14 min read

PBoC (Yeah, you know me)

China's financial markets are increasingly important to Russia's "economic sovereignty"
PBoC (Yeah, you know me)

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According to the latest Rosstat release, over 75% of households are facing financial difficulties. RBK (shoutout to Ivan Tkachev) put together a fantastic breakdown of the problem — the COVID shock has, on net, worsened the evolving balance sheet crisis Russians have been facing since the 2014 recession. There’s a huge gap between perceptions of what’s necessary to make ends meet and actual median wages. The following is the amount every member of a family needs based on polling in 000s of rubles/month:

Top to bottom: Families with children that have a disability, multi-child families, young families with kids, young families, families without children, pensioners

53.7% of the population live on 27,000 rubles or less a month. So if we take that as a baseline for comparison, over half the country is living 14,000 rubles a month short compared to the standards of living respondents think is fit for a pensioner. 80.1% of the population lives on less than 45,000 rubles a month. To be clear, these surveys reflect perceptions and not “hard” realities — we should always trust what people do more than they say. Even acknowledging the methodological limitations of polling and these surveys in a Russian context or otherwise, it’s clear that the Russian economy is now completely incapable of delivering real incomes that allow the majority of the population to feel comfortable. These political dynamics aren’t sustainable indefinitely, not in the sense of mass revolt but rather elite returns. In the same way that some financiers and asset owners finally realized during the COVID shock that they can actually benefit, conditions depending, if consumers and employees have more money to spend, Russia’s elites look abroad for opportunity because it often nets better returns. The poorer Russians become, the less attractive investments serving Russian demand become and the more intense the political pressure to compete for control of assets and industries that export and rely on external demand. The regime’s political model is not designed to handle conditions of growth. Households take out debt in response and are stuck defining down what ‘success’ looks like. Watch this year’s real wage data to see if labor shortages trigger a shift. I think it’s likelier price increases outstrip most of the wage gains, and expect those gains to be unevenly distributed by sector as well.

What’s going on?

  1. It seems that Audit Chamber head Kudrin’s reaching the limits of not only his influence as Moscow’s liberal “namer and shamer” for waste, economic, and fiscal policy, but the logic of the liberal reform instincts that guided efforts to change policy from the late 1980s through the 2000s. In an interview with RIA Novosti, Kudrin made clear that in his view the new push in the government to adjust excise taxes and related tax measures to increase revenues further is misguided. The potential for revenue gains from any increase in consumption taxes has largely been exhausted. What does that mean? Russian households and consumers have reached the point where increases in consumption taxes are likelier to discourage consumption because of costs rather than increase revenues. It’s a classic problem for tax policy — policymakers have to balance the increased rate of taxation with any potential fall in consumption from higher taxes. That Kudrin believes consumption taxes are done lifting revenues reinforces the view that state policy is failing to save and lift real incomes. Real wages are rising these days, but because of how important social transfers are to the national income — about 20-21% in total — and cost disease — wages are rising in sectors that aren’t improving productivity right now as well due to tight labor markets — real incomes aren’t keeping pace. The only way to sustainably fix that problem is to raise domestic demand, which at this point requires more spending in the form of income support, social transfers, and services and hard infrastructure investments to improve output. Privatization isn’t a panacea since it just ends up transferring ownership of assets in a political system where property rights are frequently at risk and lobbies and personal agendas and interests freely capture formal and informal institutions alike. I’d expect any additional consumption tax hikes to negatively affect consumption whenever we see the final proposal the government’s now working through.

  2. The budget’s back in surplus through the first half of 2021 erasing most of the comparative deficit it ran for the same time period in 2020. For Jan.-June, the state took in 11.3 trillion rubles ($152.55 billion) and spent 10.6 trillion rubles ($143.1 billion) exceeding spending levels in 2019 and 2020 per the Kommersant writeup. The oil price recovery, higher VAT tax rate, and tariffs on imports all kicked in to help push up revenues:

    Blue = revenues Purple = expenditures

    We can see the arc of austerity politics clearly here. Revenues rose far more than expenditures between 2016-2019, spending increased about 25% year-on-year for 2020, and has settled higher for this year with the expectation that it’ll probably drop some next year or else revenues will be increased further using tax increases over any increase in expenditures. You also get some accounting tricks skewing some of the data — in March, the last tranche of 200 billion rubles ($2.7 billion) for the government’s purchase of a controlling stake in Sberbank from the Central Bank went into the Treasury, but that money came from the National Welfare Fund. Another 146 billion rubles ($1.97 billion) came from Nornickel’s fine for the massive oil spill and environmental damage incurred last May by the company in Norilsk. State finances are in great shape in terms of revenue/expenditure balances, but it can’t borrow because it’s not spending. The irony is it could spend a bit more fairly comfortably ahead of the elections without too much concern for rising OFZ yields.

  3. Aleksandr Lukashenko’s snap visit to St. Petersburg brought good tidings for him and his inner circle in Minsk — Gazprom won’t index 2022 prices and keep natural gas prices at 2021 levels (an already heavily discounted $128.50 per cubic meter), agreements to keep looking at fixes for the losses Belarus will incur from Russia’s oil sector tax maneuver, and talked about more loans the Belarusian state desperately needs. Putin and Lukashenko have now met 6 times since February 2020, an obvious symbol of the extent to which the mismanagement of the Belarusian economy, its dependence on transfers from Russia, and now sanctions pressure from the West have made the fate of the regime in Minsk a problem (and constant headache) for Moscow. Things were bad enough that Lukashenko authorized the confiscation of currency and imposition of select capital controls back in late April including restricting purchases of foreign currency, and that order took effect just before he popped over to St. Petersburg. Annualized inflation just hit 9.9%, outpacing price increases seen in Russia. The meeting also came about because of the unhinged nature of Lukashenko’s improvisatory appeals for help — threatening to deny transit to German goods headed to Russia (or China) wasn’t about threatening Europe in a Blazing Saddles-style move whereby he holds a gun to his own head. It was aimed at the Kremlin who are highly cognizant that any interruption of goods from Europe would worsen their own domestic inflation problem and, to a lesser extent, Beijing concerned about the protean politics of the Belt and Road Initiative. The Eurasian Economic Commission has been obligated to examine the legal and market foundations for sanctions on German transit. This was a Hail Mary for political attention and an indication that behind the facade, the regime’s acutely aware of its financial limitations. At this point, only a revolution in Russian economic growth could really alter Belarus’ trajectory.

  4. Let the bidding begin! After the myriad problems modernizing the Baikal-Amur Mainline (BAM) and Trans-Siberian have emerged and the new route from El’ga to the Sea of Okhotsk to export coal proposed, Al’bert Avdolyan has stepped forward to try and save the day. Avdolyan, owner of the firm A-Property which controls 95% of the shares in the El’ga coal field, would build a privately-owned route the 500 kilometers to port at an estimated cost of $2.5-3 billion for an estimated capacity of 30 million tons annually. The route could replace the proposed 3rd stage of the BAM’s modernization and expansion, easing some of the pressure on Russian Railways (RZhD) to deliver. It’d halve the distances for coal shipments from El’ga now going to Vanino-Sovgavansky and cut them five-fold for anything shipped via Primorsky Krai and be completed in about 5 years’ time. Best of all, it’d aim to do all of this without federal subsidies or support in various guises. Anyone who thinks Avdolyan is proposing as an act of patriotism doesn’t understand the politics of infrastructure ownership in Russia — it’s a great opportunity to embarrass RZhD and, more importantly, seize control of a strategic asset while doing the Kremlin a favor. I expect we’ll see more of these types of proposals as a result of Putin’s explicit pressure to mobilize the national “investment resource.” State stinginess and the conviction that any significant increase in direct spending leads to more theft incentivizes private actors with stakes in major projects like this to step forward. State-owned firms already pay for infrastructure in a lot of remote regions and benefit from de facto local monopolies that way. There’s a major problem if this proliferates too widely, however. The state effectively owns “everything” insofar as it can claim anyone’s cash or assets at a moment’s notice. But its monopoly on final property rights, so to speak, is challenged if too much political power is diffused to private actors who form natural interest groups or alliances with local and regional political and economic actors. It can circumvent that problem when state-owned entities headquartered in Moscow or St. Petersburg make all the final personnel and investment decisions. That isn’t to say this project represents a significant change from the status quo, but it does indicate that the entrepreneurship around the investment mobilization problem facing the Kremlin and government is well underway.

COVID Status Report

23,827 new cases and a record 787 deaths in the last day with the official data now showing a clearer trend from the regional figures towards flattening. Cases are still rising in St. Petersburg despite the notable drop-off in Moscow — they hit 1,942 in Piter in the last day. We’re already seeing political pressure around the campaign season affect rationales for COVID restrictions. The governor of Ryazan oblast’, Nikolai Liubimov, just opted to ease restrictions on conferences, gatherings, and public pickets and related permitted political activity ahead of September. While this dynamic plays out in Russia, we’re seeing cases trend higher in Kazakhstan and Georgia:

The cumulative shock to Eurasia is going to grow and grow. Not only has COVID introduced a new dilemma — already exhausted resource-led growth models at the regional level will become the default preference for investment as decarbonization raises demand for other commodities — but the long-run scarring from slower vaccination campaigns and limited fiscal capacity will lower post-crisis growth. Topping it off, Russia’s failure to adequately help its own households will double the impact of China’s imbalanced recovery and Europe’s underspending on Eurasia’s growth prospects. In effect, Moscow’s austerity politics ripple out across Central Asia and, to a lesser extent, the South Caucasus by denying them the opportunity to try and export non-resource goods into the Russian market. That approach faces limits — Russian consumers are quite brand conscious, for instance. Any slowdown in Sputnik deliveries to Russia’s near abroad as a result of its political needs worsens the problem. I’m afraid only a big shift in China can reverse the trend at this point.

Market Mechanisms, Bazaar Rules

Viktor Chernomyrdin has a rather legendary status as the ungrammatical godfather of the expression “хотели как лучше, но получилось как всегда” — we wanted better, but it turned out as always. Uttered in August 1993 in regards to monetary reform, to Russianists and the Russia-curious, its become a handy way of winking to Russians that you have some semblance of understanding of post-Soviet Russian’s idioms for life in conditions tending towards crisis. Chernomyrdin is the George W. Bush of Russian politics, the man who knew too little about slinging sentences properly together. Slightly less famous, though no less perfect, was his quip in 1992 “Я – за реформы, за рынок, но не за базар” — I’m for reforms, for the market, but not for a bazaar.

Setting aside the evident course of Russia’s market and legal institutions since the 1998 ended the Soviet economy’s period of unwinding post-collapse, China’s rise as a major player on world financial markets raises new questions about how Russian elites and policymakers think view global finance and the risk of excessive dependence on the Chinese market. No one’s expecting China to rewrite the rules of global finance. Financial elites centered in New York, London, Paris, Geneva, Frankfurt, Singapore, and Shanghai (as Hong Kong fades) share too much in common as do the elites and asset owners in export surplus countries, those seeking convenient offshore vehicles to stash wealth to escape the state’s reach or avoid domestic fights over resources, and the hundreds of millions of homeowners across national lines depending on the appreciation of what they own to manage their finances. Still, the weight of China’s financial markets will shift investor concerns about regulatory standards, the Chinese banking sector, how liabilities are structured, default risks, as well as the escalating political pressure between the US and China around issues like the right of Chinese tech firms to list on American exchanges. Global investors hold a combined exposure worth $800 billion in China as investments surge. We can see from past years that 2020 purchases were significantly outstripped by stock buys in 2018. 2021 purchases are outpacing everything on record since the 2015 stock market crash in China:

The sheer size of China’s economy, its potential future demand, and the geopolitical needs to more deeply integrate Chinese firms and financial markets into global markets and structures of power are feeding an investor frenzy. More recently, Chinese firms looking to list in the US are facing increased scrutiny from Chinese regulators as the Biden administration has expanded executive orders signed by Trump to ban Chinese firms linked to its military from inclusion in the S&P Dow Jones indices with parallel removals taking place from FTSE Russell indices from the London investment management firm. This has had no meaningful impact on net capital inflows, however. Foreigners own a relatively small share of China’s stock market — it’s a little less than 8% based on a back of the napkin calculation from where market valuation was last fall, but that could have risen since. In the US, that figure is closer to 35-40%. What really matters is that capital account liberalization in China has to be carefully managed, and brings with it diminishing capacity on the part of the People’s Bank of China (PBoC) to manage the exchange rate directly as well as credit risks and the potential for contagion from the collapse of creditworthiness and value of assets held by large Chinese firms. Corporate bond issuers in China defaulted on a record $18 billion in the first half of this year as the PBoC and authorities in Beijing are seemingly trying to clear out the worst offenders among the economy’s many inefficient behemoths burning lots of revenues to service debts while still preventing any broader sectoral fallout. Everyone knows the creditworthiness of Chinese firms are manipulated by regulators and ratings firms to hide the degree of risk, a practice mitigated by the extent to which domestic and international investors trust the PBoC to act effectively:

Credit ratings firm Dagong Global has just been sanctioned by the state for failure to adequately evaluate borrowers, making it clear that the PBoC and government officials are cognizant that they can’t allow firms to borrow freely without some form of significant budget constraint if they aren’t efficiently using capital, even if they’re important to sectoral initiatives central to geopolitical competition with the US. These dynamics point out the erroneous conceit of post-Crimea economic policy and attempts to escape the West’s economic orbit: these risks and challenges for Chinese monetary policy and macroeconomic management exert a growing influence on Russian policy, substituting one set of dependencies and absences of true ‘sovereignty’ for another.

The Ministry of Finance’s decision to de-dollarize the National Welfare Fund (NWF) creates new problems for Russian policymakers trying to mobilize national resources to achieve regime economic targets, as does the Central Bank’s rising share of yuan-denominated reserves. Consider just how much has been accumulated and left in liquid reserves in the NWF:

The balance of assets that are “tied” and liquid will now be more subject to fluctuations in the value of CNY as well as the CNY-ruble exchange rate and bilateral balance of payments whenever national currencies are used for transactions. Sitting on a rising share of (relatively) illiquid yuan-denominated assets also raises questions about liquidity. The Central Bank and MinFin refuse to spend rubles, thus reinforcing the issue of illiquidity because banks have no reason to keep buying bonds and sustaining money creation on the part of the state if that state simply chooses to accumulate reserves and rarely putting them to adequate use. And then you have the annoyance of converting any yuan that are held into rubles, which anyone following the long dollar shadow cast by Rosneft’s past transactions can tell you can lead to unexpected and immense squeezes on the banking sector’s foreign currency liquidity in a pinch when transactions used these resources are large enough, generally in service of private interests rather than the state. For now, Russians don’t want to hold CNY, nor do Russian businesses particularly want to unless it’s useful for a specific supply chain. What’s really happening is the state trying to force adoption indirectly and increase the transaction costs for business.

Just as Russia’s now struggling with the inflationary pressures presented by US fiscal policy and the market’s difficulty processing recent inflation data since the relative strength or weakness of the US dollar push commodity prices up or down, it’ll also have to contend with the ongoing deflationary pressures around the CNY so long as the PBoC manages capital inflows in such a manner to avoid too significant a currency appreciation in defense of Chinese exporters. Moscow’s attempted monetary “multipolarity” is replacing staid ‘market’ rules that accept the benefits of the US dollar within the limits imposed by sanctions with an uneven and unclear political framework that reiterates all of the same problems of monetary and economic sovereignty, but more stupidly. If post-Crimea sanctions were the foundational “tragedy” of the current state of affairs, then the countering attempts like this are farce. One hopes that the presidential administration and government understand that they have to keep a much closer eye on China’s financial markets now. The next crisis is far more likely to come from a wave of Chinese defaults and investor flight out of the country after years of rising foreign investor market share than anything in the US where regulators, for all their flaws, quash any potential collapse in financial asset values that would spillover into the real economy quickly. Businesses secure credit against the value of their shares all the time. That practice gets a lot hairier on a market like China once a run gets going. For now, the PBoC has complete control over anything that might arise and domestic debts can readily be restructured. The ubiquitous presence of global capital — necessary for China’s geopolitical rise — narrows room for true ‘sovereignty’ in those instances, and Russia will take the hit with everyone else if that crisis ever comes to pass. Russia’s opted for the geopolitical bazaar while pretending it wants a steady market.

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