The Russian Challenge

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The Russian Challenge Russia’s Changed Outlook on the West: From Convergence to Confrontation The traditional and authoritarian values promoted by the Kremlin do not sit easily with all Russians. Support for more democratic elections is not confined to the relatively small number of liberals. Many highly educated young Russians have left the country or are seeking to leave. It remains to be seen how far the emergent post-Soviet generation wishes to distance itself from Europe, which has been a benchmark for Russian aspirations since the end of communism. Meanwhile the nationalist demon is out of its cage. There have been episodes of murderous inter-ethnic violence. Putin has warned in the past of: a kind of Amoral International, which comprises rowdy, insolent people from certain southern Russian regions, corrupt law enforcement officials who cover for ethnic mafias, so-called Russian nationalists, various kinds of separatists who are ready to turn any common tragedy into an excuse for vandalism and bloody rampage. 52 Reining in the destructive force of extremist nationalism (including fighters returning from Ukraine) will be a difficult task. Most crucially, the leadership has for a decade pursued a strategy that – as both Russian economists and outside experts warned – has led to economic stagnation. The decline set in well before the conflict began in Ukraine. Russia’s dependence on high prices for hydrocarbons has been cruelly exposed. The consequences for Russia of the conflict with Ukraine – the effect on capital markets and trade, the impact of sanctions and the heavy direct costs of Russian policy – are weighing down an already ailing economy. Patriotism and propaganda may for a while obscure economic failure (Putin has taken to making Orwellian boasts: ‘Our produce is of course much better and healthier’ 53 ) but they do not put bread on the table. This is not a model that will satisfy Russia’s aspirations to become one of the advanced powers of the modern world. Russians are famously resilient, and the country does not appear to be close to a tipping point. Over time, however, declining real incomes and the lack of resources for social and physical infrastructure, combined with the existing resentment at the high levels of corruption, will generate growing pressure for change. 52 Annual address to the Federal Assembly, 12 December 2013. 53 ‘We have managed to set up such poultry raising facilities that even Europe does not have. … Look at the situation with obesity in some countries. It is terrible. This has to do with food. Our produce is of course much better and healthier.’ Speech at a meeting of the State Duma in Crimea, 14 August 2014. Chatham House | 13
3. An Enfeebled Economy Philip Hanson Introduction The Russian economy is in poor shape. Russia’s current enfeeblement is not unique, even in Europe: the eurozone is also in trouble. Indeed, both Russia and the eurozone face strong doubts about the very systems on which they are based – Putinism and the common currency, respectively. The Russian systemic problem is politically less acute: its leadership appears for the time being to be popular, and alternatives to Putinism and Vladimir Putin himself are not conspicuous. In two respects, however, it is more acute: Russia has set itself against a large and influential part of the rest of the world and is correspondingly isolated; and, as a medium-developed country with labour productivity about two-fifths that of Germany, it is missing out on the potential of rapid, long-term, ‘catch-up’ growth. This chapter starts by setting out the main features of recent and prospective Russian economic performance. Then it reviews the influences on that performance, including that of the recent events in Ukraine and the foreign sanctions they have elicited. It finishes by suggesting some implications for Moscow’s Great Power ambitions and for Western policy. Economic performance Russian real GDP fell steeply during the 2008–09 crisis. This was followed, as in many other countries, by a recovery that fell short of a return to pre-crisis rates of growth. Then there was a marked slowdown starting in 2012. The level of economic activity in 2014 was just 0.6 per cent above that of the previous year. Official expectations for the next two years, exemplified in Figure 1 by Central Bank of Russia (CBR) projections of November 2014, are for recession and stagnation. Those projections are from two, out of many, alternative CBR scenarios. The higher one is close to an earlier Ministry of Economic Development (MinEkon) baseline scenario, which was widely regarded as too optimistic and has since been revised downwards. 54 The lower projection, as far as the period 2015–16 is concerned, is from the CBR’s worstcase scenario of 15 December 2014, in which the oil price averages $60/barrel in both those years and then recovers; this also assumes that sanctions remain in place up to and including 2017. 55 In March 2015 the government submitted to parliament a revised draft of the 2015 budget in which the average annual oil price was assumed to be $50/b, the average exchange rate was R61.5 to the US dollar, GDP fell by 3 per cent and consumer price inflation averaged 12.2 per cent. The revisions entailed additional spending cuts (from the version previously approved) to contain the federal budget deficit to 3.7 per cent of GDP. 56 Figure 1: Russian real GDP, 2005–17 (% year-on-year change) GDP % change p.a. 10 8 6 4 2 0 -2 -4 -6 -8 -10 Optimistic scenario 2005 2006 2007 2008 Worst-case scenario 2009 2010 2011 2012 2013 2014 2015 2016 2017 Sources: Rosstat (historical data); CBR (2014–17 projections). One consequence of these numbers is that Russia’s weight in the world economy has recently edged downwards and is expected to continue to do so for a while at least. Figure 2 illustrates this, using IMF projections for all of the four original BRICs. China and India, the two less developed of these countries, continue (and are expected to continue) to increase their weight in the world economy. Russia and Brazil are not. For Russia, with its leaders’ apparent belief in their country’s present and future Great Power status, this is of particular concern. Indeed, failing to increase the Russian share of world output is sometimes treated as a definition of stagnation. During the 1999–2008 boom household consumption was the main driver of Russian growth. Rising oil prices and the resultant rising inflows of petro-dollars made this possible, but of the different sources of increments in final demand for Russian production, consumption predominated. The improvement in Russia’s terms of trade, moreover, allowed real incomes and consumption to rise faster than output. 54 Ol’ga Kuvshinova and Margarita Papchenkova, ‘Minekonomrazvitiya prognoziruyet retsessiyu iz-za sanktsii i spada tsen na neft’ [‘The Ministry of Economic Development forecasts a recession because of sanctions and the fall in oil prices’], Vedomosti, 2 December 2014. 55 The ‘worst-case’ scenario produces a 2017 GDP 0.2% below the 2014 level; the more optimistic scenario generates a comparable figure of 0.6% above 2014 – not a dramatic difference. 56 See Deputy Finance Minister Aleksei Moiseev on 16 March on the new budget at http://www.minfin.ru/ru/press-center/?id_4=33119, and discussion by Ewa Fischer, ‘Amendment to the Russian budget for 2015: an attempt to maintain the status quo’ at http://www.osw.waw.pl/en/publikacje/analyses/2015-03-18/ amendment-to-russian-budget-2015-attempt-to-maintain-status-quo. 14 | Chatham House
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The Russian Challenge

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