A Sober View On The State Of The Russian Economy
At End-2023
December 19, 2023
  • Igor Lipsits

    Professor, Dr.Sci. (Economics)

Based on the latest data and news, economist Igor Lipsits analyzes the consequences for Russia’s economy due to the ramping-up of defense production, construction related to the conflict in Ukraine, Western sanctions and government policy priorities.
The original text in Russian was published in Republic. A slightly amended version is being republished here with their permission.

The government has put out upbeat data that Russian steel production rose 9.5% year-on-year in October to 6.3 million tons. Since the beginning of the year, steel production growth amounted to 5.3%, the second highest rate among the world’s major steel producers after India.

Steelmakers are being supported by an expanding domestic market: consumption for construction and industry is increasing. According to Severstal estimates for the first nine months of the year, more than 60% of Russian steel output goes to the domestic market, which has expanded 7% this year. The growth of metal consumption in construction was 9% to 27.4 million tons and 12% to 3.5 million tons in industry.

These trends are consistent with the recently approved decision to reallocate a big chunk of funds from the “closed” (secret) part of the budget for 2024 to the “open” (public) part. The biggest such reallocation came in the “national defense” line: its open part increased by RUB 725 billion. The second biggest reallocation was for “national economy,” with RUB 152.49 billion being reallocated to the open part. A considerable part of these funds will be used to reconstruct the “new territories” incorporated into Russia. This all means more smelted steel.

Recall that production in defense-related industries increased by 20-30% in the first eight months of 2023 alone. By the end of the year, the growth will most likely be even higher. Nevertheless, experts say the first signs of a slowdown are already appearing.
Of course, 12-hour work shifts could be introduced at military-industrial complex enterprises, but such intensive use of equipment – care for employees is clearly not a primary concern – could cause a growing number of accidents and downtime. Plus, building new defense factories is unrealistic at this point.

As for nondefense production, the picture is sadder: in July-September (for three months in a row), industry as a whole registered declines in production. And
“While the defense sector has been supported by injections from the budget, growth in other areas of the economy has actually stopped due to large-scale personnel shortages and sanctions on technology imports.”
Even the flaccid 1% growth of industry as a whole in September is nothing to write home about, as electricity, gas and steam production fell in September by 3%.
How can industry grow if the energy that supplies it is falling?
Crude oil supertanker AbQaiq. Source: Wiki Commons
The hunt is on for tankers carrying Russian oil

November saw attempts by Western countries to more effectively reduce Russia’s oil and gas revenues. In the second half of 2023, the Western “price ceiling” on Russian oil basically stopped working, which allowed Moscow to pencil in a significant increase in oil and gas revenues for 2024. Some of the ideas for making the sanctions more effective were quite exotic – for example, EU officials proposed that the Danish government strictly police tankers carrying oil from Russian ports in the Baltic and not let them pass through the straits owing to the danger of an oil spill (the tankers that Russia has been buying from Greek shipowners are old and thought to be unreliable).

From a legal point of view, this is possible, as the country can say it is looking out for the safety of its coast (there is such a provision in the UN Convention on the Law of the Sea). However, the Danes did not show enthusiasm for the idea, and it is dead for now.

Nevertheless, from the standpoint of Russia’s oil export revenues, November was full of threats. For example, three major Greek shippers – Minerva Marine, Thenamaris and TMS Tankers – stopped transporting Russian oil in recent weeks after new sanctions from the US. They had been carrying Russian oil for decades and remained key players even after most other Western shipping firms exited the Russian business in 2022. They transported more than 40% of all Russian oil. Such shipments brought record profits for shippers that dared to take the risks.

This latest exit of Greek companies will significantly reduce the number of ships ready to transport commodities from Russia. In October, Washington slapped the first sanctions on shippers in Turkey and the UAE for carrying Russian oil at prices above the ceiling, following that up in mid-November with sanctions against three more companies and three vessels (in December, the US Treasury and State Departments levied new sanctions against more than 250 companies and individuals in China, Turkey and the UAE for their continued support for Russia – RP).

In addition, the European Commission is proposing banning the sale to Russia of tankers for transporting crude oil and petroleum products. Such a measure would help prevent Western sanctions on Russian oil from being circumvented using a “shadow” fleet of tankers. The proposal, discussed by EU ambassadors in November, also implies that sales of tankers to third countries must include contractual terms prohibiting their resale to Russia. They would also not be allowed to be used to transport Russian crude oil or petroleum products that violate the Western price ceiling.

The problem for Russia is that to transport its oil, it had purchased from the Greek shippers about 100 old tankers (the entire Greek fleet is more than 5,500 ships, accounting for more than 31.78% of the world’s oil tankers). And countries are already afraid to let these tankers into their ports. For example, the Indian government this year barred entry into ports for loading and unloading by oil tankers, bulk carriers and general purpose vessels over 25 years old that are registered in the country or sailing under the flag of a foreign country.

State-owned companies and regions short of money
At the end of 2023, Russia’s regions faced a sharp reduction in financial assistance from the federal budget.”
(this follows from a review published by the Gaidar Institute). For July-September, transfers to regional treasuries were down 23.2% year-on-year, the highest drop among all revenue items in regional budgets. Almost all types of federal transfers, which account for every sixth ruble of regional budgets, have been slashed.

Moscow is reducing direct support for regions as more and more funds from the federal treasury are consumed by security forces and the army sent to conquer Ukraine.

In the reallocations from the closed to the open part of the budget, the federal government also increased subsidies to some state-controlled companies and for “preferential” (state-backed) mortgages (for the programs that will be in effect until July 1, 2024). Thus, budget expenditures on preferential and family mortgages next year will increase almost fourfold: from RUB 119 billion originally planned to RUB 454 billion.

Over the first eight months of 2023, 95% of all mortgages in the Russian primary real estate market were issued through preferential programs. Construction of freestanding houses is completely dependent on these programs, with 99.8% of loans issued to build them being “preferential.”

Meanwhile, no decision has yet been made on subsidizing loans that the largest state-owned companies previously raised from banks. On November 1, news emerged that officials from the biggest state-owned companies – Russian Railways, AvtoVAZ, Roscosmos, Aeroflot – had complained about rising interest rates on floating-rate bank loans amid Central Bank key rate hikes. Without subsidies, the state-owned companies said they would have to reduce investments and raise tariffs.

For example, whereas in 2023 AvtoVAZ is spending about RUB 10 billion to service loans from banks, next year, due to rising rates, these expenses will jump to RUB 17 billion, said Sergei Gromak, vice president for government and investor relations at the state-owned company, during a round table. Russian Railways First Deputy Managing Director Vadim Mikhailov agreed.

According to Mikhailov, at a key rate of 15%, rates on five-year loans to develop infrastructure will be more than 17%. In his view, “such a [high] rate for infrastructure projects, which are on the edge of delivering a return or cannot at all, does not make any sense.”

Mikhailov emphasized that Russian Railways understands “all the restrictions that exist now in terms of the budget and the use of NWF funds;” however, without government support for major infrastructure projects, the only alternative source of funds will be increasing tariffs, he warned. Starting December 1, 2024, railway freight tariffs are already scheduled to rise 10.75% (this is included in the forecast of the Ministry of Economic Development, which serves as the basis for calculating the new budget).
If the Kremlin nevertheless decides to help dangerously over-leveraged state-owned companies, this will become an additional burden on the recently approved federal budget.
What should private companies do with their floating-loan rates? The “nonlinear dynamics of the key rate in recent years,” to put it mildly, has led to a situation where more than 40% of corporate loans are now floating-rate, Mikhailov noted. Thus, not only new investment projects, but also projects that were launched two or three years ago have floating rates.

“Companies are facing a situation where they do not know what to do with the credit burden they already have, let alone how to finance new projects. For some companies, more than 50% of EBITDA (earnings before interest, taxes, depreciation and amortization) goes to make interest payments, which is a consequence of such a [high key] rate,” said Alexander Kirevnin, who leads the department that oversees financing and investment at the Ministry of Economic Development.

And let’s not forget, of course, about the unprofitability and trillion-ruble debts of military-industrial complex enterprises, which have repeatedly gone through bankruptcy, and have been saved from being liquidated only because they were transferred to the state corporation Rostec.

Now, VTB has been saddled with doing the same thing for the unprofitable United Shipbuilding Corporation.
Oleg Deripaska, a Russian billionaire and the founder of Basic Element investment group established in 1997. Source: Wiki Commons
Against the backdrop of growing requests for state subsidies (it is increasingly resembling the economy of the USSR, which was eaten through by subsidies), one can take rather seriously Oleg Deripaska’s forecast that the revenue side of the Russian budget in 2024 may look like “you hit your rump on the ice,” since global prices for some commodities may decline significantly next year.

According to Deripaska, the Russian budget may be short RUB 10-12 trillion next year. He (this time without going after the Central Bank) cited “suppressed economic growth and the tyranny of state capitalism, which is raising prices for all products and services and pulling transfers and subsidies from the budget” as the reasons for the negative outlook.

The dollar at 80?

What should we expect moving forward? It seems the state is trying to bring down the dollar exchange rate to about 80 rubles. Will it succeed in doing that? It is quite doubtful, as even at current exchange rates the demand for dollars and euros is rising, while less and less FX is flowing into the Russian market – at the beginning of 2022, the share of the dollar and euro in the revenues of the biggest Russian exporters was 96%, but now it has decreased significantly. Indeed, the yuan has become the main foreign currency in Russia.

We can expect higher budget expenditures – as always given the logic of prepayments for future purchases. A hike to the Central Bank’s key rate is also likely, but whether it will reach 16% or 17% is the question.
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