Has Putin Painted Russia into a Corner?

Written by Sijbren de Jong

Around a year and a half ago Russian President Vladimir Putin ordered the annexation of Crimea.

Whereas the takeover of the Ukrainian peninsula proceeded swiftly and without major difficulties, the ensuing conflict in eastern Ukraine has proven much more difficult to contain. Although by waging its clandestine war, Moscow succeeded in thwarting Ukraine’s ambitions to integrate westwards – for now at least – Russia has been unable to limit the fallout for itself. Rattled by sanctions, amplified by a catastrophic collapse in the price of oil, the prospects for the Russian economy look decidedly bleak. Seemingly undeterred by this perfect storm, Russia’s President looks set to continue on this course. In doing so, Putin may have maneuvered himself into a corner from where there is no escape.

With hydrocarbon revenues comprising over 50 per cent of the state budget, the collapse of the price of oil from its June 2014 high of $115 to around $56 today has thoroughly ransacked Russia’s economy. According to ING Bank, Russia needs oil at $80 per barrel to balance its budget. If prices remain at roughly $60 through next year the country will endure a two-year economic contraction. What’s more, the prospect of Iran coming out of its isolation and seeking to ramp up its oil production is likely to depress prices even further. The oil price tumbled immediately after the deal on Iran’s nuclear program was announced. It may time some time and a heavy dose of investments, but Iranian oil will make its way back onto the world market. And when that happens, Putin will bear the brunt of it. When sanctions caused Iran’s oil output to decline Russia eagerly stepped in owing to the similarity of bothcountries' chief export blends. An increase in globally available volumes of oil gives OPEC and Russia two devilish choices: either continue the ongoing price war, or collude and attempt to agree a reduction in production. Both strategies carry costs and risks, and there is no silver bullet.

Further compounding Putin’s problems is the fact that Russian regional governments’ debt grew by as much as 78 per cent in three years through 2014. Back in 2012 when there were large anti-government protests in Moscow, Putin set out plans to increase spending on healthcare, education and social services. That decision effectively doubled the debt load of Russia’s regions. The risk of a large region going bust is increasing, thus raising the risk of bailouts on an already heavily strained federal budget. Factor in the oil price collapse and the massive military spending that Putin refuses to let go, and it becomes clear that the government cannot come to the rescue indefinitely.

A way out of from under the sanctions would be the full implementation of the Minsk accord that was agreed in February 2015 between the leaders of Ukraine, Russia, France and Germany. Although Ukraine’s parliament recently approved constitutional changes that shift power from Kiev to regional governments, a measure demanded under the agreement, separatist leaders were quick to reject the initiative. According to Denis Pushilin, one of the representatives from the Donetsk-based separatists, the proposals did not grant the regions sufficient autonomy. What’s more, with violations of the cease-fire being recorded almost daily, it looks highly unlikely that the Minsk agreement will be fulfilled before the end of the year.

With Minsk not being implemented, this opens the door to a new round of sanctions. The US government seems to be preparing for exactly that. On July 18th, reports emerged that Washington stands ready to cut off western credit to Russia if Putin fails to deliver. Under the existing sanctions, some Russian companies can borrow for a maximum of 30 days compared with normal deals that last several years.

Under the new proposals, this period could be shortened to as little as a few days. In effect that means that the oligarchs in Putin’s inner circle would have to renew credit deals on a weekly basis, thereby effectively annihilating any hope of their businesses securing long-term funding on western markets.

Whereas Europe has so far refrained from blocking Russian access to the SWIFT inter-bank clearing system, as it is considered to be the ‘nuclear option’, the American proposals could very well amount to a tactical nuclear strike.

With no signs of backing down, Putin has maneuvered himself into a major predicament. He cannot play nice over Ukraine and push for sanctions relief as this would fatally expose the lies fanned out by the Kremlin’s relentless propaganda machine. Alternatively, continuing down the same path will almost certainly push the Russian economy even further into the ground and anger powerful people within the Russian business elite. Vladimir Putin has decided to play a dangerous game of geopolitical ice hockey where any decision he now takes is tantamount to scoring an own goal.

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