President Vladimir Putin faces an immense challenge in addressing Russia’s economic crisis, which has sent shockwaves through the ranks of the political and business elites. The government has cut budget spending by 10 percent and Putin has tightened the reins at state firms, intensifying competition for resources, writes Donald N. Jensen, resident fellow at the Center for Transatlantic Relations.

 

Vladimir Putin is said to be displeased by the way Igor Sechin (above) runs Rosneft. Putin has refused to bail out Sechin’s company with money from the National Welfare Fund and has diluted Sechin’s clout in the firm by approving government officials to the Rosneft board of directors. Photo: Mikhail Metzel / TASS

 

“Money is the mother’s milk of politics,” an American politician once said. That observation is certainly true in the United States—but it also gets to the core of Russian politics under Vladimir Putin. In modern Russia, the distinction between power and money is vague or inconsistently enforced. Personal wealth and control over financial resources are measures of political power.

In the early years of the Putin presidency, most Russians began receiving a higher standard of living as the economy shot skyward, fueled by the vast wealth generated by Russia’s natural resource exports. In exchange, they yielded political power to a narrow group of elites in the Kremlin and tolerated immense official corruption. Today, the global slowdown in commodity prices and Western economic sanctions—punishment for Russia’s invasion of Ukraine—have pushed the country not only into an economic recession but also into a political crisis, one exacerbated by Russia’s weak rule of law and feeble institutions.

Across the board, the economic news is bad. The International Monetary Fund predicted in July that the Russian economy would shrink by more than 3 percent this year, though some experts predict that the eventual contraction will be even larger. The average Russian has been hit especially hard: Personal income between January and July of this year was down by almost 9 percent. Real wages have declined. Pensions have been indexed, but not at a rate that reflects the rate of price increases for key consumer items. Inflation and poverty are on the rise and the ruble has lost almost half its value over the past year. These facts raise questions about the future of Putin’s rule.

The real problem lies deeper than the sanctions and the decline in energy prices. Russia suffers from a classic case of the “natural resource curse,” the tendency of easily gained wealth from commodity sales to prop up inefficient industries, squeeze out manufacturing, and fuel corruption. Russia’s bloated state sector has smothered private enterprise. The economy is in desperate need of outside investment and deregulation. Although some Russian officials acknowledge the seriousness of the problems, the top leadership is unwilling or unable to fundamentally reform a system that has given them immense political power and wealth.

This combination of rising inflation, the devaluation of the ruble, and the drop in revenue from energy exports have forced a radical rewriting of the national budget. An overall cut of around 10 percent in government spending has already been enforced and the authorities have used foreign currency reserves to make up for shortfalls. By early October, Russia’s reserves stood at $370 billion, after reaching an eight-year low of $350 billion in April. Energy companies, which account for 98 percent of Russian corporate profits and approximately half of state budget revenues, remain profitable—but they have weathered the fall in oil prices thanks to the collapse of the ruble and a tax system that makes the state bear much of the effect of price declines. The sector also faces critical problems in the long term, including a glut in global supply and increased competition from overseas.

Russia’s economic crisis has presented Putin with a political dilemma. One option is to use increasingly scarce resources to finance elements of the threatened social safety net, such as the cash-strapped pension fund, to help ensure that his broader popularity remains high. Alternatively, he could cut back expensive programs such as military modernization—though such a move would be resisted by fierce bureaucratic interests—and move that money elsewhere. Putin could also neglect people’s needs and take steps to protect his cronies, on whom his political power depends in part. These three actions are, to some degree, incompatible with each other, so Putin would find it difficult to fully implement all of them. The National Welfare Fund, for example, created in 2008 out of the Reserve Fund as a pool of money to pay for pensions when the price of oil fell, could be used to make up an expected $54 million deficit in the pension program this year. But inefficient corporations such as Gazprom and Rosneft, controlled by the Kremlin’s inner circle, have lobbied to use the money for bailouts.

Inside the ruling elite, longstanding competition over power and property has intensified as the resource base has shrunk. The “economic storm” has caused “bewilderment” and nervousness at the top, since the elites did not anticipate the West’s determination to impose effective sanctions and underestimated the effects of those sanctions.

Putin, meanwhile, seems unwilling to reduce military spending. Other options, such as getting out of the Donbass, might relieve pressure on the budget if it convinces the West to ease sanctions, but that would take time. The situation is especially urgent because the government’s financial reserves could be stretched thin in little more than a year, around the time of the State Duma elections in September 2016.

Inside the ruling elite, longstanding competition over power and property has intensified as the resource base has shrunk. The “economic storm” has caused “bewilderment” and nervousness at the top, according to one expert, since the elites did not anticipate the West’s determination to impose effective sanctions and underestimated the effects of those sanctions. Some power players are reportedly critical of Putin in private but cannot challenge his authority, since he could easily crush them. Longstanding tensions among the leaders who seek to replace Dmitry Medvedev as prime minister, and thereby formally become Putin’s heir apparent, lie just below the surface.

Especially noteworthy has been the increased rivalry among the large state corporations controlled by the so-called siloviki. Energy giant Rosneft has revived a proposal to split off the transport arm of Gazprom, its great adversary, as part of a reorganization of the natural gas sector. (Gazprom has had its performance roundly criticized by a number of experts, government officials, and reportedly Putin himself). On the one hand, the crisis generally works in favor of economic liberals and supporters of a conservative budget and structural reforms. On the other hand, despite their differences, the siloviki are digging in and trying to legitimize their influence on economic policy and secure control of key cash flows.

Putin was widely reported to have relied on a tight circle of advisors from the “power ministries” in the planning and execution of “Operation Crimea” last year and as the invasion of Ukraine unfolded. (As a rule, Putin prefers to deal with foreign policy and national security issues over domestic policy.) As the economic crisis has come to the fore, however, he has relied more frequently on the government apparatus. Putin reportedly is increasingly suspicious of oligarchs who have retained their wealth as a result of their loyalty to him and who are being hurt by Western sanctions (several of whom are skeptical about the war in Ukraine).

Putin is also reportedly irritated by the way that heads of state companies have run their enterprises, and resents their repeated requests for subsidies while the government is dealing with the economic mess. The summer departure of long-time ally Vladimir Yakunin from Russian Railways may, therefore, be due to his mismanagement of the company. Putin is also said to be displeased by the way Igor Sechin runs Rosneft. Putin has refused to bail out Sechin’s company with money from the National Welfare Fund and has diluted Sechin’s clout in the firm by approving government officials to the Rosneft board of directors. Government influence over other state enterprises may soon be further enhanced, if, as is reported, other bureaucrats slated to join the boards of state companies take over as their chairmen.

Putin’s firing of Yakunin and the apparent gains by the economic bloc in the government have caused some of Moscow’s political class to wonder whether a permanent change of course may be coming in the authoritarian course of the regime. This speculation intensified after Putin’s August meeting with Medvedev in Sochi, where the two men were filmed weightlifting in tracksuits. The encounter was interpreted in some quarters as a rehabilitation of the prime minister, who remains a symbol of cautious reform to some. One commentator more accurately criticized the episode as a nostalgic “parody” of the so-called tandem era, when Medvedev was president but Putin ruled the country as prime minister, and Russia had a rising GDP and oil prices were high. Medvedev may or may not be the reformer some people claim he is, but he has never had much weight in Russia’s informal clan system. He would need more to become the true national leader or to open up the regime.

In the end, there are few signs that the recent ferment at the top is anything more than the system rebalancing itself. After all, Yakunin’s replacement, Oleg Belozerov, is not a Western-style manager but a creature of oligarch Arkady Rotenberg, another close Putin ally. His appointment suggests that expertise was not Putin’s main criterion in picking a new railway boss and that Yakunin was more likely a victim of apparatus intrigues. Despite Putin’s displeasure with Sechin, there is no sign that the Rosneft chief will follow Yakunin out the door—Sechin reportedly retains access to the president and remains influential across the government. So far, no one in power seems to see a way out of the present economic crisis other than waiting for the return of higher oil prices. The country is thus faced with both economic and political crises, with no consensus about what to do next.

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