Severe Economic Crisis in Russia Looms

The way bad economic news pours out of Vladimir Putin’s Russia, you could almost imagine the country might be run by a KGB autocrat with no business experience or training whatsoever.

But perhaps even more disturbing for Russians these days than the horrific extent of the bad news is the type of bad news they are getting, namely news that deals with the lynchpin of the Russian economy -- its energy sector.

Hydraulic fracking technology threatens to disengage the U.S. market from foreign imports, or even to turn the U.S. into an energy exporter despite its massive consumption. Plummeting demand would dramatically reduce prices, placing Russia in dire financial jeopardy since it depends on gas revenues to balance its budget. Already, the U.S. has overtaken Russia as the world’s leading producer of natural gas.

But that’s only one side of an energy vice that is rapidly closing in on Russia. From the other side comes a potentially devastating legal attack by the European Union on Russia’s state-controlled gas monopoly, Gazprom. Right now, Americans are paying one-fourth the price charged by Gazprom to its European customers, and the EU lawyers believe that Europe’s prices are high because of illegal practices of Gazprom in restraint of trade, particularly in Central and Eastern Europe. Recent EU victories over Microsoft and Intel indicate that it will pursue its case until Gazrprom is forced to pay massive penalties and substantially alter its business model, something that could have devastating consequences on the company’s bottom line.

Leading Russia analyst Anders Aslund points out:

In 2011 Gazprom was formally the most profitable company in the world with purported net profits of $46bn, but these profits were hardly real. Investment analysts opined that no less than $40bn disappeared through inefficiency or corruption. Gazprom’s cash flow was barely positive.

Transparency International routinely ranks Russia as the most corrupt major economy on the planet (most recently, 143 out of 182 world nations); without its huge profit margins, Russia corruption could push Gazprom to the brink of bankruptcy and beyond.

Aslund does not think Gazprom can survive. He points out that it has already abandoned development of its Shtokman gas fields in the Arctic, a project that was ballyhooed until recently as heralding the rebirth of Russia as a worldwide energy force. And he predicts that Gazprom will soon be forced to give up its other main development project, the South Stream gas pipeline. The more pressure Gazprom faces from corruption and American shale, the more its influence -- and that of Russia -- will dwindle.

The ripple effects are truly terrifying for the Russian economy. Already, the Financial Times reports:

Russia has a woeful record when it comes to investment. [S]ome 70 per cent of all foreign direct investment into Russia comes from offshore havens – meaning it is Russian flight capital returning home. Things are not much better for portfolio investment, where Russian shares have always traded at a steep discount to those of its emerging market peers.

In other words, almost nobody outside Russia is willing to invest foreign money in Putin’s dictatorial regime; Russia’s level of FDI ranks with tiny European states like the Netherlands and Belgium as a result, meaning it has no outside source of investment capital.

And Russia’s domestic income prospects are no better; in fact, some commentators are already talking about Russia running out of budget cash. Economy Minister Andrei Belousov openly admits that Russia needs annual growth running well above 4% -- double what it expects over the near term due to plunging tax revenues from fading energy profits -- in order to meet Russia’s already anemic level of social spending on a sick and endangered population. Russia saw its share of the world population fall by half over the last half century, and that will happen again in the next.  Russia doesn’t rank in the top 110 nations of the world for life expectancy, and the drumbeat of analysis showing a demographic collapse is relentless.

Instead of proposing solutions, Putin has already begun lashing out, in neo-Soviet fashion, in personal attacks at cabinet ministers who are showing signs of being unable to deliver planned spending, and even Prime Minister Dmitri Medvedev has come in for a drubbing.

In another neo-Soviet move, as disturbing for what it says about the Russian political system as for what it tells us about the Russian economy, in order to make short-term ends meet on the budget, Medvedev ordered the seizure of assets of Rosneftegaz, a state-controlled holding company. How long it will be before the Kremlin turns its eye towards private and foreign assets is anyone’s guess, and this is a major reason why smart foreigners want no part of the Russian market.

As was the case in Soviet times, a major cause of budget pressure for the Kremlin is its frenzied attempt to match the United States on military spending. Russia has shown itself no less willing to roll tanks into Georgia than the USSR was to roll them into Hungary, and in fact, with Putin at the national helm, the KGB has far more power now than it ever dreamed of having in Soviet times. Just as in the Soviet era, Russia simply can’t maintain an arms race with the U.S. and simultaneously provide the basic level of assistance its population needs; its economy just doesn’t have the fundamentals or the dynamism to stand that type of pressure for long. It will crack and collapse just as the USSR’s did not long ago.

Standing in stark contrast to the EU’s bold confrontation of the Putin regime have been the craven policies of the Obama administration. Obama and his Ambassador to Russia, Michael McFaul, have shown themselves only too eager to do the exact opposite: appease Putin in any way possible. They not only looked the other way as Putin booted USAID out of country because of its efforts in support of Russian democracy, they actively supported Putin by shutting down Radio Liberty and pressing Congress not to impose any human-rights related trade sanctions on Russia.

As a result, those who stand for American values rightly feel betrayed, and they are stunned and bitter.  Leading opposition politician Vladimir Ryzhkov openly accuses Obama of pursuing a policy of appeasement under the euphemism “reset.” He writes:

In response to the aggressive anti-democratic campaign led by Putin and members of his chekist clan, the Obama administration continues its cowardly retreat from its democratic principles.  Although the Obama administration has said it is committed to defending freedom and human rights in the world, it has meekly given in to the Kremlin on two key institutions that have made invaluable contributions toward building democracy and civil society in Russia.

America has come a long way since the days of Ronald Reagan, when it was cheered around the world as a great beacon of hope for those seared in the flames of withering injustice from dictatorial regimes like Putin’s. If Americans are proud of their history, they should consider this fall from grace as the enter their polling booths in November.