The Russian Challenge

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The Russian Challenge An Enfeebled Economy The most immediate source of risk, then, is bank and corporate debt to the outside world. But that in turn creates additional risks for the public finances. There have been headaches over redrafting the 2015 federal budget to cope with an oil-price assumption of $50/b instead of $100/b. One draft produced a deficit equal to 3.8 per cent of GDP, requiring substantial drawing-down of the Reserve Fund. The proposed cuts were resisted, but might not be enough. 82 In this situation, and particularly in the wake of the rapid rouble depreciation of late 2014, Russian banks have got into difficulties. The CBR relaxed capital requirements in December; there have been runs on some banks, a couple of bank bail-outs and plans for extensive bank recapitalization. A banking crisis at some point in 2015–16 cannot be ruled out. 83 It looks as though, in the short and medium term, market conjuncture and geopolitical conflicts could create serious problems for the Russian leadership. Default on external debt is unlikely but recession and continued financial turmoil are probable. The main question is how long the recession will last. A stabilization of the oil price around $60/b, a slowing of inflation and some easing of Western sanctions are all possible during the course of 2015. A combination of those developments would indicate an early exit from recession in 2016. But none of these events is guaranteed. Confidence in Russia is fragile at the best of times, and these are not the best of times. Political implications for Russia’s Great Power ambitions The present Russian leadership seeks to make Russia a dominant regional power (at least), able to bend its neighbours to that leadership’s will. Keir Giles, in his chapter, sets out the means by which it has pursued this aim. Some of these do not, in macroeconomic terms, amount to a significant burden: cyber warfare, some forms of hostile messaging, purchasing the influence of individuals and information warfare, for example. Others could in some cases entail significant costs but do not necessarily do so in all instances: energy cut-offs, for example, may in the medium term even help a Russian supplier to charge high prices after the cut-off, and the conversion of a neighbour’s debt to a stake in its infrastructure may also pay off in commercial terms, even if that was not its main purpose. Other means of influence, and military power in particular, have high costs that are significant at a national level. Is the enfeebled Russian economy capable of supporting them? It should be borne in mind that military strength, though most conspicuously exemplified by the United States, is not the prerogative of rich nations. The Soviet Union, though much poorer than the US and its allies and lagging behind in technology, was able to maintain some sort of military balance with them up to its demise. It did this, moreover, with very little help from its Warsaw Pact allies. So Russia is not necessarily debarred by its moderate level of per capita GDP from pursuing what appear to be substantial military ambitions. The weak state of the Russian economy will at some stage set limits to the scale and pace of the Russian state armaments programme. Exactly how the conflict over that programme between (broadly) the economic bloc of the government and the military will be resolved remains to be seen. Pursuing them it certainly is. Military expenditure rose by 20 per cent a year in the four years between 2011 and 2014. That is in nominal terms, and it is likely that inflation in military hardware procurement is higher than in consumer prices. Even so, there has been a substantial increase in real terms, to over 3 per cent of GDP. 84 Will the government be able to maintain such increases in military spending, and in the ambitious state armaments programme? First indications are that it will at any rate try. The original budget plan for 2015 envisaged a nominal increase in military spending of 33 per cent, moving the total to 4 per cent of GDP. 85 In early March 2015 the cuts (in the form of postponements) in military expenditure favoured by the Ministry of Finance were still being resisted, but a federal budget deficit of 5.2 per cent of GDP was a possible corollary. 86 That would be extremely difficult to finance and would erode what little confidence the markets retain in Russian policy-making. The weak state of the Russian economy will at some stage set limits to the scale and pace of the Russian state armaments programme. Exactly how the conflict over that 82 Tat’yana Nedovina, ‘Byudzhet ne soshel’sya v raskhodakh’ [‘The budget didn’t match up on the spending side’], Kommersant’, 5 March 2015. 83 Oxford Analytica Daily Brief, ‘Russian financial system will be increasingly fragile’, 6 March 2015. 84 BOFIT Weekly, 6 March 2015. 85 Ibid., 10 October 2014. 86 Nedovina, ‘Byudzhet’. There had been some earlier compromises, however. See Ivan Safronov and Dmitrii Butrin, ‘Vozrazheniya vstupili v boi s vozrazheniyami’ [‘Objections went to war with objections’], Kommersant’, 19 February 2015. Chatham House | 21
The Russian Challenge An Enfeebled Economy programme between (broadly) the economic bloc of the government and the military will be resolved remains to be seen. It does not follow that the leadership will give up on its pursuit of regional hegemony and its stance of antagonism towards the West. Conclusions The built-in resistance of the Russian policy and business elite to radical reform of the Putinist system makes any change in the underlying operation of that system unlikely in the medium term, short of a regime change. The chances of a smooth and peaceful regime change are low. If some stable and lasting compromise were reached over Ukraine, if sanctions and counter-sanctions were withdrawn, and if uncertainties over the oil price and the rouble were eased, the binding constraints on Russian economic performance would once more be those of demography and system. The trend rate of growth of Russian GDP might then be of the order of 2–2½ per cent a year. 87 This might not satisfy the leaders’ ambition for the Russian share of global output to increase. It might even raise doubts about Russia’s plans to upgrade its military capabilities. Still, it ought to be liveable. If those conditions are not fulfilled, and conjunctural and geopolitical uncertainty remains high, the Putinist system will come under more pressure. One particular pressure point would be the leadership’s ambitious plans for military upgrading. These plans are expensive, and the conflict of priorities between military ambitions and the public finances could be acute. Meanwhile relations within the political elite are visibly strained, and the visibility is unusual. For example, Igor Sechin and one of his Rosneft vice-presidents, Mikhail Leontiev, have criticized Aleksei Kudrin, a former minister of finance and a personal friend of Putin, raising conspiracy theories about whom he had been really working for. 88 There is evidence that in mid-2014 President Putin’s inner circle of advisers had narrowed and was becoming largely confined to security and defence officials. 89 The subsequent steep fall in the oil price and the rouble brought more meetings involving the president and senior economic officials, but it is not clear whether those officials have regained their former influence on decisions. The prolonged and contentious process of budget revision, mentioned above, suggests that economic policy-making is in disarray. What do Russia’s uncertain economic prospects tell us about sanctions? By themselves, the sanctions in place at the time of writing are unlikely to provoke such economic distress as to generate pressure for radical change. On the contrary, they provide the Russian leadership with a handy scapegoat for stagflation: the West. It has been argued that they also strengthen the forces of nationalism and statism arrayed in Russia against thoroughgoing market reforms. 90 Even if, as seems probable, nationalism and statism were gaining ground in Russian policy-making before 2014, this is a serious unintended consequence of Western sanctions. The arguments for and against the sanctions so far imposed on Russia, however, are not exclusively or even primarily to do with economic consequences. Sanctions send messages. Reducing sanctions while the situation in Ukraine remains unchanged would send its own message: the West is giving up; you will get away with more adventures. In any case, a test now faces the West that is even harder than maintaining sanctions: propping up the almost bankrupt Ukrainian economy. 87 These are not numbers plucked at random. The figure of 2½ per cent is about the level of the ‘low’ prospect (of three) calculated for 2011–20 by Revold Entov and Oleg Lugovoy in ‘Growth Trends in Russia since 1998’, in Michael Alexeev and Shlomo Weber (eds), The Oxford Handbook of the Russian Economy (Oxford University Press, 2013), pp. 132–61. Kudrin and Gurvich, in ‘A new model’, suggest the figure is probably less than 2 per cent a year. 88 See https://www.youtube.com/watch?v=Cw8ll-3_Kx0 for Sechin’s remarks and http://www.gazeta.ru/business/2014/12/17/6350425.shtml for Leontiev. 89 Konstantin Gaaze, ‘Poker dlya odnogo’ [‘Poker for one’], New Times, 1 September 2014. 90 Connolly, Troubled Times. 22 | Chatham House
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