Political Risk and Threat Advisory Briefing: Putting Putin’s Russia Strategy into Perspective

Published on EGF: 08.05.2010

by Dr. Marat Terterov

Crisis response continues to dominate government thinking

In the spring of 2009 Russia remains in the midst of deep recession, as the country seeks to pull itself out of the biggest economic crisis faced since 1998. The political challenge this poses to the current Russian government of Prime Minister and former-President, Vladimir Putin, is substantial. Having largely defined the legitimacy of his two presidential terms (2000-2008) around rising national wealth and domestic prosperity, Putin’s government must now find a means of addressing the economic malaise in order to prevent the risk of dire social consequences. The immediate concern is to initially slow and ultimately reverse negative economic growth, which the World Bank predicts will contract by 4.5% in 2009. Industrial output started to decline in multiple sectors of the Russian economy in November and was contracting by 15% in the first quarter of 2009. Inflation has been rising rapidly, while the rouble has lost 40% of its value against the euro-dollar currency basket since last summer.

Russian companies have been slashing jobs, salaries and working weeks as the economy experiences its first recession in a decade amidst falling global and domestic demand, low oil prices and the drying up of international credit markets. The number of Russians who are unemployed, on forced holiday or unpaid leave has swollen to 8.7 million. The situation could deteriorate further as over a third of Russia’s companies plan more job cuts. The figure represents over 11% of the Russian workforce, where 3.5 million people have lost jobs since last August according to Russian sources. The metallurgy sector and the car industry have been particularly hard hit, with auto-maker GAZ cutting over 7,500 jobs in early 2009 while Russia's largest steel maker, Severstal , has unveiled plans to cut 9,500 jobs. The country's largest employer, Russian Railways, announced that it would lay off almost 54,000 people in April. There was no clear light at the end of the tunnel during the time of writing. To the contrary, Russian Deputy-Prime Minister and Minister of Finance, Alexei Kudrin, recently mentioned that Russia should not expect a return to the favourable conditions it has enjoyed in the recent times for many years to come.

Was Russia an island of stability in a sea of global turbulence ?

Russia’s economy seemed relatively immune to changing global circumstances initially. With oil prices reaching a peak of US$147 per barrel in July 2008, few chinks were evident in the Russian armour. Flush with oil revenues, Russia’s current account surplus was a substantial US$38 billion in mid-2008 and the Russian Central Bank had accumulated the world’s third largest foreign currency reserves at US$586 billion. The Russian government gave little regard to the rising storm in late summer 2008, referring to the country as an island of stability in a sea of global turbulence. Russian officials readily pointed to the structural weaknesses in the US regulatory institutions which gave rise to the crisis and spoke of the rouble as a possible reserve currency of international standing.

However, as the price of oil collapsed from its July peak to US$40 lows in September, the external shock was too strong for the Russian economy to absorb without impact. Within a few short weeks the Russian stock market lost more than US$700 billion and suspended trading, capital outflow reached US$130 billion, liquidity dried up and credit scarcity became prevalent. The rouble began a downward slide and the financial crisis rapidly spread into the real economy, as has already been discussed above. The Russian economy’s dependence on revenues from energy exports, lack of international competiveness and low propensity towards diversification left the country badly exposed.

The government’s initial response to the crisis has been of a fiscal nature and has so far focused on supporting the financial sector and enterprises, with rather limited support to households. As the crisis progressed from the financial sector towards the real economy, afflicting domestic demand, growth and employment, the policy focus began to shift in that direction. In November, Putin delegated Deputy-Prime Minister, Igor Shuvalov, with the task of overseeing a detailed analysis of the main industrial sectors of Russia’s economy in order to understand where the crisis was being felt the most. Having toured the country and engaged in complex dialogue with representatives of Russia’s oil and gas industry, the metallurgy sector, retailers, developers, bankers and farmers, Shuvalov’s report formed the basis of the government’s immediate anti-crisis measures at the industry level.

Uncertainty over government bail-out of enterprises and oligarchs

A list of enterprises of strategic importance for the Russian economy was drawn up as a result of Shuvalov’s investigations. These would qualify for state budgetary support, an easing of the tax burden and other relief measures under a fiscal stimulus package which centred around the establishment of a US$50 billion dollar government fund which aimed at supporting strategic enterprises in key industrial sectors. However, after US$11 billion in fiscal resources allocated under the fund had been disbursed, the government appeared to indicate that further allocations would be subject to greater restrictions. In March, Russian President, Dimitry Medvedev, referred to the economic crisis as a “test of maturity” for the country’s businessmen and called on business to show greater management initiative in adapting to the prevailing economic conditions.

This has caused friction between the state and the enterprise sector. Russia’s particularly hard-hit car manufacturers, identified as strategic on Shuvalov’s list of enterprises, have been in active dialogue with the government and called for state guarantees totalling almost 30 billion roubles (US$863 million) to support their debt-stricken business. A degree of uncertainty continues to exist about which enterprises, and which of Russian’s business tycoons (most of whom saw their fortunes decline drastically in last September’s stock market collapse) will continue to be bailed-out by the state. AvtoVaz, Russia’s largest car manufacturer, asked the government for state guarantees worth 10 billion roubles, while another major auto-manufacturing enterprise, GAZ (which is controlled by aluminium magnate and Russia’s wealthiest man prior to the crisis, Oleg Derepaska), has asked for a similar amount. Even Elena Baturina, wife of Moscow mayor Yuri Luzshkov and widely regarded as Russia’s wealthiest woman, has asked for state support to bail out her flagging real estate projects. Despite the uncertainty about state bail-outs, the total fiscal cost of measures implemented by the Russian government in 2008 and planned for 2009 amount to more than 2.9 trillion rubles or about 6.7 percent of GDP.

Putin model facing its first structural test

Dealing with rising unemployment and its associated socio-political fallout remains an overarching concern for the Russian government at present. Although high unemployment fuelled by economic recession is a concern for all governments in the industrialised societies, it poses a particular threat to regime stability in Russia, where scope for opposing political expression is limited and dissent is rarely tolerated by the state. Negative growth is unheard of in Russia during the Putin era and the domestic legitimacy of his rule has been built around political stability and rising prosperity fuelled by rapid economic growth. The Putin model is widely associated in Russia with the power and the money of the state, which could be used in a benign manner to enrich programs for workers and state dependant groups such as pensioners, as well as the intelligentsia, or other restless segments of society. Now that the Russian economy seems to have hit an unthinkable low-point and the state has become severely restricted in the volume of patronage it can dole out, the legitimacy of the Putin model is being confronted by its foremost structural test.

Widespread disturbances and public unrest associated with deteriorating economic conditions have already broken out in a number of Russian cities. Organised protests involving over a thousand demonstrators on each occasion have broken out in the Russia far eastern port city of Vladivostok in December and January. Demonstrators were protesting against the government’s decision to raise tariffs on imported used cars, which provide a source of income for thousands in a highly depressed economic environment. They carried caricatures of Putin and Medvedev and called on both to resign. While the threat posed to regime stability stemming from such demonstrations in Russia’s distant and highly criminalised far eastern provinces should not be exaggerated, Moscow still took the rather extraordinary measure of sending special riot police to Vladivostok to break up demonstrations. Wage delays have led to strikes by workers in Yekaterinburg in the Ural Mountains, whilst job cuts and removal of pensioner welfare benefits have brought thousands of people onto the streets in Siberian cities, predominantly Barnaul.

Armed riot control personnel prevented planned anti-government demonstrations from taking place in Moscow in December, detaining up to 100 people in the process. Protestors were reportedly angry about the government’s handling of the domestic financial crisis and plans to change the constitution to extend presidential and parliamentary terms. Further protests have been planned for St.Petersburg and the Russian Baltic enclave of Kaliningrad. The Kremlin’s propaganda machine has accused the West and Russian liberal factions of using the crisis to promote discontent in the country. It has also sought to point to economic and political chaos in Ukraine, Moldova, the new member states of the European Union in the Baltic and Eastern Europe to deflect Russians’ attention from social unrest in the country.

Fewer Russians believe the country is heading in the right direction

Few Russians, however, will be impressed by Vladimir Putin’s February announcements to a meeting of the ruling United Russia Party that the economic crisis is far from over and has not even reached its peak. The head of the Russian government pointed to the need for extra vigilance and called for a regime of “tough economy” in many fields of budget expenditure. It was evident that Russia would have a tough year, Putin added. While in May 2009 the government foresees the ability to meet and in some areas even expand its social obligations, more unrest cannot be ruled out for 2009 as enterprises providing employment for entire cities currently face a very uncertain future amidst an atmosphere low on confidence and high on gloom.

This view is reinforced by a very recent poll conducted by the independent Levada Centre in Moscow, which suggests that less than half of all Russians believe that the country is headed in the right direction just a year after Dmitry Medvedev was elected president on promises to follow Putin's course. As the economic crisis takes its toll, the number of Russians who believe that the country is moving in the right direction dropped to 43% in April 2009 from 59% in May 2008 when Medvedev was sworn in as the new Russian president. The crisis has also dented Medvedev's and Putin's own approval ratings, which have fallen to their lowest levels over the past year. A total of 68% of Russians approve of Medvedev's performance, down from a high of 83% in September after Russia emerged victorious in a brief war with Georgia. Putin's approval rating declined from 88% to 76% over the same period. Putin, however, remains the most powerful person in the country, with 30% of Russians saying he holds the most power compared with 12% for Medvedev.

Asset re-distribution, not reform has been the state’s priority

As Russia enters into a period of deep economic distress, the West’s misperception of the country as a resurgent international power, with an increasingly prosperous society is starting to become more evident. Wealth and power have remained highly concentrated in Russia during the boom years of the Putin presidency. High growth rates have effectively empowered the state, not society in Russia, where a vast ocean of underdevelopment has remained in a post-Soviet time warp under a thinly veiled film of capricious wealth. Opposition to the regime has become virtually non-existent, with the dominant United Russia Party inviting Putin to become party chairman at its congress of December 2007. Instead of using the country’s newfound wealth to build a foundation for political plurality, Putin’s experiment with managed democracy has been more focused on maintaining political power. This was most evident during the presidential elections of March 2008, which catered for a smooth transition of power within the Russian constitutional framework whilst also ensuring that the regime Putin created remained firmly entrenched in power. The outcome of the highly regulated electoral process was more reflective of a rotation of senior cabinet positions, rather than an actual transition of power from one political leader to another.

Neither has the government implemented any major reforms to diversity the economy away from its dependence on the energy sector, to reduce endemic corruption in the bloated public bureaucracy, or to empower the mainstream private sector through improvement of the business climate. Despite the impressive growth rates and Russia’s historic complex of “catch up syndrome” with the West, Russia’s US$1.6 trillion dollar economy remains 15 times smaller than that of the EU while national living standards are a quarter of the USA’s. Instead of taking advantage of the increasing wealth to purse economic reform and liberalisation which many experts suggest would put Russia onto a sustainable development path, the Russian government has been busy reasserting state control over most areas of economic activity deemed to be strategic.

Although foreign investment has expanded substantially in Russia during the oil boom, strategic enterprises previously controlled by Russia’s business tycoons (or oligarchs, as they are known inside the country) and foreign investors have been effectively sequestrated by the state. The state’s policy of taking back the “commanding heights” of the economy during the Putin years has resulted in the re-distribution of the nation’s strategic assets, transfer of wealth from the private sector back to the state and consolidation of Russian over foreign commercial interests. Some commentators have referred to this process as the “sale of the century in reverse”, a broad comparison with the loose days of the mid-1990s, when Russia’s oligarchs united to support President Boris Yeltsin’s presidential re-election campaign in return for the state surrendering the cream of its enterprises to the oligarchs at bargain prices.

Putin’s rising class of power bureaucrats taking control

During Boris Yeltsin’s presidency of Russia in the 1990s, the state was generally regarded to be weak while a narrow class of super-rich businessmen known as the oligarchs rapidly rose to national prominence. Crime in the business sphere was pervasive, whilst operatives from the depressed military and intelligence agencies such as the FSB (successor to the Soviet KGB) rendered their services to protect business interests in Russia’s blood stained commercial world. The power of the state grew during the Putin years, however, and most of Russia’s oligarchs were brought into the realm of the state’s national objectives. As the state started reasserting its control over the commanding heights, a new class of senior-level, powerful bureaucrats known in Russia as the siloviki began to rub shoulders with the oligarchs as Russia’s power brokers. Many of the siloviki, or hard-liners, are long-term associates of Vladimir Putin, having also graduated from the ranks of the KGB or, like current Russian president and protégé, Dimitry Medvedev, worked with Putin during his time as the head of the Committee for Foreign Economic Relations of the St.Petersburg city administration in the 1990s. Collectively, this group of Kremlin loyalists has come to form Putin’s inner circle.

They include people like former-joint deputy head of the presidential administration and now one of Putin’s deputy prime ministers, Igor Sechin; former-presidential aid and now Director of the Federal Service for Control of Drugs Circulation, Viktor Ivanov; former-long term head of the FSB and now Secretary of the Russian Security Council, Nikolai Patrushev; former-defence minister and now another deputy prime minister, Sergei Ivanov. All are from the St.Petersburg and all served in the intelligence or counter-intelligence services. Sechin and Viktor Ivanov are seen as being particularly influential and are possibly Putin’s closest allies amongst the siloviki. Their political clout has been reinforced by the re-distribution of Russian economic assets as discussed above and they are now backed by substantial financial resources.

Igor Sechin is the chairman of Rosneft, which has become Russia’s largest state-run oil company as a result of the state’s sequestration of YUKOS Oil Company. The state’s pogrom on YUKOS in 2003-2004, which entered its decisive stage just as Sechin was appointed to Rosneft, was the first and most blatant example of property re-distribution in favour of the siloviki. The company’s billionaire owner and Russia’s richest man at the time, Mikhayil Khodorkovsky, was arrested in October 2003 and remains in prison today. Viktor Ivanov heads the board of directors of Almaz-Antei, the country’s main producer of air-defence rockets, and of Aeroflot, the national airline. Sergei Ivanov oversees the military-industrial complex and is in charge of the recently created aircraft-industry monopoly. Other siloviki can be found in all key Russian enterprises and industrial sectors, as well as government ministries and law-enforcement agencies. Several former-KGB operatives occupy senior management posts in Gazprom, Russia’s biggest company by market value, and its pocket bank, Gazprombank, whose vice-president is the 28-year-old son of Sergei Ivanov.

For good measure, Andrei Patrushev, graduate of the FSB Academy and 27-year-old son of former-FSB boss, Nikolai Patrushev, was recently on secondment from the FSB to Rosneft, where he was an adviser to Igor Sechen. Patrushev junior was recently awarded a medal by Putin for his “conscientious professionalism and many years of hard work”. Alexei Gromov, Putin’s trusted press secretary from his presidential days, sits on the board of Channel One, Russia’s main television channel. Russian Railways is headed by Vladimir Yakunin, a former-Soviet diplomat at the United Nations in New York who according to several sources held a senior position in the KGB. Yakunin was at one stage widely tipped to succeed Putin to the Russian presidency. Sergei Chemezov, Putin’s KGB colleague from his days in Dresden in the 1980s, is in charge of Rosoboronexport, the state arms export agency and vast business conglomerate.

Geopolitics and big-business driving Russia’s energy relations with Europe

Gazprom is Russia’s largest and perhaps most important company, which Putin has turned into a personal project during his two presidential terms. Putin has widely advocated the use of energy as a means of Russia recapturing its power in the international arena and Gazprom has become the physical embodiment of the Russian energy weapon. Gazprom’s strength is derived from its monopolistic grip over Russia’s massive gas export market, together with the fact that the EU, which is heavily dependant on imported gas supplies, relies on Russia for 42% of its gas imports. Natural gas is becoming an increasingly popular fossil fuel in Europe and demand for it has been rising. Russia sits on top of the world’s largest gas reserves and is its largest exporter. Gazprom is the world’s largest gas producer. Russia is also the world’s second largest oil producer, after Saudi Arabia, and oil and gas exports together account for 80% of Russia’s total exports and 32% of government revenues.

Gazprom’s importance to the Russian economy cannot be overstated. The company accounts for 12% of Russia’s total industrial output, 16% of Russia’s total export receipts, 43% of Russia’s entire production of primary energy, while its gas production is a base fuel for 40% of Russian electricity generation. While the Russian oil companies operate in a fairly competitive international market, global gas supplies are far more concentrated and Russia is perceived by many experts to be using its monopoly power in order to develop a stranglehold over gas consuming countries – particularly those in the EU. While the EU is presently searching for alternative gas suppliers which would lessen its dependence on Russian gas, Gazprom is investing into additional gas supply routes to Europe in order to maintain market dominance. Geopolitics, together with the power of big business, is increasingly driving Russian energy policy and Moscow’s gas trading relationship with Europe.

Gazprom and its subsidiaries at the heart of Putin power base

Gazprom suffered from a largely negative image within Russia during the 1990s but has re-branded itself substantially both at home and abroad during the Putin presidency. The company has become a symbol of Russia’s newfound corporate power in the international arena, as rising energy prices have provided the basis for spectacular growth in its (pre-crisis) market value. Gazprom’s market value was close to US$350 billion shortly before the crisis set in last autumn, making it the world’ s third largest company by market value. Gazprom’s corporate empire, made up of its core gas business and numerous non-core subsidiaries, is also at the heart of Putin’s power base. At the outset of his presidency, Putin pushed through the appointments of current Russia president, Dimitry Medvedev and long-term St.Petersburg acolyte, Alexei Miller, to the positions of Gazprom’s Chairman of the Board of Directors (June 2000) and CEO/Chairman of the Management Board (May 2001) respectively. Appointments of other trusted individuals were likewise made to other key management posts within the company.

Parallel to Gazprom’s expansion of its widely publicised gas export business to the EU markets, Putin’s management team has likewise overseen a less visible albeit highly significant exercise in asset re-distribution. According to a recent testimonial report by leading Russian authorities, including former-Deputy Energy Minister, Vladimir Milov, and Deputy Prime Minister, Boris Nimtsov, this has included various schemes to sell off a diverse range of assets previously controlled by Gazprom at below market prices. Up to US$60 billion of Gazprom’s assets have been re-distributed as a result of such schemes according to Milov and Nimtsov. These include divestiture of up to 6.4% in Gazprom equity and further divestiture of substantial equity stakes in Gazprom subsidiary companies including Gazprom-Bank, Gazprom-Media, SOGAZ insurance, GAZFOND pension fund, SIBUR petro-chemicals enterprise, oil company SIBNEFT and others.

Most of these Gazprom subsidiaries have been transferred to the control of private businessmen with very close links to Vladimir Putin. Amongst them are Yuriy Kovalchuk, Chairman of the Board of the St.Petersburg based financial group, BANK ROSSIYA. Kovalchuk is a long term associate of Vladimir Putin and has been referred to as Putin’s personal banker. BANK ROSSIYA has benefitted from the re-distribution of Gazprom’s assets to the degree where it holds equity stakes in multiple former-Gazprom subsidiary companies as discussed above. Kovalchuk is reportedly a businessman in whom Putin places extreme trust. The two men have founded commercial enterprises in St.Petersburg during the mid-1990s and in April 2009, Kovalchuk’s 31-year-old son, Boris, was appointed to the position of deputy-Director of Russia’s state nuclear power corporation, ROSATOM. Other individuals to have benefited from sales of Gazprom’s assets include Mikhail Shelomov, owner of the Russian company ACCENT and the son of Vladimir Putin’s cousin. ACCENT also holds a 3.93 ownership stake in BANK ROSSIYA. Personal ties run deep in Putin’s Russia. Yuri Kovalchuk, for his part, has recently started to figure on the lists of Russia’s wealthiest persons, with an estimated personal fortune of US$1.9 billion.

Putin era not yet ended, Medvedev era not yet begun

As Russia seeks to come to grips with the country’s economic deterioration, the power base created by Vladimir Putin during his two presidential terms remains deeply rooted in the Russian political and economic system. Despite the crisis-driven legitimacy test which Putin’s system must currently address, there is no imminent political threat to the ruling order. Few viable alternatives to the Putin model of governance exist within Russia, despite Russians’ anxiety about the country’s present course. Indeed, the Russian populace has a tradition of surviving various forms of shock therapy, with no shortage of traumatic events of national significance in recent memory. History’s legacy has forced the Russian people to become more tolerant of hard times than many other nationalities but the ruling elites, for their part, have always lived in the shadow of political insurrection. The liberal opposition remains, for the most part, marginalised and Russia’s most credible liberals, including the current president, are firmly entrenched as part of Putin’s power base.

It is clear that neither Russia’s last presidential elections nor the economic crisis have brought an end to the Putin era. What is less clear is whether a Medvedev era will ever begin. One year after Dimitry Medvedev was inaugurated as Russia’s new president, Putin’s protégé has yet to break out of the shadows. Speculation is still rife that Medvedev will either leave his post early or make way for Putin’s return to the presidency when his own term expires in 2012. This view is reinforced by Medvedev’s own approval of extending the presidential term to 6-year periods after 2012. Yet the Russian presidency is in its own right a preponderant institution, one which yields enormous power and ability to alter the course of national events – as Putin’s own experience has shown. Long-lasting recession and depressed oil prices could bring greater pressure on the Putin governance model and compel the state to reform.

Some experts suggest that liberals within the Russian government, including Medvedev and others could lead Russia into a new perestroika in the event of deep recession and social fall out. The recent poll by the Levada Center suggested that 48% of Russians currently believe that Putin and Medvedev share power equally, and despite the president still being widely perceived as the prime minister’s subordinate, Medvedev has been taking steps to strengthen his own power base inside Russia. This is evident in the president’s increasing criticism of the government’s performance in dealing with the crisis, or his recent dismissal of some regional governors endorsed by Putin whilst appointing others he has endorsed himself. For the foreseeable future, however, Russia will continue to make its way through the challenging economic times without structural alteration to the country’s present political management.

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