Successes but no prospects for peace
Is Europe taking a step back?
A cure that doesn’t heal
A jungle of problems in the Russian forest
...but nevertheless
Profound pessimism
God, take what is not suitable for us
The collapse will happen tomorrow
No reason to go there
No way to fly anyway

Over the next two weeks, I have several flights scheduled, which will break my working timetable and temporarily reduce the number of my publications to two per week, on Tuesdays and Thursdays (June 28 and 30 and July 5 and 7).

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Successes but no prospects for peace

After two months of continuous fighting, the Russian army has made some progress toward what can be called the minimum goal of the offensive launched in early April: Encirclement of the Ukrainian cities of Severodonetsk and Lysychansk. The coming days will show whether Russia has been able to form additional capabilities to finalize the blocking, or whether it needs more time to do so, leading to stabilization of the situation for a while. Both sides remain confident they can gain a meaningful advantage on the front in the medium term, forcing the opposing side to agree to significant concessions.

A week ago, American magazine The National Interest published an article by regular contributor David Pine outlining a very complimentary plan for Russia to resolve the situation around Ukraine peacefully. In particular, Ukraine should recognize the annexation of Crimea, allow Donbas to hold a referendum on independence in three months, and reduce the number and quality of weapons in its army. Russia must withdraw its troops from the Kherson and Zaporizhzhya regions in exchange for lifting sanctions, renunciation of reparations in favor of Ukraine, and renunciation of an international war crimes trial.

Russian presidential spokesman Dmitry Peskov said that the Kremlin was not familiar with the plan (which sounds strange, given that Dmitry Simes, the magazine’s publisher, is a regular contributor to programs on Russian state television) but stressed that the Kremlin is ready for peace on straightforward terms: “A peace plan is possible after Ukraine meets all the demands of the Russian side.”

Since Russia has never clearly articulated a complete set of its demands, we can only repeat Vladimir Putin’s words at the end of March: “The conditions for a ceasefire in Ukraine are not yet ripe.”

Is Europe taking a step back?

Closing the transit of cargoes through Lithuania to Kaliningrad has become one of the most rapid sanctions imposed by the European Union against Russia. At least this is confirmed by the hysterical statements of many Russian politicians and Vladimir Putin’s meaningful silence. Usually, the Russian President plunges into silence when faced with a sharp aggravation of the situation from which he sees no way out.

In this connection, the chief of European diplomacy, Josep Borrell, phrases that the European Commission would “revise” the sanctions guidelines, under which Lithuania blocked the movement of goods between Russia and the Kaliningrad region, which can be seen as a blatant concession to Putin.

There is no blockade in Kaliningrad. Lithuania applies the Commission’s sanctions guidelines. But the EEAS (European External Action Service) will revise the guidelines to clarify that we do not want to block or prevent traffic between Kaliningrad and Russia but only to prevent circumvention of sanctions. Both should be possible, and we are working on that. It’s not about blocking; it’s about inspections of certain goods, which should be done reasonably, without blocking traffic between Russia and its exclave on the Baltic Sea.

A cure that doesn’t heal

Russian authorities are seriously concerned about the rapid strengthening of the ruble, which is perceived as a serious threat to Russian exports. Yesterday I said that the requirement for compulsory sale of all export proceeds did not force exporters to sell the currency they received: As this requirement was reduced from 100% in March to 50% at the end of May, and until this requirement was abolished June 10, currency sales on the Moscow Exchange increased. Today it became known that the Russian authorities are ready not only to cancel this requirement shortly but also to allow exporters not to credit export revenues to accounts in Russian banks. This was announced by the First Deputy Chairman of the Bank of Russia, Vladimir Chistyukhin.

We [will have] significant relaxations on the sale of foreign currency earnings... a draft presidential decree is being prepared, according to which the requirement to repatriate foreign currency earnings will apply to the volume of foreign currency earnings that need mandatory sale... If the mandatory sale is zero, as it is set today, then there should be no repatriation either.

In my view, this decision will curb further strengthening of the ruble: The main reason for the ruble’s appreciation is its limited convertibility—i.e., the bans on many current and capital transactions. As long as these bans remain in place, the ruble exchange rate dynamics will be determined by the trade balance in the Russian balance of payments.

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A jungle of problems in the Russian forest

Western sanctions are gradually affecting different sectors of the Russian economy. On Wednesday, the Federation Council held a big “Roundtable,” during which one of the participants gloomily uttered: “The industry is approaching apocalypse.”

The Federal Forestry Agency has already seen this problem: It has registered a decrease in timber felling, especially in the North-West, in some regions “by dozens of percent,” as it was reported by Alexander Panfilov, the deputy head of the agency. In recent years, 70%-75% of products in this sphere were exported, and today the main problems for the companies are growing logistic costs, failures in bank payments, and a strengthened ruble. On July 10, a ban will come into effect on the supply of products from the Russian timber industry to Europe (the “fifth” EU sanctions package), which will be a natural disaster for many, especially for the producers of plywood. According to the Ministry of Industry and Trade, Russia produces 4 million tons of these products, and 3 million tons are exported, of which 60% were supplied to the EU.

Anatoly Frishman, General Director of SVEZA (the largest producer of plywood in Europe and the only one in the Russian timber industry to come under direct sanctions, along with other assets of Alexei Mordashov), reported that the company is operating at 30%-35% of its maximum capacity, “which is essentially a disaster.”

Nikolai Ivanov, Vice President of Segezha Group, which exports 70% of its revenues, calculated that building new logistics chains to the East is too expensive and often unprofitable. “A comparison in numbers gives a 2.5 to 4.7-fold increase in logistics costs due to the need to develop new markets.”

He gave the example of supplies of pellets, which used to be sold to Europe, but now have to be sent, for instance, to Korea, where these products are ready to be purchased. In some contracts, including logistics costs, the price was as low as minus 15 euros, he complained.

“What does the manufacturer do in this case? He stops production, of course.”

...but nevertheless

Despite all the apocalyptic views of the roundtable about the future of the forest industry, a certain amount of positive mood appeared in one of the proposals voiced at the meeting. Segezha’s Nikolay Ivanov asked the government to create a legal mechanism for “intercepting” management of companies and forest lands from investors from unfriendly countries in case they leave Russia. According to Ivanov, this will allow avoiding problems “related to loss of jobs and loss of manageability of forest areas.” He noted that the share of foreign presence in the industry is high, especially in the pulp and paper and board production.

In addition to Turkish companies, there are many owners from quite unfriendly countries—Austria, Switzerland. Companies that potentially could leave Russia lease [from the government] a combined 35 million hectares of forest, about 10% of the entire available cut of the estimated logging area.

Apparently, despite the catastrophic situation, Russian business hopes that the complimentary receipt of new assets can compensate for the severity of the current problems.

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Profound pessimism

The results of the May survey of consumer expectations published by Rosstat showed a deep pessimism in the population, even though most Russians, according to sociological surveys, support Vladimir Putin and the war in Ukraine and do not feel the pressure of sanctions.

The composite index and the index of assessments of changes in the country’s economy over the past year have fallen to levels comparable to those in early 2015 and the spring of 2020. At the same time, the index of expected changes has fallen to its lowest point since early 2014, and young people, who have always been the most optimistic, are the most pessimistic about the prospects for the Russian economy.

12-month forward-looking economic sentiments by age groups

God, take what is not suitable for us

By early 2017, Promsvyazbank (PSB) was one of the 10 largest banks in Russia, and at the end of that year, the Bank of Russia announced that it needed to be bailed out and took it under its management. A year later, the Russian government decided it needed this bank, which agreed to make it the backbone bank for the defense industry sector. Therefore, the bank’s performance indicators were classified, allowing the government to use them for other tasks. So, in early 2020, the government decided to draw a line under the protracted history of failed attempts to rehabilitate Svyaz-Bank and Globex, which Vnesheconombank handled. The bailout attempt not only dragged on for more than 10 years but also resulted in growing losses for Vnesheconombank, which seriously undermined the quality of its reporting. For this purpose, both banks were transferred to PSB ownership, which immediately hid all the problems under a veil of secrecy.

This solution to the problem of failed reorganization interested a close friend of President Putin, Arkady Rotenberg. SMP Bank, which he owns, came under U.S. sanctions in March 2014, and in May of that year, by decision of the Bank of Russia, became a bailout of Mosoblbank, having received from the Bank of Russia 100 billion rubles for this purpose. (This amount later increased to 170 billion rubles.) Because Rotenberg’s sole talent was being Putin’s friend, his business projects succeeded only when he got budget money or the right to a local monopoly. The sanitation of Mosoblbank failed, and SMP Bank’s losses began to increase yearly. As a result, the banking business became a suitcase without a handle for Rotenberg, which is hard to carry and a pity to leave.

But why throw it away when you can sell it? thought Rothenberg, and the government-owned PSB decided to buy SMP Bank. As a result, the history of sanitation and the accumulated losses associated with it will disappear in the bowels of PSB. Rotenberg will get... How much Rotenberg will get, I think, depends on the decision of Vladimir Putin. Since 2019, SMP Bank received the right not to publish its financial statements, so no one can compare the “fair price” of purchase with the size of its capital and asset quality.

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The collapse will happen tomorrow

Difficulties with logistics and bank payments after the imposition of Western sanctions have not impeded the Russian steel companies: According to the World Steel Association, for the first five months of 2022, the drop in production was 2.3%, which looks normal against the background of reduced production by all the major global players, except India.

The noticeable decline in production of Russian metallurgists began in June when the EU sanctions hit Severstal: According to the results of the month, the capacities of the company were not used by 20%-25%, Aleksandr Shevelev, General Director of the company, admitted. In the second half of the year, the production volume in ferrous metallurgy may fall by 30%; Deputy Minister of Industry Viktor Yevtukhov gave this forecast. According to analysts’ estimates, Russian metallurgists have already reduced the purchase of iron ore in Russia by 25%-30%, which indicates a readiness to reduce production. The small hopes are connected with the possibility of the growth in the domestic demand: The large consumers can take advantage of the decreased prices and increase their reserves. In addition, President Putin’s promises to increase funding for infrastructure projects could boost steel demand.

The metallurgical companies’ attempts to find new sales markets do not look very successful so far: The increased length of transportation brings higher transportation costs, consumers being aware of the difficult situation faced by Russian companies, demand for price discounts, and the continuing appreciation of the ruble eating into their profits.

No reason to go there

The Duma leadership, deprived of the ability to travel abroad due to the sanctions, decided that we all have to suffer together. The HR department began inviting all the deputies’ assistants to talk to them about the difficult geopolitical situation and that everyone was advised not to travel abroad. “When applying for a leave of absence in the HR department, it is now required to manually write on the form that ‘No vacation abroad is planned.’”

By law, each of the 450 deputies can have up to seven full-time assistants, but usually, two to three people are working. No word yet on the consequences of breaking the promise, but for those who view Parliament as a full-time job, it could lead to the end of their careers.

No way to fly anyway

Passenger traffic by Russian airlines in May 2022 is down about 26% from May 2021 to 6.5 million people, with increased market concentration. The two largest companies, Aeroflot and S7, each lost 20% of passengers, while Pobeda and Ural Airlines, which are #3, and #5 lost 36% and 32% of passengers, respectively.

Russian authorities no longer hope to restore international flights, which closed after the Russian government forced the companies to expropriate the leased planes. Still, they believe that allocating 110 billion rubles from the budget to subsidize the cost of flights within the country could support public demand. The main problem today is the closure of most airports in the south of European Russia due to the ongoing war in Ukraine, which breaks the habit of many Russians spending their summer vacation at the Black Sea. For now, airports are closed until June 30, but no one has promised that the war will end by then.

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Behind the Iron Curtain

June 23, 2022