Matt Scott: Russian 2018 organisers face taxing task as inflation takes off

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“The way to crush the bourgeoisie is to grind them between the millstones of taxation and inflation.” Vladimir Iliych Lenin

The Russian bear was dancing when it held the winter Olympics and won its bid to host the 2018 FIFA World Cup. All the while it was growling a demonstration of its aggressive fighting strength in the Caucasus. But, for the moment at least, one of the world’s most historically important nations is cowed. The Russian economy has turned bearish in the extreme.

This has moved Russia Football Union (RFU) officials to reassure our industry about its suitability to host the next tournament, “The issue of Russia’s refusing to host the World Cup is out of the question,” said its president, Nikolai Tolstykh.

An exercise in Kremlinology seems worthwhile: do his words mask an inner truth? It seems there are three possible scenarios. First, that the 2018 FIFA World Cup proceeds precisely as planned. Second that a modified, cheaper version goes ahead. Third, that whatever the RFU says, the World Cup does not take place in Russia at all. Let’s call these scenarios 1, 2 and 3.

Looking at the economic context of Tolstykh’s remarks, it is quite clear that when the Kremlin took the decision to bid for the event in January 2009, the world and its economic narrative were very different.

Double-digit growth rates and rampant structural investment in China were creating unprecedented demand for natural resources. Many also expected the crash of developed financial markets to be positive for commodities prices, as western governments would be forced to intervene in financial markets with trillions of dollars of “printed money” through Quantitative Easing, hobbling their economies and raising the dollar value of hard assets.

All this would benefit resource-rich nations like Russia, so the story went, whose tax receipts from heavy industry like oil producers, metals miners and refiners would yield billions for their governments to spend on pet projects. The economic outlook was for feast not famine, and the Kremlin gorged itself on luxuries like Sochi 2014 and Russia 2018.

Yet the buoyancy in commodities prices predicted in 2009 has not endured. In its Article IV Consultation on Russia published in July, the International Monetary Fund stated that in 2013 there was a budget deficit of 1.3% of GDP, despite oil prices averaging $108.56 over the course of that year.

Since then, oil prices have plunged, dropping more than 46% over the past 12 months to touch $58.50 a barrel this week. This has coincided with the United States and European Union imposing sanctions against individuals and companies associated with the Kremlin over its backing for the Crimean insurgency, a further blow to tax receipts for the Moscow treasury.

The Kremlin has begun to introduce austerity measures, with $17.8 billion of previously intended spending sliced from the September 2014 budget, according to the Economist. But that might be a drop in the ocean against what is required.

The worsening economic outlook and sanctions have combined to cause $100 billion of capital outflows this year, with a further $50 billion anticipated in 2015, tightening the squeeze on government income. And to cap it all, the rouble has nosedived, contributing to double-digit inflation. The Central Bank of Russia has attempted to stem the collapse, buying roubles with $70 billion of its foreign-currency reserves in an effort to maintain its value in the foreign-exchange markets. That tactic failed, causing Moscow to raise interest rates this week to a punitive 17%, a last redoubt aimed at attracting investment in the rouble. That, too, failed as the rouble’s dollar value continued to cascade on Tuesday.

Dollars per rouble, December 2013 to December 2014

Source: Xe.com

Still, looking at the current crisis from Tolstykh’s perspective, this is not all bad news for Russia. It is always possible that scenario 1 transpires and Russia achieves all that was promised to FIFA in 2009 and 2010, despite the gathering economic storm. Indeed the relationship between the collapse in oil prices and the Kremlin budget deficit is not entirely clear-cut. Despite Russian central-bank interventions to prop it up, the falling rouble has in fact assisted producers in the face of falling oil prices – the budget balances with oil at 3,700 roubles, which is $52.21 at today’s prices.

Indeed hosting the World Cup is about more than a few football matches and it must be explained that Russia needs 2018 to go ahead to reinvigorate its economy. The Sochi infrastructure project contributed to what was a 60% growth in construction output there between 2009 and 2013, according to a report published in August by Timetric, an economic and industry analyst.

It said: “Having already registered a boost from the construction of infrastructure facilities, as well as hosting the 2014 Winter Olympics, the nation’s hosting of the 2018 FIFA World Cup will also require stadia, transport infrastructure, accommodation, hotels, airports and training bases.

“There are 11 host cities for the World Cup, indicating a broad demand for stadia, transport infrastructure and accommodation. According to the country’s Ministry of Sport, RUB600.0 billion (then US$19.1 billion, now $8.5 billion) is required to be spent on various infrastructure construction projects in order to prepare for games.”

This kind of internal investment drives a country’s future growth as it improves infrastructure that can benefit the economy in the long term. Also in favour of the best-case scenario 1 cited above is the economic rhythm wherein extreme bearish selloffs or “capitulations” precede strong bull markets. Oil may not be the investment du jour but there will come a day when its price recovers, and perhaps overshoots its prior level. Then the Russians will be looking pretty slick.

But in the more bearish cases there are a number of clouds on the horizon for Vladimir Putin and his government, which largely depend on how long the current situation lasts. The reserves being used to defend the currency were built to keep the Kremlin’s spending plans in place even if oil prices were to dip below $60 over a sustained, two-year period. With oil prices buoyant, ministers had until recently intended to grow the fund, which in July stood at $450 billion in foreign currencies, by 7% a year. Instead it is shrinking as money is being spent ahead of schedule.

Today, with OPEC indicating it intends to allow oil prices to fall to $40 in the months and years to come, it seems the Reserve Fund could be called upon to protect the core budget too. This surely calls into question the affordability of the World Cup four years hence, and only now, after weeks of economic turmoil in Russia, is that question being addressed.

Taking a look at the official World Cup expenditure figures, they seem tremendously conservative estimate for the cost of an 11-city World Cup requiring so much infrastructure investment. The forecast RUB600 billion (whether that amounts to $8.5 billion or indeed even $19.1 billion) seems particularly undercooked when compared with the $50 billion-plus overall cost of the corruption-blighted Sochi Olympic Games.

According to a report by two opposition politicians, the former Russian-government cabinet member Boris Nemtsov and his colleague Leonid Martynyuk, some $30 billion disappeared in graft in the Sochi construction. In these more-austere times the Kremlin will seek to limit money lost through corruption but cost control does appear to be a problem at the World Cup.

During the campaign process the Russian bid committee told FIFA in 2010 that it would cost $3.82 billion (then RUB116.5 billion) to renovate and build stadiums for the 2018 event. That figure has since ballooned to RUB300 billion, according to the most recent official estimates, made in November and before the worst of Moscow’s currency crisis.

Indeed even in the boom times there was a belief the construction risk might present challenges for the World Cup, and economic crisis will only have magnified the problems. This may lead Russia to plump for scenario 2: a World Cup without some of its promised adornments.

The Evaluation Report on Russia’s bid conducted by the head of the FIFA technical committee, Harold Mayne-Nicholls, and his team pointed to several areas of potential difficulty four years ago. “Realisation of the team facility plan depends on significant construction in general as well as upgrades to training sites,” the Mayne-Nicholls report read.

Indeed, if in 2018 scenario 2 the players may have to make do with unrefurbished facilities, the fans might be looking forward to some Soviet-era accommodation. As regards hotels, the report added: “Russia has an adequate supply of contracted rooms, largely in the three-star category, in every candidate Host City. However, the significant investment forecast indicates a dependence on construction and modernisation within the hotel sector.”

Whether that can now be afforded has become debatable and it would seem hotels would be the likeliest line item where savings can be made. But bigger problems may lie in the travel provision. The Mayne-Nicholls report found: “The high-speed railway network is limited and would only link six candidate Host Cities by 2018, [which] would put pressure on the air traffic infrastructure, potentially causing transfer challenges in view of the lack of alternative means of long-distance transport.

“The current air traffic situation is to be improved through major upgrades and capacity increases to the majority of the airports. However, any delay in the completion of the transport projects could impact on FIFA’s tournament operations and the proposed installation of temporary facilities could impose a high cost burden.”

Last month the Interfax news agency reported that work had begun on a new airport in Rostov with a 100-metre-square terminal, reportedly costing RUB37 billion ($529 million). It is due for completion in 2017. Meanwhile there is less visibility on progress in the other airports and there must be questions about whether large-scale infrastructure improvements are feasible as several major Russian banks face punishing international sanctions.

As the IMF’s Mission Chief on Russia, Antonio Spilimbergo, told reporters after the release of the Article IV consultation: “Investment in Russia is usually of a long term horizon and especially the investment that Russia needs now has a longer term horizon.

“The situation that creates more [geopolitical] uncertainty will have a negative impact on investment. So when we would think about how the geopolitical uncertainty influences the Russian economy we go to the investment channel.”

International sanctions bring other funding risks beyond the banks. Two days after the bid decision went Russia’s way the president, Vladimir Putin, indicated the oligarchs would be leaned on to fund the World Cup construction.

“I don’t rule out that [the Chelsea owner, Roman Abramovich,] may take part in one of these projects,” Putin said. “Let him open his wallet a little. It’s no big deal – he won’t feel the pinch. He has plenty of money.”

Although Abramovich is free to go about his business without facing international sanctions, there are some oligarchs who assisted with the Sochi construction, such as Arkady Rotenberg and Vladimir Yakunin, who are on the EU or US blacklists. This makes it difficult for them to access or move their assets.

Worse still for Russia, it is not just the rich oligarchs who will suffer as a result of sanctions and the corresponding economic crunch, and this is where scenario 3 could potentially come in to play, whatever Tolstykh and the Kremlin may now say.

Putin owes his position to the strong economy he fostered over almost 15 years as Russia’s most powerful man. With inflation running in excess of 10% due to the tumbling rouble, the gains made over that period are fast eroding for Russia’s general public. History has proved Russian people to be among the most stoical in the world. But can that always be relied upon?

“The big test is what happens once Russians really start to suffer,” the Sunday Times quoted what it described as the business partner of one of Russia’s richest oligarchs saying. “At first they’ll rally around him, but for how long?

“The wealthy elites are already upset at the course Putin has taken the country on but are too scared to show it. Right now Putin is unassailable but he, too, will start to feel the heat if this mess drags on.”

As food prices rise ever higher, standard-of-living protests from construction workers on government contracts could endanger the investment programme. In their mildest form such protests could endanger the timely delivery of Russia’s FIFA World Cup projects by the 2018 kick-off.

But at its most extreme, Russian social upheaval could have consequences that bring scenario 3 firmly into play. The 2018 World Cup is due to take place less than a year after the centennial of the October Revolution that saw Lenin and his fellow Bolsheviks depose its plutocratic ruling family, the Romanovs.

Now there are signs that Putin may be concerned about his own regime’s security. The introduction of “anti-extremist” laws in June was followed by rhetoric from the president to his security council last month about how any threat of a so-called “colour revolution” in Russia must be put down.

The RFU would have you believe otherwise, but as middle-class Russians continue to be ground between the millstones of a crumbling currency, rampant inflation and taxing interest rates, there really is a risk Putin’s multibillion-dollar World Cup dream might turn to dust.

Journalist and broadcaster Matt Scott wrote the Digger column for The Guardian newspaper for five years and is now a columnist for Insideworldfootball. Contact him at oc.ll1558752744abtoo1558752744fdlro1558752744wedis1558752744ni@tt1558752744ocs.t1558752744tam1558752744m.