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.
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.
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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