Following last year’s vote on constitutional amendments, Russia is currently in the middle of another electoral cycle. September 2021 will see the elections to define the composition of the Russian Parliament’s lower chamber (the State Duma) for the next five years. Ahead of this vote, PBN H+K Strategies analyzed the election’s implications for the political and economic landscape, as well as key trends shaping the business environment in Russia.
- United Russia, the ruling party, will almost certainly retain control of the State Duma. But this year’s standing question is whether it will be able to hold on to a constitutional majority. While President Putin has at times strategically distanced himself from the party, it remains instrumental for his rule and is strongly associated with his course and the current regime overall. Putin’s positioning as leader of the nation and the regime’s interests, as Russian national interests, require demonstrations of constant public approval. As such, for President Putin, the upcoming election is once again a vote of confidence from the nation
- Having been called upon in early 2020 to drive domestic economic development and a nationwide “digitalization”, Prime Minister Mikhail Mishustin’s cabinet has been juggling between initial priorities and urgent matters: the COVID-19 crisis, a historical drop in energy prices and worsening bilateral relations with the US. All of these have led to a decline in the value of the ruble and a drop in real incomes for Russian people.
- Given the general context, several consistent trends are shaping the business environment in Russia. The first is import substitution – a subject that has been around for several years – now with a great focus on the IT industry. The latest initiatives include greater support for domestic IT companies and preferences in the form of mandatory pre-installation of domestic software on all devices sold on the Russian market.
- Meanwhile, the Russian authorities have been trying to regulate the presence of foreign IT players more closely, for both political and economic reasons. In the first case, the policy is to control “undesirable” online content (particularly on YouTube, Twitter, Facebook and TikTok) and to create additional tools to do so. From the economic standpoint, the aim is to bring international companies under Russian jurisdiction and thus increase tax collection.
- As for tackling price hikes, the Russian government’s focus remains mainly on areas that have the highest social impact, such as essential goods and pharmaceuticals. This attention has resulted in both institutional and practical steps to contain prices on essential goods, such as sugar and oil, as well as essential pharmaceuticals. A key change in this area has been the introduction of Compulsory Licensing, for first time in Russian history. The government’s decision to allow domestic firms to produce COVID medications that are still under patent was presented as a necessary measure to increase access to affordable drugs for national security reasons during the pandemic. Moreover, there are indications that it may not remain an isolated case.
The upcoming State Duma elections are to be held on September 19, 2021. The legislative voting might become amongst the most difficult for the Kremlin. The current rating of the pro-Putin United Russia party is one of the lowest in its history. According to the All-Russian Center for Public Opinion Research (VTsIOM) on March 21, 2021, United Russia garnered only 29.3% of Russian voters’ intentions.
Following an extremely eventful 2020, several major factors will define the backdrop for this year’s parliamentary elections. From an institutional point of view, Russia has undergone two major events.
- Firstly, constitutional amendments were voted into law, allowing President Putin to participate in the next presidential electoral cycle.
- Secondly, the Russian government has been changed for the first time in a long time. The new government has spent its first year focusing on the main challenges at hand, including the global COVID-19 pandemic and its economic impact on an already weak economy.
Meanwhile, diplomatic relations with western countries continue to be marred by mutual suspicion, additional sanctions and political scandals. At the very center of which is the opposition figure of Alexey Navalny. His poisoning and subsequent imprisonment upon his return to Russia has galvanized both international relations and the domestic political agenda. Navalny is promoting ‘Smart Voting’ as a tactic to oppose United Russia in the upcoming Duma elections.
Nevertheless, the party’s leadership is determined to put up a fight as Presidential Administration officials seem to have set a specific goal: winning more than two-thirds of seats in the lower chamber of the Russian Parliament, maintaining a constitutional majority (301 seats out of 450). Whether it fulfills this goal or not, United Russia will almost certainly remain in control of the State Duma.
Taking into account the low ratings of the ruling party, its leadership has decided to considerably update the list of United Russia candidates by shifting from tough business administrators to “patriotically-minded” people with an active societal role in order to gain momentum in the election: public opinion leaders, presenters of socio-political television shows, and popular media figures. As a result, we expect the next Duma to pursue further intensification of protectionism, more anti-Western rhetoric, and the adoption of new laws to protect Russian sovereignty.
CONSTITUTIONAL AMENDMENTS: ANOTHER TERM FOR PRESIDENT PUTIN
The general public sentiment towards the upcoming elections this year will be influenced by a strongly criticized pension reform carried out in 2018, the COVID-19 pandemic, a worsening economic crisis, as well as amendments to the constitution permitting President Putin to run for presidency in 2024 and 2030. This year’s elections are yet another vote of confidence for the presidential political course, likely to remain unchanged in the foreseeable future.
FIRST YEAR OF THE NEW GOVERNMENT
In early 2020, President Putin dismissed the government and introduced new Prime Minister Mikhail Mishustin, relatively unknown to the general public. Given the fact that Mishustin had overseen the Federal Tax Service for almost 10 years and transformed the agency by drastically improving efficiency and making it one of the leaders in implementing digital technologies, his cabinet was expected to be more effective than the previous one. Key priorities of the new government consist of improving living standards, as well as a digital transformation of the economy and state administration. In order to achieve these goals, the government takes a proactive stance towards the business sector as its main priority is bringing the economy out of stagnation by bolstering Russian industrial and IT potential using mostly protective and preferential measures.
Inevitably, the global pandemic changed the new government’s priorities. Forced to focus mainly on damage control in 2020, the new government managed to keep afloat with some political gains. Despite all criticism, Russia was one of the first countries to announce a viable COVID-19 vaccine and start mass vaccination. With currently three registered vaccines (Sputnik V, EpiVacCorona and CoviVac), the Russian government seeks to use vaccine diplomacy to restore broken relations and increase its international influence. Despite a relatively slow vaccination campaign at home, it still remains an important internal political achievement and subject of national pride, as Russia seems to have rediscovered an important area of expertise. Having now gained momentum, the Government will most likely pursue support for Russian scientific potential and the domestic pharmaceutical industry.
Russia managed to limit the most devastating economic effects of the COVID-19 pandemic, by opting for implementing only targeted measures, rather than reintroducing a nationwide lockdown that brought the economy to a full stop after the first wave back in March 2020.
While more severe consequences have been avoided, the initially weak Russian economy is experiencing a substantial decline: GDP dropped 3% and real disposable incomes decreased by 3.5% in 2020 according to Rosstat. Nevertheless, Fitch forecasts GDP growth of 3.3% in 2021, suggesting that economic activity in the country will strengthen from the second half of 2021.
The 2020 historical drop in oil prices and weaker ruble is gradually deteriorating the national economy – despite government efforts, inflation in Russia at the end of 2020 was 4.9% (Rosstat) and expected to be around 4.7%-5.2% in 2021 as reported by the Central Bank of Russia. In attempts to compensate and alleviate the risks of further decline, the government is resorting to import substitution and regulation of foreign presence, despite risks to the investment climate from narrowing the prospects for foreign companies.
The most recent major investigation by Alexey Navalny’s Anti-Corruption Foundation (which has been classified as a “foreign agent”) about “Putin’s Palace” attracted an unusually strong public response. The investigation – along with a court decision to send Navalny to prison – provoked a series of large-scale street protests across the country.
In 2014, Navalny received a 3.5 year suspended sentence and 5 years’ probation for fraud. On his return to Russia after receiving treatment in Germany (following his poisoning), Navalny was accused of violating the terms of his conditional sentence.
While the first wave of protests back in February died out quickly, it was prolonged in April 2021 by much smaller protests. It should be expected that Navalny’s supporters will launch further waves closer to the Duma elections in September, although potential classification of his organizations as “extremist” could hamper this.
In the context of the upcoming election, the divided opposition will most likely oppose United Russia with Navalny’s Smart Voting technique. This is a mechanism aimed at eliminating the dispersion of votes between different candidates, by urging voters to support the strongest opponent to United Russia. The remaining platforms for the opposition to promote its agenda in Russia are international social media resources, such as YouTube, leading the authorities to reinforce their efforts to control online content.
Expectations around US-Russia relations are low in 2021. President Biden’s Administration is perceived by Moscow as hostile toward Russia. Bilateral relations have been facing constant challenges and mutual accusations, reaching a public boiling point around the situation with Navalny. With further US sanctions against Russia announced in April, it is unlikely that tensions between the two countries will ease soon. The latest package includes a ban on US financial institutions from trading in newly issued Russian state debt and bonds. It also targets more than 30 entities and six Russian tech companies. The new measures will inevitably push the Russian government to reciprocate with further anti-Western rhetoric and tighter control over foreign companies operating in Russia.Nevertheless, it is early to define how the relations are going to be between the Russian government and President Biden’s Administration. A first meeting between the two leaders is to be scheduled in the near future, with a potential to partially alleviate tensions. The Biden Administration’s relations with China may offer some cause for optimism, while initial meetings revealed the extent of tensions, discussions behind closed doors were frank and substantive.
Relations between Russia and the European Union are not enjoying the best of times either. However, the situation differs substantially from relations with the US. As Russia is the EU’s fifth largest trading partner, and the EU is Russia’s largest trading partner, relations remain of great importance to both sides. While Russia has managed to keep relatively strong relations with some European countries (e.g. Italy and France), general EU relations are being tested by many challenges. For example, the conflict in Ukraine not only remains unresolved, but has been lately heading towards yet another escalation and the Normandy format talks have not been able to yield substantial results. In addition, the Navalny case and allegations of activities by Russian security services on EU soil fuel distrust. With individual EU countries, relations have been disastrous at times, the latest illustrative example being a diplomatic crisis with the Czech Republic.
Since 2014, Russia has taken a number of important steps to enhance its partnership with China. The “pivot to the East” that followed the deterioration of relations with the West did not turn into a full-scale alliance between Russia and China, but ties between the two countries have significantly strengthened in almost all areas: from military cooperation to large-scale investment projects and technological exchange. Trade with China has increased against the backdrop of sanctions and Moscow is becoming the most important energy supplier to its large neighbor. Backed by warm public rhetoric, cooperation between China and Russia is another concern for US policymakers to worry about – tensions with both countries and the US are rising, bringing China and Russia closer.
Key Trends Shaping The Business Environment
The business environment is shaped by global challenges, the central political course and the priorities of Russian decision-makers. As an integral part of the decision-making process, the State Duma is the central platform where policy directions are tested, decisions are formalized and legislative tools for implementation are created.
To summarize the results of the current convocation and provide an outlook for the directions to be picked up by the 8th Duma ahead of the elections, PBN H+K Strategies analyzed the emerging trends that will shape the business environment in the country.
The need for a national recovery and further economic development will have a great impact on doing business in Russia. In direct alignment with the President’s drive for digitalization, the IT sector is at the center of this, with high hopes placed on domestic players. The instruments selected by the Government are not limited to providing support for a number of strategic industries, but also include strong protectionist measures aimed at promoting domestic goods and services, as well trying to force international players to localize production and comply with Russian law.
Support for domestic IT companies
In July 2020, President Putin signed a bill to decrease the rate of insurance contributions for Russian IT companies accredited by the Ministry of Digital Development from 14% to 7.6% and the profit tax rate from 20% to 3%. This bill was the main part of the first package of IT industry support proposals, which was presented as a powerful instrument in the process of post-covid economic recovery. As part of the second IT industry support package, the government is now considering measures related to exemption from criminal liability, expanding the list of benefits, the introduction of regulations for business access to government data, as well as further stimulation of import substitution.
Mandatory app pre-installation on all devices
Another measure to support Russian IT companies is the law on pre-installation of Russian applications on all smartphones, tablets, PCs and smart TVs sold in Russia. The sale of digital technology without pre-installed Russian software will be considered a violation of federal law.In addition, according to a representative of the Ministry of Digital Development: “From July 1, 2021 users will be able to use the Russian national search engine by default. The definition of the search engine will be established by government decree”. This decision might significantly affect the business model of leading international search engines, such as Google, and lead to a redistribution of the advertising market in the Russian internet in favor of domestic platforms.
“Crowded” drug procurement system
The Russian government is highly invested in securing supply chains and introducing preferential terms for domestic producers of pharmaceuticals. The social significance of medical supplies and the push toward import substitution in the industry results in strong preferential measures for domestic producers. Introduced in 2015, the “three’s-a-crowd” rule restricts foreign suppliers from participating in state procurement in case if at least two other applications came from localized producers. While this mechanism has been criticized and sometimes blamed for creating deficits, the Russian Ministry of Industry and Trade recently announced it is working on a new “two’s-a-crowd” rule, allowing foreign firms to be excluded from procurement auctions if one other applicant has production localized in the EAEU. This would give producers that have full-cycle production established in the EAEU additional preferences in state procurement. Overall, the Russian government is consistently pushing international companies to localize production in cooperation with domestic players or face a gradually decreasing market share.
REGULATION OF FOREIGN PRESENCE
Tightening control over online content
Against the backdrop of tight regulation of the media, the Kremlin has identified weaknesses in its ability to control content dissemination on the internet. There have been numerous public discussions about “dependence” on YouTube, the service’s “anti-Russian” policy of blocking “patriotic” content, and its resistance to compromise with the authorities. This seems to have prompted the adoption of several laws in December 2020:
- A law establishing high fines for providers and owners of internet resources that refuse to remove information banned in Russia.
- The fine for repeated refusal by legal entities to remove such material was tied to revenue, providing the basis for services like YouTube and Facebook to potentially be fined millions or billions of US dollars.
- Roskomnadzor, the Federal Service for Supervision of Communications, Information Technology and Mass Media, was given the ability to block foreign sites for “censorship” and “discrimination” against Russian media. The service will be able to partially or completely block internet resources that restrict socially significant information in Russia, including in connection with foreign sanctions against Russia.
With the coming State Duma elections, Russian officials seek to acquire more tools to control the distribution of information on international online platforms and in social media focused on Russian users. The recent Twitter case serves as a perfect illustration of that: Roskomnadzor began slowing down traffic to Twitter in Russia for failing to remove banned content. Later Roskomnadzor announced that it could completely block Twitter in Russia if the social network fails to comply.
In late January 2021, President Putin instructed the government to propose additional requirements for foreign IT companies operating in an effort to increase tax collection and bring international tech players under Russian jurisdiction. According to reports, the plan is to oblige foreign IT companies with 100 000 – 500 000 users to register subsidiaries or representative offices in Russia and pay taxes. The proposed regulation is scheduled to be adopted by the end of 2021.
The “digital residency” project will offer several options for registration: online on the Federal Tax Service website or by creating subsidiaries together with Russian companies (in this case, the Russian representative will be responsible for the foreign company). After adoption of the project, foreign services would have a month to apply for registration, or they may face penalties.
This requirement has the potential to affect many foreign IT companies, especially those that do not have representative offices in Russia – services like Facebook, Booking.com and Amazon may fall under the requirements of the new regulation. Increased pressure for foreign companies might urge tech companies to change their strategy for Russian operations.
The complex economic situation is increasingly pushing the government to implement regulatory measures in efforts to keep prices for essential goods under control due to their high social importance. For example, the Russian government recently introduced price controls on sugar and cooking oil, as well as grain export quotas. While socially oriented, the decision threatens to destabilize the market, causing losses for producers on their domestic sales and limiting their access to more lucrative foreign markets. At the same time, authorities at a variety of levels have negotiated with producers in efforts to contain prices on several categories of essential goods. While these measures are temporary, a law empowering the government to define criteria for price regulation of essential goods (a list of 24 products defined by the government) was adopted in late 2020. Doing so, the Russian government shows a willingness to intervene on a subject of importance to a large part of the electorate – prices for essential goods.
A similar trend has been observed for quite some time on the pharmaceutical market, where constantly updated essential drugs lists (EDL) provide a basis for regulating prices on a number of drugs. The latest pricing rules for this group of medicines, which have been in effect since 2020, have led to a considerable decrease in prices and, consequently, in the profitability of their sales in the Russian Federation.In an attempt to achieve the lowest price, regulators can often set their prices so low that it would be unprofitable for suppliers.Alongside the newly introduced compulsory licensing mechanism, this could result in a gradual disappearance of innovative pharmaceuticals from the market in favour of cheaper generic drugs.
For the first time in Russian history, in December 2020, the Government issued a decree allowing for a COVID-19 therapy to be produced in Russia without the consent of the patent holder. The Prime Minister’s decision to set aside IP rights was attributed to Russia’s national security interests. It has been publicly presented as an effort to improve access to COVID-19 medicine in times of crisis and fight against unfair pricing for the public’s benefit.Russian legislation has long included provisions to allow the use of IP without the patent holder’s consent in the interests of national security; the State Duma has recently voted to empower the government to create a comprehensive mechanism for implementing such decisions. After setting a precedent and creating the necessary legal background, the Government may be increasingly tempted to issue further licenses to make other drugs more accessible. Several government bodies have already spoken of the possibility to extend the practice to other foreign medical substances in Russia, including the Federal Antimonopoly Service (FAS) and the Ministry of Industry and Trade.Mishustin’s Government is ready to take action to protect the interests of the Russian state and its citizens, with less regard for possible collateral damage to foreign businesses, the country’s investment attractiveness or general reputation in front of the international community.
Oil & Gas
Being essential for both the country’s economy and influence, Russia is currently seeking to diversify its natural gas and oil markets, as the traditional EU market has adopted a strategy for a gradual transition to renewable energy. At the moment, there are three main vectors of activity in that direction. The first is completing the construction of the Nord Stream 2 gas pipeline to increase the volume of supplies and reduce the cost of gas supplied by cutting transit costs. Second, Russia is seeking an increase in the share of gas exports to the east, which involves boosting usage of the Power of Siberia gas pipeline to its full design capacity and construction of a new Power of Siberia 2 gas pipeline through Mongolia. Third is the rapid development of the LNG production sector, driven by Yamal LNG, a major international project.
However, to cover falling budget revenue, the tax burden on companies in the extractive sector has been increased. From January 2021, the reduced export duty rate for extra-viscous oil was abolished, and the export duty exemption for oil produced at fifteen fields was also abolished. Similar legislative initiatives have also been introduced in the metallurgical industry, where the severance tax was increased by 3.5 times for metals companies and fertilizer producers.
- The 2021 State Duma elections are not likely to bring any substantial change in the Russian political environment nor the general course set by the Russian President. It seems inevitable that the ruling United Russia party will keep control of the lower chamber. However, the electoral cycle and the early months of the new Duma will see a “patriotic” public agenda and suggestions of additional protectionist measures.
- Despite a significant economic decline (GDP fell 3% according to Rosstat), the Russian market remains attractive for doing business due to the room and prospects for growth – Fitch forecasts GDP growth of at least 3.3% in 2021. Alongside Russia’s core natural-resource and heavy industries, the government focus in the post-covid recovery will be the domestic IT and pharmaceutical industries.
- The 8thconvocation of the State Duma is likely to pick up familiar regulatory and policy trends after the elections. Foremost among these will be import substitution and preferential measures for domestic companies, as well as tightening control of foreign presence in attempts to force international players to localize and comply with Russian law. In the push toward a national economic recovery, these will be used to stimulate growth across several industries.
- Despite the domestic and international challenges, the Russian market remains open to international businesses. However, companies operating on the market should keep abreast of the emerging challenges and fast-changing regulatory context. Business strategies might require reevaluation and adjustment to secure the continued success of operations on the Russian market.