7 min read

Наука Могилизовать

As reports emerge of an increasingly likely withdrawal from Kherson – the costs of an escalating Russian campaign to wreck Ukraine's energy and heating infrastructure as winter comes mount – the correlation of economic and political forces within Russia are worsening.

Few would say that Russia's military mobilization since it was first announced is going well. As reports emerge of an increasingly likely withdrawal from Kherson – the costs of an escalating Russian campaign to wreck Ukraine's energy and heating infrastructure as winter comes mount – the correlation of economic and political forces within Russia are worsening. Large corporations are stuck begging for exemptions and fighting to cap their own "contributions," which notably has not been spearheaded by entreaties from the Russian Union of Industrialists and Entrepreneurs to the Duma or Presidential Administration. Long-time business ombudsman  The military's General Staff issued a statement instead several days ago clarifying that no more than 30% of the employees from any given organization would be called up to fight, a declaration pointedly responding to concerns about key workers such as aviation dispatchers. The declaration of martial law in the four annexed territories of Ukraine was used as cover to introduce what has effectively between a 3-tiered legal regime within the Russian Federation, with a huge portion of the population living in European Russia now subject to different legal protections and rights:

Red = martial law Orange = "medium" state of military preparedness Yellow = elevated state of military preparedness Grey = normal

The introduction of legal states of exception buried behind an announcement about the newly annexed territories also masked a decisive turn in budgetary policy and the coming cliff edge in 2023. There is a creeping realization that the forecast rebound in consumption activity – and with it a large chunk of federal tax revenues – aren't recovering next year and 40% of Russia's GDP is now located in regions operating under creeping martial law. Per the Audit Chamber, budget revenues as a share of GDP are expected to fall from 19% for 2022 to 16.3% in 2025. This looks even worse when you consider that the economy is going to continue contracting next year and will probably contract in real terms in 2025 as well barring domestic consumption stimulus, which would be pro-inflationary and push the Bank of Russia to hike significantly. Even more damning, and somehow flying under the radar from what I've seen in English, is that the Duma just passed a new law regarding the Budget Rule that establishes a hard nominal floor on forecast oil & gas revenues and sets a ceiling on non-oil & gas budget contributions, base oil & gas revenues, state expenditures to service debt, and the provision of credits paid out of budgetary inflows. As of now, the 'floor' for oil & gas revenues is 8 trillion rubles – MinFin is forecasting 11.67 trillion for this year with the current 'floor' at 6.15 trillion rubles. After 2025, the 8 trillion ruble floor will be indexed at 4% annually to match the Bank of Russia's inflation target. The thinking is, in part, that setting an 8 trillion ruble target will help stabilize the ruble/USD exchange rate at 62-75. The assumption is that any revenues above what's necessary to cover these parameters will then be set aside into the National Welfare Fund (NWF).

In reality, the new budget program is akin to setting fiscal and monetary policy with "hard money" measures. The decision to use the NWF to cover the deficit, a callback to the rather messy response to the Global Financial Crisis in 2008-2009, has turned the fund into an extension of the Treasury and a major component of fiscal and industrial policy. As of now, foreign-denominated assets are being magicked into ruble-denominated ones to cover needs on balance sheets (a de facto monetisation of the debt) and apparently they're now considering spending 1.4 trillion rubles from the Fund to support the domestic manufacture of airplanes by paying for procurements. The new budget parameters point to immense difficulties facing Russia's fiscal state in conditions where large fiscal expansions are more inflationary due to supply constraints and the USD/EUR sanctions turning large swathes of FX assets on balance sheets into deadweight. Setting a hard nominal floor for spending in conditions where inflation is high, uncertain, and increasingly difficult forecast is akin to setting a ceiling. The parameters are not going to be very flexible at a time when they ought to be. That has been true of prior budget cycles, with COVID providing a novel respite from the practice, but it's more intense now since the country's current account surplus can no longer provide the same financial support for the provision of financial sector liquidity for importers, for households, and for financial institutions now part and parcel of the fiscal system through the mobilization of the NWF and FX reserves by the state.

I'm drawn to this development because of how badly the current mobilization effort has gone and is going. 1 in 4 IT-specialists and programmers in Russia have fled the country since mobilization began, posing a huge economic drag on productivity, competitiveness, taxes on their consumption, and the viability of high-tech firms. The Bank of Russia doesn't even know how to assess the impact of mobilization yet. Surveys from the Gaidar Institute show that despite unemployment falling to lows around 3.8%, things are on a clearly negative trajectory that will only get worse in the short to medium-term:

Surveys show number of job vacancies y-o-y Blue = State Employment Service Red = Headhunter.ru
% Y-o-y wage growth Blue = nominal wage growth Red = real wage growth

These underlying trends, coupled with higher nominal interest rates, explain why household debt levels are falling for the first time in 7 years. Russians are now more explicitly beginning to bear the burden of adjustment imposed on them by the state's lack of borrowing, which then compounds problems for domestic demand and lending already affected by the limited availability of OFZ issuances to act as a foundational asset for banks:

Debt burden, scale of planned credit payments as % of disposable income Red = unsecured credit Orange = credit cards Green = autoloans Blue = mortgages

The fact that credit cards are still growing means more spending on basics is exposed to interest rates and credit conditions more generally though it's good that unsecured borrowing is on the decline (in theory). The decline in outstanding credit is happening as the rolling chain of budget sequestration tactics now means that pensions – indexed at 4.4% with an official inflation forecast of 5.5% for next year – will fall 1.1% in real terms, likely more given the dynamics of inflation and concentration of price increases in segments like food. The question now is to what degree the regime can continue mobilization while raiding household coffers, taking men away to the front without training, and losing specialists the longer they do not close the borders for anyone trying to leave. Hard money means harder choices. Harder choices mean more coercion and worse outcomes for mobilization.

These developments are unfolding as the export picture is worsening. Russian Railways is now looking to reduce the export quota for eastbound cargoes given to coal miners from the Kuzbass, essentially a commitment to running some mines out of business. The loss of EU markets (and ability to reexport from Rotterdam and other European ports) has added to elevated logistics costs and an emerging deficit of bearings for gondola cars used to export bulk resources like coal. Coal country is struggling. As coal prices have surged to record highs, Russian exporters are now realizing 60% discounts among buyers. Natural gas prices in Europe have, at least for the winter, defanged the energy weapon. TTF hub prices are now reacting strongly to significant demand destruction, warmer than usual weather, and natural gas storage levels passing the 90% utilization mark:

Price in EUR/MWh

Next year will be difficult. But even with countries like the Netherlands and France ripping up the energy charter, more demand destruction and shifting import balances elsewhere are in motion. H/t to Ira Joseph on Japan's falling contractual volumes (need to followup on whether they can resell these cargoes, but I believe they can):

Oil, as mentioned earlier, is also a question mark. The base forecast from MinFin et al is a 5% reduction in output next year, akin to a 500,000 barrel per day cut. Assuming prices trade around $80-95 a barrel and we bake the discount, that's more like oil at $55-70 a barrel for Russia at a time when its expenditure needs are rising as it shifts more of the population into military service. Russian metals exports appear to be stockpiling on the London Metals Exchange (mostly aluminum, but also copper and nickel) as buyers beg off purchases, which then creates a market context whereby someone will eventually take the hit, but only when the price is right at a time when metals prices have largely sold off to lower levels than pre-invasion. If this was the plan to mobilize the economy, it seems more like an exercise in gravedigging. Unfortunately, those graves will be filled by sacrifices for the war as the costs rise:

The 15% economic contraction is likelier to materialize by next year. We may start to see inklings of a new regional politics as budget deficits worsen and the center cannot provide the same kind of largesse or pressure it once did so easily. There is no relief in sight, no evidence that cooler heads are prevailing. The slow boiling of frogs continues apace as it has since 2011. But now they may be boiling themselves too. Prepare for some nasty downwards surprises in the months ahead.

Like what you read? Pass it around to your friends! If anyone you know is a student or professor and is interested, hit me up at @ntrickett16 on Twitter or email me at nbtrickett@gmail.com. Always happy to look at any freelance opportunities pertaining to Russia, Eurasia, energy and commodities, or my old love foreign policy.

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