Top of the Pops
Thanks to Jake Cordell for flagging news from MOEX that the number of retail investors registered on the platform has grown by 1.2 million people year-to-date, reaching 10 million retail investors registered in total accounting for 42% of turnover in equities. I think we can safely assume that by and large, it’s not pensioners doing the trading, so that’s nearly 1 in 7 members of the officially measured labor force who are registered as retail investors and probably skewing younger. The continued growth of retail investment poses questions for the regime’s political economy because of the wealth effect, the behavioral economic theory that people are likely to spend more as the value of their assets rise. When that much of the workforce is investing on their own and driving substantial swings in equity valuation, the effect of stock market volatility — explicitly something Russia’s own economic sovereignty guiding documents criticize abroad — matters more for real incomes and consumer spending, with the caveat that some of those who are retail investing are comfortable enough that their spending levels for physical goods or services may not change that much if they suddenly land a windfall. Unfortunately for Russia’s retail investors, Russia’s large and mid-cap stocks consistently underperform peers in other emerging markets and across developed markets:
And the ruble returns’ rise correlates to currency devaluation and the inflation of domestic equities through state policies i.e. subsidies, bans on competing imports or, particularly in the case of retailers, consolidation and improved earnings (which for commodity exporters rose thanks to currency devaluation). But without broader economic growth and without adequate growth in external demand for commodity exports — this is changing, and miners are going to drive a lot more valuation increases in the years ahead I think — returns were meh. Russia was a ‘normal’ country riding a shared wave of global growth until 2008, and since the Eurozone crisis hit in 2010, the steady turn towards economic sovereignty has been reflected by weaker equity returns. As of last fall, 79% of retail investors in Russia were prepared to invest in gold, probably mostly a reflection of its rise over the summer but also evidence that the people joining the market are serious about trying to find hedges for inflation. The rise of retail investing, therefore, is a weird case of Russians trying to find new ways to wring more money out of an economy that’s not providing them adequate material security or enough means to rise socioeconomically.
What’s going on?
The General Staff in Armenia have triggered a new crisis for the government led by Prime Minister Nikol Pashinyan as the military leadership is now demanding their resignation in support of the many Armenians who’ve been protesting since the loss of most of the territories held by Armenians in Artsakh. Pashinyan has called it an attempted coup. The development followed the dismissal of a deputy minister and head of the General Staff who criticized Pashinyan’s assertion that Iskander system’s munitions bought from Russia were not quality. In response, Pashinyan called his supporters to rally on Republic Square in Yerevan, where he, his son, and others from his government have taken to the streets. The opposition led by the “Movement to Save the Motherland” is calling its own supporters to rally there as well. This is going to develop over the course of the day, but it continues the political fallout of the war with Azerbaijan. Just yesterday, Russia had announced it was helping the Armenian military reform as the defense ministry has come out lobbying for a larger Russian military presence. Even Pashinyan has made sure to publicly seek deeper cooperation with Russia on security matter well aware of the hand he’d been dealt with the war. Pashinyan went so far as to order the military attend to its own matters and protect the borders instead of join protest activity. The protesters are the wildcard as is how the perception that Russia ‘punished’ Armenia for Pashinyan’s pursuit of a more independent policy and refusal to significantly help affects the public’s attitude if/when a new government comes to power and inevitably has to negotiate with Moscow. Also, since I missed it earlier this week, a handy overview of Kyrgyz president Sadyr Japarov’s visit to Moscow is linked here. Suffice it to say that while many maintain that Russia managed to reassert itself forcefully by the end of 2020 across Eurasia, the risks and liabilities are piling up.
The Gaidar Institute compiled its own “economic surprise” index for Russian manufacturers to measure the uncertainty they’ve experienced over time and capture the ‘vibe’ pervading the business climate at the moment. It shows a surprisingly steady downward trend pre-COVID and just how big the spike in uncertainty has been. Note that the index measures the % share of mistaken forecasts for production, demand, and prices issued by manufacturers:
Red = output Seafoam = demand Black = prices
Demand resonates as clearly the biggest source of manufacturer uncertainty, which once again exposes just how absurd the supply-side focus of government officials was during the shock. It’s not like the Gaidar Institute is known for its Keynesianism. Importantly, this measure doesn’t reflect which direction a given forecast was mistaken. Firms may have gotten it wrong in both directions. But I think what we see here is a clear decline in demand uncertainty after 2008 because growth in the economy exhausted itself and businesses knew that well, with a big fall after Crimea given recession and then stagnation. Output, however, more directly reflects state orders and budgets. So you get a situation where the supply side is more heavily managed domestically, via very different mechanisms and with a functioning market, but still politically managed whereas demand has languished and seems more inelastic. This helps explain the inflationary bottlenecks that keep appearing across the economy, despite success bringing down topline inflation.
Russkaya Stal’ and the Association of Trade Ports have sent letters to Andrei Belousov as well as transport department director Anatoly Meshcheryakov complaining that a proposed bill now in its second reading concerning the legal obligations of owners of sea port infrastructure risks serious discrimination in the function of the logistics market. Logistics, I’m aware, isn’t a gripping topic. The consequences, however, can be — recall the Magommedov brothers’ home arrest and hostile takeover of their port assets. The biggest problem with the current bill is that it would effectively oblige investors to pre-pay to help finance public investments into infrastructure, namely for Russian Railways, and force them to guarantee the execution of investment projects that are subject to market conditions, once more introducing higher costs while risking losses. What’s really happening is that state policy is trying to dragoon private investors into increasing net investment levels across the economy and footing the bill for RZhD’s investment program around the edges. It’s the business equivalent of ‘personal responsibility,’ forgoing stronger institutional structures to allow investment to actually address existing demand and instead force investors to pay for capacity that may not be needed in the end. What’s worse, the bill offers RZhD priority access to shipping capacity, which effectively discriminates against any firms that don’t need the capacity expansion. Take it as a sign that there are no plans to significantly increase investment levels using the budget while Moscow is confident it can keep raising net export levels from commodity production.
With automotive prices rising due to the semiconductor shortage, MinPromTorg has set a new import substitution target to domestically source 50% of all the electronic components in Russian car manufacture by 2025. The figure was 20% in 2019 — worth 126 billion rubles ($1.7 billion) out of a market worth 630 billion rubles ($8.57 billion). Foreign manufacturers have made some strides localizing production for supply chains in Russia, but no one takes the year target too seriously. Rather it seems that MinPromTorg is trying to create a new cross-subsidy for the defense sector since only defense manufacturers have the logistical capability to produce what’s needed at levels needed in the timeframe proposed. A possible problem there is that if domestic manufacturers start sourcing electronic components for light vehicles to defense firms, the perceived risk of sanctions exposure for any foreign manufacturer rises considerably since you never know what the US Congress might decide is a pressing matter of national security these days. It supports existing plans to get defense firms to either expand into civilian supply chains or else open up new subsidiaries that are competitive and entirely focused on non-military production. But in so doing, companies currently importing parts based on assumed regulatory equivalence will have to get new certifications, work out new supply chain kinks, and spend more on production. Import substitution beatings will continue until morale improves. This is an interesting area of industrial policy to watch, particularly if the consumer recovery proves weaker than advertised.
COVID Status Report
New cases fell to 11,928 in Russia with a rise to 446 deaths reported. Karelia seems to be having a really difficult time getting cases down, and while St. Petersburg still has the second worst infection rate per 1,000, it’s made huge progress in the last month:
Doctors are warning that infection rates may rise in the spring, however, as the British variant of the virus spreads further and vaccine take-up still lags. Regions such as Stravropol’ are working out how many cots to hold in reserve for COVID patients towards May as the strain on the healthcare system has eased and space to restructure care facilities now exists. The vaccine drive is slowly improving, so the gaps in the data witnessed since December will slowly vanish, especially if herd immunity really was achieved. We unfortunately lack the data, and no one has an adequate explanation. It’s good, though, so long as the new variants don’t take deep enough root. Case rates are only rising in a tiny portion of the country (by population) at this point and for now, new variants aren’t appearing. The one thing to note, however, is that Moscow’s numbers have been stagnant for weeks now, if lower. If that happens elsewhere and take-up doesn’t reach critical mass fast enough, well, it’s precisely how the fall wave in the UK exploded, though it would be tempered in this case by the vaccine.
I’ve been thinking over the last week as to why the Ministry of Foreign Affairs let slip that it was open to new talks in the Moscow format at the same time Biden had effectively indicated the US withdrawal process was dead in the water. NATO Secretary-General Jens Stoltenberg announced that any NATO withdrawal decision was being delayed and while everyone obsesses about the 2,500 US troops still in country, there are 10,000 NATO member state personnel in total deployed, making the US just a quarter of the force there. Yesterday, the German cabinet agreed to extend the country’s mandate for its mission in Afghanistan a year. The United States isn’t going anywhere, especially now that Ghani’s government in Kabul is starting to pull out all the stops to message to the US Congress that the Taliban aren’t negotiating in good faith regarding the presence of foreign terrorists in Afghanistan.
So what is Moscow, a convenient sideshow the Taliban were able to use for leverage to make sure president Trump stayed at the table, actually hoping to accomplish and what is it worried about? Ever since the US opted to stay in country after the initial invasion, both Russia and China have been wary about any withdrawal because of the threat of instability spilling over into neighboring countries. There is no evidence to date that either has attempted to do anything to provoke or support attacks on American troops. It has to be re-emphasized that the Pentagon itself has consistently denied that there’s any evidence linking Russian interactions with the Taliban with attacks on US soldiers (or any proof of arms sent to the Taliban if you go back and check Mattis’ testimony). Further, the furor last year was actually set off by a leak from Afghan intelligence quite clearly aimed at triggering a panic in Washington since the peace talks with the Taliban and withdrawal negotiations under Trump had been seized upon as a partisan issue by Democrats hoping to appear tough on national security. There’s actually no substantive evidence Russia was hoping for a US withdrawal in policy terms, even if propaganda outlets in Dari or other languages messaged it. What seems likelier is that the MoD and Kremlin had reliable intelligence on Trump’s own personal preferences and were confident he would push for a withdrawal as one of his campaign promises, and sought to position Moscow to have a role in negotiating the aftermath even though there was no meaningful multilateral forum for Moscow to do so. Just last week, RIA Novosti ran this piece examining why Russia wanted to bail the US out of its own quagmire as a peacemaker. It served a useful domestic messaging purpose, no downside risk, and offered lots of potential upside.
At the same time, the US has lost a great deal of credibility with the Afghan population that has historically been relatively supportive of a US presence because of the way Trump pursued his peace deal and the significant escalation of civilian deaths due to the over-use of air power to make up for a shrinking footprint deployed on the ground to fight the Taliban and other groups:
Russia hasn’t gained any support with the government in Kabul or the population, it’s simply positioned itself to have a diplomatic stake at a moment when the United States’ ability to negotiate in good faith in support of the government in Kabul took a serious hit. Viewed through this lens, it’s much easier to address the elephant in the room that both Washington and Moscow are actually worried about in Afghanistan: China.
Back in 2002-2003 when the Bush administration was laying the groundwork for the invasion of Iraq, Afghanistan’s role in US strategy was basically to act as an anchored from which the US military and the American role in shaping the security environment and architecture of the region could be projected in several directions. Iran would be encircled — Vice President Dick Cheney was pushing for military action to deter the Iranian nuclear program up until the financial crisis overtook the agenda — the US had an excuse to engage in Central Asia (focused on Kazakhstan) amid a commodities boom and serious fears of oil scarcity, and it provided an outpost next to China’s western edge. The first focus remains a reality for US planners, the second is irrelevant (it was never about controlling oil directly, but rather ensuring that the oil market was de-politicized to the extent possible), and the third became the prime reason to stay in Afghanistan as time went on. The result has been that despite lacking any normative tools like the Eurasian Economic Union and limited space for an expanded commercial presence — Kazakh oil & gas have historically been the main draw — Afghanistan and concerns over border security in Turkmenistan, Uzbekistan, and Tajikistan have been Washington’s ‘trump card’ for regional politics. Even if of limited value, the US presence gives the US government a seat at the table. China recognizes that the US military presence was a flanking maneuver of sorts, but also doesn’t relish the risks of having to provide security in Afghanistan itself.
Russia, for its part, has a different problem than the US to contend with: its relative economic decline in Central Asia. As a result of Russia’s refusal to stimulate consumer demand (ever), it’s seriously short-changed its ability to maintain its historically privileged economic position across the region. Broadly speaking, the region is comprised of commodity exporters with varying degrees of dependence on rents form said commodities (chiefly oil & gas) and states with weak domestic demand and excess labor that tends to migrate to Russia and send earnings back in the form of remittances. The space to diversify into consumer or industrial manufacture could only have worked (if it ever could) had Russia opened its market in the 2000s and sought a role for trade leadership earlier. But the last commodities boom was driven by explosive Chinese growth and by 2008, commodities markets lived and died by the strength of Chinese consumption, and China was manufacturing everything it needed:
The question since in structural terms was how long Russia could leverage its relative strength as the provider of public security goods to maintain its influence while China’s economic clout, then accelerated by the Belt and Road Initiative and expansion of investment into regional infrastructure, kept growing. The Eurasian Economic Union was a weak instrument for political influence because of its lack of power to compel regulatory harmonization among other things. It was really a trade area focused on tariff rates. Even assuming Uzbekistan joins in the near future, it’s relatively weak when it comes to setting the rules of the road for things like foreign investment, from which trade generally follows regardless of customs unions or trade zones. China’s finally catching up on the security front, if belatedly. The expansion of Chinese-manned border posts, reports of patrols into Afghan territory, and growing intelligence and security concerns in Afghanistan due to uncertainty over US policy and greater levels of investment in the region (and Pakistan) have necessitated a more pro-active security policy and upset the tenuous condominium Moscow and Beijing had previously accepted with the assumed, lasting US presence.
The only way Moscow can salvage the situation in light of the underlying trends is to create a role for itself to guarantee peace in some manner. But the Biden administration is pretty clearly backtracking on any implementation of a peace agreement, which will trigger a new and expanded round of fighting with the Taliban and the same status quo, only with even less leverage and credibility to negotiate an exit. Amidst rising tensions with Beijing, Afghanistan therefore remains a potential launchpad for air power and targeted special forces activity into Xinjiang and a useful tool to maintain a role for the United States in Central Asia. One of the few successes of Trump’s foreign policy was the expansion of contact and engagement with the Uzbek government regarding the conflict in Afghanistan and border security without Russian involvement. Ironically, Moscow’s main line to stay relevant has been to exaggerate the threat of an expansion of ISIS into Central Asia from Afghanistan, something the Taliban have done well to prevent from happening for the most part so far. It’s the same playbook Russia used when positioning itself diplomatically in Syria. The problem, however, is that in Afghanistan, the US is the security guarantor for the government alongside Afghan forces and Russia has no presence on the ground whatsoever.
What began as an opportunistic play to try and turn lemons into lemonade when Trump signaled his intention to leave has become a diplomatic trap. No matter how bad things get for the US, there’s not yet any evidence it will leave the country. And the longer it’s in the country and China’s security policy continues to more pro-actively react to potential threats, the smaller the space for Russia to maintain its influence across Central Asia. The only worse than having no actual stake or say in the outcome of the peace process is to claim one and fail spectacularly to have any actual stake or say in the peace process. Since China’s security expansion is primarily built around policing and surveillance, it’s inaccurate to suggest it’s displacing Russia. But if we conceptualize political competition in economic terms, the relative value of the assets and public goods Russia provides to the governments of Central Asia are diminishing in relative terms that the US and NATO appear to be in Afghanistan to stay for an indefinitely longer period and China’s taken up the mantle of enhancing state capacity to crack down on dissent and police the public. Attempts to get Ghani’s government in Kabul and the Taliban to talk in Moscow are a manifestation of how Russia, adept at getting parties to talk, has lost its end game with the Biden administration and wants to buy more time to consider its options while building a new relationship with Sadyr Japarov and a new Kyrgyz administration that appears friendlier to Chinese interests for the simple reason that they owe China a great deal of money. Tragically, as one might expect, the war in Afghanistan isn’t even about Afghanistan anymore. It’s increasingly about the shadow of China over US — and Russian — foreign policy.