13 min read

Ready and Stable

Moscow's got fiscal space, but faces a new supply/demand problem
Ready and Stable

Top of the Pops

First off, a note from yesterday’s bit on trade with the EU. Looks like the caveats about China’s growing trade balance were only goods, which makes a lot of sense. There’ also the tricky bit about US trade with the UK no longer counting, but that wouldn’t shift the data that much. Apologies for missing that, it makes a lot more sense. I was wondering about the calculations from USTR I’d seen and referenced from 2019 given the gap in volumes, but in my haste, I rather foolishly didn’t stress (or fully clock for that matter) that Eurostat had only covered goods in pulling the story since I was only thinking about goods trade for green tech supply chains and that was ultimately more relevant for the column. For some reference of prior years (2016-2018) for a sense of scale, I pulled the size of EU-China services trade and FDI flows that reflect manufacturing interests:

Something else to consider is that given China’s excess capacity for construction inputs, diminishing ability to absorb said excess of construction materials with debt-financed investment, and it’s large share of other supply chains for green tech components, particularly solar PVs, the shifts in currency valuations play into Europe’s Green Deal ambitions. Using the initial spending framework from before COVID as a reference, that’s about €503 billion of actual investment over a decade — we can park aside any of the EU budget funds that were reassigned to hide that Europe remained its reliably austere self when the deal was proposed — that will be commodity-intensive and increase imports from Chinese manufacturers until more is re-shored within the EU (and at higher cost given labor laws, relative wages, etc.). That’s before national plans that up that spend and also before any big spending package that may be passed in the US. Green spending plans in the short-run most likely increase China’s goods trade surplus with the EU (and US), but do nothing to help its flagging service sector recovery and growth from last year. Ironically, green stimulus abroad will probably worsen the lop-sided the post-COVID growth arc unless China shifts into exporting and consuming more services faster than expected, which means slower ‘real’ growth in China and more debt-driven spending to hit growth targets with diminishing returns and little positive effect for Chinese consumers. At the same time, the shorter-run of the commodity cycle from green stimulus will undoubtedly help Russia’s miners and their export earnings (but watch for MinFin to consider raising taxes). In the longer-run, trade will adapt to the changing currency politics between the three major economic poles in the US, China, and Europe as two of the three look to bring jobs back or in the US case, pressure firms to leave China. Apple’s now looking to move iPad production to India, the latest in America Inc.’s response to the trade war Trump started. Counter-arguments to the commodity super cycle thesis — China’s the biggest consumer, and therefore sets the pace for prices the next decade — seem to undersell that China’s consuming commodities for manufacturing exports that will grow with green stimulus spending and global corporate investments at the same time new stimulus plans will create a massive surge for fuel substitution, weatherizing, etc. in developed economies trying to build out domestic manufacturing where they can. Let the green trade games continue.

What’s going on?

  1. Despite rising housing prices towards the tail end of 2020, the volume of mortgages extended continues to rise. Experts are now expecting rates — held down by policy intervention — to rise in the second half of this year. The following is the volume of mortgages (blns rubles) issued every month):

    As we can see, starting August last year there was a massive surge in household borrowing as the relative cost of buying fell below that of renting in many cases. The real worry is risk-taking and bubble behavior. Mortgage rates are already at historic lows so banks can’t drop them further to lure customers, instead opting to compete on non-rate conditions — think less stringent credit requirements and lengthening repayment schedules. Say it stays in the range of 450-550 billion rubles a month during the spring, the latecomers to the mortgage market surge boosted by subsidies are likelier to have fewer savings, lower incomes, and worse credit and these same people are the most exposed if real wages don’t recover strongly and real incomes fall again this year. And that’s before accounting for a likely key rate upward correction at the end of 2021 or early 2022 (hard to see it happening earlier but the CBR’s messaging clearly has shifted to make that a possibility). If there isn’t an adequate income support announcement for further stimulus and the distribution of growth isn’t reflected by a rising tide for all in the national income, the upward pressure on mortgage rates in the second half of the year will start locking people out of the market that’s sustained construction demand or else lead to riskier lending before then. The banking sector isn’t at risk. Poorer consumers and income/demand recovery for those who are poorer are though.

  2. The effect of COVID scarcely touched the health of the national budget last year as new data out from the Treasury and AKRA shows that regional government revenues only fell a 2.5% year-on-year from 2019 — down from 9.38 trillion rubles ($126.9 billion) to 9.15 trillion rubles ($123.8 billion). If you include transfers from the federal center, regional revenues actually rose 10% from 11.96 trillion rubles ($161.8 billion) to 13.25 trillion rubles ($179 billion). Of course, even with a 56% rise in help from the federal center, regional expenditures exceeded revenues at 13.962 trillion rubles ($188.9 billion). The following are tax and non-tax revenues:

    Columns/lhs = revenues (blns rubles) Line/rhs = growth/contraction (% YoY)

    You can see the long shadow the oil market carnage from the March price war with Saudi Arabia casts on regional earnings, which only recovered by latish summer. But the rosier overall picture hides the story. The consolidated budget lost out on 1.4 trillion rubles ($18.9 billion) of revenues last year, all of them from regions that are net recipients of transfers from donor regions/the federal government. Donor regions were basically unaffected and 44 of 85 regions saw a net combined increase of 3% (factoring in transfers and the broader squeeze on tax collection last year to shore up budgets). This doubles down the two-speed recovery effect — it’s not just inequality between Russians based on profession and income, but regional fiscal disparities creating an uneven recovery path unless the federal center decides to increase its transfers for longer than the 2021-2023 budget seems to indicate. Without federal transfers last year, regional budget deficits would have collectively been equivalent to about 20% or more of tax and non-tax revenues, an imbalance that starves the economy of public services and investment. The ‘good news’ isn’t great up close.

  3. In more positive news, Central Bank data shows that the 4.6% rise in real wages in December corresponded to improving retail turnover and services demand in January. It’s a better sign that COVID cases really are coming down than the official caseload data (hospitalizations are down, but since hospitals are shedding COVID capacity, something tells me that there are cases where patients aren’t being recorded or else mild cases of people staying at home fall through the cracks). But the CBR warns that it’s not yet evidence that pent-up demand is actually resilient or belies substantial recovery because investment levels aren’t following suit. More importantly, though levels of borrowing remained consistent, the net outflow of bank deposits suggests people are taking cash out — both to buy, but also to cover costs that have built up if we try and factor in the various payment deferments on housing-related costs of living built into the stimulus program from last year. February data so far shows the money’s mostly going into buying homes with some gains for other consumer demand. I’d be wary of buying the recovery, though, until fiscal policy clears up more at the gathering of the Federal government. If investment levels aren’t rising, then there’s bound to be a supply crunch somewhere and that means inflationary pressure…

  4. Russia, along with Belgium, Luxembourg, Portugal, France, Finland, Switzerland, and Sweden, is calling for a review of the Vienna Convention of 1968 covering road transport at the United Nations Economic and Social Council (ECOSOC). No one expects Moscow to do the heavy diplomatic lifting here, but it’s a fascinating case of the multilateral and international exposure of Russian firms otherwise aiming to ensure the country’s economic sovereignty. In this case, Avtonet — a leading firm trying to work towards rolling out Russia’s own driverless cars — needs the convention to be reviewed for its own roadmap since the 1968 convention effectively outlaws driverless vehicles, creating legal headaches between countries if it isn’t amended as tech advances. The aim of the group Russia’s in is to introduce an amendment to allow for automated systems to be covered. What’s funny, though, is that the US, Canada, all of Asia, and Argentina aren’t party to the convention, so what’s really happening is that European countries are belatedly trying to play catch up to avoid their own dogmatic preference for rules-setting fora from hindering investment, adoption, and competitiveness. Russia’s weirdly bound by European normative standards in this arena because of the convention and it offers Moscow an excuse to appeal to multilateralism on an issue that, while not yet salient, will actually matter a great deal in the decade ahead and it seems that the domestic players trying to develop the technology would like to align their normative framework with EU countries instead of unilaterally withdrawing and, say, following China.

COVID Status Report

Cases hovered at 13,433 and reported deaths came in at 470. Overall, the situation seems stable and while the rate of decline appears to have slowed a bit, it’s still happening. The question is if it sticks with what we know:

Rospotrebnadzor is briefing that the Kent strain and varieties from South Africa and Brazil aren’t spreading, despite individual cases being found, which is reassuring though it’s unclear how good the capacity is at the regional level to track everything. There doesn’t seem to be concern that seasonal factors will affect transmission rates, which makes sense, especially if most Russians are more lax about public health requirements anyway. The other explanation for falling infection rates is that herd immunity is being achieved because of simply how many people have gotten sick. There isn’t that much evidence that we’d get mass re-infections, but the problem is that based on the peaks of infection, we’d only see people’s immunity wearing off several months later having an impact now. That’s why I’m still skeptical when you consider the vaccination data that vaccines will keep pace if that happens. It’s an if, for sure, but a serious one to consider and one the government clearly doesn’t care to worry about (perhaps rightly).

Back in Black

With Brent crude prices surging and some initial signs of recovery, if tenuous and short-term for now, “Fortress Russia” seems to be in solid shape to spend its way out of discontent to buy votes for September. Since the budget rule ‘sequesters’ any revenues with oil above roughly $42 a barrel — the actual price for a truly balanced budget is usually slightly higher — the outage in Texas offers a few weeks of fat living before OPEC+ and US shale drillers take next steps that might hold prices higher for longer:

As a corollary, BOFIT shows that at the same time Russia’s budget spending as a % of GDP hit a record high of 40% last year, the share of oil & gas revenues naturally fell. This gets tricky quickly since a great deal of corporate profit taxes and VAT receipts are tied up in oil firms themselves as well as large contractors and suppliers from the manufacturing sector plus all of these companies pay social taxes i.e. pension contributions to the state etc. All together, this significantly understates the fiscal role the sector plays directly and indirectly, so while there definitely was a big shift last year, Putin’s own claim at the big December presser that 70% of revenues were non-oil & gas was a nice bit of showmanship:

The spike in spending as % of GDP has been true in past crises, and generally subsidies as fiscal consolidation follows in the form of spending cuts. But there isn’t much room to cut, and tax rates outside of the oil & gas sector have, on the net, risen over the last few years. It’s inconceivable that MinFin will propose any major tax increases that would harm most Russian households, but it will surely look to keep higher taxes on oil & gas as prices rise, which will shift some of the fiscal burden back directly onto oil & gas taxation while also considering keeping metallurgical tax increases in place as commodity prices rise. A weak recovery may also nudge the budget as % GDP upwards slightly. The bigger question about Kremlin plans remains how further fiscal policy for the economy could be used and how inflation is factored into the policy calculus ahead of the September elections.

As oil prices rise, we should expect to see a recovery in industrial imports followed by consumer imports — this would mirror the supply-side recovery approach from last yea and relative declines in output vs. declines in consumer demand. Yesterday, the government announced it wouldn’t extend price controls on sugar and sunflower oil, solid evidence that the food price control pivot in December is proving to be the bad policy everyone always knew it was. Just wait for higher oil prices to feed into higher fuel prices as well. Food prices are inflating faster than broadly registered inflation across the economy, and there’s not any sign this is letting up yet. The drawdown on cash deposits in January may also be absorbed at the edges by rising food prices. Now there’s a new source of incoming price inflation that’ll hit consumer recovery this year and it’s once again a result of Russia’s import dependence: semiconductors.

Taiwan and South Korea have a near monopoly position on semiconductor and memory chips exports — a combined 83% and 70% market share respectively. The bottleneck in production from pullbacks in semiconductor manufacture for automative firms last year in expectation of declining auto sales for 2020 due to COVID is now spilling onto the Russian market. Imports of already completed cars, something generally reserved for wealthier Russians, aren’t experiencing markups because they’re inventoried before price markups hit. But a combination of a sea freight container shortage from the strain that China’s surging export surplus from 3-4Q last year into January and rising semiconductor costs for auto components needed for domestic production could increase domestically manufactured cars by 10-15% in the near-term. That will undoubtedly reduce the strength of consumer recovery in terms of orders for new cars. Lada models, for instance, run from 600,000 to over 1 million rubles ($8,100-$14,200). That’s a huge chunk of change vs. monthly wages, particularly if they rise 10-15% while disposable incomes stay down.

There’s the related issue of car insurance, which while not a pressing concern for costs, matters a great deal for any consumer estimating costs for the duration of vehicle ownership. New legal requirements that owners holding policies get their cars properly checked by licensed operators instead of using schemes on the gray market will encourage those operators to raise costs for inspection assuming that the competition from the (in)formal market drops off. It’s not a big cost — in the range of 720 rubles as of August for a light vehicle — but given the size of the leaked spending plan, even the smallest costs matter if the Kremlin actually wants to deliver income support.

Trade distortions from US sanctions and trade policy with China also matter. Xiamoi smartphones are expected to lose their market share to Huawei and Oppo because of US sanctions, but Huawei and Oppo may follow shortly as sanctions on Chinese firms identified as working with the Chinese military lose access to US tech and have to renegotiate supply chains right when a supply crunch for semiconductor parts as prices are bid up due to stockpiling in response to supply bottlenecks, demand surges, and US policy. The power outages in Texas forced Samsung to shut down two plants along with other semiconductor producers located in the state. For context as to how bad short, unplanned interruptions can be with just-in-time supply chains, a 30-minute outage at a Samsung plant in South Korea took 3.5% of the global supply of NAND Flash Memory Wafers — the base memory storage system that can then be divided into individual chips and requires no power to retain data — off of the global market. The outage this time is sure to create a short-term spike in order prices for higher-tech Russian manufacturers passed onto consumers or else the state when it affects defense procurements as they bid against others scrambling for supply.

The CBR’s decision to hold the key rate low has the added benefit of lowering the cost of borrowing for the state budget at the same time CPI has declined thanks largely to the deflationary effects of Russian economic policy:

But the deflationary bias of Russian macro can’t stave off price spikes from supply chain disruptions or rising prices from global market trends affecting exported and imported goods. Pre-COVID, Russia spent less than 6% of gross national income servicing its debts. If it is true that the Russian economy was more resilient last year and has a better year ahead of it, there’s clearly space to borrow a little more for a spending boost to backstop the consumer recovery and avoid the worst of the fallout from the current inflationary forces effectively imported into the economy, whether by exporters having to reference export prices against domestic ones or else by importers paying rising prices for production inputs. But it’s Russia’s domestic banks holding most of the new debt and they face their own fragilities despite the able job the CBR has done maintaining reserve adequacy ratios, providing liquidity, and eliminating or reforming banks posing larger default risks. The question now is what political coalition is the Kremlin trying to please when they inevitably release more spending. The structure of the spending proposal, when it comes, will be far more revealing than most of the political guesswork going on now. With all this, it’s clear that the focus is not actually addressing the effects — and causes — of inflation at the moment. They’re just lucky that falling disposable incomes have neutered the worst of the economy’s perpetual inflationary imbalances.

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