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September 19, 2008

Russian Petrostate Opens Its Toolbox To Respond To Financial Crisis

by Robert Coalson

Putin (center) and aluminum oligarch Deripaska (right): L'etat, c'est nous.

The Russian economy is facing its most serious challenge since the 1998 default. By the time trading was suspended this week, the country's main stock index had fallen 57 percent from May; international oil prices have fallen by a third since their peak of $147 a barrel in July.

Although markets rebounded sharply on September 19 in the face of heavy government intervention, the situation presents a considerable challenge to the system created under Vladimir Putin since 2000. On the one hand, the financial interests of the governing elite are deeply entangled with those of the state; on the other, the Kremlin must at all costs prevent the effects of the crisis from trickling downward to a general population whose docility is based on the economic stability of the last decade.

Russia is an authoritarian petrostate, and as such it has its own concerns going into a crisis of this sort and its own tools for containing it. The Kremlin's behavior now will provide essential information as to the nature of the petrostate, which is a relatively new and untested political model.

As the stock market continues to bleed -- it has lost some $750 billion since May -- the country's state-connected oligarchs may have the chance to live up to their pledges to sacrifice their fortunes for the good of the country. Metals magnate Alisher Usmanov said last October, "Everything I have, I am ready to give to Russia." Earlier in 2007, oligarch Oleg Deripaska stated: "If the state says we must give up our companies, we will give them up. I do not separate myself from the state."

Such lofty pledges are rarely borne out in real life and, so far, it is the government that is doing the giving. The Central Bank has dispersed more than $20 billion this week to shore up the economy, and additional measures -- funneled through state-controlled banks -- are being actively discussed. Russia's hefty foreign-currency reserves and the stabilization funds it created from excess oil profits in recent years have been seen as the main tools for mitigating the situation. Bloomberg reported on September 15 that a delegation of leading oligarchs -- including metals oligarch Aleksei Mordashov and oil oligarchs Viktor Vekselberg and Vagit Alekperov -- was huddled in the Kremlin with President Dmitry Medvedev, presumably discussing what more the state can do rather than offering up their vast fortunes.

Endangering Thin Support

The key for the Kremlin is not allowing the crisis to be felt among ordinary Russians. Luckily for the ruling elite, few Russians have investments or even substantial savings held in banks. However, the populace is extremely vulnerable to inflation and surprisingly sensitive to price hikes in basic commodities and services. Putin and his team scrambled aggressively during the national-election season last winter and this spring to tamp down inflation with a variety of nonmarket methods, including pressuring producers and providing subsidies through local governments.

During those elections, Putin's government struck a tacit deal with the electorate, promising stability and defense from purported outside threats in exchange for a stage-managed election with predetermined results. The Kremlin's tenuous legitimacy rests solely on those two pledges, and the ruling elite is aware of how shallow the public's support for the government really is. Putin remembers well that in the winter of 2004-05, the government pushed through a controversial plan to monetize in-kind social benefits that brought thousands of regular citizens out into the streets calling for Putin to resign. During that crisis, many regional leaders and even the patriarch of the Russian Orthodox Church spoke out against the government and were accused of fuelling the protests. Before that, the sinking of the "Kursk" nuclear submarine in August 2000 also led to widespread criticism of the government and of Putin personally.

Now, of course, the central authorities have much greater control over the media and regional administrations than they did during those previous crises. In fact, both of those experiences -- as well as the September 2004 Beslan school hostage crisis -- prompted Moscow to reassess the weaknesses in its grip on the country and take decisive measures to strengthen its position. However, the Kremlin is aware that there are no longer any outlets for the expression of popular discontent in Russia -- there are no credible opposition parties, no independent media, no legislative commissions, nothing. And this is a direct consequence of the petrostate's insistence on a complete monopoly of power.

There are already signs that the government's response to the current crisis could stoke inflation, which is running higher than predicted. Central Bank Chairman Sergei Ignatev told RIA Novosti on September 18 that the anticrisis measures were making it more difficult to roll back inflation, although he assured the public that inflation will not increase. He said he believes inflation will be 12 percent this year, while the official Central Bank forecast is 11 percent and the government predicted 7 percent when it drafted the 2008 budget. According to the government, prices have risen 0.3 percent so far in September. On September 17, Finance Minister Aleksei Kudrin warned that inflation constitutes the "greatest risk" in the current situation.

Ignatev based his optimism on the prediction that the money supply will not increase, prices for agricultural goods will remain low, and oil prices will continue to decline. Clearly, however, as the government faces the stock-market crunch, it will be tempted to boost the money supply and it will certainly be hoping that the fall in oil prices will stop or even reverse itself.

Trouble Abroad

As noted above, the petrostate's tacit pact with the public rests on two pillars -- economic stability and security from foreign threats. If one pillar -- economic stability -- begins to wobble, it can be expected the state will try to bolster the other. And this has already been happening. Anti-Westernism -- and particularly anti-Americanism -- has been running high in recent months, especially since Moscow's military intervention in Georgia last month.

On September 18, Medvedev signed friendship treaties with the Georgian breakaway territories of South Ossetia and Abkhazia. He also met with the Security Council and urged more aggressive measures to assert Russia's claims to the Arctic shelf. The same day, Putin held a televised meeting at which he announced that defense spending would be boosted by some 27 percent next year. The Russian media has played up the idea that the roots of Russia's crisis stem from global -- particularly, U.S. -- economic turmoil. There have also been suggestions that the United States is engaging in economic warfare against Russia. "Experts are certain," gazeta.ru wrote on September 10, "that the United States will try to manipulate [oil] prices to weaken the Russian economy" in response to the situation in Georgia.

It seems to be in the nature of a petrostate to deflect criticism and discontent during a crisis by pointing to or creating outside enemies, and it should be expected the Kremlin will continue in this vein and even intensify its rhetoric as it deems necessary. Russia, however, is not simply a petrostate like, say, Azerbaijan or Venezuela. It should be considered a super-petrostate, because its size, and its military and geopolitical might, enable it to exert a profound influence on events. Moscow can, through its statements and actions abroad, do much more than other petrostates can to create the impression that it is surrounded by hostile enemies. The rule of thumb is probably that the more troubled a super-petrostate is at home, the more troublesome it will be abroad.

Which brings us to oil. By definition, the petrostate thrives on high energy prices, and high energy prices are often a result of global instability. An ordinary petrostate is at the mercy of forces beyond its control, but a super-petrostate is not. Half of Russia's annual budget revenues come from energy sales and it would be irresponsible of the Kremlin not to do whatever it can to boost those revenues. Oil analyst Chris Weafer told "The Moscow Times" on September 17 that all the Russian government can do in the current situation is "pray for a floor in oil." Despite Putin's reputation as a religious man, it seems unlikely all he is doing is praying when a price difference of $10 a barrel means hundreds of millions of dollars in lost or gained revenue each day for Moscow.

If experts in Russia are convinced, as gazeta.ru wrote, that the United States is interested in manipulating the price of oil, it would be naive to believe those same experts aren't thinking about how similar manipulation could benefit Russia.

And there are many possible avenues that a petrostate headed by KGB veterans could be exploring -- such as negotiating with OPEC on production cuts (which Deputy Prime Minister Igor Sechin was doing earlier this month) or attempting to tie up the world's finite supply of oil tankers and drilling ships. Even having Russian experts issue reports about declining production in Russia can have salutary short-term effects for Moscow.

In Nigeria, once the fifth-largest supplier of oil to the United States, well-armed and organized rebels have cut production by 20 percent by targeting pipelines and other infrastructure. No one knows where their weapons -- including powerful speedboats -- come from, but they have "more serious weaponry than any other Nigerian militia to date," according to the "Christian Science Monitor" in 2006. On September 14, the rebels declared an "oil war" and have launched numerous attacks this week, including destroying a flow station on September 16 and disabling a pipeline the following day. Although there is no evidence linking Moscow to these activities, it is an example of how oil prices could be manipulated to the Kremlin's benefit.

The combination of the need to deflect domestic discontent through the perceived threat of external enemies and a desire to maintain world energy prices at high levels makes the super petrostate a particularly unpredictable international actor in times of economic crisis. Given that Russia's economic woes have been building since May, and given the dynamics of a super petrostate, it may be more correct to say the souring economy produced the conflict in Georgia than to say that conflict produced the current meltdown.

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