Russia’s Economic Difficulties (2015)

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Under President Vladimir Putin, Russia has improved its economic fortunes thanks to high oil prices.  Oil and natural gas make up 70% of the country’s exports and higher prices have enabled Putin to solidify his rule by making economic conditions more amenable for the country’s middle class, which weathered two periods of hyperinflation during the 1990s following the collapse of the Soviet Union.  However, the collapse of global oil prices, in conjunction with Western sanctions, are sending Russia down the road to recession.  Considering the fact that Russia is a prominent actor within the BRICS nations and that good economic fortunes have solidified Putin’s rule, economic difficulties in Russia could create significant upheaval not only within the country, but across the world as well.

This topic brief will break down Russia’s current economic problems, how those problems may affect Europe as a whole, and then discuss what they might mean for Putin’s political future.

Readers are also encouraged to use the links below and in the related R&D to bolster their files about this topic.

Russia’s Economic Problems

The collapse of the Soviet Union in 1991 was a traumatizing experience for many Russians.  An attempt by President Boris Yeltsin and Western nations to immediately introduce aggressive capitalist reforms in the nation failed to produce sufficient economic benefits for the majority of the country’s citizens.  Individuals with close connections to the Russian government, as well as those with sizable bank accounts, were able to purchase formerly state-owned enterprises cheaply and then pocket the profits.  The Asian financial crisis of 1997 and declining oil prices by 1998 sparked an economic crisis, causing the ruble – Russia’s currency – to plummet in value and forced the nation to default on its sovereign debt.  By the time Vladimir Putin assumed the presidency on December 31, 1999, Russia was arguably the sickest economy in Europe.  A spike in global oil prices during the 2000s helped Russia pay down its debts, solidified Putin’s image as a savior to the Russian masses, and reinvigorated the country to meddle in the affairs of its neighbors such as Georgia and Ukraine.

Now, though, the economic calculation that Putin and Russia has long depended on since 1998 is changing.  Global oil prices are moving downward as a result of a supply glut, and Western nations are making it more difficult for Russian financial institutions to access international credit markets by leveling sanctions over Russian behavior in Ukraine.  Moreover, the Russian government has made some questionable economic decisions for years.  The economy is far too dependent on oil and natural gas.  The Guardian on December 29 writes that oil and natural gas are 70% of the country’s exports and that the Russian government needs the global oil price to average $100 a barrel to balance its budget.  Also, those Russian political officials closely aligned with Putin have enriched themselves at the expense of the rest of the country.  The Guardian reveals on October 17 that independent investigations have exposed that Putin’s friends have purchased secret mansions and placed large sums of money in foreign accounts.  There are also questions about whether Putin’s belligerence is undermining the long-term health of the economy.  The Hill on December 29 explains that Russian Finance Minister Anton Siluanov has voiced concerns that expansions in the Russian military budget have come at the expense of education and infrastructure.  Since Russian belligerence is producing Western sanctions, that only compounds the country’s future economic outlook.

At present, the Russian economy is headed for recession.  Bloomberg on December 29 explains that the Russian economy slowed in November, experiencing a 0.5% decline in its gross domestic product (GDP) over November 2013 levels.  This was the first decline for the economy since October 2009, when the country was feeling some of the weight of the global financial crisis.  The reason given for the decline of the Russian GDP was shrinking investment thanks to a slide in the value of the ruble and an anemic manufacturing sector.  The UK Telegraph reports on December 29 that manufacturing purchases were slow in December.  The Guardian article previously cited from December 29 adds that construction, agriculture, and service sectors all contracted in November, although some sectors remain healthy such as energy, mining, and retail.  Nevertheless, Russia has been averaging less than 2% growth over the last year, according to The Global Times on December 24, so the country is in dire need of economic stimulus and/or more effective government policies to encourage business growth.  The New Yorker explains on December 27 that Russian businesses have been laying off workers since July, which is a sign of a poorly performing economy.  If low oil prices continue, Russia will also need to think about achieving more diversification so that the national economy is not thrown into turmoil due to the price of a single global commodity.  For example, Bloomberg reveals that Russian economists are already predicting a 4% contraction in economic activity if oil prices remain below $60 a barrel.

One of the biggest problems for the Russian economy moving forward is thwarting a currency crisis.  Three weeks ago, the ruble saw a collapse in its value as a result of continued low oil prices and fears in currency markets that the Russian central bank was printing currency to bailout Rosneft, a state-owned oil company.  U.S. News & World Report reveals on December 20 that bailout cost $50 billion (two trillion rubles) and that global capital markets believed that this money was printed instead of being pulled from existing currency reserves, thereby leading to fears of currency inflation because there was an excessive number of rubles being placed onto the market.  Less rubles were also needed in international trade markets because of declining oil prices, so fears about the stability of the currency and a lack of demand for it have combined to cut the value of the ruble in half.  A lower value of the ruble has done significant damage to the Russian economy for various reasons.  First, a collapse of the ruble took place in 1998.  The recent fall was less significant, but that collapse traumatized the Russian population as people lost their savings.  Fortune notes on December 29 that fears of a 1998-like slide taking place several weeks ago prompted Russian citizens to make a run on banks and mid-sized lender Trust Bank had to receive $2.4 billion in government loans to avoid collapsing.  CNN on December 30 discusses how bank runs have Russian banks questioning the stability of each other as the interbank lending rate, the interest rate for when banks lend money to each other in the short-term, has spiked to 18%.  In other words, the Russian economy risks a credit crunch reminiscent of Western financial institutions in 2008 when banks were refusing to assist each other because they feared whether they would receive back the money that they lent out.  The Economist on December 17 writes that Russians also ran out to buy luxury goods such as jewelry and electronics, fearing that the decline of the ruble would not allow them to purchase these goods since they would become more expensive.  Instability over prices actually prompted car manufacturers to stop sending vehicles to Russia several weeks ago since they could not be assured that the rubles they would receive back for their product would be of an estimable value.  A sliding ruble can also be bad for Russian companies and customers because they owe debts in foreign currencies such as dollars and euros.  For example, The Economist explains that Russian mortgages are denominated in foreign currency, so paying back debts may become very difficult if the ruble slides significantly.  Second, as the ruble has declined in value the price of imports has increased, requiring the Russian government to loan more of its foreign reserves to exporters.  Although the country still has sizable reserves to weather a short-term shock, the Associated Press via The Huffington Post explains on December 29 that the country’s foreign reserves have fallen below $400 billion for the first time since August 2009.  This reserve problem could grow worse in the long-term as Russia brings in less foreign currency due to a lack of investment thanks to Western sanctions and also brings in less due to low oil prices.  And third, steps by the Russian government to stop the slide of the currency might choke off other economic activity.  Newsweek notes on December 30 that the Russian central bank has raised interest rates from 10.5% to 17% in an effort to choke off inflationary pressures thanks to the ruble’s fall, but really high interest rate make acquiring loans prohibitively expensive, thereby harming the prospects for future growth in the larger economy.  As Bloomberg explains, the high interest rates could produce a 6.3-6.5% decline in consumer spending in 2015 and a decline of fixed-capital investment by an alarming 10.1-10.3%.

Another big problem for the Russian economy is Western sanctions over its behavior in Ukraine.  The United States has led the charge, much to the consternation of some European governments who have close economic ties to Russia, to sanction Putin’s government over its support for Ukrainian rebel forces and its annexation of Crimea.  The sanctions make it nearly impossible for Russian businesses to acquire foreign capital resources, largely located in Western nations, especially when it comes to refinancing corporate debt, which Russian businesses will want to do next year.  Politico on December 16 explains that President Obama is poised to sign onto new sanctions that would provide $350 million military equipment to the Ukrainian government and punish Russian energy companies.  Aside from restrictions on financing, the sanctions are a deterrent to foreign investment in Russia as investing in a sanctioned company carries a bad stigma.  It can also cause investors to face sanctions themselves.  The Christian Science Monitor writes on December 18 that Putin admits that sanctions have been responsible for 25-30% of Russia’s recent economic problems.

Ultimately, as The Business Insider discusses on December 29, Russia’s economic difficulties in recent weeks illustrate the danger of investing in emergent markets.  Many of these nations, including the BRICS, have had their economic gains based on high commodities prices, but many are in need of political reform and more aggressive policies to improve the efficiency of their economies.  With Russia’s export lifeline declining in value, it is headed for a recession because it lacks the structural supports necessary to keep the economy steady.

The Russian Contagion

There are some fears that if the Russian economy worsens and enters recession that it will compound the problems on the rest of the European continent.  As a whole, Europe is weathering poor economic performance as unemployment rates in countries such as Spain are high and investors remain skittish about the future of the euro.  There are even fears that deflation may grip the continent, sparking a lost decade or more of economic activity.

European support for American sanctions has been a bit lukewarm.  This is due to concerns about the continent’s dependence on Russian natural gas.  When Russia shut off natural gas to Ukraine several years ago it also shut off gas to some European countries such as Italy because of how gas pipelines run through Ukrainian territory.  Europeans are wary of angering one of their primary energy suppliers and fear that sanctions will only embolden Putin to become more aggressive rather than conciliatory.  There is also some fear that the sanctions may serve to make the European economy worse off.  For example, The New Yorker reveals that Russia’s middle-class has made it a habit in recent years to take their two week winter vacation, granted by Russian law, to warmer climates, thereby sparking a booming tourism industry in other European nations.  Now, though, this tourism may decline because Russians cannot afford to travel due to the ruble’s problems.  Also, countries that neighbor Russia such as Poland worry about how the ruble’s decline may zap Russian demand for imports, thereby producing lots of economic problems.  The Christian Science Monitor on December 26 explains that small businesses in Ukraine and Poland may face the brunt of Russia’s economic pain because they have been forced to delay investments into Russia and are often attractive tourist destinations.

That said, barring a catastrophic collapse of the Russian economy, Europe should be relatively safe from Russia’s recent economic pain.  The Christian Science Monitor notes how Russia accounts for less than 3% of the world’s economic output, meaning that it is less economically significant for the global economy than India or China.  Also, since 1998 some European countries and businesses have been wary of parking too much money in the Russian economy.  Putin’s punishment of oligarchs such as Mikhail Khodorkovsy and the seizure of some private energy interests have also produced a capital flight from the Russian economy.  Fortune noted that $100 billion has exited the Russian economy this year as a result of economic instability and Western sanctions.  This shows that Western firms are limiting their exposure to the Russian economy, which will probably keep Russia’s economic problems bottled up for the time being.

The Political Impact of a Declining Economy on Putin’s Regime

As explained earlier, Putin has based his political legitimacy on the growth of the Russian economy.  The U.S. News & World Report article cited earlier explains that a windfall of oil revenues in the early 2000s enabled Putin to increase pension payments, increase the wages of government employees, and bribe local officials in the Russian Federation to limit violent reactions against the state.  This practice has played out a lot in Chechnya, a volatile secessionist region that Putin has effectively brought under his control during his presidential terms.  Russia’s rising economic fortunes, according to The Economist, have helped Russia’s middle class turned a blind eye to Putin’s more repressive politics.  This so-called Putinist consumption ethic is now under siege, though, as the problems of the Russian economy worsen.  As food prices rise, especially in Russia’s rural areas, and the government begins finding it more difficult to patronize local elites, Putin’s core governing philosophy is bound to come under attack.

If faced with a question about the Russian economy’s impact on Putin, it would be fashionable to draw parallels to 1998, which served as the final nail in Boris Yeltsin’s political coffin, and say that economic problems will lead to the collapse of his leadership.  However, this is far too simplistic of an analysis.  First, Putin’s popularity still remains relatively high.  Polls place the Russian President’s approval ratings in the 75-80% range, far above what President Barack Obama receives in the United States.  Second, sanctions might be used by Putin as an excuse for Russia’s economic difficulties and that may rally support for him.  For example, sanctions against Cuba in the 1960s, which have been covered in another topic brief this year, did not lead to the deposition of the Castro regime.  International sanctions have also failed to produce regime change in North Korea and failed to undermine the support for Saddam Hussein’s regime in Iraq before he was overthrow by U.S.-led forces in 2003.  The Christian Science Monitor on December 18 noted that in his annual press conference, Putin deflected any personal blame for the economic crisis and positioned Russia as a victim of Western economic aggression.  Third, if Putin is replaced from power who would be an alternative?  Former Russian President Dmitry Medvedev is currently serving as prime minister, but he is closely aligned with Putin and the two switched offices when Medvedev’s presidential term ended in 2012.  Other alternatives to Putin such as Mikhail Khodorkovsky show no appetite for entering the fray and even one who does, activist Alexei Navalny, has not shown that he can command a large swath of political support.  For example, when running in the Moscow mayoral election last autumn, Navalny only took 27% of the vote, although The Guardian on October 17 explains that since he was under house arrest that may have contributed to the outcome.  Critics of Navalny see him as a nationalist demagogue and this is where the idea of Putin losing to a popular protest has issues.  Yes, popular protests could form against Putin’s rule if economic difficulties grow worse.  However, these protests, according to The Hill, may not be democratic in nature.  Instead, they may have a xenophobic or fascist characteristic as both ideologies have flourished in the country.  In other words, Putin may not be a great option, especially because it is uncertain about how he would handle a full-scale economic crisis, but the alternative to him might be much worse.

Still, one cannot discount the fact that if Russia’s economy enters a severe recession that Putin will not feel some degree of pressure.  The Hill and The New Yorker concur that Russians do not have a good links to outside information, at least through traditional media outlets such as television.  For example, Russians have been told that the U.S. economy is doing poorly because of low oil prices, but as I explained in last week’s topic brief that is not the case at all.  If economic conditions continue to deteriorate, Russians might be more likely to seek out alternative news sources on the Internet, which could provide a challenge to Putin’s control over society.  Also, Putin likely realizes that Western sanctions are serving as a significant deterrent to fixing some of the Russian economy’s long-term challenges.  The Economist reveals that Russian Foreign Minister Sergei Lavrov has begun to temper the country’s rhetoric about Ukraine, suggesting that the country would not need to be federalized and that the Donbas region of Eastern Ukraine, which is fighting the Ukrainian government, does not need to receive autonomy.  Previously, Russia had made demands that both conditions be met, so this could be the first sign, albeit small, of a rethinking in the Kremlin about Russia’s commitment toward undermining the Ukrainian government and whether the economic cost for doing so is worth it.

The biggest fear going forward about the Russian economy, and one that extempers should take note of, is the uncertainty of how Putin can handle a tough economic climate.  Putin has never had to preside over a prolonged period of slumping economic growth and there are questions about his ability to fix a broken economy.  The Times of Israel writes on December 27 that critics of the government, such as investor Slava Rabinovich, charge that Putin and his cronies only know propaganda and not effective economic management.  This means that the Russian government will try to mask problems instead of implementing aggressive policies to fix them, hardly the answer that investors want to hear.  Putin could also double down on his aggressiveness, believing that nationalism can be his saving grace and distract the population from economic problems.  Thus far, Putin’s has paid little heed to recommendations from his Finance Ministry to shore up the lack of government investment in human capital, especially education, so it is unclear whether he will admit that he has been wrong and change course or whether he will gamble that energy prices will soon rise and help Russia escape its present predicament.

2015 will be a very interesting year for Russia.  The country’s commitment in Ukraine, its threat to undermine diplomacy over Iran’s nuclear program, and its economic difficulties set the stage for a turbulent year.  Extempers should continue to follow the country’s monetary policy, the stability of the euro, and how Putin is coping with Russia’s economic difficulties.  Failing to deal with them just might be the beginning of the end of Putin’s brand of political leadership.

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