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Russia and the Global Economic Crisis

Author: Stephen Sestanovich, George F. Kennan Senior Fellow for Russian and Eurasian Studies
November 25, 2008

Any international economic crisis afflicts different countries in different ways, but an unfortunate few experience every painful dimension of it.  In the current crisis, Russia is confronting virtually all the negatives at once--sharply declining export earnings from energy and metals, over-leveraged corporate balance sheets and a chorus of bailout appeals, a credit crunch and banking failures, a bursting real-estate bubble and mortgage defaults, accelerating capital flight, and unavoidable pressures for devaluation.

The Russian stock market is down 70 percent from late spring. The government has burned through more than 20 percent of its foreign-exchange reserves since August. The outflow of capital in October alone was $50 billion. Next year's budget is based on a projected average price for oil of $95 per barrel; now budget planners have to work with forecasts of $50 or lower. Since Finance Minister Alexei Kudrin has said that Russian government spending goes into deficit at $70 per barrel, pressures for spending cuts are starting to mount. Severe reductions have already been announced in housing and education programs.

Russians, it seems, at last have an answer to the question they have been asking since the economic collapse of 1998: Can anything approaching that crisis happen again? The vast hard-currency reserves they accumulated during years of high oil and gas prices (and thanks to conservative fiscal policies) make it hard to imagine that Moscow might default on its debts anytime soon. Yet the very fact that this crisis has engulfed the country at a moment of high confidence in the future has made it in some respects even more shocking. Debate about how it is being handled, how far it will go, and what changes it will bring with it is becoming intense and much more open.

Russians remember, after all, that 1998 was not only an economic calamity but a political crisis--perhaps the low moment of the entire presidency of Boris Yeltsin. It toppled the government, ended the political careers of key liberal policymakers, and actually brought Communists back into the cabinet. It offered a hearing to protectionist demands for Russia to insulate itself against the fluctuations of the international economy. It revived talk of the need to hew to Russia's collectivist traditions, rather than to alien Western ideas about markets and the primacy of the individual.

The very fact that this crisis has engulfed the country at a moment of high confidence in the future has made it in some respects even more shocking.

In Russia's response to the crisis of 2008 there have been a few echoes of 1998, including a generous share of anti-Western rhetoric. President Dmitry Medvedev and others have repeatedly criticized the United States and called for a reduction in its global influence. There have also been hints of a further tightening of authoritarian rule. Many Russian commentators have interpreted Medvedev's proposal to lengthen the president's term of office as a sign that Prime Minister Vladimir Putin plans an early return to the Kremlin--perhaps to rule with heightened powers.

Yet, for all this, the most distinctive feature of the Russian leadership's overall response to the crisis has been its emphasis on the importance of further reform and on cooperation with other countries. There has been no repudiation of liberal policymakers, and few suggestions that Russia should pursue a "Third Way," much less wall itself off from the world economy. If there is one theme that unites Medvedev's many policy statements, it is that the restoration of state control of the economy must be avoided at all cost. "The government," says Arkady Dvorkovich, the president's chief economic adviser, "cannot replace the private sector, the market, and business, nor is it going to do so."  For Medvedev, the state bureaucracy is already far too powerful and is guided by Soviet-era mistrust of "free people and free enterprise." The only way to stabilize the economy and sustain growth, he has repeatedly and publicly argued, is through transparency, competition, accountability, and protection of property rights.  When Medvedev and others call for changes in international financial regulation, their message is that Russia should try to increase its influence in global processes, not withdraw from them, and abide by international norms, not talk idly of creating alternatives.

Many Russian commentators have said that if the goal is to keep a hard-hit Russian economy in the international mainstream, adjustments in Russian foreign policy are likely to follow as well. They do not predict a complete change of direction, but a less confrontational, less ideological, more prudent, more resource-constrained approach to relations with the West. The need for such adjustments is particularly obvious where resources are concerned. With housing, education, and infrastructure budgets under acute pressure, it is hard to imagine that military spending could be completely unaffected.

Military officials who were told by Putin in September that they would get a 50 percent funding increase over the next three years may well resist suggestions by President Medvedev that their budget is now on hold. Yet arguments about the urgent need for military modernization can hardly have the same force that they did earlier in the fall. Already the armed forces have had to accept a plan to cut the size of the office corps by almost 60 percent in the next three years. The Russian government's desire to delay large increases in military spending surely also contributes to its apparent interest in a new round of arms-control agreements with the incoming U.S. administration.

Given the difficulties that have marked Russia's relations with the United States and Europe over the past few years, a desire to dial down tension--and spending--is understandable. But it does not exhaust the impact of the global economic crisis on Russian foreign policy. Russia's leaders have said repeatedly they see the crisis as part of a large shift in the international balance of power. The emerging economies, especially in Asia, will have to "assume the task to unravel the world economic crisis," Medvedev said in remarks published ahead of the late November 2008 summit of the Asia-Pacific Economic Cooperation forum in Peru. These economies will, he says, "become leaders in the post-crisis period." Russia wants to be on the winning side of this transformation.

It is one thing, of course, to want to be a member of the group of rising powers, and another to be treated like one. Russia has discovered that reaching agreement with China can be just as difficult as with the West. Russian businessmen and policymakers, hoping that access to Chinese capital could ease their own economic problems, recently launched discussions with China for a $25 billion loan to facilitate pipeline construction and enable Rosneft, the state oil company, to pay debts coming due this year. The talks were suspended when the Chinese raised what one Russian participant called "quite absurd lending conditions," including access to one of Russia's largest Far Eastern oil fields.

There has been no repudiation of liberal policymakers, and few suggestions that Russia should pursue a "Third Way," much less wall itself off from the world economy. If there is one theme that unites Medvedev's many policy statements, it is that the restoration of state control of the economy must be avoided at all cost.

Unlike most other countries, Russia can always use its arms exports as a means of sweetening commercial deals. At a time when Russian economic needs are especially great, however, its customers are likely to press their advantage-seeking more advanced equipment than they have been offered in the recent past. China, whose own military purchases from Russia have slowed recently, is one Russian client likely to push for such upgrades. Iran and Venezuela are two others of special interest to the United States. It is widely thought that Russia, while steadily increasing its arms sales to Iran, has declined to sell Tehran its most advanced air-defense systems. A protracted economic crisis will surely inspire many inside the Russian defense industry--and probably within the government as well--to call for a review of this policy.

All of these strategic adjustments--in defense spending, arms control, pipeline construction, weapons exports--represent matters of high policy for Russia's leadership. Yet, all politics being local, some of the most consequential issues created by the economic crisis may prove to be those that would ordinarily be considered matters of low policy. When production falls and unemployment rises in Russia, many of the Gastarbeiter, or guest workers, that have been needed to fuel the boom are usually sent home. For countries of the Caucasus and Central Asia, which have provided most of this enormous transient labor force (some estimate more than one million workers in Moscow alone), this will be a huge jolt. Quickly, Russia will go from being an important safety valve for socioeconomic discontent to a source of it. In the short term, Russia's neighbors will doubtless see this reflux of their own citizens as a reason to maintain good relations with Moscow, in hopes of winning coordinated management of a potentially dangerous problem. In the longer term, however, they may consider it a measure of their continuing and unwelcome vulnerability to fluctuations in the Russian economy--and of the need to reduce that vulnerability if they can.

Before the current crisis hit, Russia's leaders believed rapid economic growth was shifting the global power balance in their favor. The crisis, they fear, may have an even more dramatic effect on the international pecking order--and deny them the ground they have gained in this decade.

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