clear that the Kremlin's position was that cheap SME credits could undermine the stability of the banks. It's rather laughable to see given the preferences SOE firms get to borrow using the sovereign's credit rating and access to state development banks, but it does make sense to look ahead to potential systemic risks given the refusal of the state to use sovereign debt in place of private debt to manage more of the economic fallout from 2020. Policy implementation is just as important a proximate cause – banks that fail to meet their lending targets or exceed them in terms of returns from SME lending, then a special commission can choose to reduce their subsidies and effectively deny them easy money on an important market.

In other words, the latest change is a political maneuver to create a formal control mechanism for the provision of credit in a key sector, like soft planning intended t make lending more common, less risky, and more easily contained if it goes wrong. The official policy target aimed for "no less than 530 billion rubles" lent to SMEs and self-employed individuals this year. It's crucial they make progress improving SME access to credit given how far short of past targets they've come. SMEs account for about 20% of the economy assuming no drastic contraction since COVID hit, and that's also reflective of the degree to which the service sector lags as a % of GDP. Both of these are then further worsened by falling real incomes since Russia's a middle-income country that needs to consume more services domestically to create growth. Things are clearly slowing down. In July, the rate of consumer loan issuance from banks dropped 17.4% and the issuance of credit cards declined 3%. You can increase lending to SMEs, but they still need demand to serve.

In yet more CO2 related news, Inter RAO is trying to avoid paying EU carbon taxes at the same time it's bumped up its forecast for energy exports to 19 billion kwh. Aleksandra Panina mentioned the possibility of individual firms reporting their emissions to Vedomosti as a potential solution. One of the requirements placed on energy exporters in the current policy framework is the guarantee that any given set of energy supplies being exported can reach the point of delivery – here the border – without technical limitations, presumably as a means of verifying where said energy is coming from. It turns out that Russia currently lacks any such legal mechanism to verify that, but is expected to have one in place by 2026. As of now, exporters will have to report their emissions by 2023 and calculate their costs based on said emissions by 2026. For some earnings context, Inter RAO made 50.9 billion rubles ($692 million) from energy exports to China and the EU for January-June 2021. Inter RAO's pretty screwed. The average carbon intensity of EU power generation is half its own production base and falling whereas Russia's current energy strategy won't lead to real reductions. Making it worse, the Baltic States including Finland are leaving the Russian grid per a synchronization and investment agreement to link fully with each other's power grids and the EU system. That would only leave Kaliningrad for Inter RAO exports, where it's generating capacity is loss-making and subsidized by operations elsewhere.

It's unclear to me how these all would work within the framework of the Carbon Border Adjustment Mechanism (CBAM) as it develops. For those curious, here's the most recent guiding document from European Commission published on July 16. 6 options have been put forward as to how emissions would be calculated, with the Commission identifying 3 that have a "stronger impact" – the baseline principle is to require that CBAM certificates identifying the embedded emissions in any given import be 'surrendered' after being purchased at a price comparable to the EU emissions trading scheme on a per ton basis. The long and short of it is that Russia's current approach to its energy strategy and infrastructure investment plans as well as bizarre obsession with forest carbon offsets won't work. Only a wholesale change in investment and regulatory approaches will. Electricity costs are some of the lowest in Europe and are core to what gives Russian exporters a competitive edge. That can't last forever, not with a system systematically creating underinvestment now facing these types of export risks.


COVID Status Report

18,325 new cases and 792 deaths were reported in the last day. Now we're stuck conjecturing as to what we can make of the official data. It's clear and well explored by András Tóth-Czifra in the link that herd immunity has replaced vaccinations as a state benchmark for a reason – it's out of control and it's very unlikely Moscow can get the country to even 60% fully vaccinated by year's end. July's official mortality data showed a huge spike in COVID deaths:

Russia's excess mortality is now second only to the United States, a country with over twice its population, per available data globally. Good news is that we've had 2 straight weeks of an R rate below 1 so there's reason to buy the underlying decline trend for cases despite large reporting gaps and political pressure across the regions to show things are getting better ahead of the election. But the case fatality rate on a 7-day average is still climbing. Translation: things aren't really getting much better in practice unless the virus has gotten deadlier or older people are getting it more. That may be the explanation, but that says more than the topline case count, particularly given any drop in testing (a problem in the UK since mid-July, but mediated by the much higher vaccination rate).


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