Western sanctions over the Crimea crisis are set to worsen Russia's economic downturn. But ignoring economic concerns in favor of preserving political power will soon cease to be a viable strategy for Moscow.
In recent months, Russia has been accused of imperialist posturing over the annexation of Crimea. But behind all Moscow's sound and fury in Ukraine, the Russian economy is not looking very rosy: On Wednesday of last week (26.03.2014) the World Bank warned that the Russian economy could contract markedly this year with GDP shrinking by 1.8 percent in 2014.
The World Bank said its projections represented a "high-risk scenario," but warned that even if the standoff in Crimea doesn't last, the Russian economy would only expand by 1.1 percent in 2014, which is only half the growth the World Bank projected in December 2013.
Investors running scared
The economist Igor Nikolaev, who is director of strategic analysis at the FBK, a leading Moscow-based auditing and consulting agency, is also extremely pessimistic about the Russian economy. "The state of the economy is uneasy. I would say that our economy is in a transition stage between stagnation and recession. Our forecast is that this year there won't be any economic growth. We assume that GDP will drop one or even two percent," he said.
An especially worrying factor in the Russian economy, according to Nikolaev, is the negative level of equity investment, which was down seven percent in January and 3.5 percent in February. "Unfortunately, there is a lot of uncertainty in the Russian economy at the moment," Nikolaev added.
According to the World Bank's recent warning, Russia could see a record capital outflow of 150 billion dollars (109 billion euros) if the crisis over Moscow's annexation of Ukraine's Crimean peninsula continues to shake investor confidence. On Thursday, March 27, Russian Economics Minister Alexei Ulyukayev also warned that capital outflows could total some 100 billion dollars (73 billion euros) this year, which would slow economic growth for 2014 to well below earlier forecasts of 2.5 percent.
The looming threat of Western sanctions following Crimea's annexation is also hardly beneficial to the investment climate: asset freezes and travel bans for leading Russian officials could now be supplemented by measures that would target vital sectors of the Russian economy as well as its oil and gas industry.
A pre-existing condition
Economist Nikolaev, however, thinks that the current climate and the overall economy has merely been exacerbated by recent events. "Economic uncertainty has been a factor that has had a negative influence on business for the last couple of years. Without a doubt, that uncertainty has now grown as a result of events in Crimea and sanctions because it's not quite clear how far these sanctions will go."
March saw a downgrade of Russia's credit rating by Moody's Investors Service, as well as by Standard & Poor's and Fitch, which also won't help Russia's recovery. Instead, Nikolaev predicts it could instead increase borrowing costs for Russia and encourage Russians to move their investments outside the country's borders.
A reliance on energy
Meanwhile, Western governments are looking beyond Russia's borders when it comes to the energy market. During a meeting with Canadian Prime Minister Stephen Harper on March 26, German Chancellor Angela Merkel said it was time for Europe to reform its energy policy in order to move away from its reliance on Russia.
Such measures could hit the Russian economy hard, as Nikolaev explains. "The Russian economy very much depends on the energy sector. Fuel and energy commodities make up a 70 percent proportion of overall exports. Essentially half of the budget is based on the sale of fuel and energy resources."
"There is also a contractual obligation as well as an economic dependence. So in the coming years, it's simply not realistic to fundamentally change anything," the economist added.
A costly annexation
Apart from putting the energy trade between the West and Russia at risk, making Crimea Russian also brings much more direct financial costs for Russia. For example, a measure signed into law on Monday, March 31, will gradually double Crimean pensions to raise them to the Russian pension level.
"The cost [of the annexation] is hundreds of billions of rubles," the economist said. How the bill for the annexation is to be footed, the economist is not sure. "Miracles don't exist. And money will certainly be needed: a lot has been promised. Without a doubt, for the economy and for Russia's budget, this is a very big burden."
Economically questionable, politically beneficial
But according to Nikolaev, there is no room for economic considerations amid the current political euphoria about Crimea being restored to Russia: the territory was handed to the Ukrainian Soviet Republic in 1954. "As soon as you start talking about the economy now, people start to reproach you: 'What are you talking about? […] These are historic events that are being carried out. That's just hairsplitting'," he explained.
However, Ilya Zaslavskiy, the current Robert Bosch Fellow in the Russia and Eurasia Programme at the UK think tank Chatham House, thinks it's not "big news for the Russian government to be involved in projects which are not commercially viable, but politically expedient." As one recent example, he cites the Olympic Games in Sochi, which were "the most expensive Olympics in the history of the Olympic movement."
He explains that Putin saw the annexation of Crimea as "a way to mobilize uneducated lower classes in Russia, […] mobilize higher ratings through short-term public euphoria."
Referring to the pro-Western protests that took place over several months in Kyiv, he added that "in the events that took place in Kyiv, [Putin] saw a major threat because Russian society could see that they could then replicate this chain of events in Moscow. So in a way he tried to kill two birds with one stone: erase a major political alternative and at the same time mobilize internally."
Zaslavskiy warns that Putin might need further "boost projects" similar to the annexation of Crimea if he wants to continue distracting the population from the problems of an economy the analyst labels in " stagnation or decline." Such projects, Zaslavskiy adds, are "a question of the political survival of the regime" and Putin wouldn't stop at much, including international law, to do preserve his power.
When it comes to the economy, Putin is just as ruthless, as Zaslavskiy explains. The Russian government is only prepared to carry out economic reforms that "don't infringe on the fundamentals of this regime and the way it works."
And he adds: "I don't think they are ready to carry out any major changes in terms of liberalizing markets. […] Developing small and medium-sized business is not on their agenda. Creating an independent judicial branch, reforming the police - these things will not happen. And I don't see how without them there can be a serious economic recovery."