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Ministries for Sclerosis

The econ policy impasse may stress banks in the future
Ministries for Sclerosis

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Quick heads up that Monday will be a Eurasia day. Didn’t have time today to trawl across the breadth of countries, and just wanted to flag that after the eruption of open fire between Kyrygz and Tajik border forces leaving at least 4 dead and 76 people injured on both sides of the border, the nations’ respective national security councils signed an agreement establishing a ceasefire. Given the recent constitutional change expanding Kyrygz president Sadyr Japarov’s powers as well as expectations that he’ll act in a populist and highly personalist manner to secure his position politically, the bigger question is what’s next or was it local commanders making a snap decision? I’d rather dig more through Central Asianists’ output before linking it to anything bigger or economic stories.

Oil prices are about to be put to the test as OPEC+ plans to ramp up combined output by 2.1 million barrels per day through July start on May 1. Deputy minister Aleksandr Novak is on the PR trail calling on countries “not to discriminate” against traditional energy sources in the fight against the emissions most of them cause. There’s a bit buried in the budget revenue data published by MinFin for January-February that fits into the emerging story of declining consumer confidence from February onwards and Moscow’s need to increase output as much as possible in light of the lack of fiscal stimulus for the economy announced in last Wednesday’s address — as a reminder, the social spend of 400 billion rubles ($5.33 billion) was equivalent to 0.37% of 2020 GDP on top of 2020 stimulus worth no more than 3% of GDP:

There’s often monthly flux in earnings across categories, but the real ‘tell’ is the drop in VAT and reduced earnings off of profits for February just as consumer confidence hit a mini-peak going into March and inflation started ticking up. VAT’s a consumption tax and since the COVID caseload was falling all through February, you’d expect the figure to be closer to what it was in January when any excess cash kicking around from the annual 4Q budget spending spree was unwound into the economy. An increase in oil output increases VAT collection via intermediate demand between sectors, and just as importantly, helps bump up tax collection on profits because of the imposed demand constraint on oil sector services and parts suppliers. The “trap” for OPEC+ is that once production goes up, Russia is unlikely to want to cut it back again even if prices drop significantly. That may end up being a 4Q or 1Q 2022 problem, but the pressure for Russia to try and drag OPEC+ into larger output increases will grow the weaker its consumer recovery because of its cumulative impact on tax receipts. The oil sector can act hydraulically to offset some of that. But given that 2019 output levels are the likely ceiling for production, that approach has limits.


What’s going on?

  1. Moscow’s planned to change permitting for haulage coming into the city after May 5, right in the middle of the planned 10-day paid time off that the federal government’s opted for to diffuse the spike in COVID cases. Truckers, however, are already facing a hard time getting new permits and orders are being refused from the risk of fines and some payment rates for administrative expenses are rising as much as 20%. Fines run in the range of 5,000 rubles. It’s another case of a sudden top-down mandate — the 10-day ‘holiday’ — having unintended effects. Producers trying to move product into Moscow are scrambling to hire cars and trucks that don’t meet official regulatory requirements or else operate on the “gray” market. That means more drivers and higher costs. Next thing you know, some items pop up in price around Moscow. What’s even weirder is that the legal permit to deliver at night is different than the legal permit to deliver during the day, a system I can only assume was engineered by city gatekeepers trying to create a little nudge system to pick winners and losers when times were politically tough. Pepsi Co. says it couldn’t even apply for night permits till April 26, 20% of its prepared products are delivered at night, and 40% of supplies used for milk production are delivered at night. From Kommersant’s reporting, city officials aren’t talking to businesses and the easy fix — a 5-day temporary permit — isn’t yet forthcoming. The legal change requires all shipments above 3.5 tons be inspected. Sobyanin better fix this quick before sodas at food courts start costing more.

  2. The budgetary support measures for regional budgets facing deficits seem to have contained the worst of the potential damage based on the S&P outlook. It’s expected that average deficits will only hit about 5% with an average 25% debt ratio to gross regional product. There’s a huge catch — it’s actually because the regions are so hamstrung in their ability to invest:

    Light Blue = bank loans Dark Blue = budget loans Beige = bonds Red/Orange = direct/current expenditures

    Improvements in regional budgetary outlooks, however, have little to no impact on levels of capital investment needed to meet the National Goals and support infrastructure development. Since any increase in capital investment can only be met by extremely limited changes to regional tax collection — we’re talking 2-4% tweaks on rates generally capped at relatively low level — the net effect tends to be an increase in the debt level, which then invokes disciplinary responses from the federal center. The only way to make proper use of the relatively low average debt burden relative to gross regional product is to devolve more fiscal and regulatory powers to regional governments. Instead, Moscow’s opted to worsen the plight of the “unfunded mandates” kicked to regional governments in direct contradiction with the stated National Goals laid out for 2024 back in 2018 and then amended last year to apply to 2030 instead.

  3. The income breakdown after the real income data release is grim: 34% of Russians are living on the equivalent of $8.40 a day. It’s important to acknowledge that a 3.6% fall in one quarter this year is 4 times the rate of income decline last year. When you pull up the breakdown of class by % within nominal wage bands, you get a mixed picture:

    The share of Russians earning above 27,000 rubles a month is higher this year, boosted by support measures. But these bands disguise the relative increase in poverty — housing prices are up 30+% in much of the country and the decline in average real disposable incomes points to the effects of inflation telling a different story. The country’s becoming more unequal and even the pension indexation from last March only had it up 5.6%, less than 2020 annual inflation. Total income for households reached 14.3 trillion rubles ($190.48 billion) in 1Q while they spent 14.9 trillion rubles ($198.47. billion). People have started burning through savings, and based on the income distribution and consumer demand levels, there’s no “trickle down” effect from the rich, particularly when they leave the country to travel and work remote when they can. At this rate, the vast majority of the growth realized this year will come from changes in commodity prices that will feedback into the economy and contribute to higher, persistent inflation levels.

  4. Moody’s is now warning that the growing gap between housing prices and household incomes is creating risks for the banking sector. Mortgage issuances rose 21% last year backed by the subsidy program, which is expected to slow down (relatively) to 15% growth for 2021. Without an adequate increase in the housing supply to ease the pricing pressure, the country’s main lenders will have to contend with the continued rise in housing demand and declining creditworthiness. The likely outcome is an easing of credit standards to win business, such that any sudden decline in property values would leave the banks hanging and increase the political pressure on the government to intervene. One-third of Russians are reportedly refusing mortgages after receiving preliminary approval because they don’t feel they can’t afford it. Banks aren’t yet worried about it, but the volume of mortgage issuances is on track to hit 11 trillion rubles ($146.63 billion) — somewhere in the range of 20% of household income for 2021 based on trends from 1Q. The more real incomes fall, the more burdensome future debt servicing becomes and the likelier Russians are to be trapped on the rental market with rising rents, which can only be eased with a step change in public investment into housing. Banks are fine for now, especially since the biggest lenders are state-owned. But trends are flashing red.


COVID Status Report

8,731 new cases and 397 deaths were reported by the Operational Staff. The initial jitters over a 3rd wave haven’t yet been met with official panic past frustrations that people are cutting corners and regional governments are slackening rules, but the medical expert community is noting that mutations are a big risk. Regional virologists are still sticking to the script from a few weeks back — another wave is coming, but won’t be so bad this time. But Aleksandr Beglov, governor of St. Petersburg region, denies any 3rd wave is happening despite the recent uptick in hospitalizations while acknowledging things are a little worse. That tracks with Peskov’s dismissal from the Kremlin. Unless it’s really visibly bad, governors have no reason to cop to a 3rd wave happening. Last year’s talk of saving the economy and the “supply side” shock from COVID seem likely to shape the response for the month ahead. Rospotrebnadzor is doing its best given the political context by calling the situation “tense” and trying to stress compliance with restrictive measures are vital. Funny enough, Belarus’ Ministry of Health has admitted that a 3rd wave’s begun. Best guess is that the week-on-week growth figures will come in low single digits, so I’m waiting to see if there’s any change in the data outside Moscow in next week’s releases.


Small Print Tyranny

The Kremlin’s obviously on the backfoot messaging its response to the continued decline in real incomes. Dmitri Peskov today told the press today that all efforts from the government being made are minimizing the worst of it and that the economy will recover this year, saying “the situation’s worse in a lot of countries.” There is quite literally nothing to say to the public here. Minister of Economic Development Maksim Reshetnikov took up Putin’s call to arrest real income decline, and his solution now being mocked by members of “A Just Russia” in the Duma. He’s proposing to change how incomes are calculated, thus changing the reality that Putin’s briefed on without doing anything to address material needs, structural challenges, or the continued worsening of underinvestment. This approach goes back to an earlier missive from Reshetnikov to Rosstat to improve its quarterly income methodology. All of these initiatives, in their own unhappy way, follow the logic of ‘optimization’ that’s overtaken the state since January 2020. As I see it, the Reshetnikov proposal is a prime case of what I like to think of as small print tyranny: the immobility, incapacity, and infirmity of the state institutions and individuals tasked with delivering improvements reduced to administrative paper shuffling in hopes something sticks.

It’s just one example, but a few weeks back, Reshetnikov met with Rustam Minnikhanov, head of the Republic of Tatarstan and traditionally one of the most business-friendly regions in Russia. The big takeaway from their meeting to discuss socioeconomic development and increasing regional investment was for MinEknomiki to consider changing the criteria used to offer state support for certain types of projects proposed by firms to include investments into capacity to recycle petroleum products. Reshetnikov’s big success the day after Putin’s federal address was to announce the passage of a new “golden visa” scheme given foreign investors investing enough money rights as residents. One has to wonder who the *&%! wants a golden visa from Russia these days given that there was only $200 million in foreign investment nationally for 1Q and I’m confident that’s mostly Russian money recycled from abroad. Before that, the most recent big ticket item was an early April reform backed by the ministry to eliminate redundancies between various state organs and federal and regional governments in maintaining oversight for business inspections and licensing  — important sources of regulatory rents and local political power. The state’s launching a unified registry for these purposes, increasing the center’s control over policy and degree of accountability among regional governors and leaders for outcomes in the regions. These are all administrative maneuvers, things trying to squeeze more water out of fewer stones.

The level of policy sclerosis isn’t, to my mind, proof that no one in Moscow cares about falling standards of living. To be sure, they aren’t a political priority for the regime insofar as its constituents are the elites trying to seize state resources, providing the most tax receipts, or else responsible for key sectors and political levers like employment levels. But this sclerosis is reaching levels that are catastrophic for the regime’s ability to manage public opinion and the economy. In parallel with the acceleration of income decline in 1Q, the level of consumer loans issued is up 41% in annualized terms and 17% since February alone. The average amount owed per person has reached a historic maximum — 308,000 rubles or more than 10 times the monthly wages over half the country receives during a time when prices for food and housing are rising faster than topline inflation. Net household debt rose 1.217 trillion rubles ($16.23 billion) in 1Q and now collectively is greater than 21 trillion rubles ($279.93 billion) for the first time in history. And the decline in creditworthiness and hawkish policy from the Central Bank are going to force real rates upwards, imposing yet more pain.

The harder it is to force competing interest groups to compromise, the more politically necessary the small print approach becomes. It’s not just that these tweaks to make the statistics worsen the impoverishment of the country stemming from economic policy choices that go all the way back to 2000. It’s that the decision-makers responsible for achieving progress are hostage without leadership in the Kremlin willing to impose pain on different elite groups as needed in order to resolve these impasses. Putin gave Mishustin till June 1 to unveil a plan to get the economy moving again, and a lot of that work will take place in the “bunker” of his coordination center. That there’s nothing being communicated to businesses, however, shows that they’ve got nothing to offer. Reshetnikov, Denis Manturov at MinPromTorg, anyone tasked with the actual “shovel-ready” work in economic policy can’t pass anything without the support of fiscal policy and the presidential administration. The regime’s “accountants” like Siluanov at the Ministry of Finance — their chief responsibility being the accumulation of reserves for rents, geopolitical adventures, and the regime’s Smaug complex — block any progress. The lack of coordination between fiscal policy, the ministries, and impetus to reform leave the most organized lobbies the victors.

This is where interest group politics and the structure of strategic sectors matter more the longer decision-making is paralyzed. One of the biggest reasons the oil sector continues to provide the backbone of macroeconomic management in Russia is that Russia’s leading firms broadly share economic and political interests, even if they compete over specific assets or for policy influence. They all needed output cuts to get through the 2014-2015 shock and COVID shock. Kommersant has a great writeup of what the cuts have cost and gained Russia. The squeeze on 2020 oil prices is insane when you compare the budget gains against the scale of output cuts. The top is budget revenues in trillions of rubles and bottom is the loss of output in millions of tons:

Between 2017 and 2020, the budget gained 8.7 trillion rubles — compare that to MinFin figures for oil & gas revenues and you can see that given the state’s central role directing investment and spending, the Russian economy would have been in a much worse place by 2020 without them (following in blns rubles):

The revenue bump for 2018-2020 was in the range of 2-2.5% of GDP, but the state did not turn around and spend at a higher level to expand the non-oil & gas sectors. Instead, it went into preserving a cumulative surplus of over 5 trillion rubles for 2018-2019 which almost evens out the collective deficits from 2017 and 2020 (not that these things work that way). These figures can’t factor in adequately the cumulative drag on small and medium-sized businesses and consumer demand across the economy.

I’ve described Russia’s budgetary and macro posture as “hydraulic austerity” before since the impulse is to always drive the economy back to stagnation, and that macro phenomenon ends up benefiting the defense sector, acknowledging that spending has been capped thus far presumably to avoid the Soviet problem of spiraling budgets amid economic stagnation. In January, for instance, the defense successfully lobbied Mishustin to sustain a subsidized borrowing program via VEB.RF preserving their access to credit at below market rates in light of the fact that defense firms had accumulated 700 billion rubles of unpaid debts. Those programs will undoubtedly continue while Mishustin does nothing to relieve the growing financial burden on households, a move that makes sense because it dodges any fiscal spend while utilizing the accumulation of savings held by the state to reduce the cost of borrowing for state-owned firms. Think of it like this. Petrodollar earnings parked into the National Welfare Fund and related accounts and vehicles as well as with the Central Bank were intended to prevent an overly strong ruble — no longer a problem — and to lower the cost of borrowing across the economy. Now that inflation’s spiraling up, worsened in part by borrowing subsidies for consumers, those same structures will be deployed to preserve the interests of the political blocs that are most cohesive and reliant on state support and direction without affecting private sector investment levels and, most importantly, household spending power.

Paper-pushing is the best you can do in these conditions. As we’ve seen time and again, offering tax breaks at the regional level to increase investment can’t work because Moscow holds a fiscal sword over their heads. Yet Moscow wants them to increase investment and tweak federal schema to convince businesses to spend more on modernization, new plant, and new productive capacity. Mobilizing capital via elite coercion is the obvious play. What may end up happening post-COVID is a bit crazier — the banking sector will be expected to keep lending at rates that are dictated politically to sustain activity and the viability of sectors facing a perpetual fall in domestic private sector/household demand. In other words, the bank sector cleanup from 2015-2017 and ongoing license revocations are cleaning up bad banks, but state bank lending managed with the Central Bank have become a stand-in for fiscal policy because of how weak figures like Reshetnikov actually are at cutting through major policy impasses. That means that liabilities and risks are only going to worsen as creditworthiness of anyone who isn’t the state or a firm collecting rents fall and the Kremlin disputes the objectivity of data showing how bad things are. The tyranny of Russian politics is the tyranny of small print when brute force and elite consensus are lacking. There is only a doubling down on extraction within the constraints imposed by spooks and bankers.


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