10 min read

Consigliere (on an OG String)

Mishustin ain't here to cause no trouble. He's just here to do the cabinet reshuffle
Consigliere (on an OG String)

Top of the Pops

First, a note. After some consideration, I’ll be launching semi-regular posts (to be emailed as well) on US politics. Haven’t settled yet on the format or timing, but that will happen and I’ll get back to you on what’ll end up being made available when I begin transitioning to parsing out free vs. paid subscription content.

Azerbaijan is claiming it’s taken Shusha, while Armenian reports state that fighting still rages. Once Shusha falls, Azerbaijan has effectively won militarily, though most expect combat to continue. Reports of a potential peace deal involving deployments of peacekeepers were leaked, but make little sense once Shusha falls. Baku has the initiative, the military edge, and is on its way to realizing a complete victory in Nagorno-Karabakh. The incoming humanitarian catastrophe is going to be devastating to Armenia. Few believe that Aliyev intends to negotiate a settlement allowing Armenians to stay, or at least stay on decent terms as Azerbaijani forces close on Stepanakert. Ignore the ceasefire talk for now.

In Bishkek, Japarov’s now in a fight with Kyrgyzstan’s miners as his mix of nationalist politicking and surging budget deficits raise the pressure to increase the sector’s tax burden. But doing so would hurt the bottom line of the country’s most important source of foreign currency earnings (aside from remittances) and a huge portion of GDP. Given that international investors from the West, Russia, and China all have mining interests in the country, it’s hard to see how Japarov can wiggle out of this one without finding some sort of compromise. If he doesn’t, investors are going to look elsewhere as global commodities demand recovers slowly from COVDI-19.

What’s going on?

  1. A new study from the Higher School of Economics finds that Russia is losing 3.52 trillion rubles ($45.6 billion) to weak institutional protections and governance for intellectual property, foregoing 2.2 trillion rubles ($28.5 billion) in export earnings, and losing about 300 billion rubles ($3.9 billion) from the creative value added generating IP. While Russia is a top-10 leader for science spending globally, it only generates 0.7 patents per $1 million spent. It’s a two-fold problem: inventors and innovators have little reason to mint new IP when they can’t protect it, thus weakening innovation and denying firms profits off the IP they generate — crucial for contemporary corporate balance sheets — and a lot of money spent on science in Russia is really for military purposes with little intended crossover for commercial application. Russia is nothing like the USSR when it comes to defense, but the sector is still swallowing up resources that otherwise could be used to more effectively subsidize and protect patents.

  2. Annualized inflation in October hit 4%, up from 3.7% in September from MinEkonomiki data and Rosstat. That’s in line with the Central Bank’s target:

    Title: Composite dynamics of inflation (%, in annualized terms)

    Green = consumer staples Blue = tariffs Orange = monetary inflation Black = net inflation

    Shifts in the exchange rate triggered an acceleration of price inflation in October that the Ministry holds is primarily monetary in nature. They suggest it’ll come back down in November, bringing the annualized inflation expectations to a range of 4.1-4.2%. I’m a bit more skeptical that it’s monetary given that depressed internal demand is now dragging down GDP more than declines in external prices and demand for exports, which suggests a more idiosyncratic set of push-pull factors. But on the whole, the issue flagged is exchange rate stability and now with Biden declared the winner in the US, the ruble should become a bit less volatile while traders and markets sort out what they expect.

  3. Russia’s mortgage subsidies are running out of juice to prop up demand as the average family now has to save for 21 months for a down payment, up from 19.5 months. Though legal minimums only require 15% as a down payment, that figure is closer to 30% based on analysis of credits being extended on the market. The hit to incomes this year is now undercutting the positive demand effects generated by cutting mortgage rates in a fairly transparent bid to try and help Russians build up personal wealth by inflating the housing market. The trouble with that approach is that it was never accompanied with systemic income support, such that it’s likelier to create even deeper-seated distortions and inequalities within the country’s biggest cities as service jobs have taken a bigger hit from COVID. Prices for 1 bedrooms and “comfort class” apartments — new builds and remodeled flats with newer appliances, gear, and more that are one step up from studios and flats for people on a shoestring budget — are up 9.8% and 11.8% respectively. Price inflation for property is outstripping broader inflation in the economy while incomes are weak. It’ll take even longer and longer for people to save for down payments by next year.

  4. In October, the volume of auto loans for new cars rose 16%. Subsidies for advance payments have helped drive up purchases in the short-term as consumers, having delayed decisions from earlier in the year, take advantage. But it’s expected that the demand effect will lessen by December. Banks have received state support to then lower lending costs, a parallel move to the mortgage policy approach. State purchases have also helped some parts of the industry. But until COVID is controlled, it’s hard to foresee improvements for average incomes.

COVID Status Report

Things continue to get worse. The mayor of Vladivostok reportedly has COVID, the caseload growth rate has increased the last week, and the caseload has hit nearly 21,800. On the net, the wave is building up again after measures in Moscow eased the growth rate. The bigger story is that COVID is now having a much bigger impact on GDP domestically than due to external demand declines. Tip of the hat to Tatiana Evdokimova for this:

Russia has gone from a domestically supply-constrained economy reliant on external demand to maintain incomes, rents, and the stability of its finances to a demand-constrained economy with myriad problems when it comes to supply. That’s a huge shift worth following into 2021-2022 because the distributional politics of demand constraint differ from supply constraint but both rely on institutional reforms and improvements. Russia’s “hydraulic austerity” — its default preference to consolidate the budget whenever economic crisis hits — constantly destroys growth and, ironically, state revenues and finances reverting Russia to stagnation no matter what. It’s a blinkered inversion of Minsky. Instead of using the financial power of the state to return to growth, state financial strength becomes a net drag on the economy.

The Frat Pack

Word out that Putin and Mishustin are reshuffling the cabinet a bit brought some nifty surprises: there are now 10 deputy ministers instead of 9, MinPrirody’s Kobylkin was sent off to be replaced by Aleksandr Koslov (from the Arctic file), energy minister Aleksandr Novak has been made a deputy minister and MinEnergo handed to the head of RusHydro Nikolai Shulginov. Novak’s elevation into Mishustin’s circle is a huge deal, and a good indicator of just how important oil market management and oil production management are now going to be. The oil lobby is getting soaked and wants a guy on the inside to look out for its interests, so the presidential administration relented given that Putin’s team is now stuck trying to keep Brent crude prices at $40 a barrel or higher with an incoming Biden administration that might make that balancing act a lot more difficult, despite some moves like a fracking ban on federal lands.

These personnel shifts are always intensely personal and political in nature, but it’s important to frame them as the result of a broader set of policy pressures the Kremlin has basically decided it can’t address. For example, the Center for Macroeconomic Analysis and Forecasts estimates that Russian labor productivity growth has to hit 4-4.5% annually to achieve GDP growth targets of 3-3.5% a year. But productivity can only increase if people who are secretly unemployed — those working deeply into wage arrears or else working in gray market labor arrangements — are allowed to become fully unemployed. The traditional political arrangement to head off political crisis by ensuring full(er) employment discourages proper productivity gains. How is that an oil story? Oil revenues allow state budget transfers to mask and paper over these inefficiencies through social spending and support, by keeping borrowing costs lower with the steady stream of foreign currency into banks, and so on. Pleasing the lobby is absolutely critical to the regime’s stability ahead of any political turbulence around 2024 and the end of Putin’s current term and to whatever direction economic policy takes during the new round of fiscal consolidation.

Novak is a technocrats’ technocrat. He’s never waded into a political fight and stuck to his brief and has been talking about reducing the oil sector’s tax burden to sustain output and encourage investment since the financial crisis in 2008-2009. Novak, however, also isn’t naive about political power. He’s pushed to refine Russia’s oil sector tax code to move away from its current arrangement — a frayed tapestry of conflicting tax breaks, exemptions, tax pilot programs, and more rife for political bidding and dictated by factors MinEnergo can’t control — with an excess profits tax (EPT) centrally administered by MinEnergo. Naturally, that change has gotten nowhere, at least visibly. But it shows that Novak’s elevation fits into a bit of political gamesmanship that gets quite convoluted very quickly.

Ironically, the single policymaker already in Mishustin’s cabinet who, on its face, would support an EPT is deputy minister and finance minister Anton Siluanov. It would improve fiscal stability for tax planning purposes, and give the state an easier lever to pull to increase revenues from the oil sector when needed. Siluanov, though, launched a shakedown in September looking to repeal tax breaks to raise revenues. An excess profits tax is effectively a special tax or excise tax on corporate profits i.e. returns on capital invested above a certain threshold. If such a tax reform was passed,  it could be used to more fairly distribute the tax burden between oil companies within Russia’s sector and to unilaterally or specifically raise and lower rates in a centrally sassed and controlled manner dictated by MinEnergo. Therein lies the problem for Siluanov. He would have to go through another institution that would suddenly have the prerogative to assess levels of taxation. In the current anarchic system, MinFin actually retains more relative bargaining power over companies when seeking revenues because there is no central political institution setting their marginal effective tax rate above the EPT threshold, implicitly built into the current tax regime by stipulating formulae and changes in the effective rate depending on the price of oil,  the geological complexity of an oilfield, sulfur content, etc. Novak’s being put in the ring with Siluanov to balance both sides’ interests, which also means that Mishustin is now a pivotal player in deciding these matters given the Kremlin prefers to let everyone else handle domestic policy. Face time and living day-to-day inside the decision curve are power.

The fiscal and macroeconomic consequences of this fight are massive. This is from a March World Bank report with slightly older data, but it captures the basic policy dilemma that the Kremlin has punted on and underlying trends. By refusing to spend state money and use state deficits, households are forced to take on the burden of debt without a healthy economic growth environment:

The current shakeup is really a fight about who controls the money, how it’s raised, and how much slack the oil sector can be offered in the current environment. Novak will keep advocating that they lower the tax rate and let the ministry decide how much to punish firms with. Siluanov will keep insisting the burden be kept high as it is. Neither will disagree with raising taxes elsewhere. Russian oil output is going to be a political hot potato for years to come.

Obmen, oh man

Now that the election’s been called for Biden stateside, the ripple effects for markets are becoming visible. First off, the US dollar started weakening against emerging market currencies, but really the story was mostly China:

Structurally, markets now seem to be prepped for divided government in Washington which means smaller fiscal stimulus and more creative work from the Fed to keep things on an even keel. A slightly weaker dollar would, in theory, help the ruble in exchange, but the country’s escalating challenges with COVID may blunt gains. Word from Pfizer that its vaccine is 90% effective is going to lead to a big rip up in market for West Texas Intermediate and Brent crude, but that’s mostly on short-term euphoria. As always, watch the fundamentals. USD weakness is not yet met by broader shifts across other emerging markets, and the Euro’s strength continues as a result of deflation, not positive economic news.

It’s dire how badly the second wave is devastating economic recovery in Europe. Even with a vaccine, CITI’s got a scenario in which European GDP is still down 10% in 2 years’ time. Those figures get way worse if there are any hiccups rolling them out. The fact of the matter is that COVID-19 has not been devastating (yet) for American economic power and most definitely not for China’s or most leading Asia-Pacific economies. But even with the loads of support and good feelings engendered by the recovery fund talks this summer — always far more fluff than substance since Europe loves to congratulate itself in advance — things are bleak as a conventional recession sets in. The trouble lies with the European banking sector, and this is something Russian policymakers are going to have to get a hold on if they want to recover in a weak external demand environment. From Frederik Ducrozet:

Negative rates set by the ECB are bleeding the net interest income for European banks compared to the number of assets they hold. In effect, negative rates may provide an early stimulus to borrow since banks are effectively paying borrowers to take money, but they end up constraining lending because, as profits decline, banks hold fewer reserves against the liabilities they accrue and have to become more cautious about lending. European demand destruction, at least for oil, is going to stick and Europe’s economic malaise could well drag down its neighbors, especially if it’s true that Turkey is now being threatened with a loss of access to the Customs Union because of its sponsorship and role in extremist violence in France and elsewhere. Russia’s gamble on multipolarity relied on a Europe that maintained its relevance as a leading pole of power. The closer you scrutinize the underlying data, the harder it is to see that gamble paying off as Biden lines up a transition and launches an assurance campaign for American partners.

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