Former Dean and Adjunct Professor
Socio-Political Ramifications of the Economic Crisis in Russia
by Elizabeth J. Wilcoxson
Northern Essex Community College
Like much of the rest of the world, Russia has been impacted by the financial crisis of the last few years. The ramifications have been felt both at home and in Russia's relations with the rest of the world. Although some analysts believe that the tide turned in 2010, many challenges for the Russians remain. These challenges include renegotiating treaties for the export of oil and gas, reexamining planned privatization schemes, and reassuring the population at home that they will not suffer further deprivation as the economy recovers. This paper will examine those issues and others and how Russia is beginning to address them.
Like much of the rest of the world, Russia has been impacted by the financial crisis of the last several years. The ramifications have been felt both at home and in Russia's relations with the rest of the world. Although some analysts believe that the tide turned in 2010, many challenges for the Russians remain. This presentation will examine those challenges and how Russia is beginning to address them. Let me begin by acknowledging that I am an historian, not an economist. Thus, I will paint with a broad brush rather than examining the intricacies of the Russian economic system.
Russia began to experience serious economic problems in the summer of 2008 when some foreign investors began to pull out as a result of threats made by then President Putin against companies that were in arrears on their taxes. (Mankoff, 2010) After Russia's invasion of Georgia in August of that year, the exodus accelerated. The deepening economic crisis in the U.S. after the collapse of Lehman Brothers only added to the departing funds. By the end of 2008, more than 130 billion U.S.. dollars had been withdrawn from the Russian economy. In the first quarter of 2010, foreign direct investment had declined a full 53 percent from the same period in 2008. (Li, 2010)
In 2007 Russia had been prosperous. She had accumulated the third largest foreign currency
reserves in the world; the foreign direct investment in the first nine months of 2008 had already surpassed that for the whole of 2007; and fixed investment growth stood at about 22 percent. (Effects of the Economic Crisis on Eurasia, 2009) The value of the ruble had risen steadily since 2001. (Korolev, 2009)
By the end of 2008, the picture had changed drastically. The stock market had fallen 70 percent from spring to November. (Sestanovich, 2008) Instead of planning on an income of $95 per barrel of oil, planners were working with a forecast of $50 or less. In 2009, the real gross domestic product declined by approximately 8 percent (compared to a 2.4 percent growth rate in the U.S. and an 8 perscent growth rate in China). (Li, 2010) In relation to the dollar, the ruble had depreciated by 50 percent. (Korolev, 2009) The CIA described Russia as "the 8th worst performing economy in the world in 2009." (Korolev, 2009) To make matters worse, the inflation rate rose 14.11 percent in 2008 and another 11.653 percent in 2009. (Russia Economic Forecast, 2011) By 2010, however, the economy seemed to be slowly rebounding with a GDP growth rate of 4 percent and a projection of a 4.2 percent increase in 2011. (Russian economy grew by 4% in 2010, 2011) Earlier this month, the ruble reached a two year high against the U.S. dollar which seems to support this projection. (Russian Ruble Foreign Exchange Rate Hits 2 Year High Against U.S. Dollar, 2011)
The situation in Rusia was aggravated by the fact that, in order to secure support for his political program, Putin had made a tacit promise to the Russian people that their living standard would improve. Fortunately, the large reserves accumulated during the earlier, prosperous years could be tapped to provide assistance to struggling industries and to provide support for those who were unemployed. During the early months of the downturn, the government spent more than 400 billion U.S. dollars to support companies with the requisite political connections and to keep the ruble from collapsing. About half of that money went to support the metallurgy, banking, defense, and automotive industries. (Mankoff, 2010) By expending its resources in this way, the country now will have less to invest as the world economy begins to improve. In addition, many of the insdustries that received bailout funds would have beeen better served by the process of "creative destruction" which is badly needed if they are to be made competitive in the world market.(Mankoff, 2010) On the other hand, the policy has prevented serious social unrest despite an unemployment rate which reached a high of 9.4 percent in 2009 (Mankoff, 2010) and a rise in consumer prices of 8.8 percent in 2010. (Russian Economy Grew by 4% in 2010, 2011) Russia is the only member of the G-20 where inflation increased during the economic downturn rather than decreasing as would have been expected. (Jellinek, 2009) Despite the government's efforts, layoffs occurred in single industry cities, especially those that relied on ferrous and non-ferrous metallurgy. In some cases, wages were reduced or simply not paid or unpaid furloughs were required to avert outright layoffs. (Mankoff, 2010) The area of the North Caucasus suffered the worst with unemployment in Ingushetia reaching an estimated 57 percent in early 2009. (Mankoff, 2010) This fueled a new round of insurgency in this frequently restless area.
One possible long-term impact of these decisions is that the rise of the middle class may be halted due to the layoffs and wage reductions coupled with the fall in the value of the ruble, thus forcing people, whose fortunes had blossomed in recent years, back into poverty. In an attempt to placate potentially angry citizens, Russia increased monthly unemployment benefits, although they still remained too low to be of much help in expensive cities like St. Petersburg and Moscow, and the complexity of securing benefits discouraged many of the unemployed from actually applying for them. (Mankoff, 2010) Likewise, a website to help the displaced workers find employment was difficult to locate and offered only very low-paying positions. At the behest of the government, a number of companies that had received bailouts were expected to advertise for employees throughout Moscow. An attempt to generate income by raising tariffs on imported automobiles which supported a number of jobs in the Far East did lead to protests in Vladivostok, but the unrest did not spread. So far, serious domestic unrest has been averted in part because Russian workers see the economic downturn as the fault of American economic policies and not the doing of their leaders.
Russian guest workers have also felt the impact of the economic crisis. Many of them are from Central Asia and the Caucasus, and diminished production means that some of them are being sent home. Since there were over a million guest workers in Moscow alone at the start of the crisis, a large number of people are likely to be affected before the economy returns to previous levels. (Sestanovich, 2008) This will undoubtedly add to discontent in the countries to which they return and could be a possible source of tension between those nations and Russia, Some coordination may be necessary to keep this from turning into an explosive situation.
Last summer's drought and wild fires have added a new challenge as valuable crops were lost and will have to be replaced, at least in the short term, by imports which will require expenditures of hard currency.(Nikishenkov, 2010) Many Russias hold the U.S. responsible for the climate change which led to the drought which may complicate relations between the two nations. (Amsterdam, 2010)
Probably the single most important determinant in Russia's overall economic prosperity is the price of oil and gas on the world market. About 45 percent of Russia's revenue comes from oil. (Li, 2010) In 2009, Russia was the world's second largest exporter of oil and the largest exporter of natural gas. (Central Asia: Russia, 2011) Between July 2008 and January 2009, the price of oil fell from $140 to $34 a barrel. (Addressing the Impact of the Financial Crisis on EU-Russia Energy Cooperation, 2009) Although the decline was not quite as steep, the price of gas also fell significantly during the same period. These declines led Russia to its first budget deficit in 10 years. Timothy Ash, the head of emerging markets research at the Royal Bank of Scotland, has argued that Russia needs to sell her oil at $90 a barrel in order to balance the budget. (Li, 2010) With the price of oil back up to slightly over $90 last year, Russia's woes on this score may be mitigated. (Ruble Expected to Hit Eight-Month High by the End of March, 2011)
Much of Russian oil goes to buyers in Europe. As a result of the economic crisis in Europe and the trend toward more energy conservation, consumption of oil in the European Union fell about 5 percent from 2008 to 2009, and the decline in gas usage was even greater at 6.4 percent. (Addressing the Impact of the Financial Crisis on EU-Russian Energy Cooperation, 2009) This has led to extensive negotiations between the EU and Russia, because, for the first time, Europe was faced with honoring "take or pay" clauses in their agreement. The relationship is further complicated by bi-lateral arrangements between individual European countries and Russia and by the complex web of transportation networks through which the oil and gas flow from Russia to Europe. Gas presents the more difficult problem as it must be transported through fixed pipelines, while oil can be shipped in a broader variety of manners. Furthermore, plans to privatize portions of the Russian oil and gas industries (a policy strongly supported by the EU) have been put on hold since the economic downturn, and investment in the development of new fields has likewise been sidelined. Consequently, Russia is faced with the challenge of attracting investment in order to maintain and expand its place in the world energy market. Prime Minister Putin has been actively trying to encourage western companies such as Shell and Total to participate in developing the gas reserves in the Yamal Peninsula, for example. Although it is too early to assess the impact, unrest in the Middle East and uncertainty regarding the oil supply from that part of the world may work to Russia's advantage.
Declining oil and gas consumption in Russia itself will contribute the amount available for export, thus perhaps postponing new field development. The overall consumption of gas and oil within Russia itself declined 6 percent between 2008 and 2009 as the economic crisis deepened. (Addressing the Impact of the Financial Crisis on EU-Russia Energy Cooperation, 2009) In November 2009, the Russian Parliament passed legislation dealing with energy conservation and improving energy efficiency, although it is not clear how thoroughly the legislation has been enforced. However, the cost at the gas pump for Russian motorists has increased significantly as a result of supply fluctuations, taxes, and, many believe, a deliberate policy to keep domestic prices 15-20 percent above the true cost. (Potts, 2011) Putin has recently proposed tying domestic fuel costs to the world price of oil and the creation of an energy reserve.
At least verbally, President Medvedev has indicated that one long-term result of the economic crisis needs to be the diminishment of the role of the government in the economy and the encouragement of greater competition. (Mankoff, 2010) And, apparently, he continues to believe that the state bureaucracy wields too much power and that "transparency, competition, accountability, and protection of property rights" are necessary to future growth. (Sestanovich, 2011) Legal reform will need to go hand in hand with the process of breaking up state enterprises. Since Medvedev's term of office ends in 2012, and Putin's future plans have not been articulated, the likelihood of significant progress in this area seems limited. Many of the conglomerates that Medvedev might potentially target were strengthened during Putin's presidency. In addition, many of the businesses are controlled by individuals with significant political clout. Also unresolved is the question of whether foreign investors would be able to participate in any privitazation scheme. Mankoff argues that "a serious and prolonged crisis -- particularly if other major economies return to growth sooner -- would expose the underlying flaws of the Russian state-capitalist system and create immense pressure for reform (although at the same time raising the prospect of the state losing control of the process, as happened under Mikhail Gorbachev in the late 1980s)." (Mankoff, 2010, p.14) However, if oil prices return to precrisis levels and expansion continues with a return to prosperity, the need for reform may be blunted.
There are other potential ramifications within Russia if prices do not rebound. The Russian military has been largely funded through oil profits, and any reduction in support would seriously hamper funding for much needed changes to modernize military operations. (Sestanovich, 2011) A plan to cut the officer corps by 60 percent over the next three years could be in jeopardy. The navy, if anything, is in even worse shape, and new, more dependable ships are desperately needed. The pressure to economize on military expenditures has contributed to the motivation for arms control agreements with the U.S. The current weaknesses of its military may keep Russia from future interventions in neighboring countries such as the invasion of Georgia in 2008.
The importance of oil and gas exports has insured that Russia's policy toward Europe has remained stable, although Russia's ability to use energy to influence the foreign policies of its European customers has diminished. In fact, the dispute between Russia and Ukraine which resulted in Russia suspending gas supplies to that country in January 2009 led the EU to provide funding to help modernize the energy infrastructure in Ukraine. (Sestanovich, 2011) In addition, the EU has also pursued the possibility of obtaining gas and oil from several countries in the Middle East and North Africa, although it is possible that recent events in those areas may disrupt the negotiations and strengthen the relationship with Russia. Despite the desire of the EU to diversify its energy sources, it remains, from the Russian perspective, the most likely source of future investment for the Russian economy. Investment would also give the Europeans leverage to press for further reform and privatization in the Russian economy.
Relations between Russia and the U.S. have also remained stable, perhaps even improved. The election of Barak Obama was probably a more significant factor than the economic crisis, although Russia's reduced ability to intervene in neighboring republics is also significant. So far, the improving relationship has provided several routes across Russia for the delivery of nonlethal suppplies to the war in Afghanistan and has insured that the START treaty received Russian approval. (Charap, 2010 October) Despite the economic crisis, Russia will purchase up to 65 planes from Boeing, and PepsiCo has committed to a $1 investment in Russia. In June 2010, Presidents Medvedev and Obama agreed to cooperate on energy efficiency, a project that could potentially have economic benefits for Russia. The support of the U.S. will also be important in bringing Russia into the World Trade Organization, something which Russia needs to achieve in order to recruit foreign investment for the modernization of its industrial infrastructure.
Although the economic crisis has not significantly changed Russia's relationship with Europe and the United States, it has altered the relationship with other former Soviet countries. Many of those countries have suffered even more from the economic crisis than Russia. Both the decline in military capability and the reduction of financial subsidies to those countries has encouraged those nations to look elsewhere for financial assistance. Some countries have begun to explore improved relations with Western nations. Even Russia's close ally Belarus has begun to explore new links with Europe. This has also presented an opening for China. Moldova, for example, has been offered nearly twice as much assistance from China as Russia had promised, but failed, to provide. (Sestanovich, 2011) China has invested heavily in energy, mining and construction sectors throughout Central Asia. This has meant reduced Russian influence, for example, in trying to persuade Central Asian nations to recognize South Ossetia and Abkhazia and for Kyrgyzstan to expel the U.S. from its base at Manas.
When the economy was booming in early 2008, the Russian energy conglomerate Gazprom signed several long-term contracts with producers of energy from Central Asia promising to pay much higher prices than they had previously been paid for gas which was sent to Russian pipelines. Turkmenistan was the primary beneficiary of this agreement. Russia had, for years, imported oil from Turkmenistan at low cost for domestic consumption, freeing up Russian oil for export. (Pomfret, 2011) Given the expectation that energy prices would continue to rise, it was thought that this move would serve to deter Central Asia countries from pursuing their own agreements with Europe. Russia, up to this point, held a monopoly over Turkmenistan's gas sales to the international market thus making Turkmenistan dependent on Russia for hard currency. With the drop in European consumption, Gazprom was in a position of having to pay Turkmenistan more in hard currency that it was obtaining from Europe, however. When, in April 2009, the primary pipleline between between Turkmenistan and Russia exploded, the two countries blamed each other. The government of Turkmenistan claimed that Russia had reduced the amount of gas being removed from the pipeline causing the increased pressure to result in the explosion. Needless to say, the relationship between the two countries deteriorated. Only a single pipeline from Turkmenistan to Iran had been outside of Russia's control until a pipeline to China was completed in December 2009. Turkmenistan has also begun to explore other partners, including a project to bring gas from the Caspian basin in Europe bypassing Russia by a route through the Caucasus and Turkey. Other Central Asian countries may be inclined to follow suit. The uncertainty of relations with Central Asia has led Russia to explore other alternatives for the transportation of oil. A plan which would send oil through pipelines across Turkey to markets in the Mediterranean is currently being explored. (Addresssing the Impact of the Financial Crisis on EU-Russian Energy Cooperation, 2009)
Even Russia has begun to look eastward. By 2009, China had become Russia's largest trading partner after the EU, although the actual value of the trade declined in that year as a result of the global economic crisis. (Rosner, 2010 September 20) In an effort to offsest reductions in European consumption of oil and gas and to leverage China's available capital, an agreement was worked out last year to supply China with oil for 20 years in exchange for a $25 billion credit to the state oil company and the national pipeline monopoly. (Russia, China Expand Relations with Gas, Oil Accords, 2010) A new oil terminal in Nakhodka, near the border with China, will serve as the gateway for oil deliveries to China and beyond. (Rosner, 2010) The first deliveries were scheduled to begin on January 1. Construction also began in 2010 for an oil refinery in Tianjin through a collaboration between China's national petroleum corporation and Russia's Rosneft company. (Russia, China Expand Relations with Gas, Oil Accords, 2010) The same negotiations gave China the rights to develop and produce gas from two fields in eastern Siberia. (Rosner, 2010) This will be followed by the construction of two nuclear reactors by Russia in China next year. Russia and China have also worked out terms, except for the price, of a contract for Russia to supply natural gas to China. If the remaining details can be worked out, deliveries of gas could begin in 2015. Contracts are scheduled to be signed sometimes this year.
In September 2010, Medvedev visited China in an effort to expand cooperation in the areas of banking, anti-terrorism and energy. Russia also sells arms to China, although sales have declined in recent years. Russia hopes, however, that China will want upgrades soon for this equipment. Given the very real possibility that trade with Europe may never return to pre-recession levels, Russia needs China more than China needs Russia in this relationship. The relationship is, however, plagued by fears among Russians that China's growth, fueled by Russian oil and gas, may ultimately become a threat to Russia itself. (Rosner, 2010)
Overall, the economic crisis has forced Russia to renegotiate its major exports of oil and gas, diversifying buyers and shoring up contracts. Reduced foreign investment has contributed to stalling of privatization and modernization plans in the industrial sector. The need for both trade and invstment has resulted in building a stronger alliance with China which is suspect among many Russians and may lead to rivalry in the future. Russia's inability to continue subsidies and to threaten many of her former Soviet neighbors with military intervention has led to declining influence. Relations with the west have improved somewhat at the governmental level, although many individual Russians hold the U.S. responsible for the economic crisis and even for the heat wave which took place last summer. Thus, the citizenry may not be on the same page as the government in the arena of foreign affairs. The loss of prosperity of the middle class also may have ramifications in the future. However, the populace has remained passive so far, despite the changes that the economic downturn has forced on them. The fact that the economy now appears to be on an upward path probably means that social unrest is unlikely. It remains to be seen, however, what impact, if any, these issues will have on the 2012 presidential election. The biggest question for the future is whether the problems revealed by the economic crisis will lead Russia to reform or to maintain the status quo.