#279 Gradually, then Suddenly*
Russia's Underlying Economic Troubles, India's Surge in Electronics Exports, and are Milk Cooperatives Ready to Compete?
Global Policy Watch: The Russian Economy is Hurting
Insights on global issues relevant to India
— RSJ
Russia, this Thursday, struck Dnipro with what Ukraine described as a nuclear-capable intercontinental ballistic missile (ICBM), marking a significant escalation in options it is willing to use if pushed to a corner. This move came soon after the US allowed Kyiv to use long-range NATO missiles on targets inside Russia. While there is still a debate on whether the RS-26 that was used is an ICBM, with Putin himself calling it an “experimental Oreshnik missile that has only an intermediate range”, it is possible that Russia wants to send the message to the incoming Trump administration that it can take this all the way to a nuclear attack if they continue following the Biden line. Ukraine’s defence is stretched, and it can hold out only for so long if Russia continues with this escalation. Putin, it appears, doesn’t want Trump to have any second thoughts about his promise of ending the war in Ukraine. Any ceasefire, after all, allows him to sit on about 20 per cent of Ukrainian territory with a promise of no further NATO expansion in his backyard. Putin wants to show he has an upper hand now, and he’s playing it to maximise his gains.
That’s one way of looking at it. But there’s more here than meets the eye. The Biden administration is turning the screws on the Russian economy especially hard in the last couple of months. Putin might be running out of time very soon to keep the Russian economy going. This notion goes against the headline numbers that Russia keeps putting out, suggesting how well its economy is doing. However, there’s more, as a recent piece in the Foreign Policy highlighted:
“Despite these accomplishments, Russia’s war economy is heading toward an impasse. Signs that the official data masks severe economic strains brought on by both war and sanctions have become increasingly apparent. No matter how many workers it tries to shift to the defense industry, the Kremlin cannot expand production fast enough to replace weapons at the rate they are being lost on the battlefield. Already, around half of all artillery shells used by Russia in Ukraine are from North Korean stocks. At some point in the second half of 2025, Russia will face severe shortages in several categories of weapons.
Paradoxically, the same factors that are converging to restrict Russia’s ability to wage war also mean that it cannot easily make peace.
Russia’s economic performance—marked by low unemployment and rising wages—is a product of military Keynesianism. In other words: Vast military expenditures, which are unsustainable in the long term, are artificially boosting employment and growth. Almost all the new jobs are related to the military and produce little of value to the civilian economy, where most sectors have great difficulty finding workers.
Some important lessons emerge. First, Russia’s economy cannot indefinitely sustain its war against Ukraine. Labor and production bottlenecks will condemn Russia to a defeat as long as Ukraine’s allies sustain it beyond the second half of 2025. Contrary to the myth of infinite Russian resources, the Kremlin’s armies are far from unbeatable. But Russia’s defeat demands a level of Western patience and commitment that a combination of vacillating Western leaders and volatile domestic politics renders questionable.
Second, the cessation of full-scale fighting in Ukraine will not end the West’s problems with Russia. Russia’s supersized military sector incentivises the Kremlin to use its military to extract rents from neighbouring states. The alternatives—demobilizing and incurring a recession or indefinitely funding a bloated military and defense industry—pose existential threats to Putin’s regime.” [DeVore and Mertens, Foreign Policy]
Now, read that with what the US Treasury did this week when it imposed sanctions on Gazprombank, the largest remaining non-designated bank, and more than 50 connected entities. Gazprombank is vital for the Russian military to buy materials from the international market. Concurrently, the Office of Foreign Assets Control (OFAC) issued a warning to foreign financial institutions that have joined the SPFS, the Russian alternative to SWIFT, the global financial messaging system, that has helped Russian entities to access international financial institutions and evade sanctions. Additionally, OFAC has asked banks across jurisdictions (including India) to review their exposure to institutions that have joined SPFS, failing which they will invite sanctions from the US, including exclusion from accessing US financial systems. A lot was written about the alternative payment system and possible alternatives to the dollar during the BRICS summit in Russia. The Treasury announcement attempts to nip any such efforts in the bud.
The US Treasury had kept Gazprombank out of its initial sanctions because Western Europe needed Russian gas for their energy needs, and they had to have a channel to pay for it. However, this need has reduced over the past two years as these countries have found alternatives to Russia and brought down their dependence from about 40 per cent of their total needs to below 8 per cent. Also, on Jan 1, 2025, the contract for Russian gas transiting through Ukraine and then through the pipes in Slovakia and the Czech Republic to Western Europe come to an end. There’s no chance that this is going to be renewed. Separately, earlier in November, the US Treasury Department had targeted businesses and individual actors across the 17 jurisdictions, especially in China, Turkey and India, who were helping the Russian military-industrial base evade or circumvent sanctions. Like this week, even this notice was specifically aimed at banks and financial institutions who were supporting these transactions and warned them of being shut out of US financial systems if they continued to deal with these entities.
The existing sanctions have hurt Russia, as already seen. But these latest rounds of tightening that target Gazprombank and anyone helping Russia evade sanctions will make things tougher for Putin. The trade sanctions on military goods are already creating a scenario where the Russian army will likely run out of key armaments in another six months. The strict action promised to anyone using SPFS will make importing goods and services using a cross-border payment mechanism more difficult. The ban on Gazprombank will mean that the rising forex reserves of about $300bn sitting in the Russian Central Bank (CBR) will become illiquid. The CBR deputy governor, Alexei Zabotkin, has already flagged last month that the “production capacity is depleted and that labour shortages have significantly worsened”.
The bottom line is Putin would like a quick end to the war possibly more than even Trump. There is a real constraint as import restrictions hurt further. But, more critically, how will he continue funding the war from just domestic savings and resources if export restrictions start truly biting from January? The only solution will be to coerce the private sector and citizens to pay more for the war in terms of taxes or use their capacity to support it. The labour shortage, which is already evident in having North Korean soldiers and sundry mercenaries fight on the frontlines for the Russian army, will get worse next year. Putin isn’t upping the ante in the war to signal his strength. I guess that he is desperate to be at the negotiating table to end the war. If Trump is as consummate a dealmaker as he fancies himself to be, he will find Putin for the taking if and when they sit down in February to discuss how to end the war.
India Policy Watch #1: The Full Picture
Insights on current policy issues in India
— Pranay Kotasthane
Earlier this week, a Business Standard article on India’s electronics exports surge caught my eye. The punchline:
Electronics exports reached the highest-ever mark of $19.1 billion within a seven-month period of any financial year, at the end of October 2024. This is a 24 per cent growth over the $15.4 billion export figure for the sector during the same period in the last financial year, according to the latest government data.
Further:
Nearly 55 percent of the electronics exports until October 2024 constituted smartphone exports alone. Apple was a major contributor. Exports of iPhones formed 66 percent of the smartphone exports and 37 percent of electronics exports from India until October 2024.
Last year, at the end of October, electronics was ranked the sixth-largest export, behind engineering goods, petroleum products, gems and jewellery, pharmaceuticals, and organic and inorganic chemicals. By October this year, it had jumped three positions to occupy the third slot, only behind engineering goods and petroleum products.
Electronics becoming India’s third largest export is a terrific development. A combination of China’s self-goals, the Indian government’s production-linked incentive scheme, and the changing nature of Indian consumption all seem to have played a role.
However, this is not the entire picture. This success has led many to believe that all we now need to do is double down on the current package of policies, which includes a production-linked incentive coupled with high tariffs for electronic products and components. This would be a wrong takeaway because the reality is that the rise in electronics exports continues to rely on the import of electronics components from China. Take a look at the government’s own data on imports of electronic components over the first six months of the current financial year. This category includes chips, display panels, etc.
Every month’s imports this year are higher than the imports of the corresponding month last year. Moreover, nearly 60 per cent of electronics component imports happen from China and Hong Kong. Thus, India’s surge in electronics exports is causally linked to an increase in imports from China, and this has happened despite the increase in import duties. The import increase builds upon an already large base from last year. Many components imported in the last year would have been converted into phones this year.
Most people would see this as a problem. But as we have written before, there can be no exports without imports in today’s world, where national industries have been displaced by global supply chains. The takeaway is that India’s electronics exports would have been higher only if we were to reduce import tariffs.
This observation backs the report Globalise to Localise: Exporting at Scale and Deepening the Ecosystem are Vital to Higher Domestic Value Addition in Electronics, which argues that India must first globalise and only then localise if it aspires to be a global production and export hub for electronics.
As for the concern that Chinese chips might pose a security threat, here’s why I think that fear is overblown. First, chips imported from China are not necessarily ‘Chinese’ chips. China is a much bigger player in outsourced assembly and packaging of chips than in fabrication. So, it’s highly likely that many of the packaged chips that India buys from China were originally fabricated as dies (unpackaged chips) in other countries, such as Taiwan or South Korea. Moreover, even if the chips were indeed fabricated and packaged within China, the work could actually have been done by foreign companies with facilities in China (such as Samsung, UMC, and SK Hynix), rather than ‘Chinese’ companies per se. Second, chip dependence on China is not a strategic vulnerability. As long as multiple alternative suppliers are available outside China—which is the case for most commodity chips—the dependence fails to translate into a tool of statecraft that China can deploy against India. Finally, for India’s chip assembly and packaging to take off, the frictionless import of unpackaged chips without barriers is imperative. Thus, there is no avoiding the continued import of chips from China over the next few years.
India Policy Watch #2: No Crying Over Spilt Milk
Insights on current policy issues in India
— Pranay Kotasthane
I remember the controversy that erupted before the Karnataka assembly election when Amul announced its entry into the fresh dairy market in Bengaluru. Since it came at a time when the production at the state cooperative (under KMF’s Nandini brand) had dropped, the opposition charged that the government was creating ‘artificial scarcity’ to help Amul. Politicians started saying that cooperatives, by definition, should cooperate, not compete, and a quotidian issue got linked to state pride and became a front for inter-state tensions.
This week, the story took a welcome twist. The Karnataka CM launched Nandini brand’s dairy products in Delhi-NCR, a stronghold of other firms like Amul and Mother Dairy. This competition is a positive change. With Nandini entering other markets, Karnataka should also have less problems allowing other players in. In last year’s milk shortage saga, the lack of alternatives due to protectionism by state governments led to a situation where poor consumers faced shortages while dairy farmers couldn’t sell raw milk at higher prices to private players. Let competition erase all fiefdoms under the garb of cooperatives.
HomeWork
Reading and listening recommendations on public policy matters
[Podcast] The story of title pirates in this Planet Money episode will remind you that Khosla ka Ghosla scams are for real, and not just in developing countries like India. This episode is about a title pirate in the US.
[Podcast] Here’s a Puliyabaazi with Amit Kumar comparing India-China consumption trends.
[Paper] Overcoming the Tragedy of Super Wicked Problems has a useful path-dependency analysis framework that can help in tackling wicked problems.
* Ernest Hemingway, The Sun Also Rises
The Russian strike on Dnipro was no ICBM - it was an IRBM. The Oreshnik is just a modified version of RS-26 Rubezh, which is a non-precision missile. That being said, agreed with the overall theme that Putin is now frustrated.
Interestingly, the Biden admin called Moscow and announced the change of policy re. ATACMS - in advance. And, although not required to do so (because this was no ICBM) then Moscow called Washington to announce this launch at Dnipro - in advance. So, at least the US-Russian system of avoiding escalation is actually still working. In my opinion, de-escalation is not very far away.
On the ""The Russian Economy is Hurting" topic... I think it is a mistake to evaluate America's approach piecemeal. The Americans are trying to fight on too many fronts with too many adversaries, and with each a different kind of battle. Ukraine is of one kind, China economically and geopolitically is another kind, Middle East involvement is a third kind.
With Trump, one can't be sure if the next set of adversarial relations will be Mexico on the border; and further escalations with Iran.
The other countries moves are based on all of the above too... not a 1 on 1 conflict alone. Is America over-stretching itself? Spreading itself too thin? Might it abandon some fronts earlier than others? The bigger picture is very complicated and that much harder to assess.