Taxes, spending, and geopolitics: A tricky combination to manage in Russia

Changes are coming to Russia. With the crisis in the past, economic recovery in full motion, and political stability ensured with the re-election of Vladimir Putin in March, the government has unveiled a tax and spending plan starting in 2019 – presenting a host of challenges and opportunities for businesses to manage. Meanwhile, naturally, none of this exists in a vacuum. Russian-Western relations are at their lowest point in decades and are highly unlikely to improve, dampening sentiment towards Russia. MNCs will enjoy some improved demand in Russia in the coming years, in part thanks to greater state spending, but need to develop a consistent, realistic internal view of the Russian market’s risks and opportunities to plan effectively for the long term.

Tax….

First and foremost, businesses must manage the tax hike coming in January 2019. The government announced plans to raise the VAT rate from 18% to 20%. The Russian finance ministry estimates that the increase will add 1-1.5% pp to inflation next year, and as a response Russian firms are expected to begin raising prices in Q4 this year in advance of the VAT hike, driving up prices already in the coming months. In particular, demand for IT services, restaurants, and clothing purchases face the greatest sensitivity from price increases in Russia historically.

While consumers will naturally be negatively impacted by the price hikes, B2B firms need to plan carefully regarding demand from their key customers. In light of weak demand in the market, domestic firms will be unable to fully pass on price increases to their consumers, putting more pressure on their financial position. Meanwhile, as prices rise from both the VAT hikes and more ruble weakness in light of geopolitical tensions, the central bank will likely maintain the interest rate at its elevated 7.25% for the rest of the year, keeping credit relatively expensive – or even inaccessible – for businesses.

…And spend

Immediately following Putin’s election and inauguration, he approved a social and infrastructure spending plan for his next six-year term, estimated to amount to roughly 8 trillion rubles (US$ 130 billion). Spending will rise most notably in 2020, if not in late 2019, and areas for targeted development include healthcare, education, roads, housing, science, and the digital economy to raise the productivity of workers, extend life expectancy, and raise GDP. MNCs will see greater demand from construction firms (particularly road and housing sectors) while – over the longer term – greater access to new customers in the regions. In the healthcare sector, firms will enjoy stronger demand from public hospitals, including upgrades of healthcare facilities and purchases of medical equipment and devices, as well as higher outlays of public medical insurance that could increase reimbursement coverage and/or pricing.

International tensions

US-Russian relations will steadily worsen over the next several years. Neither the US nor Russia are incentivized to alter their international postures amid current tensions, and instead will remain embroiled in reciprocal sanctions over the long term. From the US side, Trump’s turn toward a more hardline policy toward Russia in April 2018, as seen in the new round of sanctions that month, will likely dominate the rest of his term. From the Russian point of view, the domestic population sees the country as a target of Western aggression and therefore demands a leader who can provide protection and security. Case in point, as of this writing, the Russian government had just announced sanctions on unspecified goods imported from the US as retaliation for the tariffs on Russian steel and aluminum implemented earlier.

More US sanctions over the long-term have become increasingly likely, triggered potentially by events in Syria, further Russian involvement in the war in Ukraine, or further cases of Russian meddling in Western electoral processes, as examples. It’s critical for businesses to assess the practical implications of tension with the West on their operations, as these may be less significant or more manageable than headlines imply.


For more detailed analysis and recommended strategies related to any of the above topics, FSG clients should consult our Russia 2023 piece. Not a current client? You can purchase a copy of the Russia 2023 report from our online store.

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