8 min read

Fiscal Fight

The CBR's suffering a strange form of fiscal dominance
Fiscal Fight

Top of the Pops

As expected, the humanitarian ceasefire in Nagorno-Karabakh announced last night and brokered by the US government is already under strain. Safe to say it was an election stunt for the Trump administration while US policy continues to implicitly back Baku and Ankara so far.

Russia’s daily COVID caseload has hit 17,347 with no signs of stopping.

And Bigger news from Belarus:

Early yet to tell what impact it has, but the pressure is on and isn’t going anywhere.


What’s going on?

  1. Putin is proposing to NATO that, in the wake of the termination of the INF Treaty, Russia will withdraw 9M729 missiles from European territory in exchange for reciprocal removals of intermediate range nuclear weapons systems in Europe and a mutual inspection regime. Summarized as:

    Leaving aside the attempt at a diplomatic win, arms control is generally a cost control mechanism in Soviet and Russian history as well as a means of preventing a gap from developing due to competitor’s greater economic resources. This latest tack towards a treaty should be followed in line with newer fights over the proper level of funding for the military and lack of a stimulus plan for 2021. Guns or butter is always a top policy priority in an economy of shortages, self-imposed or otherwise.

  2. The Russian Union of Industrialists and Entrepreneurs is pushing Putin to agree to a plan to return business tax levels to what they were coming into 2020 from 2023 onward once the fiscal consolidation for the 2021-2023 budget is complete. In short, industries want a pro-investment national policy environment and rightly understand that the Kremlin’s current response is failing on that front. There are parallel proposals to slacken construction norms and regs and bring in the government to participate in improving the skills-base for future hires.

  3. MinFin is proposing a legal changes to the national procurements system to improve transparency, efficiency, and competitiveness in this year’s drive to fix one of the largest sources of otherwise legal corrupt practices in Russia. Over 80% of Russia’s procurement contracts are awarded on a noncompetitive basis. The volume of money spent last year on procurements is equivalent to 7+% of GDP in 2020, the liquid share of reserves in the National Welfare Fund:

    Title: General sum of tendered contracts for state procurements, trln rubles

    The most notable changes entail moving procurement contracts worth less than 3 million rubles ($39,240) to an auction format rather than a tender competition and ending duplicative two-stage tendering processes that clearly favor those with connections and larger firms.

  4. MinFin, Roskomnadzor, MinEnergo, and Rospotrebnadzor are all complaining that Ministry of Digital Development’s plan to spur investment into 5G networks risks undermining budget revenues and failing to meet its own targets. MinFin’s proposal is elegantly simple: lower tax rates for 5G and raise them for aging technologies to force companies to commit capital expenditures. That’s no doubt going to be wildly unpopular for operators working in a terrible business climate.


Shiftless when idle

The Central Bank of Russia surprised virtually no one on Friday in deciding to hold a policy pause and maintain the key rate at 4.25% citing the high degree of uncertainty. The yield curve has been consistently controlled and brought down since March, while base inflation on a monthly basis (noted on the right axis as I preferred to avoid using annualized expectations and leave out CPI since services deflation skews the underlying trend a bit) is under control and heading towards deflationary risks:

Yields remain far more attractive than counterparts in the Eurozone, the US, or Japan. Consider the following yields for the same maturity periods as of October 23rd:

You’d think that Russia’s fiscal fortress mentality will keep drawing in investors given just how bad returns for sovereign debt in developed economies are. But as we’ve seen, non-resident investors have spurned OFZs, with their share of total purchases in September hovering at a lowly 7.6% - a record low since the start of 2018. The following is measured in billions of rubles:

Blue = non-residents and subsidiary foreign organizations Red = local investors Beige = share of non-resident purchases

As I’ve noted before, the CBR has worried about bank sector liquidity and PM Mishustin has gone so far as to badger SOEs to fork over foreign currency to make sure the banking sector doesn’t have a forex liquidity crisis while under strain as foreign currency inflows both associated and not with commodity exports dry up. This month’s data on the structural deficit or surplus for liquidity shows the CBR is still firefighting. In simplified terms, a deficit means the banking sector sees net cash outflows where a surplus means that there are persistent net cash inflows into banks. Historically, the amount of liquidity available would correspond to the commodity price cycle, namely oil:

As we can see, there were a few shaky days early in the month around the time concerns about foreign currency liquidity were more pressing but efforts to rein the sector’s deficit in seem to be working. A rate cut would help juice demand and ease lending, but strengthening balance sheet outflows for banks without providing fiscal policy to create growth would be a huge risk with the current oil price outlook. Finance Ministry Anton Siluanov has said there’ll be 12.5 trillion rubles ($164 billion) in the National Welfare Fund by the end of the year, of which 8 trillion rubles ($105 billion) remains liquid. The liquid part of the NWF is now worth over 7% of GDP, at which point the excess volumes can be spent.

The Audit Chamber’s out for blood given that the NWF’s funds are poorly allocated to liquid assets generating relatively fast returns. This then further undermines the investment case with an already over-cautious spending threshold. The idea they have in mind is finding more liquid assets like bonds backing infrastructure investment and using the fund as a means of creating more lending liquidity for productive investments in the Russian economy, thus easing the burden on the CBR and helping the banking sector finance productive investment. Basically, Russia’s sitting on over 7% of its GDP in relatively liquid funding sources that could be used to build things that generate strong returns on investment, prop up banking sector liquidity, and crucially convince foreign investors that holding Russian debt is worth it for the yield because it’s actually got a growth story, not just a fiscal discipline story. Local investors seem ready to buy more, and systemically-important banks are desperate for returns.

Russia’s Central Bank is hostage to a strange form of fiscal dominance without crisis conditions for the national deficit or wild inflation (at the moment). It can’t raise interest rates cause it would kill economic activity and raise borrowing costs, it can’t ease more because of instability in the banking sector, and it’s basically waiting for some kind of rational economic plan for 2021 to emerge to be able to forecast and plan. Killing inflation is one thing, but warding off deflation - clearly a massive problem for services and a systemic risk if foreign currency earnings don’t recover - is another thing entirely. Price stability with inflation running ahead of economic growth becomes price instability for Russians trying to keep their real incomes up and handle the rise in informal banking, indebtedness, and delayed payments on debts. Monetary policy is stuck serving fiscal policy, except that fiscal policy is on autopilot in the worst way and primarily serving budget hawks in Moscow keen to use the purse strings for influence.


Skills that kills

The World Economic Forum’s put out its October report on the future of work. The country breakdown graphs were interesting and Russian companies surveyed had this to say about the length of time expected for workers to re-skill when changing jobs due to COVID:

In practical terms, the categories for 6-12 months and over 1 year are massive red flags because of the productivity and earnings drag new hires impose on company bottom lines when evaluating hiring decisions. It’s safe to say that most companies have no interest and little incentive to invest meaningfully into developing talent internally unless there’s a way to lock them into long-term commitments or they’re worried about replacing talent that leaves. Once companies are big enough, they know they can grab a recent grad, a transitioning or else recently laid-off worker with the right background desperate to earn a decent living and shove them into the deep end certain that if it doesn’t go well, they’re easily replaced or else, for a publicly-traded firm, eventually dumped as part of an efficiency drive to reassure shareholders that they’re getting more bang for their buck. The more “generic” a company’s output is in terms of the product delivered to the client, the less concern there is about marginal gaps in quality that can be ironed out by mid/senior level hires who can steer new hires along. There’s nothing wrong with that approach as a business, but it’s a massive problem during a sustained demand disruption like COVID-19 and it’s interesting to see 40% of Russian firms responding identify re-skilling periods of at least 6 months during which those new hires won’t be maximally productive. Smaller businesses are much more exposed than their larger peers to periods of lower productivity from a new hire and have to invest into skills without knowing what the market will actually look like.

The most important way to ensure companies feel comfortable investing for the longer haul is to ensure the existence of consumer demand for their products. The fact that inflation is under 4% in annual terms is evidence of a lack of demand, especially since Russia’s push-pull factors for cost are a lot more exposed to seasonality and transport than most countries due to its size, geography, and climate. The Central Bank more than doubled its estimates for capital outflow in 2020 from $25 billion to $53 billion. There’s no point in keeping your money invested on a market that isn’t generating returns or growth. It’s nothing new for Russian economic experts to note that stagnant wages are killing future growth, but I think the problem’s worse than many think.

The extent of re-skilling needs linked to job displacement in Russia are going to have a skewed and downward effect on wages. Since the services sector has been disproportionately affected by COVID, make up a smaller part of economic output, and are reliant on domestic demand for growth, the skills lag and desperation from higher unemployment levels will make it easier to pay workers less, especially as businesses cope with a need to pinch every kopek for the bottom line. That’s likely to make government jobs more attractive as their salaries are likelier to be insulated from these forces, yet the state will not be able to sustain salary increases to beat inflation expectations without economic growth generating higher revenues. Russia isn’t going to escape the pressures facing developed economies in Europe or the US, which will drag down salaries for ‘high-productivity’ jobs and, by extension, domestic demand.


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