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Vladimir Putin’s Russia is treading water in a sea of red ink

William E. Pomeranz

"Even Russia’s vaunted internal security services now have to make due with fewer resources, despite the real prospect of increased social unrest," writes William Pomeranz.

As President Vladimir Putin looks out on to the world stage, he should be relishing Russia’s renewed status as a global player.

But when Putin looks homeward, he sees a different reality. Three months into 2015, Russia’s economic forecast ranges from gloomy  to catastrophic. Yet in contrast to his aggressive response in Ukraine, Putin has been the picture of inaction domestically. He has intervened in the financial markets but not on Main Street, avoiding any hint of structural reforms.

Russian domestic and foreign policy are intimately connected, however. And the troubled domestic front is now catching up to Putin and limiting his regional and global aspirations.

Putin’s economic plan essentially boils down to preserving the state sector, with all its inefficiencies, and shrinking it by just 10 percent. The across-the-board budget cuts have been felt by all state agencies except defense. Even Russia’s vaunted internal security services now have to make due with fewer resources, despite the real prospect of increased social unrest.

So there will be no large stimulus package coming from the Russian state. Instead, a $35-billion anti-crisis program has been established. So far, though, Moscow has been extremely reluctant to spend the money. Even Putin has admitted that the program exists only on paper.

The decline in public spending and accompanying decrease in the real wages of state employees has had a domino effect on private business. Every day brings new reports of cutbacks, closures and layoffs, especially in the retail and service sectors.

When sales will revive is anyone’s guess. The Russian consumer is essentially tapped out. Indeed, between budget cuts, inflation and a declining ruble, it has been estimated by one Russian bank that by the end of 2015, Russians will be spending approximately half their disposable income on food.

All this highlights the underlying structural problems with the Russian economy and Putin’s reluctance to address them. In February, Putin gathered his top economic advisers, plus former Finance Minister Alexei Kudrin, to discuss potential reforms in state administration, law enforcement and the pension system (Russian men retire at 60; women at 55).

Including Kudrin at this meeting hinted a possible renewed focus on the domestic front, even a possible turn in a liberal direction. Yet no concrete proposals emerged, and rather than clean up government, Putin signed a law on Mar. 10 reducing penalties for corruption.

Neither the domestic consumer nor the foreign investor are about to come riding to the rescue of the Russian economy. But in trying to preserve his system of state capitalism and central control, Putin is busy spending the country’s hard currency reserves, which have decreased from $490 billion to $360 billion over the past year.

And new demands keep pouring in: $50 billion has been allocated from the emergency reserve fund to plug Russia’s 2015 budget deficit, with additional payments likely required in 2016; Rosneft, the major oil producer, wants $21 billion, and Gazprom, Russia’s natural gas production company, just asked for $3.2 billion. The entire banking sector also remains fragile.

Meanwhile, Crimea requires significant resources. And no one has yet volunteered to pay the considerable debts of Russia’s regional governments, largely ignored in the Kremlin’s anti-crisis planning.

In this sea of red ink, the only possible salvation is an increase in energy prices. When and how fast this can occur, however, remains anyone’s guess. Putin most likely can survive this economic downturn — he still faces no real political opposition. But without any fundamental structural reforms, he will arrive at the same stagnant (albeit smaller) economy that Russia started with before this crisis.

There is also one last bill to be paid: Ukraine. The fighting in eastern Ukraine may have diminished, but the final implementation of the Minsk II accord is a long way off. Kiev seems in no hurry to decentralize power to the regions and again start transferring state salaries and pensions to Donetsk and Lugansk. The payments have been suspended as long as these territories are outside the control of the Ukrainian government.

Russian Foreign Minister Sergei Lavrov now demands that the West consider sanctions on Ukraine for failing to implement Minsk II. One can appreciate his apprehension, however, because if Kiev won’t pay for eastern Ukraine, Moscow will have to. That means paying for a sitting army and separate regimes in both enclaves — neither of which has shown much interest in governing.

Putin can pursue the path of negotiations while probing for other weaknesses, among the nations that issued the sanctions, for example, or inside the European Union. Yet without any new dramatic foreign policy successes, Russia will increasingly be defined by its underperforming economy.

This growing sense of economic unease is reflected in national opinion polls.  In a recently announced survey, 82 percent of all Russians viewed inflation as the No. 1 problem facing the country. Some 55 percent indicated that the Russian government was not doing enough to address inflation and falling incomes.

The annexation of Crimea clearly distracted people from their economic problems. The “liberation” of Debaltseve did not. Putin can no longer push his domestic challenges to the side. Instead, they are increasingly becoming his greatest source of vulnerability.

The opinions expressed here are solely those of the author.

This article was originally published in Reuters.

About the Author

William E. Pomeranz

William E. Pomeranz

Director, Kennan Institute

William Pomeranz, the Director of the Wilson Center’s Kennan Institute, is an expert guide to the complexities of political and economic developments in Russia, particularly through the lens of law. He leverages extensive, hands-on experience in international and Russian jurisprudence to address a wide range of legal issues, from the development of Russia’s Constitution to human rights law to foreign investment and sanctions. He is also the author of Law and the Russian State: Russia's Legal Evolution from Peter the Great to Vladimir Putin (Bloomsbury, 2018).

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Kennan Institute

The Kennan Institute is the premier U.S. center for advanced research on Russia and Eurasia and the oldest and largest regional program at the Woodrow Wilson International Center for Scholars. The Kennan Institute is committed to improving American understanding of Russia, Ukraine, Central Asia, the Caucasus, and the surrounding region though research and exchange.  Read more