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Dec 17, 2014 | 19:43 GMT

Russia's Economic Crisis Reveals Fault Lines

Russia's Economic Crisis Reveals Fault Lines
(ALEXANDER NEMENOV/AFP/Getty Images)
Summary

Russia's deteriorating economic situation has struck another blow to Russian President Vladimir Putin and his ability to maintain a firm hold on the country and the government. Uncertainty in the Russian economy continued for another day Dec. 17 as the Russian government was forced to step in to stabilize the ruble after the currency plummeted by 20 percent the previous day. The fall in the ruble's value came after the Central Bank of Russia raised interest rates from 10.5 percent to 17 percent — the largest interest hike since the devastating 1998 financial crisis that led to Russia's massive defaults. These developments in what was already a weakening economy has increased pressure on and within the Kremlin, spawning rumors throughout Russia about the cause of this instability and what could come next.

Before the past few frantic days, the Russian economy was already in a sharp decline caused by several factors. Russian industrial growth and production began stagnating in 2013, and the Russian-supported conflict in Ukraine has soured investor sentiment and prompted economic sanctions from the West. Moreover, oil prices have fallen below the government budget's target of $93 per barrel for 2014 and $80 per barrel for 2015.

Many within Russia are characterizing the decision to raise interest rates at such a crucial time, without an expectation that the currency and markets would react negatively, as mismanagement, although the issue is not that simple. Although the markets and the currency have stabilized for the most part, the Russian government now is looking at several options to buttress the economy. The most widely discussed option is the possibility of enacting controls to prevent capital flight. Before 2004, the Central Bank of Russia approved all currency transactions in foreign currencies — a requirement that could be reinstated. Russia also could tighten the limits on such transactions, which were eased in 2006 and have loosened further since then. Russia has even put forth the idea of allowing its currency to fall, without interventions, in 2015 — a plan under serious consideration now.

Another possible option is for Moscow to use its massive financial reserves to prop up the markets and the currency. Between its currency reserves, the National Wealth Fund and the National Reserve Fund, Russia currently has $587 billion. However, as Russia saw in the 2008-2009 financial crisis, this money can be spent very quickly. During the crisis, Russia spent approximately $280 billion of its reserves on the market and the currency. This option would mostly just buy time for the Russian government.

A highly unfavorable option would be for the central bank to raise interest rates again. Russia has done this before in times of crisis. In May 1998, Russia raised interest rates from 30 percent to 150 percent, and in the 2009 recession, rates rose from 6 percent to 10.5 percent. The more minor rise in interest rates in 2009 did not spark much social backlash, but protests erupted across the country during the 1998 crisis.

The Russian People's Responses

Russians' reactions to the Kremlin's latest drastic measures have varied. Some panicked, as evidenced by a run on banks for foreign currency Dec. 16. Russians reportedly also rushed to appliance stores to buy washing machines or televisions to unload their rubles before stores could react to the currency change and change their prices. This is why some businesses closed their doors Dec. 17 — Apple is not selling iPhones, and Volvo is not selling cars — and could remain closed for another few days until it is clearer whether the ruble will destabilize further.

There has not been the kind of frantic response to wild currency, market and interest rate fluctuations that was seen in 1998. However, social backlash could manifest as inflation and food prices continue to rise. With the ruble and market shifts seen Dec. 16, a spokesman for Russia's Retail Companies Association said food prices will increase 15 percent in the next few months. Because of Russia's economic decline, food prices have already risen by 20 percent in the past four months, and the price of gasoline has risen by 10 percent despite declining oil prices.

Since the fall of the Soviet Union, the Russian people have weathered economic pain fairly well, having gone through the Soviet collapse, the 1998 financial crisis and the economic crisis of 2008-2009. However, Putin said in early December that the Kremlin may have to impose controls on food and gasoline costs to relieve the economic pressure on Russian citizens. In November, Putin's close confidant, Deputy Premier Sergei Ivanov, met with many of the country's regional leaders and warned them to have plans in place should street protests break out over the economic situation.

Hints of such unrest have arisen already. Minor protests erupted across the country in November when it was revealed that the economic situation will force the health care system to close down several hospitals and clinics across the country starting Jan. 1. Though the protests never grew larger than a few thousand people, there was a marked change in the demonstrators' tone. In Moscow, a woman carried a sign that read, "Putin screwed up Ukraine, and now health care." This illustrates that Russians now are blaming Putin for the Ukraine crisis and that other problems Russia is facing are bleeding over into the economic situation.

Putin has been able to manage the tensions with the West and failures in Ukraine by stirring up nationalism in recent months. However, the worse the economic situation in Russia gets, the less the Russian people will tolerate the Kremlin's stance on Ukraine and against the West.

Reactions in the Business Sector

Russia's current economic conditions, particularly over the last few days of instability, have created complications for some of Russia's business sectors, such as agriculture. Grain exports reached a record high as exporters cut prices to speed up sales in case the Russian government imposes price controls in the future. Moreover, Russian Agricultural Minister Nikolai Fyodorov said the central bank's rate hike could prompt the government to abandon a preferential lending program for farmers that compensates interest paid on loans to farmers up to a certain rate.

Russia's oligarchs have taken a major hit because of the economic decline and the instability of the markets and the currency. Many of the top oligarchs have lost between 20 and 50 percent of their wealth, either through their investments or their companies. Owner of the food retail giant Magnit, Sergei Galitsky, lost nearly $1 billion solely because of the ruble's instability over the past two days.

The oligarch class is important for several reasons. First, the oligarchs managed to remain in powerful business positions after Putin cracked down on the oligarch class in the early to mid-2000s. The remaining oligarchs have an understanding with Putin that they will keep out of politics if they can keep their empires in Russia. This understanding has mostly held, but as their fortunes fall away, the oligarchs could pull their support for Putin's government. Putin has also relied on many of these oligarchs to help prop up the market and the currency in the past, but their ability to help the state in such matters now is currently limited.

Another reason for the oligarchs' importance is that some of the industries they are involved in, such as metals, make up the foundation of entire regions in Russia. For example, the steel company Novolipetsk is based in Lipetsk Oblast and employs 64 percent of the local population. With the recent dramatic changes in the economy, Novolipetsk has already begun laying off workers — a step that could pose a challenge to the survival of whole cities.

Kremlin Infighting

The overall decline in the economy and the recent uncertainty has raised tensions within the government, making Putin's control of his teams in the Kremlin less certain. When the ruble plummeted, disturbing Russia's markets on Dec. 16, Putin and his team seemed to shut down. The president worked as if nothing unusual had occurred. His spokesman, Dmitri Peskov, said Putin's office would not comment on the currency and market situation and that the president had planned no meetings on the issue. In short, Putin is acting calmly, but he does have a large press conference planned for Dec. 18, at which he will be forced to address the deteriorating economy.

Meanwhile, the primary officials acting as the face of the current crisis are Prime Minister Dmitri Medvedev, central bank chief Elvira Nabiullina, Finance Minister Anton Siluanov and Economic Development Minister Alexei Ulyukayev. These government members have already been under attack in recent weeks for failing to predict the level to which oil prices have fallen. In the past two days, they have faced increasing attacks by rival politicians, Duma members and commentators across the country. Many critics have put most of the blame for the Dec. 17 instability on Nabiullina and Medvedev and have called for them to be sacked. Putin could be seen as using Medvedev and Nabiullina as scapegoats for the current economic predicament.

Many political commentators have called on Putin to bring former Finance Minister Alexei Kudrin back to power, but as prime minister. The argument for this move is that Kudrin could help restore investor confidence in Russia, since Western economists see him as a reformer. This suggestion comes as Kudrin is rumored to be in talks to rejoin Yabloko, one of the more liberal and Western-friendly opposition parties in Russia. Meanwhile, the hawkish elements in the government — such as Ivanov and Sergei Glazyev, an economic adviser to Putin — are pushing publicly to scrap Nabiullina's and Medvedev's policies in favor of implementing currency controls and building a highly planned economy.

A peculiar twist is that the recent crisis is building pressure on one of the most elite figures in Russia: the head of Rosneft, Igor Sechin. On Dec. 12, Rosneft (which carries massive debts) issued approximately $10.9 billion in new bonds, which the central bank said commercial banks would accept as collateral for the company's loans. A report originating at Interfax — though it has now spread — indicated that this was a secret plan Sechin and Nabiullina had made to collapse the currency and help Rosneft's debts. Sechin has called the rumors a "provocation." However, this situation did lead numerous Russian Duma members to call for Sechin's resignation, with lawmaker Ilya Ponomarev saying that sacking Sechin would calm the markets and send the right signal to investors.

Sechin and the economic teams, particularly from Siluanov's and Medvedev's camps, have been at loggerheads over other major economic decisions, such as whether the Russian government should assist Rosneft with its debts or sell a large stake in the oil firm — something Sechin firmly opposes. Negotiations are underway that could lead to a compromise, such as a smaller sale of the government's stakes in Rosneft and some financial assistance from the government for the debt-laden oil firm. 

Fissures and disagreements have formed within Putin's top team on how to manage the current economic crisis, just as Putin is already losing the confidence of Russia's security chiefs. Because of the failure to predict a change in Ukraine, Putin has already purged factions within the Federal Security Service. Moreover, in recent weeks, Nikolai Patrushev — head of the Russian Security Council and former Federal Security Service chief — has faced public criticism and allegations of corruption from opposition factions led by Alexei Navalny. This could signal even greater pressure among Russia's security elite, one of Putin's primary sources of power and stability. With many of Putin's supporting factions in disarray, the Russian president is facing another test of his ability to retain the confidence of the people and those inside the Kremlin. 

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