Russia’s elite pose greatest threat to crisis-hit Putin

Russian president Vladimir Putin is discovering the financial sanctions imposed for his interfering in Ukraine are more powerful than he was expecting, writes Alan Philps.

A businessman counts Russian rouble banknotes. REUTERS/Eduard Korniyenko

The collapse in the value of the Russian currency, the rouble, has revealed a glaring weakness in the network of control that Vladimir Putin has built up over his 15 years in power. His domination of Russian political life is almost total, and he has increased the state’s control of the energy sector – the main earner of foreign currency – to a near monopoly. Yet his power is based on the one thing he cannot control: the price of oil.

This is no hidden threat to stability in the Kremlin, but one that has been in plain sight since the 1980s. It was the oil price slump that revealed the weakness in the Soviet Union, forcing the then Kremlin leader, Mikhail Gorbachev, to beg the western powers for money to feed his people.

Russia’s economy is far more sophisticated now than that of the creaking Soviet empire, and living standards have improved in ways that were unimaginable in the 1980s. Yet Russia has failed to use the fat years of high oil prices to reduce dependence on the export of unpredictably priced commodities.

This week’s crisis has three other elements that have turned it from a financial problem to a systemic threat. When sanctions were imposed by the United States and the European Union in July, the Kremlin shrugged them off as pinpricks. Despite the claims of the official Russian media, they were not designed to topple Mr Putin but to make him rethink his occupation by proxy forces of eastern Ukraine. A key element is banning access to western capital by some companies closely connected to the state, including Rosneft, Russia’s national champion in the oil industry.

These sanctions are a stealth weapon under-appreciated by Mr Putin. Russian companies have borrowed heavily abroad to the tune of $660 billion, and these debts need to be regularly refinanced. But Russia has a shortage of domestic capital, since the rich do not trust Mr Putin and they send their money abroad at the first opportunity.

The anxiety of the business community was magnified when the state seized control of the oil company Bashneft from its owner, Vladimir Yevtushenkov, boss of the Sistema conglomerate, and put him under house arrest to stop him challenging the seizure.

Panic set in when all elements of the crisis – declining oil revenue, financial sanctions, lack of domestic capital and the absence of the rule of law – came together when Rosneft needed refinancing and had to turn to the state for help.

The company raised $10.8 billion in an operation financed in murky circumstances by the Central Bank of Russia. The bank’s credibility collapsed, and ordinary Russians rushed to change their roubles into dollars or spend them before they lost even more value.

The crisis will inevitably reflect on Mr Putin’s grip on power. He came to the presidency as a man who would not allow a repetition of the 1998 financial crisis, which the then president, Boris Yeltsin, was clearly incapable of managing. His prestige is now tarnished: he failed to predict the strength of the US and European reaction to his seizure of Crimea and intervention in eastern Ukraine. He failed to understand that the so-called smart financial sanctions are far more effective than they seem. He did not understand that Chinese banks would not step in to fill the gap left by the absence of western credit.

To Russian consumers of state media, Mr Putin appears as an all-conquering hero, having foiled the plots of the West in Ukraine. The message was rammed home in a Hollywood-style trailer ahead of his news conference on Thursday.

At the press conference, he accused foreigners of wanting to “chain the bear” and “remove his fangs and claws”. Many Russians may now see things in less black and white terms: his annexation of Crimea may have been a tactical triumph but it was also a strategic disaster.

Talk of some kind of mass protest is misplaced. Opinion polls show that the belief among the Russian people that they can effect change at the top of the political system is limited.

The danger to Mr Putin comes from the clans that control the economy. The tensions between these interest groups are rarely seen in public and hardly understood abroad, though the financial straits of Rosneft, run by Mr Putin’s close ally Igor Sechin, have lifted the curtain on what might happen if the crisis weakens.

For the moment, Mr Putin has to consolidate the ruling elite. It is no coincidence that Mr Yevtushenkov has been released from house arrest as a sop to the business community. Having underestimated the effect of sanctions, Mr Putin has to put the country on an emergency footing, without scaring potential investors.

Having dithered a while, the government has put in place a raft of measures to halt the currency’s slide. These have stopped short of imposing currency controls, a move seen as a “nuclear option” which would reverse Russia’s integration into the global economy

Ultimately, Russia cannot escape a dramatic economic contraction lasting a couple of years at least.

Russia could survive as it has done in the past, but on one condition: the lifting of sanctions. This would require Mr Putin to withdraw all his forces from eastern Ukraine and abandon the puppets his intelligence services have installed there. This is no easy thing: hitherto, Mr Putin’s military adventures - the invasion of Georgia and the arming of the Syrian regime – have gone unpunished.

If he is reluctant to give up the crown of all-conquering hero, the future looks grim: a Russia cut off from the West could end up as a client of China.

Mr Putin’s dilemma provides a lesson for the rest of the world. As Anders Aslund, a leading economic expert on the Russian economy, has noted, even at a time when US power is declining, “financial sanctions are far more effective in the modern globalised world than many thought possible.” With Barack Obama set to authorise a new level of sanctions, this looks more true than ever.

Alan Philps is a commentator on global affairs

On Twitter: @aphilps