A series of protests broke out in Armenia last month over a seemingly insignificant increase in the price of electricity. But this increase is part of a larger trend of rate hikes by utility companies that have the pernicious effect of driving up inflation. As IMR analyst Ezekiel Pfeifer explains, these rate hikes have a particularly destructive effect in Russia, where demonstrations may just break out next.
According to various estimates, five to ten thousands people have been protesting in Armenia against the rising electricity prices. Photo: hetq.am
In the Armenian capital of Yerevan, protesters recently occupied central streets for several weeks to show their outrage over a planned hike in electricity rates. The hike originally requested by monopoly Electricity Networks of Armenia was over 40 percent and represented the third increase in the last two years. After the public complained, it was lowered to 16 percent, but people were still incensed and started the protests branded #ElectricYerevan. But does this electricity rate increase really matter?
Let’s see: the 16 percent increase would bring the cost for daytime electricity to 48.78 drams per kilowatt hour, or 5.85 rubles, equal to about 10 cents. This may not seem like much, but it’s significantly higher than the rate for Moscow, for example, which is one of the most expensive in Russia (5.03 rubles per kilowatt hour). As one analyst pointed out, the average salary in Armenia (about $370 per month) is much less than in Moscow (about $1,050 per month) and is closer to that in nearby Dagestan, one of Russia’s poorest regions, where electricity costs just 2.23 rubles.
This is all to say that for average Armenians, the price increase really would hit their pocketbooks. (For now, as a result of the protests, the government has agreed to pay for the increase itself.) But it also has another grave effect on the economy: the rate hikes are a significant contributor to inflation, an economic scourge that hits everyone in a country hard but hits poor people the hardest. Armenians may not be protesting against it, but they probably should be—and Russians should follow suit. The problem is even worse in Russia, and in fact the annual rate increases demanded by Russian government monopolies could single-handedly deal a huge blow to the economy.
The rate of inflation has actually been slowing in Armenia in recent years, going from 8.2 percent in 2010 down to 5.8 percent in 2013 and down to 3 percent last year—although it jumped back up to 5.1 percent in the first quarter of 2015. The rate in Russia, which topped out at a calamitous 16.9 percent in March and has since fallen to 15.3 percent in June, has been one of the twenty worst in the world this year (next to countries facing humanitarian disasters like Syria, Libya, and Yemen). Keep in mind, the country’s medium-term inflation target is 4 percent. This high rate has been accompanied by negative economic growth—the Russian economy shrunk by 1.9 percent in the first quarter of 2015—resulting in that deadly combination known as stagflation. The economy’s poor performance is partly a result of the Russian Central Bank having raised its benchmark interest rate in December from 10.5 percent all the way to 17 percent, following a sudden collapse in the value of the ruble. A high interest rate creates a major barrier to economic growth, which Russia was already struggling to achieve due to a precipitous drop in the price of oil and economic sanctions by the West.
The Central Bank has gradually lowered the rate back down to 11.5 percent, and many want bank head Elvira Nabiullina to lower it further—but she’s worried: the annual raising of utility rates this summer is threatening to accelerate inflation once again. The rate increase of over 8 percent will cause a “serious” one-time jump in inflation, according to Deputy Finance Minister Maxim Oreshkin. “The main reason for inflation is the actions of state monopolies, which are constantly raising their rates,” argues economist Abel Aganbegyan. “The Central Bank does not have leverage over state monopolies and has no ability to influence the budget or many other government decisions that raise prices.”
So why are these state-run monopolies always torpedoing the economy by raising their rates? To start let’s take the case of Electric Networks of Armenia (ENA), the electricity monopoly that triggered the Yerevan street protests with its rate hike. ENA, of course, is owned by a Russian conglomerate, Inter RAO, which is chaired by Igor Sechin, a close associate of President Vladimir Putin and the head of state oil behemoth Rosneft. ENA justified the electricity price increase by saying that the production capacity of Armenia’s hydroelectric stations had decreased and that repairs were urgently needed on the country’s sole nuclear power plant, located in the city of Metsamor about twenty miles from Yerevan. A sharp drop in the value of the national currency, the dram—which occurred partly due to the Armenian economy’s dependence on Russia and partly due to the strengthening of the U.S. dollar—has made imported fuel more expensive as well. Critics insisted that the real reasons for the continual increases were graft and mismanagement. (ENA’s books might be audited by a commission of Armenian and Russian officials, which would practically guarantee a subjective and opaque result.)
Russia has a backward system in which there is actually an enormous surplus of electricity production—that’s right, a surplus, despite the annual increases in rates. But it has no incentive to cut down on the supply, because the producers are paid for this surplus.
There is probably some truth to all of these claims. But these rate hikes, both in the case of the Armenian electric company and Russian state monopolies, are near constant. This stands in contrast to most of Europe, for example, where electricity rates tend to fluctuate from year to year according to market conditions. On the other hand, in Russia, even with the economy tanking, utility rates are rising some 10–15 percent in various regions. In the northern Komi Republic, one of the country’s poorer regions, the increase is almost 15 percent. In Karelia, another downtrodden area near the border with Finland, the hike is 10.2 percent. The average is 8.5 percent.
This must mean that Russia is facing a shortage of electric power just like Armenia supposedly is, right? And that it must raise rates to invest in new sources of energy? No—the reality is precisely the opposite. Russia has a backward system in which there is actually an enormous surplus of electricity production—that’s right, a surplus, despite the annual increases in rates. But it has no incentive to cut down on the supply, because the producers are paid for this surplus. In 2014, there was an excess of 15 gigawatts of production capacity that was almost entirely paid for, at a cost of millions and millions of rubles. To put this in perspective, the famous Hoover Dam has a capacity of about 2 gigawatts. This year, Deputy Energy Minister Vyacheslav Kravchenko estimates that the level of excess production in Russia will rise to 20–25 gigawatts.
This surplus is partly the result of years of excessive outlays for investment programs—outlays that led to rate hikes. It quickly became clear, however, that this spending would not actually pay off for the state companies: their earnings were not going to increase enough to compensate for all that investment (and all that pilfering by corrupt officials). So, regulators began to reign in the rate increases, and last year the government finally froze some of them. The freeze hit companies including state-owned giant Federal Grid Company, the largest electricity transmission firm in the country, and Russian Railways, the state rail monopoly. As a result, Federal Grid Company had to depreciate assets it owns by $5.13 billion, while Russian Railways saw a 2014 loss of $1.74 billion—mostly because they could not raise their rates as they had been used to doing. This year, the rail monopoly did raise its rates, by 10 percent, and even so expects a loss. The company said that next year, if it is allowed to hike prices by 15.7 percent, it will still need $423 million in state subsidies. If it can only raise them by 7.5 percent, it will need $2.46 billion from the budget.
Because of these companies’ failures and despite their frequent rate increases, many of them have built up massive amounts of debt. Last week, a State Duma committee approved a 32 billion ruble ($562 million) bailout of Lenenergo, the state company that provides St. Petersburg with electricity. Electricity Networks of Armenia, the company that set off the Yerevan protests, has also built up millions of dollars in debt. With Russia’s economy foundering, consumer debt is spiking as well. In April, Inter RAO chairman Sechin called the level of non-payment in the electricity sector “critically high,” while Prime Minister Dmitry Medvedev said last month that debt owed by gas consumers had reached 163 billion rubles ($2.86 billion) in May.
Apparently, it used to be thought that the vast majority of households paid their utility bills in full but that fly-by-night management companies pocketed part of the money, resulting in unpaid debts to the utility companies. But because Russians’ wages are falling—disposable income dropped by 4 percent in April, the sixth month in a row that it decreased—it’s likely that consumers are now not paying their bills in full. Utility companies can eventually respond to non-payment by cutting off service. That means that one day, if you haven’t paid your bill, you have no hot water. In many cases, these people then complain to the local authorities—maybe they haven’t been paid their salary in months, or they aren’t getting their pension in full—and now they have their hot water cut off? Sometimes local officials can help. But what happens if they can’t? One possibility is that we'll start seeing #ElectricYekaterinburg, or #ElectricKazan, or, perhaps the most likely of all, #ElectricMoscow.
