Top of the Pops
The resumption of price inflation recorded for August 17-23 didn't just liquidate 5 weeks of (very) weak deflation. It's triggered a freakout among policymakers now wondering what they can do as official annualized inflation sits at 6.68% and looks like it'll keep climbing per the usual 3-4Q trends in past data. Prices for Russian sovereign bonds took a hit on news of rising inflation as market participants are now looking to see if the Central Bank continues its key rate hikes. Clearly "normalization" hasn't done the trick intended. Key rates aside, we're already seeing ratings agencies warn consumers that mortgage rates are will climb to about 0.5-1% to around 9% and consumer credit rates for anyone charging on a card will reach 14.5-22% assuming the key rate stays in the 6-6.25% corridor already forecast. The political costs of a rate hike will be far smaller for the regime after the elections, though there's no reason to assume the current policy course wasn't decided (relatively) independently. However, I do suspect that normalization was agreed upon because it was politically viable and happened to match the usual inflation trough over the summer. If a further hike happens, that'll trickle into credit costs across the economy. Thanks to Tatiana Evdokimova for her usual good work:
If we accept at face value the IMF's forecast that Russia will exceed its pre-COVID size this year, there are still some dots that have to be connected. Monetary policy is a blunt instrument when fighting inflation unless the proximate cause of price increases truly is an unrestrained expansion of the money supply and squabbles between different sectors and elites. Effectively, you quash inflation with a rate hike by making the economy worse for most people and many businesses. The fewer can afford costs of credit, the weaker demand is and, by extension, the weaker inflation is. There's already plenty of reason to believe that whatever growth we're seeing is largely about the monetary value of resource exports that led to some additional industrial demand. Consumers are still spending – the SberIndex shows consumer spending was up 13.4% year-on-year for August 16-22. But within the context of a relatively low base effect from the income hit last year, the inflation context, and the social breakdown of who can afford to keep purchases up, another rate hike will probably worsen the damage already done to countless families and consumers hiding behind base effects and the impulse from cheaper mortgages. Inequality is a poor measure of the problem. Growth with a lower manufacturing utilization rate and higher number of zombie manufacturers suggests it's those who can afford imports sustaining spending for now, but everyone took some sort of hit the last 18 months.
What's going on?
The growth and demand surge from earlier this year has led to a crunch on labor markets in Russia. More people are actively looking to make a change – data from Kelly Services shows a whopping 76% of employees in Moscow and St. Petersburg are planning to look for new work soon. The reasons why hint at both the scale of the labor shock and adjusted income and cost of living expectations. Following are % of respondents:
Pay is the big story here, followed by being bored. 34% of 76% is 26.6% of all employees thinking about new posts because they want better pay. Interestingly, Kelly Services' head of Russia and Eastern Europe Ekaterina Gorokhova says the current boom seen for job-seekers and firms hiring is analagous to what was seen in 2005-2006 right when oil prices really ramped up. Seeing that kind of churn on major urban labor markets despite relatively weak underlying demand data, at least for a longer period of strong growth, suggests that inflation affects the rush for higher pay. We can see this also reflected in firms creating more positions for young workers who are early career. There's a demand story, yes, but also a cost story. If labor's more scarce, it gets harder to underpay. And voila. Inflation.
MinPromTorg has found a new way to cap expected rising energy costs by creating a category of "qualified energy-intensive consumers" (QECs). Russia would borrow from EU states with similar legal structures around their heavy industries. These industries would be partially or fully exempt from various service surcharges and operate on the basis of a unified, lower tariff for power transmission regardless of voltage and which physical points they're using. In the UK and EU, QECs account for 16-24% of consumers in the data cited. The approach is definitely an interesting way to deal with cross-subsidization that has become endemic across the energy economy. The Community of Energy Consumers – a lobbying group for the country's largest firms – estimates that as of 2020, cross-subsidization cost 1.09 trillion rubles ($14.7 billion) of which 615 billion rubles came from surcharges on wholesale power markets and 473 billion rubles came from the redistribution of costs between consumers. Since 2015, surcharges have risen and upset the pre-2015 balance aimed at preventing excessive cost inflation for households. These surcharges are supposed to finance additional capacity investment and modernization. The system in its current form has done a decent job managing costs with existing infrastructure, but has created bottlenecks leading to future inflation risks. It's expected that energy price inflation will outpace the annual inflation target from the Central Bank after 2024, for instance.
Per analysis from Vygon Consulting, investment surcharges in the first retail zone for power markets – Central Russia and the Urals – will account for 27% of the end cost for power consumers by 2025. In Siberia, that figure is just 13%. They'll yield a combined 700 billion rubles for modernization and investment and another 300 billion rubles to subsidize households and remote regions. Last year stretched this dynamic out due to market disruptions. Day-ahead power costs fell 6-9% some months as the economy contracted, but the costs of power generation rose with inflation according the Market Council. The effect was that surcharges accounted for 37% of end power prices in 2020. Unfortunately, the inflation risks for power are as segmented as the surcharges' share of regional power cost. If inflation in Central Russia and the Urals for energy in the year ahead is expected around 6%, it's 12% in Siberia. Distance imposes considerable costs for power grids. Not only do you have to run transmission lines that lose power over distance a very long way and maintain them, but you have to manage the placement of power plants in regions that weren't developed per a particularly rational economic plan as well as minimize costs to sustain the low inflation regime that dominates decision-making. At some point, the question is why these sorts of transfers have to be managed entirely within the sector instead of by larger federal spending initiatives. The real use of the QEC initiative is to address potential carbon adjustment risks for metallurgical exporters posed by EU policy. We're seeing an effort to align with EU standards in some manner. Offer large industrial consumers reduced costs in exchange for investment commitments into decarbonization and efficiency, for instance. It's a very good idea. Translating it into investment will be the hard part.
Siberia 'curator' Victoria Abramchenko apparently supports Defense Minister Sergei Shoigu's idea that new 'megapolises' be built in Siberia to help address the population imbalance between European Russia, Siberia, and the Far East. Specifically, she cites the Angaro-Yenisei macroregion and southern Siberia as prime candidates. Rather tellingly, Abramchenko says she'd discussed it with him and points out that it'd be a continuation of Soviet-era development plans to unlock the region's potential. By itself, this is a small story that bears little significance. Nobody at the Ministry of Finance or Ministry of Economic Development is enamored with the prospect of throwing trillions of artificially scarce rubles at new cities that'll require significant subsidization and enducements to convince Russians to move. One can also postulate Shoigu's ambitions or whatever other insider intrigue seems relevant. What caught my eye about the release is rather the difficulties in promoting regional development within the confines of the current governing economic orthodoxy and priorities in Moscow.
Putin personally ordered the project proposed by Shoigu be worked out and explored last weekend. What may have been a stunt worked. If you can't pry more resources loose from the center to build and face various fiscal straitjackets at the regional level through the strategic use of unfunded mandates, the only real alternative to get a large federal investment is this kind of gamesmanship. Abramchenko's agreement is folded under a larger initiative she's pushing through to build more modern housing and improve the quality of life across the region to attract and retain more specialists and highly skilled labor. These clearly have electoral implications – it's United Russia's municipal deputies and regional representatives who can jump on this – but, I would argue, also reflect the diminishing space for serious development proposals in the Russian political system. Building large cities from nothing is basically a return to old planning prerogatives in a closed economy as a form of stimulus for domestic industries. Assuming they're serious, it's basically recognition that the export-led model doesn't produce enough domestic growth and a funny way of reasserting the primacy of heavier industry and construction for domestic demand with the intention of creating what would become new service hubs within the economy. Assuming it's a bargaining position, it goes to show how big your idea has to be to get the boss' attention and a lot of money in hand for basic development programs. Either way, the inability to square development aims with domestic demand needs creates this political loop.
The Federal Anti-Monopoly Service (FAS) is picking a fight with Vladimir Lisin's NLMK and three other metallurgical firms – Novostal', Tulachermet-Stal', and PMKh – for a price-fixing agreement. FAS contends that the 50% increase in the price of construction fittings evidences such an arrangement and launched snap inspections of major facilities in Moscow, Tula, and Lipetsk. If evidence of any such arrangement is found, the question is how large the fine would. Worst case scenario apparently puts it at 15% of earnings for the period in which the price agreement was in place. Andrei Tenishev, a former head of FAS' anti-cartel division, clarifies that the fine can't exceed 4% of a firm's earnings for the year in which the violation happened. Good news for industry is that it's exceedingly difficult to prove any such agreement exists. Construction fittings are a highly competitive market with lots of smaller vendors that is highly exposed to global pricing forces as well as domestic demand:
Price increases globally match the 50% range for construction fittings, especially since the mortgage scheme sustained the housing sector and there was a huge surge of remodeling and rebuilding done. It's concerning that FAS is bringing the suit forward because, I think, it points to a likely negative trend in the year and years ahead. Formal institutions invested with authority over price management will increasingly be compelled to use threats and the actual use of administrative and legal action to discipline firms in line with preferred economic targets. Belousov's long-running project to build a formal policy framework to control inflation and separate the Russian maket from global inflationary forces creates a permission structure in which policy entrepeneurs and the vestiges of the technocracy that still function have to operate. In short, we're entering the "discipline and punish" phase of inflation governance in a formal sense. I can't imagine it'll help with investment or development, particularly when domestic inflation likely remains higher as a result of inadequate capacity and supply bottlenecks. Or they could just make people poorer again and squeeze out a larger export surplus.
COVID Status Report
19,509 new cases and 798 deaths were recorded in the last day. Going off the official data, Moscow and St. Petersburg are pretty low now for deaths which goes to show that it'll be areas with lower vaccine penetrations and fewer resources that account for the persistent 800 figures we're seeing (which clearly are statistically cooked in some way):
EpiVacCorona-H has been officially registered, making it the 5th vaccine Russians can choose from as it enters production and distribution under the commercial "AURORA-CoV." Can't say they aren't spoilt for choice. MinZdrav is out briefing that the continued high death toll reflects the spread of the Delta variant, but is hoping to assure people that complications are much rarer if one's received a vaccination. They're clearly frustrated by the lack of takeup, and with good reason. RAN academic Pyotr Chumakov in St. Petersburg has modeled a likely fourth wave coming this fall based on current vaccination rates and the pitfalls of overreliance on herd immunity. His expectation is that things will worsen again at the end of September or early October. That's damning considering the level of infections settled upon in July-August that have only seen a slow decline from a peak based on data underreporting the extent of the spread of the virus. Some infection rates will inevitably decline, but new variants can quickly change the math. Based on the limits of the response and political considerations, there's simply no way we're going to see major restrictions again I think. Excess mortality data for 2020 and this year will be large enough to have a macroeconomic effect, nevermind the social implications.
Kommersant dropped a juicy bit of reporting today that, in light of the resurgent interest in pipeline politics of late, should catch more attention. Igor Sechin has personally requested that Putin allow Rosneft to export 10 bcm of gas via Gazprom's network using an agency agreement. In return, Sechin is offering to pay higher extraction taxes to net an additional 37 billion rubles ($500 million) for the federal budget. These volumes would be provided from output increases starting next year. The dude never misses a chance to ask for more.
Let's be clear that Sechin is not asking for an end to Gazprom's pipeline export monopoly. He's tried that before as a followup to killing the merger of Gazprom and Rosneft and it didn't work. By the time Gazprom lost its overall monopoly and Novatek was granted the right to export LNG in 2013, independent natural gas producers already accounted for about 20% of domestic output. That dynamic hasn't changed despite fluctuations in individual firms' production. What's more interesting is that the EU never explicitly pursued a policy mandating third-party access be given extra-territorially until rule changes in 2019 clearly aimed at Gazprom. The recent court decision upheld the principle that Gazprom would have to allow third-party access, but because of the nature of the energy sector and Russian business, you can guarantee that there would be ways to create the appearance of competition. That is to say they could have tried to require exporters using Nord Stream, Turk Stream, or the Southern Gas Corridor to legally allow competition domestically for supply from theh start. A full on mandate using market regulations from the start would have killed Gazprom's projects and most certainly been meet with legal challenges to undermine the framework. The more important point is that they could have chosen to selectively work with Russian firms to affect domestic lobbying dynamics in Russia, and to at least strengthen the appearance of the domestic framework prior to the rules revision that further politicized the project. Remarkably, Sechin's letter to Putin explicitly refers to the lifting of restrictions on Gazprom's supplies by observing anti-monopoly rules. In effect, he's saying that granting Rosneft an agency agreement – an artful means of avoiding a repeal of the export monopoly since Rosneft would be a contracted 3rd party – would allow Gazprom to dodge more regulatory heat since they'd be ostensibly playing by EU rules. Sechin is using the most recent court decision to take a pound of flesh. If only there'd been more foresight to attempt to do this actively in the past, though I suspect Washington would not have understood the logic.
I find this a fascinating microcosm of how EU regulatory and market power can be so relevant for internal decision-making in Moscow precisely because it is united, there is a uniform agreed upon regulatory framework that limits the scope for divergence between members, and the interconnection of these markets has improved over time. Sechin as a footsoldier fighting for the rule of law in Russia's energy trade with Europe was never on my bingo sheet. Turns out that external structural factors and path dependencies – in this case the needs of EU energy market integration and ripple effects of Gazprom's gas cutoffs – provided a convenient rationale for a regime insider to try and undercut his main corporate rival. Sometimes sanctions aren't the most effective tool of economic statecraft when it comes to Russia, at least not without some form of proactive engagement. Making use of rival power centers in the industry can actually induce political problems for the Kremlin having to manage rival structures with considerable policy and fiscal influence. Gazprom responded to the loss of its LNG monopoly, failure to negotiate adequate prices with China for the Power of Siberia, and massive losses at the Chayanda field and related projects by trying to restrict Novatek and other firms' access to natural gas licenses for major finds. Novatek was recently awarded additional fields near its projects on the Yamal peninsula because Mikhelson's team has actually delivered on its promises. In 2020, Rosneft produced 62.8 bcm of natural gas (8.4% of national output) with a decent asset base for future expansion:
In the longer run, considering the creation of a special circumstances under which a project would not be sanctioned – unlikely now, a BP-Rosneft gas partnership for instance – so long as Gazprom complied with EU expectations based on its existing regulatory framework would leverage these divisions. The business community outside of the SOE and 'commanding heights' is well aware that investment levels are inadequate and they need western partnerships to remain competitive as decarbonization proceeds. There are logical olive branches to extend with conditions that are likelier to impede the Kremlin's ability to vertically control the energy sector and division of spoils it creates. One could also shape such a project on the basis that it would guarantee volumes to Ukraine beyond the core pipeline access issue staked out from the recent decision. Other risks would occur as a result, for sure. I still think it's time to get more creative thinking through how economic statecraft can be used to alter and shape state capacity and preferences beyond the reflexive use of sanctions as a measure of punishment. Russia's economic policy is a mess for many reasons, and sanctions, while relevant, aren't the primary driver of its evolution since the mid-2000s. Climate change and any reset of American foreign policy priorities will require compromises. Lines of thinking like this play to Europe's strengths.
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