For Putin 3.0, it’s all about the economy

Rapidly declining oil prices and the corresponding downward spiral of the Russian ruble are currently dominating business headlines. Russian government leaders and economists now project that Russia will likely enter into recessionary territory in 2015.

Amidst this backdrop, it is worth remembering that during his first two terms as Russian president, Vladimir Putin secured a legacy as the overseer of the Russian “economic miracle.” Now facing tremendous economic headwinds, complicated by Western sanctions, how will Russia’s current economic crisis affect Putin’s sky-high approval ratings, his status as the steward of the Russian economy and his policy objectives?

In spite of his pivot toward domestic nationalists who support both the annexation of Crimea and call for an expansionist Russian state, Putin’s first two terms (2000 to 2008) were primarily characterized by major economic expansion, not adventurist foreign policy. After the devastating 1998 default, Putin shepherded Russia’s economy through eight years of uninterrupted growth, resulting in annualized 7 percent gross domestic product growth rate from 2000 to 2008. While rising global energy prices contributed significantly to Russia’s rebound, Putin introduced major economic reforms (including the flat tax) which aided Russia’s expansion. In addition to this stellar economic performance, inflation was also largely tamed during Putin’s initial tenure. When he took office in 2000, inflation was tracking at roughly 30 percent annually; by 2007, inflation was in single digits. A similar pattern involved foreign currency reserves: in January 2000, the Russian Central Bank reported hard currency reserves totaling a paltry $13 billion. By March 2008 (when Putin moved to the prime minister position), hard currency in government coffers exceeded $500 billion. Again, the effect of international energy markets was pronounced, but nevertheless Putin’s legacy was sealed as a transformative leader who resuscitated the ailing economy.

{mosads}It was this track record that produced consistently solid public approval ratings and secured his reelection to a third term in 2012. To be sure, Putin’s policies were controversial and often ran counter to market economy principles (especially as the state’s role in the economy expanded significantly under Putin), but it was a rebounding economy during his tenure that inspired confidence among Russians and led to his reelection.

Since returning to the Kremlin in March 2012, however, the economic landscape has drastically changed. Gross domestic product has steadily declined during the past two years on Putin’s watch, and Russia will likely experience negative growth in 2015, undermining his economic bona fides. The ruble’s decline — approximately 40 percent year-to-date — is again fueling inflation. Inflation will likely reach 9 percent this year and next, due largely to the devalued ruble but also in part due to inflationary pressures caused by retaliatory Russian sanctions on agricultural imports from the EU and U.S. Hard currency reserves have fallen by 16 percent ($85 billion) in the past two years, although they exceed $428 billion.

What practical implications does this pose for Putin, whose approval ratings purportedly hover at 85 percent? First, his approval ratings have nowhere to go but down, and the reversal back to their historical norm (60 to 65 percent) or potentially lower will likely be swift. While Russians may have temporarily delighted in the return of Crimea, pocketbook issues are now dominating political discourse at the expense of pro-Moscow rebels in eastern Ukraine. Some food prices are increasing by low double-digit percentages. Patriotic calls for belt-tightening may have had an initial short-term effect, but growing prices amidst a contracting economy, declining incomes and inevitable unemployment will eventually result in consumer frustration and anger.

Politicians often revert to populist spending during crises, but again the government has limited opportunities. Energy export revenues comprise approximately 50 percent of federal budget revenues, and the recently passed budget projected an oil break-even price of $100 per barrel, far in excess of the current price of $70. Major state-owned enterprises such as Rosneft and Russian Railways are requesting tens of billions of dollars in aid from the country’s hard currency reserves. Meanwhile, the budget continues to prioritize military spending, which is growing at an unprecedented rate at the expense of social services and infrastructure investment which could spur economic growth.

Small, isolated, but increasingly frequent social and labor protests are occurring due to economic issues. Most protests happen far from the major urban centers and typically do not garner press coverage, but labor specialists have noted that the number of protests the past two years parallels the number during the years of the global economic crisis. In November, doctors and medical workers in Moscow led two demonstrations to protest the closure of a number of hospitals in the capital. Estimates suggest that the first protest attracted as many as 10,000 people — a significant number given the current political environment.

This is not to suggest that Putin faces a direct threat to his leadership, even though his ratings will likely see a steep decline and pockets of social unrest may become more common. However, economic realities will force him to tack back to the center on some issues, including possibly reconsidering support for pro-Moscow rebels in eastern Ukraine as the Kremlin may seek a more conciliatory approach in an effort to reverse Western sanctions. Economic and budgetary priorities will be reconsidered; outlays scheduled for the military may be redirected toward social services to address growing dissatisfaction with Russia’s course. In an effort to provide a release for political tensions, the Kremlin may adopt a more tolerant position toward its weakened political opposition, including Alexey Navalny, who remains under house arrest.

Maneuvering Russia out of the current crisis and creating new economic drivers is critical to the Russian state, as well as to Putin’s legacy. The current environment suggests that in sharp contrast to his first two terms, Putin’s third presidential term may well be remembered for economic decline.

Colley is managing director of Highgate Consulting.