June 14, 2022

1. Two old friends. Many things to say

2. May I disagree, Your Holiness?

3. Ruble is too heavy

4. Some will suffer

5. Some will not

6. Bottom is behind us?

7. Belated decision

8. Price of the war

Two old friends. Many things to say

Vladimir Putin just met with his old friend, Alexei Kudrin, who was his partner in the St. Petersburg Mayor’s Office at the beginning of the 1990s and is now the Chairman of the Accounts Chamber.

Kudrin, along with Anatoly Chubais, played a critical role in the Russian President’s life and career by arranging for him to move to Moscow and get a job in President Boris Yeltsin’s administration. Many experts and journalists call him a liberal economist, although, in my opinion, he was never a supporter of liberal ideas in economics or, even less so, in politics. Immediately after Putin’s inauguration in May 2000, Kudrin became Minister of Finance and Deputy Prime Minister of the Russian government, a position he held until September 2011. At that time, he publicly disagreed with the decisions of President Dmitry Medvedev, who immediately dismissed him. Kudrin’s attempt to appeal to his old acquaintance, Vladimir Putin, was unsuccessful. Prime Minister Putin said the President has the right to appoint and dismiss ministers.

In December 2011, Kudrin joined the political protest movement that erupted after the mass vote count falsifications in the parliamentary elections and called for extraordinary elections to the State Duma. In the spring of 2012, Vladimir Putin was elected President of Russia for the third time, the protest subsided, and Alexei Kudrin fell into disgrace: Putin “forgot” about him for four years, offering him no position. In the summer of 2016, Putin began preparing for the next presidential election and realized he needed to present his program to society, which would be aimed at increasing economic growth and living standards: In the two years since the annexation of Crimea, real incomes had fallen by 10%. Kudrin became the head of the Center for Strategic Research, the Kremlin’s think tank. A year later, he presented Putin with the concept of an economic program, and another year after the presidential elections, Vladimir Putin nominated him to the post of Chairman of the Accounts Chamber.

On the one hand, this position occupies a high position in the Russian bureaucratic hierarchy—slightly below the Prime Minister but well above the First Deputy Prime Minister. It allows Kudrin to be in the upper echelons of power and continue to hope to become Prime Minister. On the other hand, the primary function of the Accounts Chamber is to be an auditor-accountant, controlling the spending of budgetary funds. Although all of Kudrin’s predecessors have tried to claim a broader authority and participation in setting the agenda, none has succeeded. Neither has Alexei Kudrin, who declared from his first days in office that he intended to reform the state management model and determine the priorities of the country’s development.

Although there is an old friendship between Putin and Kudrin, today, the Russian President does not need Kudrin’s advice, and the published part of the transcript of the latest meeting should show that so far, Putin does not see the need to strengthen Kudrin’s position.

During the meeting, Alexei Kudrin added some color to the portrait of the Russian political system by speaking a little about the formal nature of control over the implementation of the national projects.

Out of 1,500 indicators of [the implementation of] all state programs, much of it is technical. Only 22 percent are high-level indicators where [there are] accurate results. And the rest are often of this nature: The number of organizations that receive support. So they got help, and then what? Or the number of events held also does not characterize the result... All programs should be more results-oriented... The indicator of the outcomes should grow. For example, [today] 50 percent of the indicators are planned with almost zero dynamics; that is, they do not grow. The same result is achieved from year to year; there is no increase in goals.

Alexei Kudrin, having long ago ceased to be Minister of Finance, can now afford to criticize the budgetary policy, which deprives the regions of financial resources, making their budgets dependent on subsidies from the federal budget, and does not give them the right to make their own decisions about the use of budget funds.

Over the past two years... support for the regions has increased by half and more, sometimes twice as much... The transfer to the regions [amounted to] 3.7 trillion rubles in 2020 and 3.6 trillion rubles in 2021. That is massive support for the regions.

At the same time, all these expenditures are targeted; they are goal-oriented. There are 347 such subsidies—they have grown from 197 to 347—for each [there is] an agreement, with each region or with the majority of regions... here, the autonomy of the subject is reduced, on the one hand, because the amount of targeted support increases... before... the funds that the issue can use within the limits of its authority was about 50 percent of all support; now it is 28.

I do not know why Alexei Kudrin dislikes the current relations system between the federal and regional budgets. In 1998, the federal budget created a Regional Financial Support Fund, whose funds were distributed according to a formula developed by the government and the Federation Council, where regional governors met. Through this fund, 80% of the funds that went to the regions from the federal budget were distributed. In 1999, the share of regional budgets in revenues and expenditures of the consolidated budget was 50%. When Alexei Kudrin was the Minister of Finance, the provincial share in revenues dropped to 37% and in spending, to 40%. The Regional Support Fund was abolished in 2005 and replaced by 18 types of subsidies distributed among the regions based on individual agreements. When Kudrin ceased to be Finance Minister, there were 36 such subsidies, rising to 100 in 2016. Kudrin’s successor as Finance Minister, Anton Siluanov, did not come up with anything new: He began to split the subsidies and brought their number to 347. From Siluanov’s point of view, he has perfected and improved the system created by Kudrin.

May I disagree, Your Holiness?

Pope Francis gave an interview to a group of editors-in-chief of European Jesuit journals, saying:

What we are seeing is the brutality and ferocity with which this war is being carried out by the troops, generally mercenaries, used by the Russians. The Russians prefer to send in Chechen and Syrian mercenaries. But the danger is that we only see this, which is monstrous, and we do not see the whole drama unfolding behind this war, which was perhaps somehow either provoked or not prevented. And note the interest in testing and selling weapons. It is very sad, but at the end of the day that is what is at stake.

Someone may say to me at this point: So you are pro-Putin! No, I am not. It would be simplistic and wrong to say such a thing. I am simply against reducing complexity to the distinction between good guys and bad guys without reasoning about roots and interests, which are very complex. While we see the ferocity, the cruelty of Russian troops, we must not forget the real problems if we want them to be solved.

After reading these phrases, I realized that Pope Francis lives in no less of an illusory world than Vladimir Putin. Well, who put words in his mouth about mercenaries? About the war being waged mostly by them? And why should Chechen [legal] officers of the Interior Ministry be called mercenaries? I guess I could have gotten past that without the sequel.

What does it mean not to be reduced to a distinction “between good guys and bad guys”? Is Dad proposing to put the rapist and the victim on the same board? The murderer and the murdered? Putin and Zelensky? Maybe. Putin had his vision of the world in his head, in which Ukraine was preparing to attack Russia, and it drove the Russian President into a state of panicked terror. But let’s remember, a week before the Russian aggression began, everyone knew that Lavrov and Blinken were supposed to meet that week to, among other things, arrange a meeting between Presidents Putin and Biden. And at that meeting, the two leaders could and should have talked “about roots and interests that are very complicated” and agreed on how to solve “real problems.”

Excuse me, Your Holiness, but you are 100% pro-Putin even if you disagree with the label. 

Ruble is too heavy

Despite the efforts of the Bank of Russia, the ruble continues its appreciation: Today, it reached $1 = 56.6 by the end of the day—not since early 2015, when the price of oil dropped below $35/barrel and the Western sanctions had been imposed in August 2014, has the Russian ruble steadily been this strong. The ruble was roughly at this level throughout 2017. Given that accumulated inflation since then has been 38%, the real appreciation of the ruble could be at least 30%, which is a massive problem for many Russian exporters, primarily of ferrous metals and grain. At such a ruble exchange rate, exports of these goods become unprofitable, which has already begun to affect the activities of steel companies (see below).

The main factor of the ruble appreciation is the bans introduced by President Putin on some current and most capital transactions, among the participants of which are the residents of “unfriendly countries.” The Bank of Russia understands the excessive strictness of such restrictions, but it cannot cancel them because of their political nature. Attempts by the Russian authorities to reduce pressure on the ruble exchange rate—reduction and the abolition of the mandatory sale of foreign currency, raising the limit on private transfers abroad—have no visible impact on the foreign exchange market. Energy exports provide a record currency flow, while suppressed imports recover very slowly. Even under normal conditions, until mid-August, Russia traditionally experiences pressure to strengthen the ruble, so either the lifting of the political bans or the purchase of foreign currency by the Bank of Russia can change the situation.

Quite unexpectedly, several Russian banks started to play on the strengthening of the ruble and have recently introduced a commission fee for the balances in private clients’ foreign currency accounts, which varies from 1% to 12% per year. The banks’ argument: The impossibility of placing foreign currency resources inside the country (the demand for loans has dropped sharply) and the fear of new sanctions. Thus, banks are forcing their clients to transfer funds outside of Russia (if clients have such an opportunity) or convert foreign currency into rubles, increasing the supply of currency in the market.

In this regard, the Bank of Russia has stated that the introduction of such commissions violates the law on consumer rights, but my experience tells me that Russian bankers will find a scheme to get their way.

Some will suffer

The biggest Russian steel company, NLMK, has updated its forecast for 2022, saying that steel production could fall 26% in the second half of the year compared with last year.

The other two members of the Big Three, which account for more than 52% of Russian steel production, MMK and Severstal, did not publish their forecasts but said that 20%-40% of their equipment could be shut down as early as June.

On the one hand, this indicates that it is impossible to reorient Russian steel supplies from Europe to other regions quickly. In May, companies started complaining that non-European buyers of Russian steel started demanding 30%-40% discounts from Russian companies, citing complications in logistics and the risk of secondary sanctions.

The strong ruble also works against metallurgists: For example, according to the Russian Steel Association, the ruble exchange rate of $=63.5, combined with rising coal prices and Russian Railways’ tariff hikes, makes it unprofitable to export steel slabs to China, which in April replaced exports of finished products to Europe. Today, the ruble is 10% more expensive than the barrier set by industry association experts.

Some will not

Russian fertilizer producers turned out to be more nimble and lucky (fertilizer prices continue to rise worldwide), and in May, they managed to make up for half of the export drop recorded in April.

On April 8, the European Union restricted imports of Russian fertilizers as part of its fifth round of sanctions against Russia. After that, exports of fertilizers from Russia fell rapidly by more than 40% at the end of April. Rail shipments (i.e., to Europe) accounted for almost all the contraction. The first statistics of Russian Railways as of May results say that export transportation of fertilizers increased by 32.4% compared with April.

Bottom is behind us?

A few days ago, Deputy Prime Minister Alexander Novak predicted that the peak of the decline in oil production in Russia has passed and that in June, oil production will begin to grow. According to him, Russia is “finding a point of balance,” facing constraints, shifting supply logistics, and rising freight costs.

Interfax reported that Russia’s average daily oil and condensate production in the first 13 days of June rose by nearly 55% compared to May, which may confirm Novak’s hypothesis.

Belated decision

The European Court of Human Rights ruled that Russia’s law on foreign agents violates the right to freedom of assembly and association (Article 11 of the European Convention on Human Rights). The decision was published on the court’s website on June 14. The ECHR awarded each of the 73 NGOs claiming compensation of 10,000 euros plus the amount of the court costs. The suit, joined by 73 Russian organizations, was filed over seven years ago, and last week, President Putin signed a law that says Russia will not honor ECHR rulings handed down after March 13. 

The court’s ruling reads:

… the Government has not shown relevant and sufficient reasons for creating a special status of ‘foreign agents,’ imposing additional reporting and accounting requirements on organizations registered as ‘foreign agents,’ restricting their access to funding options, and punishing any breaches of the Foreign Agents Act in an unforeseeable and disproportionately severe manner. The cumulative effect of these restrictions—whether by design or effect—is a legal regime that places a significant ‘chilling effect’ on the choice to seek or accept any amount of foreign funding, however insignificant, in a context where opportunities for domestic funding are rather limited, especially in respect of politically or socially sensitive topics or domestically unpopular causes. The measures accordingly cannot be considered ‘necessary in a democratic society.’

The law on foreign agents is actively used in Russia to fight against freedom of speech, political opponents, and civil activists. The list of foreign agents now includes 77 NGOs, 45 media outlets, 115 individual journalists and bloggers, and seven political activists. The criteria the Ministry of Justice uses when making labeling decisions are traditionally unclear and vague for Russian legislation, giving wide latitude to interpret the term “political activity” and allowing, for example, the receipt of a salary from a company whose income is partially generated from advertising on Google’s website or YouTube to be called foreign financing.

The State Duma is currently considering amendments to this law that replace the main criterion used in labeling it: Being under a foreign influence is sufficient instead of receiving foreign funding. In addition, the new law introduces restrictions on the rights of Russian citizens who will be labeled as foreign agents: They will be prohibited from being organizers of public events; conducting teaching, educational, or training activities for children; producing informational products for them; receiving government grants; and investing in strategic enterprises.

Price of the war

Andrei Yelchaninov, first deputy chairman of the board of the Russian Military-Industrial Commission, said that in 2022, budget spending to finance arms purchases would increase by 600 billion-700 billion rubles.

The intensity of the enterprises has certainly increased: Reserve capacities are loaded, all accumulated technical and human resources are used to meet the demand for defense products of the Defense Ministry and other security agencies... We understand that under these conditions, the defense industry must not only cover the needs of the military but also replenish the spent stockpiles,” he noted. “This work is already done. The state must have a stockpile in case of warfare and protect itself from any influence.

According to the law on the budget, expenses for purchasing and repairing armaments in 2022 will exceed 1,500 billion rubles. Thus, they will be increased by 40%-45%. The 8%-10% increase can probably be justified by rising inflation, but the remainder is the price the Russian budget is beginning to pay for the war in Ukraine.

Arms manufacturers in Russia have contracts with rigid contract prices, and traditionally the Ministry of Finance refuses to consider real inflation and index the cost of contracts. The budget ministry’s strange logic leads to defense enterprises being forced to take bank loans to finance their expenses. Still, because the interest on loans is not factored into the price, the arms manufacturers stop paying the banks after a while. Lending to defense enterprises is a monopoly of the state banks, whose combined lobbying resources ensure that the Ministry of Finance (in one way or another) gives money to the banks to pay back the loans. 

Why does this logic not seem strange to the Russian Ministry of Finance? Because the state banks make steady and good money on financing defense enterprises, which allows the Ministry of Finance to negotiate the use of their facilities for other projects unrelated to the production of armaments.