Russian
President Vladimir Putin gestures as he addresses the media during a
press conference on the third day of the NATO Summit conference in
Bucharest, Friday April 4 2008.
The risk of a financial crisis in Russia has risen because of a
precipitous fall in the rouble in mid-December. Recession, falling
living standards and rising economic uncertainty look set to be key
sources of political instability over the near term.
But despite differences between the economic and security elite, it
seems unlikely that financial instability, at its current level, will be
enough to produce a political revolution in Russia similar to the one
that undid the Yanukovych government in Ukraine in February 2014.
However, the desire to avoid such an outcome will continue to inform the
actions of the Kremlin at home and abroad.
And even if a full-blown financial crisis were to send the economy
into a slump, bringing Vladimir Putin, the president, down with it,
security hardliners look better placed to choose his successor than
either the economic liberals or a vibrant popular protest movement that
has yet to emerge.
Russia finds itself in the middle of a multi-dimensional crisis. Even
before the bust-up with the West over Ukraine, Russia’s economy had
been running into trouble, growing more slowly each year since 2011,
owing to the government’s failure to undertake structural reforms
crucial for innovation and investment.
In the second half of 2014 structural deficiencies have been exposed
by a precipitous drop in global oil prices, Russia’s main source of
export revenue. The rouble followed the oil price down until
mid-December, when the Russian currency plummeted owing to a loss of
confidence in the exchange-rate policy of the Russian Central Bank
(RCB).
In turn, this has exacerbated the debt burden of foreign-currency
loans taken out by Russian firms. But because Russia’s military actions
against Ukraine have led to the imposition of Western economic
sanctions, Russia is cut off from Western capital markets.
Russian
President Vladimir Putin speaks during his annual end-of-year news
conference in Moscow, December 18, 2014. The rouble edged lower against
the dollar on Thursday, with traders saying President Vladimir Putin had
offered few concrete measures at his end-of-year news conference to
pull Russia out of a crisis.
Riding high
So far, however, Mr Putin remains popular. Before Russia’s annexation
of Crimea in March, his ratings touched a low point; afterwards, they
soared. In early December opinion polls indicated 85% approval for Mr
Putin’s work as president, with more than 62% of Russians expressing
trust in him.
Among the next most trusted politicians, four are members of the
government, and one, Vladimir Zhirinovsky, is a deputy in the State Duma
(the lower house of parliament) who supports Mr Putin on most issues.
Their ratings are in single digits, in line with a generally low level
of trust in government overall.
In addition, Mr Putin has spent years building a structure of power
that minimises the opportunities, and raises the risks, of challenging
his authority. Federal districts-large administrative divisions that
comprise several provinces-are controlled by a presidential
representative, each with their own dedicated administrative staff.
Moreover, Mr Putin’s administration also controls the key companies that
generate export revenue, either because the state owns a majority stake
in them or because their top managers are appointed on the basis of
loyalty to Mr Putin.
Some of these managers share a similar background to Mr Putin in the
Soviet-era state security service. Now, both Western sanctions and the
rouble crisis have increased the dependence of key firms on state
support, pushing them closer to Mr Putin’s administration. In control of
central and regional bureaucracies and with his popularity rating still
high, the chances of Mr Putin’s rule being brought to an end by either
mass anti-government protests or through a “palace coup” currently look
slim.
Amid high energy income, competitiveness was neglected
During his almost decade and a half as president (a post that he has
held three times) and prime minister (a post that he has held twice), Mr
Putin’s political popularity has been underwritten by Russia’s
continued economic growth, as well as by the semblance of a return to
order after the lawless 1990s.
Real GDP per head doubled between 2000 and 2013. However, this was
explained more by the overlap of Mr Putin’s rule with a rise in global
oil prices than by the success of the government’s development policies.
The Russian economy is made up of a combination of state-controlled
enterprises, companies owned by politically connected businessmen and
genuine privately-owned firms. This economic structure conditions the
kinds of policies that are politically feasible.
Rapid growth in oil and gas revenue discouraged reforms of the real
sector. Government finances, supported by a current-account surplus, as
well as growing gold and foreign-exchange reserves, remained healthy.
Beneath the surface, however, it has become more difficult for
agriculture and manufacturing to compete with imports made cheaper by
the rising rouble, itself lifted by rising hard-currency earnings.
At the same time, an economy dominated by companies run by the state
or by politically linked oligarchs has not been an attractive
destination for capital investment, outside of the high-risk,
high-reward energy sector. But whereas Russia’s current account has
stayed in surplus, its capital account has recorded mostly deficits,
sometimes large, throughout the past decade. On paper, lower oil prices
might be just the incentive required to drive economic reform and
diversification.
However, this will have been made much harder by the deterrence of
investors, perhaps for some time, owing to the apparently arbitrary and
unpredictable behaviour of the Russian leadership, at home and abroad,
over the past year.
Perhaps aware of his own limitations, Mr Putin has delegated the
administration of Russia’s finances to experts with liberal economic
credentials. In contrast, key businesses in the real sector are largely
administered by officials with more statist views. Ahead of the latest
jolt to the rouble, Russia’s public finances looked solid-with debts low
and reserves high.
The fall in the rouble earlier in 2014 was in large part because of
investor perception of the economy’s underlying structural problems,
long in gestation. This time, a misstep in the timing of monetary policy
adjustment in relation to fast-changing external conditions greatly
accelerated the pace of depreciation, exacerbating Russia’s already
worsening terms of trade (the cost of imports in terms of exports).
As the contradictions in the economy unwind, for the general population a sharp boost to inflation will be felt in early 2015.
In part, the overthrow of the Yanukovych government has given Mr
Putin an opportunity to distract attention from the problems beginning
to emerge from his neglect of the economy. Linked to this, the drop in
the rouble and the approaching recession are officially explained as
attempts by Western powers to force Russia to halt support for
anti-government militias in the east of Ukraine.
Mr Putin presents the current stand-off with the EU and the US as yet
another step by the West designed to humiliate Russia and to cut it
down to size on the international stage. To this end, Russians have been
admonished to mobilise for the country’s defence, and the expected fall
in living standards is portrayed as a necessary sacrifice to protect
Russia’s independence.
For now, people have been busy exchanging roubles for consumer
durables, lest the rouble fall further. So far, there are few signs of
discontent with the president’s explanations of the causes of the
economic crisis.
Russian
President Vladimir Putin attends a meeting with his Kazakh counterpart
Nursultan Nazarbayev at the Kremlin in Moscow, December 22, 2014.
Could be worse
Even if most of the spillover from the rouble crisis is averted-as we
think it will be-in the coming year government efforts will be directed
at minimising the effect of recession on the population. Mr Putin will
also need to mediate between two different groups in his entourage-the
liberal financial managers, and hardliners in the security apparatus and
the real sector, who are broadly inclined to more nationalist and
state-centred positions.
The more liberal technocratic group has the best chance of keeping
the country’s finances under control-and the reputation of Elvira
Nabiullina, the governor of the RCB, may even be enhanced if the rise in
the interest rates in mid-December stabilises the rouble for long
enough to maintain reserves until the oil price picks up (which we
expect to happen in the first half of 2015).
On the one hand, Mr Putin will need Ms Nabiullina’s kind of expertise
during the downturn-which, at his annual press conference on December
18th, he said would last two years. On the other hand, he will need the
hardliners to maintain control over law enforcement, the armed forces
and security apparatus, which, among other things, will be needed to
suppress the insurgent and terrorist activity in the Caucasus and keep
the lid on any signs of a resurgence in the democratic opposition in
Moscow.
The hardliners would be more amenable to restoring Soviet-style
controls over the economy and to imposing currency controls. But Mr
Putin seems to realise that this would not be sustainable, and his
economic experts are doing their best to keep the country’s economic
rules compatible with international financial markets.
Therefore, while steering clear of currency controls if at all
possible, he is likely to placate hardliners by expanding weapons
procurement for the armed forces and continuing to foment low-level
military action in the Donbas, thereby channelling the energies of
Russian nationalists who otherwise might have forced him to make
counterproductive economic policy choices.
As long as a financial meltdown and economic slump are avoided, Mr
Putin could succeed in this balancing act-preventing a build-up of
economic grievances, as well as intra-elite rivalry, that might
otherwise threaten his administration.
If not, the most likely of the other possible outcomes could be a
defeat of any popular protests and the economic elite by the hardliners,
possibly also involving the replacement of Mr Putin. In politics, this
would mean a still tighter crackdown than has been seen already in 2014,
and the administration of more populist economic policies by
centralised bureaucracy.
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