14 min read

Winning Losses

Stumbles around a US withdrawal from Iraq point to strategy wins and losses
Winning Losses

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A reminder that this will be the last week on Substack for OGs and OFZs. My reasoning and what to expect for pricing and paywalling going forward are broken down here. I’ll begin the move to Ghost at week’s end and will aim to be up and running again around August 16 after a much needed honeymoon in Chicago. If you want to get your first 3 months’ subscription discounted at Ghost, subscribe sometime this week for the monthly plan or else the annual plan, which will rollover whenever it’s renewed — I’m still working out the logistics for how those rollovers work but will provide all of the relevant promo codes, probably via Substack or else personal email (reach me at nbtrickett@gmail.com) before launching on Ghost.

Kremlin aide Andrei Belousov reportedly promised to Putin that real incomes would rise and inflation would be reined in by the end of the year to 5% in annualized terms at a meeting of the Council on Strategic Development and the National Projects. Real incomes will be up by 3% and price increases won’t undo the gains of a labor market significantly tightened from the loss of cheap, exploitable migrant labor. I’d love to know what he’s drinking. Timing is everything:

It takes time for today’s prices to filter into tomorrow’s costs and companies try to delay passing on prices initially before being forced to. There are also variables that can’t be accounted for with policy. Dry weather and drought in the US and Canada will probably push up grain prices once the summer crop is harvested and it’s also affected the availability of feed in some regions in Russia just as fertilizer prices keep climbing. Though the rate of price increases may be easing, the only way to really bring inflation down at this point will be weakening the recovery. Short-term price control measures will provide occasionally good news in the weekly data, but worsen the problem of timing — firms holding prices down take losses and eventually have to mark them up. What seems likely at the moment is the plan is to do precisely that — weaken the recovery with rate hikes and no new fiscal impulse while using the one-time payments to families in the data to show things are improving by August and then find a new way to deliver better stats. Housing prices are finally expected to fall 5-10% in the months ahead as rising rates are now scaring off consumers from subsidized mortgages. That will be good for inflation figures, but shows a lack of spending power and limited if any real income gains are doing that work. In other words, they have to decide between killing inflation and providing a strong enough base for real income gains amid slightly higher inflation due to stronger growth whose benefits don’t just flow to exporters and state officials. They can’t have it both ways.

What’s going on?

  1. Vedomosti has confirmed that the government signed off on a plan to “mobilize revenues” for the 2022-2024 budget on July 1, tasking MinFin, MinEkonomiki, MinTrans, MinEnergo, the Federal Tax Service, the Customs Service, and the Ministry of the Interior are all being asked to pitch in to reshape the tax code for the non-oil & gas sector(s) of the economy. First up, an increase in severance taxes for the metallurgical sector to collect more resource rents from metals & mineral extraction for production the state did not raise taxes on during COVID including precious metals producers who’ve benefited from export license liberalization. Most recently MinPromTorg has proposed simplifying export procedures for platinum and rare earth metals. Expect a lot more action on that side since the sector-wide mineral extraction tax (MET) for the metallurgical firms averages about 8% vs. 40-60% for oil & gas companies and the move’s expected to raise 100 billion rubles ($1.34 billion) for 2021-2023. Second up, higher export duties for ferrous and non-ferrous metals to further capture the windfall from higher prices and tame inflation for another 160 billion rubles ($2.15 billion). Apparently Economy Minister Maxim Reshetnikov made clear it was best to go after the metals firms since and the oil & gas firms pay enough as it is. Third, there’s renewed talk of selling small stakes in smaller state-owned firms, selling state-owned land, and increasing dividend repayments to the state budget. Fourth, the government sees aligning with Pillars 1 and 2 of the OECD’s global tax coordination push as useful — Pillar 1 established standards for the national taxation of giant supranational digital firms and Pillar 2 falls under the coordination of a minimum corporate profit tax rate of 15%. Finally, they want to improve the administration of fines for traffic and transport violations. These are intended to raise a combined 400 billion rubles ($5.37 billion) and it’s not clear why that figure specifically is necessary. What seems likelier to me is an overshoot under the guise of an otherwise staid set of reforms based on market conditions and the OECD alignments in particular while avoiding consumption taxes.

  2. The government has worked out changes to the system of vertical administration over regional districts through the government and Kremlin’s appointed ‘curators.’ As of now, prime minister Mikhail Mishustin has 8 deputies who handle the larger regional blocs individually who shadow 8 tasked with the same from the Kremlin. There’s plenty of overlap going on too. From Mishustin’s side, Viktoria Abramchenko is handling Siberia, Yuri Borisov is handling the Urals, Tatiana Golikova is handling the Northwest, Dmitry Grigorenko is handling the Central district, Aleksandr Novak was handed the North Caucasus, Marat Khusnullin was given the South, Dmitry Chernyshenko took the Volga region, and Yuri Trutnev retained his long-time role handling the Far East. According to the new push, their main jobs are managing social development — handling local concerns, preventing income declines, warding off excessively wasteful budget spending, and intervening in local and regional fights over resources so they don’t have to come to Mishustin or Putin’s desk:

    What’s rather hilarious is that three governors seem to have had anonymous sources leak to Vedomosti that they have no idea how the new system is actually supposed to affect decision-making or work in practice. It was announced at the Direct Line on June 30 without any prep, it seems. That the Kremlin has accepted a new “dual” system gives Mishustin a greater formal and informal role resolving regional matters and carries a clear logic as an extension of his Coordination Center — data collection, crisis management, and now social policy implementation will be vertically organized through his office. In other words, it’s now entirely on his team to keep the people happy or at least complacent enough while the Kremlin focuses all of its domestic energy on settling elite disputes or, in the case of tax reform, providing an avenue to protect the interests of big business or alternately browbeat them to action. That’s a long-term trend, but probably made far more palatable given Mishustin’s relative public popularity and lack of a clear, defined base of elite support outside of the regime’s technocratic cadres.

  3. Stevedores working at Russia’s southern ports are upset that Russian Railways hasn’t shipped planned volumes of coal using their facilities. The rail monopolist counters that loading has picked up in the south, with coal volumes doubling over 2020. Yet ports have had problems since the end of spring and by July, ports weren’t receiving as much as half of declared volumes. Coal shipments via rail in the North Caucasus are down significantly. To get a sense of the disruptions, Tuapse received just 56 rail wagons of 122 booked, Novorossiysk received 56 of 82, and Taganrog received 10 of 17. Rising coal prices led to shifting export priorities — Asian markets took precedence and China’s ban on Australian imports has shown that Russia’s infrastructure network, by dint of its size and state of development, isn’t great at handling large market shifts. The more direct proximate cause recently has been the oil price recovery and surge in earnings from shipments of crude oil and refined products to southern ports. The lack of coal shipments now threatens these stevedores’ earnings and employment, a great example of how swings on commodity markets and climate priorities can quickly become sources of labor-capital conflict in Russia because of the political management of employment and cross-sector demand. RZhD is promising it’s on the case, highlighting modernization works to expand export capacity for rail via southern ports up to 125 million tons annually and using some statistical trickery to throw critics off the scent. Southern loadings in the aggregate are up 22% to 46.2 million tons so far, coal is up 80% to 14.5 million tons, and coal is up 93.4% to 1.4 million tons for the first two weeks of July. Just one problem. The stevedores working the warehouses and wharves know that only 44% of the coal that’s been booked has actually come through while no other good has had any trouble. It’s expected warehouses will swallow losses through September.

  4. The Association of Retail Trading Companies (AKORT), an organization that includes giants Magnit, the X5 Group, and Lenta, and the Association of Internet-Trading Companies (AKIT) including Wildberries, Ozon, and “Utkonos” are warning that proposed regulations from MinPrirody making producers responsible for targets recycling goods and packaging will lead to empty shelves and a reduction of consumer choice. Basically, the technical requirements will be costly enough that retailers will have to cut down on what they offer because of attempts to create a goods registry against which inspectors and federal/regional agencies can assess their performance. MinPrirody intends to create a register for included goods and packaging used by firms that are “greenlit” for sale because they meet the necessary specifications, then by default banning the sale of any goods or packaging not included in the register. It’d be a blunt weapon to wield over firms rather than a scalpel, and one that would also undoubtedly raise some problems for implementation and enforcement. Retailers point out that there isn’t even a unified registry in existence identifying which firms make which products that would be included or banned from the registry and at present, only 3-5% of producers meet the standards the regulatory change would set. Why? Because existing regulations are already poorly administered, Russia’s a massive country, and you’re asking companies to invest a bunch without necessarily realizing significant returns because of the structure of things like power markets, transport costs and subsidies, and competition for customers on a market with stagnant or falling incomes. The companies are probably complaining far beyond what’s merited. In practice, firms are already supposed to declare the goods and packaging they make and use. Entering that into an electronic system would be relatively straightforward. But every company knows that the list would be leveraged by competitors and the state when convenient, creating an environment where policy implementation is massively undermined because of the lack of trust between business and the state. Luckily MinPromTorg is now incorporating sectoral concerns and complaints into its proposals. Worth watching how this plays out since these types of impasses will become more commonplace whenever the national decarbonization strategy is finally adopted.

COVID Status Report

23,770 new cases and 784 deaths were recorded in the last day. Cases in Moscow keep falling a bit faster than regional cases rise but the Operational Staff data shows that’s largely peaked now. If you look at the case fatality rate, the implication is that infections are still rising unless the new variant is actually deadlier or else that at-risk populations have been hit harder this time than in the past:

The fact that economists now estimate that the 3rd COVID wave will only take 0.1% off of GDP this year isn’t evidence of success or particularly strong economic resilience, but export dependence. Putin just doubled down on rhetoric that Russia recovered quickly cause of “flexible” macroeconomic policy, which is a tragically unfunny joke given that even Brazil outdid Russian stimulus in GDP terms. The fact that less capital is leaving the country via tourism is also helping around the edges. Over 6 million Russians have now officially been diagnosed with COVID-19 at some point, a far cry from the implied infection numbers if Russia really has achieved 60% collective immunity. Looks like Turkey might shut its borders to Russian tourists and others soon enough cause of Delta variant concerns, but it’s not the plan yet.

What to expect when you’re not expecting

Conditions in Afghanistan continue to deteriorate, most visibly with rockets landing near the Presidential Palace in Kabul as president Ashraf Ghani and other leaders marked the start of Eid al-Adha and the brief kidnapping and torture of the daughter of Afghanistan’s ambassador to Pakistan. Russia, Tajikistan, and Uzbekistan are launching joint drills on the Tajik-Afghan border from August 5-10 with the Russian military now positioning tanks and other heavier assets in country to prepare. Authorities in Kabul say they’ve retaken the Spin Boldak-Chaman border crossing, but the Taliban naturally denies this since it’s able to exploit foreign media’s lack of awareness of Afghanistan’s geography, regional differences and divisions, and the practical reality of politically controlling territory to exaggerate its otherwise impressive gains on the battlefield thus far.

Over the weekend, Kommersant let slip that Moscow might be cracking the door open to allowing the US to conduct some operations out of its bases in Tajikistan and Kyrgyzstan so long as it could secure buy-in from CSTO partners and strictly limit the scale of whatever the US would do and place at said bases. Unnamed sources claim the topic was raised at the June meeting between Biden and Putin in Geneva. Personally, I think it’s wishful thinking — it’s much more likely the notion was planted by the diplomatically inclined in Moscow who understand the logistical challenges a larger role managing Afghanistan’s borders and internal conflicts entails than evidence of a real change in policy. The National Security Council regularly entertains bizarre diatribes about NATO’s biological weapons ambitions against Russia and more thanks to Nikolai Patrushev and while the Ministry of Defense has gotten comfortable coordinating activity to avoid military confrontation with the US in Syria, no military enjoys the specter of managing a battle space with multiple participants who aren’t allies frequently acting at cross purposes even when interests broadly align. There’s no political cost to raising the option with Biden and his team, but Moscow would set very strict conditions that would make it quite difficult for any American administration to agree to. The question then becomes why air it publicly now? One word: China.

“The United States, which created the Afghan issue in the first place, should act responsibly to ensure a smooth transition in Afghanistan . . . It should not simply shift the burden onto others and withdraw from the country with the mess left behind unattended.” That’s Chinese foreign minister Wang Yi on the withdrawal. It turns out Beijing likes it when its competitors provide security for its exaggerated development promises of roads, rails, pipelines, mines, and more. Neither government appears to have had any clear plan for what to do in the event this happened. But now that Moscow is actually stepping up and sending men, materiel, and committing intelligence assets to handle the problem, what does Beijing do (at least publicly)? Nothing of substance. More of the same timid promises of investment if the Taliban can secure it, more talk of the China-Pakistan Economic Corridor (CPEC) and expanding its remit, and more promises of support to Dushanbe that hide behind invocations of the Shanghai Cooperation Organization (SCO) and multilateralism to dodge admitting the obvious. China has no intention of committing real resources until it absolutely has to do so. Threatening a US return to Central Asian bases would, in fact, serve its interests, but dangling it in this way reinforces that China can no longer rely on the United States to pick up the tab handling this problem.

At the same time this drama has played out, there was fleeting hope that the Biden administration had gotten serious about withdrawing the remaining contingent of US troops from Iraq. It’s an evergreen topic in Washington and talks had been noted publicly in April. The escalation of what are, crudely speaking, nuisance rocket attacks on US bases in Iraq parallel growing political pressure from Baghdad to leave. Iraqi officials from the Prime Minister’s office leaked to the media that the withdrawal of combat troops had already been discussed, a claim flatly denied by an unnamed senior US official in an incident that spoke volumes about the state of play for Biden on the issue. He’s trapped in the middle of brutal budget reconciliation negotiations for a $3.5 trillion spending package paired with a bipartisan infrastructure bill now being undermined by Republicans’ refusal to increase funding for the IRS to provide revenues and trying to work out ways to advance talks with Iran that now look definitively stalled for the next month. If it looks like the US is pulling out the remaining 2,500 combat troops in Iraq — a presence that largely exists to be shot at by militias since ISIS has been defeated in Syria and Iraq — and Washington’s lobbies grab it as proof that the US has been forced out, the White House would rather not waste the political capital fighting that fire at the moment. The latest airstrikes on ‘pro-Iran’ militias fit into that political logic. They accomplish nothing significant strategically and little tactically. The fact that no senior Pentagon official has gone officially on the record in the relevant coverage suggests that Biden wants to pull it off. It’s a matter of timing and balancing it against other priorities. Lloyd Austin, the current defense secretary, oversaw the pre-Trump drawdown. The next round of talks with officials in Washington will have to resolve this diplomatic incident and ‘reset’ things on whatever path Biden really wants.

The arc of US policy isn’t hard to intimate, the question is whether it can be executed. If the US presence in Iraq is reduced to an advisory role and it reduces the logistical burden of running air support and air strikes, that means more assets focused on Syria, parked at bases in Jordan, Kuwait, or Qatar when needed, or else more kit rotated to other theaters, refurbished, and replenished. Without the same US backstop, however, that leaves yet more room for uncertainty in the face of instability that Russia has to worry about. Lukoil is trying to unload its headaches onto Chinese firms, but Rosneft controls strategic export infrastructure from Kurdistan and Gazpromneft (if I recall correctly) still has claims for several blocs negotiated with both Erbil and Baghdad. This map is old but all of the Turkey bound oil and natural gas export pipelines are now majority owned by Rosneft as part of an evolving prepayment deal to lift crude volumes back in 2017-2018 that backstopped Rosneft’s CEFC China Energy supply deals. Rising Russian crude volumes delivered east meant finding new supply to sell to Europe:

Add in that OPEC production will only rise in importance in the years ahead — Lukoil  VP Leonid Fedun thinks OPEC may control 70-80% of all output in a radical supply/demand reduction scenario — the security of supply in Iraq and the region paradoxically matters more for price stability at the same time it’s less salient for consumers. This “double drawdown” was the core thrust of the Obama administration’s strategy that was undermined by the politics of the surge in Afghanistan and incredibly difficult environment passing anything after 2010. It’s symbolic, but the Biden administration just moved its first prisoner out of Guantanamo Bay. The legacy lives on and is visible in US strategy. Taking a wide view of it, Moscow may soon have to face the prospect of offering more for regional security if Iraqi officials get their way and the US reduces its presence and role further. Fears of instability and the desire to fill any vacuum will also follow economic needs. There’s no meaningful decline in the significance of oil prices and output for Russia’s business and investment cycles on the horizon. And as we’ve seen, stagnation and the new commodity cycle have forced the state to look at new ways to mobilize other resource rents where possible and since 2013-2014, oil rents have been insufficient to generate growth without broader range in macroeconomic policy. Washington is stumbling into a half-decent strategy while Russia stumbles into roles it probably preferred to avoid if possible and China still has no clear vision of what kind of security role it intends to play across Eurasia.

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