Russia’s Economy: A Primer

Carnegie had a piece yesterday denying that Russia has a problem with its reserves. But the article by Anton Tabakh is full of half-truths, and misleading statements. As usual, Carnegie is carrying water for the Regime.

I have covered a lot of this before in different posts on the blog, but I think putting it all in one place may be valuable for future discussions.

Health Care Spending

First, Tabakh takes on the Milov article I posted here earlier this week on the health care budget. He claims that Milov and others are panicking over nothing.

Many seem to have forgotten that for over a decade, the state has channeled the lion’s share of medical funding through the Federal Compulsory Medical Insurance Fund, not the Health Ministry. The fund’s budgets for 2016 and 2017 are 1,688 and 1,692 billion rubles, respectively. This means that healthcare spending may fall slightly in real terms, but not by a third.

But RIA Novosti reported two weeks ago that the draft budget did not provide enough money for the Fund. In addition, as Milov pointed out, what has happened is that the responsibility for funding the bulk of healthcare costs has been dumped on the regions, most of whom cannot afford it.

Reserve Fund

The Reserve Fund (sometimes called the “Stabilization Fund”) is being used to pay down Russia’s deficits. Over half of the money in that Fund will be spent next year, 1.15 trillion rubles of 2 trillion rubles.

Tabakh writes:

In short, the Reserve Fund is doing what former finance minister Alexey Kudrin had in mind when he set it up in the early 2000s: cushioning the economy from the shock of falling oil and gas prices and buying it time to adjust to new realities.

But the problem is that the government is not adjusting “to new realities”. In fact, they’re doing the opposite. They’re pretending the problems don’t exist. Problems that, by the way, are systemic, and not a temporary phenomenon. Problems that should have been addressed during the “fat” years of high oil prices. Instead the Russian Regime is taking the easy way out and using the Reserve Funds as a crutch, hoping that the price of oil will magically start rising again. Meanwhile, the Reserve Funds cannot be replenished because the price of oil is so low.

National Welfare Fund

The National Welfare Fund is supposed to be dedicated to future pension payments. Instead it is being used for other purposes. The Fund currently holds approximate 4.6 trillion rubles. However, Tabakh admits that one-third of the money in the NWF is “illiquid”. That is, the money is recorded on the Finance Ministry’s books, but it is actually physically elsewhere.

In fact, they are sitting on at least 3 different books. The Finance Ministry is, as you would expect, counting these funds as theirs. But then the money is also included in the Central Bank’s International Reserves spreadsheet. And the money is also being used to prop up VneshEconomBank, and presumably other state-owned banks. The added benefit of this is that the money in those banks earns interest. Think of it like putting money you don’t need now into a CD at your bank. That money is earning interest, but you can’t access it until a certain set time in the future.

Tabakh also says that some of the money from the NWF was used to buy eurobonds issued by Ukraine in December 2013. The Russian government is currently suing Ukraine to try to get this money back, but it is not looking promising. That is, this is money that the government has on its books as coming to them in the future, but they are likely never going to get it back.

Foreign Direct Investment

As for Foreign Direct Investment (FDI), I have discussed that here too. At this point, most of what is called “FDI” is Russian money that has been laundered out of the country, and then re-invested from offshore zones like Cyprus.

The same thing is happening when Russia “borrows” abroad. For example, when Russia did its Eurobond placement in September of this year, Minister of Finance Siluanov bragged that 53% of the sales were from the US. But in essence, the government is borrowing from itself, though the oligarchs boyars.

To be fair, Tabakh does conclude that there are systemic issues that are not being addressed by the government:

This is not to say policymakers should be complacent. Russia’s federal budget faces long-term pressure from a deficit-plagued pension system, outsized spending on the security services and military, an unstable tax base, and gaps in regional budgets that will need to be patched up. Hidden tax hikes (through fines and harsher enforcement) also raise doubts about the government’s upbeat plans for budgetary consolidation. These are the problems that should be worrying us—not the fate of the reserve funds, which were made for times like this.

The government’s plans to try to widen its tax base are fantasy at best. Given the option, most businesses will just go underground. And money will continue to seep out of the Russian economy into offshore zones. The Reserve Funds which Tabakh touts are finite, they will eventually run out. Whether that happens in 6 months or two years is not really the point. I just cannot be as upbeat as Tabakh claims he is.

Further Reading:

Capital Outflow

Diamonds & Gold

Looking for Revenue

Auctioning Assets

Where is the money?



Counter Sanctions

Last week, Russia’s Deputy Foreign Minister Sergei Ryabkov told the State Duma that Russia was developing a “series of measures” for an “asymmetrical response” if Washington imposed more sanctions.

However, the deputy FM gave no details on what the “asymmetrical response” would entail.

So Rosbalt went to the experts and asked what they thought the Kremlin would do.

HSE Professor Nikolai Petrov told the paper:

“We have already seen such options. It is most likely going to withdraw from the agreements that we signed… with the US. In addition to the agreement on weapons-grade plutonium, [which] has been suspended, there is also the agreement on medium and short-range missiles (the INF [Intermediate-Range Nuclear Forces Treaty]), and so forth.

This logic has continued ever since the “Magnitsky List”…. To cause moral damage to the enemy, we are ready to make some decisions, knowing that they do not necessarily prove beneficial to us but often the reverse and will be quite painful.”

Petrov also noted that several “agreements with US in the field of strategic arms limitation” were set to expire, and suggested that they would not be renewed.

“At the same time, the expert believes that what we are seeing today as a certain toughening of Moscow’s position, is in fact a kind of “pre-sale preparation”.

He predicted that before the end of the year, “the Kremlin will make some move to improve relations with the West…” and have the sanctions regime removed. But from a position of strength, “so that it will not look like a sign of weakness, but… another victory.”

Vice President at the Center for Political Technology Alexei Makarkin disagreed with Petrov, saying:

“…the agreement on the limitation of strategic weapons will be treated carefully because to dismantle the system of strategic stability is still scary.”

In Makarkin’s view, “the Russian government may impose certain restrictions on foreign investors.”

“If in the 1990s investment attractiveness was considered a priority, now on the contrary, the investor is considered to be a kind of threat, like a man who can find out all of our secret plans in this area, or as someone who is too dependent on the West, on its own government.”

Moscow Carnegie Center’s Alexei Malashenko thought that Russia’s options were limited.

“According to him, the economic measures Russia [has imposed] against the US would have totally insignificant consequences, given the small volume of trade between the two countries. Restrictions on entry of some officials from the US to Russia have been introduced, and to no avail…”

Pulling out of the “treaty on limiting strategic arms would only benefit the military -industrial complexes of the two countries,” Malashenko added.

If that were to happen, it would set off “a new arms race”, which Russia would lose “because the Americans are first in the world in terms of GDP, and we are twelfth.” So our sanctions “cannot harm America, no matter how hard we try,” he concluded.

Looking for Revenue

The Ministry of Finance may impose a tax on income from bank deposits, Deputy Minister Alexei Moiseev said.

According to Moiseev, the situation where people “in principle do not pay anything on deposits” is quite exceptional in world practice.

“A person with one billion rubles on deposit, and there are such people, and they pretty much do not pay any tax on the income of their deposits. You cannot do this anywhere else.”

Moiseev also noted that the President had proposed cancelling taxes on bond coupons.

Then the bond holders would not have to pay anything on earned income to the state.

Moiseev did, however, acknowledge “…that the Ministry of Finance was unable to figure out how to do it.”

“That is why we are looking at a working version of equalizing conditions through “do everything worse”, that is, nevertheless, to impose taxes on some portion of the deposit,” he said.

The Deputy Minister did take pains to impress on his listeners that the proposal was not in the budget draft law, but that the Ministry was looking at options to increase revenue, and this was one of them.

Of course, Rosbalt reminded its readers that the outcome of this proposal would be a spike in capital flight, with “more affluent investors” moving money into the financial markets abroad.

Asset Stripping Fraud

The article is a translation of a blog post by former deputy chairman of Russia’s Central Bank, Sergei Aleksashenko. In the article Aleskashenko details how the Central Bank is committing asset stripping fraud of Russian banks.

“The scheme is ridiculously simple.

  • The Central Bank turns a blind eye to capital and clients’ deposits being siphoned off from a bank;
  • those same Central Bank passive onlookers then decide that the bank has to be saved (although of 30 bail-outs, not one bank has yet managed to return to full operation);
  • the same people choose which bank will save the bankrupt bank and decide how much money has to be allocated for this noble purpose;
  • then those very same people give the DIA [Deposit Insurance Agency; the equivalent of the US FDIC] a loan for 6-8 years at an interest rate of 0.5% (that’s right – half a percentage point);
  • after that the same people [from the Central Bank], or some of them, visit the DIA where, as members of the Board of Directors, they decide to issue a loan of billions of roubles (at an interest rate of 0.51%) to the banks involved in the bail-out.
  • The bank doing the rescuing then uses the funds it has received to buy a federal loan bond at the current rate of return from the Finance Ministry and receives a guaranteed income;
  • the Finance Ministry meanwhile uses funds from the federal budget for the next 6-8 years to pay the interest on the bond sold to the bail-out banks.
  • At maturity, the bond should pay off all the money received as a loan.”

This scheme, Aleksashenko writes:

“…has already cost over one and a half trillion roubles and, taking into account the interest to be paid, the federal budget is going to have to shell out considerably more than two trillion roubles.”

Now, he concedes,

“To be fair, it should be said that the banks have paid back slightly more than 20% of the one and half trillion roubles disbursed. To this end, some assets have been transferred on to the DIA balance sheet. But their real value is unknown as the DIA site carries no information about the nature of these assets, why the DIA needs them, what it has done – or intends to do – with them.”

He continues:

“There have never been, nor are there still, any clear or transparent criteria for deciding which bank should be bailed out – and which should be left to collapse – and it is only the bureaucrats who are allowed to have anything to do with analysing proposals for bail-outs…. Moreover, after some time it emerged that the rescuers were finding the allocated funds insufficient, so multiple hasty appeals for top-ups were launched at the Central Bank because “what you sent last week was gobbled up straight away” (a quote from Korney Chukovsky’s children’s story Telephone).”

Aleksashenko concludes:

“….This way the federal budget is incurring ever more debt, although we know that there is no longer any money left in it, so any extra unplanned kopecks spent throws the Finance Minister, who is also a DIA board member, into a blind spin of rage. It looks to me as though this endless stream of new decisions about money to be allocated was one of the main reasons for the recent purge of the Central Bank’s supervisory committee.

When I decided to look at the final summary of what the sacked “supervisors” had been up to, force of habit led me first to the usual place on the DIA site in the hope of downloading the usual tables, but I didn’t find any. So the bureaucrats’ cat had a very good idea of whose meat she had been eating and decided to sweep all the information about her dinner under the carpet – to avoid any uncomfortable questions for the officials.

We must disabuse the said officials: we will find the information, we shall be asking questions, and we shall name and shame those who are personally responsible.”


Bloomberg had an article today about the sanctions titled “U.S. Stuck with Nobody Left to Sanction in Russia Over Syria”.

The “analyst”, by the way, is Michael Kofman, from the Wilson Center’s Kennan Institute in Washington.

Kofman told Bloomberg:

“While the president has full sanction authority, there’s nobody left to sanction in Russia besides the janitor in the Kremlin. In terms of expanding any kind of commercial or financial sanctions, we’re basically maxed out.”

The sanctions are not working. There are multiple reasons for this. Firstly, it is still unclear what the end goal of the sanctions is. Is it to prevent further Russian encroachment in Ukraine? Is it to force Russia to leave Crimea? Is it to oust the Russian government, and Putin specifically? We just do not know. It has never been made clear. Equally, it has not been made clear to the Russian government what they have to do to have the sanctions repealed.

Another reason the sanctions are not working is because there is no enforcement of them. I have yet to hear a story about someone’s bank account being frozen because of the sanctions. And the travel ban has been proven to be a joke on multiple occasions. See for example this story published in September about presidential advisor Vladislav Surkov violating his EU travel ban to visit Mt Athos in Greece, or Surkov’s more recent trip to the EU to take part in the Normandy talks.

Thirdly, for all our talk, we do not know who the real decision makers are in the Kremlin. It seems as if the US State Department had a list previously drawn up, and just went with it, without doing any real research.

And finally, we are turning a blind eye to the Russian Regime’s intentions. Western politicians and pundits have bought into this myth that the adventurism displayed by the Regime is to protect the personal wealth and power of the elites. But if that were true, wouldn’t they have retreated from the supposed threat the sanctions have placed on their personal wealth?

There are other options besides individual sanctions. There are also other options besides going “nuclear” and cutting Russia off from SWIFT. But to dismiss the current trajectory as “maxed out” is at the very least disingenuous.

Healthcare Spending

Opposition politician Vladimir Milov is running a series of blog posts on Russia’s recently published 3-year draft budget. His most recent article focuses on proposed health care expenditures.

Milov first condemns the cynicism of the Regime in its exploitation of its newly minted “constitutional majority”.

“Shortly after the elections (to do so earlier was dangerous, for obvious reasons) the Ministry of Finance published a draft three-year budget through 2020.”

There are a lot of horrible things in the draft budget, Milov writes, saying that he will continue to analyze them in future posts. But, he continues, “without exaggeration, the most anti-national and simply criminal plot is the planned radical reduction in healthcare expenditures.”

“Let’s just look at why we have such a high mortality rate in the country. Every year nearly 2 million people in Russia die, and the reasons for two-thirds of the deaths are cardiovascular disease and oncology (cancer).”

Milov includes a pie chart from Rosstat (the State Statistics Office) showing that 48.7% of deaths in 2015 were from cardiovascular disease, while another 15.7% were from cancer.


“Therefore, it would seem that the State from all of its resources should spend the most significant share [of the budget] to reduce the mortality of its citizens from the most life-threatening diseases of Russians. Especially since… we are far behind developed countries [technologically].”

But what does our State do instead, he asks. With a budget of 13 trillion rubles, they cut the programs that would help these people.

“Now these programs will be as low as only a few hundred million rubles a year…”

And meanwhile, the security services and the bureaucracy will get about 50% of the budget.

“This catastrophic cut in funding for these programs in fact can only be interpreted in one way – die, citizens, as you wish. We have the budget deficit, geopolitics, Syria, the fight against the US, and you have your cancer and your heart, and this is your problem, we are not responsible.

In general, the share of spending on health care in the budget will be greatly reduced in the next three years.”

And instead:

“All responsibility for healthcare will be shoved into the regions, whose budgets are in deficit and debt and simply do not have the money for it… and even those [regions] who have money are cutting back on medical expenses, like Sobyanin [the governor of Moscow region].”

The budget anticipates spending 113 billion rubles less on healthcare next year compared to this year, a slight increase in 2018, and another drop in 2019.

“Compare these pitiful numbers to, for example, the cost of the army, although in 2017 they are proposing to reduce [their share] from 4 trillion rubles to 3 trillion, but it is still ten times more than the authorities proposed to spend on health care. Or the 2 trillion [ruble] expenditure on the security services, the police, the National Guard, etc. (“National Security and Law Enforcement”), these costs, by the way, unlike the military, they do not plan to cut.”

Milov concludes:

“At the same time, by all possible international standards, medicine Russia is greatly underfunded – in terms of health care expenditure as a share of GDP, we hang out somewhere in the region of 80-90th place in the world, behind not only developed countries, Ukraine or Moldova, but also even a dozen African countries. You can be sure that a new round of decline in spending on medicine will throw us to the end of the world ranking of health financing, on par with Nigeria, Papua New Guinea, and the Democratic Republic of Congo, where they spend 3-4% of GDP.”

Diamonds & Gold

The Finance Ministry is cutting back purchases of precious metals and gems for Gokhran (Russia’s precious metals and gems repository) this year by 2.5 times, from 12 billion rubles to 5 billion rubles, “Izvestia” reported today.

At the same time, large-scale sales of gold and diamonds are planned to replenish the state treasury.

As of 1 October, the paper reports, the Ministry of Finance had only spent 19.9% (or 2.4 billion rubles) of the 12 billion rubles budgeted for purchasing precious metals and stones.

The Ministry’s press service told “Izvestia” that they only planned to spend about 7 billion rubles in total this year.

In conjunction the Finance Ministry intends to increase sales of precious metals and stones in the next three years. The Ministry plans to sell off about 4.522 billion rubles of the commodities this year, 10.411 billion next year, and another 10.5 billion in 2018-2019. These sales will be used to “provide operational funding for the federal budget deficit”, the Ministry claims.

In 2015-2016, purchases of these assets were doubled, analyst Roman Tkachuk told the paper. He stated that the Ministry is now returning to its pre-crisis patterns:

“Between 2012 and 2014 Gokhran bought mainly diamonds, but in the past few years, most of the funds have been invested in precious metals.”

“The relatively high prices prevailing in the market today will allow the Finance Ministry to profitably sell these assets,” the paper claims, “World prices for precious metals and diamonds have been fairly stable this year.”

“The Ministry’s decision will have a moderately negative impact on the diamond market, experts say.”

Gokhran purchases from state diamond company, “Alrosa” are secret, but according to Tkachuk, they range somewhere between “1 and 10 billion rubles a year” (or only 1-5% of the company’s total revenue).

“But the State Fund has traditionally bought… the most expensive stones, the export of which is prohibited abroad. So the news is marginally negative for the diamond company.”

Another analyst told “Izvestia” that the reduction of state purchases from “Alrosa” could make it easier for the company to sell its product abroad. But, he added, “the sale of state reserves will put additional pressure on world prices, which are already reduced in recent years.”

“At the same time, gold producers are not affected: on the one hand, the market is able to support the demand, on the other – procurement plans are stored in the Bank of Russia,” the paper wrote, quoting the head of the Union of Gold Producers:

“So far we have to more substantially cooperate with our other creditors in the market, especially with Russian banks, as well as more and more active fund development in the Far East and the Baikal region. And the high domestic liquidity of gold, as always, is provided to us by the Central Bank.”

Bad Actor, Bad Institutions

I have been noticing a theme in the Western press (and not only the English language press) with regards to its coverage of Russia. It is one that I have commented on in the past, but it was really brought to the forefront when I saw the cover photo of this week’s Economist.

The implication is that President Vladimir Putin is the problem with Russia, and that the only solution is to oust him. The publications’ articles on the topic were not much better. One about Russian hipsters (yes, they do exist) and the revival of a kind of 1970s dissident culture in the country’s two main metropolises.

Another article explicitly placed the blame for what is happening solely at the feet of Putin and a few cronies.

For years we have been told that building institutions was the answer. That depending on a single actor to reform Russia was a mistake. But now problems that were once labelled “systemic” are the fault of a single bad actor. And removing that individual from power is the answer to all our problems.

Ignored in all of this is that Putin is the product of a bad system. A system that bred him, molded him, installed him in the President’s office, and sustains his grip on power. A system that rules by fiat, has no checks and balances, no respect for the rule of law, no private property rights… A system that is, as I have written here before, essentially still feudal in nature. A system that does not respect its own Constitution. And yet we expect these same people to adhere to international law.

Meanwhile, the billionaire Alexander Lebedev is operating illegally down in Crimea, building a hotel complex, and other tourist attractions. He is now hurt that Ukrainians are bothered by his actions.

He concludes his diatribe by essentially saying “we will all laugh about this over a glass of wine in 20 years”.

Mikhail Khodorkovsky, Alexander Lebedev, and Alexei Navalny (just to name a few) have all said that they would not return Crimea to Ukraine if they were in power. But these are the “liberals” who Western pundits expect to lead Russia when the Putin era ends.

Well, good luck to them.

Capital Outflow

The Russian Regime appears to be very concerned with the potential impact that a further weakening of the ruble would have and have been warning about it. There have been several articles (some of which I have highlighted here already) mostly pointing to the fact that Rosneft’s lack of ready cash could cause major problems for the Russian currency come December.

According to Russia’s Central Bank Russian companies have $21.6 billion in external debt due by the end of the year, and another $15.2 billion due by the end of the first quarter of 2017. This does not include banks or other financial institutions.

As for the banks, Raiffeisenbank analysts predict a further outflow of capital.

“Since the beginning of the year, foreign currency in corporate accounts decreased by $20.5 billion or 14%.”

That is, every 7th dollar has left.

“Foreign exchange reserves of the banking system, the reserves on the accounts in foreign banks – remained at its lowest level in 5 years and reached $20.4 billion, down by 20% from the beginning of the year.”

The columnist Sergei Shelin wrote earlier this week that a drop in the price of oil could hurt the ruble too. But, he says, the main thing is that people panic. There are three things that could happen with the ruble:

“A more or less marked weakening of the ruble in the coming months is quite possible, although not guaranteed.”

The rising price of oil may prevent this, however. But Shelin writes, “I do not believe this is very likely.”

Second, if the ruble is again weakened, he says, “it is unlikely to be on the same scale as two years ago or even one year ago.”

And third, Shelin does not rule out “a powerful devaluation” but for this to happen, there would have to be external shocks, “such as the collapse of the global energy market, or some major adventures on the domestic and external fronts.”


Russia’s Sports Minister Vitaly Mutko has been removed from his post, and given a new role in the Russian government.

BBC’s Richard Conway had reported Mutko’s potential transfer last week:

And Conway’s sources were correct. Yesterday, President Putin named Mutko his 9th Deputy Prime Minister. Mutko’s portfolio will be that of sports, youth, and tourism.

In theory this would give Mutko more power because the more you are responsible for, the more rents you can extract. So rather than just getting kickbacks for sports, he can now take kickbacks for youth and tourism. And he can also give out more favors to more people. And I think that is why the Western media and analysts are reporting this as a promotion. But those of you who have been reading me for awhile know that I don’t view these moves as anything but lateral transfers. Because titles are not usually a true reflection of responsibilities and placement in the hierarchy.

Anton Orekh writes in Ekho Moskvy:

It is possible to simultaneously promote a person and send him to the bench. We can say this, since we are talking about sports. The appointment of Mutko to Deputy Prime Minister formally raises him in the hierarchy, but in fact, it is unclear [if this is the case]. The position may be purely nominal. Only Mutko himself became a living anecdote.

A chief might be good or bad, but should not be funny. Mutko sometimes says sensible things, and puts forward some interesting ideas, but all of this is drowned out by his eccentricities and flows of rambling verbiage.

But the truth is that Mutko had to be sacked after the Olympics, because of what happened at Rio, Orekh continues.

Sport is a showcase of Putin’s rule, because apart from sporting victories, and the bombing of Syria, we have nothing to boast of.

And with the doping scandal, he writes, “it was Mutko who primarily demonstrated a complete inability to accurately respond to the situation. Every time he was late, not by a step, but by a hundred paces. He constantly answered at random, was unable to give at least some explanation. And each new scandal was a surprise for him. He did not even have to come up with the role of scapegoat, because he chose [to take on] this role himself.”

But to sack Mutko would have been to admit that Russia was guilty, and so that option was impossible. But it was equally impossible to allow him to keep his position as Sports Minister.

“However, you could do worse: to merge into one the Ministry of Sport, Tourism and Youth Policy. That is three completely different areas of activity. It is somehow believed that sport is for young people. That tourists do sports. That young people are constantly traveling with dumbbells and skipping ropes. But, thank God, that did not happen.”

Instead it all went under “the duties of the new Deputy Prime Minister. And in this sense, the appointment of Mutko was the correct one.”

And the Sports Minister will be Pavel Kolobkov. Who performed a lot of draft organizational work, and if something in the Ministry was sensible, it was largely thanks to Kolobkov. And foreign “partners”, so to speak, are not allergic to him.”

And if Mutko will leave Kolobkov alone to get on with his work, Orekh concludes, “the current reshuffle can be evaluated as a solid four.”