Default and Design – Economic Crisis & Political Consolidation in Putin’s Russia

 

All eyes are currently on Russia, with the 2012 Presidential elections due to take place in early March and former President (and current Prime Minister) Vladimir Putin’s controversial decision to seek re-election for a third term sparking a series of public protests and demonstrations (both pro- and anti-Putin). In this article, guest author Josh Black looks back at the turbulent experiences of post-Soviet Russia to argue that the Russian debt default of 1998 should be viewed as a crucial turning point in contemporary Russian history, marking the failure of the economic liberalism associated with the Yelstin era and the birth of a new brand of ‘Putinomics’. You can read more of Josh’s work at his fantastic blog Out of the Black.

 

Default and Design – Economic Crisis & Political Consolidation in Putin’s Russia.

 

By Josh Black.

 

“Monday, August 17, 1998, is now etched in the contemporary history of Russia – perhaps as significant a date as December 25, 1991, when an independent Russia emerged from the collapse of the Soviet Union. Many pondered at the time whether the experiment in forging Russia as a modern, democratic, market-orientated country had failed.” ~ Martin Gilman, No Precedent, No Plan: Inside Russia’s 1998 Default (MIT Press, 2010)

 

Identifying historic turning points in post-Soviet Russia is like shooting fish in a barrel. There have been many crises, all with deep ramifications, so that dates regularly leap out as crucial. Obviously, for many, 8 December 1991 – the date of the secret summit between the Russian, Ukrainian and Belorussian Premiers that condemned the USSR to dissolution – is central to the emergence of a post-Imperial Russia. From a contemporary vantage point however, others – such as journalist and author Edward Lucas – increasingly point to a date at the end of the first post-communist decade – 31 December 1999 – when the resignation of Boris Yeltsin made Vladimir Putin acting President and ushered in the siloviki state that has come to represent the essence of post-Soviet Russia.

 

Rarely is 17 August 1998 – Russia’s default on its debts – considered as a date of any lasting significance. After all, economically speaking, Russia recovered strongly from the severe devolution of the rouble that followed.  If we look beyond the short-term economic impact, however, this was arguably the moment that changed everything.  As inflation soared (with prices up 38% in September 1998 alone and 85% over the course of the year), the threat of a return to the chaos of the early 1990s and the passive response of the West to Russia’s economic troubles came as a shock both to political circles and public opinion.  The reformist clique incorporating Anatoly Chubais, Yegor Gaidar and Viktor Chernomyrdin quickly fell out of favour; but while most onlookers expected a full reshuffle from Yeltsin in the midst of the havoc, his sole appointment was a new Security Chief, one Vladimir Putin.

 

 

Vladimir Putin - often depicted by his allies as Russia's 'strongman', bringing order to chaos - has become synonymous with modern Russia for many.

 

 

Although the economic impact of the 1998 debt crisis may have been transient, the lessons in political economy learnt by Putin and his coterie were not.  Indeed, many of the Kremlin’s actions over the past twelve years have been direct responses to the perceived failure of economic liberalism at the end of the 1990s.  After 1998, getting a grip on the country’s economy was seen as fundamental, political freedoms as secondary.  Daniel Triesman argues that as a result,  today Russia’s leading elites act less as ideologues or securocrats than as Directors of ‘Russia plc’; economic managers who acquire assets and pursue profit, often regardless of ‘inconvenient’ principles such as human rights and the rule of law.

 

Recalling Recession – the economic crisis of 1998 arguably left a lasting legacy which continues to reverberate in Russia today:

 

 

 

The Early Transition Economy: The Failure of Economic Liberalism

 

Bringing the Russian Federation into existence in 1991 was relatively easy; Boris Yeltsin simply put pen to paper, and then returned to the banya to bask in the glory. Conjuring and bolstering institutions to match during the chaos that followed, however, was beyond his branch of magic. An anecdote about Yeltsin serves as a useful illustration of the Kremlin’s struggle to continue to assert central authority over increasingly  unruly regions, relative to the revolution that followed. When visiting the peripheries, Yeltsin was supposed to be with his aides-cum-bodyguards at all times, to avoid giving governors an opportunity to press their claims too effectively. One governor surmounted this obstacle by suggesting he and Yeltsin get into a rowing boat too small to take any other passengers while the aides waited on the shore. When the pair returned, a sheepish Yeltsin demounted, followed by the Governor, holding a signed Presidential decree! (Interview with Leonid Smiryagin in Triesman, p.281)

 

As well as arguably giving away too much political autonomy, the new Russian state also failed in its economic responsibilities. At various points in the 1990s, one-third of the regions were withholding some or all of their tax revenues from the central treasury;  Gazprom – one of the largest and most profitable Russian companies – collected barely a quarter of its dues; and attempts to clampdown on tax evasion by the new oligarchs were constantly thwarted. Given the seller’s desperate circumstances, and decades of underinvestment, privatisation was never the hoped for cash cow. What Western support existed for the Russian transition was limited (since the US preferred to work through the IMF) and was not greatly appreciated by the Russians who resented the humiliating perception that Russia was surviving off Western food parcels. While the larger part of intergovernmental support consisted of trade-backed loans, the Russian State guaranteed imports so when many importers simply didn’t pay, this left the Finance Ministry to foot the bill. And to add insult to injury, it was the financier George Soros, whose Open Society organisation was to prove a thorn in Putin’s side in Ukraine and Georgia some years later, who kicked off the 1998 crisis, when he argued for a 15-20% devaluation of the rouble on August 13.

 

Russia worked closely with the IMF throughout the 1990s, although the relationship was often fraught, with projections frequently disappointing both parties. Despite borrowing $20bn in total (and around $12bn from the World Bank), Russia frequently failed to pay all of its workers and pensioners. Life expectancy dropped and prices soared. In 1998, the deficit was 6% of GDP, not surprisingly commensurate with unpaid federal taxes of a similar amount (Trieseman, p. 201). In a precursor to the eventual crisis and default, Russia attempted to auction a large number of bonds in July to meet its cash needs. Not only was demand underwhelming, but one of the larger domestic banks (Sberbank, now the third largest in Europe in terms of capital) bowed to its own liquidity crisis and redeemed 12bn roubles in bonds. The auction had scraped a net benefit of just 2bn roubles, against a cash flow requirement of 14bn. Inflation soared, and as a result the value of the rouble plummeted 70% against the dollar.

 

The Birth of ‘Putinomics’

 

After the chaos of the Yeltsin era, ‘Putinomics’ could be described as a form of ‘shock therapy’ for the Nation’s neuroses. Once in office, Putin began to systematically restore government control over the economy, and the years 2000 to 2009 were a paragon of stability in comparison to the preceding administration. Key politicians, such as the Gazprom Executive Dmitry Medvedev, (described in US diplomatic cables as ‘Robin’ to Putin’s ‘Batman’) and Alexei Kudrin were quickly promoted to positions of power and maintained there in perpetuity. After State buyouts of NTV and Gazprom, and the dismemberment of Yukos, the oligarchs were given a stark choice; keep your money and keep quiet, or be driven out of politics and the media.  Even those who remained loyal to Putin were not given free reign; Oleg Deripaska was given a very public dressing down for having the gumption to close a factory during the economic downturn in 2008 in a move designed and captured for public consumption as illustrated in the video clip below:

 

 

 

 

The recasting of the political landscape under Putin allowed Alexei Kudrin (Finance Minster between 2000 and 2011) a free hand when it came to reforming Russian institutions. Kudrin swept away many of the revenue traps, including the abolition of import guarantees and offsets in place of hard cash. His 13% flat tax boosted compliance, and his decision to generate a stabilisation fund meant that the Government was not caught short again in 2008, when the worst recession since 1994 hit. The renationalisation of gas and oil through Gazprom and Rosneft  and a series of effective ‘Gas Wars’ with Ukraine in particular allowed the Russian state to reap the benefits of a decade of high oil and gas prices, while external creditors were quickly repaid so that Russia was beholden to no-one. As well as being operated at less than arms-length from the Kremlin, Gazprom and Rosneft also proved useful training grounds for future political appointees, such as Igor Sechin and Sergei Naryshkin, adding weight to Trieseman’s characterisation of Russia’s rulers.

 

At their most basic level, Putin’s reforms to Russia’s economy were successful.  Under Putin, the Russian economy enjoyed a period of sustained and pleasantly surprising growth of around 6% until 2009.  Despite a continuing brain drain through emigration, improvements in the standard of living (as average wages rose from just over 1,000 roubles in 1998 to over 20,000 in 2010) made Putin seem politically invulnerable.

 

Too Far?

 

Cover Image from The Economist (21-27 January 2012)

 

Today then, the emergence of an ‘Anti-Putin’ opposition movement owes little to economics. Suggestions that the protestors have undefined goals are untrue and unfair; they are simply political, sparked by recent widespread allegations of electoral fraud. Economics does play a role, however, and an increasingly important one as the Presidential election approaches (4 March 2012 – another historic date to remember?).

 

For a start, the Kremlin has become increasingly unfriendly to non-State business since Putin’s campaign against Mikhail Khordokovsky. While the likes of BP and Shell have been hard to dislodge, despite sustained harrassment, Foreign Direct Investment has often lagged behind other economies in the region.  Recently, and in full campaign-mode, Putin even suggested that Aeroflot should offer free flights to football fans during Euro 2012 and the World Cup in 2018!

 

The other consequence of Russia’s re-conquest of the ‘Commanding Heights’ of the economy has been that, while the reformers of the 1990s tried desperately to pare down spending commitments, Putinism has thrived on sharing the proceeds of Russia’s wealth.  Putin’s final State of the Union address (to date!) in 2009 is a case in point, the then (and future?) President promised to spend 250bn roubles on housing and to match private pensions, paid for out of the assets of Yukos. As the credit crunch has intervened, the Kremlin dipped heavily into the oil stabilisation fund established by Kudrin, until a proposed increase in military spending (affecting both employment and heavy industry – two significant political weaknesses)  caused the latter to resign and join the protest movement that sprang up after the falsified elections in December 2011.

 

Then there is corruption, said to be worth £200bn as a whole in Russia, and undoubtedly boosted by large projects such as the preparations for the Sochi Winter Olympics 2014. Indeed, if anything has proved to be a catalyst for revolution over the past year, it is corruption and the recent emergence of the anti-corruption blogger, Alex Navalny, as the most significant opposition leader is testament to this. If Navalny is one leading symbol of the opposition movement though, businessmen trying to gain a foothold in the political system are not faring so well. A recent poll had Mikhail Prokhorov (billionaire owner of the New Jersey Nets basketball team) and Sergei Mironov (of the liberal Yabloko party) on 6 and 5% respectively, with the presidential elections just a month away.  Moreover, the Communists have a support base worth twice as many votes as both combined.

 

Interestingly, as Angus Roxburgh reveals, Khordokovsky was promoting the idea of a windfall tax on the oligarchs when he was arrested and jailed. The temptation to believe that a more responsible system of free enterprise might still have flourished in Russia still holds, yet although Russians show a reluctance to continue paying more in tax (and who doesn’t), suspicion of economic liberalism is still preyed on by Putin’s spokesmen, as demonstrated in this recent article.

 

 

Vladimir Putin pledged to 'win the battle for Russia' in a pre-election speech at Moscow's Luzhniki Stadium (23 February 2012).

 

 

As Putin now goes into the Russian elections leading in the polls but still unsure of victory in the first round, promises to re-privatise non-resource or defence based industries are being floated, as are plans to re-introduce gubernatorial elections.  Nonetheless, the tendency since Medvedev succeeded Putin as President has not been to roll back the measures taken to re-establish control over the economy. On the contrary, spending and inflation has risen and the government is active in promoting certain industries. Kudrin, perhaps the last instinctive free-marketer in the Russian government, has ruled out a return to office. Despite recently joining the WTO and the OECD Anti-Bribery Convention, not to mention Putin’s own ghost-written columns in Russian newspapers denouncing red tape and corruption, few officials have shown enthusiasm for any comprehensive reform. As ever, national trauma means Russia will only proceed slowly and cautiously down the road urged on it by Western economists and leader writers.

 

About the Author

 

Josh Black is a graduate of Modern History from Leeds University. He completed his degree in 2009 and has developed a particular interest in the politics of Eastern Europe through his travels and collection of many stacks of books and newspapers. He is planning to take up a place at Oxford in October 2012 to study for an MSc in Russian and Eastern European Studies. Josh regularly blogs at his own site ‘Out of the Black’ at http://joshblack2.wordpress.com/