By Samuel A. Greene, Associate Fellow, IISS, Director, Russia Institute, King’s College London
For an autocrat, winning the election is the easy part. Barring an extraordinary turn of events, Vladimir Putin will be re-elected on 18 March for his fourth term in the Russian presidency (and his fifth atop the country’s political hierarchy). The challenges facing him from 19 March onwards, however, are greater than anything he has encountered over the course of the campaign. The challenges facing Western leaders seeking to manage the relationship with Russia, meanwhile, are greater still.
Contrary to the conventional wisdom, the problems Putin will face in his latest six-year term of office are not fundamentally economic. Rather, his task will be to manage expectations and competition within the political elite, seeking to maintain control and advantage as other players turn their attention to 2024 and the question of succession. This will, if anything, make the Kremlin even less predictable than it is now, much to the consternation of Western leaders – particularly in Europe – who have been hoping for a gradual dialling down of tensions and a pathway towards greater strategic stability.
Their task, then, will be to devise a system of positive and negative incentives powerful enough to alter the cost-benefit analysis in Moscow. The apparent use of a Russian weapons-grade nerve agent in Salisbury, while creating challenges of its own, may actually provide an important opportunity for Europe in particular to alter the terms of engagement.
Russia’s economy is under control
Rumours of the demise of the Russian economy have been somewhat exaggerated. After four years of alternating stagnation and recession, Russia’s GDP grew by 1.5% in 2017 and is projected to grow by more than 2% this year. Inflation stands at 2.2%, well below the Central Bank’s target rate of 4% (and even below UK inflation rates). Wages are growing.
That is not to say that anyone – not least Russia’s government or citizens – should be happy with the state of the economy. Real disposable incomes (the money people have to spend after taxes, utilities and interest payments) have declined for four straight years. The government's projected growth of 4.7% in capital investment looks wildly optimistic, and would be a truly remarkable swing from a 0.9% contraction in 2016. Despite record-low inflation, the prime lending rate stands at 7.5%, and consumers are paying anywhere from 15 to 28% for credit.
But Russia’s economic managers – including the genuinely skilled technocrats of the Finance Ministry, Economic Development Ministry and Central Bank – believe they have things under control, and not without reason. If oil prices remain steady, the 2018 budget will have a consolidated surplus of 1.2% of GDP. Even if that slips back into deficit (and Russia ran a 1.5% of GDP deficit in 2017), Moscow can afford to borrow.
Its foreign debt stands at about US$50.5 billion (less than 4% of GDP), and is some US$5.2bn less than it was just prior to the occupation of Crimea in 2014.
Currency reserves stand at US$452bn, up 15% from this time last year – buoyed, like the budget, by strong oil prices. Yields on Russia’s ten-year bonds are currently at 7%, exactly where they were before the annexation of Crimea and the imposition of sanctions (after which they spiked to more than 14%). That puts Russian debt broadly in the same category as Mexico, Indonesia and India.
In the short- to mid-term, then, the Kremlin can use the budget to stimulate economic growth, drive investment, keep people employed and even put a bit more disposable income into consumers’ pockets. This is not likely to be sustainable in the longer term, as without significant inflows of foreign investment the cost of budgetary largesse will increasingly fall on Russian taxpayers themselves. Most observers see tax hikes and further austerity in social services – which have already been cut significantly over the last several years – as inevitable.
The challenge for Putin
Putin, however, does not have the luxury of focusing on the more distant future. The constitutional limitation to two consecutive terms sets up a crisis point when power will have to be handed over to someone else (formally, at least). But that crisis point begins now, not in 2024.
Any significant decision Putin makes after 18 March – whether involving personnel in the government, structural reform in the economy or even the long-term trajectory of government investment – will be interpreted by the political and economic elite as a sign of things to come. Such signals will allow those elites to begin calculating how much they, personally, stand to win or lose over the next six to 12 years, a period of time that, in contemporary Russian history, feels very long indeed.
The resulting jockeying for position and benefit among an elite worrying not about short-term losses but about their long-term futures would be catastrophically destabilising for a political system built not on formal command and control, but on informal understanding and relationships. As in the run-up to 2008 – when Putin kept everyone guessing about his ersatz successor until three months before the election – Putin will again seek to keep his elite in the dark for as long as possible.
In that context, it is important to recognise the role that conflict with the West has played in restructuring political incentives in Russia. While sanctions hurt, in Moscow’s own analysis it has weathered the worst of that storm and come out in reasonably good shape.
At the same time, the pressure that sanctions have put on banks’ compliance departments around the world means that even those Russian oligarchs and major corporations that are not on the various sanctions lists have had to run their financing requirements through either the Russian Central Bank or the Finance Ministry, giving the Kremlin an unprecedented amount of leverage over its economic elite. Meanwhile, those unhappy with that arrangement or their broader prospects have to contend with a president genuinely popular with the public for his foreign-policy exploits.
Thus, while seeking détente with the West might lead to a calculable decrease in the cost of capital for the Russian economy, the potential costs for Putin’s political project are incalculable. That, indeed, may be part of the reason why the Russian Economic Development Ministry’s three-year budget forecast assumes that all sanctions will remain in place.
The challenge for the West
While there is much we do not yet know about the nerve-agent attack on Sergei Skripal and his daughter Yulia in Salisbury, it conforms to patterns much broader and more troubling than Russia’s history of targeted assassinations on foreign soil (or, more frequently, at home). Taken together with the annexation of Crimea and intervention in Donbas, the downing of MH-17, provocative engagements between Russian warplanes and NATO forces, and the aggressive use of private military companies in Syria (and resulting skirmishes with American advisers there), it suggests a continued high tolerance for risk and escalation.
While the argument here is that such behaviour fits well into the Kremlin’s domestically driven incentive structure, Western leaders could be forgiven for finding this state of affairs unsatisfactory. Post-Salisbury – and assuming that Moscow does not identify and deliver to the UK a rogue element responsible for obtaining and deploying the ‘Novichok’ nerve agent – a number of potential responses are being discussed in London and more broadly.
One set of proposed responses is largely symbolic: closing down the operations of television channel RT in the UK, withdrawing the English team from the football World Cup in Russia or even expelling the Russian ambassador to London. All would serve as highly visible signals of Downing Street’s resolve.
They would, however, bring no tangible pressure to bear on the Kremlin and lead to no appreciable increase in the safety and security of the British population. Moreover, the controversy such measures would create – including critiques involving the freedom of speech, the sanctity of sport and the necessity of keeping diplomatic channels open – would sap resolve for more meaningful action.
Another set of proposals has been to crack down on Russian money – particularly the assets of state-linked high-net-worth individuals– in London. Discussions regarding the implementation of the so-called ‘Magnitsky powers’, which would allow the UK government to seize assets in a more targeted manner, have picked up speed; others have called for a more aggressive use of the new ‘Unexplained Wealth Order’ powers, and a general tightening of both law and practice around due diligence and transparency.
Financial sanctions could strengthen Putin
Such measures would have a very real impact on the individuals involved and are almost certainly worth pursuing from a domestic governance perspective – more transparency and due diligence on Western asset markets is inherently a good thing – but their political impact is less certain. Given the leverage Putin already exerts over the elite, the effect will most likely be to bind them still further to the Kremlin, consolidating rather than undermining Putin’s power.
The Salisbury crisis, however, may provide an unexpected opportunity to restructure the European relationship with Russia in a way that would reinforce both negative and positive incentives, and powerfully shift the cost-benefit analysis for the Kremlin. In an ideal world, London might prefer American involvement as well. The vagaries of Washington in 2018 – seen most recently in the firing of Secretary of State Rex Tillerson – make the US seem an unreliable partner.
What Prime Minister Theresa May called the ‘unlawful use of force’ by a hostile power on British soil – if the culpability indeed lies with Moscow – is the clearest and most immediate threat posed by Russia to the West in the post-Cold War era. While its human consequences pale in comparison to the ongoing war in Ukraine, it strikes at the heart of both Europe and NATO in a way that neither Crimea and Donbas, nor the 2008 war in Georgia did. In occurring on UK territory, rather than in the fields of eastern Ukraine, it is a blow physically closer to home than the downing of MH17.
Salisbury must spark a new approach
The response to Salisbury, then, should not be to simply tack more sanctions onto the list created in the wake of Crimea and the Donbas. Rather, the response can and should be a wholesale reconfiguration of the sanctions regime vis-à-vis Russia. Salisbury should not get in line behind the Crimea and Minsk processes: it should supersede and envelop them.
In terms of content, the UK and its allies might pursue two interlocking measures aimed at dramatically increasing the cost of capital for the Russian economy, and thus undermining the Kremlin’s ability to support short- and mid-term economic growth and welfare.
This would involve, in the first instance, reinforced compliance and due diligence requirements for banks, pension and other investment funds, and insurance and reinsurance companies, with an emphasis on counterparty sanctions risk and the documented and auditable identification of beneficial ownership. Governments should also revisit policies regarding the purchase of Russian sovereign debt and state-linked sub-sovereign paper; given the need to roll over about US$14.4bn in foreign debt over the next presidential term, a purchase ban would lead to gradual and significant divestment from the Russian economy.
Five new benchmarks to anchor Russian sanctions
Structurally, the Salisbury crisis may allow the divorcing of sanctions from the Minsk process on conflict resolution in the Donbas – a process that has allowed all sides to blame others for the failure of sanctions implementation. Instead, sanctions could be embedded in a process fully within Moscow’s control. With existing sanctions renewed and new ones imposed, Russia could be offered step-by-step rewards in the form of sanctions relaxation for concrete progress against clear benchmarks. These could include:
- Helping to identify and allowing for the punishment of those responsible for the Salisbury attack;
- Providing full transparency for the ‘Novichok’ weapons programme;
- Demonstrably and verifiably withdrawing Russian military and paramilitary personnel and materiel from the Donbas;
- Restoring Kiev’s control of the border in Luhansk and Donetsk oblasts;
- Restoring Kiev’s sovereignty over Crimea.
The Kremlin might, of course, choose not to accept some or all of these benchmarks, but then it would have no one but itself to blame for ongoing sanctions. More importantly, however, such steps would provide a clear and legitimate pathway towards normalisation. And they would reiterate the message that Europe’s conflict is with the behaviour of the Russian government on territory outside its borders, rather than with the security and prosperity of the Russian state itself.