Economic Issues Coming To A Head For The Russian Government
October 3, 2023
  • Igor Lipsits

    Professor, Dr.Sci. (Economics)

Igor Lipsits summarizes the developments in the Russian economy in September and details how the government is trying to fight the fuel crisis, stabilize the ruble, extract RUB 500-700 billion from exporters needed to balance the budget, and cool off lending as Russians borrow more amid rising inflation expectation.
The original text in Russian was published in Republic; a slightly amended version is being republished here with their permission.

The news flow about the Russian economy in September was simply overwhelming. We shall try to fish out the processes that are most important and fraught with long-term consequences for the country.
An oil refinery in Omsk, Siberia. Source: Wiki Commons
Oil producers and the domestic market

The ongoing fuel crisis is perhaps the most striking and consequential event for Russian industry.

It would seem that given the difficulties with selling Russian oil and petroleum products, which are under [foreign] sanctions, there should be no problem with supplies of gasoline and diesel in the domestic market. In addition, the “price-damping” mechanism that levels out the profitability of motor fuel exports and sales in the domestic market, in effect in Russia since 2019, has worked quite well, ensuring steady supplies to gas stations throughout the country. The adage “if it ain’t broke, don’t fix it” might apply here.

Nevertheless, the government decided to halve damper payments to oil companies from September 1. After all, the money is urgently needed to plug the budget deficit. But after these payments were cut, supplying the domestic market became unprofitable for oil companies.

Business responded rather predictably, sharply ratcheting up exports of motor fuel to countries that are still ready to take it. Meanwhile, as the demand for supplies of motor fuel has increased, wholesale (exchange) prices for motor fuel in the domestic market have been going up since April.

At first, the government reacted sluggishly. They said that everything is fine, that there are temporary difficulties due to the shutting of refineries for scheduled maintenance, but the country has large reserves of fuel, the Federal Antimonopoly Service is monitoring retail prices at gas stations, and so there is nothing to worry about! They underestimated the issue.

As a result, the fuel crisis intensified in September, when first in the south – in the regions closest to the front line (they are, incidentally, important zones for Russian agriculture, and it is time for the harvest) – and then closer and closer to the center of the country, shortages appeared.
Gas stations proceeded to take measures and gradually increase retail prices for gasoline and diesel fuel.
President Putin had to go out and try to calm everyone down, saying that the government did not react in a timely manner to changes in the global market amid rising oil prices, though generally oil producers and the government had agreed on how they would move forward.

However, Putin’s rhetoric about an agreement proved unfounded. In fact, the Russian government simply and heavy-handedly introduced on September 21 “a temporary restriction on the export of gasoline and diesel against the backdrop of the record rise in fuel prices within the country and shortages in some regions.”

It is claimed that by doing this, officials are seeking to force oil companies to agree to the introduction of prohibitive duties ($250 per tonne) on the export of motor fuel for companies that have not yet supplied the required amount of fuel to the domestic market.

Russian business, however, is expert at circumventing not only foreign sanctions, but restrictions imposed by its own government too.

Another factor should also be taken into account: according to oil companies, if the export of diesel is banned, then there is nowhere to put such volumes in Russia, since approximately every second tonne goes abroad. This means that if diesel fuel is not allowed to be exported, then it will not find buyers inside the country. The point here is not even prices, but the physical volume of fuel (in particular, marine fuel) needed by Russian transport.

Still, refineries should not be shut, so then where should the oil taken out of the ground go? In this scenario, refineries would be forced to export – instead of diesel – what is easiest to sell abroad – less profitable naphtha (a product of only the first stage of crude oil distillation). But then oil company profitability will suffer. And then where will the Ministry of Finance get taxes from?

Foreign trade: the government decides to take money from exporters

The main news of September in this regard was the introduction of an “exchange rate rent” on goods exported by Russian companies. This “novelty” was invented, as far as we know, by the Ministry of Finance. After all, according to the ministry’s estimates, RUB 500-700 billion is needed to balance the budget this year. So, they decided to get this money from an additional duty (from October 1 of this year until October of next year) on a wide range of exported goods that is to be tied to the ruble-dollar exchange rate (the weaker the ruble, the higher the rate). The idea is that the more the ruble depreciates, the more revenues exporters will generate in rubles.

It would seem that since exporters will have more revenues in depreciating rubles, their profits will also be greater, which means that the tax service will collect more taxes for the Ministry of Finance anyway. Why then invent such a duty?

Amid the ruble depreciation and the accelerating inflation it is fueling, the ruble costs of exporting companies will also increase. This means that it is still difficult to say what kind of profit exporters will actually make and how much the tax service will be able to take. Thus, the Ministry of Finance decided not to risk it – meaning not to share the risks of depreciation/inflation with exporters – and shake them down “right at the border” with the temporary duty.

It remains unclear how exporters will react to this. But one cannot expect them to show particular zeal for increasing imports, which feed the budget with various payments and the country as a whole with the currency to pay for imports.
According to preliminary data, monthly mortgage issuance amounted to a record RUB 849 billion in September. In the picture: an advertisement for a 2% mortgage in Russia's Far East. Source: VK
Monetary and currency policy: the Kremlin and government trying to stabilize the ruble

Even Putin understands that the depreciation of the ruble is fraught with accelerated inflation, and rising prices make voters very anxious.

Therefore, at a meeting with members of the government, he said that it was necessary to clearly understand why the ruble weakened. “The situation in the FX market has become the main factor behind accelerating inflation, and this is now one of the main issues,” Putin said, remotely addressing Prime Minister Mikhail Mishustin and economic bloc ministers.

It is necessary to “make the appropriate decisions in a timely manner, without delay,” the president said, without, however, specifying what decisions he had in mind. After all, the reason for the rise in prices (rates) of FX is obvious – significantly less convertible currency is coming into the country than before. Meanwhile, the demand for it (in rubles) – to pay for imports and to move capital out of the country – is high and rising, as the government pours more and more money into the economy – for defense orders, payments to soldiers and support for the poorest segments of the population. The Central Bank has been carefully but persistently talking about rising pressure on the FX market from this overhang of rubles for a long time.

This means that to stabilize the FX market, more convertible currency must flow into it. Technically, Putin himself already made an attempt to do that when he “persuaded” exporters of mineral fertilizers to bring back to Russia and sell part of the FX earnings that they keep in foreign accounts. In fact, he explicitly allowed exporters to do this by decree back in July.

The effect of the “president’s request” (supplemented by a raise to the Central Bank’s key rate in order to dampen the incentive for banks to take out loans and buy FX with them) was weak and short-lived: the dollar exchange rate briefly fell by a few rubles, but after a few days it went up again. As a result, the ruble became one of the worst performing currencies in the world and recorded its longest period of sustained losses since 2014: since October 2022, the ruble is down against the dollar in nine out of 11 months.

And since imports to Russia are not falling, imported goods are becoming more and more expensive in rubles. As a result, annual inflation, according to Rosstat, accelerated from 2.3% in April to 5.5% as of mid-September, while at year-end the Central Bank forecasts inflation of 7.5% (in August, the monthly rate corresponded to annual inflation of 12.0%).
Meanwhile, even though Russian oil is rising in price, there is still no significant increase in the surplus of export earnings over imports.
Perhaps the reason for this is that Russian oil companies continue to sell oil not for freely convertible currency, but for non-convertible currency (like Indian rupees). It is no coincidence that VTB head Andrei Kostin proudly said that they had learned to convert rupees into rubles through intermediary countries, without dollars. The second possible reason is that exporters are simply leaving an increasing portion of their earnings (especially in FX) in foreign accounts.

Where will things go from here? It is possible that the state will decide (as in the case of fuel) to simply begin to stabilize the exchange rate using administrative methods, destroying the FX market. For example, on September 25 Economic Development Minister Maxim Reshetnikov proposed creating something similar to the “Chinese model” for the ruble, “a kind of membrane between the domestic ruble market and the foreign ruble market,” though he clarified that “two rates is an extremely harmful phenomenon… [that] we are opposed to.”

Borrowing and lending: you only live once!

You only live once! This expression comes to mind when you find out that Russians borrowed almost a trillion rubles from banks in a month.

First of all, they took out mortgages: according to preliminary data, monthly mortgage issuance amounted to a record RUB 849 billion. Banks’ mortgage portfolios rose RUB 579 billion over the month to surpass RUB 16 trillion (RUB 16.44 trillion). Consumer loans also rose – by RUB 314 billion, or 2.4%, to RUB 13.4 trillion. Car loans were up RUB 62 billion to RUB 1.49 trillion.

This behavior is evidence that the population is in a hurry to spend the money being paid out to families of soldiers and use it for the first mortgage installments. The pickup in borrowing can also be seen as a result of increased financial literacy, as people do not believe the cheerful statements by the president and government about the economy – on the contrary, they believe that things will get worse and more expensive in the future. Simply put,
“Inflation expectations have become alarming. Thus, people are in a hurry to take out loans before inflation accelerates and the cost of borrowing rises even more.”
The situation for lenders is already frightening the Central Bank. In its latest banking sector report, the Central Bank admits that the growth of consumer loans is becoming problematic: “the quality of new loans remains low. In the second quarter of 2023, the share of loans with a >80% DSTI (debt service-to-income ratio) was 27% and [that with] a 50-80% DSTI was 33%.” In other words, almost a third of borrowers already give more than 80% of their income to pay off their loans.

But since the Central Bank has raised its key rate to 13% and is threatening to hike it further, people are afraid that the cost of borrowing will become even higher and are rushing to apply for loans now. This is what inflation expectations do.

More and more families, meanwhile, are going bankrupt across the country: the number of bankrupt citizens in the first quarter of 2023 was up 40.3% versus the same period in 2022 (to 76,000 people).

Overall, September marked a month of increasing problems in the FX markets, accelerating inflation and a rising debt burden of the population. The trend of using purely administrative methods in economic policy also became quite visible. This does not bode well for the Russian economy going forward.
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