A Year of Miscalculations

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By FPI Eurasia Analyst Hannah Thoburn and Anton Barbashin

It was supposed to have been a “year of victories” for Russia. Only twelve months ago, Russia was concluding preparations for the Sochi Olympic Winter Games, an expensive, flashy and colorful production designed to prove that Russia, led by the pugnacious Vladimir Putin, was back, fully developed, and ready to claim its place as one of the world’s most influential powers. Russia’s 2014 may have begun on a high note, but thanks in large part to a raft of poor decisions and miscalculations by its leadership, now finds itself in its most vulnerable position since Mr. Putin first took power fifteen years ago. In fact, the decisions that in Putin’s view were supposed to strengthen Russia have endangered both his regime and Russia’s stability.

The Sochi Olympics’ success was quickly overshadowed the loss of a key and easily malleable ally, Ukraine’s Viktor Yanukovych, the invasion and annexation of Crimea, and the appearance and continuation of conflict in eastern Ukraine. Russia saw its relationships with most western counties dramatically deteriorate. The sanctions that followed its military actions in Ukraine were seriously exacerbated by the collapse of world oil prices.

The game changer which catalyzed the worsening fallout between Russia and the West was the annexation of Crimea in March of 2014. Despite the Kremlin’s futile attempts to justify this endeavor, the annexation is an unprecedented violation of international law that the world hasn’t experienced since the mid-20th century. Unlike the proclamation of independence of Kosovo in 1999 or South Ossetia and Abkhazia in 2008, the Crimean case stands out as unique. Unlike in the case of Kosovo or South Ossetia/Abkhazia, which can arguably be grouped together as examples of external actors intervening to create autonomous statelets, Crimea was the forceful taking of territory—an outright redrawing of borders.

That the West would respond to Russian aggression with economic sanctions was likely anticipated by Putin and his team, but their robustness, as well as the unity of the Europeans imposing them, was likely not foreseen. European nations like Germany that rely heavily on Russian gas imports and have strong bilateral trade ties have ignored the cries of their business communities and have led the charge to get tough. And despite Russia’s blatant attempts to divide Europe and U.S., the end of 2014 saw year transatlantic ties at their strongest point perhaps since the Balkan crises of the late 1990s. NATO received a new infusion of purpose; a reason to refresh its activities and has strengthened the unity of the alliance from borders of Poland and the Baltics to the Western shores of the United States.

With its obvious on-the-ground involvement in the conflict in eastern Ukraine, Russia has indefinitely destroyed any hope it had of integrating with Ukraine economically, and lost the hearts and minds of the Ukrainian people for the foreseeable future. This aggressive behavior has additionally scared Russia’s closest allies—Belarus and Kazakhstan—who fear any further development of Russia’s quasi-imperial tactics. Minsk and Astana are even more concerned with the future of Russia’s economic stability, shaken by the mix of sanctions, sinking oil prices and overall economic atrophy.

Indeed, it is quite evident today that when taking the decision to annex Crimea, the Kremlin did not calculate for a rapid decrease in the oil prices and did not properly estimate the degree to which the Russian economy is dependent on the West. They likewise underestimated that strength of the Western response to their actions in Ukraine.

Since the infamous referendum that “legitimized” the annexation of Crimea on the 16th of March, the price for a barrel of Brent crude has gone from $108, to below $50 in early January. The consistently high price of oil—which long stood around $110 per barrel—falsely assured the Russian government that such circumstances would persist into perpetuity. Throughout the downhill slide of oil prices, Russian state officials as well as President Putin himself have tried to convince themselves and the people of Russia that oil prices would not fall below each successive marker: $90, then $80, then $70. When it became clear that the global economy would not obey the Kremlin diktats, Putin blamed the U.S. and the Saudis of plotting against the Russian economy, seemingly incredulous at the confluence of events that would, in December 2014, even force Russia to cancel its long-planned gas pipeline, South Stream, across Europe’s Balkan Peninsula.

The drop in oil prices has endangered the entire logic of Putin’s economy and pushed the value of the ruble down two-fold. This damage to the Russian economy would have happened even without the imposition of sanctions, as Russia’s budget is far too dependent on revenues from hydrocarbon sales, but the western sanctions have been like a bucket of gasoline thrown into a fire, exacerbating each and every negative trend in the Russian economy. The most urgent problem that Russia faces today is the impending necessity for Russian corporations to service their massive debts to foreign investors. In October their outstanding responsibilities stood at $630 billion. In fact much of the blame for the marked fall in the ruble’s value in December can be attributed to a corporate sector that required significant infusions of foreign currency from the government to meet their debt recovery schedules. As it turns out, when the western financial world is closed to you, not many investors—including a supposedly friendly China similarly engaged in a project to subvert the global status quo—are willing to take the risks.

The heaping pile of financial reserves that were carefully collected during the boom years of high oil prices suddenly look insufficient. The total amount of reserves currently stands at $394 billion, while in August of 2011 it exceeded $544 billion. In December the Central Bank of Russia has spent more than $10 billion trying to stabilize the ruble; since March 2014 it has spent over $70 billion. The devaluation of the ruble, along with Russia’s trade embargo on Western foods, has already caused a spike in prices of 15-20%, but the full effect of inflation will only catch up to consumers by the end of the first quarter of 2015. Russia is highly dependent on imports—more than 40% of its food, no less than 60% of its clothing up to 75% of drugs and pharmaceuticals and literally 100% of electronics (Apple has increased its prices for the iPhone 6 by 68% since mid-November) come from abroad—so the overall cost of living has already begun to increase and will only continue to do so in the upcoming months. That foreign investors have begun to flee the country does not help matters. Capital flight by the end of 2014 has surpassed $150 billion, and former Russian officials even say publically that they expect at least another $100 billion to flee Russia in 2015.

Even the official prognosis for 2015 presented by the Central Bank of Russia allows for a 4.8 percent decrease in GDP, over $140 billon loss from the combination of lower oil prices and sanctions. 2015’s inflation rates are expected to hover between 12 and 15 percent. Indeed, Russia is falling into a crisis far more dangerous than the financial storm that it weathered in 2008-2009. It is one that calls for solutions far more radical than Putin is willing (or able) to countenance. The ‘plan’ for coping with this crisis—one that President Putin has twice publically laid out—is simple and inadequate: there will be no significant reforms, no modernization, no liberalization and no political compromise over the ongoing Ukrainian crisis. Putin asks the Russian people to wait and be patient. And wait they will. But for how long?

With the imposition of sanctions, the West believed that the Russian polity, like Americans or Europeans, would press their government to change its policy when they began to feel the price for the annexation of Crimea negatively impact their own financial wellbeing. That change may eventually come, but Russians currently appear all too happy to trade some of their pecuniary success for the return of a modicum of perceived Russian imperial glory. In the beginning of 2014, Putin’s approval rating stood at 65 percent, went over 70 percent after the annexation of Crimea in March, and has grown steadily since, reaching a height of 88 percent in October of 2014. Despite the falling strength of the ruble (which reached a record high of 80 rubles to the dollar on December 16), Putin still held 85 percent of the populace’s support at the end of December. Moreover, more than 59 percent of Russians believe that the nation is going the right direction, a number that is 16 percent greater than it was in January of 2014.

President Putin will exploit this resource—the trust of the Russian people in the goodness of their tsar—to continue his foreign policy and introduce most any illiberal legislation and practices in order to stymie any protests and anti-government movements that try to raise their heads. Putin is feeding on the deep-seated fear of the Russian people that they will lose the existing illusion of stability and prosperity. In doing so, and in doubling down on his current path, Putin has ensured that the system he created will remain susceptible to collapse.

Putin has lost Ukraine, and has lost the West, but with the loss of the economy, he is in jeopardy of stretching his luck further than it will go. That risk may not be immediate, but it is clear that the existing system is unsustainable in the long run. For the foreseeable future, the Kremlin will find it necessary to operate in a permanent crisis management mode, a stance that is both costly and clumsily reactive. The state media-promoted illusion of Russia as a besieged castle is capable of sustaining his popularity among Russians for now. But the number of problems is quickly growing beyond the capabilities of their resolution.

Anton Barbashin is an analyst at Center for Polish-Russian Dialogue and Understanding in Warsaw. He tweets at @ABarbashin. Hannah Thoburn is a Eurasia Analyst at Washington, DC’s Foreign Policy Initiative. She tweets at @HannahThoburn.

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