As oil prices have dropped dramatically over the past month, Russia has been one of the nations hurting most. In fact, it’s possible that collapsing prices, combined with a raft of other economic problems, may be enough to force Vladimir Putin to back off of his domination of eastern Ukraine — which has begun to feel almost permanent just eight months after the annexation of Crimea.
Between the more than 4,000 dead in Eastern Ukraine and Russia’s continued acts of military provocation against Europe and the West, the country has grown significantly more aggressive abroad since March, and seems to have little interest in backing off. Ukraine’s defense minister is now reporting that there are 7,500 Russian troops in the eastern part of the country. The strategic port city of Mariupol continues to face assault by pro-Russian separatists with Kremlin-supplied weapons. Other border nations, including Estonia and Finland, are seeing signs of aggression too.
But Russia’s current destabilization of Eastern Europe may not be here to stay — and there were signs of that development even before the oil news.
The country’s military escalation abroad has been accompanied by a steep economic downturn at home. Since the beginning of the year, the ruble has lost 30 percent of its value, and Russia’s central bank has already spent 20 percent of the country’s foreign-exchange reserves in an attempt to prop it up. The IMF has cut its Russian economic growth projection for 2015 to just 0.5 percent, and the outlook will only worsen with oil prices plummeting over the past several weeks.
While the country has sufficient reserve funds to weather the short-term storm, the medium-to-long term is another question entirely, says Natasha Udensiva, a managing partner at Eurasia Energy Associates and a lecturer in international affairs at Columbia University. How long might the Russians be able to maintain their current stance? “They say they’ll be fine for two, three years,” Udensiva tells NRO. “I think they’ll be fine for at least one year and a half. Despite this huge inflation and all the terrible things going on in the country, they still have a lot of assets.”
A large factor in the ruble’s erosion of value has been the fall in global oil prices, which have declined steadily since the summer and fallen off even quicker in the past couple weeks. A large part of the currency’s dive is connected to the markets’ view of Russia’s economy as dependent on the price of oil, and Russia’s economy is pegged to high oil prices. Leon Aron, resident scholar and director of Russian Studies at the American Enterprise Institute tells NRO. “According to Russian and Western economists, Russia can balance the budget only at $117 a barrel; the national economy can only grow at $92–93 a barrel; and it goes into a recession at $80 or less.” As of this writing, the price hovers around $70 a barrel.
Sanctions imposed on Russia by the United States and the European Union on top Russian-government officials, state-controlled oil companies, and major Russian banks are keeping the pressure on its economy — as much through perception as practical value. “Russian economists call them ‘gray’ sanctions,” Aron says. “That is, they create a sensibility, one very damaging in the mid to long run.” One of their particularly damaging effects is that Russian corporations, even those not directly affected by the sanctions, are now all but unable to borrow money from Western banks. Meanwhile, the country has $300 billion in corporate debt maturing over the next two years, and it’ll need to be refinanced. Udensiva agrees: “The sanctions are really squeezing them. There are a lot of projects they have to put on hold — mega projects — because they have absolutely no cash flow.”
Even without the external pressure of sanctions and cheap oil, Russia’s economy is hardly healthy. Rife with corruption and cronyism, lacking a true free market and or functional infrastructure, the economy has been headed for trouble for quite a while. According to Udensiva, economists had been predicting a decline well before the crisis in Ukraine. Only high oil prices had papered over the problems, she says, and fundamental reforms to the economy (such as a more independent legal system, less state control of industry, and lower levels of subsidies) are necessary.
In the midst of Russia’s general economic malaise, some have touted its recently signed $400 billion gas deal with China as a sign of an economic pivot to Asia away from Europe, even of a burgeoning political alliance between the two countries. But Aron is skeptical, arguing the deal is uniquely advantageous to China and will have little effect on Russia’s continued dependence on exporting gas to Europe. “Gas sales to China — even if everything goes as planned — are not likely to reach even one-fifth of Russia’s exports to Europe,” he says. Unlike Europe, he explains, China still gets most of its energy from coal, and has signed the agreement only because it came at a steep discount to the prices Russia offers to Europe and because China only has to make minimal investments. And with an economic model is grounded in exports to the West, China isn’t about to join Russia in a political alliance against the West. Pursuit of that chimerical alliance is a sign of Putin’s desperation, Aron says — it’s “something that Putin wants from China so much that he is willing to conclude energy agreements that most Russian independent economists have described as at best questionable and at worst losing money for Russia in the long run.”
One might hope that the economic consequences of Russia’s actions abroad will lead to political pressure on Putin at home, but that’s never a sure thing. According to the Levada Center, Russia’s most trusted polling source, Putin’s approval rating hit an all-time high of 88 percent in October 2014.
Yet it’s clear that Putin’s rule and Russia’s actions in Ukraine increasingly come at a real economic cost to Russian citizens.
An example: This summer, massive capital flight forced Putin to divert funds from Russia’s main pension fund in order to finance infrastructure projects, something he had promised he would never do just a year before. One of Putin’s early accomplishments in office was to stabilize Russia’s pensions, which had been ravaged by the economic turmoil of the 1990s; one of his main blocs of support is state workers and retirees. Aron asks, “Will Putin’s political base — the pensioners and the state employees (doctors, teachers) — accept beggaring?”
In addition, talk of expensive government bailouts has begun. Rosneft, Russia’s (state-controlled) largest oil company, is asking the government for a $49 billion bailout in order to continue financing its $55 billion debt. If the government accedes, more companies may ask for similar deals, and the government’s remaining reserve funds will become increasingly depleted. And as The Economist notes, it was Russia’s massive increase in military spending starting in 2008 that first caused its reserve funds to cease to grow. Putin will find it difficult to back off of his defense buildup if he’d like to continue meddling in Eastern Europe.
None of these questions seemed to be on Putin’s mind during a recent interview he gave to the state-controlled TASS news agency. Instead, he simply declared that Russia’s actions in Crimea and afterward have all been strategic decisions that will end well for the country. How is he so sure? “Because we are right. Truth is power.”
Indeed it is. Russia’s economic numbers are in, and they don’t lie.
— Nat Brown is an associate editor of National Review Online.