The basics of the economy. Defects of the budgetary policy. Putin made an offer that Biden can(not) refuse.

December 16, 2021

Today, Alexei Navalny received the European Union’s leading human rights award, the Andrei Sakharov Prize for Freedom of Thought. Of course, Vladimir Putin did not let Alexei out of jail for this, and Daria Navalnaya received the prize for her father. In her speech, she said:

“This is the Sakharov Prize. Andrei Sakharov was one of the most pragmatic people. I don’t understand why people who campaign in his name for pragmatic relations with dictators can’t open history books. That would be a very practical move. And then they would realize that appeasing dictators and tyrants have never worked. How many people have tried to convince themselves that a madman who struggles to hold onto power will behave decently in response to concessions and flirtations? This will never happen.

The whole point of authoritarian power is to play up the stakes, be aggressive, and find new enemies.”

Vladimir Putin held a three-hour session to discuss national projects, which are a focus of his economic priorities. Three subjects caught my attention.

Supply and demand: the basics of the economy

The first was the dialogue between Putin and Deputy Prime Minister Marat Khusnullin, who oversees the construction sector, including transport and social infrastructure, with budgetary funds. In his report, the deputy prime minister first said that the Finance Ministry had authorized the advance financing of 500 billion rubles ($6.8 bln. or 2.2% of annual outlays) of expenses related to infrastructure construction. Then he expressed extreme surprise that the prices of construction materials had risen drastically. 

“... [The prices of] metal have gone up about 70 percent; bitumen, as you said, about 70 percent... we have, for example, a 100 percent increase in [price of] sand. We have schools—construction sites—already increased in price by 26 percent, housing—by 22 percent, metal bridges with spans—by 30 percent, utilities—by 19 percent... in several regions, we have found that, for example, brick has increased in price by 40 percent absolutely unreasonably.”

This tirade prompted an understandable reaction from Vladimir Putin. He demanded that the Deputy Prime Minister personally take charge of price controls.

“Are you somehow involved or does the FAS [Federal Antimonopoly Service] take part in determining these price increases... for common construction materials and so on...? Mechanisms must be constant here—not just preventive conversations. Mechanism of control should be created; direct dialogue is needed... It is necessary to keep it under control; we must set specific deadlines and specific terms; we must have information by a certain time. Put it under control and see what happens.”

Alexander Kozlov, the Minister of Natural Resources, told how such mechanisms might look later. “In October, we initiated audit, together with the Prosecutor General’s Office for those facilities that have already been built; and at our request, the Attorney General has already instructed the regions to check pricing.” 

Although all the ministers of the economic bloc took part in the meeting, none dared tell the President that an unexpected increase in demand always results in a drastic rise in prices. More so because construction companies, which have said that the budget will compensate them for all increases in the cost of construction materials, have no incentive to stall in negotiations with suppliers, seeking lower prices.

“The government is ready to allocate money to compensate contractors for the increase in the cost of construction materials for projects, the organization of which is carried out with the involvement of the federal budget”—this is what Deputy Prime Minister Khusnullin said. In economic theory, this is called a “soft budget constraint,” which always leads to inflation. Since Putin is demanding that Khusnullin increase the rate of construction, it should come as no shock that next year too, the Russian President will say with surprise, “Why has gravel gone up? Okay, gasoline has gone up—it’s harder to deliver...”

He is the only one who can do it

The second story is related to the history of Vladimir Putin’s emergence as a federal politician. He became head of the FSB in July 1998 and remembers how much the August financial crisis shook the political and economic structure of the state. “Never again!” he decided [apparently] for himself. 

Since then, Alexei Kudrin and his successor, Anton Siluanov, have always had a reliable tool for restraining the President’s desires to increase budget spending. Here is how Putin himself described this dialogueю

“Right now I do not even want to debate with the Finance Minister, because I know his answer: Let us define the priorities, and within the framework of the budget’s existing financial capacities, by defining these priorities, let us decide upon the volume of financing without destroying macroeconomic indicators. What do you say against that?”

Anton Siluanov is the only person in President Putin’s economic team today who worked at the Ministry of Finance in August 1998 and can remember that crisis firsthand. And it is unlikely that anyone else can limit Vladimir Putin’s desires so straight and short.

Defects of the budgetary policy

Another, in my opinion, very significant problem was identified by Alexei Kudrin, head of the Accounts Chamber. 

“...21 percent of buildings where first medical care is provided are in a condition that requires significant repairs. In several republics, the situation is much worse. For example, in Yakutia, 23 percent of those buildings are in an emergency condition, and the situation has been worsening over the past three years. And, for example, in Astrakhan and Tyva, 30 percent of paramedic stations are in an emergency condition...

“... these are the permanent entitlements of regions, and it would be wrong to bring them into a state of emergency or inability to maintain them. We need to pay attention to the issues of financing the primary powers of the regions permanently.

“Today it turns out that [regional] expenditures [on healthcare] are growing faster than revenues... Consequently, there will not be enough money even for expanding the network and its maintenance. Federal projects provide massive support for construction and investment in modernization. But projects can come to an end... and it will be difficult for the regions to maintain these buildings and institutions in their current position, but not in an emergency condition.”

Having very accurately identified the region’s lack of financial resources to maintain social infrastructure built with federal budget funds, Kudrin went further and criticized the existing system of budgetary transfers from the federal budget to the regions.

“... They [transfers] are all very narrow targeted; I would note the diversity and fractional nature of such subsidies even within individual federal programs. But the autonomy of the subjects [regions] is minimal, their hands are often tied here: The subject cannot send its funds to some other tasks that it sees as more important today.”

All told, this is correct. The federal Finance Ministry transfers money to the regions in 146 different channels and requires that 99% of budget expenditures be approved by Moscow. The only thing Alexei Kudrin was silent about was that he created this system when he was Finance Minister.

Putin made an offer that Biden can(not) refuse

Vladimir Putin held a video summit with Chinese President Xi Jinping. “The President [Putin] informed that literally today in our Foreign Ministry, American representatives were handed concrete proposals aimed at working out legal guarantees for Russia’s security,” presidential aide Yuri Ushakov told reporters. According to him, the proposals were handed over to U.S. Assistant Secretary of State Karen Donfried.

One summit didn’t happen; what will happen to the next one?

U.S. President Joe Biden said Wednesday that he plans to have a detailed conversation with his Russian counterpart Vladimir Putin. 

It should be recalled that a week ago, President Biden announced talks between Vladimir Putin and the leaders of the four NATO countries. But there was no follow-up to this announcement. I wonder what will happen this time?

Glasnost the Putin way 

The Russian Duma passed a law that allows the introduction of personal sanctions for violating “fundamental human rights and freedoms, the rights and freedoms of citizens of the Russian Federation” against the citizens of any country. A significant innovation is that lists of individuals subjected to Russian sanctions may become public (today, this information is not publicly available). The Russian Foreign Ministry will maintain lists of foreigners under personal sanctions, said Deputy Foreign Minister Yevgeny Ivanov.

“We want this law to show that we’re not keeping it secret and are not compiling these lists somewhere. We want these lists to be public so that foreigners involved in such things would understand the consequences.”

Guarantees not to pay attention to

After the State Corporation Rosnano paid the coupon on its bond issue on time two days ago, the company went to court to invalidate the loan agreements given under the state guarantees. The company is not satisfied that the banks did not carry sufficient risks and did not assess the reality for repayment of credits. I am humbled by the company’s reasoning:  

“In the absence of state guarantees, the bank would not have gone into loan agreements because it would have concluded that there were no confirmed sources of repayment. In the situation with state guarantees, the bank considered it possible to give a loan, being aware of the high probability of covering the debt at the expense of state guarantees, notwithstanding the infringement of the interests of the borrowers and the guarantor in the future.” 

The essence of any guarantee is that the guarantor evaluates the borrower’s risks and accepts them. In this case, the lender considers the quality of the guarantor as a de facto borrower without going into the details of the de jure borrower’s business. However, these trite truths may not be accepted by a Russian court, which would be a severe blow to the desire of banks to issue new loans guaranteed by the Russian Ministry of Finance. But this should be a headache for the Minister of Finance. The task of Rosnano’s executives is to relieve the company of the burden of debt. 

COVID news

Nearly 2,500 COVID-19 infections have been detected in Moscow in the past 24 hours, a 24% increase over the previous day, city authorities informed. Moscow has seen a rapid slowdown in the pandemic in recent weeks, so this surge looks very unusual. Is this the beginning of a new wave, or are we talking about a random fluctuation? We’ll see in the coming days.