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Шалтай-Валдай

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Putin spoke at the Valdai Club's annual conference yesterday providing the usual grist for the commentariat mill. The following are the highlights grabbed by RBK, though those with a stronger stomach might want to look at RT's full-length plenary video if they're truly curious:

Before commenting on what caught my eye, I thought Sergey Radchenko raised an important point about the ambivalence many feel regarding the participation of western intellectuals and 'thought leaders' in the event:

I completely agree about the debate surrounding the event, but don't agree for a few reasons. First, the propaganda value of the event is in my opinion mostly irrelevant. It's difficult to imagine someone in Irkutsk or Tula or Stavropol' is watching this online thinking "see!? We're really a respected power because some intellectuals showed up to talk about things that only tangentially touch on my life most of the time as I struggle to get by like most people." Now, for an educated and more elite audience, sure, there's some form of social cache watching this from afar. I don't think the regime is particularly bothered about that, it just likes having the fora and points of personal contact to remain in place the same way they do at events hosted in the West where few people are keen on condemning their hosts unless that's the explicit agenda. Second, I don't think anyone agreeing has a moral obligation to talk about human rights or Russian authoritarianism because a) there's considerable lattitude to have non-Russia specialists take part in some proceedings b) not every topic concerns those developments c) diplomatic engagement comes in many forms and one can condemn those things without necessarily using the forum to grandstand and do so. It might feel cathartic, but it's probably more useful to talk to people off the record to learn what they think is really happening in the first place than say some things that won't actually budge the public in Russia and would mostly be aimed at western audiences anyway. That said, I do respect his stance, think it's a relevant question to ask the more authoritarian the regime becomes, and fully understand that Russians fed up with the state of the political system might take that view.

As for Putin's statements, two highlighted in multiple outlets stood out. His claim that the existing model of capitalism had exhausted itself in most countries and that China provides a positive example of development showcased how absent he has become from meaningful debates about economic policy or decision-making within the Russian government unless it concerns political stability or his power in relation to elites and interest groups. Capitalism has exhausted itself many a time and always kept on ticking. The problem isn't so much capitalism in the abstract in the Russian case. It's the growth model the regime relies upon in crisis. Resource exports ceased to drive strong growth almost a decade ago and import substitution intended to shore up strategic autonomy has worsened the compression of incomes since 2013 due to the application of austerity politics. China's success lifting over 400 million people out of poverty in the 2000s drove much of the prior commodities boom that powered Russia from 1999-2008. Yet China's otherwise successful experience goes to show how politically difficult it is to transition from one growth model to another once the political interests and powers of specific lobbies, industries/sectors, and political institutions are entrenched and the only way a political system can successfully adjust requires 'distributing pain.' In other words, Putin has no clue what development drivers really do anymore. He's more likely talking about what the more ideologically rigid anti-western minders in his coterie and inner circle suggest is the case with accents of supply-side policy or the fears figures like Siluanov obsess over.

The other statement concerned global cooperation during COVID. Translated:

"In [their] words, all states declare their adherence to the ideals of cooperation, their readiness to work together to solve common problems, but unfortunately it's just words. In fact, the opposite is happening, and I repeat, the pandemic has only spurred on negative tendencies . . ."

If we take him at face value, Putin is lamenting the lack of cooperation on COVID as a geopolitical symptom of the worsening state of the world after 2008-2009 where national responses to globalization, conflicts for influence, disorder, you name it worsened across the international system. There's of course some truth to it, but it's a bit laughable given that Sputnik export contracts devolved into yet another money-making scheme for those who were well-placed. The problem is rarely whether or not states are willing to cooperate, rather it's about the terms of that cooperation. Given Russia's track record since 2012, at some point these analyses and projections become self-fulfilling prophecies when an elite adopt a brutish, blunt-force version of offensive realism without necessarily understanding how power operates in contemporary global affairs. Skip the nonsense about western values. That's about domestic discourses necessitated by an obsolescent economic model and social contract with the public as the regime figures out how to manage the years ahead.


What's going on?

The Bank of Russia just published its latest survey results for the inflation expectations of everyday Russians and the findings aren't pretty. Per the survey, Russians now expect inflation to hit 13.6% for the next year and observed inflation ticked back up to 16.3% in annualized terms, though that's still lower than the 16.5% high recorded in July. Age-old debates about what exactly drives inflation make it difficult to assess exactly what these surveys indicate because of the chicken-egg problem inflation poses: does actual inflation drive expectations or vice versa?

Orange = expected inflation Grey/Blue = observed inflation Interruption on the Graph = no face-to-face surveys were taken

What's clear is that the sustained pressure Russians face as a result of rising food prices is cause for panic at the CBR. 38% of the average household's spending in 2020 went to food, and this year's real wage dynamics don't suggest an improvement on that figure overall. That explains why the Bank, led by Elvira Nabiullina, hawkishly raised the rate by 0.75% today to 7.5%. Pre-hike, the market had begun to assume they'll continue doing so up to 8% in the months ahead but that might be too low a ceiling depending on how persistent inflation proves to be. Yet it's widely acknowledged that these interest rate increases have not affected inflation much because price increases are driven by global and national imbalances in the real economy, particularly commodity prices. The relief, if any, the rate hike will provide would come from killing consumption elsewhere in the economy and making it more difficult for households now indebted at record-levels to consume non-essential goods and services:

The level change is just there to capture the % increase since Jan. 2020, but as we can see, a roughly 20% rise in the amount of liquid cash and easily convertable assets (things like bank deposits) over the course of the pandemic is actually not that much greater in % terms than topline inflation and doesn't show any strong correspondence to specific products markets or supply chains. The rate of increase actually lines up with the pre-crisis trend. Slowing the rate of credit creation is mostly an act of economic destruction in the current context. Business and labor market churn require steady demand to push through today's headwinds, particularly since there isn't an energy crunch in Russia so the relative costs of pulling that off are lower than in China or Germany and most of the Eurozone. New data from FinExpertisa shows that in 2Q when the economy was booming, 2.66 million people were laid off by small, medium, and large-sized businesses. A smidge over 77% of the layoffs came from voluntary choices to leave jobs. Despite strong hiring, 2Q showed a net job loss of 310,000 positions. The use of loans and credits to defer layoffs from 2020 caught up to the market eventually. Fiscal policy can't solve all the bottlenecks that now exist in the Russian economy, but it could have accommodated a more even demand impulse and reacted when it became apparent that past underinvestment and under-spending led to current inflationary bottlenecks.

Russian Railways is planning to exit the rolling stock repair business per a meeting of the board of directors yesterday concerning the subsidiary "Wagon Repair Company" (Vagonnaya Remontnaya Kompaniya). The bottom line is that WRC will be sold. To whom isn't clear yet. RZhD head Oleg Belozerov has signaled the move for months, citing miserable profit performance and expected further declines in profit margins from 1.4% in 2019 to just 0.5% by 2024. Since the rail monopoly can use all the cash it can get to finance cost increases for current investment plans, especially those concerning the Baikal-Amur Mainline (BAM) and Trans-Siberian route, it might as well sell off non-core assets that aren't performing even if the sums involved aren't that large. What I'm drawn to in this story is the growth context. Without significant increases in state expenditure via RZhD and stronger domestic demand growth, the rolling stock market isn't growing fast. That tends to force producers and service providers like WRC to compete over a (relatively) static pie for market share, driving down profit margins. Imbalances between domestic and external demand drivers then create policy headaches – this year has seen record volumes of cargo transiting through Russia out of China thanks to sky-high shipping container rates, not necessarily the strength of growth in China proper or else in Europe where growth forecasts are being revised downward.

Example: RZhD owns a controlling stake in the Ulaanbaatar Railroad, which manages the Russia-Mongolia-China corridor of the Trans-Siberian route. This year has seen record cargo volumes as a result of these broader global supply chain and price forces, which have now pushed to talk up how they can convert the 7.5% growth in tonnage witnessed in 2021 into longer-term growth and profit gains. One can't reasonably bank on those gains sticking without the current supply chain disjunctures that exist, and if China's growth crawls grinds to relative halt below 3% into next year, that's not exactly a strong demand signal for transit given we're also not yet clear on what the Eurozone will be doing as the new German government forms with a potentially über hawkish finance minister in tow. Outside of the freight sector, passenger transport faces some headwinds from plans to expand the size of the domestically-manufactured and deployed civilian aviation fleet and growth in air travel. RZhD will play an important role developing hydrogen-powered transport options. For instance, there's a pilot program to launch 13 hydrogen-powered "rail buses" – seems more like trams to me... – by 2024. Yet passenger capacity investments rely almost entirely on the domestic market in a manner that freight shipments don't necessarily. Budget allocations and procurement requirements, such as handing off these newer 'green' systems to other state-owned firms or parastatals determine outcomes as do any decisions to manage ticket prices or provide subsidies for more expensive routes. The last bit works wonders for regional aviation, creating scenarios where subsidies are de facto competing against each other depending on available rail capacity. Spinning off a wagon repair firm is small potatoes in the grand scheme of thing, but provides a useful reminder that the rolling stock market in Russia is often operating on tight margins, subject to periods of surplus and deficit affected by procurement and budget cycles, and faces considerable uncertainty about the future of demand coming out of China.

Future oil & gas output faces a few headwinds. Vice minister Yuri Borisov is calling for the government to look at offering tax breaks or exemptions for hard-to-recover reserves in order to lift output, a move that would further raise the volume of Russian production sustained by foregoing tax revenues. Rosgeologiya is getting its budget cut by 20% over the next 3 years to just 12 billion rubles. That money will instead be given to Rosnedra which conducts geological studies in place of Rosgeologiya that has historically been tasked with doing barebones exploration work so that oil & gas firms don't have to spend as much on high-risk exploration, a principle dating back to the adoption of the highly progressive tax code in 2001. Without access to internal documents or discussions, we shouldn't read too much into either development in isolation. However, they both suggest a realization that output levels are going to fall with the current tax framework for the sector and that more complex studies will be needed to find new deposits instead of freeriding off of Soviet-era finds that couldn't be developed or ancillary finds bracketed off of existing projects. As far as I've seen, the MinFin and MinEnergo aren't considering a systemic tax overhaul for the oil & gas sector until 2024 at the earliest. The finance ministers and treasury want to soak in as much revenue as possible now to pull off the 2022-2024 budget consolidation at limited cost to households or businesses where feasible.

While most people tracking oil, myself included, tend to focus on the lack of a supply and investment response from US shale firms despite prices rising above $70 a barrel, there's a lack of appreciation for the degree to which Russia faces supply constraints as a result of its fiscal policy and revenue needs. Even with a relaxation of the tax burden, there simply aren't enough onshore greenfields available to raise output further above 2019 levels based on current forecasts and what appear to be the operating assumptions of MinEnergo. Underinvesting in exploration worsened the problem since a lot more resources went into prospecting offshore deposits that were never that logical to develop in the first place since they relied on high prices (though breakevens have come down a lot since 2014) and also provided convenient excuses to throw more money at Arctic development for internal rent distribution. Fears about supply investment shortfalls are probably overblown in the years ahead because they often hinge on uninterrupted, strong demand growth that may not materialize if 2022 provides a significant deflationary shock as well as underestimating the degree to which cost savings since 2014 lower aggregate spending needs after the initial, costly exploration costs are sunk. But Russia's not likely to be part of any supply growth story above what it's already capable of doing, and its policies and choices increasingly reflect that assumption or reinforce it.


COVID Status Report

A record 37,141 new cases and record 1,064 deaths were reported today. Unsurprisingly, the Kremlin through spokesperson Dmitry Peskov has made clear that there are no plans to provide additional social support to families during the federally-mandated vacation days from Oct. 30 to Nov. 7. Businesses, however, seem primed to receive some help in the form of bridging loans to ease their losses for November-December capped at a 3% annual interest rate with the gap from the real interest rate then subsidized and paid for by the state. Infection rates and hospitalizations are starting to hit medical supply chains again. The government of Chelyabinsk oblast' just ordered 240 million rubles be spent to procure oxygen compressors and, presumably, oxygen supplies for patients. Crimea's become the regional leader in the manufacture of express COVID tests, which is sort of a "good news for people who like bad news" kind of a thing. The failure of the vaccination campaign at this point is no longer about capacity or production, it's sociological. One specialist interviewed points out that around 50% of the public are completely against getting vaccinated. Things are so grim that the authorities have taken to promoting statistics about the level of collective immunity in the country, now citing a figure placing it at 45.7%. How many people have to die before it reaches the 80-90% level implied as the policy target from prior statements made by prime minister Mishustin is the open question, and the one with only tragic answers.


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