11 min read

Льготтen Gains

Льготтen Gains

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Tax reform has been top of the agenda lately and the government appears to have agreed to a compromise version of the Ministry of Finance's initial proposal to raise the tax burden on the metallurgical sector after meeting with reps from the Russian Union of Industrialists and Entrepreneurs including Roman Abramovich, Oleg Deripaska, Vladimir Potanin, and Aleksei Mordashov. The deal is to impose increased excise taxes at lower rates than MinFin proposed while setting aside higher profit taxes on dividends and windfall earnings for now. What was perhaps most telling was that Mishustin clarified the proposed profit and excise tax increase wasn't to meet fiscal goals, but rather to better align the realization of dividend earnings for investors in relation to corporate investment. Basically the state wants to get these firms to mobilize capital more effectively. These tax changes will then be incorporated into the new tax review intended to impose carbon taxes that will appease EU regulatory requirements by 2023. There's a parallel look at changing taxes on individual entrepreneurs/business owners that would exempt them from paying social insurance and similar payroll taxes while raising the income tax from 6% to 8% and raising the ceiling on the "revenues minus expenditures" profit tax formula from 15% to 20%. Are those changes fiscal in nature or about fairness? Worth looking briefly at the basic makeup of tax revenues by type of source. LHS is blns rubles, RHS is just %:

I included excises, duties, and tariffs as a consumption tax since they're levied on imports as well as exports, at the point of sale, or else affect domestic price levels. The larger point is that consumption is actually the single largest source of tax revenues by category within the consolidated budget (so including regional budgets, not just federal). Profit and income taxes normally vie with insurance/pension payments, but have diverged a bit this year. Larger point I intend to make is that the government can't raise more revenues effectively by raising taxes on consumption – a net drag on demand – but has a problem if Mishustin and co. think raising income/profit taxes can be used as a cudgel to spur investment across the real economy. It also gets at a larger, slowly emerging shift in the regime's political economy as attempts at controlling prices and inflation levels go forward. MinPromTorg is now trying to tie food retailers into long-term contracts with suppliers, for instance, as a means of market management. Following up on its findings, the Federal Anti-Monopoly Service (FAS) has given Magnit and Pyaterochka in Moscow oblast' 10 days to cut prices for socially significant goods. In practice, controls and interventions over price levels – whether they be direct or indirect – then affect fiscal policy and expected tax takes since consumption is the single largest source of revenues and price levels interact with profits/income taxes. Corporate profits might rise while personal incomes fall amid price rises, as one example. Tax reform and inflation controls go hand in hand. Fiscal politics is melding, if haltingly for now, with market management.


What's going on?

The Gaidar Institute has the latest data survey on industrial activity showing that demand has slowed, a useful reminder that the underlying trends heading into 4Q are negative domestically despite potential for some windfall export earnings (especiallly for natural gas). Optimism is notably fading and the hoped-for growth impulse from state investment next year largely hinges on the use of the National Welfare Fund. What's more Alexei Kudrin is launching attacks from the Audit Chamber on the size of Russia's borrowing operations during the COVID crisis – a valid critique insofar as huge stores of reserves could have been liquidated from the NWF but weren't – because of the introduction of protected, floating bonds. Since a large share of newer issuances are designed to ensure that investors receive returns that beat inflation, the burden for budget planning is greater. I disagree with Kudrin about any serious risks from greater debt levels, but it's an important aspect to acknowledge since inflation's still rising. The output slowdown based on 'momentum' indicators becomes more worrisome given the structure of the debts issued:

Black = planned output Orange = demand Green = supplies/stocks Grey/Blue = factual change in demand

As long as MinFin focuses on issuing bonds that are designed to guarantee returns above inflation, growth is a significant worry. There's also a bit of a power play from German Gref going on – this Wednesday, for instance, Sberbank was the sole purchaser of new issuance. There's a tacit understanding that state banks don't want to hold these bills unless they can hedge the inflation risk since foreign investors aren't much interested and now yet another sanctions bill has come out of the US House of Representatives that goes after secondary trading of any bonds issued by the Bank of Russia, National Welfare Fund, or Treasury with a maturity of 14 days or more. Growth that produces more revenues and reduces the private debt burden is structurally necessary and the 2022-2024 budget runs a net surplus that should go towards servicing a bit of the debt issued in 2020-2021. If you look at the real volumes of different categories' contribution to growth from BOFIT, that growth looks a lot weaker even if 3% for 2022 is a realistic outcome:

The level of private consumption recovery needed to sustain growth into next year at strong levels is far higher than where it is, and while this data is aged out a bit, imports remain compressed relative to exports. One net positive is that demand for industrial robots has risen 20-30% as a result of the shortfall of migrant labor, which should provide a boost to manufacturing productivity. But automation due to a supply-side labor shock in an economy where overheating wages are seen as an inflation threat, wages are often negotiated slightly down to boost employment, and there's growing post-COVD wealth inequality isn't quite the same all-around positive story. After all, the Bank of Russia is now defining the natural rate of unemployment upwards to justify further hawkishness on monetary policy. In short, things aren't looking great for 2022 even if tailwinds keep topline GDP growth at a good clip.

Natural uranium spot prices have ticked up as uranium oxide prices are now higher than $50 a ton for the first time since 2012. Rosatom doesn't expect further price increases – in fact, the SOE expects prices to settle back around $40 a ton – but the current price rise is largely driven by Canada's Sprott replenshing its stocks. A quick check for prices over the last 15 years shows how stark the effect f Fukushima was for the market and expectations of continued use in developed markets, if not further expansion. Also worth flagging that uranium prices went sky-high along with oil in 2006-2007 back when the narrative of Russia as energy superpower had a lot more currency:

So if Rosatom isn't expecting the current price rise to stick, what could change the market outlook? It's not like Rosatom's countless projects on paper are necessarily going to drive up prices by themselves, despite progress. There's a new push from the cabinet around Boris Johnson in the UK to approve a nuclear plant in Wales at Anglesey that would be operational by the early-mid 2030s and provide a huge amount of generating capacity (still being worked out). That's obviously so far away as to be of no relevance to today's price levels or supply/demand balances. The US Department of Energy led by Jennifer Granholm is trying to close deals with the Polish government to partner with US nuclear giant Westinghouse to build new plants that would phase out emissions-intensive power generation and reduce the country's exposure to natural gas prices. The same tack has been taken with Ukraine via the Department of Energy, leading to a memorandum of cooperation between Westinghouse and Energoatom.

These are all longer-term factors. For now, the uranium market isn't following other energy commodities in terms of price levels. Despite the 2000s boom, the long-term trend has been declining demand:

I'm interested to see if there are changes in attitudes and plans for small, modular reactor designs in place of larger reactors as power grids grapple with the opposing trends of decentralization and microgeneration and greater demand for centralized storage and backup capacity in case of shortfalls. As of now, it's impossible to replace natural gas without nuclear power.

The arrest of Novatek's deputy chairman of the board Mark Gitway for tax evasion in the US has affected the company's valuation and reminded Russia Inc. that political risks remain beyond a new round of US sanctions. Apparently Gitway had hidden countless assets using offshore jurisdictions between 2005 and 2016 to avoid taxation and now has to pony up $93 million. Gitway's case gets a little hairy since he's apparently a dual citizen, a fact that Dmitry Peskov had to speak to, but in accordance with Russia's own appreciation of the soveriegn power of states to police their own citizens, the Kremlin only commented on the need to ensure the legal rights of Russian citizens are respected. Boilerplate language really, and not evidence that a big fight is coming though that may change. Novatek's stock has reacted, if not catastrophically thus far to the development:

The company has not yet confirmed any actions required of them to be taken by US authorities or other effects on business operations. The timing of the arrest is noteworthy given we're just a few weeks since Novatek officially distanced itself from Rosneft's efforts to gain access to Nord Stream 2 and Gazprom's export pipelines began. Further, Novatek has been the main success story in Russia's energ sector since 2014. Technip Energies in partnership with Italian Saipem and Russian NIPIGAS just delivered the first modules for the first LNG train at Arctic LNG 2. Leonid Mikhelson is quite anxious to push the envelope and move past the first stages of Arctic LNG 2 to increase Russian output as much as possible before 2030, when he fears demand may enter decline or else soon thereafter. The resulting reputational risks will hurt those prospects as foreign lenders and partners wonder if other members of senior leadership will be caught out stashing money away illegally or worse. Add to that jitters around OFZ issuances since the US House added the additional sanctions on secondary trading of Russian sovereign debt to the National Defense Authorization Act and the move on Gitway looks a bit more serious from a risk perspective. There's little reason to believe that it will have much bearing on Arctic LNG 2 since the project's underway, Yamal delivered so well, and the company's riding high on winning two major upstream licenses on Yamal recently. Future projects may not be so lucky, at least in terms of political scrutiny.

MinTsifry is hoping to expand existing subsidy and tax break programs to further import substitution policies in the IT sector and support digitalization. The Russian Fund for the Development of Informatoin Technologies (RFPIT) will, per the latest idea, become the manager for the loan subsidy program intended to foster IT investments. The current program allows for loans to be subsidized at rates between 1-5%, with the expectation that the program will grow about 1.5 times between now and the end of 2024 till the credit portfolio reaches 150 billion rubles in size. Loans for individual "digital transformations" care capped at 5 billion rubles while 'blocs' of projects receiving funding can get loans up to 10 billion rubles. 250 projects are meant to be funded by the end of 2024. MinTsifry's push to formalize the remit for RFPIT and increase the size of the program are the latest in the government's ongoing fight to swap out all foreign software with domestic equivalents. This dynamic is one of the reasons why I'm curious about the positive wage data in the IT sector. There's clearly room for growth with the rise of e-commerce, apps, and the gig economy that's emerged for countless Russians trying to offset inadequate earnings from their part-time or full-time jobs. But the much stronger level of wage growth and labor demand would be driven by state policies aimed at creating demand domestically by restraining foreign supply for IT needs where possible, or in the case of firms like Google or Apple taming foreign firms to follow domestic regulations and political directives.

Recent state policy initiatives went as far as proposing mortgage subsidies for IT specialists returning from abroad as well as the expected digital residency for foreign businesses without a physical presence in Russia. Officials are reportedly looking at giving IT companies preferences for profit taxes. Add it all up and state policy is building up an IT bubble through market interventions and restrictions in place of macroeconomic policy, in this case running the economy hotter and stimulating demand. What's important to contemplate is that the regime's actually building up a sizeable sector of white collar jobs centered in cities. As much as they may have abandoned urban middle class voters as a core regime demographic in 2011-2012, they reinvented that urban support by propping up the IT sector in a way. Of course, wages will rise faster in IT than the rest of the economy as state contracts are bid up and companies realize they can overcharge while competing for the best talent on a labor market with a declining workforce. So long as the sector depends on state policy to maintain this kind of growth, however, you have a political constituency and business lobby with every reason to invest in stagnation. Look at the explosive growth of "tech" in the US. Many of these jobs and gains aren't actually producing large productivity gains in a systematic fashion, and in the case of stuff like rideshare apps, actually undermine public service procurement.


COVID Status Report

21,379 new cases and 828 deaths were recorded today. The overall map of infections RBK uses shows totals, so it's not terribly helpful as a snapshot of what's happening now, but it is useful to show just how much more of Russia has gone dark red in the last few months compared to the spring:

In slightly better news, Aleksandr Gorelov from Rospotrebnadzor expects the rate of transmission and infectivity to be lower this fall than last year. The agency is noting that cases are beginning to rise quickly in the regions, though. One curious stat I noticed came out of the daily scan from Our World in Data. The rate of positive cases relative to tests is basically the same as the current case fatality rate from the official data:

New restrictions aren't on the policy menu, especially since they'd take the wind out of the sails of whatever growth impulse domestically is left. Buckle up.


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